Tag Archives: #euro

Uncomfortably High

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

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

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

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

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

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

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

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

Good luck and good weekend
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For How Long?

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The US economy’s strong
Denial of this would be wrong
It’s not too surprising
That rates will be rising
The question is just, for how long?

Despite the Trump administration’s recent discussion of imposing 25% tariffs on $200 billion of Chinese imports, rather than the 10% initially mooted, the Fed looked at the economic landscape and concluded that things continue apace. While they didn’t adjust rates yesterday, as was universally expected, the policy statement was quite positive, highlighting the strength in both economic growth and the labor market, while pointing out that inflation is at their objective of 2.0%. Market expectations for a September rate hike increased slightly, with futures traders now pricing in a nearly 90% probability. More interestingly, despite the increased trade rhetoric, those same traders have increased their expectations for a December hike as well, with that number now hovering near 70%. At this point, despite President Trump’s swipe at higher rates last week, it appears that the Fed is continuing to blaze its rate-hiking path undeterred.

The consequences of the Fed’s stance are starting to play out more clearly now, with the dollar once again benefitting from expectations of higher short term rates, and equity markets around the world, but especially in APAC, feeling the heat. The chain of events continues in the following manner. Higher US rates have led to a stronger US dollar, especially vs. many emerging market currencies. The companies in those countries impacted are those that borrowed heavily in USD over the past ten years when US rates were near zero. They now find themselves struggling to repay and refinance that debt. Repayment is impacted because their local revenues buy fewer dollars while refinancing is impacted by the fact that US rates are that much higher. With this cycle in mind, it should not be surprising that equity markets elsewhere in the world are struggling. And those struggles don’t even include the potential knock-on effects of further US tariff increases. Quite frankly, it appears that this trend has further to run.

Meanwhile, the week’s central bank meetings are coming to a close with this morning’s BOE decision, where they are widely touted to raise the Base rate by 25bps, up to 0.75%. It is actually quite amusing to read some of the UK headlines talking about the BOE raising rates to the ‘highest in a decade’, which while strictly true, seems to imply so much more than the reality of still exceptionally low interest rates. However, given the ongoing uncertainty due to the Brexit situation, I continue to believe that Governor Carney is extremely unlikely to raise rates again this year, and if we are headed to a ‘no-deal’ Brexit, which I believe is increasingly likely, UK rates will head back lower again. Early this morning the UK Construction PMI data printed at a better than expected 55.8, its highest since late 2016, but despite the strong data and rate expectations, the pound has fallen 0.35% on the day.

Other currency movement has been similar, with the euro down 0.35%, Aussie and Kiwi both falling more than 0.5% and every other G10 currency, save the yen declining. The yen has rallied slightly, 0.2%, as interest rates in Japan continue to respond to Tuesday’s BOJ policy tweaks. JGB’s seem to have quickly found a new home above the old 0.10% ceiling, and there is now a growing expectation that as the 10-year yield there approaches the new 0.2% cap, the longer end of the JGB curve will rise with it taking the 30-year JGB to 1.00%. While that may not seem like much to the naked eye, when considering the nature of international flows, it is potentially quite important. The reason stems from the fact that Japanese institutional investors tend to hedge the FX exposure that comes from foreign fixed income purchases thus reducing their net yield from the higher rates received overseas to something on the order of 1.0%. And if the Japanese 30-year reaches that 1.0% threshold (it is currently yielding 0.83%), there is a growing expectation that those same investors will sell Treasuries and other bonds and bring the money home. That will have two impacts. First, I would be far less concerned over an inverting yield curve in the US as yields across the back end of the US curve would rise on those sales, and second, the dollar would likely rally overall on higher rates, but decline further against the yen. These are the type of background flows that impact the FX market, but may not be obvious to most hedgers.

