Tag Archives: #ECB

Growth Will Soon Sleep

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The place with less people than sheep
Last night said rates might be too steep
A cut now seems fated
Their dollar deflated
As Kiwis fear growth soon will sleep

You can tell it’s a dull day in the FX markets when the most interesting thing that happened was the RBNZ turned dovish in their policy statement, indicating the next interest rate move in New Zealand would be lower. This was a decided change of pace, but also cannot be too great a surprise since their larger neighbor, Australia, pivoted the same way just two weeks ago. The upshot is NZD fell sharply, down 1.4% in the wake of the statement. While I understand that given the diminutive size of the New Zealand economy, any exposures there are likely to be quite small, I think this simply reinforces the story about slowing global growth. In the same vein, we heard a similar story from Bank Negara Malaysia as they lowered their growth and inflation forecasts and hinted that they will cut rates if they see things slowing too rapidly. While the impact on MYR was less impressive, just -0.25%, it is of a piece with the overall global economic situation. That story remains one of slowing growth with central banks hopeful the slowdown is temporary but prepared to react quickly if it appears longer lasting. As I wrote yesterday, it is virtually impossible for the Fed to be responding to slowing growth without every other major central bank (and many minor ones) reacting in the same manner.

Yesterday actually saw the dollar rally during the US session, with the euro falling about 0.4% in NY hours. That helps explain why this morning it is higher by 0.15% on the session, yet lower than when I wrote yesterday. There has been limited new information on the data front (Italian Business Confidence falling more than expected to 100.8), but there has been a widely reported story about Signor Draghi hinting that the ECB is beginning to recognize that five years of negative interest rates might be having some negative impacts on the Eurozone banking sector. It certainly would have been hard to predict that an economic area that heavily relies on bank lending, rather than capital markets, would feel negative impacts from compression of bank lending margins…NOT! But back when NIRP was taking shape, the apocalyptic fears were so great these issues were simply glossed over as meaningless. And now that Eurozone growth has turned lower, the ECB’s plans to normalize rates have fallen by the wayside. It is quite possible that they, too, have painted themselves into an intractable policy corner. It is yet another reason I remain long-term bearish on the euro.

Finally, this morning’s dose of Brexit shows that the hardline euro skeptics may be coming around to PM May’s deal after all. If you recall, this afternoon there will be a series of votes in Parliament as MP’s try to find a solution, mostly to the Irish border question. However, as I have written frequently in the past, this is a truly intractable issue, one where there is no compromise available, but only capitulation on one side or the other. However, there is a growing call for Brexit to be canceled which has the euro skeptics on edge. This line of thought seems to have been PM May’s when she called for a third vote on her plan, and it may well be falling into place. Of course, the caveat for her is that she may be asked required to step down from her role in order to get it over the line. The two alternatives to her plan are now clearly either a lengthy delay, one giving time for a second vote and a reversal of Brexit, or a no-deal outcome on April 12. Since nobody seems to want the latter, and the hard-liners don’t want the former, they may finally get the votes to approve May’s deal. It is the “least worst option” as so delicately put by Jacob Rees-Mogg, one of the leaders of the euro skeptics. Given the toing and froing over the issue, it should be no surprise that the pound is little changed on the day, still hanging around 1.32 as nobody is prepared to take a position on the outcome. If pressed, I would estimate that a vote for the deal will result in the pound rallying toward 1.38 before running into significant selling, while a no-deal outcome probably sees a quick move toward 1.20. And if the result of today’s Parliamentary votes leads toward a long delay, that is likely the pound’s best friend, perhaps driving the beleaguered currency back above 1.40 for a while.

Away from that, the only other noteworthy feature today has been weakness in some oil related currencies with MXN (-1.0%), RUB (-0.75%), NOK (-0.55%) and CAD (-0.25%) all softer. It appears that after a strong run, oil prices are ebbing back somewhat, and these currencies are feeling the brunt today. Quite frankly, the currency movements seem overdone relative to the oil price decline, but it is the only connector I can find across this group.

On the data front, yesterday’s Housing Starts number was quite weak, just 1.162M (exp 1.213M) as was the Consumer Confidence reading at 124.1. We also heard from several other Fed speakers (Kaplan and Daly) both telling us that patience remains a virtue and that while they had modest concern over the yield curve inversion, it wasn’t a game changer for their current policy models. This morning’s only data point is the Trade Balance (exp -$57.0B) and then we hear from KC Fed President Esther George this evening. I am hard pressed to find a change in market sentiment at this point and so hard pressed to change my views. The equity market continues to rally based on more easy money, but monetary policy around the world continues to turn easier and easier, with the Fed still the least tight of them all. In other words, to me, the dollar still has the best position.

Good luck
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Doublespeak

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The sitting Prime Minister, May
Heard terrible news yesterday
Her plan to promote
A Brexit deal vote
Was halted much to her dismay

This forces her, later this week
A longer extension to seek
But still the EU
Seems unlikely to
Do more than add new doublespeak

In yet another twist to the Brexit saga, the Speaker of the House of Commons, John Bercow, refused to allow another vote on PM May’s deal this week. He explained that Parliamentary rules since 1604 have existed to prevent a second vote on a bill that has already been rejected unless there have been substantial changes to the bill. In this case there were no changes and PM May was simply trying to force approval based on the idea that the clock was running out of time. The pound reacted to the news yesterday by quickly dropping 0.5%, although it has since recouped 0.2% this morning.

