Tag Archives: #Germany

Clearly On Hold

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Though policy’s clearly on hold
Most central banks feel they’ve controlled
The story on growth
And yet they’re still loath
To change their inflation threshold

Amidst generally dull market activity (at least in the FX market), traders and investors continue to look for the next key catalysts to drive markets. In US equity markets, we are now entering earnings season which should keep things going for a while. The early releases have shown declining earnings on a sequential basis, but thus far the results have bested estimates so continue to be seen as bullish. (As an aside, could someone please explain to me the bullish case on stocks trading at a 20+ multiple with economic growth in the US at 2% and globally at 3.5% alongside extremely limited policy leeway for further monetary ease? But I digress.) Overnight saw Chinese stocks rock, with Shanghai soaring 2.4% and the Hang Seng 1.1%. European stocks are a bit firmer as well (DAX +0.6%, FTSE +0.4%) and US futures are pointing higher.

Turning to the central banks, we continue to hear the following broad themes: policy is in a good place right now, but the opportunity for further ease exists. Depending on the central bank this is taking different forms. For example, the Minutes of the RBA meeting indicated a growing willingness to cut the base rate further, and market expectations are building for two more cuts this year, down to 1.00%. Meanwhile, the Fed has no ability to cut rates yet (they just stopped raising them in December) but continues to talk about how they achieve their inflation target. Yesterday, Boston Fed president Rosengren posited that a stronger commitment to the symmetry around their 2.0% target could be useful. Personally, I don’t believe that, but I’m just a gadfly, not a PhD economist. At any rate, the idea is that allowing the economy to run hot without tightening is tantamount to easing policy further. In the end, it has become apparent the Fed’s (and every central bank’s) problem is that their economic models no longer are a good representation of the inner workings of the economy. As such, they are essentially flying blind. Previous relationships between growth, inflation and employment have clearly changed. I make no claim that I know what the new relationships are like, just that 10 years of monetary policy experiments with subpar results is enough to demonstrate the central banks are lost.

This is true not just in the US and Europe, but in Japan, where they have been working on QE for nearly thirty years now.

More ETF’s bought
Will be followed by more and
More ETF’s bought

“It’s vital for the Bank of Japan to continue persistently with powerful monetary easing,” Governor Haruhiko Kuroda said. As can be seen from Kuroda-san’s comments last night in the Diet, the BOJ is a one-trick pony. While it is currently illegal for the Fed to purchase equities, that is not the case in Japan, and they have been buying them with gusto. The thing is, the Japanese economy continues to stumble along with minimal growth and near zero inflation. As the sole mandate for the BOJ is to achieve their 2.0% inflation target, it is fair to say that they have been failing for decades. And yet, they too, have not considered a new model.

In the end, it seems the lesson to be learned is that the myth of omnipotence that the central banks would have us all believe is starting to crack. Once upon a time central banks monitored activity in the real economy and tried to adjust policy accordingly. Financial markets followed their lead and responded to those actions. But as the world has become more financially oriented during the past thirty years, it seems we now have the opposite situation. Now, financial markets trade on anticipation of central bank activity, and if central banks start to tighten policy, financial markets tend to throw tantrums. However, there is no tough love at central banks. Rather they are indulgent parents who cave quite quickly to the whims of declining markets. Regardless of their alleged targets for inflation or employment, the only number that really matters is the S&P 500, and that is generally true for every central bank.

Turning to this morning’s data story, the German ZEW survey was released at a better than expected 3.1. In fact, not only was this better than forecast, but it was the first positive reading in more than a year. It seems that the ongoing concerns over German growth may be easing slightly at this point. Certainly, if we see a better outcome in the Manufacturing PMI data at the end of April, you can look for policymakers to signal an all clear on growth, although they seem unlikely to actually tighten policy. Later this morning we see IP (exp 0.2%) and Capacity Utilization (79.1%) and then tonight, arguably more importantly, we see the first look at Chinese Q1 GDP (exp 6.3%).

If you consider the broad narrative, it posits that renewed Chinese monetary stimulus will prevent a significant slowdown there, thus helping economies like Germany to rebound. At the same time, the mooted successful conclusion of the US-China trade talks will lead to progress on US-EU and US-Japanese talks, and then everything will be right with the world as the previous world order is reincarnated. FWIW I am skeptical of this outcome, but clearly equity market bulls are all-in.

In the end, the dollar has been extremely quiet (volatility measures are back to historic lows) and it is hard to get excited about movement in the near-term. Nothing has yet changed my view that the US will ultimately remain the tightest policy around, and thus continue to draw investment and USD strength. But frankly, recent narrow ranges are likely to remain in place for a little while longer yet.

Good luck
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Still Some Doubt

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One vote from six hundred is all
That set apart sides in this brawl
So hard Brexit’s out
But there’s still some doubt
That hard Brexit they can forestall

Well, Parliament finally found a majority yesterday regarding Brexit. In a cross-party vote, by 313-312, Parliament voted to not leave the EU without a deal in hand. While they still hate the deal on the table, there are now discussions between PM May and opposition Labour leader Corbyn as to how they can proceed. There is lots of talk of a customs union solution, which would essentially prevent the UK from making trade deals on its own, one of the key benefits originally touted by the pro Brexit crowd. But time is still running out with PM may slated to speak to the EU next Wednesday and explain why the UK should be granted another delay. Remember, it requires a unanimous vote of the other 27 members to grant that delay.

