Tag Archives: #Fed

Weakness They’d Block

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The PBOC’s taken stock
Of how their maneuvers did rock
Most markets worldwide
Which helped them decide
More currency weakness they’d block

The Chinese renminbi remains the number one story and concern in all financial markets as investors and traders try to decipher the meaning of yesterday’s move to allow a much weaker currency, but more importantly how those actions will help drive future activities.

As always, there are two sides to every coin, in this case both figuratively and literally. From the perspective of China’s manufacturing and production capabilities it is very clear that a weaker renminbi is a benefit for its exporters. Chinese goods are that much cheaper this morning than they were Friday afternoon. This, of course, is why there is so much concern over any nation weakening their currency purposely in order to gain an advantage in trade. This is the ‘beggar thy neighbor’ policy that is decried in both textbooks and political circles. It is this idea that animates President Trump’s complaints about a too strong dollar hindering US manufacturing exports, and it is true, as far as it goes.

But it is not the whole story by a long shot. There are two potentially significant negative consequences to having a weaker currency, both of which can have significant political as well as economic impacts. The first, and most widely considered is rising inflation. Remember, if a nation’s currency weakens then all its imports are, relatively speaking, more expensive for its citizens. While small fluctuations in price may be absorbed by businesses, ultimately a steadily weakening currency will result in rising prices and increases in measured inflation. This is one of the key things that BOE Governor Carney worries about in the event of a hard Brexit, and the only reason he tries to make the case that interest rates may need to rise after Brexit. (p.s., they won’t!)

However, the other issue is generally less considered but often far more destructive to a nation. This is the problem of repayment of foreign currency debt. Remember, the US capital markets are far and away the largest, deepest and most liquid in the world, and thus companies and countries around the world all raise funding in USD. Even though US rates are high relative to the rest of the G10, that available liquidity is something that is not replicable anywhere else in the world and offers real value for borrowers. And of course, compared to many emerging markets, US rates are lower to begin with, making borrowing in dollars that much more attractive. But when another country’s currency weakens, that puts additional pressure on all the businesses that have borrowed in USD to fund themselves (and the country itself if it has borrowed in USD).

For example, according to the BIS, Chinese companies had outstanding USD debt totaling more than $1 trillion as of the end of 2018, and that number has only grown. As the renminbi weakens, that means it takes that much more local currency to repay those dollars. China has already seen a significant uptick in local bankruptcies this year, with CNY bond defaults totaling nearly $6 billion equivalent and the pace increasing. And that is in the local currency. When it comes to repaying USD debt, a weaker CNY will just exacerbate the situation. The PBOC is well aware of this problem. In fact, this issue is what will prevent the PBOC from allowing the renminbi to simply fall and find a new market clearing price. Instead, they will continue to carefully manage any further devaluation to the best of their ability. The problem they have is that despite their seemingly tight control of the market, they have created an offshore version, the quickly growing CNH market, which is far more costly to manage. In other words, there is a real opportunity for leakage of funds from China and an uncontrolled decline in the currency, or at least a much larger decline than planned. We are only beginning to see the impact of this move by the PBOC and do not be surprise if things get more volatile going forward.

But this morning, the PBOC remains in control. They fixed the onshore CNY at 6.9683, stronger than expected and in the FX market CNY has regained about 0.3% of yesterday’s losses. This stabilization has allowed a respite in yesterday’s panic and the result was that Asian equity markets rebounded in the afternoon sessions, still closing lower but well off session lows. And in Europe, the main markets are all marginally higher as I type. It should be no surprise that US futures are pointing to a modest uptick on the opening as well.

In the bond markets, Treasury prices have fallen slightly, with yields backing up 2bps. The same movement has been seen in Japan, with JGB’s 2bps higher, but actually, in Germany, yields continue to decline, down a further 3bps to yet another new record low of -0.54% as German data continues to exhibit weakness implying the Eurozone is going to fall into a recession sooner rather than later.

Finally, in the rest of the FX market, we are seeing a modest reversal of some of yesterday’s significant moves. For example, USDMXN is softer by 0.2% this morning after the peso fell nearly 2.0% yesterday. We are seeing similar activity in USDBRL, and USDKRW. These examples are just that, indications that an uncontrolled collapse is not in the cards, but that this process has not yet played itself out. In the G10 space, the RBA left rates on hold at 1.00% last night, as universally expected, and Aussie has rallied 0.4% this morning. Interestingly, one of the reasons they felt able to pause was the fact that the AUD had fallen more than 3% in the past month, easing financial conditions slightly and helping in their quest to push inflation back to their target. The other reversal this morning has been USDJPY which is higher by 0.4% after having traded to its lowest level (strongest JPY) yesterday since March 2018. As yen remains a key haven asset, it remains an excellent proxy for risk appetite, which today is recovering.

There were actually a few Fed speakers yesterday with both SF President Daly and Governor Brainerd expressing a wait and see attitude as to the impact of the escalation of trade tensions, although a clear bias in both cases to cut rates. Meanwhile, the futures market is pricing in a 100% chance of a 25bp cut in September and a 40% chance of a 50bp cut. It seems like the Fed has a lot of work to do in order to clarify their message.

With no data of note today, the FX market is likely to continue to consolidate yesterday’s moves, and awaits comments from James Bullard, St Louis Fed President and noted dove. In the end, my sense is that the Fed has lost control of the situation and that we are going to see more rate cuts than they had anticipated going forward. The question is more the timing than the actuality. In the meantime, the dollar is likely to be dichotomous, continuing to rise vs. the EMG bloc, but faring less well vs. much of the G10.

