Removal of Tariffs

According to some in Beijing
Removal of tariffs’ the thing
That ought to diminish
And fin’lly help finish
The problems the trade war did bring

Another day, another story about progress in the trade talks. Given the complete lack of movement actually seen, a cynic might conclude that both sides have realized just talking about progress is probably as effective as making progress, maybe more so. After all, making progress requires both sides to make actual decisions. Talking about progress just hints that those decisions are being made. And let’s face it; the one thing at which politicians have proven especially inept is making decisions. At any rate, the news early this morning was that part of the elusive phase one deal would be simultaneous rollbacks of the current tariff schedules. If true, that is a great leap forward from simply delaying the imposition of new tariffs. But the key is, if true. At this point, it has become difficult to recognize the difference between actual progress and trial balloons. The one thing going for this story is it was put out by the Chinese, not President Trump. Of course, that could simply be a negotiating tactic trying to force Trump’s hand.

It should be no surprise that the market reacted quite positively to the story, with equity markets in Asia turning around from early losses to close higher on the day. While the Nikkei just clawed back to +0.1%, the Hang Seng finished higher by 0.6% and Australia’s ASX 200 gained 1.0% on the day. Europe has followed the trend with the DAX leading the way, +0.75%, and the rest of the Continent showing gains of between 0.2% (CAC) and 0.6% (IBEX). And of course, US futures turned higher on the news, now showing gains of approximately 0.5% across all three.

So risk is in vogue once again. Treasuries and Bunds have both sold off sharply, with yields in the 10-year space higher by roughly 6bps in both markets. And the dollar, as would be expected, is under further pressure this morning.

A trade truce cannot come soon enough for Germany, which once again released worse than expected data. This morning’s miss was IP, which fell 0.6% in September, and is down 4.3% Y/Y. So while yesterday’s Factory Orders seemed positive, they also seem like the outlier, not the trend. However, given the dollar’s overall performance this morning, it should be no surprise that the euro has edged higher, rising 0.1% as I type. But a step back for some perspective shows that the euro has actually done essentially nothing for the past month, trading within a range barely exceeding 1.0%. It will take more than just the occasional positive or negative economic print to change this story.

And perhaps there is a story brewing that will do just that. Several weeks ago there was a Bloomberg article about inflation in the Eurozone, specifically in Spain, that highlighted the dichotomy between the low rate of measured inflation, which in Spain is running at 1.0%, and the fact that the cost of home ownership and rent is rising at a double digit pace. It turns out that the European CPI measurements have rent as just 6.5% of the index and don’t even include the costs of home ownership. In contrast, those represent more than 30% of the US CPI measurement! And housing costs throughout Europe are rising at a much faster rate, something on the order of 3.0%+ over the past five years. In other words, a CPI basket constructed to include what Europeans actually spend their money on, rather than on some theoretical construct, would almost certainly have resulted in higher CPI readings and potentially would have prevented the poisonous negative interest rate conundrum.

With this in mind, and considering Madame Lagarde’s review of ECB policy, there is a chance, albeit a small one, that the ECB will consider changing the metric, and with a change in the metric, the need for further QE and NIRP will diminish greatly. That would be hugely euro positive! This is something to watch for going forward.

The other big news that just hit the tape was from the Bank of England, where while rates were left unchanged, two members of the MPC voted to cut rates by 25bps in a complete surprise. Apparently, there is growing concern inside the Old Lady that the recent weakening data portends further problems regardless of the election outcome. Of course, regarding the election, the fact that both the Tories and Labour are promising huge new spending plans, the need for low rates is clear. After all, it is much easier to borrow if interest rates are 0.5% than 5.0%! The pound, which had been trading modestly higher before the news quickly fell 0.4% and is now back toward the lower end of its recent trading range. Sometimes I think central banks do things simply to prove that they matter to the markets, but in this case, given the ongoing economic malaise in the UK, it does seem likely that a rate cut is in the offing.

