Make Boris Bend

As Parliament seeks to extend
The timeline, and make Boris bend
The market’s decided
The deal he provided
Will ultimately pass in the end

Well, Brexit is still the number one topic in markets, although after a quiet Friday on the trade front, we got more discussion there as well. As to Brexit, Boris lost his fight to get a clean vote on the newly renegotiated deal on Saturday. Instead, Parliament voted to force a request for an extension, which at this moment the EU is considering. Interestingly, in the EU there are a number of countries that seem ready to be done with the process and no longer care if the UK exits. However, as sweet as that would be for the Brexiteers, in the end that would require courage by the country(ies) who voted no. And courage is something in short supply at the top of European (and most) governments. At any rate, given the speed with which this story changes, this morning the word is that Johnson has found the votes necessary to get his deal through Parliament, but it means that he has to get another vote. The roadblock there is in the form of John Bercow, the Speaker of the House of Commons, who has proven himself to be a virulent Bremainer, and wants nothing more than to see Boris fail.

With that as background, one might have thought the pound would have suffered, but the market has looked through all the permutations and decided that a deal is forthcoming in the near-term, or perhaps more accurately, that the odds of a no-deal Brexit have been significantly reduced. This is evident in the fact that as I type, the pound is essentially unchanged since Friday’s optimistic close at 1.2980, and has traded above 1.30 earlier in the session for the first time since May (the month, not the former PM).

However, I think the euro’s performance has been far more interesting lately. Consider that despite an ongoing run of generally awful data, showing neither growth nor inflationary impulse, the single currency continues to climb slowly. A part of this is likely a result of what has been mild dollar weakness amid increasing risk appetite. But I think that the market has also begun to recognize that a Brexit deal will remove uncertainty on the continent and the euro will benefit accordingly. From the time of the referendum in 2016 I have made it clear that Brexit was not just a British pound story, but a euro one as well. And this slow appreciation (EUR is higher by 2.7% this month, about 0.7% more than the dollar index) is a belated reaction to the fact that a Brexit deal is a benefit there as well. At any rate, much of this story is yet to be written, and a successful outcome will almost certainly result in further GBP outperformance, but the euro is likely to continue this grind higher as well.

On the trade front, comments from Chinese vice-premier Liu He explaining China would work with the US to address each other’s core concerns and that ending the trade war would be good for everyone were seen as quite positive by equity and other risk markets. In fact, the combination of optimism on the two big issues of the day, trade and Brexit has led to a clear, if modest, risk-on session. Equity markets in Asia performed well (Nikkei +0.25%, CSI 300 +0.3%), and we are seeing modest gains throughout Europe as well (DAX +0.7%, CAC +0.15%). It is certainly a positive that the trade dialog continues, but I fear we remain a very long way from a broad deal.

Another weekend event was the World Bank / IMF meetings in Washington with the commentary exactly what you would expect. Namely, everyone derided the trade war and explained it would be better if it ended. Everyone derided Brexit and said it would be better if it didn’t happen. And everyone explained that it’s time for fiscal policy to step up to the plate to help central banks. What has become very clear is that central banks are truly running out of room to help support their respective economies but it is impolitic to say so. This results in exhortations for fiscal policy pushes by those who can afford it. However, Germany remains resolute in their belief that there is no reason to implement a supplementary budget of any kind and that continuing to run a budget surplus is the best thing for the nation. Look for pressure to continue to build, but unless growth really starts to crater there, I don’t expect them to change their views, or policies.

A look around the rest of the FX market shows that the biggest gainer this weekend was KRW, rising 0.8% on optimism that a trade deal between the US and China was closer. Certainly it was not the terrible data from South Korea that helped the won rally, as exports in October have fallen nearly 20%, making eleven consecutive monthly declines in that statistic. Otherwise, the mild risk-on atmosphere has helped most EMG currencies edge higher. On the G10 front, NOK is the big winner, rising 0.55%, although that simply looks like a reaction to its sharp declines over the past two weeks.

On the data front it is extremely quiet this week as follows:

Tuesday Existing Home Sales 5.45M
Thursday Initial Claims 215K
  Durable Goods -0.7%
  -ex Transport -0.3%
  New Home Sales 701K
Friday Michigan Sentiment 96.0

Source: Bloomberg

Arguably, Durable Goods is the most interesting number of the bunch. And after a two-week deluge of Fed speakers, they have gone into their quiet period ahead of next Wednesday’s meeting. The final comments by Kaplan and Clarida were similar to the previous comments we heard, namely that the economy is in a “good place” and that they are essentially going to play it by ear on the next rate decision. As of this morning, the market is still pricing in an 89.5% probability of a rate cut.

