Tag Archives: #Fed

Hawks Are Now Doves

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Two years ago Minister May
Put Article 50 in play
But when she unveiled
Her deal, it detailed
A course many felt went astray

Instead of the exit they sought
And for which the Brexiteers fought
Today the UK
Is forced, still, to play
By rules that the EU has wrought

So, it’s Brexit day and yet there is no final solution. Later today Parliament will vote on the legally binding aspects of the negotiated deal, but that still appears destined to fail. The problem remains that the Northern Irish DUP, which holds the ten votes that maintain the Tory majority in Parliament, has categorically refused to back the deal. The problem, as they see it, is that the deal splits them away from the UK and impinges too greatly on their sovereignty. If this vote fails (it is due to take place at 10:30 this morning) then the debate will shift to what to do next. The EU has afforded the UK another two weeks to come up with any decision at all, but even that seems increasingly doubtful. Earlier this morning, it appeared that the probability of a no-deal Brexit was increasing, at least according to the market as the pound traded down to 1.30 (-0.3%), but it has since rebounded a bit and is, in fact, higher by 0.35% on the session now. It appears the ebbs and flows of the debate in Parliament are moving the price right now, so be prepared for a sharper move in a few hours. It is devilishly difficult to predict political outcomes, thus at this point, all we can do is watch and wait.

Both patience and data dependence
Are hallmarks of Powell’s transcendence
The hawks are now doves
And everyone loves
The theory of Fed independence

This takes us to the other topic of note in the markets, the Fed. Yesterday, yet again, we heard from Fed speakers who have all said virtually the same thing. The current mantra is there is no reason for the Fed to act right now on rates, and that they will carefully analyze all the data, both from the US and the rest of the world, before making their next decision. They cannot tell us frequently enough how in 1998-9, when growth elsewhere in the world was suffering (the Asian crisis was unfolding), the Fed eased policy even though things were fine in the US, and that is what helped prevent a much worse outcome. (Of course, they never discuss how those extra low rates helped inflate the tech bubble which burst dramatically the following year, but that doesn’t really suit the narrative, does it?) At any rate, it is abundantly clear that the Fed is on hold for the rest of the year, and that the balance sheet program is going to taper off and end by the autumn. And there is no question that the Fed has remained independent throughout this process, remember that!

The last of the big three stories, trade talks with China, was back in the news as well as the US delegation was seen going “line by line” through the text with their Chinese counterparts to try to come to an agreement. It does appear that the Chinese are conceding some points, with a story this morning about how US cloud companies are going to be allowed access, without a partner, into China to compete with locals. The other story was about a change in Chinese law that ostensibly addresses IP theft. These are two key issues for the US and seem to indicate that there is a real possibility that an agreement will actually make changes in the relationship that could benefit the US in the long run. Certainly, equity markets see it that way as Chinese stocks rallied sharply, more than 3% and Europe is higher along with US futures.

Elsewhere, yesterday’s BRL collapse was largely reversed, although the Turkish lira continues to suffer ahead of the local elections this weekend. In the former, it appears that foreign investors are taking advantage of a weaker real and stock market to buy in at better levels as there is an underlying belief that pension reform will be passed. In the latter, it remains to be seen how President Erdogan’s allies fare this weekend, and there is no clarity as to how he will react if he loses some measure of power.

Yesterday saw the dollar perform well, overall, despite the GDP data coming in on the soft side (2.2% vs. 2.6% expected), but again, that is backward looking data. This morning brings PCE (exp 1.4%, core 1.9%) as well as Personal Income (0.3%) and Spending (0.3%). We also see Chicago PMI (61.0), New Home Sales (620K) and Michigan Sentiment (97.8) later on. There are also a few more Fed speakers, but we pretty much know what they are going to say, don’t we?

Overall, the dollar has performed well this week, although it is a touch softer this morning. My sense is that we could see a bit more weakness by the end of the day, simply on position adjustments. And of course, if somehow the UK makes a decision of some sort, that will help the pound rebound and add to pressure on the buck. Just don’t count on that last part!

Good luck and good weekend
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So Despised

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Is anyone truly surprised
That Parliament, once authorized
To find a solution
Found no substitution
For May’s deal that they so despised?

One of the more confusing aspects of recent market activity was the rally in the pound when Parliament wrested control of the Brexit process from PM May. The idea that a group of 650 fractious politicians could possibly agree on a single idea, especially one so fraught with risks and complexities, was always absurd. And so, predictably, yesterday Parliament voted on seven different proposals, each designed to be a path forward, and none of them even came close to achieving a majority of votes. This included a vote to prevent a no-deal Brexit. In the meantime, PM May has now indicated she will resign regardless of the outcome, which, arguably, will only lead to more chaos as a leadership fight will now consume the Tories. In the meantime, there is still only one deal on the table, and it doesn’t appear to have the votes to become law. As such, while I understand that the idea of a hard Brexit is anathema to so many, it cannot be dismissed as a potential outcome. It should not be very surprising that the FX market is taking the idea a bit more seriously this morning, although only a bit, as the pound has fallen a further 0.4%, which makes the move a total of 1.0% lower in the past twenty-four hours.

One way to look at the pound’s value is as a probability weighted price of three potential outcomes; no deal, passing May’s deal and a long delay. Based on my views that spot would trade to 1.20, 1.38 or 1.40 depending on those outcomes, and assigning probabilities of 40%, 20% and 40% to those outcomes, spot is actually right where it belongs near 1.3160. But that leaves room for a lot of movement!

