Still Great Disorder

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

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

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

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

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

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

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

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

Good luck
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Toadies Galore

There once was a time in the past
When jobs like PM were a blast
With toadies galore
And laws you’d ignore
While scheming, all foes, to outlast

But these days when leading a nation
The role has outgrown bloviation
Consider Ms. May
Who just yesterday
Was subject to near ruination

Well, Brexit managed to not be the headline story for the several days between the time the current deal was tentatively agreed with the rest of the EU and the scheduled vote by the House of Commons to approve said deal. During that period, PM May made the rounds to try to sell her deal to the people of the UK. Alas, apparently she’s not a very good saleswoman. Under extreme duress, yesterday she indefinitely delayed the vote that was originally to be held this evening. Amid jeering from the floor of the House of Commons, she tried to make her case, but was singularly unable to do so. As has been the problem all along, the Irish border issue remains intractable with the opposing goals of separating the two nations legally and, more importantly, for customs purposes, while not installing a border between the two. As it currently stands, I will argue there is no compromise solution that is viable. One side is going to have to accept the other side’s demands and frankly, that doesn’t seem very likely. The upshot is that the market has once again begun to assume a no-deal Brexit with all the hyperbolic consequences that entails. And the pound? It was not a happy day if you were long as it fell 2% at its worst point, although only closed down by about 1.5%. This morning, it has regained a further 0.4%, but remains near its weakest levels since April 2017. Unless you believe in miracles (and in fairness there is no better time to do so than this time of year), my strong belief is the UK is going to exit the EU with nothing in place. The pound has further to fall, so hedgers beware.

Let’s pivot to the euro for a moment and discuss all the benefits of the single currency. First, there is the prospect of its third largest trading partner, the UK, leaving the fold and suddenly imposing tariffs on those exports. Next we have France literally on fire, as the gilets jaunes continue to run riot throughout the country while protesting President Macron’s mooted fuel tax increase. In the end, that seems to have been pulled and now he is offering tax cuts! Fiscal probity has been tossed aside in the name of political expediency. Thirdly, we have the ongoing Italian opera over the budget. The antiestablishment coalition government remains adamant that it is going to inject fiscal stimulus to the country, which is slipping into recession as we speak, but the EU powers-that-be are chuffed by the fact that the Italian budget doesn’t meet their criteria. In fact, those same powers continue down the road of seeking to impose fines on Italy for the audacity of trying to manage their own country. (Will someone please explain to me why when the French make outlandish promises that will expand their budget deficit, the EU remains mum, but when the Italians do so, it is an international crisis?)

At the same time as all of this is ongoing, the ECB is bound and determined to end QE this month and keeps talking about starting to normalize interest rates next autumn. Whistling past the graveyard anyone? When three of the four biggest nations in the EU are under significant duress, it seems impossible to consider that owning the euro is the best position. While it is clear that the situation in the US is not nearly as robust as had been believed just a month ago, and the Fed seems to be responding to that by softening their tone; at some point, the ECB is going to recognize that things in the Eurozone are also much worse, and that talk of tightening policy is going to fade from the scene. Rather, the discussion will be how large to make the new TLTRO loan program and what else can the ECB do to help support the economy since cutting rates seems out of the question given the starting point. None of that is priced into the market right now, and so as that unfolds, the euro will fall. However, in today’s session, the euro has recouped about half its losses from yesterday, rebounding by 0.4% after a more than 0.8% decline Monday. As much as there is a building discussion over the impending collapse of the dollar, it continues to seem to me that there are much bigger problems elsewhere in the world, which will help the dollar retain its haven status.

Away from those two stories, I would be remiss if I did not mention that the Reserve Bank of India’s widely respected governor, Urjit Patel, resigned suddenly Monday evening leading to a 1.5% decline in the rupee and a sharp fall in Indian equity markets Tuesday. But then, results from recent local elections seemed to shift toward the ruling BJP, instilling a bit more confidence that PM Modi will be able to be reelected next year. Given the perception of his market/business friendliness, that change precipitated a sharp reversal in markets with the rupee actually rallying 0.9% and Indian equity markets closing higher by 0.6%.

