Real Strides

In Twenty-sixteen when we learned
That Britain, the EU, had spurned
The pound took a fall
While casting a pall
On how future growth might be earned

For nearly two years chaos reigned
While Brexiteers strongly maintained
A deal will be made
With no one betrayed
And there is still much to be gained

Well last night it seems that both sides
Have finally made some real strides
It’s no real surprise
To see the pound rise
As delegates closed the divides

The big story this morning is that there seemed to be real movement in the Brexit negotiations with an agreement “95% complete” according to the UK government. The key was an agreement regarding financial services, obviously an enormous issue for the UK, whereby UK financial firms would still be given access to the EU based on the “equivalence” of regulations. While this is not quite as robust as the current situation, being within the bloc, it is seen as sufficient to allow continued cross border access in both directions. Of course, the Irish border situation remains outstanding, but there is talk that progress has been made there and that the benefit of a finance deal will be sufficient to offset hard-line concerns over Ireland.

The market response was immediate with the pound jumping more than 1.0% when the headlines hit. If a Brexit deal is reached, the pound likely has further to rise as there is no question it has suffered based on the increasing likelihood of a no-deal situation. That said, a full-throated rally seems unlikely. There are still many other issues that are going to weigh on the pound, notably the dollar’s underlying strength as well as UK economic malaise. In fact, data early this morning showed that the UK manufacturing PMI fell much more than expected to a reading of just 51.1, its lowest reading since the month after the Brexit vote. Obviously, this data did not include the positive news from today, but it is indicative of how the UK economy continues to slow along with the rest of the world. If a deal is signed, I expect the pound could rally another few percent, but anything more than 1.35 would seem to be a stretch based on the economic fundamentals.

But the Brexit story set the tone for the FX market as the dollar is softer across the board, in many other cases having fallen by more than 1% as well. For example, the euro has rallied by 0.6% amid general enthusiasm generated by yesterday’s global stock rebound. We have also seen both Aussie (+1.1%) and Kiwi (+1.4%) jump sharply, as commodity prices stabilize and risk appetite improves.

This theme was also made evident by movements in government bonds around the world, where, for example, Treasury yields are 10bps higher over the last two sessions. In addition, EMG currencies, which had a terrible month in October, have shown some life this morning. Today we see the Mexican peso has rallied 0.8%, while South Africa’s rand is up 1.5%. Even the Chinese yuan, which has been closely scrutinized due to its approaching the critical 7.00 level, has rallied today by 0.4%, its largest gain in more than three weeks. In fact, most EMG currencies are higher, with many gaining more than 0.5%. In other words, it has been a broad-based USD decline. After a strong multi-week run in the dollar, it can be no surprise that a correction has occurred.

Turning to the data situation, yesterday’s ADP number was quite strong, 227K, and the Employment Cost Index (ECI) showed that wages are rising at a 3.1% clip Y/Y, the fastest in several years. While yesterday’s Chicago PMI disappointed slightly at 58.4, that remains a very firm reading historically. Looking forward to today’s session, we hear from the BOE, where policy is forecast to be unchanged, and we will get updated economic forecasts. If a Brexit deal is signed, look for the UK to raise rates several more times next year as there should be a positive growth impact. Then from the US we see Initial Claims (exp 213K), Nonfarm Productivity (2.2%), Unit Labor Costs (1.0%) and ISM Manufacturing (59.0). While these will be seen as important, tomorrow’s payroll data is still going to be the focus, especially the Average Hourly Earnings (AHE) number. With the ECI pointing higher, if AHE shows the same thing, watch for more talk of the Fed becoming even more aggressive.

Ultimately, the US data picture continues to point to strength in the US economy, especially relative to what we are seeing throughout the rest of the world. The EU is slowing, the UK is slowing, China is slowing and so are most other places. As long as this remains the situation, it is hard to expect the dollar to retreat in any meaningful way. While no market moves in a straight line, the dollar’s trend remains higher.

