Naught But Fool’s Gold

There once was a story, oft told
That growth round the world would be bold
But data of late
Has shown that the fate
Of that tale was naught but fool’s gold

Instead round the world what we see
Are signs that the future will be
Somewhat less robust
Than had been discussed
Since money is no longer free!

The dollar is strong this morning, rising vs. essentially every other currency after a series of weak data points from China and the EU reinforced the idea that global growth is slowing. As I type my last note of the year, the euro is lower by 0.65%, the pound -0.7% and Aussie has fallen -0.9%. In the emerging market space, the damage is generally less severe, with both CNY and BRL falling -0.4% while MXN and INR have both slipped -0.3%. There are two notable exceptions to this, however, as ZAAR has tumbled 1.5% and KRW fallen -0.8%. In other words, the dollar is in the ascendant today.

What, you may ask, is driving this movement? It started early last evening when China released some closely watched economic indicators, all of which disappointed and indicated further slowing of the economy there. Fixed Asset Investment rose just 5.9%, IP rose just 5.4% and Retail Sales rose just 8.1%. As Chinese data continue to fall below estimates, it increases the odds that the PBOC will ease monetary policy further, thus undermining the renminbi somewhat. But the knock on effect of weakening Chinese growth is that the rest of Asia, which relies on China as a key market for their exports, will also suffer. Hence the sharp decline in AUD and NZD (-1.0%), along with KRW and the rest of the APAC currencies. It certainly appears as though the trade tensions with the US are having a deleterious effect on the Chinese economy, and that may well be the reason that we have heard of more concessions on their part in the discussions. Today’s story is that corn purchases will be restarting in January, yet another rollback of Chinese trade barriers.

But it was not just China that undermined the global growth story; Eurozone data was equally dismal in the form of PMI releases. In this case, Germany’s Manufacturing PMI printed at 51.5, France at 49.7 and the Eurozone as a whole at 51.4. Each of these was substantially below expectations and point to Q4 growth in the Eurozone slowing further. While the French story is directly related to the ongoing gilets jaune protests, Germany is a bigger issue. If you recall, Q3 growth there was negative (-0.2%) but was explained away as a one-off problem related to retooling auto plants for emissions changes in regulations. However, the data thus far in Q4 have not shown any substantive improvement and now call into question the idea that a Q4 rebound will even occur, let alone offset the weak Q3 data.

Adding to the Eurozone questions is the fact that the ECB yesterday confirmed it was ending QE this month, although it has explained that it will be maintaining the size of the balance sheet for “an extended period of time” after its first interest rate rise. Currently, the market is pricing in an ECB rate hike for September 2019, but I am very skeptical. The fact that Signor Draghi characterized economic risks as to the downside rather than balanced should come as no surprise (they are) but calls into question why they ended QE. Adding to the confusion is the fact that the ECB reduced its forecasts for both growth and inflation for 2018 and 2019, hardly the backdrop to be tightening policy. In the end, much of this was expected, although Draghi’s tone at the press conference was clearly more dovish than had been anticipated, and the euro fell all day yesterday and has continued on this morning in the wake of the weak data. And this doesn’t even include the Italian budget mess where Italy’s latest figures show a smaller deficit despite no adjustments in either spending or taxes. Magical thinking for sure!

Meanwhile, the UK continues to hurtle toward a hard Brexit as PM May was rebuffed by the EU in her attempts to gain some conciliatory language to bring back to her Parliament. While I don’t believe in the apocalyptic projections being made about the UK economy come April 1st next year, I do believe that the market will severely punish the pound when it becomes clear there will be no deal, which is likely to be some time in January.