Good luck
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Boris is Fumbling

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The British pound Sterling is tumbling
As traders think Boris is fumbling
His chance to succeed
By forcing, at speed
Hard Brexit with some Tories grumbling

It’s official, the only story of note in the FX markets today is Brexit. Despite central bank meetings and key data, the number one discussion is about how far the pound will fall in the event of a hard Brexit and how high the likelihood of a hard Brexit has become. Since Friday morning, the pound is down by 2.5% and there doesn’t appear to be a floor in the near term. It seems that traders have finally decided that BoJo was being serious when he said the UK would leave the EU with or without a deal come October 31. As such, today’s favorite analyst pastime is to guess how low the pound can fall with a hard Brexit. So far, there has been one estimate of parity with the dollar, although most estimates talk about 1.10 or so. The thing is, while Brexit will clearly be economically disruptive, it seems to me that the warnings of economic activity halting are vastly overstated for political reasons. After all, if you voted Remain, and you are in the media (which was largely the case) then painting as ugly a picture as possible suits your cause, whether or not it is based on factual analysis or fantasy.

But let’s discuss something else regarding the potential effects of a hard Brexit; the fears of a weaker currency and higher inflation. Are these really problems? Is not every developed country (and plenty of emerging ones) in the world seeking to weaken their currency through easier monetary policy in order to gain a competitive advantage in trade? Is not every developed country in the world complaining that inflation is too low and that lowered inflation expectations will hinder central bank capabilities? Obviously, the answer to both these questions is a resounding ‘YES’. And yet, the prospects of a weaker pound and higher inflation are seen as devastatingly bad for the UK.

Is that just jealousy? Or is that a demonstration of central bank concern when things happen beyond their control. After all, for the past decade, central banks have basically controlled the global economy. Methinks they have gotten a bit too comfortable with all that power. At any rate, apocalyptic scenarios rarely come to pass, and in fact, my sense is that while the pound can certainly fall further in the short run, we are far more likely to see the EU figure out that they don’t want a hard Brexit after all, and come back to the table. While a final agreement will never be finished in time, there will be real movement and Brexit in name only as the final details are hashed out over the ensuing months. And the pound will rebound sharply. But that move is still a few months away.

Away from Brexit, there has been other news. For example, the BOJ met last night and left policy rates on hold, as universally expected, but lowered their inflation forecast for 2019 to 1.0%, which is a stretch given it’s currently running at 0.5%. And their 2.0% target is increasingly distant as even through 2022 they see inflation only at 1.6%. At the same time, they indicated they will move quickly to ease further if necessary. The problem is they really don’t have much left to do. After all, they already own half the JGB market, and have bought both corporate bonds and equities. Certainly, they could cut rates further, but as we have learned over the past ten years, ZIRP and NIRP have not been all that effective. With all that said, the yen’s response was to rise modestly, 0.15%, but basically, the yen has traded between 107-109 for the past two months and shows no signs of breaking out.

We also saw some Eurozone data with French GDP disappointing in Q2, down to 0.2% vs. 0.3% expected, and Eurozone Confidence indicators were all weaker than expected, noticeably Business Confidence which fell to -0.12 from last month’s +0.17 and well below the +0.08 expected. This was the weakest reading in six years and simply highlights the spreading weakness on the continent. Once again I ask, do you really think the EU is willing to accept a hard Brexit with all the disruption that will entail? As to the euro, it is essentially unchanged on the day. Longer term, however, the euro remains in a very clear downtrend and I see nothing that will stop that in the near term. If anything, if Draghi and friends manage to be uber-uber dovish in September, it could accelerate the weakness.

Away from the big three, we are seeing weakness in the Scandies, down about 0.5%, as well as Aussie and Kiwi, both lower by about 0.25%. Interestingly, the EMG bloc has been much less active with almost no significant movement anywhere. It appears that traders are unwilling to do anything ahead of tomorrow’s FOMC statement and Powell’s press conference.

On the data front this morning we see Personal Income (exp 0.4%), Personal Spending (0.3%), Core PCE (0.2%, 1.7% Y/Y), Case-Shiller Home Prices (2.4%) and Consumer Confidence (125.0). Arguably, the PCE data is most important as that is what the Fed watches. Also, given that recent CPI data came in a tick higher than expected, if the same thing happens here, what will that do to the insurance cut narrative? The point is that the data of late has not warranted talk of a rate cut, at least not the US data. But will that stop Powell and company? The controlling narrative has become the Fed must cut to help the rest of the world. But that narrative will not depreciate the dollar very much. As such, I remain generally bullish the dollar for the foreseeable future.

Good luck
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Rates Will Be Hewn

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Inflation remains far too low
In Europe, and so Mario
Has promised that soon
Their rates will be hewn
And, too, will their balance sheet grow

The ECB did not act yesterday, leaving all policy unchanged, but Signor Draghi was quite clear that a rate cut, at the very least, would be coming in September. He hinted at a restart of QE, although he indicated that not everyone was on board with that idea. And he pleaded with Eurozone governments to implement more fiscal stimulus.

That plea, however, is a perfect example of why the Eurozone is dysfunctional. While the ECB, one of the key Eurozone institutions, is virtually begging governments to spend more money, another one of those institutions, the European Commission, is prepared to sanction, and even fine, Italy because they want to spend more money! You can’t make this stuff up. As another example, consider that Germany is running a 1.7% fiscal surplus this year, yet claims it cannot afford to increase its defense spending.

It is this type of contradiction that exemplifies the problem with the Eurozone, and more specifically with the euro. Every nation is keen to accept the benefits of being a member, but none want to assume the responsibilities that come along with those benefits. In other words, they all want the free option. The euro is a political construct and always has been. Initially, countries were willing to cede their monetary sovereignty in order to receive the benefits of a more stable currency. But twenty years later, it is becoming clear that the requirements for stability are greater than initially expected. In a way, the ECB’s policy response of even more NIRP and QE, which should further serve to undermine the value of the single currency, is the only possible outcome. If you were looking for a reason to be long term bearish on the euro, this is the most powerful argument.