Speaking of low rates, Signor Draghi presides over his last ECB meeting this week and while there are no new policies expected, it is universally anticipated that he will renew his call for fiscal stimulus to help the Eurozone economic outlook. Quite frankly, I think it is abundantly clear that the ECB has completely run out of ammunition to fight any further weakness, and that Madame Lagarde, when she takes the seat on November 1, will feel more like Old Mother Hubbard than anything else.

For the day, I see no reason for the risk-on attitude to change, and if anything, I imagine we can see more positive news from the UK which will only help drive things further in that direction. While in the end, I still see the dollar performing well, for now, it is on its back foot and likely to stay there for a little while longer.

Good luck
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What He’s Wrought

The High Court within the UK
Explained in a ruling today
That Boris cannot
Complete what he’s wrought
A win for those who want to stay

As I wrote last Tuesday, the Supreme Court ruling in the UK cannot be a surprise to anyone. The issue was that twelve justices who were appointed to their seats from lives of privilege and wealth, and who almost certainly each voted to Remain two years ago, were going to decide whether Boris Johnson, a rebel in every conceivable way, would be allowed to lead the UK out of the EU against their personal views. These are folks who have greatly benefitted from the UK being within the EU, and they were not about to derail that gravy train. Thus, this morning’s ruling should have been the default case in everyone’s mind.

Interestingly, the ruling went far beyond simply the legality of the prorogation, but included a call for Parliament to reconvene immediately. Naturally, John Bercow, the speaker of the House of Commons, and an alleged non-partisan player, called on both sides of the aisle to get back to work post haste. Given that prorogation was nothing new in Parliament, having occurred on a fairly regular basis since 1628 when King Charles I first did so, and since there is no written constitution in the UK by which to compare laws to a basic canon, it will be interesting in the future when another PM seeks prorogation at a time less fraught than the current Brexit induced mania, whether or not they have the ability to do so.

Nonetheless, we can expect Parliament to reconvene shortly and try to do more things to insure that Boris cannot unilaterally ignore the current law requiring the PM to ask for an extension if there is no deal agreed at the deadline. In other words, there is still plenty of action left in this process, with just 37 days left until the current deadline.

And what of Sterling you ask? When the announcement hit the tape at 5:30 this morning, it jumped a quick 0.4% to just below 1.2500. That move had all the hallmarks of short covering by day traders, and we have since removed half of that gain. Interestingly, Boris is currently at the UN session in NY meeting with his EU counterparts and trying to get a deal in place. In the end, I still believe that the EU is ready to relent on some issues to pave the way for a deal of some sort. As European economic data continues to melt down (German IFO Expectations fell to 90.8, well below forecasts and the lowest in more than a decade), there is a growing sense of urgency that the EU leadership cannot afford to allow a hard Brexit. Combining that view with the fact that everybody over there is simply tired of the process and wants it to end means that a deal remains far more likely than not. As such, I remain pretty confident that we will see a deal before the deadline, or at least agreement on the key Irish backstop issue, and that the pound will rebound sharply.

Away from that story, however, things are far less exciting and impactful. On the trade front, news that China has allowed exemptions from soybean tariffs for a number of Chinese importers has been met with jubilation in the farm belt, and has imparted a positive spin to the equity market. Last week’s trepidations over the canceling of the Chinese delegation’s trip to Montana and Nebraska is ancient history. The narrative is back to progress is being made and a deal will happen sooner or later. Equity markets have stabilized over the past two days, although in order to see real gains based on the trade situation we will need to see more definitive progress.

Bond prices continue to focus on the global industrial malaise that is essentially made evident every day by a new data release. Yesterday it was PMI, today IFO and later this week, on Thursday, we will see Eurozone confidence indicators for Industry, Services and Consumers. All three of these have been trending lower since the winter of 2017 and there is no reason to expect that trend to have changed. As such, it is no surprise that we continue to see government bond yields slide with Treasuries down a further 3bps this morning as are JGB’s. Bunds, however, have seen less buying interest and have seen yields fall just 1bp. The story with Bunds is more about the increasing calls for fiscal stimulus in the Eurozone. Signor Draghi has tried his best but the Teutons remain stoic in the face of all his pressure. But Draghi is an economist. Incoming ECB President Christine Lagarde is a politician and may well be the best choice for the role after all. If she has the political nous to change Merkel’s views, that will be enough to open the taps, arguably support growth in the EU and reduce the need for further monetary ease. However, that is a BIG if.

