Tag Archives: #Fed

Percent Twenty-Five

Posted on by

The story, once more’s about trade
As Trump, a new threat, has conveyed
Percent twenty-five
This fall may arrive
Lest progress in trade talks is made

President Trump shook things up yesterday by threatening 25% tariffs on $200 billion of Chinese imports unless a trade deal can be reached. This is up from the initial discussion of a 10% tariff on those goods, and would almost certainly have a larger negative impact on GDP growth while pushing inflation higher in both the US and China, and by extension the rest of the world. It appears that the combination of strong US growth and already weakening Chinese growth, has led the President to believe he is in a stronger position to obtain a better deal. Not surprisingly the Chinese weren’t amused, loudly claiming they would not be blackmailed. In the background, it appears that efforts to restart trade talks between the two nations have thus far been unsuccessful, although those efforts continue.

Clearly, this is not good news for the global economy, nor is it good news for financial markets, which have no way to determine just how big an impact trade ructions are going to have on equities, currencies, commodities and interest rates. In other words, things are likely more uncertain now than in more ‘normal’ times. And that means that market volatility across markets is likely to increase. After all, not only is there the potential for greater surprises, but the uncertainty prevailing has reduced liquidity overall as many investors and traders hew to the sidelines until they have a better idea of what to do. And, of course, it is August 1st, a period where summer vacations leave trading desks with reduced staffing levels and so liquidity is generally less robust in any event.

Moving past trade brings us straight to the central bank story, where the relative hawkishness or dovishnes of yesterday’s BOJ announcement continues to be debated. There are those who believe it was a stealth tightening, allowing higher 10-year yields (JGB yields rose 8bps last night to their highest level in more than 18 months) and cutting in half the amount of reserves subject to earning -0.10%. And there are those who believe the increased flexibility and addition of forward guidance are signals that the BOJ is keen to ease further. Yesterday’s price action in USDJPY clearly favored the doves, as the yen fell a solid 0.8% in the session. But there has been no follow-through this morning.

As to the other G10 currencies, the dollar is modestly firmer against most of them this morning in the wake of PMI data from around the world showing that the overall growth picture remains mixed, but more troubling, the trend appears to be continuing toward slower growth.

The emerging market picture is similar, with the dollar performing reasonably well this morning, although, here too, there are few outliers. The most notable is KRW, which has fallen 0.75% overnight despite strong trade data as inflation unexpectedly fell and views of an additional rate hike by the BOK dimmed. However, beyond that, modest dollar strength was the general rule.

At this point in the session, the focus will turn to some US data including; ADP Employment (exp 185K), ISM Manufacturing (59.5) and its Prices Paid indicator (75.8), before the 2:00pm release of the FOMC statement as the Fed concludes its two day meeting. As there is no press conference, and the Fed has not made any changes to policy without a press conference following the meeting in years, I think it is safe to say there is a vanishingly small probability that anything new will come from the meeting. The statement will be heavily parsed, but given that we heard from Chairman Powell just two weeks ago, and the biggest data point, Q2 GDP, was released right on expectations, it seems unlikely that they will make any substantive changes.

It feels far more likely that this meeting will have been focused on technical questions about how future Fed policies will be enacted. Consider that QE has completely warped the old framework, where the Fed would actually adjust reserves in order to drive interest rates. Now, however, given the trillions of dollars of excess reserves, they can no longer use that strategy. The question that has been raised is will they try to go back to the old way, or is the new, much larger balance sheet going to remain with us forever. For hard money advocates, I fear the answer will not be to their liking, as it appears increasingly likely that QE is with us to stay. Of course, since this is a global phenomenon, I expect the impact on the relative value of any one currency is likely to be muted. After all, if everybody has changed the way they manage their economy in the same manner, then relative values are unlikely to change.

Flash, ADP Employment prints at a better than expected 219K, but the initial dollar impact is limited. Friday’s NFP report is of far more interest, but for today, all eyes will wait for the Fed. I expect very limited movement in the dollar ahead of then, and afterwards to be truthful.

Good luck
Adf

 

A Rate Hike’s in Store

Posted on by

Said Mario Draghi once more
‘Through summer’ a rate hike’s in store
When pressed on the timing
That they’d end pump priming
He gave no more scoop than before

As we await this morning’s Q2 US GDP data (exp 4.1%), it’s a good time to review yesterday’s activity and why the euro has given up the ground it gained during the past week. The ECB left policy on hold, which was universally expected. However, many pundits were looking for a more insightful press conference regarding the timeline that the ECB has in mind regarding the eventual raising of interest rates. Alas, they were all disappointed. Draghi continues to use the term ‘through summer’ without defining exactly what that means. It appears that the uncertainty is whether it means a September 2019 hike or an October 2019 hike. To this I have to say, “are they nuts?” The idea that the ECB has such a precise decision process is laughable. The time in question is more than twelve months away, and there is so much that can happen between now and then it cannot be listed.