Speaking of the euro’s value, in the wake of the ECB statement yesterday morning, it fell 0.3% to 1.1100, its lowest level since mid-May 2017, however, Draghi’s unwillingness to commit to even more QE at the press conference disappointed traders and the euro recouped those early losses. This morning, it is basically right at the same level as before the statement, with traders now turning their focus to Wednesday’s FOMC meeting.

So, let’s consider that story. At this point it seems pretty clear that the Fed is going to cut rates by 25bps. Talk of 50bps has faded as the last several data points have proven much stronger than expected. Yesterday saw a blowout Durable Goods number (+2.0%, +1.2% ex transport) with both being well above expectations. This follows stronger than expected Retail Sales, CPI and payroll data this month, and even a rebound in some of the manufacturing surveys like Philly and Empire State. While the Housing Market remains on its heels, that doesn’t appear to be enough to entice a 50 bp move. In addition, we get our first look at Q2 GDP this morning (exp 1.8%) and the Fed’s favorite inflation data of PCE next week before the FOMC meeting concludes. Strength in any of this will simply cement that any cut will be limited to 25bps. Of course, there are several voting members, George and Rosengren top the list, who may well dissent on cutting rates, at least based on their last comments before the quiet period. Regardless, it seems a tall order for Chairman Powell to come across as excessively dovish given the data, and I would contend that the euro has further to fall as a result. In fact, I expect the dollar has further to climb across the board.

The other big story, of course, is the leadership change in the UK, where PM Boris had his first discussion with EU leaders regarding Brexit. Ostensibly, Boris demanded to discard the Irish backstop and the EU said absolutely not. At this point the EU is counting on a sufficient majority in the UK Parliament to prevent a no-deal Brexit, but there are still three months to go. This game is going to continue for a while yet, but at some point, it is going to be a question of whether Ireland blinks as they have the most to lose. Their economy is the most closely tied to the UK, and given they are small in their own right, don’t have any real power outside the EU. My money is on the EU changing their stance come autumn. In the meantime, the pound is going to remain under pressure as the odds of a no-deal Brexit remain high. This morning it is lower by a further 0.2%, and I see no reason for this trend to end anytime soon.

In other news, Turkey slashed rates 425bps yesterday as the new central bank head, Murat Uysal, wasted no time in the chair responding to President Erdogan’s calls for lower rates. The market’s initial response was a 1.5% decline in the lira, but it was extremely short-lived. In fact, as I type, TRY is firmer by nearly 1.0% from its levels prior to the announcement. Despite the cut, interest rates there remain excessively high, and in a world desperately seeking yield, TRY assets are near the top of the list on both a nominal and real basis.

Beyond that, it is hard to get excited about too much heading into the weekend. While equity markets suffered yesterday after some weak earnings data, futures are pointing to a better opening this morning. Treasuries are virtually unchanged as are gold and oil. So all eyes will be on the GDP data, where strength should reflect in a stronger dollar, but probably weaker equities, as the chance for more than a 25bp cut dissipates.

Good luck
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Thus Far They’ve Failed

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The ECB meeting today
Is forcing its members to weigh
The costs if they wait
To cut the base rate
Vs. benefits if they delay

Their problem is as things now stand
Recovery should be at hand
But thus far they’ve failed
As growth’s been curtailed
From Sicily to the Rhineland

Today brings the first of three major central bank meetings in the next six days as the ECB is currently meeting and the market awaits the outcome. Next week we will hear from both the BOJ and then the Fed, but for now all eyes are turned toward Frankfurt.

Expectations, as measured by the futures market, have moved to a 48% probability of a 10bp rate cut by the ECB this morning, although most of the punditry believe that Signor Draghi will simply lay the groundwork for a cut in September at the next meeting. The arguments for waiting are as follows: given the expectations of a Fed rate cut, with some still holding out hope for 50bps, the market benefits of cutting today would be quickly offset, and one of the few arrows the ECB still has left in its quiver would be wasted. The key benefit they are seeking is a weaker euro, and the concern is that any weakness will be short-lived, especially in the event of a 50bp cut by Powell. Of course, one need only look at the chart to see that the euro has been trending steadily lower for the past year, falling nearly 5% since last July, although as we await the meeting outcome it remains unchanged on the day. It’s not clear to me why else they would wait. After all, the data continues to point to ongoing Eurozone weakness every day. This morning’s example was the German Ifo Business Climate Index, which fell to 95.7, its lowest point since April 2013. It is becoming abundantly clear that Germany is heading into a recession and given Germany’s status as the largest economy in the Eurozone, representing nearly one-third of the total, that bodes ill for the entire bloc.

I maintain that it makes no sense to wait if they know that they will cut next month. They are far better off cutting now, maybe even by 20bps, and using September to restart QE, which is also a foregone conclusion. The funny thing about appointing Madame Lagarde, the uber dove, as the next ECB president, is that she won’t have anything to do once she sits down given the fact that all the easing tools will have been used already. Well, perhaps that is not strictly correct. Lagarde will be able to expand QE to cover, first, bank bonds and then, eventually equities.

(As an aside, for all you capitalists out there, the practice of central banks buying equities should cause great discomfort. After all, they can print as much money as they need to effectively buy ownership in all the public companies in an economy. And isn’t the definition of Socialism merely when the government owns the means of production? It seems to me that central bank equity purchases are a great leap down that slippery slope!)

At any rate, FX markets have largely been holding their breath awaiting the ECB outcome this morning. The same cannot be said of equity markets, where we continue to see records in the US, and markets in both Asia and Europe continue to rally on the idea that lower rates will continue to support stocks. At the same time, bond markets are also still on the march, with Bunds trading to yet another new low, touching -0.46% yesterday, and currently at -0.41%. Treasuries, too, remain bid, with the 10-year yield ticking slightly lower to 2.03%. And in the commodity space, oil prices are firmer after both a surprisingly large inventory draw and the ongoing issues in the Persian Gulf as the UK and Iran duke it out over captured tankers.