Turning to the emerging markets, the dollar is firmer against virtually all of these currencies as well. One of the biggest movers has been CNY, falling 0.5% and now trading at its weakest level since May 2017. The renminbi’s decline has been impressive since mid-April, clocking in at nearly 9%, and clearly offsetting some of the impact of the recent tariffs. But remember, the renminbi’s decline began well before any tariffs were in place, and has as much to do with a slowing Chinese economy forcing monetary policy ease in China as with the recent trade spat. At this point, capital outflows have not yet become a problem there, but if history is any guide, as we get closer to 7.00, we are likely to see more pressure on the system as both individuals and companies seek to get their money out of China and into a stronger currency. I expect that there are more fireworks in store here.

Aside from China, the usual suspects continue to fall, with TRY having blasted through 5.00 overnight and now down 1.5% on the day. But we have also seen significant weakness in ZAR (-1.75%), KRW (-1.15%), and MXN (-0.75%). Even INR is down 0.5% despite the RBI having raised rates 0.25% overnight to try to rein in rising inflation pressures there. So today’ story is clear, the dollar remains in the ascendancy on the back of optimism in the US vs. increasing pessimism elsewhere in the world.

A quick peek at today’s data shows that aside from the weekly Initial Claims (exp 220K) we see only Factory Orders (0.7%). Yesterday’s ADP Employment data was quite strong, rising 219K, while the ISM Manufacturing report fell to a still robust 58.1, albeit a larger fall than expected. However, given the Fed’s upbeat outlook, the market was able to shake off the news. At this point, however, I expect that eyes are turning toward tomorrow’s NFP report, which will be seen as taking a much more accurate reading on the economy. All in all, I see no reason for the dollar to give back its recent gains, and in fact, expect that modest further strength is in the cards.

Good luck
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A Rate Hike’s in Store

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Said Mario Draghi once more
‘Through summer’ a rate hike’s in store
When pressed on the timing
That they’d end pump priming
He gave no more scoop than before

As we await this morning’s Q2 US GDP data (exp 4.1%), it’s a good time to review yesterday’s activity and why the euro has given up the ground it gained during the past week. The ECB left policy on hold, which was universally expected. However, many pundits were looking for a more insightful press conference regarding the timeline that the ECB has in mind regarding the eventual raising of interest rates. Alas, they were all disappointed. Draghi continues to use the term ‘through summer’ without defining exactly what that means. It appears that the uncertainty is whether it means a September 2019 hike or an October 2019 hike. To this I have to say, “are they nuts?” The idea that the ECB has such a precise decision process is laughable. The time in question is more than twelve months away, and there is so much that can happen between now and then it cannot be listed.

Consider that just six months ago, Eurozone growth was widely expected to continue the pace it had demonstrated in 2017, which was why the dollar was weak and falling. But instead, despite a large majority of forecasts pointing to great things in Europe, growth there weakened sharply while growth in the US leapt forward. So here we are now, six months later, with the dollar significantly stronger and a new narrative asking why Eurozone growth has disappointed while US growth is exploding higher. Of course the US story is blamed based on the tax changes and increased fiscal stimulus from the budget bill. But in Europe, we have heard about bad weather, a flu epidemic and, more recently, rising oil prices, but certainly nothing that explains the underlying disappointment. And that was only a six-month window! Why would anyone expect the ECB, who are notoriously bad forecasters, to have any idea what will happen, with precision, in fourteen months’ time?

However, that seems to have been the driving force yesterday, lack of confirmation on the timing of the ECB’s initial rate hike next year. And based on the French GDP data this morning (0.2%, below expectations of 0.3% and far below last year’s 0.7% quarterly average), it seems that growth expectations for the Eurozone may well be missed again. Personally, I am not convinced that the ECB will raise rates at all in 2019. Given the recent trajectory of growth in the Eurozone, it appears we have already seen the top, and that before we get ‘through summer’ next year, the discussion may turn to how the ECB are going to help support the economy with further QE. Given this reality, it should be no surprise that the euro suffered yesterday, and in the wake of the weak French data, that it is still lower this morning, albeit only by an additional 0.15%.

