Opted To Stay

The BOE banker named Mark
Whose bite pales compared to his bark
Has opted to stay
To help PM May
Get through a time sure to be stark

It has been a relatively docile FX market in the overnight session with traders awaiting new information on which to take positions. With that in mind, arguably the most interesting news has been that BOE Governor, Mark Carney, has agreed to extend his term in office for a second time, establishing a new exit date of January 2020. This is a relief to Chancellor Phillip Hammond, who really didn’t want to have a new Governor during what could turn out to be a very turbulent time immediately in the wake of the actuality of Brexit, which occurs on March 31, 2019. This is actually Carney’s second extension of his term, as he agreed to extend it originally by one year in the immediate wake of the Brexit vote in 2016. The market response was positive, with the pound bouncing about 0.5% upon the news, but just around 7:00am, it has started to cede those gains and is now actually down 0.3% on the session.

Away from the Carney news, there is precious little new to discuss. Eurozone data was generally softer than expected with IP there falling a worse than expected -0.8% in July. This resulted in the Y/Y figure actually turning negative as well, indicating that growth on the Continent is starting to suffer. In fact, there is another story that explains the ECB economists (not the governing council) have lowered their growth forecasts for the Eurozone during the next three years on the basis of increased trade frictions, emerging market malaise and higher US interest rates driving the global cycle. It will be interesting to see how Signor Draghi handles this news, and whether it will force the council to rethink their current plan to reduce QE starting next month and ending it in December. We will get to find out his thoughts tomorrow morning at the 8:30am press conference following their meeting. If pressed, I would expect that Draghi will be reluctant to change policy, but the increasing dangers to the economy, especially those posed by the escalating trade tensions between the US and China, will be front and center in the discussion. In the end, the euro has fallen slightly on the day, down 0.2%.

Otherwise, it is hard to get overly excited about the market this morning. Emerging market currencies are having a mixed session with INR rebounding, finally, after indications that the RBI is going to address the ongoing rupee weakness with tighter policy and perhaps increased market intervention. TRY is firmer by about 0.9% this morning as the market awaits tomorrow’s central bank news. Current market expectations are for a 300bp rate hike to address both the weakening currency and sharply rising inflation. However, we cannot forget President Erdogan’s distaste for higher interest rates as well as his control over the economy. In fact, this morning he fired the entire governing board of the Turkish sovereign wealth fund and installed himself as Chairman. I am skeptical that the Bank of Turkey raises rates anywhere near as much as the market anticipates. Meanwhile, yesterday saw the Brazilian real fall 1.6% as the presidential election polls show that the left wing candidates are gaining ground on Jair Bolsonaro, the market favorite. Given the virtual certainty there will be a second round vote, and the fact that Bolsonaro, who leads the polls right now, is shown by every poll to lose in the second round, it seems the market is coming to grips with the idea that the politics in Brazil are going to move away from investor friendliness into a more populist scenario. I fear the real may have quite a bit further to fall over time. 5.00 anyone?

Beyond these stories, nothing else is really noteworthy. Looking ahead to today’s US data shows that PPI will be released at 8:30 with the headline number expected at +0.2%, 3.2% Y/Y, and the core +0.2%, 2.7% Y/Y. We hear from two Fed speakers, uberdove Bullard and dovish leaning Brainerd, and then at 2:00pm comes the Fed’s Beige Book.

In the end, the dollar remains strongly linked to Fed policy, and there is no evidence that Fed policy is going to change from its current trajectory. In fact, if anything, it seems more likely that policy tightening quickens rather than slows. Consider the fact that the mooted tariffs of $200 billion of Chinese goods will impact a significant portion of consumer products, and if tariffs on an additional $267 billion are in play, then virtually everything that comes from China will be higher in price. I assure you that inflation will be higher in that event, and that the Fed will be forced to raise rates even more aggressively if that is the case. My point is that the dollar is still going to be the big beneficiary of this process, and my view that it will continue to strengthen remains intact.

