Tag Archives: #dollar

Up Sh*t’s Creek

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Much time has progressed
Since last I manned a bank desk
But I have returned

Good morning all. Briefly I wanted to let you know that I have begun a new role at Sumitomo Mitsui Banking Corp. (SMBC) as of Monday morning and look forward to rekindling so many wonderful relationships while trying to assist in risk management in an increasingly uncertain world. Don’t hesitate to reach out to chat.

Said Trump well those tariffs can wait
Until it’s a much later date
That opened the door
To buy stocks and more
Now don’t you all feel simply great?

But trade is still problematique
And that’s why the view is so bleak
In Europe they’re shrinking
And China is sinking
It seems the world’s now up sh*t’s creek

Volatility continues to reign in markets as the combination of trade commentary and economic data force constant u-turns by traders and investors. Yesterday afternoon, President Trump decided to delay the imposition of tariffs on the remaining Chinese exports from the mooted September 1st start to a date in mid-December. While that hardly seems enough time to conclude any negotiations, the market reaction was swift and yesterday morning’s risk-off session was completely reversed. Stocks turned around and closed more than 1% higher. Treasuries sold off with yields jumping 5bps in the 10-year and the dollar reversed course with USDJPY rocking 1.5% higher while USDCNY tumbled more than 1%. But that was then…

The world looks less sanguine this morning, however, after data releases last night and this morning showed that the fears over a slowing global economy are well warranted. For instance, Chinese data was uniformly awful with Industrial Production falling to 4.8% growth in July, well below the 6.0% estimate and the slowest growth since they began producing data 17 years ago. Retail Sales were also much weaker than expected, rising 7.6% Y/Y in July vs. expectations of an 8.6% rise. If there were any questions as to whether or not the trade war is impacting China, they were answered emphatically last night…YES.

Then early this morning Germany released its Q2 GDP data at -0.1%, as expected but the second quarter of the past four where the economy has shrunk. Additional Eurozone data showed IP there falling -1.6%, its worst showing since February 2016. Meanwhile, inflation data continues to show a complete lack of price pressure and Eurozone Q2 GDP grew just 0.2%, also as expected but also awful. It should be no surprise that this has led to another reversal in investor psychology as the hopes engendered in the Trump comments yesterday has completely evaporated.

I would be remiss if I didn’t mention that the 2yr-10yr Treasury spread actually inverted this morning for the first time, although it had come close several times during the past months. But not only did the Treasury curve invert there, so did Gilts in the UK and we are seeing the same thing in Japan. At the same time, Bunds have fallen to yet another new low in the 10-year, trading at a yield of -0.645% as I type. The upshot is that combined with the weak economic data, the inverted yield curves have historically implied a recession was on the way. While there are those who are convinced ‘this time is different’ because of how central banks have impacted yield curves with their QE, it is all still pointing down to me.

With all that in mind, let’s take a look at markets this morning. Overnight we have seen a mixed picture in the FX market, with the yen retracing some of yesterday’s weakness, rallying 0.7%, while Aussie and the Skandies have led to the downside with all three falling 0.7% or so. As to the euro and the pound, neither has moved at all overnight. But I think it is instructive to look at the two day move, given the volatility we have seen and over that timeline, the dollar has simply rallied against the entire G10 space. Granted vs. the pound it has been a deminimis 0.1%, but CHF, EUR and CAD are all lower by 0.3% since Monday and the yen is still weaker by 0.6% snice Monday.

In the EMG space, KRW was the big winner overnight, rallying 0.8% after the tariff delay, and we also saw IDR benefit by 0.5%. CNY, meanwhile, was fixed slightly stronger and the offshore currency has held onto that strength, rising 0.35%. On the downside, ZAR is the big loser overnight, falling 1.0% as foreign investors are selling South African bonds ahead of a feared ratings downgrade into junk. We have also seen MXN retrace half of yesterday’s post trade story gain, falling 0.65% at this time.

Looking ahead to this morning’s session, there is little in the way of data that is likely to drive markets so we should continue to see sentiment as the key market mover. Right now, sentiment is not very positive so I expect risk to be jettisoned as can be seen in the equity futures with all down solidly so far. As to the dollar, I like it vs. the EMG bloc, maybe a little less vs. the G10.

Good luck
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An Aura of Fear

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An aura of fear’s been created
By actions both past and debated
Investors are scared
As they’re unprepared
Since models they’ve built are outdated

There is certainly more red than green on the screens this morning as the weekend brought us further complications across the board. The headline issue of note is the increased anxiety in Hong Kong as the ongoing protests spread to the airport forcing the cancelation of all flights there today, clearly a problem for a nation(?) that is dependent on international business and travel. President Xi is attempting to address this crisis with economic weapons rather than real ones, with the first shot fired by a state-owned company, China Huarong International Holdings Ltd, which instructed its employees to boycott Cathay Pacific Airways, the Hong Kong based airline. Given Hong Kong’s status as an open trading economy, it will have a great deal of difficulty handling boycotts from its major market.

Adding to the Chinese anxiety was word from the White House that September’s mooted trade talks may not happen at all as President Trump appears convinced that the Chinese need a deal more than the US does. As most of the escalation occurred late in the Asia day, the impact on markets there was more muted than might be expected. While it’s true the Hang Seng fell, -0.4%, Chinese stocks rallied as did Korea and India. At the same time, currency activity was less benign with the dollar continuing its strengthening pattern against most EMG currencies in APAC. For example, both INR and KRW are weaker by 0.55% this morning and the renminbi continues its measured decline, falling a further 0.1% with the dollar now trading above 7.10.

However, Europe has felt the brunt of the negative impact with early 1% rallies in equity markets there completely wiped out and both the DAX and CAC down by 0.4% as I type. Currency markets in Europe have also been less impacted with the euro edging just slightly lower, -0.1%, and the pound actually rallying 0.5% after Friday’s sharp sell-off.

But arguably, the real action has been in the bond market where Treasuries have rallied nearly a full point with the yield down 5bps to 1.68%. German bund yields are also lower, falling back to their record low of -0.59%. And adding to the risk-off feel has been the yen’s 0.5% rally, despite the fact that Japan was closed for Mountain Day, a national holiday. Finally, it wouldn’t be complete if we didn’t see pressure on US equity futures which are pointing to a 0.5% decline on the opening right now.