This has put the PM in a difficult spot as she prepares to travel to the EU council meeting in Brussels later this week. Given that there is still no clarity on how the UK wants to handle things, or at least how Parliament wants to handle things, she will need to seek an extension in order to avoid a no-deal Brexit. However, the comments from several EU members, notably Germany and France, have indicated they need some sense of direction as to what the UK wants before they will agree to that extension. Remember, too, it requires a unanimous vote by the other 27 members of the EU to grant any extension. At this stage, the market is virtually certain an extension will be granted, at least based on the fact that the pound remains little changed on the day and has been able to maintain its modest gains this year. And it is probably a fair bet that an extension will be granted. But the real question is what the UK will do with the time. As of now, there is no clarity on that at all. Unless the EU is willing to change the deal, which seems unlikely, then we are probably heading for either a new general election or a new Brexit referendum, or both. Neither of these will add certainty, although the predominant view is that a new referendum will result in a decision to stay. Do not, however, ignore the risk that through Parliamentary incompetence, next week the UK exits without a deal. That risk remains very real.

One side note on the UK is that employment data released this morning continues to beat all estimates. Wages continue to rise (+3.4%) and the Unemployment Rate fell further to 3.9%. Despite a slowing economy overall, that has been one consistent positive. It has been data like this that has helped the pound maintain those gains this year.

Elsewhere the global growth story continues to suffer overall, as both China and the Eurozone continue to lag. While there was no new data from China, we did see the German ZEW survey (-3.6 up from -13.4) and the Eurozone version as well (-2.5 up from -16.6). However, at the same time, the Bundesbank just reduced their forecast for German GDP in 2019 to 0.6%, although they see a rebound to 1.7% in 2020. My point is that though things may have stopped deteriorating rapidly, they have not yet started to show a significant rebound. And it is this dearth of economic strength that will continue to prevent the ECB from tightening policy at all for quite a while to come.

A quick glance Down Under shows that optimism in the lucky country is starting to wane. Three-year Australian government bonds have seen their yield fall to 1.495%, just below the overnight rate and inverting the front of the curve there. This calls into question the RBA’s insistence that the next move will be an eventual rate hike. Rather, the market is now pricing in almost two full rate cuts this year as Australia continues to suffer from the slowing growth in China, and the world overall. While the FX impact today has been muted, just a -0.1% decline, Aussie continues to lag vs. other currencies against a dollar that has been on its back foot lately.

Speaking of the dollar, tomorrow, of course, we hear from the Fed, with a new set of economic projections and a new Dot Plot. Since there is no chance they move rates, I continue to expect the market to be focused on the balance sheet discussion. This discussion is not merely about the size of the balance sheet, and when they stop shrinking it, but also the composition and general tenor of the assets they hold. Remember, prior to the financial crisis and the utilization of QE, the Fed generally owned just short-term T-bills and maybe T-notes out to three years. But as part of their monetary policy experiment, they extended the maturities of their holdings with the average maturity now nine years. This compares to the six-year average maturity of the entire government bond issuance. The longer this average tenor, the more monetary ease they are providing to the market, so the question they need to answer is do they want to maintain that ease now or try to shorten the current maturity, so they have the opportunity to use that policy in a time of greater need. While this remains up in the air right now, whatever decision is made it will give a strong clue into the Fed’s view of the current situation and just how strongly the economy is actually performing.

This morning’s Factory Orders data (exp 0.3%) is unlikely to have a market impact of any sort. Equity markets have been muted with US futures pointing to essentially an unchanged opening. Yesterday saw limited price action, with both the dollar and equities barely changed. My sense is today will shape up the same way. Tomorrow, however, will be a different story, of that you can be sure.

Good luck
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It All Went to Hell

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First Mario cooed like a dove
Then trade data gave things a shove
It all went to hell
As stock markets fell
While folks showed the dollar some love

It was a rocky day in markets yesterday as risk appetite was severely impaired. The ECB wound up being more dovish than many had expected by extending the guidance on interest rates and definitively rolling over the TLTRO program. And yet, this morning many analysts are complaining they didn’t do enough! The details are that interest rates will now remain where they are (-0.4% deposit rate) until at least the end of the year, well past “through the summer” as the guidance had been previously. Of course, for some time now, my own view has been that rates will remain unchanged well into 2020. In addition, the ECB said that there would be a new round of TLTRO’s initiated in September, but that the maturity of these new loans would only be two years, and the terms are not yet decided, with some indications they may not be as favorable as the current crop.

All of this followed in the wake of the ECB revising lower their 2019 GDP growth forecast from 1.7% to 1.1%. But remember, the OECD is looking for even slower growth at just 1.0%. “We never thought we were behind the curve,” said Signor Draghi, and “in any event today we are not behind the curve, for sure.” These comments are not nearly as impactful as “whatever it takes” from 2012, that’s the only thing for sure! Several other ECB members were quick to express that there was no expectation of a recession this year, but the market seems to have a less positive view. The market response to the surprisingly increased dovishness was negative across the board, with equity markets selling off in Europe (~-0.6%) and the US (-0.8%) while government bonds rallied (Treasuries -4.5bps) and the dollar strengthened materially, rising 1.2% vs. the euro.

But wait, there’s more! Overnight, Chinese trade data was released, and it turns out that exports fell -20.7% from a year ago! Now, in fairness, part of this has to do with the timing of the Chinese New Year, which was earlier this year than last, but even when stripped out of the data, the underlying trend showed a -4.7% decline. It appears that the US tariffs are really starting to bite.

Adding to the negative China sentiment were two more things. First, comments by Terry Branstad, the US ambassador to China, indicated that a trade deal was not so close (shocking!) and that the mooted meeting between President’s Trump and Xi later this month may well be postponed further. Second, in a huge surprise to Chinese investors, China Citic Securities issued a sell rating on one of the most popular stocks in the market there. The immediate response was for that particular stock, People’s Insurance Company (Group) of China, a state-owned insurer, to fall the daily 10% limit. This led the way for the Shanghai Index to fall 4.4% as investors now believe that the Chinese government is not merely willing to see equity markets fall, but actually interested in having it occur as they try to deflate the bubble that blew up during the past several months.

