Tag Archives: #china

Akin to Caffeine

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There once was a time in the past
Where weakness in growth, if forecast
Resulted in prices
That forewarned a crisis
And traders sold what they’d amassed

But nowadays weakness is seen
As something akin to caffeine
‘Cause central bank measures
Will add to their treasures
It’s like a brand new cash machine

Chinese growth data was weak last night, falling to its lowest quarterly rate in the twenty-seven years that China has measured growth on a quarterly basis. The outcome of 6.2%, while expected, confirms that the ongoing trade situation with the US is having an increasingly negative impact on GDP worldwide. Naturally, not unlike Pavlov’s dogs, the market response was to rally on the theory that the PBOC would be adding more stimulus soon. After all, every other central bank in the world (save Norway’s) is preparing to ease policy further as growth worldwide continues to slow down. And so far, the Pavlovian response of buying stocks on bad news continues to be working as evidenced by the fact that equity markets throughout Asia rose. However, the magnitude of that rise has been quite limited, with gains of between 0.2% and 0.4% the norm. in fact, that market response is actually a bad sign for the central banks, because it demonstrates that the effectiveness of their policies is expected to be much less than in the past. Diminishing returns is a normal outcome for the repeated use of anything, and monetary policy is no different. The implication of this outcome is that despite the growing certainty that the Fed, ECB, BOJ, PBOC, BOE and more are going to ease policy further, equity markets seem unlikely to benefit as much as they have in the past. And if when a recession finally arrives, look for a change of heart in the equity community. But in the meantime, party hearty!

Speaking of further policy ease, it seems the market is chomping at the bit for next week’s ECB meeting, where there are two schools of thought. The conservative view is that Signor Draghi will sound quite dovish and indicate a 10bp cut is coming in September. But that is not nearly as exciting a view as the more aggressive analysts are discussing, which is a 20bp cut next week and the introduction of QE2 in September. Interestingly, despite all this certitude about ECB rate cuts, the euro is actually slightly higher this morning (albeit just 0.1%). It appears that traders are betting on the fact that if Draghi is aggressive, the Fed will have the opportunity the following week to match and outperform the ECB. Remember, the Fed has 250bps of rate cuts before it reaches ZIRP while the ECB is already negative. Despite the recent academic work explaining that negative rates are just fine and helping the situation, it still seems unlikely that we are going to see -2.0% anywhere in the world anytime soon. Ergo, the relative policy stance implies the Fed will ease more and the dollar will suffer accordingly. Just not today. Rather, today, the dollar is little changed overall, with some gains and some losses, but few large moves.

And those have been the real stories of note over what was a very quiet weekend. This week we see a fair amount of data, including Retail Sales, but more importantly, we hear from five more Fed speakers, including Chairman Powell tomorrow, in a total of nine speeches.

 

Today Empire Manufacturing 2.0
Tuesday Retail Sales 0.2%
  -ex autos 0.2%
  IP 0.2%
  Capacity Utilization 78.2%
  Business Inventories 0.3%
Wednesday Housing Starts 1.262M
  Building Permits 1.30M
  Fed’s Beige Book  
Thursday Initial Claims 216K
  Philly Fed 5.0
  Leading Indicators 0.1%
Friday Michigan Sentiment 98.5

Given the importance of the consumer to the US economy, the Retail Sales data is probably the most important data point. Certainly, a weak outcome will result in rate cut euphoria, but it will be interesting to see what happens if there is a strong print. But otherwise, this seems more like a week where Fed speakers will dominate, as we hear from NY’s John Williams twice, as well as a mix of other governors and regional presidents. In the end, though, Powell’s comments are key, as I expect he will be looking to fine tune his message from last week’s congressional testimony.

It remains clear that the Fed has the most room to ease policy, and as long as that is the case, the dollar should remain under pressure. However, given the fact that the US economy continues to outperform the rest of the developed world, I don’t anticipate the dollar’s decline to be extreme, a few percent at most.

For today, there is precious little else to really drive things, so look for more of the recent choppiness that we have observed in markets, with no real directional bias.

Good luck
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Totally Thwarted

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The data that China reported
Showed growth there somewhat less supported
Meanwhile in Hong Kong
The protesting throng
Has bullish views totally thwarted

Once again, risk is under pressure this morning as the litany of potential economic and financial problems continues to grow rather than recede. The latest concerns began last night when China reported slowing Investment (5.6%, below 6.1% expected) and IP (5.0%, weakest since 2002) data (although Retail Sales held up) which led to further concerns over the growth trajectory in the Middle Kingdom. PBOC Governor Yi Gang assures us that China has significant firepower left to address further weakness, but traders are a little less comforted. Adding to concerns are the ongoing protests in Hong Kong over potential new legislation which would allow extradition, to mainland China, of people accused of fomenting trouble in Hong Kong. That is a far cry from the separation that has been key in allowing Hong Kong’s financial markets and economy to flourish despite its close ties to Beijing.

The upshot is that stocks in Hong Kong (-0.65%) and Beijing (-1.0%) fell again, while interest rates in Hong Kong pushed even higher. This has resulted in a liquidity shortage in Hong Kong which is supporting the HKD (+0.2% this week and finally pushing away from the HKMA’s floor). The renminbi, meanwhile, has gone the other way, softening slightly since the protests began. Other signs of pressure were evident by the weakness in AUD and NZD, both of which rely heavily on the Chinese market as their primary export destinations.

Risk is also evident in the energy markets where there has been an escalation in the rhetoric between the US and Iran after the tanker attacks yesterday. This morning the US is claiming it has video proof that Iran was behind the attacks, although it has not been widely accepted as such. Oil prices, which rose sharply yesterday, have maintained those gains, although on the other side of the oil equation is the slowing economy sapping demand. In fact, the IEA is out with a report this morning that next year, production increases in the US, Canada and Brazil will significantly outweigh anemic increases in demand, further pressuring OPEC and likely oil prices overall. However, for the moment, the market concerns are focused on the increased tension in the Gulf with the possibility of a conflict there seeming to rise daily. Remember, risk assets tend to suffer greatly in situations like this.

