Expansion is Done

The planet that’s third from the sun
Is learning expansion is done
At least with respect
To growth that’s subject
To what politicians have done

It ought not be much of a surprise that the dollar is regaining its footing this morning and has been doing so for the past several sessions. This is due to the fact that the economic data continue to point to the US as the last bastion of hope for global growth. Yesterday’s data showed that there is still life in the US economy as both Non-Manufacturing ISM (59.7) and New Home Sales (621K) handily beat expectations. At the same time, the data elsewhere around the world continues to show slowing growth.

For example, Australian GDP growth in Q4 printed at a lower than expected 0.2%, with the annual number falling to 2.3%. While RBA Governor Lowe continues to cling to the idea that falling unemployment (a lagging indicator) is going to save the day, the fact remains that the housing bubble there is deflating and the slowdown in China’s economy is having a direct negative impact on Australian growth. In the wake of the report, analysts throughout Asia adjusted their interest rate forecasts to two rate cuts this year even though the RBA has tried to maintain a neutral policy with an eventual expectation to raise rates. Aussie fell sharply, down 0.75% this morning and >2.5% in the past week. It is once again approaching the 0.70 level which has thus far proven to be formidable support, and below which it has not traded in three years. Look for it to crack this time.

But it is not just problems Down Under. In fact, the much bigger issues are in Europe, where the OECD has just released its latest forecasts for GDP growth with much lower numbers on the table. Germany is forecast to grow just 0.7% this year, the UK just 0.8% and of course, Italy which is currently suffering through a recession, is slated to grow just 0.2% this year! Tomorrow Signor Draghi and his ECB colleagues meet again and there is a growing belief that a decision on rolling over the TLTRO bank financing will be made. I have been pounding the table on this for several months and there has certainly been nothing lately to change my view. At this point, the market is now pricing in the possibility of the first ECB rate hike only in mid 2020 and my view is it will be later than that, if ever. The combination of slowing growth throughout the Eurozone, slowing growth in China and still absent inflation will prevent any rate hikes for a very long time to come. In fact, Europe is beginning to resemble Japan in this vein, where slowing growth and an aging population are the prerequisites for NIRP forever. Plus, the longer growth remains subpar, the more call for fiscal policy ease which will require additional borrowing at the government level. As government debt continues to grow, and it is growing all around the world, the ability of central banks to guide rates higher will be increasingly throttled. When you consider these issues it become very difficult to be bullish on the euro, especially in the long-term. But even in the short run, the euro is likely to feel pressure. While the euro has barely edged lower this morning, that is after a 0.35% decline yesterday which means it is down just over 1.0% in the past week.

In the UK, meanwhile, the Brexit debate continues but hope is fading that the PM will get her bill through Parliament this time. Thus far, the EU has been unwilling to make any concessions on the language of the Irish backstop, and despite a herculean effort by May, it is not clear she can find the votes. The vote is scheduled for next Tuesday, after which, if it fails, Parliament will look to pass some bills preventing a no-deal Brexit and seeking a delay. However, even those don’t look certain to pass. Just this morning, Governor Carney said that a no-deal Brexit would not, in fact, be the catastrophe that had been earlier forecast as many companies have made appropriate plans to handle it. While the underlying thesis in the market continues to be that there will be a deal of some sort, it feels like the probability of a hard Brexit is growing somewhat. Certainly, the pound’s recent performance would indicate that is the case. This morning it is down a further 0.3% which takes the move to -1.75% in the past week.

One last central bank story is that of Canada, where the economy is also slowing much more rapidly than the central bank had believed just a few weeks ago. Last week we learned that inflation is lower than expected, just 1.4%, and that GDP grew only 0.1% in Q4, actually falling -0.1% in December. This is not a data set that inspires optimism for the central bank to continue raising rates. Rather, it should become clear that the BOC will remain on hold, and more importantly likely change its hawkish slant to neutral at least, if not actually dovish. As to the Loonie, it is lower by 0.3% this morning and 2.0% since the GDP release on Friday.

Add it all up and you have a story that explains global growth is slowing down further. It is quite possible that monetary policy has been pushed to its effective limit with any marginal additional ease likely to have a very limited impact on the economy. If this is the case, it portends far more difficulty in markets ahead, with one of the most likely outcomes a significant increase in volatility. If the global economy is now immune to the effects of monetary policy anesthesia, be prepared for a few more fireworks. It remains to be seen if this is the case, but there are certainly some indications things are playing out that way. And if central banks do lose control, I would not want to have a significant equity market position as markets around the world are certain to suffer. Food for thought.

This morning we get one piece of data, Trade Balance (exp -$57.9B) and we hear from two more Fed speakers, Williams and Mester. Then at 2:00 the Fed’s Beige Book is released. It seems unlikely that either speaker will lean hawkish, even Mester who is perhaps the most hawkish on the FOMC. Comments earlier this week from other speakers, Rosengren and Kaplan, highlighted the idea of patience in their policy judgements as well as potential concern over things like the extraordinary expansion of corporate debt in this cycle, and how in the event the economy slows, many more companies are likely to be vulnerable. While fear is not rampant, equity markets have been unable to rally the past several sessions which, perhaps, indicates that fear is beginning to grow. And when fear is in vogue, the dollar (and the yen) are the currencies to hold.

