Tag Archives: #Fed

Progress Is Real

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

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

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

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

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

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

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

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

Good luck
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Brexit’s Impact

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

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

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

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

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

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

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

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

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

Good luck
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More Frustration

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

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

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

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

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

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

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

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

Good luck
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Hitting Home

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The current Fed Chairman, Jerome
Initially’d taken the tone
That interest rate hiking
Was to the Fed’s liking
Until hikes began hitting home

Then stock markets round the world crashed
And policymakers’ teeth gnashed
He then changed his mind
And now he’s outlined
His new plan where tightening’s trashed

It’s interesting that despite the fact that the employment report was seen as quite positive, the weekend discussion continued to focus on the Fed’s U-turn last Wednesday. And rightly so. Given how important the Fed has been to every part of the market narrative, equities, bonds and the dollar, if they changed their reaction function, which they clearly have, then it will be the focus of most serious commentary for a while.

But let’s deconstruct that employment report for a moment. While there is no doubt that the NFP number was great (304K, nearly twice expectations, although after a sharply reduced December number), something that has gotten a lot less press is the Unemployment Rate, which rose to 4.0%, still quite low but now 0.3% above the bottom seen most recently in November. The question at hand is, is this a new and concerning trend? If the unemployment rate continues to rise, then the Fed was likely right to stop tightening policy. Yet, most analysts, like politicians, want their cake and the ability to eat it as well. If the Fed has finished tightening because growth is slowing, is that really the outcome desired? It seems to me I would rather have faster growth and tighter policy, a much better mix all around. Now it is too early to say that Unemployment has definitely bottomed, but another month or two of rises will certainly force that to creep into the narrative. And you can bet that will include all the reasons that the Fed better start cutting rates again! Remember, too, if the Fed is turning from tightening to easing, I assure you that the idea the ECB might raise rates is absurd.

Now, with the Fed decision behind us, as well as widely applauded, and the payroll report past, what do we have to look forward to? After all, Brexit is still grinding forward to a denouement in late March, although we will certainly hear of more trials and tribulations before then. I was particularly amused by the idea that the British government has developed plans for the Queen to be evacuated in the event of a hard Brexit. WWII wasn’t enough to evacuate royalty, but Brexit will be? Not unlike Y2K (for those of you who remember that) while a hard Brexit will almost certainly be disruptive in the short run, I am highly confident that the UK will continue to function going forward. The fear-mongering that is ongoing by the British government is actually quite irresponsible.

And of course, there are the US-China trade talks. Except that this week is Chinese New Year and all of China (along with much of Asia) is on holiday. So, there are no current discussions ongoing. But markets have taken heart from the view that President’s Xi and Trump will be meeting in a few weeks, and that they will come to an agreement of some sort. The problem I see is that the big issues are not about restrictions as much as about protection of IP and forced technology transfer. And since the Chinese have consistently denied that both of those things occur, it is not clear to me how they can credibly agree to stop them. The market remains sanguine about the prospects for a trade reconciliation, but I fear the probability of a successful outcome is less than currently priced. While this will not dominate the discussion for another two weeks, be careful when it surfaces again.

Looking ahead to this week, while US data is in short supply, really just trade, we do see more central bank meetings led by the BOE (no change expected), Banxico (no change expected) and Banco do Brazil (no change expected). The biggest risk seems to be in Mexico where some analysts are calling for a 25bp rate cut to 8.00%. We also hear from six Fed speakers, including Chairman Powell again, although at this point, it seems the market has heard all it wants. After all, given Friday’s payroll report, it seems impossible to believe that any Fed member can discuss cutting rates. Not raising them is the best they’ve got for now.

Tuesday ISM Non-Manufacturing 57.1
Wednesday Trade Balance -$54.0B
  Unit Labor Costs 1.7%
  Nonfarm Productivity 1.7%
Thursday Initial Claims 220K
  Consumer Credit $17.0B

So, markets are in a holding pattern while they await the next important catalyst. The stories that have driven things lately, the Fed, Brexit and trade talks are all absent this week. That leads to the idea that the dollar will be impacted by equity and bond markets.

