Tag Archives: #dollar

Run Off The Rails

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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

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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

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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

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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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QT Anyone? (or The Three Hawksketeers)

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As summer recedes
JGB rates have collapsed
QT anyone?

As we approach the unofficial end of summer with the Labor Day holiday weekend, it seems the BOJ is finally responding to the fact that their yield curve control policy has been dismissed by the market for basically all of August. A brief history shows that ordinary QE had lost its ability to impact the Japanese economy by September 2016, by which time the BOJ owned about 40% of JGB’s outstanding and thus destroyed any sense of it being a true market. At that point, they introduced yield curve control in an attempt to insure that 10-year yields didn’t rise prematurely. Initially they set a range of +/-0.10% around zero, where if the 10-year traded outside the range they would step in and push it back. Last year they widened that range to +/-0.20%, and up until the beginning of this month, things were working smoothly.

Then the global bond rally gathered steam and JGB’s were not exempt with 10-year yields falling to -0.30% at one point earlier this week, well below the lower bound. Remarkably, the BOJ did nothing, calling into question their commitment to yield curve control. As it turns out, last night they finally acted, reducing the quantity of bonds to be purchased monthly going forward by a significant ¥50 trillion. JGB yields did rally 3bps initially, but closed the session only 1bp higher and still well below the lower bound. As I have been writing, this is simply further proof that the central banks have run out of effective monetary policy tools. As to the impact on the yen, overnight has seen a very modest strengthening of just 0.15%. For the month, however, the increase in risk aversion has seen the yen outperform every other currency in the world, rallying 2.1% against the dollar, and more against most others. While I continue to view the dollar in a positive light going forward, I also continue to see further gains for the yen against all comers.

The hawks at the ECB fear
That not only rate cuts are near
So this week they’ve shrieked
Though rates might be tweaked
That QE has no place this year

Meanwhile, from Europe we had the third of the Three Hawksketeers in the ECB on the tape overnight, Klaas Knot the President of the Dutch central bank. In line with his German colleagues Sabine Lautenschlager and Jens Weidmann, he said that while a cut in interest rates could make sense here, there is absolutely no cause for the reinitiation of QE at this time. That is to be used in dire emergencies (perhaps like a hard Brexit?). This sets up quite a battle for Signor Draghi at his penultimate meeting next month, where other ECB members, Finland’s Ollie Rehn notably, have already called for ‘impactful’ actions implying he wants to over deliver on market expectations.

The market response to the Knot comments was muted at best with Bunds and Dutch bonds seeing yields actually fall 0.5bps in today’s trade. However, that could also be a response to this morning’s Eurozone CPI data where the headline printed at 1.0%, as expected but still miles from their target of “just below 2.0%”. Of more concern though was the core number which surprisingly fell to 0.9%, adding to the case for further stimulus, at least in the ECB’s collective modeling minds. And the euro? Well it has continued its slow and steady decline this month, falling another 0.2% and now trading at its lowest level since May 2017. It continues to be very difficult to make a case for the euro to rebound significantly anytime soon. And despite the Three Hawksketeers, I am more and more convinced that QE starts up again next month. Look for further declines in the single currency.

On the trade front, everybody seems willing to take the over on a positive outcome which has supported stocks nicely. On Brexit, there have been three lawsuits filed against PM Johnson’s move to prorogue Parliament for five weeks, but the first ruling that came down this morning went in Boris’s favor. The pound is little changed on the day, even after marginally weaker than expected house price data, but for the month it is actually a touch higher, 0.2%, which just shows that the market really was focused on a hard Brexit last month. There have been several EU officials stating that prorogation should have no impact on negotiations, and some even see it my way as a strong lever to get a deal.

For all you hedgers, consider this: a 1-year ATMF option costs a bit more than 5 cents. While that is certainly higher than it was before Brexit occurred, I would contend that October will be a binary event, with a no-deal outcome driving a quite severe decline, likely to at least 1.10, while a deal should take us back to 1.30-1.35 quickly. In either case, 5 cents seems like a reasonable price to pay. And obviously, shorter term options will cost less with the same movement available.