Another interesting tidbit is that the UK government has 10,000 police on standby for potential riots this weekend as there is some talk that Parliament may simply cancel Brexit completely. You may recall that late last year, the European Court of Justice ruled that the UK could do that unilaterally, and so that remains one option. This follows from the train of thought that now that the law states they cannot leave the EU without a deal, if there is no deal to which they can agree, then not leaving is the only other choice. Arguably, the most interesting thing about this has been the market’s reaction. The pound is actually a touch softer this morning, by just 0.1%, but that was after a very modest 0.2% rally yesterday. It continues to trade just north of 1.30 and market participants are clearly not yet convinced that a solution is at hand. If that were the case, I would expect the pound to have rallied much more significantly. If Brexit is canceled, look for a move toward 1.38-1.40 initially. The thing is, it is not clear that it will maintain those levels given the ongoing economic malaise. Ultimately, if we remove Brexit from the calculations, the pound is simply another currency that needs to compare its economic fundamentals to those in the US and will be found wanting in that category as well. I expect a slow drift lower after an initial jump.

Turning to the US-China trade discussions, today Chinese vice-premier Liu He is scheduled to meet with President Trump, a sign many believe means that a deal is quite near. From the information available, it seems that the sticking points continue to be tariff related, with the US insisting that the current tariffs remain in place until the Chinese demonstrate they are complying with the deal and only then slowly rolled back. The US is also seeking the ability to unilaterally impose tariffs in the future, without retaliation, in the event that terms of the deal are not upheld by China. Naturally, China wants all tariffs removed immediately and doesn’t want to agree to unilateral action by the US. One side is going to have to back down, but I could see it being a split where tariffs remain for now, but unilateral action is not permitted. In the end, one of the key issues has always been the fact that the Chinese tend to ignore the laws they write when it is deemed to suit the national interest. Will this time be different? History shows that this time is never different, but we shall see.

Certainly, equity markets cannot get enough of the idea that this trade deal is coming as it continues to rally, especially in China, on the prospects of a successful conclusion. While markets today are generally little changed, Shanghai did manage another 1% jump last night. I guess the real question here is if a deal is agreed and President’s Trump and Xi meet and sign it sometime later this month, what will be the next catalyst for the equity market to rally? Will growth really rebound that quickly? Seems unlikely. Will the central banks add more stimulus? Also unlikely if they see these headwinds fade. In other words, can risk-on remain the market preference indefinitely?

Turning to the actual data, once again Germany showed that the slump there is real, and possibly worsening. Factory Orders fell 4.2% in February, much worse than the expected 0.2% gain and the steepest decline in two years. It is also the third decline in the past four months, hardly the sign of an economy rebounding. In fact, German growth forecasts were cut significantly today by its own Economy Ministry, taking expectations for 2019 down to 0.8% GDP growth for the year, less than half the previous forecast. But despite the lousy data, the euro is basically unchanged on the day and actually over the past week. Traders are looking for a more definitive catalyst, arguably something new from a central bank, before they make their next move. Ultimately, as the German data shows, I think it increasingly unlikely that the ECB can tighten policy in any way for a long time yet, and that bodes ill for the since currency.

There has been one noteworthy mover overnight, the Indian rupee has fallen a bit more than 1% after the RBI cut rates by 25bps at their monthly meeting last night. While this was widely anticipated, the RBI came out much more dovish than expected, indicating another cut was on the way and that they would ‘…use all tools available to it to ensure liquidity in the banking system…’ which basically means that easier money is on the way. I expect that the rupee will have a bit further to fall from here.

But otherwise, it was a pretty dull session overnight. The only data this morning is Initial Claims (exp 216K), but with payrolls tomorrow, that is unlikely to quicken any pulses. We also hear from both Loretta Mester and John Williams, but the Fed story is carved in stone for now, no policy changes this year. Yesterday’s softer than expected ISM Non-Manufacturing data will simply reconfirm that there is no reason for the Fed to start tightening again. All told, it doesn’t feel like much is going to happen today as the market starts to prepare for tomorrow’s NFP report. Unless Brexit is canceled, look for a quiet session ahead.

Good luck
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Mario’s Turn

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It’s Mario’s turn to explain
Why rates should start rising again
His problem, of course
Is he can’t endorse
A rise if it leads to more pain

Markets have been quiet overnight as traders and investors await the ECB’s policy statement, and then perhaps more importantly, Signor Draghi’s press conference to be held at 8:30 this morning. The word filtering out from the ECB is that the TLTRO discussion has moved beyond the stage of IF they need to be rolled over to the stage of HOW exactly they should construct the process. Yesterday’s OECD downgrade of Eurozone growth is likely the last straw for the more hawkish ECB members, notably Germany, Austria and the Netherlands. This is especially so given the OECD slashed their forecasts for German growth by 0.8%! As it happens, Eurozone GDP data was released this morning, and it did nothing to help the monetary hawks’ cause with Q4’s estimate revised lower to 1.1% Y/Y. While the FX market has shown little overall movement ahead of the ECB meeting, European government bonds have been rallying with Italy, the country likely to take up the largest share of the new TLTRO’s, seeing the biggest gains (yield declines) of all.

Once again, the juxtaposition of the strength of the US economy and the ongoing weakness in the Eurozone continues to argue for further gradual strength in the dollar. That US strength was reaffirmed yesterday by the much higher than expected trade deficit (lots more imports due to strong demand) as well as the ADP Employment report, which not only saw its monthly number meet expectations, but showed a massive revision to the previous month, up to 300K from the initial 213K reported. So, for all the dollar bears out there, please explain the drivers for a weaker dollar. While the Fed has definitely turned far less hawkish, so has every other central bank. FX continues to be a two-sided game with relative changes the key drivers. A more dovish ECB, and that is almost certainly what we are going to see this morning, is more than sufficient to undermine any long-term strength in the euro.