In fact, despite my warnings above, the dollar is under pressure across the board this morning while global equity markets are looking up. It seems there was a call between the US and China restarting the trade negotiation process, which was taken by investors as a sign that all would be well going forward. And while that is certainly encouraging, it seems a leap to believe a solution is at hand. However, there is no question the market is responding to that news as equity markets in Europe are all higher by between 1.0% and 2.0%, US equity futures are pointing to a 1% gain on the open, government bonds are softer across the board and the dollar is down. Even commodities are playing nice today with most rallying between 0.5%-1.0%. So everyone, RISK IS ON!!

Turning to the data story, first let me say that the euro has been helped by a better than expected German ZEW Index (-17.5 vs. exp -25), while the pound has benefitted from a modestly better than expected employment report, with Average earnings rising 3.3% and the Employment Change jumping 79K. At the same time, the NFIB Small Business Optimism Index was just released at a worse than expected 104.8, indicating that the peak may well be behind us in the US economy. At 8:30 we see PPI data (exp 2.5%, 2.6% core) however, that tends not to be a significant market mover. Rather, today is shaping up as a risk-on day and unless there is a change in the tone of the trade talks, there is no reason to believe that will change. Accordingly, for hedgers, take advantage of the pop in currencies as the big picture continues to point toward eventual further dollar strength.

Good luck
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A More Dovish Muse

The Chair of the Federal Reserve
For months has displayed steady nerve(s)
He’s gradually lifted
Fed Funds as he’s sifted
The data Fed members observe

But Friday brought more iffy news
And many now look for some clues
That Powell may soon
Abandon his tune
And search for a more dovish muse

Meanwhile o’er in Frankfurt they claim
That QE will end all the same
Though growth there is fading
There is no persuading
The Germans they’ll soon take the blame

The dollar started the Asian session on its back foot as market participants have jumped on the idea that softer employment data on Friday is going to prevent the Fed from maintaining their aggressive stance on monetary policy. And in fairness, we have already heard the first cracks in that story, as a number of Fed speakers were quite willing to admit that if the data slowed, they would not be as aggressive. However, the Fed is now in their blackout period, which means that we will not hear anything from them until they release their statement a week from Wednesday. In this market, that is an eternity with the ability for so much to happen and markets to move extraordinary distances.

As far as selling the dollar is concerned, I certainly understand the impulse given the clearly weaker US data and mildly more dovish tone of the latest comments last week. But the key thing to remember in the FX market is that everything is relative. And while US data is not as robust as it was just a few months ago, the same is true of both Eurozone and Japanese data, as well as Chinese and most EMG data. In fact, while the majority of participants continue to believe that the ECB is going to end QE on December 31st, and confirm that stance this week, there is a very big question mark regarding future European growth, especially in the event of a hard Brexit. Will the ECB have the guts ability to restart QE when inflation data suddenly starts to slide while Q4 GDP disappoints? And so while policy ease may be the proper response, having just ended their program they will be desperate to retain any credibility that they have left. At the end of the day, while the US economy appears to be slowing, it remains significantly brighter than the rest of the world. And that, eventually, is going to underpin the dollar. However, apparently not today.

Arguably, the biggest story this morning is the European Court of Justice’s ruling that the UK can unilaterally withdraw their Section 50 letter (the one where they officially declared they were leaving the EU). The upshot is the Bremainers feel there is new life and they can prevent the disastrous outcome of a hard Brexit. The one thing that seems clear, however, is that the Brexit deal, as currently negotiated, is likely to go down to defeat in the House of Commons in any vote. While that vote had been scheduled to occur tomorrow evening, just moments ago PM May took it off the agenda, with no alternative time scheduled. At the same time, her government reiterated that the UK is going through with Brexit as that was the result requested by the nation during the referendum. The FX market response to the latest histrionics has been to sell the pound. As I type, Sterling is lower by -0.45%, although that is also partially due to the fact that UK data was quite weak as well. For example, Construction Orders fell -30.7% in Q3, its worst performance since the depths of the great recession in 2009. IP fell -0.8% and GDP continues to edge along at a mere 0.1% monthly rate, having grown just 1.5% in the past year. It is becoming ever more clear that Brexit uncertainty is having a negative impact on the UK and by extension on the pound.