Meanwhile, elsewhere in the FX market, volatility is making a comeback. Between Turkey (-5.0%), Brazil (-3.0%) and Argentina (-3.0%), it seems that traders are beginning to awaken from their month’s long hiatus. Apparently, the monetary policy anesthesia that had been administered by central banks globally is wearing off. As it happens, each of these currencies is dealing with local specifics. For instance, upcoming elections in Turkey have President Erdogan on the defensive as his iron grip on power seems to be rusting and he tries to crack down on speculators in the lira. Meanwhile, recently elected Brazilian president Bolsonaro has seen his honeymoon end quite abruptly with his approval ratings collapsing and concerns over his ability to implement key policies seen as desirable by the markets, notably pension reform. Finally, Argentine president Macri remains under pressure as the slowing global growth picture severely restricts local economic activity although inflation continues to run away to unsustainable levels (4% per month!) and the peso, not surprisingly is suffering.

As to the G10, activity there has been less impressive although the dollar’s tone this morning is one of strength, not weakness. In fact, risk continues to be jettisoned by investors as can be seen by the continuing rally in government bonds (Treasury yields falling to 2.35%, Bund yields to -0.07%, JGB’s to -0.09%) while equity markets were weak in Asia and have gained no traction in Europe. Adding to the impression of risk-off has been the yen’s rally (0.2% overnight, 1.0% in the past week), a reliable indicator of market sentiment.

Turning to the data, yesterday saw the Trade Balance shrink dramatically, to -$51.1B, a much lower deficit than expected, and sufficient to positively impact Q1 GDP measurement by a few tenths of a percent. This morning we see the last reading on Q4 GDP (exp 1.8%) as well as Initial Claims (225K). Given the backward-looking nature of Q4 data, it seems unlikely today’s print will impact markets. One exception to this thought would be a much weaker than expected print, which may convince some investors the global slowdown is more advanced than previously thought with equities selling off accordingly. But a better number is likely to be ignored. We also hear from (count ‘em) six more Fed speakers today (Quarles, Clarida, Bowman, Williams, Bostic and Bullard), but given the consistency of recent comments by others it seems doubtful we will learn anything new. To recap, every FOMC member believes that waiting is the right thing to do now and that they should only respond when the data indicates there is a change, either rising inflation or a significant slowing in the economy. Although the market continues to price rate cuts before the end of the year, as yet, there is no indication that Fed members are close to believing that is necessary.

Ultimately, the same key stories are at the fore in markets. Brexit, as discussed above, slowing global growth and the monetary policy actions being taken to ameliorate that, and the US-China trade talks, which are resuming but have made no new progress. One of the remarkable features of markets lately has been the resilience of equity prices despite a constant drumbeat of bad economic news. Investors have truly placed an enormous amount of faith in central banks (specifically the Fed and ECB) to be able to come to the rescue again and again and again. Thus far, that faith has been rewarded, but keep in mind that the toolkit continues to dwindle, so that level of support is likely to diminish. In the end, I continue to see the dollar as a key beneficiary of the current policy mix, as well as the most likely ones for the near future.

Good luck
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An Own Goal

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So, Parliament’s taken control
Of Brexit, but can they cajole
Frau Merkel and friends
To finally bend
Or have they now scored an own goal

The one truism about the FX markets these days is that nobody has a real clue as to what is going to happen to the pound. Every day there is a different view as to whether or not there is going to be a deal or a hard Brexit, or something else. The latest machinations in the UK have changed the process there somewhat, with Parliament voting to wrest control of the negotiations from PM May’s hands and make decisions directly. The upshot of this is that tomorrow, they will vote on a series of bills that try to outline what the members would like to see in a Brexit outcome. Of course, it strikes me as fanciful that Parliament, in a few days’ time, will be able to come to agreement on something that has been this contentious for more than two years. And while everybody continues to claim there cannot be a hard Brexit, I almost think this new tactic will assure that outcome. The only thing we know for sure is that there is no majority FOR any direction. While there have been clear rejections of the PM’s negotiated deal, nobody has come up with something that the UK wants, and that might be acceptable to the EU. Remember, too, the EU has given just a two-week extension for Parliament to come up with something. In other words, this is all still a huge mess with no clear outcome. The pound, as should be expected, continues to chop back and forth as the flavor of the day indicates either a deal, or a crash. As I type, the pound has rallied slightly, up 0.2%, but it continues to trade within its recent range, and will likely do so until a decision, any decision, is taken.

The other story of note this morning is the news that the French and Chinese have signed some trade deals as Chinese President Xi wraps up his European tour. I admit I am a little confused that France is allowed to ‘negotiate’ directly with a non-EU member on trade deals as I thought that was the whole point of the EU, the same terms for everyone. At any rate, this optimism has bled into the US-China trade discussion which is set to become headline news again with Messrs. Lighthizer and Mnuchin arriving in Beijing today to resume those talks. The last we heard on this subject indicated concerns over whether the Chinese were willing to agree to some key US demands regarding IP protection and the available punishments in the event of a breach of the new rules. But, today, the glass is half full, so markets are rebounding on the idea that a deal is, in fact, near.

Turning back to yesterday’s yield curve story, while 10-year yields in the US have edged higher this morning, they remain below 3-month yields. There have been several articles recently describing why this inversion is not the same as the ones that we have seen in the past. Briefly, past inversions arose because the Fed was raising short-term rates in order to head off rising inflationary pressures that had built up during a recovery. And while in one sense, that is what seems to have happened this time, the missing ingredient has been the actual inflation. The Fed’s rate hikes over the past three years were partly in anticipation of higher inflation based on the declining unemployment rate (the misapplied Phillips Curve). But a key difference this time has been the fact that in the wake of QE, the Fed’s balance sheet is much larger, and by design, longer term rates are much lower than they might otherwise be. If the Fed did not own an extra $2.5 trillion of Treasuries, where would the 10-year yield actually trade? Arguably, far higher than 2.4%. And so, the crux of the argument that this time is different is based on that fact. Without QE, short-term rates would not yet be approaching long-term rates, and so no inversion discussions would be taking place.

