Tag Archives: #FX

Tired

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Speculation’s rife
Kuroda is tired of
JGB support

For the fifth consecutive session, the Japanese yen is rising amid growing speculation that the BOJ, when it meets next Monday and Tuesday, is going to adjust monetary policy tighter. During that run, which also included President Trump’s harangues on currency manipulation around the world, the yen has strengthened nearly 2%. My point is that the dollar has suffered somewhat overall during that period, so this movement is not entirely due to the BOJ story. But, as the meeting approaches, that is becoming the hottest topic in the market.

A quick look at the Japanese economy shows that inflation remains quiescent, with the latest core reading just 0.2%, a far cry from the 2.0% target the BOJ has been aiming for during the past five years. In addition, last night’s PMI data, (printing at 51.6, well below expectations of 53.2) has to give Kuroda and company pause as well. In other words, while Japan is not cratering, it doesn’t seem like there is any danger of overheating there either. However, with the Fed actively tightening, the BOE widely expected to raise rates in early August and the ECB highlighting its plans to end QE this year with interest rate increases to follow next year, the BOJ is clearly feeling somewhat left out of the mix. Apparently groupthink is a strong emotion for central bankers.

At any rate, whether justified or not, the story that is getting play is that they are going to tweak their operations, perhaps allowing (encouraging?) the long end of the JGB yield curve to see higher yields, although they will likely keep control of the 10-year space and below. But all the market needed to hear was that QE was going to be reduced and the reaction was immediate. JGB yields in the 10-year space jumped from 0.03% to 0.09%, at which point the BOJ stopped the movement by stepping in with an unlimited bid for bonds. Remember, they already own 42% of all outstanding JGB’s, and liquidity in that market is so thin that there have already been six days this year where there were absolutely zero trades in the 10-year JGB. The FX market was not going to be left out and seeing the prospect for less QE immediately added to the yen’s recent gains. It remains to be seen whether Kuroda-san will be able to actually implement any policy changes given the combination of slackening growth and still low inflation, especially with the prospects of a trade war having an even more deleterious impact on the economy. However, the market loves this story and is going to continue to run with it, at least until the BOJ announcement next Tuesday. So I would look for the yen to continue to trade slowly higher during that period.

The other big story overnight was the PBOC injection of CNY502 billion of liquidity into the market as part of their ongoing policy adjustments. It is becoming increasingly clear that the Chinese economy is having trouble dealing with the simultaneous deleveraging demanded by President Xi for the past two years and the increased trade issues that have arisen quite rapidly of late. Of course, the PBOC is no wallflower when it comes to taking action, and so having already cut reserve requirements three times this year; they decided that direct injection of funds into the market was a better method of achieving their goals. In addition the government created tax incentives for R&D, encouraged more state infrastructure spending and told banks to offer more credit to small firms. The market impact of these measures was immediate with the Shanghai Stock Exchange rallying 1.6% while the renminbi fell as much as 0.6% early, before retracing somewhat and now standing just 0.2% lower on the day.

When considering the CNY, the opposing forces are that a weaker yuan will certainly help support short-term growth due to the still significant reliance on exports by the Chinese economy. However, there is a feared tipping point at which a weak yuan may encourage significant capital outflows, thus destabilizing the Chinese economy and Chinese markets. We saw this play out three years ago, shortly after the PBOC surprised markets with its mini (2%) devaluation of the yuan. The ensuing global market sell-off was significant enough to prevent then Fed Chair Yellen to hold off on raising rates, despite having signaled that the Fed was ready to do so. However, it is not clear to me that Chairman Powell sees the world the same way as Yellen, and my take is that he would not be dissuaded from continuing the Fed’s current trajectory despite some increased global volatility. Of course, the Chinese instituted strict capital controls in the wake of the 2015 situation, so it is also not clear that the contagion can even occur this time. In the end, though, this is simply further evidence of the diverging monetary policies between the US and China, and continues to underpin my views of USDCNY moving to 7.00 and beyond before the year ends.