Away from the pound’s decline, though, the dollar is generally under pressure in the G10. For example, the euro has rallied 0.3% after modestly positive German trade and Italian IP data, although quite frankly, it seems more of a dollar negative than euro positive story. Bearing out the dollar weakness theme are the commodity currencies, with all three (AUD, CAD and NZD) firmer this morning despite declines across the board in energy, metals and agricultural prices.

Turning to the Emerging markets, the story is a little less anti-dollar as INR has fallen -0.7% after local elections added pressure to PM Modi’s political standing and called into question his ability to be reelected next year. In a more normal reaction to weaker commodity prices, both ZAR (-0.55%) and IDR (-0.5%) are suffering. At the same time, ongoing tensions regarding the US-China trade situation continue to weigh on KRW (-0.7%) and, not surprisingly, CNY (-0.5%). But away from those stories, the broad EMG theme is actually one of modest currency strength. Overall, it has been a mixed picture in the FX space.

Looking ahead to the data this week, with the UK vote now pulled from the calendar and Fed speakers absent, the market will look toward inflation data and Retail Sales for the latest clues on the economy.

Today JOLT’s Jobs Report 6.995M
Tuesday NFIB Small Biz Optimism 107.3
  PPI 0.0% (2.5% Y/Y)
  -ex food & energy 0.1% (2.6% Y/Y)
Wednesday CPI 0.0% (2.2% Y/Y)
  -ex food & energy 0.2% (2.2% Y/Y)
Thursday Initial Claims 225K
Friday Retail Sales 0.2%
  -ex autos 0.2%
  IP 0.3%
  Capacity Utilization 78.5%
  Business Inventories 0.5%

While the inflation data is important, the one thing that seems abundantly clear from recent Fed commentary is that they are unconcerned over the potential for inflation to run much higher. Instead, my sense is that they are going to be very focused on the potential first harbingers of a slowdown in the employment situation, where Initial Claims have ended their decade long decline and actually have started to rise. This is often seen as an early sign of potential economic weakness. But in the end, with the Fed quiet this week, I expect that we are going to be subject to much more foreign influence, with the ongoing Brexit situation driving the pound, the potential for a surprise from the ECB (which meets Thursday) and of course, the ongoing trade melee. In addition, we cannot forget the influence of equity markets, which continue to decline this morning after an abysmal week last week. In other words, there is plenty to drive markets this week, even absent the Fed, and for now, the dollar seems to be under pressure.

Good luck
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Headwinds Exist

Of late from the Fed we have heard
That “gradual” is the watchword
Though headwinds exist
The Fed will persist
Their rate hikes just won’t be deferred

It appears there is a pattern developing amongst the world’s central bankers. Despite increasing evidence that economic activity is slowing down, every one of them is continuing to back the gradual increase of base interest rates. Last week, Signor Draghi was clear in his assessment that recent economic headwinds were likely temporary and would not deter the ECB from ending QE on schedule and starting to raise rates next year. This week, so far, we have been treated to Fed speakers Charles Evans and Richard Clarida both explaining that the gradual increase of interest rates was still the appropriate policy despite indications that economic activity in the US is slowing. While both acknowledged the recent softer data, both were clear that the current policy trajectory of gradual rate hikes remained appropriate. Later this morning we will hear from Chairman Powell, but his recent statements have been exactly in line with those of Evans and Clarida. And finally, the Swedish Riksbank remains on track to raise rates next month despite the fact that recent economic data shows slowing growth and declining consumer and business confidence.

