A Major Broadside

The question that needs to be asked
Is, have central bank powers passed?
The ECB tried
A major broadside
But markets ignored Draghi’s blast

There has certainly been no shortage of interesting news in the past twenty-four hours, however from a markets perspective, I think the ECB actions, and the market reactions are the most critical to understand. To recap Signor Draghi’s action, the ECB did the following:

1. cut the deposit rate 10bps to -0.50%;
2. restarted QE in the amount of €20Bio per month for as long as necessary;
3. reduced the rate and extended the tenor of TLTRO III loans; and
4. introduced a two-tier system to allow some excess liquidity to be exempt from the -0.50% deposit rate.

Certainly the market was prepared for the rate cut, which had been widely telegraphed, and the talk of tiering excess liquidity had also been making the rounds. Frankly, TLTRO’s had not been a centerpiece of discussion but I think that is because most market participants don’t see them as a major force in the policy debate, which leaves the start of QE2 as the most controversial thing Draghi introduced. Well, maybe that and the fact that forward guidance is now based on achieving a “robust convergence” toward the inflation target rather than a particular timeframe.

Remember, in the past two weeks we had heard from the Three Hawksketeers (Weidmann, Lautenschlager and Knot) each explicitly saying that more QE was not appropriate. We also heard that from the Latvian central banker, Rimsevics, and perhaps most surprisingly of all, from Franҫois Villeroy de Galhau, the French central bank chief. And yet despite clearly stiff opposition, Draghi got the Council to agree. Perhaps, though, he went too far in describing the “consensus as so broad, there was no need to take a vote.” Now, while I have no doubt that no vote was taken, that statement stretches credulity. This was made clear when Robert Holzmann, the new Austrian central bank president and first time member of the ECB, gave an interview yesterday afternoon explicitly saying that the ECB could well have made a mistake by reintroducing QE.

But let’s take a look at what happened after the ECB statement and during the press conference. The initial move was for the euro to decline sharply, trading down 0.65% in the first 10 minutes after the release. When Draghi took to the stage at 8:30 and reiterated the points in the statement, the euro declined a further 30 pips, touching 1.0927, its lowest level since May 2017. But that was all she wrote for the euro’s decline. As Draghi continued to speak and answer questions, traders began to suspect that the cupboard was bare regarding anything else the ECB can do to address further problems in the Eurozone economies. This was made abundantly clear in his pleas for increased fiscal stimulus, which much to his chagrin, does not appear to be forthcoming.

It was at this point that things started to turn with the euro soaring, at one point as much as 1.5% from the lows, and closed 1.3% higher than those levels. And this morning, the rally continues with the euro up to 1.1100 as I type, a solid 0.3% gain. But the big question that now must be asked is; has the market decided the ECB is out of ammunition? After all, given the relative nature of the FX market and the importance of monetary policy on exchange rates, if the market has concluded the ECB CANNOT do anymore that is effective, then by definition, the Fed is going to promulgate easier policies than the ECB with the outcome being a rising euro. So if the Fed follows through next week and cuts 25bps, and especially if it does not close the door on further cuts, we could easily see the euro rally continue. That will not help the ECB in their task to drive inflation higher, and it will set a difficult tone for Madame Lagarde’s tenure as ECB President going forward.

Turning to the Fed, the market is still fully priced for a 25bp cut next week, but thoughts of anything more have receded. However, a December cut is still priced in as well. The problem for the Fed is that the economic data has not been cooperating with the narrative that inflation is dead. For instance, yesterday’s CPI data showed Y/Y core CPI rose 2.4%, the third consecutive outcome higher than expectations and the highest print since September 2008! Once again, I will point to the anecdotal evidence that I, personally, rarely see the price of anything go down, other than the gyrations in gasoline prices. But food, clothing and services prices have been pretty steady in their ascent. Does this mean that the Fed will stay on hold? While I think it would be the right thing to do, I absolutely do not believe it is what will happen. However, it is quite easy to believe that the accompanying statement is more hawkish than currently expected (hoped for?) and that we could see this as the end of that mid-cycle adjustment. My gut is the equity market would not take that news well. And the dollar? Well, that would halt the euro’s rise pretty quickly as well. But that is next week’s story.

As if all that wasn’t enough, we got more news on the trade front, where President Trump has indicated the possibility of an interim trade deal that could halt, and potentially roll back, tariff increases in exchange for more promises on IP protection and agricultural purchases. That was all the equity market needed to hear to rally yet again, and in fairness, if there is a true thawing in that process, it should be positive for risk assets. So, the dollar declined across the board, except against the yen which fell further as risk appetite increased.