Away from those two stories, the dollar is modestly softer this morning despite mixed to weaker Eurozone PMI data (Germany strong, France weak, Eurozone weak), and US Treasury yields that gained nearly 10bps yesterday after the BOJ story broke. Yesterday saw weaker than expected Existing Home Sales (5.38M), which is the third consecutive monthly decline. While there is no important data today, we do see the critical first look at Q2 GDP on Friday, and of course, the ECB meets Thursday, so there is ample opportunity for more opinion changing information to come to market. But right now, the dollar remains largely trapped between the positive monetary policy story and the negative political story, and so I don’t anticipate it will be breaking out in either direction in the short run. However, as long as US monetary policy continues on its current trajectory, I believe the dollar has further to run. We have not yet evolved to a point where other issues are more important, although that time may well come in the future.

Good luck
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I’m Not Thrilled

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

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

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

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

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

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

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

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

Good luck and good weekend
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Weaker Yuan Now Abided

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

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

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

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

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

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

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

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

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

Good luck
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Gone Terribly Wrong

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

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

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

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

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

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

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

Good luck
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Waiting For Jay

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

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

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

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

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

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

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

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

Good luck
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The Beast of the East

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

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

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

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

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

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

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

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

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

Good luck
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Dashing Hopes

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

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

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

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

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

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

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

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

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

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

Good luck and good weekend
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The Fed’s Fallen Short

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This morning’s inflation report
Ought show that the Fed’s fallen short
In holding down prices
And so my advice is
It’s time, those short dollars, abort

Yesterday’s session was dominated by two key themes; the suddenly increased trade tensions after the announcement of a new list of $200 billion of Chinese tariff targets, and the sharp decline in oil prices (WTI – 5.0%) after Libya declared the end of force majeure with respect to shipments from its eastern port. The oil price decline, which occurred despite a surprisingly large drawdown of US inventories, was in sync with other commodity prices, notably copper which fell 2.5% and is now down more than 16% in the past month. Copper is generally seen as an important harbinger of future economic growth given its widespread use throughout different industries, and so falling demand for copper often leads to slower economic growth. And yet, despite the declining commodity price environment, yesterday’s PPI data (3.4% Y/Y) was the strongest in more than six years while expectations for today’s CPI are similarly elevated with consensus views looking for 0.2% monthly increases in both headline and core data which translates into 2.8% headline and 2.3% core on a Y/Y basis.

If those expectations are met, the Fed will certainly continue its hiking cycle, which ought to continue to support the dollar going forward. The other key dollar support has been risk aversion, which is where the trade story comes into play. As long as trade tensions remain front-page news, investors are likely to remain skittish which means they will be reducing risk and looking for safe places to invest. US Treasuries remain the global safe haven of choice, and so both Treasuries and the dollar should continue to benefit from this situation.

Yesterday I mentioned that there had been no indication that there were background talks ongoing between the US and China regarding trade, something I found surprising given the situation. However, this morning there is a story that such talks are, in fact, proceeding which implies to me that there will be some type of solution that arrives before the next round of tariffs are in place. Look for concessions on both sides as well as comments highlighting the strength of the Sino-US relationship, especially with regard to North Korea. At least that’s my view. But it will be several months before anything comes to fruition, and so we are likely to be subject to further volatility on the subject.

One of the impacts of the China trade story was yesterday’s very sharp decline in the renminbi (-1.1%), which resulted in the currency falling to its weakest level since last August. Some pundits see this as an attempt to adjust for the recent tariff impositions by the US, but a case can be made that since the dollar was so strong overall yesterday, (USDX +0.65%), the CNY move was not really out of character. And this morning, the renminbi has already retraced half of that movement, so I am inclined to give the Chinese the benefit of the doubt here and accept the broad dollar strength thesis. In fact, one of the things that continues to haunt the PBOC is their mini devaluation in 2015, which triggered significant capital outflows and forced the imposition of very strict capital controls in China. Regardless of the trade situation, I assure you the Chinese will do all they can to prevent a repeat of that outcome. However, steady depreciation of the renminbi going forward remains my base case.

Otherwise, in G10 space the Bank of Canada raised rates by 25bps, as expected, which helped the Loonie temporarily, but in the end, it seems that weaker oil prices overwhelmed the rate hike and CAD fell 0.75% on the day. However, the BOC continues to sound upbeat on the economy for now and is positioned to continue to track the Fed’s policy for the next year or two.

