Watching With Rigor

Though Draghi said data of late
May not have appeared all that great
We’re watching with rigor
Inflation that’s vigor-
Ously rising at a high rate

After a multi week decline, the dollar is showing further signs of stabilizing this morning. And that includes its response to yesterday’s surprising comments by ECB President Mario Draghi, who indicated that despite the ECB lowering its forecasts for growth this year and next, and that despite the fact that recent data has been falling short of expectations, he still described the underlying inflation impulse as “relatively vigorous” and reconfirmed that QE would be ending in December with rates rising next year. In fact, several of his top lieutenants, including Peter Praet and Ewald Nowotny, indicated that rates ought to rise even sooner than that. Draghi, however, has remained consistent in his views that gradual removal of the current policy accommodation is the best way forward. But as soon as the words “relatively vigorous” hit the tape, the euro jumped more than 0.5% and touched an intraday high of 1.1815, its richest point since June. The thing is, that since that time yesterday morning, it has been a one-way trip lower, with the euro ultimately rising only slightly yesterday and actually drifting lower this morning.

But away from the excitement there, the dollar has continued to consolidate Friday’s gains, and is actually edging higher on a broad basis. It should be no surprise that the pound remains beholden to the Brexit story, and in truth I am surprised it is not lower this morning after news that the Labour party would definitively not support a Brexit deal based on the current discussions. This means that PM May will need to convince everyone in her tenuous majority coalition to vote her way, assuming they actually get a deal agreed. And while one should never underestimate the ability of politicians to paint nothing as something, it does seem as though the UK is going to be leaving the EU with no exit deal in place. While the pound is only down 0.15% this morning, I continue to see a very real probability of a much sharper decline over the next few months as it becomes increasingly clear that no deal will appear.

There was one big winner overnight, though, the Korean won, which rallied 4.2% on two bits of news. Arguably the biggest positive was the word that the US and Korea had agreed a new trade deal, the first of the Trump era, which was widely hailed by both sides. But let us not forget the news that there would be a second round of talks between President Trump and Kim Jong-Un to further the denuclearization discussion. This news is also a significant positive for the won.

The trade situation remains fascinating in that while Mr Trump continues to lambaste the Chinese regarding trade, he is aggressively pursuing deals elsewhere. In fact, it seems that one of the reasons yesterday’s imposition of the newest round of tariffs on Chinese goods had so little market impact is that there is no indication that the president is seeking isolationism, but rather simply new terms of trade. For all the bluster that is included in the process, he does have a very real success to hang his hat on now that South Korea is on board. Signing a new NAFTA deal might just cause a re-evaluation of his tactics in a more positive light. We shall see. But in the end, the China situation does not appear any closer to resolution, and that will almost certainly outweigh all the other deals, especially if the final threatened round of $267 billion of goods sees tariffs. The punditry has come around to the view that this is all election posturing and that there will be active negotiations after the mid-term elections are concluded in November. Personally, I am not so sanguine about the process and see a real chance that the trade war situation will extend much longer.

If the tariffs remain in place for an extended period of time, look for inflation prints to start to pick up much faster and for the Fed to start to lean more hawkishly than they have been to date. The one thing that is clear about tariffs is that they are inflationary. With the FOMC starting their meeting this morning, all eyes will be on the statement tomorrow afternoon, and then, of course, all will be tuned in to Chairman Powell’s press conference. At this point, there seems to be a large market contingent (although not a majority) that is looking for a more dovish slant in the statement. Powell must be happy that the dollar has given back some of its recent gains, and will want to see that continue. But in the end, there is not yet any evidence that the Fed is going to slow down the tightening process. In fact, the recent rebound in oil prices will only serve to put further upward pressure on inflation, and most likely keep the doves cooped up.

With that in mind, the two data points to be released today are unlikely to have much market impact with Case-Shiller Home Prices (exp 6.2%) at 9:00am and Consumer Confidence (132.0) due at 10:00. So barring any new comments from other central bankers, I expect the dollar to remain range bound ahead of tomorrow’s FOMC action.

