Tag Archives: #dollar

QE Will Soon Have Returned

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The ECB started the trend
Which helped the bond market ascend
Then yesterday Jay
Was happy to say
A rate cut he’d clearly portend

Last night from Japan we all learned
Kuroda-san was not concerned
That yields there keep falling
And if growth is stalling
Then QE will soon have returned

This morning on Threadneedle Street
The Governor and his staff meet
Of late, they’ve implied
That rates have upside
But frankly, that tune’s obsolete

This morning, every story is the same story, interest rates are going lower. Tuesday, Signor Draghi told us so. Yesterday Chairman Jay reiterated the idea, and last night, Kuroda-san jumped on the bandwagon. This morning, Governor Carney left policy unchanged, although he continues to maintain that interest rates in the UK could rise if there is a smooth exit from the EU. Gilt markets, however, clearly don’t believe Carney as yields there fall and futures markets are pricing in a 25bp rate cut by the end of the year.

But it is not just those banks that are looking to ease policy. Remember, several weeks ago the RBA cut rates to a new record low at 1.25%, and last night, Governor Lowe indicated another cut was quite realistic. Bank Indonesia cut the reserve requirement by 0.50% last night and strongly hinted that an interest rate cut was on its way. While Bangko Sentral ng Pilipanas surprised most analysts by leaving rates on hold due to an uptick in inflation, that appears to be a temporary outcome. And adding to the Asian pressure is the growing belief that the RBNZ is also set to cut rates right before Australia does so.

In fact, looking around the world, there is only one place that is bucking this trend, Norway, which actually increased interest rates this morning by 25bp to a rate of 1.25%. In fairness, Norway continues to grow strongly, estimated 2.6% GDP growth this year, and inflation there is running above the 2.0% target and forecast to continue to increase. And it should be no surprise that the Norwegian krone is this morning’s best performing currency, rallying 1.0% vs. the euro and 1.5% vs. the dollar.

But in the end, save Norway, every story is still the same story. Global GDP growth is slowing amid increased trade concerns while inflationary pressures are generally absent almost everywhere. And in that environment, policy rates are going to continue to fall.

The market impacts ought not be too surprising either. Equity investors everywhere are giddy over the thought of still lower interest rates to help boost the economy. Or if not boosting the economy, at least allowing corporations to continue to issue more debt at extremely low levels and resume the stock repurchase schemes that have been underpinning equity market performance. Meanwhile, bond market investors are pushing the central banks even further, with new low yield levels in many countries. For example, in the 10-year space, German bunds are at -0.31%; Japanese JGB’s are at -0.18%; UK Gilts yield 0.81%; and Treasuries, here at home, have fallen to 2.01% right now, after touching 1.97% yesterday. It is abundantly clear that the market believes policy rates are going to continue to fall, and that QE is going to be reinstated soon.

As to the FX markets, yesterday saw the beginning of a sharp decline in the dollar with the euro up nearly 1.0% since the FOMC announcement, the pound +0.5% and the yen +0.6%. This makes sense as given the global rate structure, it remains clear that the Fed has the most room to ease from current settings, and thus the dollar is likely to suffer the most in the short term. However, as those changes take effect, I expect that the dollar’s decline will slow down, and we will find a new short-term equilibrium. I had suggested a 3%-5% decline before settling, and that still seems reasonable. After all, despite the fall yesterday, the dollar is simply back to where it was a week ago, before all the central bank fireworks.

With the BOE out of the way, the rest of the morning brings us two data releases, Initial Claims (exp 220K) and Philly Fed (11.0). For the former, there is still real scrutiny there given the weak NFP number earlier this month, and estimates have been creeping slightly higher. A big miss on the high side will likely see rates fall further and the dollar with them. As to the latter, given the huge miss by the Empire Manufacturing print on Monday, there will be wariness there as well. A big miss here will become the second piece of news that indicates a more acute slowing of the US economy, and that will also likely see rates fall further.

In fact, that is the theme for now, everything will be an excuse for rates to fall until the meeting between President’s Trump and Xi next week, with all eyes looking for signs that the trade situation will improve. And one other thing to remember is that tensions in the Middle East are increasing after Iran claimed to have shot down a US drone. Both oil and gold prices are much higher this morning, and I assure you, Treasuries are a beneficiary of this story as well.

So, for the dollar, things look dim in the short and medium term, however, I see no reason for a prolonged decline. Hedgers should take advantage of the weakness in the buck to add to hedges over the next few weeks.

Good luck
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Lingering Issues

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Some pundits now have the impression
That we will soon be in recession
The data of late
Has spurred the debate
And could remove Powell’s discretion

Meanwhile, we just heard from Herr Draghi
That “lingering” issues made foggy
The future of growth
So he and Jay both
Will soon ease ere things turn too quaggy

Some days, there is far more to discuss than others, and today is one of those days. Markets are trying to digest all of the following information: weaker US data, weaker Eurozone data, dovish comments from Signor Draghi, confirmation the RBA is likely to cut rates again, increased likelihood that Boris Johnson will be the next PM in the UK, and increased tensions in the Middle East.

