Tariffs Can Wait

Said Trump, for now tariffs can wait
Since talks with the Chinese are great
When this news emerged
The stock market surged
While dollars and bonds did deflate

In what cannot be a very great surprise, last evening President Trump announced that there has been substantial progress in the trade negotiations with China and that the mooted tariff increases on March 2nd are going to be delayed indefinitely while the talks continue. It was pretty clear that neither side really wanted to see tariffs rise again, but if the reports are accurate, there has been some real movement in terms of the negotiations. Given the focus by all markets on this story, the reactions cannot be a great surprise. That said, the fact that Shanghai closed higher by 5.6% and other global markets are higher by just 0.2%-0.4% hints at just how much more important this issue is for China than for the US.

But in fairness, there was another driver for Chinese stocks, the ‘official’ end of the deleveraging campaign of the past two years. Despite the fact that Chinese debt levels have barely slowed their growth, the fact that the economy has clearly been under pressure from slowing global growth, and the fact that the trade situation has clearly hampered recovery attempts has led to a decision to open the credit spigots again. Two years ago, the Chinese recognized that their financial structure was wobbling due to significant growth in off balance sheet leverage. After a two-year effort to reduce those risks, the imperative of supporting the broad economy is now far more important than worrying about some arcane financial statistics. In the end, every government, whether liberal or totalitarian, can only address structural issues for short periods of time before the pressure grows too great to support growth in any way they can. As to the renminbi, it has strengthened a bit further, rising 0.3% and now trading at its strongest levels since last July. If, as has been reported, the trade deal includes a currency portion, it seems appropriate to look for the renminbi to trade back toward the 6.20 level, another 5%-7% stronger, over time.

Though wily, Prime Minister May
Might soon find she’s nothing to say
‘bout any new terms
As Parliament firms
Support for a Brexit delay

Of the other two stories that have been market drivers, let’s discuss Brexit first. PM May met with other EU leaders in Egypt over the weekend and there are now two competing theories as to what might happen. May has postponed the vote on her deal until March 12, basically daring Parliament to vote no and cause a no-deal Brexit. At the same time, while talk in Parliament has been about voting for a three-month extension, the EU has now discussed a 21-month extension as the only alternative under the theory that three months is not enough time to get anything done. Of course, for the pro-Brexit forces, 21 months is unpalatable as well since that would give enough time to hold a second referendum, which based on all the recent polling, would result in a remain vote. The pound has drifted higher by 0.2% this morning, back to the high end of its recent trading range, but until there is more clarity on the outcome, it will remain locked in a fairly narrow range. For the past seven months, the pound has traded in a range of 1.25-1.32. It seems unlikely to break out until a more definitive outcome is clear with Brexit.

Finally, regarding the third major market driver, the Fed, there were several stories in the WSJ over the weekend about how the Fed is now reevaluating its inflation target. It seems that they have become increasingly unhappy with their inability to achieve the 2.0% target, as measured by PCE. The prevailing view is that because they have been so successful at moderating inflation, people’s inflation expectations have now fallen so much that inflation cannot rise. That feels a little self-serving to me, especially since the ‘feel’ of inflation appears much higher than what is measured. At least in my world. Ask yourself if it feels like inflation is running at 1.8%, as you consider things like education, the cost of health insurance and property taxes. The point, however, is that they seem to be laying the ground to maintain easier monetary policy for a much longer period. If they are not constrained by inflation rising above their target, then rates can stay lower for longer. Frighteningly, this seems to be the Fed’s attempt to embrace MMT. In the end, if the Fed modifies their policy targets in this manner, it will be a decided dollar negative. In fact, I will need to reevaluate the premises underlying my market views. Unless, of course, all the other major central banks do the same thing, which is a fair bet.