Good luck
Adf

 

Little Fear

Much to all Free Traders’ chagrin
More tariffs are set to begin
But markets appear
To have little fear
This madness will cause a tailspin

As NY walks in this morning, there has been very limited movement in the dollar overall. While yesterday saw a modicum of dollar weakness, at least against the G10 currencies, we remain range bound with no immediate prospects for a breakout. It does appear that US data is turning more mixed than clearly bullish, as evidenced by yesterday’s Empire Manufacturing Survey data, which printed at 19, still solid but down from last month’s reading of 25.6 as well as below expectations of 23.0. A quick look at the recent history of this indicator shows that it appears to be rolling over from its recent high levels, perhaps signaling that peak growth is behind us.

At this point, it is fair to question what is causing this change in tone. During the summer, US data was unambiguously strong, with most releases beating expectations, but lately that dynamic has changed. The most obvious catalyst is the ongoing trade situation, which if anything worsened yesterday when President Trump announced that the US would be imposing 10% tariffs on an additional $200 billion of Chinese imports. In addition, these are set to rise to 25% in January if there is no further progress in the trade negotiations. As well, Trump threatened to impose tariffs on an additional $267 billion of goods, meaning that everything imported from China would be impacted. As we have heard from several Fed speakers, this process has grown to be the largest source of uncertainty for the US economy, and by extension for financial markets.

Yet financial markets seem to be quite complacent with regard to the potential damage that the trade war can inflict on the economy and growth. As evidence I point to the modest declines in US equities yesterday, but more importantly, to the rally in Asian equities overnight. While it is fair to say that the impact of this tariff war will not be directly felt in earnings results for at least another quarter or two, it is still surprising that the market is not pricing the potential negative consequences more severely. This implies one of two things; either the market has already priced in this scenario and the risks are seen as minimal, or that the rise in passive investing, which has exploded to nearly 45% of equity market activity, has reduced the stock market’s historic role as a leading indicator of economic activity. If it is the former, my concern is that actual results will underperform current expectations and drive market declines later. However, I fear the latter situation is closer to the truth, which implies that one of the long-time functions of the equity market, anticipating and discounting future economic activity, is changing. The risk here is that policymakers will lose an important signal as to expectations, weakening their collective hands further. And let’s face it, they need all the help they can get!

Turning back to the dollar, not only has the G10 has been dull, but EMG currencies are generally benign as well. In fact, the only substantive movement has come from everybody’s favorite whipping boy, TRY. This morning it is back under pressure, down 1.3% and has now erased all the gains it made in the wake of last week’s surprising 625bp rate hike. But in truth, beyond that, I can’t find an important emerging market currency that has moved more than 20bps. There are two key central bank meetings this week, Brazil tomorrow and South Africa on Thursday. Right now, expectations are for both to stand pat, leaving interest rates in both nations at 6.50%. However, the whisper campaign is brewing that South Africa may raise rates, which has undoubtedly helped the rand over the past two weeks as it has rallied some 4.5% during that time. We will know more by Thursday.

This overall lack of activity implies that traders are waiting the next important catalyst for movement, which may well be next Wednesday’s FOMC meeting! That is a very long time in the market for treading water, however, given the US data the rest of this week is second tier, and the trade situation is widely understood at this time, it is a challenge to see what else will matter until we hear from the Fed. And remember, the market has already priced in a 100% probability that they will raise rates by 25bps, so this is really all about updated forecasts, the dot plot and the press conference. But until then, my sense is that we are in for a decided lack of movement in the FX world.

Good luck
Adf

 

Inspired

It seems that inflation here’s not
Exploding, nor running too hot
That news has inspired
Stocks getting acquired
The dollar, meanwhile, went to pot

Yesterday’s CPI reading was surprisingly mild, with the headline rate rising 2.7% and the core just 2.2%. Both those readings were 0.1% below expectations and the market reaction was swift. Equity futures rallied immediately, with those gains maintained, and actually increased, throughout the session. At the same time the euro jumped 0.6%, as the CPI data moderated expectations of an ever more aggressive Fed. In other words, Goldilocks is still alive and well.

The employment situation in the US remains remarkably robust (Initial Claims were just 204K, the lowest level since December 1969!), while inflation seems to be under control. If you recall Chairman Powell’s comments from Jackson Hole, he remains data dependent, and clearly does not feel beholden to any particular economic model that defines where interest rates ought to be based on historical constructs. Rather, he seems willing to be patient if patience is required. Certainly the market understands that to be his view, as this data has helped flatten the trajectory of rate hikes further out the curve. While there is no doubt that the Fed will move later this month, and the probability of a December move remains high, next year suddenly looks much less certain, at least right now. Given this new information, it is no surprise that the dollar remains under modest pressure. And if the data starts to point to a slowdown in US growth and continued moderation in inflation, then the dollar ought to continue to suffer. But one data point does not make a trend, so let’s be careful about extrapolating this too far.

