Markets Are Waiting

For right now most markets are waiting
To see if key risks are abating
Next week it’s the Fed
Then looking ahead
The G20 is captivating

The question is what we will learn
When Powell and friends next adjourn
The bond market’s sure
A cut has allure
To help them avoid a downturn

Markets this morning are pretty uninteresting as trader and investor focus turns to the two key upcoming events, next week’s FOMC meeting and the G20 meeting at the end of the month. At this point, it is fair to say that the market is pricing in renewed monetary ease throughout most of the world. While the Fed is in their quiet period, the last comments we heard were that they would act appropriately in the event economic growth weakened. Futures markets are pricing in a 50% chance of a cut next week, and a virtually 100% chance of a cut in July, with two more after that before the end of the year. While that seems aggressive to many economists, who don’t believe that the US economy is in danger of slowing too rapidly, the futures market’s track record is pretty good, and thus cannot be ignored.

But it’s not just the US where markets are pushing toward further rate cuts, we are seeing the same elsewhere. For example, last week Signor Draghi indicated that the ECB is ready to act if necessary, and if you recall, extended their rate guidance further into the future, assuring no rate changes until the middle of next year. Eurozone futures markets are pricing in a 10bp rate cut, to -0.50%, for next June. This morning we also heard from Banque de France President, and ECB Council member, Francois Villeroy that they have plenty of tools available to address slowing growth if necessary. A key pressure point in Europe is the 5year/5year inflation contract which is now pricing inflation at 1.18%, a record low, and far below the target of, “close to, but below, 2.0%”. In other words, inflation expectations seem to be declining in the Eurozone, something which has the ECB quite nervous.

Of course, adding to the picture was the news Monday night that the PBOC is loosening credit conditions further, targeting infrastructure spending. We also heard last week from PBOC Governor Yi Gang that the PBOC has plenty of tools available to fight slowing economic output. In fact, traveling around the world, it is easy to highlight dovishness at many central banks; Australia, Canada, Chile, India, Indonesia, New Zealand and Switzerland quickly come to mind as countries that have recently cut rates or discussed the possibility of doing so.

Once again, this plays to my constant discussion of the relative nature of the FX market. If every country is dovish, it becomes harder to discern which is the most hawkish dove. In the end, it generally winds up being a case of which nation has the highest interest rates, even if they are falling. As of now, the US continues to hold that position, and thus the dollar is likely to continue to be supported.

While the Fed meeting is obvious as to its importance, the G20 has now become the focal point of the ongoing trade situation with optimists looking for a meeting between Presidents Trump and Xi to help cool off the recent inflammation, but thus far, no word that Xi is ready to meet. There are many domestic political calculations that are part of this process and I have read arguments as to why Xi either will or won’t meet. Quite frankly, it is outside the scope of this note to make that call. However, what I can highlight is that news that a meeting is scheduled will be seen as a significant positive step by markets with an ensuing risk-on reaction, meaning stronger equities and a sell-off in the bond market, the dollar and the yen. Equally, any indication that no meeting will take place is likely to see a strong risk-off reaction with the opposite impacts.

Looking at the overnight data, there have been few releases with the most notable, arguably, Chinese in nature. Vehicle Sales in China fell 16.4%, their 11th consecutive monthly decline, which when combined with slowing monthly loan growth paints a picture of an economy that is clearly feeling some pain. The only other data point was Spanish Inflation, which printed at 0.8%, clearly demonstrating the lack of inflationary impulse in the Eurozone, even in one of the economies that is growing fastest. Neither of these data points indicates a change in the easing bias of central banks.

In the US this morning we see CPI data which is expected to print at 1.9% with the ex food& energy print at 2.1%. Yesterday’s PPI data was on the soft side, so there is some concern that we might see a lower print, especially given how rapidly oil prices have fallen of late. In the end, it is shaping up as another quiet day. Equity markets around the world have been slightly softer, but that is following a weeklong run of gains, and US futures are pointing to 0.3% declines at this point. Treasury yields are off their lowest point but still just 2.12% and well below overnight rates. And the dollar is modestly higher this morning, although I don’t see a currency that has moved more than 0.2%, indicating just how quiet things have been. Look for more of the same until at least next Wednesday’s FOMC announcement.