Starting at the top, yesterday’s Empire State Manufacturing survey printed at a much worse than expected -8.6, which represented a 26.4-point decline from May’s survey and the largest fall on record. It was a uniformly awful report, with every sub-index weak. While by itself, this report is generally second tier data, it is adding to the case that the US economy is slowing more rapidly than had previously been expected and is increasing market expectations that the Fed will act sooner rather than later. We will see how that turns out tomorrow.

Then this morning, the German ZEW Survey was released at -21.1, a 19-point decline and significantly worse than expected. This is seen as a potential harbinger of further weakness in the German economy adding to what has been a run of quite weak manufacturing data. Although auto registrations in the Eurozone ticked ever so slightly higher in May (by 0.04%), the trend there also remains sharply downward. All in all, there has been very little encouraging of late from the Continent.

Then Signor Draghi got is turn at the mike in Sintra, Portugal, where the ECB is holding its annual summer festivities, and as usual, he did not disappoint. He explained the ECB has plenty of tools left to address “lingering” risks in the economy and hinted that action may be coming soon. He expressly described the ability for the ECB to cut rates further as well as commit to keep rates lower for even longer. And he indicated that QE is still available as the only rules that could restrict it are self-imposed, and easily changed. Arguably, this had the biggest impact of the morning as Eurozone equities rocketed on the prospect of lower rates, bouncing back from early losses and now higher by more than 1.0% on the day across the board. German bunds have plumbed new yield depths, touching -0.30% while the euro, to nobody’s surprise, has weakened further, ceding modest early gains to now sit lower by -0.3%. This is proof positive of my contention that the Fed will not be easing policy in isolation, and that if they start easing, you can be sure that the rest of the world will be close behind. Or perhaps even ahead!

Adding to the news cycle were the RBA minutes, which essentially confirmed that the next move there will be lower, and that two more rate cuts this year are well within reason as Governor Lowe tries to drive unemployment Down Under to just 4.5% from its current 5.2% level. Aussie has continued its underperformance on the news, falling a further 0.1% this morning and is now back to lows last touched in January 2016. And it has further to fall, mark my words.

Then there is the poor old pound, which has been falling sharply for the past week (-1.75%) as the market begins to price in an increased chance of a no-deal Brexit. This is due to the fact that Boris Johnson is consolidating his lead in the race to be the next PM and he has explicitly said that come October 31, the UK will be exiting the EU, deal or no deal. Given the EU’s position that the deal on the table is not open for renegotiation, that implies trouble ahead. One thing to watch here is the performance of Rory Stewart, a dark horse candidate who is gaining support as a compromise vs. Johnson’s more hardline stance. The point is that any indication that Johnson may not win is likely to see the pound quickly reverse its recent losses.

And finally, the Middle East continues to see increased tensions as Iran announced they were about to breach the limits on uranium production imposed by the ill-fated six-nation accord while the US committed to increase troop deployment to the area by 1000 in the wake of last week’s tanker attacks. Interestingly, oil is having difficulty gaining any traction which is indicative of just how much market participants are anticipating a global economic slowdown. OPEC, too, has come out talking about production cuts and oil still cannot rally.

To recap, bond, currency and commodity markets are all forecasting a significant slowdown in economic activity, but remarkably, global stock markets are still optimistic. At this point, I think the stock jockeys are on the wrong side of the trade.

As to today, we are set to see Housing Starts (exp 1.239M) and Building Permits (1.296M) at 8:30. Strong data is likely to have little impact on anybody’s thinking right now, but weakness will start to drive home the idea that the Fed could act tomorrow. Overall, the doves are in the ascendancy worldwide, and rightly so given the slowing global growth trajectory. Look for more cooing tomorrow and then on Thursday when both the BOJ and BOE meet.

Good luck
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Totally Thwarted

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The data that China reported
Showed growth there somewhat less supported
Meanwhile in Hong Kong
The protesting throng
Has bullish views totally thwarted

Once again, risk is under pressure this morning as the litany of potential economic and financial problems continues to grow rather than recede. The latest concerns began last night when China reported slowing Investment (5.6%, below 6.1% expected) and IP (5.0%, weakest since 2002) data (although Retail Sales held up) which led to further concerns over the growth trajectory in the Middle Kingdom. PBOC Governor Yi Gang assures us that China has significant firepower left to address further weakness, but traders are a little less comforted. Adding to concerns are the ongoing protests in Hong Kong over potential new legislation which would allow extradition, to mainland China, of people accused of fomenting trouble in Hong Kong. That is a far cry from the separation that has been key in allowing Hong Kong’s financial markets and economy to flourish despite its close ties to Beijing.

The upshot is that stocks in Hong Kong (-0.65%) and Beijing (-1.0%) fell again, while interest rates in Hong Kong pushed even higher. This has resulted in a liquidity shortage in Hong Kong which is supporting the HKD (+0.2% this week and finally pushing away from the HKMA’s floor). The renminbi, meanwhile, has gone the other way, softening slightly since the protests began. Other signs of pressure were evident by the weakness in AUD and NZD, both of which rely heavily on the Chinese market as their primary export destinations.

