Tag Archives: #Fed

Not So Fast

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While everyone thought it was nifty
The Fed was about to cut fifty
Said Jay, not so fast
We’ll not be harassed
A quarter’s enough of a gift-y

Once again, Chairman Powell had a significant impact on the markets when he explained that the Fed is fiercely independent, will not be bullied by the White House, and will only cut rates if they deem it necessary because of slowing growth or, more importantly, financial instability. Specifically, he said the Fed is concerned about and carefully watching for signs of “a loss of confidence or financial market reaction.” In this context, “financial market reaction” is a euphemism for falling stock prices. If ever there was a question about the existence of the Fed put, it was laid to rest yesterday. Cutting to the chase, Powell said that the Fed’s primary concern, at least right now, is the stock market. If it falls too far, too fast, we will cut rates as quickly as we can. Later in his speech, he gave a shout out to the fact that low inflation seems not to be a temporary phenomenon, but that was simply thinly veiled cover for the first part, a financial market reaction.

There are two things to note about these comments. First, the Fed, and really every major central bank, continues to believe they are in complete control of both their respective economies and the financial markets therein. And while it is absolutely true this has been the case since the GFC ended, at least with respect to the financial markets, it is also absolutely true that the law of diminishing returns is at work, meaning it takes much more effort and stimulus to get the same result as achieved ten years ago. At some point, probably in the not too distant future, markets are going to begin to decline and regardless of what those central banks say or do, will not be deterred from actually clearing. It will not be pretty. And second, the ongoing myth of central banks being proactive, rather than reactive, is so ingrained in the central bank zeitgeist that there is no possibility they will recognize the fact that all of their actions are, as the axiom has it, a day late and a dollar short.

But for now, they are still in command. Yesterday’s price action was informed by the fact that despite the weakest Consumer Confidence data in two years and weaker than expected New Home Sales, Powell did not affirm a 50bp cut was on its way in July. Since the market has been counting on that outcome, the result was a mild risk off session. Equity prices suffered in the US and continued to do so around the world last night and Treasuries settled below 2.00%. However, gold prices, which have been rocking lately, gave up early gains when Powell nixed the idea of a 50bp cut. And the dollar? Well, it remains mixed at best. It did rally slightly yesterday but continues to be broadly lower than before the FOMC meeting last week.

We also heard from two other Fed speakers yesterday, Bullard and Barkin, with mixed results. Bullard, the lone dissenter from the meeting made clear that he thought a 25bp reduction was all that was needed, a clear reference to Minneapolis Fed President Kashkari’s essay published on Friday calling for a 50bp cut. However, Thomas Barkin, from the Richmond Fed, sounded far less certain that the time was right for a rate cut. He sounds like he is one of the dots looking for no change this year.

And the thing is, that’s really all the market cares about right now, is what the Fed and its brethren central banks are planning. Data is a sidelight, used to embellish an idea if it suits, and ignored if it doesn’t. The trade story, of course, still matters, and given the increasingly hardened rhetoric from both sides, it appears the market is far less certain of a positive outcome. That portends the opportunity for a significant move on Monday after the Trump-Xi meeting. And based on the way things have played out for the past two years, my money is on a resumption of the dialog and some soothing words, as that will help underpin stocks in both NY and Shanghai, something both leaders clearly want. But until then, I expect a general lack of direction as investors make their bets on the outcome.

One little mentioned thing on the data front is that we have seen every regional Fed manufacturing survey thus far released show significantly more weakness than expected. Philly, Empire State, Chicago, Richmond and Dallas have all fallen sharply. That does not bode well for economic growth in either Q2 or Q3, which, in a twisted way, will play right into the President’s hands as the Fed will be forced to cut rates as a response. Strange times indeed.

This morning, two data points are released; Durable Goods (exp -0.1%, +0.1% ex transports) and the Goods Trade Balance (-$71.8B). Look for weakness in these numbers to help perk of the equity market as anticipation will grow that more rate cutting is in the offing. And look for the dollar to suffer for the same reason.

Good luck
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QE Will Soon Have Returned

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The ECB started the trend
Which helped the bond market ascend
Then yesterday Jay
Was happy to say
A rate cut he’d clearly portend

Last night from Japan we all learned
Kuroda-san was not concerned
That yields there keep falling
And if growth is stalling
Then QE will soon have returned

This morning on Threadneedle Street
The Governor and his staff meet
Of late, they’ve implied
That rates have upside
But frankly, that tune’s obsolete

This morning, every story is the same story, interest rates are going lower. Tuesday, Signor Draghi told us so. Yesterday Chairman Jay reiterated the idea, and last night, Kuroda-san jumped on the bandwagon. This morning, Governor Carney left policy unchanged, although he continues to maintain that interest rates in the UK could rise if there is a smooth exit from the EU. Gilt markets, however, clearly don’t believe Carney as yields there fall and futures markets are pricing in a 25bp rate cut by the end of the year.

But it is not just those banks that are looking to ease policy. Remember, several weeks ago the RBA cut rates to a new record low at 1.25%, and last night, Governor Lowe indicated another cut was quite realistic. Bank Indonesia cut the reserve requirement by 0.50% last night and strongly hinted that an interest rate cut was on its way. While Bangko Sentral ng Pilipanas surprised most analysts by leaving rates on hold due to an uptick in inflation, that appears to be a temporary outcome. And adding to the Asian pressure is the growing belief that the RBNZ is also set to cut rates right before Australia does so.

In fact, looking around the world, there is only one place that is bucking this trend, Norway, which actually increased interest rates this morning by 25bp to a rate of 1.25%. In fairness, Norway continues to grow strongly, estimated 2.6% GDP growth this year, and inflation there is running above the 2.0% target and forecast to continue to increase. And it should be no surprise that the Norwegian krone is this morning’s best performing currency, rallying 1.0% vs. the euro and 1.5% vs. the dollar.