At any rate, with the trade discussion today’s biggest story, risk appetite has returned, and we are seeing higher equity markets along with a weaker dollar and falling bonds. That said, the dollar’s decline is not substantial, on the order of 0.2% overall, although it has fallen against most of its counterparts. Turning to the data story, this week brings a fair amount of information, as well as Congressional Testimony by Chairman Powell and a number of other Fed speakers:

Tuesday Housing Starts 1.25M
  Building Permits 1.29M
  Case-Shiller Home Prices 4.5%
  Consumer Confidence 124.7
Wednesday Factory Orders 0.5%
Thursday Initial Claims 220K
  Q4 GDP 2.3%
  Chicago PMI 57.0
Friday Personal Income 0.3%
  Personal Spending -0.2%
  PCE 0.0% (1.7% Y/Y)
  Core PCE 0.2% (1.9% Y/Y)
  ISM Manufacturing 55.5
  Michigan Sentiment 95.7

In addition to Powell’s testimony, he speaks again Thursday morning, and is joined by five other Fed speakers throughout the week. Unless the data is extraordinarily strong, it is clear that there will be no discussion of further rate hikes. In fact, given this new focus on the inflation target, I expect that will be the topic of note amongst the group of them. And as all signs point to this being yet another way to justify easy money, look for a consensus to quickly build. If I am correct about the Fed’s turn regarding how they view inflation, the dollar will suffer going forward. This will force me to change my longer term views, so this week will be quite important to my mind. For today, however, it seems evident that risk appetite will help push the dollar somewhat lower from here.

Good luck
Adf

Carefully Looking Ahead

The Minutes explained that the Fed
Was carefully looking ahead
But so far it seems
The hawks’ fondest dreams
Of hiking again might be dead

As well, when it comes to the size
Of the Fed’s balance sheet, in their eyes
It’s likely to stay
Quite large like today
Not shrink while they, debt, monetize

Markets are little changed this morning after a lackluster session yesterday when the Fed released their Minutes from the January meeting. Overall, the tone of the Minutes seemed to be slightly less dovish than the tone of the Powell press conference that followed the meeting, as well as much of the commentary we have heard since then. Apparently, Cleveland’s Loretta Mester is not the only one who believes rates will need to be raised further this year, as the Minutes spoke of “several’ members with the same opinion. Of course, that was offset by “several” members who had the opposite view and felt that there was no urgency at all to consider raising rates further this year. Patience continues to be the watchword at the Mariner Eccles building, and I expect that as long as the economic data does not differ dramatically from forecasts, the Fed will be quite happy to leave rates on hold. They specifically mentioned the potential problems that could derail things like slowing global growth, a poor outcome in the US-China trade talks or a disruptive Brexit. But for now, it appears they are comfortable with the rate setting.

The balance sheet story was of even more interest to many market participants as the gradual running off of maturing securities has seemingly started to take a bite out of available liquidity in markets. And in fact, this seems to be where the Fed minutes indicated a more dovish stance in my eyes. While there is still a thought that rates might be raised later this year, it was virtually unanimous that shrinking the balance sheet will end this year, leaving the Fed with a much larger balance sheet (~$3.5-$4.0 trillion) than many had expected. Recall, prior to the financial crisis the Fed’s balance sheet was roughly $900 billion in size. To many, this is effectively a permanent injection of money into the economy and so should support both growth and inflation going forward. However, the risk is that when the next downturn arrives (and make no mistake, it Will arrive), the Fed will have less room to act to support the economy at that time. This is especially true since even with another one or two rate hikes, Fed Funds will have topped out at a much lower level than it has historically, and therefore there will be less rate cutting available as a policy tool.

Adding it up, it seems rate guidance was mildly hawkish and balance sheet guidance was mildly dovish thus leaving things largely as expected. It is no surprise market activity was muted.

This morning, as the market awaits the ECB Minutes, we see the dollar little changed overall, although there have been some individual currency movements. For example, AUD has fallen 0.7% (and dragged NZD down -0.5%) after a well-respected local economist changed his rate view to two RBA rate cuts later this year due to the rapidly weakening housing market. Prior to this, the market had anticipated no rate movement for at least another 18 months, so this served as quite a change. And all this came despite strong Australian employment data with the Unemployment rate remaining at 5.0% and job growth jumping by 39K.