Beyond the CPI data, we also heard from Signor Draghi at the ECB press conference. He was remarkably consistent despite the reduction in GDP growth forecasts made by his staff economists. QE will wind down as advertised, with €30 billion of purchases this month and then €15 billion for the rest of the year, ending in December. And rates will remain where they are “through summer” which has widely been interpreted to mean until September 2019. Consider that one year from now, US interest rates are very likely to be at least 75bps higher than the current 2.00% and possibly as much as 150bps higher, which means that the spread will be at least 315bps in favor of the dollar. I understand that markets are forward looking, but boy, that is a very wide spread to ignore, and I expect that the dollar will continue to benefit accordingly.

Last night we also saw important data from China, where Fixed Asset Investment rose at its slowest pace (5.3%) since the data series began in 1996. This is somewhat surprising given Beijing’s recent instructions to regional governments to increase infrastructure investment as President Xi attempts to address a slowing economy. From the Chinese perspective, this is also an unwelcome outcome for the ongoing trade dispute with the US as it may give the appearance that China is more motivated for a deal and encourage President Trump to press harder. But for our purposes, the risk is that a slowing Chinese economy results in a weaker renminbi and there is clearly concern in Beijing that if USDCNY trades to 7.00, it could well encourage a more significant capital flight from the country, something that the PBOC wants to avoid at all costs. Now, last night it fell just 0.2% on the news and has actually recouped those losses since then, but that fear remains a driving force in Chinese policy.

The other stories that continue are in Turkey, where it should be no surprise that President Erdogan was extremely disappointed in the central bank for its surprisingly large rate hike yesterday morning. While the lira has held on to the bulk of its early gains, given Erdogan’s unpredictability, it is easy to contemplate further changes in the central bank governance that would be seen as quite negative for TRY. In Italy, the budget battles continue with no outcome yet, but this morning’s spin being somewhat less positive than yesterday’s, with concerns FinMin Tria will not be able to prevent a breech of the EU’s 3.0% budget deficit limit. And finally, BOE Governor Carney, in a closed door briefing with the PM and her cabinet, indicated that one possible scenario if there is no Brexit deal would be for crashing house prices but rising interest rates, a true double whammy. And on that subject, there has been no indication that a deal is any closer at this time. But all of these have been secondary to the CPI story, which seemed to change the tone of the markets.

This morning brings a raft of US data as follows: Retail Sales (exp 0.4%, 0.5% ex autos); IP (0.3%); Capacity Utilization (78.3%); Business Inventories (0.6%); and Michigan Consumer Sentiment (96.7). Arguably, the Retail Sales data will be the most closely watched as investors try to get a better understanding of just how the US economy is performing, but quite frankly, that number would need to be quite strong to alter the impressions from yesterday. Finally, we hear from Chicago Fed President Charles Evans, which could be interesting based on the CPI data’s change to impressions. In the end, though, I expect a relatively quiet session. It’s Friday and traders will want to reduce exposures.

Good luck and good weekend
Adf

 

A Charade

The news there was movement on trade
Twixt China and us helped persuade
Investors to buy
Though prices are high
And it could well be a charade

We also learned wholesale inflation
Was lower across the whole nation
Thus fears that the Fed
Might still move ahead
Aggressively lost their foundation

The dollar is little changed overall this morning, although there are a few outlier moves to note. However, the big picture is that we remain range bound as traders and investors try to determine what the path forward is going to look like. Yesterday’s clues were twofold. First was the story that Treasury Secretary Mnuchin has reached out to his Chinese counterpart, Liu He, and requested a ministerial level meeting in the coming weeks to discuss the trade situation more actively ahead of the potential imposition of tariffs on $200 billion of Chinese imports. This apparent thawing in the trade story was extremely well received by markets, pushing most equity prices higher around the world as well as sapping a portion of dollar strength in the FX markets. Remember, the cycle of higher tariffs leading to higher inflation and therefore higher US interest rates has been one of the factors underpinning the dollar’s broad strength.

