Tag Archives: #Brexit

An Own Goal

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So, Parliament’s taken control
Of Brexit, but can they cajole
Frau Merkel and friends
To finally bend
Or have they now scored an own goal

The one truism about the FX markets these days is that nobody has a real clue as to what is going to happen to the pound. Every day there is a different view as to whether or not there is going to be a deal or a hard Brexit, or something else. The latest machinations in the UK have changed the process there somewhat, with Parliament voting to wrest control of the negotiations from PM May’s hands and make decisions directly. The upshot of this is that tomorrow, they will vote on a series of bills that try to outline what the members would like to see in a Brexit outcome. Of course, it strikes me as fanciful that Parliament, in a few days’ time, will be able to come to agreement on something that has been this contentious for more than two years. And while everybody continues to claim there cannot be a hard Brexit, I almost think this new tactic will assure that outcome. The only thing we know for sure is that there is no majority FOR any direction. While there have been clear rejections of the PM’s negotiated deal, nobody has come up with something that the UK wants, and that might be acceptable to the EU. Remember, too, the EU has given just a two-week extension for Parliament to come up with something. In other words, this is all still a huge mess with no clear outcome. The pound, as should be expected, continues to chop back and forth as the flavor of the day indicates either a deal, or a crash. As I type, the pound has rallied slightly, up 0.2%, but it continues to trade within its recent range, and will likely do so until a decision, any decision, is taken.

The other story of note this morning is the news that the French and Chinese have signed some trade deals as Chinese President Xi wraps up his European tour. I admit I am a little confused that France is allowed to ‘negotiate’ directly with a non-EU member on trade deals as I thought that was the whole point of the EU, the same terms for everyone. At any rate, this optimism has bled into the US-China trade discussion which is set to become headline news again with Messrs. Lighthizer and Mnuchin arriving in Beijing today to resume those talks. The last we heard on this subject indicated concerns over whether the Chinese were willing to agree to some key US demands regarding IP protection and the available punishments in the event of a breach of the new rules. But, today, the glass is half full, so markets are rebounding on the idea that a deal is, in fact, near.

Turning back to yesterday’s yield curve story, while 10-year yields in the US have edged higher this morning, they remain below 3-month yields. There have been several articles recently describing why this inversion is not the same as the ones that we have seen in the past. Briefly, past inversions arose because the Fed was raising short-term rates in order to head off rising inflationary pressures that had built up during a recovery. And while in one sense, that is what seems to have happened this time, the missing ingredient has been the actual inflation. The Fed’s rate hikes over the past three years were partly in anticipation of higher inflation based on the declining unemployment rate (the misapplied Phillips Curve). But a key difference this time has been the fact that in the wake of QE, the Fed’s balance sheet is much larger, and by design, longer term rates are much lower than they might otherwise be. If the Fed did not own an extra $2.5 trillion of Treasuries, where would the 10-year yield actually trade? Arguably, far higher than 2.4%. And so, the crux of the argument that this time is different is based on that fact. Without QE, short-term rates would not yet be approaching long-term rates, and so no inversion discussions would be taking place.

The opposing view, however, is that we have continued to see weaker data in the US and throughout the world, which implies that global growth is slowing. So, inverted yield curve or not, a recession may well be coming. It is important to remember that an inverted yield curve does not cause a recession per se, it has simply been a pretty reliable indicator of upcoming recessions based on its history over the past 50 years. And, in truth, the indicator that gets the most press is the 2yr-10yr spread, which as of yet has not inverted, although remains quite close to flat at just 15bps right now.

The reason this discussion matters is it helps drive market views of the Fed’s next steps and therefore the market reactions to those steps. As I have maintained consistently, however, the US is unlikely to head into recession without dragging the rest of the world along for the ride. And correspondingly, if the rest of the world is actually headed toward a recession, the US is certainly going to see slower growth. But as this relates to the dollar’s value, there is no evidence the US is weakening faster than the EU, the UK, China or most of the rest of the world, and so as dovish as the Fed may sound, other central banks will be more dovish still. The dollar should still be the main beneficiary of this situation, especially if it includes a significant equity correction and risk-off scenario.

Turning to this morning’s story, Housing Starts (exp 1.213M), Building Permits (1.3M), Case-Shiller House Prices (4.0%) and Consumer Confidence (132.0) are on the docket as well as three Fed speakers (Harker, Evans and Daly) two of whom have already spoken overseas but whose comments have not been widely circulated yet. Overall, the dollar is slightly softer this morning, but that is after several positive sessions, so in the end, we continue to chop in our trading range waiting for the next key driver. At this point, my money is on Brexit, but you never know.

