Now She’s Complaining

Remember when Yellen was Chair
And wouldn’t raise rates on a dare?
Well now she’s complaining
They should be constraining
Growth lest prices rise everywhere

Former Fed Chair, Janet Yellen, was interviewed by the Wall Street Journal yesterday and was substantially more plainspoken than during her policymaking years. (Perhaps Chairman Powell’s new style has rubbed off on her). At any rate, she closed ranks with every other central bank chief in the world decrying President Trump’s criticism of the Fed and demanding that central banks remain independent. But more interestingly, she seemed to indicate that higher rates were appropriate, so much so that she was willing to dismiss the shape of the yield curve as being important. When asked about that, her response was, “this time is different.” While that sentiment is understandable given the structural changes of the Fed’s balance sheet and its impact on long term yields, history has shown that ‘this time is never different’! In the end, though, the woman who never saw a bad reason to delay normalizing policy has suddenly turned hawkish. And while this will have no impact on markets, it does speak to the politics involved in central banking, independence be damned. Every government wants to see low rates to help support their economy. Yellen apparently was more than happy to accommodate the Obama Administration’s desires, but suddenly sees the economic rationalization for higher rates today. Go figure!

In the meantime, the dollar is doing little this morning, edging lower in mixed fashion. In the G10 bloc the biggest mover has been the pound, rising 0.5% after wage data showed growth of 3.1% excluding bonuses, the highest pace since January 2009. However, despite this rise, there was no change in the market pricing for the next BOE rate hike. Instead, it is clear that the BOE will remain on the sidelines until the Brexit situation becomes clearer. There is no way Governor Carney can consider raising rates ahead of a possible hard Brexit given the economic uncertainty that would surround that outcome. However, FX traders seem willing to bet that higher rates are eventually in store. That said, there has been no new movement on the negotiations and now all eyes will be focused on the EU meeting tomorrow and Thursday to see if something new is proposed.

Meanwhile, the Italians passed a budget last night, maintaining their 2.4% deficit projection and the EU is duly unhappy. There is now a two-week period where the EU will scrutinize the budget and either accept it or send it back for revision. If the latter, that would be the first time in history it occurred, despite the fact that the French ran budget deficits greater than the 3.0% explicit ceiling for more than a decade. Italian markets are responding favorably this morning, with both bond and stocks there rallying a bit, but there is certainly potential for further discord. Consider the fact that if the EU backs down after their recent declarations that the Italian budget was unacceptable, its ability to persuade any other nation going forward will be dramatically reduced. On the other hand, by acting they may foster a market crisis if the Italian government fights back, which based on their actions to date, they almost certainly will. As this is Europe, I expect there will be some fudge ultimately agreed, but that does not mean there won’t be more damage first. As to the euro, it is little changed on the day, and actually on the month as it has recouped its losses from the first week and seems pretty comfortable trading either side of 1.1600.

Versus the emerging market bloc, however, the dollar is somewhat softer today, falling against virtually all its main counterparts here. While the year-to-date numbers for most of this group show dollar strength, recent price action has been consolidative rather than extensive. This morning’s numbers show strength in ZAR (0.7%), KRW (0.75%), MXN (0.25%) and even CNY (0.2%), with very few decliners. As global equity markets (China excepted) seem to have found a temporary floor this morning, this FX movement appears to be of the relief variety, as investors and traders start to dip their respective toes back into risky markets. If equity markets truly find their footing, then these currencies have room to rebound further. However, another leg lower in stocks will almost certainly be followed by the EMG bloc feeling more pressure.

Turning to the US data picture, yesterday’s Retail Sales numbers were disappointing, with the headline rising only 0.1% (had been expected 0.6%) and the ex-auto number falling -0.1%. Unfortunately, it is unclear what impact Hurricane Florence had on the data, so these numbers may be quite misleading…or not. We just don’t know yet. This morning’s data brings IP (exp 0.2%) and Capacity Utilization (78.2%) along with the JOLT’s Job Openings number (6.945M). However, these numbers are not usually market movers in their own right, but rather form part of a larger pattern. As such, there is every reason to believe that the dollar will be driven by equity markets today, and with futures pointing higher in the US, it seems that risk is being embraced for now. Based on recent activity, that should actually help the dollar, although that is the opposite of what we have known for the past decade.