But the other piece of news that seemed to impact the dollar was a bit more surprising, PPI. Generally, this is not a data point that FX traders care about, but given the overall focus on inflation and the fact that it printed lower than expected (-0.1%, 2.8% Y/Y for the headline number and -0.1%, 2.3% Y/Y for the core number) it encouraged traders to believe that this morning’s CPI data would be softer than expected and therefore reduce some of the Fed’s hawkishness. However, it is important to understand that PPI and CPI measure very different things in somewhat different manners and are actually not that tightly correlated. In fact, the BLS has an entire discussion about the differences on their website (https://www.bls.gov/ppi/ppicpippi.htm). The point is that PPI’s surprising decline is unlikely to be mirrored by CPI today. Nonetheless, upon the release, the dollar softened across the board.

This morning, however, the dollar has edged slightly higher, essentially unwinding yesterday’s weakness. As the market awaits news from three key central banks, ECB, BOE and Bank of Turkey, traders have played things pretty close to the vest. Expectations are that neither the BOE or the ECB will change policy in any manner, and in fact, the BOE doesn’t even have a press conference scheduled so there is likely to be very little there. As to Draghi’s presser at 8:30, assuming there is no new guidance as expected, questions will almost certainly focus on the fact that the ECB staff economists have reduced their GDP growth forecasts and how that is likely to impact policy going forward. It will be very interesting to hear Draghi dance around the idea that softer growth still requires tighter policy.

But certainly the most interesting meeting will be from Istanbul, where current economist forecasts are for a 325bp rate rise to 22.0% in order to stem the decline of the lira as well as try to address rampant inflation. The problem is that President Erdogan was out this morning lambasting higher interest rates as he was implementing new domestic rules on FX. In the past, many transactions in Turkey were denominated in either USD or EUR (things like building leases) as the financing was in those currencies, and so landlords were pushing the FX risk onto the tenants. But Erdogan decreed that transactions like that are now illegal, everything must be priced in lira, and that existing contracts need to be converted within 30 days at an agreed upon rate. All this means is that if the currency continues to weaken, the landlords will go bust, not the tenants. But it will still be a problem.

Elsewhere, momentum for a Brexit fudge deal seems to be building, although there is also talk of a rebellion in the Tory party amongst Brexit hardliners and an incipient vote of no confidence for PM May to be held next month. Certainly, if she is ousted it would throw the negotiations into turmoil and likely drive the pound significantly lower. But that is all speculation as of now, and the market is ascribing a relatively low probability to that outcome.

FLASH! In the meantime, the BOE left rates on hold, in, as expected, a unanimous vote, and the Bank of Turkey surprised one and all, raising rates 525bps to 24.0%, apparently willing to suffer the wrath of Erdogan. And TRY has rallied more than 5% on the news, and is now trading just around 6.00, its strongest level since late August. While it is early days, perhaps this will be enough to help stabilize the lira. However, history points to this as likely being a short reprieve unless other policies are enacted that will help stabilize the economy. And that seems a much more daunting task with Erdogan at the helm.

Elsewhere in the EMG bloc we have seen both RUB and ZAR continue their recent hot streaks with the former clearly rising on the back of rising oil prices while the latter is responding to a report from Moody’s that they are unlikely to cut South Africa to a junk rating, thus averting the prospect of wholesale debt liquidation by foreign investors.

As mentioned before, this morning brings us CPI (exp 0.3%, 2.8% Y/Y for headline, 0.2%, 2.4% Y/Y for core). Certainly, anything on the high side is likely to have a strong impact on markets, unwinding yesterday’s mild dollar weakness as well as equity market strength. This morning we hear from Fed governor Randy Quarles, but he is likely to focus on regulation not policy. Meanwhile, yesterday we heard from Lael Brainerd and she was quite clear that the Fed was on the correct path and that two more rate hikes this year were appropriate, as well as at least two more next year with the possibility of more than that. So Brainerd, who had been one of the most dovish members for a long time, has turned hawkish.

All in all, traders will be focused on two things at 8:30, CPI and Draghi, with both of them important enough to move markets if they surprise. However, the big picture remains one where the Fed is the central bank with the highest probability of tightening faster than anticipated, while the ECB, given the slowing data from Europe, seems like the one most likely to falter. All that adds up to continued dollar strength over time.