As to the rest of the market, some of the biggest gainers this morning are directly related to the US-China trade story, with the offshore renminbi trading higher by 0.6% and back to its strongest level in three months’ time. In addition we have seen NOK rally 0.85%, which seems to be on the back of stronger oil and the fact that easing trade tensions are likely to further support the price of crude. Combining this with the fact that the krone has been mysteriously weak given its fundamentals, relatively strong economic growth and positive interest rates, it looks like a lot of short positions are getting squeezed out.

Finally, I would be remiss if I didn’t mention the Brazilian real, which yesterday tumbled 2.0% after a widely anticipated auction of off-shore oil drilling rights turned into a flop, raising just $17 billion, far less than the $26 billion expected. In fact, two of the three parcels had no bids, and no oil majors were involved. While they will certainly put them up for auction again, the market’s disappointment was clear. It should also be no surprise that the real is rebounding a bit on the open, currently higher by 0.5%.

On the data front this morning the only thing of note is Initial Claims (exp 215K) and there are two more Fed speakers on the agenda, Kaplan and Bostic. However, the plethora of speakers we have heard this week have all remained on message, things are good and policy is appropriate, but if needed we will do more.

And that’s really it. I expect we will continue to hear more about the trade talks and perhaps get a bit more clarity on the proposed tariff rollbacks. But it will take a lot to turn the risk story around, and as such, I expect the dollar will continue to be under pressure as the session progresses.

Good luck
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A Currency Pact

The market is focused on trade
And hoping that progress is made
There’s news China’s backed
A currency pact
If tariff boosts can be delayed

Activity overnight was considerably more volatile than usual as conflicting stories regarding the US-China trade talks hit the tape. Risk was quickly jettisoned after a story from the South China Morning Post indicated that the talks, starting this morning in Washington, would be cut short. Shortly thereafter, the White House denied that report encouraging traders to buy back their stocks and sell bonds. Then Fox Business reiterated the original report less than a half hour later and the sell-off happened all over again. Finally, two positive reports helped equity markets recoup all of their overnight losses and took the shine off bonds. The first of those was that the currency pact that had been agreed between the US and China back in May (when chances of a big deal seemed realistic) was being dusted off and likely would be part of a mini-deal with the US agreeing to delay the imposition of new tariffs next Tuesday. And finally, President Trump has allowed US firms to sell non-critical technology to Huawei again, which was seen as additional thawing of the trade situation.

Of course, all this means is that we are back where we started, the trade talks are due to begin this morning and the Chinese delegation is scheduled to leave tomorrow evening. Arguably, the story that both sides are willing to agree on a currency pact as part of this round, and the indications that there are low level things that can be agreed, bode well for the rest of the week. But make no mistake, the major issues; IP theft, forced technology transfer and state subsidies are nowhere near being solved, and quite frankly, given they are integral to China’s economic model, seem unlikely ever to be solved. But for equity bulls, at least, hope springs eternal.

The FX impact in the end has been for a much softer dollar pretty much across the board. The idea is that if risk is to be embraced again, the higher yields available in Emerging Markets, as well as developed markets on a swapped basis, are the place to be. While the biggest mover overnight has been SEK, that is actually due to a surprising CPI report, with the annual pace of price increases rising to 1.5%, above the 1.3% expectation and a boon for the Riksbank who has been trying to normalize monetary policy by raising rates back to, and above, zero again. This report has given the market reason to believe that at their next meeting, in two weeks, while they won’t hike, they will continue to give guidance that a hike is coming before the end of the year. As such, SEK has rallied a solid 1.4%, although arguably, the trend is still for a weaker krone.

But the rest of the G10 has performed as well, with AUD, NZD and NOK all higher by 0.6% and the euro, despite disappointing data from both Germany and France, higher by 0.5%. Even the pound is higher this morning, up 0.35%, as the market awaits word on the outcome of a lunch meeting between Boris and Irish PM Leo Varadkar as they try to find a compromise. It seems to make the most sense that Varadkar is representing the EU given Ireland will be the nation most negatively impacted by a hard Brexit. My sense is we should start to hear about the outcome of this lunch around the time that US CPI is released, although I would read a delay as quite positive. The longer it takes; it seems the more likely that they are making headway on a compromise which would be very bullish for the pound. But until we actually see the news, the broad dollar trend is all we have.

