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
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The Fed’s Fallen Short

This morning’s inflation report
Ought show that the Fed’s fallen short
In holding down prices
And so my advice is
It’s time, those short dollars, abort

Yesterday’s session was dominated by two key themes; the suddenly increased trade tensions after the announcement of a new list of $200 billion of Chinese tariff targets, and the sharp decline in oil prices (WTI – 5.0%) after Libya declared the end of force majeure with respect to shipments from its eastern port. The oil price decline, which occurred despite a surprisingly large drawdown of US inventories, was in sync with other commodity prices, notably copper which fell 2.5% and is now down more than 16% in the past month. Copper is generally seen as an important harbinger of future economic growth given its widespread use throughout different industries, and so falling demand for copper often leads to slower economic growth. And yet, despite the declining commodity price environment, yesterday’s PPI data (3.4% Y/Y) was the strongest in more than six years while expectations for today’s CPI are similarly elevated with consensus views looking for 0.2% monthly increases in both headline and core data which translates into 2.8% headline and 2.3% core on a Y/Y basis.

If those expectations are met, the Fed will certainly continue its hiking cycle, which ought to continue to support the dollar going forward. The other key dollar support has been risk aversion, which is where the trade story comes into play. As long as trade tensions remain front-page news, investors are likely to remain skittish which means they will be reducing risk and looking for safe places to invest. US Treasuries remain the global safe haven of choice, and so both Treasuries and the dollar should continue to benefit from this situation.

Yesterday I mentioned that there had been no indication that there were background talks ongoing between the US and China regarding trade, something I found surprising given the situation. However, this morning there is a story that such talks are, in fact, proceeding which implies to me that there will be some type of solution that arrives before the next round of tariffs are in place. Look for concessions on both sides as well as comments highlighting the strength of the Sino-US relationship, especially with regard to North Korea. At least that’s my view. But it will be several months before anything comes to fruition, and so we are likely to be subject to further volatility on the subject.

One of the impacts of the China trade story was yesterday’s very sharp decline in the renminbi (-1.1%), which resulted in the currency falling to its weakest level since last August. Some pundits see this as an attempt to adjust for the recent tariff impositions by the US, but a case can be made that since the dollar was so strong overall yesterday, (USDX +0.65%), the CNY move was not really out of character. And this morning, the renminbi has already retraced half of that movement, so I am inclined to give the Chinese the benefit of the doubt here and accept the broad dollar strength thesis. In fact, one of the things that continues to haunt the PBOC is their mini devaluation in 2015, which triggered significant capital outflows and forced the imposition of very strict capital controls in China. Regardless of the trade situation, I assure you the Chinese will do all they can to prevent a repeat of that outcome. However, steady depreciation of the renminbi going forward remains my base case.

Otherwise, in G10 space the Bank of Canada raised rates by 25bps, as expected, which helped the Loonie temporarily, but in the end, it seems that weaker oil prices overwhelmed the rate hike and CAD fell 0.75% on the day. However, the BOC continues to sound upbeat on the economy for now and is positioned to continue to track the Fed’s policy for the next year or two.

From the UK, this morning, we received PM May’s latest Brexit position paper which is seeking to have the UK track EU goods regulations, but simultaneously looking for the UK to go completely its own way regarding services and seek trade agreements around the world on that basis. While it is an interesting idea, and one with merit given that services represent ~80% of the UK economy, with less than nine months before the Brexit date, it feels like they may not be able to complete much of the process in time. However, the BOE appears completely ready to raise rates next month with the market pricing an 80% probability of the event and Governor Carney commenting that growth in the UK continues to perform as the BOE expected in its rebound from Q1. The pound, however, has added a small 0.1% decline this morning to yesterday’s 0.5% slide.

Beyond these stories, nothing of note to the FX markets has really been evident. Given the strength of yesterday’s dollar move, it would be no real surprise if there was a small retracement, but in fact, I have a feeling that we are going to see high side surprises in the CPI data which will only serve to increase Fed expectations and support the dollar. So my money is on the dollar continuing its strengthening trend of the week and closing yet higher today.