Interestingly, the San Francisco Fed just released a research paper explaining that inflation was NOT likely to rise significantly and that the increases earlier this year, which have been ebbing lately, were the result of acyclical factors. The paper continued that as those factors revert to more normal, historical levels, inflation was likely to fall back below the Fed’s 2.0% target. But despite their own research, there is no indication that the Fed is going to change their tune. In fact, the conundrum I see is that Powell’s Fed has become extremely data focused, seemingly willing to respond to short term movement in the numbers despite the fact that monetary policy works with a lag at least on the order of 6-12 months. In other words, even though the Fed is completely aware that their actions don’t really impact the data for upwards of a year, they are moving in the direction of making policy based on the idiosyncrasies of monthly numbers.

All this sounds like a recipe for some policy mistakes going forward. However, as I wrote two weeks ago, current attempts to normalize policy are very likely simply addressing previous policy mistakes. After all, the fact that pretty much every central bank in the G20 is seeking to ‘normalize’ monetary policy despite recent growth hiccups is indicative of the fact that they all realize their policies are in the wrong place for the end of the economic cycle. Belatedly, it seems they are beginning to understand that they will have very limited ability to address the next economic downturn, which I fear will occur much sooner than most pundits currently predict.

The reason I focus on the central banks is because of their outsized impact on the currency markets. After all, as I have written many times, the cyclical factor of relative interest rates continues to be one of the main drivers of FX movements. So as long as central banks are telling us that they are on a mission to raise rates, the real question becomes the relative speed with which they are adjusting policy and how much of that adjustment is already priced into the market. The reason that yesterday’s comments from Evans and Clarida are so important is that the market had begun pricing out rate hikes for 2019, with not quite two currently expected. However, if the Fed maintains its hawkish tone that implies the dollar has further room to rise.

Speaking of the dollar, despite the risk-on sentiment that has been evident in equity markets the past two sessions, the dollar continues to perform well. That sentiment seems to be driven by the idea that the Trump-Xi meeting on Saturday will produce some type of compromise and restart the trade talks. I am unwilling to handicap that outcome as forecasting this president’s actions has proven to be extremely difficult. We shall see.

Pivoting to the market today, the dollar is actually little changed this morning, with the largest G10 movement being a modest 0.3% rally in the pound Sterling. There are numerous articles describing the ongoing machinations in Parliament in the UK regarding the upcoming Brexit vote, and today’s view seems to be that something will pass. However, away from the pound, the G10 is trading within 10bps of yesterday’s close, although yesterday did see the dollar rally some 0.4% across the board. Yesterday’s US data showed that consumer confidence was slipping from record highs and that house prices were rising less rapidly than forecast, although still at a 5.1% clip. This morning brings the second look at Q3 GDP (exp 3.5%) as well as New Home Sales (575K) and the Goods Trade Balance (-$76.7B). However, Chairman Powell speaks at noon, and that should garner the bulk of the market’s attention. Until then, I anticipate very little price action in the FX markets, and truthfully in any market.

Good luck
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The Doves’ Greatest Friend

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

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

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

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

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

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

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

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

Good luck and good weekend
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Uncomfortably High

Said Carney, exhaling a sigh
The odds are “uncomfortably high”
More pain will we feel
If there is no deal
When England waves Europe bye-bye

Yesterday the BOE, in a unanimous decision, raised its base rate by 25bps. This outcome was widely expected by the markets and resulted in a very short-term boost for the pound. However, after the meeting, Governor Carney described the odds of the UK leaving the EU next March with no transition deal in hand as “uncomfortably high.” That was enough to spook markets and the pound sold off pretty aggressively afterwards, closing the day lower by 0.9%. And this morning, it has continued that trend, falling a further 0.2% and is now trading back below 1.30 again.

By this time, you are all well aware that I believe there will be no deal, and that the market response, as that becomes increasingly clear, will be to drive the pound still lower. In the months after the Brexit vote, January 2017 to be precise, the pound touched a low of 1.1986, but had risen fairly steadily since then until it peaked well above 1.40 in April of this year. However, we have been falling back since that time, as the prospects for a deal seem to have receded. The thing is, there is no evidence that points to any willingness to compromise among the Tory faithful and so it appears increasingly likely that no deal will be agreed by next March. Carney put the odds at 20%, personally I see them as at least 50% and probably higher than that. In the meantime, the combination of ongoing tightening by the Fed and Brexit uncertainty impacting the UK economy points to the pound falling further. Do not be surprised if we test those lows below 1.20 seen eighteen months ago.