Good luck
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More Trouble is Brewing

The PMI data last night
From China highlighted their plight
More trouble is brewing
While Xi keeps pursuing
The policies to get things right

Any questions about whether the trade conflict between the US and China was having an impact on the Chinese economy were answered last night when the latest PMI readings were released. The Manufacturing PMI fell to 50.2, it’s lowest level in more than two years and barely above the expansion/contraction level of 50.0. Even more disconcertingly for the Chinese, a number of the sub-indices notably export sales and employment, fell further below that 50.0 level (to 46.9 and 48.1 respectively), pointing to a limited probability of a rebound any time soon. At the same time, the Services PMI was also released lower than expected, falling to 53.9, its lowest level since last summer. Here, too, export orders and employment numbers fell (to 47.8 and 48.9 respectively), indicating that the economic weakness is quite broad based.

Summing up, it seems safe to say that growth in China continues to slow. One question I have is how is it possible that when the Chinese release their GDP estimates, the quarter-to-quarter movement is restricted to 0.1% increments? After all, elsewhere in the world, despite much lower headline numbers (remember China is allegedly growing at 6.5% while Europe is growing at 2.0% and the US at 3.5%), the month-to-month variability is much greater. Simple probability would anticipate that the variance in China’s data would be higher than in the rest of the world. My point is that, as in most things to do with China, we don’t really know what is happening there other than what they tell us and that is like relying on a pharmaceutical salesman to prescribe your medicine. There are several independent attempts ongoing to get a more accurate reading of GDP growth in China, with measures of electricity utilization or copper imports seen as key data that is difficult to manipulate, but they all remain incomplete. And it seems highly unlikely that President Xi, who has been focused on improving the economic lot of his country, will ever admit that the growth figures are being manipulated. But I remain skeptical of pretty much all the data that they provide.

At any rate, the impact on the renminbi continues to be modestly negative, with the dollar touching another new high for the move, just below 6.9800, in the overnight session. This very gradual weakening trend seems to be the PBOC’s plan for now, perhaps in order to make a move through 7.00 appear less frightening if it happens very slowly. I expect that it will continue for the foreseeable future especially as long as the Fed remains on track to tighten policy further while the PBOC searches for more ways to ease policy without actually cutting interest rates. Look for another reserve requirement ratio cut before the end of the year as well as a 7 handle on USDCNY.

Turning to the euro, data this morning showed that Signor Draghi has a bit of a challenge ahead of him. Eurozone inflation rose to 2.2% with the core reading rising to 1.1%, both slightly firmer than expected. The difference continues to be driven by energy prices, but the concern comes from the fact that GDP growth in the Eurozone slowed more than expected last quarter. Facing a situation where growth is slowing and inflation rising is every central banker’s nightmare scenario, as the traditional remedies for each are exactly opposite policies. And while the fluctuations are hardly the stuff of a disaster, the implication is that Europe may be reaching its growth potential at a time when interest rates remain negative and QE is still extant. The risk is that the removal of those policies will drive the Eurozone back into a much slower growth scenario, if not a recession, while inflation continues to creep higher. It is data of this nature, as well as the ongoing political dramas, that inform my views that the ECB will maintain easier policy for far longer than the market currently believes. And this is why I remain bearish on the euro.

Yesterday the pound managed to trade to its lowest level since the post-Brexit vote period, but it has bounced a bit this morning, +0.35%. That said, the trend remains lower for the pound. We are now exactly five months away from Brexit and there is still no resolution for the Irish border issue. Every day that passes increases the risk that there will be no deal, which will certainly have a decidedly negative impact on the UK economy and the pound by extension. Remember, too, that even if the negotiators agree a deal, it still must be ratified by 28 separate parliaments, which will be no easy task in the space of a few months. As long as this is the trajectory, the risk of a sharp decline in the pound remains quite real. Hedgers take note.

Elsewhere, the BOJ met last night and left policy unchanged as they remain no closer to achieving their 2.0% inflation goal today than they were five years ago when they started this process. However, the market has become quite accustomed to the process and as such, the yen is unchanged this morning. At this time, yen movement will be dictated by the interplay between risk scenarios and the Fed’s rate hike trajectory. Yen remains a haven asset, and in periods of extreme market stress is likely to perform well, but at the same time, as the interest rate differential increasingly favors the dollar, yen strength is likely to be moderated. In other words, it is hard to make a case for a large move in either direction in the near term.