Needless to say, this information did not help assuage investor feelings anywhere, with the rest of Asia suffering on the day (Nikkei -2.0%, Hang Seng -1.9%) while Europe is also going down that road with the Stoxx 600 currently lower by -0.8%. And US futures? They too are under pressure, -0.4% as I type following yesterday’s -0.8% declines. [As an aside, can someone please explain to me why global index purveyors like MSCI are willing to include Chinese shares in their indices? Given the clear government market manipulation that exists there, as well as the foreign investment restrictions, the idea that they represent a true valuation of a company is laughable.]

So that is the backdrop as we head into the US session with employment data the first thing we’ll see. Expectations are currently as follows:

Nonfarm Payrolls 180K
Private Payrolls 170K
Manufacturing Payrolls 11K
Unemployment Rate 3.9%
Average Hourly Earnings 0.3% (3.3% Y/Y)
Average Weekly Hours 34.5
Housing Starts 1.197M
Building Permits 1.289M

The data of late has pretty consistently shown the US economy holding its own relative to everywhere else in the world. Meeting expectations today would simply reinforce that view. Now, Fed speakers this week (Brainerd, Williams and Clarida) have been consistent in their comments that given the current situation and outlook, there is no need to raise rates further. And yet, that is still relatively hawkish compared to the ECB who has actually added more stimulus. Chairman Powell speaks this afternoon as well, but it would be remarkable if he were to change the message. In the end, the relative story remains the same; the US is still the best performing economy (although it is showing signs of slowing) and the dollar is likely to continue to benefit from that reality.

Good luck and good weekend
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Mario’s Turn

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It’s Mario’s turn to explain
Why rates should start rising again
His problem, of course
Is he can’t endorse
A rise if it leads to more pain

Markets have been quiet overnight as traders and investors await the ECB’s policy statement, and then perhaps more importantly, Signor Draghi’s press conference to be held at 8:30 this morning. The word filtering out from the ECB is that the TLTRO discussion has moved beyond the stage of IF they need to be rolled over to the stage of HOW exactly they should construct the process. Yesterday’s OECD downgrade of Eurozone growth is likely the last straw for the more hawkish ECB members, notably Germany, Austria and the Netherlands. This is especially so given the OECD slashed their forecasts for German growth by 0.8%! As it happens, Eurozone GDP data was released this morning, and it did nothing to help the monetary hawks’ cause with Q4’s estimate revised lower to 1.1% Y/Y. While the FX market has shown little overall movement ahead of the ECB meeting, European government bonds have been rallying with Italy, the country likely to take up the largest share of the new TLTRO’s, seeing the biggest gains (yield declines) of all.

Once again, the juxtaposition of the strength of the US economy and the ongoing weakness in the Eurozone continues to argue for further gradual strength in the dollar. That US strength was reaffirmed yesterday by the much higher than expected trade deficit (lots more imports due to strong demand) as well as the ADP Employment report, which not only saw its monthly number meet expectations, but showed a massive revision to the previous month, up to 300K from the initial 213K reported. So, for all the dollar bears out there, please explain the drivers for a weaker dollar. While the Fed has definitely turned far less hawkish, so has every other central bank. FX continues to be a two-sided game with relative changes the key drivers. A more dovish ECB, and that is almost certainly what we are going to see this morning, is more than sufficient to undermine any long-term strength in the euro.

Beyond the ECB meeting, however, the storylines remain largely the same, and there has been little movement in any of the major ones. For example, the Brexit deadline is drawing ever closer without any indication that a solution is at hand. Word from the EU is that they are reluctant to compromise because they don’t believe it will be sufficient to get a deal over the line. As to PM May, she is becoming more explicit with her internal threats that if the euroskeptics don’t support her deal, they will be much less pleased with the ultimate outcome as she presupposes another referendum that will vote to Remain. The pound continues to struggle in the wake of this uncertainty, falling another 0.25% overnight which simply indicates that despite all the talk of the horror of a no-deal Brexit, there is a growing probability it may just turn out that way.

Looking at the US-China trade talks, there has been no word since Sunday night’s WSJ story that said the two sides were moving closer to a deal. The trade data released yesterday morning was certainly significant but is really a reflection of the current global macroeconomic situation, namely that the US economy continues to be the strongest in the world and continues to absorb a significant amount of imports. At the same time, weakness elsewhere has manifested itself in reduced demand for US exports. In addition, there was probably some impact from US importers stuffing the channel ahead of worries over increased tariffs. With that concern now dismissed after the US officially stated there would be no further tariff increases for now, channel stuffing is likely to end, or at least slow significantly. Given the lack of information regarding the status of the trade talks, there is no way to evaluate their progress. The political imperatives on both sides remain strong, but there are some very difficult issues that have yet to be addressed adequately. In the meantime, the reniminbi has been biding its time having stabilized over the past two weeks after a 3.0% rally during the previous three months. That stability was evident overnight as it is essentially unchanged on the day.

Beyond those stories there is precious little to discuss today. There is a bit of US data with Initial Claims (exp 225K) along with Nonfarm Productivity (+1.6%) and Unit Labor Costs (+1.6%) all released this morning. In addition, we hear from Fed governor Brainerd (a known dove) early this afternoon. But those things don’t seem likely to be FX drivers today. Rather, it is all about Signor Draghi and his comments. The one other thing to note is that risk appetite in markets, in general, has been ebbing of late. US Equities have fallen in six of the past eight sessions and futures are pointing lower again. The same has largely been true throughout Europe, where markets are lower this morning by roughly 0.4%. fear is a growing factor in markets overall, and as we all know by now, both the dollar and the yen are the main FX beneficiaries in that scenario. It feels like the dollar has room to edge higher today, unless Draghi is quite hawkish. And that is a low probability outcome!

