Tag Archives: #Fed

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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10%’s Not Enough

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Said Trump, 10%’s not enough
It’s time that we really get tough
So starting next week
A quarter we’ll seek
Believe me, this ain’t just a bluff

If there was any question as to whether or not markets had fully priced in a successful conclusion of the US-China trade talks, last night’s price action should have answered it in full. President Trump is clearly feeling his oats, as his approval rating rises alongside the stock market and the economy, and so he changed the landscape once again. With Chinese Vice-premier Liu He, the chief negotiator in the trade talks, scheduled to arrive in the US later this week to continue, and in the market’s view conclude, those discussions, the President, last night, threatened to increase tariffs on $200 billion of goods to 25% from the current 10%, and to impose 25% tariffs on another $325 billion of goods, which is essentially everything else the US imports from China. In a heartbeat, views changed from rainbows and unicorns to Armageddon. Equity markets around the world plunged, commodity prices tumbled and the dollar and yen both rallied. Interestingly, Treasury prices have not moved much yet, although with the UK and Japan on holiday, overseas Treasury markets are extremely thin, so it could be there just hasn’t been any trading. Of course, it also could be that Treasury prices had already incorporated a less rosy future than equity markets, and so have less need to adjust.

One of the most common themes espoused lately has been the remarkable decline in asset price volatility this year, with measures in equities, bonds and currencies all pushing to cyclical lows. While there is a contingent of analysts (present company included) who believes that this is the calm before the storm, it is also true that market activity has been unidirectional since January, with that direction higher.

With respect to volatility, nothing has yet changed regarding the view that volatility increases when prices fall in both equity and bond markets although the relationship between volatility and the dollar is far less structured. In fact, there has been a significant increase in the amount of short volatility bets being made in the market, similar to the situation we saw at the beginning of 2018. Of course, I’m sure we all remember the disintegration of the XIV ETF (really it was an ETN), when a spike in volatility reduced its value by more than 85% in two days. Well, currently, records show that there is an even larger short volatility position now than there was last February when things went pear-shaped. The point is it is worthwhile to be careful in the current environment.

As to the dollar, historically volatility has increased in both rising and declining dollar environments depending on the circumstances. Given the dollar’s overall strength lately has been accompanies by a decline in volatility, it seems a fair bet to assume that if the dollar were to reverse lower, it would do so in a volatile manner rather than as a steady adjustment. Remember, too, currencies tend to overshoot when large moves occur. However, at this point, I would expect that fear in other markets will continue to support the dollar, and hence keep volatility at bay.

A recap of price movement overnight shows that the Shanghai Composite fell 5.5% and the Hang Seng fell 2.9% (the Nikkei was closed). Europe is currently trading with both the DAX and CAC falling 2.0% (FTSE is also closed) and US futures are pointing to nearly 2.0% losses on the open as well.

Meanwhile, the dollar is broadly higher. It has rallied 0.5% vs. the pound, offsetting a large part of Friday’s GBP rally that was based on the rumor PM May and Labour leader Corbyn were soon going to announce agreement on a Brexit deal. While nothing has come of it yet, that does explain the pound’s sharp Friday movement. AUD and NZD are both lower by 0.5% as the market looks to this evening’s RBA meeting with a 50% probability of a rate cut priced and the belief that the RBNZ will need to match that tomorrow if it occurs. Aussie is back below 0.70, and my sense is it has further to fall, especially if the trade situation deteriorates. Elsewhere in the G10, the euro is little changed after slightly better than expected PMI data seems to have been enough to offset trade concerns. And finally, the yen, as would be expected of a haven asset, is higher by 0.25%.

Versus emerging market currencies, the dollar has had an even stronger performance. It should be no surprise that CNY has fallen sharply (-0.75%) especially since the PBOC cut the RRR for small and medium sized banks by another 1.0% in an effort to stabilize markets. Elsewhere in Asia both INR and KRW fell 0.65% with other currencies having a slightly less negative result. EEMEA has seen ZAR fall 1.0% and TRY -1.20% although the latter has more to do with the possibility that the recent election in Istanbul, where President Erdogan’s party lost, would be overturned and a new one held thus undermining the concept of democracy in Turkey even further. Finally, LATAM markets are waking up under modest pressure, but have not yet fallen sharply.