Good luck
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Not Quite Yet Elated

The sell-off in stocks has abated
Though bulls are not quite yet elated
Most bonds, which had jumped
This morning were dumped
While dollar bears still are frustrated

Two days of substantial equity weakness has halted this morning, with Asian markets rebounding nicely and Europe also on the rise. As usual, it is not clear exactly what caused this reaction, but there are several reasonable candidates. The first was a softer than expected US inflation print yesterday morning. If, in fact, inflation in the US continues to remain just north of 2.0%, then the Fed may feel much less urgency to raise rates aggressively, and markets around the world will appreciate that change of stance. Remember, one of the reasons that we have seen such disruption elsewhere in the world, most notably throughout emerging market economies and markets, is that during the eight year long period of US ZIRP, companies and governments around the world gorged themselves on cheap USD debt. Eight rate hikes later, that debt is no longer so cheap, especially when it comes time for those borrowers to refinance. So any hint that the Fed will have a lower terminal rate is going to be perceived as a market positive.

The other news was a surprise increase in the Chinese trade surplus, which rose to $31.7B, far above the expected $19.4B. Exports, to everyone’s surprise, rose 14.5% despite the tariff situation. While some of this may be due to timing issues of when these shipments were recognized, the news was positive nonetheless. I expect that as we go forward, Chinese export data is likely to suffer, but for now, the news is better than expected. Beyond those two stories, it is difficult to make a case for any real change anywhere.

One of the interesting things about the past two sessions is that while risk was clearly being jettisoned, the dollar was not a beneficiary like it had been in the past during these events. Traditionally, dollar strength accompanies weak equity and commodity markets, but not this time. Of course, one of the big issues in the market right now is the structural deficit in the US. Expansionary fiscal policy here has resulted in the highest non-wartime budget deficits on record, now approaching $1 trillion for this year and certain to be more than that next year, which means that the Treasury is going to need to issue a lot more debt to pay for things. At the same time, the Fed continues to reduce its bid for Treasury bonds as it shrinks its balance sheet steadily. This combination of events is almost certainly going to lead to higher US interest rates out the curve, as more price sensitive investors become the marginal buyer.

For the past six months, higher US rates have been an unalloyed USD positive, driving the dollar back to its levels of late last year and scotching all the talk of a significant dollar decline. But if you recall, I wrote about the opposing structural and cyclical issues facing the dollar several months ago, where the cyclical highlighted the faster growth in the US economy and higher interest rates as a dollar support, while the structural issues of growing twin deficits (budget and current account) pointed to a weaker currency going forward. It is entirely possible that the market’s recent behavior, where despite a risk-off situation the dollar is falling, is an indication that the structural issues are starting to lead the conversation. If that is the case, the dollar is likely to have seen its peak. While it is too early to know for sure, this is something that we will monitor closely going forward.

With regard to specifics in today’s session, most currencies have halted their rally but not really declined much. Other than the Chinese trade data, there has not been much of interest released today, and in the US all we get is Michigan Sentiment (exp 100.4). What we do know is that it is a Friday at the end of a stressful week for markets, which typically results in less active markets. Equity futures in the US are pointing higher, and as long as the US markets follow suit with Asia and Europe and rebound, I expect the dollar will do very little on the day. However, if we see this early strength turn around and US equity markets wind up closing lower on the day, look for much more global anxiety over the weekend and the risk-off sentiment to resume in earnest next week. That includes, at this time, further dollar weakness. So unusually, a modest equity market rally should result in modest USD strength, while a sell-off will likely see the dollar suffer as well.

Good luck and good weekend
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Change Can Come Fast

There once was a market that soared
With tech stocks quite widely adored
The Fed, for eight years
Suppressed any fears
And made sure that rates were kept floored

But nothing, forever, can last
Now ZIRP and QE’s time has passed
Investors are frightened
‘Cause Powell has tightened
Beware because change can come fast!

Many of you will have noticed that equity markets sold off sharply in the past twenty-four hours, and that as of now, it appears there is more room to run in this correction. The question in situations like these is always, what was the catalyst? And while sometimes it is very clear (think Brexit or the Lehman bankruptcy) at other times movements of this nature are simply natural manifestations of a very complex system. In other words, sometimes, and this appears to be one of them, markets simply move because a confluence of seemingly minor events all occur at the same time. Trying to ascribe the movement to yesterday’s PPI reading, or comments from the IMF meetings, or any other specific piece of information is unlikely to be satisfying and so all I will say is that sometimes, markets move further than you expect.

