Hawks Would Then Shriek

Lagarde and Chair Powell both seek
Consensus, when later this week
Their brethren convene
While doves are still keen
To ease more, though hawks would then shriek

Markets are relatively quiet this morning as investors and traders await three key events as well as some important data. Interestingly, neither the Fed nor ECB meetings this week are likely to produce much in the way of fireworks. Chairman Powell and his minions have done an excellent job convincing market participants that the temporary cyclical adjustment is finished, that rates are appropriate, and that they are watching everything closely and prepared to act if necessary. Certainly Friday’s blowout NFP data did not hurt their case that no further easing is required. By now, I’m sure everyone is aware that we saw the highest headline print since January at 266K, which was supported by upward revisions of 41K to the previous two months’ data. And of course, the Unemployment Rate fell to 3.5%, which is back to a 50-year low. In fact, forecasts are now showing up that are calling for a 3.2% or 3.3% Unemployment Rate next November, which bodes well for the incumbent and would be the lowest Unemployment Rate since 1952!

With that as the economic backdrop in the US, it is hard for the doves on the Fed to make the case that further easing is necessary, but undoubtedly they will try. In the meantime, ECB President Lagarde will preside over her first ECB meeting where there are also no expectations for policy changes. Here, however, the situation is a bit tenser as the dramatic split between the hawks (Germany, the Netherlands and Austria) and the doves (Spain, Portugal and Italy) implies there will be no further action anytime soon. Madame Lagarde has initiated a policy review to try to find a consensus on how they should proceed, although given the very different states of the relevant economies, it is hard to believe they will agree on anything.

Arguably, the major weakness in the entire Eurozone construct is that the lack of an overarching continent-wide fiscal authority means that there is no easy way to transfer funds from those areas with surpluses to those with deficits. In the US, this happens via tax collection and fiscal stimulus agreed through tradeoffs in Congress. But that mechanism doesn’t exist in Europe, so as of now, Germany is simply owed an extraordinary amount of money (~€870 billion) by the rest of Europe, mostly Italy and Spain (€810 billion between them). The thing is, unlike in the US, those funds will need to be repaid at some point, although the prospects of that occurring before the ECB bails everyone out seem remote. Say what you will about the US running an unsustainable current account deficit, at least structurally, the US is not going to split up, whereas in Europe, that is an outcome that cannot be ruled out. In the end, it is structural issues like this that lead to long term bearishness on the single currency.

However, Friday’s euro weakness (it fell 0.45% on the day) was entirely a reaction to the payroll data. This morning’s 0.15% rally is simply a reactionary move as there was no data to help the story. And quite frankly, despite the UK election and pending additional US tariffs on China, this morning is starting as a pretty risk neutral session.

Speaking of the UK, that nation heads to the polls on Thursday, where the Tories continue to poll at a 10 point lead over Labour, and appear set to elect Boris as PM with a working majority in Parliament. If that is the outcome, Brexit on January 31 is a given. As to the pound, it has risen 0.2% this morning, which has essentially regained the ground it lost after the payroll report on Friday. At 1.3165, its highest point since May 2019, the pound feels to me like it has already priced in most of the benefit of ending the Brexit drama. While I don’t doubt there is another penny or two possible, especially if Boris wins a large majority, I maintain the medium term outlook is not nearly as robust. Receivables hedgers should be taking advantage of these levels.

On the downside this morning, Aussie and Kiwi have suffered (each -0.2%) after much weaker than expected Chinese trade data was released over the weekend. Their overall data showed a 1.1% decline in exports, much worse than expected, which was caused by a 23% decline in exports to the US. It is pretty clear that the trade war is having an increasing impact on China, which is clearly why they are willing to overlook the US actions on Hong Kong and the Uighers in order to get the deal done. Not only do they have rampant food inflation caused by the African swine fever epidemic wiping out at least half the Chinese hog herd, but now they are seeing their bread and butter industries suffer as well. The market is growing increasingly confident that a phase one trade deal will be agreed before the onset of more tariffs on Sunday, and I must admit, I agree with that stance.