Good luck
Adf

 

A deal Has Been Made

The story is once again trade
As news that a deal has been made
Twixt Mex and DC
Helped traders agree
The dollar would slowly degrade

Right now, there are two essential stories that the market is following; the Fed and US trade negotiations. While Friday’s news was all about the Fed (with a small dose of PBOC), yesterday we turned back to trade as the key market driver. The announcement that a tentative agreement had been reached between the US and Mexico regarding NAFTA negotiations was hailed in, most quarters, as a positive event. It is beyond the scope of this discussion to opine on the merits of the actual negotiation, only on its market impact. And that was unambiguous. Equity markets rallied everywhere while the dollar continued its recent decline. In fact, the dollar has now fallen for seven of the past eight sessions and is trading back at levels not seen in four weeks. So much for my thesis that continued tighter policy by the Fed would support the buck.

But I think it is worth examining why things are moving the way they are, and more importantly, if they are likely to continue the recent trend, or more likely to revert to the longer run story.

Earlier this year, as the narrative evolved from synchronous global growth to the US leading the way and policy divergence, buying dollars became a favored trade, especially in the hedge fund community. In fact, it grew to be so favored that positioning, at least based on CFTC figures, showed that it was near record levels. And while the dollar continued to rally right up until early last week, everybody carrying that position was happy. This was not only because their view was correct, but also because the current interest rate market paid them to maintain the position, a true win-win situation.

In the meantime, another situation was playing out at the same time; the increasingly bombastic trade rhetoric, notably between the US and China, but also between the US and Mexico, Canada and Europe. With the imposition of tariffs on $50 billion of Chinese imports by the US, and the reciprocal tariffs by China, the situation was seen as quite precarious. While there was a mild reprieve when the US delayed imposing tariffs on imported European autos last month, a key issue had continued to be the ongoing NAFTA renegotiations. These stories, when highlighted in the press, typically led to risk-off market reactions, one of which included further USD strength.

So between the two stories, higher US rates and increasing risk on the trade front, there were two good reasons to remain long dollars. However, one of the oft-mentioned consequences of the stronger dollar has been the pressure it applies to EMG economies that were heavy dollar borrowers over the past ten years. Suddenly, their prospects dimmed greatly because they felt the double whammy of less inward investment (as USD investments became more attractive due to higher US rates) and a weaker currency eating up a greater proportion of local currency revenues needed to repay dollar debt and its interest. This led to increasing angst over the Fed’s stated views that gradual rate hikes were appropriate regardless of the international repercussions. This also led to significant underperformance by EMG equity markets as well as their currencies, forced the hands of several EMG central banks to raise rates to protect their currencies, and completely decimated a few places, notably Argentina and Turkey.

But that all started to change in earnest last Friday. While the dollar had been retracing some of its recent gains prior to the Jackson Hole meeting, when Chairman Powell hinted that he saw no reason that inflation would continue much beyond the Fed’s target level (although without the benefit of a rationale for that view), the market interpreted that as the Fed ‘s rate hiking trajectory would be shallower than previously thought, and that four rate hikes this year was no longer a given. In fact there are those who now believe that September may be the last rate hike for several quarters (I am not in the group!) Now adding to that the positive news regarding trade with Mexico, with the implication that there is an opportunity to avoid a truly damaging trade war, all of those long dollar positions are feeling far less confident and slowly unwinding. And my sense is that will continue for a bit longer, continuing to add pressure to the dollar. What is interesting to me is that the euro, for example, has retraced back above 1.17 so quickly (remember, it was trading at 1.13 just two weeks ago) and it is not clear that many positions have been cleared out. That implies that we could see further dollar weakness ahead as long as there is no other risk-off catalyst that arises.

The thing is, I don’t think this has changed the long run picture for the dollar, which I think will continue to outperform over time, as while the Fed may slow its trajectory, it is not stopping any time soon. And the reality is that the ECB is still well over a year away from raising rates, with Japan further behind than that. Meanwhile, the PBOC is actively easing as the Chinese economy continues to slow. In the end, the dollar remains the best bet in the medium term. But in the short run, I think the euro could well trade toward 1.19 before stalling, with other currencies moving a similar amount.

As to today’s session, there has been a decided lack of data from either Asia or Europe, and nothing really on the cards for the US. We remain in a lackluster holiday week, as US trading desks remain lightly staffed ahead of the Labor Day holiday next Monday. So to me, momentum is pointing to continued dollar weakness for now, and I expect that is what we will see for the rest of the week.

Good luck
Adf

And what has happened as that angst has grown, and fears of a repeat of the EMG crisis of 1998-9 were raised?