And that’s really it for today. The dollar continues to largely grind higher vs. its EMG counterparts, and, quite frankly, its G10 counterparts as well. Equity markets remain in their trade euphoria clouds, and bond markets seem a bit more cautious. Yesterday saw US Q2 GDP revised down to 2.0%, as expected, but the consumer spending measurement was an even stronger than expected 4.7%. This morning the BEA releases Personal Income (exp 0.3%), Personal Spending (0.5%) and PCE (1.4%, 1.6% core) all at 8:30. We also see Chicago PMI (47.5) at 9:45 and Michigan Sentiment (92.3) at 10:00. The Fed is mercifully quiet going into the weekend so barring a shocking outcome in PCE or a White House tweet, the best bet is a continued slow grind higher in the dollar.

Good luck and good weekend
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The Optimists Reign

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This morning the optimists reign
As China was keen to explain
They felt it unwise
That tariffs should rise
They’d rather start talking again

Equity bulls are on the rampage this morning as all the negative stories have been overwhelmed by positive sentiment from two areas, China and Italy. From China last night we heard that despite President Trumps’ latest decision to increase tariffs further on Chinese imports, the nation would not escalate the situation, and instead wanted to maintain the dialog and seek common ground. Spokesman Gao Feng said that while China is protesting, they are not responding. He also confirmed that ongoing communications would likely lead to another face-to-face meeting in Washington in September. We heard confirmation from Treasury Secretary Mnuchin that a meeting in Washington was to take place in September, although the final details have not yet been decided.

However, this was more than enough for the bulls to stampede as once again they seem willing to believe that a solution is close at hand. One need only look at the timeline of every other trade negotiation in history to recognize that these things take a very long time to come to agreement. And of course, as I have written before, there are fundamental issues that seem unlikely to ever be addressed to the satisfaction of both sides. For example, while a key issue for the US is the theft of IP by Chinese companies, the Chinese won’t even acknowledge that takes place and therefore cannot agree to stop something they don’t believe is happening. Recall, as well, the issue when talks broke down in late spring, that the issue was the US was seeking the agreement be enshrined in law, as is the case in the US and every Western nation, but the Chinese refused claiming that was an infringement of their sovereignty and that they would simply make rules that would be followed. These are very big canyons to cross and will take a long time to do so. While it is certainly good news that the Chinese are not escalating things, and in fact, are making efforts to reduce market tensions via their CNY fixing activities, we are still a long way from a deal.

The upshot of the China story is that Asian equity markets rebounded from their lows to close near unchanged while European markets are all higher on the order of 1.0%. Treasury yields have edged up slightly as have yields in most sovereign bond markets, and the two main haven currencies, yen and Swiss francs, have both weakened slightly.

The other story that has the bulls on the move is from Rome, where Italian President, Sergio Mattarella has given the nod to the coalition of 5-Star and the Democratic Party (known as the PD and which, contrary to yesterday’s comment, is actually a center left party) to try to form a government. The thing that makes this so surprising, and bodes ill for any government’s longevity, is that 5-Star came to power by constantly attacking the PD as corrupt and the major problem in the country. But their combined fear of an election, where the League is likely to win an outright majority at this time, has pushed these unlikely bedfellows together. The market, however, loves it with Italian equities higher by 1.9% and Italian BTP’s (their sovereign bonds) rallying nearly a full point driving the 10-year yield down to a new historic low of 0.96%. Think about that for a moment, Italian 10-year yields are more than 50bps lower than US yields!

All in all, it is clearly a risk-on type of day. Looking at the FX markets shows a mixed bag of results although the theme is really modest movement. For example, in the G10, the biggest mover has been NOK, which is lower by 0.25%, while the biggest gainer is AUD, up just 0.2%. The latter has been helped by the China story, while the former is suffering after weaker than expected GDP data showed Q2 growth at just 0.3% in the quarter, well below expectations of a 0.5% rebound from last quarter’s negative print.