Two currencies that have had notable moves are GBP and CNY. The pound seems to be benefitting from the fact that there was a huge short position built over the past two months and the steady stream of anti-Brexit news seems to have put Boris on his back foot. If he cannot get his way, which is increasingly doubtful, then the market will continue to reprice Brexit risk and the pound has further to rally. At the same time, the renminbi’s rally has continued as well. Yesterday, you may recall, I mentioned the technical position, an island reversal, which is often seen as a top or bottom. When combining the technical with the positive trade story and the idea that the Fed has a chance to be seen as the central bank with the most easing ahead of it, there should be no surprise that USDCNY is falling. This morning’s 0.45% decline takes the two-day total to about 1.0%, a big move in the renminbi.

Turning to this morning’s data, Retail Sales are the highlight (exp 0.2%, 0.1% ex autos) and then Michigan Sentiment (90.8) at 10:00. Equity futures are pointing higher and generally there is a very positive attitude as the week comes to an end. At this point, I think these trends continue and the dollar continues to decline into the weekend. Longer term, though, we will need to consider after the FOMC next week.

Good luck and good weekend
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Though Bond Prices Tumbled

There once was a time when the buck
Reacted when bonds came unstuck
If fear was seen rising
It wasn’t surprising
If traders would back up the truck

But lately though bond prices tumbled
The dollar just hasn’t been humbled
Instead of declining
Investors are pining
For dollars as other cash crumbled

First, a moment of silence to remember the horrific events of 18 years ago this morning…

As the market awaits tomorrow’s ECB meeting, it is not surprising that FX markets have remained pretty benign. In fact, looking across both G10 and EMG currencies, the largest mover overnight was the Hungarian forint, which has fallen 0.4%, a moderately exaggerated move relative to the shallow rally in the dollar. Arguably, yesterday’s modestly lower than expected CPI print has reduced some of the pressure on the central bank there to keep policy firm, hence the selloff. But otherwise, there are really no stories of direct currency interest today and no data of note overnight.

As such, I thought it would be interesting to take a look at government bond yields and their gyrations lately. It was just eight days ago when 10-year Treasury yields were trading at 1.45% as expectations for further coordinated policy ease by the major central banks became the meme du jour. Economic data appeared to be rolling over (ISM at 49.1, German GDP -0.1%, Eurozone CPI 0.9%, etc.) which inspired thoughts of massive policy ease by the big 3 central banks. The market narrative evolved into the ECB cutting rates by 0.20% and restarting QE to the tune of €35 billion / month while the Fed cut 0.50% and the BOJ cut rates by 0.10% and pumped up QE further. It seemed as though analysts were simply trying to outdo one another’s forecasts so they could be heard above the din. And after all, we had seen central banks all around the world cutting rates during the previous two months (Australia, New Zealand, Philippines, South Korea, India et al.) so it seemed natural to expect the biggest would be acting soon.

During this time, the FX market responded as might be expected during a pretty clear risk-off scenario, the dollar and the yen rallied while other currencies suffered. In fact, we have seen several currencies trade near historic lows lately (CLP, COP, BRL, INR, PHP to name a few). Equity markets were caught between fear and the idea that central bank ease would support stock prices, and while there were certainly wobbles, in the end greed won out.

But then a funny thing happened to the narrative; a combination of data and commentary started to turn the tide (sorry for the mixed metaphor). We heard from a variety of central bank speakers, notably from the ECB, who were clearly pushing back on the narrative. Weidmann, Lautenschlager, Knot and Villeroy were all adamant that there was no reason for the ECB to consider restarting QE. At the same time, just before the quiet period we heard from a number of Fed members (Rosengren, George, Kaplan, Barkin) who were quite clear they didn’t see the need for an aggressive rate cutting stance, and then Chairman Powell, in the last words before the quiet period, basically stuck to the party line of the current stance being a modest mid-cycle adjustment as they closely monitored the data.

It cannot be a surprise that the market has adjusted its views ahead of the first of the three central bank meetings tomorrow. But boy, what an adjustment. 10-year Treasury yields have rallied 27bps, 10-year Bunds are higher by 19bps and 10-year JGB yields are up 8.5bps (there’s a lot less activity there as the BOJ already owns so many bonds there is very little ability to trade.) However, this is not a risk-on move despite the movement in yields. This has been a massive position unwinding. A couple of things highlight the lack of risk appetite. First, the dollar continues to move higher overall. While individual currencies may have good days periodically, nothing has changed the long-term trend of dollar strength. And history shows that when risk is sought, dollars are sold. Equity markets have also been underwhelming lately, with very choppy price action but no direction. Granted, stocks are not falling, but they are certainly not rallying like risk is being ignored. And finally, gold, which had been performing admirably during the fear period, has ceded some of its recent gains as positions there are also unwound.