Good luck
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Disconcerted

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On Friday the yield curve inverted
With policymakers alerted
That risks have increased
And growth may have ceased
Both prospects have them disconcerted

While the weekend machinations over Brexit have certainly been intense, the big story this morning is the mild inversion of the US yield curve that occurred on Friday. For the first time since 2007, 10-year yields fell below 3-month yields, a signal that the market is anticipating rate cuts by the Fed in order to shore up weakening growth. In fact, according to the futures market, there is now a ~60% probability of a Fed rate CUT by the end of the year, with a 20% probability of two rate cuts! Following this train of thought, US equity markets had their worst performance in months on Friday, and overnight, Asian markets sold off sharply. However, early this morning, German Ifo data printed at a better than expected 99.6 level, which has helped stop the European equity decline in its tracks. Nonetheless, there is a decided undercurrent of concern over the future of the global economy, and risk positions are being pared back around the world.

This is being seen most clearly in government bond markets where, for example, both Australian and New Zealand 10-year yields have traded to historic low levels, with both now well below 2.0%. Japanese 10-year yields have fallen to -0.09%, pushing toward the bottom end of the BOJ’s yield curve control levels, and German bunds have also retreated to negative territory, currently trading at a yield of -0.01%. I have to admit that while my forecasts for 2019 included lower yields based on a weakening growth outlook, I did not expect these levels to materialize in Q1, but rather only by the end of the year. This price activity is an indication of two things; first that longstanding positions are being unwound as investors reassess the global growth situation; and second, that markets can move awfully fast.

Other indicators have also shown a decided move toward risk aversion with gold rallying nearly 3% in the past two weeks, while the dollar, despite declining interest rates, has rebounded sharply from its post-FOMC lows. As I have consistently maintained, while the Fed surprised one and all by turning so dovish last week, there is little possibility that the Fed will be dovish while other central banks continue their efforts at policy normalization. Certainly, while the odd smaller country may still be considering tighter monetary policy (Norway, Hungary or the Czech Republic), no major central bank can possibly consider tightening policy amid slowing global growth and a complete lack of inflationary pressure. And as I constantly maintain, FX is a relative game, where policy on both sides must be considered. In the current environment, the US not only has the highest rates, thus the most attractive investment landscape, but also retains its haven status in times of trouble. Dollar bears have a long road to hoe before seeing substantial weakness in the buck.

The PM is under the gun
While MP’s, her deal, still do shun
It’s Parliament’s turn
To try to discern
What people in England want done

Meanwhile, back in Merry Olde England, the Brexit situation has absolutely no more clarity than it did last week, in fact it may have less. While politicians on all sides of the argument claim they do not want a hard Brexit, there has been precious little movement in the direction of a solution. And remember, the law still states that the UK will leave the EU this Friday. Yes, the EU has offered a two-week extension, but that is not yet the law in the UK and must be approved in a bill. But in the end, is two weeks sufficient to change minds when two plus years has not been able to do so?

There are stories that a deal is being worked out where Parliament supports the deal and PM May resigns, although she has no obvious successor at this point. And while there is talk of either a second referendum or canceling Article 50, the first would require a significant delay, one that would go well past the EU elections due in late May, and that is a problem, while the second would require a complete backtracking of what the current government has been promising for the past two plus years, not the type of thing that endears politicians to their constituents. As it stands now, it appears that this week Parliament will debate a series of open bills that will try to build some support for a path forward, but even this idea is fraught as party whips may well seek to prevent MP’s from voting their conscience and try to maintain a party line. In other words, it is still a gigantic mess. The one thing that continues to be a very real risk, whether it is this Friday or April 12, is the reality of a hard Brexit. In my estimation, all markets are underpricing that probability, and there is a very real risk that the pound could fall much lower. Hedgers, while option prices are somewhat rich, I would contend they offer a great deal of value at this time. Please consider them.

So, looking at the FX market this morning, we see the dollar little changed overall, but some of the key currencies weaker, notably the euro (-0.2% and the pound (-0.3%). Earlier in the session, but were weaker still, but the release of the German Ifo data helped them as well as European equities.

As to data this week, there is a decent amount coming, as well as a lot of Fedspeak.

Tuesday Housing Starts 1.215M
  Building Permits 1.3M
  Case-Shiller Home Prices 4.0%
  Consumer Confidence 132.0
Wednesday Trade Balance -$57.0B
  Current Account -$130B
Thursday Initial Claims 225K
  Q4 GDP 1.8% (last est 2.6%)
Friday Personal Income 0.3%
  Personal Spending 0.3%
  PCE 0.0% (1.4% Y/Y)
  Core PCE 0.2% (1.9% Y/Y)
  Chicago PMI 61.0
  Michigan Sentiment 97.8
  New Home Sales 620K

On top of all this, we hear from ten different Fed speakers, several of them speaking more than once. This started last night when Chicago Fed President Charles Evans was speaking at an event in HK and said that policy is in a good place and the Fed is watching the data carefully. In other words, if further weakness shows up, they will definitely consider easing, while if the current malaise is short-lived, and growth rebounds, look for talk of another rate hike. At this time, it is abundantly clear that the market is turning quite pessimistic, pricing in rate cuts. But it does appear the Fed is not predisposed in either direction for now.

