Just How He Feels

On Wednesday the Chairman reveals
To all of us, just how he feels
If dovish expect
Bulls to genuflect
If hawkish, prepare for some squeals

This is an early note as I will be in transit during my normal time tomorrow.

On Friday, the dollar continued its early morning rebound and was generally firmer all day long. The worst performer was the British pound, which fell more than 1.0% after Friday’s note was sent. It seems that the Brexit story is seen as increasingly tendentious, and much of the optimism that we had seen develop during the past three weeks has dissipated. While the pound remains above its lowest levels from earlier in the month, it certainly appears that those levels, and lower ones, are within reach if there is not some new, positive news on the topic. This appears to be an enormous game of chicken, and at this point, it is not clear who is going to blink first. But every indication is that the pound’s value will remain closely tied to the perceptions of movement on a daily basis. Hedgers need to be vigilant in maintaining appropriate hedge levels as one cannot rule out a significant move in either direction depending on the next piece of news.

But away from the pound, the story was much more about lightening positions ahead of the weekend, and arguably ahead of this week’s FOMC meeting. The pattern from earlier in the week; a weaker dollar along with higher equity prices around the world and higher government bond yields, was reversed in a modest way. US equity markets closed slightly softer, the dollar, net, edged higher, and 10-year Treasury yields fell 2bps.

The big question remains was the dollar’s recent weakness simply a small correction that led to the other market moves, or are we at the beginning of a new, more significant trend of dollar weakness? And there is no easy answer to that one.

Looking ahead to this week shows the following data will be released:

Tuesday Case-Shiller House Prices 6.2%
  Consumer Confidence 312.2
Wednesday New Home Sales 630K
  FOMC Decision 2.25%
Thursday Initial Claims 208K
  Goods Trade Balance -$70.6B
  Q2 GDP 4.2%
Friday PCE 0.2% (2.3% Y/Y)
  Core PCE 0.1% (2.0% Y/Y)
  Personal Income 0.4%
  Personal Spending 0.3%
  Chicago PMI 62.5
  Michigan Sentiment 100.8

So clearly, the FOMC is the big issue. It is universally expected that they will raise the Fed funds rate by 25bps to 2.25%. The real question will be with the dot plot, and the analysis as to whether the sentiment in the room is getting even more hawkish, or if the CPI data from two weeks ago was enough to take some of the edge off their collective thinking, and perhaps even change the median expectations of the path of rate hikes. I can virtually guarantee you that if the dot plot shows a lower median, even if it is because of a change by just one FOMC member, equity markets will explode higher around the world, the dollar will fall and government bond yields will rise. However, my own view is that the data since we have last heard from any Fed speaker has not been nearly soft enough to consider changing one’s view. Instead, I expect a neutral to hawkish statement, and a little pressure on equities.

But the big picture narrative does seem to be starting to change, and so any dollar benefit is likely to be short lived. Be ready to hear a great deal more about the structural deficits and how that will force the dollar lower. One last thing, tariffs on $200 billion of Chinese imports go into effect on Monday, which will only serve to add upward pressure to inflation data, and ultimately keep the FOMC quite vigilant. I remain committed to the idea that the cyclical factors will regain their preeminence, but it just may take a few weeks or months for that to be apparent. In the meantime, look for the dollar to slowly slide lower.

Good luck
Adf

A Terrible Day

The UK’s Prime Minister May
Last night had a terrible day
Her plans for a deal
Were seen as unreal
As hawks in the EU held sway

But elsewhere the market’s embraced
The concept that fear was misplaced
Instead, stocks they’re buying
And so, fortifying
The idea, for risk, they have taste

Arguably, the key headline this morning was the extremely poor reception British PM May received from her 27 dinner companions at the EU dinner last night. She continues to proffer the so-called Chequers deal (named for the PM’s summer residence where the deal was agreed amongst Tory members several weeks ago), which essentially says the UK will toe the EU line when it comes to manufactured and agricultural goods, but wants a free hand in services and immigration. French President Macron was quick to dismiss the notion as he remains adamant that leaving the EU should be seen as a disaster, lest any other nations (Italy are you watching?) consider the idea. At any rate, while the pound had been rallying for the past week, reaching its highest level since early July, that all came a cropper last night. The growing hope that a Brexit deal would be found has been shattered, at least for now, and it should be no surprise that the pound has suffered for it. This morning, it is leading the way lower, having fallen 0.6% from yesterday’s closing levels.

