Tag Archives: #Fed

The Hard Way

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The quarter has come to an end
And Brexit’s now just round the bend
Meanwhile Chairman Jay
Has learned the hard way
Experience is his best friend

It has been more than a week and the market continues to talk about the liquidity crunch that drove repo rates to 10.0% briefly. The Fed did respond, albeit somewhat slowly, and have seemingly been able to get things under control at this point. But in the WSJ this weekend there was a very interesting article asking, how could this have happened? After all, the Fed’s primary responsibility is to ensure that there is sufficient funding in the system. And I think for all market participants, this is a critical question. Since the Fed is essentially the world’s central bank, if they are losing control of the plumbing of the US money markets, what does that say about their ability to implement monetary policy effectively.

The back story revolves around actions that occurred shortly after John Williams was named NY Fed President, despite a complete lack of markets experience (he is a PhD Economist and Fed lifer, never having held a job in the private sector). In one of his first acts, he dismissed two key lieutenants, the head of the Markets Desk and the head of Financial Services, both of whom had been with the Fed for more than twenty years, and both of whom had intimate familiarity with market crises. After all, they were both in their roles during the Financial crisis, when Williams was one of a hundred economists working for the Fed’s Board of Governors. In other words, he has zero real world or market experience, and he fired the two most experienced market hands in his organization. While there has never been an explanation as to why he made that move, it clearly came back to haunt him, and the Fed at large, last week.

The issue for markets is now one of confidence. It doesn’t matter that things seem to be under control at this point, and all the talk of a standing repo facility being implemented to insure there is always sufficient liquidity are addressing the symptoms, not the cause. In addition, there is almost no question that the Fed is going to start rebuilding its balance sheet, as apparently, watching that paint dry was a bit more exciting than anticipated. But in the end, if market participants lose faith that the Fed can effectively manage its processes, then it will significantly change the overall atmosphere in markets. Remember, we have spent the last ten plus years being taught that central banks, and the Fed in particular, have one job, to protect financial markets. Two weeks ago, we realized that the ECB has basically run out of ammunition in its efforts to continue to address Europe’s problems. If the Fed has lost the knowhow regarding what is needed to manage the US financial system, that is a MUCH larger problem. I’m not saying they have, just that the repo market gyrations are an indication that they will have to work very hard to convince markets they are still in charge.

Turning to the market situation overnight, there has been very little of interest overall. In fact, the best way to describe things would be mixed. For example, the dollar is slightly firmer vs. the euro (+0.15%) but slightly weaker vs the pound (-0.15%). And the truth is, as I look across the board, that is a pretty good description of the entire FX market, modest gains and losses without any trend to note. European equity markets are little changed, US futures are the same and Asian markets were mixed (Nikkei -0.5%, Hang Seng +0.5%). Finally, bond markets have shown almost no movement with 10-year yields in the major bonds within 1 basis point of Friday’s levels.

As today is quarter end, it feels like most market participants have already straightened up their positions and are waiting for tomorrow to start anew. Meanwhile, we have seen a bunch of data, with the most noteworthy so far being the very slightly better than expected Chinese PMI data, with Manufacturing PMI printing at 49.8 vs. expectations at 49.6. So, while that is better than a further decline, it still points to contraction and slowing growth in China.

Looking ahead to today’s session and the week upcoming, though, there is a lot of new information on the way, including the payroll report on Friday.

Today Chicago PMI 50.0
Tuesday ISM Manufacturing 51.0
  ISM Prices Paid 50.5
Wednesday ADP Employment 140K
Thursday Initial Claims 215K
  Factory Orders -0.3%
  ISM Non-Manufacturing 55.1
Friday Nonfarm Payrolls 146K
  Private Payrolls 130K
  Manufacturing Payrolls 3K
  Unemployment Rate 3.7%
  Average Hourly Earnings 0.3% (3.2% Y/Y)
  Average Weekly Hours 34.4
  Participation Rate 63.2%
  Trade Balance -$54.5B

In addition to the payroll report, we have fourteen Fed speakers, essentially the entire FOMC, this week. My conclusion from this excessive schedule is that the Fed is very concerned that their message is not getting across effectively and that they feel compelled to clarify and repeat the message. However, given the wide disparity of opinions on the Board, my sense is this onslaught of speeches will simply add to the confusion. Chairman Powell has a tough road ahead to get his views accepted given what seem to be hardening positions on both sides of the argument. In fact, the only way the doves can win out, in my view, is if the economic data here starts to deteriorate significantly, but of course, that is not an outcome they seek either!