In the end, the global growth story remains the biggest question out there, and as that develops, so will go the dollar, and all markets with it.

Good luck
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Rapidly Falling

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Magnanimous is the EU
Extending the deadline for two
Weeks so that May
Might still get her way
And England can bid them adieu

But data this morning displayed
That Eurozone growth, as surveyed
Was rapidly falling
While Mario’s stalling
And hopes for a rebound now fade

On a day where it appeared the biggest story would be the short delay granted by the EU for the UK to try to make up their collective mind on Brexit, some data intruded and changed the tone of the market. No one can complain things are dull, that’s for sure!

Eurozone PMI data was released this morning, or actually the Flash version which comes a bit sooner, and the results were, in a word, awful.

German Manufacturing PMI 44.7
German Composite PMI 51.5
French Manufacturing PMI 49.8
French Composite PMI 48.7
Eurozone Manufacturing PMI 47.6
Eurozone Composite PMI 51.3

You may have noticed that manufacturing throughout the Eurozone is below that key 50.0 level signaling contraction. All the data was worse than expected and the German Manufacturing number was the worst since 2012 in the midst of the Eurobond crisis. It can be no surprise that the ECB eased policy last week, and perhaps is only surprising that they didn’t do more. And it can be no surprise that the euro has fallen sharply on the release, down 0.6% today, and it has now erased all of this week’s gains completely. As I constantly remind everyone, FX is a relative game. While the Fed clearly surprised on the dovish side, the reality is that other countries all have significant economic concerns and what we have learned in the past two weeks is that virtually every central bank (Norway excepted) is doubling down on further policy ease. It is for this reason that I disagree with the dollar bears. There is simply no other economy that is performing so well that it will draw significant investment flows, and since the US has about the highest yields in the G10 economies, it is a pretty easy equation for investors.

Now to Brexit, where the EU ‘gifted’ the UK a two-week extension in order to allow PM May to have one more chance to get her widely loathed deal through Parliament. The EU debate was on the amount of time to offer with two weeks seen as a viable start. In any case, they are unwilling to delay beyond May 22 as that is when EU elections begin and if the UK is still in the EU, but doesn’t participate in the elections, then the European Parliament may not be able to be legally constituted. Of course, the other option is for a more extended delay in order to give the UK a chance to run a new referendum, and this time vote the right way to remain.

And finally, there is one last scenario, revoking Article 50 completely. Article 50 is the actual law that started the Brexit countdown two years ago. However, as ruled by the European Court of Justice in December, the UK can unilaterally revoke this and simply remain in the EU. It seems that yesterday, a petition was filed on Parliament’s website asking to do just that. It has over two million signatures as of this morning, and the interest has been so high it has crashed the servers several times. However, PM May is adamant that she will not allow such a course of action and is now bound and determined to see Brexit through. This impact on the pound is pretty much what one might expect, a very choppy market. Yesterday, as it appeared the UK was closer to a no-deal outcome, the pound fell sharply, -1.65%. But this morning, with the two-week delay now in place and more opportunity for a less disruptive outcome, the pound has rebounded slightly, up 0.3% as I type. Until this saga ends, the pound will remain completely dependent on the Brexit story.

Away from those two stories, not much else is happening. The trade talks continue but don’t seem any closer to fruition, with news continuing to leak out that the Chinese are not happy with the situation. Government bond yields around the world are falling with both German and Japanese 10-year yields back in negative territory, Treasuries down to 2.49%, there lowest level since January 2018, and the same situation throughout the G10. Overall, the dollar has been the big winner throughout the past twenty-four hours, rallying during yesterday’s session and continuing this morning. In fact, risk aversion is starting to become evident as equity markets are under pressure this morning along with commodity prices, while the dollar and yen rally along with those government bond prices. The only US data point this morning is Existing Home Sales (exp 5.1M) which has been trending lower steadily for the past 18 months. There is also a bunch of Canadian data (Inflation and Retail Sales) which may well adjust opinions on the BOC’s trajectory. However, it seems pretty clear that the Bank of Canada, like every other G10 central bank, has finished their tightening cycle with the only question being when they actually start to ease.