Consider, though, that by many measures equity prices, especially in the US, are extremely richly valued. Things like the Shiller CAPE, or the Buffet idea of total market cap/GDP both show recent equity market levels at or near historic highs. And while the tax cuts passed into law for 2018 have clearly helped profitability this year, 2019 comparisons will simply be that much tougher to meet. There are other situations regarding the market that are also likely having an impact, like the increase in algorithmic trading, the dramatic increase in passive indexing and the advent of risk parity strategies. All of these tended to lead to buying interest in the same group of equities, notably the tech sector, which has been the leading driver of the stock market’s performance. If these strategies are forced to sell due to investor withdrawals, they will do so with abandon (after all, they tend to be managed by computer programs not people, and there is no emotion involved at all) and we could see a substantial further decline. Something to keep in mind.

But how, you may ask, is this impacting the FX markets? Interestingly, the dollar is not showing any of its risk-off tendencies through this move. In fact, it has fallen against almost all counterpart currencies. And while in some cases, there is a valid story that has nothing to do with the dollar per se, in many cases, it appears that this is simply dollar weakness. For example, the euro has rallied 0.5% this morning, after a 0.25% gain yesterday. Part of this has been driven by modestly higher than expected inflation data from several Eurozone countries (Spain and Ireland) while there is likely also a benefit from the story that the Brexit negotiations seem to be moving to a conclusion. However, despite the positive Brexit vibe, the pound has only managed a 0.15% rise this morning. The big winner in the G10 space has been Sweden, where the krone has rallied 1.5% after it also released higher than expected CPI data (2.5%) and the market has priced in further tightening by the Riksbank.

Looking at the EMG space, the dollar has fallen very consistently here, albeit not universally. We haven’t paid much attention to TRY lately, but it has rallied 1.4% today, and 5.5% in the past month. While yesterday they did claim to create some measures to help address the rising inflation there, they appear fairly toothless and I suspect the lira’s recent strength has more to do with the market correcting a massive decline than investor appetite for the currency. But all of the CE4 are rallying today, albeit in line with the euro’s 0.5% move, and there have been no stories of note from the region.

Looking to APAC, the movement has actually been far less pronounced with THB the best performer, rising 0.7% but the rest of the space largely trading within 0.2% of yesterday’s close. In other words, there is no evidence that, despite a significant decline in equity markets throughout the region, that risk-off sentiment has reached dramatic proportions. Now, if equity markets continue their sharp decline today, my best guess is that we will see a bit more activity in the currency markets, likely with the dollar the beneficiary.

Finally, LATAM currencies have had a mixed performance, with MXN rising 0.5% this morning, but BRL having fallen more than 1% on news that the mooted finance minister for Jair Bolsonaro (assuming he wins the second round election) is being investigated for corruption.

Turning to this morning’s session, the key data point of the week is released, with CPI expected to have declined to 2.4% in September (from 2.7%) and the core rate to have risen to 2.3%, up from August’s reading of 2.2%. With every comment from a Fed speaker focused on the idea of continuing to increase Fed Funds until they reach neutral, this data has the opportunity to have a real impact. If the release is firmer than expected, look for bonds to suffer, equities to suffer more and the dollar to find support. However, if this data is weak, then I would expect that the dollar could fall further, maybe back toward the bottom of its recent range, while the equity market finds some support as fears of an overly tight Fed dissipate.

So there is every opportunity for some more market fireworks today. As I believe that inflation remains likely to continue rising, especially based on the anecdotal evidence of rises in wages, I continue to see the dollar finding support. Of course, that doesn’t speak well of how the equity market is likely to perform if I am correct.

Good luck
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The Next Year Or So

Said Williams, “the next year or so”
Should see rates reach neutral, you know
At that point we’ll see
If our GDP
Is humming or soon set to slow

The dollar is under very modest pressure this morning, although in reality it is simply continuing to consolidate its recent gains. While there have been individual currency stories, the big picture continues apace.

