Appetite’s Whet

Both Powell and Kaplan agreed
That lower rates are what we need
The table’s now set
And appetite’s whet
For more cuts to soon be decreed

If there was any uncertainty, prior to yesterday, about a rate cut by the Fed at the end of this month, it should be completely eliminated now. Not only did Chairman Jay reiterate that the Fed was “carefully monitoring” the situation (shouldn’t that always be the case?) and that the Fed would use all its available tools to maintain the expansion, but we heard from Dallas Fed President Robert Kaplan that he was turning in favor of a ‘risk management’ cut in order to be sure that things don’t start to turn down soon. Given the integration in the global economy over the past years and given the fact that the US still represents 24% of global GDP, it should be no surprise that things occurring elsewhere in the world have an impact on the US and vice versa. As such, it is not unreasonable for the Fed to try to take the global economic situation into account when determining US monetary policy. And one thing that is clear is that global GDP growth is falling. So folks, we have seen the top in interest rates around the world and the only question is just how quickly they will fall in different jurisdictions.

In a nutshell, that is the FX story. Historically, relative monetary policy has been one of the prime drivers of FX rates, with currencies attached to tight policy appreciating vs. those attached to loose policy. This has been the basis of the carry trade, and arguably, nothing about this process has changed. It’s just that for the first time in memory, pretty much every nation is driving policy in the same direction, in this case looser. This leads to a probable outcome where currency values remain largely stable. After all, if everybody cuts by 25bps, aren’t we all still in the same place?

The irony is that, as discussed by RBA Governor Lowe several weeks ago, if every central bank is cutting rates at the same time, the effectiveness of those rate cuts will be severely diminished. Remember, one of the key transmission mechanisms of rate cuts is to reduce the currency’s value in order to help support trade, and eventually growth. But if everybody cuts, that mechanism will be severely impaired, and so the central banks will be forced to find new tools. And while they are actively looking for new ways to ease policy, in the end, monetary policy is simply some combination of interest rates and money supply. Until now, central banks have focused on managing interest rates. But this is why MMT, or something like it, is a growing possibility. When thoughts turn to money supply as the only other thing to adjust, and as ‘new’ thinking permeates the political class, MMT is going to become increasingly attractive. I’m not sure which nation will be the first to publicly embrace the idea of debt monetization (my money’s on Japan though), but you can be sure that whichever it is will see its currency depreciate sharply, at least until other nations follow their lead. Only time will tell, but that is not a positive future.

With that as a somewhat depressing backdrop, let’s look at market activity. Generally speaking, the dollar has done little this morning after yesterday’s rally. Or perhaps yesterday’s rally was more a function of other currency weakness. Remember, the pound’s decline was all about Brexit, not the US. The euro’s decline was all about weakening economic sentiment in the Eurozone and the idea that the ECB would be acting sooner rather than later. Yesterday also saw the Mexican peso fall sharply, more than 1%, after President Trump tweeted about reimposing tariffs on China. It seems that traders are still nervous over more tariffs, and with the ongoing border situation between the US and Mexico, see any tariff threats as potentially applying to Mexico as well.

But this morning, the biggest movers are RUB and TRY, both recouping about 0.4% of yesterday’s losses. The G10 currencies are within 0.10% of yesterday’s levels and show no sign of breaking out in the near term. Of course, that is subject to another Brexit announcement or comments from central bankers, however, nothing is scheduled on those fronts. Equity markets, too, have had little direction as investors await the next shoe to drop. Interest rate markets remain fully priced for a 25bp rate cut by the Fed in two weeks, while there remains some uncertainty as to just what Signor Draghi will announce next week. I will say that if he did announce a 10bp rate cut, it would have a pretty big impact on the single currency, and not in a positive manner.

As to bonds, both Treasuries and Bunds remain 10-15bps from their recent lows but show no signs of selling off further (higher yields). Rather, those markets are demonstrating all the behavior of a consolidation after a large unwinding move. Given the strong trend lower in central bank policy rates, it seems highly unlikely that yields in the government space, and by extension elsewhere, have anywhere to go but down.

Turning to today’s data, we see Housing Starts (exp 1.261M), Building Permits (1.3M) and then at 2:00 the Fed releases its Beige Book. But we have no more Fed speakers and it seems highly unlikely that any of that will be enough to change any views. One other thing happening this afternoon is the G7 FinMins are meeting in France, but those talks are highly focused on taxation of tech companies with monetary policy a sidelight. After all, everybody is already cutting rates, so what else can they say?

