Tag Archives: #china

At the Nonce

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In Hanoi, the talks fell apart
In London, there’s cause to take heart
The market response
Sell stocks at the nonce
But Sterling looks good on the chart

The Trump-Kim denuclearization talks in Hanoi ended abruptly last evening as North Korea was apparently not willing to give up their program completely although they were seeking full sanctions relief. It appears that many investors were quite hopeful for a better outcome as equity markets across Asia fell as soon as the news hit the tape. Not surprisingly, South Korea was worst hit, with the KOSPI falling 1.5% while the won fell 0.5%. But the Nikkei in Japan fell 0.8% and Shanghai was down by 0.5% as well. In the currency market, the yen, benefitting from a little risk aversion, gained 0.2%, while the renminbi slipped slightly, down just 0.1%

Of course, the US-China trade talks are still ongoing and the big news there was that the US has, for the time being, removed the threat of increased tariffs. It appears that real progress has been made with respect to questions on technology transfer as well as verification of adherence to the new rules. It is surprising to me that this was not a bigger story for markets, although that may well be a sign that a deal is fully priced in already. In the meantime, Chinese data continues to disappoint with the Manufacturing PMI falling to 49.2, its third consecutive print below 50.0 and the weakest number in three years. It certainly appears as though President Xi is feeling real pressure to get a deal done. Of course, the Chinese equity market has had an even more impressive performance than that of the US so far this year, so it may be fair to say they, too, have priced in a deal. While things seem pretty good on this front right now, what is becoming apparent is that any hiccup in this process is likely to result in a pretty sharp equity market correction.

Turning to the UK, it appears that PM May’s game of chicken was really being played with the hard-liners in the Tory party who appeared perfectly willing to leave the EU with no deal. In yesterday’s debates, they were conspicuous by their silence on the subject and the growing belief is that May will be able to get support for her deal (with a side annex regarding the length of the Irish backstop) approved. While this will probably result in a three-month delay before it all happens, that will simply be to ensure that the proper legislation can be passed in Parliament. In another surprising market outcome, the pound has remained unchanged today despite the positive news. As I mentioned yesterday, the pound has rallied steadily for the past several weeks, and it appears that it may have run out of steam for the time being. While an approval vote will almost certainly result in a further rally, I’m skeptical that it has that much further to run. Unless, of course, there is a significantly more dovish turn from the Fed.

Speaking of the Fed, yesterday’s Powell testimony was just as dull as Tuesday’s. Arguably, the most interesting discussion was regarding the “Powell put” as one congressman harped on the concept for much of his allotted time. In the end, Powell explained that financial markets have an impact on the macroeconomy and that the Fed takes into account all those factors when making decisions. In other words, yes there is a put, but they want us to believe that the strike price is not simply based on the S&P 500, but on global markets in general. Given the importance of this comment, it was quite surprising that equity markets yesterday did not rally, but instead fell slightly. And futures are pointing lower this morning. At the same time, the dollar is generally under pressure with the euro rising 0.4% and now trading above 1.14 for the first time in three weeks. The single currency remains, however, right in the middle of its trading range for the past four months. In other words, this is hardly groundbreaking territory.

It is hard to ascribe the euro’s strength to any data this morning, although there has been plenty of that released, because generally it was in line with expectations. But even more importantly, it continues to show there is a lack of inflationary pressure throughout the Eurozone, which would undermine any thoughts the ECB will tighten earlier than now anticipated. Perhaps the one exception to that were comments from ECB member Francois Villeroy who explained that keeping rates negative for too long could have a detrimental impact on transmitting monetary policy properly. While that is certainly true, it has not been seen as a major concern to date.

Turning to this morning’s data story, Q4 GDP growth will finally be released (exp 2.4%) as well as Chicago PMI (57.8). In addition, we hear from six Fed speakers today starting with Vice-Chair Clarida at 8:00 this morning and finishing up with Chairman Powell at 7:00 this evening. However, given we just got two days of testimony from Powell, it is not clear what else they can say that will change views.

Overall, the dollar remains under pressure, and while it rallied during yesterday’s session, it has reversed that move so far this morning. As I have consistently said, the market is highly focused on the Fed’s more dovish turn and so sees the dollar softening. However, as other central banks become more clearly dovish, and they will as slowing growth permeates around the world, the dollar should regain its footing. Probably not today though.

Good luck
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Tariffs Can Wait

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Said Trump, for now tariffs can wait
Since talks with the Chinese are great
When this news emerged
The stock market surged
While dollars and bonds did deflate

In what cannot be a very great surprise, last evening President Trump announced that there has been substantial progress in the trade negotiations with China and that the mooted tariff increases on March 2nd are going to be delayed indefinitely while the talks continue. It was pretty clear that neither side really wanted to see tariffs rise again, but if the reports are accurate, there has been some real movement in terms of the negotiations. Given the focus by all markets on this story, the reactions cannot be a great surprise. That said, the fact that Shanghai closed higher by 5.6% and other global markets are higher by just 0.2%-0.4% hints at just how much more important this issue is for China than for the US.