Meanwhile, mixed data from Europe has leaned slightly bullish as surprisingly strong French Composite PMI data (49.9 vs 49.0 expected) offset surprisingly weak German Manufacturing PMI data (47.6 vs 49.7 expected). I guess the market already knows that Germany is slowing more rapidly than other nations in the Eurozone (except for Italy) due to the ongoing trade friction between the US and China. But despite the ongoing Gilets Jaune protests, the French economy managed to find some strength. At any rate, the euro has edged higher by 0.15% after the reports. At the same time, the pound has also rallied 0.15% after releasing the largest budget surplus on record (since 1993), and perhaps more importantly, on some apparent movement by the EU on Brexit. PM May is hinting that she may be able to get a legally binding way to end the backstop in a codicil to the Brexit negotiations, which if she can, may allow cover for the more euro skeptical members of her party to support the deal. There is no question the pound remains completely beholden to the Brexit story and will continue to do so for at least another month.

Pivoting to the trade talks, there are several stories this morning about how negotiators are preparing a number of memos on separate issues with the idea they will be brought together at the Trump-Xi meeting to be held in the next several weeks. There is no question that the market continues to view the probability of a deal as to be quite high, but I keep looking at the key issues at stake, specifically with regards to IP and the coercion alleged by US companies, and I remain skeptical that China will back away from that tactic. The Chinese do not view the world through the same eyes as the US, or the Western World at large. As per an article in the WSJ this morning, “We must never follow the Western path of constitutionalism, separation of powers and judicial independence,” Mr. Xi said in an August speech. That comment does not strike me as a basis for compromise nor enforcement of any deal that relies on those issues. But for now, the market continues to believe.

And that’s pretty much the stuff that matters today. We do get most of our data for the week this morning with Initial Claims (exp 229K), Durable Goods (1.5%, 0.3% ex transport), Philly Fed (14.0) and Existing Home Sales (5.00M). While individually, none of them have a huge impact, the suite of information if consistently strong or weak, could well lead to some movement given the broad sweep of the economy covered. There are no Fed speakers on the docket today, and so it doesn’t appear that there is much reason to expect real movement today. Equity markets around the world have seen limited movement and US futures are flat to slightly lower. Treasury yields are slightly firmer but remain at the bottom end of their recent trading range. Overall, it seems like a dull day ahead.

Good luck
Adf

 

The Hawks Will Oppose

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

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

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

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

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

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

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

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

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

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

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

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

Good luck
Adf

Great Apprehensions

In England the rate of inflation
Has fallen despite expectation
By Carney and friends
That recent price trends
Would offer rate hike validation

But markets have turned their attentions
To news of two likely extensions
The deadline on trade
And Brexit charade
Have tempered some great apprehensions

Two key data points lead the morning news with UK inflation falling below the BOE’s 2.0% target for the first time since the Brexit vote while Eurozone IP fell far more sharply than expected. Headline CPI in the UK declined to 1.8% while core remained at 1.9%, with both printing lower than market expectations. Given the slowing economic picture in the UK (remember the slowest growth in six years was reported for Q4 and 2018 as a whole), this cannot be that much of a surprise. Except, perhaps, to Governor Carney and his BOE brethren. Carney continues to insist that the BOE may need to raise rates in the event of a hard Brexit given the possibility of an inflation spike. Certainly, there is no indication that is likely at the present time, but I guess anything is possible. Granted he has explained that nothing would be done until the “fog of Brexit” has lifted but given the overall global growth trajectory (lower) and the potential for disruption, it seems far more likely that the next BOE move is down, not up. The pound originally sold off on the news but has since reversed course and is higher by 0.3% as I type. Overriding the data seems to be a growing belief that both sides will blink in the Brexit negotiations resulting in a tentative agreement of a slightly modified deal with a few extra months made available to ratify everything. That’s probably not a bad bet, but it is by no means certain.