In the EMG bloc we have also seen broad based strength paced this morning by HUF’s 0.7% rally. While much of this move is simply on the back of the euro’s rise, Hungary did have a quite successful auction of 5yr-15yr bonds which encouraged additional forint buying. Otherwise, the rest of the CE4 have moved directly in line with the euro and gains throughout Asia were only on the order of 0.2%. Of course, those markets closed before all the trade news had been released, so assuming nothing changes on that front (a difficult assumption) APAC currencies are likely to perform well tonight.

Turning to today’s session, we see our most important data of the week with CPI (exp 1.8%, 2.4% ex food & energy) as well as the usual Initial Claims data (220K). Regarding the former, Tuesday’s PPI report was surprisingly soft, with the headline number printing at -0.3% on the month and dragging the annual number down to just 1.4%. While there have been no forecast shifts amongst economists, there is still some lingering concern (hope?) amongst market participants that we could see a soft number here as well. The issue is a soft number would seem to open the door for the Fed to be far more aggressive in their rate cutting. Remember, Chairman Powell has repeated several times lately that the committee is watching the data closely and will do what they need to do in order to maintain the expansion while achieving their twin goals of stable prices and maximum employment. Obviously, with the Unemployment Rate at 3.5%, there is not much concern there. But falling inflation will ring alarm bells.

One last thing, though, regarding employment. The Initial Claims data is often a very good leading indicator of the overall employment situation, starting to rise well before the nonfarm numbers start to decline. Since the financial crisis, Initial Claims have tumbled from a peak of 665K in March 2009 to the low 200’s that we have seen for the past year. But recently, it appears that the number is beginning to creep higher again, with the 210k-215k readings that we had been seeing regularly now edging toward 220K and beyond. And while I know that seems extremely subtle, I merely caution that Initial Claims is a measure of job cuts, so if they are actually growing, that bodes ill for the economy’s future performance.

As to today, unless and until we hear more from the Trade talks or Boris, don’t look for much movement. But certainly the bias is to add risk for the day meaning the dollar should remain under pressure.

Good luck
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Powell’s Fixation

The latest release on inflation
Revealed, despite Powell’s fixation,
That prices have yet
To pose a real threat
So, look for more accommodation

Much to the Fed’s chagrin, yesterday’s inflation data was disappointing, with CPI rising just 1.8% in May, below both expectations and their target. Of course, they don’t target CPI, but PCE instead, however, history has shown that PCE typically runs about 0.3%-0.4% below CPI. Regardless of the statistic they view, what is abundantly clear is that price pressures, at least as measured by the both the Labor and Commerce departments, remain well below the level the Fed believes is consistent with a healthy economy. And it is this outcome which continues to animate the investment community.

If we ignore the comments from the White House and simply focus on the economic data, it is pretty easy to see why expectations of a rate cut are growing rapidly. The employment situation seems to have peaked and started to reverse, price pressures remain quiescent and every Q2 GDP forecast is for a pretty significant slowdown relative to Q1’s 3.1% rate. Given what appears to be a weakening trajectory in the US economy (not even considering the possibility of bigger issues driven by a full-blown trade war) and given that the Fed has implicitly assumed the responsibility to manage economic growth, a rate cut might seem pretty tempting at this point. While next week’s meeting seems quite aggressive for this line of thought, July, where the market is pricing in nearly a 100% probability, makes sense barring a sudden upturn in the data.

One of the things that has been weighing on the inflation data has been the sharp decline in oil prices over the past two months. Even with today’s 3.5% rally on the news of two oil tanker attacks in the Persian Gulf, WTI is lower by more than 20% since the third week of April. And the oil data continues to point to softening demand and growing supplies. Slowing global growth is sapping that demand, but producers continue to drill as quickly as possible. So, the central bank logic continues to be; lower interest rates will help sustain economic growth which will push up demand for energy (read oil prices) and help inflation get back to their comfort zone. Alas, that has been shown to be a pretty tenuous path for central banks to achieve their desired results and there is limited reason to believe it will work this time. In the end, it is becoming abundantly clear that we are about to embark on the next round of monetary ease, even in those nations which never tightened from the last round.