However, while the dollar is modestly firmer this morning across the board, my strong dollar thesis is being severely tested of late. We have seen the dollar fall broadly all week despite the resumption of the march higher in US yields. Or is it because of that movement that the dollar is falling? Let’s consider the alternatives.

Several months ago I wrote about the conflicting cyclical and structural aspects of the market that were impacting the dollar’s value. The cyclical factors were US growth outpacing the rest of the world and the Fed tightening monetary policy faster than any other central bank. This combination led to higher US rates and a better investment environment in the US than elsewhere, and consequently, an increase in dollar buying for global investors to take advantage of the opportunities. Thus higher short-term interest rates led to a higher US dollar, along with a flatter yield curve.

On the other hand, the structural questions that hang over the US economy consist of the impact of late cycle fiscal stimulus in the form of both tax cuts and increased spending. The fact that this was occurring at the same time the Fed was reducing the size of its balance sheet meant that at some point, it seemed likely that increased Treasury supply would find decreased demand. The growing budget and current account deficits would in turn pressure the dollar lower while the excess Treasury supply would push long-term yields higher ending up with a weaker dollar and a steeper yield curve.

Starting in April, it became clear that the cyclical story was the primary market driver, with strong US growth pushing up short-term rates as well as US corporate earnings. Investors flocked to the US to take advantage with the dollar rallying sharply while US equity markets significantly outperformed their foreign counterparts. This was especially notable in the EMG space, where a decade of QE had forced funds to the highest yielding assets they could find, which happened to be those EMG markets. But now that there was an alternative, those funds were quick to return to the US, driving EMG equity markets lower and hammering those currencies as well. There was also a great deal of concern that if the divergence in markets continued, it could result in much more significant losses elsewhere that would eventually come back to haunt US markets.

But a funny thing happened last week, US CPI printed lower than expected. Now you might not think that a 0.1% miss on a number would be that important, but essentially what that signaled to markets was that the Fed would be more likely to ease back on the pace of tightening, thereby slowing the rise in the short-term interest rate structure. It also indicated that US growth may not be as robust as had been previously thought, and therefore, opportunities here, while still excellent, needed to be weighed against what was going on elsewhere in the world. At the same time, elsewhere in the world we have seen continued central bank rhetoric about removing policy accommodation, with ECB President Draghi’s press conference seen as mildly hawkish, while the BOJ seems to be in stealth taper mode. We have also seen the trade situation get pushed to the back of the collective market’s mind as the US imposed a lower tariff rate than expected on Chinese goods, and has not yet moved forward on any other tariffs.

But wait, there’s more!, after four months of selling off, EMG assets have suddenly started to look like they represent a ‘value’ play, with the first buyers tentatively dipping their toes back into those markets. And finally, remember that the speculative long dollar position has been building for months and reaching near record levels. Adding it all up leads to the following conclusion: there is room for the dollar to continue this decline in the medium term. Continued fund movement into EMG markets combined with the reduction of the long dollar positions will be more than sufficient to continue to drive the dollar lower.

That combination is what has taken place this week, and despite the break today, it seems quite viable that we will continue to see this pattern for a bit longer. In the end, I don’t think that the market will completely ignore the cyclical dollar prospects, but for now, the broad structural story is holding sway. Add to this the idea that market technicians are going to get excited about selling dollars because it has reached levels below the 50-day and 100-day moving averages, and thus is ‘breaking out lower’, and we could be in for a couple of months of dollar weakness. If this is true, while individual currencies could still underperform, like the pound if the Brexit situation collapses, it is entirely possible that Chairman Powell could find himself in the best position he could imagine, continuing to remove policy ease while the dollar falls, thus ameliorating the President’s concerns. But it’s not clear to me that is such a good thing overall. We shall see.

