Tag Archives: #FX

Ere Brexit’s Birthday

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The UK Prime Minister May
Is seeking an outcome one day
Where Europe realizes
That some compromises
Are needed ere Brexit’s birthday

It has been a painfully quiet FX market overnight with very limited new information crossing the tapes. Lately, the biggest market moves have been seen in the Turkish lira, which after falling nearly 5% yesterday has rebounded just under 2% today. The thing is that Turkey’s importance in the broad scheme of the market is so marginal, it is tiresome to mention too frequently. And let’s face it; as long as President Erdogan is running things, this situation is unlikely to improve.

Arguably the only other noteworthy story overnight is the continued angst in the UK over International Trade Secretary, Liam Fox’s comments about the increasing probability of a hard Brexit. Certainly the analyst community all jumped on the bandwagon yesterday with regard to the discussion, but in the end, there is still precious little movement in the negotiations. There was a Bloomberg article this morning that was quite disconcerting, at least if you want to see a deal put in place. It basically hypothesized that PM May was counting on an increased willingness by the EU to compromise in order that the bloc may show a unified stance to President Trump at the G20 meeting scheduled for November in Buenos Aires. That seems pretty thin gruel for negotiating tactics and doesn’t sound like a winning play to me, but then I’m not a politician.

Reviewing the key issues outstanding, I still don’t see how the Irish border situation can be resolved effectively. Northern Ireland demands that there is no ‘hard’ border between themselves and Ireland, but as that will now be the only land border between the UK and the EU, something will be necessary to insure the proper movement of people and goods between nations. (Perhaps they can use the Shrodinger’s Cat model, where the border simultaneously does and doesn’t exist until someone looks to cross it.) In effect, one side is going to have to cave in, and right now, neither side is willing to do so. As long as this remains the case, I maintain that a hard Brexit is the most likely outcome and that the pound has further to fall.

But away from that, there is just not much to discuss. The dollar, overall, is slightly softer, giving back some of its recent gains, but that remains trading activity not news driven movement. Data has been sparse with soft German IP offset by ongoing strong trade data the most noteworthy Eurozone prints. The RBA left rates on hold, as universally expected, although perhaps the statement was seen as a bit more hawkish than anticipated as the Aussie dollar is actually today’s top performer in the G10, rising 0.6%. But after that, there is nothing to note.

And quite frankly, the only thing on the calendar this morning in the US is the JOLTs Jobs Report, which is simply going to show that the employment situation in the US remains quite strong. But we know that already and it was reconfirmed last Friday with the payroll report.

All told, it is shaping up to be an uninspiring day in the FX markets. Given we have seen some pretty steady strength in the dollar for the past week, I wouldn’t be surprised to see this morning’s mild weakness extend further. But I wouldn’t read any long-term thoughts into a day with low volumes where prices are correcting.

Good luck
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Turning To Fearing

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The deadline for Brexit is nearing
And hoping is turning to fearing
No deal’s yet in sight
But both sides delight
In claiming that they’re persevering

This morning, the two stories that have captured the FX market’s attention are Brexit and its impact on the pound and Chinese policy changes and their impact on the yuan.

Starting in the UK, the pound is under pressure this morning, down 0.55%, as comments from International Trade Secretary, Liam Fox, have rattled traders. According to Fox, the odds that there is no Brexit deal have now risen to 60%, certainly enough to qualify as “uncomfortably high”, Governor Carney’s description last week in his comments following the BOE meeting. It appears that both sides remain committed to their positions and there has been very little movement from either London or Brussels of late. Meanwhile, in the UK, the politics of the situation has resulted in the new favorite pastime of guessing who will replace PM May when she finally loses a no-confidence vote. And while March 31 is the technical deadline, the reality is that if there is no agreement in place by October, it is likely to be too late. Remember that once an agreement is reached, it needs to be enacted into law by all the nations in the EU as well as the UK, with any one of them able to derail the process. Last year I posited that the odds of reaching a deal were extremely low. I believe this is exactly what is playing out now.