One other story out of China describes comments from PBOC Governor Yi Gang that essentially said there was no reason for them to ease policy aggressively at this time, although they have plenty of tools available if they need to do so in the future. It is clear they are still quite concerned over inflating a housing bubble and will do all they can to prevent any further excess leverage in the real estate sector. It should not be surprising that the renminbi benefitted from these comments as it is 0.25% stronger than yesterday. The combination of a slightly more hawkish PBOC and the positive trade news was all it took.

Turning to this morning’s session, things are pretty quiet at this time. There are only two minor pieces of data, Case Shiller House Prices (exp 2.90%) and Consumer Confidence (133.0). On the speaker front, nobody is scheduled today although yesterday we heard from a number of doves, Bullard, Daly and Williams, all of whom agreed with the recent rate cut. With the day’s big news out of the way, I anticipate a relatively uneventful session. Overall the dollar is slightly softer on the day, and it seems reasonable to believe that trend will stay in place so look for a modest decline as the day progresses.

Good luck
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A Major Broadside

The question that needs to be asked
Is, have central bank powers passed?
The ECB tried
A major broadside
But markets ignored Draghi’s blast

There has certainly been no shortage of interesting news in the past twenty-four hours, however from a markets perspective, I think the ECB actions, and the market reactions are the most critical to understand. To recap Signor Draghi’s action, the ECB did the following:

1. cut the deposit rate 10bps to -0.50%;
2. restarted QE in the amount of €20Bio per month for as long as necessary;
3. reduced the rate and extended the tenor of TLTRO III loans; and
4. introduced a two-tier system to allow some excess liquidity to be exempt from the -0.50% deposit rate.

Certainly the market was prepared for the rate cut, which had been widely telegraphed, and the talk of tiering excess liquidity had also been making the rounds. Frankly, TLTRO’s had not been a centerpiece of discussion but I think that is because most market participants don’t see them as a major force in the policy debate, which leaves the start of QE2 as the most controversial thing Draghi introduced. Well, maybe that and the fact that forward guidance is now based on achieving a “robust convergence” toward the inflation target rather than a particular timeframe.

Remember, in the past two weeks we had heard from the Three Hawksketeers (Weidmann, Lautenschlager and Knot) each explicitly saying that more QE was not appropriate. We also heard that from the Latvian central banker, Rimsevics, and perhaps most surprisingly of all, from Franҫois Villeroy de Galhau, the French central bank chief. And yet despite clearly stiff opposition, Draghi got the Council to agree. Perhaps, though, he went too far in describing the “consensus as so broad, there was no need to take a vote.” Now, while I have no doubt that no vote was taken, that statement stretches credulity. This was made clear when Robert Holzmann, the new Austrian central bank president and first time member of the ECB, gave an interview yesterday afternoon explicitly saying that the ECB could well have made a mistake by reintroducing QE.

But let’s take a look at what happened after the ECB statement and during the press conference. The initial move was for the euro to decline sharply, trading down 0.65% in the first 10 minutes after the release. When Draghi took to the stage at 8:30 and reiterated the points in the statement, the euro declined a further 30 pips, touching 1.0927, its lowest level since May 2017. But that was all she wrote for the euro’s decline. As Draghi continued to speak and answer questions, traders began to suspect that the cupboard was bare regarding anything else the ECB can do to address further problems in the Eurozone economies. This was made abundantly clear in his pleas for increased fiscal stimulus, which much to his chagrin, does not appear to be forthcoming.

It was at this point that things started to turn with the euro soaring, at one point as much as 1.5% from the lows, and closed 1.3% higher than those levels. And this morning, the rally continues with the euro up to 1.1100 as I type, a solid 0.3% gain. But the big question that now must be asked is; has the market decided the ECB is out of ammunition? After all, given the relative nature of the FX market and the importance of monetary policy on exchange rates, if the market has concluded the ECB CANNOT do anymore that is effective, then by definition, the Fed is going to promulgate easier policies than the ECB with the outcome being a rising euro. So if the Fed follows through next week and cuts 25bps, and especially if it does not close the door on further cuts, we could easily see the euro rally continue. That will not help the ECB in their task to drive inflation higher, and it will set a difficult tone for Madame Lagarde’s tenure as ECB President going forward.