Turning to this week’s data, there is not much overall, but we do see CPI data Friday.

Tuesday JOLTs Job Openings 7.24M
Thursday Initial Claims 220K
  Trade Balance -$50.2B
  PPI 0.2% (2.3% Y/Y)
  -ex food & energy 0.2% (2.5% Y/Y)
Friday CPI 0.4% (2.1% Y/Y)
  -ex food & energy 0.2% (2.1% Y/Y)

We also will hear a lot of Fed speaking, with eleven speeches from eight different FOMC members including Chairman Powell on Thursday. This week’s talks could well be market moving as last week’s press conference was not as smooth as it might have been. Look for lots of nuance as to what the Fed is looking at and why they think it is appropriate to be patient. As of now, it doesn’t seem that there is any leaning toward an “insurance” rate cut in the near term, but, especially if Friday’s CPI data is softer than expected, that theme could well change. As such, for now, I don’t see a good policy reason for the dollar to retreat, and if the trade situation deteriorates, it should help the buck, but given the mercurial dynamics of the President’s negotiating tactics, I wouldn’t rule out a complete reversal of things before long.

Good luck
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Rather Wrong

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While Powell said growth may be strong
He still thinks it seems rather wrong
That prices won’t rise
So it’s no surprise
That rates will go lower ‘ere long

After the FOMC left policy largely unchanged yesterday (they did tweak the IOER down by 5bps) and the statement was parsed, it appeared that the Fed’s clear dovish bias continues to drive the overall tone of policy. Growth is solid but inflation remains confusingly soft and it appeared that the Fed was moving closer to the ‘insurance’ rate cut markets have been looking hoping for to prevent weakness from showing up. Stocks rallied and so did bonds with the yield on the 10yr falling to 2.45% just before the press conference while stock markets were higher by 0.5% or so. But then…

According to Powell the story
Is price declines are transitory
So patience remains
The thought in Fed brains
With traders stuck in purgatory

Powell indicated that the majority view at the Fed was that the reason we have seen such weak price data lately is because of transitory issues. These include reduced investment management fees in the wake of the sharp equity market declines in Q4 of last year and the change in the way the Fed gathered price data at retail stores where they now collect significantly greater amounts of data digitally, rather than having ‘shoppers’ go to stores and look at price tags. The upshot is that while he was hardly hawkish in any sense of the word, trying to maintain as neutral a stance as possible, he was far more hawkish than the market had anticipated. Not surprisingly, markets reversed their earlier moves with 10yr yields shooting higher by 6bps, closing higher than the previous day’s close, while equity markets ceded all their early gains and wound up falling about 0.7% on average between the three major indices.

What about the dollar? Well, it followed the same type of trajectory as other assets, softening on the dovish ideas throughout the session before rallying a sharp 0.55% in the wake of Powell’s press conference opening statement. Since then, it has largely maintained the rebound, although this morning it is softer by about 0.1% across the board.

Looking ahead, markets are going to continue to focus on the interplay between the data releases and the central bank comments. Nothing has changed with regard to the overarching dovish bias evident in almost all central banks, but in order for them to act, rather than merely talk, the data will have to be clearly deteriorating. And lately, the best description of the data releases has been mixed. For example, yesterday saw a huge ADP Employment number, 275K, boding well for tomorrow’s NFP report. However, ISM Manufacturing fell sharply to 52.8, well below last month’s 55.3 reading as well as far below the 55.0 market expectation. So, which one is more important? That’s the thing. As long as we see strength in some areas of the economy along with weakness in others, the Fed is almost certainly going to sit on the sidelines. That is, of course, unless the inflation data starts to move more aggressively in either direction. I think it is far better than even money that Fed funds are 2.25%-2.50% on December 31.