Risk is also evident in the energy markets where there has been an escalation in the rhetoric between the US and Iran after the tanker attacks yesterday. This morning the US is claiming it has video proof that Iran was behind the attacks, although it has not been widely accepted as such. Oil prices, which rose sharply yesterday, have maintained those gains, although on the other side of the oil equation is the slowing economy sapping demand. In fact, the IEA is out with a report this morning that next year, production increases in the US, Canada and Brazil will significantly outweigh anemic increases in demand, further pressuring OPEC and likely oil prices overall. However, for the moment, the market concerns are focused on the increased tension in the Gulf with the possibility of a conflict there seeming to rise daily. Remember, risk assets tend to suffer greatly in situations like this.

Aside from the weaker Aussie (-0.25%) and Kiwi (-0.55%), we have also seen strength in the yen (+0.2%), a huge rally in Treasuries (10-year yield down 4.5bps), gold pushing higher (+1% and back to its highest level in three years) and the dollar, overall performing well. The latter is evidenced by the decline in the euro (-0.2%), the pound (-0.3%) and basically the rest of the G10 with similar declines.

This is the market backdrop as we await the last major piece of data before the FOMC meeting next week, this morning’s Retail Sales numbers. Current expectations are for a 0.6% increase, with the ex-autos number printing at 0.3%. But recall, last month economists were forecasting a significant gain and instead the headline number was negative. A similar result this morning would certainly add more pressure on Chairman Powell and friends next week. And that is really the big underlying story across all markets, just how soon are we likely to see the Fed or the ECB or the BOJ turn clearly dovish and ease policy.

It has become abundantly clear that inflation is the only data point that the big central banks are focusing on these days. And given their fixation on achieving a, far too precise, level of 2.0%, they are all failing by their own metrics. Wednesday’s US CPI data was softer than expected leading to reduced expectations for the PCE data coming at the end of the month. In the Eurozone, 5y/5y inflation swaps, one of the ECB’s key metrics for inflation sentiment, has fallen below 1.20% and is now at its lowest level since the contract began in 2003. And in Japan, CPI remains pegged just below 1.0%, nowhere near the target level. It is this set of circumstances, more than any questions on growth or employment, that will continue to drive monetary policy. With this in mind, one can only conclude that money is going to get easier going forward. I still don’t think the Fed moves next week, but I could easily see a 50bp cut in July. Regardless, markets are going to continue to pressure all central banks until policy rates are lowered, mark my words.

Regarding the impact of these actions on the dollar, it becomes a question of timing more than anything else. As I have consistently maintained, if the Fed starts to ease aggressively, you can be sure that the ECB and BOJ, as well as a host of other central banks, will be doing so as well. And in an environment of global weakness, I expect the dollar will remain the favored place to maintain assets.

As for today, a weak Retail Sales print is likely to see an initial sell-off in the dollar but look for it to reverse as traders focus on the impacts likely to be felt elsewhere.

Good luck and good weekend
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Markets Are Waiting

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

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

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

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

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

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

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

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

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

Good luck
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Doves There Held Sway

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It seems that a day cannot pass
When one country ‘steps on the gas’
Twas China today
Where doves there held sway
With funding for projects en masse

If I didn’t know better, I would suspect the world’s central banks of a secret accord, where each week one of them is designated as the ‘dove du jour’ and makes some statement or announcement that will serve to goose stock prices higher. Whether it is Fed speakers turning from patience to insurance, the ECB promising more of ‘whatever it takes’ or actual rate cuts a la the RBA, the central banks have apparently realized that the only place they continue to hold sway is in global stock markets. And so, they are going to keep on pushing them for as long as they can.

This week’s champion is the PBOC, which last night eased restrictions further on infrastructure investment by local governments, allowing more issuance of ‘special bonds’ and encouraging banks to lend more for these projects. At the same time, the CNY fix was its strongest in a month, back below the 6.90 level, as the PBOC makes clear that for the time being, it is not going to allow the yuan to display any unruly behavior. True to form, Chinese equity markets roared higher led by construction and cement companies, and once again we see global equity markets in the green.

While in the short run, investors remain happy, the problem is that in the medium and longer term, it is unclear that the central banking community has sufficient ammunition left to really help economic activity. After all, how much lower is the ECB going to cut rates from their current -0.4% level? And will that really help the economy? How many more JGB’s can the BOJ buy given they already own about 50% of the market? In truth, the Fed and the PBOC are the only two banks with any real leeway to ease policy enough to have a real economic impact, rather than just a financial markets impact. And for a world that has grown completely reliant on central bank activity to maintain economic growth, that is a real problem.

Adding to these woes is the ongoing trade war situation which seems to change daily. The latest news on this front is that if President Xi won’t sit down with President Trump at the G20 meeting in Japan later this month, then the US will impose tariffs on all Chinese imports. However, it seems the market is becoming inured to statements like these as there has been precious little discussion on the subject, and the PBOC’s actions were clearly far more impactful.

The question is, how long can markets continue to ignore what is a clearly deteriorating global economic picture before responding? And the answer is, apparently, quite a long time. Or perhaps that question is aimed only at equity markets because bond markets clearly see a less rosy future. At some point, we are going to see a central bank announcement result in no positive impact, or perhaps even a negative one, and when that occurs, be prepared for a rockier ride.