But in the end, save Norway, every story is still the same story. Global GDP growth is slowing amid increased trade concerns while inflationary pressures are generally absent almost everywhere. And in that environment, policy rates are going to continue to fall.

The market impacts ought not be too surprising either. Equity investors everywhere are giddy over the thought of still lower interest rates to help boost the economy. Or if not boosting the economy, at least allowing corporations to continue to issue more debt at extremely low levels and resume the stock repurchase schemes that have been underpinning equity market performance. Meanwhile, bond market investors are pushing the central banks even further, with new low yield levels in many countries. For example, in the 10-year space, German bunds are at -0.31%; Japanese JGB’s are at -0.18%; UK Gilts yield 0.81%; and Treasuries, here at home, have fallen to 2.01% right now, after touching 1.97% yesterday. It is abundantly clear that the market believes policy rates are going to continue to fall, and that QE is going to be reinstated soon.

As to the FX markets, yesterday saw the beginning of a sharp decline in the dollar with the euro up nearly 1.0% since the FOMC announcement, the pound +0.5% and the yen +0.6%. This makes sense as given the global rate structure, it remains clear that the Fed has the most room to ease from current settings, and thus the dollar is likely to suffer the most in the short term. However, as those changes take effect, I expect that the dollar’s decline will slow down, and we will find a new short-term equilibrium. I had suggested a 3%-5% decline before settling, and that still seems reasonable. After all, despite the fall yesterday, the dollar is simply back to where it was a week ago, before all the central bank fireworks.

With the BOE out of the way, the rest of the morning brings us two data releases, Initial Claims (exp 220K) and Philly Fed (11.0). For the former, there is still real scrutiny there given the weak NFP number earlier this month, and estimates have been creeping slightly higher. A big miss on the high side will likely see rates fall further and the dollar with them. As to the latter, given the huge miss by the Empire Manufacturing print on Monday, there will be wariness there as well. A big miss here will become the second piece of news that indicates a more acute slowing of the US economy, and that will also likely see rates fall further.

In fact, that is the theme for now, everything will be an excuse for rates to fall until the meeting between President’s Trump and Xi next week, with all eyes looking for signs that the trade situation will improve. And one other thing to remember is that tensions in the Middle East are increasing after Iran claimed to have shot down a US drone. Both oil and gold prices are much higher this morning, and I assure you, Treasuries are a beneficiary of this story as well.

So, for the dollar, things look dim in the short and medium term, however, I see no reason for a prolonged decline. Hedgers should take advantage of the weakness in the buck to add to hedges over the next few weeks.

Good luck
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Loosen the Screws

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Said President Trump, come next week
That he and Xi are set to speak
Meanwhile he complains
The euro remains
Too weak, and a boost there he’ll seek

But that was all yesterday’s news
Today Jay will offer his views
On whether the Fed
Is ready to shred
Its old plans and loosen the screws

ECB President Draghi once again proved his mettle yesterday by managing to surprise the market with an even more dovish set of comments when he spoke at the ECB gathering in Sintra, Portugal. Essentially, the market now believes he promised to cut interest rates further and restart QE soon, despite the fact that rates in the Eurozone remain negative and that the ECB has run up against their self-imposed limits regarding percentage of ownership of Eurozone government bonds. In other words, once again, Draghi will change the rules to allow him to go deeper down the rabbit hole otherwise, these days, known as monetary policy.

Markets were Europhoric, on the news, with equities on the Continent all rising 1.5% or so, while government bond yields fell to new lows. German Bund yields touched a new, all-time, low at -0.326%, but we also saw French OAT yields fall to a record low of 0.00% in the 10-year space. In fact, all Eurozone government bonds saw sharp declines in yields. For Draghi, I’m sure the most gratifying result was that the 5 year/5 year inflation swap contract rebounded from 1.18%, up to 1.23%, still massively below the target of “close to, but below, 2.0%”, but at least it stopped falling. In addition, the euro fell, closing the day lower by 0.2% and back below the 1.12 level, and we also saw gold add to its recent gains, as lower interest rates traditionally support precious metals prices.

US markets also had a big day yesterday with both equity and bond markets continuing the recent rally. Clearly, the idea that the ECB was ready to add further stimulus was a key driver of the move, but that news also whetted appetites for today’s FOMC meeting and what they will do and say. Adding fuel to the equity fire was President Trump’s announcement that he would be meeting with Chinese President Xi at the G20 next week, with plans for an “extended meeting” there. This has created the following idea for traders and investors; global monetary policy is set to get much easier while the trade war is soon coming to an end. The combination will remove both of the current drags on global economic growth, so buy risky assets. Of course, the flaw in this theory is that if Trump and Xi come to terms, then the trade war, which has universally been blamed for the world’s economic troubles, will no longer be weakening the economy and so easier monetary policy won’t be necessary. But those are just details relative to the main narrative. And the narrative is now, easy money is coming to a central bank near you, and that means stocks will rally!

Let’s analyze that narrative for a moment. There is a growing suspicion that this is a coordinated attempt by central bankers to rebuild confidence by all of them easing policy at the same time, thus allowing a broad-based economic benefit without specific currency impacts. After all, if the ECB eases, and so does the Fed, and the BOJ tonight, and even the BOE tomorrow, the relative benefits (read declines) to any major currency will be limited. The problem I have with the theory is that coordination is extremely difficult to achieve out in the open, let alone as a series of back room deals. However, it does seem pretty clear that the data set of late is looking much less robust than had been the case earlier this year, so central bank responses are not surprising.

And remember, too, that BOE Governor Carney keeps trying to insist that UK rates could rise in the event of a smooth Brexit, although this morning’s CPI data printed right on their target of 2.0%, with pipeline pressures looking quite subdued. This has resulted in futures markets pricing in rate cuts despite Carney’s threats. This has also helped undermine the pound’s performance, which continues to be a laggard, even with yesterday’s euro declines. The fact that markets are ignoring Carney sets a dangerous precedent for the central banking community as well, because if markets begin to ignore their words, they may soon find all their decisions marginalized.