Consider that just six months ago, Eurozone growth was widely expected to continue the pace it had demonstrated in 2017, which was why the dollar was weak and falling. But instead, despite a large majority of forecasts pointing to great things in Europe, growth there weakened sharply while growth in the US leapt forward. So here we are now, six months later, with the dollar significantly stronger and a new narrative asking why Eurozone growth has disappointed while US growth is exploding higher. Of course the US story is blamed based on the tax changes and increased fiscal stimulus from the budget bill. But in Europe, we have heard about bad weather, a flu epidemic and, more recently, rising oil prices, but certainly nothing that explains the underlying disappointment. And that was only a six-month window! Why would anyone expect the ECB, who are notoriously bad forecasters, to have any idea what will happen, with precision, in fourteen months’ time?

However, that seems to have been the driving force yesterday, lack of confirmation on the timing of the ECB’s initial rate hike next year. And based on the French GDP data this morning (0.2%, below expectations of 0.3% and far below last year’s 0.7% quarterly average), it seems that growth expectations for the Eurozone may well be missed again. Personally, I am not convinced that the ECB will raise rates at all in 2019. Given the recent trajectory of growth in the Eurozone, it appears we have already seen the top, and that before we get ‘through summer’ next year, the discussion may turn to how the ECB are going to help support the economy with further QE. Given this reality, it should be no surprise that the euro suffered yesterday, and in the wake of the weak French data, that it is still lower this morning, albeit only by an additional 0.15%.

Elsewhere the pound fell yesterday after the EU rejected, out of hand, PM May’s solution for the UK to collect tariffs on behalf of the EU. That basically destroyed her attempt to find a middle ground between the Brexiteers and the Bremainers, and now calls into question her ability to remain in office. In fact, she is running out of time to come up with a deal that has a chance of getting implemented. The current belief is that if they do not agree on something by the October EU meeting, there will not be sufficient time for all 29 members to approve any deal. It is with this in mind that I continue to question the BOE’s concerns over slowing inflation. My gut tells me that if they do raise rates next week, it will need to be reversed by the November meeting after the Brexit situation spirals out of control. The pound fell 0.65% yesterday and is down a further 0.1% this morning. That remains the trend.

Another noteworthy event from Tokyo occurred last night as the BOJ was forced to intervene in the JGB market for the second time this week, bidding for an unlimited amount of bonds at 0.10% in the 5-10 year sector. And this time, they bought ~$74 billion worth. Speculation remain rife that they are going to adjust their QQE program next week, but given the fact that it has been singularly unsuccessful in achieving its aim of raising inflation to 2.0% (currently CPI there is running at 0.2%), this appears to be a serious capitulation. If they change policy without any success behind them, the market is likely to aggressively buy the yen. USDJPY is down 1.7% in the past six sessions, and while it rallied slightly yesterday, it seems to me that USDJPY lower is the most likely future outcome.

Yesterday morning’s overall dollar malaise reversed during the US session and has carried over to this morning’s trade. And while most movement so far this morning is modest, averaging in the 0.1%-0.2% range, it is nearly universally in favor of the buck.

This morning brings the aforementioned GDP data as well as Michigan Sentiment (exp 97.1, down a full point from last month), although the former will be the key number to watch. Yesterday’s equity market session was broadly able to shake off the poor earnings forecast of a major tech firm, and this morning has a different FANG member knocking it out of the park. My point is that risk aversion is not high, so this dollar strength remains fundamental. At this point, I look for the dollar to continue to benefit from the current broad narrative of diverging monetary policy, and expect that we will need to see some particularly weak US data to change that story.

Good luck and good weekend
Adf

 

No Tariffs For Now

Posted on by

Herr Juncker and Trump had their meeting
And what they both claimed bears repeating
No tariffs for now
As both sides allow
The current regime with no cheating

Whew! That pretty much sums up the market reaction to yesterday afternoon’s hastily arranged press conference with President Trump and European Commission President Jean-Claude Juncker. Both were all smiles as they announced that there would be no tariffs imposed at this time while the US and EU begin more serious trade negotiations with an eye toward reducing trade friction in manufactured goods. In addition, Europe would be seeking to purchase more US soybeans and LNG in a good faith effort to reduce the current trade imbalance. And finally, they would be addressing the current US tariffs on steel and aluminum imports from Europe. It can be no surprise that the market reacted quite positively to this news, with equities in the US finishing higher and European markets all performing well this morning. It should also not be that surprising that the euro jumped immediately upon the news, rising 0.25%, although this morning it has given back those gains after both French and German Consumer Confidence data extended their trend declines amid disappointing outcomes.

While it is still anybody’s guess how this will ultimately play out, the news is certainly an encouraging sign that there can be movement in a positive direction on the trade front. The same appears to be true regarding NAFTA negotiations with both Canada and Mexico reconfirming that a trilateral deal is the goal, and apparently making headway toward achieving those aims.

However, the same optimism is nowhere to be found regarding trade relations between China and the US, with no indication that the situation has shown any positive movement. In the meantime, China continues to respond to signs of weakening growth on the mainland, this time by further reducing capital requirements for banks’ lending to SME’s. While the PBOC has not specifically cut rates, generally seen as a broad monetary policy step, these targeted capital requirement and reserve ratio cuts can be very powerful tools for the targeted recipients, allowing them to expand their loan books and driving profits in the banking sector. But no matter how the easing of monetary policy is implemented, it is still easing of monetary policy and will have an impact on both Chinese equity markets and the renminbi’s exchange rate. While the currency weakened, as would be expected, falling 0.5% overnight, the Shanghai composite fell as well, which is somewhat surprising. Although, in fairness, the Shanghai exchange has rallied nearly 8% over the past two weeks, so this could simply be a case of “selling the news.” In the end, especially if the trade situation between the US and China remains fraught, I expect that USDCNY has further to run, and 7.00 remains on the radar.