But in fairness, there was another driver for Chinese stocks, the ‘official’ end of the deleveraging campaign of the past two years. Despite the fact that Chinese debt levels have barely slowed their growth, the fact that the economy has clearly been under pressure from slowing global growth, and the fact that the trade situation has clearly hampered recovery attempts has led to a decision to open the credit spigots again. Two years ago, the Chinese recognized that their financial structure was wobbling due to significant growth in off balance sheet leverage. After a two-year effort to reduce those risks, the imperative of supporting the broad economy is now far more important than worrying about some arcane financial statistics. In the end, every government, whether liberal or totalitarian, can only address structural issues for short periods of time before the pressure grows too great to support growth in any way they can. As to the renminbi, it has strengthened a bit further, rising 0.3% and now trading at its strongest levels since last July. If, as has been reported, the trade deal includes a currency portion, it seems appropriate to look for the renminbi to trade back toward the 6.20 level, another 5%-7% stronger, over time.

Though wily, Prime Minister May
Might soon find she’s nothing to say
‘bout any new terms
As Parliament firms
Support for a Brexit delay

Of the other two stories that have been market drivers, let’s discuss Brexit first. PM May met with other EU leaders in Egypt over the weekend and there are now two competing theories as to what might happen. May has postponed the vote on her deal until March 12, basically daring Parliament to vote no and cause a no-deal Brexit. At the same time, while talk in Parliament has been about voting for a three-month extension, the EU has now discussed a 21-month extension as the only alternative under the theory that three months is not enough time to get anything done. Of course, for the pro-Brexit forces, 21 months is unpalatable as well since that would give enough time to hold a second referendum, which based on all the recent polling, would result in a remain vote. The pound has drifted higher by 0.2% this morning, back to the high end of its recent trading range, but until there is more clarity on the outcome, it will remain locked in a fairly narrow range. For the past seven months, the pound has traded in a range of 1.25-1.32. It seems unlikely to break out until a more definitive outcome is clear with Brexit.

Finally, regarding the third major market driver, the Fed, there were several stories in the WSJ over the weekend about how the Fed is now reevaluating its inflation target. It seems that they have become increasingly unhappy with their inability to achieve the 2.0% target, as measured by PCE. The prevailing view is that because they have been so successful at moderating inflation, people’s inflation expectations have now fallen so much that inflation cannot rise. That feels a little self-serving to me, especially since the ‘feel’ of inflation appears much higher than what is measured. At least in my world. Ask yourself if it feels like inflation is running at 1.8%, as you consider things like education, the cost of health insurance and property taxes. The point, however, is that they seem to be laying the ground to maintain easier monetary policy for a much longer period. If they are not constrained by inflation rising above their target, then rates can stay lower for longer. Frighteningly, this seems to be the Fed’s attempt to embrace MMT. In the end, if the Fed modifies their policy targets in this manner, it will be a decided dollar negative. In fact, I will need to reevaluate the premises underlying my market views. Unless, of course, all the other major central banks do the same thing, which is a fair bet.

At any rate, with the trade discussion today’s biggest story, risk appetite has returned, and we are seeing higher equity markets along with a weaker dollar and falling bonds. That said, the dollar’s decline is not substantial, on the order of 0.2% overall, although it has fallen against most of its counterparts. Turning to the data story, this week brings a fair amount of information, as well as Congressional Testimony by Chairman Powell and a number of other Fed speakers:

Tuesday Housing Starts 1.25M
  Building Permits 1.29M
  Case-Shiller Home Prices 4.5%
  Consumer Confidence 124.7
Wednesday Factory Orders 0.5%
Thursday Initial Claims 220K
  Q4 GDP 2.3%
  Chicago PMI 57.0
Friday Personal Income 0.3%
  Personal Spending -0.2%
  PCE 0.0% (1.7% Y/Y)
  Core PCE 0.2% (1.9% Y/Y)
  ISM Manufacturing 55.5
  Michigan Sentiment 95.7

In addition to Powell’s testimony, he speaks again Thursday morning, and is joined by five other Fed speakers throughout the week. Unless the data is extraordinarily strong, it is clear that there will be no discussion of further rate hikes. In fact, given this new focus on the inflation target, I expect that will be the topic of note amongst the group of them. And as all signs point to this being yet another way to justify easy money, look for a consensus to quickly build. If I am correct about the Fed’s turn regarding how they view inflation, the dollar will suffer going forward. This will force me to change my longer term views, so this week will be quite important to my mind. For today, however, it seems evident that risk appetite will help push the dollar somewhat lower from here.

Good luck
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No Magical Date

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March 1st is no magical date
Said Trump, while investors fixate
On whether a deal
On trade will be sealed
By then, or if tariffs can wait

After a day where there was mercifully little discussion of the ongoing trade negotiations, they have come back to the fore. Yesterday, President Trump indicated that the March 1st deadline for a deal was now far more flexible than had previously been indicated. Based on the reports that there has been substantial progress made so far, it seems a foregone conclusion that tariffs will not be rising on March 2nd. However, key issues remain open, notably the question of forced technology transfer and IP theft. Of course, as the Chinese maintain that neither one of those things currently occur, it is difficult for them to accept a resolution and change their methods. On the flip side, both Trump and Xi really need a deal to remove a major economic concern as well as to demonstrate their ability to help their respective nations.

One of the things that appears to be on the agenda is a Chinese pledge to maintain a stable yuan going forward, rather than allowing the market to determine its value. Looking back, it is ironic that the IMF allowed the yuan to join the SDR in 2016 to begin with, given that it continues to lack a key characteristic for inclusion in the basket; the ability to be “freely usable” to make payments for international transactions. And while the PBOC had been alleging that they were slowly allowing more market influence on the currency in their efforts to internationalize it, the results of the trade talks seem certain to halt whatever progress has been made and likely reverse some portion of it. It should be no surprise that the yuan strengthened on the back of these reports with the currency rallying 0.8% since yesterday morning. If currency control is part of the deal, then my previous views that the renminbi will weaken this year need to be changed. Given the continued presence of financial controls in China, if they choose to maintain a strong CNY, they will be able to do so, regardless of what happens in the rest of the world.