On the Continent, the data story was also lackluster, with Eurozone IP falling a much worse than expected -0.9% in December and -4.2% Y/Y. It is abundantly clear that Germany’s problems are not unique and that the probability of a Eurozone recession in 2019 is growing. After all, Italy is already there, and France has seen its survey data plummet in the wake of the ongoing Gilets Jaunes protests. However, despite this data, the euro has held onto yesterday’s modest gains and is little changed on the day. The thing is, I still cannot figure out a scenario where the ECB actually raises rates given the economic situation. Even ECB President Draghi has recognized that the risks are to the downside for the bloc’s economy, and yet he is fiercely holding onto the idea that the next move will be higher rates. It won’t be higher rates. The next move is to roll over the TLTRO’s and interest rates will remain negative for as far as the eye can see. There is a growing belief in the market that because the Fed has halted its policy tightening, the dollar will fall. But since every other central bank is in the same boat, the relative impact still seems to favor the US.

Away from those stories, the market continues to believe that a US-China trade deal is almost done. At least, that’s the way equity markets are trading. President Trump’s comment that he would consider extending the March 1 tariff deadline if there was sufficient progress and it looked like a deal was in the offing certainly helped sentiment. But as with the Brexit issue, where the Irish border situation does not offer a simple compromise, the US requests for ending forced technology transfer and IP theft as well as the reduction of non-tariff barriers strike at the heart of the Chinese economic model and will not be easily overcome. It seems that the most likely outcome will be a delay of some sort and then a deal that will have limited long-term impact but will get played up by both sides as win-win. In the meantime, the PBOC will continue to add stimulus to the economy, as will the fiscal authorities, as they seek to slow the rate of decline. And you can be sure that no matter how the economy actually performs, the GDP data will be firmly above expectations.

And those are the big stories. The dollar has had a mixed performance overnight with two currencies making substantial gains, NZD +1.25% and SEK +0.6%, both of which responded to surprises by their respective central banks. The RBNZ left rates on hold, as universally expected, but instead of offering signs of further rate cuts, simply explained that rates would remain on hold for two years before likely rising. This was taken as hawkish and the currency responded accordingly. Similarly, the Riksbank in Stockholm explained that they still see the need for rates to rise later this year despite the current slowing growth patterns throughout Europe. As I had written yesterday, expectations were growing that they would back away from any policy tightening, so the krone’s rally should be no real surprise. But beyond those two stories, movement has been much less substantial in both the G10 and EMG blocs.

This morning’s data brings CPI (exp 1.5% headline, 2.1% core) which will be closely watched by all markets. Any further weakness will likely see another leg higher in equity markets as it will cement the case for the Fed having reached the end of the tightening cycle. A surprise on the high side ought to have the opposite impact, as concerns the Fed might not yet be done will resurface. There are also three Fed speakers, but for now, that message of Fed on hold seems pretty unanimous across the FOMC.

Absent a surprise, my money is on a directionless day today. The dollar’s recent rally has stalled and without a new catalyst will have a hard time restarting. However, there is no good reason to think things have gotten worse for the buck either.

Good luck
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Progress Is Real

In Beijing, talks focused on trade
Continue as both sides conveyed
That progress is real
With hopes for a deal
Increasing, or so it’s portrayed

Once again, the market is embracing the idea that a trade deal is coming and coming soon. Talks in Beijing have restarted and while yesterday President Trump indicated he would not be meeting Chinese President Xi by month’s end, as had been suggested last week, this morning, Mr Trump expressed a desire to meet with him “very soon”. Investors have taken this to mean that while a deal may not be completed by the initial March 1st deadline, there will be an extension of the truce and no tariff increases at that time. It should be no surprise that the equity market has taken this news well, with Asian stocks generally rallying (Nikkei +2.6%, Shanghai +0.7%), European stocks following suit (DAX + 1.3%, CAC + 1.1%) and US equity futures pointing higher (DJIA + 0.8%, S&P + 0.7%). Adding to the bullishness has been the news that there is a tentative deal in Congress to avoid a second government shutdown. So, all the stars have aligned for the bulls today.

And yet, the data continues to be lackluster with limited prospect to improve in the short run. A random sampling of recent releases shows that UK growth (as mentioned yesterday) was the weakest in six years and shows no signs of picking up ahead of Brexit. But also, Norwegian inflation is sinking along with Mexican IP and the Australian housing market. South African Unemployment remains near a record 27.5% and even the NFIB Survey here at home has fallen to its lowest level since November 2016 (Trump’s election), although it remains much closer to its historic highs than its lows. The point is that despite soothing words from central bank officials that recent weaker data is temporary, it is looking nothing of the sort. I’m not sure when temporary morphs into long-term, but we are now pushing into our fifth consecutive month of slowing global data and the trend shows no signs of abating.