We all know that equity markets had a stellar January and the question is, can that continue? With bond markets also rallying, they seem to be telling us different stories. Equities are looking to continued strength in the economy, while bonds see the opposite. I have to admit, based on the data we continue to see around the world, it appears that the bond market may have it right. As such, despite my concerns over the dollar’s future given the Fed’s pivot, a reversal in equities leading to a risk off scenario would likely underpin the dollar. While it is very modestly higher this morning, it is fair to call it little changed. I think the bias will be for a softer dollar unless things turn ugly. If that does happen, make sure your exposures are hedged as the dollar will benefit.

Good luck
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As Patient As Needed

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More rate hikes? The Fed said, ‘no way!’
With growth slowing elsewhere we’ll stay
As patient as needed
Since now we’ve conceded
Our hawkishness led us astray

If you needed proof that central bankers are highly political rather than strictly focused on the economics and financial issues, how about this:

Dateline January 24, 2019. ECB President Mario Draghi characterizes the Eurozone economy as slowing more than expected yet continues to support the idea that interest rates will be rising later this year as policy tightening needs to continue.

Dateline January 30, 2019. Federal Reserve Chairman Jay Powell characterizes the US economy as solid with strong employment yet explains that there is no need to consider raising rates further at this time, and that the ongoing balance sheet reduction program, which had been on “autopilot” is to be reevaluated and could well slow or end sooner than previously expected.

These are certainly confusing actions when compared to the comments attached. Why would Draghi insist that policy tightening is still in the cards if the Eurozone economy is clearly slowing? Ongoing pressure from the monetary hawks of northern Europe, notably Germany’s Bundesbank, continues to force Draghi to hew a more hawkish line than the data might indicate. As to the Fed, it is quite clear that despite the Fed’s description of a strong economy, Powell has succumbed to the pressure to support the equity market, with most of that pressure coming from the President. And yet central bankers consistently try to maintain that they are above politics and cherish their independence. There hasn’t been an independent central banker since Paul Volcker was Fed Chair from 1979-1987.

Nonetheless, this is where we are. The Fed’s dovishness was applauded by the markets with equities rallying briskly in the US (1.5%-2.2% across the indices) and following in Asia (Nikkei and Hang Seng both +1.1%) although Europe has shown less pluck. But Europe has, as described above, a slowing growth problem. This is best characterized by Italy, whose Q4 GDP release this morning (-0.2%) has shown the nation to be back in recession, their third in the past five years! It should be no surprise that Italy’s stock market is lower (-0.6%) nor that it is weighing on all the European indices.

Not surprisingly, government bond yields around the world are largely lower as well. This reaction is in a piece with market behavior in 2017 through the first three quarters of 2018, where both stocks and bonds rallied consistently on the back of monetary policy actions. I guess if easy money is coming back, and as long as there is no sign of inflation, there is no reason not to own them both. Certainly, the idea that 10-year Treasury yields are going to start to break higher seems to be fading into the background. The rally to 3.25% seen last November may well mark a long term high.

And what about the dollar? Well, if this is the new normal, then my views on the dollar are going to need to change as well. Consider this, given that the Fed has tightened more than any other central bank, the dollar has benefitted the most. We saw that last year as the dollar rallied some 7%-8% across the board. But now, the Fed has the most room to ease policy in comparison to every other G10 central bank, and so if the next direction is easy money, the dollar is certain to suffer the most. Certainly, that was the story yesterday afternoon in NY, where the dollar gave up ground across the board after the FOMC statement. Against the euro, the initial move saw the dollar sink 0.75% in minutes. Since then, it has traded back and forth but is little changed on the day, today, with the euro higher by just an additional 0.1%. We saw a similar move in the yen, rallying 0.7% immediately, although it has continued to strengthen and is higher by another 0.35% this morning. Even the pound, which continues to suffer from Brexit anxiety, rallied on the Fed news and has continued higher this morning as well, up another 0.2%. The point is, if the Fed is done tightening, the dollar is likely done rallying for now.

Other stories have not disappeared though, with the Brexit saga ongoing as it appears more and more likely to come down to a game of brinksmanship in late March. The EU is adamant they won’t budge, and the UK insists they must. I have a feeling that nothing is going to change until late March, just ahead of the deadline, as this game of chicken is going to play out until the end.