So, all in all, the market is ready for a Fed easing party, although this morning’s price action has been very quiet ahead of the actual news at 2:00 this afternoon. Futures markets are currently pricing a 23% chance of a rate cut today and an 85% chance of one in July. One thing I don’t understand is why nobody is talking about ending QT this month, rather than waiting until September. After all, the balance sheet run-off has been blamed for undermining the economy just as much as the interest rate increases. An early stop there would be seen as quite dovish without needing to promise to change rates. Just a thought.

And really, these are the stories that matter today. If possible, this Fed meeting is even more important than usual, which means that the likelihood of large movement before the 2:00pm announcement is extremely small. There is no other data today, and overall, the dollar is ever so slightly softer going into the announcement. This is a reflection of the anticipated easing bias, but obviously, it all depends on what the Chairman says to anticipate the next move.

Good luck
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Constant Hyperbole

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On Wednesday the FOMC
Will offer their latest decree
Will Fed funds be pared?
Or will Jay be scared
By Trump’s constant hyperbole?

The one thing that’s patently clear
Is rates will go lower this year
And lately some clues
Show Powell’s new views
Imply NIRP he’ll soon engineer

Once again, market movement overnight has been muted as traders and investors look ahead to Wednesday’s FOMC meeting and Chairman Powell’s press conference afterwards. Current expectations are for the removal of the word ‘patient’ from the statement and some verbiage that implies rates will be adjusted as necessary to maintain the US growth trajectory. Futures markets are pricing just a 25% probability of a rate cut on Wednesday, but a virtual certainty of one at the July meeting in six weeks’ time. With that said, there are several bank analysts calling for a cut today, or a 50bp cut in July. The one thing that seems abundantly clear is that interest rates in the US have reached their short-term peak, with the next move lower.

However, in the Mariner Eccles building, they have another dilemma, the fact that Fed funds are just 2.50%, the lowest cyclical peak in history. It has been widely recounted that the average amount of rate cutting by the Fed when fighting a recession has been a bit more than 500bps, which given the current rate, results in two possibilities: either they will have to quickly move to use other policy tools, like QE; or interest rates in the US are going to go negative before long! And quite frankly, I expect that it will be a combination of both.

Consider, while the Fed did purchase some $3.5 trillion of assets starting with QE1 in 2009, the Fed balance sheet still represents just 19% of US GDP. This compares quite favorably with the ECB (45%) and the BOJ (103%), but still represents a huge increase from its level prior to the financial crisis. Funnily enough, while there was a great deal of carping in Congress about QE by the (dwindling) hard-money set of Republicans, if the choice comes down to NIRP (Negative Interest Rate Policy) or a larger balance sheet, I assure you the politicians will opt for a larger balance sheet. The thing is, if the economy truly begins to slow, it won’t be a choice, it will be a combination of both, NIRP and QE, as the Fed pulls out all the stops in an effort to prevent a downturn.

And NIRP, in the US, will require an entirely new communications effort because, as in Europe and Japan, investors will find themselves on the wrong side of the curve when looking for short term investments. Money market funds are going to get crushed, and corporate treasuries are going to have to find new places to invest. It will truly change the landscape, and it is not clear it will do so in a net positive way. But regardless, NIRP is coming to a screen near you once the Fed starts cutting, although we are still a number of months away from that.

With that in mind, the obvious next question is how it will impact other markets. I expect that the initial reaction will be for a sharp equity rally, as that is still the default response to rate cuts. However, if the Fed is looking ahead and sees trouble on the horizon, that cannot be a long-term positive for equities. It implies that earnings numbers are going to decline, and no matter how ‘bullish’ interest rate cuts may seem, declining earnings are hard to overcome.

Bonds, on the other hand, are easy to forecast, with a massive rally in Treasuries, a lagging rally in corporates, as spreads widen into a weakening economy, but for high-yield bonds, I would expect significant underperformance. Remember, during the financial crisis, junk bond yield spreads rose to 20.0% over Treasuries. In another economic slowdown, I would look for at least the same, which compares to the current level of about 5.50%.

Finally, the dollar becomes a difficult question. Given the Fed has far more room to ease policy than does the ECB, the BOJ, the BOE or the BOC, it certainly seems as though the first move would be lower in the buck. However, if the Fed is easing policy that aggressively, you can be sure that every other central bank is going to quickly follow. Net I expect that we could see a pretty sharp initial decline, maybe 5%-7%, but that once the rest of the world gets into gear, the dollar will find plenty of support.

A quick look at markets overnight shows that the dollar is little changed overall, with some currencies slightly firmer and others slightly softer. However, there is no trend today, nor likely until we hear from the Fed on Wednesday.

Looking at data this week, it is much less interesting than last week’s and unlikely to sway views.

Today Empire Manufacturing 10.0
Tuesday Housing Starts 1.239M
  Building Permits 1.296M
Wednesday FOMC Rates 2.50% (unchanged)
Thursday BOJ Rates -0.10% (unchanged)
  Initial Claims 220K
  Philly Fed 11.0
  Leading Indicators 0.1%
Friday Existing Home Sales 5.25M

As I said, not too interesting. And of course, once the Fed meeting is done, we will get to hear more from the various Fed members, with two speakers on Friday afternoon (Brainard and Mester) likely to be the beginning of a new onslaught.

Yes, the trade situation still matters, but there is little chance of any change there until the G20 meeting next week, and that assumes President’s Trump and Xi agree to meet. So, for now, it is all about the Fed. One last thing, the ECB has their Sintra meeting (their answer to Jackson Hole) this week, and it is likely that we will hear more about their thinking when it comes to easing policy further given their current policy settings include NIRP and a much larger balance sheet already. Any hint that new policies are coming soon will certainly undermine the single currency. Look for that beginning on Wednesday as well.

