Tag Archives: #emerging markets

A Weakening Buck

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Said Powell, we’ve had quite some luck
Inflation’s apparently stuck
Right at two percent
So I won’t lament
If we see a weakening buck

You likely noticed the dollar’s sharp decline on Friday, which actually began shortly before Chairman Powell spoke in Jackson Hole. For that, you can thank the PBOC who reinstated their Countercyclical Factor (CCF). The CCF was the fudge the PBOC created in January of last year to help them regain control of the USDCNY fixing each day. Prior to that, the goal had been to slowly allow the FX market establish the fixing rate in their efforts to internationalize the yuan. But then, market turmoil upset the apple cart and they were no longer pleased with the yuan’s direction. In fact, that was the last time USDCNY made a move toward 7.00. But once they instituted the CCF, which is claimed to include market parameters, they essentially resumed command of the currency and at that time, simply walked it higher over the course of the ensuing year. At that point, they felt things were under control, and early this year they abandoned the CCF as unnecessary. Until Friday, when after the yuan made yet another attempt at 7.00, they decided it was time to reestablish control of the currency. And so, Friday, the yuan rallied in excess of 1.5% and has now stabilized, at least temporarily, around 6.80. With the PBOC’s thumb on the scale, I expect that we are going to see a reduction in CNY volatility, and arguably, a very mild appreciation over time.

Which leads us to discuss the other catalyst for dollar weakness on Friday, Chairman Powell’s speech. In it, he basically said that although inflation has reached their 2.0% target, there is limited reason to expect it to continue to go higher. The market’s take on those comments was that the Fed was likely to slow the trajectory of rate hikes, thereby undermining the dollar. The broad dollar index fell about 0.6% during the speech and has retained those losses since. One of the interesting things is that nobody has accused Powell of succumbing to pressure from Trump with regard to changing his tone. But economists around the world are clearly happier.

Their joy stems from the following sequence of events. In the decade since the financial crisis, when interest rates were pushed to zero or below by developed country central banks, there was a huge expansion of US dollar debt taken on by EMG countries and companies within them. As long as rates were low, and the dollar remained on the soft side, those borrowers had limited issues when it came to rolling over the debt and paying the interest. But once the Fed started to tighten policy, both raising rates and shrinking the available number of dollars in the global system, the dollar rebounded. This was a double whammy for those EMG borrowers because refinancing became more expensive on a rate basis, and it took more local currency to pay the interest, hurting their local currency cash flows as well. This has been a key underlying issue for numerous EMG nations like Argentina, Turkey, Brazil, Indonesia and India. It has exacerbated their currency weakness and expanded their current account deficits.

So now, if Powell and the Fed are going to slow down their efforts on the basis of the idea that inflation is not going to continue to rise, it will reduce the pressure on all of those nations and more. Hence the joy from economists. I guess the only thing that can derail this is if inflation doesn’t actually slow down. Remember, despite the fact that the Fed follows PCE, CPI has been rising sharply lately, and they cannot ignore that fact. If that trend continues, and there is a fair chance that it will, look for PCE to follow and for Powell to have to walk back those comments. I guess we shall see.

As to the overnight session, the dollar is little changed from Friday’s closes as we begin the week leading up to the Labor Day holiday in the US. We actually saw our first substantive data release in more than a week overnight, with the German IFO index rising for the first time in nine months to a much better than expected 103.8. But the euro has been unable to take advantage of the news and is essentially unchanged on the day, along with everything else. As to the US data calendar, it remains on the quiet side, although we do see the latest reading of the aforementioned PCE data.

Tuesday Case-Shiller Home Prices 6.5%
  Goods Trade Balance -$68.6B
Wednesday Q2 GDP 2nd Est 4.0%
Thursday Initial Claims 214K
  Personal Income 0.3%
  Personal Spending 0.4%
  PCE 0.1% (2.2% Y/Y)
  Core PCE 0.2% (2.0% Y/Y)
Friday Chicago PMI 63.0
  Michigan Sentiment 95.5

I expect that unless something remarkable happens to the GDP data on Wednesday, that all eyes will be on the Income and Spending data on Thursday. But in the end, there is a new tone to the market, one which is decidedly less dollar bullish, and given the number of dollar long positions that remain in place, I expect that we may see the dollar nursing its wounds for quite a while. This is a plus for receivables hedgers, as it does appear the dollar has stopped rallying for now. Just don’t get greedy!

Good luck
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No Progress Was Made

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In Washington, talks about trade
Twixt us and the Chinese decayed
Both sides pitched their views
But couldn’t enthuse
The other. No progress was made

Today, though, the Fed Chairman Jay
Will speak and might seek to convey
How high rates may rise
Or how he’ll devise
A plan to keep prices at bay

Two key themes dominate the FX markets this morning, yesterday’s failure of low-level trade talks between the US and China to make any progress and the beginning of the Kansas City Fed’s Jackson Hole conference.

Starting with trade, last evening, the talks ended with no progress of note. Both sides explained that they had expressed their views, but there was no indication that there was movement on either side toward a compromise. Obviously, politics will play a huge role in this process, and so it becomes extremely difficult to forecast how things will evolve. However, as the day progressed yesterday, it seemed increasingly likely that nothing beneficial would occur, and so the dollar regained its footing. In fact, it had its best day (+0.6%) since it reached its recent peak early last week and reversed course lower. Interestingly, this morning the dollar has given back some of that ground, but net remains higher than when I wrote yesterday morning. It has become clearer to me that the market presumption is more trade angst will lead to a firmer dollar, which is simply an additional catalyst for dollar strength in the near and medium term. But we will need to watch the trade situation carefully, as any indication that progress is being made is likely to result in a dollar retreat.