Good luck and good weekend
Adf

Money More Dear

Next week, though it’s certainly clear
The Fed will price money more dear
The dollar’s incurred
Some selling and spurred
More weakness than seen since last year

The dollar remains under pressure this morning with a number of stories having a separate, but a cumulative impact on the buck. For example, overnight we learned that New Zealand’s GDP grew 1.0% in Q2, higher than the expected 0.7% outcome, and sufficient to get investors and traders to consider that the RBNZ, which just last month promised to maintain record low interest rates until at least 2020, may wind up raising rates sooner than that. A surprise of this nature usually leads to currency strength and so it is this morning with NZD higher by 0.8%.

Or consider the UK, where Retail Sales data surprised one and all by rising 0.3% in August (3.3% Y/Y), a much better performance than expected. This was enough to overcome the ongoing Brexit malaise and drive the pound higher by 0.7% and back to its highest level in two months. In truth, this is somewhat surprising given the quite disappointing outcome from the EU meeting Wednesday night in Brussels. Rather than more positive remarks about the viability of a deal being completed, we heard more of the hard-core negativity from the French and Irish, basically saying if the UK doesn’t cave, then there will be no deal. This is certainly not a welcome outcome, especially since there are only 190 days until Brexit will occur, deal or no. Meanwhile, PM May continues to fight a rearguard action against the avid pro-Brexiters in her party in order to retain her position.

Logically, I look at the situation and believe there is no real chance of a satisfactory deal being agreed on time. Frankly, the Irish border issue is intractable in my view. But given that this is entirely about politics, and the Europeans and British are both famous for kicking the can down the road, I suspect that something along the lines of a pure fudge, with neither side agreeing anything, will be achieved in order to prevent a complete disaster. However, there is a very real probability that the UK will simply leave the EU with no deal of any sort, and if that is the case, the initial market reaction will be for a sharp sell-off in the pound.

Interestingly, despite the fact that the little Eurozone data released was on the soft side, the euro has managed to continue its recent rally and is higher by 0.4% as I type. This seems more of a piece with the general dollar weakness that we have witnessed the past two sessions than anything else.

Another potential conundrum is US interest rates, where 10-year Treasury yields jumped to 3.08% yesterday, their highest level since early May, and now gathering momentum for the breakout that many pundits have been expecting for a while. Remember, short Treasury futures are one of the largest positions in the market. This thought process has been led by two concurrent features; the Fed continues to raise short term rates while the Treasury, due to increased fiscal policy stimulus and a growing budget deficit, will be forced to increase the amount of debt issued. When this is wrapped up with the fact that the Fed is reducing the size of its balance sheet, thus removing the one true price-insensitive bid from the market, it seemed a recipe for much higher 10-year yields. The fact that we remain at 3.08% nine months into the year is quite surprising, at least to me. But it is entirely possible that we see a much more aggressive sell-off in Treasuries going forward, especially if the Fed tweaks their message next week to one that is more hawkish.

In this context, let me give a concrete example of just how important the central bank message really is. This morning, Norgesbank raised interest rates in Norway by 25bps, as was universally expected. This was the first time in 7 years they raised rates, and are doing so because the economy there is expanding rapidly while inflation moves closer to their target. But in their policy discussion, they reduced the forecast pace of future interest rate hikes, surprising everyone, and the result was a sharp decline in NOK. Versus the euro it fell more than 1%, which translated into a 0.7% decline vs. the dollar. The point is the market is highly focused on the policy statements as well as the actual moves.

This is equally true, if not more so, with regard to the Fed. Current expectations are that the Fed will raise rates 25bps next week and another 25bps in December. Where things get cloudier is what next year will look like, and how fast they will continue to tighten policy. It is for this reason that next week’s meeting is so widely anticipated, because the Fed will release its updated dot plot, the effective forecasts of each Fed member as to where Fed funds will be at various points in the future. If the dot plot implies higher rates than the last iteration in June, you can expect the dollar to benefit from the outcome. Any implication of a slower pace of rate hikes will certainly undermine the dollar.

In the end, the mixture of new information has been sufficient to push the dollar lower by 0.3% when looking at the broad dollar index. Interestingly, despite its recent weakness, it remains within the trading range that has defined its movement since it stopped appreciating in April. Frankly, I expect this range trading to continue unless the Fed significantly changes its tune.