Good luck
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Doves There Held Sway

It seems that a day cannot pass
When one country ‘steps on the gas’
Twas China today
Where doves there held sway
With funding for projects en masse

If I didn’t know better, I would suspect the world’s central banks of a secret accord, where each week one of them is designated as the ‘dove du jour’ and makes some statement or announcement that will serve to goose stock prices higher. Whether it is Fed speakers turning from patience to insurance, the ECB promising more of ‘whatever it takes’ or actual rate cuts a la the RBA, the central banks have apparently realized that the only place they continue to hold sway is in global stock markets. And so, they are going to keep on pushing them for as long as they can.

This week’s champion is the PBOC, which last night eased restrictions further on infrastructure investment by local governments, allowing more issuance of ‘special bonds’ and encouraging banks to lend more for these projects. At the same time, the CNY fix was its strongest in a month, back below the 6.90 level, as the PBOC makes clear that for the time being, it is not going to allow the yuan to display any unruly behavior. True to form, Chinese equity markets roared higher led by construction and cement companies, and once again we see global equity markets in the green.

While in the short run, investors remain happy, the problem is that in the medium and longer term, it is unclear that the central banking community has sufficient ammunition left to really help economic activity. After all, how much lower is the ECB going to cut rates from their current -0.4% level? And will that really help the economy? How many more JGB’s can the BOJ buy given they already own about 50% of the market? In truth, the Fed and the PBOC are the only two banks with any real leeway to ease policy enough to have a real economic impact, rather than just a financial markets impact. And for a world that has grown completely reliant on central bank activity to maintain economic growth, that is a real problem.

Adding to these woes is the ongoing trade war situation which seems to change daily. The latest news on this front is that if President Xi won’t sit down with President Trump at the G20 meeting in Japan later this month, then the US will impose tariffs on all Chinese imports. However, it seems the market is becoming inured to statements like these as there has been precious little discussion on the subject, and the PBOC’s actions were clearly far more impactful.

The question is, how long can markets continue to ignore what is a clearly deteriorating global economic picture before responding? And the answer is, apparently, quite a long time. Or perhaps that question is aimed only at equity markets because bond markets clearly see a less rosy future. At some point, we are going to see a central bank announcement result in no positive impact, or perhaps even a negative one, and when that occurs, be prepared for a rockier ride.

Turning to the FX markets this morning, the dollar has had a mixed session, although is arguably a touch softer overall. So far this month, the euro, which is basically unchanged this morning, has rallied 1.4%, while the pound, which is a modest 0.15% higher this morning after better than expected wage data, is higher by just 0.5%. My point is that despite some recent angst in the analyst community that the dollar was due to come under significant pressure, the overall movements have been quite small.

In the EMG bloc, there has also been relatively little movement this month (and this morning) as epitomized by the Mexican peso, which fell nearly 3% last week after the threat of tariffs being imposed unless immigration changes were made by Mexico, and which has recouped essentially all of those losses now that the tariffs have been averted. China is another example of a bit of angst but no substantial movement. This morning, after the PBOC drove the dollar fix lower, the renminbi is within pips of where it began the month. Again, FX markets continue to fluctuate in relatively narrow ranges as other markets have seen far more activity.

Repeating what I have highlighted many times, FX is a relative market, and the value of one currency is always in comparison to another. So, if monetary policies are changing in the same direction around the world, then the relative impact on any currency is likely to be muted. It is why, despite the fact that the US has more room to ease policy than most other nations, I expect the dollar to quickly find its footing in the event the Fed gets more aggressive. Because we know that if the Fed is getting aggressive, so will every other central bank.

Data this morning has seen the NFIB Small Business Optimism Index rise to 105.0, indicating that things in the US are, perhaps, not yet so dire. This is certainly not the feeling one gets from the analyst community or the bond market, but it is important to note. We do see PPI as well this morning (exp 2.0%, 2.3% core) but this is always secondary to tomorrow’s CPI report. The Fed remains in its quiet period so there will be no speakers, and the stock market is already mildly euphoric over the perceived policy ease from China last night. Quite frankly, it is hard to get excited about much movement at all in the dollar today, barring any new commentary from the White House.

Good luck
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Progress Was Made

The Presidents, Trump and Xi, met
Attempting, trade talks, to reset
Some progress was made
Though China downplayed
Reductions in tariffs as yet

Risk is back! At least it is for today, with the news that there has been a truce, if not an end, to the trade war between the US and China seen as a huge positive for risky assets. And rightly so, given that the trade contretemps has been one of the key drivers of recent investor anxiety. In addition, the G20 managed to release a statement endorsed by all parties, albeit one that was a shadow of its former self. There remain significant disagreements on the value of the G20 with the Trump administration still convinced that these gatherings seek to institutionalize rules and regulations that are contra to the US best interests.