But what about other places? Well, the ECB seems stuck between a rock and a hard place as Q1 data has been disappointing overall and they are running out of tools to fight a slowdown. Given the current rate structure, the question being debated in the halls in Frankfurt is just how low can rates go before having a net detrimental impact on the economy. If we see any further weakness from the Eurozone, we are going to find out. That brings us to this morning’s PMI data, where Bloomberg tried hard to put a positive spin on what remains lousy data. Germany (44.4), Italy (49.1) and France (50.0) remain desultory at best. The Eurozone print (47.2) is hardly the stuff of dreams, although in fairness, it was better than analysts had been expecting. So perhaps we are seeing the beginnings of a stabilization in the decline, rather than a continuing acceleration of such. But that hardly gives a rationale for tighter policy. The ECB remains stuck on hold on the rate front and is certainly going to see significant uptake of their new TLTRO’s when they come out. It remains difficult to see a reason for the euro to rebound given the underlying economic weakness in the Eurozone, especially with the ECB committed to negative rates for at least another year.

What about the UK? Well, the BOE met this morning and left rates on hold by a unanimous vote. They also released new economic forecasts that showed reduced expectations for inflation this year, down to 1.6%, with the out years remaining essentially unchanged. They indicated that the delay in Brexit would have a limited impact as they continue to plan on a smooth transition, and their growth forecasts changed with 2019 rising to 1.5% on the back of the inventory led gains in Q1, although the out years remain unchanged. Here, too, there is no urgency to raise rates, although they keep trying to imply that slightly higher rates would be appropriate. However, the market is having none of it, pricing a 30% chance of a 25bp rate cut before the end of next year. The pound chopped on the news, rallying at first, but falling subsequently and is now sitting at 1.3050, essentially unchanged on the day.

Of course, Brexit continues to influence the pound’s movements and recent hints from both PM May and Labour Leader Corbyn indicate that it is possible they are going to agree a deal that includes permanent membership of a customs union with the EU. Certainly, verification of that will help the pound rally back. But boy, if I voted for Brexit and this is what they delivered, it would be quite upsetting. In essence, it destroys one of the main benefits of Brexit, the ability to manage their own trade function. We shall see how it plays out.

This morning brings more data, starting with Initial Claims (exp 215K), Nonfarm Productivity (2.2%) and Unit Labor Costs (1.5%) at 8:30, then Factory Orders (1.5%) at 10:00. The onslaught of Fed speakers doesn’t start until tomorrow, so that’s really it for the day. Equity futures are rallying this morning as the idea that the markets fell yesterday seems more like a mirage than a market response to new information. In the end, you cannot fight city hall, and though Powell tried to sound tough, I didn’t see anything to change the view that the Fed remains biased toward cutting rates as their next move.

Good luck
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Biding Their Time

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While markets in Europe are closed
For May Day, the Fed is disposed
To biding their time
Til prices do climb
Or else til slow growth is exposed

As Fed day dawns in NY, market activity has been muted around the world for two reasons. First, it happens to be May Day, an official holiday in 66 nations around the world, including most of Europe, honoring labor solidarity. While May Day was initially a pagan rite of spring (the origin of the Maypole) it was coopted in the mid 1800’s by the International Labor movement as a day to recognize its demands for better working conditions, including the beginning of the eight-hour workday norm. To this day, it remains a labor holiday, with large marches overnight throughout Korea, Indonesia, Taiwan and other Asian nations as well as in Europe, where the French, specifically, are concerned given the recent history of violent protests by the gilets jaunes.

But of more interest is the other reason market activity has been muted, the FOMC meeting ends this afternoon and the market will hear the latest words of wisdom from Chairman Powell at 2:30pm.

There are currently no expectations that Fed policy is going to change at this meeting, at least not by the Wall Street analyst community. Instead, all eyes are on the tone of the statement as well as Powell’s responses to the Q&A at his press conference.

