The Doves Are Ascendant

A recap of central bank actions
Shows sameness across all the factions
The doves are ascendant
And markets dependent
On easing for all their transactions

Yesterday’s markets behaved as one would expect given the week’s central bank activities, where policy ease is the name of the game. Stock markets rose sharply around the world, bond yields fell with the dollar following yields lower. Commodity prices also had a good day, although gold’s rally, as a haven asset, is more disconcerting than copper’s rally on the idea that easier policy will help avert a recession. And while, yes, Norway did raise rates 25bps…to 1.25%, they are simply the exception that proves the rule. Elsewhere, to recap, the three major central banks all met, and each explained that further policy ease, despite current historically easy policy, is not merely possible but likely going forward.

If there were questions as to why this is the case, recent data releases serve as an excellent answer. Starting in the US yesterday, Philly Fed, the second big manufacturing survey, missed sharply on the downside, printing at 0.3, down from last month’s 16.6 reading and well below expectations of 11.0. Combined with Monday’s Empire Manufacturing index, this is certainly a negative harbinger of economic activity in the US.

Japan’s inflation
Continues to edge lower
Is that really bad?

Then, last night we saw Japanese CPI data print at 0.7%, falling 0.2% from the previous month and a strong indication that the BOJ remains far behind in their efforts to change the deflationary mindset in Japan. It is also a strong indication that the BOJ is going to add to its current aggressive policy ease, with talk of both a rate cut and an increase in QE. The one thing that is clear is that verbal guidance by Kuroda-san has had effectively zero impact on the nation’s views of inflation. While the yen has softened by 0.2% this morning compared to yesterday’s close, it remains in a clear uptrend which began in April, or if you step back, a longer-term uptrend which began four years ago. Despite the fact that markets are anticipating further policy ease from Tokyo, the yen’s strength is predicated on two factors; first the fact that the US has significantly more room to ease policy than Japan and so the dollar is likely to have a weak period; and second, the fact that overall evaluations of market risk (just not the equity markets) shows a great deal of concern amongst investors and the yen’s haven status remains attractive.

Closing out our analysis of economic malaise, this morning’s Flash PMI data from Europe showed that while things seem marginally better than last month, they are still rotten. Once again, Germany’s Manufacturing PMI printed well below 50 at 45.4 with the Eurozone version printing at 47.8. These are not data points that inspire confidence in central bankers and are amongst the key reasons that we continue to hear from virtually every ECB speaker that there is plenty of room for the ECB to ease policy further. And while that is a suspect sentiment, there is no doubt that they will try. But once again, the issue is that given the current status of policy, the Fed has the most room to ease policy and that relative position is what will maintain pressure on the buck.

Away from the central bank story, there is no doubt that market participants have ascribed a high degree of probability to the Trump-Xi meeting being a success at defusing the ongoing trade tensions. Certainly, it seems likely that it will help restart the talks, a very good thing, but that is not the same thing as making concessions or coming to agreement. It remains a telling factor that the Chinese are unwilling to codify the agreement in their legal system, but rather want to rely on administrative rules and guidance. That strikes as a very different expectation, compared to the rest of the developed world, regarding what international negotiations are designed to achieve. When combined with the fact that the Chinese claim there is no IP theft or forced technology transfer, which are two of the key issues on the table for the US, I still have a hard time seeing a successful outcome. But I am no trade expert, so my views are just my own.

And finally, Brexit has not really been in the news that much lately, at least not on this side of the pond, but the Tory leadership contest is down to the final two candidates, Boris Johnson and Jeremy Hunt, the Foreign Secretary. The process now heads to the roughly 160,000 active members of the Conservative Party, with Johnson favored to prevail. His stance on Brexit is he would prefer a deal, but he will not allow a delay past the current October 31, 2019 deadline, deal or no deal. It is this dynamic which has undermined the pound lately and driven its lagging performance for the past several months. However, this will take more time to play out and so I expect that the pound will remain in limbo for a while yet.

On the data front, we see only Existing Home Sales (exp 5.25M) this morning, but with the FOMC meeting now past and the quiet period over, we hear from two Fed speakers, Governor Brainerd (a dove) and Cleveland Fed President Mester (a hawk). At this point, all indications are that the Fed is leaning far more dovish than before, so it will be telling to hear Ms Mester. If she comes across as dovish, I would expect that we will see both stocks and bonds rally further with the dollar sinking again. Thus, a tumultuous week is ending with the opportunity for a bit more action. The dollar remains under pressure and I expect that to be the case for the foreseeable future.

