Throw Her a Bone

Next week at the ECB meeting
We’re sure to hear Christine entreating
The whole Eurozone
To throw her a bone
And spend more, lest growth start retreating

In England, though, it’s now too late
As recent releases all state
The ‘conomy’s slowing
And Carney is knowing
Come month end he’ll cut the base rate

The dollar is finishing the week on a high note as it rallies, albeit modestly, against virtually the entire G10 space. This is actually an interesting outcome given the ongoing risk-on sentiment observed worldwide. For instance, equity markets in the US all closed at record highs yesterday, and this morning, European equities are also trading at record levels. Asia, not wanting to be left out, continues to rally, although most markets in APAC have not been able to reach the levels seen during the late 1990’s prior to the Asian crisis and tech bubble. At the same time, we continue to see Treasury and Bund yields edging higher as yield curves steepen, another sign of a healthy risk appetite. Granted, commodity prices are not uniformly higher, but there are plenty that are, notably iron ore and steel rebar, both crucial signals of economic growth.

Usually, in this type of market condition, the dollar tends to decline. This is especially so given the lack of volatility we have observed encourages growth in carry trades, with investors flocking to high yield currencies like MXN, IDR, BRL and ZAR. However, it appears that at this juncture, the carry trade has not yet come back into favor, as that bloc of currencies has shown only modest strength, if any, hardly the signal that investor demand has increased.

This leaves us with an unusual situation where the dollar is reasonably well-bid despite the better risk appetite. Perhaps investors are buying dollars to jump on board the US equity train, but I suspect there is more to the movement than this. Investigations continue.

Narrowing our focus a bit more, it is worthwhile to consider the key events upcoming, notably next week’s ECB and BOJ meetings and the following week’s FOMC and BOE meetings. Interestingly, based on current expectations, the Fed meeting is likely to be far less impactful than either the ECB or BOE.

First up is the BOJ, where there is virtually no expectation of any policy changes, and in fact, that is true for the entire year. With the policy rate stuck at -0.10%, futures markets are actually pricing in a 5bp tightening by the end of the year. Certainly, Japan has gone down the road of increased fiscal stimulus, and if you recall last month’s outcome, the BOJ essentially admitted that they would not be able to achieve their 2.0% inflation target during any forecastable timeline. With that is the recent history, and given that inflation remains either side of 1.0%, the BOJ is simply out of bullets, and so will not be doing anything.

The ECB, however, could well be more interesting as the market awaits their latest thoughts on the policy review. Madame Lagarde has made a big deal about how they are going to review procedures and policy initiatives to see if they are designed to meet their goals. Some of the things that have been mooted are a change in the inflation target from “close to but below 2.0%” to either a more precise target or a target range, like 1.5% – 2.5%. Of even more interest is the fact that they have begun to figure out that their current inflation measures are inadequate, as they significantly underweight housing expense, one of the biggest expenses for almost every household. Currently, housing represents just 4% of the index. As a contrast, in the US calculation, housing represents about 41% of the index! And the anecdotes are legion as to how much housing costs have risen throughout European cities while the ECB continues to pump liquidity into markets because they think inflation is missing. Arguably, that has the potential to change things dramatically, because a revamped CPI calculation could well inform that the ECB has been far too easy in policy and cause a fairly quick reversal. And that, my friends, would result in a much higher euro. Today however, the single currency has fallen prey to the dollar’s overall strength and is lower by 0.25%.

As I mentioned, I don’t think the FOMC meeting will be very interesting at all, as there is a vanishingly small chance they change policy given the economy keeps chugging along and inflation has been fairly steady, if not rising to their own 2.0% target. The BOE meeting, however, has the chance to be much more interesting. This morning’s UK Retail Sales data was massively disappointing, with December numbers printing at -0.8%, -0.6% excluding fuel. This was hugely below the expected outcomes of +0.8% and +0.6% respectively. Apparently, Boris’s electoral victory did not convince the good people of England to open their wallets. And remember, this was during Christmas season, arguably the busiest retail time of the year. It can be no surprise that the futures market is now pricing a 75% chance of a rate cut and remember, earlier this week we heard from three different BOE members that cutting rates was on the table. The pound, which has been rallying for the entire week has turned around and is lower by 0.2% this morning with every chance that this slide continues for the next week or two until the meeting crystalizes the outcome.