And what of the trade talks between the US and China? Well, so far there is no word of a breakthrough, and the only hints have been that the two sides remain far apart on some key issues. Do not be surprised to see another round of talks announced before the March 2 tariff deadline, or an agreement to postpone the raising of tariffs at that time as long as talks continue. Meanwhile, Chinese data released overnight showed Manufacturing PMI a better than expected (though still weak) 49.5 while Non-Manufacturing PMI actually rose to 54.7, its best reading since September, although still seeming to trend lower. However, the market there applauded, and the renminbi continues to perform well, maintaining its gains from the last week where it has rallied ~1.5%.

The US data picture continues to be confused from the government shutdown, but this morning we are due to receive Initial Claims (exp 215K and look for a revision higher from last week’s suspect 199K) as well as New Home Sales (569K). Yesterday’s ADP Employment number was much better than expected at 213K, and of course, tomorrow, we get the payroll report. Given the Fed’s hyper focus on data now, that could be scrutinized more closely than usual for guesstimates of how the Fed might react to a surprise.

In the end, the market tone has changed to mirror the Fed with a more dovish nature, and given that, the prospects for the dollar seem to have diminished. For now, it seems it has further to fall.

Good luck
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Will We Understand?

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The current Fed Chairman named Jay
Will speak to us later today
The question at hand
Will we understand
The message that he will relay?

Meanwhile, nearby trade talks resume
Midst fears that a failure spells doom
For Trump and for Xi
They need victory
To help both economies boom

Three main stories continue to dominate the headlines; Brexit, the Fed and US-China trade talks. Given that all three remain unsettled, it should not be surprising that markets have shown little direction of late. This is evidenced by the fact that, once again, the dollar is little changed this morning against the bulk of its counterparts while both Treasury yields and equity prices remain rangebound.

Starting with the Fed, this afternoon at 2:00 the policy statement is released and then at 2:30 Chairman Powell holds his first of eight press conferences this year. We all know about the change in tone from Fed speakers since the December meeting where the Fed funds rate was raised 25bps to 2.50%. Since then, we have seen every Fed speaker back away from the previous narrative of slow and steady rate hikes to the new watchword, ‘patience’. In other words, previous expectations of two or three rate hikes this year have been moderated and will only occur if the data supports them. At this point, it seems pretty clear that the Fed will not raise rates in March, and likely not in June either, unless the data between now and then brightens significantly. As to the second half of the year, based on the slowing trajectory of global growth, it is becoming harder to believe they will push rates higher at all this year.

This is a significant change of expectations and will certainly impact other markets, notably the dollar. Given the view that any dollar strength was predicated on tighter Fed policy, the absence of such tightening should negatively impact the buck. But as I frequently point out, the dollar is a two-sided coin, and if the Fed is tightening less than expected, you can be certain that so is every other central bank, with the possibility of easing elsewhere coming into play. On a relative basis, I continue to see the dollar being the beneficiary of the tightest monetary policy around.

Moving to the trade talks, while hopes remain high, it seems expectations need to be moderated. The US is seeking major structural changes from China, including the reduction of subsidies for SOE’s and changes in terms for partnerships between US and Chinese firms. China built its economic model on those terms and seems unlikely to give them up. And that doesn’t include the IP theft issue, which the Chinese deny while the US continues to maintain is the reality. I think the best case scenario is that the talks continue and that any tariff increases remain on hold for another 90 days to try to achieve a settlement. But I would not rule out the chance that the talks break down and that higher tariffs are put into place come March 2nd. If the former occurs, I expect equity markets to rally on hope, while the dollar comes under modest pressure. However, if they break down, equities will suffer around the world and I expect to see safe havens, including the dollar, rally.

Finally, to Brexit, where yesterday Parliament voted to have PM May go back and reopen negotiations but did not vote to prevent a no-deal Brexit. This is what May wanted, but it is not clear it will solve any problems. The EU has been adamant that they will not reopen negotiations on the deal, although they seem willing to discuss the ‘political’ issues like the nature and timing of the backstop deal regarding Ireland. At this point, it seems May is playing chicken with her own party, as well as Labour, and trying to force them to vote for the current deal as the best they can get. But with time running out and the requirement that a unanimous vote of the EU is needed in order to delay the timeline, the chance of a no-deal Brexit is certainly increasing. The pound suffered yesterday after the vote, falling about 1%, although this morning it has bounced 0.25% from those levels. It is very clear that the market has ascribed a diminishing probability to a no-deal Brexit, but hedgers need to be careful. That probability is definitely not zero! And if it does come about, the pound will fall very sharply very quickly. A 10% decline is not unreasonable under those circumstances.