With the Brexit story now waiting for its next headlines, which will likely take at least a few days to arrive, and the US-China trade story awaiting next week’s meetings in Beijing, it is central banks all the way as the key market drivers for now. This morning’s Initial Claims (exp 219K) and Durable Goods (0.7%, 0.2% -ex transport) seem unlikely to be key movers.

So Mario, it’s all up to you today. How dovish Draghi sounds will be the key event for today, and likely the impetus behind movement until next Wednesday when Chairman Powell takes the spotlight. Personally, I think he will be far more dovish than the market is currently pricing and we will see the dollar rally further.

Good luck
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Sans Details

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In England and Scotland and Wales
A new PM finally hails
With Boris the man
We know the game plan
Is Brexit, as yet sans details

As of 7:05 this morning, it was finally official that Boris Johnson was elected as the new leader of the UK’s Conservative and Unionist Party (aka the Tories) by a substantial margin. By all rights, as of tomorrow, he will be the new Prime Minister of the UK. Congratulations Boris!

And so, the Brexit story now takes a new turn as Boris was instrumental in campaigning for the vote three years ago, and has been a vocal supporter ever since, unlike his predecessor, Theresa May. He has been abundantly clear that if the EU does not reopen the negotiations, he will take the UK out of the EU without a deal. Yet to date, the EU has been adamant that the only deal available is the one they have already tabled. Since the beginning, I have maintained that while the UK will certainly be negatively impacted by a no-deal Brexit, the EU will also feel significant pain. This is especially true in northern Europe, with Germany, France and the Netherlands amongst the biggest exporters to the UK. Thus, we are now involved in the biggest game of chicken seen in the global economy in a very long time. (While the politicians describe this as brinksmanship, I think chicken is a better label.) At this point, it is anybody’s guess how things will turn out, but what we do know is that if there really is a no-deal Brexit, the pound will fall much further, the euro will decline, and global growth will slow further.

As it happens, we are already seeing the UK economy slip, with the latest evidence being this morning’s CBI report which printed at a much worse than expected -34, its lowest since the immediate wake of the Brexit vote in 2016. And not surprisingly, the pound remains under pressure, down 0.1% as I type, which makes 2.1% during the past month. In addition, we heard from BOE member Saunders, who confirmed that the BOE default assumption of a smooth Brexit may not be the outcome, and that monetary policy will need to adjust to the new realities in that case. While he continues to fear a stagflationary outcome, there remains little case for the BOE to raise rates anytime soon. The evidence is abundantly clear that in a global rates environment that is declining, there is virtually no chance the UK would tighten policy in any way. Despite the fact that the US has far more room to cut rates than the UK, the problems attendant to Brexit, at least initially, are going to continue to weigh on the pound going forward.

Away from the Brexit story, all eyes are turning toward the ECB meeting to be held in two days’ time in Frankfurt. While most analysts around the world are convinced that Signor Draghi is going to use this meeting to set the table for more action in September, the market is moving toward my view that a rate cut is coming Thursday. OIS markets are pricing in a 40% probability of a 10bp cut, and there are a few outlier analysts who are even calling for 20 bps right away. After all, if you consider what NY Fed president Williams said last week about how, when rates are low, acting aggressively right away is a better strategy than a slow decline in rates, that would argue for 20 bps on Thursday. The other question is whether they will introduce some sort of tiering into the program to allow the European banks, which have been getting killed by the negative rate charges, to exempt some portion of their excess reserves from the penalty rates. That is actually a huge deal, and one where there is very little clarity. In the meantime, despite the fact that the market is certain the Fed is going to cut rates by 25 bps next week, I think the euro has room to fall further in the interim. It is lower by 0.25% this morning, and I expect a move toward 1.10, especially as I believe they will cut Thursday.

As to the rest of the G10, the dollar is broadly stronger, but the magnitude of change remains very modest, on the order of 0.10%-0.20%. In the EMG space, the dollar has also seen broad strength, although here, too, the size of the movement remains muted, with the biggest losers falling just 0.3% (PLN, HUF, IDR). It should be no surprise that markets continue to bide their time as we await the official news from the ECB as well as Friday’s US GDP data, which will clearly play into the FOMC decision next week.

And that’s pretty much today’s story. Equity earnings continue to be released, and it seems that most are beating the lowered expectations that are out there. This has been enough to prevent further equity market damage but has not led to significant gains. On the rate front, Treasuries have been stagnant for the past few sessions with 10-year yields standing at 2.03%, well off the highs seen two weeks ago in a technical sell-off, but certainly with plenty of room to decline from here, especially in the event the Fed does cut 50. We get one piece of data, Existing Home Sales (exp 5.33M), but that seems unlikely to change many views regardless of the outcome. So, my view remains that the dollar’s slow drift higher is still the most likely outcome for now.

Good luck
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A Half Point’s Preferred

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Said Williams, the Fed must be swift
When acting if growth is adrift
The market inferred
A half point’s preferred
Which gave all stock markets a lift

If there was any doubt that markets are still entirely beholden to the Fed, they should have been removed after yesterday’s price action. First, recall that a number of emerging market central banks cut interest rates, some in a complete market surprise (South Korea), while others were anticipated (Indonesia, South Africa, Ukraine) and yet all of those currencies strengthened on the day. It is always curious to me when a situation like that occurs, as it forces a deeper investigation as to the market drivers. But this investigation was pretty short as all the evidence pointed in one direction; the Fed. Yesterday afternoon, NY Fed President John Williams gave an, ostensibly, academic speech about how central banks should respond to economic weakness and highlighted that they should act quickly and aggressively in such cases. Notably, he said, “take swift action when faced with adverse economic conditions” and “keep interest rates lower for longer.” The market interpretation of those comments was an increased expectation for a 50bp rate cut by the Fed at the end of the month. Stocks reversed early losses, bonds rallied, with yields falling 4bps and the dollar fell as much as 0.5%. While a spokesperson for the NY Fed made a statement later trying to explain that Williams’ speech was not about policy, just academic research, the market remained convinced that 50bps is coming to a screen near you on July 31! We shall see.