At any rate, equity markets around the world have rallied sharply with Shanghai jumping 2.5%, the Nikkei up 1.25% and the South Korean KOSPI rising by 1.75%. In Europe, the FTSE is higher by 1.75%, the DAX by 2.2% and the CAC, despite ongoing riots in Paris and throughout France, higher by 1.0%. Ahead of the opening here, futures are pointing to an opening on the order of 2.0% higher as well. It should be no surprise that Treasury bonds have fallen somewhat, although the 2bp rise in 10-year yields is dwarfed relative to the equity movements. And finally, the dollar is lower, not quite across the board, but against many of its counterparts. Today, EMG currencies are leading the way, with CNY rising 0.9%, MXN rising 1.7% and RUB up 0.75% indicative of the type of price movement we have seen.

However, the trade story is not the only market driver today, with news in the oil market impacting currencies as well. The story that OPEC and Russia have agreed to extend production cuts into 2019, as well as the news that Alberta’s Premier has ordered a reduction of production, and finally, the news that Qatar is leaving OPEC all combining to help oil jump by more than 3% this morning. The FX impact from oil, however, was mixed. While the RUB and MXN both rallied sharply, as did CAD (+0.9%) and BRL (+0.9%), those nations that are major energy importers, notably India (INR -1.1%), have seen their currencies suffer. I would be remiss not to mention the fact that the euro, which is a large energy importer, has actually moved very little as the two main stories, trade war truce and oil price rise, have offsetting impacts in FX terms on the Continent.

But through it all, there is one currency that is universally underperforming, the British pound, which has fallen 0.3% vs. the dollar and much further against most others. Brexit continues to cast a long shadow over the pound with today’s story that the DUP, the small Northern Irish party that has been key for PM May’s ability to run a coalition government, is very unhappy with the Brexit deal and prepared to not only vote against it in Parliament next week, but to agree a vote of no confidence against PM May as well. This news was far too much for the pound, overwhelming even much better than expected Manufacturing PMI data from the UK (53.1 vs. exp 51.5). So the poor pound is likely to remain under pressure until that vote has been recorded next Tuesday. As of now, it continues to appear that the Brexit deal will fail in its current form, and that the UK will be leaving the EU with no framework for the future in place. This has been the market’s collective fear since the beginning of this process, and the pound will almost certainly suffer further in the event Parliament votes down the deal.

While all this has been fun, the week ahead brings us much more news and
information, as it is Payrolls week in the US.

Today ISM Manufacturing 57.6
  ISM Prices Paid 70.0
  Construction Spending 0.4%
Wednesday ADP Employment 197K
  Nonfarm Productivity 2.3%
  Unit Labor Costs 1.2%
  ISM Non-Manufacturing 59.2
  Fed’s Beige Book  
Thursday Initial Claims 220K
  Trade Balance -$54.9B
  Factory Orders -2.0%
Friday Nonfarm Payrolls 200K
  Private Payrolls 200K
  Manufacturing Payrolls 19K
  Unemployment Rate 3.7%
  Average Hourly Earnings 0.3% (3.1% Y/Y)
  Average Weekly Hours 34.5
  Michigan Sentiment 97.0

So a lot of data, and even more Fed speakers, with a total of 11 speeches, including congressional testimony by Chairman Powell on Wednesday, from six different Fed Governors and Presidents. Now we have heard an awful lot from the Fed lately and it has been interpreted as being somewhat less hawkish than the commentary from September and October. In fact, Minneapolis President Kashkari was out on Friday calling for an end to rate hikes, although he is arguably the most dovish member of the FOMC. Interestingly, the trade truce is likely to lead to one less problem the Fed has highlighted as an economic headwind, and may result in some more hawkish commentary, but my guess is that the current mindset at the Eccles Building is one of moderation. I continue to believe that a December hike is a done deal, but I challenge anyone who claims they have a good idea for what 2019 will bring. The arguments on both sides are viable, and the proponents are fierce in their defense. While the Fed continues to be a key driver of FX activity, my sense is that longer term FX views are much less certain these days, and will continue down to be that way as the Fed strives to remove Forward Guidance from the tool kit. Or at least put it away for a while. I still like the dollar, but I will admit my conviction is a bit less robust than before.