But that was yesterday’s story, and at this point is virtually ancient history. Today is all about the Fed symposium in Jackson Hole, Wyoming, specifically about Chairman Powell’s speech at 10:00am EDT. Analysts and traders are waiting to hear his latest thoughts on monetary policy and how he sees it evolving. Yesterday we heard from two regional Fed presidents, Dallas’s Richard Kaplan and KC’s Esther George, both of whom said that the committee was entirely focused on its Congressional mandates of price stability and maximum employment, and that they would not be swayed by comments from the President. And incidentally, both said they see at least four more rate hikes between now and the end of next year. In fact Ms George is in the camp leaning toward six more over that time frame. Of course, this is all dependent on the evolution of the US economy. As long as it continues to grow in the current manner, it seems there will be no dissuading the Fed from removing accommodation. That said, Mr. Powell’s speech this morning is seen as critical in helping define exactly how much tightening is on the way. The funny thing about those expectations is that Powell is probably the last person who is likely to set expectations in that manner. He is all about pragmatism and reacting to the data as it evolves. Certainly, if the US economy continues to grow quickly, he will be leading the charge for higher rates. But if cracks start to show, or the trade situation causes deterioration in the economic data, I expect he will be perfectly happy to pause.

Speaking of cracks in the data, yesterday brought us New Home Sales, which disappointed by rising only 627K in July, down 1.7% from June’s level and back to the lowest since last October. This followed softer than expected Existing Home Sales data on Wednesday and seems to indicate that the housing market may have peaked for now. Given its importance to the overall economy, that is a somewhat worrying sign, especially given the state of employment here. If the best employment data in decades cannot help perk up housing, it may well be ripe for a more substantial correction. Following that line of reasoning further, it is an open question as to whether we have seen the peak in US growth and just how rapidly the situation here might change. Food for thought, but it is still early days for this idea.

A quick survey of FX market movement overnight shows that the dollar’s decline is pretty uniform. The G10 leader higher is AUD (+0.8%), which has shown a positive reaction to the changing of PM’s there, with Malcolm Turnbull out and Scott Morrison, the previous Treasurer, now the PM. But the euro and pound are both firmer by about 0.4% despite lackluster UK mortgage data and Eurozone data that merely met expectations. As I said, today’s dollar weakness appears more a response to the trade story than data.

In the EMG bloc, ZAR is firmer by 1.1% as traders decided that comments by President Trump regarding South African land reform were actually not that relevant and would not impact policy. But we have also seen CNY rocket higher by nearly 1.0%, (post trade talk reaction?), RUB jump 1.0% on the back of higher oil prices and even TRY has found its footing, at least temporarily, rising 0.4%.

But in the end, it would be surprising to see much market movement between now and Powell’s speech. Rather, I expect that the market will absorb the Durable Goods data (exp -0.5%, +0.5% ex Transport) with aplomb and be right here when he starts. After that it is dependent on what he says. If pressed, I expect that he will subtly reaffirm the Fed’s independence, talk up the economy, and indicate monetary policy is on the right trajectory for now, in other words, US rates have plenty further to rise this year and next, at least. And as rates rise, so goes the dollar.

Good luck
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Wanton Cries

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The Minutes served to reinforce
The Fed is remaining on course
Next month rates will rise
Amid wanton cries
By doves, though the hawks will endorse

One of the reasons that I have become a fan of Jerome Powell is that he is willing to speak truth to power. And even though he sits in one of the most powerful chairs in the world, I would contend that he faces a much greater power every day; a legacy of Fed Chairs who carefully cultivated the impression that they alone could turn the dials and knobs of policy properly and with precision. Reality has shown that despite excellent PR work on behalf of Fed Chairs, they were no better at forecasting the economy’s future than anyone else, and in fact, were considerably worse than numerous Wall Street analysts. This difference in approach by Powell vs. his predecessors is made crystal clear in this quote from the Minutes released yesterday afternoon: “A number of participants emphasized the considerable uncertainty in estimates of the neutral rate of interest, stemming from sources such as fiscal policy and large-scale asset purchase programs. Against this background, continuing to provide an explicit assessment of the federal funds rate relative to its neutral level could convey a false sense of precision.” [My emphasis.] It is little things like this that give me hope Chairman Powell will maintain the humility necessary to be effective in his role.

At any rate, the upshot of the Minutes was that growth was continuing apace, the trade situation, while not yet causing significant problems, has the potential to do so in the future and impact policy decisions, but raising rates in September is baked in the cake. There was some discussion of weakness in emerging markets, but this was also seen as insufficient to change the trajectory of US growth, and therefore the current policy settings. In other words, the Minutes simply reiterated what we already knew, until potential problems become real ones, Fed Funds are going higher.

It can be no surprise that the dollar gained in the wake of the release, but also no surprise that the movement has been muted. Although peak to trough, the euro fell some 0.5%, it rebounded and is now only modestly softer than yesterday’s post-Minutes closing level. As I have maintained all along, all eyes are on tomorrow’s speech by Chairman Powell, as it will give us a chance to learn something new, rather than rehash what we gleaned three weeks ago.