The other big story this morning is the anticipation of the ECB meeting results, not so much in terms of policy changes, as none are expected, but in terms of the follow-on press conference where Signor Draghi will be asked about the timing of interest rate increases and the meaning of the term “through the summer” which was inserted into the last statement. Analysts have been debating if that means rates could be raised in August or September of next year, or if it implies a longer wait before a rate move. The futures market doesn’t have a full 10bp rate hike priced in until January 2020, significantly past the summer. The other question of note is how the ECB will handle reinvestment of their current portfolio, and whether they will seek to smooth the reinvestment program or simply wait until debt matures before purchasing more. The reason this matters is that their portfolio has a very uneven distribution of maturities, which could lead to more volatility in European Government bond markets if they choose the latter path.

In the end, given that Eurozone data continues to disappoint on a regular basis, it seems that whatever path they choose for rate hikes and reinvestment, it will seek to maintain as much support as possible for now. Other than the Germans, there does not appear to be a strong constituency to aggressively tighten monetary policy, and there are nations, like Italy and Greece, which would much prefer to see policy remain ultra accommodative for the foreseeable future. While the euro has been range trading for the past two months between 1.15 and 1.18, I continue to look for a break lower eventually.

Away from those stories, things have been less interesting. Most of the G10 is trading in a fairly narrow range, with Aussie the laggard, -0.4%, on the back of weaker metals prices. EMG currencies have similarly been fairly quiet with limited movement overall.

Yesterday’s US data showed that the housing market is starting to suffer a bit more consistently as New Home Sales fell to 631K, well below expectations and the lowest level since last October. Adding this to the miss in Existing Home Sales on Monday shows that the combination of still rising house prices and rising mortgage rates is starting to have a more substantial impact on the sector. This morning we see Durable Goods data (exp 3.0%, 0.5% -ex Transport) and the weekly Initial Claims data (215K), which continues to show the strength of the job market. However, regarding US data, all eyes remain on tomorrow’s first look at Q2 GDP, where the range of expectations is broad, from 3.8% to 5.2%, and traders will be trying to parse how the data will impact the Fed’s activities.

In the meantime, US equity futures are mixed this morning with the NASDAQ pointing lower after some weaker than expected earnings guidance from a FANG member, while Dow futures are pointing higher on the back of relief over the trade situation. As to the dollar, I expect that it will see modest weakness overall as positions continue to be adjusted ahead of tomorrow’s key GDP release.

Good luck
Adf

 

Trump’s Latest Tirade

Posted on by

There once was a time when men thought
That trade wars should never be fought
But that was back then
And now those same men
Think trade wars can help votes be bought

However, attacking free trade
By building a tariff blockade
Can open the doors
To currency wars
Just like in Trump’s latest tirade

Jerome Powell’s job got a LOT tougher on Friday, when President Trump not only reiterated his concern over the Fed raising rates and the impact it would have on the economy, (i.e. tapping on the brakes), but on the impact Fed policy is having on the dollar as it continues to rise. The President then called out China, Europe and Japan for manipulating their currencies lower and calling it unfair and a serious problem.

Now put yourself in Powell’s seat. Maintaining Fed independence, and any perceptions thereof is crucial. But so is managing monetary policy as he see’s fit. However, now that Trump has complained about rising US interest rates and the ongoing policy divergence we have seen over the past fifteen months, if the US economy slows and the Fed believes that a change in policy is appropriate, it may look like he is bending to the President’s will. At the same time, if he continues to raise rates because he believes that is appropriate, he will seemingly come under further pressure from the President. As I said, his job got a lot harder. One doesn’t have to be too cynical to believe that Powell and the Fed will continue to raise rates until the economy falters, at which point it will be clearly appropriate for the Fed to ease policy, and there will be no question of the Fed’s independence. Of course, purposely engineering a slowdown or recession doesn’t seem like such a wonderful idea either.

At the same time, the President has just created his fall guy for any bad outcomes in the economy. If things go bad, he blames the Fed and says, ‘I told you this would happen if they raised rates.’ And if everything continues with positive growth, he claims it’s his policies in spite of the Fed that is doing the job.

With that as the lay of the land, it should be no surprise that on the back of Trump’s discussion of currency manipulation, that the dollar fell sharply in Friday’s session. The dollar Index fell 0.75% with almost every major currency rallying. As the Asian session opens this evening, we are seeing some follow through in that price action, with the dollar index down a further 0.2%. JPY is leading the way higher, up 0.45%, but the movement remains widespread.

Interestingly, it appears that most of the punditry have decided that the dollar’s rally is now over. With the President now keen to see the dollar fall, that is what will happen. I, however, disagree with that assessment. At this point, as long as the interest rate divergence continues, I see no reason to believe that traders are going to change their tune. The carry available remains too great a temptation to ignore. In fact, I wouldn’t be surprised if we see the current level of dollar bullishness, as measured by open futures positions, rise over the next several weeks, as traders take advantage of the dollar’s short-term decline to add to positions at better levels. Until we start to see concrete changes in monetary policy (and there is no indication that any other country is going to tighten policy sooner than they otherwise would have), the dollar still holds all the cards. In fact, if the ongoing trade ructions lead to a more significant equity market correction, meaning risk is jettisoned, then the dollar will probably rise further. I will change my views when policy changes, but for now, I see this move as a temporary correction.