Good luck
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A Little Less Clear

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In China, the outcome this year
For growth is a little less clear
The target has changed
To feature a range
That’s lower, but still not austere

The Chinese have reduced their target rate of GDP growth to a range of 6.0%-6.5% from last year’s “about 6.5%” goal. It is, of course, unsurprising that the Chinese met last year’s goal, on paper, as despite significant evidence from individual economic data points, given the lack of independence of the Chinese statistics agency and the political imperative for President Xi to be seen as a great economic leader, 6.6% was determined to be the appropriate representation in 2018. However, given the fact that the growth trajectory in China has been slowing steadily for the past decade, and adding the fact that global growth continues to slow, it seems that even the mighty Chinese bureaucracy can no longer be certain of a particular outcome, hence the range. There is a large group that remains skeptical of the veracity of Chinese data (myself included), and the ongoing gradual reduction in forecasts that we have seen during the past several years simply reinforces the idea that previous data was too rosy.

At the same time, further fiscal stimulus was announced with a cut in VAT and more infrastructure spending, so for now, China remains focused on fiscal support rather than adding more monetary ease and potentially reflating the credit bubble they have spent the last two years trying to deflate. Much of this forecast, naturally, depends on a successful conclusion to the trade talks with the US, and while Sunday night there was a report indicating the deal is almost done, it is not done yet. If, in fact, the mooted deal falls through, look for analyst revisions lower and even government guidance toward the lower end of this range.

As to the renminbi, China has pledged to maintain a stable currency, although they have not indicated exactly what the benchmark for stability will be. This remains a key focus for President Trump and is ostensibly part of the nascent trade agreement. While I believe that economic pressures would naturally tend toward a weaker renminbi over time, as I had forecast at the beginning of the year, the one thing I know is that if the Chinese choose to strengthen the currency in the short run, regardless of the macroeconomic factors that may exist, they will be able to do so. Wall Street analysts are slowly adjusting their forecasts toward a stronger CNY this year, and if a trade agreement is reached, that seems exactly correct. Of course, if the talks founder, all bets are off.

Meanwhile, one week before PM May is set to have another Parliamentary vote on her Brexit deal, she continues to try to get a modification to the terms of the Irish backstop. Uncertainty remains high as to the actual outcome, but it appears to me that either the deal, as written and newly interpreted, will squeak through, resulting in a short delay in order that all sides can pass the appropriate legislation, or the deal will fail and Parliament will vote to ask for a 6-9 month delay with the intent of having a new referendum. While there is still a chance that the UK leaves without a deal at the end of the month, it does seem to be a very small chance. With that in mind, a look at the pound, which has fallen ~1.5% in the past week (-0.15% overnight), and it appears that we are witnessing another ‘buy the rumor, sell the news’ outcome. As hopes grew that there would be no hard Brexit, the pound steadily rallied for a number of weeks. I have maintained that even a positive outcome has only limited further potential upside given the UK economy remains mired in a slowdown and their largest trading partner, the EU, is slowing even more rapidly. Don’t be surprised to see the pound jump initially on a positive vote next week, but it will be short-lived, mark my words.

Pivoting to the euro, this morning’s Services PMI data was mildly better than the flash projections of two weeks ago. The current market interpretation is that the slowdown in the Eurozone has stabilized. And while that may be true for the moment, it is in no way clear the future portends a resumption in growth. Meanwhile, the euro has continued its recent drift lower, with a very modest decline this morning, just 5bps, but approaching a 1% decline in the past week. The ongoing discussion about the ECB is focused on exactly what tools they have available in the event that the slowdown proves more long-lasting than currently hoped expected. I continue to believe that TLTRO’s will be rolled over with an announcement by June, but after that, the cupboard is bare. Pushing rates to an even more negative level will be counterproductive as the negative impact on banks will almost certainly curtail their lending activity. And restarting QE just months after they ended it would be seen as an indication the ECB has no idea what is going on in the Eurozone economy. Therefore, though Signor Draghi will be reluctant to discuss much about this on Thursday at his press conference, pressure on the ECB will increase when they lower their growth and inflation forecasts further. Look for the euro to continue to drift slowly lower and talk of TLTRO’s to increase.

Last night the RBA left rates on hold, which was universally expected, but the market continues to expect an eventual reduction in the overnight interest rate Down Under. The housing market bubble has been rapidly deflating, and while employment has so far held up, remember employment is a lagging indicator. With that in mind, it is not surprising that AUD has fallen -0.25% overnight, and I think the underlying trend will still point lower. This is especially true if the US-China trade talks falter given China’s status as Australia’s largest trading counterparty. Slowing growth in China means slowing growth in Australia, count on it.

As can be seen from these discussions, the dollar is modestly higher overall this morning, although movement in any given currency has been fairly small. While President Trump continues to decry the dollar’s strength, the US remains the only large economy that is not slowing sharply. And as I have written consistently, with the Fed’s clear stance that further tightening is off the table, you can be sure that no other central bank will be looking to tighten policy anytime ahead of the Fed. The president will not get satisfaction on this front anytime soon.

Turning to this morning’s data, we see ISM Non-Manufacturing (exp 57.3) and New Home Sales (600K). We also hear from Fed uber-dove Neel Kashkari, but now that the Fed has turned dovish overall, it is not clear that he can say much that will alter impressions in the market. While throughout February, the dollar was on its back foot, taking a step back shows that it has been range trading since last October. Given the recent data situation, as well as the sentiment shifts we have seen, it does appear that the dollar can grind back toward the top of that trading range (think of the euro at 1.1200), but we are still lacking a catalyst for a substantial change.