As to the US-China trade situation, this morning there is more fear of tariffs by the US, but the negotiation is ongoing. Funnily enough, my reading of the signs is that China is, in fact, blinking here and beginning to make some concessions. The last thing President Xi can afford is for the Chinese economy to slow sharply and put millions of young men out of work. Historically, excessive unemployed youth can lead to revolution, a situation he will seek to avoid at all costs. If it means he must spin some concessions to the US into a story of strengthening the Chinese economy, that is what he will do. It would certainly be ironic if President Trump’s hardball negotiating tactics turned out to be successful in opening up the Chinese economy and broadly pushing forward a more internationalist agenda, but arguably, it cannot be ruled out. Consider the ramifications on the political debate in the US if that were to be the case!! As to the market implications, I would expect that risk would be quickly embraced, equity markets would rally sharply as would the dollar, while expectations for the Fed would revert to tighter policy in 2019 and beyond. Treasuries, on the other hand, would fall sharply and yields on the 10-year would likely test their highs from early November. We shall see.

This morning brings Retail Sales (exp 0.2%, ex autos 0.2%), IP (0.3%) and Capacity Utilization (78.6%). Data that continues to show the US growing, especially in the wake of the weakness seen elsewhere in the world, should continue to underpin the dollar going forward. While I understand the structural issues like the massive budget and current account deficits should lead to dollar weakness, we are still in a cyclical phase of the market, and the US remains the best place to be for investment, so it remains premature to write off further dollar strength.

Good luck, good weekend and happy holidays to you all.

FX Poetry will return on January 2nd with forecasts for next year, and in regular format starting January 3rd.

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Still Great Disorder

While PM May fought off defeat
The Brexit debate’s incomplete
There’s still great disorder
O’er the Irish border
And angst for the man in the street

Was it much ado about nothing? In the end, PM May won the no-confidence vote, but in a singularly unimpressive manner with more than one-third of the Conservative MP’s voting against her. The upshot is that while she cannot be challenged again for another year, it clarified the strength of the opposition to her handling of the Brexit negotiations. At the same time, the EU has reiterated that the deal, as negotiated, represents all they are willing to offer. May’s strategy now seems to be to delay any vote until such time that the choice is clearly binary; accept the deal or exit with no deal. Despite the increasingly dire warnings that have come from the BOE and some private forecasters, I have lost my faith in the idea that a deal would be agreed. If this is the case, the impact on the pound is going to be quite negative for some time. Over the past two days, the pound has rallied 1.3% although it remains quite close to its post vote lows. However, in the event of a hard Brexit, look for the pound to test its historic lows from 1985, when it traded at approximately 1.05.

As to the rest of the market, it is central bank day in Europe with the Norgebank leaving rates on hold but promising to raise them in Q1; the Swiss National Bank leaving rates on hold and describing the necessity of maintaining a negative interest rate spread vs. the euro as the Swiss economy slows and inflation along with it; and, finally, the market awaits the ECB decision, where Signor Draghi is universally expected to confirm the end of QE this month. One of the interesting things about Draghi’s actions is that he is set to end QE despite his own internal forecasts, which, according to ‘sources’ are going to be reduced for both growth and inflation in 2019. How, you may ask, can a central banker remove policy accommodation despite weakening data? Arguably the answer is that the ECB fears the consequences of going back on its word more than the consequences of implementing the wrong policy. In any event, look for Draghi to speak of transient and temporary causes to the reduced forecasts, but express optimism that going forward, Eurozone growth is strong and will be maintained as inflation edges toward their target of just below 2.0%.

Of greater consequence for the euro this morning, which has rallied a modest 0.1%, is the news from Italy that they have adjusted their budget forecasts to expect a very precise 2.04% deficit in 2019, down from the previous budget deficit forecast of 2.4%. Personally I question the changes other than the actual decimal place on the forecast, but the market has accepted them at face value and we have seen Italian assets rally, notably 10-year BTP’s where yields have fallen 10bps and the spread with German bunds has fallen a similar amount. While the situation in France does not seem to have improved very much, the market is clearly of the view that things in Europe are better than they were last week. However, caution is required in accepting that all the issues have been adequately addressed. They have not.