Beyond the ECB meeting, however, the storylines remain largely the same, and there has been little movement in any of the major ones. For example, the Brexit deadline is drawing ever closer without any indication that a solution is at hand. Word from the EU is that they are reluctant to compromise because they don’t believe it will be sufficient to get a deal over the line. As to PM May, she is becoming more explicit with her internal threats that if the euroskeptics don’t support her deal, they will be much less pleased with the ultimate outcome as she presupposes another referendum that will vote to Remain. The pound continues to struggle in the wake of this uncertainty, falling another 0.25% overnight which simply indicates that despite all the talk of the horror of a no-deal Brexit, there is a growing probability it may just turn out that way.

Looking at the US-China trade talks, there has been no word since Sunday night’s WSJ story that said the two sides were moving closer to a deal. The trade data released yesterday morning was certainly significant but is really a reflection of the current global macroeconomic situation, namely that the US economy continues to be the strongest in the world and continues to absorb a significant amount of imports. At the same time, weakness elsewhere has manifested itself in reduced demand for US exports. In addition, there was probably some impact from US importers stuffing the channel ahead of worries over increased tariffs. With that concern now dismissed after the US officially stated there would be no further tariff increases for now, channel stuffing is likely to end, or at least slow significantly. Given the lack of information regarding the status of the trade talks, there is no way to evaluate their progress. The political imperatives on both sides remain strong, but there are some very difficult issues that have yet to be addressed adequately. In the meantime, the reniminbi has been biding its time having stabilized over the past two weeks after a 3.0% rally during the previous three months. That stability was evident overnight as it is essentially unchanged on the day.

Beyond those stories there is precious little to discuss today. There is a bit of US data with Initial Claims (exp 225K) along with Nonfarm Productivity (+1.6%) and Unit Labor Costs (+1.6%) all released this morning. In addition, we hear from Fed governor Brainerd (a known dove) early this afternoon. But those things don’t seem likely to be FX drivers today. Rather, it is all about Signor Draghi and his comments. The one other thing to note is that risk appetite in markets, in general, has been ebbing of late. US Equities have fallen in six of the past eight sessions and futures are pointing lower again. The same has largely been true throughout Europe, where markets are lower this morning by roughly 0.4%. fear is a growing factor in markets overall, and as we all know by now, both the dollar and the yen are the main FX beneficiaries in that scenario. It feels like the dollar has room to edge higher today, unless Draghi is quite hawkish. And that is a low probability outcome!

Good luck
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Expansion is Done

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The planet that’s third from the sun
Is learning expansion is done
At least with respect
To growth that’s subject
To what politicians have done

It ought not be much of a surprise that the dollar is regaining its footing this morning and has been doing so for the past several sessions. This is due to the fact that the economic data continue to point to the US as the last bastion of hope for global growth. Yesterday’s data showed that there is still life in the US economy as both Non-Manufacturing ISM (59.7) and New Home Sales (621K) handily beat expectations. At the same time, the data elsewhere around the world continues to show slowing growth.

For example, Australian GDP growth in Q4 printed at a lower than expected 0.2%, with the annual number falling to 2.3%. While RBA Governor Lowe continues to cling to the idea that falling unemployment (a lagging indicator) is going to save the day, the fact remains that the housing bubble there is deflating and the slowdown in China’s economy is having a direct negative impact on Australian growth. In the wake of the report, analysts throughout Asia adjusted their interest rate forecasts to two rate cuts this year even though the RBA has tried to maintain a neutral policy with an eventual expectation to raise rates. Aussie fell sharply, down 0.75% this morning and >2.5% in the past week. It is once again approaching the 0.70 level which has thus far proven to be formidable support, and below which it has not traded in three years. Look for it to crack this time.

But it is not just problems Down Under. In fact, the much bigger issues are in Europe, where the OECD has just released its latest forecasts for GDP growth with much lower numbers on the table. Germany is forecast to grow just 0.7% this year, the UK just 0.8% and of course, Italy which is currently suffering through a recession, is slated to grow just 0.2% this year! Tomorrow Signor Draghi and his ECB colleagues meet again and there is a growing belief that a decision on rolling over the TLTRO bank financing will be made. I have been pounding the table on this for several months and there has certainly been nothing lately to change my view. At this point, the market is now pricing in the possibility of the first ECB rate hike only in mid 2020 and my view is it will be later than that, if ever. The combination of slowing growth throughout the Eurozone, slowing growth in China and still absent inflation will prevent any rate hikes for a very long time to come. In fact, Europe is beginning to resemble Japan in this vein, where slowing growth and an aging population are the prerequisites for NIRP forever. Plus, the longer growth remains subpar, the more call for fiscal policy ease which will require additional borrowing at the government level. As government debt continues to grow, and it is growing all around the world, the ability of central banks to guide rates higher will be increasingly throttled. When you consider these issues it become very difficult to be bullish on the euro, especially in the long-term. But even in the short run, the euro is likely to feel pressure. While the euro has barely edged lower this morning, that is after a 0.35% decline yesterday which means it is down just over 1.0% in the past week.