This morning also brought news about the continuing slowdown in Eurozone growth as PMI data was released slightly softer than expected. French, German and therefore, not surprisingly, Eurozone Services data was all softer than expected, and in each case has continued the trend in evidence all year long. It is very clear that Eurozone growth peaked in Q4 2017 and despite Signor Draghi’s confidence that steady growth will lead inflation to rise to the ECB target of just below 2.0%, the evidence is pointing in the opposite direction. While the ECB may well stop QE by the end of the year, it appears that there will be no ability to raise rates at all in 2019, and if the current growth trajectory continues, perhaps in 2020 as well. Yesterday saw the euro decline 0.7%, amid a broad-based dollar rally. So far this morning, after an early extension of that move, it has rebounded slightly and now sits +0.1% on the day. But in the end, the euro, too, will remain under pressure from the combination of tighter Fed policy and a decreasing probability of the ECB ever matching that activity. We remain in the 1.1500-1.1800 trading range, which has existed since April, but as we push toward the lower end of that range, be prepared for a breakout.

Finally, the other mover of note overnight was CNY, with the renminbi falling to new lows for the move and testing 6.90. The currency has declined more than 8% since the middle of June as it has become increasingly clear that the PBOC is willing to allow it to adjust along with most other emerging market currencies. While the movement has been steady, it has not been disorderly, and as yet, there is no evidence that capital outflows are ramping up quickly, so it is hard to make the case the PBOC will step in anytime soon. And that is really the key; increases in capital outflows will be the issue that triggers any intervention. But while many pundits point to 7.00 as the level where that is expected to occur, given the still restrictive capital controls that exist there, it may take a much bigger decline to drive the process. With the Chinese economy slowing as well (last night’s Caixin Services PMI fell to 52.8, below expectations and continuing the declining trend this year) a weaker yuan remains one of China’s most important and effective policy tools. There is no reason for this trend to end soon and accordingly, I believe 7.50 is reasonable as a target in the medium term.

Turning to this morning’s payroll report, here are the current expectations:

Nonfarm Payrolls 190K
Private Payrolls 189K
Manufacturing Payrolls 22K
Unemployment Rate 3.9%
Average Hourly Earnings (AHE) 0.3% (2.7% Y/Y)
Average Weekly Hours 34.5
Trade Balance -$46.5B
ISM Non-Manufacturing 58.6

Wednesday’s ADP number was much stronger than expected at 213K, and the whisper number is now 205K for this morning. As long as this data set continues to show a strong labor market, and there is every indication it will do so, the only question regarding the Fed is how quickly they will be raising rates. All of this points to continued dollar strength going forward as the divergence between the US economy and the rest of the world continues. While increasing angst over trade may have a modest impact, we will need to see an actual increase in tariffs, like the mooted 25% on $200 billion in Chinese imports, to really affect the economy and perhaps change the Fed’s thinking. Until then, it is still a green light for dollar buyers.

Good luck and good weekend
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Is That Despair?

Forward guidance is
Kuroda-san’s newest hope
Or is that despair?

The BOJ has committed to keep the current extremely low levels for short- and long-term interest rates for an “extended period of time.” Many of you will recognize this phrase as Ben Bernanke’s iteration of forward guidance. This is the effort by central banks to explain to the market that even though rates cannot seemingly go any lower, they promise to prevent them from going higher for the foreseeable future. Alas, forward guidance is akin to Hotel California, from which, as The Eagles famously sang back in 1976, “you can check out but you can never leave.” As the Fed found out, and the ECB will learn once they finally end QE (assuming they actually do so), changing tack once you have promised zero rates forever can have market ramifications. The first indication that forward guidance might be a problem came with the ‘taper tantrum’ in 2013, but I’m confident it won’t be the last.