The opposing view, however, is that we have continued to see weaker data in the US and throughout the world, which implies that global growth is slowing. So, inverted yield curve or not, a recession may well be coming. It is important to remember that an inverted yield curve does not cause a recession per se, it has simply been a pretty reliable indicator of upcoming recessions based on its history over the past 50 years. And, in truth, the indicator that gets the most press is the 2yr-10yr spread, which as of yet has not inverted, although remains quite close to flat at just 15bps right now.

The reason this discussion matters is it helps drive market views of the Fed’s next steps and therefore the market reactions to those steps. As I have maintained consistently, however, the US is unlikely to head into recession without dragging the rest of the world along for the ride. And correspondingly, if the rest of the world is actually headed toward a recession, the US is certainly going to see slower growth. But as this relates to the dollar’s value, there is no evidence the US is weakening faster than the EU, the UK, China or most of the rest of the world, and so as dovish as the Fed may sound, other central banks will be more dovish still. The dollar should still be the main beneficiary of this situation, especially if it includes a significant equity correction and risk-off scenario.

Turning to this morning’s story, Housing Starts (exp 1.213M), Building Permits (1.3M), Case-Shiller House Prices (4.0%) and Consumer Confidence (132.0) are on the docket as well as three Fed speakers (Harker, Evans and Daly) two of whom have already spoken overseas but whose comments have not been widely circulated yet. Overall, the dollar is slightly softer this morning, but that is after several positive sessions, so in the end, we continue to chop in our trading range waiting for the next key driver. At this point, my money is on Brexit, but you never know.

Good luck
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Disconcerted

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On Friday the yield curve inverted
With policymakers alerted
That risks have increased
And growth may have ceased
Both prospects have them disconcerted

While the weekend machinations over Brexit have certainly been intense, the big story this morning is the mild inversion of the US yield curve that occurred on Friday. For the first time since 2007, 10-year yields fell below 3-month yields, a signal that the market is anticipating rate cuts by the Fed in order to shore up weakening growth. In fact, according to the futures market, there is now a ~60% probability of a Fed rate CUT by the end of the year, with a 20% probability of two rate cuts! Following this train of thought, US equity markets had their worst performance in months on Friday, and overnight, Asian markets sold off sharply. However, early this morning, German Ifo data printed at a better than expected 99.6 level, which has helped stop the European equity decline in its tracks. Nonetheless, there is a decided undercurrent of concern over the future of the global economy, and risk positions are being pared back around the world.

This is being seen most clearly in government bond markets where, for example, both Australian and New Zealand 10-year yields have traded to historic low levels, with both now well below 2.0%. Japanese 10-year yields have fallen to -0.09%, pushing toward the bottom end of the BOJ’s yield curve control levels, and German bunds have also retreated to negative territory, currently trading at a yield of -0.01%. I have to admit that while my forecasts for 2019 included lower yields based on a weakening growth outlook, I did not expect these levels to materialize in Q1, but rather only by the end of the year. This price activity is an indication of two things; first that longstanding positions are being unwound as investors reassess the global growth situation; and second, that markets can move awfully fast.

Other indicators have also shown a decided move toward risk aversion with gold rallying nearly 3% in the past two weeks, while the dollar, despite declining interest rates, has rebounded sharply from its post-FOMC lows. As I have consistently maintained, while the Fed surprised one and all by turning so dovish last week, there is little possibility that the Fed will be dovish while other central banks continue their efforts at policy normalization. Certainly, while the odd smaller country may still be considering tighter monetary policy (Norway, Hungary or the Czech Republic), no major central bank can possibly consider tightening policy amid slowing global growth and a complete lack of inflationary pressure. And as I constantly maintain, FX is a relative game, where policy on both sides must be considered. In the current environment, the US not only has the highest rates, thus the most attractive investment landscape, but also retains its haven status in times of trouble. Dollar bears have a long road to hoe before seeing substantial weakness in the buck.

The PM is under the gun
While MP’s, her deal, still do shun
It’s Parliament’s turn
To try to discern
What people in England want done

Meanwhile, back in Merry Olde England, the Brexit situation has absolutely no more clarity than it did last week, in fact it may have less. While politicians on all sides of the argument claim they do not want a hard Brexit, there has been precious little movement in the direction of a solution. And remember, the law still states that the UK will leave the EU this Friday. Yes, the EU has offered a two-week extension, but that is not yet the law in the UK and must be approved in a bill. But in the end, is two weeks sufficient to change minds when two plus years has not been able to do so?

There are stories that a deal is being worked out where Parliament supports the deal and PM May resigns, although she has no obvious successor at this point. And while there is talk of either a second referendum or canceling Article 50, the first would require a significant delay, one that would go well past the EU elections due in late May, and that is a problem, while the second would require a complete backtracking of what the current government has been promising for the past two plus years, not the type of thing that endears politicians to their constituents. As it stands now, it appears that this week Parliament will debate a series of open bills that will try to build some support for a path forward, but even this idea is fraught as party whips may well seek to prevent MP’s from voting their conscience and try to maintain a party line. In other words, it is still a gigantic mess. The one thing that continues to be a very real risk, whether it is this Friday or April 12, is the reality of a hard Brexit. In my estimation, all markets are underpricing that probability, and there is a very real risk that the pound could fall much lower. Hedgers, while option prices are somewhat rich, I would contend they offer a great deal of value at this time. Please consider them.

So, looking at the FX market this morning, we see the dollar little changed overall, but some of the key currencies weaker, notably the euro (-0.2% and the pound (-0.3%). Earlier in the session, but were weaker still, but the release of the German Ifo data helped them as well as European equities.

As to data this week, there is a decent amount coming, as well as a lot of Fedspeak.