Meanwhile, away from the trade saga, the ongoing central bank activities remain the top story for markets. This has been made clear by comments from several central bankers in the past 24 hours. First, we heard from Cleveland Fed President Mester who, unlike the rest of the speakers lately, indicated that she expects rates to be higher by the end of the year. her view is that 3.00% is the neutral rate and that while waiting right now makes sense, the growth trajectory she expects will require still higher rates. However, while the FX market paid her some attention, it is not clear that the equity market did. Two things to note are that she is likely the most hawkish member of the Fed to begin with, and she is not a voting member this year, so will not be able to express her views directly.

Remember, too, that at 2:00 this afternoon, the FOMC Minutes of the January meeting will be released. Market participants and analysts are all very interested to see the nature of the conversation that led to the remarkable reversal from ‘further rate hikes are likely, to ‘patience is appropriate for now’ all while economic data remained largely unchanged. Until that release, most traders will be reluctant to add to any positions and movement is likely to be muted.

Across the pond, ECB Member Peter Praet continues to discuss the prospect of rolling over TLTRO’s which begin coming due in June of next year. Remember, one of the key issues for the Eurozone banks who availed themselves of this funding is that once the maturities fall below one year, it ceases to be considered long term funding and impacts bank capital ratios. Banks will then either have to call in loans that were made on the basis of this funding, or raise loan interest rates, or see their profits reduced as they pay more for their capital. None of these situations will help Eurozone growth. So, despite claims that banks must stand on their own, and TLTRO’s will only be rolled over if there is a monetary policy case to be made, the reality is that it is quite clear the ECB will roll these loans over. If they don’t, it will require the restarting of asset purchases or some other easing measure.

Once again, I will highlight that given the current growth and inflation trajectories in the Eurozone, there is a vanishingly small probability that the ECB will allow policy to get tighter than its current settings, and a pretty large probability that they will ease further. This will not help the euro regardless of the Fed’s actions. Yesterday saw the euro rally on the back of the updated trade story, but that has been stopped short as the market begins to accept the idea that the ECB is not going to tighten policy at all. Thus, this morning, the euro is unchanged.

The final story of note is, of course, Brexit, where the most recent word is that PM May is seeking to get a subtle change in the EU stance on the backstop plan thus allowing a new vote, this time with a chance of passing. The pro-Brexit concern is that the current form of the backstop will force the UK to be permanently attached to the EU’s trade regime with no say in the matter, exactly the opposite of what they voted for. May is meeting with EU President Juncker today, and it is quite possible that the EU is starting to feel the pressure of the ramifications of a no-deal Brexit and getting concerned. The Brexit outcome remains highly uncertain, but the FX implications remain the same; a Brexit deal will help the pound rally initially, while a no-deal Brexit will see a sharp decline in Sterling. Yesterday there was hope for the deal and the pound rallied. This morning, not so much as the pound has given back half the gain and is down 0.2% on the day.

Elsewhere, the dollar has been mixed with gainers and losers in both the G10 and the EMG blocs as everybody awaits the Minutes, which is the only data for the day. It is hard to believe there will be much movement ahead of them, and afterwards, it will depend on what they say.

Good luck
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Two Countries that Fought

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There once were two countries that fought
‘bout trade as each one of them thought
The other was cheating
Preventing competing
By champions both of them sought

They sat down to seek a solution
So both could avoid retribution
But talks have been tough
And not yet enough
To get a deal for execution

The US-China trade talks continued overnight, and though progress in some areas has been made, clearly it has not yet been enough to bring in the leadership. The good news is that the talks are set to continue next week back in Washington. The bad news is that the information coming out shows that two of the key issues President Trump has highlighted, forced technology transfer and subsidies for SOE’s, are nowhere near agreement. The problem continues to be that those are pillars of the Chinese economic model, and they are going to be loath to cede them. As of this morning, increased tariffs are still on the docket for midnight, March 2, but perhaps next week enough progress will be made to support a delay.

Equity markets around the world seemed to notice that a deal wasn’t a slam dunk, and have sold off, starting with a dull session in the US yesterday, followed by weakness throughout Asia (Nikkei -1.1%, Shanghai -1.4%). Interestingly, the European markets have taken a different view of things this morning, apparently attaching their hopes to the fact that talks will continue next week, and equity markets there are quite strong (DAX +1/0%, FTSE +0.4%). And the dollar? Modestly higher at this time, but overall movement has been muted.

Asian markets also felt the impact of Chinese inflation data showing CPI fell to 1.7% last month, below expectations and another indication that growth is slowing there. However, the loan data from China showed that the PBOC is certainly making every effort to add liquidity to the economy, although it has not yet had the desired impact. As to the renminbi, it really hasn’t done anything for the past month, and it appears that traders are biding their time as they wait for some resolution on the trade situation. One would expect that a trade deal could lead to modest CNY strength, but if the talks fall apart, and tariffs are raised further, look for CNY to fall pretty aggressively.

As to Europe, the biggest news from the continent was political, not economic, as Spain’s PM was forced to call a snap election after he lost support of the Catalan separatists. This will be the nation’s third vote in the past four years, and there is no obvious coalition, based on the current polls, that would be able to form. In other words, Spain, which has been one of the brighter lights in the Eurozone economically, may see some political, and by extension, economic ructions coming up.