From the UK, this morning, we received PM May’s latest Brexit position paper which is seeking to have the UK track EU goods regulations, but simultaneously looking for the UK to go completely its own way regarding services and seek trade agreements around the world on that basis. While it is an interesting idea, and one with merit given that services represent ~80% of the UK economy, with less than nine months before the Brexit date, it feels like they may not be able to complete much of the process in time. However, the BOE appears completely ready to raise rates next month with the market pricing an 80% probability of the event and Governor Carney commenting that growth in the UK continues to perform as the BOE expected in its rebound from Q1. The pound, however, has added a small 0.1% decline this morning to yesterday’s 0.5% slide.

Beyond these stories, nothing of note to the FX markets has really been evident. Given the strength of yesterday’s dollar move, it would be no real surprise if there was a small retracement, but in fact, I have a feeling that we are going to see high side surprises in the CPI data which will only serve to increase Fed expectations and support the dollar. So my money is on the dollar continuing its strengthening trend of the week and closing yet higher today.

Good luck
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Both Sides Will Lose

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The trade story’s back in the news
With stock markets singing the blues
Two hundred bill more
Confirms the Trade War
Will happen, and both sides will lose

The Trump administration’s announcement last evening that they are targeting another $200 billion of Chinese imports for tariffs, this time 10% across the board, has interrupted the markets recent sense of calm. In fact, the immediate response was for equity markets around the world to fall sharply and the dollar to regain its footing. Investors had come to believe that the initial salvo of tariffs on $34 billion by each nation would be the extent of things, and that negotiations would soon begin. However, assuming things with this administration is a fraught activity as unpredictability has been Trump’s hallmark since his election.

It is interesting to consider the market ramifications of this growing trade war between the US and China. For instance, since March 22, the day the first tariffs were announced, the Shanghai Index is down more than 15% while the S&P 500 is higher by a bit more than 3.0%. While economists have ridiculed Trump’s statement that “trade wars are easy to win”, it certainly seems that the US has so far come out ahead, at least on this measure. At the same time, the Chinese renminbi has fallen ~5.6% over the same period, which could mean that investors are more confident that the US will come out ahead…or it could mean that the PBOC has simply forced guided the currency lower in an effort to offset the impact of the tariffs.

However, the one thing that I take away from this process is that neither side is going to back down anytime soon. As Trump is leading the charge, he is unlikely to back off without having won some major concessions from the Chinese. At the same time, Chinese President Xi, who has spent the past five years consolidating his power, cannot afford to look weak to the home crowd. So my advice is to prepare for higher prices on lots of things that you buy, because this is likely to drag on for a long time.

As an aside, while the politics may favor Xi, I think given the nature of the imbalance, where the Chinese not only have far more items that can be taxed, but that they remain a largely mercantilist economy depending on exports for growth, it means that China’s economic situation is likely to deteriorate far more than that of the US. However, it is not clear to me that I would call that ‘winning’!

At any rate, the one thing that seems almost certain is that the dollar is going to be a major beneficiary of this process. Not only are other currencies going to suffer as their nations’ exports are reduced and growth impaired, but the ensuing inflationary impact of tariffs on the US is going to encourage the Fed to be more aggressive. Given the dollar’s positive response to the tightening of Fed policy already, as well as the growing divergence between the US economy and the rest of the world, the brewing trade war has simply increased my dollar bullishness.

Pivoting to the overnight markets, the dollar has rallied for a second straight day, showing strength against all its G10 counterparts and most EMG currencies. There continues to be a dearth of data on which to base trading outcomes and it seems most likely that the dollar’s recent strength, while receiving a catalyst from the trade situation, is a continuation of its rebound from last week’s decline. In the end, the dollar is still largely range bound and has been so since its rally ended in mid May. I continue to believe we will need new data of note to encourage a breakout, with the next real opportunity tomorrow’s CPI print. A surprisingly high print will get tongues wagging over the Fed picking up the pace, and likely support the dollar. However, I don’t believe the opposite is true. A weaker than expected print will simply confirm that the Fed will stay on its current trajectory, which may not help the dollar much, but should not undermine it.