It should be no surprise that EMG currencies have a slightly larger range, but still, the biggest mover is ZAR, which has gained 0.5% while the weakest currency is TRY, falling 0.4%. From South Africa we learned that price pressures are less acute than anticipated as PPI actually fell in July engendering hope that the SARB can encourage more growth by maintaining the rate structure rather than raising rates. Meanwhile, Turkey continues to see erosion in both the number of incoming tourists, a key industry and source of hard currency, and incoming investment, where foreigners were net sellers of both stocks and bonds last week.

The one other noteworthy move has been CNY, where the renminbi is firmer by 0.25% today after the PBOC very clearly indicated their interest in preventing a sharp decline. The fix overnight was significantly stronger than every forecast and that has helped squeeze the differential between the fix and the currency market back below 1.0%. It is worthwhile to keep an eye on this spread as it can be a harbinger of bigger problems to come if it expands. Remember, the current band is 2.0%, so actions to change that or allow a breech are clear policy statements.

This morning we finally get some useful data led by the second look at Q2 GDP (exp 2.0%) and Initial Claims (214K). Overnight we saw German state inflation data point to continued weakening growth with the national number due soon. We also heard from SF Fed president Daly yesterday who was clearly on board for another rate cut, while Richmond’s Patrick Harker was far less enthused. However, neither one is a voter, so they tend to be seen in a bit less important light.

There is no reason to think that the equity rally will fade, barring a tweet of some sort from the White House. As such, it seems the dollar will likely remain in its current holding pattern, with some gainers and some losers, until the next shoe drops.

Good luck
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The EU Will Succumb

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Said Boris, the time has now come
To exit ‘neath Parliament’s thumb
I spoke to the Queen
She sees what I mean
And soon the EU will succumb

Prorogue: verb
1: defer, postpone
2: to terminate a session of (something, such as a British parliament) by royal prerogative

I thought it would be useful to offer a definition of this word as it will certainly be in the news for the next few weeks. In fact, every year there is a prorogation of parliament in September as MP’s, after returning from their summer holidays need time to prepare for and attend their party conferences. The idea is that parliament is officially closed, but it has not been dissolved, thus there is no requirement for a new election.

What makes things different this year, of course, is Brexit. Boris has asked the queen to prorogate parliament for one additional week, until October 14 when she is slated to give the Queen’s Speech, which traditionally opens the new session. If this request is granted, the result is that parliament will not be in session, and therefore unable to create legislation to block a no-deal Brexit, until just two weeks before the deadline. Naturally MP’s are up in arms over the decision as those seeking to block a no-deal Brexit suddenly find themselves with fewer options. Personally, however, I think it is a brilliant move to put more pressure on the EU. Undoubtedly the EU is counting on parliament to override Boris’s stated intention of leaving with no deal if one cannot be found by the current deadline. Suddenly, this avenue has been closed off and the EU is now that much closer to feeling significant pain for which they have not planned.

To highlight the situation, the German Institute for Economic Research, or DIW, has just put forth its latest forecast for Q3 GDP growth in Germany at -0.2%. If correct, and they have an excellent track record, that means the last four quarters of GDP in Germany will have been -0.1%, 0.0%, -0.1% -0.2%. I don’t know about you, but that looks like a recession to me. With that as the backdrop, a hard Brexit, where German autos would suddenly be subject to a 10% tariff in the UK thus resulting in reduced demand in Germany’s third largest market, will be very tough to swallow. While there are those who claim Boris would be irresponsible to allow the damage to the UK economy by leaving with no deal, it is just as easy to describe Chancellor Merkel as irresponsible to not drive forward a deal rather than subject Germany to further, unnecessary pain. As I said, I think it is a brilliant move on PM Johnson’s part.

Of course, FX traders being what they are, see only the trees, not the forest, and so the pound has sold off sharply this morning, at one point trading lower by 1.1% although as I type it is down 0.7% at 1.2200. Nothing has changed regarding the pound’s reliance on the Brexit outcome and a hard Brexit will almost certainly result in a sharp, short-term decline, likely toward 1.10, while a deal will result in a sharp rebound, possibly back to the 1.35 level. My money is on a last minute deal and a rebound.