All told, I think it is fair to say that in the waning days of summer, risk is seen as a growing concern for investors. With that in mind, we do see some important data this week as follows:

Tuesday NFIB Small Biz 104.9
  CPI 0.3% (2.1% Y/Y)
  -ex food & energy 0.2% (1.7%Y/Y)
Thursday Initial Claims 214K
  Retail Sales 0.3%
  -ex autos 0.4%
  Empire State Mfg 2.75
  Philly Fed 10.0
  IP 0.1%
  Capacity Utilization 77.8%
  Business Inventories 0.1%
Friday Housing Starts 1.257M
  Building Permits 1.27M
  Michigan Sentiment 97.3

So, as you can see, Thursday is the big day, with a significant amount of data to be released. The ongoing conundrum of weakening manufacturing and still robust sales will, hopefully, be better explained afterwards, but my fear is as the global economy continues to suffer under the twin pressures of trade issues and declining inflation, that the path forward is lower, not higher.

In addition to this data, we see some important data from elsewhere in the world, notably Chinese IP (exp 5.8%) and Retail Sales (exp 8.6%) with both data points to be released Tuesday night and notably lower than last month’s results. It is abundantly clear that China is suffering a pretty major economic slowdown. The other noteworthy data point will be German Q2 GDP growth on Wednesday, currently forecast to be -0.1%, a serious issue for the continent and ample reason for the ECB to be more aggressive in their September meeting.

Wrapping it all up, there seems little reason for optimism in the near term as the key global issues, namely trade and growth, continue to falter. Central banks are also very obviously stretched to the limits of their abilities to smooth the process which means that unless there is a major change in governmental views on increased fiscal stimulation, slower growth is on the horizon. With it will come reduced risk and corresponding strength in haven assets like the yen, gold, Treasuries, Bunds and the dollar. While today offers no new information, these trends remain intact and show no signs of abating any time soon.

Good luck
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Potency Waning

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There once was a time in the past
When central banks tried to forecast
When signals were flashing
That rates needed slashing
‘Cause growth wasn’t growing so fast

But now that so many have found
Their rates near the real lower bound
The tools they’ve remaining
See potency waning
Unable to turn things around

Another day, another rate cut to mention. This time Peru cut rates 25bps responding to slowing growth both domestically and in their export markets as well as muted inflation pressures. Boy, we’ve heard that story a lot lately, haven’t we? But that’s the thing, if every central bank cut rates, then it’s like none of them have done so. Remember, FX markets thrive on the differential between policy regimes, with higher interest rates both drawing capital while reducing demand for loans, and correspondingly growth. So, if you can recall the time when there were economies that were growing rapidly, raising rates was the preferred method to prevent overheating.

But it’s been more than a decade since that has been a concern of any central bank, anywhere in the world. Instead, we are in the midst of a ‘race to the bottom’ of interest rates. Every country is trying to stimulate their economy and cutting interest rates has always been the preferred method of doing so, at least from a monetary perspective. (Fiscal stimulus is often far more powerful but given the massive debt loads that so many countries currently carry, it has become much harder to implement and fund.) One of the key transmission mechanisms for pumping up growth, especially for smaller nations with active trade policies, was the weakening in their currency that was a byproduct of cutting rates. But with everybody cutting rates at the same time (remember, we have had six central banks cut rates in the past week!) that mechanism is no longer working. And this is one of the key reasons that no country has been able to set themselves apart and halt their waning growth momentum.

A perfect example of this is the UK, where Q2 GDP figures released this morning printed at -0.2% for the quarter taking the Y/Y figure down to 1.0%. Obviously, the Brits have other issues, with just 84 days left before the Brexit deadline, but it is also clear that the global slowdown is having an impact. And the problem for the BOE is the base rate is just 0.75%, not much room to cut if the UK enters a recession. In fact, that is largely true around the world, there’s just not much room to cut rates at this point.

The upshot is that markets continue to demonstrate increasing volatility. In the FX markets there has been a growing dichotomy with the dollar showing solid strength against virtually the entire emerging market bloc but having a much more muted reaction vs. the rest of the G10. Of course, since the financial crisis, the yen (+0.3% today) has been seen as a safe haven and has benefitted in times of turmoil. So too, the Swiss franc (+0.2%), although not quite to the same extent given the much smaller size of the economy.

But perhaps the most interesting thing of late is that the euro has not fallen further, especially given the ongoing internal struggles it is having. Italy, for example, looks about set to dissolve its government and have new elections with all the polls showing Matteo Salvini, the League party’s firebrand leader set to win a majority. He has been pushing to cut taxes, spend on infrastructure and allow the Italian budget deficit to grow. That is directly at odds with the EU’s stability policy, and while both Italian stocks (-2.25%) and bonds (+25bps) have suffered today on the news, the euro itself has held up well, actually rallying 0.25% and recouping yesterday afternoon’s losses. Given the ongoing awful data out of the Eurozone (German Exports -0.1%, French IP -2.3%) it is becoming increasingly clear that the ECB is going to ease policy further next month. In fact, between Europe’s upcoming recession and Italy’s existential threat to the euro, I would expect it to have fallen further. Arguably, the rumor that the German government may increase spending has been crucial in supporting the single currency today, but if they don’t, I think we are going to see further weakness there as well.

In the meantime, the dollar is starting to pick up against a variety of EMG currencies this morning with MXN falling 0.4%, INR 0.6% and CNY 0.15%. Also, under the risk-off ledger we are seeing equity markets suffer this morning with both Germany (-1.25%) and France (-1.0%) suffering alongside Italy and US futures pointing to -0.6% declines on the open. It is not clear to me why the market so quickly dismissed their concerns over the escalating trade war by Tuesday, after Monday’s sharp devaluation of the CNY. This is a long-term affair and just because the renminbi didn’t continue to collapse doesn’t mean that things are better. They are going to get worse and risk will be reduced accordingly, mark my words.

