Tag Archives: #china

Another Cut’s Quite Apropos

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The Chair said, ‘inflation’s too low
And there’s something you all need to know
Lest prices soon rise
We’ll not compromise
Thus another cut’s quite apropos

There are a number of discussion topics in the market this morning so let’s get right to it.

First the Fed surprised exactly nobody yesterday afternoon by leaving policy unchanged, (except for a ‘technical’ adjustment to IOER, which they raised by the expected 5bps). However, the talk this morning is all about the tone of the statement and the ensuing press conference. In the end, it appears that the Fed is leaning slightly more dovish than they had seemed to be previously, with a still greater focus on inflation. Powell and friends appear to be increasingly concerned that inflation expectations are still declining, and are terrified of an ultimate outcome similar to the past two decades in Japan. As such, it appears they are getting set to move from an inflation target to a price level target. This means that if inflation runs below target for a period of time, as it has been doing ever since it was officially announced in 2012, they will be comfortable allowing it to run above target in order to make up ground. The conclusion is that the bar to raising rates is now impossibly high, at least assuming prices don’t follow the lead of Argentina or Venezuela. And if anything, especially with the impact of the coronavirus still just being discussed and modeled, the likelihood is for more rate cuts before the end of the year.

Speaking of the coronavirus, the WHO has suddenly figured out what the rest of the world has known for a week, this is a serious problem that is spreading quickly. The death toll is over 170 and the number of cases is quickly approaching 8000. The economic impact is growing as more and more companies halt activity in China, more flights are canceled to and from all cities in China, and fear spreads further. Last night, Taiwan’s stock market reopened for the first time in a week and fell 5.75%. Meanwhile the Taiwan dollar fell 1.0%. And the renminbi? Well onshore markets are still closed, and will be so through Monday, at least, but the CNH traded below 7.00 (dollar higher) in London early this morning and remains within basis points of that level as NY walks in. As I wrote on Monday, this will be the best indicator of sentiment as it is the only thing that can actively trade that reflects opinions on the mainland. It should be no surprise that the other Asian equity markets that were open also fell sharply (Nikkei -1.7%, Hang Seng -3.1%, KOSPI -1.7%) as investors just don’t know what to do at this stage. Fear remains the key driver, and will continue to be until there is some sense that the infection rate is slowing down. To date, that has not been the case.

And finally, the Old Lady just announced no change in the base rate, which according to the futures market had been a 50:50 chance. The pound’s response was an immediate pop and it is now higher by 0.4% on the day, making it the best performing G10 currency. Data early in the month prompted a number of dovish comments from three BOE members, including Governor Carney himself, but the data we have seen recently has shown much more positive momentum in the wake of PM Johnson’s December electoral victory. Clearly, a number of fears have receded and tomorrow is the big day, when the UK officially leaves the EU. The EU Parliament voted overwhelmingly to approve the deal, as the UK’s Parliament did last week. So the UK has reclaimed its total sovereignty and now must make its own way in the world. As I have said all along, while there is a risk that no trade deal is agreed by year end, I think the odds are vanishingly small that Boris will risk his current political strength by pushing things to that level. Come summer, a short delay will be agreed and eventually a deal will be signed. Meanwhile, the US will be seeking a deal as well. Overall, I like the pound throughout the year on the twin features of an increasingly weaker USD (QE related) and the positivity of the situation on the ground there.

And those are the three big stories of the morning. We did get some data, notably the German employment report which showed the Unemployment Rate remained unchanged at 5.0%, while the number of people unemployed fell by…2k. This was better than the expected 5k increase in unemployment, but can we step back for a moment and consider what this actually means. Do you know how many people are employed in Germany? I didn’t think so. But the answer is 41.73 million. So, this morning’s data, showing a net change of 7k vs. expectations represents exactly a 0.0167% improvement. In other words, IT DOESN’T MATTER. And I think we need to consider this issue on a regular basis. So much is made of a number being better or worse than expected when most of the time it is well within the margin of error of any estimate. Nonetheless, the euro has edged higher this morning, by just 0.15%, but my goodness it has been stable of late. And quite frankly, in the short term, barring a massive uptick in coronavirus cases which changes broad risk sentiment, I see no reason for it to do much. Ultimately, I still like the single currency to edge higher throughout the year on the back of my weaker dollar call.

This morning brings two more data points in the US, with Initial Claims (exp 215K) and Q4 GDP (2.0%) released at 8:30. However, unless the GDP number is significantly different from expectations, the market focus will remain on the coronavirus issue. Equity markets in Europe are under pressure (DAX -1.1%, CAC -1.4%) and US futures are pointing in the same direction, with all 3 indices leaning about 0.75% lower. Meanwhile, Treasury yields continue to fall with the 10-year now at 1.56%, its lowest level in three months. With no Fed speakers on the docket, today is a risk day, and that arrow is pointing lower. Look for EMG currencies to suffer, while the yen benefits.

Good luck
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Truly a Curse

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In China, it’s gotten much worse
This virus that’s truly a curse
How fast will it spread?
And how many dead?
Ere treatment helps it to disperse.

Despite the fact that we have two important central bank meetings this week, the Fed and the BOE, the market is focused on one thing only, 2019-nCoV, aka the coronavirus. The weekend saw the number of confirmed infections rise to more than 2800, with 81 deaths as of this moment. In the US, there are 5 confirmed cases, but the key concern is the news that prior to the city of Wuhan (the epicenter of the outbreak) #fom locked down, more than 5 million people left town at the beginning of the Lunar New Year holiday. While I am not an epidemiologist, I feel confident in saying that this will seem worse before things finally settle down.