Good luck
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A Lack of Pizzazz

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This week, central banks, numb’ring three
Released information that we
Interpreted as
A lack of pizzazz
So, don’t look for tight policy

Yesterday’s release of the ECB Minutes from their January meeting didn’t garner nearly as much press as the FOMC Minutes on Wednesday. However, they are still important. The topic du jour was the analysis necessary to help them determine if rolling over the TLTRO’s was the appropriate policy going forward. Not surprisingly, the hawks on the committee, like Austria’s Ewald Nowotny, said there is no hurry and a decision doesn’t need to be taken until June when the first of these loans fall below twelve months in their remaining term. I am pretty sure that he is against adding any more stimulus at all. At the same time, given the recession in Italy and slowing growth picture throughout Germany and France, and given that Italian and French banks had been the first and third most active users of the financing, in the end, the ECB cannot afford to let them lapse. I remain 100% convinced that these loans will be rolled over in an effort to ‘avoid tightening financial conditions’, not in order to ease them further. However, the market impact of the Minutes was muted at best, as has been this morning’s data releases; one confirming that German GDP was flat in Q4, and more importantly, the decline in the Ifo Business Climate indicator to 98.5, its lowest level in four years. Meanwhile, Eurozone inflation remains absent from the discussion with January’s data confirmed to have declined to a 1.4% Y/Y rise. Nothing in this data indicates the ECB will tighten policy in 2019, and quite frankly, I would be shocked to see them move in 2020 as well.

The other central bank information of note was the Bank of Canada, where Governor Poloz spoke in Montreal and explained that while the current policy setting (base rates are 1.75%) remain below their range of estimates of the neutral rate (2.5%-3.5%), current conditions dictate that there is no hurry to tighten further, especially with the ongoing uncertainty emanating from the US and the overall global trade situation. So here is another central bank that had been talking up the tightening process and has now backed away.

In virtually every case, the central banks continue to hang their hats on the employment market’s strength, and the idea that a tight jobs market will lead to higher wages, and thus higher inflation. The thing is, this Phillips Curve model has two flaws; first it only relates lower unemployment to higher wages, not higher general inflation; and second, it is based on an analysis of the UK from 1861-1957, which may not actually be a relevant timeline compared to the global economy in 2019. And one other thing to remember is that employment is a lagging indicator with respect to economic signals. This means that it is backward looking and has been demonstrated to have limited predictive power. My point is that despite a clearly strong employment situation, it is still entirely possible that global growth can slow much further and much more quickly than policymakers would have you believe.

Back to the currency markets, the upshot of all the new information was that traders have essentially left both the euro and the Loonie unchanged for the past two days. In fact, they have left most currencies that way. This morning’s largest G10 mover is the pound, which just recently has extended its losses to -0.40% after it became clear that the EU was NOT going to make any concessions regarding the backstop issue as had been believed just yesterday. The latest story is that the UK is going to ask for a three-month extension, which is likely to be granted. The thing is, the problem is not going to get any easier to solve in three months’ time than it is now. This will simply extend the time of uncertainty.

Of course, the other story is the trade talks and the positive spin that we continue to hear despite the information that there remain wide differences on key issues like enforcement of any deals as well as the speed with which the Chinese are willing to open up their markets. It is all well and good for the Chinese to say they will buy more corn, or more soybeans or more oil, but while nice, those pledges don’t address the question of IP protection and state subsidies. I remain concerned that any deal, if it is brokered, will be much less impactful than is claimed. And it is quite possible that the US will not remove any of the current tariffs until they have validation that the Chinese have upheld their side of any deal. I feel like the market is far too optimistic on this subject, but then again, I am a cynic.

While FX markets have been slow to respond to these stories, we continue to see equity markets wholeheartedly embrace the idea that a deal is coming soon and there is no reason to worry. Last night, Chinese equity markets rallied sharply (Shanghai +1.9%), although the Nikkei actually slipped -0.2%. European markets this morning are higher by around 0.4%-0.5%, as they, too, seem bullish on the trade picture. Certainly, it is not based on the economic picture in the Eurozone.

But as we have seen for the past several weeks, central banks, Brexit and trade are the only stories that matter. Right now, investors and traders are giving mixed signals, with the equity markets feeling positive, but currency and bond markets much less so. My money is on the bond market vs. the stock market as having correctly analyzed the situation.

Good luck and good weekend
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The Hawks Will Oppose

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As growth there continually slows
The ECB already knows
More policy ease
Will certainly please
The doves, though the hawks will oppose

If you manage to get past Brexit and the US-China trade talks, there are two other themes that are clearly dominating recent economic discussions. The first is the slowing of global growth based on what has been an increasingly long run of disappointing data around the world. Granted part of this is attributed to the ongoing uncertainty over the Brexit outcome, and part of this is attributed to the ongoing uncertainty over the trade talks. But there seems to be a growing likelihood that slowing growth is organic. By that I mean that even without either Brexit or the questions over trade, growth would be slowing. Virtually every day we either see weaker than expected data, or we hear from central bankers that they are closely watching the data to insure their policies are appropriate.

The recent change has been the plethora of those central bankers who are highlighting the weak data and the need to reevaluate what had been tightening impulses. In the past several days we have heard that message from SF Fed President Daly, ECB member Coeuré and ECB member Villeroy, all of whom have pointed out that raising rates no longer seems appropriate. What has been more surprising is that the more hawkish central bankers (Mester and George in the US, Weidmann and Nowotny at the ECB) have not pushed back at all, and instead have subtly nodded their heads in agreement. At this point, my gut tells me that the probability of another rate hike this year by any major central bank is near zero.

This observation leads to the other story which continues to gain ground, with yet another WSJ story on the subject this morning, MMT. Modern Monetary Theory, you may recall, is the post-hoc rationalization that limiting government spending because of silly things like debt and deficits is not merely unnecessary, but actually ‘immoral’ if that spending could be used for benefits like free college tuition or free healthcare for all or a minimum basic wage. It seems that MMT is set to overturn 250 years of economic analysis and upend simple things like supply and demand. The frightening thing about this discussion is that it is being taken very seriously at the highest political levels on both sides of the aisle, which implies to me that we are going to see some changes in the law within the next few years. After all, what politician doesn’t love the idea that they can spend on every harebrained idea and not have to worry about funding it through tax revenues. The guns and butter approach is every elected official’s dream. Borrowing ceilings? Bah, why bother. Deficits growing to 10% or more of GDP? No big deal! The Fed can simply print the money to pay for things and there is no consequence!