Good luck
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Both Sides Will Lose

The trade story’s back in the news
With stock markets singing the blues
Two hundred bill more
Confirms the Trade War
Will happen, and both sides will lose

The Trump administration’s announcement last evening that they are targeting another $200 billion of Chinese imports for tariffs, this time 10% across the board, has interrupted the markets recent sense of calm. In fact, the immediate response was for equity markets around the world to fall sharply and the dollar to regain its footing. Investors had come to believe that the initial salvo of tariffs on $34 billion by each nation would be the extent of things, and that negotiations would soon begin. However, assuming things with this administration is a fraught activity as unpredictability has been Trump’s hallmark since his election.

It is interesting to consider the market ramifications of this growing trade war between the US and China. For instance, since March 22, the day the first tariffs were announced, the Shanghai Index is down more than 15% while the S&P 500 is higher by a bit more than 3.0%. While economists have ridiculed Trump’s statement that “trade wars are easy to win”, it certainly seems that the US has so far come out ahead, at least on this measure. At the same time, the Chinese renminbi has fallen ~5.6% over the same period, which could mean that investors are more confident that the US will come out ahead…or it could mean that the PBOC has simply forced guided the currency lower in an effort to offset the impact of the tariffs.

However, the one thing that I take away from this process is that neither side is going to back down anytime soon. As Trump is leading the charge, he is unlikely to back off without having won some major concessions from the Chinese. At the same time, Chinese President Xi, who has spent the past five years consolidating his power, cannot afford to look weak to the home crowd. So my advice is to prepare for higher prices on lots of things that you buy, because this is likely to drag on for a long time.

As an aside, while the politics may favor Xi, I think given the nature of the imbalance, where the Chinese not only have far more items that can be taxed, but that they remain a largely mercantilist economy depending on exports for growth, it means that China’s economic situation is likely to deteriorate far more than that of the US. However, it is not clear to me that I would call that ‘winning’!

At any rate, the one thing that seems almost certain is that the dollar is going to be a major beneficiary of this process. Not only are other currencies going to suffer as their nations’ exports are reduced and growth impaired, but the ensuing inflationary impact of tariffs on the US is going to encourage the Fed to be more aggressive. Given the dollar’s positive response to the tightening of Fed policy already, as well as the growing divergence between the US economy and the rest of the world, the brewing trade war has simply increased my dollar bullishness.

Pivoting to the overnight markets, the dollar has rallied for a second straight day, showing strength against all its G10 counterparts and most EMG currencies. There continues to be a dearth of data on which to base trading outcomes and it seems most likely that the dollar’s recent strength, while receiving a catalyst from the trade situation, is a continuation of its rebound from last week’s decline. In the end, the dollar is still largely range bound and has been so since its rally ended in mid May. I continue to believe we will need new data of note to encourage a breakout, with the next real opportunity tomorrow’s CPI print. A surprisingly high print will get tongues wagging over the Fed picking up the pace, and likely support the dollar. However, I don’t believe the opposite is true. A weaker than expected print will simply confirm that the Fed will stay on its current trajectory, which may not help the dollar much, but should not undermine it.

The other potential driver is going to be the general risk tone in markets. It is very clear that the dollar has regained its status as a safe haven, and with every escalation in the trade war, risk aversion will lead to further dollar strength. This is especially true given that the other potential havens, JPY and CHF, continue to offer negative interest rates and so are far less attractive to investors looking for a short-term home for their assets. To me, all the evidence still points to the dollar’s next leg being a move up potentially testing the levels seen back in the beginning of 2017 over time.

On the data front, this morning brings PPI (exp 0.2% for both headline and core) but all eyes will be on tomorrow’s CPI, not today’s number. We also hear from NY Fed President Williams late this afternoon. Given both the timing, some four weeks since the last FOMC meeting, and his elevated role, it is possible that he could create some volatility by adding new information to the mix. However, my read is that the data trajectory has remained quite steady, and although he will almost certainly mention the trade situation and its potential to upend the economy, I doubt there will be new information forthcoming. So in the end, I like the dollar to continue to grind higher as the day progresses.