The consequences for the pound are unlikely to be pretty. I expect that we will see pressure continue to increase as it becomes clear that there is no deal forthcoming. So unlike the market action right after the initial Brexit vote in June 2016, where the pound fell more than 10% overnight, and shed another 10% in the ensuing four months, I expect that this will be steady downward pressure, although the net 20% decline cannot be ruled out. After all, there will be no announcement that talks have ended, merely a lack of progress to be seen. Consider that a further 20% decline from here will put the historic low level of 1.06, set back in 1985, on the radar. And while that may well be too pessimistic, it remains extremely difficult to make a bullish pound case at this time. Unless we see a negotiating breakthrough in the next month or so, hedgers need to be prepared for a much lower pound over time.

Turning to China, late Friday night the PBOC imposed a new restriction on FX trading by reinstituting a 20% reserve requirement against short yuan forward positions. The idea here is that Chinese banks will not be willing to allocate the funds necessary to maintain those positions, and therefore will not allow clients to sell CNY forward. In 2015, during the last CNY devaluation, when capital outflows really gathered pace, this was one of the tools that the PBOC employed to stem the yuan’s weakness. What this tells me is that despite the rhetoric from the government about the trade situation and their willingness to tough it out, there is growing concern that if USDCNY reaches 7.00, citizens will start to become much more aggressive in their efforts to reduce their exposure to the yuan, and flee to other, safer currencies. Ironically, given what has started this process, this includes the dollar as well as the yen and Swiss franc. As is typical of the Chinese, they announced this change late Friday night when markets were closed. And while the initial market reaction to the news in China’s morning was for the yuan to strengthen a bit, that strength has reversed and USDCNY is now higher by 0.25%. If 7.00 is truly the pain point, I fear we are going to see some fireworks before the end of the summer.

Beyond those two stories, the dollar is firmer overall, but there is less specificity than it simply being a strong dollar day. The euro is lower by 0.25% after German Factory Orders fell a much worse than expected -4.0%, taking the Y/Y level negative for the first time in two years. But given the breadth of the dollar’s strength this morning, I would argue the euro would have declined no matter the number. As the trade rhetoric continues apace, I expect the dollar to remain well bid against all comers.

Turning to the data this week, it is far less interesting than last week’s onslaught, but we do end the week with CPI.

Tuesday JOLT’s Job Openings 6.646M
  Consumer Credit $16.0B
Thursday Initial Claims 220K
  PPI 0.2% (3.4% Y/Y)
  -ex food & energy 0.2% (2.8% Y/Y)
Friday CPI 0.2% (3.0% Y/Y)
  -ex food & energy 0.2% (2.3% Y/Y)

Beyond the inflation data, we have only two Fed Speakers, and given the continued strong run of data, it remains hard to believe that we will hear any new dovishness by anyone. I am hard-pressed to derive a scenario that leads to significant dollar weakness in the short run. Until the US data turns, I believe that the Fed will continue to tighten policy and that the dollar will benefit. And that seems likely to last through at least the end of the year.

Good luck
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Uncomfortably High

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Said Carney, exhaling a sigh
The odds are “uncomfortably high”
More pain will we feel
If there is no deal
When England waves Europe bye-bye

Yesterday the BOE, in a unanimous decision, raised its base rate by 25bps. This outcome was widely expected by the markets and resulted in a very short-term boost for the pound. However, after the meeting, Governor Carney described the odds of the UK leaving the EU next March with no transition deal in hand as “uncomfortably high.” That was enough to spook markets and the pound sold off pretty aggressively afterwards, closing the day lower by 0.9%. And this morning, it has continued that trend, falling a further 0.2% and is now trading back below 1.30 again.