Surveying markets this morning, the broad dollar index is a touch higher, +0.1%, but that is a mixture of a wide array of movements by individual currencies. For example, the euro has fallen back below 1.16 this morning, also down 0.1%, despite (because of?) seemingly positive Flash PMI data, which showed the Eurozone Composite PMI rising to a less than expected 54.4. Growth estimates for Q3 remain at 0.4%, but of course annualized that number becomes just 1.6%, unimpressive when compared to the US current growth trajectory. The pound is tracking the euro as a lack of supportive news and ongoing concerns over Brexit continue to weigh on the currency. The largest G10 mover was AUD, falling 0.7% despite a lack of obvious catalysts. No data was released and no comments of substance made, although local politics has put PM Turnbull on the defensive despite continued strong performance in the Australian economy. Perhaps, Aussie’s decline is related to that.

Turning to the emerging markets, the picture is one of mostly weaker currencies with the notable exception of the Russian ruble, which gained 0.4% on the back of modest strength in oil prices. Otherwise, we have seen broad-based dollar strength here with CNY having fallen 0.4% as tariffs on an additional $16 billion of goods went into effect at midnight last night. Other EMG decliners include KRW (-0.9%); ZAR (-0.6%) and INR (-0.4%). In fact, the odd thing is that the dollar index isn’t higher than it is given the uniformity of movement.

As to this morning’s data releases, Initial Claims (exp 215K) and New Home Sales (645K) are on the docket. Yesterday’s Existing Home Sales disappointed slightly, printing at 5.34M, a 0.7% decline from last month and softer than the 5.4M expected. Not only did the number of homes sold disappoint, but also the median price fell, perhaps indicating that the housing market may well have peaked. Another data point to monitor on the economy, and more importantly as to future Fed actions.

It appears that excess long dollar positions may have finally been wrung from the market after six consecutive days of a falling dollar. With all eyes turning toward Jackson Hole tomorrow and Chairman Powell’s speech, I expect that today will continue to see consolidation, likely with modest further USD strength. But until Powell speaks, it is hard to know just how hawkish or dovish he is feeling right now. My advice is to use a day like today, when markets are quiet, to manage risks ahead of tomorrow, where the opportunity for larger movement is clear.

 

Good luck
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What Lies Ahead

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This afternoon, word from the Fed
Might tell us ‘bout what lies ahead
How high might rates rise?
Or did they revise
Their balance sheet forecasts instead?

As the market awaits the release of the FOMC minutes this afternoon, the dollar is extending its recent losses. While there have been many potential catalysts, as usual I would suggest that none of them are long term in nature. Consider that during the past three months, we have seen significant long dollar positions build up in the speculative community as the dollar rallied sharply amid tighter Fed monetary policy. In fact, the CFTC report has shown that short currency positions have grown toward record levels. However, a combination of events including; mixed US data, recovering foreign data, concerns over potential yield curve inversion by Fed presidents and Trump’s complaints about higher interest rates, have served to cool the ardor of the dollar bulls more recently. As such, in the past week we have seen the dollar retrace a bit more than 2.5% of the 8.6% rally that started in April. Many pundits continue to point to the President’s comments as the driving factor, although I put less stock in that. History is replete with instances of Presidents complaining about the Fed, and arguably the only reason this seems to be an issue is that during the Obama administration, as rates remained at zero for virtually the entire time, he had nothing to complain about.

So as we survey the landscape, what can we surmise about the FX markets right now? While there has been a lull in important data lately, this morning did bring news that wage growth in the Eurozone rose to 2.2% annually, well ahead of previous figures and a sign that inflation may begin to percolate there. But beyond that, there has been virtually nothing of substance since last week’s UK Employment and Inflation data showed that growth there was still solid despite Brexit uncertainties. Regarding the trade situation, there has been precious little news lately as both the US and China prepare for some mid-level meetings this week, but expectations are limited for any breakthroughs. Additionally, many pundits are pointing to recent political troubles for President Trump as a catalyst to sell dollars, and that may have been a driving force, but if there is one thing I have observed about the current administration, it excels at changing the subject and withstanding attacks. In other words, I see nothing that, by itself, would be reason for alarm over the dollar’s future course.

Do not mistake this for a change in the underlying macroeconomic conditions, which still point to structural dollar weakness. I am, of course, referring to the massive budget and current account deficits. But as of now, there is no evidence that the structural has overtaken the cyclical with regard to trading decisions. As long as the US continues to have the strongest economy, especially with an upward trajectory, and the Fed remains the central bank leading the way toward tighter monetary policy, the dollar should retain its strength.

Regarding the FOMC Minutes today, it seems that the key questions to be answered are; has there been more discussion on the eventual size of the balance sheet; what constitutes r* (the neutral interest rate); and how to respond if the long end of the curve refuses to follow short rates higher and the curve inverts. However, given that we are going to hear directly from Chairman Powell first thing Friday morning, I would suggest that today’s Minutes are going to be somewhat stale, and would be surprised if there is anything truly newsworthy in the release.

Scanning the markets this morning, while the dollar is generally weaker, it is not universally so. The euro is leading the way higher (+0.35%) in the G10 space, seemingly on the aforementioned wage data as well as simple short covering. However, AUD is a touch softer (-0.15%) after comments by RBA deputy governor DeBelle indicated that policy rates Down Under were appropriate and unlikely to change for quite a while to come as they try to encourage inflation back to its targeted level of 2.5%.