Turning to the FX markets this morning, the dollar has had a mixed session, although is arguably a touch softer overall. So far this month, the euro, which is basically unchanged this morning, has rallied 1.4%, while the pound, which is a modest 0.15% higher this morning after better than expected wage data, is higher by just 0.5%. My point is that despite some recent angst in the analyst community that the dollar was due to come under significant pressure, the overall movements have been quite small.

In the EMG bloc, there has also been relatively little movement this month (and this morning) as epitomized by the Mexican peso, which fell nearly 3% last week after the threat of tariffs being imposed unless immigration changes were made by Mexico, and which has recouped essentially all of those losses now that the tariffs have been averted. China is another example of a bit of angst but no substantial movement. This morning, after the PBOC drove the dollar fix lower, the renminbi is within pips of where it began the month. Again, FX markets continue to fluctuate in relatively narrow ranges as other markets have seen far more activity.

Repeating what I have highlighted many times, FX is a relative market, and the value of one currency is always in comparison to another. So, if monetary policies are changing in the same direction around the world, then the relative impact on any currency is likely to be muted. It is why, despite the fact that the US has more room to ease policy than most other nations, I expect the dollar to quickly find its footing in the event the Fed gets more aggressive. Because we know that if the Fed is getting aggressive, so will every other central bank.

Data this morning has seen the NFIB Small Business Optimism Index rise to 105.0, indicating that things in the US are, perhaps, not yet so dire. This is certainly not the feeling one gets from the analyst community or the bond market, but it is important to note. We do see PPI as well this morning (exp 2.0%, 2.3% core) but this is always secondary to tomorrow’s CPI report. The Fed remains in its quiet period so there will be no speakers, and the stock market is already mildly euphoric over the perceived policy ease from China last night. Quite frankly, it is hard to get excited about much movement at all in the dollar today, barring any new commentary from the White House.

Good luck
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So Distorted

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Said Draghi, if things get much worse
Then more money, I will disburse
And negative rates
Which everyone hates
Will never go into reverse!

This morning, the Germans reported
That IP there’s lately been thwarted
Now markets are waiting
For payrolls, debating
Why everything seems so distorted

India. Malaysia. New Zealand. Philippines. Australia. India (again). Federal Reserve (?). ECB (?).

These are the major nations that have cut policy rates in the past two months, as well as, of course, the current forecasts for the two biggest central banks. Tuesday and Wednesday we heard from a number of Fed speakers, notably Chairman Powell, that if the economy starts to weaken, a rate cut is available and the Fed won’t hesitate to act. At this point, the futures market has a 25% probability priced in for them to cut rates in two weeks’ time, with virtual certainty they will cut by the late July meeting.

Then yesterday, Signor Draghi guided us further out the calendar indicating that interest rates in the ECB will not change until at least the middle of 2020. Remember, when this forward guidance started it talked about “through the summer” of 2019, then was extended to the end of 2019, and now it has been pushed a further six months forward. But of even more interest to the markets was that at his press conference, he mentioned how further rate cuts were discussed at the meeting as well as restarting QE. Meanwhile, the newest batch of TLTRO’s will be available at rates from -0.3% to 0.10%, slightly lower than had previously been expected, but certainly within the range anticipated. And yet, despite this seeming dovishness, the market had been looking for even more. In the end, the euro rallied yesterday, and has essentially maintained its recent gains despite Draghi’s best efforts. After all, when comparing the policy room available to the Fed and the ECB, the Fed has the ability to be far more accommodative in the near term, and markets seem to be responding to that. In the wake of the ECB meeting, the euro rallied a solid 0.5%, and has only ceded 0.1% of that since. But despite all the angst, the euro has not even gained 1.0% this week, although with the payroll report due shortly, that is certainly subject to change.

Which takes us to the payroll report. Wednesday’s ADP data was terrible, just 27K although the median forecast was for 180K, which has a number of analysts quite nervous.

Nonfarm Payrolls 185K
Private Payrolls 175K
Manufacturing Payrolls 5K
Unemployment Rate 3.6%
Participation Rate 62.9%
Average Hourly Earnings 0.3% (3.2% Y/Y)
Average Weekly Hours 34.5

Given the way this market is behaving, if NFP follows ADP, look for the dollar to fall sharply along with a big bond market rally, and arguably a stock market rally as well. This will all be based on the idea that the Fed will be forced to cut rates at the June meeting, something which they are unwilling to admit at this point. Interestingly, a strong print could well see stocks fall on the idea that the Fed will not cut rates further, at least in the near future, but it should help the dollar nicely.

Before I leave for the weekend, there are two other notable moves in the FX markets, CNY and ZAR. In China, an interview with PBoC Governor Yi Gang indicated that they have significant room to ease policy further if necessary, and that there is no red line when it comes to USDCNY trading through 7.00. Those comments were enough to weaken the renminbi by 0.3%, above 6.95, and back to its weakest level since November. Confirmation that 7.00 is not seen as a crucial level implies that we are going to see a weaker CNY going forward.

As to ZAR, it has fallen through 15.00 to the dollar, down 0.5% on the day and 3.4% on the week, as concerns grow over South Africa’s ability to manage their way through the current economic slump. Two key national companies, Eskom, the electric utility, and South African Airways are both struggling to stay afloat, with Eskom so large, the government probably can’t rescue them even if they want to. Slowing global growth is just adding fuel to the fire, and it appears there is further room for the rand to decline.