Turning to the Fed, the market is still fully priced for a 25bp cut next week, but thoughts of anything more have receded. However, a December cut is still priced in as well. The problem for the Fed is that the economic data has not been cooperating with the narrative that inflation is dead. For instance, yesterday’s CPI data showed Y/Y core CPI rose 2.4%, the third consecutive outcome higher than expectations and the highest print since September 2008! Once again, I will point to the anecdotal evidence that I, personally, rarely see the price of anything go down, other than the gyrations in gasoline prices. But food, clothing and services prices have been pretty steady in their ascent. Does this mean that the Fed will stay on hold? While I think it would be the right thing to do, I absolutely do not believe it is what will happen. However, it is quite easy to believe that the accompanying statement is more hawkish than currently expected (hoped for?) and that we could see this as the end of that mid-cycle adjustment. My gut is the equity market would not take that news well. And the dollar? Well, that would halt the euro’s rise pretty quickly as well. But that is next week’s story.

As if all that wasn’t enough, we got more news on the trade front, where President Trump has indicated the possibility of an interim trade deal that could halt, and potentially roll back, tariff increases in exchange for more promises on IP protection and agricultural purchases. That was all the equity market needed to hear to rally yet again, and in fairness, if there is a true thawing in that process, it should be positive for risk assets. So, the dollar declined across the board, except against the yen which fell further as risk appetite increased.

Two currencies that have had notable moves are GBP and CNY. The pound seems to be benefitting from the fact that there was a huge short position built over the past two months and the steady stream of anti-Brexit news seems to have put Boris on his back foot. If he cannot get his way, which is increasingly doubtful, then the market will continue to reprice Brexit risk and the pound has further to rally. At the same time, the renminbi’s rally has continued as well. Yesterday, you may recall, I mentioned the technical position, an island reversal, which is often seen as a top or bottom. When combining the technical with the positive trade story and the idea that the Fed has a chance to be seen as the central bank with the most easing ahead of it, there should be no surprise that USDCNY is falling. This morning’s 0.45% decline takes the two-day total to about 1.0%, a big move in the renminbi.

Turning to this morning’s data, Retail Sales are the highlight (exp 0.2%, 0.1% ex autos) and then Michigan Sentiment (90.8) at 10:00. Equity futures are pointing higher and generally there is a very positive attitude as the week comes to an end. At this point, I think these trends continue and the dollar continues to decline into the weekend. Longer term, though, we will need to consider after the FOMC next week.

Good luck and good weekend
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Another False Dawn

Will Mario cut rates again?
And if so, by twenty or ten
Plus when will he start
To fill up his cart
With more bonds to piss off Wiedmann

Today is all about the ECB which will release its policy statement at 7:45 this morning. Then at 8:30, Signor Draghi will hold his press conference where reporters will attempt to dig deeper. At this stage, markets have priced in a 0.10% cut in the base rate, to -0.50%, with a 32% chance of a 0.20% cut. Just last week markets had priced in a 50% chance of that larger cut, so clearly the commentary from the hawks had an impact. At the same time, 80% of analysts surveyed are expecting a restart to QE with estimates of €30B – €35B per month as the jumping off point. This remains the case despite the vocal opposition by German, Dutch and French central bankers. Clearly, Draghi will have a lot of convincing to do in order to get his way. As I mentioned yesterday, bond prices have retreated driving yields higher which in the case of Bunds and other European paper implies a somewhat lower expectation of more QE.

It is also important to see what type of forward guidance we get as this has become one of the most powerful tools in central bank toolkits. Promises of a continuation in this policy until a specific inflation target is met would be quite powerful. Similarly, any indication that the ECB’s self-imposed limits on QE are under review would also be seen as quite bond bullish with both of these messages sure to undermine the euro. And perhaps that is the interim goal, weakening the euro such that the Eurozone can import a little inflation. Of course with Chinese prices declining and the huge trade uncertainty restricting business investment thus keeping a lid on growth, even a weak euro doesn’t seem that likely to drive inflation higher. At least not the time being. But central bankers remain convinced that they must do something, even if they know it will be ineffective. Finally, you can be sure there will be further pleas for fiscal stimulus to help address the current economic malaise. (Of course, Brussels will still seek to prevent the Italians from adding stimulus, of that you can be sure.)