As I write, the IMF is holding its annual meeting in Indonesia and so we are hearing much commentary from key financial officials around the world. Yesterday, IMF Managing Director Lagarde told us that the ongoing trade tensions were set to slow global growth. Overnight, we heard from NY Fed President John Williams, who said that the US economy continued to be strong and that while there is no preset course, it seemed likely that the Fed would continue to adjust policy until rates reached ‘neutral’. Of course, as nobody knows exactly where neutral is, there was no way to determine just how high rates might go. However, there was no indication that the Fed was going to pause anytime soon. Dallas Fed President Robert Kaplan, who said that he foresaw three more rate hikes before any pause, corroborated this idea. According to the dot plot, 3.00% seems to be the current thinking of where the neutral rate lies as long as inflation doesn’t push significantly higher than currently expected. All this points to the idea that the Fed remains on course to continued policy tightening, with the risks seemingly that if inflation rises more than expected, they will respond accordingly.

The other truly noteworthy news was from the UK, where it appears that a compromise is in sight for the Brexit negotiations. As expected, there is some fudge involved, with semantic definitions of the difference between customs and regulatory checks, but in the end, this cannot be a great surprise. The impetus for change came from Germany, who has lately become more concerned that a no-deal Brexit would severely impact their export industries, and by extension their economy. The currency impact was just as would be expected with the pound jumping one penny on the report and having continued to drift higher from there. This seems an appropriate response as no deal is yet signed, but at least it appears things are moving in the right direction. In the meantime, UK data showed that Q3 GDP growth is on track for a slightly better than expected outcome of 0.7% for the quarter (not an annualized figure).

As to the other ongoing story, there has been no change in the tone of rhetoric from the Italian government regarding its budget, but there are still five days before they have to actually submit it to their EU masters. It remains to be seen how this plays out. As I type, the euro has edged up 0.15% from yesterday’s close, but taking a step back, it is essentially unchanged for the past week. If you recall, back in August there was a great deal of discussion about how the dollar had peaked and that its decline at that time portended a more significant fall going forward. At this point, after the dollar recouped all those losses, that line of discussion has been moved to the back pages.

Turning to the emerging markets, Brazil remains a hot topic with investors piling into the real in expectations (hopes?) of a Bolsonaro win in the runoff election. That reflected itself in yet another 1.5% rise in the currency, which is now higher by more than 10% over the past month. The China story remains one where the renminbi seems to be on the cusp of a dangerous level, but has not yet fallen below. Equity markets there took a breather from recent sharp declines, ending the session essentially flat, but there is still great concern that further weakness in the CNY could lead to a sharp rise in capital outflows, or correspondingly, more draconian measures by the PBOC to prevent capital movement.

But after those two stories, it is harder to find something that has had a significant impact on markets. While Pakistan just reached out to the IMF for a $12 billion loan, the Pakistani rupee is not a relevant currency unless you live there. However, this issue is emblematic of the problems faced by many emerging economies as the Fed continues to tighten policy. Excessive dollar borrowing when rates were low has come back to haunt many of these countries, and there is no reason to think this process will end soon. Continue to look for the dollar to strengthen vs. the EMG bloc as a whole.

This morning brings our first real data of the week, PPI (exp 2.8%, 2.5% ex food & energy). However, PPI is typically not a market mover. Tomorrow’s CPI data, on the other hand, will be closely watched for signs that inflation is starting to test the Fed’s patience. But for now, other than the Brexit news, which is the first truly positive non-dollar news we have seen in a while, my money is on a quiet session with limited FX movement. The only caveat is if we see significant equity market movement, whereby a dollar reaction would be normal. This is especially so if equities fall and so risk mitigation leads to further dollar buying.

Good luck
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Growth Would Be Marred

The IMF’s Christine Lagarde
Explained global growth would be marred
By tariffs imposed
Which keep borders closed
To products that ought not be barred

The dollar has continued its recent ascent this morning, edging higher still against most of its counterparts as US interest rates continue to climb. In fact, as I type, the 10-year Treasury has breached 3.25% for the first time in more than seven years, and quite frankly, there is no reason to think this trend is going to stop. Rather, given the significant amount of new issuance that will be required by the Treasury Department, and the fact that the Fed is reducing the amount of bonds that it purchases as it shrinks its balance sheet, we should expect to see yields continue higher. Back in January I forecast that the 10-year yield would reach 4.00% by the end of the year. For the longest time that seemed impossible, but while still a difficult conclusion, given the speed with which yields have risen recently, it doesn’t seem quite as far-fetched as it used to.