In the end, though, despite these important issues, risk sentiment continues to be broadly driven by the trade situation between the US and China. Helping that sentiment this morning has been the news that China just purchased several million tons of US soybeans for the first time since the trade tussle began. That has encouraged investors to believe that a truce is coming, and with it, a resumption of the previous regime of steadily increasing global growth. Caution is required here, as well, given the still nascent level of discussions and the fact that the US negotiators, LIghthizer and Navarro, are known trade hawks. While it would certainly be better for all involved if an agreement is reached, it is far from certain that will be the case.

Recapping, the dollar has been under pressure this morning on the basis of a broad view of a better risk environment across markets. These include PM May’s retaining her seat, movement on the Italian budget issue and positive signs from the US-China trade conflict. And yet the dollar is only softer by some 0.1% or so, on average. Nothing has changed my view that the underlying fundamentals continue to favor the greenback.

Pivoting to the emerging markets, INR has performed well again, rallying 0.3% overnight which makes more than 1% this week while nearly erasing the losses over the past month. It appears that investors have taken a new view on the necessity of an independent central bank. Recall that the RBI governor stepped down on Monday as he was at odds with the government about the path of future policy, with ex-governor Patel seeking to maintain tighter money and address excess leverage and non-performing loans, while the government wanted easy money and fast growth in order to be reelected. The replacement is a government hack that will clearly do PM Modi’s bidding and likely cut rates next. Yet, market participants are rewarding this action as evidenced not only by the rupee’s rally, but also by the performance of the Indian stock market, which has led APAC markets higher lately. To this observer, it appears that this short term gain will be overwhelmed by longer term losses in both equities and the currency, if monetary policy falls under the government’s thumb. But right now, that is not the case, and I wouldn’t be surprised to see movement in this direction elsewhere as governments try to maintain economic growth at all costs. This is a dangerous precedent, but one that is ongoing nonetheless.

Yesterday’s CPI data was right in line with expectations at 2.2% for both headline and core, and the market had limited response. This morning brings only Initial Claims (exp 225K) and then the monthly Budget Figures are released this afternoon (exp -$188B). In other words, there is limited new information due once we hear from Signor Draghi. As long as there is a broad risk-on consensus, which appears to be the case, look for the dollar to remain under pressure. But I continue to see this as a short-term phenomenon. At some point, the market will recognize that the rest of the world is going to halt any efforts at tightening policy as global growth slows, and that will help support the dollar.

Good luck
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QE He’ll Dismember

The head of the Fed, Chairman Jay
Implied there might be a delay
In how far the Fed
Will push rates ahead
Lest policy does go astray

Meanwhile, his Euro counterpart,
Herr Draghi’s had no change of heart
He claims, come December
QE he’ll dismember
Despite slower growth in Stuttgart

In what can only be seen as quite a twist on the recent storylines, Wednesday’s US CPI data was soft enough to give pause to Chairman Powell as in two consecutive speeches he highlighted the fact that the US economy is facing some headwinds now, and that may well change the rate trajectory of the Fed. While there was no indication of any change coming in December, where a 25bp rate hike is baked in, there is much more discussion about only two rate hikes next year, rather than the at least three that had been penciled in by the Fed itself back in September. Powell mentioned the slowing growth story internationally, as well as the winding down of fiscal stimulus as two potential changes to the narrative. Finally, given that the Fed has already raised rates seven times, he recognized that the lagged effects of the Fed’s own policies may well lead to slower growth. The dollar has had difficulty maintaining its bid from the past several weeks, and this is clearly the primary story driving that change of heart.

At the same time, Signor Draghi, in a speech this morning, reiterated that the risks to growth in the Eurozone were “balanced”, his code word to reassure the market that though recent data was soft, the ECB is going to end QE in December, and as of now, raise rates next September. Now, there is a long time between now and next September, and it is not hard to come up with some scenarios whereby the Eurozone economy slows much more rapidly. For example, the combination of a hard Brexit and increased US tariffs on China could easily have a significant negative impact on the Eurozone economy, undermining the recent growth story as well as the recent (alleged) inflation story. For now, Draghi insists that all is well, but at some point, if the data doesn’t cooperate, then the ECB will be forced to change its tune. His comments have helped support the euro modestly today, but the euro’s value is a scant 0.1% higher than its close yesterday.