Aside from the weaker Aussie (-0.25%) and Kiwi (-0.55%), we have also seen strength in the yen (+0.2%), a huge rally in Treasuries (10-year yield down 4.5bps), gold pushing higher (+1% and back to its highest level in three years) and the dollar, overall performing well. The latter is evidenced by the decline in the euro (-0.2%), the pound (-0.3%) and basically the rest of the G10 with similar declines.

This is the market backdrop as we await the last major piece of data before the FOMC meeting next week, this morning’s Retail Sales numbers. Current expectations are for a 0.6% increase, with the ex-autos number printing at 0.3%. But recall, last month economists were forecasting a significant gain and instead the headline number was negative. A similar result this morning would certainly add more pressure on Chairman Powell and friends next week. And that is really the big underlying story across all markets, just how soon are we likely to see the Fed or the ECB or the BOJ turn clearly dovish and ease policy.

It has become abundantly clear that inflation is the only data point that the big central banks are focusing on these days. And given their fixation on achieving a, far too precise, level of 2.0%, they are all failing by their own metrics. Wednesday’s US CPI data was softer than expected leading to reduced expectations for the PCE data coming at the end of the month. In the Eurozone, 5y/5y inflation swaps, one of the ECB’s key metrics for inflation sentiment, has fallen below 1.20% and is now at its lowest level since the contract began in 2003. And in Japan, CPI remains pegged just below 1.0%, nowhere near the target level. It is this set of circumstances, more than any questions on growth or employment, that will continue to drive monetary policy. With this in mind, one can only conclude that money is going to get easier going forward. I still don’t think the Fed moves next week, but I could easily see a 50bp cut in July. Regardless, markets are going to continue to pressure all central banks until policy rates are lowered, mark my words.

Regarding the impact of these actions on the dollar, it becomes a question of timing more than anything else. As I have consistently maintained, if the Fed starts to ease aggressively, you can be sure that the ECB and BOJ, as well as a host of other central banks, will be doing so as well. And in an environment of global weakness, I expect the dollar will remain the favored place to maintain assets.

As for today, a weak Retail Sales print is likely to see an initial sell-off in the dollar but look for it to reverse as traders focus on the impacts likely to be felt elsewhere.

Good luck and good weekend
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Doves There Held Sway

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It seems that a day cannot pass
When one country ‘steps on the gas’
Twas China today
Where doves there held sway
With funding for projects en masse

If I didn’t know better, I would suspect the world’s central banks of a secret accord, where each week one of them is designated as the ‘dove du jour’ and makes some statement or announcement that will serve to goose stock prices higher. Whether it is Fed speakers turning from patience to insurance, the ECB promising more of ‘whatever it takes’ or actual rate cuts a la the RBA, the central banks have apparently realized that the only place they continue to hold sway is in global stock markets. And so, they are going to keep on pushing them for as long as they can.

This week’s champion is the PBOC, which last night eased restrictions further on infrastructure investment by local governments, allowing more issuance of ‘special bonds’ and encouraging banks to lend more for these projects. At the same time, the CNY fix was its strongest in a month, back below the 6.90 level, as the PBOC makes clear that for the time being, it is not going to allow the yuan to display any unruly behavior. True to form, Chinese equity markets roared higher led by construction and cement companies, and once again we see global equity markets in the green.

While in the short run, investors remain happy, the problem is that in the medium and longer term, it is unclear that the central banking community has sufficient ammunition left to really help economic activity. After all, how much lower is the ECB going to cut rates from their current -0.4% level? And will that really help the economy? How many more JGB’s can the BOJ buy given they already own about 50% of the market? In truth, the Fed and the PBOC are the only two banks with any real leeway to ease policy enough to have a real economic impact, rather than just a financial markets impact. And for a world that has grown completely reliant on central bank activity to maintain economic growth, that is a real problem.

Adding to these woes is the ongoing trade war situation which seems to change daily. The latest news on this front is that if President Xi won’t sit down with President Trump at the G20 meeting in Japan later this month, then the US will impose tariffs on all Chinese imports. However, it seems the market is becoming inured to statements like these as there has been precious little discussion on the subject, and the PBOC’s actions were clearly far more impactful.

The question is, how long can markets continue to ignore what is a clearly deteriorating global economic picture before responding? And the answer is, apparently, quite a long time. Or perhaps that question is aimed only at equity markets because bond markets clearly see a less rosy future. At some point, we are going to see a central bank announcement result in no positive impact, or perhaps even a negative one, and when that occurs, be prepared for a rockier ride.

Turning to the FX markets this morning, the dollar has had a mixed session, although is arguably a touch softer overall. So far this month, the euro, which is basically unchanged this morning, has rallied 1.4%, while the pound, which is a modest 0.15% higher this morning after better than expected wage data, is higher by just 0.5%. My point is that despite some recent angst in the analyst community that the dollar was due to come under significant pressure, the overall movements have been quite small.

In the EMG bloc, there has also been relatively little movement this month (and this morning) as epitomized by the Mexican peso, which fell nearly 3% last week after the threat of tariffs being imposed unless immigration changes were made by Mexico, and which has recouped essentially all of those losses now that the tariffs have been averted. China is another example of a bit of angst but no substantial movement. This morning, after the PBOC drove the dollar fix lower, the renminbi is within pips of where it began the month. Again, FX markets continue to fluctuate in relatively narrow ranges as other markets have seen far more activity.

Repeating what I have highlighted many times, FX is a relative market, and the value of one currency is always in comparison to another. So, if monetary policies are changing in the same direction around the world, then the relative impact on any currency is likely to be muted. It is why, despite the fact that the US has more room to ease policy than most other nations, I expect the dollar to quickly find its footing in the event the Fed gets more aggressive. Because we know that if the Fed is getting aggressive, so will every other central bank.