As to this morning’s data we see PPI here at home (exp 1.7%, 2.4% core) and Canadian Employment Data where the Unemployment Rate is forecast to remain unchanged at 5.5%. Earnings data in the US continues to be mixed, at best, with Uber the latest big-name tech company to disappoint driving its stock price lower after the close yesterday.

I’m sorry, I just cannot see the appeal of risky assets at this time. Global growth is continuing to slow, trade activity is falling rapidly and there are a number of possible catalysts for major disruption, (e.g. hard Brexit, Italian intransigence, and Persian Gulf military escalations). Safety is the order of the day which means that the yen, Swiss franc and dollar, in that order, should be the beneficiaries. And don’t forget gold, which looks for all the world like it is heading up to $1600/oz.

Good luck and good weekend
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Fears Have Been Slaked

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For several days markets have quaked
As muck about trade has been raked
But Wednesday’s retracement
And China’s emplacement
Of yuan means some fears have been slaked

Yesterday was a session for those with strong stomachs. Equities plummeted (DJIA -589) early as did bond yields (10-year Treasury yields fell to 1.59%) with both markets pointing to an imminent recession. But then, as sometimes happens, things turned around inexplicably. There was no data to drive the change, as there was really no data yesterday. The only Fed comments were from Chicago’s Evans, a known dove, who said that the recent escalation in trade tensions could well warrant further rate cuts. But we already knew that and had heard it on Tuesday from two other Fed speakers.

However, the fear that was rampant at the opening (gold exploded through $1500/oz, USDJPY traded below 105.50) just as quickly dissipated and through the rest of the session, equities rallied back to flat, Treasury prices fell such that yields actually closed the day higher than the day before, and both the dollar and yen reversed early gains and settled slightly lower on the day. Gold, however, maintained most of its gains.

Price action like that, which can be quite unsettling, tends to be indicative of a great deal of uncertainty in markets. In fact, that is what markets do best, with bulls and bears fighting it out for supremacy. But the ultimate conclusion has to be that recent market trends are being questioned. As I wrote yesterday, and has been widely mentioned elsewhere as well, there is a fundamental difference of opinion between the stock and bond markets, where bonds investors see a much gloomier economic future than stock investors. In fact, it is fair to say, that stock investors are so fixated on the potential benefits of lower interest rates that they seem to be forgetting why those lower rates are being contemplated, slowing growth. At some point, this conundrum will be resolved, either as Treasury yields rebound amid stronger growth indications, or with lower stock prices as the economic data defines a worse economic situation than currently expected. While my view, alas, remains the latter is more likely, it is still an open question as to how things play out.

The end result, however, is that as I have written frequently in the past, volatility in markets is going to be with us for some time to come. Today, though, it is not as evident as it was yesterday. Equity markets around the world have shown modest gains, generally on the order of 0.5%, while bond prices have been fairly stable along with the dollar. In fact, the dollar has done very little overall.

There has been much made of the fact that the PBOC fixed USDCNY at 7.0039, above the 7.00 level and its weakest fix since 2008. However, market expectations were for a fix at an even higher level, ~7.0130, so despite the optics on the surface, this was seen as an attempt to mitigate the recent anxiety. Ultimately, the PBOC is likely to allow a very gradual depreciation of the yuan going forward as they find themselves caught between competing problems. On the one hand, slowing growth indicates the need for a weaker yuan to help support exporters. However, the flip side is that the huge increase in USD borrowings by Chinese companies, especially in the local property sector, means that a weaker yuan will crimp their ability to service and repay that debt, potentially leading to larger systemic issues. Clearly the PBOC wants to avoid anything like that, so slow and steady seems the most likely outcome.

And in fact, that is probably what we are going to see in a number of currencies as the impacts of the growing trade conflict widens around the world. The dollar will continue to be a key destination for investment as long as the US economy, even if it is slowing somewhat, remains stronger than economies elsewhere. Yesterday we saw the aggressive actions of three Asian central banks, and last night the Philippines cut rates by 25bps as well. Markets are pricing in cuts pretty much everywhere in the world so the fact that the Fed is likely to produce at least two more cuts is hardly a reason to avoid the dollar. In fact, US rates continue to trade above every other developed market rate and, as such, remain attractive to foreign investors. There is no evidence that situation will change in the near-term, and so support for the dollar is likely to remain firm.

A quick look at today’s price action shows what I would describe as consolidation of recent moves. Looking across the board, the dollar has had a strong week against most currencies. The two exceptions have been the yen, which has rallied 1.25% on increased market fears, and the euro, which surprisingly has rallied about 1.0% this week. But otherwise, the dollar has been ascendant vs. virtually everything else. As long as economic uncertainty remains the driving force in markets, and that seems like a pretty good bet, the dollar should continue to perform well.

On the data front, the only thing to be released is Initial Claims (exp 215K) and there are no Fed speakers on the calendar. That implies that the FX market will take its cues from elsewhere, with equities the leading candidate. In the current framework, stronger equities means less risk and less reason to hold dollars, so given Europe’s modest rebound and US futures pointing higher, that seems like a reasonable expectation for today, a modestly softer buck.

Good luck
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Demand, More, to Whet

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In Asia three central banks met
And all three explained that the threat
Of trade tensions rising
Required revising
Their pathway, demand, more, to whet

The RBNZ cut rates 50bps last night, surprising markets and analysts, all of whom were expecting a 25bp rate cut. The rationale was weakening global growth and increased uncertainty over the escalation of the trade fight between the US and China were sufficient cause to attempt to get ahead of the problem. They seem to be following NY Fed President Williams’ dictum that when rates are low, cutting rates aggressively is the best central bank policy. It should be no surprise that the NZD fell sharply on the news, and this morning it is lower by 1.4% and back to levels not seen since the beginning of 2016.

The Bank of Thailand cut rates 25bps last night, surprising markets and analysts, none of whom were expecting any rate cut at all. The rationale was … (see bold type above). The initial FX move was for a 0.9% decline in THB, although it has since recouped two-thirds of those losses and currently sits just 0.3% lower than yesterday’s close. THB has been the best performing currency in Asia this year as the Thai economy has done a remarkable job of skating past many of the trade related problems affecting other nations there. However, the central bank indicated it would respond as necessary going forward, implying more rate cuts could come if deemed appropriate.