And it’s important to remember that the reason the markets are responding has nothing to do with the human tragedy, per se, but rather that the economic impact has the potential to be quite significant. At this point, risk is decidedly off with every haven asset well bid (JPY +0.35%, 10-year Treasury yields -7bps, gold +0.8%) while risk assets have been quickly repriced lower (Nikkei -2.0%, DAX -2.0%, CAC -2.1%, FTSE 100 -2.1%, DJIA futures -1.4%, SPX futures -1.4%, WTI -3.0%).

Economists and analysts are feverishly trying to model the size of the impact to economic activity. However, that is a Sisyphean task at this point given the combination of the recency of the onset of the disease as well as the timing, at the very beginning of the Lunar New year, one of the most active commercial times in China. The Chinese government has extended the holiday to February 2nd (it had been slated to end on January 30th), and they are advising businesses in China not to reopen until February 9th. And remember, China was struggling to overcome a serious slowdown before all this happened.

It should be no surprise that one of the worst performing currencies this morning is the off-shore renminbi, which has fallen 0.8% as of 7:00am. In fact, I think this will be a key indicator of what is happening in China as it is the closest thing to a real time barometer of sentiment there given the fact that the rest of the Chinese financial system is closed. CNH is typically a very low volatility currency, so a movement of this magnitude is quite significant. In fact, if it continues to fall sharply, I would not be surprised if the PBOC decided to intervene in order to prevent what it is likely to believe is a short-term problem. There has been no sign yet, but we will watch carefully.

And in truth, this is today’s story, the potential ramifications to the global economy of the spreading infection. With that in mind, though, we should not forget some other featured news. The weekend brought a modestly surprising outcome from Italian regional elections, where Matteo Salvini, the populist leader of the League, could not overcome the history of center-left strength in Emilia-Romagna and so the current coalition government got a reprieve from potential collapse. Salvini leads in the national polls there, and the belief was if his party could win the weekend, it would force the governing coalition to collapse and new elections to be held ushering in Salvini as the new PM. However, that was not to be. The market response has been for Italian BTP’s (their government bonds) to rally sharply, with 10-year yields tumbling 18bps. This has not been enough to offset the risk-off mentality in equity markets there, but still a ray of hope.

We also saw German IFO data significantly underperform expectations (Business Climate 95.9, Expectations 92.9) with both readings lower than the December data. This is merely a reminder that things in Germany, while perhaps not accelerating lower, are certainly not accelerating higher. The euro, however, is unchanged on the day, as market participants are having a difficult time determining which currency they want to hold as a haven, the dollar or the euro. Elsewhere in the G10, it should be no surprise that AUD and NZD are the laggards (-0.85% and -0.65% respectively) as both are reliant on the Chinese economy for economic activity. Remember, China is the largest export destination for both nations, as well as the source of a significant amount of inbound tourism. But the dollar remains strong throughout the space.

Emerging markets are showing similar activity with weakness throughout the space led by the South African rand (-1.0%) on the back of concerns over the disposition of state-owned Eskom Holdings, the troubled utility, as well as the general macroeconomic concerns over the coronavirus outbreak and its ultimate impact on the South African economy. Meanwhile, the sharp decline in the price of oil has weighed on the Russian ruble, -0.9%.

As I mentioned above, we do have two key central bank meetings this week, as well as a significant amount of data as follows:

Today New Home Sales 730K
  Dallas Fed Manufacturing -1.8
Tuesday Durable Goods 0.5%
  -ex Transport 0.3%
  Case Shiller Home Prices 2.40%
  Consumer Confidence 128.0
Wednesday Advance Goods Trade Balance -$65.0B
  FOMC Rate Decision 1.75% (unchanged)
Thursday BOE Rate Decision 0.75% (unchanged)
  Initial Claims 215K
  GDP (Q4) 2.1%
Friday Personal Income 0.3%
  Personal Spending 0.3%
  Core PCE Deflator 1.6%
  Chicago PMI 49.0
  Michigan Sentiment 99.1

Source: Bloomberg
Regarding the BOE meeting, the futures market is back to pricing in a 60% probability of a rate cut, up from 47% on Friday, which seems to be based on the idea that the coronavirus is going to have a significant enough impact to require further monetary easing by central banks. As to the Fed, there is far more discussion about what they may be able to do in the future as they continue to review their policies, rather than what they will do on Wednesday. Looking at the spread of data this week, we should get a pretty good idea as to whether the pace of economic activity in the US has changed, although forecasts continue to be for 2.0%-2.5% GDP growth this year.

And that’s really it for the day. Until further notice, the growing epidemic in China remains the number one story for all players, and risk assets are likely to remain under pressure until there is some clarity as to when it may stop spreading.

Good luck
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Insane Consequences

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The last time the Year of the Rat
Was with us, the markets fell flat
In two thousand eight
The crisis was great
Let’s hope this year’s better than that

Alas as the New Year commences
The Chinese can’t offer pretenses
That virus is spreading
And fears are it’s heading
Worldwide, with insane consequences

Markets this morning are on alert as fears increase regarding a more rapid spread of the coronavirus first identified last week in China. Late yesterday afternoon, Wuhan, the epicenter of the virus’ outbreak was shut down by Chinese authorities. This means that all air and long distance train travel out of the city has been halted. The thing is Wuhan has 11 million residents, larger than NYC, and keeping tabs on all of them is impossible. Then just hours ago, two other cities with a combined population of 8.5 million, Huanggang and Ezhou, announced they, too, were restricting all long distance travel out as well as closing public spaces like movie theaters and internet cafes. The death toll attributed to this virus is up to 17 now, and more than 500 confirmed cases have been recorded.