The difference this time is that markets do not seem to be embracing that as a panacea for all their troubles. While equity markets are modestly higher this morning, that follows two lackluster sessions with small losses. We continue to hear pundits highlighting a Fed cut as an important driver, but slowing global growth, especially the continued weakness in China, means that earnings estimates continue to slide and with them, expected equity gains. Add to this mix the unraveling of a few stories (Tesla, government pressure on tech companies) and suddenly the future is not so bright. We have also seen continued concern registered via the Treasury market, where 10-year yields have edged lower again today, trading at 2.11% as I type. While this is a few bps higher than the recent lows, it remains more than 50bps below where we started 2019 and the trend remains firmly downward. And rightly so if inflation is going to continue to decline.

The FX market has weighed all this evidence and remains…confused. While the dollar remains stronger overall in 2019, it has given back some of its gains during the past several weeks, at least against most G10 currencies. Today is a perfect example of the mixed view we’ve seen lately with the euro and the pound within 0.05% of yesterday’s closing levels, albeit the euro is higher and the pound lower. We see Aussie down 0.3% but CHF up 0.3%. You get the picture, there is little in the way of a trend. And quite frankly, that is likely to remain the case until we actually see the Fed (or ECB or BOJ or BOE) actually change policy. Broadly, there is little evidence that global growth is going to improve in the short run, and so FX movement is going to be based on the relative rate of weakness we see in economic data and the corresponding interest rate assumptions that will follow.

Looking at this morning’s data, we really only see Initial Claims (exp 216K), which is generally not a market mover. However, given the heightened sensitivity to the employment situation based on last Friday’s weak NFP report, any uptick here (above, say 230K) might have an outsized impact. Arguably, tonight’s Chinese data in Retail Sales and IP is likely to have a much bigger impact. And that’s really the day. Once again it looks like limited activity and correspondingly, limited movement in markets.

Good luck
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Markets Are Waiting

For right now most markets are waiting
To see if key risks are abating
Next week it’s the Fed
Then looking ahead
The G20 is captivating

The question is what we will learn
When Powell and friends next adjourn
The bond market’s sure
A cut has allure
To help them avoid a downturn

Markets this morning are pretty uninteresting as trader and investor focus turns to the two key upcoming events, next week’s FOMC meeting and the G20 meeting at the end of the month. At this point, it is fair to say that the market is pricing in renewed monetary ease throughout most of the world. While the Fed is in their quiet period, the last comments we heard were that they would act appropriately in the event economic growth weakened. Futures markets are pricing in a 50% chance of a cut next week, and a virtually 100% chance of a cut in July, with two more after that before the end of the year. While that seems aggressive to many economists, who don’t believe that the US economy is in danger of slowing too rapidly, the futures market’s track record is pretty good, and thus cannot be ignored.

But it’s not just the US where markets are pushing toward further rate cuts, we are seeing the same elsewhere. For example, last week Signor Draghi indicated that the ECB is ready to act if necessary, and if you recall, extended their rate guidance further into the future, assuring no rate changes until the middle of next year. Eurozone futures markets are pricing in a 10bp rate cut, to -0.50%, for next June. This morning we also heard from Banque de France President, and ECB Council member, Francois Villeroy that they have plenty of tools available to address slowing growth if necessary. A key pressure point in Europe is the 5year/5year inflation contract which is now pricing inflation at 1.18%, a record low, and far below the target of, “close to, but below, 2.0%”. In other words, inflation expectations seem to be declining in the Eurozone, something which has the ECB quite nervous.

Of course, adding to the picture was the news Monday night that the PBOC is loosening credit conditions further, targeting infrastructure spending. We also heard last week from PBOC Governor Yi Gang that the PBOC has plenty of tools available to fight slowing economic output. In fact, traveling around the world, it is easy to highlight dovishness at many central banks; Australia, Canada, Chile, India, Indonesia, New Zealand and Switzerland quickly come to mind as countries that have recently cut rates or discussed the possibility of doing so.