In sum, the global economic outlook continues to weaken (as evidenced by today’s German IP print at -1.9% and the Bundesbank’s reduction in GDP forecast for 2019 to just 0.6%) and so easier monetary policy appears the default projection. For now, that translates into a weaker dollar (more room to move than other countries) and stronger stocks (because, well lower rates are always good, regardless of the reason), while Treasuries and Bunds should continue to see significant inflows driving yields there lower.

Good luck and good weekend
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Certainty’s Shrinking

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The data from yesterday showed
That Services growth hadn’t slowed
But ADP’s number
Showed job growth aslumber
An outcome that doesn’t, well, bode

This morning it’s Mario’s turn
To placate the market’s concern
His toolkit keeps shrinking
And certainty’s sinking
That he can prevent a downturn

The glass is always half-full if you are an equity trader, that much is clear. Not only did they interpret Chairman Jay’s words on Tuesday as a rate cut was coming soon (although he said no such thing), but yesterday they managed to see the combination of strong ISM Non-Manufacturing data (56.9 vs exp 55.5) and weak ADP Employment data (27K vs exp 180K) as the perfect storm. I guess they see booming profits from Services companies alongside rate cuts from the Fed as job growth slows. At any rate, by the end of the day, equity markets had continued the rally that started Tuesday with any concerns over tariffs on Mexican imports relegated to the dustbin of last week.

Meanwhile the Treasury market continues to have a different spin on things with 10-year yields still plumbing multi-year depths (2.10%) while the 5yr-30yr spread blows out to its steepest (88bps) since late 2017. The interpretation here is that the bond market is essentially forecasting a number of Fed rate cuts as the economy heads into recession shortly. It isn’t often that markets have such diametrically opposed views of the future, but history has shown that, unfortunately in this case, the bond market has a better track record than the stock market. And there is one other little tidbit of market data worth sharing, the opposing moves of gold and oil. Last week was only the third time since at least the early 1980’s that gold prices rallied at least 5.2% while oil fell at least 8.7%, an odd outcome. The other two times? Right before the Tech Bubble burst and right before the Global Financial Crisis. Granted this is not a long track record, but boy, it’s an interesting outcome!

The point is, signs that economic growth is slowing in the US are increasing. One thing of which we can be sure is that while slowing growth elsewhere may not lead to a US recession, a US recession will absolutely lead to much slower growth everywhere else in the world. Remember, the IMF just this week reduced their GDP growth forecasts yet again for 2019, and their key concern, the deteriorating trade situation between the US and the rest of the world, is showing no signs of dissipating.

Into this mix steps Mario Draghi as the ECB meets today in Vilnius, Lithuania (part of their annual roadshow). At this point, it is clear the ECB will define the terms of the new TLTRO’s with most analysts’ views looking for very generous terms (borrowing at -0.4%) although the ECB has tried to insist that these will only last two years rather than the four years of the last program. There is also talk of the ECB investigating further rate cuts, with perhaps a tiered structure on which reserves will be subject to the new, lower rate. And there is even one bank analyst forecasting that the ECB will restart QE come January 2020. Futures markets are pricing in a rate cut by Q1 2020, which is certainly not the direction the ECB intended when they changed their forward guidance to ‘rates will remain where they are through at least the end of the year.’ At that time, they were thinking of rate hikes, but that seems highly unlikely now.

With all of this in mind, let us now consider how this might impact the FX market. As I consistently point out, FX is a relative game. This means that expectations for both currencies matter, not just for one. So, the idea that the Fed has turned dovish, ceteris paribus, would certainly imply the dollar has room to fall. But ceteris is never paribus in this world, and as we are likely to hear later today at Draghi’s press conference, the ECB is going to be seen as far more dovish than just recently supposed. (What if the TLTRO’s are for three years instead of two? That would be seen as quite dovish I think.) The point is that while the signs of a weaker US economy continue to grow, those same signs point to weakness elsewhere. In the end, while the dollar may still soften further, as expectations about the Fed race ahead of those about the ECB or elsewhere, that is a short-term result. As I wrote earlier this week, 2% or so further weakness seems quite viable, but not much more than that before it is clear the rest of the world is in the same boat and policy eases everywhere.

FX market activity overnight has shown the dollar to be under modest pressure, with the euro up 0.3% while the pound and most of the rest of the G10 are up lesser amounts (0.1%-0.2%). However, many EMG currencies remain under pressure with MXN -0.75% after Fitch downgraded its credit rating to BBB-, the lowest investment grade, and weakness in ZAR and TRY helping to support the broad dollar indices. But in the big picture, the dollar remains in a trading range as we will need to see real policy changes before there is significant movement.

Turning to this morning’s data, aside from the Draghi presser at 8:30, we also see Initial Claims (exp 215K), the Trade Balance (-$50.7B), Nonfarm Productivity (3.5%) and Unit Labor Costs (-0.8%). But the reality is that, especially after yesterday’s ADP number, all eyes will be on tomorrow’s NFP print. In the event that ADP was prescient, and we see a terrible number, watch for a huge bond market rally and a weaker dollar. But if it is more benign, around the 185K expected, then I don’t see any reason for markets to change their recent tune. Expectations of future Fed rate cuts as ‘insurance’ will help keep the dollar on its back foot while supporting equities round the world.