 

A Weakening Buck

Said Powell, we’ve had quite some luck
Inflation’s apparently stuck
Right at two percent
So I won’t lament
If we see a weakening buck

You likely noticed the dollar’s sharp decline on Friday, which actually began shortly before Chairman Powell spoke in Jackson Hole. For that, you can thank the PBOC who reinstated their Countercyclical Factor (CCF). The CCF was the fudge the PBOC created in January of last year to help them regain control of the USDCNY fixing each day. Prior to that, the goal had been to slowly allow the FX market establish the fixing rate in their efforts to internationalize the yuan. But then, market turmoil upset the apple cart and they were no longer pleased with the yuan’s direction. In fact, that was the last time USDCNY made a move toward 7.00. But once they instituted the CCF, which is claimed to include market parameters, they essentially resumed command of the currency and at that time, simply walked it higher over the course of the ensuing year. At that point, they felt things were under control, and early this year they abandoned the CCF as unnecessary. Until Friday, when after the yuan made yet another attempt at 7.00, they decided it was time to reestablish control of the currency. And so, Friday, the yuan rallied in excess of 1.5% and has now stabilized, at least temporarily, around 6.80. With the PBOC’s thumb on the scale, I expect that we are going to see a reduction in CNY volatility, and arguably, a very mild appreciation over time.

Which leads us to discuss the other catalyst for dollar weakness on Friday, Chairman Powell’s speech. In it, he basically said that although inflation has reached their 2.0% target, there is limited reason to expect it to continue to go higher. The market’s take on those comments was that the Fed was likely to slow the trajectory of rate hikes, thereby undermining the dollar. The broad dollar index fell about 0.6% during the speech and has retained those losses since. One of the interesting things is that nobody has accused Powell of succumbing to pressure from Trump with regard to changing his tone. But economists around the world are clearly happier.

Their joy stems from the following sequence of events. In the decade since the financial crisis, when interest rates were pushed to zero or below by developed country central banks, there was a huge expansion of US dollar debt taken on by EMG countries and companies within them. As long as rates were low, and the dollar remained on the soft side, those borrowers had limited issues when it came to rolling over the debt and paying the interest. But once the Fed started to tighten policy, both raising rates and shrinking the available number of dollars in the global system, the dollar rebounded. This was a double whammy for those EMG borrowers because refinancing became more expensive on a rate basis, and it took more local currency to pay the interest, hurting their local currency cash flows as well. This has been a key underlying issue for numerous EMG nations like Argentina, Turkey, Brazil, Indonesia and India. It has exacerbated their currency weakness and expanded their current account deficits.

So now, if Powell and the Fed are going to slow down their efforts on the basis of the idea that inflation is not going to continue to rise, it will reduce the pressure on all of those nations and more. Hence the joy from economists. I guess the only thing that can derail this is if inflation doesn’t actually slow down. Remember, despite the fact that the Fed follows PCE, CPI has been rising sharply lately, and they cannot ignore that fact. If that trend continues, and there is a fair chance that it will, look for PCE to follow and for Powell to have to walk back those comments. I guess we shall see.

As to the overnight session, the dollar is little changed from Friday’s closes as we begin the week leading up to the Labor Day holiday in the US. We actually saw our first substantive data release in more than a week overnight, with the German IFO index rising for the first time in nine months to a much better than expected 103.8. But the euro has been unable to take advantage of the news and is essentially unchanged on the day, along with everything else. As to the US data calendar, it remains on the quiet side, although we do see the latest reading of the aforementioned PCE data.

Tuesday Case-Shiller Home Prices 6.5%
  Goods Trade Balance -$68.6B
Wednesday Q2 GDP 2nd Est 4.0%
Thursday Initial Claims 214K
  Personal Income 0.3%
  Personal Spending 0.4%
  PCE 0.1% (2.2% Y/Y)
  Core PCE 0.2% (2.0% Y/Y)
Friday Chicago PMI 63.0
  Michigan Sentiment 95.5

I expect that unless something remarkable happens to the GDP data on Wednesday, that all eyes will be on the Income and Spending data on Thursday. But in the end, there is a new tone to the market, one which is decidedly less dollar bullish, and given the number of dollar long positions that remain in place, I expect that we may see the dollar nursing its wounds for quite a while. This is a plus for receivables hedgers, as it does appear the dollar has stopped rallying for now. Just don’t get greedy!