The US-Chinese rapprochement
Has bolstered the Chinese yuan
Thus equities rose
Although I suppose
This could be another false dawn

It wouldn’t be a complete day without some new trade story and today’s is clearly on the positive side. President Trump delayed the imposition of the additional 5% tariffs on Chinese goods by two weeks, so they will now not go into effect until October 15. This gesture of good will is allegedly to allow the Chinese to celebrate their founding day without new clouds. The Chinese were appreciative and indicated they were now looking at imports of agricultural items, something they have purposely shunned in an attempt to pressure President Trump politically. Of course, given the swine fever that has decimated more than half the Chinese hog population, it seems likely that they are pretty keen to import US pork. At any rate, look for the next round of trade talks to occur during the first half of October while the détente is ongoing. The market response was immediately positive with the Nikkei and Shanghai indices both closing higher by 0.75%, although Eurozone equity markets are little changed, clearly waiting the ECB decision. Perhaps even more impressively, the renminbi has rallied 0.4% to its strongest level since August 23 and closing the gap on the charts that opened up when China last raised tariffs on US goods. At this point, market technicians may get involved as there is an island top in place on the charts. Don’t be surprised if USDCNY falls back to at least 7.00 before this move is over, and perhaps below if the trade situation seems to be easing.

Finally, the last of our big 3 stories, Brexit, has seen more political machinations and an uproar in the UK as the government was forced to release its planning document for a no-deal Brexit. Despite the fact that there were several potential scenarios, all the focus was on the worst-case which described massive potential shortages of food, fuel and medicine along with potential rioting. I have not seen the probability estimates for that scenario, and I’m pretty sure that no news source that favors Remain (all of them?) will publish one. However, despite the uproar in the papers, the pound is unchanged on the day. Remember, parliament is not in session, nor will it be until October 14. It will be fascinating to watch how this plays out. As to the pound, it remains a binary play; hard Brexit leads to 1.10 or below; any deal agreed leads to 1.30-1.35. Place your bets!

This morning we see the most important data of the week, CPI (exp 1.8%, 2.3% ex food & energy) as well as the weekly Initial Claims number (215K). If we see the recent trend continue, where CPI edges higher (was as low as 1.5% in February), that could well give pause to the FOMC. After all, cutting rates when inflation is rising and growth is stable at trend is much tougher to justify. That said, if the FOMC doesn’t cut I would expect a market bloodbath and a cacophony from the White House that would be unbearable, especially if Mario somehow manages to be extremely dovish.

Finally, a short time ago the Central Bank of Turkey cut rates more than expected to 16.5%, with new Central Bank head, Murat Cetinkaya, clearly accepting President Erdogan’s view that high rates cause inflation. At any rate, the lira has been the best performer of the day, rallying 1.1% as I type. Broadly, the dollar is softer ahead of the ECB, but that is simply position squaring before the decision. All the action will come after that.

Good luck
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Much Dissension

The market has turned its attention
To Draghi to see if he’ll mention
More buying of bonds
Or if he responds
To those who expect much dissension

While there were fireworks galore yesterday in London, where the UK Parliament had their last meeting before prorogation, this morning sees a much calmer market attitude overall. In brief, Boris did not fare well yesterday as he was unable to achieve his goal of a snap election while Parliament passed a law requiring him to ask for an extension on Brexit if there is no deal at the deadline. (I wonder what will happen if he simply chooses not to do so as that seems entirely feasible given the situation there). The market has absorbed the past several days’ activities with increasing amazement, but ultimately, FX traders have started to price out the probability of a hard Brexit. This is clear from the pound’s nearly 3.0% rally in the past week. While much will certainly take place during the next five weeks of prorogation, notably the party conferences, it would seem the only true surprise can be that a deal has been agreed, at which point the pound will be much higher. I don’t foresee that outcome, but it cannot be ruled out.

With Brexit on the back burner, the market is moving on to the trio of central bank meetings over the next nine days. This Thursday we hear from Signor Draghi while next week brings Chairman Powell on Wednesday and then Governor Carney on Thursday. What makes the ECB meeting so interesting is the amount of pushback that Draghi and his fellow doves have received lately from the northern European hawks. While it is never a surprise that the Germans or Austrians remain monetary hawks, it is much more surprising that Franҫois Villeroy de Galhau, the French ECB member and Governor of the Bank of France, has also been vocal in his rejection of the need for further QE at this time. The issue breaks down to whether the ECB should use its very limited arsenal early in an effort to prevent a broader economic downturn, or whether they should wait until they see the whites of recession’s eyes before acting. The tacit admission from this argument is that there is only a very limited amount of ammunition left for the ECB, despite Draghi’s continuous comments that they have many things they can do if necessary.