By this time, you are all well aware that I believe there will be no deal, and that the market response, as that becomes increasingly clear, will be to drive the pound still lower. In the months after the Brexit vote, January 2017 to be precise, the pound touched a low of 1.1986, but had risen fairly steadily since then until it peaked well above 1.40 in April of this year. However, we have been falling back since that time, as the prospects for a deal seem to have receded. The thing is, there is no evidence that points to any willingness to compromise among the Tory faithful and so it appears increasingly likely that no deal will be agreed by next March. Carney put the odds at 20%, personally I see them as at least 50% and probably higher than that. In the meantime, the combination of ongoing tightening by the Fed and Brexit uncertainty impacting the UK economy points to the pound falling further. Do not be surprised if we test those lows below 1.20 seen eighteen months ago.

This morning also brought news about the continuing slowdown in Eurozone growth as PMI data was released slightly softer than expected. French, German and therefore, not surprisingly, Eurozone Services data was all softer than expected, and in each case has continued the trend in evidence all year long. It is very clear that Eurozone growth peaked in Q4 2017 and despite Signor Draghi’s confidence that steady growth will lead inflation to rise to the ECB target of just below 2.0%, the evidence is pointing in the opposite direction. While the ECB may well stop QE by the end of the year, it appears that there will be no ability to raise rates at all in 2019, and if the current growth trajectory continues, perhaps in 2020 as well. Yesterday saw the euro decline 0.7%, amid a broad-based dollar rally. So far this morning, after an early extension of that move, it has rebounded slightly and now sits +0.1% on the day. But in the end, the euro, too, will remain under pressure from the combination of tighter Fed policy and a decreasing probability of the ECB ever matching that activity. We remain in the 1.1500-1.1800 trading range, which has existed since April, but as we push toward the lower end of that range, be prepared for a breakout.

Finally, the other mover of note overnight was CNY, with the renminbi falling to new lows for the move and testing 6.90. The currency has declined more than 8% since the middle of June as it has become increasingly clear that the PBOC is willing to allow it to adjust along with most other emerging market currencies. While the movement has been steady, it has not been disorderly, and as yet, there is no evidence that capital outflows are ramping up quickly, so it is hard to make the case the PBOC will step in anytime soon. And that is really the key; increases in capital outflows will be the issue that triggers any intervention. But while many pundits point to 7.00 as the level where that is expected to occur, given the still restrictive capital controls that exist there, it may take a much bigger decline to drive the process. With the Chinese economy slowing as well (last night’s Caixin Services PMI fell to 52.8, below expectations and continuing the declining trend this year) a weaker yuan remains one of China’s most important and effective policy tools. There is no reason for this trend to end soon and accordingly, I believe 7.50 is reasonable as a target in the medium term.

Turning to this morning’s payroll report, here are the current expectations:

Nonfarm Payrolls 190K
Private Payrolls 189K
Manufacturing Payrolls 22K
Unemployment Rate 3.9%
Average Hourly Earnings (AHE) 0.3% (2.7% Y/Y)
Average Weekly Hours 34.5
Trade Balance -$46.5B
ISM Non-Manufacturing 58.6

Wednesday’s ADP number was much stronger than expected at 213K, and the whisper number is now 205K for this morning. As long as this data set continues to show a strong labor market, and there is every indication it will do so, the only question regarding the Fed is how quickly they will be raising rates. All of this points to continued dollar strength going forward as the divergence between the US economy and the rest of the world continues. While increasing angst over trade may have a modest impact, we will need to see an actual increase in tariffs, like the mooted 25% on $200 billion in Chinese imports, to really affect the economy and perhaps change the Fed’s thinking. Until then, it is still a green light for dollar buyers.

Good luck and good weekend
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For How Long?

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The US economy’s strong
Denial of this would be wrong
It’s not too surprising
That rates will be rising
The question is just, for how long?