Good luck
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Problem’s Aplenty

Two stories have traders’ attention
The first showed the Fed’s apprehension
That their preferred path
Was earning the wrath
Of markets, thus causing dissention

The other is that the G20
(According to the cognoscenti)
May let Xi explain
A trade war’s insane
Since both men have problems aplenty

Once again the market has narrowed its focus on two things only, in this case the Minutes from the November FOMC meeting and the upcoming dinner between Presidents Trump and Xi at the G20 meeting in Buenos Aires. It seems that traders in virtually every market are taking their cues from these stories.

Starting with the Minutes, it is clear that the Fed finds itself at an inflection point in their policymaking with the easy part now behind them. Up until September, it was evident that policy was extremely accommodative, and the Fed’s goal of gradually reducing that accommodation was easy to achieve, hence the steady pace of a 25bp rate hike every other meeting. However, despite the fact that nobody actually knows where the neutral rate of interest (also known as r*) is, it is apparent that the current Fed funds rate is much closer to that mythical rate than it used to be. Hence the dilemma. How much further should the Fed raise rates, and at what pace? The last thing they want is to raise rates sufficiently to slow the economy into a recession. But they also remain quite wary of policy settings that are too easy, since that could lead to financial instability (read bubbles) and higher inflation. This is why they get paid the big bucks!

Signals from the US economy lately have been mixed, with the housing market slowing along with auto sales, but general consumer confidence and spending remaining at very high levels. Underpinning the latter is the ongoing strength in the labor market, where the Unemployment rate remains near 50 year lows of 3.7%. There is a caveat with the labor market though, and that is the Initial Claims data, which had been trending lower consistently for the past nine years, but has suddenly started to tick higher over the past month. While this could simply be a temporary fluctuation based on changes in seasonal adjustments, it could also be the proverbial canary in the coalmine. We will have a better sense next Friday, when the November NFP report is released, but based on the recent Initial Claims data, a soft employment report is entirely within reason.

The upshot is that the Fed is no longer certain of its near term rate path which means that many of the investing memes of the past ten years, notably buy-the-dip, may no longer make sense. Instead, the volatility that we have seen lately across all markets is likely to be with us going forward. But remember, too, that volatility is a market’s natural habitat. It has been the extreme monetary policies of central banks that have moderated those natural movements. And as central banks back away from excessive monetary ease, we should all expect increased volatility.

The second story is the upcoming meeting between Presidents Trump and Xi tomorrow night. Signals from Trump going into the meeting have been mixed (aren’t all his signals mixed?) but my take is that sentiment is leaning toward at least a pause in any escalation of the trade war, with the true optimists expecting that concrete progress will be made toward ending the tariffs completely. Color me skeptical on the last part, but I wouldn’t be surprised if a temporary truce is called and negotiations restarted as both men are under increasing domestic pressure (China’s PMI just fell to 50.0 last night indicating the economy there is slowing even more rapidly than before) and so a deal here would play well both on a political level, as well as to markets in each country. And when the needs of both parties are aligned, that is when deals are made. I don’t think this will end the tension, but a reduction in the inflammatory rhetoric would be a welcome result in itself.

Recapping the impact of the two stories, the fact that the Fed is no longer inexorably marching interest rates higher has been seen as quite the positive for equities, and not surprisingly a modest negative for the dollar. Meanwhile, optimism that something positive will come from the Trump-Xi dinner tomorrow has equity bulls licking their collective chops to jump back into the market, while FX traders see that as a dollar negative. In other words, both of the key stories are pointing in the same direction. That implies that prices already reflect those views, and that any disappointment will have a more significant impact than confirmation of beliefs.

As it happens, the dollar is actually a bit firmer this morning, rallying vs. most of its G10 counterparts, but only on the order of 0.2%. The pound remains under pressure as traders continue to try to handicap the outcome of the Parliamentary vote on Brexit on December 11, and the signs don’t look great. Meanwhile, the euro has softened after weaker than expected CPI data (headline 2.0%, core 1.0%) and continued weak growth data are making Signor Draghi’s plans to end QE next month seem that much more out of touch.

This morning brings a single data point, Chicago PMI (exp 58.0) as well as a speech from NY Fed President John Williams. However, at this point, given we have heard from both the Chairman and vice-Chairman already this week, it seems unlikely that Williams will surprise us with any new views. Remember, too, that Powell testifies to Congress next week, so we will get to hear an even more detailed discussion on his thinking on Tuesday. Until then, it seems that the dollar will continue its recent range trading. The one caveat is if there truly is a breakthrough tomorrow night in Buenos Aires, we can expect the dollar to respond at the opening in Asia Sunday night. But for today, it doesn’t feel like much is on the cards.