In the emerging markets, yesterday was notable for the 2% decline in BRL, which traded back through 4.00 for the first time since early 2016. The catalyst appears to have been stepped up concerns over the upcoming presidential election, where one of the favorites, Lula da Silva, remains in prison and ineligible to run. As there has been virtually no data released in the past week, we can only ascribe the movement to politics. This morning also sees the ruble falling 1.25% as talk of increased sanctions on Russia, including by the Eurozone economies, makes the rounds. And while movements in the Turkish lira have settled to less dramatic levels, it continues to slowly drift lower, falling another 1% this morning. In the end, while the G10 is faring well, EMG currencies are having a much less positive day.

Before the FOMC Minutes are released, we see our first data of the week in the form of Existing Home Sales (exp 5.4M), although I would be shocked if it impacted the FX markets in any way of note. Rather, look for a quiet morning as traders await the Minutes, and then a quiet afternoon once they realize that nothing new was learned. This week is all about Friday’s Powell speech. Further consolidation in the dollar ahead of that seems the most likely outcome in my view.

Good luck
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Diminished

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There is a small nation called Greece
Which eight years ago had to cease
Expending their cash
Which led to a crash
And caused GDP to decrease

Today is important due to
The fact that austerity’s through
The bailout is finished
Though Greece is diminished
While people there barely make do

Even though all eyes are on emerging markets these days, and rightly so in many cases, I thought it was worthwhile to note that the Greek sovereign debt crisis is ‘officially’ over as of today. While the situation in Greece doesn’t seem to have improved that much overall, today is the day that the bailouts officially end and Greece returns to the group of nations that are fully independent-ish. In fact, the Troika still controls much of what Greece is allowed to do with respect to spending priorities and budget discipline, and the nation remains a basket case in most ways. But reality on the ground could never dissuade the Troika from touting that their programs were a huge success and that everybody will live happily ever after. At any rate, it is probably a good thing that this chapter in Europe’s history has finally closed, but I would wager that if you surveyed the Greek people, not many would find good things to say about the future, let alone the past. In the end, though, Greece remains a tiny nation within the Eurozone, and what happens there impacts markets through sentiment changes, not through financial ones.

At the same time, there is a much bigger problem brewing in Italy, with many of the same issues surfacing there as occurred in Greece, and fears that the recently elected, anti-establishment government may make decisions inconsistent with the EU’s wishes. But Italy is not a small country. It is the third largest in the Eurozone and carries the largest amount of debt, €2.3 trillion worth. The one thing of which I am confident is that we have not seen the last problems to emanate from the Eurozone, and correspondingly, with the euro itself.

Reverting to emerging markets, while everyone recognizes the wreck that is Venezuela, on Friday night they made some major adjustments to their currency regime, devaluing the official bolivar by 95% (now approaching the black market rate) and redenominating the currency by removing 5 zeroes from its value. But in the end, the currency is just a symptom of their problems, not the cause, and it will remain the basket case that it has become over the past twenty years until there is a new government in place.

Moving on to more frequently discussed EMG currencies, like TRY (-2.2%), INR (+0.3%) and RUB (-0.2%), things are far less interesting. Remarkably, a 2% decline in the Turkish lira seems like a good day after recent gyrations, and the rest of the FX world seems to be on vacation, with very little substantive movement overnight. As we are coming to the end of August, it should be no real surprise that markets are getting quiet as there are more and more traders on holiday, and unless there is a specific story on which to trade, those that are manning the desks seem likely to play things close to the vest.

Meanwhile, there was virtually no data of note released overnight, and no commentary from any officials. The US-China trade situation seems like it might be moving toward a better place, with ongoing negotiations designed to arrive at an outcome in November, but there is still a long time to go before anything truly positive arrives. And in the meantime, Thursday we are due to see new tariffs imposed on $16 billion more of Chinese goods. Otherwise, there’s just not that much happening.

And the calendar this week is underwhelming as well, although the KC Fed’s Jackson Hole Symposium does kick off on Friday with Chairman Powell starting the festivities Friday morning.

Wednesday Existing Home Sales 5.4M
  FOMC Minutes  
Thursday Initial Claims 215K
  New Home Sales 645K
Friday Durable Goods -0.5%
  -ex Transport 0.5%

So the reality is that Wednesday’s FOMC Minutes will be carefully scrutinized for any sign that there is growing concern over the trade issue, and then Friday’s Powell speech is the next thing that will really matter. My sense is that we are looking forward to a very quiet week, with modest gyrations in the dollar, but no trend extension likely.

Good luck
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Decidedly Bleak

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The view turned decidedly bleak
For EMG nations this week
Though Turkey was worst
Some others were cursed
As well, since more funding they seek

The Argies are feeling put out
The rand had an actual rout
In LATAM they all
Enjoyed (?) quite a fall
But China, more weakness, did flout!

In truth, this morning things are rather dull in the FX markets, although I’m pretty sure that most traders are relieved. It has been an extremely difficult week for emerging market currencies and volatility remains pretty high. As an example, this week saw the South African rand fall nearly 6%, with 1% coming overnight. In LATAM, while the Argentine peso fell nearly 6% that was not the only casualty. Brazil felt the sting with the real falling 2.75%; Chile saw its peso down 3.5% while the Colombian version fell 2.7%. In fact, the best performing peso was Mexico’s, falling only 1% this week.