A week that began with the market absorbing the EU’s efforts at a dovish surprise is ending with clarification that dovishness is the new black. It is always, and everywhere, the chic way to manage your central bank!

Good luck and good weekend
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Not Yet Inflated

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Good luck
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Heavy-Handed

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There once was a large bloc of nations
That gathered to foster relations
On how they should trade
That they might dissuade
A conflict midst trade accusations

But slowly their mission expanded
As rules on more things they demanded
One nation resented
These unprecedented
Requests which they thought heavy-handed

This nation expressed their dissention
By voting to leave that convention
But three years have passed
And no deal’s amassed
Support so they need an extension

I apologize for the length of this morning’s ditty, but sometimes it takes more than one stanza to tell the story.

Brexit is once again the top story today, although the FOMC meeting and US-China trade talks are still in the news. With just nine days left before the UK is due to leave the EU, there is still no agreed upon deal between the two sides of the negotiation. Today, the EU has a council meeting of all its leaders and PM May will be making a speech and asking for an extension. The question has been, how long would she request? At this time, it appears it will be short, just three months, as she is seeking to get the negotiated text voted on in Parliament one more time. However, there has been pushback by several other EU members concerned that three months won’t be enough time to change anything. In fact, some EU members want a much longer delay in order to push for a second Brexit vote; you know, to get the ‘right’ answer this time. At any rate, Brexit continues to be a slow-motion train wreck and all are fascinated to watch, if not to live through its consequences.

As an aside, a conversation I had yesterday with a local who has become more engaged in politics there, indicated that there is an abject fear of leaving without a deal, and that despite the many bad things about PM May’s deal, there will be many MP’s who vote for it rather than allowing a hard Brexit. Certainly that is what May is counting on. We shall see. The FX market continues to react to the ebbs and flows of the conversation and this morning is ebbing. The pound is down 0.3% as it seems some traders are losing confidence in the outcome. As I have repeatedly said, despite the fears of a no-deal outcome, the law remains for the UK to leave next Friday whether there is a deal in place or not, and that is a non-zero probability. If that is the case, the pound will suffer greatly, especially because that is clearly not the current expectation. Hedgers be ready.

On to the FOMC, which will release their policy statement at 2:00 this afternoon, along with their latest economic projections (expected to see GDP growth lowered slightly) and the infamous dot plot. Chairman Powell had made an effort, prior to the quiet period, to minimize the importance of the dots as those projections do not contain error bars showing the level of uncertainty attached to the forecasts. But the market is still talking about them non-stop. I guess six years of harping on the importance of forward guidance, BY THE FED, has trained market participants to pay attention to forward guidance. My money remains on the idea that the median dot will be at no more rate increases this year, and a more pronounced reduction in the long-term neutral rate. However, there are a number of analysts who are warning that the dot plot could look much more hawkish, highlighting another rate hike this year and one more next year. if that is the case, I expect equity markets to suffer, as it is pretty clear the market has priced out any further rate hikes.

In addition, we cannot forget the balance sheet story, where I remain convinced that the balance sheet roll-off will be slated to end by June, and that the composition will be focused on shorter term securities. The idea that shortening the maturity profile now will result in more ammunition for fighting the next economic downturn will prove quite appealing. After all, a big fear of the Fed is the howls of protest from the Austrian school (read Congressional monetary hawks) if they restart QE during the next recession. Shortening the average maturity of holdings now will allow them to maintain the size of the balance sheet while still adding stimulus in the next downturn by extending the maturity then.

And finally, on the trade front, despite a story yesterday indicating the Chinese were backing away from earlier agreements on IP security, the US delegation of Lighthizer and Mnuchin are heading to Beijing this week, with the Chinese delegation expected to come back here the week after in the final push for a deal. Certainly, equity markets have priced in a successful deal here, and probably so has the dollar. Interestingly, Treasury markets continue to look at the world with a very different view of much slower growth now, and in the future. It appears there is a bit more skepticism by bond traders on the successful outcome of a trade deal, than that of equity traders.

Overall, the dollar is marginally firmer this morning, but as we have seen the last several days, individual currency movements have been muted. The Indian rupee continues to perform well as an equity market rally in Mumbai has drawn in foreign investment and the market increasingly prices in a Modi victory in the upcoming election, which is seen as the most economic friendly outcome available. But even there, the rupee has only rallied 0.3% this morning. Throughout the G10, movement continues to be extremely limited, with 0.1% being the extent of today’s activity (the pound excepted).

Ahead of the FOMC meeting, there is no data to be released today, and equity futures are basically flat, pointing to very modest 0.1% declines on the open. Look for very little movement until the FOMC announcement and the following press conference. And then, it will all depend on the outcome.