Good luck
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Markets Are Waiting

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For right now most markets are waiting
To see if key risks are abating
Next week it’s the Fed
Then looking ahead
The G20 is captivating

The question is what we will learn
When Powell and friends next adjourn
The bond market’s sure
A cut has allure
To help them avoid a downturn

Markets this morning are pretty uninteresting as trader and investor focus turns to the two key upcoming events, next week’s FOMC meeting and the G20 meeting at the end of the month. At this point, it is fair to say that the market is pricing in renewed monetary ease throughout most of the world. While the Fed is in their quiet period, the last comments we heard were that they would act appropriately in the event economic growth weakened. Futures markets are pricing in a 50% chance of a cut next week, and a virtually 100% chance of a cut in July, with two more after that before the end of the year. While that seems aggressive to many economists, who don’t believe that the US economy is in danger of slowing too rapidly, the futures market’s track record is pretty good, and thus cannot be ignored.

But it’s not just the US where markets are pushing toward further rate cuts, we are seeing the same elsewhere. For example, last week Signor Draghi indicated that the ECB is ready to act if necessary, and if you recall, extended their rate guidance further into the future, assuring no rate changes until the middle of next year. Eurozone futures markets are pricing in a 10bp rate cut, to -0.50%, for next June. This morning we also heard from Banque de France President, and ECB Council member, Francois Villeroy that they have plenty of tools available to address slowing growth if necessary. A key pressure point in Europe is the 5year/5year inflation contract which is now pricing inflation at 1.18%, a record low, and far below the target of, “close to, but below, 2.0%”. In other words, inflation expectations seem to be declining in the Eurozone, something which has the ECB quite nervous.

Of course, adding to the picture was the news Monday night that the PBOC is loosening credit conditions further, targeting infrastructure spending. We also heard last week from PBOC Governor Yi Gang that the PBOC has plenty of tools available to fight slowing economic output. In fact, traveling around the world, it is easy to highlight dovishness at many central banks; Australia, Canada, Chile, India, Indonesia, New Zealand and Switzerland quickly come to mind as countries that have recently cut rates or discussed the possibility of doing so.

Once again, this plays to my constant discussion of the relative nature of the FX market. If every country is dovish, it becomes harder to discern which is the most hawkish dove. In the end, it generally winds up being a case of which nation has the highest interest rates, even if they are falling. As of now, the US continues to hold that position, and thus the dollar is likely to continue to be supported.

While the Fed meeting is obvious as to its importance, the G20 has now become the focal point of the ongoing trade situation with optimists looking for a meeting between Presidents Trump and Xi to help cool off the recent inflammation, but thus far, no word that Xi is ready to meet. There are many domestic political calculations that are part of this process and I have read arguments as to why Xi either will or won’t meet. Quite frankly, it is outside the scope of this note to make that call. However, what I can highlight is that news that a meeting is scheduled will be seen as a significant positive step by markets with an ensuing risk-on reaction, meaning stronger equities and a sell-off in the bond market, the dollar and the yen. Equally, any indication that no meeting will take place is likely to see a strong risk-off reaction with the opposite impacts.

Looking at the overnight data, there have been few releases with the most notable, arguably, Chinese in nature. Vehicle Sales in China fell 16.4%, their 11th consecutive monthly decline, which when combined with slowing monthly loan growth paints a picture of an economy that is clearly feeling some pain. The only other data point was Spanish Inflation, which printed at 0.8%, clearly demonstrating the lack of inflationary impulse in the Eurozone, even in one of the economies that is growing fastest. Neither of these data points indicates a change in the easing bias of central banks.

In the US this morning we see CPI data which is expected to print at 1.9% with the ex food& energy print at 2.1%. Yesterday’s PPI data was on the soft side, so there is some concern that we might see a lower print, especially given how rapidly oil prices have fallen of late. In the end, it is shaping up as another quiet day. Equity markets around the world have been slightly softer, but that is following a weeklong run of gains, and US futures are pointing to 0.3% declines at this point. Treasury yields are off their lowest point but still just 2.12% and well below overnight rates. And the dollar is modestly higher this morning, although I don’t see a currency that has moved more than 0.2%, indicating just how quiet things have been. Look for more of the same until at least next Wednesday’s FOMC announcement.

Good luck
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Oy Vey!

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The jobs report was quite the dud
And traders began smelling blood
If Powell and friends
Would not make amends
Then stocks would be dragged through the mud

Then later, down Mexico’s way
The tariff dispute went away
At least for the moment
Though Trump could still foment
More problems by tweeting, oy vey!

This morning, despite the confusion
The outcome’s a foregone conclusion
Stock markets will rise
While bonds scrutinize
The data, and fight the illusion

I’m not even sure where to start this morning. Friday’s market activity was largely as I had forecast given the weak payrolls report, just a 75K rise in NFP along with weaker earnings numbers, leading to a massive increase in speculation that the Fed is going to cut, and cut soon. In fact, the probability for a June cut of 25bps is now about 50/50, with a full cut priced in for the July meeting and a total of 70bps of cuts priced in for the rest of 2019. Equity markets worldwide have rallied on the weak data as a new narrative has developed as follows: weaker US growth will force the Fed to ease policy sooner than previously forecast and every other central bank will be forced to follow suit and ease policy as well. And since the reaction function for equity markets has nothing to do with economic activity, being entirely dependent on central bank largesse, it should be no surprise that stock markets are higher everywhere. Adding to the euphoria was the announcement by the Trump administration that those potential Mexican tariffs have been suspended indefinitely after progress was made with respect to the ongoing immigration issues at the US southern border.

This combination of news and data was all that was needed to reverse the Treasury market rally from earlier in the week, with 10-year yields higher by 5bps this morning, and the dollar, which had fallen broadly on Friday, down about 0.6% across the board after the payroll report, has rebounded against most of its counterpart currencies. The one outlier here is the Mexican peso, which after the tariff threat had fallen by nearly 3%, has rebounded and is 2.0% higher vs. the dollar this morning.