Away from Brexit, the other really big story is the more definitive instance of the 2yr-10yr yield curve inversion. Prior to yesterday’s session, that inversion had been, at most, 1bp and only for a few hours intraday. However, last night we closed at a 5bp inversion and we are watching overall yields fall sharply. This morning 30yr Treasury yields have reached new historic lows at 1.92%. Bunds are also seeing significant demand with the 10yr there seeing its yield fall to -0.72%, also a new historic low. Arguably, yesterday’s late equity market decline was a response to the steeper inversion and if the inversion goes further, I imagine equity markets will decline as well.

With risk being set aside across most markets, the dollar continues to be a main beneficiary. Looking at the dollar’s performance this month, only three currencies have outperformed the greenback, the yen (+1.5%), the Swiss franc (+1.0%) and the pound (+0.7%). The first two are clearly haven assets, while the pound happens to be slightly higher based on the fluctuations in thought around the Brexit outcome. Otherwise, the dollar reigns supreme against both G10 and EMG currencies. In fairness, though, the euro is essentially unchanged on the month as market participants are still trying to decide whether it exhibits haven characteristics and can be a substitute for the dollar, or whether it should be considered part of the masses. Given the interest rate structure in the Eurozone, my view remains weakness ahead, but certainly that is not a given.

An interesting aside has been the beginnings of a discussion by pundits and policymakers that the dollar’s strength is hurting other nations as well, and that a concerted effort to push it down may be appropriate. Consider that there are trillions of outstanding USD debt issued by countries and companies throughout the emerging markets and as the dollar rises, their ability to repay and refinance that debt is made increasingly difficult. Large scale debt defaults will not be a boon for global economic activity and so one solution is to drive the dollar lower and prevent those defaults from occurring. While it is still early days, listen closely as this idea gains credence, because if it does it will certainly help slow the dollar’s rise.

As to the rest of today’s session, there is no US data today, although tomorrow starts a run of important info. We do, however, hear from two Fed speakers, Daly and Barkin, the former being quite the dove while the latter is more middle-of-the-road. And we cannot forget about the Italian political negotiations as 5-Star and the Democratic Party (funnily enough it is a center right party in Italy) try to agree on the terms of a government to prevent new elections. Trade? Yeah, it’s still there but there is nothing new on that front to move things. In the end, I see no reason for the dollar to retreat yet.

Good luck
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No Solutions Are Near

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There is a group that’s quite elite
And every six months they all meet
In France this weekend
They tried to pretend
That problems, worldwide, they could treat

Alas what was really quite clear
Is that no solutions are near
The trade war remains
The source of most pains
And Brexit just adds to the fear

It has been a pretty dull session overnight with the dollar somewhat softer, Treasuries rallying and equities mixed. With the G7 meeting now over, the takeaways are that the US remains at odds with most members over most issues, but that those members are still largely reliant on the US as their major trade counterparty and overall security umbrella. In the end, there has been no agreement on any issue of substance and so things remain just as they were.

And exactly how are things? Well, the US economy continues to motor along with all the indications still pointing to GDP growth of 2.0% annualized or thereabouts in Q3, continuing the Q2 pace. This contrasts greatly with the Eurozone, for example, where German GDP was confirmed at -0.1% in Q2 this morning as slowing global trade continues to weigh on the economy there. Perhaps the most remarkable thing is that Jens Weidmann, the Bundesbank president, remains firm in his view that negative growth is no reason for easier monetary policy. While every other central bank in the world would be responsive to negative output, the Bundesbank truly does see things differently. As an aside, it is also interesting to see Weidmann revert to his old, uber-hawkish, self as opposed to the show of pragmatism he displayed when he was vying to become the next ECB President. You can be sure that Madame Lagarde will have a hard time convincing him that once the current mooted measures (cutting rates further and more QE) fail, extending policy to other asset purchases or other, as yet unconsidered, tools will be appropriate.

