Tag Archives: #Draghi

Somewhat Dismayed

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The ECB’s somewhat dismayed
That risk appetite, as conveyed
By stocks is excessive
And has made a mess of
Their plans.  Now they’re really afraid

It is interesting that two of the most memorable battle cries in financial markets were coined by men of the driest character and background.  We all remember the beginning of the Eurozone debt crisis, not ten years ago, when the so-called doom loop created by banks in a given country owning excessive amounts of their own government’s debt and when that debt became suspect (Portugal, Italy, Greece, Spain) the banks in those nations went to the wall.  The ECB was forced to step in to save the day, and did so, but things did not calm down until Super Mario Draghi, then ECB President (and now Italian PM) uttered his famous, off-the-cuff, remark of the ECB doing “whatever it takes” to save the euro.

Less of us were involved in the markets in December 1996 when then Fed Chair Alan Greenspan uttered the other famous market expression, “irrational exuberance” while speaking about the inflating of the tech bubble (which inflated for another 3 ½ years) and questioning if prices at that time had run too far ahead of sensible valuations.

In hindsight, both of the problems about which these catch phrases were created were the result of policy failures on the part of governments (debt crisis) or the central bank itself (tech bubble), but in neither case was the speaker able to take an objective view, thus calling out forces beyond their control as the cause of the problem.

Since then, both phrases have become part of the financial lexicon as shorthand for a situation that exists and the willingness of central bankers to address a problem.  This leads us to this morning’s release by the ECB of their Financial Stability Review where a subsection was titled “Financial markets exhibited remarkable exuberance as US yields rose. (author’s emphasis)”  Arguably, the title pales in comparison to ‘irrational exuberance’, but more importantly, it highlights, once again, the inability of a central bank to recognize that the folly of their own policies is what is driving the problems in markets and economies.

Ostensibly they are concerned that a mere 10% decline in US equity markets could result in “…a significant tightening of euro-area financial conditions, similar to around a third of the tightening witnessed after the coronavirus shock in March 2020.”  Wow!  A 10% decline?  If one were looking for a prime example of a fragile economy, clearly the Eurozone is exhibit A.  Once again, what we see is a central bank that is unwilling, or unable, to recognize that the fallout from its own policies is the underlying problem while seeking an alternative scapegoat explanation in order to present themselves in the best possible light.  After all, if the US markets decline, its not the ECB’s fault!

Inadvertently, perhaps, but clearly, the ECB has outlined one truth; given the synchronicity of central bank policies around the world, all economies are more tightly linked together and will rise and fall together.  Although there are those who claim particular markets have better prospects than others, the reality has become that correlations between equity markets around the world are very high, with the only real question how equities correlate to bonds.  It is this last issue where we have seen significant changes lately.  For quite a long time, the correlation between the S&P 500 and the 10-year US Treasury was positive, meaning that both bond and stock prices rallied and fell together.  However, since about February 2021, that relationship has turned around and is now solidly negative, with bond prices rising and stock prices falling.  It is this latter relationship that is the classic risk-on / risk-off meme, something that had gone missing for years.  Apparently, it is coming back, and that terrifies the ECB.

The timing of the report’s release could not have been better as this morning is a very clear risk-off session.  Yesterday afternoon, US equity markets sold off pretty sharply in the last half-hour of the session.  That sell-off has persisted throughout Asia (Nikkei -1.3%, Shanghai -0.5%, Hong Kong was closed) and Europe (DAX -1.3%, CAC -1.1%, FTSE 100 -1.1%).  US futures are also in the red (Dow -0.6%, SPX -0.8%, Nasdaq -1.2%), so the concerns are global in nature.

A bit more interestingly is the bond market’s behavior, where it appears that owning sovereign paper from any nation is unpopular today.  Treasury yields have backed up 2 basis points and we are seeing higher yields throughout Europe as well (Bunds +1.3bps, OATs +0.5bps, Gilts +2.1bps).  Apparently, the bond market concerns stem from the UK’s inflation report which showed that while CPI rose, as expected to 1.5%, RPI (Retail Price Index) rose much more than expected to 2.9% Y/Y.  While both are designed to be measures of average price increases over time, the RPI considers housing prices and mortgages.  Not surprisingly, given the explosion in housing prices, RPI is much higher and rising faster.  It also may represent a more accurate representation of people’s cost of living.  (Here’s a thought experiment: what would US RPI be right now given CPI just jumped to 4.2%?)  At any rate, it appears investors are shunning both stocks and bonds this morning.