At any rate, the market stories today are largely the same as those from yesterday. Perhaps the key headline was the IMF announcement that they had reduced their estimates for global growth for 2018 and 2019 by 0.2% to 3.7% for both years. The key change since their last estimate was the increased trade tensions between the US and China and the estimated impact those will have on nations around the globe. However, they did not adjust their estimate of US growth, which is likely to encourage the Trump Administration to continue down the path of further tariffs in their negotiation strategy.

Beyond that story, we are still in the grips of the Italian budget situation, where there has been no indication that the coalition government is going to adjust policy to reduce the projected deficit. Given that every one of these situations in Europe turns into a game of chicken, it is probably too early to assume no solution will be found. However, it is important to remember that DiMaio and Salvini, the heads of the 5-Star and League parties respectively, and the real power in the government, are both anti-establishment, and there appears to be a very real chance that they ignore the European Commission and the EU rules. Certainly the Italian stock and bond markets are concerned over that outcome, as 10-year yields there have risen another 10bps while the FTSE MIB has fallen a further 0.5%. This process will continue to weigh on the euro for now so it should be no surprise that the single currency has fallen by 0.5% this morning. But arguably it is not only the Italian situation impacting the euro, we also saw German trade data, which reported a significant decline in imports, -2.7%. While this did result in an increased trade surplus, sharply falling imports is not a sign of economic strength, and so this was likely not seen as a positive. Net, the combination of ongoing tighter US monetary policy and stalling growth in Europe should help underpin the dollar going forward.

Looking at the rest of the G10 space, the dollar is firmer virtually across the board, with the only exception the Japanese yen, which is flat on the day. Though some may argue that slightly better than expected Economy Wathers Survey data helped, this appears to me to be a consequence of a broader risk-off sentiment that is sweeping the markets. A stronger dollar and a stronger yen are natural consequences of this mentality. What is interesting, however, is that two other natural haven assets, gold and Treasuries, are not performing in the same way. I think the explanation for both is the same: higher US short term rates, now above 2.0% across products, is of sufficient attraction to draw frightened investors into Treasury bills rather than taking the risk of a 10-year note. As well, now that cash earns a return, the opportunity cost of holding gold has increased substantially. Given this situation, it appears there is much further to go for the dollar, as fear will drive investors to short term dollar holdings. With this in mind, I suspect we will hear much less about an inverting yield curve for a time. After all, given the sharp rise in 10-year yields and the increased demand for short term assets, it will be very hard for that to occur.

Flipping to emerging markets, the dollar is broadly stronger here as well, across all three regions. In fact, the only noteworthy exception is BRL, which rallied 1.5% yesterday in the wake of the results of Sunday’s presidential election. It is clear that the market remains highly in favor of a President Bolsonaro there, and I expect that as we approach the run-off vote in three weeks’ time the real will continue to perform well. However, this movement has all the earmarks of a ‘buy the rumor, sell the news’ scenario, which means that a sharp dollar rally could well result in the wake of the run-off vote no matter who wins. Granted, if Fernando Haddad, the left wing candidate wins, I would expect the real’s decline to be much sharper.

Away from that, USDCNY is trading above 6.93 today as the Chinese continue to try to ease policy domestically without causing too much market turmoil. While the Trump Administration is apparently looking at naming China a currency manipulator in the latest report due shortly, given the dollar’s overall strength, it appears to me that the movement is entirely within the confines of the overall market. Quite frankly, it still seems as though the Chinese are quite concerned about a ‘too-weak’ renminbi as a trigger to an increase in capital outflows, and so will prevent excessive weakness for now. That said, I expect CNY will continue to weaken going forward.

And that’s really it for today. The NFIB Small Business Optimism Report was released at 107.9, softer than expected but still tied for the second highest reading of all time. Confidence in the economy remains strong. All we have for the rest of the day are speeches by Chicago Fed President Evans and NY’s John Williams. However, given what we have heard lately and the dearth of new news likely to change opinions, it beggars belief to think that anything new will come from these comments. In other words, there is nothing standing in the way of the dollar continuing to rise on the back of ever tighter US monetary policy.