Data this morning has seen the NFIB Small Business Optimism Index rise to 105.0, indicating that things in the US are, perhaps, not yet so dire. This is certainly not the feeling one gets from the analyst community or the bond market, but it is important to note. We do see PPI as well this morning (exp 2.0%, 2.3% core) but this is always secondary to tomorrow’s CPI report. The Fed remains in its quiet period so there will be no speakers, and the stock market is already mildly euphoric over the perceived policy ease from China last night. Quite frankly, it is hard to get excited about much movement at all in the dollar today, barring any new commentary from the White House.

Good luck
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Oy Vey!

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The jobs report was quite the dud
And traders began smelling blood
If Powell and friends
Would not make amends
Then stocks would be dragged through the mud

Then later, down Mexico’s way
The tariff dispute went away
At least for the moment
Though Trump could still foment
More problems by tweeting, oy vey!

This morning, despite the confusion
The outcome’s a foregone conclusion
Stock markets will rise
While bonds scrutinize
The data, and fight the illusion

I’m not even sure where to start this morning. Friday’s market activity was largely as I had forecast given the weak payrolls report, just a 75K rise in NFP along with weaker earnings numbers, leading to a massive increase in speculation that the Fed is going to cut, and cut soon. In fact, the probability for a June cut of 25bps is now about 50/50, with a full cut priced in for the July meeting and a total of 70bps of cuts priced in for the rest of 2019. Equity markets worldwide have rallied on the weak data as a new narrative has developed as follows: weaker US growth will force the Fed to ease policy sooner than previously forecast and every other central bank will be forced to follow suit and ease policy as well. And since the reaction function for equity markets has nothing to do with economic activity, being entirely dependent on central bank largesse, it should be no surprise that stock markets are higher everywhere. Adding to the euphoria was the announcement by the Trump administration that those potential Mexican tariffs have been suspended indefinitely after progress was made with respect to the ongoing immigration issues at the US southern border.

This combination of news and data was all that was needed to reverse the Treasury market rally from earlier in the week, with 10-year yields higher by 5bps this morning, and the dollar, which had fallen broadly on Friday, down about 0.6% across the board after the payroll report, has rebounded against most of its counterpart currencies. The one outlier here is the Mexican peso, which after the tariff threat had fallen by nearly 3%, has rebounded and is 2.0% higher vs. the dollar this morning.

To say that we live in a looking glass world where up is down and down is up may not quite capture the extent of the overall market confusion. One thing is certain though, and that is we are likely to continue to see market volatility increase going forward.

Let’s unpack the Fed portion of the story, as I believe it will be most helpful in trying to anticipate how things will play out going forward. President Trump’s threats against Mexico really shook up the market but had an even bigger impact on the Fed. Consider, we have not heard the word ‘patient’ from a Fed speaker since Cleveland Fed President Loretta Mester used the word on May 3rd. When the FOMC minutes were released on May 22, the term was rampant, but the world had changed by then. In the interim, we had seen the US-China trade talks fall apart and an increase in tariffs by both sides, as well as threats of additional actions, notably the banning of Huawei products in the US and the restriction of rare earth metals sales by China. At this point, the trade situation is referred to as a war by both sides and most pundits. We have also seen weaker US economic activity, with Retail Sales and Housing data suffering, along with manufacturing and production. While no one is claiming we are in recession yet, the probabilities of one arriving are seen as much higher.

The result of all this weak data and trade angst was a pretty sharp sell-off in the equity markets, which as we all know, seems to be the only thing that causes the Fed to react. And it did so again, with the Fed speakers over the past two weeks highlighting the weakening data and lack of inflation and some even acknowledging that a rate cut would be appropriate (Bullard and Evans.) This drove full on speculation that the Fed was about to ease policy and futures markets have now gone all-in on the idea. It would actually be disconcerting if the Fed acted after a single poor data point, so June still seems only a remote possibility, but when they meet next week, look for a much more dovish statement and for Chairman Powell to be equally dovish in the press conference afterward.

And remember, if the Fed is turning the page on ‘normalization’ there is essentially no chance that any other major central bank will be able to normalize policy either. In fact, what we have heard from both the ECB’s Draghi and BOJ’s Kuroda-san lately are defenses of the many tools they still have left to utilize in their efforts to raise inflation and inflationary expectations. But really, all they have are the same tools they’ve used already. So, look for interest rates to fall further, even where they are already negative, as well as more targeted loans and more QE. And the new versions of QE will include purchases that go far beyond government bonds. We will see much more central bank buying of equities and corporate bonds, and probably mortgages and municipals before it is all over.

Ultimately, the world has become addicted to central bank policy largesse, and I fear the only way this cycle will be broken is by a crisis, where really big changes are made (think debt jubilee), as more of the same is not going to get the job done. And that will be an environment where havens will remain in demand, so dollars, yen, Treasuries and Bunds, and probably gold will all do quite well. Maybe not immediately, but that is where we are headed.

Enough doom and gloom. Let’s pivot to the data story this week, which is actually pretty important:

Today JOLTs Jobs Report 7.479M
Tuesday NFIB Small Biz 102.3
  PPI 0.1% (2.0% Y/Y)
  -ex food & energy 0.2% (2.3% Y/Y)
Wednesday CPI 0.1% (1.9% Y/Y)
  -ex food & energy 0.2% (2.1% Y/Y)
Thursday Initial Claims 216K
Friday Retail Sales 0.7%
  -ex autos 0.3%
  IP 0.1%
  Capacity Utilization 78.7%
  Michigan Sentiment 98.1

Clearly CPI will be closely watched, with any weakness just fanning the flames for rate cuts sooner. Also, after the weak NFP report Friday, I expect closer scrutiny for the Initial Claims data. This has been quite steady at low levels for some time, but many pundits will be watching for an uptick here as confirmation that the jobs market is starting to soften. Finally, Retail Sales will also be seen as important, especially given the poor outcome last month, which surprised one and all.