To say that we live in a looking glass world where up is down and down is up may not quite capture the extent of the overall market confusion. One thing is certain though, and that is we are likely to continue to see market volatility increase going forward.

Let’s unpack the Fed portion of the story, as I believe it will be most helpful in trying to anticipate how things will play out going forward. President Trump’s threats against Mexico really shook up the market but had an even bigger impact on the Fed. Consider, we have not heard the word ‘patient’ from a Fed speaker since Cleveland Fed President Loretta Mester used the word on May 3rd. When the FOMC minutes were released on May 22, the term was rampant, but the world had changed by then. In the interim, we had seen the US-China trade talks fall apart and an increase in tariffs by both sides, as well as threats of additional actions, notably the banning of Huawei products in the US and the restriction of rare earth metals sales by China. At this point, the trade situation is referred to as a war by both sides and most pundits. We have also seen weaker US economic activity, with Retail Sales and Housing data suffering, along with manufacturing and production. While no one is claiming we are in recession yet, the probabilities of one arriving are seen as much higher.

The result of all this weak data and trade angst was a pretty sharp sell-off in the equity markets, which as we all know, seems to be the only thing that causes the Fed to react. And it did so again, with the Fed speakers over the past two weeks highlighting the weakening data and lack of inflation and some even acknowledging that a rate cut would be appropriate (Bullard and Evans.) This drove full on speculation that the Fed was about to ease policy and futures markets have now gone all-in on the idea. It would actually be disconcerting if the Fed acted after a single poor data point, so June still seems only a remote possibility, but when they meet next week, look for a much more dovish statement and for Chairman Powell to be equally dovish in the press conference afterward.

And remember, if the Fed is turning the page on ‘normalization’ there is essentially no chance that any other major central bank will be able to normalize policy either. In fact, what we have heard from both the ECB’s Draghi and BOJ’s Kuroda-san lately are defenses of the many tools they still have left to utilize in their efforts to raise inflation and inflationary expectations. But really, all they have are the same tools they’ve used already. So, look for interest rates to fall further, even where they are already negative, as well as more targeted loans and more QE. And the new versions of QE will include purchases that go far beyond government bonds. We will see much more central bank buying of equities and corporate bonds, and probably mortgages and municipals before it is all over.

Ultimately, the world has become addicted to central bank policy largesse, and I fear the only way this cycle will be broken is by a crisis, where really big changes are made (think debt jubilee), as more of the same is not going to get the job done. And that will be an environment where havens will remain in demand, so dollars, yen, Treasuries and Bunds, and probably gold will all do quite well. Maybe not immediately, but that is where we are headed.

Enough doom and gloom. Let’s pivot to the data story this week, which is actually pretty important:

Today JOLTs Jobs Report 7.479M
Tuesday NFIB Small Biz 102.3
  PPI 0.1% (2.0% Y/Y)
  -ex food & energy 0.2% (2.3% Y/Y)
Wednesday CPI 0.1% (1.9% Y/Y)
  -ex food & energy 0.2% (2.1% Y/Y)
Thursday Initial Claims 216K
Friday Retail Sales 0.7%
  -ex autos 0.3%
  IP 0.1%
  Capacity Utilization 78.7%
  Michigan Sentiment 98.1

Clearly CPI will be closely watched, with any weakness just fanning the flames for rate cuts sooner. Also, after the weak NFP report Friday, I expect closer scrutiny for the Initial Claims data. This has been quite steady at low levels for some time, but many pundits will be watching for an uptick here as confirmation that the jobs market is starting to soften. Finally, Retail Sales will also be seen as important, especially given the poor outcome last month, which surprised one and all.

Mercifully, the Fed is in its quiet period ahead of their meeting next week, so we won’t be hearing from them. Right now, however, the momentum for a rate cut continues to build and stories in the media are more about potential weakness in the economy than in the strength that we had seen several months ago. If the focus remains on US economic activity softening, the dollar should come under pressure, but once we see that spread to other areas, notably the UK and Europe, where they had soft data this morning, I expect those pressures to equalize. For today, though, I feel like the dollar is still vulnerable.

Good luck
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Certainty’s Shrinking

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The data from yesterday showed
That Services growth hadn’t slowed
But ADP’s number
Showed job growth aslumber
An outcome that doesn’t, well, bode

This morning it’s Mario’s turn
To placate the market’s concern
His toolkit keeps shrinking
And certainty’s sinking
That he can prevent a downturn

The glass is always half-full if you are an equity trader, that much is clear. Not only did they interpret Chairman Jay’s words on Tuesday as a rate cut was coming soon (although he said no such thing), but yesterday they managed to see the combination of strong ISM Non-Manufacturing data (56.9 vs exp 55.5) and weak ADP Employment data (27K vs exp 180K) as the perfect storm. I guess they see booming profits from Services companies alongside rate cuts from the Fed as job growth slows. At any rate, by the end of the day, equity markets had continued the rally that started Tuesday with any concerns over tariffs on Mexican imports relegated to the dustbin of last week.

Meanwhile the Treasury market continues to have a different spin on things with 10-year yields still plumbing multi-year depths (2.10%) while the 5yr-30yr spread blows out to its steepest (88bps) since late 2017. The interpretation here is that the bond market is essentially forecasting a number of Fed rate cuts as the economy heads into recession shortly. It isn’t often that markets have such diametrically opposed views of the future, but history has shown that, unfortunately in this case, the bond market has a better track record than the stock market. And there is one other little tidbit of market data worth sharing, the opposing moves of gold and oil. Last week was only the third time since at least the early 1980’s that gold prices rallied at least 5.2% while oil fell at least 8.7%, an odd outcome. The other two times? Right before the Tech Bubble burst and right before the Global Financial Crisis. Granted this is not a long track record, but boy, it’s an interesting outcome!

The point is, signs that economic growth is slowing in the US are increasing. One thing of which we can be sure is that while slowing growth elsewhere may not lead to a US recession, a US recession will absolutely lead to much slower growth everywhere else in the world. Remember, the IMF just this week reduced their GDP growth forecasts yet again for 2019, and their key concern, the deteriorating trade situation between the US and the rest of the world, is showing no signs of dissipating.