The problem with the 50bp theme is that the economic data of late has actually been generally, although not universally, better than expected. Consider that last week, both core CPI (2.1%) and PPI (2.3%) printed a tick higher than expectations; Retail Sales were substantially stronger at 0.4% vs. the 0.1% expected; and both the Empire State and Philly Fed indices printed stronger than expected at 4.3 and 21.8 respectively. Also, the jobs report at the beginning of the month was much stronger than expected. Of course, there have been negatives as well, with IP (0.0%), Housing Starts (-0.9%) and Building Permits (-6.1%) all underperforming. In addition, we cannot forget the situation elsewhere in the world, where China printed Q2 GDP at 6.2%, its lowest print in the 27 years they have been releasing quarterly data, while Eurozone data continues to suffer as well. The implication is that if you assume there is a case for a rate cut at all, the case for a 50bp rate cut relies on much thinner gruel.

At this point, even if we continue to see stronger than expected US data, I believe that Powell and company are locked into a rate cut. Given that futures markets have fully priced that in, as well as the fact that the equity markets are unquestionably counting on that cut, disappointment would serve to truly disrupt markets, potentially impinging on financial conditions and certainly draw the ire of the White House. None of these consequences seem worthwhile for the potential benefit of leaving 25bps of dry powder in the magazine. Add to this the fact that we have heard from several Fed members; Bostic, Kaplan and George, none of whom are enthused about a rate cut at all. Now, of those three, only Esther George is a current voter, but one dissenting vote will not be enough to sway a clearly dovish FOMC. Add it all up and I think we see 25bps when the dust settles. Of course, if that’s the case, it is entirely realistic to see equity prices ‘sell the news’ unless Powell is hyper dovish in the press conference.

And in truth, that is the entire story today. Virtually every story in the financial press focuses on rate cuts, whether the question about the Fed, or the discussion of all the other central banks that have already acted. There is an ongoing argument about whether the ECB actually cuts rates next week, or if they simply prepare the market for a cut in September and the reinstitution of QE in January. Most analysts are opting for the latter, believing that Signor Draghi will wait and see, but if they know they are going to cut, why wait? I think there is a much better chance of immediate action than is being priced into the market.

On the Brexit front, the voting by Tory members continues, and by all accounts, Boris is still in the lead and due to be the next PM. That will continue to pressure the pound, as unless there is further movement by the EU, the chances of a no-deal Brexit will continue to rise. In fact, next week will be quite momentous as we hear from the ECB and get the UK voting results on Thursday.

Away from these stories, most things fall into the background. For example, China Minsheng Group, a major Chinese conglomerate, is defaulting on a $500 million bond repayment due in August. Clearly, this is not a positive event, but more importantly speaks to two specific issues, the lack of US dollar liquidity available in emerging markets as well as the true nature of the slowdown in the Chinese economy. This will be used as further ammunition for the camp that believes the Chinese significantly overstate their economic data.

Turning to this morning’s activity, the only data point is the Michigan Sentiment data (exp 98.5) and we get one more Fed speech, from uber-dove James Bullard. The dollar is stronger today, after yesterday’s afternoon selloff, having risen 0.35% vs. the euro and with gains also against the yen (0.3%), Aussie (0.25%) and most emerging market currencies (MXN 0.3%, ZAR 0.6%, CNY 0.1%). My sense is that yesterday afternoon’s price action was a bit overdone on the dollar, and so we will see more of that unwound ahead of the weekend. Look for modest further USD strength.

Good luck and good weekend
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Could Not Be Severer

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For two years the EU played rough
On Brexit and called every bluff
They forced the UK
To see it their way
And every pushback they’d rebuff

But now that the date’s drawing nearer
And Johnson can’t be any clearer
He’ll walk with no deal
It’s now become real
That Brexit could not be severer

So Barnier finally blinked
Agreeing the Irish were linked
And in a surprise
He talked compromise
Though as yet, no new deal’s been inked

The pound is higher this morning as news that the EU is willing to discuss a compromise for the Irish border has clearly changed the discussion. If you recall, the EU has been adamant that the only deal available is the one that erstwhile PM May negotiated, which includes a section on the Irish border that could easily keep the UK beholden to the EU in perpetuity. Naturally, the Brexiteers were not happy with that outcome and it eventually led to May’s resignation.

The problem for the EU is that Boris Johnson, who is the most likely candidate to become the new PM when results are announced next week, has been abundantly clear that if the EU doesn’t fix the parts of the deal that are controversial, he will take the UK out on October 31 without a deal. And there is no indication he is bluffing. So suddenly the EU has figured out that a no-deal Brexit is a real possibility and that they may no longer have the upper hand. Consider that the UK has already suffered economically during the run-up to the actual exit, while the EU’s suffering has been self-inflicted and not related to Brexit at all. Given the EU’s economy is broadly slowing already, the last thing they need is something like Brexit, which would likely tip the EU into recession if there is no deal. And voila, the EU has finally figured out that they have much to lose in this negotiation.

It should be no surprise that the pound has rallied on the news, although the 0.5% rally is not that impressive. But it’s a start, and if the two sides can come to an agreement on the Irish situation, then there is a real opportunity for the pound to rebound sharply. After all, a smooth Brexit has always been likely to drive the pound back toward 1.40. While it is still way too early to assume that outcome, at least it is back on the table.