Good luck
Adf

Uncomfortably High

Said Carney, exhaling a sigh
The odds are “uncomfortably high”
More pain will we feel
If there is no deal
When England waves Europe bye-bye

Yesterday the BOE, in a unanimous decision, raised its base rate by 25bps. This outcome was widely expected by the markets and resulted in a very short-term boost for the pound. However, after the meeting, Governor Carney described the odds of the UK leaving the EU next March with no transition deal in hand as “uncomfortably high.” That was enough to spook markets and the pound sold off pretty aggressively afterwards, closing the day lower by 0.9%. And this morning, it has continued that trend, falling a further 0.2% and is now trading back below 1.30 again.

By this time, you are all well aware that I believe there will be no deal, and that the market response, as that becomes increasingly clear, will be to drive the pound still lower. In the months after the Brexit vote, January 2017 to be precise, the pound touched a low of 1.1986, but had risen fairly steadily since then until it peaked well above 1.40 in April of this year. However, we have been falling back since that time, as the prospects for a deal seem to have receded. The thing is, there is no evidence that points to any willingness to compromise among the Tory faithful and so it appears increasingly likely that no deal will be agreed by next March. Carney put the odds at 20%, personally I see them as at least 50% and probably higher than that. In the meantime, the combination of ongoing tightening by the Fed and Brexit uncertainty impacting the UK economy points to the pound falling further. Do not be surprised if we test those lows below 1.20 seen eighteen months ago.

This morning also brought news about the continuing slowdown in Eurozone growth as PMI data was released slightly softer than expected. French, German and therefore, not surprisingly, Eurozone Services data was all softer than expected, and in each case has continued the trend in evidence all year long. It is very clear that Eurozone growth peaked in Q4 2017 and despite Signor Draghi’s confidence that steady growth will lead inflation to rise to the ECB target of just below 2.0%, the evidence is pointing in the opposite direction. While the ECB may well stop QE by the end of the year, it appears that there will be no ability to raise rates at all in 2019, and if the current growth trajectory continues, perhaps in 2020 as well. Yesterday saw the euro decline 0.7%, amid a broad-based dollar rally. So far this morning, after an early extension of that move, it has rebounded slightly and now sits +0.1% on the day. But in the end, the euro, too, will remain under pressure from the combination of tighter Fed policy and a decreasing probability of the ECB ever matching that activity. We remain in the 1.1500-1.1800 trading range, which has existed since April, but as we push toward the lower end of that range, be prepared for a breakout.

Finally, the other mover of note overnight was CNY, with the renminbi falling to new lows for the move and testing 6.90. The currency has declined more than 8% since the middle of June as it has become increasingly clear that the PBOC is willing to allow it to adjust along with most other emerging market currencies. While the movement has been steady, it has not been disorderly, and as yet, there is no evidence that capital outflows are ramping up quickly, so it is hard to make the case the PBOC will step in anytime soon. And that is really the key; increases in capital outflows will be the issue that triggers any intervention. But while many pundits point to 7.00 as the level where that is expected to occur, given the still restrictive capital controls that exist there, it may take a much bigger decline to drive the process. With the Chinese economy slowing as well (last night’s Caixin Services PMI fell to 52.8, below expectations and continuing the declining trend this year) a weaker yuan remains one of China’s most important and effective policy tools. There is no reason for this trend to end soon and accordingly, I believe 7.50 is reasonable as a target in the medium term.

Turning to this morning’s payroll report, here are the current expectations:

Nonfarm Payrolls 190K
Private Payrolls 189K
Manufacturing Payrolls 22K
Unemployment Rate 3.9%
Average Hourly Earnings (AHE) 0.3% (2.7% Y/Y)
Average Weekly Hours 34.5
Trade Balance -$46.5B
ISM Non-Manufacturing 58.6

Wednesday’s ADP number was much stronger than expected at 213K, and the whisper number is now 205K for this morning. As long as this data set continues to show a strong labor market, and there is every indication it will do so, the only question regarding the Fed is how quickly they will be raising rates. All of this points to continued dollar strength going forward as the divergence between the US economy and the rest of the world continues. While increasing angst over trade may have a modest impact, we will need to see an actual increase in tariffs, like the mooted 25% on $200 billion in Chinese imports, to really affect the economy and perhaps change the Fed’s thinking. Until then, it is still a green light for dollar buyers.