Not only did Aussie and Kiwi fall, but we also saw weakness in the renminbi (-0.15%), INR (-0.2%) and IDR (-0.2%) as all are feeling the pain from slowing trade growth. On the plus side in the EMG bloc, the Chilean peso continues to stage a rebound from its worst levels, well above 800, seen two weeks ago. This morning it has risen another 0.85%, which takes the gain this month to 4.8%. But other than that story, which is really about ebbing concern after the government responded quickly and positively to the unrest in the country, the rest of the EMG bloc is little changed on the day.

Turning to the data this week, we have the following:

Tuesday NFIB Small Business Optimism 103.0
  Nonfarm Productivity -0.1%
  Unit Labor Costs 3.4%
Wednesday CPI 0.2% (2.0% Y/Y)
  -ex Food & Energy 0.2% (2.3% Y/Y)
  FOMC Rate Decision 1.75%
Thursday ECB Rate Decision -0.5%
  PPI 0.2% (1.2%)
  -ex Food & Energy 0.2% (1.7%)
  Initial Claims 215K
Friday Retail Sales 0.4%
  -ex autos 0.4%

Source: Bloomberg

While there is nothing today, clearly Wednesday and Thursday are going to have opportunities for increased volatility. And the UK election results will start trickling in at the end of the day on Thursday, so if there is an upset brewing, that will be when things are first going to be known.

All this leads me to believe that today is likely to be uneventful as traders prepare for the back half of the week. Remember, liquidity in every market is beginning to suffer simply because we are approaching year-end. This will be more pronounced next week, but will start to take hold now.

Good luck
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Quite a Breakthrough

Is stealing IP now taboo?
If so that is quite a breakthrough
Now maybe Phase One
Can finally be done
Or is this just more déjà vu?

Tell me if you’ve heard this one before; a phase one trade deal is really close! For the umpteenth time in the past six months, this is the story driving markets this morning, although, in fairness, today’s version may have a bit more substance to it. That substance comes from an announcement by China that they are going to institute penalties on IP theft and potentially lower the threshold for considering criminal punishments for those convicted of the crime. This, of course, has been one of the key US demands in the negotiations thus far and the fact that the Chinese have conceded the argument is actually quite a big deal. Recall, if you will, that when this entire process started, the Chinese wouldn’t even admit that the practice was ongoing. Now they are considering enshrining the criminality of these actions into law. That is a huge change. Perhaps the current US stance in the negotiations is beginning to bear fruit.

Given this positive turn in the discussions, it should be no surprise that risk assets are in demand today and we are seeing equity markets rally around the world. Overnight in Asia, we saw strength across the board (Nikkei +0.8%, Hang Seng +1.5%, Shanghai +0.7%) and we are seeing solid gains in Europe as well (DAX +0.4%, CAC +0.3%, FTSE 100 +0.8%). The two outliers, Hong Kong and London have additional positive stories to boot. In Hong Kong the weekend’s local council elections resulted in the highest turnout in years and not surprisingly, given the ongoing protests for democracy, the pro-democracy candidates won 85% of the seats. HK Chief Executive Carrie Lam was quick to respond by explaining the government will listen carefully to the public on this issue. One other aspect of the elections was that they were completely peaceful, with no violence anywhere in the city this weekend, a significant difference to recent activity there, and that was also seen as a risk positive outcome.

Meanwhile, in the UK, PM Boris Johnson released his election manifesto and it was far more sensible than his predecessor’s attempt three years ago. While it included spending promises on infrastructure and increased hiring of nurses for the National Health Service, there were few other spending categories. Of course, he did remind everyone that a Tory majority will allow him to deliver Brexit by January 31 and he assured that the trade deal would be complete by the end of 2020. The latest polls show that the Tories lead 42% to 30% for Labour with the rest still split amongst minor players. Also, a Datapraxis study shows that on current form, the Tories will win 349 of the 650 seats in Parliament, a solid majority that will allow Boris to implement his policies handily. Given this news less than three weeks from the election, investors and traders are becoming increasingly bullish on the outcome and the pound has benefitted accordingly this morning, rising 0.3%. Now, it is still well below the levels seen last month, when it briefly peeked over 1.30 in the euphoria that Boris was going to get Brexit done by October 31. But, it is today’s clear winner in the G10 space.