Mercifully, the Fed is in its quiet period ahead of their meeting next week, so we won’t be hearing from them. Right now, however, the momentum for a rate cut continues to build and stories in the media are more about potential weakness in the economy than in the strength that we had seen several months ago. If the focus remains on US economic activity softening, the dollar should come under pressure, but once we see that spread to other areas, notably the UK and Europe, where they had soft data this morning, I expect those pressures to equalize. For today, though, I feel like the dollar is still vulnerable.

Good luck
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Called Into Question

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A key market gauge of recession,
The yield curve, has called into question
Growth’s pace up ahead
And whether the Fed
Will restart financial repression

While markets this morning have stopped falling, there is no question that investors are on heightened alert. Yesterday saw further declines in the major stock indices and a continuation of the dollar’s rally alongside demand for Treasuries and Bunds. Today’s pause is hardly enough to change the predominant current view which can best be summed up as, AAAAGGGHHHH!

In the Treasury market, 10-year yields reached their steepest inversion vs. 3-month yields, 14bps, since 2007. While many pundits and analysts focus on the 2-year vs. 10-year spread, which remains slightly positive, the Fed itself has published research showing the 3-month vs. 10-year spread is a better indicator of future recessions. So the combination of fears over a drawn out trade war between the US and China and ongoing uncertainty in Europe given the Brexit drama and the uptick in tensions between Italy and the European Commission regarding Italy’s mooted budget, have been enough to send many investors hunting for the safest assets they can find. In this classic risk-off scenario, the fact that the dollar and the yen remain the currencies of choice is no surprise.

But let’s unpack the stories to see if the fear is warranted. On the trade front, every indication of late is that both sides are preparing for a much longer conflict. Just this morning China halted all imports of US soybeans. The other chatter of note is the idea that the Chinese may soon halt shipments of rare-earth metals to US industry, an act that would have significant negative consequences for the US manufacturing capability in the technology and aerospace industries. Of course, the US ban on Huawei and its increased pressure to prevent any allies from buying their equipment strikes at the heart of China’s attempts to move up the value chain in manufacturing. All told, until the G20 meeting in about a month’s time, I cannot foresee any thaw in this battle, and so expect continued negative consequences for the market.

As to Brexit, given the timing is that there won’t be a new Prime Minister until September, it seems that very little will happen in this arena. After all, Boris Johnson is already the favorite and is on record as saying a hard Brexit suits him just fine. While my personal view is that the probability of that outcome is more than 30%, I am in the minority. In fact, I would argue the analyst community, although not yet the market, is coalescing around the idea that no Brexit at all has become the most likely outcome. We have heard more and more MP’s talk about a willingness to hold a second referendum and current polls show Remain well ahead in that event. Of course, the FX market has not embraced that view as evidenced by the fact the pound remains within spitting distance of its lowest levels in more than two years.

Finally, the resurrection of the Italy story is the newest addition to the market’s menu of pain, and this one seems like it has more legs. Remarkably, the European Commission, headed by Jean-Claude Juncker, is demanding that Italy reduce its fiscal spending by 1.5% of GDP despite the fact that it is just emerging from a recession and growth this year is forecast to be only 0.3%. This is remarkable given the Keynesian bent of almost all global policymakers. Meanwhile, Matteo Salvini, the leader of the League whose power is growing after his party had a very strong showing in last week’s EU elections, has categorically rejected that policy prescription.

But of more interest is the fact that the Italian Treasury is back to discussing the issuance of ‘minibots’ which are essentially short-term Italian notes used by the government to pay contractors, and which will be able to trade in the market as a parallel currency to the euro. While they will be completely domestic, they represent a grave threat to the sanctity of the single currency and will not be lightly tolerated by the ECB or any other Eurozone government. And yet, it is not clear what the rest of Europe can do to stop things. The threat of a fine is ludicrous, especially given that Italy’s budget deficit is forecast to be smaller than France’s, where no threats have been made. The thing is, introduction of a parallel currency is a step into the unknown, and one that, in the short-term, is likely to weigh on the euro significantly. However, longer term, if Italy, which is generally perceived as one of the weaker links in the Eurozone, were to leave, perhaps that would strengthen the remaining bloc on a macroeconomic basis and the euro with it.

With that as background, it is no surprise that investors have been shunning risk. While this morning markets are rebounding slightly, with equity indices higher by a few tenths of a percent and Treasury yields higher by 3bps, the trend remains firmly in the direction of less risk not more.

The final question to be asked is, how will the Fed respond to this widening array of economic issues? Arguably, they will continue to focus on the US story, which while slowing, remains the least problematic of the major economies. At least that has been the case thus far. But today we have the opportunity to change things. Data this morning includes the first revision of Q1 GDP (exp 3.1%) as well as Initial Claims (215K) and the Goods Trade Balance (-$72.0B) at 8:30. There are concerns that the Q1 data falls below 3.0% which would not only be politically inconvenient, but perhaps a harbinger of a faster slowdown in Q2. Then, throughout the next week we get a significant run of data culminating in the payroll report next Friday. So, for now, the Fed is going to be watching closely, as will all market participants.

The predominant view remains that growth around the world is slowing and that the next easing cycle is imminent (fed funds futures are pricing in 3 rate cuts by the end of 2020!) However, Fed commentary has not backed up that view as yet. We will need to see the data to have a better idea, but for now, with risk still being shunned, the dollar should remain bid overall.

Good luck
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Support They Withdrew

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Elections across the EU
Showed people there no longer view
The powers that be
As able to see
Their woes, so support they withdrew

The weekend saw the conclusion of the EU elections which resulted in a significant change in the political landscape there. No longer do the two centrist parties represent a majority but rather, huge gains were made by more extreme nationalist parties in almost every country. For example, in the UK, the Brexit party dominated, winning >30% of the vote, with both Tories and Labour losing significant share. In Germany, Chancellor Merkel’s Christian Democrats saw their vote share decline dramatically, well below 30%, and in France, President Macron’s party lost out to the National Front’s Marine Le Pen. It appears that there is a great deal of anxiety afoot in the EU, which of course is only enflamed by the imminent (?) exit of the UK.