Good luck
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Doublespeak

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The sitting Prime Minister, May
Heard terrible news yesterday
Her plan to promote
A Brexit deal vote
Was halted much to her dismay

This forces her, later this week
A longer extension to seek
But still the EU
Seems unlikely to
Do more than add new doublespeak

In yet another twist to the Brexit saga, the Speaker of the House of Commons, John Bercow, refused to allow another vote on PM May’s deal this week. He explained that Parliamentary rules since 1604 have existed to prevent a second vote on a bill that has already been rejected unless there have been substantial changes to the bill. In this case there were no changes and PM May was simply trying to force approval based on the idea that the clock was running out of time. The pound reacted to the news yesterday by quickly dropping 0.5%, although it has since recouped 0.2% this morning.

This has put the PM in a difficult spot as she prepares to travel to the EU council meeting in Brussels later this week. Given that there is still no clarity on how the UK wants to handle things, or at least how Parliament wants to handle things, she will need to seek an extension in order to avoid a no-deal Brexit. However, the comments from several EU members, notably Germany and France, have indicated they need some sense of direction as to what the UK wants before they will agree to that extension. Remember, too, it requires a unanimous vote by the other 27 members of the EU to grant any extension. At this stage, the market is virtually certain an extension will be granted, at least based on the fact that the pound remains little changed on the day and has been able to maintain its modest gains this year. And it is probably a fair bet that an extension will be granted. But the real question is what the UK will do with the time. As of now, there is no clarity on that at all. Unless the EU is willing to change the deal, which seems unlikely, then we are probably heading for either a new general election or a new Brexit referendum, or both. Neither of these will add certainty, although the predominant view is that a new referendum will result in a decision to stay. Do not, however, ignore the risk that through Parliamentary incompetence, next week the UK exits without a deal. That risk remains very real.

One side note on the UK is that employment data released this morning continues to beat all estimates. Wages continue to rise (+3.4%) and the Unemployment Rate fell further to 3.9%. Despite a slowing economy overall, that has been one consistent positive. It has been data like this that has helped the pound maintain those gains this year.

Elsewhere the global growth story continues to suffer overall, as both China and the Eurozone continue to lag. While there was no new data from China, we did see the German ZEW survey (-3.6 up from -13.4) and the Eurozone version as well (-2.5 up from -16.6). However, at the same time, the Bundesbank just reduced their forecast for German GDP in 2019 to 0.6%, although they see a rebound to 1.7% in 2020. My point is that though things may have stopped deteriorating rapidly, they have not yet started to show a significant rebound. And it is this dearth of economic strength that will continue to prevent the ECB from tightening policy at all for quite a while to come.

A quick glance Down Under shows that optimism in the lucky country is starting to wane. Three-year Australian government bonds have seen their yield fall to 1.495%, just below the overnight rate and inverting the front of the curve there. This calls into question the RBA’s insistence that the next move will be an eventual rate hike. Rather, the market is now pricing in almost two full rate cuts this year as Australia continues to suffer from the slowing growth in China, and the world overall. While the FX impact today has been muted, just a -0.1% decline, Aussie continues to lag vs. other currencies against a dollar that has been on its back foot lately.

Speaking of the dollar, tomorrow, of course, we hear from the Fed, with a new set of economic projections and a new Dot Plot. Since there is no chance they move rates, I continue to expect the market to be focused on the balance sheet discussion. This discussion is not merely about the size of the balance sheet, and when they stop shrinking it, but also the composition and general tenor of the assets they hold. Remember, prior to the financial crisis and the utilization of QE, the Fed generally owned just short-term T-bills and maybe T-notes out to three years. But as part of their monetary policy experiment, they extended the maturities of their holdings with the average maturity now nine years. This compares to the six-year average maturity of the entire government bond issuance. The longer this average tenor, the more monetary ease they are providing to the market, so the question they need to answer is do they want to maintain that ease now or try to shorten the current maturity, so they have the opportunity to use that policy in a time of greater need. While this remains up in the air right now, whatever decision is made it will give a strong clue into the Fed’s view of the current situation and just how strongly the economy is actually performing.

This morning’s Factory Orders data (exp 0.3%) is unlikely to have a market impact of any sort. Equity markets have been muted with US futures pointing to essentially an unchanged opening. Yesterday saw limited price action, with both the dollar and equities barely changed. My sense is today will shape up the same way. Tomorrow, however, will be a different story, of that you can be sure.