The other theme of the overnight session has been central bank rate cuts, with South Korea surprising analysts with a 25bp cut to 1.50% while they lowered forecasts for both growth and inflation for 2019 and 2020. The ongoing trade situation between the US and China is a major headache for the Koreans, and don’t forget they have their own direct trade issue with Japan regarding the Japanese export of key materials for Korean manufacturing. We also saw Indonesia cut rates 25bps, beginning the reversal of the 175bps of rate hikes they implemented in 2018. While growth there remains solid, with inflation falling and forecasts for slowing growth in its key export markets, this was not a great surprise. Analysts are looking for two more cuts this year as well. Interestingly, neither the won nor rupiah weakened on the news, with both currencies firmer by 0.15% when the market closed in Asia time.

And perhaps that is the theme for today, mild dollar weakness despite other nation’s activities. But the operative word is mild. In fact, the pound’s rally, which was also helped by surprisingly robust Retail Sales data, is by far the largest move of the session. Otherwise, in both G10 and EMG spaces, we are seeing some back and forth on the order of 0.10%-0.20%, hardly enough to get excited about.

Clearly, there is much more market discussion on the earnings season as it unfolds in the US. Yesterday’s big news was Netflix, which missed estimates on subscriber growth in Q2 and has seen its stock fall sharply in the aftermarket. But Eurozone equities are under pressure as well after weak results from SAP and Nordea Bank presage further struggles on the continent.

Now here’s something to consider. Right now, the market is fully priced for a Fed cut at the end of the month, and there is a strong expectation that the ECB meeting next week is going to outline its future policy ease. Those have been key drivers in the broad equity market rally we have seen since June, and if either Powell or Draghi disappoints, equity markets are certainly going to suffer. But what if earnings data comes in broadly worse than expected, a la Netflix last night, and equity prices fall regardless of the rate story. After all, by almost every measure, valuations in the US equity space are quite high so a decline may well be due on its own, rate cuts or not. The question is how those same central banks will respond. Will they ease more aggressively to prevent a further decline, or will they ignore the outcome? In the past, this wasn’t really a consideration as central banks were focused only on inflation and employment or growth. But these days I’m not so sure that is the case. Just beware if earnings data start to stumble.

Turning to this morning’s session, there are only two US data points, Initial Claims (exp 216K) and Leading Indicators (0.1%). We also hear from two Fed speakers, Bostic and Williams, although both have already explained their views earlier this week. On that subject, we heard from FOMC voter Esther George yesterday and she has been the first Fed speaker to be clear that there is no reason for a rate cut anytime soon. Now she has always been one of the more hawkish Fed members and it would not shock me if she dissented at the next vote assuming a rate cut is the outcome. Wouldn’t it be interesting if the first dissent under Powell’s tenure was looking for a cut and the second, in the following meeting, was looking to stay on hold? It certainly indicates there is a diversity of opinion at the Fed, at least with regard to the proper policy implementation if not with regard to Keynesianism.

And that’s all there is for today. Earnings data are likely to be the main drivers as neither data point is seen as a market mover. With the dollar on its back foot this morning, I see no reason for it to turn around at this time. Look for a further slow decline.

Good luck
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Be Prepare for Mayhem

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Next week when the former PM
Steps down be prepared for mayhem
Both Johnson and Hunt
Are willing to punt
May’s deal, which they’re quick to condemn

Remember, back in the day, when I suggested that the probability of a hard Brexit was much higher than the market was assuming? In fact, I have been highlighting this fact pretty consistently since, at least, January heading up to the original deadline. Well, now, it appears that the market is figuring out that the probability of a hard Brexit is higher than they previously assumed. Last night, in a debate between the two candidates for PM, front-runner Boris Johnson and Jeremy Hunt, both were clear that the Irish backstop was dead in the water, and both were clear that they would be willing to walk away with no deal. Ongoing negotiations have become more difficult as the UK is making more demands and the EU is now complaining that the UK is trying to “bully” them! This is the funniest statement that I have ever seen. For two years, the EU essentially bullied PM May into agreeing to things that were unpalatable, including the Irish backstop. Now all of a sudden, the EU’s tender feelings have been hurt by the UK pushing back!

Since the original vote, pundits around the world have assumed that the UK would bear the brunt of the fallout from Brexit. After all, the rest of the EU is the UK’s largest trading partner, and the UK only represents something like 10% of EU exports. But as the EU dips back into recession with monetary policy already stretched, it is becoming clearer that the EU will suffer greatly in a no-deal Brexit. Just ask Germany how its auto manufacturers will be impacted when suddenly there are tariffs on BMW’s in the UK. The point is that both sides are likely to feel pain, although it seems the UK has already absorbed part of it, while the rest of the EU has been laboring under the assumption that the UK would cave in eventually. My view is there is no chance of a deal at this point and there are only two possible outcomes; no-deal Brexit or no Brexit. However, there seems to be limited willingness to hold a second referendum to try to overturn the first one, with major splits within both main parties there. And that leads to a no-deal Brexit. Be prepared.

It should be no surprise that this has had a pretty big impact on the pound this morning, which has fallen by 0.75% to its lowest level since January 2017. And this is despite better than expected employment data where wages grew a stronger than expected 3.6% in May, while the Unemployment rate remained at 45-year lows of 3.8%. While the UK economy seems to be holding up reasonably well, I continue to look for the BOE to cut rates in November after the hard Brexit occurs, if only as a precaution for a quick slowdown. Meanwhile, the pound is likely to continue to decline between now and then, testing 1.20 before long. However, vs. the euro, where the pound has also been sliding, I expect that trend to stabilize and even reverse. This is due to the fact that the Eurozone is going to suffer far more than currently anticipated from a hard Brexit. Right now, the cross is trading at 0.9030. I would look for a move in the euro to 1.05-1.06 and the cross to head down to 0.88.