Alas, it appears to be another day with limited cause for FX movement, which for hedgers is great, but for traders, not so much.

Good luck
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Half Has Allure

The Fed Reserve Chairman named Jay
Is tasked, market fears, to allay
He did it in spades
Explaining that trade
And Brexit, could possibly weigh

On growth in the US this year
And so he implied cuts were near
A quarter seems sure
But half has allure
Since price rises never appear

Every market story today is the same story; the Fed is going to cut rates at the end of the month. In fact, the only mystery at this point is whether it will be the 25bps that is currently fully priced in by the futures market, or if the Fed will jump in with a 50bp cut. Every market around the world has felt the impact of this story and will continue to do so until the actual cut arrives.

The knock-on effects have been largely what would be expected from a lower rate environment. For example, equity prices have risen almost everywhere, closing at new record highs in the US yesterday and trading in the green throughout Asia overnight and Europe today. The dollar has fallen back, much to President Trump’s delight I’m sure, giving up some of its recent gains with declines of 0.5% vs. the euro, 0.6% vs. the pound and 0.7% vs. the yen. Emerging market currencies have also rallied a bit with, for example, BRL rising 1.3%, ZAR 1.8% and KRW up 0.8%. Even CNY has rallied slightly, +0.25%, although as we already know, its volatility is managed to a much lower level than other currencies.

Bond markets, on the other hand, have not demonstrated the same exuberance as stocks, commodities (gold +2.0%) or currencies today as they had clearly anticipated the news last week. If you recall, Bunds had traded to new record lows last week, touching -0.41% before reversing course, and are now “up” to a yield of -0.31%. And 10-year Treasuries, after trading to 1.935% a week ago, have since reversed course, picking up nearly 12bps at one point, although have given back a tick this morning. In fact, many traders have been looking at the market technicals and see room for bond yields to trade higher in the short-term, although the long-term trend remains for lower yields.

But those are simply the market oriented knock-on effects. There will be other effects as well. For example, it is now patently clear that a new central bank easing cycle is unfolding. We already knew the ECB was preparing to cut, and you can be sure they will both cut rates and indicate a restarting of QE at their next meeting on July 25. Meanwhile, by that date, Boris Johnson is likely to be the new UK PM which means that the BOE is going to need to prepare for a hard Brexit in a few months’ time. Part of that preparation is going to be lower interest rates and possibly the restarting of QE there as well. In fact, this morning, Governor Carney was on the tape discussing the issues that will impact the UK in the event of a hard Brexit, including slowing growth, lower confidence and weakness in markets. Japan? Well, they never stopped easing, but are likely to feel a renewed sense of urgency to push harder on that string, especially if USDJPY starts to fall more substantially. And finally, of the major economies, China will also certainly be looking to ease monetary policy further as growth there continues to lag desired levels and the trade situation continues to weigh on sentiment. The biggest problem the PBOC has is they have no sure-fire way to cut rates without quickly reinflating the leverage bubble they have been working to reduce for the past three years.

And of course, away from the major central banks, you can be sure that we are going to see easier monetary policy pretty much everywhere else in the world. This is especially true throughout the emerging markets, the countries that have suffered the most from the combination of higher US rates and a stronger dollar.

The irony of all this is that, as RBA Governor Lowe pointed out two weeks ago when they cut rates, if everybody cuts rates at the same time, one of the key transmission mechanisms, a weaker currency, is likely to have far less impact because the relative rate structure will remain the same. This is the reason that the dollar is likely to come under pressure in the short-run, because the Fed has more room to cut rates than most other central banks. But in the end, if everybody reaches ZIRP, currency valuations will need to be decided on other criteria with macroeconomic performance likely to be a key driver. And in the end, the dollar still comes up looking like the best bet.

And that’s really it. Every story is about the Fed cutting rates and how it will impact some other country, market, company, policy, etc.. Brexit is hanging out there, but until the new PM is named, nothing is going to change. The trade talks have restarted, but there is no conclusion in sight. Granted, several individual currencies have suffered of their own accord lately, notably MXN which fell more than 2.0% on Monday after the FinMin resigned due to philosophical differences with President AMLO, and TRY, which fell a similar amount at the end of last Friday after President Erdogan fired the central bank president and replaced him with someone more likely to cut rates. But those are special situations, and in truth, a good deal of those losses have been mitigated by the Fed story. As I said, it is all one story today.