Good luck and good weekend
Adf

For How Long?

The US economy’s strong
Denial of this would be wrong
It’s not too surprising
That rates will be rising
The question is just, for how long?

Despite the Trump administration’s recent discussion of imposing 25% tariffs on $200 billion of Chinese imports, rather than the 10% initially mooted, the Fed looked at the economic landscape and concluded that things continue apace. While they didn’t adjust rates yesterday, as was universally expected, the policy statement was quite positive, highlighting the strength in both economic growth and the labor market, while pointing out that inflation is at their objective of 2.0%. Market expectations for a September rate hike increased slightly, with futures traders now pricing in a nearly 90% probability. More interestingly, despite the increased trade rhetoric, those same traders have increased their expectations for a December hike as well, with that number now hovering near 70%. At this point, despite President Trump’s swipe at higher rates last week, it appears that the Fed is continuing to blaze its rate-hiking path undeterred.

The consequences of the Fed’s stance are starting to play out more clearly now, with the dollar once again benefitting from expectations of higher short term rates, and equity markets around the world, but especially in APAC, feeling the heat. The chain of events continues in the following manner. Higher US rates have led to a stronger US dollar, especially vs. many emerging market currencies. The companies in those countries impacted are those that borrowed heavily in USD over the past ten years when US rates were near zero. They now find themselves struggling to repay and refinance that debt. Repayment is impacted because their local revenues buy fewer dollars while refinancing is impacted by the fact that US rates are that much higher. With this cycle in mind, it should not be surprising that equity markets elsewhere in the world are struggling. And those struggles don’t even include the potential knock-on effects of further US tariff increases. Quite frankly, it appears that this trend has further to run.

Meanwhile, the week’s central bank meetings are coming to a close with this morning’s BOE decision, where they are widely touted to raise the Base rate by 25bps, up to 0.75%. It is actually quite amusing to read some of the UK headlines talking about the BOE raising rates to the ‘highest in a decade’, which while strictly true, seems to imply so much more than the reality of still exceptionally low interest rates. However, given the ongoing uncertainty due to the Brexit situation, I continue to believe that Governor Carney is extremely unlikely to raise rates again this year, and if we are headed to a ‘no-deal’ Brexit, which I believe is increasingly likely, UK rates will head back lower again. Early this morning the UK Construction PMI data printed at a better than expected 55.8, its highest since late 2016, but despite the strong data and rate expectations, the pound has fallen 0.35% on the day.

Other currency movement has been similar, with the euro down 0.35%, Aussie and Kiwi both falling more than 0.5% and every other G10 currency, save the yen declining. The yen has rallied slightly, 0.2%, as interest rates in Japan continue to respond to Tuesday’s BOJ policy tweaks. JGB’s seem to have quickly found a new home above the old 0.10% ceiling, and there is now a growing expectation that as the 10-year yield there approaches the new 0.2% cap, the longer end of the JGB curve will rise with it taking the 30-year JGB to 1.00%. While that may not seem like much to the naked eye, when considering the nature of international flows, it is potentially quite important. The reason stems from the fact that Japanese institutional investors tend to hedge the FX exposure that comes from foreign fixed income purchases thus reducing their net yield from the higher rates received overseas to something on the order of 1.0%. And if the Japanese 30-year reaches that 1.0% threshold (it is currently yielding 0.83%), there is a growing expectation that those same investors will sell Treasuries and other bonds and bring the money home. That will have two impacts. First, I would be far less concerned over an inverting yield curve in the US as yields across the back end of the US curve would rise on those sales, and second, the dollar would likely rally overall on higher rates, but decline further against the yen. These are the type of background flows that impact the FX market, but may not be obvious to most hedgers.