Tuesday Housing Starts 1.215M
  Building Permits 1.3M
  Case-Shiller Home Prices 4.0%
  Consumer Confidence 132.0
Wednesday Trade Balance -$57.0B
  Current Account -$130B
Thursday Initial Claims 225K
  Q4 GDP 1.8% (last est 2.6%)
Friday Personal Income 0.3%
  Personal Spending 0.3%
  PCE 0.0% (1.4% Y/Y)
  Core PCE 0.2% (1.9% Y/Y)
  Chicago PMI 61.0
  Michigan Sentiment 97.8
  New Home Sales 620K

On top of all this, we hear from ten different Fed speakers, several of them speaking more than once. This started last night when Chicago Fed President Charles Evans was speaking at an event in HK and said that policy is in a good place and the Fed is watching the data carefully. In other words, if further weakness shows up, they will definitely consider easing, while if the current malaise is short-lived, and growth rebounds, look for talk of another rate hike. At this time, it is abundantly clear that the market is turning quite pessimistic, pricing in rate cuts. But it does appear the Fed is not predisposed in either direction for now.

In the end, the global growth story remains the biggest question out there, and as that develops, so will go the dollar, and all markets with it.

Good luck
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Doublespeak

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The sitting Prime Minister, May
Heard terrible news yesterday
Her plan to promote
A Brexit deal vote
Was halted much to her dismay

This forces her, later this week
A longer extension to seek
But still the EU
Seems unlikely to
Do more than add new doublespeak

In yet another twist to the Brexit saga, the Speaker of the House of Commons, John Bercow, refused to allow another vote on PM May’s deal this week. He explained that Parliamentary rules since 1604 have existed to prevent a second vote on a bill that has already been rejected unless there have been substantial changes to the bill. In this case there were no changes and PM May was simply trying to force approval based on the idea that the clock was running out of time. The pound reacted to the news yesterday by quickly dropping 0.5%, although it has since recouped 0.2% this morning.

This has put the PM in a difficult spot as she prepares to travel to the EU council meeting in Brussels later this week. Given that there is still no clarity on how the UK wants to handle things, or at least how Parliament wants to handle things, she will need to seek an extension in order to avoid a no-deal Brexit. However, the comments from several EU members, notably Germany and France, have indicated they need some sense of direction as to what the UK wants before they will agree to that extension. Remember, too, it requires a unanimous vote by the other 27 members of the EU to grant any extension. At this stage, the market is virtually certain an extension will be granted, at least based on the fact that the pound remains little changed on the day and has been able to maintain its modest gains this year. And it is probably a fair bet that an extension will be granted. But the real question is what the UK will do with the time. As of now, there is no clarity on that at all. Unless the EU is willing to change the deal, which seems unlikely, then we are probably heading for either a new general election or a new Brexit referendum, or both. Neither of these will add certainty, although the predominant view is that a new referendum will result in a decision to stay. Do not, however, ignore the risk that through Parliamentary incompetence, next week the UK exits without a deal. That risk remains very real.

One side note on the UK is that employment data released this morning continues to beat all estimates. Wages continue to rise (+3.4%) and the Unemployment Rate fell further to 3.9%. Despite a slowing economy overall, that has been one consistent positive. It has been data like this that has helped the pound maintain those gains this year.

Elsewhere the global growth story continues to suffer overall, as both China and the Eurozone continue to lag. While there was no new data from China, we did see the German ZEW survey (-3.6 up from -13.4) and the Eurozone version as well (-2.5 up from -16.6). However, at the same time, the Bundesbank just reduced their forecast for German GDP in 2019 to 0.6%, although they see a rebound to 1.7% in 2020. My point is that though things may have stopped deteriorating rapidly, they have not yet started to show a significant rebound. And it is this dearth of economic strength that will continue to prevent the ECB from tightening policy at all for quite a while to come.

A quick glance Down Under shows that optimism in the lucky country is starting to wane. Three-year Australian government bonds have seen their yield fall to 1.495%, just below the overnight rate and inverting the front of the curve there. This calls into question the RBA’s insistence that the next move will be an eventual rate hike. Rather, the market is now pricing in almost two full rate cuts this year as Australia continues to suffer from the slowing growth in China, and the world overall. While the FX impact today has been muted, just a -0.1% decline, Aussie continues to lag vs. other currencies against a dollar that has been on its back foot lately.

Speaking of the dollar, tomorrow, of course, we hear from the Fed, with a new set of economic projections and a new Dot Plot. Since there is no chance they move rates, I continue to expect the market to be focused on the balance sheet discussion. This discussion is not merely about the size of the balance sheet, and when they stop shrinking it, but also the composition and general tenor of the assets they hold. Remember, prior to the financial crisis and the utilization of QE, the Fed generally owned just short-term T-bills and maybe T-notes out to three years. But as part of their monetary policy experiment, they extended the maturities of their holdings with the average maturity now nine years. This compares to the six-year average maturity of the entire government bond issuance. The longer this average tenor, the more monetary ease they are providing to the market, so the question they need to answer is do they want to maintain that ease now or try to shorten the current maturity, so they have the opportunity to use that policy in a time of greater need. While this remains up in the air right now, whatever decision is made it will give a strong clue into the Fed’s view of the current situation and just how strongly the economy is actually performing.

This morning’s Factory Orders data (exp 0.3%) is unlikely to have a market impact of any sort. Equity markets have been muted with US futures pointing to essentially an unchanged opening. Yesterday saw limited price action, with both the dollar and equities barely changed. My sense is today will shape up the same way. Tomorrow, however, will be a different story, of that you can be sure.