In the UK, meanwhile, the Brexit debate continues but hope is fading that the PM will get her bill through Parliament this time. Thus far, the EU has been unwilling to make any concessions on the language of the Irish backstop, and despite a herculean effort by May, it is not clear she can find the votes. The vote is scheduled for next Tuesday, after which, if it fails, Parliament will look to pass some bills preventing a no-deal Brexit and seeking a delay. However, even those don’t look certain to pass. Just this morning, Governor Carney said that a no-deal Brexit would not, in fact, be the catastrophe that had been earlier forecast as many companies have made appropriate plans to handle it. While the underlying thesis in the market continues to be that there will be a deal of some sort, it feels like the probability of a hard Brexit is growing somewhat. Certainly, the pound’s recent performance would indicate that is the case. This morning it is down a further 0.3% which takes the move to -1.75% in the past week.

One last central bank story is that of Canada, where the economy is also slowing much more rapidly than the central bank had believed just a few weeks ago. Last week we learned that inflation is lower than expected, just 1.4%, and that GDP grew only 0.1% in Q4, actually falling -0.1% in December. This is not a data set that inspires optimism for the central bank to continue raising rates. Rather, it should become clear that the BOC will remain on hold, and more importantly likely change its hawkish slant to neutral at least, if not actually dovish. As to the Loonie, it is lower by 0.3% this morning and 2.0% since the GDP release on Friday.

Add it all up and you have a story that explains global growth is slowing down further. It is quite possible that monetary policy has been pushed to its effective limit with any marginal additional ease likely to have a very limited impact on the economy. If this is the case, it portends far more difficulty in markets ahead, with one of the most likely outcomes a significant increase in volatility. If the global economy is now immune to the effects of monetary policy anesthesia, be prepared for a few more fireworks. It remains to be seen if this is the case, but there are certainly some indications things are playing out that way. And if central banks do lose control, I would not want to have a significant equity market position as markets around the world are certain to suffer. Food for thought.

This morning we get one piece of data, Trade Balance (exp -$57.9B) and we hear from two more Fed speakers, Williams and Mester. Then at 2:00 the Fed’s Beige Book is released. It seems unlikely that either speaker will lean hawkish, even Mester who is perhaps the most hawkish on the FOMC. Comments earlier this week from other speakers, Rosengren and Kaplan, highlighted the idea of patience in their policy judgements as well as potential concern over things like the extraordinary expansion of corporate debt in this cycle, and how in the event the economy slows, many more companies are likely to be vulnerable. While fear is not rampant, equity markets have been unable to rally the past several sessions which, perhaps, indicates that fear is beginning to grow. And when fear is in vogue, the dollar (and the yen) are the currencies to hold.

Good luck
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Quite Sublime

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The markets are biding their time
Awaiting a new paradigm
On trade and on growth
While hoping that both
Instill attitudes quite sublime

The dollar has rebounded this morning as most of the news from elsewhere in the world continues to point to worsening economic activity. For example, the German ZEW survey printed at -13.4, which while marginally better than the expected -13.6, remains some 35 points below its long-term average of +22. So, while things could always be worse, there is limited indication that the German economy is rebounding from its stagnation in H2 2018. Meanwhile, Italian Industrial Orders fell to -1.8%, well below the +0.5% expectation, and highlighting the overall slowing tenor of growth in the Eurozone. As I have mentioned over the past several days, we continue to hear a stream of ECB members talking about adding stimulus as they slowly recognize that their previous views of growth had been overestimated. With all this in mind, it should be no surprise the euro is lower by 0.25% this morning, giving back all of yesterday’s gains.

At the same time, Swedish inflation data showed a clear decrease in the headline rate, from 2.2%, down to the Riksbank’s 2.0% target. This is a blow to the Riksbank as they had been laying the groundwork to raise rates later this year in an effort to end ZIRP. Alas, slowing growth and inflation have put paid to that idea for now, and the currency suffered accordingly with the krone falling 1.5% on the release, and remaining there since then. Despite very real intentions by European central bankers to normalize policy, all the indications are that the economy there is not yet ready to cooperate by demonstrating solid growth.

The last data point of note overnight was UK employment, where the Unemployment rate remained at a 40 year low of 4.0% and the number of workers grew by 167K, a better than expected outcome. In addition, average earnings continue to climb at a 3.4% pace, which remains the highest pace since 2008. Absent the Brexit debate, and based on previous comments, it is clear that the BOE would feel the need to raise rates in this situation. But the Brexit debate is ongoing and uncertainty reigns which means there will be no rate hikes anytime soon. The latest news is that Honda is closing a factory in Swindon, although they say the driving impulse is not Brexit per se, but weaker overall demand. Nonetheless, the 4500 jobs lost will be a blow to that city and to the UK overall. Meanwhile, the internal politics remain just as jumbled as ever, and the political infighting on both sides of the aisle there may just result in the hard Brexit that nobody seems to want. Basically, every MP is far more concerned about their own political future than about the good of the nation. And that short-sightedness is exactly how mistakes are made. As it happens, the strong UK data has supported the pound relative to other currencies, although it is unchanged vs. the dollar this morning.

Pivoting to the EMG bloc, the dollar is generally, but not universally higher. Part of that is because much of the dollar’s strength has been in the wake of European data well after Asian markets were closed. And part of that is because today’s stories are not really dollar focused, but rather currency specific. Where the dollar has outperformed, the movement has been modest (INR +0.2%, KRW +0.2%, ZAR +0.4%), but it has fallen against others as well (BRL -0.2%, PHP -0.2%). In the end, there is little of note ongoing here.

Turning to the news cycle, US-China trade talks are resuming in Washington this week, but the unbridled optimism that seemed to surround them last week has dissipated somewhat. This can be seen in equity markets which are flat to lower today, with US futures pointing to a -0.2% decline on the opening while European stocks are weaker by between -0.4% and -0.6% at this point in the morning. On top of that, Treasury yields are creeping down, with the 10-year now at 2.66% and 10-year Bunds at 0.10%, as there is the feeling of a modest risk-off sentiment developing.