The point is that in the current market environment, it is very difficult to draw lessons from the price movement. Market moves lately have been all about position adjustments and very little about either market fundamentals (data) or monetary policy. While this is not the first time markets have behaved in this manner, in the past these periods have tended to be pretty short. The ECB meeting tomorrow will allow views to crystalize regarding future monetary policy there, and my sense is that we will go back to the previous market driver of the policy narrative. In fact, it is arguably quite healthy that we have seen this correction as it allows markets a fresh(er) start with new information. However, there is still nothing I see on the horizon which will weaken the dollar overall.

This morning the only thing of note on the calendar is PPI (exp 1.7%, 2.2% core). It is hard to believe that it will change any views. At this point, look for continued position adjustments (arguably modest further declines in bond prices but no direction in the dollar) as we all await Signor Draghi and the ECB tomorrow morning.

Good luck
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Not Making Hay

In China, despite what they say
The ‘conomy’s not making hay
Their exports are lagging
With industry gagging
On stuff manufactured each day

The upshot’s the PBOC
Released billions of renminbi
Reserve rates are shrinking
And everyone’s thinking
They’ll shrink further ere ought twenty

Long before trading started last evening, Chinese trade data set the tone for the markets as exports there shrank by 1.0% in USD terms, a clear indication that the trade war is starting to bite. Imports fell further (5.6%), but overall, the trade surplus was significantly smaller than expected. In the current market environment, it cannot be a surprise that the response was for a rally in Asian equity markets as the weak data presages further policy ease by the Chinese. In fact, there are numerous articles discussing just what options they have. Friday afternoon they cut the reserve ratio by a full percentage point, and analysts all over are expecting at least one more cut before the end of the year. As to direct interest rate cuts, that is far less clear given the still problematic bubble tendencies in the Chinese real estate market. The PBOC is quite concerned over allowing that bubble to blow up further, so any reductions in the benchmark rate are likely to be modest…at least until the renminbi starts to strengthen again.

Speaking of the currency, while it has remained quite stable overall, -0.2% this morning, +0.65% in the past week, it remains one of the easiest tools for the PBOC to utilize. The government there has also sought to stimulate via fiscal policy, with significant tax cuts proposed and some implemented, but thus far, those have not been effective in supporting economic growth. While I am confident that when the next GDP number prints in mid-October it will be above 6.0%, there are an increasing number of independent reports showing that growth there is much slower than that, with some estimates more in line with the US at 3.0%. At any rate, equity markets continue to believe that a trade deal will happen sooner rather than later, and as long as talks continue, look for a more positive risk attitude across markets.

The other big news this morning is from the UK, where British PM Boris Johnson met with his Irish counterpart, Taoiseach Leo Varadkar, to discuss how to overcome the Irish backstop conundrum. It is interesting to see the two attitudes; Boris quite positive, Leo just the opposite, but in the end, nothing was agreed. In this instance, Ireland is at far more risk than the UK as its much smaller economy is far more dependent on free access to the UK than vice versa. But thus far, Varadkar is holding his ground. Another Tory cabinet member, Amber Rudd, quit Saturday night, but Boris is unmoved. There was an interesting article over the weekend describing a possible way for Boris to get his election; he can call for a no-confidence vote in his government, arguably losing, and paving the way for the election before the Brexit deadline. Certainly it seems this would put parliament in an untenable position, support him to prevent the election, but that would imply they support his program, or defeat him and have the election he wants.

Of course, while all this is ongoing, the currency market is looking at the pound and trying to decide the ultimate outcome. For the past two weeks, it is clear that a belief is growing there will be no Brexit at all as the pound continues to rally. This morning it is higher by 0.6% and back to its highest level in over a month. Part of that, no doubt, was the UK GDP data, which surprised one and all by showing a 0.3% gain in July, which virtually insures there will be no technical recession yet. But the pound is a solid 3.5% from its lows seen earlier this month. I continue to believe that the EU will blink and a deal will be cobbled together with the pound rebounding much further.