This morning brings a bit more data with Initial Claims (exp 210K) and Philly Fed (17.0) due at 8:30 while Existing Home Sales (5.35M) are released at 10:00. Yesterday’s housing data was mixed with New Home Sales rising more than expected, but Building Permits plunging. And remember that both of those data points tend to have a great deal of volatility. With that in mind, looking at the longer term trend shows that while Housing Starts seem to be rebounding from a bad spot, the trend in Permits is clearly downward, which doesn’t speak well for the housing market in the medium term.

In the end, as I wrote yesterday, continued modest dollar weakness seems the most likely outcome for now, but I suspect that we are coming to the end of this soft patch, and that the dollar will find its legs soon. I remain confused as to why there is so much bullishness attached to the Eurozone economy given the data continues to underperform. And there is no indication that the ECB is going to suddenly turn truly hawkish. Current levels strike me as attractive for dollar buyers.

Good luck
Adf

 

Rate Hikes to Condone

Today’s UK data has shown
The pace of price rises has grown
Surprising most folks
And likely to coax
Mark Carney, rate hikes to condone

The British pound is outperforming today, currently up 0.35%, as the market responds to a higher than expected inflation reading released this morning. CPI printed at 2.7%, well above the 2.4% consensus view and perhaps signaling that UK inflation, after a summer reprieve, is set to return to its post-Brexit peak of 3.1%. This has traders increasing their estimates of rate activity by the BOE, starting to price in tighter policy despite the ongoing uncertainty created by Brexit. As such, it should not be too surprising that the pound is firmer.

But the pound is by no means alone in its performance characteristics this morning, with the dollar weaker against virtually all comers. In fact, only two of the G10 bloc has suffered today, CHF (-0.45%) and JPY (-0.1%), the two haven currencies. The implication is that risk-taking is back. Certainly equity markets have been holding up their end of that bargain, with US markets strong performance yesterday feeding into strength throughout most of APAC last night led by Shanghai’s 1.1% gains and the Nikkei’s 1.0% rally. European shares, however, have seen a less positive reaction, as they are up at the margin, but only a few basis points, with some markets, notably Italy, actually suffering. (Italy, however, is feeling the effects of the imminent budget deadline with no cogent plan in place and significant differences between the government’s election promises and the fiscal restraint imposed by the EU.) But the other haven asset of note, US Treasuries, has also sold off, with the 10-year yield now trading at 3.05%, its highest level since late May. All told, despite the ongoing trade tensions, it seems that market participants are increasingly comfortable adding to their risk profiles.

More proof of this concept comes from the huge leveraged debt financing completed yesterday by Blackstone Group, where they borrowed $13.5 billion to purchase 55% of a Thompson-Reuters data company called Refinitiv (who comes up with these names?) At any rate, despite ratings of B- by S&P and Caa2 by Moody’s, and a leverage ratio of between 7x and 8x of EBITDA, the deal was massively oversubscribed with yields printing at, for example, 8.25% for 8-year unsecured notes, down from an initial expectation of 9.00%. High leverage, covenant lite debt is all the rage again. What could possibly go wrong?

But I digress. Back in the currency world, the dollar’s weakness has manifested itself in the EMG bloc as well as G10. For example, despite a softer than expected inflation reading from South Africa, where the headline fell to 4.9% while core fell to 4.2%, the rand is firmer by 1.8% this morning. The story here is confusing as some pundits believe that the central bank may be forced to raise rates in order to help protect the rand, which despite today’s rally is still lower by 10% this year. We have seen this type of behavior from Russia, India and Indonesia, three nations where domestic concerns have been outweighed by their currency’s weakness. However, there is a large contingent that believe the SARB will stay on the sidelines as they seek to encourage growth ahead of the presidential elections scheduled for the middle of next year.

It is not just the rand, however, that is showing strength today, but a broad spectrum of EMG currencies. These include MXN (+0.35%), INR (+0.45%), TRY (+1.5%), RUB (+0.5%) and HUF (+0.25%); as wide a cross-section as we are likely to see. In other words, this has much more to do with broad trends than specific data or stories. And with that in mind, it is hard to fight the tape.