Good luck
Adf

No Progress Was Made

In Washington, talks about trade
Twixt us and the Chinese decayed
Both sides pitched their views
But couldn’t enthuse
The other. No progress was made

Today, though, the Fed Chairman Jay
Will speak and might seek to convey
How high rates may rise
Or how he’ll devise
A plan to keep prices at bay

Two key themes dominate the FX markets this morning, yesterday’s failure of low-level trade talks between the US and China to make any progress and the beginning of the Kansas City Fed’s Jackson Hole conference.

Starting with trade, last evening, the talks ended with no progress of note. Both sides explained that they had expressed their views, but there was no indication that there was movement on either side toward a compromise. Obviously, politics will play a huge role in this process, and so it becomes extremely difficult to forecast how things will evolve. However, as the day progressed yesterday, it seemed increasingly likely that nothing beneficial would occur, and so the dollar regained its footing. In fact, it had its best day (+0.6%) since it reached its recent peak early last week and reversed course lower. Interestingly, this morning the dollar has given back some of that ground, but net remains higher than when I wrote yesterday morning. It has become clearer to me that the market presumption is more trade angst will lead to a firmer dollar, which is simply an additional catalyst for dollar strength in the near and medium term. But we will need to watch the trade situation carefully, as any indication that progress is being made is likely to result in a dollar retreat.

But that was yesterday’s story, and at this point is virtually ancient history. Today is all about the Fed symposium in Jackson Hole, Wyoming, specifically about Chairman Powell’s speech at 10:00am EDT. Analysts and traders are waiting to hear his latest thoughts on monetary policy and how he sees it evolving. Yesterday we heard from two regional Fed presidents, Dallas’s Richard Kaplan and KC’s Esther George, both of whom said that the committee was entirely focused on its Congressional mandates of price stability and maximum employment, and that they would not be swayed by comments from the President. And incidentally, both said they see at least four more rate hikes between now and the end of next year. In fact Ms George is in the camp leaning toward six more over that time frame. Of course, this is all dependent on the evolution of the US economy. As long as it continues to grow in the current manner, it seems there will be no dissuading the Fed from removing accommodation. That said, Mr. Powell’s speech this morning is seen as critical in helping define exactly how much tightening is on the way. The funny thing about those expectations is that Powell is probably the last person who is likely to set expectations in that manner. He is all about pragmatism and reacting to the data as it evolves. Certainly, if the US economy continues to grow quickly, he will be leading the charge for higher rates. But if cracks start to show, or the trade situation causes deterioration in the economic data, I expect he will be perfectly happy to pause.

Speaking of cracks in the data, yesterday brought us New Home Sales, which disappointed by rising only 627K in July, down 1.7% from June’s level and back to the lowest since last October. This followed softer than expected Existing Home Sales data on Wednesday and seems to indicate that the housing market may have peaked for now. Given its importance to the overall economy, that is a somewhat worrying sign, especially given the state of employment here. If the best employment data in decades cannot help perk up housing, it may well be ripe for a more substantial correction. Following that line of reasoning further, it is an open question as to whether we have seen the peak in US growth and just how rapidly the situation here might change. Food for thought, but it is still early days for this idea.

A quick survey of FX market movement overnight shows that the dollar’s decline is pretty uniform. The G10 leader higher is AUD (+0.8%), which has shown a positive reaction to the changing of PM’s there, with Malcolm Turnbull out and Scott Morrison, the previous Treasurer, now the PM. But the euro and pound are both firmer by about 0.4% despite lackluster UK mortgage data and Eurozone data that merely met expectations. As I said, today’s dollar weakness appears more a response to the trade story than data.

In the EMG bloc, ZAR is firmer by 1.1% as traders decided that comments by President Trump regarding South African land reform were actually not that relevant and would not impact policy. But we have also seen CNY rocket higher by nearly 1.0%, (post trade talk reaction?), RUB jump 1.0% on the back of higher oil prices and even TRY has found its footing, at least temporarily, rising 0.4%.

But in the end, it would be surprising to see much market movement between now and Powell’s speech. Rather, I expect that the market will absorb the Durable Goods data (exp -0.5%, +0.5% ex Transport) with aplomb and be right here when he starts. After that it is dependent on what he says. If pressed, I expect that he will subtly reaffirm the Fed’s independence, talk up the economy, and indicate monetary policy is on the right trajectory for now, in other words, US rates have plenty further to rise this year and next, at least. And as rates rise, so goes the dollar.

Good luck
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