Away from the pound, the rest of the G10 space has been quite dull, with the euro slipping a scant 0.1% after German IFO data showed that while the economy may not be getting worse, it is not yet getting much better. In keeping with the equity driven risk-on theme, the yen is softer this morning as well, -0.2%, but that is entirely risk related.

Turning to the EMG space, there has been a touch more activity but still nothing remarkable. On the positive side we see CLP rising 0.7% which has all the earmarks of a position consolidation after a very troubled couple of weeks. There has been no specific news although a background story has been focused on shifts in the local pension scheme. It seems there are five funds, labeled A through E with A the most aggressive, invested 60% in international equities, while E is the most conservative, investing 92% in local fixed income assets. It seems that in the wake of the protests, there was a substantial shift into the A fund, which has outperformed given the peso’s weakness. However, it now appears that local investment advisors are highlighting the benefits of the E fund which will result in CLP purchases and corresponding CLP strength. This is certainly consistent with the idea that risk is back in vogue so perhaps we have seen the worst in CLP. But otherwise, nothing much of interest here either.

During this holiday shortened week, we actually get a decent amount of data with most of it released Wednesday morning.

Tuesday Case Shiller Home Prices 3.30%
  New Home Sales 707K
  Consumer Confidence 127.0
Wednesday Initial Claims 221K
  Q3 GDP 1.9%
  Durable Goods -0.8%
  -ex Transport 0.1%
  Chicago PMI 46.9
  Personal Income 0.3%
  Personal Spending 0.3%
  Core PCE 0.1% (1.7% Y/Y)
  Fed’s Beige Book  

Source: Bloomberg

In addition to this, where my sense is the market will be most focused on the Personal Income and Spending data, we hear from Chairman Powell later this evening. While it is always an event when a Fed chair speaks, it seems pretty unlikely that we are going to learn anything new here. At this stage, it has been made quite clear that the Fed is on hold for the foreseeable future. If that is not the message, then you can look for market fireworks.

So the session today is shaping up to be risk focused which means that away from the yen and maybe Swiss franc, I expect the dollar to be softer rather than firmer.

Good luck
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Dying To See

Said Trump, it’s not me it’s the Fed
Preventing us moving ahead
While China and Xi
Are dying to see
A deal where all tariffs are dead

It should be no surprise that President Trump was at the center of the action yesterday, that is the place he most covets. In a speech at the Economic Club of New York, he discussed pretty much what we all expected; the economy is doing great (low unemployment, low inflation and solid growth); the Fed is holding the economy back from doing even better (give us negative rates like Europe and Japan, we deserve it) and the Chinese are dying to do a deal but the US is not going to cave in and remove tariffs without ironclad assurances that the Chinese will stop their bad behavior. After all, this has been the essence of his economically focused comments for the past year. Why would they change now? But a funny thing happened yesterday, the market did not embrace all this is good news, and we started to see a little bit of risk aversion seeping into equity prices and filter down to the bond and currency markets.

For example, although the Dow Jones Industrial Average closed yesterday just 0.3% from the all-time high set last Thursday, there has been no follow-through in markets elsewhere in the world, and, in fact, US futures are pointing lower. Now arguably, this is not entirely a result of Trump’s comments, after all there are plenty of problems elsewhere in the world. But global markets have proven to be quite vulnerable to the perception of bad news on the US-China trade negotiations front, and the fact that there is no deal clearly set to be signed is weighing on investors’ collective minds. So last night, we saw Asian markets suffer (Nikkei -0.85%, Hang Seng -1.8%, KOSPI -0.85%, Shanghai -0.35%) and this morning European markets are also under pressure (DAX -0.75%, CAC -0.45%, FTSE -0.55%, Spain’s IBEX -1.65%, Italy’s MIB -1.3%). In other words, things look pretty bad worldwide, at least from a risk perspective.