Despite the Trump administration’s recent discussion of imposing 25% tariffs on $200 billion of Chinese imports, rather than the 10% initially mooted, the Fed looked at the economic landscape and concluded that things continue apace. While they didn’t adjust rates yesterday, as was universally expected, the policy statement was quite positive, highlighting the strength in both economic growth and the labor market, while pointing out that inflation is at their objective of 2.0%. Market expectations for a September rate hike increased slightly, with futures traders now pricing in a nearly 90% probability. More interestingly, despite the increased trade rhetoric, those same traders have increased their expectations for a December hike as well, with that number now hovering near 70%. At this point, despite President Trump’s swipe at higher rates last week, it appears that the Fed is continuing to blaze its rate-hiking path undeterred.

The consequences of the Fed’s stance are starting to play out more clearly now, with the dollar once again benefitting from expectations of higher short term rates, and equity markets around the world, but especially in APAC, feeling the heat. The chain of events continues in the following manner. Higher US rates have led to a stronger US dollar, especially vs. many emerging market currencies. The companies in those countries impacted are those that borrowed heavily in USD over the past ten years when US rates were near zero. They now find themselves struggling to repay and refinance that debt. Repayment is impacted because their local revenues buy fewer dollars while refinancing is impacted by the fact that US rates are that much higher. With this cycle in mind, it should not be surprising that equity markets elsewhere in the world are struggling. And those struggles don’t even include the potential knock-on effects of further US tariff increases. Quite frankly, it appears that this trend has further to run.

Meanwhile, the week’s central bank meetings are coming to a close with this morning’s BOE decision, where they are widely touted to raise the Base rate by 25bps, up to 0.75%. It is actually quite amusing to read some of the UK headlines talking about the BOE raising rates to the ‘highest in a decade’, which while strictly true, seems to imply so much more than the reality of still exceptionally low interest rates. However, given the ongoing uncertainty due to the Brexit situation, I continue to believe that Governor Carney is extremely unlikely to raise rates again this year, and if we are headed to a ‘no-deal’ Brexit, which I believe is increasingly likely, UK rates will head back lower again. Early this morning the UK Construction PMI data printed at a better than expected 55.8, its highest since late 2016, but despite the strong data and rate expectations, the pound has fallen 0.35% on the day.

Other currency movement has been similar, with the euro down 0.35%, Aussie and Kiwi both falling more than 0.5% and every other G10 currency, save the yen declining. The yen has rallied slightly, 0.2%, as interest rates in Japan continue to respond to Tuesday’s BOJ policy tweaks. JGB’s seem to have quickly found a new home above the old 0.10% ceiling, and there is now a growing expectation that as the 10-year yield there approaches the new 0.2% cap, the longer end of the JGB curve will rise with it taking the 30-year JGB to 1.00%. While that may not seem like much to the naked eye, when considering the nature of international flows, it is potentially quite important. The reason stems from the fact that Japanese institutional investors tend to hedge the FX exposure that comes from foreign fixed income purchases thus reducing their net yield from the higher rates received overseas to something on the order of 1.0%. And if the Japanese 30-year reaches that 1.0% threshold (it is currently yielding 0.83%), there is a growing expectation that those same investors will sell Treasuries and other bonds and bring the money home. That will have two impacts. First, I would be far less concerned over an inverting yield curve in the US as yields across the back end of the US curve would rise on those sales, and second, the dollar would likely rally overall on higher rates, but decline further against the yen. These are the type of background flows that impact the FX market, but may not be obvious to most hedgers.

Turning to the emerging markets, the dollar is firmer against virtually all of these currencies as well. One of the biggest movers has been CNY, falling 0.5% and now trading at its weakest level since May 2017. The renminbi’s decline has been impressive since mid-April, clocking in at nearly 9%, and clearly offsetting some of the impact of the recent tariffs. But remember, the renminbi’s decline began well before any tariffs were in place, and has as much to do with a slowing Chinese economy forcing monetary policy ease in China as with the recent trade spat. At this point, capital outflows have not yet become a problem there, but if history is any guide, as we get closer to 7.00, we are likely to see more pressure on the system as both individuals and companies seek to get their money out of China and into a stronger currency. I expect that there are more fireworks in store here.