Adding to the anxiety in the market overall is the quickening collapse of the Brexit situation, where it seems the math is getting much harder for PM May to get the just agreed deal through Parliament. Yesterday’s sharp decline in the pound, more than 1.5%, has been followed by a modest rebound, but that seems far more likely to be a trading event rather than a change of heart on the fundamentals. In my view, there are many more potential negatives than positives likely to occur in the UK at this point. A hard Brexit, a Tory rebellion ousting May, and even snap elections with the chance for a PM Corbyn all would seem to have negative overtones for the pound. The only thing, at this time, that can support the currency is if May somehow gets her deal agreed in Parliament. It feels like a low probability outcome, and that implies that the pound will be subject to more sharp declines over time.

Pivoting to the Emerging markets, the trade story with China continues to drive equity markets, or at least all the rumors about the trade story do that. While it seems that there are mid-level conversations between the two nations ahead of the scheduled meeting between Trump and Xi later this month, we continue to hear from numerous peanut gallery members about whether tariffs are going to be delayed or increased in size. This morning’s story is no deal is coming and 25% tariffs are on their way come January 1. It is no surprise that equity futures are pointing lower in the US. Look for CNY to soften as well, albeit not significantly so. The movement we saw last week was truly unusual.

Other EMG stories show that Mexico, the Philippines and Indonesia all raised base rates yesterday, although the currency impacts were mixed. Mexico’s was widely anticipated, so the 0.5% decline this morning seems to be a “sell the news” reaction. The Philippines surprised traders, however, and their peso was rewarded with a 0.5% rally. Interestingly, Bank Indonesia was not widely expected to move, but the rupiah has actually suffered a little after the rate hike. Go figure.

Yesterday’s US data arguably leaned to the strong side with only the Philly Fed number disappointing while Empire State and Retail Sales were both quite strong. This morning brings IP (exp 0.2%) and Capacity Utilization (78.2%), although these data points typically don’t impact the FX market.

As the week comes to a close, it appears the dollar is going to remain under some pressure on the back of the newly evolving Fed narrative regarding a less aggressive monetary policy. However, if we see a return of more severe equity market weakness, the dollar remains the haven of choice, and a reversal of the overnight moves can be expected.

Good luck and good weekend
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A Major Mistake

There once was a pundit named Fately
Who asked, is Fed policy lately
A major mistake
Or did Yellen break
The mold? If she did t’was sedately

Please sanction my poetic license by listing Janet Yellen as the primary suspect in my inquiry; it was simply that her name fit within the rhyme scheme better than her fellow central bankers, all of whom acted in the same manner. Of course, I am really discussing the group of Bernanke, Draghi, Kuroda and Carney as well as Yellen, the cabal that decided ZIRP (zero interest rate policy), NIRP (negative interest rate policy) and QE (quantitative easing) made sense.

Recently, there has been a decided uptick in warnings from pundits about how current Fed Chair, Jay Powell, is on the verge of a catastrophic policy mistake by raising interest rates consistently. There are complaints about his plainspoken manner lacking the subtleties necessary to ‘guide’ the market to the correct outcome. In this case, the correct outcome does not mean sustainable economic growth and valuation but rather ever higher equity prices. There are complaints that his autonomic methodology (which if you recall was actually instituted by Yellen herself and simply has been followed by Powell), does not take into account other key issues such as wiggles in the data, or more importantly the ongoing rout in non-US equity markets. And of course, there is the constant complaint from the current denizen of the White House that Powell is undermining the economy, and by extension the stock market, by raising rates. You may have noticed a pattern about all the complaints coming back to the fact that Powell’s policy actions are no longer supporting the stock markets around the world. Curious, no?

But I think it is fair to ask if Powell’s policies are the mistake, or if perhaps, those policies he is unwinding, namely QE and ZIRP, were the mistakes. After all, in the scope of history, today’s interest rates remain exceedingly low, somewhere in the bottom decile of all time as can be seen in Chart 1 below.