There is really no other story in the FX markets right now other than the evolution of the trade war into a currency war. While there will be some data this week, and the ECB meets Thursday, everything we hear will be in a response to Trump’s comments. The G20 arrived at no decisions, which can be no surprise, as they never do. However, all the talk is on the trade cum currency war that is brewing. At this point, given the ECB is not going to change anything, (perhaps they will refine their rate message more specifically, but I doubt it), it is headline roulette until the Fed meets next month. And even then, there is no expectation of a move until September, so really we are beholden to the headlines for now. I wish I could give more guidance than that, but let’s face it; nobody knows what will happen there.

Good luck
Adf

I’m Not Thrilled

Posted on by

Said President Trump, “I’m not thrilled”
With how Chairman Powell’s fulfilled
Both job and price mandates
By raising Fed Fund rates
‘Cause soon the Dow Jones could get killed

“I’m not thrilled. I don’t like all of this work that we’re putting into the economy and then I see rates going up. I am not happy about it. But at the same time I’m letting them do what they feel is best.” So said President Trump in an interview on CNBC yesterday afternoon. It should be no surprise that the FX market response was immediate, with the dollar reversing earlier gains.

While this is not the first time that a US president has tried to persuade the Federal Reserve to cut rates (they never want higher rates, I assure you!), it is the first time since George H.W. Bush pushed then Chairman Greenspan to reduce rates more quickly in 1992 (he didn’t). This is a situation fraught with serious consequences as the independence of a nation’s central bank is seen as one of the keys to a developed economy’s success. For instance, recall just several weeks ago when Turkey’s President Erdogan essentially took over making monetary policy there, and how the market has behaved since, with TRY already significantly weaker.

As long as the Fed remains on course to continue raising rates, and despite the Trump comments, Fed Funds futures showed no change in the probability for two more rate hikes this year, I see little reason to change my stance on the dollar’s future strength. However, the bigger problem is if the Fed, independently, decides that slowing the pace of rate hikes is justified by the data, it could still appear to be politically motivated, and so reduce whatever credibility the Fed still maintains. This will remain a background story, at the very least, for a while. So far, there is no indication that Chairman Powell is going to change his stance, which means that policy divergence remains the lay of the land.

In the meantime, the other big FX story comes from China. We discussed yuan weakness yesterday and in the overnight session, the PBOC fixed the onshore currency at its weakest point in more than a year, which in fairness is simply following the dollar’s overall strength, but then when USDCNY made new highs for the year above 6.83, a large Chinese state-owned bank was seen aggressively selling dollars. This tacit intervention helped to steady the market and worked to support the Shanghai Stock Exchange as well, which ultimately rose 2.0% on the day. It is, however, difficult to follow all the twists and turns in the US-China relationship these days, as literally minutes ago, President Trump raised the ante yet again, by saying that he is “ready to go” with regard to imposing tariffs on $500 billion of Chinese goods. That represents all Chinese exports to the US and is considerably larger than ever mentioned before.

Tariffs and protectionism have a very poor history when it comes to enhancing any country’s economic situation, but it is very possible that this continuous ratcheting of pressure may actually be effective at achieving policy changes in this situation as China has plenty of domestically created economic problems already. Recall, President Xi has been on the warpath about excess leverage and the PBOC had been tightening policy in order to squeeze that out of the system. However, growth in China has suffered accordingly, and the recent data indicates that it may be slowing even more. With that in mind, a full-scale trade war with the US would likely be disastrous for China. The last thing they can afford is to see reduced production numbers, as well as loss of access to critical component and technology imports. It is not impossible that Xi blinks first, or that the two presidents recognize that a face-saving deal is in both their interests. It may take a little while, but I have a sense that could well be the outcome. However, until then, look for USDCNY to continue to rally sharply, with a move to 7.00 and beyond very viable. This morning, despite the intervention overnight, it has subsequently weakened 0.4% and shows no signs of stopping.

Finally, one last story has returned from the past to haunt markets, Italy. There appeared to be a push by Five-Star leader, Luigi di Maio, to have the Finmin, Giovanni Tria, removed from office. You may recall that back in May, things got very dicey in Italy before the current government was finally formed as President Mattarella rejected the first proposed cabinet because of the Euroskeptic proposed for the FinMin post. Tria was the compromise selection designed to calm markets down, and it worked. So, if he were forced out, and it has been denied by the Finance Ministry that is the situation, it could lead us right back into a euro area crisis. This is especially true since the populist coalition of the League and Five-Start has gained further strength in the interim. While Italian bond markets suffered on the news, it was not sufficient to impact the euro much. However, we need to keep an eye on this story as it could well resurface in a more malevolent manner.

And that is really today’s situation. Overall the dollar is mildly weaker, but given its performance all week, that has more to do with profit taking on a Friday than other news. Clearly the Trump comments undermined the dollar to some extent, but until policies are seen changing, I think that will only be a temporary situation. With no data due this morning, and no speakers on the agenda, it has all the feelings of a quiet day upcoming. It is, after all, a Friday in July, so the summer doldrums seem appropriate.