Turning to the emerging markets, the dollar is firmer against virtually all of these currencies as well. One of the biggest movers has been CNY, falling 0.5% and now trading at its weakest level since May 2017. The renminbi’s decline has been impressive since mid-April, clocking in at nearly 9%, and clearly offsetting some of the impact of the recent tariffs. But remember, the renminbi’s decline began well before any tariffs were in place, and has as much to do with a slowing Chinese economy forcing monetary policy ease in China as with the recent trade spat. At this point, capital outflows have not yet become a problem there, but if history is any guide, as we get closer to 7.00, we are likely to see more pressure on the system as both individuals and companies seek to get their money out of China and into a stronger currency. I expect that there are more fireworks in store here.

Aside from China, the usual suspects continue to fall, with TRY having blasted through 5.00 overnight and now down 1.5% on the day. But we have also seen significant weakness in ZAR (-1.75%), KRW (-1.15%), and MXN (-0.75%). Even INR is down 0.5% despite the RBI having raised rates 0.25% overnight to try to rein in rising inflation pressures there. So today’ story is clear, the dollar remains in the ascendancy on the back of optimism in the US vs. increasing pessimism elsewhere in the world.

A quick peek at today’s data shows that aside from the weekly Initial Claims (exp 220K) we see only Factory Orders (0.7%). Yesterday’s ADP Employment data was quite strong, rising 219K, while the ISM Manufacturing report fell to a still robust 58.1, albeit a larger fall than expected. However, given the Fed’s upbeat outlook, the market was able to shake off the news. At this point, however, I expect that eyes are turning toward tomorrow’s NFP report, which will be seen as taking a much more accurate reading on the economy. All in all, I see no reason for the dollar to give back its recent gains, and in fact, expect that modest further strength is in the cards.

Good luck
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Still At Its Peak

Three central bank meetings this week
Seem unlikely, havoc to wreak
When they all adjourn
Attention will turn
To joblessness, still at its peak

In the current central bank calendric cycle, the ECB meeting was the first to be completed, and last Thursday we learned virtually nothing new about Mario Draghi’s plans. The ECB is going to reduce QE further starting in October and is due to end it completely by year end. As to interest rates, ‘through summer’ remains the watchword, with markets forecasting a 10bp rate rise in either September or October of next year.

This week brings us the other three big central bank meetings, starting with the BOJ’s announcement tomorrow evening, then the FOMC on Wednesday and finally the BOE on Thursday. Going in reverse order, the market remains convinced that Governor Carney will raise rates 25bps, with a more than 80% probability priced in by futures traders. While I think it is a mistake, it does seem increasingly likely it will be the outcome. As to the Fed, there are no expectations of any policy adjustments at this meeting, and as there is no press conference following, I expect that the statement, when released Wednesday afternoon, will have little market impact.

This takes us to tomorrow evening’s BOJ meeting, which is the only one where there seems to be any real uncertainty. Last week I discussed the questions at hand which boil down to whether or not Kuroda and company have come to believe that QQE is not only ineffective, but actually beginning to have a detrimental impact on the Japanese economy. After all, they have been at it for the better part of five years and have still had zero success in achieving their 2.0% inflation goal. The three biggest problems are that Japanese banks have seen their business models decimated by increasingly narrow lending spreads; the ETF purchase program has had an increasingly large distortive impact on the Japanese stock markets as the BOJ now owns roughly 4% of all Japanese equities; and finally, the yield curve control plan has essentially broken the JGB market as evidenced by the fact that they continue to see sessions where there are actually no trades in the 10-year JGB. (Consider what would happen if there were no trades in 10-year Treasuries one day!)