Good luck
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Soon On the Way

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While Powell did not actually say
That rate cuts were soon on the way
He hinted as much
So traders did clutch
The idea and quickly made hay

If there was ever any doubt as to what is driving the equity markets, it was put to rest yesterday morning. Chairman Powell, during his discussion of the economy and any potential challenges said the following, “We are closely monitoring the implications of these developments for the U.S. economic outlook and, as always, we will act as appropriate to sustain the expansion.” Nowhere in that comment does he actually talk about cutting rates, but the market belief is that ‘appropriate action’ is just that. The result was a powerful equity market rally (DJIA and S&P +2.1%, NASDAQ +2.6%), a modest Treasury sell-off and further weakness in the dollar. At this point, Wall Street analysts are competing to define the terms of the Fed’s next easing cycle with most now looking for at least two rate cuts this year, but nobody expecting a move later this month. And don’t forget the futures market, where traders are pricing in 60bps of rate cuts before the end of the year, so two cuts and a 40% probability of a third.

All of this is ongoing in the face of continuing bombastic trade rhetoric by both the US and China, and with President Trump seemingly quite comfortable with the current situation. While it appears that he views these as negotiating tactics, it seems clear that the strategy is risky and could potentially spiral into a much more deeply entrenched trade war. However, with that in mind, the one thing we all should have learned in the past two plus years is that forecasting the actions of this President is a mug’s game.

Instead, let’s try to consider potential outcomes for various actions that might be taken.

Scenario 1: status quo, meaning tariffs remain in place but don’t grow on either side and trade talks don’t restart. If the current frosty relationship continues, then markets will become that much more reliant on Fed largesse in order to maintain YTD gains, let alone rally. Global growth is slowing, as is growth in trade (the IMF just reduced forecasts for 2019 again!), and earnings data is going to suffer. In this case, the market will be pining for ‘appropriate action’ and counting on the Fed to cut rates to support the economy. While rate cuts will initially support equities, there will need to be more concrete fiscal action to extend any gains. Treasuries are likely to continue to see yields grind lower with 2.00% for the 10-year quite viable, and the dollar is likely to continue to suffer in this context as expectations for US rate cuts will move ahead of those for the rest of the world. Certainly, a 2% decline in the dollar is viable to begin with. However, remember that if the economic situation in the US requires monetary ease, you can be sure that the same will be true elsewhere in the world, and when that starts to become the base case, the dollar should bottom.

Scenario 2: happy days, meaning both President’s Xi and Trump meet at the G20, agree that any deal is better than no deal and instruct their respective teams to get back to it. There will be fudging on both sides so neither loses face domestically, but the threat of an all-out trade war dissipates quickly. Markets respond enthusiastically as earnings estimates get raised, and while things won’t revert to the 2016 trade situation, tariffs will be removed, and optimism returns. In this case, without any ‘need’ for Fed rate cuts, the dollar will likely soar, as once again, the US economic situation will be seen as the most robust in the world, and any latent Fed dovishness is likely to be removed. Treasury prices are sure to fall as risk as quickly embraced and 2.50%-2.75% 10-year Treasuries seems reasonable. After all, the 10-year was at 2.50% just one month ago.

Scenario 3: apocalypse, the trade war escalates as both Presidents decide the domestic political benefits outweigh the potential economic costs and everything traded between the two nations is subject to significant tariffs. Earnings estimates throughout the world tumble, confidence ebbs quickly and equity markets globally suffer. While this will trigger another bout of central bank easing globally, the impact on equity markets will be delayed with fear running rampant and risk rejected. Treasury yields will fall sharply; 1.50% anyone? The dollar, however, will outperform along with the yen, as haven currencies will be aggressively sought.

Obviously, there are many subtle gradations of what can occur, but I feel like these three descriptions offer a good baseline from which to work. For now, the status quo is our best bet, with the chance of happy days coming soon pretty low, although apocalypse is even more remote. Just don’t rule it out.

As to the markets, the dollar has largely stabilized this morning after falling about 1% earlier in the week. Eurozone Services PMI data printed ever so slightly higher than expected but is still pointing to sluggish growth. The ECB is anticipated to announce the terms of the newest round of TLTRO’s tomorrow, with consensus moving toward low rates (-0.4% for banks to borrow) but terms of just two years rather than the previous package’s terms of four years. Given the complete lack of inflationary pulse in the Eurozone and the ongoing manufacturing malaise, it is still very hard for me to get excited about the euro rallying on its own.

This morning brings ADP Employment data (exp 185K) as well as ISM Non-Manufacturing (55.5) and then the Fed’s Beige Book is released at 2:00. We hear from three more Fed speakers, Clarida, Bostic and Bowman, so it will be interesting to see if there is more emphasis on the willingness to respond to weak markets activity. One thing to note, the word patience has not been uttered by a single Fed member in a number of days. Perhaps that is the telling signal that a rate cut is coming sooner than they previously thought.

