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
Adf

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
Adf

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
Adf