Looking ahead to today’s market, we see our only important data point of the week, CPI (exp 1.6%, 2.0% core) and we also get Initial Claims (223K). But Chairman Powell testifies in front of the Senate today, and we hear from Williams, Bostic, Barkin, Kashkari and Quarles before the day is through as well. Given the Minutes released yesterday indicated a majority of FOMC members were ready to cut this month, it will be interesting to see how dovish this particular group sounds today, especially in the wake of the Chairman’s comments yesterday. Overall, I think the bias will be more dovish, and that the dollar probably has a bit further to fall before it is all over.

Good luck
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Beggar Thy Neighbor

A story that’s making the rounds
Although, it, so far, lacks real grounds
Is that the US
Might try to depress
The dollar ‘gainst euros and pounds

If so, that’s incredible news
And dollar bulls need change their views
But beggar thy neighbor
Does naught but belabor
The trade war, instead, it, defuse

The most interesting story that has started to gain traction is the idea that the Trump administration is considering direct intervention in the FX markets. While most pundits and investors focus on the Fed and how its monetary policy impacts the value of the dollar (which is completely appropriate), the legal framework in the US is that the Treasury is the department that has oversight of the currency. This means that dollar policy, such as it is beyond benign neglect, is formulated by the Secretary of the Treasury, not the FOMC. This is why the Treasury produces the report about other countries and currency manipulation every six months. Also, this is not a new situation, it has been the case since the abandonment of the Bretton Woods Agreement in 1971.

Since the Clinton Administration, the US policy has been a ‘strong dollar is in the US best interest’. This was made clear by then Treasury Secretary Robert Rubin and has been an accepted part of the monetary framework ever since. The issue with a strong dollar, of course, is that it can be an impediment for US exporters as their goods and services may become uncompetitively priced. Now, during the time when the US’s large trade deficits were not seen as problematic, the strong dollar was not seen as an issue. Clearly, earnings results from multinational corporations were impacted, but the government was not running policy with that as a priority. However, the current administration is far more mercantilist than the previous three or four, and as we have seen from the President’s Twitter feed, dollar strength has moved up the list of priorities.

It is this set of circumstances that has analysts and economists pondering the idea that the Treasury may direct the Fed to intervene directly in the FX market, selling dollars. History has shown that when a country intervenes by itself in the FX market, whether to prevent strength or weakness, it has generally been a failure. The only times when intervention has worked has been when there has been a general agreement amongst a large group of nations that a currency is either too strong or too weak and that intervention is appropriate. The best known examples are the Plaza Accord and the Louvre Accord from the mid-1980’s, where the G7 first agreed that the dollar was overvalued, then that it had reached an appropriate level. The initial announcement alone was able to drive the dollar lower by upwards of 10%, and the active intervention was worth another 5%. The result was a longer term weakening of nearly 40% before it was halted by the Louvre Accord. But other than those situations, for the large freely floating currencies, intervention has been effective at slowing a trend, but not reversing one. And the current dollar trend remains higher.

If the US does decide to intervene directly, this will have an enormous short-term impact on the FX market (and probably all markets) as it represents a significant policy reversal. However, in the end, macroeconomic fundamentals and relative monetary policy stances are still going to drive the value of every currency. With that in mind, it could be a long time before those influences become dominant again. Of course, the other thing is that the history of beggar-thy-neighbor FX policy is one of abject failure, with all nations seeking the same advantage, and none receiving any. Certainly, this is something to keep on your radar.

Away from that story, the dollar is actually stronger this morning, with the euro having breached 1.12, the pound tumbling toward 1.24 and most currencies, both G10 and EMG on the back foot. In fact, this is the problem for the Trump administration on this front, the growth situation elsewhere in the world continues to deteriorate more rapidly than in the US. Not only did Friday’s employment data help support the dollar, but this morning we saw very weak UK and Italian Retail Sales data to add to the economic malaise in those areas. In fact, economists are now forecasting negative GDP growth in the UK for Q2, and markets are pricing in a 25bp rate cut by the BOE before the end of the year. Meanwhile, in the Eurozone, all the talk is about how quickly the ECB is going to restart QE, with new estimates it could happen as soon as September with amounts up to €40 billion per month. While that seems to be a remarkably quick reversal (remember, they just ended QE six months ago), with the prospect of an ECB President Lagarde, who has lauded QE as an excellent policy tool, it cannot be ruled out.