As to the dollar, there is nothing that has occurred anywhere to dissuade me from my ongoing bullish view. Until we see some more significant changes in the data, the dollar will remain top dog.

Good luck
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Quite Frankly Floored

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Most pundits were, quite frankly, floored
That leaving the ECB Board
Was one of the hawks
Who tired of talks
‘bout QE the Germans abhorred

The dollar is stronger than where I left it Tuesday evening after a rally in yesterday’s NY session. Determining the catalyst for that rally has been difficult given the only economic data of note was New Home Sales (713K), which while quite strong are generally not seen as market moving, and the limited commentary overheard. However, there are three things that conspired, I believe, to drive the dollar higher.

First was the surprise resignation of Sabine Lautenschlaeger from the ECB Executive Board. Ms. Lautenschlaeger was one of the most ardent hawks on the ECB and was quite vocal that there was no need to resume QE at the current time. In fact, she had been proffering that message since the last meeting when Mario first hinted that QE2 was on the table. In the end, though, she was not able to garner enough support to dissuade Signor Draghi from going ahead with it, and it appears she decided that her voice was no longer taken into consideration. Whomever is chosen as her replacement is almost certain to have less hawkish views, and so the market recognized that the tone of the ECB has turned more dovish. A dovish ECB is likely to result in easier policies and correspondingly a weaker euro.

We also heard from Chicago Fed President Charles Evans, a known dove, who indicated that he saw no reason for further rate cuts this year. It appears that he was one of the dots in the middle, comfortable with last week’s cut but calling it quits then. He highlighted that if the economy deteriorated for some reason, he would not be against further cuts, but at the present time, they were not necessary. So, a Fed dove was mildly hawkish, helping cement the idea that the Fed was less likely to cut rates again this year. This can only be seen as dollar bullish.

Finally, we have the calendar as we approach quarter-end and the financing requirements necessary for banks and other financial firms when they report positions. The stricter regulatory environment that has been in place since the financial crisis means that there is an increased demand for dollars on virtually every institution’s balance sheet. That is one reason we have seen issues within the Fed Funds market with all the discussion about the Fed’s repo facility and recent activities. However, there are many institutions that simply buy dollars in order to put their balance sheet in order.

Add them all up, and you have the makings of a dollar rally, which has seen the euro decline 0.85% since yesterday morning, the pound fall 1.2% and the yen fall 0.5%. Granted, the pound has its own issues relating to Boris’s return to Parliament and the inflamed rhetoric on both sides of the aisle there leading to an increase in belief that a hard Brexit is still possible. But the tell that this is simply a dollar rally and not a risk off event is the fact that the yen fell sharply, alongside a rally in equities and decline in the bond market.

The question at this time is whether the rally continues, or if it was merely a one-day event. At this point, the evidence seems to indicate that a slow continuation of the dollar rally is the most likely outcome. Certainly, there will be nothing hawkish coming from ECB policymakers as the hawks seem more willing to quit than continue to lose their battle. Eurozone data continues to implode and another key German institute, the DIW Institute, announced its expectation that when German GDP for Q3 is released on November 14, it will show growth at -0.2%, the second consecutive decline and put Germany in a technical recession. As an aside, it is interesting to see just how crucial the idea of monetary discipline is to Germans, in general, and German bankers in particular. Despite the fact that Germany probably has the weakest growth in the Eurozone, its ECB members are amongst the most hawkish. If that ever changes, you can be sure the euro will fall far more rapidly!

As to the Fed, it seems to me that there is a clear level of comfort developing on the FOMC that two cuts were sufficient in the current circumstances to stanch any bleeding in the economy, and barring an escalation in the trade war, they seem ready to stand pat. If that is the case, then dollars will retain their relative attractiveness. And of course, the calendar is beyond all our reach, but we will need to see if Friday, when the spot value date turns to October 1, whether or not there is reduced demand for the greenback. My sense is that pressure will dissipate quickly, and possibly reverse as those dollars are seen as short-term needs. But for the rest of the day, I think the dollar has room to run a little further.