With all of this as baggage, there has been increasing discussion that the BOJ may seek to tweak the program to try to make it more effective. However, they have painted themselves into a corner because if they reduce their activity in the JGB market, the market is likely to see it as a reduced commitment to QE and it is likely to result in higher yields there, which can easily lead to two separate but related outcomes. First, USDJPY is likely to fall further, as higher JGB yields lead to more interest for Japanese investors to bring their funds home. Given the disinflationary impact of a stronger currency, this would be a disaster. And second, if there is less support for JGB’s, given the fungibility of money and the open capital markets that exist, we are likely to see yields rise in US, UK, European and other developed markets. While Chairman Powell may welcome this as it will reduce concern over the Fed inverting the yield curve, the rest of the world, which retains far easier monetary policy, is likely to be somewhat less welcoming of that outcome. And this is all based on anonymous reports that the BOJ is going to make some technical adjustments to their program, not change the nature of what they are doing. So if you are looking for some fireworks this week, the BOJ is your best bet.

However, beyond the central banks, the market will turn its attention to Friday’s employment report here in the US. Last Friday saw a robust GDP report, as widely expected, and further proof of the divergence between the US and the rest of the global economy. This Friday could simply add to that impression. Here is the full listing of this week’s data, which is quite robust:

Tuesday BOJ Rate Decision -0.10% (unchanged)
  Personal Income 0.4%
  Personal Spending 0.4%
  PCE 0.1% (2.3% Y/Y)
  Core PCE 0.1% (2.0% Y/Y)
  Case-Shiller Home Prices 6.4%
  Chicago PMI 62.0
Wednesday ADP Employment 185K
  ISM Manufacturing 59.5
  ISM Prices Paid 75.8
  FOMC Rate Decision 2.00% (unchanged)
Thursday BOE Rate Decision 0.75% (+0.25%)
  Initial Claims 221K
  Factory Orders 0.7%
Friday Nonfarm Payrolls 190K
  Private Payrolls 185K
  Manufacturing Payrolls 22K
  Unemployment Rate 3.9%
  Average Hourly Earnings 0.3% (2.7% Y/Y)
  Average Weekly Hours 34.5
  Trade Balance -$46.2B
  ISM Non-Manufacturing 58.7

So, as you can see there is much to be learned this week. With the focus on the central banks and Friday’s payroll data, don’t lose sight of tomorrow’s PCE report, because remember, that is the Fed’s go-to number on inflation. Overall, looking at forecasts, things remain remarkably strong in the US economy this long into an expansion, which is something that has many folks concerned. We also continue to see important corporate earnings releases this week for Q2, which given the high profile misses we had last week, could well impact markets beyond individual equity names.

As to the dollar through all this, it is a touch softer this morning, but remains on the strong side of its recent trading range. While I still like it higher, there is so much potential new information coming this week, it is probably wisest to remain as neutral as possible for now. For hedgers, that means the 50% rule is in effect.

Good luck
Adf

Weaker Yuan Now Abided

Apparently China’s decided
Their strong money stance was misguided
So look for, ahead
More easing instead
And weaker yuan now abided

Arguably, the biggest story in the FX markets overnight was the sharp decline in the Chinese yuan. For the first time in more than a year, the PBOC set the fixing rate for the dollar above 6.70, which seemed to signal a willingness to allow the currency to fall much further. As I type, the offshore version is trading near 6.80, having fallen 0.8% on the session. As I have discussed over the past months, even absent the trade situation, there are ample reasons to see the renminbi decline further. However, it now seems likely that the ongoing trade dispute with the US is starting to have a bigger impact on the Chinese economy (remember we already saw weak data last week) and that a simple response is to allow the currency to fall.

The trade dispute with the US has come at a bad time for China. They have been tightening liquidity standards for the past two years in an effort to reduce leverage in their economy and the housing bubbles that resulted. But now, the slower growth precipitated by that policy combined with restrictions on their exports is forcing that policy to be reconsidered. So far the PBOC has not actually cut rates, but they have reduced bank reserve requirements by one full percent and encouraged significantly more lending to SME’s. However, in the end, given their still mercantilist economy, a weaker currency is likely to be the best policy available for their conflicting goals of less leverage and strong growth. I’m beginning to think that 7.00 is a conservative estimate for USDCNY at year-end. What is abundantly clear is that there will be further weakness in the near term.