Good luck
Adf

A New Complication

Last Friday it seemed immigration
Had ceased as a cause of vexation
In Europe, but then
On Monday again
It suffered a new complication

The euro first rose, then declined
But now there’s a new deal designed
To finally forestall
For once and for all
The chance Merkel might have resigned

Remarkably, the immigration debate in Germany continues to dominate the news. Last night, German Interior Minister Horst Seehofer agreed to a new deal regarding the immigration situation and withdrew his threatened resignation. This led to a major sigh of relief in the markets as the fear of Frau Merkel’s coalition falling apart has once again receded. While Merkel clearly remains in a weakened state, if this deal can be signed by all the parties involved (a big if), the market may be able to move on to its next concerns. It should be no surprise that the euro has rebounded on the news, after all it has tracked the announcements extremely closely, but the rebound this morning, just 0.1%, has been somewhat lackluster after yesterday’s rout. Perhaps that has as much to do with the release of Eurozone Retail Sales data, which disappointed by printing at 0.0% in May, less than expected and yet another indication that growth in the Eurozone is on a slowing trajectory.

As an aside, if I were Mario Draghi, I might be starting to get a little more nervous given that the Eurozone economy is almost certainly trending toward slower growth and the ECB has very little ammunition available to counter that trend. Rates remain negative and QE is set to run its course by the end of the year. It is not clear what else the ECB can do to combat a more severe slowdown in the economy there.

But away from the daily immigration saga in Germany, the dollar has had a mostly softer session. This is primarily due to the fact that it had a particularly strong rally yesterday and we are seeing short-term profit taking.

China remains a key theme of the market as well, with the renminbi having fallen for twelve of the past thirteen sessions with a total decline of nearly 5.0%. While it has rebounded somewhat this morning (+0.35%), that is small beer relative to its recent movement. Last night, PBOC Governor Yi Gang was on the tape explaining that the bank would “keep the yuan exchange rate basically stable at a reasonable and balanced level.” That was sufficient for traders to stop their recent selling spree and begin to take profits. While there are some pundits who believe that the Chinese will allow the renminbi to decline more sharply, I believe there is still too much fear that a sharper decline will lead to more severe capital outflows and potential economic destabilization at home. As such, I expect to see the CNY decline managed in a steady and unthreatening manner going forward. But I remain pretty sure that it will continue to decline.

Other than those two stories, here’s what’s happening today. SEK has been the biggest winner in the G10, rising 1.25% after the Riksbank, although leaving rates on hold at -0.5%, virtually promised they would begin raising them by the end of the year. That is a faster pace than expected and so the currency reaction should be no surprise. However, keep in mind that Sweden is highly dependent on trade, and as trade rhetoric increases, they could well be collateral damage in that conflict. Aussie is the next biggest winner, having risen 0.7% after the RBA also left rates on hold, as expected, but the statement was seen as having a mildly hawkish tinge to it. But remember, AUD had fallen more than 4.5% in the past month, so on a day when the dollar is under pressure, it can be no surprise that the rebound is relatively large.

In the EMG space, MXN is today’s big winner, rallying 1.3% as the new story is that there are now more areas between the US and Mexico where President Trump and President-elect Obrador will be able to find common ground. Certainly both presidents are of the populist stripe, and so perhaps this is true. But my gut tells me that once AMLO and his Congress are sworn in (it doesn’t happen until December 1!) the market will recognize that the investment environment in Mexico is set to deteriorate, and so the currency will follow.