5000 yr interest rate chart

So maybe the mistake was that the illustrious group of central bankers mentioned above chose to maintain these extraordinary monetary policies for nearly a decade, rather than begin the unwinding process when growth had recovered several years after the recession ended. As the second chart shows, the Fed waited seven years into a recovery before beginning the process of slowly unwinding what had been declared emergency policy measures. Was it really still an emergency in 2015, six years after the end of the recession amid 2.0% GDP growth, which caused the Fed to maintain a policy stance designed to address a severe recession?

Chart 2

real gdp growth

My point is simply that any analysis of the current stance of the Federal Reserve and its current policy trajectory must be seen in the broader context of not only where it is heading, but from whence it came. Ten years of extraordinarily easy monetary policy has served to build up significant imbalances and excesses throughout financial markets. Consider the growth in leveraged loans, especially covenant lite ones, corporate debt or government debt, all of which are now at record levels, as key indicators of the current excesses. The history of economics is replete with examples of excesses leading to shakeouts throughout the world. The boom and bust cycle is the very essence of Schumpeterian capitalism, and as long as we maintain a capitalist economy, those cycles will be with us.

The simple fact is that every central bank is ‘owned’ by its government, and has been for the past thirty years at least. (Paul Volcker is likely the last truly independent Fed Chair we have had, although Chairman Powell is starting to make a name for himself.) And because of that ownership, every central bank has sought to keep rates as low as possible for as long as possible to goose growth above trend. In the past, although that led to excesses, the downturns tended to be fairly short, and the rebounds quite robust. However, the advent of financial engineering has resulted in greater and greater leverage throughout the economy and correspondingly bigger potential problems in the next downturn. The financial crisis was a doozy, but I fear the next one, given the massive growth in debt outstanding, will be much worse.

At that point, I assure you that the first person who will be named as the culprit for ‘causing’ the recession will be Jay Powell. My point here is that, those fingers need to be pointed at Bernanke, Yellen, Draghi, Carney and Kuroda, as it was their actions that led to the current significantly imbalanced economy. The next recession will have us longing for the good old days of 2008 right after Lehman Brothers went bankrupt, and the political upheaval that will accompany it, or perhaps follow immediately afterwards, is likely to make what we are seeing now seem mild. While my crystal ball does not give me a date, it is becoming abundantly clear that the date is approaching far faster than most appreciate.

Be careful out there. Markets and politics are going to become much more volatile over the next several years.

One poet’s view!

The Doves’ Greatest Friend

Despite signs that growth is now slowing
Said Draghi, he would keep on going
With plans to soon end
The doves’ greatest friend
QE, which has kept Europe growing

While all eyes have been focused on the recent equity market gyrations, which in fairness have been impressive, there are other things ongoing that continue to have medium and long-term ramifications. One of the most important is the ECB and its future path of monetary policy. Yesterday, to no one’s surprise they left policy on hold, but of more interest were the comments Signor Draghi made during his press conference following the meeting. Notably, he continued to characterize the risks to the Eurozone economy as “balanced” despite the fact that virtually every piece of data we have seen in the past two months has indicated growth is slowing there more rapidly than previously anticipated.

If you recall, the declared rationale for the ending of QE was that Eurozone growth had been running above its potential throughout 2017 and it was expected to continue to do so this year. Alas, that no longer seems to be the case. Instead, recent data indicates that the growth impulse there is back at potential, if not slightly below. Recent PMI and IP data have all shown weakness, which when added to the stresses induced by Brexit uncertainty and slowing growth in China make for a substandard future. But not according to Draghi, who indicated that the ECB is going to end QE in December regardless, and that rate hikes are still slated to start next year. Perhaps he is correct and this is simply a temporary rough patch. The problem is the message from recent equity market performance is that there is a growing widespread concern that trouble is brewing everywhere around the world. Of course Draghi’s biggest problem is that if the Eurozone tips into a recession in 2019, they will have a serious problem trying to add monetary stimulus to the economy given the current, still ultra easy, settings. As I have written frequently in the past, this is why I continue to expect the dollar to outperform going forward. Yesterday saw the early morning rally in the euro reverse completely and the single currency closed -0.2%, and this morning it is a further 0.25% lower. The trend is your friend, and this trend is still for a lower euro.