It has become increasingly clear that most markets have made peace with the idea that the trade situation is not going to improve in the short run. Next week the US will impose 10% tariffs on $200 billion of Chinese imports and the administration is already preparing its list for an additional $267 billion of goods to be taxed. No economist believes that this will enhance the pace of growth; rather the universal assumption is that global growth will slow amid this process. And yet investors and traders have simply decided to ignore this outcome, with a large contingent explicitly declaring that they believe these are simply negotiating tactics and that there will be no long-term impact. While I hope they are correct, I fear this is not the case, and that instead, we are going to see this process carry on for an extended period of time, driving up prices and inflation and forcing the Fed to tighten policy more than currently priced by markets. If I am correct, then the likelihood of a significant repricing of risk is quite large. But again, that is only if I am correct.

As to today’s session, we see our first real data of the week with Housing Starts (exp 1.23M) and Building Permits (1.31M) as well as the reading on the Current Account (-$103.5B). But with risk-on today’s theme, these data would have to be drastically weak, sub 1.0M, to have an impact. Instead, it appears that the dollar will remain under pressure today, and perhaps through the rest of the week into next as the market awaits the Fed rate hike next week, and more importantly the statement describing their future views. Until then, this seems to be the theme.

Good luck
Adf

 

Things Went Awry

A decade has passed since the day
That Lehman collapsed all the way
It sank several banks
And brought us Dodd-Frank
In effort to curb foul play

And during those ten years gone by
A number of things went awry
Some xenophobes won
And they’ve overrun
Attempts, good ideas, to apply

The upshot is markets worldwide
Have started to feel the downside
Of higher Fed rates
While there are debates
If euros or dollars will slide

Despite a number of ongoing stories that may ultimately impact markets, notably the US-China trade situation, Italian budget discussions and Brexit negotiations, movement overnight in the FX market has been benign. This morning, the broad dollar index is lower by about 0.25%, with most G10 currencies having strengthened by similar amounts, but the EMG bloc remains under pressure with TRY (-1.5%), INR (-0.75%), KRW (-0.5%) and ZAR (-0.5%) all leaning in the other direction. However, when stepping back to get perspective, the situation can fairly be summed up by saying EMG currencies have been weakening pretty consistently for the past six plus months, while the G10 has barely moved at all since the end of May when the dollar’s sharp rise came to a halt.

Given the relatively uninteresting state of markets this morning, and the fact that there is virtually no data of note until Wednesday this week, I thought I might take a short retrospective look at how things have changed since the financial crisis ten years ago.

Remarkably, last Friday was the tenth anniversary of Lehman Brothers bankruptcy filing. The ensuing ten years has brought about significant changes in the way markets behave, regulators oversee things and investors approach the process. Arguably, the bigger question is what will the next ten years look like. And while there is no way to be sure, there do seem to be several trends that have further to run.

The hardest thing to understand is how a debt fueled crisis resulted in policies designed to increase debt further. While during the immediacy of the extremely deep recession in 2009 there were few complaints about central bank policy trends, which were seen as emergency measures, the first eyebrows were raised when interest rates went negative in Sweden, and then followed throughout Europe and then finally in Japan. But even that would likely have been seen as generally reasonable if the interest rate cycle had been of a more normal duration. Instead, central bankers around the world collectively decided that expanding global money supply inexorably for ten years was the prudent thing to do. Consider that despite global growth chugging along at about 3.5%, global money supply has risen more than 100% since 2008, which means it has grown at nearly an 8% annual clip. As evidenced by the large gap between economic and monetary growth, it is clear that some great portion of that new money found a home outside the ‘real’ economy.

In fact, it is this situation that has defined market activity since 2008, while simultaneously confusing half the economic community. That money has found a home in global debt and equity markets, causing massive inflation there, while only trickling into the real economy and thus allowing measured price inflation, like CPI or PCE, to remain subdued. Most market analysts understood this concept within months of the process beginning, but mainstream economists and policymakers claimed to be puzzled by the lack of inflation, and so were willing to maintain ‘emergency’ policy for ten years, despite rebounding global growth. Now, clearly through this period there were areas in the world that had slowdowns (notably Europe in 2011 and China in 2015), but the idea that flooding the market with funds and then leaving them in place for nigh on ten years was economically prudent seems hard to swallow.

And of course, there were real consequences to these actions, not simply numeric arguments. Income and wealth inequality exploded, as those already rich were the main beneficiaries of the global stock and bond market rallies. At the same time, lower skilled labor found themselves under enormous pressure from a combination of technological improvements in production, reducing the demand for labor and globalization increasing the supply of labor. In hindsight, it should be no surprise at all that we have seen a significant increase in the number of nationalists being elected around the world, especially in the G10. After all, it is much easier to demonize foreign workers than industrial robots, especially since they don’t vote.