The RBI cut rates 35bps last night, surprising markets and analysts, most of whom were expecting a 25bp rate cut. The rationale was… (see bold type above). The accompanying policy statement was clearly dovish and indicted that future rate cuts are on the table if the economic path does not improve. However, this morning INR is actually stronger by 0.3% as there was a whiff of ‘buy the rumor, sell the news’ attached to this move. The rupee had already weakened 3% this week, so clearly market anticipation, if not analysts’ views, was for an even more dovish outcome.

These are not the last interest rate moves we are going to see, and we are going to see them from a widening group of central banks. You can be sure, given last night’s activity, that the Philippine central bank is going to be cutting rates when they meet this evening and now the question is, will they cut only the 25bps analysts are currently expecting, or will they take their cues from last night’s activity and cut 50bps to get ahead of the curve? Last night the peso fell 0.4% and is down 2.5% in the past week. It feels to me like the market is pricing in a bigger cut than 25bps. We shall see.

This central bank activity seems contra to the fact that equity markets are stabilizing quickly from Monday’s sell-off. The idea that because the PBOC didn’t allow another sharp move lower last night in the renminbi is an indication that there is no prospect for further weakness in the currency is ridiculous. (After all, CNY did fall 0.4% overnight). The global rate cutting cycle is starting to pick up steam, and as more central banks respond, it will force the others to do the same. The market has now priced in a 100% probability of a 25bp Fed cut at the September meeting. Comments from Fed members Daly and Bullard were explicit that the increased trade tensions have thrown a spanner into their models and that some preemption may be warranted.

A quick survey of government bond yields shows that Treasuries are down 4bps to 1.66%, new lows for the move; Bunds are down 5.5bps to -0.59% and a new historic low; while JGB’s are down 3bps to -0.21%, below the BOJ’s target of -0.2% / +0.2% for the first time since they instituted their yield curve control process. Bond investors and stock investors seem to have very different views of the world right now, but there are more markets aligning with bonds than stocks.

For instance, gold prices are up another 1% overnight, to $1500/oz, their highest in six years and show no sign of slowing down. Oil prices are down just 0.2% overnight, but more than 8% in the past week, as demand indicators decline more than offsetting production declines.

And of course, economic data continues to demonstrate the ongoing economic malaise globally. Early this morning, June German IP fell 1.5%, much worse than expected and from a downwardly revised May number, indicating even further weakness. It is becoming abundantly clear that the Eurozone is heading into a recession and that the ECB is going to be forced into aggressive action next month. Not only do I expect a 20bp rate cut, down to -0.60%, but I expect that QE is going to be restarted right away and expanded to include a larger portion of corporate bonds. And don’t rule out equities!

So, for now we are seeing simultaneous risk-on (equity rally) and risk-off (bond, gold, yen rallies) on our screens. The equity investor belief in the benefits of lower interest rates is quite strong, although I believe we are reaching a point where lower rates are not the solution to the problem. The problem is economic uncertainty due to changes in international trade relations, it is not a lack of access to capital. But lowering rates is all the central banks can do.

Overall, the dollar is stronger this morning as only a handful of currencies, notably the yen as a haven and INR as described above, have managed to gain ground. I expect that this will continue to be the pattern unless the Fed does something truly surprising like a 50bp cut in September or even more unlikely, a surprise inter-meeting cut. They have done that before, but it doesn’t seem to be in Chairman Powell’s wheelhouse.

The only data today is Consumer Credit this afternoon (exp $16.0B) and we hear from Chicago Fed President Charles Evans, a known dove later today. But equity futures are pointing higher and for now, the idea that Monday’s sharp decline was an opportunity rather than a harbinger of the future remains front and center. However, despite the equity market, I have a feeling the dollar is likely to maintain its overnight gains and perhaps extend them as well.

Good luck
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Weakness They’d Block

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The PBOC’s taken stock
Of how their maneuvers did rock
Most markets worldwide
Which helped them decide
More currency weakness they’d block

The Chinese renminbi remains the number one story and concern in all financial markets as investors and traders try to decipher the meaning of yesterday’s move to allow a much weaker currency, but more importantly how those actions will help drive future activities.

As always, there are two sides to every coin, in this case both figuratively and literally. From the perspective of China’s manufacturing and production capabilities it is very clear that a weaker renminbi is a benefit for its exporters. Chinese goods are that much cheaper this morning than they were Friday afternoon. This, of course, is why there is so much concern over any nation weakening their currency purposely in order to gain an advantage in trade. This is the ‘beggar thy neighbor’ policy that is decried in both textbooks and political circles. It is this idea that animates President Trump’s complaints about a too strong dollar hindering US manufacturing exports, and it is true, as far as it goes.

But it is not the whole story by a long shot. There are two potentially significant negative consequences to having a weaker currency, both of which can have significant political as well as economic impacts. The first, and most widely considered is rising inflation. Remember, if a nation’s currency weakens then all its imports are, relatively speaking, more expensive for its citizens. While small fluctuations in price may be absorbed by businesses, ultimately a steadily weakening currency will result in rising prices and increases in measured inflation. This is one of the key things that BOE Governor Carney worries about in the event of a hard Brexit, and the only reason he tries to make the case that interest rates may need to rise after Brexit. (p.s., they won’t!)

However, the other issue is generally less considered but often far more destructive to a nation. This is the problem of repayment of foreign currency debt. Remember, the US capital markets are far and away the largest, deepest and most liquid in the world, and thus companies and countries around the world all raise funding in USD. Even though US rates are high relative to the rest of the G10, that available liquidity is something that is not replicable anywhere else in the world and offers real value for borrowers. And of course, compared to many emerging markets, US rates are lower to begin with, making borrowing in dollars that much more attractive. But when another country’s currency weakens, that puts additional pressure on all the businesses that have borrowed in USD to fund themselves (and the country itself if it has borrowed in USD).