The timing of all this is extraordinarily poor. China is about to embark on a week-long holiday celebration of the New Year, this year being the Year of the Rat. Typically, this is a time of active travel within and out of China, as well as a time of significant consumer activity. But clearly, locking down major cities with a population approaching 20 million is not instilling confidence anywhere. Chinese equity markets, which historically have always rallied in the last session prior to the New Year holiday, fell sharply last night, with Shanghai falling 2.75% and the Hang Seng down 1.5%. While this fear has not filtered into European equity markets, they remain essentially flat, we have seen increasing demand for Treasuries with the yield on the 10-year falling to 1.75% and German bund yields falling to -0.275%. The last piece of this puzzle is the yuan, which fell 0.4% in its last on-shore session ahead of the holiday. However, CNH continues to trade so do not be surprised to see further weakness there if we continue to hear more negative stories regarding the health situation in China.

But, back to the Year of the Rat. What does it mean in economic and financial terms? The Chinese have a twelve year cycle within their calendar, so the last Year of the Rat was in 2008. I’m sure you all remember how 2008 finished, with the financial crisis unfolding in the wake of Lehman Brothers’ bankruptcy that September. Clearly, nobody wants to see that happen again! But there are certainly anecdotal indicators that might give one pause. The latest anecdote comes from Bob Prince, CIO of Bridgewater Associates, the giant hedge fund, who explained that “…we’ve probably seen the end of the boom-bust cycle.” This is disturbingly similar to a different Prince, Chuck, the former CEO of Citibank, when he defended loosening lending standards in 2008 by remarking, “As long as the music is playing, you’ve got to get up and dance. We’re still dancing.” Perhaps an even more famous comment of this nature was made by Irving Fisher, the renowned economist whose work on debt-deflation and in monetary economics earned him wide acclaim, but who just nine days before the stock market crash of 1929 declared that stocks had “reached what looks like a permanently high plateau.” Now granted, 1929 was not the Year of the Rat, but pronouncements of this nature do have a habit of coming back to bite the speaker in the butt. Given the remarkably long tenure of the current economic and stock market gains, caution that things might change is in order. I’m not predicting an imminent collapse of anything, just highlighting that many market prices seem somewhat excessive and reliant upon a continued perfect outcome of moderate growth and easy money.

Looking at this morning’s activity, the major news will be made in Frankfurt, where the ECB has left policy unchanged (Deposit rate -0.5%, QE €20 billion/month) and now all eyes and ears will turn to Madame Lagarde’s press conference at 8:30 NY time. She is expected to announce the results of the ECB’s internal review of their inflation target, with the ongoing “close to but below 2.0%” likely to be changed to a more precise 2.0%, with an emphasis on the symmetry of that target, implying that slightly higher inflation will be acceptable as well. Alas for the ECB, higher inflation is just not in the cards, at least as long as they maintain interest rates at -0.5%. They can push on that string as much as they like and still will not achieve their goals. As to the single currency, this morning it is unchanged, continuing to hover just below 1.11, right in the middle of its effective 1.10/1.12 range that has been in place since October. We will need something really significant to change this mindset, and my sense is it will not come from within the Eurozone, but rather be driven by the US.

Other than that story, the UK Parliament approved the Brexit bill, which now needs to be ratified by the rest of the EU and is due to be addressed next Wednesday. Then Brexit will well and truly be done, a scant forty-two months after the initial vote. Of course, the next step is the trade negotiations, but even Boris would not risk blowing things up, now that he is in power, so look for an approved delay and an eventual deal next year. Meanwhile, the pound, which has been the best performing G10 currency this week, has stopped its run higher for now, and is actually lower by a modest 0.15% this morning. The other G10 currency movement of note was the Aussie dollar, rallying 0.4% after Unemployment surprisingly fell to 5.1%, thus offering some good news for a change.

In the emerging markets, while CNY is the biggest loser, the rest of the space has been pretty uneventful. On the positive side, CLP is higher by 0.5% after the central bank there indicated they would start to intervene if the peso started to decline too rapidly on the back of weakening commodity prices.

Aside from the ECB press conference, there are two pieces of data today; Initial Claims (exp 214K) and Leading Indicators (-0.2%). But at this point, unless Lagarde says something very surprising, it is shaping up as a very quiet session.

Good luck
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Cashiered!

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In China, a virus appeared
That seems to be worse than first feared
It’s spreading so quickly
That markets turned sickly
And stock market bulls got cashiered!

Some of you may remember the SARS virus from the winter of 2002-3, when a respiratory illness, emanating from Guangdong in China, spread quickly around the world resulting in some 800 odd deaths, but more importantly from the market’s perspective, created a very real risk-off environment. As an example, from January through March of 2003, the Dow Jones fell more than 16%, largely on fears that the virus would continue to spread and ultimately reduce economic activity worldwide. Fortunately, that was not the case, as those diagnosed with the virus were isolated and the spread of the disease ended. Naturally, risk was reignited and all was right with the world…until 2008.

I remind everyone of this history as this morning, there is another coronavirus that has been discovered in central China, this time Wuhan seems to be ground zero, and has begun to spread rapidly from human to human. In just a few weeks, more than 200 cases have been reported with several deaths. However, the big concern is that the Lunar New Year celebration begins on Saturday and this is the heaviest travel time of the year within China and for Chinese people around the world. And if your goal was to spread a virus, there is no better way to do so than by getting infected people on airplanes and sending them around the world! Of course, this is nobody’s goal, however it is a very real potential consequence of the confluence of the new virus and the Lunar New Year. The market has reacted just as expected, with risk aversion seen across markets (equities lower, bonds higher) and specific stocks reacting to anticipated direct effects. For example, every Asian airline stock has been aggressively sold lower, while manufacturers of things like latex gloves and face masks have rallied sharply.