The thing is that while the Fed has, at least, made some strides to finally reduce the money supply, both raising rates and allowing their balance sheet to actually shrink, they remain the only central bank doing so. And even though the ECB is slowing its QE purchases, they are still adding funds, while both China and Japan continue to add money to the system indefinitely. Current forecasts show that global money supply will not start to shrink until the end of next year at the earliest based on current policy trajectories and expectations. However, that makes the heroic assumption that when money supply starts to shrink, financial markets will be unaffected. And that seems highly unlikely given how crucial those excess funds have been to financial market performance for the past decade.

Summing up, the Lehman bankruptcy triggered a global crisis that was built on excessive leverage, notably in the US housing market. The crisis response was to cut short-term interest rates dramatically while flooding the markets with cash in order to drive down long-term interest rates. The consequences of this policy, which was repeated around the world once the Fed led the way, was a massive rally in both equity and fixed income markets, and a modest rebound in economic growth. Financial engineering became the norm (issue cheap debt to repurchase shares and drive up EPS and stock prices while increasing balance sheet leverage), whereas R&D and Capex shrank in comparison. The dollar, meanwhile, initially rallied sharply as a safe haven, and despite periodic bouts of weakness, it has continued its long-term uptrend, thus pressuring export industries to move production offshore. And the result of all that economic and financial change has been the rise of nationalist political parties around the world as well as significant pressure on the global free trade movement amongst nations.

There is a great irony in the fact that for many years after the crisis, central bankers were terrified of global deflation, and sought aggressively to push inflation higher. Well, now they have done so in spades, and it will be quite interesting to see how they respond to this more traditional monetary phenomenon. As the Fed continues on its current policy path, we are seeing an increasing number of EMG central banks forced to raise rates as well, despite suspect economic growth, as inflation is breaking out all over the bloc. Friday saw Russia raise rates in a surprise, and all eyes are on Brazil and South Africa this week. My fear is that ten years of emergency monetary accommodation has left the world in a precarious position, one where the future will see even bigger problems than the crisis ten years ago. Ask yourself this, how will global markets respond to a debt “jubilee”, where debt is simply erased from the books and investors are left in the lurch? Don’t think it can’t happen.

And with that as a backdrop, let’s quickly look ahead to a very limited week of data as follows:

Today Empire Manufacturing 23.0
Tuesday TIC Flows $65.1B
Wednesday Housing Starts 1.23M
  Building Permits 1.31M
Thursday Initial Claims 210K
  Philly Fed 16.5
  Existing Home Sales 5.36M

With the FOMC meeting next week, all eyes are going to turn in that direction. While expectations are universal for a 25bp rate hike, the question is how hawkish or dovish will they sound. The interesting thing is that recent comments by Fed speakers have been far more focused on the potential of the ongoing trade issues to negatively impact the economy. (Secretly I believe that they are actually quite happy with this as if things turn south they will be able to blame someone else and the market will accept that explanation.) At any rate, the data of late has been mixed, with the wage data showing stronger than expected growth, while CPI was actually soft. Given the dearth of important data this week, I expect that the dollar will continue its recent wishy-washy performance, with some days of modest rallies and some days of modest declines, but no new trend evolving.

Good luck
Adf

A Charade

The news there was movement on trade
Twixt China and us helped persuade
Investors to buy
Though prices are high
And it could well be a charade

We also learned wholesale inflation
Was lower across the whole nation
Thus fears that the Fed
Might still move ahead
Aggressively lost their foundation

The dollar is little changed overall this morning, although there are a few outlier moves to note. However, the big picture is that we remain range bound as traders and investors try to determine what the path forward is going to look like. Yesterday’s clues were twofold. First was the story that Treasury Secretary Mnuchin has reached out to his Chinese counterpart, Liu He, and requested a ministerial level meeting in the coming weeks to discuss the trade situation more actively ahead of the potential imposition of tariffs on $200 billion of Chinese imports. This apparent thawing in the trade story was extremely well received by markets, pushing most equity prices higher around the world as well as sapping a portion of dollar strength in the FX markets. Remember, the cycle of higher tariffs leading to higher inflation and therefore higher US interest rates has been one of the factors underpinning the dollar’s broad strength.