Once again, this plays to my constant discussion of the relative nature of the FX market. If every country is dovish, it becomes harder to discern which is the most hawkish dove. In the end, it generally winds up being a case of which nation has the highest interest rates, even if they are falling. As of now, the US continues to hold that position, and thus the dollar is likely to continue to be supported.

While the Fed meeting is obvious as to its importance, the G20 has now become the focal point of the ongoing trade situation with optimists looking for a meeting between Presidents Trump and Xi to help cool off the recent inflammation, but thus far, no word that Xi is ready to meet. There are many domestic political calculations that are part of this process and I have read arguments as to why Xi either will or won’t meet. Quite frankly, it is outside the scope of this note to make that call. However, what I can highlight is that news that a meeting is scheduled will be seen as a significant positive step by markets with an ensuing risk-on reaction, meaning stronger equities and a sell-off in the bond market, the dollar and the yen. Equally, any indication that no meeting will take place is likely to see a strong risk-off reaction with the opposite impacts.

Looking at the overnight data, there have been few releases with the most notable, arguably, Chinese in nature. Vehicle Sales in China fell 16.4%, their 11th consecutive monthly decline, which when combined with slowing monthly loan growth paints a picture of an economy that is clearly feeling some pain. The only other data point was Spanish Inflation, which printed at 0.8%, clearly demonstrating the lack of inflationary impulse in the Eurozone, even in one of the economies that is growing fastest. Neither of these data points indicates a change in the easing bias of central banks.

In the US this morning we see CPI data which is expected to print at 1.9% with the ex food& energy print at 2.1%. Yesterday’s PPI data was on the soft side, so there is some concern that we might see a lower print, especially given how rapidly oil prices have fallen of late. In the end, it is shaping up as another quiet day. Equity markets around the world have been slightly softer, but that is following a weeklong run of gains, and US futures are pointing to 0.3% declines at this point. Treasury yields are off their lowest point but still just 2.12% and well below overnight rates. And the dollar is modestly higher this morning, although I don’t see a currency that has moved more than 0.2%, indicating just how quiet things have been. Look for more of the same until at least next Wednesday’s FOMC announcement.

Good luck
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Waiting to See

At midnight the US imposed
The tariffs that Trump had disclosed
We’re waiting to see
How President Xi
Responds, or if China’s now hosed

It’s all about the tariffs this morning as the US increased the tariff rate on $200 billion of Chinese imports to 25% as of midnight last night. China has promised to retaliate but has not yet announced what they will do. One of the problems they have is they don’t import that much stuff from the US, so they cannot match it exactly. There was an unintentionally humorous article in Bloomberg this morning that tried to outline the ‘powerful’ tools China has to respond; namely selling US Treasuries, allowing the CNY to weaken further, or stop buying US soybeans. The humor stemmed from the fact that they basically destroyed their own arguments on the first two, leaving just the soybean restriction as potentially viable and even that is problematic.

Consider the Treasury sales first. As the Chinese own ~$1.1 trillion, if they sold a significant chunk, they would almost certainly drive US yields higher as Treasury prices fell. But two problems with this are; they would undermine the value of whatever bonds they retained and more problematically, what else would they do with the dollars? After all, the Treasury market is pretty much the only one that is large enough to handle that type of volume on a low risk basis. I guess they could convert the dollars to euros and buy Italian BTP’s (there are a lot of those outstanding) but their risk profile would get significantly worse. And of course, selling all those dollars would certainly weaken the dollar, which would not help the Chinese economy one bit.

On the flip side, allowing the renminbi to weaken sharply presents an entirely different problem, the fact that the Chinese are terrified that they would lose control of the capital flow situation if it weakened too far. Remember in 2015, when the Chinese created a mini-devaluation of just 1.5%, it triggered a massive outflow as USDCNY approached 7.00. The Chinese people have no interest in holding their assets in a sharply depreciating currency, and so were quick to sell as much as they could. The resultant capital flows cost China $1 trillion in FX reserves to prevent further weakness in the currency. Given we are only 2% below that level in the dollar right now, it seems to me the Chinese will either need to accept massive outflows and a destabilizing weakening in the renminbi, or more likely, look for another response.