Something else to consider on this issue is how it will impact the Brexit negotiations, which have made no headway at all. PM May lost yet another Parliamentary vote to get the right to go back and try to renegotiate terms, so is weakened further. The EU does not want a hard Brexit but feels they cannot even respond to the UK as the UK has not put forth any new ideas. At this point, I would argue the market is expecting a delay in the process and an eventual deal of some sort. But a delay requires the assent of all 27 members that are remaining in the bloc. With Spain now in political flux, and the subject of the future of Gibraltar a political opportunity for domestic politics, perhaps a delay will not be so easy to obtain. All I know is that I continue to see a non-zero probability for a policy blunder on one or both sides, and a hard Brexit.

A quick look at the currency markets here shows the euro slipping 0.2% while the pound has edged higher by 0.1% this morning. Arguably, despite the Brexit mess, the pound has been the beneficiary of much stronger than expected Retail Sales data (+1.0% vs. exp +0.2%), but in the end, the pound is still all about Brexit. The sum total of the new economic information received in the past 24 hours reaffirms that global growth is slowing. Not only are inflation pressures easing in China, but US Retail Sales data was shockingly awful, with December numbers falling -1.2%. This is certainly at odds with the tune most retail companies have been singing in their earnings reports, and given the data was delayed by the shutdown, many are wondering if the data is mistaken. But for the doves on the Fed, it is simply another point in their favor to maintain the status quo.

Recapping, we see trade talks dragging on with marginal progress, political pressure growing in Spain, mixed economic data, but more bad news than good news, and most importantly, a slow shift in the narrative to a story of slowing growth will beget the end of monetary tightening and could well presage monetary ease in the not too distant future. After all, markets are pricing in rate cuts by the Fed this year and no rate movement in the ECB (as opposed to Draghi’s mooted rate hikes later this year) until at least 2020. The obvious response to this is…add risk!

A quick look at today’s data shows Empire State Manufacturing (exp 7.0), IP (0.1%), Capacity Utilization (78.7%) and Michigan Sentiment (94.5). We also have one last Fed speaker, Raphael Bostic from Atlanta. Virtually all the recent Fed talk has been about when to stop the balance sheet runoff, with Brainerd and Mester the latest to discuss the idea that it should stop soon. And my guess is it will do just that. I would be surprised if they continue running down the balance sheet come summer. The changes going forward will be to the composition, less mortgages and more Treasuries, but not the size. And while some might suggest that will remove a dollar support, I assure you, if the Fed has stopped tightening, no other nation is going to continue. Ironically, this is not going to be a dollar negative, either today or going forward.

Good luck and good weekend
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Compromised

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The punditry seemed quite surprised
That trade talks have been compromised
If President’s Xi
And Trump can’t agree
To meet, forecasts need be revised

What then, ought the future might hold?
It’s likely that stocks will be sold
And Treasuries bought
As safety is sought
Plus rallies in dollars and gold

Risk appetites have definitely diminished this morning as evidenced by yesterday’s US equity decline alongside a very weak showing in Asia overnight. The proximate cause is the news that President’s Trump and Xi are not likely to meet ahead of the March 1 deadline regarding increased tariffs on Chinese goods. And while trade talks are ongoing, with Mnuchin and Lighthizer heading to Beijing next week, it seems pretty clear that the market was counting on a breakthrough between the presidents in a face-to-face meeting. However, not unlike the intractable Irish border situation in the Brexit discussions, the question of state subsidies and IP theft forced technology transfer are fundamental to the Chinese economy and therefore essentially intractable for Xi. I have consistently maintained that the market was far too sanguine about a positive outcome in the near-term for these talks, and yesterday’s news seems to support that view.

Of course, eventually a deal will be found, it is just not clear to me how long it will take and how much pain both sides can stand. Whether or not Fed Chair Powell believes he capitulated to Trump regarding interest rates, it is clear Trump sees it in that light. Similarly, it appears the president believes he has the upper hand in this negotiation as well and expects Xi to blink. That could make for a much rockier path forward for financial markets desperate to see some stability in global politics.

The trade news was clearly the key catalyst driving equities lower, but we continue to see weakening data as well, which calls into question just how strong global growth is going to be during 2019. The latest data points of concern are Italian IP (-0.8%, exp +0.4%) and the German trade surplus falling to €13.9B from €20.4B in November. Remember, Germany is the most export intensive nation in the EU, reliant on running a significant trade surplus as part of its macroeconomic policy structure. If that starts to shrink, it bodes ill for the future of the German economy, and by extension for the Eurozone as a whole. While it cannot be too surprising that the Italian data continues to weaken, it simply highlights that the recession there is not likely to end soon. In fact, it appears likely that the entire Eurozone will be mired in a recession before long. Despite the ongoing flow of weak data, the euro, this morning, is little changed. After a steady 1.25% decline during the past week, it appears to have found a little stability this morning and is unchanged on the day.

In fact, lack of movement is the defining feature of the currency markets this morning as the pound, yen, Loonie, kiwi, yuan, rupee and Mexican peso are all trading within a few bps of yesterday’s levels. The only currency to have moved at all has been Aussie, which has fallen 0.25% on continued concerns over the growth prospects both at home and in China, as well as the ongoing softness in many commodity prices.