Unlike the FOMC or most other central banks, the ECB tries not to actually vote on policy, but rather come to a consensus. However, in this case, it may come to a vote, which would likely be unprecedented in and of itself. It would also highlight just how great the split between views remains, and implies that Madame Lagarde, when she takes the reins on November 1st, will have quite a lot of work ahead if she wants to continue along the dovish path.

In the doves’ favor is this morning’s data releases which showed French IP rebounding less than expected from last month’s disastrous reading (0.3%, -0.2% Y/Y) and Italian IP falling more sharply than expected (-0.7%). Meanwhile, after better than expected GDP data yesterday, the UK employment situation also showed a solid outcome with the Unemployment Rate falling back to 3.8% while earnings rose 4.0%, their highest rate since 2008.

And what did this do for currencies? Well, in that respect neither of these data points had much impact. The euro is lower by a scant 0.1% while the pound is essentially unchanged on the day. In fact, that is a pretty good description of the day overall, with the bulk of the G10 trading +/-0.20% from yesterday’s closing levels although the Skandies have seen more substantial weakness (SEK -0.8%, NOK -0.6%). In both cases, CPI was released at softer than expected levels (SEK 1.4%, 1.6% core; NOK 1.6%, 2.1% core) for August, which puts a crimp in the both central banks’ goal to push interest rates higher by the end of the year.

Turning to emerging markets, the largest movers have been ZAR which gained 0.5% after Factory Output fell a less than expected 1.1% and hope springs eternal for further stimulus driving bond investment. In second place was the renminbi, which has gained 0.25% overnight after the government there, in the guise of SAFE, removed barriers for investment in stocks and bonds. Clearly China has been trying to increase the importance of the renminbi within global financial markets, and allowing freer capital flow is one way to address that concern. However, this process has been ongoing for more than 20 years which begs the question, why now? It is quite reasonable to estimate that the continued pressure being applied by the US via the tariffs and trade war are forcing China to change many things that they would have preferred to keep under their own control. And while it is certainly possible they would have done this anyway, history suggests that the Chinese do not willingly reduce their control over any aspect of the economy. Just a thought. At any rate, initially this freedom is likely to see an inflow of assets as most investors and fund managers are underweight Chinese assets. The newfound ability to move funds in and out is likely to see an inflow to start, with corresponding CNY strength.

Beyond those stories though, it has been pretty dull. Treasury yields are lower by just 1bp, hardly the stuff of a risk assessment, while equity markets are slightly softer after a mixed, but basically flat, day yesterday. At this point, the market is looking toward Signor Draghi, who given futures markets are pricing a 100% chance of a 10bp cut and a 50% chance of a 20bp cut, along with a strong probability of the restarting of QE, has the chance to significantly disappoint. If that is the case, look for the euro to rally quickly, although a move of more than 1.0%-1.5% seems unlikely.

As for today, the NFIB Small Business Optimism Index was released at a bit worse than expected 103.1, perhaps indicating the peak is behind us (certainly my view) and at 10:00 we see the JOLTS Job Opening report (exp 7.331M). But it is really shaping up to be a quiet one with everyone thinking about the ECB until Thursday morning.

Good luck
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Run Off The Rails

In England and Scotland and Wales
The saga has run off the rails
So Boris is gambling
A vote will keep scrambling
Dissent and extend his coattails

Meanwhile market focus has turned
To data, where much will be learned
When payrolls are shown
And if they have grown
Watch stocks rise as havens are spurned

The Brexit story remains front page news as the latest twists and turns create further uncertainty over the outcome. Boris is pushing for an election to be held on October 15 so that he can demonstrate he has a sufficient majority to exit with no deal when the EU next meets on October 17-18, thus forcing the EU’s hand. However, parliament continues to do what they can to prevent a no-deal Brexit and have passed a bill directing the PM to seek an extension if there is no deal agreed by the current Halloween deadline. With that in hand, they will agree to a vote on October 29, thus not allowing sufficient time for a new government to do anything ahead of the deadline.