Elsewhere, the dollar is softer in most cases. The continuation of last week’s risk rally has reduced the desire to hold dollars and we continue to see yields edge higher as well. Beyond the pound’s rally, which is the largest in the G10 space, AUD and NZD have pushed back up by about 0.3% on the China stimulus story, but the rest of G10 is quite dull. In the EMG bloc, ZAR is today’s big winner, +0.8%, as hopes for more global stimulus increase the relative attractiveness of high yielding ZAR denominated bonds. But otherwise, here too, things are uninteresting.

Looking to the data this week, it is an Inflation and Retail Sales week with no Fed speak as they are now in their quiet period ahead of next week’s meeting.

Today Consumer Credit $16.0B
Tuesday NFIB Small Biz Optimism 103.5
  JOLT’s Job Openings 7.311M
Wednesday PPI 0.0% (1.7% Y/Y)
  -ex food & energy 0.2% (2.2% Y/Y)
Thursday Initial claims 215K
  CPI 0.1% (1.8% Y/Y)
  -ex food & energy 0.2% (2.3% Y/Y)
Friday Retail Sales 0.2%
  -ex autos 0.1%
  Michigan Sentiment 90.5

Aside from this, we hear from both the ECB and BOJ this Thursday with expectations for a rate cut and potentially more QE by Signor Draghi, while there are some thoughts that Kuroda-san will be cutting rates in Japan as well. Ultimately, nothing has changed the broad sweep of central bank policy ease. As long as everybody is easing, the relative impact of monetary policy on the currency market will be diminished. And that means that funds will continue to flow to the best performing economies with the best prospects. Despite everything ongoing, the US remains the choice, and the dollar should remain supported overall.

Good luck
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Run Off The Rails

In England and Scotland and Wales
The saga has run off the rails
So Boris is gambling
A vote will keep scrambling
Dissent and extend his coattails

Meanwhile market focus has turned
To data, where much will be learned
When payrolls are shown
And if they have grown
Watch stocks rise as havens are spurned

The Brexit story remains front page news as the latest twists and turns create further uncertainty over the outcome. Boris is pushing for an election to be held on October 15 so that he can demonstrate he has a sufficient majority to exit with no deal when the EU next meets on October 17-18, thus forcing the EU’s hand. However, parliament continues to do what they can to prevent a no-deal Brexit and have passed a bill directing the PM to seek an extension if there is no deal agreed by the current Halloween deadline. With that in hand, they will agree to a vote on October 29, thus not allowing sufficient time for a new government to do anything ahead of the deadline.

But Boris, being Boris, has intimated that despite the extension bill, he may opt not to seek that extension and simply let the UK leave. That would really sow chaos in the UK as it would call into question many constitutional issues; but based on the current agreement with the EU, that action may not be able to be changed. After all, even if the EU offers the extension, the UK must accept it, which seemingly Boris has indicated he won’t. Needless to say, there is no clarity whatsoever on how things will play out at this time, so market participants remain timid. The recent news has encouraged the view that there will be no hard Brexit and has helped the pound recoup 2.0% this week. However, this morning it is slipping back a bit, -0.3%, as traders and investors are just not sure what to believe anymore. Nothing has changed my view that the EU will seek a deal and cave-in on the Irish backstop issue, especially given the continuous stream of terrible European data.

To that point, German IP was released at a much worse than expected -0.6% this morning, with the Y/Y outcome a -4.2% decline. I know that Weidmann and Lautenschlager are ECB hawks, but it is starting to feel like they are willing to sacrifice their own nation’s health on the altar of economic fundamentalism. The ECB meeting next Thursday will be keenly watched and everything Signor Draghi says at the press conference that follows will be parsed. But we have a couple of things coming before that meeting which will divert attention. And that doesn’t even count this morning’s surprise announcement by the PBOC that they were cutting the RRR by 0.5% starting September 16 in an effort to ease policy further without stoking the real estate bubble there.

So let’s look at today’s festivities, where the US payroll report is released at 8:30 and then Chairman Powell will be our last Fed speaker ahead of the quiet period and September 18 FOMC meeting. Here are the current expectations:

Nonfarm Payrolls 160K
Private Payrolls 150K
Manufacturing Payrolls 5K
Unemployment Rate 3.7%
Average Hourly Earnings 0.3% (3.0% Y/Y)
Average Weekly Hours 34.4