And the rest of Europe? Well, Italy continues to slide into recession as well while the country remains without a government. Ongoing talks between Five-Star and the center-left PD party remain stuck on all the things on which weird coalitions get stuck. But fear of another election, where League leader, Matteo Salvini, is almost certain to win a ruling majority will force them to find some compromise for a few months. None of this will help the economy there. Meanwhile, France is muddling along with an annualized growth rate below 1.0%, better than Germany and Italy, but still a problem. Despite the fact that the Fed has much more monetary leeway than the ECB, the problems extant in the Eurozone are such that buying the euro still seems quite a poor bet.

Turning to the UK, PM Johnson was quite the charmer at the G7, but with just over two months left before Brexit, there is still no indication a deal is in the offing. However, I remain convinced that given the dire straits in the Eurozone economic outlook, the willingness to allow a hard Brexit will fall to zero very quickly as the deadline approaches. A deal will be cut, whether a fudge or not is unclear, but it will change the tone completely. While the pound has edged higher this morning, +0.4%, it remains quite close to its post-vote lows at 1.2000 and there is ample room for a sharp rebound when the deal materializes. For hedgers, please keep that in mind.

The other story, of course, remains the trade war, where the PBOC is overseeing a steady deterioration in the renminbi while selectively looking for places to ease monetary policy and support the economy. Growth on the mainland has been slowing quite rapidly, and while I don’t expect reported data to surprise on the downside, indicators like commodity inventories and electricity usage point to a much weaker economy than one sporting a 6.0% growth handle. Of course, the G7 did produce a positive trade story, the in-principal agreement between the US and Japan on a new trade deal, but that just highlights the other pressure on the EU aside from Brexit, namely the need to make a deal with the US. Bloomberg pointed out the internal problem as to which constituency will be thrown under the bus; French farmers or German automakers. The US is seeking greater agricultural access, and appears willing to punish the auto companies if it is not achieved. (Once again, please explain to me how the EU can possibly allow a hard Brexit with this issue on the front burner).

And that is really today’s background news. The overnight session saw modest dollar weakness overall, and it would be easy to try to define sentiment as risk-off given the strength in the yen (+0.3%), gold (+0.2%) and Treasuries (-3bps). But equities are holding their own and there is no palpable sense in the market that fear has been elevated. Mostly, trading desks remain thinly staffed given the time of year, and I expect more meandering than trending in FX today. Of course, any tweet could change things quickly, but for now, yesterday’s modest dollar strength looks set to be replaced by today’s modest dollar weakness.

Good luck
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Lest Bubbles They Stoke

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There is a fine fellow named Jay
Who not too much later today
Will take to the stage
And help us to gauge
How quickly Fed funds will decay

This week several Fed members spoke
And all of them sought to invoke
That growth is still fine
Thus they’ve drawn the line
On more cuts, lest bubbles they stoke

It is quite remarkable that despite ongoing unrest in Hong Kong, with the temperature there rising each week, as well as the countdown to Brexit getting shorter and shorter, the only thing that matters right now is Jay Powell’s speech this morning from Jackson Hole. It is the defining theme of today’s market activity.

Let me set the stage to begin: interest rate markets are pricing in a rate cut in September, another in October and then a chance of one in December with “certainty” of that third cut by March 2020. Given that GDP growth in the US is running at 2.1% annually, Retail Sales have consistently beaten expectations and are up more than 4% in the past year and the Unemployment Rate, at 3.7%, is a tick away from its post-WWII lows, three cuts seem like a lot of monetary stimulus. After all, despite the fact that the Fed watches the PCE Deflator as their inflation gauge of choice, we all know that inflation is running higher than its current reading of 1.4%. The government’s own evidence is from CPI readings which most recently showed prices rising at a 1.8% level, with the core reading there at 2.1%. And ask yourself if even that conveys the feel of inflation. My guess is: Not. Even. Close.