But Boris, being Boris, has intimated that despite the extension bill, he may opt not to seek that extension and simply let the UK leave. That would really sow chaos in the UK as it would call into question many constitutional issues; but based on the current agreement with the EU, that action may not be able to be changed. After all, even if the EU offers the extension, the UK must accept it, which seemingly Boris has indicated he won’t. Needless to say, there is no clarity whatsoever on how things will play out at this time, so market participants remain timid. The recent news has encouraged the view that there will be no hard Brexit and has helped the pound recoup 2.0% this week. However, this morning it is slipping back a bit, -0.3%, as traders and investors are just not sure what to believe anymore. Nothing has changed my view that the EU will seek a deal and cave-in on the Irish backstop issue, especially given the continuous stream of terrible European data.

To that point, German IP was released at a much worse than expected -0.6% this morning, with the Y/Y outcome a -4.2% decline. I know that Weidmann and Lautenschlager are ECB hawks, but it is starting to feel like they are willing to sacrifice their own nation’s health on the altar of economic fundamentalism. The ECB meeting next Thursday will be keenly watched and everything Signor Draghi says at the press conference that follows will be parsed. But we have a couple of things coming before that meeting which will divert attention. And that doesn’t even count this morning’s surprise announcement by the PBOC that they were cutting the RRR by 0.5% starting September 16 in an effort to ease policy further without stoking the real estate bubble there.

So let’s look at today’s festivities, where the US payroll report is released at 8:30 and then Chairman Powell will be our last Fed speaker ahead of the quiet period and September 18 FOMC meeting. Here are the current expectations:

Nonfarm Payrolls 160K
Private Payrolls 150K
Manufacturing Payrolls 5K
Unemployment Rate 3.7%
Average Hourly Earnings 0.3% (3.0% Y/Y)
Average Weekly Hours 34.4

Yesterday’s ADP number was much stronger than expected at 195K, but the employment data from the ISM surveys has been much weaker so there is a wide range of estimates this month. In addition, the government has been hiring census workers, and it is not clear how that will impact the headline numbers and the overall data. I think the market might be a little schizophrenic on this number as a good number could serve to reinforce that the economy is performing well enough and so drive earning expectations, and stocks with them, higher. But a good number could detract from the ongoing Fed ease story which, on the surface, would likely be a stock market negative. In a funny way, I think Powell’s 12:30 comments may be more important as market participants will take it as the clear direction the Fed is leaning. Remember, futures are pricing in certainty that the Fed cuts 25bps at the meeting, with an 11% probability they cut 50bps! And the comments we have heard from recent Fed speakers have shown a gamut of viewpoints exist on the FOMC. Interesting times indeed! At this point, I don’t think the Fed has the gumption to stand up to the market and remain on hold, so 25bps remains the most likely outcome.

As to the rest of the world, next week’s ECB meeting will also be highly scrutinized, but lately there has been substantial pushback on market and analyst expectations of a big easing package. Futures are currently pricing in a 10bp cut with a 46% chance of a 20bp cut. Despite comments from a number of hawks regarding the lack of appetite for more QE, the majority of analysts are calling for a reinstitution of the asset purchase program as soon as October. As to the euro, while it has edged higher this week, just 0.35%, it remains in a long-term downtrend and has fallen 1.6% this month. The ECB will need to be quite surprisingly hawkish to do anything to change the trend, and I just don’t see that happening. Signor Draghi is an avowed dove, as is Madame Lagarde who takes over on November 1. Look for the rate cuts and the start of QE, and look for the euro to continue its decline.

Overall, though, today has seen a mixed picture in the FX market with both gainers and losers in G10 and EMG currencies. Some of those movements have been significant, with ZAR, for example, rallying 0.75% as investment continues to flow into the country, while CHF has fallen 0.6% as haven assets are shed in the current environment. Speaking of shedding havens, how about the 10-year Treasury, which has seen yields rebound 15bps in two days, a truly impressive squeeze on overdone buyers. But for now, things remain generally quiet ahead of the data.

Given it is Friday, and traders will want to be lightening up any positions outstanding, I expect that this week’s dollar weakness may well see a modest reversal before we go home. Of course, a surprise in the data means all bets are off. And if Powell sounds remotely hawkish? Well then watch out for a much sharper dollar rally.

Good luck
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QT Anyone? (or The Three Hawksketeers)

As summer recedes
JGB rates have collapsed
QT anyone?

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

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

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

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

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

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

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

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

Good luck and good weekend
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