Pivoting to the trade story, the latest news is that senior officials will be speaking by phone this week and the chances of a meeting, probably in Beijing in the next few weeks are rising. The problem is that there are still fundamental differences in world views and unless one side caves, which seems unlikely right now, I don’t see a short-term resolution. What is more remarkable is the fact that the lack of any discernible progress on trade is no longer seen as an issue by any markets. Or at least not a major one. While equity markets have softened over the past two sessions, the declines have been muted and, at least in the US, indices remain near record highs. Bond yields have risen a bit, implying the worst of the fear has passed, although in fairness, they remain incredibly low. But most importantly, the dialog has moved on, with trade no longer seen as the key fundamental factor it appeared to be just two months ago.

Turning to this morning’s news, there is only one data point, JOLT’s Job Openings (exp 7.47M) but of much more importance we hear from Chairman Powell at 8:45 this morning, followed by Bullard, Bostic and Quarles later in the day. Powell begins his testimony to Congress tomorrow morning, but everyone will be listening carefully to see if he is going to try to walk back expectations for the July rate cut that is fully priced into the market. My money is on confirming the cut on the basis of continued low inflation readings. However, given that is the market expectation, there is no reason to believe the dollar will suffer on the news, unless he is hyper dovish. So, the current strong stance of the buck seems likely to continue for the rest of the day.

Good luck
Adf

Some Real Fed Appeasing

The jobs report Friday suggested
That everyone who has requested
Employment has found
That jobs still abound
And companies are still invested

The market response was less pleasing
At least for the bulls who seek easing
With equities falling
And yields, higher, crawling
Look, now, for some real Fed appeasing

We are clearly amidst a period of ‘good news is bad’ and ‘bad news is good’ within the market context these days. Friday was the latest evidence of this fact as the much better than expected Nonfarm Payroll report (224K vs. 160K expected) resulted in an immediate sell-off in equity and bond markets, with the dollar rallying sharply. The underlying thesis remains that weakness in the US (and global) economy will be sufficient to ensure easier monetary policy, but that the problems will not get so bad as to cause a recession. That’s a pretty fine line to toe for the central banks, and one where history shows they have a lousy record.

However, whether it is good or bad is irrelevant. What is abundantly clear is that this is the current situation. So, Friday saw all three major US indices fall from record highs; it saw 2-year Treasury yields back up 11bps and 10-year yields back up 8pbs; and it saw the dollar rally roughly 0.75%.

The question is, why were markets in those positions to begin with? On the equity side of the ledger, prices have been exclusively driven by expectations of Fed policy. Until the NFP report, not only was a 25bp rate cut priced into Fed funds for the FOMC meeting at the end of the month, but there was a growing probability of a 50bp rate cut. This situation is fraught with danger for equity investors although to date, the bulls have been rewarded. At least the bond story made more sense from a macroeconomic perspective, as broadly weaker economic data (Friday’s numbers excepted) had indicated that both the US and global economies were slowing with the obvious prescription being easier monetary policy. This had resulted in German bunds inverting relative to the -0.40% deposit rate at the ECB as well as US 10-year yields falling below 2.00% for the first time in several years. Therefore, stronger data would be expected to call that thesis into question, and a sell-off in bonds made sense.

And finally, for the dollar, the rally was also in sync with fundamentals as higher US yields, and more importantly, the prospect of less policy ease in the future, forced the dollar bears to re-evaluate their positions and unwind at least some portion. As I have been writing, under the assumption that the Fed does indeed ease policy, it makes sense that the dollar should decline somewhat. However, it is also very clear that the Fed will not be easing policy in a vacuum, but rather be leading a renewed bout of policy ease worldwide. And as the relative interest rate structure equalizes after all the central banks have finished their easing, the US will still likely be the most attractive investment destination, supporting the dollar, but also, dollar funding will still need to be found by non-US businesses and countries, adding to demand for the buck.

With this as a backdrop, the week ahead does not bring much in the way of data, really just CPI on Thursday, but it does bring us a great deal of Fed speak, including a Powell speech tomorrow and then his House and Senate testimony on Wednesday and Thursday. And don’t forget the ECB meeting on Thursday!