Good luck
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Doves Are in Flight

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Our central bank’s doves are in flight
As this week the Fed will rewrite
Their previous view
That one hike or two
Was needed to make things alright

Instead as growth everywhere slows
More policy ease they’ll propose
Perhaps not QE
But all will agree
The balance sheet’s size reached its lows

If you were to throw a dart at a map of the world, whichever country you hit would almost certainly be in the midst of easing monetary policy (assuming of course you didn’t hit the ocean.) It is virtually unanimous now that the next move in interest rates is going to be lower. In fact, there are only two nations that are poised to go the other way, Norway and Hong Kong. The former because growth there continues to motor along and, uniquely in the world, inflation is above their target range, most recently printing at 2.6%. The latter is actually under a different kind of pressure, draining liquidity from its economy as there has been a huge inflow of funds driving rates down and pressuring the HKD to the bottom of its band. But aside from those two, its easy money everywhere. Last week the ECB surprised the market by announcing the implementation of a new round of TLTRO’s, rather than just talking about the idea. That was a much faster move than the market had anticipated.

This week it is the Feds turn, where new forecasts and a new dot plot are due. It is widely assumed that economic forecasts will be marked lower given the slowing data picture that has emerged in the US, with the most notable data point being the 20K rise in NFP last month, well below the 180K expected. As such, and given the change in rhetoric since the last dot plot was revealed in December, it is now assumed that the median expectation for FOMC members will be either zero or one rate hikes this year, down from two to three. My money is on zero, with only a few of the hawks (Mester and George) likely to still see even one rate hike in the future.

To me, however, the market surprise will come with regard to the balance sheet reduction that has been ongoing for the past two years. What was “paint drying” in October, and “on autopilot” in December is going to end by June! Mark my words. It is already clear that the Fed wants to stop tightening policy, and despite the claims that the slow shrinkage of the balance sheet would have a limited impact, it is also clear that the impact of reducing reserves has been more than limited. In a similar vein to the ECB acting instead of talking about TLTRO’s last week, look for the Fed to stop the shrinkage by June. There is no right answer to the question, how large should the Fed’s balance sheet be? Instead, it is always seen as a range. However, given the current desire to stop the tightening, why would they wait any longer? If I’m wrong it is because they could simply stop at the end of this month and be done with it, but that might send a panicky message, so June probably fits the bill a bit better.

This is going to hit the market in a very predictable way; a weaker dollar, stronger stocks and stronger bonds. The stock story is easy, as less tightening will continue to be perceived as a boon to earnings and eventually to the economy. Funnily enough, the message to the bond market is likely to be quite different. With 10-year yields already below 2.60% (2.58% this morning), news that the Fed is more concerned about growth is likely to drive inflows, and maybe even help the curve invert. Remember, short end rates are already 2.50%, so it won’t take much to get to an inversion. As to the dollar, while everybody is in easing mode, the new information that the Fed is taking another step will be read as quite dovish and force more long dollar positions to be covered. In the end, I maintain that the situation in the Eurozone remains worse than that in the US, but the timing of announcements and perception of surprise is going to drive the short-term price activity.

Elsewhere in markets, while the China trade talks remain a background story for now, Brexit is edging ever closer. There is still no clear outcome there, although PM May is apparently going to try to get her deal through Parliament again this week. You have to admire her tenacity, if not her success. But here’s an interesting tidbit that hasn’t been widely reported: the vote last week by Parliament to prevent a no-deal Brexit wasn’t binding! In other words, absent an agreed delay by the rest of the EU, Brexit is still going to happen at the end of the month, deal or no deal. Again, my point is that the probability of a no-deal Brexit remains distinctly non-zero, and the idea that the pound has reflected Brexit risk at its current level of 1.32 is laughable. If they can’t figure it out, the pound will go a LOT lower.

Of course, today, there is virtually nothing going on in the FX markets, with G10 currencies all within 0.1% of their closing levels on Friday. Even the EMG bloc has seen limited movement with the Indian rupee the only currency to have moved more than 0.5% all day. The rupee’s strength has been evident over the past three weeks as recent fiscal stimulus has attracted significant investment inflows. But beyond that, nothing.

Away from the Fed, this week is extremely quiet on the data front as well:

Tuesday Factory Orders 0.3%
Wednesday FOMC Interest Rate 2.50%
Thursday Initial Claims 225K
  Philly Fed 4.5
Friday Existing Home Sales 5.10M

And that’s it. After the Fed meeting, there is only one speech scheduled, Raphael Bostic on Friday, but given that Powell will be all over the air on Wednesday, it is unlikely to matter much. So this week shapes up as a waiting game, nothing until the FOMC on Wednesday, and then react to whatever they do. Look for quiet FX markets until then.

Good luck
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All We’ve Endured

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“Legal changes” have now been “secured”
Which, following all we’ve endured
Encouraged the buying
Of pounds, clarifying
The thought that soft Brexit’s assured

In the ongoing game of chicken, otherwise known as the Brexit negotiations, it seems the EU was the one who flinched. Last night, British PM Theresa May returned from a Strasbourg meeting with European Commission President Jean-Claude Juncker after obtaining potentially substantial modifications to the Irish backstop portion of the negotiated deal. If you recall, this has been the sticking point because the twin objectives of first; preventing a hard border between Ireland and Northern Ireland; and second, insuring that if the UK is outside the EU customs union, appropriate tariffs can be collected, and goods inspected were leading to opposite solutions. The Irish backstop was designed to help alleviate British concerns they would be stuck in the customs union forever. However, as it had previously been written, that did not seem to be the case. Now comes some new language, touted as legally binding, that ostensibly insures that the UK can opt out of the customs union if desired. While I am no lawyer, and thus not qualified to give a legal opinion, my reading of the plain language leaves the impression that nothing much has changed.