For example, according to the BIS, Chinese companies had outstanding USD debt totaling more than $1 trillion as of the end of 2018, and that number has only grown. As the renminbi weakens, that means it takes that much more local currency to repay those dollars. China has already seen a significant uptick in local bankruptcies this year, with CNY bond defaults totaling nearly $6 billion equivalent and the pace increasing. And that is in the local currency. When it comes to repaying USD debt, a weaker CNY will just exacerbate the situation. The PBOC is well aware of this problem. In fact, this issue is what will prevent the PBOC from allowing the renminbi to simply fall and find a new market clearing price. Instead, they will continue to carefully manage any further devaluation to the best of their ability. The problem they have is that despite their seemingly tight control of the market, they have created an offshore version, the quickly growing CNH market, which is far more costly to manage. In other words, there is a real opportunity for leakage of funds from China and an uncontrolled decline in the currency, or at least a much larger decline than planned. We are only beginning to see the impact of this move by the PBOC and do not be surprise if things get more volatile going forward.

But this morning, the PBOC remains in control. They fixed the onshore CNY at 6.9683, stronger than expected and in the FX market CNY has regained about 0.3% of yesterday’s losses. This stabilization has allowed a respite in yesterday’s panic and the result was that Asian equity markets rebounded in the afternoon sessions, still closing lower but well off session lows. And in Europe, the main markets are all marginally higher as I type. It should be no surprise that US futures are pointing to a modest uptick on the opening as well.

In the bond markets, Treasury prices have fallen slightly, with yields backing up 2bps. The same movement has been seen in Japan, with JGB’s 2bps higher, but actually, in Germany, yields continue to decline, down a further 3bps to yet another new record low of -0.54% as German data continues to exhibit weakness implying the Eurozone is going to fall into a recession sooner rather than later.

Finally, in the rest of the FX market, we are seeing a modest reversal of some of yesterday’s significant moves. For example, USDMXN is softer by 0.2% this morning after the peso fell nearly 2.0% yesterday. We are seeing similar activity in USDBRL, and USDKRW. These examples are just that, indications that an uncontrolled collapse is not in the cards, but that this process has not yet played itself out. In the G10 space, the RBA left rates on hold at 1.00% last night, as universally expected, and Aussie has rallied 0.4% this morning. Interestingly, one of the reasons they felt able to pause was the fact that the AUD had fallen more than 3% in the past month, easing financial conditions slightly and helping in their quest to push inflation back to their target. The other reversal this morning has been USDJPY which is higher by 0.4% after having traded to its lowest level (strongest JPY) yesterday since March 2018. As yen remains a key haven asset, it remains an excellent proxy for risk appetite, which today is recovering.

There were actually a few Fed speakers yesterday with both SF President Daly and Governor Brainerd expressing a wait and see attitude as to the impact of the escalation of trade tensions, although a clear bias in both cases to cut rates. Meanwhile, the futures market is pricing in a 100% chance of a 25bp cut in September and a 40% chance of a 50bp cut. It seems like the Fed has a lot of work to do in order to clarify their message.

With no data of note today, the FX market is likely to continue to consolidate yesterday’s moves, and awaits comments from James Bullard, St Louis Fed President and noted dove. In the end, my sense is that the Fed has lost control of the situation and that we are going to see more rate cuts than they had anticipated going forward. The question is more the timing than the actuality. In the meantime, the dollar is likely to be dichotomous, continuing to rise vs. the EMG bloc, but faring less well vs. much of the G10.

Good luck
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More Doubt He Is Sowing

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In Beijing, the Chinese yuan
Fell sharply as it’s now been drawn
Into the trade fight
Much to the delight
Of bears, who had shorts layered on

For President Xi, though, the risk
Is money there exits the fisc
With growth there still slowing
More doubt he is sowing
So capital flight could be brisk

Things changed overnight as the PBOC fixed the renminbi below 6.90, much weaker than expected and then the currency fell sharply in subsequent trading in both the on-shore and offshore markets. As you will have no doubt seen, USDCNY is trading somewhere in the vicinity of 7.08 this morning, although the price has been quite volatile. While that represents a decline of more than 1.5% compared to Friday’s closing levels, the more important questions revolve around the PBOC’s new strategy going forward.

Recall, one of the reasons that there was a strong market belief in the sanctity of the 7.00 level was that four years ago, when the PBOC surprised markets with a mini-devaluation, locals took their cash and ran for the hills. Capital outflows were so great, in excess of $1 trillion, that the PBOC needed to institute strict new rules preventing further flight. That was a distinct loss of face for an institution that was trying to modernize and prove that it could manage things like G10 countries where capital flows more freely. Ever since, the assumption was that the Chinese population would get nervous if the renminbi weakened beyond that level and correspondingly, the PBOC would not allow that outcome to occur.

But that was then, in the days when trade was simply a talking point rather than the focus of policy. As the trade war intensifies, the Chinese have fewer tools with which to fight given the massive imbalance that exists. The result of this is that increases in US tariffs cannot be matched and so other weapons must be used, with changes in the exchange rate the most obvious. While the PBOC claims they can continue to manage the currency and maintain its stability, the one thing I have learned throughout my career is that markets have a way of abusing claims of that nature, at least for a while. Back in January I forecast USDCNY to reach 7.40 by the end of this year and, as of this morning, that seems quite realistic.

But the impact on markets is far greater than simply the USDCNY exchange rate. This has been the catalyst for a significant amount of risk-off behavior with equity markets throughout Asia (Nikkei -1.75%, Shanghai -1.6%, Hang Seng -2.85%) and Europe (DAX -1.85%, CAC -2.25%, FTSE -2.25%) sharply lower; Treasury (1.76%) and Bund (-0.51%) yields sharply lower, the Japanese yen (+0.6%) and Swiss franc (+0.75%) both sharply higher and most emerging market currencies (e.g. MXN -1.5%, INR -1.4%, ZAR -1.2%, KRW -0.9%) falling alongside the renminbi. It should be no surprise that gold is higher by 1.0%, to a 6-year high, as well this morning and oil prices (-1.1%) are falling amid concerns of waning demand from the slowing global growth story.