Turning to today’s session, we do get the final reading of Q2 GDP (exp 2.0%) as well as the ancillary data that comes with that report. I always look at the Personal Consumption component (4.7%) as the best measure of demand, so keep an eye there. And of course, we get Initial Claims (212K), but that series’ stability has been extraordinary and largely taken it out of the conversation. If we do start to see that rise, however, beware of weakening nonfarm numbers and a lot more dovish rhetoric from the Fed.

As to the Fed, we have six, count ‘em, speakers today with nary a hawk in sight. As such, amongst Kaplan, Bullard, Clarida, Daly, Kashkari and Barkin, I expect rationales as to why another rate cut or two makes sense, or at the very least highlights of weakening global growth and impending problems like Brexit which require easier Fed policy as a response. However, given they are all known on the dovish side, I don’t think it matters that much. For now, I don’t see anything derailing the dollar and look for a modest further increase throughout the session.

Good luck
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A Major Broadside

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The question that needs to be asked
Is, have central bank powers passed?
The ECB tried
A major broadside
But markets ignored Draghi’s blast

There has certainly been no shortage of interesting news in the past twenty-four hours, however from a markets perspective, I think the ECB actions, and the market reactions are the most critical to understand. To recap Signor Draghi’s action, the ECB did the following:

1. cut the deposit rate 10bps to -0.50%;
2. restarted QE in the amount of €20Bio per month for as long as necessary;
3. reduced the rate and extended the tenor of TLTRO III loans; and
4. introduced a two-tier system to allow some excess liquidity to be exempt from the -0.50% deposit rate.

Certainly the market was prepared for the rate cut, which had been widely telegraphed, and the talk of tiering excess liquidity had also been making the rounds. Frankly, TLTRO’s had not been a centerpiece of discussion but I think that is because most market participants don’t see them as a major force in the policy debate, which leaves the start of QE2 as the most controversial thing Draghi introduced. Well, maybe that and the fact that forward guidance is now based on achieving a “robust convergence” toward the inflation target rather than a particular timeframe.

Remember, in the past two weeks we had heard from the Three Hawksketeers (Weidmann, Lautenschlager and Knot) each explicitly saying that more QE was not appropriate. We also heard that from the Latvian central banker, Rimsevics, and perhaps most surprisingly of all, from Franҫois Villeroy de Galhau, the French central bank chief. And yet despite clearly stiff opposition, Draghi got the Council to agree. Perhaps, though, he went too far in describing the “consensus as so broad, there was no need to take a vote.” Now, while I have no doubt that no vote was taken, that statement stretches credulity. This was made clear when Robert Holzmann, the new Austrian central bank president and first time member of the ECB, gave an interview yesterday afternoon explicitly saying that the ECB could well have made a mistake by reintroducing QE.

But let’s take a look at what happened after the ECB statement and during the press conference. The initial move was for the euro to decline sharply, trading down 0.65% in the first 10 minutes after the release. When Draghi took to the stage at 8:30 and reiterated the points in the statement, the euro declined a further 30 pips, touching 1.0927, its lowest level since May 2017. But that was all she wrote for the euro’s decline. As Draghi continued to speak and answer questions, traders began to suspect that the cupboard was bare regarding anything else the ECB can do to address further problems in the Eurozone economies. This was made abundantly clear in his pleas for increased fiscal stimulus, which much to his chagrin, does not appear to be forthcoming.

It was at this point that things started to turn with the euro soaring, at one point as much as 1.5% from the lows, and closed 1.3% higher than those levels. And this morning, the rally continues with the euro up to 1.1100 as I type, a solid 0.3% gain. But the big question that now must be asked is; has the market decided the ECB is out of ammunition? After all, given the relative nature of the FX market and the importance of monetary policy on exchange rates, if the market has concluded the ECB CANNOT do anymore that is effective, then by definition, the Fed is going to promulgate easier policies than the ECB with the outcome being a rising euro. So if the Fed follows through next week and cuts 25bps, and especially if it does not close the door on further cuts, we could easily see the euro rally continue. That will not help the ECB in their task to drive inflation higher, and it will set a difficult tone for Madame Lagarde’s tenure as ECB President going forward.