The other noteworthy news was Chinese data released last night, which showed that GDP, as expected, grew at 6.0%, Retail Sales also met expectations at 8.0%, while IP (+6.9%) and Fixed Asset Investment (+5.4%) were both a bit better than forecast. The market sees this data as proof that the economy there is stabilizing, especially with the positive vibe of the just signed phase one trade deal. The renminbi has benefitted, rallying a further 0.3% on the session, and has now gained 4.6% since its weakest point in early September 2019. This trend has further to go, of that I am confident.

On the data front this morning, we have Housing Starts (exp 1380K), Building Permits (1460K), IP (-0.2%), Capacity Utilization (77.0%), Michigan Sentiment (99.3) and JOLT’s Job Openings (7.25M). So plenty of news, but it is not clear it is important enough to change opinions in the FX market. As such, I expect that today’s dollar strength is likely to continue, but certainly not in a major way.

Good luck and good weekend
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Up, Up and Away

Said Powell, “We’re in a good place”
On growth, but we don’t like the pace
That prices are rising
And so we’re surmising
More QE’s what needs to take place

Today, then, we’ll hear from Christine
Who is now the ECB queen
This is her first chance
To proffer her stance
On policy and what’s foreseen

And finally, in the UK
The vote’s taking place through the day
If Boris does badly
Bears will sell pounds gladly
If not, it’s up, up and away

There is much to cover this morning, so let’s get right to it.

First the Fed. As universally expected they left rates on hold and expressed confidence that monetary policy was appropriate for the current conditions. They lauded themselves on the reduction in unemployment, but have clearly changed their views on just how low that number can go. Or perhaps, what they are recognizing is that the percentage of the eligible labor force that is actually at work, which forms the denominator in the unemployment rate, is too low, so that there is ample opportunity to encourage many who had left the workforce during the past decade to return thus increasing the amount of employment and likely helping the Unemployment Rate to edge even lower. While their forecasts continue to point to 3.5% as a bottom, private sector economists are now moving their view to the 3.0%-3.2% level as achievable.

On the inflation front, to say that they are unconcerned would greatly understate the case. They have made it abundantly clear that it will require a nearly unprecedented supply shock to have them consider raising rates anytime soon. However, they continue to kvetch about too low inflation and falling inflation expectations. They have moved toward a policy that will allow inflation to run higher than the “symmetric 2% target” for a while to make up for all the time spent below that level. And the implication is that if we see inflation start to trend lower at all, they will be quick to cut rates regardless of the economic growth and employment situation. Naturally, the fact that CPI printed a touch higher than expected (2.1%) was completely lost on them, but then given their ‘real-world blinders’ that is no real surprise. The dot plot indicated that they expect rates to remain on hold at the current level throughout all of 2020, which would be a first during a presidential election year.

And finally, regarding the ongoing concerns over the short term repo market and their current not-QE policy of buying $60 billion per month of Treasury bills, while Powell was unwilling to commit to a final solution, he did indicate that they could amend the policy to include purchases of longer term Treasury securities alongside the introduction of a standing repo facility. In other words, not-QE has the chance to look even more like QE than it currently does, regardless of what the Chairman says. Keep that in mind.

Next, it’s on to the ECB, which is meeting as I type, and will release its statement at 7:45 this morning followed by Madame Lagarde meeting the press at 8:30. It is clear there will be no policy changes, with rates remaining at -0.5% while QE continues at €20 billion per month. Arguably there are two questions to be answered here; what is happening with the sweeping policy review? And how will Madame Lagarde handle the press conference? Given she has exactly zero experience as a central banker, I think it is reasonable to assume that her press conferences will be much more political in nature than those of Signor Draghi and his predecessors. My fear is that she will stray from the topic at hand, monetary policy, and conflate it with her other, nonmonetary goals, which will only add confusion to the situation. That said, this is a learning process and I’m sure she will get ample feedback both internally and externally and eventually gain command of the situation. In the end, though, there is precious little the ECB can do at this point other than beg the Germans to spend some money while trying to fend off the hawks on the committee and maintain policy as it currently stands.