However, for the BOJ, now trumps the future, and they needed to do something now. But forward guidance was not the only thing they added last night. It was the cover for their attempts to adjust policy without actually tightening. So, yield curve control now has a +/- 20bp range around 0.0% for the 10-year JGB, double the previous level, and thus somewhat more flexible. And they reduced the amount of reserves subject to the -0.10% deposit rate in order to alleviate some of the local banks’ profit issues. In the end, their commitment to maintaining zero interest rates for that extended period of time was sufficient for FX traders to sell the yen (it fell -0.40%), and JGB yields actually fell a few bps, closing at 0.065%, which is down from 0.11% ahead of the meeting. All in all, I guess the BOJ did a good job last night.

There is, however, one other thing to mention, and that is they reduced their own inflation forecasts (to 1.1% in 2019, 1.5% in 2020 and 1.6% in 2021) for the next three years, indicating that even they don’t expect to achieve that elusive 2.0% target before 2022 at the earliest. In the end, the BOJ will continue to buy JGB’s and equity ETF’s and unless there is a substantial acceleration in global growth, (something which seems increasingly unlikely) they will continue to miss their inflation target for a very long time. As to the yen, I expect that while it fell a bit last night, it is still likely to drift higher over time.

In Europe the story is still
That growth there is starting to chill
The data last night
Did naught to delight
Poor Mario, testing his will

Beyond the BOJ, and ahead of the FOMC announcement tomorrow, the major news was from the Eurozone where GDP and Inflation data was released. What we learned was that, on the whole, growth continued to slow while inflation edged higher than expected. Eurozone GDP rose 0.3% in Q2, its slowest pace in a year, while headline inflation rose 2.1%, its fastest rate since early 2013. Of course the latter was predicated on higher energy prices with core CPI rising only 1.1%, still a long way from the ECB’s target. The point is that given the slowing growth trajectory in the Eurozone, it seems that Draghi’s confidence in faster growth causing inflation to pick up on the continent may be unwarranted. But that remains the official line, and it appears that the FX market has accepted it as gospel as the euro has traded higher for a third consecutive day (+0.3%) and is now back in the top half of its trading range. If Q3 growth continues the trajectory that Q2 has extended, it will call into question whether the ECB can stop buying bonds, or at the very least, just how long rates will remain at -0.4%, with those looking for a September 2019 rate hike sure to be disappointed.

There is one country in Europe, however, that is performing well, Sweden. GDP growth there surprised the market yesterday, rising 1.0% in Q2 and 3.3% Y/Y. This has encouraged speculation that the Riksbank will be raising rates fairly soon and supported the krone, which has rallied 1.0% since the announcement.

The final piece of news to discuss from last night was from China, where the PMI readings all fell below expectations. The official Manufacturing data was released at 51.2, down from last month’s 51.5 and the third consecutive monthly decline. The non-manufacturing number fell to 54.0, its weakest print since October 2016. These are the first data from China that include the impact of the US tariffs, and so are an indication that the Chinese economy is feeling some effects. I expect that the government there will add more stimulus to offset any more severe impact, but that will simply further complicate their efforts at reducing excess leverage in the economy. Meanwhile, the renminbi slid 0.25% overnight.

This morning’s data releases bring us Personal Income (exp 0.4%), Personal Spending (0.4%) and PCE (2.3% headline, 2.0% core), as well as the Case-Shiller Home price index (6.4%), Chicago PMI (62.0) and Consumer Confidence (126.0). In other words, there is much for us to learn about the economy. While I believe the PCE data could be market moving, especially if it is stronger than expected, I continue to believe that traders and investors remain far more focused on Friday’s payroll report than this data. Recent weakness in equity markets has some folks on edge, although futures this morning look benign. But if we do see that weakness continue, the chances of a full-blown risk off scenario materializing will grow substantially. And that means, the dollar has the potential to rally quite sharply. Keep that in mind as a tail risk, one where the tail grows fatter each day that equity markets disappoint.

Good luck
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