Good luck and good weekend
Adf

 

Weaker Yuan Now Abided

Posted on by

Apparently China’s decided
Their strong money stance was misguided
So look for, ahead
More easing instead
And weaker yuan now abided

Arguably, the biggest story in the FX markets overnight was the sharp decline in the Chinese yuan. For the first time in more than a year, the PBOC set the fixing rate for the dollar above 6.70, which seemed to signal a willingness to allow the currency to fall much further. As I type, the offshore version is trading near 6.80, having fallen 0.8% on the session. As I have discussed over the past months, even absent the trade situation, there are ample reasons to see the renminbi decline further. However, it now seems likely that the ongoing trade dispute with the US is starting to have a bigger impact on the Chinese economy (remember we already saw weak data last week) and that a simple response is to allow the currency to fall.

The trade dispute with the US has come at a bad time for China. They have been tightening liquidity standards for the past two years in an effort to reduce leverage in their economy and the housing bubbles that resulted. But now, the slower growth precipitated by that policy combined with restrictions on their exports is forcing that policy to be reconsidered. So far the PBOC has not actually cut rates, but they have reduced bank reserve requirements by one full percent and encouraged significantly more lending to SME’s. However, in the end, given their still mercantilist economy, a weaker currency is likely to be the best policy available for their conflicting goals of less leverage and strong growth. I’m beginning to think that 7.00 is a conservative estimate for USDCNY at year-end. What is abundantly clear is that there will be further weakness in the near term.

Meanwhile, Carney’s plan to raise rates
In August is in dire straits
The data keeps showing
That UK growth’s slowing
My bet now is he hesitates

This morning’s UK Retail Sales data was the last big data point of the week, and completed a picture of an economy that is not expanding quite so rapidly as had been previously thought. While things aren’t as dire as the Q1 data implied, Retail Sales fell -0.5% in Jun with the -ex fuel number -0.6%. Both were significantly lower than forecast and added to the softer inflation and wage growth data seen earlier this week. As such, none of this data really supports the idea that the BOE needs to raise rates next month, despite a clearly articulated desire by Governor Carney to do so. The problem he faces, along with many other central bankers, is that policy rates remain at emergency settings deep into a recovery, and the concern now is that they won’t have any policy tools available when the next downturn comes. In other words, they are out of ammo and need to reload, which means they need higher policy rates. But if the data don’t warrant that stance, they run the risk of causing a recession in order to be able to fight one. It is an unenviable position, but one that they brought upon themselves with their gigantic monetary policy experiment. When the softening data trend is added to the ongoing Brexit uncertainty, I have a hard time seeing a rationale for the BOE to move next month. The market continues to price a >70% probability, but I think that will ebb over the next few weeks.

One thing that is not surprising is that the pound has fallen below 1.30, down a further 0.6% this morning (and 2.0% on the week) and is now trading at its lowest level since last September. While it no longer appears that PM May is going to be ousted, it does seem as though the odds of the UK leaving the EU with no deal in place are growing shorter. I continue to look for the pound to fall further.

Away from those two stories, yesterday brought the second day of Chairman Powell’s Congressional testimony, this time to the House Financial Services Committee. The comment getting the most press has been “[the rate setting committee] believes that, for now, the best way forward is to keep gradually raising” rates. The idea is that the highlighted words are a strong indication that the Fed remains policy dependent, and so will carefully evaluate the situation at each meeting. That said, expectations remain that they will raise rates in September and December, and that data would need to be significantly worse, or the trade dispute clearly become a bigger problem, to change that view.

In the end, those Fed expectations should continue to support the dollar. In fact, the dollar has rallied pretty sharply across the board this morning, with the Dollar Index up 0.5%. That breadth of strength is indicative of the fact that the market continues to expect divergent monetary policies between the US and the rest of the world for now. We will need to see much weaker US data to change that view, and the dollar’s trajectory.

This morning brings the last data of the week, with Initial Claims (exp 220K), Philly Fed (21.5) and Leading Indicators (0.4%). We also hear from Fed Governor Randall Quarles, although given that we just got two days of Powell, it is hard to believe that he will be saying something different. While yesterday’s Housing data was disappointing, it was not enough to change any views on the US economy, especially given that Housing Starts is a known volatile series, and so easily dismissed. It is hard to view the current market and economic situation without concluding that the dollar’s rally has further to go. Hedgers keep that in mind, especially as you begin to look at your 2019 exposures.

Good luck
Adf

 

Gone Terribly Wrong

Posted on by

Said Powell, the ‘conomy’s strong
And hence we’ll keep moving along
Our rate-raising path
Until the bond math
Proves that we’ve gone terribly wrong

The dollar responded by soaring
In markets no one would call boring
The question, of course
Is will the Fed force
The rest of the world to trade-warring?

The dollar is much stronger this morning after a combination of things helped underpin the current theme of the US economy leading global growth. Yesterday Chairman Powell was certainly upbeat, calling the US economy quite strong and indicating that the Fed, while not on autopilot, believes that their current path of gradual rate increases is the correct one. When pressed on how the current trade issues would impact the Fed’s actions, Powell demurred indicating that it was still too early to know what would occur. He did, however, highlight that historically nations that were open to trade fared better economically than those that chose a different, more protectionist path. After his testimony, the dollar turned in a solid performance rising 0.5% vs. the euro, 1.0% vs. the pound and 0.3% vs. the yen. The greenback’s strength was also evident in the emerging market space with USDCNY rising 0.3% by the end of the day. But that was yesterday and we are more interested in what is happening today.