Of course, given that the Turkish lira was where all this started; we cannot ignore its movement. If you recall, last week it collapsed, falling nearly 40% at its weakest. Then, in response to several moves by the central bank restricting liquidity and stealthily hiking interest rates, it recouped nearly half that loss. However, this morning, the lira is once again falling, down about 5% as I type. The only thing we know for sure is that this volatility is unlikely to end soon as the market will continue to test the central bank, as well as President Erdogan’s ability to continue his policies of folly.

Finally, a quick look at APAC currencies shows INR as the only one with significant movement, falling 2% and breeching the 70.00 level for the first time ever. But the rest of this space, though it definitely saw volatility, wound up little changed on the week. And despite a great deal of anxiety about the renminbi, it is essentially exactly where it started on Monday.

The message that can be gleaned from this movement is that there are a great many countries which have fiscal imbalances, and whose prospects for future growth are being impacted by a combination of two US policies. First, as the Fed continues to raise rates and withdraw liquidity from markets via shrinking its balance sheet, those nations that relied on cheap dollar funding for their recent growth are finding themselves under pressure. And, of course, the second US policy impacting these nations is the reintroduction of tariffs on trade. Most emerging markets are heavily reliant on exports, with the US as a major destination. Slowing trade growth is also going to negatively impact these economies, and force a re-evaluation of the level of their currencies. As long as these two policies continue, and there is absolutely no sign they are going to change any time soon, every emerging market currency will be living under its own Sword of Damocles.

Meanwhile, in the G10 space, things are decidedly less interesting. While the euro did manage to trade to new lows for the move earlier this week, it has been able to reverse those losses and is now essentially flat since last Friday. The same can be said for most of the space, with the early week panic having dissipated, and very little information to drive currency movement otherwise. The weekly data was very much as expected, showing that the Eurozone and the UK are both rebounding from a very weak Q1, but hardly exploding higher. Rather, both continue to lag US growth numbers, and while the BOE did hike rates two weeks ago, and the ECB continues to slowly wind down QE, neither seems likely to increase the pace of their policy tightening, and so change the near term outlook for their respective currencies. And remember that Brexit continues to hang over the pound (its very own Sword of Damocles), with a distinct lack of movement on that front, other than the calendar which now shows just over seven months to come to a deal.

As to the US, data this week was somewhat mixed with some quite positive results (Retail Sales and Productivity) and some weaker data (Housing Starts and Philly Fed). All told, the weakness was not nearly enough to change the Fed’s trajectory, of that I am certain. And so, in the end, there is no reason to change any views with regard to the dollar; as the Fed continues to tighten policy, the dollar will continue to rise, albeit slowly.

Good luck
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More Concerned

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More pressure has lately been felt
In China, despite Road and Belt
As growth there is slowing
And Xi Jinping’s knowing
He must change the cards he’s been dealt

So last night, the news that we learned
Was both sides have grown more concerned
Thus trade talks would start
While traders took heart
And short-sellers of yuan got burned

While the Turkey situation has not disappeared completely, the central bank there appears to be regaining some control over the lira through surreptitious rate hikes. Cagily, they have stopped offering one-week liquidity, which theoretically could be had for ‘just’ 17.75% and instead are forcing banks to fund at the more expensive overnight window. This amounts to an effective 300bp rate rise and has been a key reason, along with yesterday’s announced moves regarding short positions, as to why the Turkish lira has rebounded so sharply from its worst levels. This hasn’t changed the macroeconomic picture, nor can it address the ongoing political row between the US and Turkey, but it has been effective in cooling the ardor of traders to short the lira. We will continue to monitor the situation, but it appears, that for now, TRY will no longer be the primary topic in FX markets.

Which allows us to turn our attention to China, where last night it was announced that low level trade talks between the US and China would start later this month in Washington. That is clearly the best news we have heard on the trade front in months, and although the process for further tariffs continues apace in the US, and it seems highly likely that next weeks imposition of tariffs on $16 billion of Chinese goods would go ahead, traders took the news very positively. The FX response was to reverse the renminbi’s recent decline, which prior to the news had seen it trade above 6.95 and perilously close to the 7.00 level many analysts have targeted as critical in PBOC deliberations. But this morning, USDCNY has fallen 0.75%, quite a large move for the currency pair, as fears of further escalation in the trade war seem to have abated slightly. There is certainly no guarantee that these talks will amount to anything or bring about further discussions, let alone a solution, but for now, they have been extremely well received by markets. Not only did the yuan rally, but also the Shanghai Composite reversed its early weakness, having fallen 1.8% at the open, and closed lower by only 0.65%. Hong Kong shares, too, rebounded from early weakness to close only marginally lower. It is important to remember that one of the drivers of the Shanghai market had been much weaker than expected earnings from Tencent, the Chinese internet firm that owns WeChat, China’s answer to Facebook. But there is no question that the news about trade talks was a critical factor in the rebound.

With these two stories as the lead, it is not surprising that the dollar has ceded some of its recent gains and is a touch softer overall this morning. Other EMG currencies that had seen significant pressure like ZAR (+0.1%), MXN (+0.5%), and RUB (+0.3%) have at least stabilized, if not reversed course. Fear of contagion remains rampant amongst emerging market investors and I expect that they will only return to markets slowly. And of course, it is entirely possible that the measures taken by the various authorities will turn out to be insufficient to address what in many cases are structural problems, and the currency rout will resume. But for now, it feels like a modicum of calm has been restored.