Ever since the Fed’s pivot to patience in January, financial conditions in the US (and worldwide) have eased considerably. After all, government bond yields have tumbled (Treasuries -25bps, Bunds -25 bps, JGB’s -7bps) while equity markets have soared (S&P +21%, DAX +18%, Nikkei +16%). This combination has reduced corporate bond yields in both the investment and non-investment grade sectors, thus freeing up further cash flow and helping to prime the economy’s collective pump. At the same time, as evidenced by Monday’s data, PCE inflation, the number the Fed uses in their models, has fallen back well below their 2.0% symmetrical target, printing at 1.5% in March. The problem for the Fed is that their go to move of preemptive rate hikes when growth starts to pick up has been increasingly called into question. And not just by President Trump, who laughably suggested a 1.0% rate cut for today, but by economists of all stripes who are still at a loss as to why their cherished econometric models no longer represent economic reality.

‘Patience’ seems to be the Fed’s way of explaining that since they don’t have a clue as to what to expect from the economic data going forward, they have decided to sit on their hands. Arguably, that is a pretty good move, although I’m sure they are not keen to admit they are clueless right now. But in the end, it has become clear that throughout the central bank community, the idea of raising interest rates simply because growth numbers improved, if there is no concurrent rise in inflation has become discredited. As long as inflation remains quiescent, at least on a measured basis, the pressure to maintain or cut rates will be enormous. And while every central banker will explain they are apolitical, there is no question that they respond to political pressure like everyone else in government.

So the real question is at what point will central banks start easing further if inflation continues to stagnate? Ironically, I would argue that central banks have painted themselves into a different corner lately, continuously making the claim that 2.0% inflation, or thereabouts depending on the country, is necessary to insure a healthy economy. But if growth is solid and inflation is falling, are they going to cut rates further, to the extent possible given current levels, in order to revive inflation at the risk of blowing asset bubbles? And that doesn’t even consider the issue for Japan, Sweden, Switzerland and the Eurozone, where interest rates are already negative, and how those central banks will respond if either growth or inflation weakens more aggressively. The point is, despite all its warts, it continues to be clear that the US economy remains the most attractive place to invest capital. And with that, the dollar will continue to be supported.

Recapping the most recent data shows that yesterday’s Chicago PMI was quite disappointing at 52.6, well below expectations and the lowest print in more than two years. A harbinger of the future or an outlier? We will find out more this morning when the national ISM number is released (exp 55.0). The other data point of note in the US yesterday was Case-Shiller Home prices, which rose only 3.0%, reinforcing the idea that the housing market continues to cool. Meanwhile, Canadian GDP for February printed at -0.1%, with forecasts for Q1 now falling down to stagnation north of the border. So even though the housing market in the US is under modest pressure, the broad economy here continues to outperform just about everywhere else in the world.

This morning we also see ADP Employment (exp 180K) and then the Fed speaks. Overall, the dollar has been under modest pressure for the past several sessions, but all told, the movement has barely been a 1% decline. And while choppy, the trend remains in the dollar’s favor at this point. I have yet to see an argument that supports a much weaker dollar, at least on a cyclical basis, and as such, see no reason to change my views of further dollar strength ahead.

Good luck
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Mere Nonchalance

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On Friday we learned the US
Grew faster, but not to excess
The market response
Was mere nonchalance
In stocks, but the buck did depress

This morning in Europe, however,
The outcome did not seem as clever
Growth there keeps on slowing
Thus Mario’s going
To need a new funding endeavor

If you needed a better understanding of why the dollar, despite having declined ever so modestly this morning, remains the strongest currency around, the contrasting data outcomes from Friday in the US and this morning in the Eurozone are a perfect depiction. Friday saw US GDP in Q1 rise 3.2% SAAR, significantly higher than expected, as both trade and inventory builds more than offset softer consumption. Whatever you make of the underlying pieces of the number, it remains a shining beacon relative to the rest of the G10. Proof positive of that difference was this morning’s Eurozone sentiment data, where Business Confidence fell to 0.42, its weakest showing in nearly three years while Economic Sentiment fell to 104, its sixteenth consecutive decline and weakest since September 2016.