Elsewhere the pound fell yesterday after the EU rejected, out of hand, PM May’s solution for the UK to collect tariffs on behalf of the EU. That basically destroyed her attempt to find a middle ground between the Brexiteers and the Bremainers, and now calls into question her ability to remain in office. In fact, she is running out of time to come up with a deal that has a chance of getting implemented. The current belief is that if they do not agree on something by the October EU meeting, there will not be sufficient time for all 29 members to approve any deal. It is with this in mind that I continue to question the BOE’s concerns over slowing inflation. My gut tells me that if they do raise rates next week, it will need to be reversed by the November meeting after the Brexit situation spirals out of control. The pound fell 0.65% yesterday and is down a further 0.1% this morning. That remains the trend.

Another noteworthy event from Tokyo occurred last night as the BOJ was forced to intervene in the JGB market for the second time this week, bidding for an unlimited amount of bonds at 0.10% in the 5-10 year sector. And this time, they bought ~$74 billion worth. Speculation remain rife that they are going to adjust their QQE program next week, but given the fact that it has been singularly unsuccessful in achieving its aim of raising inflation to 2.0% (currently CPI there is running at 0.2%), this appears to be a serious capitulation. If they change policy without any success behind them, the market is likely to aggressively buy the yen. USDJPY is down 1.7% in the past six sessions, and while it rallied slightly yesterday, it seems to me that USDJPY lower is the most likely future outcome.

Yesterday morning’s overall dollar malaise reversed during the US session and has carried over to this morning’s trade. And while most movement so far this morning is modest, averaging in the 0.1%-0.2% range, it is nearly universally in favor of the buck.

This morning brings the aforementioned GDP data as well as Michigan Sentiment (exp 97.1, down a full point from last month), although the former will be the key number to watch. Yesterday’s equity market session was broadly able to shake off the poor earnings forecast of a major tech firm, and this morning has a different FANG member knocking it out of the park. My point is that risk aversion is not high, so this dollar strength remains fundamental. At this point, I look for the dollar to continue to benefit from the current broad narrative of diverging monetary policy, and expect that we will need to see some particularly weak US data to change that story.

Good luck and good weekend
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No Tariffs For Now

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Herr Juncker and Trump had their meeting
And what they both claimed bears repeating
No tariffs for now
As both sides allow
The current regime with no cheating

Whew! That pretty much sums up the market reaction to yesterday afternoon’s hastily arranged press conference with President Trump and European Commission President Jean-Claude Juncker. Both were all smiles as they announced that there would be no tariffs imposed at this time while the US and EU begin more serious trade negotiations with an eye toward reducing trade friction in manufactured goods. In addition, Europe would be seeking to purchase more US soybeans and LNG in a good faith effort to reduce the current trade imbalance. And finally, they would be addressing the current US tariffs on steel and aluminum imports from Europe. It can be no surprise that the market reacted quite positively to this news, with equities in the US finishing higher and European markets all performing well this morning. It should also not be that surprising that the euro jumped immediately upon the news, rising 0.25%, although this morning it has given back those gains after both French and German Consumer Confidence data extended their trend declines amid disappointing outcomes.

While it is still anybody’s guess how this will ultimately play out, the news is certainly an encouraging sign that there can be movement in a positive direction on the trade front. The same appears to be true regarding NAFTA negotiations with both Canada and Mexico reconfirming that a trilateral deal is the goal, and apparently making headway toward achieving those aims.

However, the same optimism is nowhere to be found regarding trade relations between China and the US, with no indication that the situation has shown any positive movement. In the meantime, China continues to respond to signs of weakening growth on the mainland, this time by further reducing capital requirements for banks’ lending to SME’s. While the PBOC has not specifically cut rates, generally seen as a broad monetary policy step, these targeted capital requirement and reserve ratio cuts can be very powerful tools for the targeted recipients, allowing them to expand their loan books and driving profits in the banking sector. But no matter how the easing of monetary policy is implemented, it is still easing of monetary policy and will have an impact on both Chinese equity markets and the renminbi’s exchange rate. While the currency weakened, as would be expected, falling 0.5% overnight, the Shanghai composite fell as well, which is somewhat surprising. Although, in fairness, the Shanghai exchange has rallied nearly 8% over the past two weeks, so this could simply be a case of “selling the news.” In the end, especially if the trade situation between the US and China remains fraught, I expect that USDCNY has further to run, and 7.00 remains on the radar.