Meanwhile, G10 currencies are also mildly firmer this morning, although the dollar remains near its recent highs. For example, while the euro is higher by 0.3%, it is still trading with a 1.13 handle. There has been very little Eurozone data to drive markets, but there have been several articles discussing the ongoing trauma in Italy and how concerns over the new government’s fiscal policies may still turn disastrous.

Looking toward the UK, Retail Sales data there was quite strong, rising 0.7% in July, well above expectations for a 0.2% rise. However, the benefit to the pound has been minimal, with it rising just 0.1% on the news. Brexit remains a huge cloud over the currency (and the economy) and every day there is no positive news means that there is that much less time to create a solution. You all know I foresee a hard Brexit, not so much on principle as much as because I fear the May government simply cannot decide how to proceed and is not strong enough to impose a decision.

The last noteworthy piece of news in this space comes from Oslo, where the Norgesbank left rates on hold, as expected, but also essentially cemented the idea that they will be raising rates in September, joining the growing list of countries that are beginning to remove the excess accommodation put in place as a response to the financial crisis. After all, the tenth anniversary of the Lehman bankruptcy, the time many hold as the starting point to the crisis, is coming up in less than a month!

This morning’s US data brings Housing Starts (exp 1.2M), Building Permits (1.28M), Initial Claims (217K) and Philly Fed (22). Yesterday’s data was pretty strong, with the Empire Mfg print higher than expected and productivity growth showing its highest outcome since Q1 2015. In all, there is nothing in the data that suggests the Fed is going to change its tune, and if the trade situation eases, it is even more likely the Fed remains steady. All in all, despite modest softness this morning, the dollar remains the best bet going forward.

Good luck
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Somewhat Misguided

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The story in Turkey remains
One loaded with stresses and strains
While Erdogan dithers
The lira, it withers
And everything points to more pains

It seems, though, most traders decided
Their fears turned out somewhat misguided
So havens they’ve sold
From Swiss francs to gold
As safety’s now soundly derided.

The crisis in Turkey is, literally, yesterday’s news! This morning, while there have been no policy changes announced by the Turkish government, it seems that markets are feeling a bit less stressed. In fact, the Turkish lira has rebounded 5.5% as I type, although it is still lower by 25% in the past week. There has been no indication that President Erdogan is going to allow interest rates to rise nor has there been any hint that the Turkish government is going to heed calls to address its fundamental economic problems. Rather, it appears that in the manner of autocrats everywhere facing economic stress, Erdogan is blaming foreign influences for his domestic problems. It makes no sense to me that this crisis in Turkey has ended, but it is not that surprising that after a market move of the magnitude we have just seen in TRY, it should pause. Remember, too,
a key stressor has been the US-Turkish dustup over the detention of an American pastor and the tariffs imposed by President Trump in an effort to force Erdogan to comply with the US request to release him. And that shows no signs of ending either. The point is that while things today have calmed down, my sense is this is a temporary lull.

Moving on from Turkey, we see that China released a passel of data last night, none of which impressed. Fixed Asset Investment fell to 5.5%, the smallest gain in this series since it began in 1996. Retail Sales fell to 8.8%, below expectations and continuing the downward trend that has been evident for the past two years, while Industrial Production rose 6.0%, also below expectations, and continuing the gradual decline in the pace of this statistic. Taking it all together demonstrates that China’s efforts to reel in excessive debt growth earlier this year is starting to pay dividends. The problem for President Xi is that combining that effort with a trade fight with the US is starting to have a bigger nationwide impact than he would like to see. This is why we will continue to see the PBOC ease policy further this year, and why I continue to expect further pressure on the renminbi going forward. There have been many analysts who claim that the PBOC will prevent the currency from weakening beyond 6.90 or 7.00 as they fear the potential effects on capital flows. I disagree with that assessment and expect we can see a further decline in CNY as long as the dollar continues its broad based rally.

As to other emerging markets that had been severely impacted yesterday, we have seen most of those currencies rebound this morning. For instance, ZAR has rallied 2.5%, RUB is +1.5% and MXN is +0.9%. The point is that with TRY taking a breather, the same has been true elsewhere in this space.

Turning to the G10, we received a significant amount of data this morning with most of it better than expected. For example, UK Unemployment fell to 4.0% while Eurozone GDP grew at a 0.4% rate in Q2, a tick higher than expected. We also saw the German ZEW Sentiment Index rise to -13.7, up significantly from last month and a full 7 points better than expected. There were myriad individual national prints regarding GDP, employment and inflation, most of which showed that Q2 growth in the Eurozone was better than Q1. However, none of that has had much of an impact on the euro, which continues to hover unchanged on the day around 1.1400. While this level is a few pips better than the lows seen yesterday, there is no indication that traders have changed their collective minds regarding the euro’s eventual strength. The pound, meanwhile, has rebounded a touch this morning, +0.15%, but that seems more to do with the fact that Brexit has been off the front page than with any specific data releases. Ultimately, unless the Brits figure out a fudge and can get the Europeans to go along, I fear the pound will test the post Brexit vote lows seen two years ago.