Aside from China, the usual suspects continue to fall, with TRY having blasted through 5.00 overnight and now down 1.5% on the day. But we have also seen significant weakness in ZAR (-1.75%), KRW (-1.15%), and MXN (-0.75%). Even INR is down 0.5% despite the RBI having raised rates 0.25% overnight to try to rein in rising inflation pressures there. So today’ story is clear, the dollar remains in the ascendancy on the back of optimism in the US vs. increasing pessimism elsewhere in the world.

A quick peek at today’s data shows that aside from the weekly Initial Claims (exp 220K) we see only Factory Orders (0.7%). Yesterday’s ADP Employment data was quite strong, rising 219K, while the ISM Manufacturing report fell to a still robust 58.1, albeit a larger fall than expected. However, given the Fed’s upbeat outlook, the market was able to shake off the news. At this point, however, I expect that eyes are turning toward tomorrow’s NFP report, which will be seen as taking a much more accurate reading on the economy. All in all, I see no reason for the dollar to give back its recent gains, and in fact, expect that modest further strength is in the cards.

Good luck
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Percent Twenty-Five

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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
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Is That Despair?

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Forward guidance is
Kuroda-san’s newest hope
Or is that despair?

The BOJ has committed to keep the current extremely low levels for short- and long-term interest rates for an “extended period of time.” Many of you will recognize this phrase as Ben Bernanke’s iteration of forward guidance. This is the effort by central banks to explain to the market that even though rates cannot seemingly go any lower, they promise to prevent them from going higher for the foreseeable future. Alas, forward guidance is akin to Hotel California, from which, as The Eagles famously sang back in 1976, “you can check out but you can never leave.” As the Fed found out, and the ECB will learn once they finally end QE (assuming they actually do so), changing tack once you have promised zero rates forever can have market ramifications. The first indication that forward guidance might be a problem came with the ‘taper tantrum’ in 2013, but I’m confident it won’t be the last.

However, for the BOJ, now trumps the future, and they needed to do something now. But forward guidance was not the only thing they added last night. It was the cover for their attempts to adjust policy without actually tightening. So, yield curve control now has a +/- 20bp range around 0.0% for the 10-year JGB, double the previous level, and thus somewhat more flexible. And they reduced the amount of reserves subject to the -0.10% deposit rate in order to alleviate some of the local banks’ profit issues. In the end, their commitment to maintaining zero interest rates for that extended period of time was sufficient for FX traders to sell the yen (it fell -0.40%), and JGB yields actually fell a few bps, closing at 0.065%, which is down from 0.11% ahead of the meeting. All in all, I guess the BOJ did a good job last night.

There is, however, one other thing to mention, and that is they reduced their own inflation forecasts (to 1.1% in 2019, 1.5% in 2020 and 1.6% in 2021) for the next three years, indicating that even they don’t expect to achieve that elusive 2.0% target before 2022 at the earliest. In the end, the BOJ will continue to buy JGB’s and equity ETF’s and unless there is a substantial acceleration in global growth, (something which seems increasingly unlikely) they will continue to miss their inflation target for a very long time. As to the yen, I expect that while it fell a bit last night, it is still likely to drift higher over time.

In Europe the story is still
That growth there is starting to chill
The data last night
Did naught to delight
Poor Mario, testing his will

Beyond the BOJ, and ahead of the FOMC announcement tomorrow, the major news was from the Eurozone where GDP and Inflation data was released. What we learned was that, on the whole, growth continued to slow while inflation edged higher than expected. Eurozone GDP rose 0.3% in Q2, its slowest pace in a year, while headline inflation rose 2.1%, its fastest rate since early 2013. Of course the latter was predicated on higher energy prices with core CPI rising only 1.1%, still a long way from the ECB’s target. The point is that given the slowing growth trajectory in the Eurozone, it seems that Draghi’s confidence in faster growth causing inflation to pick up on the continent may be unwarranted. But that remains the official line, and it appears that the FX market has accepted it as gospel as the euro has traded higher for a third consecutive day (+0.3%) and is now back in the top half of its trading range. If Q3 growth continues the trajectory that Q2 has extended, it will call into question whether the ECB can stop buying bonds, or at the very least, just how long rates will remain at -0.4%, with those looking for a September 2019 rate hike sure to be disappointed.