Away from the Brexit story, things are a bit less exciting on the currency front. Broadly the dollar is strong today, as weaker Eurozone data (German ZEW Sentiment fell more than expected to -24.5) has pundits discussing a recession in Germany and confirming a more aggressive policy ease from the ECB. As such, the euro is lower by 0.3% this morning, as all the dovishness from the Fed is being offset by all the dovishness from ECB members.

Down Under, the RBA Minutes continue to highlight the need to keep policy accommodative as they, too, recognize that their old models need tweaking and that lower rates will not lead directly to further inflation. Aussie, which has actually performed pretty well overall since Powell’s first testimony last week, is lower by 0.2%. While the RBA is likely to remain on hold for now, look for more cuts as soon as the Fed starts to cut.

And those have really been the key drivers in the market today. Looking at the CE4, all of them have fallen roughly the same 0.3% as the euro meaning there is no new information to be gleaned. LATAM currencies are barely budged and APAC has also seen very limited movement overnight. The same can be said of global equity markets, which have seen very limited movement, on the order of 0.2% as investors await the next big story. Arguably, that story will start to be told next week by the ECB, with the punchline added by the FOMC at the end of the month. In the meantime, earnings season is beginning, so individual equity prices are likely to see movement, but it is hard to get excited about a macro move in the near term. And bonds? Well, they have stopped falling as the overly aggressive long positions seem to have been unwound. I expect they will start to rally again, albeit at a slower pace than we saw at the beginning of the month.

This morning brings the most interesting data of the week, Retail Sales (exp 0.1%, 0.1% ex autos), as well as a spate of Fed speakers including Chairman Powell at 1:00 this afternoon. If Retail Sales disappoint already low expectations, look for bonds to rally along with stocks as the dollar falls. If they are quite strong, I think the market is far less prone to react as the July rate cut is still a done deal. It just will have a much smaller probability of being a 50bp cut.

Good luck
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Akin to Caffeine

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There once was a time in the past
Where weakness in growth, if forecast
Resulted in prices
That forewarned a crisis
And traders sold what they’d amassed

But nowadays weakness is seen
As something akin to caffeine
‘Cause central bank measures
Will add to their treasures
It’s like a brand new cash machine

Chinese growth data was weak last night, falling to its lowest quarterly rate in the twenty-seven years that China has measured growth on a quarterly basis. The outcome of 6.2%, while expected, confirms that the ongoing trade situation with the US is having an increasingly negative impact on GDP worldwide. Naturally, not unlike Pavlov’s dogs, the market response was to rally on the theory that the PBOC would be adding more stimulus soon. After all, every other central bank in the world (save Norway’s) is preparing to ease policy further as growth worldwide continues to slow down. And so far, the Pavlovian response of buying stocks on bad news continues to be working as evidenced by the fact that equity markets throughout Asia rose. However, the magnitude of that rise has been quite limited, with gains of between 0.2% and 0.4% the norm. in fact, that market response is actually a bad sign for the central banks, because it demonstrates that the effectiveness of their policies is expected to be much less than in the past. Diminishing returns is a normal outcome for the repeated use of anything, and monetary policy is no different. The implication of this outcome is that despite the growing certainty that the Fed, ECB, BOJ, PBOC, BOE and more are going to ease policy further, equity markets seem unlikely to benefit as much as they have in the past. And if when a recession finally arrives, look for a change of heart in the equity community. But in the meantime, party hearty!

Speaking of further policy ease, it seems the market is chomping at the bit for next week’s ECB meeting, where there are two schools of thought. The conservative view is that Signor Draghi will sound quite dovish and indicate a 10bp cut is coming in September. But that is not nearly as exciting a view as the more aggressive analysts are discussing, which is a 20bp cut next week and the introduction of QE2 in September. Interestingly, despite all this certitude about ECB rate cuts, the euro is actually slightly higher this morning (albeit just 0.1%). It appears that traders are betting on the fact that if Draghi is aggressive, the Fed will have the opportunity the following week to match and outperform the ECB. Remember, the Fed has 250bps of rate cuts before it reaches ZIRP while the ECB is already negative. Despite the recent academic work explaining that negative rates are just fine and helping the situation, it still seems unlikely that we are going to see -2.0% anywhere in the world anytime soon. Ergo, the relative policy stance implies the Fed will ease more and the dollar will suffer accordingly. Just not today. Rather, today, the dollar is little changed overall, with some gains and some losses, but few large moves.

And those have been the real stories of note over what was a very quiet weekend. This week we see a fair amount of data, including Retail Sales, but more importantly, we hear from five more Fed speakers, including Chairman Powell tomorrow, in a total of nine speeches.

 

Today Empire Manufacturing 2.0
Tuesday Retail Sales 0.2%
  -ex autos 0.2%
  IP 0.2%
  Capacity Utilization 78.2%
  Business Inventories 0.3%
Wednesday Housing Starts 1.262M
  Building Permits 1.30M
  Fed’s Beige Book  
Thursday Initial Claims 216K
  Philly Fed 5.0
  Leading Indicators 0.1%
Friday Michigan Sentiment 98.5

Given the importance of the consumer to the US economy, the Retail Sales data is probably the most important data point. Certainly, a weak outcome will result in rate cut euphoria, but it will be interesting to see what happens if there is a strong print. But otherwise, this seems more like a week where Fed speakers will dominate, as we hear from NY’s John Williams twice, as well as a mix of other governors and regional presidents. In the end, though, Powell’s comments are key, as I expect he will be looking to fine tune his message from last week’s congressional testimony.