Yesterday’s ADP number was much stronger than expected at 195K, but the employment data from the ISM surveys has been much weaker so there is a wide range of estimates this month. In addition, the government has been hiring census workers, and it is not clear how that will impact the headline numbers and the overall data. I think the market might be a little schizophrenic on this number as a good number could serve to reinforce that the economy is performing well enough and so drive earning expectations, and stocks with them, higher. But a good number could detract from the ongoing Fed ease story which, on the surface, would likely be a stock market negative. In a funny way, I think Powell’s 12:30 comments may be more important as market participants will take it as the clear direction the Fed is leaning. Remember, futures are pricing in certainty that the Fed cuts 25bps at the meeting, with an 11% probability they cut 50bps! And the comments we have heard from recent Fed speakers have shown a gamut of viewpoints exist on the FOMC. Interesting times indeed! At this point, I don’t think the Fed has the gumption to stand up to the market and remain on hold, so 25bps remains the most likely outcome.

As to the rest of the world, next week’s ECB meeting will also be highly scrutinized, but lately there has been substantial pushback on market and analyst expectations of a big easing package. Futures are currently pricing in a 10bp cut with a 46% chance of a 20bp cut. Despite comments from a number of hawks regarding the lack of appetite for more QE, the majority of analysts are calling for a reinstitution of the asset purchase program as soon as October. As to the euro, while it has edged higher this week, just 0.35%, it remains in a long-term downtrend and has fallen 1.6% this month. The ECB will need to be quite surprisingly hawkish to do anything to change the trend, and I just don’t see that happening. Signor Draghi is an avowed dove, as is Madame Lagarde who takes over on November 1. Look for the rate cuts and the start of QE, and look for the euro to continue its decline.

Overall, though, today has seen a mixed picture in the FX market with both gainers and losers in G10 and EMG currencies. Some of those movements have been significant, with ZAR, for example, rallying 0.75% as investment continues to flow into the country, while CHF has fallen 0.6% as haven assets are shed in the current environment. Speaking of shedding havens, how about the 10-year Treasury, which has seen yields rebound 15bps in two days, a truly impressive squeeze on overdone buyers. But for now, things remain generally quiet ahead of the data.

Given it is Friday, and traders will want to be lightening up any positions outstanding, I expect that this week’s dollar weakness may well see a modest reversal before we go home. Of course, a surprise in the data means all bets are off. And if Powell sounds remotely hawkish? Well then watch out for a much sharper dollar rally.

Good luck
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No Longer Afraid

This morning twixt Brexit and trade
The market’s no longer afraid
More talks are now set
Though there’s no deal yet
And Parliament’s built a blockade

Yesterday saw a risk grab after the situation in Hong Kong moved toward a positive outcome. This morning has seen a continuation of that risk rally after two more key stories moved away from the abyss. First, both the US and China have confirmed that trade talks will resume in the coming weeks, expected sometime in early October, when Vice-premier Liu He and his team visit Washington. While the current tariff schedules remain in place, and there is no certainty that either side will compromise on the outstanding issues, it is certainly better that the talks continue than that all the news is in the form of dueling tweets.

It should be no surprise that Asian equity markets rallied on the news, (Nikkei +2.1%, Shanghai +1.0%), nor that European markets are following in their footsteps (DAX +0.85%, CAC +0.9%). It should also not be surprising that Treasury yields are higher (+5bps) as are Bund yields (+5bps); that the yen and dollar have suffered (JPY -0.2%, DXY -0.25%) and that gold prices are lower (-0.7%).

Of course, the other big story is Brexit, where yesterday PM Boris Johnson suffered twin defeats in his strategy of ending the mess once and for all. Parliament passed a bill that prevents the government from leaving the EU without a deal and requires the PM to ask for a delay if no deal is agreed by mid-October. Then in a follow-up vote, they rejected the call for a snap election as Labour’s Jeremy Corbyn would not support the opportunity to become PM himself. While Boris plots his next move, the market is reducing the probability of a hard Brexit in the pound’s price thus it has rallied further this morning, +0.7%, and is now higher by more than 2% since Tuesday morning.

However, while the news on both fronts is positive right now, remember nothing is concluded and both stories are subject to reversal at any time. In other words, hedgers must remain vigilant.

Turning to the rest of the market, there have been two central bank surprises in the past twenty-four hours, both of which were more hawkish than expected. First, the Bank of Canada yesterday left rates on hold despite the market having priced in a 25bp rate cut. They pointed to still solid growth and inflation near their target levels as reason enough to dissent from the market viewpoint. The market response was an immediate 0.5% rise in the Loonie with a much slower pace of ascent since then. However, all told, CAD is stronger by a bit over 1.1% since before the meeting. If you recall, analysts were less convinced than the market that a cut was coming, but they still have one penciled in by the end of the year. Meanwhile, the market is now 50/50 they will cut in October and about 65% certain it will happen by December.