Granted, I don’t have 250 years of experience myself, but I do have over 35 years of market experience, and I disagree that there will be no consequences. This time is never different, only the rationales for bad actions change. Ultimately, the question of importance from an FX perspective is, how will currency markets be impacted by these policies? The answer is it will depend on the sequence of timing as different countries adopt them, but I would expect things to go something like this for every country:

Explicit MMT adoption will lead to currency strength as expectations of faster growth will lead to investment inflows. Currency strength will have two results, first MMT proponents will initially claim that the old way of thinking about the economy has been all wrong given that increased supply will lead to a higher priced currency. But the second outcome, which will take a little longer to become evident, will be an increase in inflation and destruction of corporate earnings, both of which will lead to a decided outflow of investment and a much weaker currency. At that point, the available options will be to raise interest rates (leading to recession) or raise taxes (leading to recession). Transitioning from massive fiscal and monetary stimulus, to neither will have a devastating impact on an economy. I only hope that the proponents of this lunacy are held to account during those dark days, but I doubt that will happen.

However, despite my fears that this will occur much sooner than anyone currently expects, it will not be policy this year. Alas, leading up to the 2020 presidential elections, it may look like a good call for Mr. Trump next year.

Let’s move back to today’s markets. After another strong session on Friday, the dollar has given back some of those gains this morning. Friday’s move was on the back of the Coeuré statements that the ECB will be considering rolling over the TLTRO’s, something that I mentioned several weeks ago as a given. But that more dovish rhetoric from the ECB was enough to drive it lower. This morning’s rebound (EUR, GBP and AUD +0.35% each) looks more like profit taking given there has been exactly zero new information in the markets. In fact, all eyes are on the central bank Minutes that will be released later this week as traders are looking for more clarity on just how dovish the central banks are turning. At this point, it feels like there is a pretty consistent view that rate hikes are over everywhere.

What about data this week? In truth, there is very little, with the FOMC Minutes the clear highlight:

Wednesday FOMC Minutes  
Thursday Initial Claims 229K
  Philly Fed 14.0
  Durable Goods 1.5%
  -ex transport 0.2%
  Existing Home Sales 5.00M

However, we do have six Fed speeches this week from five different FOMC members (Williams speaks twice). Based on all we have heard, there is no reason to believe that the message will be anything other than a continuation of the recent dovishness. In fact, as most of the speeches are Friday, I wouldn’t be surprised to see the dovishness ramped up if Thursday’s data is softer than forecast. That is clearly the direction for now. We also hear from four more ECB speakers, including Signor Draghi on Friday. These, too, are likely to reflect the new dovish tone that is breaking out all over.

In the end, the dollar remains hostage to the Fed first, then other central banks. Right now, the narrative has changed quickly from Fed tightening to a Fed that is willing to wait much longer before getting concerned over potential inflation. Unless other central bankers are really dovish, I expect the market will see the current dialog as a dollar negative. Right up until the point where the ECB flinches and says further ease is necessary. But for today, modest further dollar depreciation seems to be about right.

Good luck
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More Frustration

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In Europe, the dominant nation
Is starting to feel more frustration
As data implies
They’ll soon demonize
The Chinese US for their degradation

The story in Europe continues to be one of diminishing growth across the board. Early this morning, German Factory Order data was released showing orders unexpectedly fell -1.6% in December after a downwardly revised -0.2% decline in November. Weakness was seen in every sector as both domestic and foreign demand shrank. There is no way to paint this as anything other than a sign of ongoing economic malaise. Once again, I will point out that there is a vanishingly small probability that the ECB will consider raising interest rates later this year, with a far more likely scenario being that further policy ease is on the way. The immediate impact of this data was to see the euro continue its recent decline, having fallen a further 0.2% this morning and now trading back below the 1.14 level.

Speaking of potential further easing of ECB monetary policy, the discussion regarding TLTRO’s is starting to heat up. These (Targeted Long-Term Refinancing Operations) were one of the several ways the ECB expanded their balance sheet during the Eurobond crisis several years ago. The idea was that the ECB made cheap (or even negative rate) liquidity available to Eurozone banks that wanted to fund an increase in their loan books. If the loans qualified (based on the recipients) banks actually got paid to borrow the money from the ECB. So, it was a pretty sweet deal for them, getting paid on both sides of the transaction. Because these loans had initial terms of four and five years, they also counted toward banks’ capital ratios and thus helped reduce their overall cost of funding.

But starting in June, the first of these loans will fall under twelve months until repayment is due, and thus will no longer be able to be counted as long-term capital. As I have written before, there are two possible scenarios: this financing rolls off and banks are forced to fund their outstanding loans in the markets at a much higher price. The result of this will be either slimmer profit margins for the banks, undermining their balance sheets, or they will be forced to raise rates or call in those outstanding loans, neither of which will help the growth story in Europe. The other, far more likely, choice is for the ECB to roll the TLTRO’s over, allowing the banks to maintain their interest rate margins and insuring that there is no tightening of monetary policy in the Eurozone. Given the ongoing weakness in data, which do you think is going to happen? Exactly, they will be rolled over, despite the fact that the ECB is unwilling to commit to that right now. It would be shocking if that is not the outcome!