The other big story this morning is the anticipation of the ECB meeting results, not so much in terms of policy changes, as none are expected, but in terms of the follow-on press conference where Signor Draghi will be asked about the timing of interest rate increases and the meaning of the term “through the summer” which was inserted into the last statement. Analysts have been debating if that means rates could be raised in August or September of next year, or if it implies a longer wait before a rate move. The futures market doesn’t have a full 10bp rate hike priced in until January 2020, significantly past the summer. The other question of note is how the ECB will handle reinvestment of their current portfolio, and whether they will seek to smooth the reinvestment program or simply wait until debt matures before purchasing more. The reason this matters is that their portfolio has a very uneven distribution of maturities, which could lead to more volatility in European Government bond markets if they choose the latter path.

In the end, given that Eurozone data continues to disappoint on a regular basis, it seems that whatever path they choose for rate hikes and reinvestment, it will seek to maintain as much support as possible for now. Other than the Germans, there does not appear to be a strong constituency to aggressively tighten monetary policy, and there are nations, like Italy and Greece, which would much prefer to see policy remain ultra accommodative for the foreseeable future. While the euro has been range trading for the past two months between 1.15 and 1.18, I continue to look for a break lower eventually.

Away from those stories, things have been less interesting. Most of the G10 is trading in a fairly narrow range, with Aussie the laggard, -0.4%, on the back of weaker metals prices. EMG currencies have similarly been fairly quiet with limited movement overall.

Yesterday’s US data showed that the housing market is starting to suffer a bit more consistently as New Home Sales fell to 631K, well below expectations and the lowest level since last October. Adding this to the miss in Existing Home Sales on Monday shows that the combination of still rising house prices and rising mortgage rates is starting to have a more substantial impact on the sector. This morning we see Durable Goods data (exp 3.0%, 0.5% -ex Transport) and the weekly Initial Claims data (215K), which continues to show the strength of the job market. However, regarding US data, all eyes remain on tomorrow’s first look at Q2 GDP, where the range of expectations is broad, from 3.8% to 5.2%, and traders will be trying to parse how the data will impact the Fed’s activities.

In the meantime, US equity futures are mixed this morning with the NASDAQ pointing lower after some weaker than expected earnings guidance from a FANG member, while Dow futures are pointing higher on the back of relief over the trade situation. As to the dollar, I expect that it will see modest weakness overall as positions continue to be adjusted ahead of tomorrow’s key GDP release.

Good luck
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Twixt Juncker and Trump

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The meeting today in DC
Twixt Juncker and Trump will be key
In helping determine
If cars that are German
Are hit with a new import fee

Markets overnight have been relatively muted as today’s big story revolves around EU President Jean-Claude Juncker’s meeting with President Tump in Washington. The agenda is focused on tariffs and trade as Juncker seeks to de-escalate the current trade policy differences. At this point, while most market participants would love to see signs that the US is backing off its recent threats, and that progress is made in adjusting the terms of trade, I don’t sense that there is a lot of optimism that will be the case. Remarkably, the US equity market has been able to virtually ignore the trade story, with only a few individual companies suffering due to direct impacts from the situation (or poor quarterly numbers), but that has not been true elsewhere in the world. Other equity markets have fared far worse in the wake of the trade battle, and I see no reason for those prospects to improve until there is a resolution. At the same time, while the dollar has fallen from its highs seen early last week, it remains significantly stronger than it was three months ago. In fact, during the recent escalation in Presidential rhetoric, while we saw a reaction last Friday, the reality is that there has been little overall movement.