It is extremely difficult to look at the Eurozone data and conclude that the ECB is not going to open the taps again soon. In fact, while the official line remains that no decisions have been made regarding the terms of the new TLTRO’s that are to be offered starting in June, it is increasingly clear that those terms are going to be very close to the original terms, where banks got paid to borrow money from the ECB and on-lend it to clients. The latest comment came from Finnish central bank chief Ollie Rehn where he admitted that hopes for a rebound in H2 of this year are fading fast.

With that as the backdrop, this week is setting up for the chance for some fireworks as we receive a great deal of new information on both the economic and policy fronts. In fact, let’s take a look at all the information upcoming this week right now:

Today Personal Income 0.4%
  Personal Spending 0.7%
  PCE 0.2% (1.6% Y/Y)
  Core PCE 0.1% (1.7% Y/Y)
Tuesday Employment Cost Index 0.7%
  Case-Shiller Home Prices 3.2%
  Chicago PMI 59.0
Wednesday ADP Employment 181K
  ISM Manufacturing 55.0
  ISM Prices Paid 55.4
  Construction Spending 0.2%
  FOMC Rate Decision 2.5% (unchanged)
Thursday BOE Rate Decision 0.75% (unchanged)
  Initial Claims 215K
  Unit Labor Costs 1.4%
  Nonfarm Productivity 1.2%
  Factory Orders 1.5%
Friday Nonfarm Payrolls 181K
  Private Payrolls 173K
  Manufacturing Payrolls 10K
  Unemployment Rate 3.8%
  Participation Rate 62.9%
  Average Hourly Earnings 0.3% (3.4% Y/Y)
  Average Weekly Hours 34.5
  ISM Non-Manufacturing 57.0

So, by Friday we will have heard from both the Fed and the BOE, gotten new readings on manufacturing and prices, and updated the employment situation. In addition, on Friday, we have four Fed speakers (Evans, Clarida, Williams and Bullard) as the quiet period will have ended.

Looking at this morning’s data, the PCE numbers continue to print below the Fed’s 2.0% target and despite recently rising oil prices, there is no evidence that is going to change. With the employment situation continuing its robust performance, the Fed is entirely focused on this data. As I wrote on Friday, it has become increasingly clear that the Fed’s reaction function has evolved into ‘don’t even consider raising rates until inflation is evident in the data for a number of months.’ There will be no more pre-emptive rate hikes by Jay Powell. Inflation will need to be ripping higher before they consider it. And in fact, as things progress, it is entirely possible that the Fed does cut rates despite ongoing solid GDP growth, if they feel inflation is turning lower in a more protracted manner. As of Friday, the futures market had forecast a 41% probability of a Fed rate cut by the end of 2019. In truth, I am coming around to the belief that we could see more than one cut before the year ends, especially if we see any notable slowing in the US economy. (At this point, the Fed’s only opportunity to surprise the market dovishly is if they do cut rates on Wednesday, (although in the wake of the GDP data, that seems a little aggressive.)

The real question is if the Fed turns more dovish, will that be a dollar negative. One thing for certain is that it won’t be an equity negative, and it is unlikely to have a negative impact on Treasuries either, but by rights, the dollar should probably suffer. After all, a more dovish Fed will offset the dovishness emanating from other nations.

The problem with this thesis is that it remains extremely expensive for speculators to short the dollar given the still significantly higher short-term rates in the US vs. anywhere else in the G10. And so, we are going to need to see real flows exiting the US to push the dollar lower. Either that, or a change in the narrative that the Fed, rather than being on hold, is getting set to take rates back toward zero. For now, neither of those seem very likely, and so significant dollar weakness seems off the table for the moment. As such, while it was no surprise that the dollar fell a bit on Friday as profit taking was evident after a strong run higher, the trend remains in the dollar’s favor, so hedgers need to take that into account. And for all you hedgers, given the significant reduction in volatility that we have witnessed during the past several months, options are an increasingly attractive alternative for hedging. Food for thought.