So, what’s a hedger to do? The first thing to consider is whether these moves are temporary fluctuations that will quickly be reversed, or the start of longer-term trends. Given the imbalances that have been building within markets for the past decade and given that central banks have a greatly reduced set of monetary tools with which to manage things, despite their comments otherwise, this could well be the tipping point where markets start to unwind significant positions. After all, the one thing that truly underpinned gains in both equity and bond markets, especially corporate and high-yield bond markets, was confidence that regardless of fiscal policy failures, the central banks would be able to maintain a level of stability.

However, this morning that belief seems a little less secure. It will not take much for investors to decide that, ‘it’s been a good run and now might be a good time to take some money off the table’, at least figuratively. Last week saw equity markets suffer their worst week of the year and this week is not starting any better. Yes, the Fed has room to cut rates further, but will 200bps be enough to stop a global recession? Arguably, that’s the question that needs to be answered. From where I sit, that answer is no, but then I am a cynic. Of course, that cynicism is born of a long career in financial markets.

Thus, my take is that there is further to run in most of these currencies, and that assuming a quick reversion would be a mistake. While option prices are clearly higher this morning than last week, they remain low by historic standards and should be considered for their value in uncertain times. Just sayin’.

What else does this week have to offer? Well, the US data set is not that substantial, but we do hear from a number of Fed speakers, which given last week’s confusion will be extremely important and closely watched. There are also a number of foreign central bank meetings that will be interesting regarding their rate maneuvers.

Today ISM Non-Manufacturing 55.5
Tuesday JOLT’s Job Openings 7.317M
Wednesday RBNZ Rate Decision 1.25% (25bp cut)
  RBI Rate Decision 5.50% (25bpcut)
  Consumer Credit $16.0B
Thursday Philippine Rate Decision 4.25% (25bp cut)
  Initial Claims 215K
Friday PPI 0.2% (1.7% Y/Y)
  -ex food & energy 0.2% (2.4% Y/Y)

We also hear from three dovish Fed speakers; Brainerd, Bullard and Evans, who are likely to give more reasons for further rate cuts, especially if markets continue to fall. As to the three central banks with decisions to make, they find themselves in a difficult place. All three are extremely concerned about their currencies’ value and don’t want to exert further downward pressure on them, yet all three are facing slowing economies and need to do something to boost demand. In fact, this is going to be the central bank conundrum for some time to come across both developing and G10 countries as they try to continually manage the impossible trilateral of exchange rates, interest rates and growth.

All of this adds up to yet more reasons for higher volatility across all asset classes in the near future. It appears that these are the first cracks in the old economic order, and there is no way to know how everything will play out going forward. As long as risk is being jettisoned though, Treasuries, the yen, the Swiss franc and the dollar will see demand. Keep that in mind as you manage your risks.

Good luck
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Weakness Worldwide

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The Fed followed through on their pledge
To cut rates, as they try to hedge
‘Gainst weakness worldwide
But Jay clarified
It’s not a trend as some allege

The market response was quite swift
With equities given short shrift
Commodities fell
While bonds did excel
In FX, the buck got a lift

Something has really begun to bother me lately, and that is the remarkable inconsistency over the benefits/detriments of a currency’s value. For example, the dollar has been relatively strong lately, and as you are all aware, I believe will continue on that path overall. The key rationales for the dollar’s strength lie in two factors; first, despite yesterday’s cut, US interest rates remain much higher than every other G10 country, in most cases by more than 100bps, and so the relative benefit of holding dollars vs. other currencies continues. The second reason is that the US economy is the strongest, by far, of the G10, as recent GDP data demonstrated, and while there are certain sectors of weakness, notably housing and autos, things look reasonably good. This compares quite favorably to Europe, Japan and Oceania, where growth is slowing to the point that recession is a likely outcome. The thing is, article after article by varying analysts points to the dollar’s strength as a major problem. While President Trump rightly points out that a strong dollar can hinder US exports, and as a secondary effect corporate earnings, remember that trade represents a small portion of the US economy, just 12% as of the latest data.

Contrast this widespread and significant concern over a strong currency with the angst over the British pound’s recent performance as it continues to decline. Sterling is falling not only because the dollar is strong, but also because the market is repricing its estimates of the likelihood of a no-deal Brexit. Ever since the Brexit vote the pound has been under pressure. Remember that the evening of the vote, when the first returns pointed to a Remain win, the pound touched 1.50. However, once the final results were in, the pound sold off sharply, losing as much as 20% of its value within four months of the vote. However, since then, during the negotiation phase, the pound actually rallied back as high as 1.4340 when it looked like a deal would get done and agreed. Alas, that never occurred and now that no-deal is not only back on the table, but growing as a probability, the pound is back near its lows. And this is decried as a terrible outcome! So, can someone please explain why a strong currency is bad but a weak currency is also bad? You can’t have it both ways. Arguably, every complaint over the pound’s weakness is a political statement clothed in an economic argument. And the same is true as to the dollar’s strength, with the difference there being that the President makes no bones about the politics.

In the end, the beauty of a floating currency regime is that the market adjusts based on actual and expected flows, not on political whims. If there is concern over a currency’s value, that implies that broader policy adjustments need to be considered. In fact, one of the most frightening things we have heard of late is the idea that the US may intervene directly to weaken the dollar. Intervention has a long and troubled history of failure, especially when undertaken solo rather than as part of a globally integrated plan a la the Plaza Accord in the 1980’s. An unsolicited piece of advice to the President would be as follows: if you want the strongest economy in the world, be prepared for a strong currency to accompany that situation. It is only natural.

With that out of the way, there is no real point in rehashing the FOMC yesterday as there are myriad stories already available. In brief, they cut 25bps, but explained it as an insurance cut because of global uncertainties. Weak sauce if you ask me. The telling thing is that during the press conference, when Powell explained that this was not the beginning of a new cycle and the stock market sold off sharply, he quickly backtracked and said more cuts could come as soon as he heard about the selloff. It gets harder and harder to believe that the Fed sees their mandate as anything other than boosting the stock market.

