Laden With Fears

When lending, a term of ten years
At one time was laden with fears
But not anymore
As bond prices soar
And bond bulls regale us with cheers

Another day, another record low for German bund yields, this time -0.396%, and there is no indication that this trend is going to stop anytime soon. While this morning’s PMI Composite data was released as expected (Germany 52.6, France 52.7, Eurozone 52.2), it continues at levels that show subdued growth. And given the ongoing weakness in the manufacturing sector, the major fear of both economists and investors is that we are heading into a global recession. Alas, I fear they are right about that, and when the dust settles, and the NBER looks back to determine when the recession began, don’t be surprised if June 2019 is the start date. At any rate, it’s not just bund yields that are falling, it is a universal reaction. Treasuries are now firmly below 2.00% (last at 1.95%), but also UK Gilts (0.69%), French OATs (-0.06%) and JGB’s (-0.15%). Even Italy, where the ongoing fight over their budget situation is getting nastier, has seen its yields fall 13bps today down to 1.71%. In other words, bond markets continue to forecast slowing growth and low inflation for some time to come. And of course, that implies further policy ease by the world’s central bankers.

Speaking of which:

In what was a mini bombshell
Said Mester, it’s too soon to tell
If rates should be lowered
Since, as I look forward
My models say things are just swell

Yesterday, Cleveland Fed president Loretta Mester, perhaps the most hawkish member of the Fed, commented that, “I believe it is too soon to make that determination, and I prefer to gather more information before considering a change in our monetary-policy stance.” In addition, she questioned whether lowering rates would even help address the current situation of too-low inflation. Needless to say, the equity markets did not appreciate her comments, and sold off when they hit the tape. But it was a minor reaction, and, in the end, the prevailing wisdom remains that the Fed is going to cut rates at the end of this month, and at least two more times this year. In truth, we will learn a great deal on Friday, when the payroll report is released, because another miss like last month, where the NFP number was just 75K, is likely to bring calls for an immediate cut, and also likely to see a knee-jerk reaction higher in stocks on the premise that lower rates are always good.

The IMF leader Lagarde
(Whom Greeks would like feathered and tarred)
Come later this year
The euro will steer
As ECB prez (and blowhard)

The other big news this morning concerns the changing of the guard at the ECB and the other EU institutions that have scheduled leadership changes. In a bit of a surprise, IMF Managing Director, Christine Lagarde, is to become the new ECB president, following Mario Draghi. Lagarde is a lawyer, not a central banker, and has no technocratic or central banking experience at all. Granted, she is head of a major supranational organization, and was French FinMin at the beginning of the decade. But all that reinforces is that she is a political hack animal, not that she is qualified to run the second most important policymaking institution in the world. Remember, the IMF, though impressive sounding, makes no policies, it simply hectors others to do what the IMF feels is correct. If you recall, when Chairman Powell was nominated, his lack of economics PhD was seen as a big issue. For some reason, that is not the case with Lagarde. I cannot tell if it’s because Powell has proven to be fine in the role, or if it would be seen as politically incorrect to complain about something like that since she ticks several other boxes deemed important. At any rate, now that politicians are running the two largest central banks (or at least will be as of November 1), perhaps we can dispel the fiction that central banks are independent of politics!

Away from the bond market, which we have seen rally, the market impact of this news has arguably been mixed. Equity markets in Asia were generally weak (Nikkei -0.5%, Shanghai -1.0%), but in Europe, investors are feeling fine, buying equities (DAX +0.6%, FTSE + 0.8%) alongside bonds. Arguably, the European view is that Madame Lagarde is going to follow in the footsteps of Signor Draghi and continue to ease policy aggressively going forward. And despite Mester’s comments, US equity futures are pointing higher as well, with both the DJIA and S&P looking at +0.3% gains right now.

Gold prices, too, are anticipating lower interest rates as after a short-term dip last Friday, with the shiny metal trading as low as $1384, it has rebounded sharply and after touching $1440, the highest print in six years, it is currently around $1420. I have to admit that the combination of fundamentals (lower global interest rates) and market technicals (a breakout above $1400 after three previous failed attempts) it does appear as though gold is heading much higher. Don’t be surprised to see it trade as high as $1700 before this rally is through.