The other noteworthy items from yesterday were comments from St Louis Fed president Bullard that he thought rates ought to remain on hold for the foreseeable future. Granted, he has been one of the two most dovish Fed members (Kashkari being the other) for a long time, but he was clearly gratified that the rest of the committee appears to have come around to his point of view. And finally, the Initial Claims data printed at a higher than expected 234K. While in the broad scheme of things, that is still a low number, it is higher than the recent four-week average, and when looking at a chart of claims, it looks more and more like the bottom for this number is likely behind us.

A great deal has been written recently about the reliability of the change in the Unemployment rate as a signal for a pending recession. History shows that once the Unemployment rate rises 0.4% from its trough, a recession has followed more than 80% of the time. Thus far, that rate has risen 0.3% from its nadir, and if claims data continues to rise, which given recent numbers seems quite possible, the implication is a recession is in our future. The one thing we know about recessions is that the Fed has never been able to forecast their onset. Given the fact that this recovery is quite long in the tooth, at 115 months of age, it cannot be surprising that a recession is on the horizon. My concern is that the horizon is beneath our feet, not in the distance.

There is no US data to be released today although next week brings both inflation and manufacturing data. But for now, all eyes are on the deteriorating view of the trade situation, which is likely to keep pressure on equity markets (futures are currently pointing lower by 0.5%) while helping support the dollar as risk is continuously reduced.

Good luck and good weekend
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A Bad Dream

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According to pundits’ new theme
December was just a bad dream
Though Europe’s a mess
And China feels stress
The fallout was way too extreme

The thing is, the data of late
Worldwide has not really been great
The only thing growing
Is debt which is sowing
The seeds of a troubled debate

The dollar has been edging higher over the past several sessions which actually seems a bit incongruous based on other market movements. Equity investors continue to see a glass not half full, but overflowing. Bond yields are edging higher in sync with those moves as risk is being acquired ‘before it’s too late’. But the dollar, despite the Fed’s virtual assurance that we have seen the last of the rate hikes, has been climbing against most counterparts for the past two sessions.

Some of this is clearly because we are getting consistently bad economic data from other countries. For example, last night saw Services PMI data from around the world. In France, the index fell to 47.8, its worst showing in five years. German data printed a slightly worse than expected 53.0, while the Eurozone as a whole remained unchanged at 51.2 It should be no surprise that Italy, which is currently in recession, saw its number fall below 50 as well, down to 49.7. Thus, while Brexit swirls on in the background, the Eurozone economy is showing every sign of sliding toward ever slower growth and inflation. As I have been repeating for months, the ECB will not be tightening policy further. And as the Brexit deadline approaches, you can be sure that the EU will begin to make more concessions given the growing domestic pressure that already exists due to the weakening economy. Net, the euro has decline 0.2% this morning, and is ebbing back to the level seen before the Fed capitulated.

Speaking of Brexit, the UK Services PMI data fell to 50.1, its worst showing in two- and one-half years, simply highlighting the issues extant there. PM May’s strategy continues to consist of trying to renegotiate based on Parliament’s direction, but the EU continues to insist it cannot be done. While very few seem to want a hard Brexit, there has been very little accomplished of late that seems likely to prevent it. And the pound? It has fallen a further 0.2% and is trading back just above 1.30, its lowest level in two weeks and indicative of the fact that the certainty about a deal getting done, or at the very least a delay in any decision, is starting to erode.

With the Lunar New Year continuing in Asia, there is no new news on the trade front, just the ongoing impact of the tariffs playing out in earnings releases and economic reports. But this story is likely to be static until the mooted meeting between the two presidents later this month. My observation is that the market has priced in a great deal of certainty that a deal will be agreed and that the tariff regime will end. Quite frankly, that seems very optimistic to me, and I think there is a very real chance that things deteriorate further, despite the incentives on both sides to solve the problem. The issue is that the US’s trade concerns strike at the very heart of the Chinese economic model, and those will not be easily changed.

Elsewhere, the yen has been falling modestly of late, which is not surprising given the recent risk-on sentiment in markets, but the Japanese economy has not shown any signs that the key concern over inflation, or lack thereof, has been addressed. During December’s equity meltdown, the yen rallied ~4.5%. Since then, it has rebound about half way, and in truth, since equity markets stabilized in the middle of January, the yen has been in a tight trading range. At this point, given the complete lack of ability by the BOJ to impact its value based on monetary policy settings, and given the strong belief that it represents a safe haven in times of trouble (which is certainly true for Japanese investors), the yen is completely beholden to the market risk narrative going forward. As long as risk is embraced, the yen is likely to edge lower. But on risk off days, look for it to rebound sharply.

And that’s really all we have for today. This evening’s State of the Union address by President Trump has the potential to move markets given the contentious nature of his current relationship with the House of Representatives. There is growing talk of another Federal government shutdown in two weeks’ time, although as far as the FX market was concerned, I would say the last one had little impact. Arguably, the dollar’s weakness during that period was directly a result of the change in Fed rhetoric, not a temporary interruption of government services.

At 10:00 this morning the ISM Non-Manufacturing data is released (exp 57.2), which while softer than last month remains considerably higher than its European and Chinese counterparts. Overall, as markets continue to reflect an optimistic attitude, I would expect that any further dollar strength is limited, but in the event that fear returns, the dollar should be in great demand. However, that doesn’t seem likely for today.