At this point, the key market drivers seem to be on hold, and until we receive new information, I expect limited activity. So, tomorrow’s FOMC Minutes and Thursday’s ECB Minutes will both be parsed carefully to try to determine the level of concern regarding growth in the US and Europe. And of course, any news on either trade or Brexit will have an impact, although neither seems very likely today. With all that in mind, today is shaping up to be a dull affair in the FX markets, with limited reason for the dollar to extend its early morning gains, nor to give them back. There is no US data and just one speaker, Cleveland’s Loretta Mester, who while generally hawkish has backed off her aggressive stance from late last year. Given that she speaks at 9:00 this morning, it may be the highlight of the session.

Good luck
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Compromised

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The punditry seemed quite surprised
That trade talks have been compromised
If President’s Xi
And Trump can’t agree
To meet, forecasts need be revised

What then, ought the future might hold?
It’s likely that stocks will be sold
And Treasuries bought
As safety is sought
Plus rallies in dollars and gold

Risk appetites have definitely diminished this morning as evidenced by yesterday’s US equity decline alongside a very weak showing in Asia overnight. The proximate cause is the news that President’s Trump and Xi are not likely to meet ahead of the March 1 deadline regarding increased tariffs on Chinese goods. And while trade talks are ongoing, with Mnuchin and Lighthizer heading to Beijing next week, it seems pretty clear that the market was counting on a breakthrough between the presidents in a face-to-face meeting. However, not unlike the intractable Irish border situation in the Brexit discussions, the question of state subsidies and IP theft forced technology transfer are fundamental to the Chinese economy and therefore essentially intractable for Xi. I have consistently maintained that the market was far too sanguine about a positive outcome in the near-term for these talks, and yesterday’s news seems to support that view.

Of course, eventually a deal will be found, it is just not clear to me how long it will take and how much pain both sides can stand. Whether or not Fed Chair Powell believes he capitulated to Trump regarding interest rates, it is clear Trump sees it in that light. Similarly, it appears the president believes he has the upper hand in this negotiation as well and expects Xi to blink. That could make for a much rockier path forward for financial markets desperate to see some stability in global politics.

The trade news was clearly the key catalyst driving equities lower, but we continue to see weakening data as well, which calls into question just how strong global growth is going to be during 2019. The latest data points of concern are Italian IP (-0.8%, exp +0.4%) and the German trade surplus falling to €13.9B from €20.4B in November. Remember, Germany is the most export intensive nation in the EU, reliant on running a significant trade surplus as part of its macroeconomic policy structure. If that starts to shrink, it bodes ill for the future of the German economy, and by extension for the Eurozone as a whole. While it cannot be too surprising that the Italian data continues to weaken, it simply highlights that the recession there is not likely to end soon. In fact, it appears likely that the entire Eurozone will be mired in a recession before long. Despite the ongoing flow of weak data, the euro, this morning, is little changed. After a steady 1.25% decline during the past week, it appears to have found a little stability this morning and is unchanged on the day.

In fact, lack of movement is the defining feature of the currency markets this morning as the pound, yen, Loonie, kiwi, yuan, rupee and Mexican peso are all trading within a few bps of yesterday’s levels. The only currency to have moved at all has been Aussie, which has fallen 0.25% on continued concerns over the growth prospects both at home and in China, as well as the ongoing softness in many commodity prices.

The other noteworthy items from yesterday were comments from St Louis Fed president Bullard that he thought rates ought to remain on hold for the foreseeable future. Granted, he has been one of the two most dovish Fed members (Kashkari being the other) for a long time, but he was clearly gratified that the rest of the committee appears to have come around to his point of view. And finally, the Initial Claims data printed at a higher than expected 234K. While in the broad scheme of things, that is still a low number, it is higher than the recent four-week average, and when looking at a chart of claims, it looks more and more like the bottom for this number is likely behind us.

A great deal has been written recently about the reliability of the change in the Unemployment rate as a signal for a pending recession. History shows that once the Unemployment rate rises 0.4% from its trough, a recession has followed more than 80% of the time. Thus far, that rate has risen 0.3% from its nadir, and if claims data continues to rise, which given recent numbers seems quite possible, the implication is a recession is in our future. The one thing we know about recessions is that the Fed has never been able to forecast their onset. Given the fact that this recovery is quite long in the tooth, at 115 months of age, it cannot be surprising that a recession is on the horizon. My concern is that the horizon is beneath our feet, not in the distance.

There is no US data to be released today although next week brings both inflation and manufacturing data. But for now, all eyes are on the deteriorating view of the trade situation, which is likely to keep pressure on equity markets (futures are currently pointing lower by 0.5%) while helping support the dollar as risk is continuously reduced.

Good luck and good weekend
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Incessant Whining

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Can someone help me understand
Why euros remain in demand?
Theira growth rate’s declining
While incessant whining
Is constant from Rome to Rhineland

Another day, another failure in Eurozone data. This morning’s culprits were German and Spanish IP, both of which fell sharply. The German outcome was a fourth consecutive monthly decline, with a surprise fall of 0.4%, as compared to expectations for a 0.7% rise. Not only that, November’s release was revised lower to -1.3%. It seems pretty clear that positive growth momentum in Germany has faded. At the same time, Spain, which had been the best growth story in the entire Eurozone, also released surprisingly weak IP data, -6.2%, its largest decline in seven years, and significantly lower than the -2.3% expected. This marks two consecutive months of decline, and three of the past four. It appears that the Spanish growth story is also ebbing.