The other hawkish surprise came from Stockholm this morning, where the Riksbank left rates on hold, as expected, but reiterated their view that a hike was still appropriate this year and that they expected to get rates back to positive before too long (currently the rate is -0.25%). While analysts don’t believe they will be able to follow through on this commitment, the FX market responded immediately and SEK is today’s top performer in the G10 space, rallying 0.9%.

The only data we have seen today was a much weaker than expected Factory Orders print from Germany (-2.7%), simply reinforcing the fact that the country is heading into a recession. That said, general dollar weakness on the risk grab has the euro higher by 0.25% as I type.

In the EMG space, we continue to see traders and investors piling into positions in their ongoing hunt for yield now that overall risk sentiment has improved. In the past two sessions we have seen LATAM, in particular, outperform with BRL higher by 1.8%, MXN up 1.65% and COP up 1.35%. But it is not just LATAM, ZAR is higher by 2.0% in that time frame, and KRW is up 1.3%. In fact, if you remove ARS from the equation (which obviously has its own major problems), every other EMG currency is higher since Tuesday’s close.

On the data front, yesterday’s US Trade deficit was a touch worse than expected at -$54.0B, but still an improvement on June’s data. This morning we see a number of things including ADP Employment (exp 148K), Initial Claims (215K), Nonfarm Productivity (2.2%), Unit Labor Costs (2.4%), Durable Goods orders (2.1%, -0.4% ex transport) and finally ISM Non-manufacturing (54.0). So there’s plenty of updated information to help ascertain just how the US economy is handling the stresses of the trade war and the global slowdown. As to Fed speak, there is nobody scheduled for today although we heard from several FOMC members yesterday with a range of views; from uber-dove Bullard’s call for a 50bp cut, to Dallas’s Kaplan discussing all the reasons that a cut is not necessary right now.

Despite the data dump today, I think all eyes will be on tomorrow where we not only get the payroll report, but Chairman Powell speaks at lunchtime. As such, there is no reason, barring a White House tweet, for the current risk on view to change and so I expect the dollar will continue to soften right up until tomorrow’s data. Then it will depend on that outcome.

Good luck
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The Fun’s Just Begun

In Hong Kong, the protestors won
In England, the fun’s just begun
But as of today
Bremain’s holding sway
And risk has begun a new run

As New York walks in this morning, there have been significant changes in several of the stories driving recent price action with the upshot being that risk is clearly in favor today. Things started in Hong Kong, where Carrie Lam, the territory’s Chief Executive, formally withdrew the extradition bill that had prompted three months of increasingly violent protests there. The quick back story is that this bill was presented in June as a response to a situation where a man accused of murder in Taiwan could not be returned there for trial due to the lack of formal extradition mechanisms in the existing legal framework. However, the bill they crafted was quite open-ended and would have allowed for extradition to the mainland for minor infractions, a situation seen as fraught with danger for Hong Kong’s shrinking independence. That is what begat the protests, and although they have grown in scope as well as size, it is seen as a significant first step to restoring order. It is hard to believe that Beijing is happy with this outcome as they were strong supporters of the bill, but thus far, they have made no comment.

As it happens, financial markets saw this as a significant change in the tone for the future and there was a massive equity rally in HK, while risk assets generally performed well at the expense of haven assets. So the Hang Seng rose nearly 4.0% with other APAC stock markets also gaining, albeit not to the same extent. European markets are also on the move this morning, with gains ranging from the FTSE 100’s +0.4% to the FTSE MIB (Italy) up 1.65%. And don’t worry, US equity futures are all pointing higher as well, on the order of 0.75%. Meanwhile, Treasuries have sold off modestly, with the 10-year yield higher by 3bps, Bunds have fallen further, with yields there up by 6bps, and the yen has bucked the trend in currencies, falling 0.25% amid a broad dollar decline. Finally, gold is lower by 0.65%, although remains near the top of its recent trading activity.

The other story that has seen significant changes comes from London, where PM Boris Johnson has not only lost a vote regarding his ability to deliver Brexit, but also has lost his slim majority in parliament after a single member defected to the LibDems. Subsequent to that, there was a vote on a bill brought to the floor to prevent the PM from forcing a no-deal Brexit, one which Boris opposed but passed 328-301 with 21 Tories voting against the PM. Johnson summarily fired those rebels from the party and now leads a minority government. His current tactic is to push for a snap election on October 14 or 15 so that a new government will be available to speak to the EU at a formal meeting on October 18. However, he needs two-thirds of all members of parliament to vote for that, meaning he needs the Labour party to agree. If you are confused by this back and forth, don’t feel too badly, I think pretty much everyone is, and there is certainly no clarity as to what will come next.