Today Consumer Credit $17.0B
Tuesday NFIB Small Biz 105
  JOLT’s Jobs Report 7.47M
Wednesday FOMC Minutes  
Thursday ECB Meeting -0.4%
  Initial Claims 222K
  CPI 0.0% (1.6% Y/Y)
  -ex food & energy 0.2% (2.0% Y/Y)
Friday PPI 0.1% (1.6% Y/Y)
  -ex food & energy 0.2% (2.3% Y/Y)

Remember, that on top of the FOMC Minutes to be released Wednesday afternoon, we will hear from seven different Fed speakers a total of thirteen times this week, including Powell’s testimony on Capitol Hill. Amongst this crowd will be the two most dovish members of the FOMC, Bullard and Kashkari, as well as key members Williams and Quarles. It will be extremely interesting to see how these speakers spin the jobs data relative to their seemingly growing bias toward easing. Much has been made of the idea of an ‘insurance’ rate cut, in order to prevent anything from getting out of hand. But Powell will also need to deal with the allegations that he is capitulating to President Trump’s constant demands for lower interest rates and more QE if he comes across as dovish. I don’t envy him the task.

Regarding the ECB meeting, despite continuing weakness in most of the Eurozone data, it feels like it is a bit too soon for them to ease policy quite yet. First off, they have the issue of what type of impact pushing rates even further negative will have on the banking system there. With the weekend news about Deutsche bank retrenching across numerous products, with no end of red ink in sight, the last thing Signor Draghi wants is to have to address a failing major bank. But it is also becoming clearer, based on comments from other ECB members (Coeure and Villeroy being the latest) that a cut is coming soon. And don’t rule out further QE. The ECB is fast becoming desperate, with no good options in sight. Ultimately, this also plays into my belief that despite strong rationales for the dollar to decline, it is the euro that will suffer most.

However, the fun doesn’t really start until tomorrow, when Chairman Powell speaks at 8:45am. So for today, it appears that markets will consolidate Friday’s moves with limited volatility, but depending on just how dovish Powell sounds, we are in for a more active week overall.

Good luck
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More Concern

Most data of late have been weak
Thus central banks are set to tweak
Their policy rates
As they have mandates
Designed to keep growth at a peak

Now later this morning we’ll learn
If payrolls are starting to turn
Last month’s poor display
And weakness today
Would certainly cause more concern

It’s payroll day in the US and markets have been extremely quiet overnight. In fact, given yesterday’s July 4th holiday here in the US, they have been quiet for two days. However, don’t let the lack of market activity distract you from the fact that there are still a lot of things ongoing in the global economy.

For example, a key question on analysts’ minds has been whether or not a recession is in the offing. Data continues to generally disappoint, with this morning’s sharply lower German Factory Orders (-2.2%) and UK Labor Productivity (-0.5%) as the latest in a long line of crummy results. And given last month’s disappointment on the US payroll front (recall the outcome was 75K vs. the 185K expected) today’s numbers are being closely watched. Here are the current median expectations based on economist surveys:

Nonfarm Payrolls 160K
Private Payrolls 153K
Manufacturing Payrolls 0K
Unemployment Rate 3.6%
Average Hourly Earnings 0.3% (3.2% Y/Y)
Average Weekly Hours 34.4

A couple of things to note are the fact that the NFP number, even if it comes in at the median expectation, still represents a declining rate of job growth compared to what the US experienced in 2018. This is likely based on two factors; first that this historically long expansion is starting to slow down, and second, that there are less available workers to fill jobs as population growth remains restrained. The other thing to remember is that the Unemployment Report has always been a lagging indicator, looking backwards at how things were, rather than giving direction about the future. The point is that worsening of this data implies that things are already slowing. As I wrote Wednesday, don’t be surprised if when the inevitable recession finally gets determined, that it started in June 2019. I failed to mention the ADP report on Wednesday as a data release, but it, too, disappointed, printing at 102K, some 40K below expectations.