Good luck
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As Patient As Needed

More rate hikes? The Fed said, ‘no way!’
With growth slowing elsewhere we’ll stay
As patient as needed
Since now we’ve conceded
Our hawkishness led us astray

If you needed proof that central bankers are highly political rather than strictly focused on the economics and financial issues, how about this:

Dateline January 24, 2019. ECB President Mario Draghi characterizes the Eurozone economy as slowing more than expected yet continues to support the idea that interest rates will be rising later this year as policy tightening needs to continue.

Dateline January 30, 2019. Federal Reserve Chairman Jay Powell characterizes the US economy as solid with strong employment yet explains that there is no need to consider raising rates further at this time, and that the ongoing balance sheet reduction program, which had been on “autopilot” is to be reevaluated and could well slow or end sooner than previously expected.

These are certainly confusing actions when compared to the comments attached. Why would Draghi insist that policy tightening is still in the cards if the Eurozone economy is clearly slowing? Ongoing pressure from the monetary hawks of northern Europe, notably Germany’s Bundesbank, continues to force Draghi to hew a more hawkish line than the data might indicate. As to the Fed, it is quite clear that despite the Fed’s description of a strong economy, Powell has succumbed to the pressure to support the equity market, with most of that pressure coming from the President. And yet central bankers consistently try to maintain that they are above politics and cherish their independence. There hasn’t been an independent central banker since Paul Volcker was Fed Chair from 1979-1987.

Nonetheless, this is where we are. The Fed’s dovishness was applauded by the markets with equities rallying briskly in the US (1.5%-2.2% across the indices) and following in Asia (Nikkei and Hang Seng both +1.1%) although Europe has shown less pluck. But Europe has, as described above, a slowing growth problem. This is best characterized by Italy, whose Q4 GDP release this morning (-0.2%) has shown the nation to be back in recession, their third in the past five years! It should be no surprise that Italy’s stock market is lower (-0.6%) nor that it is weighing on all the European indices.

Not surprisingly, government bond yields around the world are largely lower as well. This reaction is in a piece with market behavior in 2017 through the first three quarters of 2018, where both stocks and bonds rallied consistently on the back of monetary policy actions. I guess if easy money is coming back, and as long as there is no sign of inflation, there is no reason not to own them both. Certainly, the idea that 10-year Treasury yields are going to start to break higher seems to be fading into the background. The rally to 3.25% seen last November may well mark a long term high.

And what about the dollar? Well, if this is the new normal, then my views on the dollar are going to need to change as well. Consider this, given that the Fed has tightened more than any other central bank, the dollar has benefitted the most. We saw that last year as the dollar rallied some 7%-8% across the board. But now, the Fed has the most room to ease policy in comparison to every other G10 central bank, and so if the next direction is easy money, the dollar is certain to suffer the most. Certainly, that was the story yesterday afternoon in NY, where the dollar gave up ground across the board after the FOMC statement. Against the euro, the initial move saw the dollar sink 0.75% in minutes. Since then, it has traded back and forth but is little changed on the day, today, with the euro higher by just an additional 0.1%. We saw a similar move in the yen, rallying 0.7% immediately, although it has continued to strengthen and is higher by another 0.35% this morning. Even the pound, which continues to suffer from Brexit anxiety, rallied on the Fed news and has continued higher this morning as well, up another 0.2%. The point is, if the Fed is done tightening, the dollar is likely done rallying for now.

Other stories have not disappeared though, with the Brexit saga ongoing as it appears more and more likely to come down to a game of brinksmanship in late March. The EU is adamant they won’t budge, and the UK insists they must. I have a feeling that nothing is going to change until late March, just ahead of the deadline, as this game of chicken is going to play out until the end.

And what of the trade talks between the US and China? Well, so far there is no word of a breakthrough, and the only hints have been that the two sides remain far apart on some key issues. Do not be surprised to see another round of talks announced before the March 2 tariff deadline, or an agreement to postpone the raising of tariffs at that time as long as talks continue. Meanwhile, Chinese data released overnight showed Manufacturing PMI a better than expected (though still weak) 49.5 while Non-Manufacturing PMI actually rose to 54.7, its best reading since September, although still seeming to trend lower. However, the market there applauded, and the renminbi continues to perform well, maintaining its gains from the last week where it has rallied ~1.5%.

The US data picture continues to be confused from the government shutdown, but this morning we are due to receive Initial Claims (exp 215K and look for a revision higher from last week’s suspect 199K) as well as New Home Sales (569K). Yesterday’s ADP Employment number was much better than expected at 213K, and of course, tomorrow, we get the payroll report. Given the Fed’s hyper focus on data now, that could be scrutinized more closely than usual for guesstimates of how the Fed might react to a surprise.

In the end, the market tone has changed to mirror the Fed with a more dovish nature, and given that, the prospects for the dollar seem to have diminished. For now, it seems it has further to fall.

Good luck
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