Turning to the UK election, the pound had been performing quite well as the market was clearly of the opinion that the Tories were going to win and that the Brexit uncertainty would finally end next month. However, the latest polls showed the Tory lead shrinking, and given the fragmentation in the electorate and the UK’s first-past-the-post voting process, it is entirely possible that the result is another hung Parliament which would be a disaster for the pound. The polls close at 5:00pm NY time (10:00pm local) and so it will be early evening before we hear the first indications of how things turn out. The upshot is a Tory majority is likely to see a further 1%-1.5% rally in the pound before it runs out of momentum. A hung Parliament could easily see us trade back down to 1.22 or so as all that market uncertainty returns, and a Labour victory would likely see an even larger decline as the combination of Brexit uncertainty and a program of renationalization of private assets would result in capital fleeing the UK ASAP. When we walk in tomorrow, all will be clear!

Clearly, those are the top stories today but there is still life elsewhere in the markets. Ffor example, the Turkish central bank cut rates more than expected, down to 12.0%, but the TRY managed to rally 0.25% after the fact. Things are clearly calming down there. In Asia, Indian inflation printed higher than expected at 5.54%, although IP there fell less than expected (-3.8%) and the currency impact netted to nil. The biggest gainer in the Far East was KRW, rising 0.65% after a strong performance by the KOSPI (+1.5%) and an analyst call for the KOSPI to rise 12% next year. But other than the won, the rest of the space saw much less movement, albeit generally gaining slightly after the Fed’s dovish stance.

In the G10, the pound has actually slipped a bit this morning, -0.2%, but otherwise, movement has been even smaller than that. Yesterday, after the Fed meeting, the dollar fell pretty sharply, upwards of 0.5% and essentially, the market has maintained those dollar losses this morning.

Looking ahead to the data today we see Initial Claims (exp 214K) and PPI (1.3%, 1.7% core). However, neither of those will have much impact. With the Fed meeting behind us, we will start to hear from its members again, but mercifully, not today. So Fed dovishness has been enough to encourage risk takers, and it looks for all the world like a modest risk-on session is what we have in store.

Good luck
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Hawks Would Then Shriek

Lagarde and Chair Powell both seek
Consensus, when later this week
Their brethren convene
While doves are still keen
To ease more, though hawks would then shriek

Markets are relatively quiet this morning as investors and traders await three key events as well as some important data. Interestingly, neither the Fed nor ECB meetings this week are likely to produce much in the way of fireworks. Chairman Powell and his minions have done an excellent job convincing market participants that the temporary cyclical adjustment is finished, that rates are appropriate, and that they are watching everything closely and prepared to act if necessary. Certainly Friday’s blowout NFP data did not hurt their case that no further easing is required. By now, I’m sure everyone is aware that we saw the highest headline print since January at 266K, which was supported by upward revisions of 41K to the previous two months’ data. And of course, the Unemployment Rate fell to 3.5%, which is back to a 50-year low. In fact, forecasts are now showing up that are calling for a 3.2% or 3.3% Unemployment Rate next November, which bodes well for the incumbent and would be the lowest Unemployment Rate since 1952!

With that as the economic backdrop in the US, it is hard for the doves on the Fed to make the case that further easing is necessary, but undoubtedly they will try. In the meantime, ECB President Lagarde will preside over her first ECB meeting where there are also no expectations for policy changes. Here, however, the situation is a bit tenser as the dramatic split between the hawks (Germany, the Netherlands and Austria) and the doves (Spain, Portugal and Italy) implies there will be no further action anytime soon. Madame Lagarde has initiated a policy review to try to find a consensus on how they should proceed, although given the very different states of the relevant economies, it is hard to believe they will agree on anything.

Arguably, the major weakness in the entire Eurozone construct is that the lack of an overarching continent-wide fiscal authority means that there is no easy way to transfer funds from those areas with surpluses to those with deficits. In the US, this happens via tax collection and fiscal stimulus agreed through tradeoffs in Congress. But that mechanism doesn’t exist in Europe, so as of now, Germany is simply owed an extraordinary amount of money (~€870 billion) by the rest of Europe, mostly Italy and Spain (€810 billion between them). The thing is, unlike in the US, those funds will need to be repaid at some point, although the prospects of that occurring before the ECB bails everyone out seem remote. Say what you will about the US running an unsustainable current account deficit, at least structurally, the US is not going to split up, whereas in Europe, that is an outcome that cannot be ruled out. In the end, it is structural issues like this that lead to long term bearishness on the single currency.

However, Friday’s euro weakness (it fell 0.45% on the day) was entirely a reaction to the payroll data. This morning’s 0.15% rally is simply a reactionary move as there was no data to help the story. And quite frankly, despite the UK election and pending additional US tariffs on China, this morning is starting as a pretty risk neutral session.