Are they buying commodities?  Not on your life!  Prices in this sector are down across the board led by WTI (-1.8%) but seeing Gold (-0.6%) and Silver (-2.0%) suffering along with base metals (Cu -2.4%, Al -0.9%, Zn -0.85%) and foodstuffs (Soy -0.8%, Wheat -1.7%, Corn -0.3%).  Oh yeah, bitcoin, which many believe is a hedge of some sort, is lower by 16% in the past 24 hours and more than one-third in the past week.

So, what are investors buying?  Pretty much the only thing higher today is the dollar which has rallied vs. every currency we track.  In the G10, NZD (-0.9%) is the laggard followed by NOK (-0.8%) and AUD (-0.7%) with the strong theme there being weakness in the commodity sector.  But the European currencies are all under pressure as well, with EUR (-0.2%) and GBP (-0.3%) suffering.  Even JPY (-0.4%) is not holding up its end of the risk-off bargain, declining vs. a robust dollar.

Emerging markets are seeing similar activity with every currency flat to down led by TRY (-0.6%), ZAR (-0.45%) and MXN (-0.4%), all suffering from commodity weakness.  CE4 currencies are also under pressure, following the euro down while APAC currencies had less angst overnight, sliding on the order of 0.2%.

On the data front, today only brings the FOMC Minutes from the April meeting, which will be scrutinized to see how much discussion on tapering took place, if any, but let’s face it, other than Robert Kaplan of Dallas, it seems pretty clear from everybody else that has spoken, that it is not a current topic of conversation.  As it happens, we will hear from 3 more Fed speakers (Bullard, Quarles and Bostsic) as well, but all of them have been on message since the meeting so don’t look for any changes.

Certainly, based on today’s price action, the idea that 10-year yields are driving the dollar remains alive and well.  If yields continue to back up, the dollar will remain bid, and after all, given its recent decline, it has room to move as a simple correction.  I continue to look at 1.2350 as the critical level in the euro, and by extension the dollar writ large.  A break above there opens the chance for a much more substantial dollar decline.  But that does not appear to be on the cards for today.

Good luck and stay safe
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Central Banks Scoff

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In Italy more cash is needed
Or so Super Mario pleaded
The virus is raging
And Mario’s waging
A war so its spread is impeded

Meanwhile Chairman Jay and his mates
Remain steadfast that in the States
Though forecasts are nice
They will not suffice
It’s hard growth they need to raise rates

And lastly, from China we learned
Inflation just might have returned
Though central banks scoff
Bond markets sold off
As clearly some folks are concerned

In the financial world these days, there is only one true constant, the Fed remains as dovish as possible.  Yesterday, Chairman Powell, speaking at an IMF sponsored event, explained that the Fed would continue to aggressively support the economy until it is once again “great”.  (And here I thought that description of America was verboten.)  He harped on the 9 million to 10 million jobs that are still missing from before the Covid-induced crisis and said any inflationary pressures this year would be temporary.  His colleague, SF Fed President Daly doubled down on those comments, once again explaining that the Fed will not react to mere forecasts of growth, they will wait until they see hard data describing that growth is real, before considering tightening policy.

Regarding inflation, Powell, when asked specifically on the subject, explained, “We would be monitoring inflation expectations very carefully.  If we see them moving persistently and materially above levels we’re comfortable with, then we’d react to that.”  Remember, the Fed constantly reminds us they have the tools to deal with rising inflation.  But talk is cheap.  It remains an open question as to whether they have the fortitude to address rising inflation in an economy that has not come close to reaching full employment, let alone maximum employment.  Recall Q4 2018, when a modest increase in interest rates and gradual reduction in the size of the balance sheet led to a sharp stock market sell-off and a reversal of Fed policies via the “Powell Pivot.”  And the economy then was clearly in better shape than now.