With that as our cheerful backdrop, let’s consider what to expect ahead of the release:

Weaker than expected results – If the NFP number prints at 90K or less, look for equity markets to rejoice as they perceive the Fed will become even more aggressive in their attempts to head off a recession, and the idea of a 50bp rate cut at the end of the month takes hold. Bond markets, too, will soar on the same expectations, while the dollar is likely to give up its overnight gains (granted they were only about 0.2%) as a more aggressive Fed will be seen as a signal to sell the buck. The key conundrum in this scenario remains equities, which continue to rally into weaker economic conditions. At some point, if the economy continues to weaken, the negative impact on earnings is going to outweigh the kneejerk reaction of buying when the Fed cuts, but as John Maynard Keynes reminded us all, ‘markets can stay irrational far longer than you can stay solvent.’

Results on or near expectations – If we see a print in the 120K-180K range, I would expect traders to be mildly disappointed as the call for a more aggressive Fed policy would diminish. Thus equities might suffer slightly, especially given they are sitting at record highs, while bonds are likely to see yields head back toward 2.0%. The dollar, meanwhile, is likely to maintain its overnight gains, and could well see a modest uptick as the idea of more aggressive Fed easing starts to ebb, at least for now.

Stronger than expected results – Any print above 180K will almost certainly, perversely, see a stock market selloff. It is abundantly clear that equity buyers are simply counting on Fed largesse to keep the party going. The market has nothing to do with the fundamentals of the economy or individual company situations. With this in mind, strong data means that the Fed will have no call to cut rates. The result is that the futures market will likely reprice the odds of a rate cut in July lower, perhaps to a 50% probability, while equity traders will take the news as a profit-taking opportunity given the lack of reason for a follow through higher in stocks. Bonds will get tossed overboard as well, as concerns about slowing growth will quickly abate, and a sharp move higher in 10-year yields is entirely realistic. As a point of information, the last time the payroll report was released on July 5th, in 2013, 10-year yields rallied 25bps on a surprising payroll outcome. And remember, technical indicators show that the bond market is massively overbought, so there is ample opportunity for a sharp move. And finally, because of the holiday yesterday, trading desks will have skeleton staffs, further reducing liquidity. Oh yeah, and the dollar will probably see significant gains as well.

The point is that there are two possible outcomes that could see some real fireworks (pun intended) today, so stay on your toes. While one number is just that, a single data point, given the recent trend in place, today’s data seem to have a lot of importance. If pressed, my sense is that the trend of weaker data that has been evident worldwide is going to manifest itself with something like a 50K print, and an uptick in the Unemployment Rate to 3.7% or 3.8%.

We will know shortly.

Good luck and good weekend
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Still Writing Obits

The Germans, the Chinese and Brits
Have seen manufacturing hits
But in the US
There’s been more success
Though bears are still writing obits

It is fair to say that the global economic growth rate continues to slow. We have seen weaker data as the norm, whether in manufacturing, housing or agriculture; we have seen a never-ending stream of central bankers expressing concern over this slowing growth and promising to respond appropriately; and we continue to see equity markets trade to new highs. Something seems amiss.

Yesterday was a perfect example of this phenomenon with an ISM print of 51.7, its fourth consecutive decline and the weakest reading since October 2016. In fairness, it was better than consensus estimates of 51.0, and the US was the only major economy to show continued expansion in the sector, but the trend is foreboding. The new orders component was exceptionally weak, and highlights those concerns going forward. And yet, equity prices traded to new highs yesterday afternoon, before ceding some ground into the close.

There has been a pretty complete disconnect between the fundamentals of stock valuation (at least the theories we learned in finance class about discounted future cash flows) and the actual price of stocks. And this is a global phenomenon, not merely a US outlier.

Of course, the missing link in this puzzle is central bank activities. Markets have become entirely dependent on central bank largesse to justify their valuations. Central bankers, after a decade of ZIRP and NIRP led to a huge increase in the financialization of the global economy, are now beholden to markets when they make decisions. This was made plain in January, when the Fed pivoted after equity markets plummeted following their last rate increase. They literally could not stand the pressure for even two weeks before reversing course.

So, the question becomes, will equity markets now dictate every central bank action going forward? While rhetorical, it is not hard to believe that the answer is yes. Despite all the current conversation regarding an uncomfortably low inflation rate as the driver for policy ease, it is abundantly clear that the only data point on which every central bank focuses, is their domestic stock market. I fear this is a situation that will result in extremely negative outcomes at some point in the future. However, there is no way to determine, ex ante, when those negative outcomes will manifest themselves. That is why bulls are happy, they buy every dip and have been rewarded, and why bears are miserable, because despite their certainty they are correct, thus far the central banks have been able to delay the pain.