It remains clear that the Fed has the most room to ease policy, and as long as that is the case, the dollar should remain under pressure. However, given the fact that the US economy continues to outperform the rest of the developed world, I don’t anticipate the dollar’s decline to be extreme, a few percent at most.

For today, there is precious little else to really drive things, so look for more of the recent choppiness that we have observed in markets, with no real directional bias.

Good luck
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Soon On the Way

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Said Brainerd and Williams and Jay
A rate cut is soon on the way
Inflation’s quiescent
And growth’s convalescent
So easing will help save the day

We have learned a great deal this week about central bank sentiment from the Fed, the ECB, the BOE, Sweden’s Riksbank as well as several emerging market central banks like Mexico and Serbia. And the tone of all the commentary is one way; easier policy is coming soon to a central bank near you.

Let’s take a look at the Fed scorecard to start. Here is a list of the FOMC membership, voting members first:

Chairman Jerome Powell                – cut
Vice-Chair Richard Clarida             – cut
Lael Brainerd                                    – cut
Randal Quarles                                 – cut
Michelle Bowman                            – ?
NY – John Williams                           -cut
St Louis James Bullard                    – cut
Chicago – Charles Evans                  – cut
KC – Esther George                           – stay
Boston – Eric Rosengren                 – cut

Non-voting members
Philadelphia – Patrick Harker       – cut
Dallas – Robert Kaplan                    – ?
Minneapolis – Neel Kashkari         – cut 50!
Cleveland – Loretta Mester            – stay
Atlanta – Rafael Bostic                    – stay
Richmond – Thomas Barkin          – stay

While we have not yet heard from the newest Governor, Michelle Bowman, it would be unprecedented for a new governor to dissent so early in their tenure. In the end, based on what we have heard publicly from voting members, only Esther George might dissent to call for rates to remain on hold, but it is clear that at least a 25bp cut is coming at the end of the month. The futures market has priced it in fully, and now the question is will they cut 50. At this point, it doesn’t seem that likely to me, but there are still two weeks before the meeting, so plenty can happen in the interim.

But it’s not just the Fed. The ECB Minutes were released yesterday, and the telling line was there was “broad agreement” that the ECB should “be ready and prepared to ease the monetary policy stance further by adjusting all of its instruments.” It seems pretty clear to me (and arguably the entire market) that they are about to ease policy. There are many analysts who believe the ECB will wait until their September meeting, when they produce new growth and inflation forecasts, but a growing number of analysts who believe that they will cut later this month. After all, if the Fed is about to cut based on weakening global growth, why would the ECB wait?

And there were the Minutes from Sweden’s Riksbank, which were released this morning and showed that their plans for raising rates as early as September have now been called into question by a number of the members, as slowing global growth and ongoing trade uncertainties weigh on sentiment. While Sweden’s economy has performed better than the Eurozone at large, it will be extremely difficult for the Riksbank to tighten policy while the ECB is easing without a significant adjustment to the krona. And given Sweden’s status as an open economy with significant trade flows, they cannot afford for the krona to strengthen too much.

Meanwhile, Banco de Mexico Minutes showed a split in the vote to maintain rates on hold at 8.25% last month, with two voters now looking for a cut. While inflation remains higher than target, again, the issue is how long can they maintain current policy rates in the face of cuts by the Fed. Look for rate cuts there by autumn. And finally, little Serbia didn’t wait, cutting 25bp this morning as growth there is beginning to slow, and recognizing that imminent action by the ECB would need to be addressed anyway.

In fairness, the macroeconomic backdrop for all this activity is not all that marvelous. For example, just like South Korea reported last week, Singapore reported Q2 GDP growth as negative, -3.4% annualized, a much worse than expected outcome and a potential harbinger of the future for larger economies. Singapore’s economy is hugely dependent on trade flows, so given the ongoing US-China trade issues, this ought not be a surprise, but the magnitude of the decline was significant. Speaking of China, their trade data, released last night, showed slowing exports (-1.3%) and imports (-7.3%), with the result a much larger than expected trade surplus of $51B. Additionally, we saw weaker than expected Loan growth and slowing M2 Money Supply growth, both of which point to slower economic activity going forward. Yesterday’s other important economic data point was US CPI, where core surprised at 2.1%, a tick higher than expected. However, the overwhelming evidence that the Fed is going to cut rates has rendered that point moot for now. We will need to see that number move much higher, and much faster, to change any opinions there.

The market impact of all this has generally been as expected. Equity prices, at least in the US, continue to climb as investors cling tightly to the idea that lower interest rates equal higher stock prices. All three indices closed at new records and futures are pointing higher across the board. The dollar, too, has been under pressure, as would be expected given the view that the Fed is going to enter an easing cycle. Of course, while the recent trend for the dollar has been down, the slope of the line is not very steep. Consider that the euro is only about 1% above its recent cyclical lows from late April, and still well below the levels seen at the end of June. So while the dollar has weakened a bit, it is quite easy to make the case it remains within a trading range. In fact, as I mentioned yesterday, if all central banks are cutting rates simultaneously, the impact on the currency market should be quite limited, as the relative rate stance won’t change.

Finally, a quick word about Treasury bonds as well as German bunds. Both of these markets were hugely overbought by the end of last week, as investors and speculators jumped on the idea of lower rates coming soon. And so, it should be no surprise that both of these markets have seen yields back up a decent amount as those trades are unwound. This morning we see 10-year yields at 2.13% in the US and -0.21% in Germany, well off the lows of last week. However, this trade is entirely technical and at some point, when these positions are gone, look for yields on both securities to head lower again.

This morning brings just PPI (exp 1.6%, 2.2% core) which is unlikely to have much impact on anything. With no more Fed speakers to add to the mix, I expect that we will continue to see equities rally, and that the dollar, while it may remain soft, is unlikely to move too far in any direction.

Good luck and good weekend
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