Good luck
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Both Flexed Their Muscles

In China more policy ease
Did nothing to help to appease
The stock market bears
Who unloaded shares
Along with their spare RMB’s

Then tempers between Rome and Brussels
Got hotter as both flexed their muscles
The latter declared
The budget Rome shared
Was certain to cause further tussles

This morning the dollar has resumed its uptrend. The broad theme remains that tighter US monetary policy continues to diverge from policies elsewhere around the world, and with that divergence, dollar demand has increased further.

China’s weekend action is the latest manifestation of this trend as Sunday they announced a one-percentage point cut in the Required Reserve Ratio (RRR) for all banks. This should release up to RMB 1.2 trillion (~$175billion) of liquidity into the market, helping to foster further economic activity, support the equity markets and keep a lid on interest rates. At least that’s the theory. Alas for the Chinese, whose markets were closed all of last week for national holidays, the Shanghai Composite fell 3.7% on the day, as they caught up with last week’s global equity market decline. It is not clear if the loss would have been greater without the RRR cut, but one other noteworthy feature of the session was the absence of any official attempts to support the market, something we have seen consistently in the past. It ought not be surprising that the renminbi also suffered overnight, as it fell nearly 0.5% and is now trading through the 6.90 level. If you recall, this had been assumed to be the ‘line in the sand’ that the PBOC would defend in an effort to prevent an uptick in capital outflows. As it is just one day, it is probably too early to make a judgment, but this bears close watching. Any acceleration higher in USDCNY will have political repercussions as well as market ones.

Speaking of political repercussions, the other noteworthy story is the ongoing budget saga in Italy. There has been no backing down by the populist government in Rome, with Matteo Salvini going so far as to call Brussels (the EU) the enemy of Italy in its attempts to impose further austerity. The Italians are required to present their budget to the EU by next Monday, and thus far, the two sides are far apart on what is acceptable for both the country and EU rules. At this point, markets are clearly getting somewhat nervous as evidenced by the ongoing decline in Italian stock and bond markets, where 10-year yields have jumped another 15bps (and the spread to German bunds is now >300bps) while the FTSE-MIB Index is down another 2.5% this morning. Given that this is all happening in Europe, it is still a decent bet that they will fudge an outcome to prevent disaster, but that is by no means a certainty. Remember, the Italian government is as antiestablishment as any around, and they likely relish the fight as a way to beef up their domestic support. In addition to the Italian saga, German data was disappointing (IP fell -0.3% vs. expectations of a 0.4% gain), and the combination has been sufficient to weigh on the euro, which is down by 0.4% as I type.

Beyond these stories, the other big news was the Brazilian election yesterday, where Jair Bolsonaro, the right wing candidate, came first with 46% of the vote, and now leads the polls as the nation prepares for a second round vote in three weeks’ time. The Brazilian real has been the exception to EMG currency weakness over the past month, having rallied nearly 9% during the last month. It will be interesting to see if it continues that trend when markets open there this morning, but there is no question that the markets believe a Bolsonaro administration will be better for the economy going forward.

Otherwise, the stories remain largely the same. Ongoing US economic strength leading to tighter Fed policy is putting further pressure on virtually all EMG currencies throughout the world. And it is hard to see this story changing until we see the US economy show signs of definitive slowing.

Turning to the upcoming week, data is sparse with CPI being the key release on Thursday.

Tuesday NFIB Business Optimism 108.9
Wednesday PPI 0.2% (2.8% Y/Y)
  -ex food & energy 0.2% (2.5% Y/Y)
Thursday Initial Claims 206K
  CPI 02% (2.4% (Y/Y)
  -ex food & energy 0.2% (2.3% Y/Y)
Friday Michigan Sentiment 100.5

As to Fed speakers, we have three regional Fed Presidents (Evans, Williams and Bostic) speaking a total of seven times this week. However, it is pretty clear from comments lasts week that there is no indication the Fed is going to relax their view that gradually tighter policy is appropriate for now. The one thing that can derail this move would be much softer than expected CPI data on Thursday, but that just doesn’t seem that likely now. Look for the dollar to continue to trend higher all week.