But the euro is not the only currency to decline this morning, in fact, dollar strength has been pretty widespread. For example, AUD has fallen -1.45% after RBA Governor Lowe explained that the balance of risks for the Australian economy had tilted lower. The market has understood that as a ‘promise’ that future rate hikes have been delayed indefinitely. Aussie’s fall helped drag Kiwi lower as well, with NZD down -0.65%. Meanwhile, the ongoing decline in oil prices, most recently on the back of rising US inventories, has undermined CAD (-0.6%), NOK (-0.4%), MXN (-0.5%) and RUB (-0.4%). Interestingly, the pound, which had been lower earlier, is the one G10 currency that has held its own this morning. Of course, it has been declining steadily for more than two weeks, ever since the last big Parliamentary vote. What appears to be happening is that traders grew to believe that with Parliament taking charge of the negotiations, a deal would be reached, and the risk of a hard Brexit diminished. But funnily enough, Parliament is learning that despite their distaste for the Irish border solution proposed by PM May, there is no obvious better way to address that intractable problem. Traders are starting to lose their confidence that the outcome will be a deal, as despite a universal claim that a hard Brexit should not and cannot happen, it just might happen.

Turning to emerging markets, we have seen weakness across the board there as well. One of the big changes that the Fed has wrought by changing its stance from ongoing hawkishness to apparent dovishness is that many APAC central banks, that had been raising rates steadily alongside the Fed last year, are now backing away from those policies. Last night Bank of Thailand left rates on hold and later this week we will hear from both the Philippines (no change expected) and India (possible 25bp rate cut). Both mark a change from recent policy direction. So, while the dollar suffered in the wake of the Fed’s change, as that sentiment propagates around the world, I expect that the dollar will find its footing. After all, if every central bank is easing policy, the forces driving the FX market will need to be non-monetary. And for now, the US remains the best economy around, despite recent signs of slowing here.

One other story I need to mention is an article in Bloomberg (https://www.bloomberg.com/news/articles/2019-02-06/imf-staff-floats-dual-money-to-allow-much-deeper-negative-rates?srnd=markets-vp) that talks about a paper written at the IMF suggesting the creation of e-money to be issued alongside current cash. E-money would have negative interest rates and an exchange rate with cash which would drive the value of cash lower over time (effectively creating a negative interest rate for holding cash). Given my current role as Chief Strategist at 9th Gear Technologies, I have a particular interest in the concept of e-money, as I do believe cash will become scarcer and scarcer over time. I have also been vocal in my concerns that e-money will result in permanent negative interest rates, and that was before the IMF weighed in with that exact view.

Turning to this morning’s data releases, US Trade data is due (exp -$54.0B) at 8:30, and then we hear from the Fed’s Randall Quarles this afternoon. However, his focus continues to be on regulation, so I don’t anticipate any new monetary policy information. If the news from Asia is the new trend, then expect to see talk of easier money from all around the world, with the Fed, once again becoming the tightest policy around, thus supporting the dollar. I don’t imagine it will happen all at once, as there are still those harping on the Fed’s U-turn, but eventually, the news will be other banks easing while the Fed stands pat.

Good luck
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As Patient As Needed

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More rate hikes? The Fed said, ‘no way!’
With growth slowing elsewhere we’ll stay
As patient as needed
Since now we’ve conceded
Our hawkishness led us astray

If you needed proof that central bankers are highly political rather than strictly focused on the economics and financial issues, how about this:

Dateline January 24, 2019. ECB President Mario Draghi characterizes the Eurozone economy as slowing more than expected yet continues to support the idea that interest rates will be rising later this year as policy tightening needs to continue.

Dateline January 30, 2019. Federal Reserve Chairman Jay Powell characterizes the US economy as solid with strong employment yet explains that there is no need to consider raising rates further at this time, and that the ongoing balance sheet reduction program, which had been on “autopilot” is to be reevaluated and could well slow or end sooner than previously expected.

These are certainly confusing actions when compared to the comments attached. Why would Draghi insist that policy tightening is still in the cards if the Eurozone economy is clearly slowing? Ongoing pressure from the monetary hawks of northern Europe, notably Germany’s Bundesbank, continues to force Draghi to hew a more hawkish line than the data might indicate. As to the Fed, it is quite clear that despite the Fed’s description of a strong economy, Powell has succumbed to the pressure to support the equity market, with most of that pressure coming from the President. And yet central bankers consistently try to maintain that they are above politics and cherish their independence. There hasn’t been an independent central banker since Paul Volcker was Fed Chair from 1979-1987.

Nonetheless, this is where we are. The Fed’s dovishness was applauded by the markets with equities rallying briskly in the US (1.5%-2.2% across the indices) and following in Asia (Nikkei and Hang Seng both +1.1%) although Europe has shown less pluck. But Europe has, as described above, a slowing growth problem. This is best characterized by Italy, whose Q4 GDP release this morning (-0.2%) has shown the nation to be back in recession, their third in the past five years! It should be no surprise that Italy’s stock market is lower (-0.6%) nor that it is weighing on all the European indices.

Not surprisingly, government bond yields around the world are largely lower as well. This reaction is in a piece with market behavior in 2017 through the first three quarters of 2018, where both stocks and bonds rallied consistently on the back of monetary policy actions. I guess if easy money is coming back, and as long as there is no sign of inflation, there is no reason not to own them both. Certainly, the idea that 10-year Treasury yields are going to start to break higher seems to be fading into the background. The rally to 3.25% seen last November may well mark a long term high.

And what about the dollar? Well, if this is the new normal, then my views on the dollar are going to need to change as well. Consider this, given that the Fed has tightened more than any other central bank, the dollar has benefitted the most. We saw that last year as the dollar rallied some 7%-8% across the board. But now, the Fed has the most room to ease policy in comparison to every other G10 central bank, and so if the next direction is easy money, the dollar is certain to suffer the most. Certainly, that was the story yesterday afternoon in NY, where the dollar gave up ground across the board after the FOMC statement. Against the euro, the initial move saw the dollar sink 0.75% in minutes. Since then, it has traded back and forth but is little changed on the day, today, with the euro higher by just an additional 0.1%. We saw a similar move in the yen, rallying 0.7% immediately, although it has continued to strengthen and is higher by another 0.35% this morning. Even the pound, which continues to suffer from Brexit anxiety, rallied on the Fed news and has continued higher this morning as well, up another 0.2%. The point is, if the Fed is done tightening, the dollar is likely done rallying for now.