Now, while none of this should be surprising, a quick look at market levels shows us that the current impact of this virus has been widespread, at least from a market perspective. For example, equity markets have suffered across the board, although Asia was worst hit (Nikkei -0.9%, Hang Seng -2.8%, Shanghai -1.4%, DAX -0.25%, CAC -0.85%, FTSE -1.0%). Treasury yields have fallen 2bps, although bund yields are actually higher by 0.5bps this morning on the back of stronger than expected ZEW survey data.

And in the currency market, the dollar is broadly, although not universally, higher. It can be no surprise that APAC currencies are under the most pressure given the risk-off causality, with KRW -0.75% and CNY -0.55%, its largest daily decline since last August. But we are also seeing weakness throughout LATAM with both BRL (-0.45%) and MXN (-0.35%) among the day’s worst performers.

In the G10 space, the results have been a bit more mixed, and actually seem more related to data than the general risk sentiment. For example, the pound is today’s big winner, +0.35% after UK Employment data was released with much better than expected results. While the Unemployment Rate remained unchanged at 3.8%, the 3M/3M Employment Change rose 208K, nearly double expectations and the first really good piece of data seen from the UK in two weeks (recall PMI data was a bit better than expected). This has resulted in some traders questioning whether the BOE will cut rates next week after all. Futures markets continue to price a 61% probability, although that is down from 70% on Friday.

Elsewhere, the euro reversed small early losses and now has small gains after the ZEW Expectations data (26.7 vs. 15.0 expected), while the yen has benefitted ever so slightly on two different fronts. First, the broad risk-off market flavor has helped keep the yen underpinned, but more importantly, the BOJ met last night, and although they left policy unchanged, as universally expected, there continues to be a growing belief that the next move there is going to be a tightening! This was reinforced by the BOJ raising its growth estimates for both 2019 (0.8%, up from 0.6%) and 2020 (0.9% up from 0.7%). Of course, offsetting that somewhat was the decline in the BOJ’s inflation forecast, down to 0.8% in 2020 from the previous expectation of 0.9%. In the end, it is difficult to get overly excited about the Japanese economy’s prospects, with a much greater likelihood of significant yen strength emanating from a more severe risk-off event.

Looking ahead to the week, not only is the Fed in its quiet period, but there is a very limited amount of US data set to be released.

Wednesday Existing Home Sales 5.43M
Thursday Initial Claims 214K
  Leading Indicators -0.2%

Source: Bloomberg

Of course, there are two other events this week that may have a market impact, although my personal belief is that neither one will do so. This morning the US Senate takes up the Articles of Impeachment for President Trump that were finally proffered by the House of Representatives. And while the politicos in Washington and the talking heads on TV are all atwitter over this situation, financial markets have collectively yawned throughout the entire process. I see no reason for that stance to change at this point.

The other event is the World Economic Forum in Davos, the annual get together of the rich and famous, as well as those who want to be so, to pontificate on all things they deem important. However, it beggars belief that anything said from this conference is going to change any investment theories, let alone any fiscal or monetary policies. This too, from the market’s perspective, is unlikely to have any impact at all.

And that’s really it for today. Lacking catalysts, I anticipate a quiet session overall. Short term, the dollar still seems to have some life. But longer term, I continue to look for a slow decline as the effects of the Fed’s QE begin to be felt more keenly.

Good luck
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Throw Her a Bone

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Next week at the ECB meeting
We’re sure to hear Christine entreating
The whole Eurozone
To throw her a bone
And spend more, lest growth start retreating

In England, though, it’s now too late
As recent releases all state
The ‘conomy’s slowing
And Carney is knowing
Come month end he’ll cut the base rate

The dollar is finishing the week on a high note as it rallies, albeit modestly, against virtually the entire G10 space. This is actually an interesting outcome given the ongoing risk-on sentiment observed worldwide. For instance, equity markets in the US all closed at record highs yesterday, and this morning, European equities are also trading at record levels. Asia, not wanting to be left out, continues to rally, although most markets in APAC have not been able to reach the levels seen during the late 1990’s prior to the Asian crisis and tech bubble. At the same time, we continue to see Treasury and Bund yields edging higher as yield curves steepen, another sign of a healthy risk appetite. Granted, commodity prices are not uniformly higher, but there are plenty that are, notably iron ore and steel rebar, both crucial signals of economic growth.

Usually, in this type of market condition, the dollar tends to decline. This is especially so given the lack of volatility we have observed encourages growth in carry trades, with investors flocking to high yield currencies like MXN, IDR, BRL and ZAR. However, it appears that at this juncture, the carry trade has not yet come back into favor, as that bloc of currencies has shown only modest strength, if any, hardly the signal that investor demand has increased.

This leaves us with an unusual situation where the dollar is reasonably well-bid despite the better risk appetite. Perhaps investors are buying dollars to jump on board the US equity train, but I suspect there is more to the movement than this. Investigations continue.

Narrowing our focus a bit more, it is worthwhile to consider the key events upcoming, notably next week’s ECB and BOJ meetings and the following week’s FOMC and BOE meetings. Interestingly, based on current expectations, the Fed meeting is likely to be far less impactful than either the ECB or BOE.

First up is the BOJ, where there is virtually no expectation of any policy changes, and in fact, that is true for the entire year. With the policy rate stuck at -0.10%, futures markets are actually pricing in a 5bp tightening by the end of the year. Certainly, Japan has gone down the road of increased fiscal stimulus, and if you recall last month’s outcome, the BOJ essentially admitted that they would not be able to achieve their 2.0% inflation target during any forecastable timeline. With that is the recent history, and given that inflation remains either side of 1.0%, the BOJ is simply out of bullets, and so will not be doing anything.