Finally, the dollar continues to be the least interesting of markets with a mixed performance today, and an overall unchanged outcome. The pound continues to suffer as the Brexit situation meanders along and the uncertainty engendered hits economic activity. In fact, this morning’s PMI data was awful (50.2) and IHS/Markit is now calling for negative GDP growth in Q2 for the UK. Aussie data, however, was modestly better than expected helping both AUD and NZD higher, despite soft PMI data from China. EMG currencies are all over the map, with both gainers and losers, but the defining characteristic is that none of the movement has been more than 0.3%, confirming just how quiet things are.

As to the data story, this morning brings Initial Claims (exp 223K), the Trade Balance (-$54.0B), ISM Non-Manufacturing (55.9) and Factory Orders (-0.5%). While the ISM data may have importance, given the holiday tomorrow and the fact that payrolls are due Friday morning, it is hard to get too excited about significant FX movement today. However, that will not preclude the equity markets from continuing their rally on the basis of more central bank largesse.

Good luck
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A New Plan

While all eyes are turned toward Japan
Most central banks made a new plan
If there’s no trade truce
They’ll quickly reduce
Their base rates, stock markets, to fan

As the week comes to a close, the G20 Summit, and more importantly, tomorrow’s meeting between President’s Trump and Xi are the primary focus of investors and traders everywhere. While there is still great uncertainty associated with the meeting, at this point I would characterize the broad sentiment as an expectation that the two leaders will agree to resurrect the talks that were abruptly ended last month, with neither side imposing additional tariffs at this time. And quite frankly, that does seem like a pretty reasonable expectation. However, that is not nearly the same thing as assuming that a deal will be forthcoming soon. The negotiations remain fraught based on the simple fact that both nations view the world in very different ways, and what is SOP in one is seen as outside the bounds in the other. But in the meantime, I expect that markets will take the news that the situation did not deteriorate as a massive bullish signal, if only because the market has taken virtually everything that does not guaranty an apocalypse as a massive bullish signal.

At the same time, it has become abundantly clear that the major central banks have prepared for the worst and are all standing by to ease policy further in the event the talks fall apart. Of course, the major central banks have all been pretty clear lately that they are becoming increasingly comfortable with the idea that interest rates can remain much lower than historical levels without stoking inflation. In fact, there are still several central bankers, notably Kuroda-san and Signor Draghi, who feel they are fighting deflation. In fairness, the latest data, released just last night, highlights that runaway inflation is hardly a cause for concern as Japan clocked in at 1.1%, with core at 0.9% and the Eurozone reported inflation at a rip roaring 1.2%, with core at 1.1%. It has been data of this nature that stokes the imagination for further policy ease, despite the fact that both these central banks are already working with negative interest rates.

Now, it must be remembered that there are 18 other national leaders attending the meeting, and many of them have their own concerns over their current relationship with the US. For example, the president has threatened 25% tariffs on imported autos, a move which would have a significantly negative impact on both Germany (and by extension the EU) and Japan. For now, those tariffs are on hold, but it is also clear that because of the intensity of the US-China trade situation, talks about that issue with both the EU and Japan have been relegated to lower level officials. The concern there is that the original six-month delay could simply run out without a serious effort to address the issue. If that were to be the case, the negative consequences on both economies would be significant, however, it is far too soon to make any judgements on the outcome there.

And quite frankly, that is pretty much the entire story for the day. Equity markets remain mixed, with Asia in the red, although the losses were relatively modest at between 0.25% and 0.50%. Europe, meanwhile, has taken a more positive view of the outcome, with markets there rising between 0.2% and 0.5%, which has left US futures pointing to modest, 0.2%, gains at the opening. Bond prices are actually slightly lower this morning (yields higher) but remain within scant basis points of the lows seen recently. For example, Bunds are trading at -0.319%, just 1.5bps from its recent historic low while Treasuries this morning are trading at 2.017%, just 4bps from its recent multi-year lows. Perhaps the most remarkable news from the sovereign bond market was yesterday’s issuance by Austria of 100-year bonds with a coupon of just 1.20%! To my mind, that does not seem like a reasonable return for the period involved, but then, that may be very backwards thinking.