Other stories have not disappeared though, with the Brexit saga ongoing as it appears more and more likely to come down to a game of brinksmanship in late March. The EU is adamant they won’t budge, and the UK insists they must. I have a feeling that nothing is going to change until late March, just ahead of the deadline, as this game of chicken is going to play out until the end.

And what of the trade talks between the US and China? Well, so far there is no word of a breakthrough, and the only hints have been that the two sides remain far apart on some key issues. Do not be surprised to see another round of talks announced before the March 2 tariff deadline, or an agreement to postpone the raising of tariffs at that time as long as talks continue. Meanwhile, Chinese data released overnight showed Manufacturing PMI a better than expected (though still weak) 49.5 while Non-Manufacturing PMI actually rose to 54.7, its best reading since September, although still seeming to trend lower. However, the market there applauded, and the renminbi continues to perform well, maintaining its gains from the last week where it has rallied ~1.5%.

The US data picture continues to be confused from the government shutdown, but this morning we are due to receive Initial Claims (exp 215K and look for a revision higher from last week’s suspect 199K) as well as New Home Sales (569K). Yesterday’s ADP Employment number was much better than expected at 213K, and of course, tomorrow, we get the payroll report. Given the Fed’s hyper focus on data now, that could be scrutinized more closely than usual for guesstimates of how the Fed might react to a surprise.

In the end, the market tone has changed to mirror the Fed with a more dovish nature, and given that, the prospects for the dollar seem to have diminished. For now, it seems it has further to fall.

Good luck
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If Things Go Very Wrong

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Last year he thought growth would be strong
This year, “if things go very wrong”
It seems Signor Draghi
Just might restart QE
And rate hikes? They’ll ne’er come along!

Markets continue to bide their time ahead of tomorrow’s FOMC statement and the press conference by Chairman Powell. In addition, the Brexit saga continues with a series of votes scheduled today in Parliament that may help determine the next steps in that messy process. And of course, the next round of US-Chinese trade talks are set to begin tomorrow. So, there is plenty of potential news on the near-term horizon. But before I touch on those subjects, I wanted to highlight comments from ECB President Draghi yesterday speaking to EU lawmakers in Brussels. From the Bloomberg article this morning:

        The president of the European Central Bank blamed “softer external demand and some country and sector-specific factors” for the slowdown, but indicated he still has some confidence in the underlying strength of the economy.
       “If things go very wrong, we can still resume other instruments in our toolbox. There is nothing objecting to that possibility,” he told lawmakers in Brussels in response to a question on whether net asset purchases could be restarted. “The only point is under what contingency are we going to do this. And at this point in time, we don’t see such contingency as likely to materialize, certainly this year.”

Basically, he opened the door to reinstate QE, something which just two months ago would never have been considered. And while he tried to downplay the problems, it is clear there is growing concern in Frankfurt about Eurozone growth. Surprisingly, to me, the euro barely budged on the report, as I would have anticipated a sell-off. However, given the Fed is due to make its comments tomorrow, it appears that traders are waiting to see where Powell comes out on the hawkish-dovish spectrum. Because to me, Draghi’s comments were quite dovish. But essentially, the euro has been unchanged since trading opened in Asia yesterday, so clearly the market doesn’t see these comments as newsworthy.

Now, looking at the other three stories, there has been virtually no new information released since last week. Regarding the Fed, yesterday’s WSJ had an article that looked like a Fed plant discussing how unimportant the balance sheet issue was, and how the Fed sees no evidence that shrinking the balance sheet is having any impact on markets. That assessment is quite controversial as many investors and pundits see the balance sheet as a key issue driving recent market volatility. I expect we will hear more on Wednesday from Powell, but I also expect that now that Powell has shown he cannot withstand pressure from a declining stock market, that the pace of balance sheet reduction is going to slow. I wouldn’t be surprised to see it cut in half with a corresponding rally in both stocks and bonds on the news. In this event, the dollar should come under pressure as well.

As to Brexit, there still seems to be this disconnect between the UK and the EU in that the UK continues to believe that if Parliament votes to renegotiate parts of the deal, the EU will do so. Thus far, the EU has been pretty consistent that they like the deal the way it is and that there is not enough time to make changes. But from what I have seen this morning, it seems the most likely outcome is the ‘Malthouse proposal’ which will essentially do just that. Get support from Parliament to go back and change the Irish backstop arrangement. While I know that there is no desire for a hard Brexit, it strikes me that one cannot yet be ruled out.

Finally, on to the trade talks, we continue to get conflicting information from the US side as to where things stand, but ultimately the key issue is much more likely to be enforcement of any deal, rather than the deal itself. There is a great wariness that the Chinese will agree to something, and then ignore the details and go back to business as usual. Or perhaps create new and different non-tariff barriers to maintain their advantages. While the equity market continues to be positive on the process, I don’t see things quite so rosily. I think a deal would be great, but I don’t ascribe more than a 50% chance to getting one. However, I do expect that any tariff increases will be postponed for another round of talks to be enabled.

Beyond those stories, not too much of note is happening, which is evident by the fact that there has been almost no movement in the FX market, or any market for that matter. The G10 currencies are within pips of yesterday’s closing levels, and even EMG currencies are generally little changed. One exception is BRL, which has fallen -0.6% as ongoing news regarding the mining disaster and its impact on CRDV, a huge Brazilian mining conglomerate, seems to be generating a little angst. But otherwise, even this bloc of currencies is little changed. Equity markets are close to flat, as are bond and commodity markets. In other words, investors and traders are looking to the horizon and waiting for the big stories to play out. First in line is the Brexit voting, so perhaps later this afternoon we will see some movement, but I suspect that the FOMC is actually THE story of note for most people right now.

Good luck
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