The ECB, however, could well be more interesting as the market awaits their latest thoughts on the policy review. Madame Lagarde has made a big deal about how they are going to review procedures and policy initiatives to see if they are designed to meet their goals. Some of the things that have been mooted are a change in the inflation target from “close to but below 2.0%” to either a more precise target or a target range, like 1.5% – 2.5%. Of even more interest is the fact that they have begun to figure out that their current inflation measures are inadequate, as they significantly underweight housing expense, one of the biggest expenses for almost every household. Currently, housing represents just 4% of the index. As a contrast, in the US calculation, housing represents about 41% of the index! And the anecdotes are legion as to how much housing costs have risen throughout European cities while the ECB continues to pump liquidity into markets because they think inflation is missing. Arguably, that has the potential to change things dramatically, because a revamped CPI calculation could well inform that the ECB has been far too easy in policy and cause a fairly quick reversal. And that, my friends, would result in a much higher euro. Today however, the single currency has fallen prey to the dollar’s overall strength and is lower by 0.25%.

As I mentioned, I don’t think the FOMC meeting will be very interesting at all, as there is a vanishingly small chance they change policy given the economy keeps chugging along and inflation has been fairly steady, if not rising to their own 2.0% target. The BOE meeting, however, has the chance to be much more interesting. This morning’s UK Retail Sales data was massively disappointing, with December numbers printing at -0.8%, -0.6% excluding fuel. This was hugely below the expected outcomes of +0.8% and +0.6% respectively. Apparently, Boris’s electoral victory did not convince the good people of England to open their wallets. And remember, this was during Christmas season, arguably the busiest retail time of the year. It can be no surprise that the futures market is now pricing a 75% chance of a rate cut and remember, earlier this week we heard from three different BOE members that cutting rates was on the table. The pound, which has been rallying for the entire week has turned around and is lower by 0.2% this morning with every chance that this slide continues for the next week or two until the meeting crystalizes the outcome.

The other noteworthy news was Chinese data released last night, which showed that GDP, as expected, grew at 6.0%, Retail Sales also met expectations at 8.0%, while IP (+6.9%) and Fixed Asset Investment (+5.4%) were both a bit better than forecast. The market sees this data as proof that the economy there is stabilizing, especially with the positive vibe of the just signed phase one trade deal. The renminbi has benefitted, rallying a further 0.3% on the session, and has now gained 4.6% since its weakest point in early September 2019. This trend has further to go, of that I am confident.

On the data front this morning, we have Housing Starts (exp 1380K), Building Permits (1460K), IP (-0.2%), Capacity Utilization (77.0%), Michigan Sentiment (99.3) and JOLT’s Job Openings (7.25M). So plenty of news, but it is not clear it is important enough to change opinions in the FX market. As such, I expect that today’s dollar strength is likely to continue, but certainly not in a major way.

Good luck and good weekend
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Pundits Maligned

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Phase one of the trade deal’s been signed
And though many pundits maligned
The outcome, it’s clear
That in the, term, near
Its impact on trading’s been kind

Amid a great deal of hoopla yesterday morning, President Trump signed the long-awaited phase one trade deal with China. The upshot is that the US has promised to roll back the tariffs imposed last September by 50%, as well as delay the mooted December tariffs indefinitely while the Chinese have promised to purchase upwards of $95 billion in US agricultural products over the next two years as well as agreeing to crack down on IP theft. In addition, the Chinese have committed to preventing excess weakness in the renminbi, and in fact CNY has been strengthening steadily for the past month as the negotiations came to an end. For example, this morning CNY is firmer by 0.15% and since mid-December it has rallied nearly 2.0%. Clearly there are larger trade issues outstanding between the two nations, notably forced technology transfer as well as numerous non-tariff barriers, but something is better than nothing.

Taking a step back, though, the bilateral nature of the deal is what has many pundits and economists unhappy. Certainly the economic theories I was taught, and that have been prevalent since David Ricardo first developed the theory of comparative advantage in 1817, indicate that multilateral trade is a better outcome for all concerned. Alas, the current political backdrop, where populism has exploded in response to the unequal outcomes from the globalization phenomenon of the past sixty years, has tarred multilateralism with a very bad reputation. And while it is far outside the purview of this commentary to dissect the issues, it is important to understand they exist and how they may impact markets. Given that the relative value of a nation’s currency is an important driver of trade outcomes, we cannot ignore it completely. Ultimately, as things currently stand, the market has seen this deal as a positive outcome, and risk appetite remains strong. As such, haven assets like the yen, dollar and Swiss franc are likely to remain on the back foot for the time being.

Beside the trade story, there has been scant new information on which to base trading decisions. Important data remains limited with the only notable print being German CPI at 1.5%, exactly as expected, although EU Car registrations bucked the trend and rose sharply, 21.7%, perhaps indicating we have seen a bottom on the Continent. But in reality, the market is now looking for the next big thing, and quite frankly, nobody really knows what that is. After all, the Fed has promised it is on hold, as are the ECB and BOJ, at least for the time being. Perhaps it is the BOE’s meeting in two weeks’ time, where the market continues to price in a growing probability of a rate cut. Of course, if the market is pricing it in, it is not likely to be that big a surprise, is it?