Good luck
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Really Quite Splendid

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For traders, the month that just ended
Turned out to be really quite splendid
The stock market soared
As risks were ignored
Just like Chairman Powell intended

The problem is data last night
Showed growth’s in a terrible plight
Both Europe and China
Can lead to angina
If policymakers sit tight

Now that all is right with the world regarding the Fed, which has clearly capitulated in its efforts to normalize policy, the question is what will be the driving forces going forward. Will economic data matter again? Possibly, assuming it weakens further, as that could quickly prompt actual policy ease rather than simply remaining on hold. But reading between the lines of Powell’s comments, it appears that stronger than expected data will result in virtually zero impetus to consider reinstating policy tightening. We have seen the top in Fed funds for many years to come. Remember, you read it here first. So, we are now faced with an asymmetric reaction function: strong data = do nothing; weak data = ease.

Let’s, then, recap the most recent data. Last night the Caixin Manufacturing PMI data from China was released at a lower than expected 48.3, its lowest point in three years. That is simply further evidence that the Chinese economy remains under significant pressure and that President Xi is incented to agree to a trade deal with the US. Interestingly, the Chinee yuan fell 0.6% on the news, perhaps the first time in months that the currency responded in what would be considered an appropriate manner to the data. That said, the yuan remains nearly 2% stronger than it began the year. We also saw PMI data from Europe with Germany (49.7) and Italy (47.8) both underperforming expectations, as well as the 50.0 level deemed so crucial, while France (51.2) rebounded and Spain (52.4) continued to perform well. Overall, the Eurozone data slid to 50.5, down a full point and drifting dangerously close to contraction. And yet, Signor Draghi contends that this is all just temporary. He will soon be forced to change his tune, count on it. The euro, however, has held its own despite the data, edging higher by 0.2% so far this morning. Remember, though, with the Fed having changed its tune, for now, I expect the default movement in the dollar to be weakness.

In the UK, the PMI data fell to 52.8, well below expectations, as concerns over the Brexit situation continue to weigh on the economy there. The pound has fallen on the back of the news, down 0.3%, but remains within its recent trading range as there is far more attention being paid to each item of the Brexit saga than on the monthly data. Speaking of which, the latest story is that PM May is courting a number of Labour MP’s to see if they will break from the party direction and support the deal as written. It is quite clear that we have two more months of this process and stories, although I would estimate that the broad expectation is of a short delay in the process beyond March and then an acceptance of the deal. I think the Europeans are starting to realize that despite all their tough talk, they really don’t want a hard Brexit either, so look for some movement on the nature of the backstop before this is all done.

Finally, the trade talks wrapped up in Washington yesterday amid positive signs that progress was made, although no deal is imminent. Apparently, President’s Trump and Xi will be meeting sometime later this month to see if they can get to finality. However, it still seems the most likely outcome is a delay to raising tariffs as both sides continue the talks. The key issues of IP theft, forced technology transfer and ongoing state subsidies have been important pillars of Chinese growth over the past two decades and will not be easily changed. However, as long as there appears to be goodwill on both sides, then there are likely to be few negative market impacts.

Turning to this morning’s data, it is payroll day with the following expectations:

Nonfarm Payrolls 165K
Private Payrolls 170K
Manufacturing Payrolls 17K
Unemployment Rate 3.9%
Average Hourly Earnings 0.3% (3.2% Y/Y)
Average Weekly Hours 34.5
ISM Manufacturing 54.2
Michigan Sentiment 90.8

Clearly, the payroll data will dominate, especially after last month’s huge upside surprise (312K). Many analysts are looking for a reversion to the mean with much lower calls around 100K. Also, yesterday’s Initial Claims data was a surprisingly high 253K, well above expectations, although given seasonalities and the potential impacts from the Federal government shutdown, it is hard to make too big a deal over it. But as I highlighted in the beginning, the new bias is for easier monetary policy regardless of the data, so strong data will simply underpin a stock market rally, while weak data will underpin a stock market rally on the basis of easier money coming back. In either case, the dollar will remain under pressure.

Good luck and good weekend
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A Market Doomsday

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Last week it was Mario’s turn
To tell us what gave him heartburn
The risk which is growing
That Europe is slowing
Thus, negative rates won’t adjourn

This week eyes are on Chairman Jay
Whose last comments tried to defray
The idea the rates
That he regulates
Will e’er cause a market doomsday

As we begin the new week, the biggest weekend event was the reopening of the US Federal government, although apparently it could shut down again in three weeks. Funnily enough, while economists have calculated that each week the government was closed, GDP would be reduced by 0.1%, nobody seemed to care that much. I think if traders can explain an anomaly, they will ignore it in pricing. And certainly, a government shutdown is a big picture anomaly.

But all the other stories remain the same. Brexit is still unresolved with the next series of votes to be held tomorrow. It remains unclear exactly how things will play out, but it seems pretty clear that neither side wants a no-deal outcome. However, whether that means a vote to delay things, or acceptance of the deal that was roundly rejected just two weeks ago is completely uncertain. Of course, the third option is that they simply opt not to leave the EU, which is within their power. At this point, it seems the most likely outcome is a delay, as nobody likes the deal, and PM May has consistently indicated she would follow the vote to leave.

With that as the background, the pound is lower by -0.4% this morning, actually one of the larger movers in FX overnight. This appears to be short term profit taking by traders who have been accumulating long positions over the past month. But keep in mind that the big, long-term positions remain short pounds. So as long as there is no hard Brexit, which seems highly unlikely given both sides’ stated opposition to that outcome, there is room for the pound to rebound in the next months. However, I continue to like the dollar far better than the pound given the potential for future growth in both places. And while the Fed may not be aggressively tightening policy anymore, I don’t think we are that close to easing. Meanwhile, the BOE is watching the UK economy slow perceptibly, and cannot be serious about raising rates in the near term.