The final thought was to further restrict soybean imports from the US. While the Chinese can certainly stop that trade instantly, the problems here are twofold. First, they need to find replacement supplies, as they need the soybeans regardless of where they are sourced, and second, given the Swine virus that has decimated the pig herds in China, they need to find more sources of protein for their people, not fewer. So, no pork and less soybeans is not a winning combination for Xi. The point is, while US consumers will likely feel the pressure from increased tariff rates via higher prices, the Chinese don’t have many easy responses.

And let’s talk about US prices for a moment. Shouldn’t the Fed be ecstatic to see something driving prices higher? After all, they have been castigating themselves for ‘too low’ inflation for the past seven years. They should be cheering on the President at this stage! But seriously, yesterday’s PPI data was released softer than expected (2.2%, 2.4% core) and as much as both Fed speakers and analysts try to convince us that recently declining measured inflation is transitory, the market continues to price rate cuts into the futures curve. This morning brings the CPI data (exp 2.1%, 2.1% core) but based on data we have seen consistently from around the world, aside from the oil price rally, there is scant evidence that inflation is rising. The only true exceptions are Norway, where the oil driven economy is benefitting greatly from higher oil prices, and the disasters of Argentina and Turkey, both of which have tipped into classic demand-pull inflation, where too much money is chasing too few goods.

Turning to market performance, last night saw the Shanghai Composite rally 3.1% after the imposition of tariffs, which is an odd response until you understand that the government aggressively bought stocks to prevent a further decline. The rest of Asia was mixed with the Nikkei lower by a bit and the KOSPI higher by a bit. European shares are modestly higher this morning, on average about 0.5%, in what appears to be a ‘bad news is good’ scenario. After all, French IP fell more than expected (-0.9%) and Italian IP fell more than expected (-1.4%). Yes, German Trade data was solid, but there is still scant evidence that the Eurozone is pulling out of its recent malaise so weaker data encourages traders to believe further policy ease is coming.

In the FX market, there has been relatively little movement in any currency. The euro continues to trade either side of 1.12, the pound either side of 1.30 and the yen either side of 110.00. It is very difficult to get excited about the FX market given there is every indication that the big central banks are well ensconced in their current policy mix with no changes on the horizon. That means that both the Fed and the ECB are on hold (although we will be finding out about those TLTRO’s soon) while both the BOJ and PBOC continue to ease policy. In the end, it turns out the increased tariffs were not that much of a shock to the system, although if the US imposes tariffs on the rest of Chinese imports, I expect that would be a different story.

This morning we hear from Brainerd, Bostic and Williams, although at this point, patience in policy remains the story. The inflation data mentioned above is the only data we get (although Canadian employment data is released for those of you with exposures there), and while US equity futures are tilted slightly lower at this time, it feels like the market is going to remain in the doldrums through the weekend. That is, of course, unless there is a shocking outturn from the CPI data. Or a trade deal, but that seems pretty remote right now.

Good luck and good weekend
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The Chaff from the Wheat

As markets await the report
On Payrolls they’re having to sort
The chaff from the wheat
From Threadneedle Street
As Carney, does rate hikes exhort

The gloom that had been permeating the analyst community (although certainly not the equity markets) earlier this year, seems to be lifting slightly. Recent data has shown a stabilization, at the very least, if not the beginnings of outright growth, from key regions around the world. The latest news was this morning’s surprising Eurozone inflation numbers, where CPI rose a more than expected 1.7% in April, while the core rate rose 1.2%, matching the highest level it has seen in the past two years. If this is truly a trend, then perhaps that long delayed normalization of monetary policy in the Eurozone may finally start to occur. Personally, I’m not holding my breath. Interestingly, the FX market has responded by selling the euro with the single currency down 0.2% this morning and 1.0% since Wednesday’s close. I guess that market doesn’t see the case for higher Eurozone rates yet.