So in an uninspiring market, let’s look at what is coming up in today’s session. On the data front we see Initial Claims (exp 218K) and then Retail Sales (0.3%, 0.5% ex autos) as well as Philly Fed (3.8). Arguably, of just as much importance for the global economic outlook is tonight’s Chinese data where we will see; GDP (6.0%), Fixed Asset Investment (5.2%), Retail Sales (7.9%) and IP (5.9%). Remember, 6.0% growth has been President Xi’s target, and given the recent trajectory lower, any weaker than expected data is likely to be a risk-off sign, although it is likely to see a PBOC response in short order as well. Meanwhile, the US consumer continues to play its supporting role in the global economy, so any downside in this morning’s data is also likely to be a stock market negative.

On the speaker front, there are no Fed speakers today, although Philly’s Patrick Harker will regale us tomorrow. Later this afternoon ECB President Lagarde will be on the tape, and given she is still learning how much impact her words have on markets, there is always a chance of some unintentional excitement. Finally, yesterday, for the first time, we heard a Fed speaker explain that even though not-QE is not QE, the market may still consider it to be QE and the resulting rise in the price of risk assets may well be excessive. Dallas Fed President Kaplan is the first Fed member to publically admit that they may need to address this issue going forward. Certainly, the fact that the short-term repo program continues to be extended, and is now expected to run through April, rather than the original February completion, is an indication that the Fed still does not have control over the money markets. It is this last point which holds the potential to drive more significant market moves in the event of a communication or policy error. Just not today.

The dollar is mildly softer overall this morning, while we are seeing a very modest bias higher in equity markets around the world. Treasury yields are unchanged, just below 1.78%, and the previous narratives regarding recession probabilities and curve inversions as well as ongoing QE activities have just faded into the background. It all adds up to what is likely to be another quiet day in the FX markets, with no compelling story to drive movement.

Good luck
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A Dangerous Game

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In ‘Nineteen the story was trade
As Presidents Trump and Xi played
A dangerous game
While seeking to blame
The other for why growth decayed

But ‘Twenty has seen both adjust
Their attitudes and learn to trust
That working together,
Like birds of a feather,
Results in an outcome, robust

In a very quiet market, the bulk of the discussion overnight has been about the upcoming signing ceremony in the East Room of the White House tomorrow, where the US and China will agree the phase one piece of a trade deal. Despite the fact that this has been widely expected for a while, it seems to be having a further positive impact on risk assets. Today’s wrinkle in the saga has been the US’ removal of China from the Treasury list of currency manipulators. Back in August, in a bit of a surprise, the US added China to that list formally, rather than merely indicating the Chinese were on notice, as President Trump sought to apply maximum pressure during the trade negotiations. Now that the deal is set to be signed, apparently the Chinese have made “enforceable commitments” not to devalue the yuan going forward, which satisfied the President and led to the change in status. The upshot is that the ongoing positive risk framework remains in place thus supporting equity markets while undermining haven assets. In other words, just another day where the politicians seek to anesthetize market behavior, and have been successful doing so.

Chinese trade data released last night was quite interesting on two fronts; first that the Chinese trade surplus with the US shrank 11%, exactly what the President was seeking, and second, that the Chinese found many substitute markets in which to sell their wares as their overall trade surplus rose to $425 billion from 2018’s $351 billion. And another positive for the global growth watch was that both exports (+7.6%) and imports (+17.7%) grew nicely, implying that economic growth in the Middle Kingdom seems to be stabilizing. As to the yuan, it has been on a tear lately, rising 1.4% this year and nearly 4.5% since early September right after the US labeled China a currency manipulator. So, here too, President Trump seems to have gotten his way with the Chinese currency having regained almost all its losses since the November 2016 election. Quite frankly, it seems likely that the yuan has further to climb as prospects for Chinese growth brightened modestly and investors continue to hunt for yield and growth opportunities.

But away from the trade story there is precious little else to discuss. The pound remains under pressure (and under 1.30) as the idea of a BOE rate cut at the end of the month gains credence. Currently the market is pricing in a 47% probability of a rate cut, which is up from 23% on Friday. After yesterday’s weak GDP data, all eyes are focused on tomorrow’s UK CPI data as well as Friday’s Retail Sales where any weakness in either one is likely to see the market push those probabilities up even further.

As haven assets are shed, the Japanese yen has finally breached the 110 level for the first time since May and quite frankly there doesn’t appear to be any reason for the yen to stop declining, albeit slowly. Barring some type of major risk-off event, which is always possible, the near term portents are for further weakness. However, as the year progresses, ongoing Fed QE should serve to reverse this movement.

Even the Emerging markets have been dull overnight, with no currency moving more than 0.3%, which in some cases is nearly the bid-ask spread. For now, most market participants have become quite comfortable that no disasters are looming and that, with the US-China trade deal about to be completed, there is less likelihood of any near-term angst on that front. While a phase two deal has been mooted, given the issues that the US has indicated are important (forced technology transfer, state subsidies), and the fact that they are essentially non-starters in China, it seems highly improbable that there will be any progress on that issue this year.

On the data front, this morning brings the first US data of the week, where NFIB Small Business Optimism actually disappointed at 102.7 and the market is now awaiting December CPI data (exp 2.4%, 2.3% ex food & energy) at 8:30. The headline forecast represents a pretty big uptick from November, but that is directly related to oil’s price rally last month. The core, however, remains unchanged and well above the 2.0% Fed target. Of course that target is based on PCE, something that is designed to print lower, and there has been abundant evidence that the Fed’s idea of the target is to miss it convincingly on the high side. In other words, don’t look for the Fed to even consider a tighter policy stance unless CPI has a 3 handle.

And that’s really it for the session. Equity futures are pointing slightly higher as European equity indices are edging in that direction as well. Treasury yields are hovering just above 1.80%, little changed on the day and showing no directional bias for the past several weeks. If anything, the dollar is slightly higher this morning, but I would be surprised if this move extends much further at all.