Speaking of the UK, that nation heads to the polls on Thursday, where the Tories continue to poll at a 10 point lead over Labour, and appear set to elect Boris as PM with a working majority in Parliament. If that is the outcome, Brexit on January 31 is a given. As to the pound, it has risen 0.2% this morning, which has essentially regained the ground it lost after the payroll report on Friday. At 1.3165, its highest point since May 2019, the pound feels to me like it has already priced in most of the benefit of ending the Brexit drama. While I don’t doubt there is another penny or two possible, especially if Boris wins a large majority, I maintain the medium term outlook is not nearly as robust. Receivables hedgers should be taking advantage of these levels.

On the downside this morning, Aussie and Kiwi have suffered (each -0.2%) after much weaker than expected Chinese trade data was released over the weekend. Their overall data showed a 1.1% decline in exports, much worse than expected, which was caused by a 23% decline in exports to the US. It is pretty clear that the trade war is having an increasing impact on China, which is clearly why they are willing to overlook the US actions on Hong Kong and the Uighers in order to get the deal done. Not only do they have rampant food inflation caused by the African swine fever epidemic wiping out at least half the Chinese hog herd, but now they are seeing their bread and butter industries suffer as well. The market is growing increasingly confident that a phase one trade deal will be agreed before the onset of more tariffs on Sunday, and I must admit, I agree with that stance.

Not only did Aussie and Kiwi fall, but we also saw weakness in the renminbi (-0.15%), INR (-0.2%) and IDR (-0.2%) as all are feeling the pain from slowing trade growth. On the plus side in the EMG bloc, the Chilean peso continues to stage a rebound from its worst levels, well above 800, seen two weeks ago. This morning it has risen another 0.85%, which takes the gain this month to 4.8%. But other than that story, which is really about ebbing concern after the government responded quickly and positively to the unrest in the country, the rest of the EMG bloc is little changed on the day.

Turning to the data this week, we have the following:

Tuesday NFIB Small Business Optimism 103.0
  Nonfarm Productivity -0.1%
  Unit Labor Costs 3.4%
Wednesday CPI 0.2% (2.0% Y/Y)
  -ex Food & Energy 0.2% (2.3% Y/Y)
  FOMC Rate Decision 1.75%
Thursday ECB Rate Decision -0.5%
  PPI 0.2% (1.2%)
  -ex Food & Energy 0.2% (1.7%)
  Initial Claims 215K
Friday Retail Sales 0.4%
  -ex autos 0.4%

Source: Bloomberg

While there is nothing today, clearly Wednesday and Thursday are going to have opportunities for increased volatility. And the UK election results will start trickling in at the end of the day on Thursday, so if there is an upset brewing, that will be when things are first going to be known.

All this leads me to believe that today is likely to be uneventful as traders prepare for the back half of the week. Remember, liquidity in every market is beginning to suffer simply because we are approaching year-end. This will be more pronounced next week, but will start to take hold now.

Good luck
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Tempting the Fates

Around the world most central banks
Have, monthly, been forced to give thanks
That tempting the fates
With negative rates
Has not destroyed euros or francs

And later today we will hear
From Draghi, the man who made clear
“Whatever it takes”
Would fix the mistakes
Investors had grown, most, to fear

With Brexit on the back burner for the day, as the UK awaits the EU’s decision on how long of a delay to grant, the market has turned its attention to the world’s central banks. Generally speaking, monetary ease remains the primary focus, although there are a few banks that are bucking the trend.

Starting with the largest for today, and world’s second most important central bank, the ECB meets today in what is Mario Draghi’s final policy meeting at the helm. Given their actions last month, where they cut the deposit rate a further 10bps to -0.50% and restarted QE to the tune of €20 billion per month, there is no expectation for any change at all. In fact, the only thing to expect is more exhortations from Draghi for increasing fiscal policy stimulus by Germany and other Northern European nations that are not overly indebted. But it will not change anything at this stage, and he has already tied Madame Lagarde’s hands going forward with their most recent guidance, so this will be the farewell tour as everybody regales him for saving the euro back in 2012.

But there have been a number of other moves, the most notable being the Swedish Riksbank, which left rates unchanged, but basically promised to raise them by 25bps in December to return them to 0.00%. Apparently they are tired of negative rates and don’t want them to become habit forming. While I admire that concept, the problem they have is growth there is slowing and inflation is falling well below their target of 2.0%. The most recent reading was 1.5%, but the average going back post the financial crisis is just 1.1%. SEK gained slightly after their comments, rallying 0.15% this morning, but the trend in the krone remains lower and I think they will need to raise a lot more than 25bps to change that.