Away from those stories, this morning brings us the ADP Employment report (exp 178K) and we cannot forget that NFP comes on Friday. Eurozone data was generally soft, as was Japanese data, but that has all become part of the new narrative of a temporary lull in the global economy before things pick up again when the big issues (trade and Brexit) are behind us. The risk is those issues don’t resolve in a positive manner, and the slowdown is not as temporary as hoped. If global growth keeps deteriorating, all ideas on monetary policy will need to be reconsidered, which will have a direct impact on views of the future of the dollar, equity markets and bonds. So far, things haven’t changed enough to bring that about, but beware a situation where economic data continues to slide.

Good luck
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A Market Doomsday

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Last week it was Mario’s turn
To tell us what gave him heartburn
The risk which is growing
That Europe is slowing
Thus, negative rates won’t adjourn

This week eyes are on Chairman Jay
Whose last comments tried to defray
The idea the rates
That he regulates
Will e’er cause a market doomsday

As we begin the new week, the biggest weekend event was the reopening of the US Federal government, although apparently it could shut down again in three weeks. Funnily enough, while economists have calculated that each week the government was closed, GDP would be reduced by 0.1%, nobody seemed to care that much. I think if traders can explain an anomaly, they will ignore it in pricing. And certainly, a government shutdown is a big picture anomaly.

But all the other stories remain the same. Brexit is still unresolved with the next series of votes to be held tomorrow. It remains unclear exactly how things will play out, but it seems pretty clear that neither side wants a no-deal outcome. However, whether that means a vote to delay things, or acceptance of the deal that was roundly rejected just two weeks ago is completely uncertain. Of course, the third option is that they simply opt not to leave the EU, which is within their power. At this point, it seems the most likely outcome is a delay, as nobody likes the deal, and PM May has consistently indicated she would follow the vote to leave.

With that as the background, the pound is lower by -0.4% this morning, actually one of the larger movers in FX overnight. This appears to be short term profit taking by traders who have been accumulating long positions over the past month. But keep in mind that the big, long-term positions remain short pounds. So as long as there is no hard Brexit, which seems highly unlikely given both sides’ stated opposition to that outcome, there is room for the pound to rebound in the next months. However, I continue to like the dollar far better than the pound given the potential for future growth in both places. And while the Fed may not be aggressively tightening policy anymore, I don’t think we are that close to easing. Meanwhile, the BOE is watching the UK economy slow perceptibly, and cannot be serious about raising rates in the near term.

But this week is really about two things, the FOMC meeting and the trade talks with China. Looking at the latter first, both sides have made encouraging noises, but the key issues for the US remain IP theft and SOE support, neither of which have been adequately addressed. I know the equity market has been euphoric over every hint that the trade war would end, and tariffs would be removed, but I think they are way ahead of themselves. I fear there is, at best, a 50:50 chance that talks are concluded successfully before the March deadline. However, I think it likely that as long as the dialog remains open, the US postpones implementation of new, larger tariffs. As to the FX impact, you can be sure that the PBOC is going to prevent CNY from weakening in any substantial way until the talks are concluded one way or the other. But given the ongoing weak data in China, I continue to expect to see the renminbi weaken over time.