But the other piece of news that seemed to impact the dollar was a bit more surprising, PPI. Generally, this is not a data point that FX traders care about, but given the overall focus on inflation and the fact that it printed lower than expected (-0.1%, 2.8% Y/Y for the headline number and -0.1%, 2.3% Y/Y for the core number) it encouraged traders to believe that this morning’s CPI data would be softer than expected and therefore reduce some of the Fed’s hawkishness. However, it is important to understand that PPI and CPI measure very different things in somewhat different manners and are actually not that tightly correlated. In fact, the BLS has an entire discussion about the differences on their website (https://www.bls.gov/ppi/ppicpippi.htm). The point is that PPI’s surprising decline is unlikely to be mirrored by CPI today. Nonetheless, upon the release, the dollar softened across the board.

This morning, however, the dollar has edged slightly higher, essentially unwinding yesterday’s weakness. As the market awaits news from three key central banks, ECB, BOE and Bank of Turkey, traders have played things pretty close to the vest. Expectations are that neither the BOE or the ECB will change policy in any manner, and in fact, the BOE doesn’t even have a press conference scheduled so there is likely to be very little there. As to Draghi’s presser at 8:30, assuming there is no new guidance as expected, questions will almost certainly focus on the fact that the ECB staff economists have reduced their GDP growth forecasts and how that is likely to impact policy going forward. It will be very interesting to hear Draghi dance around the idea that softer growth still requires tighter policy.

But certainly the most interesting meeting will be from Istanbul, where current economist forecasts are for a 325bp rate rise to 22.0% in order to stem the decline of the lira as well as try to address rampant inflation. The problem is that President Erdogan was out this morning lambasting higher interest rates as he was implementing new domestic rules on FX. In the past, many transactions in Turkey were denominated in either USD or EUR (things like building leases) as the financing was in those currencies, and so landlords were pushing the FX risk onto the tenants. But Erdogan decreed that transactions like that are now illegal, everything must be priced in lira, and that existing contracts need to be converted within 30 days at an agreed upon rate. All this means is that if the currency continues to weaken, the landlords will go bust, not the tenants. But it will still be a problem.

Elsewhere, momentum for a Brexit fudge deal seems to be building, although there is also talk of a rebellion in the Tory party amongst Brexit hardliners and an incipient vote of no confidence for PM May to be held next month. Certainly, if she is ousted it would throw the negotiations into turmoil and likely drive the pound significantly lower. But that is all speculation as of now, and the market is ascribing a relatively low probability to that outcome.

FLASH! In the meantime, the BOE left rates on hold, in, as expected, a unanimous vote, and the Bank of Turkey surprised one and all, raising rates 525bps to 24.0%, apparently willing to suffer the wrath of Erdogan. And TRY has rallied more than 5% on the news, and is now trading just around 6.00, its strongest level since late August. While it is early days, perhaps this will be enough to help stabilize the lira. However, history points to this as likely being a short reprieve unless other policies are enacted that will help stabilize the economy. And that seems a much more daunting task with Erdogan at the helm.

Elsewhere in the EMG bloc we have seen both RUB and ZAR continue their recent hot streaks with the former clearly rising on the back of rising oil prices while the latter is responding to a report from Moody’s that they are unlikely to cut South Africa to a junk rating, thus averting the prospect of wholesale debt liquidation by foreign investors.

As mentioned before, this morning brings us CPI (exp 0.3%, 2.8% Y/Y for headline, 0.2%, 2.4% Y/Y for core). Certainly, anything on the high side is likely to have a strong impact on markets, unwinding yesterday’s mild dollar weakness as well as equity market strength. This morning we hear from Fed governor Randy Quarles, but he is likely to focus on regulation not policy. Meanwhile, yesterday we heard from Lael Brainerd and she was quite clear that the Fed was on the correct path and that two more rate hikes this year were appropriate, as well as at least two more next year with the possibility of more than that. So Brainerd, who had been one of the most dovish members for a long time, has turned hawkish.