Now some of this is idiosyncratic, like Hong Kong, where the protests are becoming more violent and more entrenched and have demonstrably had a negative impact on the local economy. Of even more concern is the growing possibility that China decides to intervene directly to quell the situation, something that would likely have significant negative consequences for global markets. Too, Germany is sliding into recession (we will get confirmation with tomorrow’s Q3 GDP release) and so the engine of Europe is slowing growth throughout the EU, and the Eurozone in particular. And we cannot forget Spain, where the fourth election in four years did nothing to bring people together, and where the Socialist Party is desperately trying to cobble together a coalition to get back in power, but cannot find enough partners, even though they have begun to climb down from initial comments about certain other parties, namely Podemos, and consider them. The point is, President Trump is not the only reason that investors have become a bit skeptical about the future.

In global bond markets, we are also seeing risk aversion manifest itself, notably this morning with 10-year Treasury yields falling more than 6bps, and other havens like Bunds (-4bps) and Gilts (-5bps) following suit. There has been a great deal of ink spilled over the recent bond market price action with two factions completely at odds. There continue to be a large number of pundits and investors who see the long-term trend of interest rates still heading lower and see the recent pullback in bond prices as a great opportunity to add to their long bond positions. Similarly, there is a growing contingent who believe that we have seen the lows in yields, that inflation is beginning to percolate higher and that 10-year yields above 3.00% are going to be the reality over the course of the next year. This tension is evident when one looks at the price action where since early September, we have seen a 40bp yield rally followed by a 35bp decline in the span of five weeks. Since then, we have recouped all the losses, and then some, although we continue to see weeks where there are 15bp movements, something that is historically quite unusual. Remember, bonds have historically been a dull trading vehicle, with very limited price activity and interest generated solely for their interest-bearing qualities. These days, they are more volatile than stocks! And today, there is significant demand, indicating risk aversion is high.

Finally, the dollar continues to benefit against most of its counterparts in both the G10 and EMG blocs, at least since I last wrote on Friday. In fact, there are four G10 currencies that have performed well since then, each with a very valid reason. First, given risk aversion, it should be no surprise that both the yen and Swiss franc have strengthened in this period. Looking further, the pound got a major fillip yesterday when Nigel Farage said that his Brexit party would not contest any of the 317 seats the Tories held going into the election, thus seeming to give a boost to Boris Johnson’s electoral plans, and therefore a boost toward the end of the Brexit saga with a deal in hand. Finally, last night the RBNZ surprised almost the entire market by leaving rates on hold at 1.0%, rather than cutting 25bps as had been widely expected. The reaction was immediate with kiwi jumping 1.0% and yields in New Zealand rallying between 10 and 15 bps across the curve.

Turning to the Emerging markets, the big mover has been, of course, the Chilean peso, the erstwhile star of LATAM which has fallen more than 5.0% since Friday in the wake of the government’s decision to change the constitution in an effort to address the ongoing social unrest. But this has dragged the rest of the currencies in the region down as well, with Colombia (-2%) and Mexico (-1.7%) also feeling the effects of this action. The removal of Peruvian president, Evo Morales, has further undermined the concept of democracy in the region, and investors are turning tail pretty quickly. Meanwhile, APAC currencies have also broadly suffered, with India’s rupee the worst performer in the bunch, down 1.1% since Friday, as concerns about slowing growth there are combining with higher than expected inflation to form a terrible mix. But most of the region is under pressure due to the ongoing growth and trade concerns, with KRW (-0.9%) and PHP (-0.7%) also feeling strains on the trade story. The story is no different in EEMEA, with the bulk of the bloc lower by between 0.5% and 0.85% during the timeframe in question.

Turning to this morning, we see our first important data of the week, CPI (exp 0.3%, 0.2% core) for the month and (1.7%, 2.4% core) on an annual basis. But perhaps more importantly Chairman Powell speaks to Congress today, and everybody is trying to figure out what it is he is going to say. Most pundits believe he is going to try to maintain the message from the FOMC meeting, and one that has been reinforced constantly by his minions on the committee, namely that the economy is in a good place, that rates are appropriately set and that they will respond if they deem it necessary. And really, what else can he say?

However, overall, risk remains on the back foot today, and unless Powell is suddenly very dovish, I expect that to remain the case. As such, look for the dollar to continue to edge higher in the short term, as well as the yen, the Swiss franc and Treasuries.

Good luck
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