Good luck
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Still Under Stress

As traders are forced to assess
A bond market still under stress
Today’s jobs report
Might be of the sort
That causes some further regress

Global bond markets are still reeling after the past several sessions have seen yields explode higher. The proximate cause seems to have been the much stronger data released Wednesday in the US, where the ADP Employment and ISM Non-Manufacturing reports were stellar. Adding to the mix were comments by Fed Chairman Powell that continue to sing the praises of the US economy, and giving every indication that the Fed was going to continue to raise rates steadily for the next year. In fact, the Fed funds futures market finally got the message and has now priced in about 60bps of rate hikes for next year, on top of the 25bps more for this year. So in the past few sessions, that market has added essentially one full hike into their calculations. It can be no surprise that bond markets sold off, or that what started in the US led to a global impact. After all, despite efforts by some pundits to declare that the ECB was the critical global central bank as they continue their QE process, the reality is that the Fed remains top of the heap, and what they do will impact everybody else around the world.

Which of course brings us to this morning’s jobs data. Despite the strong data on Wednesday, there has been no meaningful change in the current analyst expectations, which are as follows:

Nonfarm Payrolls 185K
Private Payrolls 180K
Manufacturing Payrolls 12K
Unemployment Rate 3.8%
Participation Rate 62.7%
Average Hourly Earnings (AHE) 0.3% (2.8% Y/Y)
Average Weekly Hours 34.5
Trade Balance -$53.5B

The market risk appears to be that the release will show better than expected numbers today, which would encourage further selling in Treasuries and continuation of the cycle that has driven markets this week. What is becoming abundantly clear is that the Treasury market has become the pre-eminent driver of global markets for now. Based on the data we have seen lately, there is no reason to suspect that today’s releases will be weak. In fact, I suspect that we are going to see much better than expected numbers, with a chance for AHE to touch 3.0%. Any outcome like that should be met with another sharp decline in Treasuries as well as equities, while the dollar finds further support.

Away from the payroll data, there have been other noteworthy things ongoing around the world, so lets touch on a few here. First, there is growing optimism that with the Tory Party conference now past, and PM May still in control, that now a Brexit deal will be hashed out. One thing that speaks to this possibility is the recent recognition by Brussels that the $125 trillion worth of derivatives contracts that are cleared in London might become a problem if there is no Brexit deal, with payment issues needing to be sorted, and have a quite deleterious impact on all EU economies. As I have maintained, a fudge deal was always the most likely outcome, but it is by no means certain. However, today the market is feeling better about things and the pound has responded by rallying more than a penny. The idea is that with a deal in place, the BOE will have the leeway to continue raising rates thus supporting the pound.

Meanwhile, stronger than expected German Factory orders have helped the euro recoup some of its recent losses with a 0.25% gain since yesterday’s close. But the G10 has not been all rosy as the commodity bloc (AUD, NZD and CAD) are all weaker this morning by roughly 0.4%. Other currencies under stress include INR (-0.6%) after the RBI failed to raise interest rates as expected, although they explained there would be “calibrated tightening” going forward. I assume that means slow and steady, but sounds better. We have also seen further pressure on RUB (-1.3%) as revelations about Russian hacking efforts draw increased scrutiny and the idea of yet more sanctions on the Russian economy make the rounds. ZAR (-0.75%) and TRY (-2.0%) remain under pressure, as do IDR (-0.7%) and TWD (-0.5%), all of which are suffering from a combination of broad dollar strength and domestic issues, notably weak financial situations and current account deficits. However, there is one currency that has been on a roll lately, other than the dollar, and that is BRL, which is higher by 3.4% in the past week and 8.0% since the middle of September. This story is all about the presidential election there, where vast uncertainty has slowly morphed into a compelling lead for Jair Bolsonaro, a right-wing firebrand who is attacking the pervasive corruption in the country, and also has University of Chicago trained economists as his financial advisors. The market sees his election as the best hope for market-friendly policies going forward.

But for today, it is all about payrolls. Based on what we have heard from Chairman Powell lately, there is no reason to believe that the Fed is going to adjust its policy trajectory any time soon, and if they do, it is likely only because they need to move tighter, faster. Today’s data could be a step in that direction. All of this points to continued strength in the dollar.

Good luck and good weekend
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