In the meantime, the market continues to consider BOE Governor Carney’s comments in the wake of yesterday’s meeting, where he tried to convince one and all that the tendency for UK rates will be higher once Brexit is finalized (and assuming a smooth transition). And perhaps, if there truly is a global recovery trend and policy normalization becomes a reality elsewhere, that will be the case. But here, too, the market does not seem to believe him as evidenced by the pound’s ongoing weakness (-0.3% and back below 1.30) and the fact that interest rate futures continue to price in virtually no chance of rate hikes in the UK before 2021.

While we are discussing the pound, there is one other thing that continues to confuse me, the very fact that it is still trading either side of 1.30. If you believe the narrative, the UK cannot leave the EU without a deal, so there is no chance of a hard Brexit. After all, isn’t that what Parliament voted for? In addition, according to the OECD, the pound at 1.30 is undervalued by 12% or so. Combining these two themes, no chance of a hard Brexit and a massively undervalued pound, with the fact that the Fed has seemingly turned dovish would lead one to believe that the pound should be trading closer to 1.40 than 1.30. And yet, here we are. My take is that the market is not yet convinced that a hard Brexit is off the table or else the pound would be much higher. And frankly, in this case, I agree. It is still not clear to me that a hard Brexit is off the table which means that any true resolution to the situation should result in a sharp rally in the pound.

Pivoting to the rest of the FX market, the dollar is stronger pretty much across the board this morning, and this is after a solid performance yesterday. US data yesterday showed a significant jump in Nonfarm Productivity (+3.6%) along with a decline in Unit Labor Costs (-0.9%), thus implying that corporate activity was quite robust and the growth picture in the US enhanced. We also continue to see US earnings data that is generally beating (quite low) expectations and helping to underpin the equity market’s recent gains. Granted the past two days have seen modest declines, but overall, stocks remain much higher on the year. In the end, it continues to appear that despite all the angst over trade, and current US policies regarding energy, climate and everything else, the US remains a very attractive place to invest and dollars continue to be in demand.

Regarding this morning’s data, not only do we see the payroll report, but also the ISM Non-manufacturing number comes at 10:00.

Nonfarm Payrolls 185K
Private Payrolls 180K
Manufacturing Payrolls 10K
Unemployment Rate 3.8%
Participation Rate 62.9%
Average Hourly Earnings 0.3% (3.3% Y/Y)
Average Weekly Hours 34.5
ISM Non-Manufacturing 57.0

One cannot help but be impressed with the labor market in the US, where for the last 102 months, the average NFP number has been 200K. It certainly doesn’t appear that this trend is going to change today. In fact, after Wednesday’s blowout ADP number, the whisper is for something north of 200K. However, Wednesday’s ISM Manufacturing number was disappointingly weak, so there will be a great deal of scrutiny on today’s non-manufacturing view.

Adding to the mix, starting at 10:15 we will hear from a total of five Fed speakers (Evans, Clarida, Williams, Bowman, Bullard) before we go to bed. While Bullard’s speech is after the markets close, the other four will get to recount their personal views on the economy and future policy path with markets still open. However, given that we just heard from Chairman Powell at his press conference, and that the vote to leave rates was unanimous, it seems unlikely we will learn too much new information from these talks.

Summing up, heading into the payroll report the dollar is firm and shows no signs of retreating. My take is a good number will support the buck, while a weak one will get people thinking about that insurance rate cut again, and likely undermine its recent strength. My money is on a better number today, something like 230K, and a continuation of the last two days of dollar strength.

Good luck and good weekend
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Palpably Real

For Jay and his friends at the Fed
Inflation seems just about dead
So all the debate
‘bout rate hikes can wait
With focus on Brexit instead!

Thus turning to England, we learned
The deal, once again, has been spurned
Now fears of no deal
Are palpably real
Though markets seem quite unconcerned

While the headline news is arguably the second defeat of PM May’s Brexit deal in Parliament, I am going to touch on a different theme to start; namely the Fed.