At any rate, that’s what the market is pricing. As NY walks in this morning, equity markets around the world have shown modest gains (US futures included), bonds are falling with 10-year Treasury yields back up to 1.64% and the dollar is stronger almost across the board. Arguably, expectations are for Powell to confirm that July was not a ‘one and done’ rate cut but rather the beginning of several insurance cuts. The fly in that ointment comes from the comments we heard yesterday from a series of regional Fed Presidents, all of whom said that they saw little reason to cut rates further at this time. Effectively their argument was that growth is solid, unemployment low and inflation pretty close to target. While all paid heed to the fact that the Fed funds rate was above the 10-year yield, they were unwilling to buy into the idea that the curve inversion was presaging a recession at this time. There is just not enough evidence to them.

With the Fed’s hawks in full flight, it will certainly be tricky for Powell to describe anything about the FOMC as coordinated. Remember, the Minutes showed us members who didn’t want to cut at all as well as members wanting to cut by 50bps. That’s a pretty wide dispersion of thought. All told, he has a pretty tough job today if he doesn’t want to spook the markets.

As I have no idea what he will say, let’s game out two different views; first he manages to surprise dovishly and second, more likely in my opinion, he disappoints and sounds more hawkish than the market (and President) wants.

Dovish Surprise – If he confirms the markets current pricing and, for example, doubles down saying QE is an effective tool and they will use it again, look for a sharp equity rally to begin with, as well as a bond rally and dollar weakness. Certainly that would be the initial price action. However, it is not clear how long that would last. After all, if the current claim is growth is solid, what is the reason for all the ‘insurance’? At some point, market participants will ask that very question, as well as, what does the Fed know that we don’t? The result would be a reversal of equity gains, although bonds would likely still rally. And the dollar? I think a rebound would be in order as well as strength in the yen and Swiss franc. However, even if he does manage to sound dovish, I don’t see the dollar falling more than 2%-3% before finding a floor. At this point, I cannot paint a scenario where the dollar enters a longer term downtrend. Overall, my unscientific odds on this outcome are less than 25%.

Hawkish Disappointment – This seems far more likely to be the outcome, if only because to my eyes, the market has really gotten ahead of itself with regard to rate cuts. Essentially, if Powell doesn’t confirm that July’s cut was the beginning of a new rate-cutting cycle, the market is going to be disappointed. If he pushes back at all, sounding more like Esther George or Eric Rosengren, the two dissenters, than James Bullard or Neel Kashkari, the 50bp advocates, the market will be REALLY disappointed.

In the first case, I expect we will see equity markets fall a percent or a bit more today, with Europe giving up its early gains and the US quite weak. Bonds are a tougher call here, although I expect that the initial price action would be for further weakness. Remember, despite the fact that yields are 15bps from the low point seen two weeks ago, they are still down 37bps this month. There is plenty of room to fall. As to the dollar, that will rally further against everything, the yen included. I would expect the euro to finally test, and break, 1.10, and we could easily see 1% weakness and more throughout the emerging markets.

If he pushes back, well today may be remembered in market history as PB (Powell’s black) Friday. Equity markets would see significant losses as all the bets on further easy policy would be shed immediately. Bonds, too, would fall sharply as the idea that the Fed would no longer need to cut rates would change the entire sentiment there. And finally, the dollar would explode higher. Any ideas that the Fed has further room to cut rates than virtually all its counterparties, a key dollar bearish thesis, would be swept away and the dollar would really appreciate sharply. Think about EUR at 1.08; GBP at 1.20 (and that’s without the Brexit story); and the yen back to 108.00. However, given the risk of this type of market disruption, I do not believe this is at all likely either. In the end, a mild disappointment seems the most likely outcome, so look for stocks to close the week on a low note and the dollar on a high note.

Before he speaks at 10:00 this morning, we do see New Home Sales (exp 647K), but quite frankly, nobody cares about that today. It is all Powell, all the time.