Good luck
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Wind At His Sails

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In England and Scotland and Wales
Young Boris has wind at his sails
A thumping great win
To Labour’s chagrin
Has put Brexit back on the rails

As well, from the US, the news
Is bears need start singing the blues
The trade deal is done
At least for phase one
Thus more risk, investors did choose

An historic victory for PM Boris Johnson yesterday has heralded a new beginning for the UK. Historic in the sense that it is the largest majority in Parliament for either party since Margret Thatcher’s second term, and historic in the sense that the Labour party won the fewest seats since 1935. One can only conclude that Jeremy Corbyn’s vision of renationalization of industry and high taxes was not the direction in which the UK wants to head. Perhaps the only concern is the Scottish National Party winning 49 of the 58 seats available and will now be itching to rerun the Scottish independence referendum. But that is an issue for another day, and today is all about a huge relief rally in equities as the threat of a hard Brexit essentially disappears, while the pound has also benefitted tremendously, rising 1.7% from yesterday’s closing level and having traded almost a full percent higher than that in the early aftermath of the results. So here we are this morning at 1.3390, right at my forecast for the initial move in the event of a Johnson victory. The question of course, is where do we go from here?

Before I answer, I must also mention the other risk positive story, about which I’m sure you are already aware, the news that President Trump has signed off on terms of a phase one trade deal with China. The details thus far released indicate China has promised to buy $50 billion of agricultural products from the US, and will be more vigilant in protection of IP rights, while the US is set to reduce the tariff rates already imposed and delay, indefinitely, the tariffs that were due to come into effect this Sunday. Not surprisingly, equity markets around the world rallied sharply on this news as well while haven investments like Treasuries, Bunds and the yen (and the dollar) have all fallen.

So everyone is feeling good this morning and with good reason, as two of the major political uncertainties that have been hanging over the market have been resolved. With this in mind, we can now try to answer the question of what’s next in the FX markets.

History has shown that while macroeconomic factors have some impact on the relative value of currencies, that impact is driven by the corresponding interest rates in each nation. So a nation that has strong economic growth and relatively tighter monetary policy is likely to see a strong currency while the opposite is also true. Now this correlation is hardly perfect, and financial theory cannot be completely ignored regarding a country’s fiscal balances (current account, trade and budget), where deficits tend to lead to a weaker currency, at least in theory, and surpluses the opposite. Obviously, one need only look at the dollar these days to recognize that despite the US’s significant negative fiscal position, the dollar remains relatively quite strong.

But ever since the financial crisis, there has been another part of monetary policy that has had a significant impact on the FX market, namely QE. As I’ve written before, when the US was implementing QE’s 1, 2 and 3, the dollar fell markedly each time, by 22%, 25% and 17% over a period of 9 months, 11 months and 22 months respectively. Clearly that pattern demonstrates the law of diminishing returns, where a particular action has a weaker and weaker effect the more frequently it is used. Of course, in each of these cases, the Fed funds rate was at 0.00%, so QE was the only tool in the toolbox. This brings us to the current situation; positive interest rates but the beginning of QE4. I know that none of us think 1.5% is a robust return on our savings, but remember, US interest rates are the highest in the G10, by a lot. In addition, the economy seems to be doing pretty well with GDP ticking over above 2.0%, Unemployment at 50 year lows and wage gains solidly at 3.0% or higher. Equity markets in the US make new highs on a regular basis and measured inflation is running right around 2.0%. And yet…the Fed is clearly looking at QE despite all their protestations. Buying $60 billion per month of T-bills with the newly stated option of extending those purchases to coupons is clearly expanding the balance sheet and driving risk accumulation further. And that is QE!

So with the knowledge that the Fed is engaged in QE4, and the history that shows the dollar has fallen pretty significantly during each previous QE policy, my view is that we are about to embark on a reasonable weakening of the US dollar for the next year or so. Now, clearly the initial conditions this time are different, with positive growth and interest rates, but while that will likely limit the dollar’s decline to some extent, it won’t prevent it. If pressed, I would say that we are likely to see the dollar fall by 10% or so over the next 12-18 months. And that is regardless of the outcome of the US elections next year. In the event that we were to see a President Warren or President Sanders, I think the dollar would suffer far more aggressively, but right now, removing the effect of the election still points to a slow decline in the buck. So for receivables hedgers, it is likely to be a situation where patience is a virtue.

Turning to the data story, last night we saw the Japanese Tankan report fall to 0, below expectations of 3 and down from its previous reading of 5. But the yen’s 0.35% decline overnight has more to do with risk appetite than that particular number. However, I’m sure PM Abe and BOJ Governor Kuroda are not thrilled with the implications for the economy. Otherwise, there has been precious little else of note released leaving us to ponder this morning’s Retail Sales data (exp 0.5%, 0.4% ex Autos) and wait to hear pearls of wisdom from NY Fed President Williams at 11:00. Of course, given the fact the Fed just finished meeting and there appears very little uncertainty over their immediate future course, my guess is the only thing he can try to defend is ‘not QE’ and how they are on top of the repo situation. But today is a risk on day, so while we may not extend these movements much further, I feel we are likely to maintain the gains vs. the dollar across the board.

In a final note, this will be the last poetry until January as I will be on vacation and then will return with my prognostications for 2020 to start things off.

Good luck, good weekend and happy holidays to all
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Hawks Would Then Shriek

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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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A Future Quite Bright

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The data from China last night
Implied that growth might be all right
The PMI rose
And everyone knows
That points to a future quite bright!