While the value of the dollar clearly has an impact on trade, historically the reverse has been far less clear. In other words, although there have been knee-jerk reactions to a particular trade number that missed expectations, or similar to Friday’s movement, knee-jerk reactions to political statements about trade policy, generally speaking, trade’s impact on the dollar has been very hard to discern. Several months ago I highlighted the tension between short-term and long-term drivers of the dollar. On the short-term side, which is what I believe has been dominant this year, is monetary policy and interest rate differentials. These have clearly been moving aggressively in the dollar’s favor. On the long-term side is the US’ fiscal account, namely its current account deficit and trade deficit. Economic theory tells us that a country that runs significant deficits in these accounts will see its currency decline over time in order to help balance things. In fact, this has been the crux of the view that the dollar will fall in the long run. However, given the US’ unique situation as the global reserve currency, and the fact that so much global trade is priced in dollars as opposed to other currencies, there remains an underlying demand for dollars that is not likely to disappear anytime soon.

The point here is that if the current trade situation deteriorates further, with additional tariffs imposed on all sides, and growth slows correspondingly, it is still not clear to me that the dollar will suffer. In fact, most other countries will seek to weaken their own currencies in order to offset the tariffs, which means the dollar will likely continue to outperform. In other words, in addition to the US monetary policy benefit, it seems likely that the dollar will be the beneficiary of policy adjustments elsewhere designed to weaken other currencies. And ironically, in the current political situation, that is only likely to generate even more Presidential rhetoric on the subject. Quite frankly, I feel the dollar has potentially much further to climb as long as trade is the topic du jour.

Of course, that doesn’t mean it will rally ever day. In fact, today the dollar is very modestly softer vs. most of its counterparts. The biggest gainer has been CNY, which is firmer by 0.55% overnight, as China appears very interested in calming things down. But away from that move, most currency gains have been on the order of 0.1% or so. The most notable data overnight was the German IFO report, which declined for the eighth consecutive month and is now back to levels last seen in March 2017. While the ECB continues to look ahead to the ending of their extraordinary monetary policy, the economy does not seem to be cooperating with their views of a sustainable recovery. While I think there is very little chance that the ECB changes its stance on bond buying, meaning come December, they will be done, it remains an open question as to when they might start to raise rates. This is especially true given the potential for an escalating trade conflict between the US and the EU resulting in slower growth on both sides of the Atlantic. If that is the case, the ECB will have a much harder time normalizing policy. At this time, however, it is still way too early to make any determinations, and I suspect that tomorrow’s ECB meeting will give us very little new information.

Meanwhile, the market is still extremely focused on the BOJ meeting early next week, with varying views as to the potential for any policy shifts there. What does seem clear is there has at least been discussion of the timing of ending QE, but no decisions have been made. The problem for the BOJ is that after more than five years of aggressive bond buying, not only have they broken the JGB market, but they have not been able to achieve anywhere near the results they had sought. Given that the BOJ balance sheet is now essentially the same size as the Japanese economy (for comparison, in the US despite its remarkable growth during QE, it remains ~20% of the US economy), there are growing concerns that current policy may be doing more harm than good. Apparently there are limits to just how much a central bank can do to address inflation. As to the yen, if the market perception turns to the BOJ stepping back from constant injections of funds, it is very likely that the yen will find itself in great demand and USDJPY will fall steadily. I maintain my view that 100.00 is a viable target for the end of the year.

Today brings just New Home Sales data (exp 670K, a 2.8% decline from last month) but this is generally not a key figure for markets. Rather, today’s price action will be dependent on the outcome of the Trump-Juncker meeting and whatever comments follow at the press conference. A conciliatory tone by President Trump would almost certainly result in a stock market rally and modest dollar strength. Continued combativeness is likely to see stocks under pressure and the dollar, at least initially, falling as well.

Good luck
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Gone Terribly Wrong

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Said Powell, the ‘conomy’s strong
And hence we’ll keep moving along
Our rate-raising path
Until the bond math
Proves that we’ve gone terribly wrong

The dollar responded by soaring
In markets no one would call boring
The question, of course
Is will the Fed force
The rest of the world to trade-warring?