Yesterday’s CPI data printed on the soft side (Headline 1.5%, Core 2.1%) with both coming in 0.1% below expectations. And while the Fed does not target this reading, it is still an important part of the discussion. That discussion continues to turn toward the idea that the Fed has already overtightened policy and that the next move will be a rate cut. Given the overall slowing in US data and highlighting that the Fed has been completely unable to achieve their inflation target of 2.0%, I expect that the next series of Fed comments, once they are past their meeting next week, will focus on greater efforts to achieve their mandate (the self-imposed 2.0% inflation target) and what needs to be done accordingly. I would look for the end of the balance sheet roll-off quite soon, perhaps in April, but in any case, by June, and I would look for futures markets to start pricing in a full rate cut by the middle of next year. I guess the only question is will the equity market continue to rally despite the weakening underlying fundamentals. Certainly, based on the past ten years of experience, the answer is yes. But can markets defy fundamentals forever? I guess we shall see.

PS. If the Fed is starting to turn more actively dovish, rather than its current passive stance, that will immediately undermine the dollar’s value. While for now I continue to see further upside potential for the buck, that is subject to change if the policies underlying that stance change as well.

Now to Brexit. Poor PM May. She really did work hard to try to find a solution as to how to avoid a hard Brexit, but the EU has literally zero interest in seeing the UK leave their bloc and thrive. If that were the case, the temptation for other unhappy countries (Italy anyone?) to also exit would be too great. As such, it was always in the EU’s long-term interest to play hardball like they did. It can also be no surprise that the widely touted adjustment to the codicil to the agreement was an attempt to bamboozle with flowery words, rather than an effort to put something legally binding in place. As such, once Attorney General Cox declared that the new language was no better than the old, which occurred just as I was getting prepared to publish my note yesterday, it was clear that there was no chance of passage. The fact that the vote lost by a smaller amount, only 149 votes vs. 230 votes the first time, is small consolation.

However, now Parliament has taken over and will have to come up with some plans on their own. It is generally much easier to howl from the peanut gallery than to take responsibility so we shall watch this with great interest. It seems that a majority in Parliament want to vote on a bill that will prevent a no-deal Brexit but given there is only one deal on the table and they handily rejected it, that implies they need a postponement from the EU. It is not enough for the UK to say they want to postpone. In fact, the other 27 members of the EU must all vote unanimously to agree. At this point, there has been no clarity on how long a delay they would like, nor what they plan to do with the time. And the EU has made it clear that those are important aspects of agreeing to a delay. For now, the debate in Parliament rages on, and I assume we will learn their answers in the next day or two, and certainly by the end of the week.

Funnily enough, the FX market has weighed the evidence and decided that there will categorically not be a hard Brexit and the odds of no Brexit are increasing. The pound, after yesterday’s wild ride, is back on an upswing and higher by 0.65% as I type. The one thing of which we can be sure is that the pound will continue to react to headline news until a definitive outcome exists. For my money, it appears as though the market is underpricing the probability of a hard Brexit. While I am pretty sure that nobody really wants one, the fact remains that it continues to be a real possibility even if only by legislative accident. One never knows who is looking at the situation there and sees a chance for personal political gain by allowing a hard Brexit. And in the end, given each MP is a politician first and foremost, that cannot be ignored!

Otherwise, the trade talks are ongoing with a positive spin put forth by the US top negotiator, Robert Lighthizer, although no deal is agreed as yet. Overnight data from Down Under showed weakening Consumer Confidence as the housing market there continues to implode, thus it is no surprise to see AUD having fallen by 0.25% and hugging recent lows. And in truth, little else of note is happening in these markets.

This morning we see Durable Goods (exp -0.5%, +0.1% ex Transport) as well as PPI (1.9%, 2.6% core) although nobody really cares about PPI with CPI just having been released. The Fed is now in their quiet period as they meet next week, so we will not get comments there. This leaves the Brexit debate as the primary focus for the FX market today. Based on all that I have read, I actually expect that the debate there will take more than one day, and that we won’t really get much new information today. Hence, I expect limited market activity for now.

Good luck
Adf