But getting trounced in EU elections is not nearly enough to stop those currently holding power in individual country governments from changing their ways, this much is clear. As evidence I point to the process for selecting the new leadership of the ECB, the European Commission and the European Council, which will continue to be managed according to the old rules of country size combined with the recentness of those nations holding one of the seats. The point is that while thus far there has been some lip service paid to the changes afoot, the entrenched political class are not about to give up their positions without a fight.

It is with this in mind that I continuously view the euro with such skepticism. Not only are individual countries riven, but the broad leadership seems unwilling to accept that the world is different than when the EU was formed. For now, markets continue to view the situation as tenable but weakening. And given the lack of fiscal policy initiatives across the bloc, (except for Italy which is on the road to getting penalized for them), currency values remain beholden to monetary policy efforts. With that in mind, all eyes will be on the ECB meeting next week when the latest economic forecasts are presented. Recent data has shown that surveys point to further weakness, but domestic consumption has held up well across most of the nations using the euro. However, given the clear slowdown being seen in both the US and China, it is difficult to believe that the ECB will sound remotely hawkish. I expect that the new TLTRO’s will have very favorable terms as Signor Draghi will do everything he can to goose the economy before he leaves in October. And despite the growing call for looser policy in the US, I expect the dollar to maintain its current strength.

In China a small bank went bust
And traders are losing their trust
The PBOC
Can preempt the spree
Of weakness that pundits discussed

The other interesting news over the weekend was that the PBOC assumed control of Baoshang Bank, a small lender that turned out to be highly overextended with off balance sheet transactions. This is the first time in more than 20 years this has been necessary, and the market impacts were mostly as one would expect. Shares in other small banks suffered, the PBOC injected ~$20 billion into the system to help offset some of the pressure and the yuan fell a further 0.25%. The one mild surprise was that the Shanghai Composite actually closed higher on the day, but that was in response to the new PBOC liquidity. Chinese data remains suspect and there is no evidence that anything regarding the US-China trade situation has improved since last week’s split. While the Chinese continue to claim they will maintain a stable currency, the pressure continues to build for the yuan to weaken further.

Away from those two stories, the wires have been relatively quiet. The dollar is firmer across the board this morning, rising about 0.2% uniformly, as risk continues to be reduced by investors around the world. Treasury yields have fallen back below 2.30% in the 10-year, while similar duration Bunds traded as low as -0.16% before edging back to their current -0.14% level. European equity markets are soft, albeit not collapsing, and US equity futures are pointing to a lower opening. The data to be released this week is relatively limited which means that markets are going to be looking for subtler clues from the central banking community for the next directional trends.

Today Case-Shiller Home Prices 2.6%
  Consumer Confidence 130.0
Thursday Initial Claims 215K
  Q2 GDP (2nd look) 3.1%
  Goods Trade Balance -$72.0B
Friday Personal Income 0.3%
  Personal Spending 0.2%
  Core PCE 0.2% (1.6% Y/Y)
  Chicago PMI 53.7
  Michigan Sentiment 101.5

We have a much less active Fed speaker calendar with just two, Clarida and Williams, but given the overall consistency of what we have heard lately, i.e. patience is the proper policy but the possibility of easing has not been ruled out, unless one of these two sounds highly dovish, I don’t expect much response. The week is setting up to focus on Thursday and Friday’s data, as well as waiting to hear about the next steps on Brexit or European leadership. It seems for now that the trade story has moved to the back burner. Given all this, it is hard to get excited about pending movement in the dollar, and I imagine that barring a self-induced market sell-off, there will be little of note ongoing this week with the dollar remaining in a fairly tight range.

Good luck
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Completely Dissolved

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The last time the FOMC
Sat down to discuss policy
The trade talks were purring
While folks were concurring
A hard Brexit never could be

But since then the world has evolved
And good will completely dissolved
So what they discussed
They now must adjust
If problems are e’er to be solved

It wasn’t too long ago that the Fed was the single most important topic in markets. Everything they said or did had immediate ramifications on stocks, bonds and currencies. In some circles, the Fed, and their brethren central banks, were seen as omnipotent, able to maintain growth by simply willing it higher. A natural consequence of that narrative was that the FOMC Minutes especially, but generally those of all the major central banks, were always seen as crucial in helping to better understand the policy stance, as well as its potential future. But that time has passed, at least for now. Yesterday’s FOMC Minutes were, at best, the third most important story of the day mostly because they opened the window on views that are decidedly out of date. Way back then, three weeks ago, the backdrop was of a slowly resolving trade dispute between the US and China with a deal seeming imminent, growing confidence that a no-deal Brexit was out of the picture, and an equity market that was trading at all-time highs. My how quickly things can change!

To summarize, the Minutes expressed strong belief amongst most members that patience remained the proper stance for now, although a few were concerned about too low inflation becoming more ingrained in the public mind. And then there was a technical discussion of how to manage the balance sheet regarding the tenors of Treasury securities to hold going forward, whether they should be focused in the front end, or spread across the curve. However, no decisions were close to being made. It should be no surprise that the release had limited impact on markets.

The thing is, over the past few sessions we have heard an evolution in some FOMC members’ stance on things, specifically with Bullard and Evans discussing the possibility of cutting rates, although as of now, they are the only two. However, we have heard even some of the more hawkish members willing to imply that rate cuts could be appropriate if the ‘temporary’ lull in the growth and inflation data proves more long-lasting. As has been said elsewhere, while the bar for cutting rates is high, the bar for raising rates is much, much higher. The next move is almost certainly lower.

And what has caused this evolution in thought since the last FOMC meeting? Well, the obvious answers are, first, the sharp escalation in the trade war, with the US raising tariffs on $200B of Chinese imports from 10% to 25% as well as threatening to impose that level of tariffs on the other $325B of Chinese imports. And second, the fact that the Brexit story has spiraled out of control, with further cabinet resignations (today Andrea Leadsom, erstwhile leader of the Tories in the House of Commons quit the Cabinet) adding to pressure on PM May to resign and opening up the potential for a hardline Boris Johnson to become the next PM and simply pull the UK out of the EU with no deal.