Away from those three currencies, the dollar appears generally firmer, but movement has not been large. Turning to the data front, yesterday’s releases showed that home prices continue to ebb slightly in the US while Consumer Confidence remains high. This morning brings the first inklings of the employment situation with the ADP report (exp 189K) and then Chicago PMI (60.0) coming at 9:45. Equity futures are pointing higher as the market looks to build on yesterday’s modest rally. All the talk remains about how October has been the worst month in equity markets all year, but in the broad scheme of things, I would contend that, at least in the US, prices remain elevated compared to traditional valuation benchmarks like P/E ratios. At any rate, it seems unlikely that either of today’s data points will drive much FX activity, meaning that the big trend of a higher dollar is likely to dominate, albeit in a gradual fashion.

Good luck
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A Narrative Challenge

From Europe, the data released
Showed growth there has clearly decreased
For Draghi this poses
(What everyone knows is)
A narrative challenge, at least

Once upon a time there was a group of nations that came together in an effort to reap the theoretical benefits of closely adhering to the same types of economic policies. They believed that by linking together, they would create a much larger ‘domestic’ market, and therefore would be able to compete more effectively on the global stage. They even threw away their own currencies and created a single currency on which to depend. Under the guidance of their largest and most successful member, this currency was managed by a completely independent central bank, so they could never be accused of printing money recklessly. And after a few initial hiccups, this group generally thrived.

But then one day, clouds arose on the horizon, where from across the great ocean, a storm (now known as the Great financial crisis) blew in from the west. At first it appeared that this group of nations would weather the storm pretty well. But quickly these nations found out that their own banks had substantial exposure to the key problem that precipitated the storm, real estate investment in the US. Suddenly they were dragged into the maelstrom and their economies all weakened dramatically. The after effects of this included questions about whether a number of these countries would be able to continue to repay their outstanding debt. This precipitated the next crisis, where the weakest members of the club, the PIIGS, all saw their financing costs skyrocket as investors no longer wanted to accept the risk of repayment. This had the added detriment of weakening those nations’ banks further, as they had allocated a significant portion of their own balance sheets to buying home country debt. (The very debt investors were loath to own because of the repayment risks.)

Just when things reached their nadir, and the very weakest piggy looked like it was about to leave the group, a knight in shining armor rode to the rescue, promising to do “whatever it takes” to prevent the system from collapsing and the currency from breaking up. Being a knight in good standing, he lived up to those words and used every monetary policy trick known to mankind in order to save the day. These included cutting interest rates not just to zero, but below; force-feeding interest-free loans to the banks so that that they could on lend that money to companies throughout the group; and finally buying up as much sovereign, and then corporate, debt as they could, regardless of the price.

Time passed (five years) and that shining knight was still doing all those same things which helped avoid the worst possible outcomes, but didn’t really get the group’s economy growing as much as hoped. In fact, it seems that last year was the best it was going to get, where growth reached 2.5%. But now there are new storm clouds brewing, both from the West as well as from within, and the growth narrative has changed. And it appears this new narrative may not have a happy ending.

Data released this morning showed that GDP growth in Italy was nil, matching Germany’s performance, and helping to drag Eurozone growth down to 0.2% for Q3, half the expected rate. French growth, while weaker than expected at 0.4%, was at least positive. In addition, a series of confidence and sentiment indicators all demonstrated weakness describing a situation where not only has the recent performance been slipping, but expectations for the future are weakening as well. It can be no surprise that the euro has slipped further on the news, down 0.2% this morning and continuing its recent trend. During the month of October, the single currency has fallen more than 2.2%, and quite frankly, there doesn’t appear to be any reason in the short run for that to change.

What may change, though, is Signor Draghi’s tune if Eurozone growth data continues to weaken. It will be increasingly difficult for Draghi to justify ending QE and eventually raising rates if the economy is truly slowing. Right now, most analysts are saying this is a temporary thing, and that growth will rebound in Q4, but with the ongoing trade fight between the US and China weakening the Chinese economy, as well as the Fed continuing to raise interest rates and reduce dollar liquidity in global markets, it is quite realistic to believe that there will be no reprieve. And none of that includes the still fragile Italian budget situation as well as the potential for a ‘hard’ Brexit, both of which are likely to negatively impact the euro. And don’t get me started about German politics and how the end of the Merkel era could be an even bigger problem.