The economic news of note this morning comes from the UK, where CPI failed to rise as expected and printed at 2.4%. The market’s immediate response was to sell the pound off further, another 0.7%, as futures markets reduced the probability that the BOE will raise rates next month. While that probability is still a touch over 70%; that is down 10 points from yesterday’s estimates. Obviously, despite the extremely low levels of interest rates in the UK (the base rate is 0.75%) and despite a continued robust employment picture, inflation in both wages and goods remains quiescent. In other words, the case for the August rate hike remains somewhat suspect, and that is before the discussion of the impact of Brexit. Speaking of Brexit, the Parliamentary maneuvers are apparently becoming quite rough as PM May is fighting to hold onto power. Apparently, though she won several key votes today, the tactics used resulted in some very hard feelings amongst MP’s on both sides of the aisle and could well result in less ability for the PM to continue in power going forward. In the end, given the recent data releases and the potential for Brexit to lead to a full-blown political crisis in the UK, it is still difficult for me to believe that the BOE moves next month. I feel like the combination of reaffirmation by the Fed and the disintegrating case in the UK means the pound is soon going to breach 1.30 and start to trade at much lower levels.

But it was not just the UK where inflation data disappointed, the EU also saw final CPI data for June released and the core number was revised downward to 0.9%, although the headline number of 2.0% was reaffirmed. While one data point will not be enough to change views, there is no question that Signor Draghi will have an increasingly difficult time remaining confident that inflation will be converging on the ECB’s target of ‘close to but below 2.0%.’ And remember, oil prices, which have been supporting the headline number, are now falling sharply, so it would not be surprising to see Eurozone CPI data print still lower next month. In the end, I continue to look for the euro to break its recent trading range to the downside. This morning has helped my cause with the euro declining a further 0.4% on top of yesterday’s fall.

But the story is similar everywhere in the world. Disappointing Chinese data has helped to twist the PBOC into tighter knots as they seek to reduce excess leverage in the economy while supporting growth. As I have highlighted time and again, the renminbi is going to be the relief valve for this process and is almost certain to head to 7.00. Of course, another key risk here is that President Xi decides that the only way to combat the mooted $200 billion of US tariffs is to actively weaken the currency, which would result in a much larger move, and likely one that was far less smooth. All I’m saying is that for those with CNY exposure, care must be taken. Paying the points to hedge here is, I believe, a very prudent step at this time.

Looking at today’s session, in addition to the second leg of Chairman Powell’s testimony, this time to the House Financial Services Committee, we see Housing Starts (exp 1.32M) and Building Permits (1.30M) at 8:30. However, all eyes will be on Powell to see if he has anything else to add to yesterday’s bullish sentiment. The data story continues to underpin my view that the dollar has further to run against all its counterparts. Today should not prove any different than yesterday.

Good luck
Adf

 

Waiting For Jay

Posted on by

The markets are waiting for Jay
To testify later today
The hawks are excited
As they feel united
More hawkishness he will convey

Yesterday’s Retail Sales data was the latest data point highlighting the US economy’s continued robust expansion. The 0.5% headline gain matched expectations, but it was the revision higher of last month’s 0.8% reading (which if you recall was much higher than expectations then) to 1.3% that really got tongues wagging. Several analysts raised their expectations for Q2 GDP to above 5.0% in the wake of the report, although the market response seems somewhat puzzling. Both equity and bond markets yesterday were essentially flat, oil prices tumbled more than 4% and the dollar was slightly softer. Arguably, after robust data, one would have expected higher stocks, higher bond yields (lower prices) and a stronger dollar. This should serve to remind everyone that while trends remain in place, there is rarely a one-for-one reaction from data to market prices.

However, what the data does accomplish is paint a picture of a still quite strong economy as a backdrop to Chairman Powell’s testimony to the Senate Banking Committee later this morning. If we have learned one thing about Powell, it is that he is willing to use plain English to describe his views, rather than couch those views in the obfuscation of economic jargon. But perhaps far more importantly, he consistently reminds his audience that there are many important concepts (e.g. the neutral interest rate or the natural rate of unemployment, NAIRU) that are not observable and where the Fed relies on estimates from its models. And while these variables are seen as critical to the PhD set, Chairman Powell recognizes that they cannot be used to fine tune the economy. It is this trait that sets Powell apart from his recent predecessors, and I personally believe, in a good way. At any rate, while the prepared remarks are fairly neutral in tone, there is a growing belief that the Q&A is likely to lean hawkish when it comes to monetary policy questions. However, I imagine that there will also be a significant amount of preening by certain Senators when they lambaste the Fed’s actions regarding banks and the recent stress tests. In fact, my sense is that he will not get to speak too much about the economy, and as such, I don’t expect his testimony to have much market impact at all.

With that said, there is certainly nothing from the recent data that would indicate the Fed is about to slow down its tightening, and the market is now pricing a 62% probability of two more rate hikes this year. In the end, this remains dollar supportive in my view.