Consider that the acceptance of two policy changes that have been mooted lately, although are still quite controversial, would result in the Austrian issue as being seen as a virtual high-yield bond. Those are the abolition of cash and the acceptance of MMT as the new monetary policy framework. I can assure you that if when cash is abolished, interest rates will turn permanently negative, thus making a yield of 1.20% seem quite attractive, despite the century tenor. As to MMT, it could play out in one of two ways, either government bonds issued as perpetual 0.0% coupons, or the end of issuing debt completely, since the central banks would merely need to print the currency and pay it as directed. In this case too, 1.20% would seem awfully good.

Finally, let’s look at the FX markets this morning, where the dollar is modestly softer against most of its counterparts. But when I say modestly, I am not kidding. Against G10 currencies, the largest movement overnight was NZD’s 0.14% appreciation, with everything else + or – 0.1% or less. In other words, the FX markets are looking at the Trump-Xi meeting and waiting for the outcome before taking a view. Positions remain longer, rather than shorter, USD, but as I have written recently, that view is beginning to change on the back of the idea that the Fed has much further to ease than other central banks. While I agree that is a short-term prospect, I see the losses as limited to the 3%-5% range overall before stability is found.

Turning to the data picture, yesterday saw GDP print as expected at 3.1%. This morning we get Personal Income (exp 0.3%), Personal Spending (0.4%), Core PCE (1.6%). Chicago PMI (53.1) and Michigan Sentiment (98.0). However, barring an outlandish miss in anything, it seems unlikely there will be too much movement ahead of tomorrow’s Trump-Xi meeting. Look for a quiet one.

Good luck and good weekend
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Retreated

Rate cuts “may be warranted soon”
Said James yesterday afternoon
The bond market soared
Though stocks ‘cross the board
Retreated the third day of June

Will someone please explain to me how the Fed expects to be preemptive on economic movements by looking in the rearview mirror? Given that data is almost always backwards looking, (only the ISM surveys really try to look ahead) it seems it would be a far better process to simply explain the reaction function will follow the economy. It is abundantly clear that they have completely lost the ability to lead the economy. So now, following a spate of softer data leading to comments from St Louis Fed President James Bullard about cutting rates soon, Treasury yields have plumbed new depths for the move, touching as low as 2.07% on Monday, and although they have rebounded slightly this morning, there is no indication this movement is going to stop. Weaker ISM data, slower housing growth and ongoing trade uncertainty have certainly stacked the deck against the Fed standing pat. Chairman Powell speaks this morning and markets will be anxiously awaiting his wisdom on the subject. (Spoiler alert, his only choice will be to sound dovish as any hawkish tone will immediately reflect in an equity sell-off.)

Similarly, we continue to see German bund yields pressing to new lows, -0.21% this morning, and the pressure on the ECB to respond is growing stronger. Just this weekend there was a story in Bloomberg describing Eurozone inflation as starting to trend higher. Alas, this morning’s data printed weaker than expected with headline CPI at 1.2% and core at 0.8%. While the euro has barely reacted, interest rate markets are starting to price in even more easing by the ECB and analyst’s comments are moving towards the need for Signor Draghi to do something to show that the ECB is in control. The problem for Draghi is he only has a few more months in the seat and all eyes are looking toward his potential replacement. While there is no strong consensus pick, the view is developing that whoever takes the role will be more hawkish than Draghi, by default. At least initially. However, if Eurozone growth continues to falter and inflation remains around 1.0%, instead of nearer its target of “close to but below 2.0%”, that hawkishness is likely to fade. And one last thing, Eurozone inflation expectations, as measured by five year forward five-year swaps have fallen to near record lows of 1.28%. In other words, nobody thinks inflation is making a comeback soon.