There is one country in Europe, however, that is performing well, Sweden. GDP growth there surprised the market yesterday, rising 1.0% in Q2 and 3.3% Y/Y. This has encouraged speculation that the Riksbank will be raising rates fairly soon and supported the krone, which has rallied 1.0% since the announcement.

The final piece of news to discuss from last night was from China, where the PMI readings all fell below expectations. The official Manufacturing data was released at 51.2, down from last month’s 51.5 and the third consecutive monthly decline. The non-manufacturing number fell to 54.0, its weakest print since October 2016. These are the first data from China that include the impact of the US tariffs, and so are an indication that the Chinese economy is feeling some effects. I expect that the government there will add more stimulus to offset any more severe impact, but that will simply further complicate their efforts at reducing excess leverage in the economy. Meanwhile, the renminbi slid 0.25% overnight.

This morning’s data releases bring us Personal Income (exp 0.4%), Personal Spending (0.4%) and PCE (2.3% headline, 2.0% core), as well as the Case-Shiller Home price index (6.4%), Chicago PMI (62.0) and Consumer Confidence (126.0). In other words, there is much for us to learn about the economy. While I believe the PCE data could be market moving, especially if it is stronger than expected, I continue to believe that traders and investors remain far more focused on Friday’s payroll report than this data. Recent weakness in equity markets has some folks on edge, although futures this morning look benign. But if we do see that weakness continue, the chances of a full-blown risk off scenario materializing will grow substantially. And that means, the dollar has the potential to rally quite sharply. Keep that in mind as a tail risk, one where the tail grows fatter each day that equity markets disappoint.

Good luck
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Still At Its Peak

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Three central bank meetings this week
Seem unlikely, havoc to wreak
When they all adjourn
Attention will turn
To joblessness, still at its peak

In the current central bank calendric cycle, the ECB meeting was the first to be completed, and last Thursday we learned virtually nothing new about Mario Draghi’s plans. The ECB is going to reduce QE further starting in October and is due to end it completely by year end. As to interest rates, ‘through summer’ remains the watchword, with markets forecasting a 10bp rate rise in either September or October of next year.

This week brings us the other three big central bank meetings, starting with the BOJ’s announcement tomorrow evening, then the FOMC on Wednesday and finally the BOE on Thursday. Going in reverse order, the market remains convinced that Governor Carney will raise rates 25bps, with a more than 80% probability priced in by futures traders. While I think it is a mistake, it does seem increasingly likely it will be the outcome. As to the Fed, there are no expectations of any policy adjustments at this meeting, and as there is no press conference following, I expect that the statement, when released Wednesday afternoon, will have little market impact.

This takes us to tomorrow evening’s BOJ meeting, which is the only one where there seems to be any real uncertainty. Last week I discussed the questions at hand which boil down to whether or not Kuroda and company have come to believe that QQE is not only ineffective, but actually beginning to have a detrimental impact on the Japanese economy. After all, they have been at it for the better part of five years and have still had zero success in achieving their 2.0% inflation goal. The three biggest problems are that Japanese banks have seen their business models decimated by increasingly narrow lending spreads; the ETF purchase program has had an increasingly large distortive impact on the Japanese stock markets as the BOJ now owns roughly 4% of all Japanese equities; and finally, the yield curve control plan has essentially broken the JGB market as evidenced by the fact that they continue to see sessions where there are actually no trades in the 10-year JGB. (Consider what would happen if there were no trades in 10-year Treasuries one day!)