Good luck
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Retreated

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Rate cuts “may be warranted soon”
Said James yesterday afternoon
The bond market soared
Though stocks ‘cross the board
Retreated the third day of June

Will someone please explain to me how the Fed expects to be preemptive on economic movements by looking in the rearview mirror? Given that data is almost always backwards looking, (only the ISM surveys really try to look ahead) it seems it would be a far better process to simply explain the reaction function will follow the economy. It is abundantly clear that they have completely lost the ability to lead the economy. So now, following a spate of softer data leading to comments from St Louis Fed President James Bullard about cutting rates soon, Treasury yields have plumbed new depths for the move, touching as low as 2.07% on Monday, and although they have rebounded slightly this morning, there is no indication this movement is going to stop. Weaker ISM data, slower housing growth and ongoing trade uncertainty have certainly stacked the deck against the Fed standing pat. Chairman Powell speaks this morning and markets will be anxiously awaiting his wisdom on the subject. (Spoiler alert, his only choice will be to sound dovish as any hawkish tone will immediately reflect in an equity sell-off.)

Similarly, we continue to see German bund yields pressing to new lows, -0.21% this morning, and the pressure on the ECB to respond is growing stronger. Just this weekend there was a story in Bloomberg describing Eurozone inflation as starting to trend higher. Alas, this morning’s data printed weaker than expected with headline CPI at 1.2% and core at 0.8%. While the euro has barely reacted, interest rate markets are starting to price in even more easing by the ECB and analyst’s comments are moving towards the need for Signor Draghi to do something to show that the ECB is in control. The problem for Draghi is he only has a few more months in the seat and all eyes are looking toward his potential replacement. While there is no strong consensus pick, the view is developing that whoever takes the role will be more hawkish than Draghi, by default. At least initially. However, if Eurozone growth continues to falter and inflation remains around 1.0%, instead of nearer its target of “close to but below 2.0%”, that hawkishness is likely to fade. And one last thing, Eurozone inflation expectations, as measured by five year forward five-year swaps have fallen to near record lows of 1.28%. In other words, nobody thinks inflation is making a comeback soon.

Adding to the interest rate gloom was Australia, last night, cutting its base rate to 1.25%, as widely expected. RBA Governor Lowe made it clear that given the slowing picture in China and the overall slowdown in global growth, the door is open for further rate cuts there. Markets are pricing in at least two more by the end of the year.

How about Switzerland? The nation with the world’s lowest interest rates, the cash rate is -0.75%, is being forecast to cut them further. Given the haven status of the Swiss franc and its recent appreciation vs. the euro, analysts are now looking for another rate cut there. So is the futures market, with a 50% probability of a 25bp cut priced in for March 2020., and SNB President Thomas Jordan has done nothing to dissuade these ideas. If anything, I would expect a cut before the end of the year.

My point is that despite the recent turn in US markets regarding interest rates, where virtually every analyst has come around to the idea that the next move in rates will be lower, and clearly there are Fed members in that camp, none of this happens in isolation. As the above discussion highlights, more dovish policy is quickly becoming the baseline forecast for virtually every country that matters.

So, what does that do for the dollar? Yesterday’s price action showed the dollar’s worst performance since mid-March, when Chairman Powell surprised the market with an uber-dovish policy statement and press conference. Bullard’s comments were enough to turn views toward a rate cut happening much sooner than previously anticipated. And so, if the Fed has truly turned around their thought process, then it will be no surprise for the dollar to have a weak period. Of course, this will only last until we hear Draghi talk about the room for further easing and the need to maintain price stability near the ECB’s target. Once it is clear that the ECB is also going to ease further, the dollar will likely find a bottom. Remember, the ECB meets tomorrow and Thursday, with Draghi’s press conference at 8:30 Thursday morning. Given the recent data, and the overall trade situation, it is not impossible that the ECB turns far more dovish this week. However, my sense is they will focus on the terms of the new TLTRO’s and not on restarting QE. So, the dollar probably has a few weeks of underperformance ahead of it, but it is only a matter of time before the ECB (and correspondingly the BOJ, BOE and BOC) jump on the dovish bandwagon.

As an aside, I keep reading that the only way for the Fed to create a dovish surprise later this month is to cut immediately (the market is pricing in a 25bp cut at the July meeting) but I disagree. All they have to do is cut by more than 25bps when they cut. There is no rule that says 25bps is the proper amount to move rates. If the consensus view is turning to a sharper slowdown, it would be better to get ahead of the problem than to be seen as offering policy prescriptions that are ‘too little, too late.’ It appears to me that President Trump will get his way regarding the Fed, with easier money to come sooner rather than later. Alas, I fear that the stock market may not respond in the manner desired. At this point, cutting rates speaks to panic at the Fed that things are much worse than they have been describing. If that is the perception, equity markets have only one way to go…down.

On the data front, yesterday saw the weakest ISM print since October 2016, which is completely in line with what we are seeing around the world, slowing manufacturing growth. This morning, the only hard data is Factory Orders (exp -0.9%) but both Powell and NY Fed President Williams speak. The default expectation for them both is turning more dovish, and if they live up to that billing, the dollar is likely to continue its recent decline. But, if somehow they sound hawkish, look for the dollar to reverse higher quickly. Remember, FX is still a relative game and its recent weakness is predicated on a more dovish Fed. Changing that changes the market’s perception.