The other potential driver is going to be the general risk tone in markets. It is very clear that the dollar has regained its status as a safe haven, and with every escalation in the trade war, risk aversion will lead to further dollar strength. This is especially true given that the other potential havens, JPY and CHF, continue to offer negative interest rates and so are far less attractive to investors looking for a short-term home for their assets. To me, all the evidence still points to the dollar’s next leg being a move up potentially testing the levels seen back in the beginning of 2017 over time.

On the data front, this morning brings PPI (exp 0.2% for both headline and core) but all eyes will be on tomorrow’s CPI, not today’s number. We also hear from NY Fed President Williams late this afternoon. Given both the timing, some four weeks since the last FOMC meeting, and his elevated role, it is possible that he could create some volatility by adding new information to the mix. However, my read is that the data trajectory has remained quite steady, and although he will almost certainly mention the trade situation and its potential to upend the economy, I doubt there will be new information forthcoming. So in the end, I like the dollar to continue to grind higher as the day progresses.

Good luck
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Now In Disarray

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The saga of Minister May
Improved not one whit yesterday
When Boris resigned
Pound Sterling declined
And her party’s now in disarray

The news from the UK continues to dominate market headlines as less than twenty-four hours after the resignation of the Brexit Minister David Davis, Boris Johnson, a Brexit hardliner and Foreign Minister also resigned from PM May’s cabinet. While PM May replaced both men quickly, the problem is one of appearances in that she seems to be losing control over her government. The market’s immediate reaction was to sell the pound (it fell 0.7% yesterday after the news and has maintained those losses) as concerns over a leadership challenge and potentially a new election were brought to the fore. However, since then, it seems things have quieted down a bit and there is even talk that this could be a Sterling positive as it may result in a softer Brexit with less economic impact. In the meantime, this morning’s data showed that GDP has been rebounding from Q1’s flat reading, with the monthly May reading rising 0.3% and although IP data was soft (-0.4% in May), Construction was strong (+1.6%) and it appears that Governor Carney will still have enough ammunition to justify a rate increase next month. The risk to that outlook is if a leadership challenge emerges in Parliament and PM May is deposed. In that event, market participants may take a dimmer view of the near future depending on who replaces her.

Away from the British Isles, however, there is less excitement in the G10 economies. The big US news remains political with President Trump naming Brett Kavanaugh to replace retiring Supreme Court Justice Anthony Kennedy. However, on the economic front, there has been precious little news or commentary. In fact, until Thursday’s CPI reading, I expect the US story to be benign unless something surprising happens in the Treasury auctions beginning today, where the US is raising $69 billion via 3yr, 10yr and 30yr auctions.

From Germany we saw the ZEW surveys disappoint with the Sentiment Index falling to -24.7, its lowest print since December 2011 during the European bond crisis. This has encouraged a reversal in the euro, which is down 0.3% this morning after a week of gains. As well, the other, admittedly minor, Eurozone data also pointed to modest Eurozone weakness, thus giving the overall impression that the recent stabilization on the continent may be giving way to another bout of weakness. However, we will need to see more important data weaken to confirm that outcome. Certainly, Signor Draghi is convinced that the worst is behind them, but he has always been an optimist.

In the emerging markets, Turkey has once again stolen the headlines as President Erdogan named his son-in-law as Minister of Finance and Economics, thus following through on his threat promise to take firmer control over monetary policy. In the cabinet reshuffle he also removed the last vestiges of central banking experience so I would look for inflation in Turkey to start to really take off soon, and the currency to fall sharply. And that is despite the fact that it fell 3% yesterday after the announcement. In fact, I would look for more moves of that nature and a print above 5.00 in the not too distant future.

But other than that, while the dollar is stronger this morning, it is not running away. The broad theme today seems to be modest profit taking by traders who had been running short dollar positions, and so a bit of further strength would be no surprise. On the data front, the NFIB Small Business Optimism Index was released earlier at 107.2, stronger than expected and still showing that small businesses remain confident in the economic situation for now. The JOLTs jobs report comes at 10:00 and should simply confirm that the employment situation in the US remains robust. My gut tells me that modest further dollar strength is on tap for today, but really, barring a political bombshell, I expect that things will be very quiet overall. It is the middle of summer after all.

Good luck
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