There is another inflation issue I find puzzling as well, and that is the Fed’s inexorable faith that the Core PCE number is the right way to measure inflation.  This is especially true since a number of Fed members, including Powell, have been vocal in their view that the U-3 Unemployment Rate, the one published the first Friday of each month, is a very imperfect indicator of the overall jobless situation despite its long history as a key indicator.  So, happily, they are willing to question the totality of the information available from a single data point.  And yet, while they pay some lip service to inflation expectations, they are absolutely beholden to a single inflation data point, and one that has very little in common with most people’s reality.  One would think that given their broad-mindedness regarding unemployment, that same attitude might extend to inflation.  Alas, my understanding is that their econometric models don’t work well with any other data point, and so rather than building models based on reality, they create their reality from the data that works.

While on the subject of inflation, Chinese data overnight showed that, while CPI rose only 0.4% Y/Y, PPI rose a much greater than expected 4.4%.  This matters because China remains the world’s major manufacturing center and if prices at the factory are rising there, the implication is that those higher prices are coming to a product near you soon. Another sign of pending inflation comes from an IHS Markit report explaining that the PMI price data is running at its highest level since 2008 and is showing no signs of slowing down.  Add to this the increases in shipping costs, and rising prices for every day items seem in store.  Thank goodness the Fed has tools!

A quick look at Europe shows a tale of two countries, with Italy heading into its fourth wave of lockdowns and PM Draghi putting together a €40 billion support package following on from a €30 billion package a few months ago.  The vaccine rollout remains slow and insufficient and the government has closed bars and restaurants (and that’s really a crime, given just how good the food is there!)  Germany, on the other hand, is leading the hawkish contingent of the ECB along with the Dutch, in pushing for tapering the PEPP activity as those economies have been far more resilient to the virus and are starting to see some price pressures.  Granted, this morning’s German IP data (-6.4% Y/Y) was much worse than expected, but forecasts remain quite positive there.  Unlike the Fed, the ECB seems to be turning a bit more hawkish, indicating the Frugal Four are gaining in power.  ECB PEPP purchases declined to just €10.2 billion last week, far below their average in Q1 and even more surprising given Madame Lagarde’s comments in the wake of the ECB meeting that they would be far more active in Q2.

Adding all the new information together brings us to a market situation this morning where Treasury bonds have sold off, yields are higher by 5 basis points in the US and about 4 basis points in the major European markets except Italy, where they are 8 basis points higher.  Equity markets are mixed in Europe (DAX +0.1%, CAC +0.25%, FTSE -0.1%) after broad weakness in Asia (Hang Seng -1.1%, Shanghai -0.9%) and US futures are little changed to slightly higher at this time.

Rather, it is the dollar that is today’s big winner, rallying against all its G10 counterparts with NOK (-0.6%) the laggard on still soft oil prices, but weakness seen in JPY (-0.3%) and AUD (-0.25%) with smaller declines elsewhere.  The yen’s weakness appears corrective in nature, as it had strengthened 1.7% in the past week. While Aussie is simply chopping about in its recent 0.7550/0.7675 trading range and slipping today.

In the EMG bloc, CZK (-0.65%) is the worst performer, followed by RUB (-0.5%) and KRW (-0.3%), although the bulk of the bloc is somewhat softer this morning.  Here, too, we appear to be seeing some trading reactions to the past week’s dollar weakness, although the bigger trend remains for dollar strength.

On the data front, PPI (exp 0.5%, 3.8% Y/Y) is the only release with the core expectations (0.2%, 2.7% Y/Y) also well above the Fed target.  Of course, the relationship between PPI and Core PCE is limited at best, however, it is certainly indicative of the fact that there are rising price pressures throughout many sectors of the economy.  It is not unreasonable to expect them to show up in PCE soon, as they will certainly begin to show up in CPI next week.

Only one Fed speaker is on the docket today, Dallas Fed President Kaplan, but it would be beyond shocking if he said anything that was different than what we have both read and heard this week; nothing will change until the hard data achieves their targets.

Despite new information this morning, or perhaps because of it, the market theme remains the same, Treasury yields are the key driver of markets, with the dollar following in step while equities will have an inverse relationship.  And, while Treasury yields are off their recent highs, they appear to have finished this short-term correction.  I have a feeling the dollar will be firmer today and continue with that into next week, at least.