The dollar is much stronger this morning after a combination of things helped underpin the current theme of the US economy leading global growth. Yesterday Chairman Powell was certainly upbeat, calling the US economy quite strong and indicating that the Fed, while not on autopilot, believes that their current path of gradual rate increases is the correct one. When pressed on how the current trade issues would impact the Fed’s actions, Powell demurred indicating that it was still too early to know what would occur. He did, however, highlight that historically nations that were open to trade fared better economically than those that chose a different, more protectionist path. After his testimony, the dollar turned in a solid performance rising 0.5% vs. the euro, 1.0% vs. the pound and 0.3% vs. the yen. The greenback’s strength was also evident in the emerging market space with USDCNY rising 0.3% by the end of the day. But that was yesterday and we are more interested in what is happening today.

The economic news of note this morning comes from the UK, where CPI failed to rise as expected and printed at 2.4%. The market’s immediate response was to sell the pound off further, another 0.7%, as futures markets reduced the probability that the BOE will raise rates next month. While that probability is still a touch over 70%; that is down 10 points from yesterday’s estimates. Obviously, despite the extremely low levels of interest rates in the UK (the base rate is 0.75%) and despite a continued robust employment picture, inflation in both wages and goods remains quiescent. In other words, the case for the August rate hike remains somewhat suspect, and that is before the discussion of the impact of Brexit. Speaking of Brexit, the Parliamentary maneuvers are apparently becoming quite rough as PM May is fighting to hold onto power. Apparently, though she won several key votes today, the tactics used resulted in some very hard feelings amongst MP’s on both sides of the aisle and could well result in less ability for the PM to continue in power going forward. In the end, given the recent data releases and the potential for Brexit to lead to a full-blown political crisis in the UK, it is still difficult for me to believe that the BOE moves next month. I feel like the combination of reaffirmation by the Fed and the disintegrating case in the UK means the pound is soon going to breach 1.30 and start to trade at much lower levels.

But it was not just the UK where inflation data disappointed, the EU also saw final CPI data for June released and the core number was revised downward to 0.9%, although the headline number of 2.0% was reaffirmed. While one data point will not be enough to change views, there is no question that Signor Draghi will have an increasingly difficult time remaining confident that inflation will be converging on the ECB’s target of ‘close to but below 2.0%.’ And remember, oil prices, which have been supporting the headline number, are now falling sharply, so it would not be surprising to see Eurozone CPI data print still lower next month. In the end, I continue to look for the euro to break its recent trading range to the downside. This morning has helped my cause with the euro declining a further 0.4% on top of yesterday’s fall.

But the story is similar everywhere in the world. Disappointing Chinese data has helped to twist the PBOC into tighter knots as they seek to reduce excess leverage in the economy while supporting growth. As I have highlighted time and again, the renminbi is going to be the relief valve for this process and is almost certain to head to 7.00. Of course, another key risk here is that President Xi decides that the only way to combat the mooted $200 billion of US tariffs is to actively weaken the currency, which would result in a much larger move, and likely one that was far less smooth. All I’m saying is that for those with CNY exposure, care must be taken. Paying the points to hedge here is, I believe, a very prudent step at this time.

Looking at today’s session, in addition to the second leg of Chairman Powell’s testimony, this time to the House Financial Services Committee, we see Housing Starts (exp 1.32M) and Building Permits (1.30M) at 8:30. However, all eyes will be on Powell to see if he has anything else to add to yesterday’s bullish sentiment. The data story continues to underpin my view that the dollar has further to run against all its counterparts. Today should not prove any different than yesterday.