Good luck
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Good Times Will Endure

Elections are out of the way
The outcome caused little dismay
Investors seem sure
Good times will endure
With stocks set to rally today

The dollar, however, is weak
Some pundits claim we’ve seen the peak
Still folks at the Fed
See rate hikes ahead
Which could, on those views, havoc wreak

The midterm elections are now past, with expectations largely fulfilled. The Democrats will run the House, while the Senate’s Republican majority has actually grown by four seats to a 53-47 count. At least that’s what appears to be the case at this time, although there are some runoff elections that need yet to be completed in the next weeks. The traditional view of a political split is that gridlock will ensue and very little in the way of new policy will come out of the next Congress. However, in this case, things may not actually work out that way. Consider the fact that President Trump’s populist leanings may well dovetail with Democratic priorities, especially on spending. It wouldn’t be that surprising if the next budget is even more stimulative than the last, especially as by next summer it is highly likely that the US growth impulse will be slowing down somewhat as the effects of the last stimulus fade away. And through it all, there is no indication that the Fed is going to stop raising interest rates, so I might argue that things haven’t changed all that much.

The risks to this view are if the new Democratic majority in the House chooses to use their power to rehash the battles from 2016 or, more disconcertingly for markets, decide that they want to proceed with an Impeachment process against the President. Two things about this issue are that, first, with the Republicans in control of the Senate, there is essentially zero probability that the President would be removed from office, so it would all be for show. But second, as I mentioned yesterday, the last time we saw this movie, in the autumn of 1998, the dollar fell sharply during the proceedings. This is just something to keep in mind as headlines start to flow going forward.

Enough about the elections. The market response overnight showed equity markets feeling a little better, with Europe higher and US futures pointing in the same direction, although APAC markets were largely flat. Meanwhile, the dollar has come under pressure across the board. The latter seems a little counterintuitive, although I guess it is simply a result of the embrasure of risk by investors. There is no need to flock to dollars, or yen for that matter, if expectations turn positive. And that’s what we seem to have seen.

Focusing on the FX market, the dollar is down pretty sharply across the board. Both the euro and the pound are higher by more than 0.5% despite what I would argue was some mildly negative news. In the Eurozone, while German IP was a touch firmer than expected at +0.2%, Retail Sales data throughout the Eurozone was actually quite weak, with both Italian and Austrian data showing contraction while the French managed to just hold on to an unchanged result, and all three coming well short of expectations.

Meanwhile, the pound continues to trade on hopes that a Brexit breakthrough is coming, despite the fact that yesterday’s widely publicized cabinet meeting produced exactly nothing. PM May has two potential problems here; first is the question of actually coming up with a deal that her cabinet can agree to support that also has EU support, a task that has thus far been out of reach. Second, remember that May has a coalition partner, not a majority in Parliament, and the Labor Party is now coming on record that they will vote against any deal. If that is the case, it is entirely possible that it all falls apart and the UK leaves the EU with no deal in place. While the pound has rallied nicely over the past week, up more than 3.5%, I continue to see the downside risks being significantly greater than the upside. Certainly the rally on a deal announcement would be much smaller in magnitude than the decline in the event of a hard Brexit. Hedgers must keep this in mind as they manage their risks.

As to the rest of the G10, the dollar has fallen even further than the euro and pound, with 0.7% pretty common across virtually the entire bloc. The only two exceptions are JPY, with a more modest 0.3% rally and CAD with a similar gain. My sense is the former is all about risk reduction mitigating some of the dollar weakness, while the latter is related to the fact that oil prices continue to fall, having come down nearly 20% from their highs reached in early October.

In the EMG bloc, there is broad dollar weakness as well with IDR leading the way (+1.5%) and ZAR jumping a solid 1.25%. We discussed the IDR story yesterday as investment flows continue to find their way back to the country given its continued strong growth and low inflation. ZAR, on the other hand, has benefitted from the combination of broad dollar weakness and gold’s recent strength, with the “barbarous relic” having rallied more than 4% in the past month. But it is not just those two currencies showing strength this morning; it is a universal dollar down day, with most freely traded currencies rising more than 0.5%.

And that’s really the day overall. There is no US data to be released today, and the Fed is just starting its two-day meeting, although there is no expectation that there will be any policy change regardless of the fact that it has been pushed back a day in deference to Election day yesterday. There is certainly no reason to believe that the dollar will reverse course in the near term, unless we see a significant uptick in US data that might cause the Fed to step up their pace of activity. However, that is not going to happen today, no matter what, and so I would look for the dollar to continue the overnight move and sell off modestly from this morning’s levels. Although I do not believe that the big picture has changed, any dollar strength is likely to be fleeting in the near future.