In the meantime, we continue to see Brexit uncertainty plague the pound, which after a 0.5% decline yesterday has continued to fall this morning (-0.2%) as there is no indication that a compromise is in the offing. With the pound back to its lowest levels since late summer, and the trend decidedly lower, it will take a significant breakthrough in the Brexit negotiations to change things. This morning, the NIESR (a well-regarded British economic research institute) published a report that a hard Brexit will result in GDP growth being 1.6% lower than it otherwise would have been in 2019. That’s a pretty big hit, and simply adds to the Brexit concerns going forward. But the clock is still ticking and there is no indication that a solution can be found for the Irish border situation. One side will have to cave, and at this point, my money is on the UK.

As to the rest of the G10 space, the commodity bloc (AUD, CAD and NZD) has had a rough go of it overnight, with all three falling 0.5% or more in the session. It seems that concerns over slowing Chinese and global growth is being recognized as commodity prices continue to slide. With that, these currencies are also taking a beating with Aussie falling back near 0.7000, its lowest level since January 2016. Keep in mind that the more questions that are raised about the global growth trajectory, the more these currencies are likely to suffer.

Turning to our favorite EMG currency, CNY, it traded to a new low for the move overnight, although has since recouped some of those losses. The PBOC fixed the yuan at another new low (6.9510), and that saw both the offshore and onshore markets push the currency down below (dollar above) 6.9700. This is the weakest that the renminbi has been since December 2016 when the PBOC was forced to intervene more aggressively to prevent a rout. Remember they remain extremely concerned that if it trades above 7.00 that will be seen as a trigger for an increase in capital outflows from the country, and lead to a spiraling lower currency and greater domestic issues. Last time the market reached these levels, the PBOC withdrew liquidity from the offshore market, driving interest rates there massively higher, and forcing speculators with short positions to cover. That could well be what we will see next week, but as of now, there has been no activity like that observed. Speculators will only be deterred if the cost of speculation is high, which is not yet the case. Given that, I expect that we will see a run at 7.00 before long, likely next week, unless the PBOC acts. Words will not be sufficient to stop the move.

Away from CNY, other EMG currencies are almost universally weaker with declines ranging between 0.1% and 0.6%. The point is that this is a wide and shallow move, not one driven by specific national idiosyncrasies.

Yesterday’s data showed that defense spending was propping up the US manufacturing sector, with Durable Goods surprising to the high side although the ex-Defense number was soft. This morning, however, brings the most important data of the week, Q3 GDP. The median forecast is for growth of 3.3% and there will be a great deal of scrutiny on any revisions to Q2. A strong number ought to help support the dollar, as it will back up the Fed’s contention that strong growth demands higher interest rates. A soft number, or a big revision lower to Q2, seems likely to have a bigger impact though, as positions are still long dollars, and that would be a chink in its armor. Later this morning we see the Michigan Consumer Sentiment data (exp 99.0) and we also hear from Signor Draghi again, perhaps to try to clarify his message. But as it stands, if data is as expected, the dollar remains the best bet. This is even more likely if we continue to see equity markets decline. Spoiler alert, they have been doing that in Asia and Europe, and US futures are pointing in the same direction!

Good luck and good weekend
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Watching With Rigor

Though Draghi said data of late
May not have appeared all that great
We’re watching with rigor
Inflation that’s vigor-
Ously rising at a high rate

After a multi week decline, the dollar is showing further signs of stabilizing this morning. And that includes its response to yesterday’s surprising comments by ECB President Mario Draghi, who indicated that despite the ECB lowering its forecasts for growth this year and next, and that despite the fact that recent data has been falling short of expectations, he still described the underlying inflation impulse as “relatively vigorous” and reconfirmed that QE would be ending in December with rates rising next year. In fact, several of his top lieutenants, including Peter Praet and Ewald Nowotny, indicated that rates ought to rise even sooner than that. Draghi, however, has remained consistent in his views that gradual removal of the current policy accommodation is the best way forward. But as soon as the words “relatively vigorous” hit the tape, the euro jumped more than 0.5% and touched an intraday high of 1.1815, its richest point since June. The thing is, that since that time yesterday morning, it has been a one-way trip lower, with the euro ultimately rising only slightly yesterday and actually drifting lower this morning.