Adding to the interest rate gloom was Australia, last night, cutting its base rate to 1.25%, as widely expected. RBA Governor Lowe made it clear that given the slowing picture in China and the overall slowdown in global growth, the door is open for further rate cuts there. Markets are pricing in at least two more by the end of the year.

How about Switzerland? The nation with the world’s lowest interest rates, the cash rate is -0.75%, is being forecast to cut them further. Given the haven status of the Swiss franc and its recent appreciation vs. the euro, analysts are now looking for another rate cut there. So is the futures market, with a 50% probability of a 25bp cut priced in for March 2020., and SNB President Thomas Jordan has done nothing to dissuade these ideas. If anything, I would expect a cut before the end of the year.

My point is that despite the recent turn in US markets regarding interest rates, where virtually every analyst has come around to the idea that the next move in rates will be lower, and clearly there are Fed members in that camp, none of this happens in isolation. As the above discussion highlights, more dovish policy is quickly becoming the baseline forecast for virtually every country that matters.

So, what does that do for the dollar? Yesterday’s price action showed the dollar’s worst performance since mid-March, when Chairman Powell surprised the market with an uber-dovish policy statement and press conference. Bullard’s comments were enough to turn views toward a rate cut happening much sooner than previously anticipated. And so, if the Fed has truly turned around their thought process, then it will be no surprise for the dollar to have a weak period. Of course, this will only last until we hear Draghi talk about the room for further easing and the need to maintain price stability near the ECB’s target. Once it is clear that the ECB is also going to ease further, the dollar will likely find a bottom. Remember, the ECB meets tomorrow and Thursday, with Draghi’s press conference at 8:30 Thursday morning. Given the recent data, and the overall trade situation, it is not impossible that the ECB turns far more dovish this week. However, my sense is they will focus on the terms of the new TLTRO’s and not on restarting QE. So, the dollar probably has a few weeks of underperformance ahead of it, but it is only a matter of time before the ECB (and correspondingly the BOJ, BOE and BOC) jump on the dovish bandwagon.

As an aside, I keep reading that the only way for the Fed to create a dovish surprise later this month is to cut immediately (the market is pricing in a 25bp cut at the July meeting) but I disagree. All they have to do is cut by more than 25bps when they cut. There is no rule that says 25bps is the proper amount to move rates. If the consensus view is turning to a sharper slowdown, it would be better to get ahead of the problem than to be seen as offering policy prescriptions that are ‘too little, too late.’ It appears to me that President Trump will get his way regarding the Fed, with easier money to come sooner rather than later. Alas, I fear that the stock market may not respond in the manner desired. At this point, cutting rates speaks to panic at the Fed that things are much worse than they have been describing. If that is the perception, equity markets have only one way to go…down.

On the data front, yesterday saw the weakest ISM print since October 2016, which is completely in line with what we are seeing around the world, slowing manufacturing growth. This morning, the only hard data is Factory Orders (exp -0.9%) but both Powell and NY Fed President Williams speak. The default expectation for them both is turning more dovish, and if they live up to that billing, the dollar is likely to continue its recent decline. But, if somehow they sound hawkish, look for the dollar to reverse higher quickly. Remember, FX is still a relative game and its recent weakness is predicated on a more dovish Fed. Changing that changes the market’s perception.

Good luck
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Will Powell React?

The Treasury curve is implying
That growth as we knew it is dying
Will Powell react?
Or just be attacked
For stasis while claiming he’s trying?

Scanning markets this morning shows everything is a mess. Scanning headlines this morning shows that fear clearly outpolls greed as the driving force behind trading activity. The question at hand is, ‘Have things gone too far or is this just the beginning?’

Treasury and Bund yields are the best place to start when discussing the relative merits of fear and greed, and this morning, fear is in command. Yields on 10-year Treasuries have fallen to 2.23% and 10-year Bunds are down to -0.17%, both probing levels not seen in nearly two years. The proximate causes are numerous. First there is the continued concern over the trade war between the US and China with no sign that talks are ongoing and the market now focusing on a mooted meeting between President’s Trump and Xi at the G20 in June. While there is no chance the two of them will agree a deal, as we saw in December, it is entirely possible they can get the talks restarted, something that would help mitigate the current market stress.