In the end, though, the story on global growth remains one of a slowdown throughout the world. For all their largesse to date, central banks have not yet been able to reverse that trend.

With that out of the way, let’s see what those central bank activities have wrought in the FX markets. The first thing to note was that the dollar actually had an impressive day yesterday, rallying 0.7% vs. the euro and 0.5% vs. the pound after the ISM data. Given the better than expected print, market participants decided that the Fed may not be as aggressive cutting rates after all, and so the key recent driver of dollar weakness was reevaluated. Of course, one day’s reaction does not a trend make, and this morning, the dollar is backing off yesterday’s rally slightly.

Last night the RBA cut rates another 25bps, to a record low of 1.00%, and left the door open for further rate cuts in the future. Aussie, however, is higher by 0.4% this morning on a classic, sell the rumor, buy the news reaction. In the end, Australia remains entirely dependent on growth in China and as that economy slows, which is clearly happening, it will weigh on the Australian economy. While Australia managed to avoid ZIRP in the wake of the financial crisis, this time around I think it is inevitable, and we will see AUD resume its multiyear weakening trend.

Weighing on the pound further this morning were two data points, the Construction PMI at 43.1, its weakest in more than ten years, as well as the ongoing malaise in housing prices in the UK. Brexit continues to garner headlines locally, although it has not been front page news elsewhere in the world because of all the other concerns like trade, OPEC, North Korea, and in the US, the beginnings of the presidential campaigns.

But there is a very interesting change ongoing in the Brexit discussion. Throughout the process, the EU has appeared to have the upper hand in the negotiations, forcing their views on outgoing PM May. But with all signs pointing to a new PM, Boris Johnson, who has made clear he will leave with or without a deal, suddenly Ireland is finding itself under extreme pressure. A recent report by the central bank there indicated that a hard Brexit could result in a 4.0% decline in Irish GDP! That is HUGE. At the same time, the EU will require Ireland to uphold the border controls that are involved in the new separate relationship. This means they will need to perform any inspections necessary as well as arrange to collect tariffs to be charged. And the UK has made it clear that they will not contribute a penny to that process. Suddenly, Ireland is in a bad situation. In fact, it is entirely realistic that the EU needs to step in to delay the impact and cave to an interim deal that has nothing to do with PM May’s deal. At least that is the case if they want to maintain the integrity of their borders, something which has been given short shrift until now. My point is that there is still plenty of Brexit mischief ahead, and the pound is going to continue to react to all of it. In the end, I continue to believe that a hard Brexit will result in a weaker pound, but I am not so sure it will be as weak as I had previously believed. Maybe 1.20-1.25 is the right price.

In the US today there is no data to be released although we do hear from NY Fed president Williams and Cleveland Fed President Mester this morning. If the Fed is serious about staying on hold at the end of this month, rather than cutting the 25bps that the market has already priced, they better start to speak more aggressively about that fact. Otherwise, they are going to find themselves in a situation where a disappointed equity market sells off sharply, and the pressure ratchets even higher on them to respond. Food for thought as we hear from different Fed speakers during the month.

Good luck
Adf

 

Cow’ring In Fear

Tis coming increasingly clear
That growth is at ebb tide this year
The PMI data
When looked at, pro rata
Shows industry cow’ring in fear

Meanwhile in Osaka, the meet
Twixt Trump and Xi lowered the heat
On tariffs and trade
Which most have portrayed
As bullish, though some are downbeat

With all the buildup about the meeting between President’s Trump and Xi, one might have thought that a cure for cancer was to be revealed. In the end, the outcome was what was widely hoped for, and largely expected, that the trade talks would resume between the two nations. Two addenda were part of the discussion, with Huawei no longer being shut out of US technology and the Chinese promising to buy significantly more US agricultural products. Perhaps it was the two addenda that have gotten the market so excited, but despite the results being largely in line with expectations, equity markets around the world have all exploded higher, with both Shanghai and Tokyo rallying more than 2.2%, Europe seeing strong gains, (DAX +1.35%, FTSE + 1.15%) and US futures pointing sharply higher (DJIA +1.1%, NASDAQ +1.75%). In other words, everybody’s happy! Oil prices spiked higher as well, with WTI back over $60 due to a combination of an extension of the OPEC+ production cuts and the boost from anticipated economic growth after the trade truce. Gold, on the other hand, is lower by 1.4% as haven assets have suffered. After all, if the apocalypse has been delayed, there is no need to seek shelter.