The point is, there is still no good reason to believe the dollar’s rally has ended. Speaking of Brexit, the pound is under pressure this morning, down -0.35%, as the market absorbs the most recent UK budget, where austerity has ended while growth is slowing. Of course, everything in the UK is still subject to change depending on the Brexit outcome, but as yet, there has been no breakthrough on the Irish border issue.

As to the rest of the G10, Aussie and Kiwi both benefitted from a bounce in the Chinese stock market, at least that’s what people are talking about. However, it makes little sense to me that a tiny bounce there would have such a big impact. Rather, I expect that both currencies will cede at least some of those gains before the day is done. Meanwhile, the yen has softened, which has been attributed to a risk-on sentiment there, and in fairness, Treasury yields have risen as well, but the rest of the risk clues are far less clear.

Speaking of China, the PBOC fixed the renminbi at a new low for the move, 6.9724, which promptly saw it trade even closer to 7.00, although it is now essentially unchanged on the day. The market talk is that traders are waiting for the meeting between Presidents Trump and Xi, later this mornth, to see if a further trade war can be averted. If tensions ease in the wake of the meeting, look for USDCNY to slowly head lower, but if there is no breakthrough, a move through 7.00 would seem imminent.

And that’s really it for this morning. Yesterday’s US data showed PCE right at 2.0% for both headline and core, while Personal Spending rose 0.4%, as expected. Today’s data brings only the Case-Shiller Home Price Index (exp 5.8%) and Consumer Confidence (136.0), neither of which is likely to move markets. In addition, the Fed is now in its quiet period, so no more Fed speak until the meeting next week. Equity futures are pointing slightly higher, but that is no guarantee of how the day proceeds. In the end, it is hard to make a case for a weaker dollar quite yet.

Good luck
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The Doves’ Greatest Friend

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

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

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

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

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

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

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

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

Good luck and good weekend
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Trembling With Fear

The one thing increasingly clear
Is markets are trembling with fear
As stock markets tumble
Most central banks fumble
Their message, then get a Bronx cheer

Being a central banker has become much more difficult recently, especially in the wake of yesterday’s global equity market rout. It seems that policies that they have collectively promulgated, QE and ZIRP/NIRP are now quite long in the tooth, and no longer having the positive impact desired. Let’s recap quickly.

The Great recession in 2008 called for an extraordinary monetary response by central banks around the world, and rightly so. The deepest recession since the Great Depression saw liquidity across many markets completely dry up. Even FX, arguably the most liquid market of them all, had structural problems. So the combination of QE and USD swap lines offered by the Fed to the rest of the world’s central banks was an appropriate response to help untangle the mess. Alas, fiscal policy never chipped in to the recovery and central banks took it upon themselves to do all the lifting, thus relieving governments of the need to make hard decisions. In hindsight, this was a key mistake!

Fast forward ten years to today and the situation, remarkably, is that most of that extraordinary monetary stimulus is still sloshing around the world as other than the Fed and the Bank of Canada (who raised rates yesterday and indicated they would be quickening the pace of doing so in the future), no other major central bank has done anything of note. The ECB, the BOJ and the PBOC are all still adding liquidity to their systems, while the BOE has raised rates just 25bps, net, from the lows established after the crisis. And the same is true of peripheral nations like Switzerland, Sweden and Australia, where interest rates remain at their post crisis nadirs (-0.75%, -0.50% and 1.50% respectively).

The problem for these central banks is that growth is starting to slow on a global basis. Whether it is the increased trade friction between the US and China, concerns over Brexit or simply that the US recovery (which still arguably drives most of the global economy) is now the longest on record and due to end, the situation is increasingly fraught. And that’s the rub. If interest rates are already negative, what can central banks do to stimulate the economy in the event of a recession? The answer, of course, is not much. More QE and even deeper negative interest rates are unlikely to have the same positive impact the first efforts had, in fact they could have the opposite effect by generating greater concern amongst investors and causing a more severe sell-off in markets. But politically, no central bank will be able to sit by and do nothing if a recession does appear. As I said, central banking has become much more difficult lately.