Good luck, good weekend and stay safe
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As Much As They Want

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Said Madame Lagarde with some jaunt
“They can test us as much as they want”
We’ve exceptional tools
And we still make the rules
These are words that could come back to haunt

If there were any questions as to the key driver in the markets, Madame Lagarde answered them tacitly this morning in a televised interview.  The number one driver of all things financial continues to be the yield on the 10-year Treasury bond and its knock-on effects for other markets.  Hence, when asked about the rising yields in the European sovereign markets, where similar to the Treasury market, yields are broadly at or near one-year high levels, she uttered what almost seemed like a challenge, “They can test us as much as they want.  We have exceptional circumstances to deal with at the moment and we have exceptional tools to use at the moment, and a battery of those.  We will use them as and when needed in order to deliver on our mandate and deliver on our pledge to the economy.”  While this doesn’t quite rise to Signor Draghi’s famous “whatever it takes” comment, it is certain that Lagarde was trying for the same impact.

Perhaps, however, something is lost in the translation from Italian to French, as the bond market stifled a collective yawn at her comments and yields continue to climb higher this morning, albeit not quite as dramatically as yesterday. So, a quick tour of European bond markets shows yields on the Bunds, OATs and Gilts all about 1 basis point higher, following right along with Treasury yields which are 2.2bps above yesterday’s close as I type.  While there is no doubt that this move higher in yields is getting a bit long in the tooth, and it would not be surprising to see a short-term respite, the underlying drivers, which remain a combination of anticipated excess new supply and rising prices, are still very much in place.  In fact, later today apparently President Biden is going to introduce his newest spending bill with a $2.25 trillion price tag.  This merely adds fuel to that fire of excess supply expectations.

There is one other thing that seems to belie the image of strength put forth by Lagarde, as well as by Chair Powell; the fact that they both go out of their way to explain that if when the time ever comes that they are actually going to slow down monetary injections, let alone actually reverse them, they will do so only after having given ample warning well in advance of such actions.  In other words, they remain terrified that taper tantrums are going to occur if they ever stop expanding their balance sheet, with a resulting decline in asset prices.  Now, the one thing that is abundantly clear, especially in the US, is that while there is a great deal of Fedspeak about achieving maximum employment, the Fed’s key indicator is the S&P 500.  Thus, a falling stock market will bring about a change in Fed policy faster than anything else.  However, it seems to me advance notice of tapering would not change the market reaction, merely its timing, so it is not clear what benefit they see in the idea.

Nonetheless, it remains the working thesis of central banks everywhere, that they must give significant forward guidance in order to be effective.  Yet once the market perceives an inflection point in that guidance, it is going to react immediately, even if the promised policy change is not until some future date.  My personal belief is that central banks would be far better off simply changing policies as they deem necessary without forward guidance and allow markets to find a new equilibrium after the policy change.  But that is a radical idea in today’s world.

In any case, there has been nothing new to change the ongoing narrative which remains the reflationary story is driving yields higher and the dollar along with them.  meanwhile, equity prices are beginning to struggle in the face of those rising yields as fixed income has started to become a viable alternative investment to equities, and the discount factor for future growth continues to point to lower current prices.  Thus, while markets this morning are taking a pause on their recent trajectory, with the dollar modestly softer along with most equity markets and commodities, much of this can be attributed to the fact that it is month and quarter end (and fiscal year end for many Asian nations), so recent positions may be reduced for balance sheet purposes.

So, let’s take a look at markets today.  Equity markets in Asia were mostly under pressure with the Nikkei (-0.9%), Hang Seng (-0.7%) and Shanghai (-0.4%) all weaker on the close.  Europe has seen a more mixed picture as the DAX (0.0%) has recovered from mild early losses, but the CAC (-0.2%) and FTSE 100 (-0.3%) are both feeling a bit of pressure.  US futures, meanwhile, continue their bipolar activities, this time with the NASDAQ (+0.65%) rising while the DOW (-0.2%) is under the gun.  However, remember that much rebalancing is likely to be seen again today given the calendar, so do not be surprised if there are short-term reversals to recent trends.

As to commodities, oil prices (-0.4%) are a touch softer this morning while gold (+0.1%) and silver (+0.25%) seem to have stabilized for the time being.  The base metal story is more mixed with Cu (+0.7%) on the day, but the rest of the main trading metals generally softer by a similar amount.