And finally, the Fed. On Wednesday Chairman Powell will have a press conference after the statement is released at 2:00 EST. (There is zero expectation that policy will change.) There has been a great deal of carping by Street economists that because Powell is not a PhD economist himself, he cannot adequately deliver the message. But I disagree. Instead, I would argue the reason there has been difficulty in articulating the Fed’s stance is that they don’t really know what to do. The current situation is unprecedented historically, between the size of the balance sheet and the level of interest rates relative to the growth trajectory of the economy. They have already had to change the way they manage interest rates, no longer adjusting balances in the market and instead paying interest on excess reserves. The upshot of that change is that there is no history for them to examine regarding potential outcomes. At the same time, to a wo(man), every Fed member is adamant that because Treasuries have behaved well, the balance sheet rundown is not having any impact on markets at all. To which I ask, if it’s not having an impact, why did they do it in the first place? Clearly the Fed thought that QE was going to help support the economy by supporting the stock market (you remember, the Portfolio Balance Channel). So how can they seriously believe that if the implementation of QE was stimulative, its reduction would not reverse that stimulus? It is arguments like this that frustrate investors and help chip away at the Fed’s credibility.

As to the markets today, the dollar is pretty well behaved, having stabilized after pretty substantial weakness on Friday. Other than the pound mentioned above, not much significant movement has been observed. Equity markets are softer around the world and US futures are pointing in the same direction. Treasury yields have not moved from Friday, and oil prices are slipping slightly. It is hard to characterize the market as anything other than confused.

On the data front, although the government shutdown has ended, all the data has not been collected, let alone collated, so I expect that we will start to see things during the week. Of course, Friday brings the payroll report, and that seems set to be released. There is nothing of note scheduled today, so I will wait to list things until tomorrow when there is more certainty as to what is coming and when. So, for today, there seems little reason for the dollar to do much unless something really negative occurs in equities. That’s not my base case, but you never know, especially as there are key earnings releases later this week (Apple, Amazon, Microsoft, Alphabet) and any rumors could drive things. But overall, I expect a quiet session today.

Good luck
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Plan B

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As PM May turns to ‘Plan B’
The choices are not one, but three
Will Brexit be hard?
Or will she discard
The vote so Bremainers feel glee

The third choice is seek a delay
From Europe so that the UK
Can head to the polls
To sort out their goals
And maybe this time choose to stay

Once again Brexit remains the topic du jour as the ongoing political maelstrom in the UK is both riveting and agonizing at the same time. The latest news is that PM May survived the no-confidence vote. Her next step was to reach out to all opposition parties to try to determine what they wanted to see in Brexit as a prelude to going back to the EU with more demands requests. But the market has dismissed that idea as a non-starter (which I think is correct) and instead is clearly expecting that the decision will be for the UK to seek an extension of several months so that the UK can organize a second referendum on the question. At that point, the result would be binary, either stay in the EU or accept a hard Brexit. At least, that seems to be the current thinking amongst market participants and pundits. The pound has continued its slow recovery from the December lows as investors and traders start to assume that there will be no Brexit after all, and that the only reason the pound trades at its current levels is because of the prospect of leaving the EU. I cannot handicap how a second referendum would turn out, but it does appear that any result would be extremely close in either direction. Like many of you, I am ready for this saga to end, but I fear we will be hearing about it for another six months. In the meantime, the pound will remain hostage to the latest thoughts on the outcome, with Brexit still resulting in a significant decline, while confidence in Bremain will result in sterling strength.

As an indication of just how remarkable the Brexit story has become, Fed activity has faded from the front pages. We continue to hear from Fed speakers and the consistent message is that the Fed is now in ‘wait-and-see’ mode, with no rate hikes likely in the near future unless economic data indicates that prices are rising sharply. It appears that the Fed is losing faith in its Phillips Curve models, and although there doesn’t seem to be a consensus on what should replace them, concerns over runaway inflation based on continued low Unemployment rates are diminishing.

Economic data from around the world continues to moderate, if not outright slow, and while recession remains in the future, it is arguably closer. The upshot is that no central banks are going to consider tightening policy further for quite a while, and the odds favor more policy ease from the big banks instead. As I have consistently written, the FX market remains entirely focused on the Fed without considering the fact that the ECB is in no position to think about raising interest rates later this year and is, in fact, more likely to have to reintroduce QE as the Eurozone economy slows. If the market is beginning to price in rate cuts by the Fed, which it is, then rate cuts by the ECB (or at least QE2) is a given. It is very difficult to see a path where the Fed eases and the ECB doesn’t follow suit, if not lead. This is not a positive outlook for the single currency.