Meanwhile, other central bank activity saw Norway leave rates unchanged at 1.50% as core inflation there remains above their 2.0% target. NOK’s response was essentially nil. Indonesia cut rates by 25bps, as widely expected, its fourth consecutive rate cut, and although the rupiah is ever so slightly softer this morning, -0.2%, its performance this year has been pretty solid, having gained 2.3% YTD. Finally, the Turkish central bank cut rates by a surprising 250bps this morning, much more than the 100bps expected. If you recall, President Erdogan has been adamant that higher interest rates beget higher inflation, and even fired the previous central bank head to replace him with someone more malleable. Interestingly, a look at Turkish inflation shows that it has been falling despite (because of?) recent rate cuts. And today, despite that huge cut, the initial currency impact was pretty modest, with the lira falling 0.5% immediately, but already recouping some of those losses. And in the broader picture, the lira’s recent trend has clearly been higher and remains so after the cut.

On the data front we saw PMI data from the Eurozone and it simply reinforced the idea that the Eurozone is heading into a recession. Germany’s numbers were worse than expected (Manufacturing 41.9, Composite 48.6) which was enough to drag the Eurozone data down as well (Manufacturing 45.7, Composite 50.2). It seems clear that when Germany reports their Q3 GDP next month it will be negative and Germany will ‘officially’ be in a recession. It is data of this nature that makes it so hard to turn bullish on the single currency. Given their economic travails, the Teutonic austerity mindset, which was enshrined in law, and the fact that the ECB is essentially out of bullets, it is very difficult to have a positive view of the euro in the medium term. This morning, ahead of the ECB policy statement, the euro is little changed, and I see no reason for it to move afterwards either.

So, there was lots of central bank activity, but not so much FX movement in response. My sense is that FX traders are now going to fully turn their attention to the FOMC meeting next week, as even though a rate cut seems assured, the real question is will the Fed call a halt to the mid-cycle adjustment, or will they leave the door open to further rate cuts. The risk with the former is that the equity market sells off sharply, thus tightening financial conditions, sowing fear in Washington and forcing a reversal. However, the risk with the latter is that the Fed loses further credibility, something they have already squandered, by being proven reactive to the markets, and less concerned with the economy writ large.

For today’s session, we have the only real data of the week, Durable Goods (exp -0.7%, -0.2% ex Transport), and Initial Claims (215K) at 8:30, then New Home Sales (702K) at 10:00. We also see the US PMI data (Manufacturing 50.9, Services 51.0) although the market generally doesn’t pay much attention to this. Instead it focuses on the ISM data which won’t be released until next week.

Without any Fed speakers on the docket, once again the FX market is likely to take its cues from equities, which are broadly higher this morning after a number of better than expected earnings announcements. In this risk-on environment, I think the dollar has room to edge lower, but unless we start to see the US data really deteriorate, I have a feeling the Fed is going to try to end the rate cuts and the dollar will benefit going forward. Just not today.

Good luck
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Quite Frankly Floored

Most pundits were, quite frankly, floored
That leaving the ECB Board
Was one of the hawks
Who tired of talks
‘bout QE the Germans abhorred

The dollar is stronger than where I left it Tuesday evening after a rally in yesterday’s NY session. Determining the catalyst for that rally has been difficult given the only economic data of note was New Home Sales (713K), which while quite strong are generally not seen as market moving, and the limited commentary overheard. However, there are three things that conspired, I believe, to drive the dollar higher.

First was the surprise resignation of Sabine Lautenschlaeger from the ECB Executive Board. Ms. Lautenschlaeger was one of the most ardent hawks on the ECB and was quite vocal that there was no need to resume QE at the current time. In fact, she had been proffering that message since the last meeting when Mario first hinted that QE2 was on the table. In the end, though, she was not able to garner enough support to dissuade Signor Draghi from going ahead with it, and it appears she decided that her voice was no longer taken into consideration. Whomever is chosen as her replacement is almost certain to have less hawkish views, and so the market recognized that the tone of the ECB has turned more dovish. A dovish ECB is likely to result in easier policies and correspondingly a weaker euro.