But this week is really about two things, the FOMC meeting and the trade talks with China. Looking at the latter first, both sides have made encouraging noises, but the key issues for the US remain IP theft and SOE support, neither of which have been adequately addressed. I know the equity market has been euphoric over every hint that the trade war would end, and tariffs would be removed, but I think they are way ahead of themselves. I fear there is, at best, a 50:50 chance that talks are concluded successfully before the March deadline. However, I think it likely that as long as the dialog remains open, the US postpones implementation of new, larger tariffs. As to the FX impact, you can be sure that the PBOC is going to prevent CNY from weakening in any substantial way until the talks are concluded one way or the other. But given the ongoing weak data in China, I continue to expect to see the renminbi weaken over time.

And finally, the Fed. On Wednesday Chairman Powell will have a press conference after the statement is released at 2:00 EST. (There is zero expectation that policy will change.) There has been a great deal of carping by Street economists that because Powell is not a PhD economist himself, he cannot adequately deliver the message. But I disagree. Instead, I would argue the reason there has been difficulty in articulating the Fed’s stance is that they don’t really know what to do. The current situation is unprecedented historically, between the size of the balance sheet and the level of interest rates relative to the growth trajectory of the economy. They have already had to change the way they manage interest rates, no longer adjusting balances in the market and instead paying interest on excess reserves. The upshot of that change is that there is no history for them to examine regarding potential outcomes. At the same time, to a wo(man), every Fed member is adamant that because Treasuries have behaved well, the balance sheet rundown is not having any impact on markets at all. To which I ask, if it’s not having an impact, why did they do it in the first place? Clearly the Fed thought that QE was going to help support the economy by supporting the stock market (you remember, the Portfolio Balance Channel). So how can they seriously believe that if the implementation of QE was stimulative, its reduction would not reverse that stimulus? It is arguments like this that frustrate investors and help chip away at the Fed’s credibility.

As to the markets today, the dollar is pretty well behaved, having stabilized after pretty substantial weakness on Friday. Other than the pound mentioned above, not much significant movement has been observed. Equity markets are softer around the world and US futures are pointing in the same direction. Treasury yields have not moved from Friday, and oil prices are slipping slightly. It is hard to characterize the market as anything other than confused.

On the data front, although the government shutdown has ended, all the data has not been collected, let alone collated, so I expect that we will start to see things during the week. Of course, Friday brings the payroll report, and that seems set to be released. There is nothing of note scheduled today, so I will wait to list things until tomorrow when there is more certainty as to what is coming and when. So, for today, there seems little reason for the dollar to do much unless something really negative occurs in equities. That’s not my base case, but you never know, especially as there are key earnings releases later this week (Apple, Amazon, Microsoft, Alphabet) and any rumors could drive things. But overall, I expect a quiet session today.

Good luck
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A Terrible Sight

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The data from China last night
Described their economy’s plight
With trade talks ongoing
Their growth is still slowing.
For Xi, it’s a terrible sight

While the Martin Luther King holiday in the US will close markets and keep things quiet here, the rest of the world continues to be active. Equity markets in Europe are weak on the back of disappointing data from China. In fact, that has been the story of the day. Chinese GDP in Q4 was reported at 6.4% higher than Q4 2018, its slowest pace of growth since the financial crisis in 2009. And when considered on an annual basis, the 6.6% growth in calendar 2018 was the slowest pace of growth since 1990. Retail Sales and Industrial Production also continued their long-term downtrends, with no sign that things are set to reverse anytime soon. While the trade situation with the US is clearly weighing on the Chinese economy, they are also reaping the ‘benefits’ of the decades of increased leverage needed to achieve previous growth targets. The telling statistic I’ve seen is that ten years ago, one dollar of leverage bought $0.80 worth of additional growth. Today that number is ~$0.15 of additional growth for each new dollar of leverage. That is not the recipe for long term success!

In the meantime, despite the comments on Friday about China proposing a path to reduce the US trade deficit to zero over six years, it seems that substantive talks on protecting IP and preventing its forced transfer to local Chinese partners have gone nowhere. (In addition, the idea that reducing that trade deficit to zero would be net beneficial is not actually clear. (This article by Mike Ashton, @inflation_guy (https://mikeashton.wordpress.com/author/mikeashton/)  does an excellent job of describing potential outcomes.) At any rate, Friday’s good vibes are not nearly as apparent this morning.

Of course, the other storyline that has been nonstop is Brexit, with today the deadline for PM May to put forth her Plan B. It remains unclear as to what she can actually change to get Parliament to agree, but she will try for something. An interesting analysis I saw this weekend actually made the case that the risk of a no-deal Brexit was actually vanishingly small. The idea is that Parliament will vote to make that outcome illegal, meaning the government cannot accept that as an outcome. (Remember, Parliament and the government are not the same institution, similar to our legislative and executive branches in the US.) The alternatives are to delay the deadline in order to get a new referendum put together, or to unilaterally decide not to leave. The problem I have with that idea is that it seems a bit like Parliament declaring that recessions are illegal. As much as they would like to avoid having them, it is not clear they control the situation. Certainly, the FX market is coming around to that view as the pound has been rallying for five weeks (although there was virtually no movement overnight), but it seems to me that there is still a significant risk of a no-deal outcome, which given the recent rally, will almost certainly result in a sharp fall in the pound.