Speaking of easing policy, the PBOC has been at it consistently as growth in China ebbs with no indication they will be reducing these efforts soon. While policy rates remain unchanged, the PBOC has continued to inject excess liquidity into the market there (so far this week they have injected CNY 1.169 Billion) in an effort to bring down short term financing costs for banks. The objective is to help the banks maintain their loan books, especially for those loans that are underperforming. As long as the renminbi remains relatively firm (and although weakening 0.3% overnight remains more than 3.0% from the 7.00 level that is seen as critical in preventing capital outflows), they will be able to continue this easing policy. However, at the point in time that the renminbi begins to weaken (and it will at some point), the PBOC will find its toolkit somewhat more restricted. Remember, despite the fact that so much has occurred in markets and policy circles recently, we are less than three weeks into 2019. There is plenty of time for trader and investor views to change if forecasted activities don’t materialize.

Once again, beyond those three stories, FX remains generally dull. Overall, the dollar is little changed this morning, rising against some currencies (CNY, NZD, RUB, MXN) and falling against others (JPY, EUR, GBP, BRL). The data releases were uninspiring with Eurozone inflation the most noteworthy release but coming in exactly as expected at 1.6% headline and 1.0% core. Those are not inflation rates that quicken the pulse. Yesterday’s Beige Book indicated an increase in uncertainty by a number of businesses but described ongoing decent economic activity. This morning we see Initial Claims (exp 220K) and Philly Fed (10.0), with the latter more likely to be interesting than the former. But for now, FX market attention continues to focus on Brexit first and then the Fed. And today that is not a recipe for excitement! I see little reason, at this point, for the dollar to do much of anything today.

Good luck
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Disgraced

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Prime Minister May was disgraced
As Parliament calmly laid waste
To hopes that her deal
With Europe could heal
The schism that Brexit emplaced

Yesterday’s Parliamentary vote on the Brexit deal negotiated between PM May’s government and the EU resulted in a resounding rejection. While the UK remains fairly evenly divided on the absolute concept of Brexit, what was made clear was that the terms proposed were unacceptable to all sides. As I have maintained, the Irish border issue is an intractable one, where one side or the other simply must cede ground. There is no middle way. At this time, neither side is willing to do so, and quite frankly, unless Northern Ireland is willing to reunite with Ireland, (which seems highly unlikely any time soon), there can be no deal that will be acceptable to both sides. This leaves three potential outcomes; the UK could leave the EU with no deal in hand and go back to WTO tariff rules; the UK could opt not to leave at all (based on the European Court of Justice ruling from November); or there is a small possibility that the deadline could be delayed a number of months in order to reopen negotiations.

Let’s unpack those three choices.
1. In a no-deal Brexit, pretty much every published analysis by economists has forecast a nearly apocalyptic result for the UK economy, with a deep recession followed by much slower growth. Or course, every one of those economists likely voted to remain as the demographics of the vote showed professionals, especially financial industry professionals, overwhelmingly voted to remain. In other words, they are talking their book. Will the UK suffer? Almost certainly. Will the UK collapse into a depression? Absolutely not. The UK was a strong and viable nation before the EU came into existence and will certainly continue to be so going forward. The market impact of this outcome is likely to be quite negative in the short term, however, with both the pound and UK equity markets falling sharply if it becomes clear this will be the outcome. While both will recover eventually, the timing on that is unclear.

2. If the May government opted to remain in the EU, essentially repudiating the results of the referendum, I fear it would lead to riots in the streets, certainly in the Midlands which led the vote to leave. In fact, I could see an alliance between the French gilets jaune and the Brexiteers as both will be taking to the streets in an effort to change the government. A unilateral decision not to leave would have much deeper consequences with regard to the political system within the UK, as there would be whole swathes of the nation that would cease to trust the government entirely. I actually think this is the least likely scenario, although in the event it occurred, I would expect both the pound and the FTSE to rally sharply initially, but as the consequences of that act became clearer, I imagine both would suffer greatly.

3. Delaying the deadline seems like the best fudge available to both sides at this point, although the initial comments by EU officials followed the line that, given the depth of the defeat of the already negotiated deal, there seems little chance to make small changes and get a new result. This will also require unanimous approval by the remaining 27 members of the EU, which sounds daunting, although if there it was believed there was a serious chance of coming up with a better deal would get done. Here, too, the market response will be for a rally in the pound, and probably the FTSE, as investors would likely take the stance that the delay presages a deal.