On the data front, yesterday’s ISM data was quite strong at 60.2, well above expectations and a further indication that the economic divergence theme remains alive and well. This morning we await only Factory Orders (exp -0.1%) and Vehicle Sales (17.0M), with the latter likely to be more interesting to market players than the former. Of course, tomorrow is July 4th, and so trading desks are on skeleton staff already. That means that liquidity is probably a bit sparse, and that interest in taking positions is extremely limited. Look for a lackluster session with the dollar probably edging a bit lower, but things to wind up early as everybody makes their escape.

Good luck
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Not So Benign

The worries in China have spread
From stocks to renminbi instead
Its recent decline
Seems not so benign
And could drive more market bloodshed

Well, if President Xi’s goal is to make China the most talked about nation in financial markets, he is clearly on the right track. Of course, he may not like the tone of the conversation!

Once again, Chinese markets are dominating the global discussion with continued declines overnight in equity markets there (Shanghai -1.1%, Shenzhen -1.3%) alongside the recent weakness in the renminbi. This morning, CNY has fallen a further 0.4%, with the dollar now trading above 6.60 for the first time since last December. It is becoming abundantly clear that the PBOC is quite willing to allow further weakness in what appears to be a reaction to the ongoing trade dispute with the US. In the past two weeks, USDCNY has risen every day with the total movement clocking in at more than 3%, and quite frankly, there doesn’t seem to be any reason for it to stop. Last night the PBOC was seen intervening heavily in the market in an effort to moderate the decline, but it seems highly unlikely that the government there wants to stop it completely. As I mentioned yesterday, their key concern is that a more rapid decline in the yuan will result in significant capital outflows, or at the very least a sharp drop in capital inflows, and that has the potential to destabilize markets in China, and eventually, elsewhere in the world. And for a country that has been trying to burnish its image as a responsible global financial citizen, causing global market destabilization is clearly not the desired outcome. At any rate, given the ongoing standoff regarding the US-China trade situation, it seems highly unlikely that CNY will stop falling soon. Look for a gradual decline with a year-end target of 7.00 still quite viable in my mind.

Away from China, however, FX market activity has been less exciting. While the dollar continues its broad trend higher, the pace remains muted. For example, this morning, amongst the G10 currencies only NZD has moved more than 0.2%, with kiwi falling 0.6% as the market prepares for the RBNZ meeting this afternoon. Expectations are for no change in policy, but the suspicion is that the bank is becoming more dovish due to escalating trade rhetoric between the US and China.

Important economic data from the G10 is more notable by its absence than by what it is telling us about the economy. Last night brought us UK Home Price data, showing the slowest rate of price increases in five years, with prices in London actually falling by 1.9%. Combining this with testimony by Jonathan Haskel, who will take his seat on the MPC come September 1st, which showed him to be somewhat more dovish than Ian McCafferty, the member he is replacing, has clearly weighed on the pound. Otherwise, we saw a bit of mixed confidence data from Italy, soft confidence data from France and weak Irish Retail sales. None of this was very inspiring as evidenced by the euro’s 0.2% decline.

Meanwhile, the emerging market space remains under pressure as concerns over trade weigh heavily on the sector. It is important to remember that virtually every EMG country is dependent on its export sector for economic growth, and as the global free-trade framework that has existed for the past 70 years starts to come undone, these economies are going to suffer. The only potential exception right now is for the oil producers as President Trump’s recent call for a complete boycott of Iranian crude products has helped drive oil prices up by nearly 4% this week. So RUB, MXN and MYR have been able to outperform their EMG peers, although this morning all three are down vs. the dollar. In fact, the dollar has demonstrated strength throughout the market today, just as it has been doing for the past several months.

As to this morning, we see Durable Goods data (exp -1.0%, +0.5% ex transport) and we hear from two Fed speakers, Randy Quarles and Eric Rosengren. However, it seems unlikely that any of this will have a major market impact. Rather, I expect that the broad equity weakness that has been evident of late will continue (currently futures are pointing to a -0.5% opening in the US) and the risk-off tone that has engendered will help the dollar to remain underpinned. And of course, there is the ever present risk of some new commentary from President Trump that has the chance to upset markets. So volatility remains a good bet, as does modest continued dollar strength. This story is not even close to ending.