Good luck
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Lack of Dismay

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The deadline for tariffs is nigh
And Friday they’ll start to apply
But so far today
The lack of dismay
Has forced pundits all to ask why

Tomorrow is tariff day, as the US is set to impose 25% tariffs on $34 billion of Chinese goods beginning at midnight tonight. The Chinese are prepared to respond in kind, and it seems that the second battle of the emerging trade war (steel and aluminum were the first) is about to begin. Interestingly, financial markets remain extremely calm at the prospect of escalation with equity prices rebounding from Tuesday’s late losses and the dollar ceding some of its recent gains. I question how long this can continue, especially if we move on to stage three of the battle, where President Trump has promised tariffs on an additional $200 billion of Chinese goods. That poses a bigger problem for China as they only import about $135 billion in goods from the US each year (hence the deficit!)

The question at hand, though, is what type of impact this will have on markets going forward. Economic theory tells us that consumers will seek substitutes for those goods but that prices will rise somewhat to offset the effects of either paying the tariffs or accounting for the higher cost of the substitutes. In other words, inflation, which has been steadily moving higher in the US, is destined to continue that trend, if not accelerate somewhat. From there, it is a short hop to higher US interest rates and a stronger dollar. However, if this process continues long enough, it is likely to undermine the US growth story. If that were to happen, weakening data would likely cause the Fed to grow more cautious in their policy normalization drive. In that event, we are likely to see the dollar’s current strengthening trend stall. As is so often the case, one set of stimuli with a particular response leads to another set of stimuli with the opposite impact. The thing is, it will probably be 2019 before there is any indication that US growth is really slowing due to the trade story, and so I see only a limited chance that the Fed adjusts its policy trajectory this year. In other words, I think despite the tariffs, the Fed will still raise rates twice more in 2018.

Perhaps we will get a better idea of the Fed thinking on the subject when the Minutes of June’s FOMC meeting are released this afternoon. And while we have heard from several FOMC members that they are beginning to become concerned about the impact of the trade war, at this point, the data continues to favor policy continuation.

In the meantime, the dollar is a bit softer this morning as Germany finally printed some good data. For the first time this year, Factory Orders rose (+2.6%). While that is encouraging, it still begs the question as to whether this is the outlier number, or whether the previous five months of data were the aberration. But the euro is higher by 0.35% and pushing back toward 1.1700. That said, it has largely been range bound, between 1.1550 and 1.1750, for the past month. It doesn’t strike me that today’s data point is going to change that.

From the UK, Governor Carney was on the tape explaining that the growth picture there has been good enough to warrant higher rates if it continues. Yesterday saw the Services PMI in the UK rise to 55.1, well above expectations of 54.0, and its highest level in 9 months. The futures market has now increased its probability of an August rate hike to 82%, which barring any disastrous announcement on Brexit, seems sufficient to allow the BOE to act. However, nothing I have read has indicated that the UK is going to come up with a workable solution for the current Brexit issues, and I continue to believe that next March, the UK will be leaving the EU with no deal in hand. If that is the case, whatever the BOE was planning will come under renewed scrutiny, and it seems unlikely that rates there will go any higher. In addition, just like in the wake of the actual vote, I would expect the pound to suffer significantly at that time. All of this tells me that GBP receivables hedgers need to be very proactive in managing those risks, especially when we get a bounce in cable.

In the emerging markets, there has been one major move since I last wrote; MXN is higher by nearly 2.5%. While the move was just beginning Tuesday morning, the market has become enamored of the idea that President Trump and President-elect Obrador are going to be great friends and solve many of the problems that exist between the two nations. I don’t mean to be negative, but I find it hard to believe that will be the case. In fact, I expect that based on campaign rhetoric, the US and Mexico will see increased tension, which I am certain will lead to the peso suffering more than the dollar. In the end, Mexico is far more reliant on the US than the other way around, so stress in that relationship will hurt the peso first.

But otherwise, amid a smattering of data and news, the dollar is mildly softer this morning. After the Minutes are released and digested, all eyes will turn toward tomorrow’s payroll report. And in fact, we get a preview this morning with the ADP employment print (exp 190K) and Initial Claims (225K). We also see ISM Non-Manufacturing (58.3), which is likely to continue to show the current strength of the US economy. In the end, we are range bound, but as of now I still see a better case for dollar strength than weakness going forward.

Good luck
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