With all of this as baggage, there has been increasing discussion that the BOJ may seek to tweak the program to try to make it more effective. However, they have painted themselves into a corner because if they reduce their activity in the JGB market, the market is likely to see it as a reduced commitment to QE and it is likely to result in higher yields there, which can easily lead to two separate but related outcomes. First, USDJPY is likely to fall further, as higher JGB yields lead to more interest for Japanese investors to bring their funds home. Given the disinflationary impact of a stronger currency, this would be a disaster. And second, if there is less support for JGB’s, given the fungibility of money and the open capital markets that exist, we are likely to see yields rise in US, UK, European and other developed markets. While Chairman Powell may welcome this as it will reduce concern over the Fed inverting the yield curve, the rest of the world, which retains far easier monetary policy, is likely to be somewhat less welcoming of that outcome. And this is all based on anonymous reports that the BOJ is going to make some technical adjustments to their program, not change the nature of what they are doing. So if you are looking for some fireworks this week, the BOJ is your best bet.

However, beyond the central banks, the market will turn its attention to Friday’s employment report here in the US. Last Friday saw a robust GDP report, as widely expected, and further proof of the divergence between the US and the rest of the global economy. This Friday could simply add to that impression. Here is the full listing of this week’s data, which is quite robust:

Tuesday BOJ Rate Decision -0.10% (unchanged)
  Personal Income 0.4%
  Personal Spending 0.4%
  PCE 0.1% (2.3% Y/Y)
  Core PCE 0.1% (2.0% Y/Y)
  Case-Shiller Home Prices 6.4%
  Chicago PMI 62.0
Wednesday ADP Employment 185K
  ISM Manufacturing 59.5
  ISM Prices Paid 75.8
  FOMC Rate Decision 2.00% (unchanged)
Thursday BOE Rate Decision 0.75% (+0.25%)
  Initial Claims 221K
  Factory Orders 0.7%
Friday Nonfarm Payrolls 190K
  Private Payrolls 185K
  Manufacturing Payrolls 22K
  Unemployment Rate 3.9%
  Average Hourly Earnings 0.3% (2.7% Y/Y)
  Average Weekly Hours 34.5
  Trade Balance -$46.2B
  ISM Non-Manufacturing 58.7

So, as you can see there is much to be learned this week. With the focus on the central banks and Friday’s payroll data, don’t lose sight of tomorrow’s PCE report, because remember, that is the Fed’s go-to number on inflation. Overall, looking at forecasts, things remain remarkably strong in the US economy this long into an expansion, which is something that has many folks concerned. We also continue to see important corporate earnings releases this week for Q2, which given the high profile misses we had last week, could well impact markets beyond individual equity names.

As to the dollar through all this, it is a touch softer this morning, but remains on the strong side of its recent trading range. While I still like it higher, there is so much potential new information coming this week, it is probably wisest to remain as neutral as possible for now. For hedgers, that means the 50% rule is in effect.

Good luck
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A Rate Hike’s in Store

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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
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No Tariffs For Now

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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
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Twixt Juncker and Trump

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The meeting today in DC
Twixt Juncker and Trump will be key
In helping determine
If cars that are German
Are hit with a new import fee

Markets overnight have been relatively muted as today’s big story revolves around EU President Jean-Claude Juncker’s meeting with President Tump in Washington. The agenda is focused on tariffs and trade as Juncker seeks to de-escalate the current trade policy differences. At this point, while most market participants would love to see signs that the US is backing off its recent threats, and that progress is made in adjusting the terms of trade, I don’t sense that there is a lot of optimism that will be the case. Remarkably, the US equity market has been able to virtually ignore the trade story, with only a few individual companies suffering due to direct impacts from the situation (or poor quarterly numbers), but that has not been true elsewhere in the world. Other equity markets have fared far worse in the wake of the trade battle, and I see no reason for those prospects to improve until there is a resolution. At the same time, while the dollar has fallen from its highs seen early last week, it remains significantly stronger than it was three months ago. In fact, during the recent escalation in Presidential rhetoric, while we saw a reaction last Friday, the reality is that there has been little overall movement.