All in all, traders will be focused on two things at 8:30, CPI and Draghi, with both of them important enough to move markets if they surprise. However, the big picture remains one where the Fed is the central bank with the highest probability of tightening faster than anticipated, while the ECB, given the slowing data from Europe, seems like the one most likely to falter. All that adds up to continued dollar strength over time.

Good luck
Adf

 

Their Canard

At last both the Germans and Brits
Realized, nations both, would take hits
If Brexit was hard
So now their canard
Is claiming, details, they’ll omit

The tone of the market changed early yesterday afternoon when a story hit the tape about Brexit indicating that both sides had moved closer to finding an agreement. While some might say this is simply a muddle-through effort (and I would be one of those) the facts seem to be that both sides are willing to move forward with far less specificity than had previously been demanded. In a nutshell, the prior stance had called for a Brexit agreement that was explicit as to the solutions for things like the Irish border issue when the UK leaves the EU. In essence, while both sides agree a transition period is necessary, the EU especially, was demanding to know the details of how things would eventually fall out. Of course, the UK couldn’t discuss those given the amount of internal dissention amongst the May government on the issue. But now, the Germans have said that those details could wait until after the March 2019 exit, and that the future trade agreement can be negotiated in more detail then. This opens the door for a more wishy-washy Brexit agreement, which is likely the only type that can be approved by both the UK Parliament and the EU’s 28 other members.

The market impact was immediate with the pound gapping higher by 1% when the story was released, and although it has given back a portion of those gains, it remains higher overall today. The euro, too, jumped at the same time, albeit not quite as far, with an immediate bump of 0.5%, most of which it has retained. The real question, though, seems to be; is this a temporary situation, or has there been a fundamental change in the FX market?

Certainly there is a valid argument that a positive turn in the Brexit negotiations should lead to further pound strength. After all, while the dollar has appreciated a solid 6% against a basket of currencies since April, the pound has fallen more than 10% over that time. It is not unreasonable to assume that the difference is attributable to the steadily deteriorating views on a positive Brexit outcome. If the Brexit situation becomes less fraught, then a rebound in the pound would be a natural outcome. While one day does not make a trend, we will watch this closely going forward.

But aside from the news on Brexit, the main theme in the markets continues to be the ongoing meltdown in EMG currency and equity markets. Yesterday saw some of the worst behavior we have witnessed in this move, and the term contagion was bandied about in many analyses. This morning, things have settled down a bit, and actually we are seeing several of the worst hit currencies claw back a small portion of recent losses. For example, ZAR, which had fallen nearly 6.0% yesterday, is higher by 0.75% this morning. MXN, which lost 2.5% yesterday at its worst, has since regained about half of that with 0.5% coming this morning. Meanwhile, both TRY and ARS, the leaders of the pack when it comes to collapsing currencies, are both higher by a bit over 1% this morning. Of course, relative to their 20+% declines in the past month, this is small beer. However, the point is that the market feels far more stable this morning than yesterday’s situation.

Despite this morning’s stability, though, the broader issues remain. I assure you that neither Turkey nor Argentina have solved their macroeconomic problems. Inflation remains rampant in both nations and will continue to do so for a while. India, Brazil and Indonesia still have large C/A deficits and the Fed has not yet changed its tune. They will raise rates by 25bps later this month, and the odds are still quite high they will do so again in December. This tells me that today’s price action is a breather as traders and investors prepare themselves for tomorrow’s payroll report. Remember, one of the things we learned from Powell’s Jackson Hole speech was that the Fed is closely watching the data and has concerns about an overheating economy. If tomorrow’s data shows higher than expected hourly earnings, or a dip to 3.7% Unemployment, those could well be the signals that add urgency to their tightening process.

Meanwhile, looking ahead to the rest of the US session, we get quite a bit of data as follows:

ADP Employment 190K
Initial Claims 214K
Nonfarm Productivity 3.0%
Unit Labor Costs -0.9%
Factory Orders -0.6%
ISM Non-Manufacturing 56.8

This week’s ISM data was very strong, and the Trade Deficit has blown out as US growth outpaces that of pretty much every other developed nation. So as far as the data story goes, there is no reason to believe that the Fed is going to pause in the near term, despite concerns over the shape of the yield curve. And given that stance, I remain a firm believer in the dollar’s potential. Until the Fed changes its tune, I see no reason to change mine.

Good luck
Adf