Is it just me? Or does there seem to be something of a dichotomy when discussing the situation in China? This morning has a decidedly risk-on tone as equity markets in Asia (Nikkei +1.0%, Hang Seng +0.4%, Shanghai +0.15%) rallied after stronger than expected Chinese PMI data was released Friday night. For the record, the official Manufacturing PMI rose to 50.2, its first print above 50.0 since April, while the non-Manufacturing version rose to 54.4, its highest print since March. Then, this morning the Caixin PMI data, which focuses on smaller companies, also printed a bit firmer than expected at 51.8. These data releases were sufficient to encourage traders and investors to scoop up stocks while they dumped bonds. After all, everything is just ducky now, right?

And yet…there are still two major issues outstanding that have no obvious short-term solution, both of which can easily deteriorate into a much worse situation overall. The first, of course, is the trade fiasco situation, where despite comments from both sides that progress has been made, there is no evidence that progress has been made. At least, there is no timeline for the completion of phase one and lately there has been no discussion of determining a location to sign said deal. Certainly it appears that the current risk profile in markets is highly dependent on a successful conclusion of these talks, at least as evidenced by the fact that every pronouncement of an impending deal results in a stock market rally.

The second issue is the ongoing uprising in Hong Kong. China has begun to use stronger language to condemn the process, and is extremely unhappy with the US for passing the Hong Kong Human Rights and Democracy Act last week. However, based on China’s response, we know two things: first that completing a trade deal is more important than words about Hong Kong. This was made clear when the “harsh” penalties imposed in the wake of the Act’s passage consisted of sanctions on US-based human rights groups that don’t operate in China and the prevention of US warships from docking in Hong Kong. While the latter may seem harsh, that has already been the case for the past several months. In other words, fears that the Chinese would link this law to the trade talks proved unfounded, which highlights the fact that the Chinese really need these talks to get completed.

The second thing we learned is that China remains highly unlikely to do anything more than complain about what is happening in Hong Kong as they recognize a more aggressive stance would result in much bigger international relationship problems. Of course, the ongoing riots in Hong Kong have really begun to damage the economy there. For example, Retail Sales last night printed at -24.3%! Not only was this worse than expected, but it was the lowest in history, essentially twice as large a decline as during the financial crisis. GDP there is forecast to fall by nearly 3.0% this year, and unless this is solved soon, it seems like 2020 isn’t going to get any better. But clearly, none of the troubles matter because, after all, PMI rose to 50.2!
Turning to Europe, PMI data also printed a hair better than expected, but the manufacturing sector remains in dire straits. Germany saw a rise to 44.1 while France printed at 51.7 and the Eurozone Composite at 46.9. All three were slightly higher than the flash data from last week, but all three still point to a manufacturing recession across the continent. And the biggest problem is that the jobs sub-indices were worse than expected. At the same time, Germany finds itself with a little political concern as the ruling coalition’s junior partner, the Social Democrats, just booted out their leadership and replaced it with a much more left wing team who are seeking changes in the coalition agreement. While there has been no call for a snap election, that probability just increased, and based on the most recent polls, there is no obvious government coalition with both the far left and far right continuing to gain votes at the expense of the current government. While this is not an immediate problem, it cannot bode well if Europe’s largest economy is moving toward internal political upheaval, which means it will pay far less attention to Eurozone wide issues. This news cannot be beneficial for the euro, although this morning’s 0.1% decline is hardly newsworthy.

Finally, with less than two weeks remaining before the British (and Scottish, Welch and Northern Irish) go to the polls, the Conservatives still hold between a 9 and 11 point lead, depending on which poll is considered, but that lead has been shrinking slightly. Pundits are quick to recall how Theresa May called an election in the wake of the initial Brexit vote when the polls showed the Tories with a large lead, but that she squandered that lead and wound up quite weakened as a result. At this point, it doesn’t appear that Boris has done the same thing, but stranger things have happened. At any rate, the FX market appears reasonably confident that the Tories will win, maintaining the pound above 1.29, although unwilling to give it more love until the votes are in. I expect that barring any very clear gaffes, the pound will range trade ahead of the election and in the event of a Tory victory, see a modest rally. If we have a PM Corbyn, though, be prepared for a pretty sharp decline.

Looking ahead to this week, we have a significant amount of US data, culminating in the payroll report on Friday:

Today ISM Manufacturing 49.2
  ISM Prices Paid 47.0
  Construction Spending 0.4%
Wednesday ADP Employment 140K
  ISM Non-Manufacturing 54.5
Thursday Initial Claims 215K
  Trade Balance -$48.6B
  Factory Orders 0.3%
  Durable Goods 0.6%
  -ex Transport 0.6%
Friday Nonfarm Payrolls 190K
  Private Payrolls 180K
  Manufacturing Payrolls 40K
  Unemployment Rate 3.6%
  Average Hourly Earnings 0.3% (3.0% Y/Y)
  Average Weekly Hours 34.4
  Michigan Sentiment 97.0

Source: Bloomberg

As we have seen elsewhere around the world, the manufacturing sector in the US remains under pressure, but the services sector remains pretty robust. But overall, if the data prints as expected, it is certainly evidence that the US economy remains in significantly better shape than that of most of the rest of the world. And it has been this big picture story that has underpinned the dollar’s strength overall. Meanwhile, with the Fed meeting next week, they are in their quiet period, so there will be no commentary regarding policy until the next statement and press conference. In fact, next week is set to be quite interesting with the FOMC, the UK election and then US tariffs slated to increase two weeks from yesterday.

And yet, despite what appear to be numerous challenges, risk remains the primary choice of investors. As such, equities are higher and bonds are selling off although the dollar remains stuck in the middle for now. We will need to get more news before determining which way things are likely to break for the buck in the near term.

Good luck
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