This morning brings the final central bank meeting of the week with the BOE on the docket at 7:00am. At this point, with rates still near historic lows and Brexit on the horizon, the BOE is firmly in the wait and see camp. Concerns have to be building as more economic indicators point to a slump, with today’s PMI data (48.0) posting its third consecutive month below the 50.0 level. I think it is clear that a hard Brexit will have a short-term negative impact on the UK economy, likely making things worse before they get better, but I also believe that the market has already priced in a great deal of that weakness. And in the end, I continue to believe that the EU will blink as they cannot afford to drive Europe into a recession just to spite the UK. So there will be no policy change here.

One interesting outcome since the Fed action yesterday was how many other central banks quickly cut interest rates as well. Brazil cut the Selic rate by 50bps, to a record low 6.00% as they had room from the Fed move and then highlighted the fact that a key pension reform bill seemed to have overwhelming support and was due to become law. This would greatly alleviate government spending pressures and allow for even more policy ease. As well, the Middle East saw rate cuts by Saudi Arabia, the UAE, Qatar and Bahrain all cut rates by 25bps as well. In fact, the only bank that does not seem likely to respond is the PBOC, where they have been trying to use other tools, rather than interest rate policy, to help bolster the economy there.

This morning sees the dollar broadly higher with both the euro and pound down by ~0.40%, and similar weakness in a number of EMG currencies like MXN and INR. Even the yen has weakened this morning by 0.2%, implying this is not so much a risk-off event as a dollar strength event. Data today brings Initial Claims (exp 212K) and ISM Manufacturing (52.0). Regarding the ISM data, yesterday saw an extremely weak Chicago PMI print of just 44.4, its lowest since December 2015. Given how poor the European and Chinese PMI data were overnight and this morning, I wouldn’t be surprised to see a weak outcome there. However, I don’t think that will be enough to weaken the dollar much as the Fed just gave the market its marching orders. We will need to see a very weak payroll report tomorrow to change any opinions, but for today, the dollar remains in the ascendancy.

Good luck
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Boris is Fumbling

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The British pound Sterling is tumbling
As traders think Boris is fumbling
His chance to succeed
By forcing, at speed
Hard Brexit with some Tories grumbling

It’s official, the only story of note in the FX markets today is Brexit. Despite central bank meetings and key data, the number one discussion is about how far the pound will fall in the event of a hard Brexit and how high the likelihood of a hard Brexit has become. Since Friday morning, the pound is down by 2.5% and there doesn’t appear to be a floor in the near term. It seems that traders have finally decided that BoJo was being serious when he said the UK would leave the EU with or without a deal come October 31. As such, today’s favorite analyst pastime is to guess how low the pound can fall with a hard Brexit. So far, there has been one estimate of parity with the dollar, although most estimates talk about 1.10 or so. The thing is, while Brexit will clearly be economically disruptive, it seems to me that the warnings of economic activity halting are vastly overstated for political reasons. After all, if you voted Remain, and you are in the media (which was largely the case) then painting as ugly a picture as possible suits your cause, whether or not it is based on factual analysis or fantasy.

But let’s discuss something else regarding the potential effects of a hard Brexit; the fears of a weaker currency and higher inflation. Are these really problems? Is not every developed country (and plenty of emerging ones) in the world seeking to weaken their currency through easier monetary policy in order to gain a competitive advantage in trade? Is not every developed country in the world complaining that inflation is too low and that lowered inflation expectations will hinder central bank capabilities? Obviously, the answer to both these questions is a resounding ‘YES’. And yet, the prospects of a weaker pound and higher inflation are seen as devastatingly bad for the UK.

Is that just jealousy? Or is that a demonstration of central bank concern when things happen beyond their control. After all, for the past decade, central banks have basically controlled the global economy. Methinks they have gotten a bit too comfortable with all that power. At any rate, apocalyptic scenarios rarely come to pass, and in fact, my sense is that while the pound can certainly fall further in the short run, we are far more likely to see the EU figure out that they don’t want a hard Brexit after all, and come back to the table. While a final agreement will never be finished in time, there will be real movement and Brexit in name only as the final details are hashed out over the ensuing months. And the pound will rebound sharply. But that move is still a few months away.

Away from Brexit, there has been other news. For example, the BOJ met last night and left policy rates on hold, as universally expected, but lowered their inflation forecast for 2019 to 1.0%, which is a stretch given it’s currently running at 0.5%. And their 2.0% target is increasingly distant as even through 2022 they see inflation only at 1.6%. At the same time, they indicated they will move quickly to ease further if necessary. The problem is they really don’t have much left to do. After all, they already own half the JGB market, and have bought both corporate bonds and equities. Certainly, they could cut rates further, but as we have learned over the past ten years, ZIRP and NIRP have not been all that effective. With all that said, the yen’s response was to rise modestly, 0.15%, but basically, the yen has traded between 107-109 for the past two months and shows no signs of breaking out.

We also saw some Eurozone data with French GDP disappointing in Q2, down to 0.2% vs. 0.3% expected, and Eurozone Confidence indicators were all weaker than expected, noticeably Business Confidence which fell to -0.12 from last month’s +0.17 and well below the +0.08 expected. This was the weakest reading in six years and simply highlights the spreading weakness on the continent. Once again I ask, do you really think the EU is willing to accept a hard Brexit with all the disruption that will entail? As to the euro, it is essentially unchanged on the day. Longer term, however, the euro remains in a very clear downtrend and I see nothing that will stop that in the near term. If anything, if Draghi and friends manage to be uber-uber dovish in September, it could accelerate the weakness.

Away from the big three, we are seeing weakness in the Scandies, down about 0.5%, as well as Aussie and Kiwi, both lower by about 0.25%. Interestingly, the EMG bloc has been much less active with almost no significant movement anywhere. It appears that traders are unwilling to do anything ahead of tomorrow’s FOMC statement and Powell’s press conference.

On the data front this morning we see Personal Income (exp 0.4%), Personal Spending (0.3%), Core PCE (0.2%, 1.7% Y/Y), Case-Shiller Home Prices (2.4%) and Consumer Confidence (125.0). Arguably, the PCE data is most important as that is what the Fed watches. Also, given that recent CPI data came in a tick higher than expected, if the same thing happens here, what will that do to the insurance cut narrative? The point is that the data of late has not warranted talk of a rate cut, at least not the US data. But will that stop Powell and company? The controlling narrative has become the Fed must cut to help the rest of the world. But that narrative will not depreciate the dollar very much. As such, I remain generally bullish the dollar for the foreseeable future.