It should be no surprise that the euro has fallen further, down another 0.3% this morning and back to its lowest levels in two weeks. As I have consistently maintained, FX movements rely on two stories, with the relative strength of one currency’s economy and monetary policy stance compared to the other’s. And while the Fed’s U-turn at the end of January, marked an important point in the market’s collective eyes, thus helping to undermine the dollar strength story, the fact that the European growth story seems to be diminishing so rapidly is now having that same impact on the euro. The EU has reduced, yet again, its growth forecasts for the EU and virtually every one of its member nations. Italy’s forecast was cut to just 0.2% GDP growth in 2019. Germany’s has been cut to 1.1% from a previous forecast of 1.9% in 2019. As I have written repeatedly, the idea that the ECB can tighten policy any further given the economic outlook is fantasy. Look for a reversal by June and either a reinstatement of QE, or forward guidance eliminating any chance of a rate hike before 2021! Rolling over TLTRO’s is a given.

But the euro is not the only currency under pressure this morning, in fact, the dollar, once again, is on the move. The pound, for example, is also down by 0.3% as the market awaits the BOE’s rate decision. There is no expectation for a rate move, but there is a great deal of interest in Governor Carney’s comments regarding the future. Given the ongoing uncertainty with Brexit (which shows no signs of becoming clearer anytime soon), it remains difficult to believe that the BOE can raise rates. This is especially true because the economic indicators of late have all shown signs of a substantial slowdown of UK growth. The PMI data was awful, and growth forecasts by both private and government bodies continue to be reduced. However, despite the fact that the measured inflation rate has been falling back to the 2.0% target more quickly than expected, there is a great deal of discussion amongst BOE members that wages are growing quite quickly and thus are set to push up overall inflation. This continues to be the default mindset of central bankers around the world, as it is built into their models, despite the fact that there is scant evidence in the past ten years that rising wages has fed into measured price inflation. And while it is entirely possible that inflation is coming soon to a store near you, the recent evidence has pointed in the opposite direction. Inflation data around the world continues to decline. Despite Carney’s claims that Brexit may force the BOE to raise rates after a sudden spike higher in inflation, I think that is an extremely low probability event.

In the meantime, the Brexit saga continues with no obvious answers, increasing frustration on both sides, and just fifty days until the UK is slated to exit the EU. Parliament is due to vote on PM May’s Plan B next week, although it now appears that might be delayed until the end of the month. But in the end, Plan B is just Plan A, which was already soundly rejected. At this point, it is delay or crash, and as the pound’s recent decline implies, there are more and more folks thinking it is crash.

Other currency news saw the RBI cut rates 25bps last night in what was a mild surprise. If you recall I mentioned the possibility yesterday, although the majority of analysts were looking for no movement. Interestingly, the rupee actually rallied on the news (+0.2%), apparently on the belief that the new RBI Governor, Shaktikanta Das, has a more dovish outlook which is going to support both growth and the current market friendly government of PM Modi. However, beyond that, the dollar is broadly higher this morning. This is of a piece with the fact that equity markets are generally under pressure after a lackluster decline yesterday in the US; commodity prices have continued their recent slide, and government bonds are firming up with yields in the havens, like Treasuries and Bunds, declining. In addition, the one other currency performing well this morning is the yen. In other words, it appears we are seeing a mild risk-off session

Turning to the data, yesterday’s Trade deficit was significantly smaller than expected at ‘just’ -$49.7B with lower imports the driving force there. Arguably, we would rather see that number shrink on higher exports, but I guess tariffs are having their intended effect. This morning, the only scheduled data is Initial Claims (exp 221K), which jumped sharply last week, but have been averaging about 225K for the past several months. However, given what might be a turn in the Unemployment Rate trend, it is entirely possible that this number starts trending slightly higher. We will need to keep watch.

At this point, the dollar has continued to perform well for the past several sessions and there is no reason to believe that will change. The initial dollar weakness in the wake of the Fed’s more dovish commentary is now being offset by what appears to be ongoing weakness elsewhere in the world. I admit I expected to see the dollar remain under pressure for a longer period than a week, but so far, that’s been the case, one week of softening followed by a rebound with no obvious reason to see it stop. If equity markets continue to underperform, then it seems likely the dollar will remain bid.

Good luck
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More Frustration

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In Europe, the dominant nation
Is starting to feel more frustration
As data implies
They’ll soon demonize
The Chinese US for their degradation

The story in Europe continues to be one of diminishing growth across the board. Early this morning, German Factory Order data was released showing orders unexpectedly fell -1.6% in December after a downwardly revised -0.2% decline in November. Weakness was seen in every sector as both domestic and foreign demand shrank. There is no way to paint this as anything other than a sign of ongoing economic malaise. Once again, I will point out that there is a vanishingly small probability that the ECB will consider raising interest rates later this year, with a far more likely scenario being that further policy ease is on the way. The immediate impact of this data was to see the euro continue its recent decline, having fallen a further 0.2% this morning and now trading back below the 1.14 level.

Speaking of potential further easing of ECB monetary policy, the discussion regarding TLTRO’s is starting to heat up. These (Targeted Long-Term Refinancing Operations) were one of the several ways the ECB expanded their balance sheet during the Eurobond crisis several years ago. The idea was that the ECB made cheap (or even negative rate) liquidity available to Eurozone banks that wanted to fund an increase in their loan books. If the loans qualified (based on the recipients) banks actually got paid to borrow the money from the ECB. So, it was a pretty sweet deal for them, getting paid on both sides of the transaction. Because these loans had initial terms of four and five years, they also counted toward banks’ capital ratios and thus helped reduce their overall cost of funding.