But away from the excitement there, the dollar has continued to consolidate Friday’s gains, and is actually edging higher on a broad basis. It should be no surprise that the pound remains beholden to the Brexit story, and in truth I am surprised it is not lower this morning after news that the Labour party would definitively not support a Brexit deal based on the current discussions. This means that PM May will need to convince everyone in her tenuous majority coalition to vote her way, assuming they actually get a deal agreed. And while one should never underestimate the ability of politicians to paint nothing as something, it does seem as though the UK is going to be leaving the EU with no exit deal in place. While the pound is only down 0.15% this morning, I continue to see a very real probability of a much sharper decline over the next few months as it becomes increasingly clear that no deal will appear.

There was one big winner overnight, though, the Korean won, which rallied 4.2% on two bits of news. Arguably the biggest positive was the word that the US and Korea had agreed a new trade deal, the first of the Trump era, which was widely hailed by both sides. But let us not forget the news that there would be a second round of talks between President Trump and Kim Jong-Un to further the denuclearization discussion. This news is also a significant positive for the won.

The trade situation remains fascinating in that while Mr Trump continues to lambaste the Chinese regarding trade, he is aggressively pursuing deals elsewhere. In fact, it seems that one of the reasons yesterday’s imposition of the newest round of tariffs on Chinese goods had so little market impact is that there is no indication that the president is seeking isolationism, but rather simply new terms of trade. For all the bluster that is included in the process, he does have a very real success to hang his hat on now that South Korea is on board. Signing a new NAFTA deal might just cause a re-evaluation of his tactics in a more positive light. We shall see. But in the end, the China situation does not appear any closer to resolution, and that will almost certainly outweigh all the other deals, especially if the final threatened round of $267 billion of goods sees tariffs. The punditry has come around to the view that this is all election posturing and that there will be active negotiations after the mid-term elections are concluded in November. Personally, I am not so sanguine about the process and see a real chance that the trade war situation will extend much longer.

If the tariffs remain in place for an extended period of time, look for inflation prints to start to pick up much faster and for the Fed to start to lean more hawkishly than they have been to date. The one thing that is clear about tariffs is that they are inflationary. With the FOMC starting their meeting this morning, all eyes will be on the statement tomorrow afternoon, and then, of course, all will be tuned in to Chairman Powell’s press conference. At this point, there seems to be a large market contingent (although not a majority) that is looking for a more dovish slant in the statement. Powell must be happy that the dollar has given back some of its recent gains, and will want to see that continue. But in the end, there is not yet any evidence that the Fed is going to slow down the tightening process. In fact, the recent rebound in oil prices will only serve to put further upward pressure on inflation, and most likely keep the doves cooped up.

With that in mind, the two data points to be released today are unlikely to have much market impact with Case-Shiller Home Prices (exp 6.2%) at 9:00am and Consumer Confidence (132.0) due at 10:00. So barring any new comments from other central bankers, I expect the dollar to remain range bound ahead of tomorrow’s FOMC action.

Good luck
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A Rate Hike’s in Store

Said Mario Draghi once more
‘Through summer’ a rate hike’s in store
When pressed on the timing
That they’d end pump priming
He gave no more scoop than before

As we await this morning’s Q2 US GDP data (exp 4.1%), it’s a good time to review yesterday’s activity and why the euro has given up the ground it gained during the past week. The ECB left policy on hold, which was universally expected. However, many pundits were looking for a more insightful press conference regarding the timeline that the ECB has in mind regarding the eventual raising of interest rates. Alas, they were all disappointed. Draghi continues to use the term ‘through summer’ without defining exactly what that means. It appears that the uncertainty is whether it means a September 2019 hike or an October 2019 hike. To this I have to say, “are they nuts?” The idea that the ECB has such a precise decision process is laughable. The time in question is more than twelve months away, and there is so much that can happen between now and then it cannot be listed.