Good luck and good weekend
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So Ended the Equity Slump

There once was a president, Trump
Who sought a great stock market jump
He reached out to Xi
Who seemed to agree
So ended the equity slump

The story of a single phone call between Presidents Trump and Xi was all it took to change global investor sentiment. Last evening it was reported that Trump and Xi spoke at length over the phone, discussing the trade situation and North Korea. According to the Trump, things went very well, so much so that he requested several cabinet departments to start putting together a draft trade agreement with the idea that something could be signed at the G20 meeting later this month in Buenos Aires. (As an aside, if something is agreed there it will be the first time something useful ever came out of a G20 meeting!) The market response was swift and sure; buy everything. Equity markets exploded in Asia, with Shanghai rallying 2.7% and the Hang Seng up over 4%. In Europe the rally is not quite as robust, but still a bit more than 1% on average across the board, and US futures are pointing higher as well, with both S&P and Dow futures higher by just under 1% as I type.

I guess this answers the question about what was driving the malaise in equity markets seen throughout October. Apparently it was all about trade. And yet, there are still many other things that might be of concern. For example, amid a slowdown in global growth, which has become more evident every day, we continue to see increases in debt outstanding. So more leverage driving less growth is a major long-term concern. In addition, the rise of populist leadership throughout the world is another concern as historically, populists don’t make the best long-term economic decisions, rather they are focused on the here and now. Just take a look at Venezuela if you want to get an idea of what the end game may look like. My point is that while a resolution of the US-China trade dispute would be an unalloyed positive, it is not the only thing that matters when it comes to the global economy and the value of currencies.

Speaking of currencies lets take a look at just how well they have performed vs. the dollar in the past twenty-four hours. Starting with the euro, since the market close on October 31, it has rallied 1.2% despite the fact that the data released in the interim has all been weaker than expected. Today’s Manufacturing PMI data showed that Germany and France both slowed more than expected while Italy actually contracted. And yet the euro is higher by 0.45% this morning. It strikes me that Signor Draghi will have an increasingly difficult time describing the risks to the Eurozone economy as “balanced” if the data continues to print like today’s PMI data. I would argue the risks are clearly to the downside. But none of that was enough to stop the euro bulls.

Meanwhile, the pound has rallied more than 2% over the same timeline, although here the story is quite clear. As hopes for a Brexit deal increase, the pound will continue to outperform its G10 brethren, and there was nothing today to offset those hopes.

Highlighting the breadth of the sentiment change, AUD is higher by more than 2.5% since the close on Halloween as a combination of rebounding base metal prices and the trade story have been more than sufficient to get the bulls running. If the US and China do bury the hatchet on trade, then Australia may well be the country set to benefit most. Reduced trade tensions should help the Chinese economy find its footing again and given Australia’s economy is so dependent on exports to China, it stands to reason that Australia will see a positive response as well.

But the story is far more than a G10 story, EMG currencies have exploded higher as well. CNY, for example is higher by 0.85% this morning and more than 1.6% in the new month. Certainly discussion of breeching 7.00 has been set to the back burner for now, although I continue to believe it will be the eventual outcome. We’ve also seen impressive response in Mexico, where the peso has rallied 1.2% overnight and more than 2% this month. And this is despite AMLO’s decision to cancel the biggest infrastructure project in the country, the new Mexico City airport.

Other big EMG winners overnight include INR (+1.3%), KRW (+1.1%), IDR (+1.1%), TRY (+0.8%) and ZAR (+0.5%). The point is that the dollar is under universal pressure this morning as we await today’s payroll report. Now arguably, this pressure is simply a partial retracement of what has been very steady dollar strength that we’ve seen over the past several months.

Turning to the data, here are current expectations for today:

Nonfarm Payrolls 190K
Private Payrolls 183K
Manufacturing Payrolls 15K
Unemployment Rate 3.7%
Average Hourly Earnings (AHE) 0.2% (3.1% Y/Y)
Average Weekly Hours 34.5
Trade Balance -$53.6B
Factory Orders 0.5%

I continue to expect that the AHE number is the one that will gain the most scrutiny, as it will be seen as the best indicator of the ongoing inflation debate. A strong print there could easily derail the equity rally as traders increase expectations that the Fed will tighten even faster, or at least for a longer time. But absent that type of result, I expect that the market’s euphoria is pretty clear today, so further USD weakness will accompany equity strength and bond market declines.

Good luck and good weekend
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