That is all a preamble to discuss what is going on in markets right now. FX is a backburner issue with equities front and center around the world. While European markets have stabilized at this time, one session of stability is not sufficient to declare an end to the rout. In the end, markets remain beholden to broad sentiment, the narrative if you will, and for the past ten years that narrative was that continued low inflation combined with steady growth would allow the central banks to maintain ultra easy monetary policy with no negative side effects. But in the past year, the cracks in that narrative have grown to the point where it is no longer seen as viable. First, inflation has begun to creep higher in certain areas around the world, notably the US and China. At the same time, growth data appears to have peaked last quarter. Tomorrow we will see the first estimate of Q3 GDP growth in the US (exp 3.3%), which is already considerably lower than Q2. In addition, we have seen Chinese growth slow more than expected and German growth fall to 0.0% in Q3. The combination of rising inflation and slower growth has put central banks in a bind forcing them to choose which issue to address first. The problem is by addressing one they are likely to exacerbate the other. So as the Fed fights threats of higher inflation, it impedes growth. Meanwhile, China has opted to support growth, thus feeding faster inflation. In the end, as the next recession looms closer, central banks will find themselves with fewer policy arrows in their quiver.

But this is an FX note, so let’s take a quick look at the market this morning. The dollar is a touch softer, with both the euro and the pound higher by 0.15% while we are seeing similar moves in most emerging market currencies. Activity in the market seems muted relative to the excitement in equities, but my sense is this will not last. Rather, if the equity sell-off continues, the dollar should find itself in a much stronger position. As to the stories that have been driving things in FX, the Italian budget, Brexit, central bank policies, there have been no real changes in the past twenty-four hours. The possible exception is that the interest rate futures market in the US has removed one price hike from the Fed’s expected path as concern grows that a continues slide in the stock market will lead to weaker growth and less need to keep driving rates higher. It seems that the Fed realizes that it began its tightening process far too late (thank you Chair Yellen!) and is now desperately trying to catch up so they can respond to the next downturn. But hey, the ECB is MUCH further behind.

Looking forward to today’s session, we start with the ECB meeting, where they announced no change in policy rates, but we still await Signor Draghi’s press conference at 8:30. It will be interesting if he continues to characterize the Eurozone economy risks as balanced, or if the downside risks are now elevated. If the latter, look for the euro to decline sharply! We also get US data including Durable Goods (exp -1.0%, ex transport +0.5%) and the Goods Trade Balance (-$74.9B). Yesterday’s New Home Sales data was awful, just 553K, well below expectations, and another sign that parts of the economy here are rolling over. I still don’t believe that the data turn has been enough to change the Fed’s mind about a December rate hike, but if numbers start to fall, watch out. Tomorrow’s GDP print will be quite important to the market. But today, I think the ECB dominates the story.

Good luck
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Just Let It Go

Said Brussels to Italy, No
Your budget is not apropos
Go fix it and then
Come back here again
Said Italy, just let it go

In England, meanwhile, PM May
Is finding she can’t get her way
A challenge is forming
With more Tories warming
Up to the thought she shouldn’t stay

The world seems to be getting messier by the day. Despite the ongoing vitriol in the US election process, the dollar continues to benefit from the fact that problems elsewhere seem to be worse. For example, the euro is under pressure this morning with two key stories driving the market. First, in an unprecedented move, the EU rejected Italy’s draft budget by claiming that it’s deficit targets were not in line with EU directives of reducing debt. Not surprisingly, the populist government in Italy simply said that fiscal stimulus was required to get the economy growing again, and they were going to enact it anyway. There are two issues here impacting the euro, the first being that markets are likely to drive Italian interest rates higher and add significant pressure to the Italian economy, notably the banking sector, which is tightly tied to those rates. The second is that if a major country is willing to ignore EU guidance on an important issue like this, what does that say about the credibility of the entire EU construct and the euro by default.

The other key issue was the release of much weaker than expected Flash PMI data for Germany, France and the entire Eurozone. Remember yesterday the Bundesbank indicated that GDP growth in Q3 would be flat in Germany, undermining markets there. Well, today, we learned that growth in Q4 isn’t exactly shining either, with the Manufacturing PMI printing at 52.3, its lowest level since early 2016. This data added to the pressure on the euro, which has fallen 0.6% on the day and is now touching 1.1400 for the first time since mid-August. It appears that regardless of the ongoing structural concerns in the US, the cyclical growth and interest rate story remains the market’s driver for now.