However, for the time being, PM May’s first course of business is to fight off the no-confidence motion brought by Labour Leader Jeremy Corbyn in his attempt to bring down the government and force a general election. Pundits believe that while the deal was unacceptable, May will hold on. The problem is, she has no ideas as to how to move the process forward. Certainly, the probability of a no-deal Brexit has increased somewhat after the vote. Interestingly, the FX markets have not really priced for that outcome. In fact, since the original vote date, December 11, when May pulled the bill to try to garner more support, the pound has rallied pretty steadily and is nearly 3% higher over the past month. It would seem that FX traders believe a deal will be found.

The other story of note is that the Chinese government is now set to cut taxes in an effort to add fiscal stimulus to their ongoing monetary stimulus efforts. Remember, they have already cut bank reserve requirements by another 1% this year, adding to 2% cuts from last year, and they have created a loan targeting policy for SME’s. Now income tax cuts are to be included as well. This highlights just how poorly the Chinese economy is performing right now, and how critical President Xi believes it is to continue publishing GDP growth above 6%. While the FX market has shown little response to these actions, they have had a much more positive impact on equity markets, with yesterday’s rallies easily attributed to the announcement. The one thing that is certain is that Xi will continue to do whatever he things is necessary to support economic growth in the short run, regardless of the potential longer-term negative consequences. After all, despite being President for life, he is still a politician!

Pivoting to the data story, yesterday Germany reported 2018 GDP growth of just 1.5%, its weakest performance in 5 years, although there was no report on Q4 growth. Given the surprise decline in Q3, pundits were watching to see if Germany had entered a technical recession, although it appears not to be the case. However, it is clear that growth in the engine of Europe is continuing to slow which doesn’t bode well for the entire Eurozone. Nor does it bode well for the ECB’s nascent attempts to remove policy accommodation. In fact, their biggest fear has to be that growth slows further there and they have basically no monetary tools left to combat the situation. This morning’s data has shown that inflation continues to ebb in Europe (France 1.6%, Germany 1.7%, Spain 1.2%, Italy 1.1%), and the UK (2.1%) as well, which reduces pressure to tighten policy at all. While US inflation is also softening, it continues to puzzle me that there is any belief the ECB (or the BOE for that matter) will consider raising interest rates any time soon. So even if the Fed is more dovish (and given remarks from the always hawkish KC President Esther George yesterday, it is clear that there is no rate hike in the near future in the US), the idea that any other central bank is going to be tightening policy is absurd.

In fact, I would argue that the dollar’s recent weakness has been predicated solely on the idea that the Fed will back off on previously forecast rate hikes. But if the Fed is stopping, you can be 100% certain that any thoughts of tighter policy elsewhere are also out the window, and so relatively speaking, the US remains the tightest policy around. I still like the dollar for that reason.

Good luck
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Animal Spirits Were Stirred

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All week from the Fed we have heard
That patience is their new watchword
The market’s reaction
Implied satisfaction
And animal spirits were stirred!

While it may be a new day, nothing has really changed. Yesterday we heard from both Chairman Powell and vice-Chairman Clarida and both said essentially the same thing: the Fed is watching both the economy and markets closely, and given where policy rates currently stand, they can afford to be patient before acting next. On the subject of the Fed’s balance sheet, neither indicated there was cause for a policy change, but Powell, when asked, remarked that if they thought the shrinking balance sheet was becoming a problem, they would not hesitate to adjust policy. The market interpretation was: the Fed is not going to raise rates anytime soon so we better buy stocks as quickly as we can. The result was yet another rally in equities with all three US market indices rising about 0.5% on the day. At this point, even the Fed must recognize that they have gotten their message across.

The next key story that remains ongoing is the trade situation between the US and China. There was no specific news on the subject and no comments from either side. The market view is that there was clearly some progress made during the initial discussions earlier this week and many people are optimistic that the next round of talks, which will include more senior representatives from both sides, can lead to a permanent resolution. As long as that remains the collective mindset, it is one less pressure point for global equity markets. However, it must be remembered that the US is seeking significant changes in the structure of the Chinese economy, and so a complete resolution will not be easy to achieve, especially in the accelerated timeline currently extant. I expect an extension of the timeline as the first concrete result.