This morning, the UK Attorney General, Geoffrey Cox, is going over the package and will be giving his far more qualified opinion to Parliament shortly. (**FLASH – GEOFFREY COX SAYS THE LEGAL RISK OF THE NEW IRISH BACKTOP IS UNCHANGED**) The vote on the deal is still scheduled for 7:00pm this evening (3:00pm EDT) although there are some MP’s who would like a one-day delay in order to be able to read and understand it themselves. In the interim, the market has had quite a wild ride. From yesterday morning, when the pound was trading below 1.30, we have seen a more than 2.0% rally which in the past two hours has completely unwound! Thus, 1.2975 => 1.3250 => 1.3015 has been the movement in the past twenty-four hours. It seems the initial euphoria is being replaced by a more skeptical view that these changes will be enough to turn the Brexit tide in Parliament. At this point, it’s a mug’s game to try to forecast the outcome of this vote. The last I saw was that the deal would lose by 50 votes or so, a much better performance than last time, but still a loss. My gut tells me that a hard Brexit is still a possible outcome, and that there is no certainty whatsoever that Parliament will be able to prevent that.

But away from the pound, the only other currency that has shown any real movement has been the Philippine peso, which has declined a sharp 1.65% overnight. This occurred after the new President of the central bank there explained that the peso had strengthened as much as it could and that given low inflation readings, further rate cuts were on the table. At least this market movement makes sense!

Ongoing stories include the US-China trade talks, where there has been no additional progress, at least none publicized. The Chinese remain concerned that any meeting between the Presidents be just a signing ceremony rather than finalizing negotiations as they are worried that President Trump might reject a deal at the final moments with President Xi thus losing face in the process. I am confident we will hear more on this subject in the next days, and the latest signs point to a positive outcome, but here, too, nothing is certain.

The other ongoing story of note is the rapid change of tack by the world’s central banks. At this point in time, there is only one central bank that is remotely hawkish, the Norgesbank in Norway, where inflation has been running above target, and more importantly, has seen a rising trajectory. However, beyond that, the rest of the world is firmly in the dovish camp. In fact, at this point, the question seems to be just how much more dovish they will become as it grows increasingly clear that global growth is slowing rapidly. While there is the odd positive surprise on the data front, the weight of evidence is pointing to further slowing. The problem the ECB and BOJ have is that they have very little ammunition left to fight slowing growth. While the Fed could certainly cut rates if necessary, that would be quite an abrupt turn of events, given it has been barely three months since they last raised them, and would damage their credibility further. And the PBOC definitely has some room, but they continue to fight their battle against overleverage, and so are stuck between the Scylla of slowing growth and the Charibdis of excess debt. In the end, look for Scylla to win this battle.

Turning to the data story, yesterday’s Retail Sales report printed at +0.2%, after a downward revision of the December print to -1.6%. While there was significant disbelief in the December data point when it was first released, it looks like it was real. The most immediate impact was to the Atlanta Fed’s GDP Now tracker, which fell sharply and is now estimating a 0.5% GDP growth rate for Q1. As to today, CPI is due shortly, with the market expecting 1.6% headline and 2.2% core readings. The Fed remains concerned that they have been unable to generate sufficient inflation. Personally, I think we have too much inflation, but that’s just one man’s opinion.

The upshot of all this is that nothing has changed in the big picture with regard to the dollar. While risk has been embraced in the past two sessions, the dollar story remains one of relative monetary policy stances, and in that camp, the Fed reigns supreme, and by extension, the dollar!

Good luck
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Disruption and Mayhem

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Tomorrow when Parliament votes,
According to some anecdotes,
Another rejection
Will force introspection
As well as a search for scapegoats

For traders the story that’s clear
Is Brexit may soon engineer
Disruption and mayhem
And soon a new PM
Who’s not named May just might appear!

As we begin a new week, all eyes remain focused on the same key stories that have been driving markets for the past several months; the Fed, Brexit and the US-China trade talks. Ancillary issues like weakening Eurozone and Japanese growth continue to be reported but are just not as compelling as the first three.

Starting with Brexit this morning, after a weekend of failed negotiations, PM May looks on course to lose the second vote on her negotiated deal. Interestingly, the EU has been unwilling to make any concessions of note which implies they strongly believe one of two things: either the lack of a deal will force a delay and second referendum which will result in Remain winning, or they will be effectively unscathed by Brexit. I have to believe they are counting on the first outcome, as it is a purely political calculation, and in the spirit of European referenda since the EU’s creation, each time a vote went against the EU’s interest (Maastricht, Treaty of Lisbon, etc.) the government of the rejecting country ignored the result and forced another vote to get the ‘right’ result. However, in this case, it appears the EU is playing a very risky game. None of the other referenda had the same type of economic consequences as Brexit, and a miscalculation will be very tough to overcome.

While several weeks ago, it appeared that PM May had been building some support, the latest estimates are for a repeat of the 230-vote loss from late January. The question is what happens after that. And to that, there is no clear answer. The probability of a hard Brexit continues to rise, although many still anticipate a last-minute deal. But the pound has declined for nine consecutive sessions by a total of 3.0% (-0.2% overnight) and unless some good news shows up, has the opportunity to fall much further. The next several weeks will certainly be interesting, but for hedgers, quite difficult.

As to the Fed, last night Chairman Powell was interviewed on 60 Minutes along with former Fed Chairs Bernanke and Yellen. Powell explained that the economy was strong with a favorable outlook and that rates were at an appropriate level for the current situation. When questioned on the impact of President Trump’s complaints, he maintained that the Fed remained apolitical and independent in their judgements. And when asked about the stock market, he essentially admitted that they have expanded their mandate to include financial markets. Given the broad financialization of the economy, I guess this makes sense. At any rate, there is no way a Fed chair will ever describe the economy poorly or forecast lower growth as it would cause a panic in markets.