Turning to the UK, yesterday saw a rally in the pound after a story circulated that the EU was going to offer a compromise on how to treat the UK after Brexit, allowing them to stay within the customs union. However, this morning, there appears to be a growing insurgency within the Tory party and a challenge to PM May appears to be coming. If she were ousted, that would become quite problematic with regards to the ongoing negotiations as Cabinet members would change, and policy direction would likely as well. Given the late date, just five months left before the split is finalized, it would speak to a much higher probability of a hard Brexit with no deal, and a much lower pound. With this in mind, it is not surprising that the pound has ceded yesterday’s gains and is down 0.6% as well this morning.

Away from those two stories, the dollar is generally, but not universally, stronger. It is noteworthy that USDCNY is higher by 0.2%, pushing back to the top of its recent range just above 6.95, and starting to move into the area where many are counting on the PBOC to intervene. There are a number of analysts who continue to believe that a move above 7.00 will lead to a significant increase in capital outflows from China, and a much bigger risk-off movement. This is something about which the Chinese are extremely concerned. However, looking around APAC currencies overnight, both INR (+0.5%) and KRW (+0.25%), arguably the next most important ones, showed strength vs. the dollar as yesterday’s sharp decline in oil prices was seen as a positive for both of these large oil importers.

On the rate front, the Riksbank in Stockholm left interest rates on hold, as expected, but basically promised to raise them in either December or February. SEK is modestly weaker vs. the dollar, but almost unchanged vs. the euro, perhaps a better measure of the impact. This morning, the Bank of Canada will also announce its rate decision with expectations nearly universal that they will raise rates by 25bps to 1.75%. Ahead of the announcement, the Loonie is flat.

And those are really the FX stories of the day. Equity markets around the world seem to be rebounding from yesterday’s US led sell-off, although US equity futures are still pointing lower as I type. Treasury yields have fallen from yesterday’s closing levels, but remain in the vicinity of 3.15%. As mentioned, oil prices tumbled yesterday by more than 4% after Saudi Arabia indicated they would make up for any reduction in Iranian crude exports due to the US sanctions that are to begin in earnest next week. And gold, the traditional safe haven, is basically flat on the day, although about 1% lower than the peak of $1240/oz it reached during the nadir of yesterday’s equity market movement.

This morning we see our first real data of the week, with New Home Sales expected to print at 625K. We also get the Fed’s Beige Book at 2:00pm. Speaking of the Fed, yesterday Atlanta Fed President Bostic reiterated that the Fed was on the right path and that gradual rate increases were appropriate. Today we hear from Bullard, Mester and Bostic again. While the housing data has softened lately, and even some of the earnings data has been a bit softer than expected, there is no strong rationale for any of these regional presidents to change their views. In fact the one thing I would mention about earnings is how many companies are raising prices to cover increased materials costs or tariff impacts. If anything, that sounds pretty inflationary to me, and I would guess to the Fed as well.

If US equity markets follow through on the opening and continue to decline, the dollar should remain well bid overall. But my sense is that we are going to see some bargain hunters coming in here, help the stock markets bounce and see the dollar decline by the time NY goes home.

Good luck
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Some Whiplash

It seems that the pumping of cash
By China was good for a flash
Of higher stock prices
But there’s still a crisis
So traders there felt some whiplash

In Europe, the same might be said
As traders, Italian debt fled
The EU today
Rome’s budget will weigh
With portents of more strife ahead

Remember how the officially induced rally in the Chinese equity market was going to stabilize markets? Yeah, me neither. It seems that, last night, despite lots more talk and promises of more funding, investors in those equity markets were decidedly unimpressed with the prospects and have resumed their active share selling. Overnight saw the Shanghai composite decline 2.25% and drag the rest of Asian markets lower alongside (Nikkei -2.7%, Hang Seng -2.9%). The impact on the CNY was very much as would be expected, a modest decline of 0.25% as traders test the PBOC resolve of preventing a move to 7.00.

This has also impacted European markets, which are lower across the board, none more so than Germany’s DAX which has fallen 2.0%. Given the ongoing angst over the Italian budget situation, one might have expected the Italian markets to be the worst performers, but Germany revealed its own little secret this morning, Q3 GDP growth there is expected to be 0.0%! That’s right, Europe’s strongest economy is going to suffer a stagnant quarter, and so equity markets have responded accordingly. This is not to imply that all is rosy in Rome, just that the Germans had a bigger surprise today.