Good luck
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Compromising

It cannot be very surprising
That Canada is compromising
Their views about trade
Thus now they have made
A deal markets find stabilizing

This morning, as the fourth quarter begins, arguably the biggest story is that Canada and the US have agreed terms to the trade pact designed to replace NAFTA. Canada held out to the last possible moment, but in the end, it was always clear that they are far too reliant on trade with the US to actually allow NAFTA to disintegrate without a replacement. The upshot is that there will be a new pact, awkwardly named the US-Mexico-Canada Agreement (USMCA) which is expected to be ratified by both Canada and Mexico quite easily, but must still run the gauntlet of the US Congress. In the end, it would be shocking if the US did not ratify this treaty, and I expect it will be completed with current estimates that it will be signed early next year. The market impact is entirely predictable and consistent with the obvious benefits that will accrue to both Canada and Mexico; namely both of those currencies have rallied sharply this morning with each higher by approximately 0.9%. I expect that both of these currencies will maintain a stronger tone vs. the dollar than others as the ending of trade concerns here will be a definite positive.

There is another trade related story this morning, although it does not entail a new trade pact. Rather, Chinese PMI data was released over the weekend with both the official number (50.8) and the Caixin small business number (50.0) falling far more sharply than expected. The implication is that the trade situation is beginning to have a real impact on the Chinese economy. This puts the Chinese government and the PBOC (no hint of independent central banking here) in a difficult position.

Much of China’s recent growth has been fueled by significant increases in leverage. Last year, the PBOC unveiled a campaign to seek to reduce this leverage, changing regulations and even beginning to tighten monetary policy. But now they are caught between a desire to add stability to the system by reducing leverage further (needing to tighten monetary policy); and a desire to address a slowing domestic economy starting to feel the pinch of the trade war with the US (needing to loosen monetary policy). It is abundantly clear that they will loosen policy further as the political imperative is to insure that GDP growth does not slow too rapidly during President Xi’s reign. The problem with this choice is that it will build up further instabilities in the economy with almost certain future problems in store. Of course, there is no way to know when these problems will manifest themselves, and so they will likely not receive much attention until such time as they explode. A perfect analogy would be the sub-prime mortgage crisis here ten years ago, where leading up to the collapse; every official described the potential problem as too small to matter. We all know how that worked out! At any rate, while the CNY has barely moved this morning, and in fact has remained remarkably stable since the PBOC stepped in six weeks ago to halt its weakening trend, it only makes sense that they will allow it to fall further as a pressure release valve for the economy.

Away from those two stories though, the FX market has been fairly dull. PMI data throughout the Eurozone was softer than expected, but not hugely so, and even though there are ongoing questions about the Italian budget situation, the euro is essentially unchanged this morning. In the past week, the single currency is down just under 2%, but my feeling is we will need to see something new to push us away from the 1.16 level, either a break in the Italy story or some new data or comments to alter views. The next big data print is Friday’s payroll report, but I expect we might learn a few things before then.

In the UK, while the Brexit deadline swiftly approaches, all eyes are now focused on the Tory party conference this week to see if there is a leadership challenge to PM May. Given that the PM’s ‘Chequers’ proposal has been dismissed by both the EU and half the Tory party, it seems they will need to find another way to move forward. While the best guess remains there will be some sort of fudge agreed to before the date, I am growing more concerned that the UK is going to exit with no deal in place. If that is what happens, the pound will be much lower in six-months’ time. But for today, UK Manufacturing PMI data was actually a surprising positive, rising to 53.8, and so the signals from the UK economy continue to be that it is not yet collapsing.

Away from those stories, though, I am hard pressed to find new and exciting news. As this is the first week of the month, there is a raft of data coming our way.

Today ISM Manufacturing 60.1
  ISM Prices Paid 71.0
  Construction Spending 0.4%
Wednesday ADP Employment 185K
  ISM Non-Manufacturing 58.0
Thursday Initial Claims 213K
  Factory Orders 2.0%
Friday Nonfarm Payroll 185K
  Private Payroll 183K
  Manufacturing Payroll 11K
  Unemployment Rate 3.8%
  Average Hourly Earnings 0.3% (2.8% Y/Y)
  Average Weekly Hours 34.5
  Trade Balance -$53.5B

On top of the payroll data, we hear from eight Fed speakers this week, including more comments from Chairman Powell tomorrow. At this point, however, there is no reason to believe that anything is going to change. The Fed remains in tightening mode and will raise rates again in December. The rest of the world continues to lag the US with respect to growth, and trade issues are likely to remain top of mind. While the USMCA is definitely a positive, its benefits will only accrue to Mexico and Canada as far as the currency markets are concerned. We will need to see some significant changes in the data stream or the commentary in order to alter the dollar’s trend. Until then, the dollar should maintain an underlying strong tone.

Good luck
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