Good luck and good weekend
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Under Stress

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The week that just passed was a mess
With both bulls and bears under stress
As equities fell
Most bonds performed well
And dollars? A roaring success

Pundits have been searching for adjectives to describe the week that is ending today. Tumultuous strikes me as an accurate reflection, but then stormy, tempestuous and volatile all work as well. In the end though, the broad trends have not changed at all. Equities continue to retreat from their mid-summer highs, bonds continue to rally sharply while yield curves around the world flatten and the dollar continues to march higher.

So what is driving all this volatility? It seems the bulk of the blame is laid at the feet of President Trump as his flipping and flopping on trade policy have left investors and traders completely confused. After all, late last week he declared tariffs would be imposed on the rest of Chinese imports not already subject to them, then after market declines he decided that a portion of those tariffs would be delayed from September until December. But then the Chinese struck back saying they would retaliate and now the President has highlighted he will be speaking directly with President Xi quite soon. On the one hand, it is easy to see given the numerous changes in stance, why markets have been so volatile. However, it beggars belief that a complex negotiation like this could possibly be completed on any short timeline, and almost by definition will take many more months, if not years. There is certainly no indication that either side is ready to capitulate on any of the outstanding issues. So the real question is, why are markets responding to every single tweet or comment? To quote William Shakespeare, “It is a tale told by an idiot, full of sound and fury signifying nothing.” Alas, there is every indication that this investor and trader behavior is going to continue for a while yet.

This morning we are back in happy mode, with the idea that the Presidents, Trump and Xi, are going to speak soon deemed a market positive. Equity markets around the world are higher (DAX +1.0%, CAC +1.0%, Nikkei +0.5%); bond markets have been a bit more mixed with Treasuries (+2bps) and Gilts (+4.5bps) selling off a bit but we continue to see Bunds (-1.5bps) rally. In fact we are at new all-time lows for Bund yields with the 10-year now yielding -0.73%!

As to the dollar, it is still in favor, with only the pound showing any real life in the G10 space, having rallied 0.65% this morning with the market continuing to be impressed with yesterday’s Retail Sales data there. In fact, if we look over the past week, the pound is the only G10 currency to outperform the dollar, having rallied more than 1.0%. On the flip side, the Skandies are this week’s biggest losers with both SEK and NOK down by 1.35% closely followed by the euro’s 1.1% decline, of which 0.3% has happened overnight.

The FX market continues to track the newest thoughts regarding relative central bank policy changes and that is clearly driving the euro. For example, yesterday, St Louis Fed President Bullard, likely the most dovish FOMC member (although Kashkari gives him a run), sounded almost reticent to continue cutting rates, and ruled out the idea that an intermeeting cut was necessary. While he supported the July cut, and will likely vote for September, he again ruled out 50bps and didn’t sound like more made sense. At the same time, Finnish central bank president Ollie Rehn, a key ECB member, explained that come September, the ECB would act very aggressively in order to get the most bang for the buck (euro?). The indication was not only will they cut rates, and possibly more than the 10bps expected, but QE would be restarted and expanded, and he did not rule out movement into other products (equities anyone?) as well. In the end, the market sees that the ECB is going to basically do everything else they can right away as they watch the Eurozone economy sink into recession. Meanwhile, most US data continues to point to a much more robust growth situation.

Let’s look at yesterday’s US data where Retail Sales were very strong (0.7%, 1.0% ex autos) and Productivity, Empire Manufacturing and Philly Fed all beat expectations. Of course, confusingly, IP was a weaker than expected -0.2% and Capacity Utilization fell to 77.5%. Adding to the overall confusion is this morning’s Housing data where Starts fell to 1191K although Permits rose to 1336K. In the end, there is more data that is better than worse which helps explain the 2.1% growth trajectory in the US, which compares quite favorably with the 0.8% GDP trajectory on the continent. As long as this remains the case, look for the dollar to continue to outperform.

Oh and one more thing, given the problems in the Eurozone, do you really believe the EU will sit by and watch the UK exit without changing their tune? Me either!

Next week brings the Fed’s Jackson Hole symposium and key speeches, notably by Chairman Powell. As to today, there is no reason to expect the dollar to do anything but continue its gradual appreciation.

Good luck and good weekend
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