The third key story has been Brexit, which continues to be a complete mess. Next week’s Parliamentary vote looks destined to fail, and now there is a growing movement for the deadline to be extended three months to the end of June. While that requires a unanimous vote to do so, comments from European members seem to be heading in that direction. The pound has benefitted from the discussion, as traders believe that the extra three months will help alleviate the risk of a no-deal Brexit and the forecast consequences on both the economy and the currency in that event. However, the Irish border remains unchanged and there has been no indication that the UK will accept an effective walling off of Northern Ireland for the sake of the deal. We shall see.

Two other stories are also gaining in their importance, the rebound in oil prices and further weakness in the Eurozone economy. As to the first, the OPEC agreement to cut production by 1.2 million barrels/day has served to remove fears of an oil glut and recent inventory figures have backed that up. As well, while WTI has traded back above $50/bbl, there is a growing belief that the US fracking community is not going to be able to produce as much oil as previously thought, especially if prices slip back below that $50 level. Oil prices have rallied for nine consecutive days but remain far below levels seen just last October. Historically, rising commodity prices have gone hand in hand with a declining dollar, and for right now, that correlation has been holding.

Finally, we continue to see weak economic data from the Eurozone, with this morning’s Italian IP data (-1.6% in Nov) the latest in a string that has shown Europe’s manufacturing sector is under increasing pressure. This story is the one that has received shortest shrift from the market overall. In fact, I would argue it has been completely ignored, certainly by FX traders. While everyone focuses intently on the Fed and the recent change of heart regarding future rate hikes, there has been almost no discussion with regard to the ECB and how, as economic growth continues to slow in the Eurozone, the idea that they will be tightening policy further come September is laughable. At some point, the market will realize that the Eurozone is in no position to normalize policy further, and that instead, the question will arise as to when they will seek to add more stimulus. My gut tells me that a change in forward guidance will be the first step as they extend the concept of rate hikes from; “not until the end of summer” to something along the lines of “when we deem appropriate based on the economic data”. In other words, the current negative rate regime will be indefinite, and if (when) the next recession arrives, look for a reintroduction of QE there. My point is that the euro has no business rallying in any substantive way.

With all of this as background, a quick tour of markets shows that while the dollar actually performed fairly well during the US session yesterday, it is giving back some of those gains this morning. For example, the euro, despite weak data, is higher by 0.3%. The pound, on the back of the renewed Brexit deal hope is higher by 0.5%. Firmer commodity prices have helped AUD (+0.6%), NZD (+0.9%) and CAD (+0.3%). But the biggest consistent winner of late has been CNY, which has rallied a further 0.65% overnight and is now up 1.6% this week. This is a far cry from the situation just a few weeks ago, when there were concerns the yuan might break through the 7.00 level. Two things come to mind here as to the cause. The first possibility is that there has been an increase in investment flows into the Chinese bond market, where yields remain higher than in much of the developed world, and the Chinese bond market is slowly being added to global bond indices requiring fund managers to add positions there. The second, slightly more conspiratorial idea is that the Chinese government is pushing the yuan higher during the trade negotiations with the US to insure that its value is not seen as an impediment to reaching any deal. Whatever you think of President Trump’s tactics, there is no question that the Chinese economy has come under increased pressure since the imposition of US tariffs on their exports. It is not hard to believe that the stronger yuan is a direct response to help reach an agreement as quickly as possible.

And that’s pretty much everything to watch today. This morning we get CPI data with expectations for headline to print at -0.1% (1.9% Y/Y) and ex food & energy to print at +0.2% (2.2% Y/Y). Thankfully there are no more Fed speakers, but I would say given the near unanimity of the message from the nine speakers this week, we have a pretty good idea of what they are thinking. Equity futures are pointing slightly lower following European markets, which are softer today. However, given that equity markets around the world have rallied steadily all week, it can be no real surprise that a little profit taking is happening on a Friday. As to the dollar, in the short term I think it remains under pressure, but over time, I continue to see more reasons to own it than to short it.

Good luck and good weekend
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