In fact, while I have written consistently on both topics over the past several months, the Fed remained the top driver previously. But now, these events are clearly completely outside the control of monetary officials and markets are going to respond to them as they unfold. In other words, look for more volatility, not less going forward.

With that as a backdrop, it can be no surprise that risk is being jettisoned across the board this morning. Equity markets are down around the world (Shanghai -1.4%, Nikkei -0.6%, DAX -1.75%, FTSE -1.4%, DJIA futures -0.9%, Nasdaq futures -1.25%); Treasuries (2.35%) and Bunds (-0.11%) are both in demand with yields falling; and the dollar is back on top of the world, with the yen along for the ride. A quick survey of G10 currencies shows the euro -0.15% and back to its lowest level since May 2017, the pound -0.2% extending its losing streak to 13 consecutive down days, while Aussie and Canada are both lower by 0.25%.

In the emerging markets, despite the fact that the PBOC continues to fix the renminbi stronger than expected, and still below 6.90, the market will have none of it and CNY is lower by a further 0.2% this morning and back above 6.94. Despite higher oil prices RUB and MXN are both softer by 0.6% and 0.4% respectively. CE4 currencies are under pressure with HUF leading the way, -0.4%, but the rest down a solid 0.25%-0.3%. In other words, there is no place to hide.

The hardest thing for risk managers to deal with is that these events are completely unpredictable as they are now driven by emotions rather than logical economic considerations. As such, the next several months are likely to see a lot of sharp movement on each new headline until there is some resolution on one of these issues. Traders and investors will be quite relieved when that happens, alas I fear it will be mid-summer at the earliest before anything concrete is decided. Until then, rumors and stories will drive prices.

Turning to today’s session we see a bit of US data; Initial Claims (exp 215K) and New Home Sales (675K). Tuesday’s Existing Home Sales disappointed and represented the 14th consecutive month of year-on-year declines. Of more interest, we have four Fed speakers (Kaplan, Barkin, Bostic and Daly) at an event and given what I detect is the beginnings of a change in view, these words will be finely parsed. So, at this point the question is will the fear factor outweigh the possible beginning of a more dovish Fed narrative. Unless all four talk about the possibility of cutting rates as insurance, I think fear still reigns. That means the dollar’s recent climb has not ended.

Good luck
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Mostly Mayhem

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There once was a female PM
Whose task was the fallout, to stem,
From Brexit, alas
What then came to pass
Was discord and mostly mayhem

And so, because progress has lumbered
Theresa May’s days are now numbered
The market’s concern
Is Boris can’t learn
The problems with which he’s encumbered

In the battle for headline supremacy, at least in the FX market’s eyes, Brexit has once again topped the trade war today. The news from the UK is that PM May has now negotiated her own exit which will be shortly after the fourth vote on her much-despised Brexit bill in Parliament. The current timing is for the first week of June, although given how fluid everything seems to be there, as well as a politician’s preternatural attempts to retain power, it may take a little longer. However, there seems to be virtually no possibility that the legislation passes, and Theresa May’s tumultuous time as PM seems set to end shortly.

Of course, that begs the question, who’s next? And that is the market’s (along with the EU’s) great fear. It appears that erstwhile London Mayor, Boris Johnson, is a prime candidate to win the leadership election, and his views on Brexit remain very clear…get the UK out! In the lead up to the original March 31 deadline, you may recall I had been particularly skeptical of the growing sentiment at the time that a hard Brexit had been taken off the table. In the end, the law of the land is still for the UK to leave the EU, deal or no deal, now by October 31, 2019. It beggars belief that the EU will readily reopen negotiations with the UK, especially a PM Johnson, and so I think it is time to reassess the odds of the outcome. Here is one pundit’s view:

  May 16, 2019 May 17, 2019
Soft Brexit 50% 20%
Vote to Remain 30% 35%
Hard Brexit 20% 45%

Given this change in the landscape, it can be no surprise that the pound continues to fall. This morning sees the beleaguered currency lower by a further 0.3% taking the move this month to 3.2%. And the thing is, given the nature of this move, which has been very steady (lower in 9 of the past 10 sessions with the 10th unchanged), there is every reason to believe that this has further room to run. Very large single day moves tend to be reversed quickly, but this, my friends is what a market repricing future probability looks like. The most recent lows, near 1.25 in December look a likely target at this time.

Of course, the fact that the market seems more focused on Brexit than trade doesn’t mean the trade story has died. In fact, equity markets in Asia suffered, as have European ones, on the back of comments from the Chinese Commerce Ministry that no further talks are currently scheduled, and that the Chinese no longer believe the US is negotiating in good faith. As such, risk is clearly being reduced across the board this morning with not merely equity weakness, but haven strength. Treasury (2.37%) and Bund (-0.11%) yields continue to fall while the yen (+0.2%) rallies alongside the dollar.

In FX markets, the Chinese yuan has fallen again (-0.3%) and is now trading at 6.95, quite close to the supposed critical support (dollar resistance) level of 7.00. There continues to be a strong belief in the market, along with the analyst community, that the PBOC won’t allow the renminbi to weaken past that level. This stems from market activity in 2015, when the Chinese surprised everyone with a ‘mini-devaluation’ of 1.5% one evening in early August of that year. The ensuing rush for the exits by Chinese nationals trying to save their wealth cost the PBOC $1 trillion in FX reserves as they tried to moderate the renminbi’s decline. Finally, when it reached 6.98 in late December 2016, they changed the capital flow regulations and added significant verbal suasion to their message that they would not allow the currency to fall any further.