As to today’s session, the only data point in the US is NFIB Small Business confidence (exp 106.9). This could actually be quite important in telling us how the trade saga is playing out amongst small companies. Thus far, corporate America seems to have weathered the storm, although if the President does go through with his threatened 25% tariffs on $200 billion of Chinese goods, I expect that will have a larger negative impact on the economy. But for now, it remains full speed ahead in the US, and that includes for the Fed, which is almost certainly going to raise rates in September and again in December. In fact, I think the real risk is that they hike more than three times in 2019, and they do it sooner than the market is expecting. And that, my friends, will continue to support the dollar.

Good luck
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Quite Foreboding

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In this, the eighth month of the year
The market’s succumbing to fear
With Turkey imploding
It feels quite foreboding
And folks, it can get more severe!

On Friday I discussed the Turkey situation as one beginning to spiral out of control. Well, this morning it has lived up to that billing with the lira falling an additional 7.5% as I type, although that includes a substantial recovery from its worst levels today. Now, the central bank there has finally reacted by loosening reserve requirements and offering foreign currency loans to local banks in unlimited size, but those moves have had only a limited positive impact on the currency. And since President Erdogan refuses to countenance higher interest rates, it seems that the next move is going to be capital controls, and it is likely to come pretty soon. In fact, if the recent pace of the lira’s decline continues unchecked, and I see no reason for it to stop yet, I expect that we will see capital controls before the week is out, and maybe as soon as tomorrow.

Here’s the thing. Turkey’s growth over the past decade has largely been debt driven (after all, who’s hasn’t?) but the Turks have been one of the most aggressive in using USD funding such that dollar debt represents >50% of the total debt in the economy. When the Fed turned from ultra easy monetary policy to begin tightening, it really began to hurt them. And as Chairman Powell has not only continued the process begun under Yellen, but increased the pace, the pain has become unbearable for Turkey’s economy. So it is fair to say that Turkey’s problems are self-inflicted (had they taken a more local and gradual path toward growth they arguably wouldn’t be in this bind), but those problems are not unique within the emerging markets, and at a certain point to investors, it doesn’t matter.

As I mentioned Friday, herd behavior amongst investors is the rule, not the exception. And as liquidity in Turkish asset markets dries up, and it has, investment managers will be looking to sell other risky assets in order to manage their overall portfolios. That is a key reason why ZAR has fallen by 2.5% this morning. Too, the Mexican peso has fallen 2% and even the Korean won, which is nobody’s idea of an emerging market (per capita GDP ranks ahead of Spain, Italy and New Zealand according to the CIA) has fallen 1.0%. The point is, if an asset manager cannot sell what he wants to sell to reduce risk, then he will sell what he can sell in order to limit portfolio damage. And this is how contagion starts!

So does Turkey really matter? In the FX markets, prior to the recent situation, the Turkish lira was a favored carry trade component, with investors seeking to earn what had been very high yields with a relatively stable currency. But that trade is over, and by all appearances, Turkey is going to be facing a recession pretty soon, which means that real trade flows are likely to diminish as well. In that sense, Turkey doesn’t matter too much.

But when you put this situation in the context of what else is happening in the world, this could well be the proverbial last straw. We have already been dealing with escalating trade tensions that show no sign of ebbing; a seeming stalemate in the Brexit talks opening the door to the UK crashing out of the EU with no deal; a populist government in Italy threatening to challenge Eurozone fiscal rules; and not least, a Federal Reserve that, despite everything else going on, is hell-bent and determined to continue raising interest rates. It should be no surprise that a number of equity markets around the world have struggled so far this year, but there is still a lot more green than red on screens. However, market sentiment can only take so much stress before investors decide that the risk is no longer worth the reward. I fear that we may be approaching that point. Market sentiment can be fleeting, and right now, we seem to be watching it flee!

With that in mind, a look at the G10 currency space confirms everything we have seen for the past several sessions. The dollar is broadly higher, with the euro -0.3% and the pound -0.2% although the yen, as is its wont in a crisis, has rallied 0.5%. Equity markets around the world are bathed in red, with the Nikkei falling 2% overnight and European shares, on average, down about 0.5%. US equity futures are pointing to a -0.3% opening in New York as well. Treasuries and Bunds have continued their modest rally, with yields falling another 1-2bps, and commodity prices are under pressure again. In other words, this is a classic risk off performance.

What can stop this? Historically, it has been the IMF that would step in and help support a country and its currency when stressed in this manner (remember Argentina a few months ago getting a $50 billion line of credit), but I am skeptical of that happening this time around. There are two things likely to prevent the IMF from getting involved: first, President Erdogan has been extremely vocal in his disdain for orthodox economic policies like raising interest rates in to help combat rising inflation, but the IMF will demand tighter monetary and tighter fiscal policy, neither of which Erdogan is likely to embrace; and second, for the IMF to act, the US has to be on sides, and the current situation has been partly aggravated by the diplomatic row between the US and Turkey. It seems hard to believe that President Trump will give the IMF the leeway to extend help. Unfortunately, I fear that there is more turmoil in our future.

Turning to the data review this week, there is a modest uptick in the volume of data, but it is not clear any of it will be critical to the Fed’s view of the world.

Tuesday NFIB Small Business 106.9
Wednesday Nonfarm Productivity 2.3%
  Unit Labor Costs 0.3%
  Empire State Mfg 20
  Retail Sales 0.1%
  -ex Autos 0.3%
  IP 0.3%
  Capacity Utilization 78.2%
Thursday Housing Starts 1.26M
  Building Permits 1.31M
  Initial Claims 215K
  Philly Fed 22
Friday Michigan Sentiment 98

Arguably, Retail Sales will be the most watched number, but everything we have heard from Fed speakers of late has been full speed ahead, so we will need to see much weaker data to change that perspective. Either that or a total collapse in the emerging market space, with the latter situation seemingly far more likely than the former. In the end, I see no reason to change my views on the dollar’s broad trajectory, which remains higher for the foreseeable future.