Turning to the Fed, the market is still fully priced for a 25bp cut next week, but thoughts of anything more have receded. However, a December cut is still priced in as well. The problem for the Fed is that the economic data has not been cooperating with the narrative that inflation is dead. For instance, yesterday’s CPI data showed Y/Y core CPI rose 2.4%, the third consecutive outcome higher than expectations and the highest print since September 2008! Once again, I will point to the anecdotal evidence that I, personally, rarely see the price of anything go down, other than the gyrations in gasoline prices. But food, clothing and services prices have been pretty steady in their ascent. Does this mean that the Fed will stay on hold? While I think it would be the right thing to do, I absolutely do not believe it is what will happen. However, it is quite easy to believe that the accompanying statement is more hawkish than currently expected (hoped for?) and that we could see this as the end of that mid-cycle adjustment. My gut is the equity market would not take that news well. And the dollar? Well, that would halt the euro’s rise pretty quickly as well. But that is next week’s story.

As if all that wasn’t enough, we got more news on the trade front, where President Trump has indicated the possibility of an interim trade deal that could halt, and potentially roll back, tariff increases in exchange for more promises on IP protection and agricultural purchases. That was all the equity market needed to hear to rally yet again, and in fairness, if there is a true thawing in that process, it should be positive for risk assets. So, the dollar declined across the board, except against the yen which fell further as risk appetite increased.

Two currencies that have had notable moves are GBP and CNY. The pound seems to be benefitting from the fact that there was a huge short position built over the past two months and the steady stream of anti-Brexit news seems to have put Boris on his back foot. If he cannot get his way, which is increasingly doubtful, then the market will continue to reprice Brexit risk and the pound has further to rally. At the same time, the renminbi’s rally has continued as well. Yesterday, you may recall, I mentioned the technical position, an island reversal, which is often seen as a top or bottom. When combining the technical with the positive trade story and the idea that the Fed has a chance to be seen as the central bank with the most easing ahead of it, there should be no surprise that USDCNY is falling. This morning’s 0.45% decline takes the two-day total to about 1.0%, a big move in the renminbi.

Turning to this morning’s data, Retail Sales are the highlight (exp 0.2%, 0.1% ex autos) and then Michigan Sentiment (90.8) at 10:00. Equity futures are pointing higher and generally there is a very positive attitude as the week comes to an end. At this point, I think these trends continue and the dollar continues to decline into the weekend. Longer term, though, we will need to consider after the FOMC next week.

Good luck and good weekend
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The Fun’s Just Begun

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In Hong Kong, the protestors won
In England, the fun’s just begun
But as of today
Bremain’s holding sway
And risk has begun a new run

As New York walks in this morning, there have been significant changes in several of the stories driving recent price action with the upshot being that risk is clearly in favor today. Things started in Hong Kong, where Carrie Lam, the territory’s Chief Executive, formally withdrew the extradition bill that had prompted three months of increasingly violent protests there. The quick back story is that this bill was presented in June as a response to a situation where a man accused of murder in Taiwan could not be returned there for trial due to the lack of formal extradition mechanisms in the existing legal framework. However, the bill they crafted was quite open-ended and would have allowed for extradition to the mainland for minor infractions, a situation seen as fraught with danger for Hong Kong’s shrinking independence. That is what begat the protests, and although they have grown in scope as well as size, it is seen as a significant first step to restoring order. It is hard to believe that Beijing is happy with this outcome as they were strong supporters of the bill, but thus far, they have made no comment.

As it happens, financial markets saw this as a significant change in the tone for the future and there was a massive equity rally in HK, while risk assets generally performed well at the expense of haven assets. So the Hang Seng rose nearly 4.0% with other APAC stock markets also gaining, albeit not to the same extent. European markets are also on the move this morning, with gains ranging from the FTSE 100’s +0.4% to the FTSE MIB (Italy) up 1.65%. And don’t worry, US equity futures are all pointing higher as well, on the order of 0.75%. Meanwhile, Treasuries have sold off modestly, with the 10-year yield higher by 3bps, Bunds have fallen further, with yields there up by 6bps, and the yen has bucked the trend in currencies, falling 0.25% amid a broad dollar decline. Finally, gold is lower by 0.65%, although remains near the top of its recent trading activity.