Finally, turning to the trade talks, the weekend news indicated that there has been agreement over the currency question with the Chinese accepting an effective floor to the renminbi. Although the Chinese denied that there was a one-way deal, they repeated their mantra of maintaining a stable currency. As yet, no signing ceremony has been scheduled, so the deal is not done. However, Chinese equity markets rebounded sharply overnight (after Friday’s debacle) as expectations grow that a deal will be ready soon. It continues to strike me that altering the Chinese economic model is likely to take longer than a few months of negotiations and anything that comes out of these talks will be superficial at best. However, any deal will certainly be the catalyst for a sharp equity rally, of that you can be sure. One other thing to note about China is that we continue to see softening data there. Over the weekend, Loan growth was reported at a much lower than expected CNY 703B ($79.4B), not the type of data that portends a rebound. And early this morning, Vehicle Sales were reported falling 13.8%! Again, more evidence of a slowing economy there.

In the meantime, Friday’s payroll data was a lot less positive than had been expected. The headline NFP number of just 20K (exp 180K) was a massive disappointment, and though previous months were revised higher, it was just by 12K. However, the Unemployment Rate fell to 3.8% and Average Hourly Earnings rose 3.4% Y/Y, the strongest since 2007. Housing data was also positive, so the news, overall, was mixed. Friday saw markets turn mildly negative on the US, with both equities and the dollar under pressure.

Add it all up and you have a picture of slowing global growth with the idea that monetary policy is going to tighten quickly fading from view. The critical concern is that central bankers have run out of tools to help positively impact their economies when things slow down. And that is a much larger long-term worry than a modest slowing of growth right now.

Looking at the data this week, two key data points will be released, Retail Sales and CPI. Here is the full list:

Today Retail Sales -0.1%
  -ex autos 0.2%
  Business Inventories 0.6%
Tuesday NFIB Small Biz Optimism 102.0
  CPI 0.2% (1.6% Y/Y)
  -ex food & energy 0.2% (2.2% Y/Y)
Wednesday Durable Goods -0.7%
  -ex transport 0.2%
  PPI 0.2% (1.9% Y/Y)
  -ex food & energy 0.2% (2.6% Y/Y)
  Construction Spending 0.4%
Thursday Initial Claims 225K
  New Home Sales 620K
Friday Empire Manufacturing 10.0
  IP 0.4%
  Capacity Utilization 78.5%
  Michigan Sentiment 95.5
  JOLT’s Jobs Report 7.22M

So, lots of stuff, plus another Powell speech this evening, but I think Retail Sales will be the big one. Recall, last month, Retail Sales fell 1.2% and nobody believed it. But I have to say the forecast is hardly looking for a major rebound. In the end, though, the US economy continues to be the top performing one around, and while the Fed may no longer be tightening, we are seeing easing pressures elsewhere (RBA, ECB). Today’s price action has shown little overall movement in the dollar, but the future still portends more strength.

Good luck
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At the Nonce

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In Hanoi, the talks fell apart
In London, there’s cause to take heart
The market response
Sell stocks at the nonce
But Sterling looks good on the chart

The Trump-Kim denuclearization talks in Hanoi ended abruptly last evening as North Korea was apparently not willing to give up their program completely although they were seeking full sanctions relief. It appears that many investors were quite hopeful for a better outcome as equity markets across Asia fell as soon as the news hit the tape. Not surprisingly, South Korea was worst hit, with the KOSPI falling 1.5% while the won fell 0.5%. But the Nikkei in Japan fell 0.8% and Shanghai was down by 0.5% as well. In the currency market, the yen, benefitting from a little risk aversion, gained 0.2%, while the renminbi slipped slightly, down just 0.1%

Of course, the US-China trade talks are still ongoing and the big news there was that the US has, for the time being, removed the threat of increased tariffs. It appears that real progress has been made with respect to questions on technology transfer as well as verification of adherence to the new rules. It is surprising to me that this was not a bigger story for markets, although that may well be a sign that a deal is fully priced in already. In the meantime, Chinese data continues to disappoint with the Manufacturing PMI falling to 49.2, its third consecutive print below 50.0 and the weakest number in three years. It certainly appears as though President Xi is feeling real pressure to get a deal done. Of course, the Chinese equity market has had an even more impressive performance than that of the US so far this year, so it may be fair to say they, too, have priced in a deal. While things seem pretty good on this front right now, what is becoming apparent is that any hiccup in this process is likely to result in a pretty sharp equity market correction.

Turning to the UK, it appears that PM May’s game of chicken was really being played with the hard-liners in the Tory party who appeared perfectly willing to leave the EU with no deal. In yesterday’s debates, they were conspicuous by their silence on the subject and the growing belief is that May will be able to get support for her deal (with a side annex regarding the length of the Irish backstop) approved. While this will probably result in a three-month delay before it all happens, that will simply be to ensure that the proper legislation can be passed in Parliament. In another surprising market outcome, the pound has remained unchanged today despite the positive news. As I mentioned yesterday, the pound has rallied steadily for the past several weeks, and it appears that it may have run out of steam for the time being. While an approval vote will almost certainly result in a further rally, I’m skeptical that it has that much further to run. Unless, of course, there is a significantly more dovish turn from the Fed.

Speaking of the Fed, yesterday’s Powell testimony was just as dull as Tuesday’s. Arguably, the most interesting discussion was regarding the “Powell put” as one congressman harped on the concept for much of his allotted time. In the end, Powell explained that financial markets have an impact on the macroeconomy and that the Fed takes into account all those factors when making decisions. In other words, yes there is a put, but they want us to believe that the strike price is not simply based on the S&P 500, but on global markets in general. Given the importance of this comment, it was quite surprising that equity markets yesterday did not rally, but instead fell slightly. And futures are pointing lower this morning. At the same time, the dollar is generally under pressure with the euro rising 0.4% and now trading above 1.14 for the first time in three weeks. The single currency remains, however, right in the middle of its trading range for the past four months. In other words, this is hardly groundbreaking territory.