Good luck
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Somewhat Restrictive

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Said Evans, if I were predictive
A setting that’s somewhat restrictive
Might be just the thing
To slightly hamstring
This growth that’s become quite addictive

Chicago Fed president Charles Evans, a reliable dovish voice on the FOMC, spoke yesterday and made news because of his more hawkish tone. “If inflation [PCE] continues to be on the order of 2, 2.2 (percent) — I’m not expecting it to get as high as 2.5 — that suggests only a modest amount of restrictiveness above our neutral rate might be called for in 2020,” he said and continued, “ It would not surprise me at all if we make a judgment to move to a somewhat restrictive setting.” For a dove, that is a remarkable admission of the strength of the economy and the growing belief that monetary policy is now sending the wrong signals.

Remember, despite the fact that the Fed has raised rates seven times for a total of 175bps since December 2015, Fed funds remain well below the inflation rate so real interest rates remain negative. In fact, this morning we will see just how far below as CPI is due to be released at 8:30 and expected to print at 3.0% with the core rate at 2.3%. Historically, real interest rates have been positive to the tune of 2.0% and while there have clearly been fundamental changes in the economy that may warrant a lower real interest rate (e.g. technological advances driving efficiencies, globalization), negative real rates are only called for during a recession or worse. If the doves are now on board the rate raising train, and these comments seem to suggest that they are, the Fed could become even more aggressive in 2019, with a press conference after every meeting, and therefore the opportunity to explain their actions. Don’t be surprised if they raise rates in January 2019 especially if the emerging markets don’t completely crater. And if you want a hint of how this will impact the dollar, last night’s price action, with the DXY rising 0.5% and the euro finally breaking out of its recent trading range, falling by a similar amount, are very good prognosticators.

But the caveat is, if the emerging markets don’t crater, and that is an important caveat. Last night, the Turkish lira saw a significant escalation in the recent market tension as it fell nearly 10% at one point and though it has recovered slightly, remains down by 7% as I type. The thing is, nothing new has been revealed. It appears that as the week is drawing to a close, traders and investors are simply coming to the conclusion that President Erdogan is not going to allow the central bank the leeway it needs to manage the economy in an orthodox manner, and that things could well spiral out of control. The fact that Turkey and the US remain at odds over the arrest of an American pastor by Istanbul, and that sanctions are being imposed, is just adding fuel to the fire. This is the proverbial falling knife. Don’t try to catch it. Until the politics changes, the currency is likely to continue in freefall.

The question is, will this infect other emerging markets, and by extension developed country markets? If last night is any indication, it may just be starting to do so. Equity markets throughout Europe are lower, some pretty sharply (Germany -1.5%, Italy -1.7%) as concerns have been raised over some of the large European banks’ exposures to Turkey. We saw weakness in Japanese equities (-1.3%) despite the fact that GDP growth there in Q2 was shown to be a better than expected 1.9% annualized. US equity futures are also softer, down about 0.5% at this point, and Treasury yields are falling (10yr -4bps) as investors are fleeing to safe havens. In other words, it is beginning to look like that infection is starting to spread.

As is often the case, these concerns make themselves known in almost random fashion. Certain currencies respond to the news in a negative way, while others that you may assume would see the same type of response don’t move. It is also important to watch the movement over a week or two, rather than on a given day, as those trends can be more revealing. For example, RUB is barely softer this morning, down just 0.3%, despite increased sanctions imposed by the US because of the poisoning of an ex Russian spy in London earlier this year. But this week it has fallen 5.6%, a pretty hefty move, and indicative of the fact that there is growing concern there. Another currency feeling the pressure this morning is ZAR, which has fallen 1.1% and 4% on the week. But as it had strengthened sharply through Q1, it is only down 2% in the past year. However, the recent trend is ominous and it certainly appears that ZAR has further to fall. MXN is another interesting case, where it has fallen 1.25% overnight and 2.6% this week, but remains far stronger than its levels earlier this summer in the run up to the presidential election there. However, regardless of the market’s relief that AMLO does not seem to be as radical as initially feared, emerging market disease can be quite contagious, and it would not surprise me at all to see the peso fall another 5% or even more if we see additional pressure elsewhere.

The key to remember here is that there is a great deal of herd behavior demonstrated by investors, especially emerging market investors, and if they start to leave one market because there is fear of a serious problem, it can easily spread to other markets, especially if liquidity in that first market dries up. We have been witnessing individual market problems all year, and each one seemed isolated due to specific local events. But I am getting the feeling that we may have reached a tipping point, where there have been enough individual events to cause a re-evaluation of the general trend. If this is indeed the case, then the Fed may well slow the pace of its rate hikes, but the dollar should benefit anyway as the safest haven of all.

Do not be surprised if we see wider spread weakness across emerging market currencies going forward, and by extension, the G10 as well. There are likely to be two exceptions to this rule, JPY and CHF, but otherwise, I fear thin summer markets may lead us to some larger moves across the board. So stay alert and maintain those hedge ratios.

Good luck and good weekend
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