However, this is not only about trade. Economic data around the world continues to drift broadly lower with the latest surprise being this morning’s German Unemployment rate rising to 5.0% as 60,000 more Germans than expected found themselves out of work. We have also been ‘treated’ to the news that layoffs by US companies (Ford and GE among others) are starting to increase. The auto sector looks like it is getting hit particularly hard as inventories build on dealer lots despite what appears to be robust consumer confidence. This dichotomy is also evident in the US housing market where despite strong employment, rising wages and declining mortgage rates, home prices are stagnant to falling, depending on the sector, and home sales have been declining for the past fourteen months in a row.

The point is that the economic fundamentals are no longer the reliable support for markets they had been in the recent past. Remember, the US is looking at its longest economic expansion in history, but its vigor is clearly waning.

Then there are the political ructions ongoing. Brexit is a well-worn story, yet one that has no end in sight. The pound remains under pressure (-0.1%, -3.0% in May) and UK stocks are falling sharply (-1.3%, -3.3% in May). As the Tory leadership contest takes shape, Boris Johnson remains the frontrunner, but Parliament will not easily cede any power to allow a no-deal Brexit if that is what Johnson wants. And to add to the mess, Scotland is aiming to hold a second independence referendum as they are very keen to remain within the EU. (Just think, the opportunity for another border issue could be coming our way soon!)

Then there is the aftermath of the EU elections where all the parties that currently are in power in EU nations did poorly, yet the current national leadership is tasked with finding new EU-wide leaders, including an ECB President as well as European Commission and European Council presidents. So, there is a great deal of horse-trading ongoing, with competence for the role seen as a distant fifth requirement compared to nationality, regional location (north vs. south), home country size (large vs. small) and gender. Meanwhile, Italy has been put on notice that its current financial plans for fiscal stimulus are outside the Eurozone stability framework but are not taking the news sitting down. It actually makes no sense that an economy crawling out of recession like Italy should be asked to tighten fiscal policy by raising taxes and cutting spending, rather than encouraged to reinvigorate growth. But hey, the Teutonic view of the world is austerity is always and everywhere the best policy! One cannot be surprised that Italian stocks are falling (-1.3%, -8.0% this month).

At any rate, the euro also remains under pressure, falling yesterday by 0.3%, a further 0.1% this morning and a little more than 1% this month. One point made by many is that whoever follows Signor Draghi in the ECB President’s chair is likely to be more hawkish, by default, than Draghi himself. With that in mind, later this year, when a new ECB leader is named, if not yet installed, the euro has the chance to rally. This is especially so if the Fed has begun to cut rates by then, something the futures market already has in its price.

Other mayhem can be seen in South Africa, where the rand has broken below its six-month trading range, having fallen nearly 3% this week as President Ramaphosa has yet to name a new cabinet, sowing concern in the market as to whether he will be able to pull the country out of its deep economic malaise (GDP -2.0% in Q1). And a last piece of news comes from Venezuela, where the central bank surprised one and all by publishing economic statistics showing that GDP shrank 19.2% in the first nine months of 2018 while inflation ran at 130,060% last year. That is not a misprint, that is the very definition of hyperinflation.

Turning to today’s session, there is no US data of note nor are any Fed members scheduled to speak. Given the overnight price action, with risk clearly being cast aside, it certainly appears that markets will open that way. Equity futures are pointing to losses of 0.6% in the US, and right now it appears things are going to remain in risk-off mode. Barring a surprise positive story (or Presidential tweet), it feels like investors are going to continue to pare back risk positions for now. As such, the dollar is likely to maintain its current bid, although I don’t see much cause for it to extend its gains at this time.

Finally, to answer the question I posed at the beginning, there is room for equity markets to continue to fall while haven bonds rally so things have not yet gone too far.

Good luck
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Disconcerted

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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