The other story that has seen significant changes comes from London, where PM Boris Johnson has not only lost a vote regarding his ability to deliver Brexit, but also has lost his slim majority in parliament after a single member defected to the LibDems. Subsequent to that, there was a vote on a bill brought to the floor to prevent the PM from forcing a no-deal Brexit, one which Boris opposed but passed 328-301 with 21 Tories voting against the PM. Johnson summarily fired those rebels from the party and now leads a minority government. His current tactic is to push for a snap election on October 14 or 15 so that a new government will be available to speak to the EU at a formal meeting on October 18. However, he needs two-thirds of all members of parliament to vote for that, meaning he needs the Labour party to agree. If you are confused by this back and forth, don’t feel too badly, I think pretty much everyone is, and there is certainly no clarity as to what will come next.

With that convoluted process in mind, from a markets perspective the result is clear, the probability of a no-deal Brexit has receded for the moment and the pound has been the biggest beneficiary, rallying 0.9% this morning and is now more than two cents above yesterday’s depths. While this move certainly makes sense given the current understanding of the situation, it is by no means the end of the story. If anything, it is the end of chapter one. Later today we should know if there is going to be another election and then it will take a little time before the market understands the odds of those outcomes. Remember, if there is an election and Jeremy Corbyn is seen with a chance to win, it will not be a positive for the pound or the UK economy either. For now, the market is focused on a somewhat lower probability of a hard Brexit and the pound is benefitting accordingly. However, I don’t think the binary nature of the problem has disappeared, simply been masked temporarily. For hedgers, implied volatility has fallen sharply on the back of this news and the ensuing move, but I would argue uncertainty remains quite high. Options still make a lot of sense here.

Past those two stories, there is no further news on the trade front, although that will certainly become the topic du jour again soon. In the meantime, recent data has continued to paint a mixed picture at best for the G10 economies. For example, yesterday’s ISM data printed at 49.1, well below expectations and the worst print since January 2016. While one print below 50.0 does not indicate a recession is upon us, it is certainly a harbinger of slower growth in the future. Then this morning we saw Service PMI’s from Europe with Italy’s much weaker than expected while France, Germany and the Eurozone as a whole printed at expectations. However, expectations still point to slowing growth, especially in combination with the manufacturing surveys which are mostly sub 50.0. In the UK, the PMI was also weak, 50.6, and there is talk that Q3 is going to result in modest negative GDP performance causing a technical recession in the UK joining Germany and Italy in that regard. In the end, while the trade war may be negatively impacting both the US and China, it is also clearly having a big impact throughout Europe and the rest of the world.

As to the rest of the FX market, the risk on behavior has led to broad based dollar weakness, with the euro rebounding 0.35%, Aussie and Kiwi up similar amounts and the Skandies rallying even further, +0.7%. Canada is a bit of an outlier here as oil prices have been under pressure lately, although have bounced 1.0% this morning, but more importantly, the BOC meets with great uncertainty as to whether they will cut rates or not. Markets are pricing in a 92% chance they will do so, but the analyst community is split about 50/50 on the prospects for a cut today. That said, those same analysts are looking for cuts later this year, so this seems more about timing than the ultimate result.

In the EMG bloc ZAR has had another winning day, rising 1.4% as international bond buyers continue to aggressively buy South African paper after the country averted a recession. But broadly, the dollar is lower against virtually all EMG currencies due to risk-on sentiment.

On the data front, this morning brings the Trade Balance (exp -$53.4B) a modest decline from last month’s outcome, and then the Beige Book comes at 2:00 but that’s all. We will hear from a plethora of Fed speakers today, five in all, ranging from uber doves Kashkari and Bullard to moderate Robert Kaplan from Dallas. Yesterday, Bullard in another speech said the Fed should cut 50bps at the upcoming meeting while Boston’s Rosengren said there didn’t seem to be the need to do anything right now. A full cut plus some is still priced in at this point.

In the end, broad risk sentiment is today’s driver. As long as that remains positive, look for the dollar to remain under pressure.