With that convoluted process in mind, from a markets perspective the result is clear, the probability of a no-deal Brexit has receded for the moment and the pound has been the biggest beneficiary, rallying 0.9% this morning and is now more than two cents above yesterday’s depths. While this move certainly makes sense given the current understanding of the situation, it is by no means the end of the story. If anything, it is the end of chapter one. Later today we should know if there is going to be another election and then it will take a little time before the market understands the odds of those outcomes. Remember, if there is an election and Jeremy Corbyn is seen with a chance to win, it will not be a positive for the pound or the UK economy either. For now, the market is focused on a somewhat lower probability of a hard Brexit and the pound is benefitting accordingly. However, I don’t think the binary nature of the problem has disappeared, simply been masked temporarily. For hedgers, implied volatility has fallen sharply on the back of this news and the ensuing move, but I would argue uncertainty remains quite high. Options still make a lot of sense here.

Past those two stories, there is no further news on the trade front, although that will certainly become the topic du jour again soon. In the meantime, recent data has continued to paint a mixed picture at best for the G10 economies. For example, yesterday’s ISM data printed at 49.1, well below expectations and the worst print since January 2016. While one print below 50.0 does not indicate a recession is upon us, it is certainly a harbinger of slower growth in the future. Then this morning we saw Service PMI’s from Europe with Italy’s much weaker than expected while France, Germany and the Eurozone as a whole printed at expectations. However, expectations still point to slowing growth, especially in combination with the manufacturing surveys which are mostly sub 50.0. In the UK, the PMI was also weak, 50.6, and there is talk that Q3 is going to result in modest negative GDP performance causing a technical recession in the UK joining Germany and Italy in that regard. In the end, while the trade war may be negatively impacting both the US and China, it is also clearly having a big impact throughout Europe and the rest of the world.

As to the rest of the FX market, the risk on behavior has led to broad based dollar weakness, with the euro rebounding 0.35%, Aussie and Kiwi up similar amounts and the Skandies rallying even further, +0.7%. Canada is a bit of an outlier here as oil prices have been under pressure lately, although have bounced 1.0% this morning, but more importantly, the BOC meets with great uncertainty as to whether they will cut rates or not. Markets are pricing in a 92% chance they will do so, but the analyst community is split about 50/50 on the prospects for a cut today. That said, those same analysts are looking for cuts later this year, so this seems more about timing than the ultimate result.

In the EMG bloc ZAR has had another winning day, rising 1.4% as international bond buyers continue to aggressively buy South African paper after the country averted a recession. But broadly, the dollar is lower against virtually all EMG currencies due to risk-on sentiment.

On the data front, this morning brings the Trade Balance (exp -$53.4B) a modest decline from last month’s outcome, and then the Beige Book comes at 2:00 but that’s all. We will hear from a plethora of Fed speakers today, five in all, ranging from uber doves Kashkari and Bullard to moderate Robert Kaplan from Dallas. Yesterday, Bullard in another speech said the Fed should cut 50bps at the upcoming meeting while Boston’s Rosengren said there didn’t seem to be the need to do anything right now. A full cut plus some is still priced in at this point.

In the end, broad risk sentiment is today’s driver. As long as that remains positive, look for the dollar to remain under pressure.

Good luck
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The Result Europe’s Fearing

The dollar, like art and fine wine
Continues, its peers, to outshine
Like Veblen explained
The more it has gained
The more buyers want to say, “Mine!”

Has the dollar become a Veblen Good? Given its recent performance and the underlying drivers of dollar strength, it certainly seems to behave like one, even if the rationale behind the dollar demand is not quite what Thorstein Veblen imagined in 1899. For those unfamiliar with the term, a Veblen Good is one where demand increases as its price rises, completely opposite to most items. It was defined by Dr Veblen in his 1899 book; The Theory of the Leisure Class, explaining that certain items saw increased demand based on the idea of exclusivity, thus the higher the price the more demand shown.