Into this mix steps Mario Draghi as the ECB meets today in Vilnius, Lithuania (part of their annual roadshow). At this point, it is clear the ECB will define the terms of the new TLTRO’s with most analysts’ views looking for very generous terms (borrowing at -0.4%) although the ECB has tried to insist that these will only last two years rather than the four years of the last program. There is also talk of the ECB investigating further rate cuts, with perhaps a tiered structure on which reserves will be subject to the new, lower rate. And there is even one bank analyst forecasting that the ECB will restart QE come January 2020. Futures markets are pricing in a rate cut by Q1 2020, which is certainly not the direction the ECB intended when they changed their forward guidance to ‘rates will remain where they are through at least the end of the year.’ At that time, they were thinking of rate hikes, but that seems highly unlikely now.

With all of this in mind, let us now consider how this might impact the FX market. As I consistently point out, FX is a relative game. This means that expectations for both currencies matter, not just for one. So, the idea that the Fed has turned dovish, ceteris paribus, would certainly imply the dollar has room to fall. But ceteris is never paribus in this world, and as we are likely to hear later today at Draghi’s press conference, the ECB is going to be seen as far more dovish than just recently supposed. (What if the TLTRO’s are for three years instead of two? That would be seen as quite dovish I think.) The point is that while the signs of a weaker US economy continue to grow, those same signs point to weakness elsewhere. In the end, while the dollar may still soften further, as expectations about the Fed race ahead of those about the ECB or elsewhere, that is a short-term result. As I wrote earlier this week, 2% or so further weakness seems quite viable, but not much more than that before it is clear the rest of the world is in the same boat and policy eases everywhere.

FX market activity overnight has shown the dollar to be under modest pressure, with the euro up 0.3% while the pound and most of the rest of the G10 are up lesser amounts (0.1%-0.2%). However, many EMG currencies remain under pressure with MXN -0.75% after Fitch downgraded its credit rating to BBB-, the lowest investment grade, and weakness in ZAR and TRY helping to support the broad dollar indices. But in the big picture, the dollar remains in a trading range as we will need to see real policy changes before there is significant movement.

Turning to this morning’s data, aside from the Draghi presser at 8:30, we also see Initial Claims (exp 215K), the Trade Balance (-$50.7B), Nonfarm Productivity (3.5%) and Unit Labor Costs (-0.8%). But the reality is that, especially after yesterday’s ADP number, all eyes will be on tomorrow’s NFP print. In the event that ADP was prescient, and we see a terrible number, watch for a huge bond market rally and a weaker dollar. But if it is more benign, around the 185K expected, then I don’t see any reason for markets to change their recent tune. Expectations of future Fed rate cuts as ‘insurance’ will help keep the dollar on its back foot while supporting equities round the world.

Good luck
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Retreated

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Rate cuts “may be warranted soon”
Said James yesterday afternoon
The bond market soared
Though stocks ‘cross the board
Retreated the third day of June

Will someone please explain to me how the Fed expects to be preemptive on economic movements by looking in the rearview mirror? Given that data is almost always backwards looking, (only the ISM surveys really try to look ahead) it seems it would be a far better process to simply explain the reaction function will follow the economy. It is abundantly clear that they have completely lost the ability to lead the economy. So now, following a spate of softer data leading to comments from St Louis Fed President James Bullard about cutting rates soon, Treasury yields have plumbed new depths for the move, touching as low as 2.07% on Monday, and although they have rebounded slightly this morning, there is no indication this movement is going to stop. Weaker ISM data, slower housing growth and ongoing trade uncertainty have certainly stacked the deck against the Fed standing pat. Chairman Powell speaks this morning and markets will be anxiously awaiting his wisdom on the subject. (Spoiler alert, his only choice will be to sound dovish as any hawkish tone will immediately reflect in an equity sell-off.)

Similarly, we continue to see German bund yields pressing to new lows, -0.21% this morning, and the pressure on the ECB to respond is growing stronger. Just this weekend there was a story in Bloomberg describing Eurozone inflation as starting to trend higher. Alas, this morning’s data printed weaker than expected with headline CPI at 1.2% and core at 0.8%. While the euro has barely reacted, interest rate markets are starting to price in even more easing by the ECB and analyst’s comments are moving towards the need for Signor Draghi to do something to show that the ECB is in control. The problem for Draghi is he only has a few more months in the seat and all eyes are looking toward his potential replacement. While there is no strong consensus pick, the view is developing that whoever takes the role will be more hawkish than Draghi, by default. At least initially. However, if Eurozone growth continues to falter and inflation remains around 1.0%, instead of nearer its target of “close to but below 2.0%”, that hawkishness is likely to fade. And one last thing, Eurozone inflation expectations, as measured by five year forward five-year swaps have fallen to near record lows of 1.28%. In other words, nobody thinks inflation is making a comeback soon.

Adding to the interest rate gloom was Australia, last night, cutting its base rate to 1.25%, as widely expected. RBA Governor Lowe made it clear that given the slowing picture in China and the overall slowdown in global growth, the door is open for further rate cuts there. Markets are pricing in at least two more by the end of the year.

How about Switzerland? The nation with the world’s lowest interest rates, the cash rate is -0.75%, is being forecast to cut them further. Given the haven status of the Swiss franc and its recent appreciation vs. the euro, analysts are now looking for another rate cut there. So is the futures market, with a 50% probability of a 25bp cut priced in for March 2020., and SNB President Thomas Jordan has done nothing to dissuade these ideas. If anything, I would expect a cut before the end of the year.

My point is that despite the recent turn in US markets regarding interest rates, where virtually every analyst has come around to the idea that the next move in rates will be lower, and clearly there are Fed members in that camp, none of this happens in isolation. As the above discussion highlights, more dovish policy is quickly becoming the baseline forecast for virtually every country that matters.