Good luck
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Under Stress

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The week that just passed was a mess
With both bulls and bears under stress
As equities fell
Most bonds performed well
And dollars? A roaring success

Pundits have been searching for adjectives to describe the week that is ending today. Tumultuous strikes me as an accurate reflection, but then stormy, tempestuous and volatile all work as well. In the end though, the broad trends have not changed at all. Equities continue to retreat from their mid-summer highs, bonds continue to rally sharply while yield curves around the world flatten and the dollar continues to march higher.

So what is driving all this volatility? It seems the bulk of the blame is laid at the feet of President Trump as his flipping and flopping on trade policy have left investors and traders completely confused. After all, late last week he declared tariffs would be imposed on the rest of Chinese imports not already subject to them, then after market declines he decided that a portion of those tariffs would be delayed from September until December. But then the Chinese struck back saying they would retaliate and now the President has highlighted he will be speaking directly with President Xi quite soon. On the one hand, it is easy to see given the numerous changes in stance, why markets have been so volatile. However, it beggars belief that a complex negotiation like this could possibly be completed on any short timeline, and almost by definition will take many more months, if not years. There is certainly no indication that either side is ready to capitulate on any of the outstanding issues. So the real question is, why are markets responding to every single tweet or comment? To quote William Shakespeare, “It is a tale told by an idiot, full of sound and fury signifying nothing.” Alas, there is every indication that this investor and trader behavior is going to continue for a while yet.

This morning we are back in happy mode, with the idea that the Presidents, Trump and Xi, are going to speak soon deemed a market positive. Equity markets around the world are higher (DAX +1.0%, CAC +1.0%, Nikkei +0.5%); bond markets have been a bit more mixed with Treasuries (+2bps) and Gilts (+4.5bps) selling off a bit but we continue to see Bunds (-1.5bps) rally. In fact we are at new all-time lows for Bund yields with the 10-year now yielding -0.73%!

As to the dollar, it is still in favor, with only the pound showing any real life in the G10 space, having rallied 0.65% this morning with the market continuing to be impressed with yesterday’s Retail Sales data there. In fact, if we look over the past week, the pound is the only G10 currency to outperform the dollar, having rallied more than 1.0%. On the flip side, the Skandies are this week’s biggest losers with both SEK and NOK down by 1.35% closely followed by the euro’s 1.1% decline, of which 0.3% has happened overnight.

The FX market continues to track the newest thoughts regarding relative central bank policy changes and that is clearly driving the euro. For example, yesterday, St Louis Fed President Bullard, likely the most dovish FOMC member (although Kashkari gives him a run), sounded almost reticent to continue cutting rates, and ruled out the idea that an intermeeting cut was necessary. While he supported the July cut, and will likely vote for September, he again ruled out 50bps and didn’t sound like more made sense. At the same time, Finnish central bank president Ollie Rehn, a key ECB member, explained that come September, the ECB would act very aggressively in order to get the most bang for the buck (euro?). The indication was not only will they cut rates, and possibly more than the 10bps expected, but QE would be restarted and expanded, and he did not rule out movement into other products (equities anyone?) as well. In the end, the market sees that the ECB is going to basically do everything else they can right away as they watch the Eurozone economy sink into recession. Meanwhile, most US data continues to point to a much more robust growth situation.

Let’s look at yesterday’s US data where Retail Sales were very strong (0.7%, 1.0% ex autos) and Productivity, Empire Manufacturing and Philly Fed all beat expectations. Of course, confusingly, IP was a weaker than expected -0.2% and Capacity Utilization fell to 77.5%. Adding to the overall confusion is this morning’s Housing data where Starts fell to 1191K although Permits rose to 1336K. In the end, there is more data that is better than worse which helps explain the 2.1% growth trajectory in the US, which compares quite favorably with the 0.8% GDP trajectory on the continent. As long as this remains the case, look for the dollar to continue to outperform.

Oh and one more thing, given the problems in the Eurozone, do you really believe the EU will sit by and watch the UK exit without changing their tune? Me either!

Next week brings the Fed’s Jackson Hole symposium and key speeches, notably by Chairman Powell. As to today, there is no reason to expect the dollar to do anything but continue its gradual appreciation.

Good luck and good weekend
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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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