Now, the dollar is certainly not a rare item given the trillions of them that are currently circulating around the globe. Yet the price of dollars, at least in terms of other currencies, continues to climb despite the numerous studies that demonstrate it is overvalued at current levels. This behavior leads to the question of why, if the dollar is so overvalued, is demand increasing? At this point it seems pretty clear that the rationale is twofold. First is the fact that the financial markets definition of a safe haven begins with US Treasury paper and to buy Treasuries one needs to first buy dollars. So in the current environment, where uncertainty over trade policy, politics and Brexit are constant headlines, havens are in great demand. In fact, the more concern there is, the more demand regardless of the price of the dollar. The second issue is that because the dollar is the funding currency of choice globally, given the deepest and most liquid capital markets exist in the US, there has been a significant amount of issuance by non-US entities, both companies and foreign governments, in USD. As the dollar rises, these borrowers are forced to scramble to obtain as many dollars as they can in order to repay their loans. This simply adds to the demand for dollars, actually increasing that demand the higher the price of the buck. In the end, almost regardless of the relative interest rate structures in different countries, the dollar is destined, for now, to continue rising. Hedgers need to keep that in mind.

In England a showdown is nearing
Which Brexiteers are loudly cheering
By later today
If Boris holds sway
Look for the result Europe’s fearing

In more specific news, the pound has plumbed new depths for the move, trading below 1.20 for the first time since the flash crash in October 2016, as Parliament returns from their summer holiday. Bremainers are trying to pass legislation that takes the Brexit decision out of PM Johnson’s hands and requires a deal to be in place before leaving. Meanwhile, Boris is adamant that he has to have the ability to ‘threaten’ a no-deal in order to win any concessions. In fact, Johnson has said he will call for an election on October 14 if the legislation passes. This would prevent any further parliamentary activity, although negotiations would be ongoing.

Of course, one of the market’s key concerns is an election could wind up with a PM Jeremy Corbyn, the socialist leader of the Labour party , and someone greatly feared by financial markets given his stated desire to nationalize entire swathes of the economy. At this point, there appear to be three possible outcomes; Boris stays in power and despite best efforts oversees a no-deal Brexit; an election where Corbyn becomes the new PM; or the EU caves on the Irish backstop and a deal is verbalized so the hard edges are removed. Arguably in either of the first two situations the pound has further to fall, while clearly the last situation will result in a sharp rebound of the pound, and the euro. My money remains on a deal as the EU cannot look at their economic situation and believe they can withstand the stress of a hard Brexit right now. Consider this, if the EU holds firm and the economy suffers greatly, politicians throughout the EU will find themselves under huge pressure, and likely many will lose their next elections, because of this decision. And that is probably the only thing about which politicians really care.

So with that as a backdrop, what else do we have to look forward to this week? The China trade talks have still not even agreed on a date, so that remains on the back burner for now, although every day without some concrete positive news indicates a longer and longer time before anything positive can happen. Meanwhile, new tariffs were imposed on $115 billion of Chinese imports starting Sunday. Hong Kong is still simmering with the Chinese claiming they can invoke emergency powers (read martial law) if necessary. Argentina is on the cusp, having imposed very strict capital controls last Friday to try to husband whatever hard currency they still have. And sentiment around the world continues to move toward a recessionary outcome.

Looking ahead to this week, there is much Fedspeak and some quite important data, culminating in the payroll report on Friday.

Today ISM Manufacturing 51.3
  ISM Prices Paid 46.8
  Construction Spending 0.3%
Wednesday Trade Balance -$53.4B
  Fed’s Beige Book  
Thursday ADP Employment 149K
  Initial Claims 215K
  Nonfarm Productivity 2.2%
  Unit Labor Costs 2.4%
  Factory Orders 1.0%
  Durable Goods 2.1%
  -ex Transport -0.4%
  Ism Non-Manufacturing 54.0
Friday Nonfarm Payrolls 160K
  Private Payrolls 150K
  Manufacturing Payrolls 5K
  Unemployment Rate 3.7%
  Average Hourly Earnings 0.3% (3.0% Y/Y)
  Average Weekly Hours 34.4

So obviously, everyone will be waiting for Friday’s payroll report, but before then we hear from five speakers and Chairman Powell speaks Friday at 12:30pm.

The RBA left rates on hold last night, as expected but further cuts are coming, especially as China’s economy slows further. That said, AUD is the top G10 performer overnight. Meanwhile, the other piece of positive news we saw was South African GDP rising at 3.1% in Q2, much better than expected and enough to help the rand rally 0.7%. Other than those two pieces of news though, it has really been all about Brexit and the pound. For now, that makes sense as the market awaits the outcome of this afternoon’s parliamentary vote. Until then, risk is under pressure and havens will likely perform well.

Good luck
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