So, what does that do for the dollar? Yesterday’s price action showed the dollar’s worst performance since mid-March, when Chairman Powell surprised the market with an uber-dovish policy statement and press conference. Bullard’s comments were enough to turn views toward a rate cut happening much sooner than previously anticipated. And so, if the Fed has truly turned around their thought process, then it will be no surprise for the dollar to have a weak period. Of course, this will only last until we hear Draghi talk about the room for further easing and the need to maintain price stability near the ECB’s target. Once it is clear that the ECB is also going to ease further, the dollar will likely find a bottom. Remember, the ECB meets tomorrow and Thursday, with Draghi’s press conference at 8:30 Thursday morning. Given the recent data, and the overall trade situation, it is not impossible that the ECB turns far more dovish this week. However, my sense is they will focus on the terms of the new TLTRO’s and not on restarting QE. So, the dollar probably has a few weeks of underperformance ahead of it, but it is only a matter of time before the ECB (and correspondingly the BOJ, BOE and BOC) jump on the dovish bandwagon.

As an aside, I keep reading that the only way for the Fed to create a dovish surprise later this month is to cut immediately (the market is pricing in a 25bp cut at the July meeting) but I disagree. All they have to do is cut by more than 25bps when they cut. There is no rule that says 25bps is the proper amount to move rates. If the consensus view is turning to a sharper slowdown, it would be better to get ahead of the problem than to be seen as offering policy prescriptions that are ‘too little, too late.’ It appears to me that President Trump will get his way regarding the Fed, with easier money to come sooner rather than later. Alas, I fear that the stock market may not respond in the manner desired. At this point, cutting rates speaks to panic at the Fed that things are much worse than they have been describing. If that is the perception, equity markets have only one way to go…down.

On the data front, yesterday saw the weakest ISM print since October 2016, which is completely in line with what we are seeing around the world, slowing manufacturing growth. This morning, the only hard data is Factory Orders (exp -0.9%) but both Powell and NY Fed President Williams speak. The default expectation for them both is turning more dovish, and if they live up to that billing, the dollar is likely to continue its recent decline. But, if somehow they sound hawkish, look for the dollar to reverse higher quickly. Remember, FX is still a relative game and its recent weakness is predicated on a more dovish Fed. Changing that changes the market’s perception.

Good luck
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Stopped at the Border

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On Friday the President tweeted
Unless immigration, unneeded,
Is stopped at the border
I will give the order
To raise tariffs til it’s defeated

Friday’s big market news was President Trump’s threat of new tariffs, this time on Mexico, if they don’t address the illegal immigration issue domestically. This is a novel approach to a non-economic problem, but given the President’s embrace of the tariff process, perhaps it is not that surprising. The impact across markets, however, was substantial, with equities suffering while haven assets, notably Treasuries and Bunds, both rallied sharply. In fact, those moves have continued through the overnight session and we now see the 10-year US Treasury yielding just 2.10%, its lowest since September 2017, while 10-year Bunds are yielding a record low -0.21%! In other words, fear is rife that the future is going to be less amenable to investors than the recent past.

Meanwhile, equity markets have also suffered with Friday’s global sell-off continuing this morning in Europe after a mostly negative day in Asia. As to the dollar, it has been a bit more mixed, falling sharply against the yen (JPY +1.1% Friday, flat today), rising sharply against emerging market currencies (MXN -2.5% Friday, -0.3% today), but actually sliding slightly vs. its other G10 counterparts.

It is instructive to consider why the dollar is not maintaining its full status as a haven. Ultimately, the reason is that expectations for aggressive rate cuts by the Fed are becoming the default market expectation. This compares to a much less aggressive adjustment by other central banks, and so the relative forecasts point to a narrowing interest rate differential. Consider that the futures market has now priced in three rate cuts by Q1 2020 in Fed funds. Six months ago, they were pricing in three rate hikes! That is a huge sentiment change, and yet the dollar is actually stronger today than it was at the beginning of the year by about 2%. The point is that while recent economic estimates in the US continue to be downgraded, estimates for the rest of the world are being downgraded equally. In fact, there is substantially greater concern that China’s GDP growth could slow far more than that of the US adding to knock-on effects elsewhere in the world.

One of the things I have consistently maintained is that a slowdown in the US will not happen in isolation, and if the US is slowing, so will be the rest of the world. This means there is virtually no probability that the Fed will cut rates without essentially every other country easing policy as well, and that all important (at least for FX traders) interest rate differential is not likely to shrink nearly as much as reflected by simply looking at the Fed’s activities. A perfect example is Australia, where tomorrow’s RBA meeting is expected to see a 25bp rate cut, with the market pricing between two and three more during the next several quarters. Aussie has been suffering lately and is likely to continue to do so going forward, especially as pressure remains on China’s economy.

The Fed’s done a year-long review
Of policies they might turn to
They’re hoping to find
A new frame of mind
In order to reach a breakthrough

The other story about which you will hear a great deal this week is the gathering at the Chicago Fed of the FOMC and academics as they try to find a better way to effect policy. The positive aspect of this process is that they recognize they are not really doing a very good job. The negative aspect is that they continue to believe inflation remains too low and are extremely frustrated by their impotence to change the situation. We have already heard a number of the ideas; ranging from choosing a higher inflation target to allowing inflation to run hot (if it ever gets there based on their measurements). Alas, there seems little chance that the fundamental issue, the fact that their models are no longer reasonable representations of the real world, will be addressed. To a (wo)man, they all continue to strongly believe in a Keynesian world where more stimulus equals more economic activity. I would contend that, not dissimilar to the differences between Newtonian physics and particle physics, interest rates at the zero bound (and below) no longer have the same impact as they do at higher levels. And it is this failure by all central bankers to recognize the non-linearity of results which will prevent a viable solution from being found until a crisis materializes. And even then I’m not optimistic.