So, what is an investor or a hedger to conclude from all this? Is the trade deal more important? Or is it the ongoing data story? While both of those may have short-term impacts, the reality remains that it is still the central banks that exert the most influence on markets. The Fed’s complete conversion from hawk to dove in six weeks has been THE dominant force in markets since December. Not only has that conversion helped the US markets, but it has dramatically reduced pressure on other nations to maintain their own hawkishness. This can be seen in the BOE, where earlier talk of needing to hike rates in the event of Brexit has abated. It can be seen in the ECB where the conversation has changed from raising rates in the autumn to what other measures of stimulus can they provide given the current negative rates and bloated balance sheet. (TLTRO’s will absolutely be rolled over.) In Scandinavia, both Norway and Sweden have seen inflation data decline and are now seen as far more likely to leave rates on hold rather than raising them as had been expected just a few months ago. And not to be outdone, the PBOC, which had been in the midst of a two-year program to reduce excess leverage in China, has handily turned far more dovish, injecting significant liquidity and ‘encouraging’ banks to make loans to SME’s there. So, in the end, while the trade story may garner headlines for a few more weeks, it remains a central bank controlled world.

As to today, the dollar is dipping slightly after a continued solid rally during yesterday’s session. This has been more evident in the EMG space than in G10. For example, MXN (+0.4%) and BRL (+0.95%) are leading the way in LATAM while INR (+0.7%) and CNY (+0.3%) have benefitted from the dollar’s lackluster performance. And of course, the dovish turn by the Fed has had an especially beneficial impact on EMG currencies since so many companies located there borrow in dollars. The idea that US rates have stopped rising has been one of the biggest changes we have seen.

However, it is important to remember that on a relative basis, US policy remains tighter than that anywhere else in the world, and as it becomes clearer that other central banks will turn more dovish, the dollar should retain its footing.

We have already seen the NFIB data print weaker than expected, and the only other data point today is the JOLT’s Jobs report (exp 6.90M), however, we do hear from Chairman Powell at 12:45 this afternoon, so all eyes will be on him. The thing is, given the data we have seen since the Fed changed course has continue to be weak, I would argue the only surprise can be dovish. In other words, comments hinting that the Fed will end the balance sheet roll-off, or a reevaluation of the neutral rate lower would be the type of thing to start a big rally. In the event that something like that were to occur, look for equities to rocket and the dollar to fall. But given the sudden increase in stories about prices rising in consumer products (yesterday’s WSJ talking about cat litter and detergent, today’s about Whole Foods raising prices), it seems hard to believe that a more dovish tone is likely.

In the end, the dollar has had a good run over the past two weeks. If that is ending, it is entirely reasonable, but don’t look for a collapse.

Good luck
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Brexit’s Impact

From England and Scotland and Wales
The data is telling us tales
That Brexit’s impact
Is set to subtract
From growth and reduce Retail Sales

With less than seven weeks left before the UK is scheduled to leave the EU, the impact of two years of uncertainty is becoming clearer. This morning’s GDP data showed that growth declined -0.4% in December, dragging the Q4 number down to a below expected 0.2% and a full year number of just 1.4%, its weakest since 2009. As is always the case, uncertainty is the bane of economic activity. While the politics of brinksmanship may make sense in the long run, it is difficult to see the near-term benefits. And brinksmanship appears to be PM May’s last hope at putting in place the agreed deal by the UK Parliament. Despite her renewed efforts at getting the EU to offer some adjustments to the negotiated deal, there has been little willingness evident on the EU side to do so. However, the EU mandarins are not so ignorant as to believe that a hard Brexit will have no impact on their own nations’ economies, it is just that they believe that by holding firm the UK will blink first and Parliament will ratify the deal. I think PM May is of the same opinion. And perhaps they are correct, that is exactly what will happen. However, politics is not an exact science, and it appears there is still a very real probability that a hard Brexit is what we will get.