It is hard to ascribe the euro’s strength to any data this morning, although there has been plenty of that released, because generally it was in line with expectations. But even more importantly, it continues to show there is a lack of inflationary pressure throughout the Eurozone, which would undermine any thoughts the ECB will tighten earlier than now anticipated. Perhaps the one exception to that were comments from ECB member Francois Villeroy who explained that keeping rates negative for too long could have a detrimental impact on transmitting monetary policy properly. While that is certainly true, it has not been seen as a major concern to date.

Turning to this morning’s data story, Q4 GDP growth will finally be released (exp 2.4%) as well as Chicago PMI (57.8). In addition, we hear from six Fed speakers today starting with Vice-Chair Clarida at 8:00 this morning and finishing up with Chairman Powell at 7:00 this evening. However, given we just got two days of testimony from Powell, it is not clear what else they can say that will change views.

Overall, the dollar remains under pressure, and while it rallied during yesterday’s session, it has reversed that move so far this morning. As I have consistently said, the market is highly focused on the Fed’s more dovish turn and so sees the dollar softening. However, as other central banks become more clearly dovish, and they will as slowing growth permeates around the world, the dollar should regain its footing. Probably not today though.

Good luck
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Maybe Once More

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Said Powell, by patient I mean
We won’t rush to raise in ‘Nineteen
Unless prices soar
Then maybe once more
Though not ‘til past next Halloween

To nobody’s surprise, Chairman Powell explained that while the economy in the US is in good shape, given all the other things happening around the world (Brexit, trade situation, slowing Chinese and European growth) it was prudent for the Fed to watch the data carefully before acting to change policy again. Arguably, the market heard this as a confirmation of the now growing dovish bias and so the dollar came under a bit of further pressure. Interestingly, the equity market did not hear the same cooing of doves as it struggled all day ending slightly softer.

When discussing the balance sheet, he indicated that it was a hot topic at the FOMC, and that they were carefully studying the timing of the eventual end of the current policy of QT. But by far, the single most gratifying thing he said was, “It is widely agreed that federal government debt is on an unsustainable path.” He later added, “The idea that deficits don’t matter for countries that can borrow in their own currencies is just wrong.” (my emphasis). This was a none too subtle rebuttal to any thoughts that MMT has any validity. The Senators did not really ask many interesting questions, but today he heads to the House, where a certain freshman representative from the Bronx, NY, is grasping at the idea that as long as the US borrows in dollars, we can always pay them back by printing whatever we need with no consequence. You can be certain that she will spend her entire allotment of time on that particular issue, although I suspect she will not come off looking like she either understands the issues nor will have convinced the Chairman.

At any rate, while the questions are likely to be more entertaining, they will almost certainly not be any more meaningful as today Representatives will get their moments of preening on camera. Certainly nothing has happened between yesterday and today that will have changed the Chairman’s views.

In Parliament there’s a new view
Postponement’s the right thing to do
Three months or one year?
No answer is clear
As both sides, the other, eschew

Turning to the other key market story, Brexit, the only thing that is clear is that it remains extremely confusing. As of this morning, it appears that PM May has changed her tune regarding a delay and is now willing to accept a short one of three months. Her problem is that she has lost so much influence from the continuing morass it is no longer clear she will get what she wants. There now appears to be a growing movement for a longer delay, on the order of nine months, which would give the Bremainers the chance to organize a new referendum. That, of course, is the last thing the hard-liners want, another vote, as it could reverse the outcome. At the same time, all of this is contingent upon the EU agreeing to a delay. Now, they have said they will do so if there is a clear path outlined for what the UK is trying to accomplish, but as is obvious from this discussion, that is not the case.

The market, however, is in the process of reinterpreting the outcome. It appears that the new worst case is seen as acceptance of the already negotiated deal with a small possibility of no Brexit at all. It seems the idea of a hard Brexit is receding from view. We can tell because the pound continues to rally this morning, up another 0.45% today which takes the move to +2.5% since Friday when this chain of events took form. This is the highest the pound has traded since last July, when it was on its way down from the previous bout of optimism. One telling sign of the potential outcome is that the hardest of hard-liners, Jacob Rees-Mogg, has backed down on his adamant demands of the removal of the Irish backstop, instead saying an annex addressing the situation could be acceptable. To me this indicates the hard-liners have lost. While I am no insider, it looks very much to me like there will be a three-month delay and acceptance of the current deal. As to the pound in that case, it will depend if Governor Carney can keep his word regarding concerns over inflation. My view there is that slowing global growth will prevent any further policy tightening, and the pound will quickly run out of Brexit steam.

Elsewhere, data from the Eurozone shows that the economy continues to slow, albeit at a less intimidating rate. A series of Eurozone sentiment and confidence indicators all printed lower than last month, but not quite as low as had been feared expected. But the euro has been the beneficiary of the current focus on Fed dovishness and has been trading higher for the past two weeks. Of course, the extent of that move has been just 1.2%, with the single currency unchanged this morning. So, while the headlines are accurate to say the dollar has been slumping, the reality is that the movement has been quite limited.

Away from those stories, the FX market has seen relatively few events of note. INR is softer this morning by 0.5% after Pakistan’s air force allegedly shot down two Indian fighter jets in an escalation of tensions in the Kashmir region. That may well be weighing on global risk sentiment as well, but not in too great a manner. President Trump’s meeting with Kim Jong-Un has not seemed to impact the KRW, although a positive outcome there would almost certainly help the won significantly. And past that, nada.

On the data front this morning we see Factory Orders (exp 0.5%) and then Chairman Powell sits down in front of the House. The current trend remains for the dollar to soften as the market’s focus continues to be on the Fed turning dovish. As time passes, we will see every central bank turn dovish, and at that time, the dollar is likely to find more support. But for now, a slowly ebbing dollar remains the most likely outcome.

Good luck
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