Away from those two stories, things remain remarkably dull in the FX world. The ongoing government shutdown in the US has had limited impact (arguably just that some data has not been released), while within the Eurozone, data continues to ebb and the political will to make changes of substance remains absent. Japan remains in stasis and there is virtually no possibility, in my view, that either the ECB or the BOJ tightens policy at all in 2019. In fact, I continue to believe that they will both seek to ease further at the margins.

What about the emerging market you may ask? Again, the story remains one of limited new news, at least news that is sufficient to drive market movement. Overall, investors and traders are wedded to the big picture stories like trade and Brexit, and we continue to see broad based moves accordingly.

The data story this week is unimpressive (largely due to the shutdown) with just two data points coming, tomorrow’s Existing Home Sales (exp 5.24M) and Thursday’s Initial Claims (218K). With the Fed meeting next week, they are now in their quiet period so there are no speakers on the docket. Arguably, the ECB meeting on Thursday is the biggest FX news of the week, but there is no expectation for anything new. I imagine the press conference will focus on the previous comments about tightening later this year in the context of the ongoing economic slowdown there, but we have a few days before we have to worry about that. In the end, the dollar is modestly higher this morning, but I expect it to see very limited movement in the holiday market.

Good luck
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Ill at Ease

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The nation that once ruled the seas
Has lately been brought to its knees
The Minister, Prime
Has run out of time
And Parliament’s still ill at ease

In ten days, some votes will be held
As MP’s there all feel compelled
To take more control
Around the black hole
Of Brexit, so fears might be quelled

There continue to be two main stories driving markets, Brexit and the trade war between the US and China. Everything else has faded into the background amid moderating global growth and concerns of worse to come.

Starting with Brexit, in a week and a half (it’s actually 11 days, but that didn’t fit into the limerick), Parliament will be holding a series of votes to try to wrest control of the process from the government and to explain their demands on behalf of the ‘people’. Alas, what is clear is that there is no consensus on how to proceed, with a large number not wanting to go through with it at all, while others seek a hard Brexit. PM May has insisted that the vote was for leaving the EU, and that is exactly what the UK is going to do. Currently, the best idea that anybody seems to have is to seek to delay the official date for up to a year in order to come up with more support for any action at all. There is talk of holding a second referendum, talk of a snap election to help PM May win a mandate on how to proceed, and talk of a hard Brexit. The one thing that is clear is that the deal on the table will not be the roadmap, at least not as currently written.

With all that in mind, the FX market is starting to vote, and they are coming around to the idea that there will be no Brexit at all. At least that is my take on the fact that the pound has been rising steadily since the beginning of the year. While it is actually slightly softer this morning (-0.35%) on the back of weaker than expected Retail Sales figures (-0.9% in Dec), it is higher by 3.5% since January 2nd. My view that a hard Brexit will result in a much lower pound is universal, while a deal would clearly help the pound’s value. But no Brexit at all might open up a very significant rally. Remember, before the vote, the pound was trading around 1.45-1.50. Price action indicates to me that there are more and more traders and speculators who are betting on no Brexit and a sharp rebound. I will say that if there is a decision to hold a second referendum, look for the pound to rally very sharply, easily another 5%-8%, and to do so quickly. I just don’t think there will be another referendum.

As to the trade spat, the WSJ published an article of rumors and innuendo about the idea that the US is contemplating removing tariffs as a sign of good faith and a spur to help an agreement be reached. What was interesting was that at the very end of the article, it was mentioned that all of this talk was in the context of how to move the talks forward, and not an agreed plan of action. But equity markets around the world continue to look for positive catalysts and the end of the trade war would definitely fit that bill. Given the story was published late yesterday afternoon, it is no surprise that equity markets around the world have rallied, with Asia (Nikkei +1.3%, Shanghai +1.4%) and Europe (+1.0%-1.5% across the board) both performing quite well while US futures are pointing higher as well, albeit not quite as robustly (+0.4%). But the dollar has seen very little impact from this news as aside from the pound’s modest decline, it is doing very little overall.

Beyond those stories, much less of note is happening. Next week the ECB meets, and we are starting to see analysts discuss the prospects for the previously expected rate hikes later this year. Given the ongoing softness in Eurozone data, it remains hard to believe that the ECB is going to think that raising rates is the correct move. Rather, more likely will be an extension of the TLTRO’s and interest rates remaining right where they are for an extended period from here. All eyes will be on Signor Draghi’s characterization of the economy, as to whether risks are tilted to the downside or things are balanced, but even if he claims balance, the reality is the data is pointing lower. At some point, that will be acknowledged, and it will be clearer to all that policy will not tighten further in Europe for many years. In fact, it is much easier to believe that the next move will be for easier policy than tighter. And as I have continued to explain, I believe that will help the dollar overall.

As to this morning’s data, we see IP (exp 0.2%), Capacity Utilization (78.5%) and Michigan Sentiment (97.0). Canadian Inflation is also on the docket (1.7%), which hardly seems a reason to expect higher rates there. Looking ahead, there are no more Fed speakers until the meeting on the 30th as they have entered their quiet period. But the message we have received is quite clear, patience is a virtue and there will be no rate hike in either January or March. After that, if the data supports the idea that growth and inflation are picking up, I think they will move, but unfortunately, given the overall tone of data, that seems unlikely. As to the tone for today, it is hard to get too excited about the FX market without further specific news. It wouldn’t surprise to see the pound drift a bit lower as there will be some profit taking on the recent move, but for now, the dollar is likely to remain under very modest pressure overall. Especially if equities in the US perform like those elsewhere.

Good luck and good weekend
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