Before moving on to the Italian story, let me note that the situation in China needs to be watched carefully going forward for another reason. For the past ten years, central banks around the world have controlled the price action in markets. Whether it was the first QE implementation by Benny the Beard, or Signor Draghi’s “whatever it takes” comments, when central bankers spoke, markets responded as the bankers desired. But lately, those same central banks seem to have lost a little bit of their mojo, as comments they make in an effort to sway markets have a shorter and shorter half-life. The fact that despite a concerted effort by every senior financial official in China, including President Xi, to talk up equity markets, and by reference the health of the Chinese economy, has had such a short lived impact, may well imply that the meme of central banks controlling markets is coming to an end.

And to my mind, that would be a good thing. Ten years of unprecedented monetary policy actions have dramatically distorted price signals in virtually every market. Whether it is the abnormally low spread between high-yield debt and government bonds, or the idea that P/E ratios of 100 are the signs of a good investment, markets no longer offer price discovery. Or perhaps they no longer offer the opportunity to discern value in a price. Keep in mind that there are still more than €5 trillion of debt outstanding that have negative interest rates. But while I may see this as a positive step toward markets regaining their functionality, the central banks are likely to feel very differently. If their words are no longer effective tools to manage markets, they will be forced to enact actual policies, some of which may be contrary to fiscal considerations. ‘Forward guidance’ is much easier to implement (and comes with much less political fallout) than actual policy changes. Just remember, if this thesis is correct, market volatility in every market is going to increase going forward.

Now back to our regularly scheduled programming. The Italian budget continues to be topic number one in terms of current risks to market stability. Thus far the Italian government has been unwilling to change its plans and the EU is studying them closely to determine if the budget breaks the rules. The problem for the EU is that if they crack down hard, reject the budget and tell Rome what to do, it is likely to further inflame the anti-establishment forces in Italy, and potentially have a bigger detrimental impact on the European Parliament elections to be held early next year. However, if they do nothing, the risk is that Italy finds itself in a situation where it has increased difficulty in refinancing its debt, and that could stress the entire Eurozone project. It was much easier for the EU to act tough with Greece, whose economy was so tiny. Italy has the third largest economy in the Eurozone , and if they have financing troubles it could quickly lead to problems throughout the continent, and directly impact the euro. In other words, there is no good answer.

The market impact of this ongoing situation has been a gradual erosion in the euro’s value, which fell about 0.7% yesterday, although it has stabilized this morning. While the German GDP story is obviously a negative for the currency, the reality is that the euro, for now, is beholden to the Italian budget story. If Italy remains recalcitrant, look for further weakness. Meanwhile, the pound, too, suffered yesterday, falling a penny alongside the euro, as the ongoing Brexit story continues to weigh on the currency. Consider that there are essentially five months left to find a compromise and that the problem has not gotten any easier. Despite the lack of progress, I still expect some sort of face-saving deal at the end of the process, but the risk situation is highly skewed. If there is no deal, look for the pound to fall very sharply, maybe another 5% right away, whereas any deal will likely only see a relief rally of 2% or so. Hedgers beware.

And those are really the only stories that matter today. There is a great deal of discussion regarding the US midterm elections, and how any given result may impact markets, but that is well beyond the purview of this note. Generally, risk was tossed overboard yesterday as 10-year Treasury yields fell 5bps, gold rallied and so did the dollar, the yen and the Swiss franc. This morning, there has been less movement in that group of havens, although risk assets remain under pressure. My sense is that given the absence of any US data, the broad risk profile will drive the dollar. To me, all signs point to further equity weakness and therefore more haven buying. I like the dollar in that scenario.

Good luck
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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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Ready To Burn

The chances last week of a deal
On Brexit quite clearly seemed real
But Saturday showed
T’is still a long road
Ere both sides, their bad feelings, heal

Meanwhile there’s another concern
In Europe, while Italians spurn
Demands to be sparing
And start in repairing
A fiscal house ready to burn

Thus far today, the evidence is mixed as to whether the equity market rout cum risk-off scenario is truly over, or simply took a breather on Friday. The rebound in stock markets around the world on Friday was met with a collective sigh of relief, but the overnight session saw APAC markets give up almost all of that ground with most closing down between 1.5%-2.0%. Europe opened lower as well although has since traded back to flat as traders everywhere wait for the US session to begin. Currently, futures are pointing lower by 0.4%, but there is a long time between now and the open, so sentiment may shift yet again before then. The key question is will investors, who have not seen a substantial correction in US equity markets in more than nine years, see this as the beginning of the end? Or as a chance to buy the dip? At this point, we can only wait and watch.