We also heard from Chicago Fed President Charles Evans, a known dove, who indicated that he saw no reason for further rate cuts this year. It appears that he was one of the dots in the middle, comfortable with last week’s cut but calling it quits then. He highlighted that if the economy deteriorated for some reason, he would not be against further cuts, but at the present time, they were not necessary. So, a Fed dove was mildly hawkish, helping cement the idea that the Fed was less likely to cut rates again this year. This can only be seen as dollar bullish.

Finally, we have the calendar as we approach quarter-end and the financing requirements necessary for banks and other financial firms when they report positions. The stricter regulatory environment that has been in place since the financial crisis means that there is an increased demand for dollars on virtually every institution’s balance sheet. That is one reason we have seen issues within the Fed Funds market with all the discussion about the Fed’s repo facility and recent activities. However, there are many institutions that simply buy dollars in order to put their balance sheet in order.

Add them all up, and you have the makings of a dollar rally, which has seen the euro decline 0.85% since yesterday morning, the pound fall 1.2% and the yen fall 0.5%. Granted, the pound has its own issues relating to Boris’s return to Parliament and the inflamed rhetoric on both sides of the aisle there leading to an increase in belief that a hard Brexit is still possible. But the tell that this is simply a dollar rally and not a risk off event is the fact that the yen fell sharply, alongside a rally in equities and decline in the bond market.

The question at this time is whether the rally continues, or if it was merely a one-day event. At this point, the evidence seems to indicate that a slow continuation of the dollar rally is the most likely outcome. Certainly, there will be nothing hawkish coming from ECB policymakers as the hawks seem more willing to quit than continue to lose their battle. Eurozone data continues to implode and another key German institute, the DIW Institute, announced its expectation that when German GDP for Q3 is released on November 14, it will show growth at -0.2%, the second consecutive decline and put Germany in a technical recession. As an aside, it is interesting to see just how crucial the idea of monetary discipline is to Germans, in general, and German bankers in particular. Despite the fact that Germany probably has the weakest growth in the Eurozone, its ECB members are amongst the most hawkish. If that ever changes, you can be sure the euro will fall far more rapidly!

As to the Fed, it seems to me that there is a clear level of comfort developing on the FOMC that two cuts were sufficient in the current circumstances to stanch any bleeding in the economy, and barring an escalation in the trade war, they seem ready to stand pat. If that is the case, then dollars will retain their relative attractiveness. And of course, the calendar is beyond all our reach, but we will need to see if Friday, when the spot value date turns to October 1, whether or not there is reduced demand for the greenback. My sense is that pressure will dissipate quickly, and possibly reverse as those dollars are seen as short-term needs. But for the rest of the day, I think the dollar has room to run a little further.

Turning to today’s session, we do get the final reading of Q2 GDP (exp 2.0%) as well as the ancillary data that comes with that report. I always look at the Personal Consumption component (4.7%) as the best measure of demand, so keep an eye there. And of course, we get Initial Claims (212K), but that series’ stability has been extraordinary and largely taken it out of the conversation. If we do start to see that rise, however, beware of weakening nonfarm numbers and a lot more dovish rhetoric from the Fed.

As to the Fed, we have six, count ‘em, speakers today with nary a hawk in sight. As such, amongst Kaplan, Bullard, Clarida, Daly, Kashkari and Barkin, I expect rationales as to why another rate cut or two makes sense, or at the very least highlights of weakening global growth and impending problems like Brexit which require easier Fed policy as a response. However, given they are all known on the dovish side, I don’t think it matters that much. For now, I don’t see anything derailing the dollar and look for a modest further increase throughout the session.

Good luck
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Past Its Shelf Life

The narrative most of this year
Described central banks full of fear
So rates they would cut
Which might help somewhat
But so far that hasn’t been clear

Instead every meeting’s been rife
With conflict, dissension and strife
For NIRP, the doves pine
While hawks like to whine
That policy’s past its shelf life

At the end of a week filled with numerous central bank meetings, it’s time to consider what we’ve learned. Arguably, the first thing is that groupthink in the central banking community is not quite as widespread as we previously believed. This was made evident by the three dissenting votes at the FOMC on Wednesday as well as last week’s ECB meeting, where at least five members of the council argued vociferously for no further stimulus. The funny thing is that while I understand the European monetary hawks’ zeitgeist, (German hyperinflation of the 1920’s) the fact remains that Europe is slipping into recession and arguably the ECB is correct in trying to address that. With that said, I would argue they would have been far better off extending the TLTRO’s to an even longer maturity and cut rates there, allowing banks to earn from the ECB while they lend to clients at a positive rate. Simply cutting the deposit rate to -0.50% is very unlikely to spur growth further, at least based on the fact that it has not helped yet.