Good luck
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Doves Are in Flight

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Our central bank’s doves are in flight
As this week the Fed will rewrite
Their previous view
That one hike or two
Was needed to make things alright

Instead as growth everywhere slows
More policy ease they’ll propose
Perhaps not QE
But all will agree
The balance sheet’s size reached its lows

If you were to throw a dart at a map of the world, whichever country you hit would almost certainly be in the midst of easing monetary policy (assuming of course you didn’t hit the ocean.) It is virtually unanimous now that the next move in interest rates is going to be lower. In fact, there are only two nations that are poised to go the other way, Norway and Hong Kong. The former because growth there continues to motor along and, uniquely in the world, inflation is above their target range, most recently printing at 2.6%. The latter is actually under a different kind of pressure, draining liquidity from its economy as there has been a huge inflow of funds driving rates down and pressuring the HKD to the bottom of its band. But aside from those two, its easy money everywhere. Last week the ECB surprised the market by announcing the implementation of a new round of TLTRO’s, rather than just talking about the idea. That was a much faster move than the market had anticipated.

This week it is the Feds turn, where new forecasts and a new dot plot are due. It is widely assumed that economic forecasts will be marked lower given the slowing data picture that has emerged in the US, with the most notable data point being the 20K rise in NFP last month, well below the 180K expected. As such, and given the change in rhetoric since the last dot plot was revealed in December, it is now assumed that the median expectation for FOMC members will be either zero or one rate hikes this year, down from two to three. My money is on zero, with only a few of the hawks (Mester and George) likely to still see even one rate hike in the future.

To me, however, the market surprise will come with regard to the balance sheet reduction that has been ongoing for the past two years. What was “paint drying” in October, and “on autopilot” in December is going to end by June! Mark my words. It is already clear that the Fed wants to stop tightening policy, and despite the claims that the slow shrinkage of the balance sheet would have a limited impact, it is also clear that the impact of reducing reserves has been more than limited. In a similar vein to the ECB acting instead of talking about TLTRO’s last week, look for the Fed to stop the shrinkage by June. There is no right answer to the question, how large should the Fed’s balance sheet be? Instead, it is always seen as a range. However, given the current desire to stop the tightening, why would they wait any longer? If I’m wrong it is because they could simply stop at the end of this month and be done with it, but that might send a panicky message, so June probably fits the bill a bit better.

This is going to hit the market in a very predictable way; a weaker dollar, stronger stocks and stronger bonds. The stock story is easy, as less tightening will continue to be perceived as a boon to earnings and eventually to the economy. Funnily enough, the message to the bond market is likely to be quite different. With 10-year yields already below 2.60% (2.58% this morning), news that the Fed is more concerned about growth is likely to drive inflows, and maybe even help the curve invert. Remember, short end rates are already 2.50%, so it won’t take much to get to an inversion. As to the dollar, while everybody is in easing mode, the new information that the Fed is taking another step will be read as quite dovish and force more long dollar positions to be covered. In the end, I maintain that the situation in the Eurozone remains worse than that in the US, but the timing of announcements and perception of surprise is going to drive the short-term price activity.

Elsewhere in markets, while the China trade talks remain a background story for now, Brexit is edging ever closer. There is still no clear outcome there, although PM May is apparently going to try to get her deal through Parliament again this week. You have to admire her tenacity, if not her success. But here’s an interesting tidbit that hasn’t been widely reported: the vote last week by Parliament to prevent a no-deal Brexit wasn’t binding! In other words, absent an agreed delay by the rest of the EU, Brexit is still going to happen at the end of the month, deal or no deal. Again, my point is that the probability of a no-deal Brexit remains distinctly non-zero, and the idea that the pound has reflected Brexit risk at its current level of 1.32 is laughable. If they can’t figure it out, the pound will go a LOT lower.

Of course, today, there is virtually nothing going on in the FX markets, with G10 currencies all within 0.1% of their closing levels on Friday. Even the EMG bloc has seen limited movement with the Indian rupee the only currency to have moved more than 0.5% all day. The rupee’s strength has been evident over the past three weeks as recent fiscal stimulus has attracted significant investment inflows. But beyond that, nothing.

Away from the Fed, this week is extremely quiet on the data front as well:

Tuesday Factory Orders 0.3%
Wednesday FOMC Interest Rate 2.50%
Thursday Initial Claims 225K
  Philly Fed 4.5
Friday Existing Home Sales 5.10M

And that’s it. After the Fed meeting, there is only one speech scheduled, Raphael Bostic on Friday, but given that Powell will be all over the air on Wednesday, it is unlikely to matter much. So this week shapes up as a waiting game, nothing until the FOMC on Wednesday, and then react to whatever they do. Look for quiet FX markets until then.

Good luck
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Both Driver and Bane

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

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

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

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

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

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

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

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

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

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

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

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

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

Good luck and good weekend
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Cause For Concern

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Once more to Great Britain we turn
And so we ask, ‘what did we learn?’
May’s Deal lacks appeal
But No-Deal they feel
Is still quite a cause for concern

Where’s Howie Mandel when you need him to say, “Deal…or No Deal?”