And for the most part, it worked for the next 15 months. However, clearly the situation has changed given the ongoing trade negotiations, and arguably given the deterioration in the relationship between the US and China. While the Chinese have pledged to avoid currency manipulation, it is not hard to argue that their current activities in maintaining yuan strength are just that, manipulation. Given the capital controls in place, meaning locals won’t be able to rush for the doors, it is entirely realistic to believe the PBOC could say something like, ‘we believe it is appropriate for the market to have a greater role in determining the value of the currency and are widening the band around the fix to accommodate those movements.’ A 5% band would certainly allow a much weaker renminbi while remaining within the broad context of their policy tools. In other words, I am not convinced that 7.00 is a magic line, perhaps more like a Maginot Line. If your hedging policy relies on 7.00 being sacrosanct, it is time to rethink your policy.

Overall, the dollar is firmer pretty much everywhere, with yesterday’s broad strength being modestly extended today. Yesterday’s US data was much better than expected as Housing starts grew 5.6% and Philly Fed printed at a higher than expected 16.6. Later this morning we see the last data of the week, Michigan Sentiment (exp 97.5). We also hear from two more Fed speakers, Clarida and Williams, although we have already heard from both of them earlier this week. Yesterday Governor Brainerd made an interesting series of comments regarding the Fed’s attempts to lift inflation, highlighting for the first time, that perhaps their models aren’t good descriptions of the economy any more. After a decade of inability to manage inflation risk, it’s about time they question something other than the market. While I am very happy to see them reflecting on their process, my fear is they will conclude that permanent easy money is the way of the future, a la Japan. If that is the direction in which the Fed is turning, it will have a grave impact on the FX markets, with the dollar likely to suffer the most as the US is, arguably, the furthest from that point right now. But that is a future concern, not one for today.

Good luck and good weekend
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“Talks” Become “War”

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At what point do “talks” become “war”?
And how long can traders ignore
The signs that a truce
Are, at best, abstruse?
It seems bulls don’t care any more

So, markets continue to shine
But something’s a bit out of line
If problems have past
Then why the forecast
By bonds of a further decline

I can’t help being struck this morning by the simultaneous rebound in equity markets alongside the strong rally in bond markets. They seem to be telling us conflicting stories or are perhaps simply focusing on different things.

After Monday’s equity market rout set nerves on edge, and not just among the investor set, but also in the White House, it was no surprise to hear a bit more conciliatory language from the President regarding the prospects of completing the trade negotiations successfully. That seemed to be enough to cool the bears’ collective ardor and brought bargain hunters dip buyers back into the market. (Are there any bargains left at these valuations?) This sequence of events led to a solid equity performance in Asia despite the fact that Chinese data released last night was, in a word, awful. Retail Sales there fell to 7.2%, the lowest in 16 years and well below forecasts of 8.6% growth. IP fell to 5.4%, significantly below the 6.5% forecast, let alone last month’s 8.5% outturn. And Fixed Asset Investment fell to 6.1%, another solid miss, with the result being that April’s economic performance in the Middle Kingdom was generally lousy. We have already seen a number of reductions in GDP forecasts for Q2 with new expectations centering on 6.2%.

But the market reaction was not as might have been expected as the Shanghai composite rose a solid 1.9%. It seems that China is moving into the ‘bad news is good’ scenario, where weak data drives expectations of further monetary stimulus thus supporting stock prices. The other interesting story has been the change in tone in the official Chinese media for domestic Chinese consumption, where they have become more stridently nationalist and are actively discussing a trade “war”, rather than trade “talks”. It seems the Chinese are girding for a more prolonged fight on the trade front and are marshaling all the resources they can. Of course, at the end of the day, they remain vulnerable to significant pain if the second set of tariffs proposed by the US is enacted.

One consequence of this process has been a weakening Chinese yuan, which has fallen 2.7% since its close on Friday May 3rd, and is now at its weakest point since mid-December. At 6.9150 it is also less than 2% from the 7.00 level that has been repeatedly touted by analysts as a no-go zone for the PBOC. This is due to concerns that the Chinese people would be far more active in their efforts to protect their capital by moving it offshore. This is also the reason there are such tight capital flow restrictions in China. It doesn’t help the trade talks that the yuan has been falling as that has been a favorite talking point of President Trump, China’s manipulation of their currency.

This process has also renewed pundit talk of the Chinese selling all their Treasury holdings, some $1.1 trillion, as retaliation to US tariffs. The last idea makes no sense whatsoever, as I have mentioned in the past, if only because the question of what they will do with $1.1 trillion in cash has yet to be answered. They will still need to own something and replacing Treasuries with other USD assets doesn’t achieve anything. Selling dollars to buy other currencies will simply weaken the dollar, which is the opposite of the idea they are trying to manipulate their currency to their advantage, so also makes no sense. And finally, given the huge bid for Treasuries, with yields on the 10-year below 2.40%, it seems there is plenty of demand elsewhere.

Speaking of the Treasury bid, it seems bond investors are looking ahead for weaker overall growth, hence the declining yields. But how does that square with equity investors bidding stocks back up on expectations that a trade solution will help boost the economy. This is a conundrum that will only be resolved when there is more clarity on the trade outcome.

(Here’s a conspiracy theory for you: what if President Trump is purposely sabotaging the talks for now, seeking a sharp enough equity market decline to force the Fed to ease policy further. At that point, he can turn around and agree a deal which would result in a monster rally, something for which we can be sure he would take credit. I’m not saying it’s true, just not out of the question!)

At any rate, nothing in the past several sessions has changed the view that the trade situation is going to continue to be one of the key drivers for market activity across all markets for the foreseeable future.

After that prolonged diatribe, let’s look at the other overnight data and developments. German GDP rose 0.4%, as expected, in Q1. This was a significant uptick from the second half of last year but appears to be the beneficiary of some one-off issues, with slower growth still forecast for the rest of the year. Given expectations were built in, the fact that the euro has softened a bit further, down 0.1% and back below 1.12, ought not be too surprising. Meanwhile, the pound is little changed on the day, but has drifted down to 1.2900 quietly over the past two sessions. Despite solid employment data yesterday, it seems that traders remain unconvinced that a viable solution will be found for Brexit. This morning the word is that PM May is going to bring her thrice-defeated Brexit deal to Parliament yet again in June. One can only imagine how well that will go.