In the meantime, the market took no succor in this morning’s data, with the pound falling a further 0.35% on the day, increasing its month-to-date decline to 1.7% with the trend still firmly lower. While BOE Governor Carney has claimed repeatedly that he may need to raise rates in the event of a hard Brexit due to a price shock, I continue to believe there is virtually no probability that will occur. The initial negative impact on the economy will overwhelm any inflationary impulse, certainly from a political perspective, if not actually from an economic one. Despite the fact that the Fed appears to be on hold at this time, I would still bet on further policy ease rather than tightness from the BOE.

But the pound is not the only currency suffering this morning, in fact every G10 currency is weaker vs. the dollar as it becomes clearer with each passing day that the ability of central banks to remove policy accommodation from a weakening global economy is becoming more and more restricted. A good example is Norway, where growth has held up reasonably well (1.7% in Q4) but inflation has failed to meet expectations. This morning’s CPI data showed the headline rate fall a more than expected 0.4% to 3.1%. While that is clearly above their target, it is a product of the recent rise in oil prices. On a core basis, inflation is quickly falling back to its 2.0% target, and while the market is still pricing a rate hike for March, it is with less conviction. Another weak reading before the next Norgesbank meeting in March is likely to ice that expectation completely. Tightening into an environment of slowing global growth is extremely difficult for any country, let alone a peripheral oil exporter, to accomplish successfully. As it happens, NOK is lower by 0.55% as I type.

But it is not just G10 currencies under pressure this morning, it is the entire complex of dollar counterparts. EMG has seen broad based, albeit not extreme, weakness. The leading decliner is ZAR, with the rand falling 1.1% after the main electric utility, Eskom, disclosed further power cuts leading to concerns over slowdowns in production and mining. The utility is struggling under a massive debt burden and has been on the edge of bankruptcy for some time. But away from that country specific outcome, the dollar’s gains have averaged on the order of 0.2%-0.3% throughout all three EMG blocs.

Looking ahead to data this week we will see January inflation data as well as the delayed Retail Sales numbers amongst a full slate.

Tuesday NFIB Small Business 103.2
  JOLT’s Job Openings 6.9M
Wednesday CPI 0.1% (1.5% Y/Y)
  -ex food & energy 0.2% (2.1% Y/Y)
Thursday Initial Claims 225K
  PPI 0.1% (2.1% Y/Y)
  -ex food & energy 0.2% (2.5% Y/Y)
  Retail Sales 0.2%
  -ex autos 0.1%
Friday Empire Manufacturing 7.0
  IP 0.1%
  Capacity Utilization 78.7%
  Michigan Sentiment 94.5

We also have nine Fed speeches from six different FOMC members including Chairman Powell tomorrow afternoon. However, the Fed has lately been very consistent with the market clearly understanding that they are on hold for the time being. In fact, the market is beginning to price rate cuts into the curve by the end of this year, although the Fed itself has not indicated anything of the sort. One last Fed note; SF Fed President Mary Daly, in an interview on Friday, indicated that the FOMC was actively discussing the merits of using the balance sheet as part of the ‘regular’ toolkit, not simply keeping it for emergencies when interest rates were at the zero bound. That is a bit ironic given that prior to the financial crisis, the balance sheet was the main feature of how the Fed managed interest rates, increasing or reducing reserves in order to guide interest rates to their desired levels. But in this case, it sounds more like the first oblique embrasure of MMT, the idea that debt monetization is not only fine, but that it is immoral not to manage policy in that manner if there are still unemployed people out there. After all, the only risk is inflation, and they have that under control!!!

I am the first to admit that the dollar’s recent strength has surprised me. While I have maintained that it would eventually strengthen, I did not foresee the market embracing the idea that every other central bank would reverse the tightening bias so quickly. But it has. So for now, the US remains the tightest monetary policy out there, and the dollar is likely to continue to benefit accordingly.

Good luck
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More Frustration

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

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

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

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

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

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

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

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

Good luck
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