Good luck
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Worries ‘Bout Debt

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In DC this weekend they met
The World Bank and IMF set
They bitched about Trump
Explained there’s no slump
But did express worries ‘bout debt

Markets are on the quiet side this morning as they consolidate the gains seen on Friday. Risk continues to be in vogue and so haven currencies; dollars, Swiss francs and Japanese yen, remain under modest pressure. That said, the FX market remains broadly range bound, at least within the G10 space.

The annual World Bank / IMF meetings were held this past weekend in Washington D.C. and all the global economic glitterati were present. Arguably there were three key themes; central bank independence is paramount to successful policy and there is great concern over President Trump’s ongoing, and increasingly strident, complaints about the Fed. Secondly there continues to be broad concern over the slowing growth trajectory that was highlighted by the IMF reducing their global growth forecast yet again last week, this time down to 3.3% in 2019 from their 3.7% estimate last October. Finally, there was evidence that the massive growth in debt around the world is starting to make a few policymakers more nervous.

Of course, the question is will policymakers actually change anything that they do given their concerns? As to the first, the only hope they have is to raise the issue frequently enough so that it gains a broad consensus amongst the non-economic set. Frankly, if you asked the proverbial man on the street who was Fed Chair, or the names of any of the other governors, I would wager less than one in ten people would know any of the answers. At the same time, with the President’s constant haranguing, the Fed remains an excellent scapegoat for any weakness in the US economy going forward. As much as it galls the establishment, there is no reason to believe that this behavior is going to change throughout the rest of the Trump presidency and probably well beyond that.

Regarding the second issue, slowing growth, once again given the current stance of virtually the entire global economic central bank community, it is unclear they have any ability to do anything else. After all, the whole group is already set at ultra-easy money, with limited ability to move any further. But perhaps more importantly, it is questionable whether the central banks are the actual drivers of economic growth, as much as they would like to think they are. Arguably, economic growth comes from a combination of consumer demand and production of those goods and services demanded. The last time I checked, the Fed neither consumed very much nor produced anything (other than hot air and paperwork). All I’m saying is that the ongoing belief that central banks control the economy might be faulty. What they do control is money and financial assets, but as we have seen during the past decade, a strong rally in financial assets does not necessarily translate into strong growth.

Finally, regarding the massive increase in debt that we have seen during the past decade, they are absolutely right to be concerned about this process. As Rogoff and Reinhart explained in their classic book, This Time is Different, excessive debt is the one thing that has consistently been shown to have a negative effect on economic growth. And while the definition of excessive may be uncertain, it is abundantly clear that debt/GDP ratios >100% is excessive.

Add it all up and it seems unlikely that there is going to be a surge in economic growth in the near future, or even the medium term. Thus, when comparing the situations across the globe, the current status is likely to remain the future status.

Turning to the upcoming week, we have a fair amount of data as well as another group of Fed speakers.

Today Empire Manufacturing 6.7
Tuesday IP 0.2%
  Capacity Utilization 79.1%
Wednesday Trade Balance -$53.5B
  Fed Beige Book  
Thursday Initial Claims 205K
  Philly Fed 10.4
  Retail Sales 0.9%
  -ex autos 0.7%
  Business Inventories 0.4%
Friday Housing Starts 1.23M
  Building Permits 1.30M

In addition to this, we hear from five more Fed speakers, although none of them are the big guns like Powell or Williams. And as I have repeatedly described, the Fed story is already well known and unlikely to change unless the data really starts to adjust. Add to this the fact that now Brexit is a back-burner issue and there remains scant information on the US-China trade talks and quite frankly, this week in FX is going to be all about US equity market earnings data. If the data is good and risk is embraced, the dollar will suffer and vice versa.

Good luck
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