In yet another loss for beleaguered British PM May, the House of Commons yesterday approved a bill ruling out a no-deal Brexit for the UK. Of course, the day before they defeated the only Brexit deal on the table. Like a spoiled child, they cannot figure out what they want, but they know they want something. The next step is to request an extension of the deadline, which is now just 15 days away. However, even on that subject there is no clarity. The length of that extension has been open to debate with many different answers. For the pro-Brexit crowd, those willing to see a no-deal outcome, they want as short a delay as possible. Anything beyond six months is likely to allow a second referendum, with the current polls showing that Bremain would be the winner. Naturally, those who want to remain are seeking the longest extension possible.

But it is important to remember that the other 27 members of the EU need to approve the extension unanimously, which when it comes to EU activities is certainly the exception, not the rule. For example, what if Hungary, which is currently at odds with the EU over other issues, decides to vote against an extension simply to tweak the rest of the bloc’s collective nose? My point is that an extension, while pretty likely, is hardly guaranteed. And we have already heard from a number of different EU members on the importance of a rationale for an extension. Ultimately, now that Parliament has taken control of the process from PM May, they have to decide what they want to do, not merely what they want to avoid. And thus far, that information has been lacking.

Turning to the market reaction, the pound rallied sharply yesterday, a full 2.0%, as traders and investors gained confidence that the UK would not be crashing out of the EU without a deal. Of course, given the current lack of alternatives, that remains a fraught situation. This morning, it has ceded about 0.65% of those gains between profit-taking and a dawning realization that just because they voted not to leave without a deal, that hasn’t actually solved the problem. In the end, there is much more to this process and this story, with the potential for both a bigger rally, if somehow the UK comes up with a viable solution, or a much bigger decline, if the delay doesn’t help solve the problem.

The other noteworthy news has been the postponement of a meeting between President’s Xi and Trump to sign any trade deal. While there had been recent indications that progress was being made, apparently it has not been enough progress to schedule a meeting. In the end, as I have written repeatedly, it is difficult for China to agree to not steal IP and force technology transfers when they have maintained, all along, that they don’t do that to begin with. In addition, yesterday President Trump indicated he was in “no hurry” to sign a deal, so this cloud is likely to hang over the global economy for a while yet.

As evidence of that cloud, Chinese data last night pointed to further slowing in the economy there as IP fell to a 5.3% growth rate, the slowest since 2002! While Retail Sales remained unchanged at 8.2%, auto sales continue to decline, falling -2.8% in the January-February period from year ago levels. (The Chinese statistics agency combines Jan and Feb every year to try to smooth the impact of the Chinese New Year, which typically floats in that period.) Interestingly, the combination of these two stories, trade disappointment and weak data, has led to the renminbi slipping 0.5% this morning, a pretty big move for the currency.

Away from those two stories, we continue to see signs of slowing growth around the developed world with rising Swedish Unemployment (6.6% vs. 6.3% previously) and a continued lack of inflationary pressure from both Germany (1.5%) and France (1.3%). This has helped reverse the euro’s recent modest strength with the single currency lower by 0.25% this morning.

In fact, the dollar is having a strong day virtually everywhere, with Aussie and Kiwi both falling more than 0.5% after the weak Chinese data raised concerns over their key export market. Meanwhile, even the yen is lower by 0.45%, as the economic story there continues to point to slowing growth and the possibility of yet more monetary policy ease. The problem for Kuroda-san is there are precious few things left to do. After all, he already has negative interest rates and owns 43% of the JGB market, as well as 10% of the equity market, all while maintaining a cap on the yield of the 10-year JGB. Barring explicit monetization of the debt, meaning relieving the Japanese government of the obligation to repay the debt on their balance sheet, the list is short. However, if they do go to explicit monetization, you can be sure the yen will fall sharply.

Equity markets, however, remain oblivious of all the potential problems that exist and continue to focus on a single thing, easy money. Slowing growth and weaker profitability are meaningless in the new world. The only thing that matters is free cash. My observation on this phenomenon is that it has diminishing returns. And despite ongoing efforts to prop up the economy by central banks everywhere, equity markets, while well off the lows seen in December, have not been able to take the next step higher. To my untrained eye, it appears that the top has been put in, and that lower is the most likely direction over time. But perhaps not today, where equities continue to hang in there and US futures are pointing slightly higher.

Today’s data is just Initial Claims (exp 225K) and New Home Sales (620K), neither of which is likely to have a significant impact. With no Fed speakers, the market is going to be focused on the UK, with their next vote to extend the Brexit deadline, but away from that, has no obvious catalysts. Given the dollar’s decline yesterday, and the rebound thus far today, my money is on a modest continuation of the rebound, at least for the rest of the day.