Good luck
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Called Into Question

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A key market gauge of recession,
The yield curve, has called into question
Growth’s pace up ahead
And whether the Fed
Will restart financial repression

While markets this morning have stopped falling, there is no question that investors are on heightened alert. Yesterday saw further declines in the major stock indices and a continuation of the dollar’s rally alongside demand for Treasuries and Bunds. Today’s pause is hardly enough to change the predominant current view which can best be summed up as, AAAAGGGHHHH!

In the Treasury market, 10-year yields reached their steepest inversion vs. 3-month yields, 14bps, since 2007. While many pundits and analysts focus on the 2-year vs. 10-year spread, which remains slightly positive, the Fed itself has published research showing the 3-month vs. 10-year spread is a better indicator of future recessions. So the combination of fears over a drawn out trade war between the US and China and ongoing uncertainty in Europe given the Brexit drama and the uptick in tensions between Italy and the European Commission regarding Italy’s mooted budget, have been enough to send many investors hunting for the safest assets they can find. In this classic risk-off scenario, the fact that the dollar and the yen remain the currencies of choice is no surprise.

But let’s unpack the stories to see if the fear is warranted. On the trade front, every indication of late is that both sides are preparing for a much longer conflict. Just this morning China halted all imports of US soybeans. The other chatter of note is the idea that the Chinese may soon halt shipments of rare-earth metals to US industry, an act that would have significant negative consequences for the US manufacturing capability in the technology and aerospace industries. Of course, the US ban on Huawei and its increased pressure to prevent any allies from buying their equipment strikes at the heart of China’s attempts to move up the value chain in manufacturing. All told, until the G20 meeting in about a month’s time, I cannot foresee any thaw in this battle, and so expect continued negative consequences for the market.

As to Brexit, given the timing is that there won’t be a new Prime Minister until September, it seems that very little will happen in this arena. After all, Boris Johnson is already the favorite and is on record as saying a hard Brexit suits him just fine. While my personal view is that the probability of that outcome is more than 30%, I am in the minority. In fact, I would argue the analyst community, although not yet the market, is coalescing around the idea that no Brexit at all has become the most likely outcome. We have heard more and more MP’s talk about a willingness to hold a second referendum and current polls show Remain well ahead in that event. Of course, the FX market has not embraced that view as evidenced by the fact the pound remains within spitting distance of its lowest levels in more than two years.

Finally, the resurrection of the Italy story is the newest addition to the market’s menu of pain, and this one seems like it has more legs. Remarkably, the European Commission, headed by Jean-Claude Juncker, is demanding that Italy reduce its fiscal spending by 1.5% of GDP despite the fact that it is just emerging from a recession and growth this year is forecast to be only 0.3%. This is remarkable given the Keynesian bent of almost all global policymakers. Meanwhile, Matteo Salvini, the leader of the League whose power is growing after his party had a very strong showing in last week’s EU elections, has categorically rejected that policy prescription.

But of more interest is the fact that the Italian Treasury is back to discussing the issuance of ‘minibots’ which are essentially short-term Italian notes used by the government to pay contractors, and which will be able to trade in the market as a parallel currency to the euro. While they will be completely domestic, they represent a grave threat to the sanctity of the single currency and will not be lightly tolerated by the ECB or any other Eurozone government. And yet, it is not clear what the rest of Europe can do to stop things. The threat of a fine is ludicrous, especially given that Italy’s budget deficit is forecast to be smaller than France’s, where no threats have been made. The thing is, introduction of a parallel currency is a step into the unknown, and one that, in the short-term, is likely to weigh on the euro significantly. However, longer term, if Italy, which is generally perceived as one of the weaker links in the Eurozone, were to leave, perhaps that would strengthen the remaining bloc on a macroeconomic basis and the euro with it.

With that as background, it is no surprise that investors have been shunning risk. While this morning markets are rebounding slightly, with equity indices higher by a few tenths of a percent and Treasury yields higher by 3bps, the trend remains firmly in the direction of less risk not more.

The final question to be asked is, how will the Fed respond to this widening array of economic issues? Arguably, they will continue to focus on the US story, which while slowing, remains the least problematic of the major economies. At least that has been the case thus far. But today we have the opportunity to change things. Data this morning includes the first revision of Q1 GDP (exp 3.1%) as well as Initial Claims (215K) and the Goods Trade Balance (-$72.0B) at 8:30. There are concerns that the Q1 data falls below 3.0% which would not only be politically inconvenient, but perhaps a harbinger of a faster slowdown in Q2. Then, throughout the next week we get a significant run of data culminating in the payroll report next Friday. So, for now, the Fed is going to be watching closely, as will all market participants.

The predominant view remains that growth around the world is slowing and that the next easing cycle is imminent (fed funds futures are pricing in 3 rate cuts by the end of 2020!) However, Fed commentary has not backed up that view as yet. We will need to see the data to have a better idea, but for now, with risk still being shunned, the dollar should remain bid overall.

Good luck
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