Good luck
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More Clear

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The contrast could not be more clear
Twixt growth over there and right here
While Europe is slowing
The US is growing
So how come a rate cut is near?

It seems likely that by the time markets close Friday afternoon, investors and traders will have changed some of their opinions on the future given the extraordinary amount of data and the number of policy statements that will be released this week. Three major central banks meet, starting with the BOJ tonight, the Fed tomorrow and Wednesday and then the BOE on Thursday. And then there’s the data download, which includes Eurozone growth and inflation, Chinese PMI and concludes with US payrolls on Friday morning. And those are just the highlights. The point is that this week offers the opportunity for some significant changes of view if things don’t happen as currently forecast.

But before we talk about what is upcoming, perhaps the question at hand is what is driving the Fed to cut rates Wednesday despite a run of better than expected US economic data? The last that we heard from Fed members was a combination of slowing global growth and business uncertainty due to trade friction has been seen as a negative for future US activity. Granted, US GDP grew more slowly in Q2 at 2.1%, than Q1’s 3.1%, but Friday’s data was still better than expected. The reduction was caused by a combination of inventory reduction and a widening trade gap, with consumption maintaining its Q1 pace and even speeding up a bit. The point is that things in the US are hardly collapsing. But there is no doubt that growth elsewhere in the world is slowing down and that prospects for a quick rebound seem limited. And apparently, that is now the driving force. The Fed, which had been described as the world’s central bank in the past, seems to have officially taken on that mantle now.

One fear of this action is that it will essentially synchronize all major economies’ growth cycles, which means that the amplitude of those cycles will increase. In other words, look for higher highs and lower lows over time. Alas, it appears that the first step of that cycle is lower which means that the depths of the next recession will be wider and worse than currently expected. (And likely worse than the last one, which as we all remember was pretty bad.) And it is this prognosis that is driving global rates to zero and below. Phenomenally, more than 25% of all developed market government bonds outstanding now have negative yields, something over $13.4 Trillion worth. And that number is going to continue to grow, especially given the fact that we are about to enter an entirely new rate cutting cycle despite not having finished the last one! It is a strange world indeed!

Looking at markets this morning, ahead of the data onslaught, shows that the dollar continues its winning ways, with the pound the worst performer as more and more traders and investors begin bracing for a no-deal Brexit. As I type, Sterling is lower by 0.55%, taking it near 1.23 and its lowest point since January 2017. As long as PM BoJo continues to approach the EU with a hard-line stance, I expect the pound to remain under pressure. However, I think that at some point the Irish are going to start to scream much louder about just how negative things will be in Ireland if there is no deal, and the EU will buckle. At that point, look for the pound to turn around, but until then, it feels like it can easily breech the 1.20 level before summer’s out.

But the dollar is generally performing well everywhere, albeit not quite to the same extent. Rather we are seeing continued modest strength, on the order of 0.1%-0.2% against most other currencies. This has been the pattern for the past several weeks and it is starting to add up to real movement overall. It is no wonder that the White House has been complaining about currency manipulation elsewhere, but I have to say that doesn’t appear to be the case. Rather, I think despite the international community’s general dislike of President Trump, at least according to the press, investors continue to see the US as the destination with the most profit opportunity and best prospects overall. And that will continue to drive dollar based investment and strengthen the buck.

Away from the FX markets, we have seen pretty inconsequential movement in most equity markets with two exceptions (FTSE +1.50% on the weak pound and KOSPI -1.8% on increasing trade issues and correspondingly weaker growth in South Korea). As to US futures markets, they are pointing to essentially flat openings here this morning, although the earnings data will continue to drive things. And bond markets have seen similarly modest movement with most yields within a basis point or two of Friday’s levels. Consider two bonds in Europe in particular; Italian 10-year BTP’s yield 1.54%, more than 50bps less than Treasuries, and this despite the fact that the government coalition is on the rocks and the country’s fiscal situation continues to deteriorate amid a recession with no ability to cut rates directly; and Greek 10-year yields are 2.05% vs. 2.08% for US Treasuries! Yes, Greek yields are lower than those in the US, despite having defaulted on their debt just 7 years ago! It is a strange world indeed.

A look at the data this week shows a huge amount of information is coming our way as follows:

Tuesday BOJ Rate Decision -0.10% (unchanged)
  Personal Income 0.4%
  Personal Spending 0.3%
  Core PCE 1.7%
  Case-Shiller Home Prices 2.4%
  Consumer Confidence 125.0
Wednesday ADP Employment 150K
  Chicago PMI 50.5
  FOMC Rate Decision 2.25% (-25bps)
Thursday BOE Rate Decision 0.75% (unchanged)
  Initial Claims 214K
  ISM Manufacturing 52.0
  ISM Prices Paid 49.6
  Construction Spending 0.3%
Friday Trade Balance -$54.6B
  Nonfarm Payrolls 165K
  Private Payrolls 160K
  Manufacturing Payrolls 5K
  Unemployment Rate 3.6%
  Average Hourly Earnings 0.2% (3.2% Y/Y)
  Average Weekly Hours 34.4
  Factory Orders 0.8%
  Michigan Sentiment 98.5

And on top of that we see Chinese PMI data Tuesday night, Eurozone GDP and Inflation on Wednesday and a host of other Eurozone and Asian data releases. The point is it is quite possible that the current view of the world changes if the data shows a trend, especially if that trend is faster growth. Right now, the default view is global growth is slowing with the question just how quickly. However, a series of strong prints could well stop that narrative in its tracks. And ironically, that is likely the best opportunity for the dollar to stop what has been an inexorable, if slow, climb higher. However, the prospects of weak data elsewhere are likely to see an acceleration of central bank easing around the world with the dollar benefitting accordingly.

In sum, there is an awful lot happening this week, so be prepared for potentially sharp moves on missed expectations. But unless the data all points to faster growth away from the US while the US is slowing, the dollar’s path of least resistance remains higher.

Good luck
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