Turning to this weeks’ data dump, there is a ton of stuff coming, culminating in Friday’s NFP report:

Today ISM Manufacturing 53.0
  ISM Prices Paid 52.0
  Construction Spending 0.4%
Tuesday Factory Orders -0.9%
Wednesday ADP Employment 185K
  ISM Non-Manufacturing 55.5
  Fed’s Beige Book  
Thursday Initial Claims 215K
  Trade Balance -$50.7B
  Nonfarm Productivity 3.5%
  Unit Labor Costs -0.8%
Friday Nonfarm Payrolls 183K
  Private Payrolls 175K
  Manufacturing Payrolls 4k
  Unemployment Rate 3.6%
  Average Hourly Earnings 0.3% (3.2% Y/Y)
  Average Weekly Hours 34.5

There are also eleven Fed speakers including Chairman Powell on Tuesday morning as well as the aforementioned Fed conclave regarding new policy tools. In other words, there is plenty available to move markets this week. And that doesn’t even take into consideration the ongoing trade situation, where fears are extremely high, but both China and Mexico have said they want to sit down and discuss things again.

At this point, given how much new information will be added to the mix, it is impossible to say how markets will perform. However, with that in mind, we will need to see some extraordinarily weak US data to change the idea that the US is still the ‘cleanest dirty shirt in the laundry’, to use a terrible metaphor. As well, do not be surprised to see Mexico, at least, agree to implement new policies to address the immigration issue and reduce pressure on the peso. In the end, I continue to look for the dollar to maintain its overall strength, but a modest drift lower against G10 counterparts is well within reason.

Good luck
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Here To Stay

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Fed speakers are starting to say
That lower rates are here to stay
It’s not about trade
Instead they’re dismayed
Inflation just won’t go their way

Since the FOMC meeting two weeks ago, we have heard a steady stream of Fed speakers with one main theme, current interest rate policy is appropriate for the economy right now. While the market continues to price in another rate cut for later this year, and economists and analysts are starting to lean in that direction as well, the Fed remains resolute in their conviction that they don’t need to do anything. When asked about the trade situation, they mouth platitudes about how free trade helps everyone. When asked about political pressures, they insist they are immune to any such thing. These responses cannot be any surprise and are what every FOMC member would have said any time during the past century. However, there is one theme that is starting to coalesce that is different; the idea that interest rates are going to be permanently lower in the future than they have been in the past.

NY Fed President John Williams has highlighted the fact that recent research indicates r* (the theoretical neutral rate of interest) for the five main economies (US, UK, Japan, Eurozone and Canada) has fallen to just 0.5% from something more like 2.5% prior to the financial crisis. The implication is that there is no reason for interest rates to rise much further, if at all, from current levels as that would result in tightening monetary policy with a corresponding slowing of economic activity. If this is correct, it bodes ill for central banks abilities to help moderate future economic downturns. After all, if rates are near zero when an economy slows down, interest rate cuts are unlikely to have a material impact on the situation. Of course, this is what led to unconventional policies like QE and forward guidance, and we can only assume that every central bank is trying to think up new unconventional policies as those lose their efficacy. Do not be surprised if legislation appears that allows the Fed to purchase any assets it deems appropriate (stocks, real estate, etc.) in its efforts to address the next downturn. This is also why MMT has gained favor in so many places (although not the Fed) as it removes virtually all restrictions on spending and fiscal policy and reduces the role of monetary policy.

One other thing that seems incongruous is the precision with which the Fed believes is should be able to manage inflation. Inflation is a broad reading of price pressures over millions of items ranging from houses to pencils. Its measurement remains controversial and imperfect, at best. Pricing decisions continue to be made by the sellers of products, not by government fiat, and so the idea that the Fed can use a blunt tool like the general level of interest rates, to fine-tune price changes is, on the face of it, absurd. Is there really a difference between 1.6% and 2.0% inflation? I understand the implications regarding compounding, and of course the biggest issue is that cost of living adjustments in programs like Social Security and Medicare have enormous fiscal consequences and are entirely dependent on these measurements. But really, precision is a mistake in this case. It would be far more sensible, and achievable, for the Fed to target an inflation range like 1.5%-2.5% and be happy to focus on that rather than aiming for a target and miss it consistently in the seven years since it was defined.

Now back to markets. While Asian equity markets continued the US sell-off, it seems that the course has been run for now elsewhere. European shares are higher by between 0.5% and 1.0% this morning, while US futures are pointing to a 0.75% or so rebound at the open. At this point, all the tariff news seems to be in the market, and there continues to be a strong belief that a deal will get done, most likely in June when President’s Xi and Trump meet on the sidelines of the G20 meetings in Japan. The dollar continues to hold its own, although it has not been able to make any general headway higher lately.

In the currency market, this morning shows that risk is being tentatively reacquired as the yen falls (-0.35%) while EMG currencies edge higher (MXN +0.25%, INR +0.3%). The G10 beyond the yen is little changed, although most of those currencies suffered during yesterday’s equity rout. One thing that appears to be ongoing lately is that central banks have been slowly reducing the dollar portion of their holdings, taking advantage of the dollar’s recent strength to diversify their portfolios. That would certainly be a valid explanation for the dollar’s inability to make any substantive gains lately.

On the data front, overnight saw a disappointing German ZEW Index reading of -2.1 (exp +5.0), which implies that the hoped for rebound in Germany may still be a bit further away than the ECB is counting on. At the same time, UK labor markets continue to show robust strength with another 99K jobs created and average earnings continuing to grow at a solid 3.3% pace. However, neither of these data points had any impact on the FX market. In the US, the NFIB Business Index rose to 103.5, slightly better than forecast and demonstrating a resiliency in the small business psyche in this country. However, we don’t see any further data here today, and so if pressed, I would expect the FX market to be uninspiring. If equity markets manage to maintain their rebound, then I would expect a modicum of dollar weakness as investors rush back into the EMG bloc, but I think it far more likely that there is little movement overall.

Good luck
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