But a funny thing happened on the way to market salvation, Manufacturing PMI data was released, and not only was it worse than expected pretty much everywhere around the world, it was also below the 50 level pretty much everywhere around the world. Here are the data for the world’s major nations; China 49.4, Japan 49.3, Korea 47.5, Germany 45.0, and the UK 48.0. We are awaiting this morning’s US ISM report (exp 51.0), but remember, that Friday’s Chicago PMI, often seen as a harbinger of the national scene, printed at a disastrous 49.7, more than 3 points below expectations and down 4.5 points from last month.

Taking all this into account, the most important question becomes, what do you do if you are the Fed? After all, the Fed remains the single most important actor in financial markets, if not in the global economy. Markets are still pricing in a 25bp rate cut at the end of this month, and about 100bps of cuts by the end of the year. In the meantime, the most recent comments from Fed speakers indicate that they may not be that anxious to cut rates so soon. (see Richmond Fed President Thomas Barkin’s Friday WSJ interview.) If you recall, part of the July rate cut story was the collapse of the trade talks and the negative impact that would result accordingly. But they didn’t collapse. Now granted, the PMI data is pointing to widespread economic weakness, which may be enough to convince the Fed to cut rates anyway. But was some of that weakness attributable to the uncertainty over the trade situation? After all, if global trade is shrinking, and it is, then manufacturing plans are probably suffering as well, even without the threat of tariffs. All I’m saying is that now that there is a trade truce, will that be sufficient for the Fed to remain on hold?

Of course, there is plenty of other data for the Fed to study before their next meeting, perhaps most notably this Friday’s payroll report. And there is the fact that with the market still fully priced for a rate cut, it will be extremely difficult for the Fed to stand on the side as the equity market reaction would likely be quite negative. I have a feeling that the markets are going to drive the Fed’s activities, and quite frankly, that is not an enviable position. But we have a long time between now and the next meeting, and so much can, and likely will, change in the interim.

As to the FX market, the dollar has been a huge beneficiary of the trade truce, rallying nicely against most currencies, although the Chinese yuan has also performed well. As an example, we see the euro lower by 0.3%, the pound by 0.45% and the yen by 0.35%. In fact, all G10 currencies are weaker this morning, with the true outliers those most likely to benefit from lessening trade tensions, namely CNY and MXN, both of which have rallied by 0.35% vs. the dollar.

Turning to the data this week, there is plenty, culminating in Friday’s payrolls:

Today ISM Manufacturing 51.0
  ISM Prices Paid 53.0
Wednesday ADP Employment 140K
  Trade Balance -$54.0B
  Initial Claims 223K
  ISM Non-Manufacturing 55.9
  Factory Orders -0.5%
Friday Nonfarm Payrolls 160K
  Private Payrolls 153K
  Manufacturing Payrolls 0K
  Unemployment Rate 3.6%
  Average Hourly Earnings 0.3% (3.2% Y/Y)
  Average Weekly Hours 34.4

So, there will be lots to learn about the state of the economy, as well as the latest pearls of wisdom from Fed members Clarida, Williams and Mester in the first part of the week. And remember, with Thursday’s July 4th holiday, trading desks in every product are likely to be thinly staffed, especially Friday when payrolls hit. Also remember, last month’s payroll data was a massive disappointment, coming in at just 75K, well below expectations of 200K. This was one of the key themes underpinning the idea that the Fed was going to cut in July. Under the bad news is good framework, another weak data point will virtually guaranty that the Fed cuts rates, so look for an equity market rally in that event.

In the meantime, though, the evolving sentiment in the FX market is that the Fed is going to cut more aggressively than everywhere else, and that the dollar will suffer accordingly. I have been clear in my view that any dollar weakness will be limited as the rest of the world follows the Fed down the rate cutting path. Back in the beginning of the year, I was a non-consensus view of lower interest rates for 2019, calling for Treasuries at 2.40% and Bunds at 0.0% by December. And while we could still wind up there, certainly the consensus view is for much lower rates as we go forward. Things really have changed dramatically in the past six months. Don’t assume anything for the next six!

Good luck
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