But starting in June, the first of these loans will fall under twelve months until repayment is due, and thus will no longer be able to be counted as long-term capital. As I have written before, there are two possible scenarios: this financing rolls off and banks are forced to fund their outstanding loans in the markets at a much higher price. The result of this will be either slimmer profit margins for the banks, undermining their balance sheets, or they will be forced to raise rates or call in those outstanding loans, neither of which will help the growth story in Europe. The other, far more likely, choice is for the ECB to roll the TLTRO’s over, allowing the banks to maintain their interest rate margins and insuring that there is no tightening of monetary policy in the Eurozone. Given the ongoing weakness in data, which do you think is going to happen? Exactly, they will be rolled over, despite the fact that the ECB is unwilling to commit to that right now. It would be shocking if that is not the outcome!

But the euro is not the only currency to decline this morning, in fact, dollar strength has been pretty widespread. For example, AUD has fallen -1.45% after RBA Governor Lowe explained that the balance of risks for the Australian economy had tilted lower. The market has understood that as a ‘promise’ that future rate hikes have been delayed indefinitely. Aussie’s fall helped drag Kiwi lower as well, with NZD down -0.65%. Meanwhile, the ongoing decline in oil prices, most recently on the back of rising US inventories, has undermined CAD (-0.6%), NOK (-0.4%), MXN (-0.5%) and RUB (-0.4%). Interestingly, the pound, which had been lower earlier, is the one G10 currency that has held its own this morning. Of course, it has been declining steadily for more than two weeks, ever since the last big Parliamentary vote. What appears to be happening is that traders grew to believe that with Parliament taking charge of the negotiations, a deal would be reached, and the risk of a hard Brexit diminished. But funnily enough, Parliament is learning that despite their distaste for the Irish border solution proposed by PM May, there is no obvious better way to address that intractable problem. Traders are starting to lose their confidence that the outcome will be a deal, as despite a universal claim that a hard Brexit should not and cannot happen, it just might happen.

Turning to emerging markets, we have seen weakness across the board there as well. One of the big changes that the Fed has wrought by changing its stance from ongoing hawkishness to apparent dovishness is that many APAC central banks, that had been raising rates steadily alongside the Fed last year, are now backing away from those policies. Last night Bank of Thailand left rates on hold and later this week we will hear from both the Philippines (no change expected) and India (possible 25bp rate cut). Both mark a change from recent policy direction. So, while the dollar suffered in the wake of the Fed’s change, as that sentiment propagates around the world, I expect that the dollar will find its footing. After all, if every central bank is easing policy, the forces driving the FX market will need to be non-monetary. And for now, the US remains the best economy around, despite recent signs of slowing here.

One other story I need to mention is an article in Bloomberg (https://www.bloomberg.com/news/articles/2019-02-06/imf-staff-floats-dual-money-to-allow-much-deeper-negative-rates?srnd=markets-vp) that talks about a paper written at the IMF suggesting the creation of e-money to be issued alongside current cash. E-money would have negative interest rates and an exchange rate with cash which would drive the value of cash lower over time (effectively creating a negative interest rate for holding cash). Given my current role as Chief Strategist at 9th Gear Technologies, I have a particular interest in the concept of e-money, as I do believe cash will become scarcer and scarcer over time. I have also been vocal in my concerns that e-money will result in permanent negative interest rates, and that was before the IMF weighed in with that exact view.

Turning to this morning’s data releases, US Trade data is due (exp -$54.0B) at 8:30, and then we hear from the Fed’s Randall Quarles this afternoon. However, his focus continues to be on regulation, so I don’t anticipate any new monetary policy information. If the news from Asia is the new trend, then expect to see talk of easier money from all around the world, with the Fed, once again becoming the tightest policy around, thus supporting the dollar. I don’t imagine it will happen all at once, as there are still those harping on the Fed’s U-turn, but eventually, the news will be other banks easing while the Fed stands pat.

Good luck
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Disgraced

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Prime Minister May was disgraced
As Parliament calmly laid waste
To hopes that her deal
With Europe could heal
The schism that Brexit emplaced

Yesterday’s Parliamentary vote on the Brexit deal negotiated between PM May’s government and the EU resulted in a resounding rejection. While the UK remains fairly evenly divided on the absolute concept of Brexit, what was made clear was that the terms proposed were unacceptable to all sides. As I have maintained, the Irish border issue is an intractable one, where one side or the other simply must cede ground. There is no middle way. At this time, neither side is willing to do so, and quite frankly, unless Northern Ireland is willing to reunite with Ireland, (which seems highly unlikely any time soon), there can be no deal that will be acceptable to both sides. This leaves three potential outcomes; the UK could leave the EU with no deal in hand and go back to WTO tariff rules; the UK could opt not to leave at all (based on the European Court of Justice ruling from November); or there is a small possibility that the deadline could be delayed a number of months in order to reopen negotiations.

Let’s unpack those three choices.
1. In a no-deal Brexit, pretty much every published analysis by economists has forecast a nearly apocalyptic result for the UK economy, with a deep recession followed by much slower growth. Or course, every one of those economists likely voted to remain as the demographics of the vote showed professionals, especially financial industry professionals, overwhelmingly voted to remain. In other words, they are talking their book. Will the UK suffer? Almost certainly. Will the UK collapse into a depression? Absolutely not. The UK was a strong and viable nation before the EU came into existence and will certainly continue to be so going forward. The market impact of this outcome is likely to be quite negative in the short term, however, with both the pound and UK equity markets falling sharply if it becomes clear this will be the outcome. While both will recover eventually, the timing on that is unclear.