Finally, the dollar is under some pressure today, although given its run over the past week, this appears merely to be a short-term corrective.  In the G10, NOK (+0.5%) is the leading gainer, despite oil’s modest decline, as the market continues to look at the Norwegian economy and forecast Norgesbank may be the first G10 bank to raise interest rates. Inflation pressures appear to be building in the country and growth remains on the upswing.  Away from the krone, the rest of the bloc is firmer by between 0.2% and 0.3% with modest impact from CPI data across Europe showing prices rising compared to February, but a tick less than forecast in the major countries.  The one exception is JPY (-0.25%) which is simply cratering of late and has now declined about 7.5% in 2021. It appears that we are beginning to see an increase in unhedged Treasury buying by Japanese investors, with the 10-year yield spread now above 165 basis points, a level that historically has seen significant interest from the Japanese investment community.  In fact, if drawing a long-term trend line from its recent peak in early 2017, USDJPY appears to be breaking higher with a target of 112.00 a very real near-term possibility.

Regarding EMG currencies, there is general strength there as well, led by ZAR (+0.7%) and RUB (+0.6%) which have been two of the overall better performers for the week.  But in a broader sense, we are seeing modest reversals of what had been EMG currency weakness for the past week or more.

On the data front, ADP Employment (exp 550K) is the first part of the employment picture this morning with some whisper numbers growing for the NFP on Friday to over 1 million new jobs as the economy reopens.  We also see Chicago PMI (61.0), which should show continued growth in the manufacturing sector.  Overnight, Chinese PMI data (Composite 55.3) was much better than expected and indicates that the Chinese economy has moved past the Lunar New year lull.  There are no Fed speakers, but really, people will be focused on the new spending package, and more importantly, the indications of how it will be funded.  The less tax discussion, the likelihood of the bigger negative impact on the bond market.

As to the dollar today, the current trend remains clearly higher, but with month-end rebalancing taking place here as well, a touch of further weakness is quite viable on the day.

Good luck and stay safe
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Markets Rejoice

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He once said, “Whatever it takes”
To fix all the prior mistakes
Is what he would do
And Draghi came through
Though that was ere Covid outbreaks

But now Italy’s in a bind
As Conte, the PM, resigned
So, Draghi’s first choice
(And markets rejoice)
To lead a land that’s much maligned

***FLASH***  Mario Draghi accepts mandate to form new Italian government!

Now that GameStop fever is ebbing, far more quickly than Covid-19 I might add, it is time to look elsewhere for market drivers and sentiment.  With this in mind, we turn to the nation that puts the “I” in PIGS, Italy.  My personal experience in Italy is that it is a beautiful country, with extraordinary history and even better food.  The people are warm and welcoming, and it is truly a delightful place.  Alas, it is also, historically, one of the worst run nations on earth.  Attention to detail and a sense of urgency are two things that tend to be missing from the Italian culture, but both are necessary to be able to govern effectively.  Thus, it is not surprising that Italy has had 66 different governments since the end of WWII, with the most recent one falling two weeks ago.  The norm has been for coalitions, often fractious, to come together on short-term issues and then fall apart when longer term questions need to be addressed.

This is an apt description of the current situation, where PM Giuseppe Conte, a law professor with no previous political experience, was tapped to lead a disparate coalition of center-left and radical-left parties in an effort to prevent Matteo Salvini’s Lega Nord, a right-wing party, from taking control.  While this effort stumbled along for nearly two years, it recently foundered when a key supporter of the coalition, Matteo Renzi, withdrew his support and Conte lost a vote of no-confidence in the Italian Senate.  Conte has been unable to piece together another coalition which leaves two choices; the President, Sergio Mattarella, can appoint someone else to try to do so, or elections must be held.

Enter Mario Draghi.  Since his time as ECB President ended in 2019, he has been relatively quiet on most issues, and has not been willing to get involved in the morass of Italian politics at all.  Arguably, because of that, he remains the most popular public figure (non sports or entertainment) in the country.  And so, President Mattarella is meeting with Draghi today to ask him to form a new government with wide latitude to do “whatever it takes” to fix Italy’s many problems.  While the early word from political figures there is mixed, at best, the market thinks this is the best idea since sliced bread.  This is clear from both the equity market, where the FTSE MIB has rallied by a world-beating 2.7% today, as well as from the bond market, where BTPs have rallied sharply with yields falling 9.2 basis points and the spread to bunds has fallen to just over 100 basis points, its tightest level since 2016.