Moving on to another economy that seems to be getting ready to tighten policy, UK employment data was released this morning and it was quite strong yet again. The Unemployment Rate remained at its 42-year lows of 4.2%, as 137K more jobs were created in the past three months. Not only that, but Average Earnings at 2.7% continue to print above recent inflation, resulting in real wage gains and a further clue that the UK economy, despite the ongoing Brexit drama and uncertainty, remains fairly solid. Certainly the market expects Governor Carney to raise rates next month, with futures pricing in a greater than 80% probability at this time, and so we will have to see some much weaker data on Q2 GDP or inflation later this week to change that view. The pound has benefitted this morning, edging up a further 0.1%, which makes about 0.5% of gains over the past four sessions. Not that inspiring, but at least logical today.

Overall, the dollar is marginally lower this morning, although it is a mixed picture vs. individual currencies. For example, MXN is weaker by 0.7% on the back of the decline in oil prices with RUB similarly lower by 0.4%. However, other currencies have shown modest strength vs. the dollar, notably CHF, INR and NZD, each with their own idiosyncratic story. The point is there is no overriding theme in the FX market this morning.

One thing I think worth pointing out is that the yen has recently lost some of its safe haven luster. Ever since the financial crisis, the yen had become seen as a haven in the face of market turmoil, rallying when nervousness was evident. I have always thought that characterization misplaced. Prior to the crisis, being short yen to fund other assets was a hugely prevalent position, known as the carry trade. When those assets started to decline sharply during the crisis, all that we saw was those carry trades unwind, which, by definition, included yen purchases. Investors weren’t indicating they preferred yen to other assets; they were closing outstanding positions. But the haven narrative stuck and so we have lived with it for a decade now. Perhaps we are finally coming round to a period where that narrative will diminish, and old havens, notably the dollar and gold, will make a comeback. Certainly the dollar is holding up its end of the bargain overall, so my sense is that gold may not be too far behind if we see another market disruption. In the meantime, the yen has fallen 0.2% this morning and is actually trading back at its lowest level since early January. It would not be surprising to see further yen weakness over the coming months, especially if my thesis on the haven issue is true.

Before we hear from the Chairman, Capacity Utilization (exp 78.3%) and IP (0.6%) are to be released. However, unless something extraordinary prints there, I expect that markets will remain quiet until Powell starts. At that point, it is all up to him.

Good luck
Adf

 

The Beast of the East

Posted on by

This weekend the data released
By China showed growth had decreased
Investment has slowed
And that doesn’t bode
Too well for the Beast of the East

It has been a fairly quiet session overnight, as the weekend news cycle seems to have reverted back toward the summer doldrums of the past. While traders and investors remain on edge over the brewing trade conflict between the US and China, and how that may impact the rest of the world, the only actual news was Chinese data out last night.

It can be no surprise that the GDP figure, at 6.7%, was exactly as forecast [Woe betide the statistician in China who releases a GDP number less than President Xi declares], but it was somewhat surprising that both IP (6.0%) and Fixed Asset Investment (6.0%) were both released at levels softer than expected, and more importantly, at the softest levels in 15-20 years. Given that it is too early for the trade situation to have impacted the Chinese data, the most likely situation is that even the Chinese are beginning to recognize that growth on the mainland is set to slow further. In fairness, China has made a big deal about their pivot away from mercantilist policies to a more domestically focused economy, and given that Retail Sales (9.0%) were actually slightly firmer than expected, perhaps they are moving in that direction. However, unlike most developed countries, China’s domestic consumption is only around 50% of the economy (it is between 70% and 80% for OECD nations), and so that modestly better performance is not likely to be enough to maintain the growth trajectory that Xi wants over time.

In the end, though, there was only limited market reaction to the news, with Chinese equity markets slightly softer (Shanghai -0.25%) and the renminbi, though initially falling slightly, has since rebounded and is firmer by 0.3% as I type. Of course, in context, the dollar is softer across the board this morning with most major currencies appreciating by a similar amount.

Aside from the Chinese news, there was precious little of interest to drive trading. Oil prices have been sliding as Saudi Arabia has agreed to pump more oil and the US and other nations are considering tapping their strategic reserves in an effort to lower prices. Earnings season is underway with continued high hopes for US companies and less robust ones for the rest of the world. However, US equity futures are barely higher at this time, <0.1%, indicating a wait-and-see attitude has developed. And rounding things out, Treasury yields have edged higher by about 1bp although they remain well below levels seen back in May.

Pivoting to the data for the week, it is a mixed bag, with arguably the most important events Chairman Powell’s testimony to the Senate on Tuesday and House on Wednesday.

Today Empire Manufacturing 22
  Retail Sales 0.5%
  -ex autos 0.4%
  Business Inventories 0.4%
Tuesday Capacity Utilization 78.3%
  IP 0.6%
  Powell Testimony  
  TIC Flows $34.3B
Wednesday Housing Starts 1.32M
  Building Permits 1.333M
  Powell Testimony  
  Fed Beige Book  
Thursday Initial Claims 220K
  Philly Fed 22

However, we cannot ignore Retail Sales this morning, which is seen as a descriptor of the current economic situation. This has been one of the highlights of the economic story in the US, especially in the wake of the tax cuts and stimulus spending bills at the beginning of the year.