Good luck
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Growth There, To Defend

The Chinese want banks there to lend
In order to get folks to spend
So now banks need hold
Less cash, we are told
As Xi tries, growth there, to defend

Chinese banks are feeling a bit sprightlier this morning after the PBOC announced yesterday that they were cutting the required reserve ratio (RRR) by 50bps. This will release roughly $100 billion into the Chinese economy over time and should certainly act as a stimulant. As is typical, though, the PBOC has instructed the banks there on just how to use these funds. It seems that large banks are going to be required to increase debt/equity swaps with large, mostly state-owned, borrowers in order to prevent those firms from deteriorating further. (None of these banks are happy about this.) Meanwhile, small banks have been instructed to increase lending to the private sector SME’s.

The recent data from China has consistently disappointed and the escalating trade rhetoric between the US and China clearly has President Xi somewhat spooked. The last thing he can afford is for Chinese growth to slow significantly, especially if he is seen as part of the cause based on the trade dispute. It should be no surprise, then, that CNY has fallen a bit further this morning (-0.6%) in the wake of this activity, and it is actually now lower on a YTD basis. The currency remains one of the key safety valves for the Chinese economy, and especially given the broader global growth slowdown that appears to be occurring, I expect its weakness to continue. While the PBOC needs to be wary of allowing it to decline too rapidly, for fear that it will encourage significant capital outflows, a gradually weaker yuan is a very likely outcome as the year progresses.

The other noteworthy news from the weekend was the Turkish election, where President Recep Erdogan claimed victory with ~52.5% of the vote. In addition, his AKP party also won a majority in parliament, which means that he will be able to continue to strengthen his grip on power. The market’s initial reaction was for a TRY rally of as much as 3.0%, but it has already ceded all of those gains and is now lower by 0.2% as I type. Remember, Erdogan’s view is that high interest rates are the “mother and father of all evil” and he has promised to take a more active role in monetary policy now that he has won the election. Look for the lira to continue to decline, with 5.00 soon to be breached and 6.00 probably not that far behind.

But away from those stories, there is not much to discuss. German Ifo data printed at 101.8, which was 0.1 higher than expected, but still represents the sixth decline in the past seven months and is now at a more than one year low. In other words, nothing has changed with regards to the idea that the Eurozone economy is slowing down further, diverging from the ongoing growth story in the US. However, the euro is barely softer this morning, just 0.1%, as it continues to consolidate its gains from late last week. At the same time, the pound has fallen 0.25% despite a lack of economic news. It appears that the lack of positive movement on the Brexit talks is beginning to weigh more forcefully on the currency. The pound is down more than 5% this quarter, and by all indications, there is no solution in the offing for the more intractable Brexit issues, notably the Irish border and the transition arrangements. There are but nine months left before the UK is going to exit the EU and it increasingly looks like there will be no deal in place when it occurs. Despite the fact that the market is currently pricing in a 65% probability of an August rate hike, I remain of the view that the BOE is going to be on hold for quite a while yet.

Turning to the US, we see a bit of important data this week as follows:

Today New Home Sales 667K
Tuesday Case-Shiller Home Prices 6.8%
  Consumer Confidence 128
Wednesday Durable Goods -0.6%
  -ex transport 0.4%
Thursday Initial Claims 220K
  Q1 GDP (3rd look) 2.2%
Friday Personal Income 0.4%
  Personal Spending 0.4%
  Core PCE 0.2% (1.9% Y/Y)
  Chicago PMI 60.0
  Michigan Confidence 99

Durable Goods is likely to be the most carefully scrutinized, although the PCE data on Friday can clearly have an impact, especially if it is weaker than expected. We also hear from five more Fed speakers, mostly hewing from the center or dovish side of the spectrum. In the end, unless we see a major trade breakthrough, I expect that the US story is going to continue to be one of economic outperformance for now, tighter monetary policy and continued gradual strength in the dollar.

Good luck
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