Remember, Italy has been one of the worst hit nations from Covid, as the infections appeared there early and the economy is hugely reliant on tourism and services, exactly the areas Covid destroyed.  Add to that the government’s general incompetence which has slowed the distribution of the vaccines (although in fairness, this seems to be true throughout Europe, Germany included) and you have a situation where the economy, which shrunk 9.0% in 2020, remains on course to shrink again through at least the first half of 2021.  It is not clear, by any means, that Draghi will accept the position, nor if he does, if he will be able to bring together the disparate views in the Italian congress to pass legislation that helps the situation.  But, boy, the markets are all-in on the trade!

The Draghi story has been icing on the market bullish cake this morning with risk continuing to be embraced as US stimulus talks turn away from the bipartisan idea and therefore toward a quicker passage under budget reconciliation terms (where the Senate does not have a chance to filibuster).  As well, in many nations we have seen upticks in data releases, although there are still some, notably China, where the data is falling short of estimates.

Starting with equities, Asia saw strength in the Nikkei (+1.0%) and Hang Seng (+0.2%) but Shanghai (-0.5%) fell after Caixin PMI Services data (52.0) fell short of expectations and pretty significantly from last month’s reading of 56.3.  While still above the key 50.0 level, momentum in China appears to be stalling for now.  Europe is all green, but Italy is truly the outlier.  The DAX (+0.7%) comes next and then the CAC (+0.3%) and FTSE 100 (+0.2%) are both positive, but just barely.  As to US futures, after yesterday’s strong session, with all three indices rising around 1.5%, and after some strong earnings reports yesterday afternoon, futures are higher by modest amounts, led by the NASDAQ’s 0.6% climb.

Bond markets are offering the same message, with yields higher in Treasuries (2.1bps), bunds (1.1bps) and Gilts (1.1bps).  Meanwhile, the bonds of the PIGS are all rallying on the combination of general risk attitude and the hope that good news in Italy will spread.

Oil continues its winning ways, rising another 0.5% this morning which puts WTI above $55/bbl, a level many technicians believe opens the way for a sharper rally from here.  Gold, after a dreadful day yesterday, is still under modest pressure, down 0.15%, but silver, after an even more dreadful day yesterday, having fallen more than 8%, is actually bouncing a bit, and up 0.5% as I type.

Finally, the dollar is generally stronger vs. G10 currencies, with only AUD and NZD (both +0.1%) showing any life.  The kiwi story is based on stronger than expected employment data indicating the economy is rebounding and more monetary support may not be necessary, while Aussie seems to be benefitting from strong PMI data.  But otherwise, the dollar is on top this morning, with broad-based gains although they are not substantial.  SEK (-0.4%) is the worst performer, followed by the pound (-0.25%) and euro (-0.25%), both of which saw underwhelming PMI services data. In the EMG bloc the picture is more mixed, with both gainers and losers, although it is hard to piece together a coherent story.  The CE4 are the laggards, down 0.3% on average as they track the euro.  LATAM is also underperforming, although both MXN and BRL are softer by just 0.2%.  On the plus side, RUB (+0.3%) leads the way, arguably on oil’s uptick, and then some APAC currencies eked out marginal gains as well.  However, given the modest magnitude of movement, this feels an awful lot like position adjustments.

On the data front today we see ADP Employment (exp 50K) and ISM Services (56.7).  The former will attract more attention than the latter, in my view, as the market looks ahead to Friday’s NFP data. It would also be a mistake if I did not mention that Eurozone CPI was released this morning at a much higher than expected 0.9% (1.4% core) which is hard to reconcile with the collapsing economic activity.  Although perhaps, inflation is not dependent on demand as much as supply, and central bankers have it completely wrong.  Nah.

For now, the dollar’s correction continues, and we are right at the 1.2010 level that proved the breakout point in December.  At this stage, a move to 1.1950 seems a good bet, but we will need to see many more positions unwind if we are to overcome the dollar weakness narrative.  The confusing part is the ongoing equity rally alongside the dollar rally, something we have not seen for quite a while.  But that doesn’t mean it can’t continue for a while longer.  I still like the dollar to fall in H2, but right now, momentum is building for further dollar strength.

Good luck and stay safe
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Make Boris Bend

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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

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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

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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

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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

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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

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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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