Elsewhere in the G10 we have the what looks like a risk-off session. The dollar is modestly stronger against pretty much all of that bloc except for the yen (+0.2%) and the Swiss franc (+0.1%), the classic haven assets. So, bonds (Bund yields are -0.10%, their lowest since 2016) and currencies are shunning risk, while equity traders continue to lap it up. As I said, there is a conundrum.

This morning we finally get some US data led by Retail Sales (exp 0.2%, 0.7% ex autos) as well as Empire Manufacturing (8.5), IP (0.0%) and Capacity Utilization (78.7%) all at 8:30. Business Inventories (0.0%) are released at 10:00 and we also hear from two more Fed speakers, Governor Quarles and Richmond Fed President Barkin. However, it seems unlikely that, given the consistency of message we have heard from every Fed speaker since their last meeting, with Williams and George yesterday reinforcing the idea that there is no urgency for the Fed to change policy in the near term and politics is irrelevant to the decision process, that we will hear anything new from these two.

In the end, it feels like yesterday’s equity rebound was more dead-cat than a start of something new. Risks still abound and slowing economic growth remains the number one issue. As long as US data continues to outperform, the case for dollar weakness remains missing. For now, the path of least resistance is for a mildly firmer buck.

Good luck
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Still Feeling Stressed

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The overnight data expressed
That China is still feeling stressed
But Europe’s reports
Showed growth of some sorts
Might finally be manifest

The dollar is on its heels this morning after data from Europe showed surprising strength almost across the board. Arguably the most important data point was Eurozone GDP printing at 0.4% in Q1, a tick higher than expected and significantly higher than Q4’s 0.2%. The drivers of this data were Italy, where Q1 GDP rose 0.2%, taking the nation out of recession and beating expectations. At the same time Spain grew at 0.7%, also better than expectations while France maintained its recent pace with a 0.3% print. Interestingly, Germany doesn’t report this data until the middle of May. However, we did see German GfK Consumer Confidence print at 10.4, remaining unchanged on the month rather than falling as expected. Adding to the growth scenario were inflation readings that were generally a tick firmer than expected in Italy, Spain and France. While these numbers remain well below the ECB target of “close to but just below” 2.0%, it has served to ease some concerns about Europe’s future. In the end, the euro has rallied 0.25% while European government bond yields are all higher by 2-5bps. However, European equity markets did not get the memo and remain little changed on the day.

Prior to these releases we learned that China’s PMI data was softer than expected, with the National number printing lower at 50.1, while the Caixin number printed at 50.2. Even though both remain above the 50.0 level indicating future growth, there is an increasing concern that China’s Q1 GDP data was more the result of a distorted comparison to last year’s data due to changed timing of the Lunar New Year. Remember, that holiday has a large impact on the Chinese economy with manufacturing shutdowns amid widescale holiday making, and so the timing of those events each year are not easily stabilized with seasonal adjustments to the data. As such, it is starting to look like Q1’s 6.4% GDP growth may have been somewhat overstated. Of course, China remains opaque in many ways, so we may need to wait until next month’s PMI data to get a better handle on things. One other clue, though, has been the ongoing decline in the price of copper, a key industrial metal and one which China represents approximately 50% of global demand. Arguably, a falling copper price implies less demand from China, which implies slowing growth there. Ultimately, while it is no surprise that the renminbi is little changed on the day, Chinese equities edged higher on the theory that the PBOC is more likely to add stimulus if the economic slowdown persists.

Of course, the other China story is that the trade talks are resuming in Beijing today and market participants will be watching closely for word that things are continuing to move in the right direction. You may recall the President Xi Jinping gave a speech last week where he highlighted the changes he anticipated in Chinese policy, all of which included accession to US demands in the trade talks. At this point, it seems the negotiators need to “simply” hash out the details, which of course is not simple at all. But if the direction from the top is broadly set, a deal seems quite likely. However, as I have pointed out in the past, the market appears to have already priced in the successful conclusion of a deal, and so when (if) one is announced, I would expect equity markets to fall on a ‘sell the news’ response.

Turning to the US, yesterday’s data showed that PCE inflation (1.5%, core 1.6%) continues to lag expectations as well as remain below the Fed’s 2.0% target. With the FOMC meeting starting this morning, although we won’t hear the outcome until tomorrow afternoon, the punditry is trying to determine what they will say. The universal expectation is for no policy changes to be enacted, and little change in the policy statement. However, to me, there has been a further shift in the tone of the most recent Fed speakers. While I believe that Loretta Mester and Esther George remain monetary hawks, I think the rest of the board has morphed into a more dovish contingent, one that will respond quite quickly to falling inflation numbers. With that in mind, yesterday’s readings have to be concerning, and if we see another set of soft inflation data next month, it is entirely possible that the doves carry the day at the June meeting and force an end to the balance sheet roll-off immediately as a signal that they will not let inflation fall further. I think the mistake we are all making is that we keep looking for policy normalization. The new normal is low rates and growing balance sheets and we are already there.

As Powell and friends get together
The question is when, it’s not whether
More policy easing
Will seem less displeasing
So prices can rise like a feather

Looking at this morning’s releases, the Employment Cost Index (exp 0.7%) starts us off with Case-Shiller home prices (3.2%) and then Chicago PMI (59.0) following later in the morning. However, with the Fed meeting ongoing, it seems unlikely that any of these numbers will move the needle. In fact, tomorrow’s ADP number would need to be extraordinary (either high or low) to move things ahead of the FOMC announcement. All this points to continued low volatility in markets as players of all stripes try to figure out what the next big thing will be. My sense is we are going to see central banks continue to lean toward easier policy, as the global focus on inflation, or the lack thereof, will continue to drive policy, as well as asset bubbles.

Good luck
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