Meanwhile, Carney’s plan to raise rates
In August is in dire straits
The data keeps showing
That UK growth’s slowing
My bet now is he hesitates

This morning’s UK Retail Sales data was the last big data point of the week, and completed a picture of an economy that is not expanding quite so rapidly as had been previously thought. While things aren’t as dire as the Q1 data implied, Retail Sales fell -0.5% in Jun with the -ex fuel number -0.6%. Both were significantly lower than forecast and added to the softer inflation and wage growth data seen earlier this week. As such, none of this data really supports the idea that the BOE needs to raise rates next month, despite a clearly articulated desire by Governor Carney to do so. The problem he faces, along with many other central bankers, is that policy rates remain at emergency settings deep into a recovery, and the concern now is that they won’t have any policy tools available when the next downturn comes. In other words, they are out of ammo and need to reload, which means they need higher policy rates. But if the data don’t warrant that stance, they run the risk of causing a recession in order to be able to fight one. It is an unenviable position, but one that they brought upon themselves with their gigantic monetary policy experiment. When the softening data trend is added to the ongoing Brexit uncertainty, I have a hard time seeing a rationale for the BOE to move next month. The market continues to price a >70% probability, but I think that will ebb over the next few weeks.

One thing that is not surprising is that the pound has fallen below 1.30, down a further 0.6% this morning (and 2.0% on the week) and is now trading at its lowest level since last September. While it no longer appears that PM May is going to be ousted, it does seem as though the odds of the UK leaving the EU with no deal in place are growing shorter. I continue to look for the pound to fall further.

Away from those two stories, yesterday brought the second day of Chairman Powell’s Congressional testimony, this time to the House Financial Services Committee. The comment getting the most press has been “[the rate setting committee] believes that, for now, the best way forward is to keep gradually raising” rates. The idea is that the highlighted words are a strong indication that the Fed remains policy dependent, and so will carefully evaluate the situation at each meeting. That said, expectations remain that they will raise rates in September and December, and that data would need to be significantly worse, or the trade dispute clearly become a bigger problem, to change that view.

In the end, those Fed expectations should continue to support the dollar. In fact, the dollar has rallied pretty sharply across the board this morning, with the Dollar Index up 0.5%. That breadth of strength is indicative of the fact that the market continues to expect divergent monetary policies between the US and the rest of the world for now. We will need to see much weaker US data to change that view, and the dollar’s trajectory.

This morning brings the last data of the week, with Initial Claims (exp 220K), Philly Fed (21.5) and Leading Indicators (0.4%). We also hear from Fed Governor Randall Quarles, although given that we just got two days of Powell, it is hard to believe that he will be saying something different. While yesterday’s Housing data was disappointing, it was not enough to change any views on the US economy, especially given that Housing Starts is a known volatile series, and so easily dismissed. It is hard to view the current market and economic situation without concluding that the dollar’s rally has further to go. Hedgers keep that in mind, especially as you begin to look at your 2019 exposures.

Good luck
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Waiting For Jay

The markets are waiting for Jay
To testify later today
The hawks are excited
As they feel united
More hawkishness he will convey

Yesterday’s Retail Sales data was the latest data point highlighting the US economy’s continued robust expansion. The 0.5% headline gain matched expectations, but it was the revision higher of last month’s 0.8% reading (which if you recall was much higher than expectations then) to 1.3% that really got tongues wagging. Several analysts raised their expectations for Q2 GDP to above 5.0% in the wake of the report, although the market response seems somewhat puzzling. Both equity and bond markets yesterday were essentially flat, oil prices tumbled more than 4% and the dollar was slightly softer. Arguably, after robust data, one would have expected higher stocks, higher bond yields (lower prices) and a stronger dollar. This should serve to remind everyone that while trends remain in place, there is rarely a one-for-one reaction from data to market prices.