Consider that just six months ago, Eurozone growth was widely expected to continue the pace it had demonstrated in 2017, which was why the dollar was weak and falling. But instead, despite a large majority of forecasts pointing to great things in Europe, growth there weakened sharply while growth in the US leapt forward. So here we are now, six months later, with the dollar significantly stronger and a new narrative asking why Eurozone growth has disappointed while US growth is exploding higher. Of course the US story is blamed based on the tax changes and increased fiscal stimulus from the budget bill. But in Europe, we have heard about bad weather, a flu epidemic and, more recently, rising oil prices, but certainly nothing that explains the underlying disappointment. And that was only a six-month window! Why would anyone expect the ECB, who are notoriously bad forecasters, to have any idea what will happen, with precision, in fourteen months’ time?

However, that seems to have been the driving force yesterday, lack of confirmation on the timing of the ECB’s initial rate hike next year. And based on the French GDP data this morning (0.2%, below expectations of 0.3% and far below last year’s 0.7% quarterly average), it seems that growth expectations for the Eurozone may well be missed again. Personally, I am not convinced that the ECB will raise rates at all in 2019. Given the recent trajectory of growth in the Eurozone, it appears we have already seen the top, and that before we get ‘through summer’ next year, the discussion may turn to how the ECB are going to help support the economy with further QE. Given this reality, it should be no surprise that the euro suffered yesterday, and in the wake of the weak French data, that it is still lower this morning, albeit only by an additional 0.15%.

Elsewhere the pound fell yesterday after the EU rejected, out of hand, PM May’s solution for the UK to collect tariffs on behalf of the EU. That basically destroyed her attempt to find a middle ground between the Brexiteers and the Bremainers, and now calls into question her ability to remain in office. In fact, she is running out of time to come up with a deal that has a chance of getting implemented. The current belief is that if they do not agree on something by the October EU meeting, there will not be sufficient time for all 29 members to approve any deal. It is with this in mind that I continue to question the BOE’s concerns over slowing inflation. My gut tells me that if they do raise rates next week, it will need to be reversed by the November meeting after the Brexit situation spirals out of control. The pound fell 0.65% yesterday and is down a further 0.1% this morning. That remains the trend.

Another noteworthy event from Tokyo occurred last night as the BOJ was forced to intervene in the JGB market for the second time this week, bidding for an unlimited amount of bonds at 0.10% in the 5-10 year sector. And this time, they bought ~$74 billion worth. Speculation remain rife that they are going to adjust their QQE program next week, but given the fact that it has been singularly unsuccessful in achieving its aim of raising inflation to 2.0% (currently CPI there is running at 0.2%), this appears to be a serious capitulation. If they change policy without any success behind them, the market is likely to aggressively buy the yen. USDJPY is down 1.7% in the past six sessions, and while it rallied slightly yesterday, it seems to me that USDJPY lower is the most likely future outcome.

Yesterday morning’s overall dollar malaise reversed during the US session and has carried over to this morning’s trade. And while most movement so far this morning is modest, averaging in the 0.1%-0.2% range, it is nearly universally in favor of the buck.

This morning brings the aforementioned GDP data as well as Michigan Sentiment (exp 97.1, down a full point from last month), although the former will be the key number to watch. Yesterday’s equity market session was broadly able to shake off the poor earnings forecast of a major tech firm, and this morning has a different FANG member knocking it out of the park. My point is that risk aversion is not high, so this dollar strength remains fundamental. At this point, I look for the dollar to continue to benefit from the current broad narrative of diverging monetary policy, and expect that we will need to see some particularly weak US data to change that story.

Good luck and good weekend
Adf