Good luck
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Palpably Real

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For Jay and his friends at the Fed
Inflation seems just about dead
So all the debate
‘bout rate hikes can wait
With focus on Brexit instead!

Thus turning to England, we learned
The deal, once again, has been spurned
Now fears of no deal
Are palpably real
Though markets seem quite unconcerned

While the headline news is arguably the second defeat of PM May’s Brexit deal in Parliament, I am going to touch on a different theme to start; namely the Fed.

Yesterday’s CPI data printed on the soft side (Headline 1.5%, Core 2.1%) with both coming in 0.1% below expectations. And while the Fed does not target this reading, it is still an important part of the discussion. That discussion continues to turn toward the idea that the Fed has already overtightened policy and that the next move will be a rate cut. Given the overall slowing in US data and highlighting that the Fed has been completely unable to achieve their inflation target of 2.0%, I expect that the next series of Fed comments, once they are past their meeting next week, will focus on greater efforts to achieve their mandate (the self-imposed 2.0% inflation target) and what needs to be done accordingly. I would look for the end of the balance sheet roll-off quite soon, perhaps in April, but in any case, by June, and I would look for futures markets to start pricing in a full rate cut by the middle of next year. I guess the only question is will the equity market continue to rally despite the weakening underlying fundamentals. Certainly, based on the past ten years of experience, the answer is yes. But can markets defy fundamentals forever? I guess we shall see.

PS. If the Fed is starting to turn more actively dovish, rather than its current passive stance, that will immediately undermine the dollar’s value. While for now I continue to see further upside potential for the buck, that is subject to change if the policies underlying that stance change as well.

Now to Brexit. Poor PM May. She really did work hard to try to find a solution as to how to avoid a hard Brexit, but the EU has literally zero interest in seeing the UK leave their bloc and thrive. If that were the case, the temptation for other unhappy countries (Italy anyone?) to also exit would be too great. As such, it was always in the EU’s long-term interest to play hardball like they did. It can also be no surprise that the widely touted adjustment to the codicil to the agreement was an attempt to bamboozle with flowery words, rather than an effort to put something legally binding in place. As such, once Attorney General Cox declared that the new language was no better than the old, which occurred just as I was getting prepared to publish my note yesterday, it was clear that there was no chance of passage. The fact that the vote lost by a smaller amount, only 149 votes vs. 230 votes the first time, is small consolation.

However, now Parliament has taken over and will have to come up with some plans on their own. It is generally much easier to howl from the peanut gallery than to take responsibility so we shall watch this with great interest. It seems that a majority in Parliament want to vote on a bill that will prevent a no-deal Brexit but given there is only one deal on the table and they handily rejected it, that implies they need a postponement from the EU. It is not enough for the UK to say they want to postpone. In fact, the other 27 members of the EU must all vote unanimously to agree. At this point, there has been no clarity on how long a delay they would like, nor what they plan to do with the time. And the EU has made it clear that those are important aspects of agreeing to a delay. For now, the debate in Parliament rages on, and I assume we will learn their answers in the next day or two, and certainly by the end of the week.

Funnily enough, the FX market has weighed the evidence and decided that there will categorically not be a hard Brexit and the odds of no Brexit are increasing. The pound, after yesterday’s wild ride, is back on an upswing and higher by 0.65% as I type. The one thing of which we can be sure is that the pound will continue to react to headline news until a definitive outcome exists. For my money, it appears as though the market is underpricing the probability of a hard Brexit. While I am pretty sure that nobody really wants one, the fact remains that it continues to be a real possibility even if only by legislative accident. One never knows who is looking at the situation there and sees a chance for personal political gain by allowing a hard Brexit. And in the end, given each MP is a politician first and foremost, that cannot be ignored!

Otherwise, the trade talks are ongoing with a positive spin put forth by the US top negotiator, Robert Lighthizer, although no deal is agreed as yet. Overnight data from Down Under showed weakening Consumer Confidence as the housing market there continues to implode, thus it is no surprise to see AUD having fallen by 0.25% and hugging recent lows. And in truth, little else of note is happening in these markets.

This morning we see Durable Goods (exp -0.5%, +0.1% ex Transport) as well as PPI (1.9%, 2.6% core) although nobody really cares about PPI with CPI just having been released. The Fed is now in their quiet period as they meet next week, so we will not get comments there. This leaves the Brexit debate as the primary focus for the FX market today. Based on all that I have read, I actually expect that the debate there will take more than one day, and that we won’t really get much new information today. Hence, I expect limited market activity for now.

Good luck
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