While the value of the dollar clearly has an impact on trade, historically the reverse has been far less clear. In other words, although there have been knee-jerk reactions to a particular trade number that missed expectations, or similar to Friday’s movement, knee-jerk reactions to political statements about trade policy, generally speaking, trade’s impact on the dollar has been very hard to discern. Several months ago I highlighted the tension between short-term and long-term drivers of the dollar. On the short-term side, which is what I believe has been dominant this year, is monetary policy and interest rate differentials. These have clearly been moving aggressively in the dollar’s favor. On the long-term side is the US’ fiscal account, namely its current account deficit and trade deficit. Economic theory tells us that a country that runs significant deficits in these accounts will see its currency decline over time in order to help balance things. In fact, this has been the crux of the view that the dollar will fall in the long run. However, given the US’ unique situation as the global reserve currency, and the fact that so much global trade is priced in dollars as opposed to other currencies, there remains an underlying demand for dollars that is not likely to disappear anytime soon.

The point here is that if the current trade situation deteriorates further, with additional tariffs imposed on all sides, and growth slows correspondingly, it is still not clear to me that the dollar will suffer. In fact, most other countries will seek to weaken their own currencies in order to offset the tariffs, which means the dollar will likely continue to outperform. In other words, in addition to the US monetary policy benefit, it seems likely that the dollar will be the beneficiary of policy adjustments elsewhere designed to weaken other currencies. And ironically, in the current political situation, that is only likely to generate even more Presidential rhetoric on the subject. Quite frankly, I feel the dollar has potentially much further to climb as long as trade is the topic du jour.

Of course, that doesn’t mean it will rally ever day. In fact, today the dollar is very modestly softer vs. most of its counterparts. The biggest gainer has been CNY, which is firmer by 0.55% overnight, as China appears very interested in calming things down. But away from that move, most currency gains have been on the order of 0.1% or so. The most notable data overnight was the German IFO report, which declined for the eighth consecutive month and is now back to levels last seen in March 2017. While the ECB continues to look ahead to the ending of their extraordinary monetary policy, the economy does not seem to be cooperating with their views of a sustainable recovery. While I think there is very little chance that the ECB changes its stance on bond buying, meaning come December, they will be done, it remains an open question as to when they might start to raise rates. This is especially true given the potential for an escalating trade conflict between the US and the EU resulting in slower growth on both sides of the Atlantic. If that is the case, the ECB will have a much harder time normalizing policy. At this time, however, it is still way too early to make any determinations, and I suspect that tomorrow’s ECB meeting will give us very little new information.

Meanwhile, the market is still extremely focused on the BOJ meeting early next week, with varying views as to the potential for any policy shifts there. What does seem clear is there has at least been discussion of the timing of ending QE, but no decisions have been made. The problem for the BOJ is that after more than five years of aggressive bond buying, not only have they broken the JGB market, but they have not been able to achieve anywhere near the results they had sought. Given that the BOJ balance sheet is now essentially the same size as the Japanese economy (for comparison, in the US despite its remarkable growth during QE, it remains ~20% of the US economy), there are growing concerns that current policy may be doing more harm than good. Apparently there are limits to just how much a central bank can do to address inflation. As to the yen, if the market perception turns to the BOJ stepping back from constant injections of funds, it is very likely that the yen will find itself in great demand and USDJPY will fall steadily. I maintain my view that 100.00 is a viable target for the end of the year.

Today brings just New Home Sales data (exp 670K, a 2.8% decline from last month) but this is generally not a key figure for markets. Rather, today’s price action will be dependent on the outcome of the Trump-Juncker meeting and whatever comments follow at the press conference. A conciliatory tone by President Trump would almost certainly result in a stock market rally and modest dollar strength. Continued combativeness is likely to see stocks under pressure and the dollar, at least initially, falling as well.

Good luck
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