In the meantime, there are several stories that are important, but whose market impact has been diluted by the broad risk theme that has exerted itself in the past week. The first is about Brexit, where last week it seemed that a deal would be announced at the EU Summit to be held this Wednesday in Brussels. Alas, over the weekend, intense negotiations broke down and no further ones are slated ahead of that meeting. It seems that the Irish border issue remains intractable for now, as Ireland’s demand of no hard customs border with Northern Ireland cannot fit within the EU framework unless Northern Ireland is essentially separated from England. And neither side has been willing to cave on the issue, which, after all, is entirely about national sovereignty where fudging is far more difficult. Surprisingly, despite this setback, the pound is actually slightly higher on the day, having rallied 0.15%, although the euro has rallied double that. So EURGBP is stronger as the market continues to believe that the UK will be impacted more negatively than the EU in the event of a no-deal outcome.

Keep in mind, though, that both the Germans and Dutch have lately figured out that the UK is one of their top export markets for autos, chemicals and agriculture, and that the direct impact to those two nations is likely to be significantly greater than to most of the rest of the bloc. The point is that if there is no deal, the euro, which has gained some 12% vs. the pound since the initial Brexit vote in 2016, may find itself under more pressure than currently anticipated. In any event, it is hard to get excited about either currency in the short term.

Adding to the euro’s woes is the Italian budget situation, where the government in Rome will submit its budget proposals today. There has been no change to their recent estimates of a 2.4% deficit for next year, and that is based on what are seen as overly optimistic GDP growth forecasts, which means the actual number is likely to be much higher. There is also no indication that either 5-Star or the League are about to sacrifice their hard earned political capital and cave in to the EU’s demands.

You may recall that in Greece, when this situation played out, newly elected PM Alexis Tsipris sounded full of fury when telling his people they would never give in. You may also recall that he caved within a week of the first meeting. The difference this time is that, as the third largest economy in the EU, Italy actually matters to the entire structure there. With that in mind, my forecast is for some mollifying words on both sides but for the Italians to get their way, or at least most of it. While this may be a short-term euro positive, I think it actually undermines the long-term prospects for the currency.

Beyond these two headline stories we continue to hear about the US-China trade situation, which has not improved one iota since last week. Much concern was expressed at the IMF meetings over the weekend, but this is entirely being controlled by President Trump, and will almost certainly continue until at least the mid-term elections are past. At that point, it would not be surprising to see a softening of rhetoric and a deal finally agreed. But while that may make sense, it is by no means certain. In the meantime, the renminbi continues to trade toward the lower end of its recent range although there has been no indication that the PBOC is going to let it slide much further.

And those are the main stories for the session, which quite frankly remains far more focused on the equity markets than the dollar. Data this week brings the latest reading of Retail Sales and a few other things as well:

Today Empire Manufacturing 19
  Retail Sales 0.6%
  -ex autos 0.4%
  Monthly Budget $71.0B
Tuesday IP 0.2%
  Capacity Utilization 78.2%
  JOLT’s Job Openings 6.945M
  TIC Flows $47.7B
Wednesday Housing Starts 1.22M
  Building Permits 1.276M
  FOMC Minutes  
Thursday Initial Claims 212K
  Philly Fed 20
  Leading Indicators 0.5%
Friday Existing Home Sales 5.30M

Interestingly, I don’t think the Minutes will matter that much as we have heard extensively from so many Fed members explaining their views. Rather, today’s Retail Sales is likely to be the most important number of the week, as it could be the first sign the tariffs are having an impact.

In the end, all eyes remain focused on the equity and bond markets (which have been little changed overnight with 10-year yields up just 1bp to 3.15%), and I think the dollar remains secondary for now. But right now it seems risk-off is a dollar negative, so if equities fall, don’t be surprised to see the dollar fall too.

Good luck
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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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