However, what the data does accomplish is paint a picture of a still quite strong economy as a backdrop to Chairman Powell’s testimony to the Senate Banking Committee later this morning. If we have learned one thing about Powell, it is that he is willing to use plain English to describe his views, rather than couch those views in the obfuscation of economic jargon. But perhaps far more importantly, he consistently reminds his audience that there are many important concepts (e.g. the neutral interest rate or the natural rate of unemployment, NAIRU) that are not observable and where the Fed relies on estimates from its models. And while these variables are seen as critical to the PhD set, Chairman Powell recognizes that they cannot be used to fine tune the economy. It is this trait that sets Powell apart from his recent predecessors, and I personally believe, in a good way. At any rate, while the prepared remarks are fairly neutral in tone, there is a growing belief that the Q&A is likely to lean hawkish when it comes to monetary policy questions. However, I imagine that there will also be a significant amount of preening by certain Senators when they lambaste the Fed’s actions regarding banks and the recent stress tests. In fact, my sense is that he will not get to speak too much about the economy, and as such, I don’t expect his testimony to have much market impact at all.

With that said, there is certainly nothing from the recent data that would indicate the Fed is about to slow down its tightening, and the market is now pricing a 62% probability of two more rate hikes this year. In the end, this remains dollar supportive in my view.

Moving on to another economy that seems to be getting ready to tighten policy, UK employment data was released this morning and it was quite strong yet again. The Unemployment Rate remained at its 42-year lows of 4.2%, as 137K more jobs were created in the past three months. Not only that, but Average Earnings at 2.7% continue to print above recent inflation, resulting in real wage gains and a further clue that the UK economy, despite the ongoing Brexit drama and uncertainty, remains fairly solid. Certainly the market expects Governor Carney to raise rates next month, with futures pricing in a greater than 80% probability at this time, and so we will have to see some much weaker data on Q2 GDP or inflation later this week to change that view. The pound has benefitted this morning, edging up a further 0.1%, which makes about 0.5% of gains over the past four sessions. Not that inspiring, but at least logical today.

Overall, the dollar is marginally lower this morning, although it is a mixed picture vs. individual currencies. For example, MXN is weaker by 0.7% on the back of the decline in oil prices with RUB similarly lower by 0.4%. However, other currencies have shown modest strength vs. the dollar, notably CHF, INR and NZD, each with their own idiosyncratic story. The point is there is no overriding theme in the FX market this morning.

One thing I think worth pointing out is that the yen has recently lost some of its safe haven luster. Ever since the financial crisis, the yen had become seen as a haven in the face of market turmoil, rallying when nervousness was evident. I have always thought that characterization misplaced. Prior to the crisis, being short yen to fund other assets was a hugely prevalent position, known as the carry trade. When those assets started to decline sharply during the crisis, all that we saw was those carry trades unwind, which, by definition, included yen purchases. Investors weren’t indicating they preferred yen to other assets; they were closing outstanding positions. But the haven narrative stuck and so we have lived with it for a decade now. Perhaps we are finally coming round to a period where that narrative will diminish, and old havens, notably the dollar and gold, will make a comeback. Certainly the dollar is holding up its end of the bargain overall, so my sense is that gold may not be too far behind if we see another market disruption. In the meantime, the yen has fallen 0.2% this morning and is actually trading back at its lowest level since early January. It would not be surprising to see further yen weakness over the coming months, especially if my thesis on the haven issue is true.

Before we hear from the Chairman, Capacity Utilization (exp 78.3%) and IP (0.6%) are to be released. However, unless something extraordinary prints there, I expect that markets will remain quiet until Powell starts. At that point, it is all up to him.

Good luck
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Dashing Hopes

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

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

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

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

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

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

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

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

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

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

Good luck and good weekend
Adf