As long as growth in the US continues above its estimated long term trend (which is often pegged just below 2.0%), the Fed is going to continue to tighten policy via both rate hikes and a shrinking balance sheet, and the dollar should remain relatively well bid. While there is a case to be made that added fiscal stimulus at this stage in the economic cycle is a mistake (classical economics indicates tighter fiscal policy is warranted), there is no mistaking that the US economy remains the key engine of growth for the world, and that as the Fed tightens policy further, the dollar is set to benefit more.

Good luck
Adf

Dashing Hopes

Posted on by

Said Trump when he landed in London
Your Brexit deal needs to be undone
Because as it stands
We’ll never shake hands
On trade, dashing hopes ere they’ve begun

On Thursday, PM Theresa May has had yet another trying day. President Trump came to town and wasted no time skewering her recently outlined Brexit framework indicating that if the UK heads down her preferred road (you remember, trade in goods to remain within the EU umbrella, but services to be wide open) that the US would not be able to sign a free trade deal. Trump’s point, albeit indelicately made, is that a comprehensive trade deal with the UK will be impossible because the EU will be involved. And, as you may remember, Trump has several issues with the way the EU approaches trade. This was a terrible blow to May because she has clearly been counting on a deal with the US to help offset the changed status with the EU.

It should be no surprise that the pound did not take the news well and as I type, it is lower by 0.6% today and 1.7% this week. And this is despite the fact that Governor Carney virtually promised to raise rates at next month’s BOE meeting. We are still a long way from any resolution on the Brexit situation, and I continue to believe that uncertainty over the outcome will weigh on Pound Sterling. The pound remains some 12.5% below its levels prior to the Brexit vote two years ago. While it is still well clear of the lows seen at the beginning of last year (1.2000 or so) given my belief that there will be no Brexit deal signed, I expect that the market will return to those lows over time. Higher rates or not, confidence in the UK right now is somewhat lacking.

The other big news overnight was the Chinese data releases that showed that the trade surplus rose sharply to $41.6 billion with the US portion rising to a record $29 billion. This may be a timing issue with many companies anxiously shipping product ahead of the imposition of tariffs. But it also could simply reflect that the Chinese economy is slowing down, thus import growth is ebbing, while the US economy continues to power ahead and lead the global economy. In the end, I am certain that the Trump administration will look at these numbers and feel further justification in their stance on trade.

But on top of the trade data, Chinese Money Supply growth continues to ebb, a sign that economic activity on the mainland is slowing. Other indications of a Chinese slowdown are that the government’s campaign to reduce excess leverage seems to have gone into reverse. There have been several stories about how Beijing is now looking for local governments to insure they spend allocated money rather than worry about cutting back on new allocations. It seems that there is a growing fear that real GDP growth (not necessarily what is reported) is slipping more quickly than President Xi is prepared to accept. With this in mind, it is no surprise that the renminbi is under further pressure this morning, down 0.45%, and is now trading back at levels not seen since last August. And it has further to fall. I expect that we will be testing 7.00 before the year is over.

One last noteworthy item was yesterday’s CPI release, where headline CPI printed at 2.9%, its highest since 2012, and the ex food & energy number printed at 2.3%. What this tells us is that wage gains are barely keeping up with inflation, and so consumers are not really benefitting from the recent modest uptick we have seen there. We heard from both Chairman Powell and Philly President Harker yesterday and both indicated they were comfortable with the Fed’s current trajectory. Both also indicated that while the trade situation has not yet impacted the economy in any meaningful way, they could foresee how that might come about and cause the Fed to rethink their strategy. As of now, I remain in the four hikes this year camp, and will need to see a substantial change to the economic data to change that view.

Turning to the overnight FX performance, the dollar has continued its recent uptrend, rising against almost all its counterparts in both the G10 and the EMG. In fact, the dollar has risen every day this week, completely unwinding last week’s decline. There was a modest amount of data from the Eurozone, all pointing to the ongoing lack of inflation in the region, which continues to undermine the ECB’s case to normalize policy quickly. We also continue to see issues throughout emerging markets with TRY, for example, plummeting 6% this week as the market responds to President Erdogan’s cabinet moves. Remember, he installed his son-in-law as FinMin and ousted all the market friendly ministers in the cabinet. As I have written before, this currency has much further to fall.

Meanwhile, US equity markets continue to power ahead, well at least the big tech names continue to do so and that has been sufficient to drive the averages higher overall. However, market breadth continues to narrow which is always an ominous trend. Treasury yields have been stable in the 10-year space, but the 2-year continues to march higher and that spread is down to 26bps, edging ever closer to inversion. While I believe that the signaling effect this time is not quite the same due to the massive distortions in bond markets brought about by QE, I am in a minority view there.

In the end, the big trends remain intact, which means to me that the dollar is going to continue its march higher. Hedgers keep that in mind as you start to think about your 2019 hedging needs.

Today’s only data is Michigan Sentiment (exp 98.2) and then we hear from Atlanta Fed President Rafael Bostic. But given what we just heard from Harker and Powell (and Brainerd and Williams earlier in the week), there is no indication that the Fed is going to change its tune in the near future. The trend is your friend, and right now that trend is for the dollar to continue to rally.

Good luck and good weekend
Adf