At the same time, the FOMC also has a wide range of opinions on display. Not only were there two hawkish dissents, there was a dovish one as well. And based on the dot plot, after this cut, there are now ten of the seventeen members who see no further rate action in 2019. Meanwhile, the market is still pricing in a 69% probability of a cut by the December meeting. There was a comment by a famous hedge fund trader that Chairman Powell is the weakest chairman in decades, based on these dissents, but it was just three years ago, in the September 2016 meeting when Janet Yellen chaired the Fed, that there were also three dissents at a meeting, with all three seeking a rate hike, while the Fed stood pat. The point is, it is probably a bit unfair to be claiming Powell is weak because some members have different views. And in the big picture, shouldn’t we want a diversity of ideas at the Fed? I think that would make for a healthier debate.

Two other meetings stand out, the BOJ and the PBOC, or at least actions by those banks stand out. While the BOJ left policy on hold officially, they not only promised a re-evaluation of the current monetary policy framework, but last night, they significantly reduced the amount of JGB’s that they purchased in the longer maturities. The absent ¥50 billion surprised market players and helped drive the yields on the back end higher by between 3-4bps. The BOJ have made it clear that they are interested in a steeper yield curve, and that’s just what they got. Their problem is that despite decades of ZIRP and then NIRP, as well as a massive QE program, their inflation target remains as far away as ever. Last night, for example, CPI was released at 0.5% Y/Y ex fresh food, the lowest level since mid-2017. It seems pretty clear that their actions have been a failure for decades and show no sign of changing. Perhaps they could use a little dissent!

Finally, the PBOC cut its 1-year Loan Prime Rate (its new monetary benchmark) by 5bps last night, the second consecutive cut and an indication that they are trying to add stimulus without inflating any financial bubbles. While this move was widely anticipated, they did not change the level of the 5-year Rate, which was also anticipated. The overall difference here, though, is that the PBOC is clearly far less concerned with what happens to investors than most Western central banks. After all, they explicitly take their marching orders from President Xi, so the overall scope of policy is out of their hands.

When looking at the impact of these moves, though, at least in the currency markets, the thrust was against the grain of what was desired by the central banks. If you recall last week, the euro initially declined, but then rallied sharply by the end of the day after the ECB meeting and has largely maintained those gains. Then yesterday we saw JPY strength, with no reprieve overnight after their change of stance, while the renminbi has actually strengthened 0.2% overnight in the wake of the rate cut. As I have been writing, central banks are slowly losing their grip on the markets, a situation which I believe to be healthy, but also one that will see increased volatility over time.

Looking at the market activity overnight, the screen shows that one of the best performers was INR, with the rupee gaining 0.5%. This comes on the back of the government’s announced $20 billion stimulus plan of corporate tax cuts. While equity markets there responded joyfully, Sensex +5.3%, government bonds fell sharply, with 10-year yields rising 15bps as bond investors questioned the ability of the government to run larger deficits. But away from that, the FX market was quite dull. EMG currencies saw both gainers and losers, with INR the biggest mover. G10 currencies were pretty much the same story with NZD the biggest mover, falling 0.4% after S&P explained that New Zealand banks still had funding problems.

The other two big stories have had mixed impact, with positive trade vibes being felt as low-level talks between the US and China have been ongoing this week, while the UK Supreme Court is now done with its hearings and we all simply await the decision. At the same time, EC President Juncker sounded positive that a Brexit deal could be done although Ireland continues to claim that nothing is close. The pound rallied on Juncker’s comments, but fell back below 1.25 after Ireland weighed in. Ask yourself if you think the rest of the EU will tolerate a solo Irish dissent on getting to a deal. It ain’t gonna happen.

As to today’s session, there is no data to be released but we will hear from three Fed speakers, Williams first thing, then Rosengren and Kaplan. It will be interesting to see how they try to spin things as to the Fed’s future activities. With that in mind, the biggest surprise seems like it can come from the UK , if we hear from the Supreme Court later today. While there is no clarity when they will rule, it is not out of the question. As to the dollar, it has no overall momentum and I see no reason for it to develop any without a catalyst.

Good luck and good weekend
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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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