2. If the May government opted to remain in the EU, essentially repudiating the results of the referendum, I fear it would lead to riots in the streets, certainly in the Midlands which led the vote to leave. In fact, I could see an alliance between the French gilets jaune and the Brexiteers as both will be taking to the streets in an effort to change the government. A unilateral decision not to leave would have much deeper consequences with regard to the political system within the UK, as there would be whole swathes of the nation that would cease to trust the government entirely. I actually think this is the least likely scenario, although in the event it occurred, I would expect both the pound and the FTSE to rally sharply initially, but as the consequences of that act became clearer, I imagine both would suffer greatly.

3. Delaying the deadline seems like the best fudge available to both sides at this point, although the initial comments by EU officials followed the line that, given the depth of the defeat of the already negotiated deal, there seems little chance to make small changes and get a new result. This will also require unanimous approval by the remaining 27 members of the EU, which sounds daunting, although if there it was believed there was a serious chance of coming up with a better deal would get done. Here, too, the market response will be for a rally in the pound, and probably the FTSE, as investors would likely take the stance that the delay presages a deal.

However, for the time being, PM May’s first course of business is to fight off the no-confidence motion brought by Labour Leader Jeremy Corbyn in his attempt to bring down the government and force a general election. Pundits believe that while the deal was unacceptable, May will hold on. The problem is, she has no ideas as to how to move the process forward. Certainly, the probability of a no-deal Brexit has increased somewhat after the vote. Interestingly, the FX markets have not really priced for that outcome. In fact, since the original vote date, December 11, when May pulled the bill to try to garner more support, the pound has rallied pretty steadily and is nearly 3% higher over the past month. It would seem that FX traders believe a deal will be found.

The other story of note is that the Chinese government is now set to cut taxes in an effort to add fiscal stimulus to their ongoing monetary stimulus efforts. Remember, they have already cut bank reserve requirements by another 1% this year, adding to 2% cuts from last year, and they have created a loan targeting policy for SME’s. Now income tax cuts are to be included as well. This highlights just how poorly the Chinese economy is performing right now, and how critical President Xi believes it is to continue publishing GDP growth above 6%. While the FX market has shown little response to these actions, they have had a much more positive impact on equity markets, with yesterday’s rallies easily attributed to the announcement. The one thing that is certain is that Xi will continue to do whatever he things is necessary to support economic growth in the short run, regardless of the potential longer-term negative consequences. After all, despite being President for life, he is still a politician!

Pivoting to the data story, yesterday Germany reported 2018 GDP growth of just 1.5%, its weakest performance in 5 years, although there was no report on Q4 growth. Given the surprise decline in Q3, pundits were watching to see if Germany had entered a technical recession, although it appears not to be the case. However, it is clear that growth in the engine of Europe is continuing to slow which doesn’t bode well for the entire Eurozone. Nor does it bode well for the ECB’s nascent attempts to remove policy accommodation. In fact, their biggest fear has to be that growth slows further there and they have basically no monetary tools left to combat the situation. This morning’s data has shown that inflation continues to ebb in Europe (France 1.6%, Germany 1.7%, Spain 1.2%, Italy 1.1%), and the UK (2.1%) as well, which reduces pressure to tighten policy at all. While US inflation is also softening, it continues to puzzle me that there is any belief the ECB (or the BOE for that matter) will consider raising interest rates any time soon. So even if the Fed is more dovish (and given remarks from the always hawkish KC President Esther George yesterday, it is clear that there is no rate hike in the near future in the US), the idea that any other central bank is going to be tightening policy is absurd.

In fact, I would argue that the dollar’s recent weakness has been predicated solely on the idea that the Fed will back off on previously forecast rate hikes. But if the Fed is stopping, you can be 100% certain that any thoughts of tighter policy elsewhere are also out the window, and so relatively speaking, the US remains the tightest policy around. I still like the dollar for that reason.

Good luck
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Naught But Fool’s Gold

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There once was a story, oft told
That growth round the world would be bold
But data of late
Has shown that the fate
Of that tale was naught but fool’s gold

Instead round the world what we see
Are signs that the future will be
Somewhat less robust
Than had been discussed
Since money is no longer free!

The dollar is strong this morning, rising vs. essentially every other currency after a series of weak data points from China and the EU reinforced the idea that global growth is slowing. As I type my last note of the year, the euro is lower by 0.65%, the pound -0.7% and Aussie has fallen -0.9%. In the emerging market space, the damage is generally less severe, with both CNY and BRL falling -0.4% while MXN and INR have both slipped -0.3%. There are two notable exceptions to this, however, as ZAAR has tumbled 1.5% and KRW fallen -0.8%. In other words, the dollar is in the ascendant today.

What, you may ask, is driving this movement? It started early last evening when China released some closely watched economic indicators, all of which disappointed and indicated further slowing of the economy there. Fixed Asset Investment rose just 5.9%, IP rose just 5.4% and Retail Sales rose just 8.1%. As Chinese data continue to fall below estimates, it increases the odds that the PBOC will ease monetary policy further, thus undermining the renminbi somewhat. But the knock on effect of weakening Chinese growth is that the rest of Asia, which relies on China as a key market for their exports, will also suffer. Hence the sharp decline in AUD and NZD (-1.0%), along with KRW and the rest of the APAC currencies. It certainly appears as though the trade tensions with the US are having a deleterious effect on the Chinese economy, and that may well be the reason that we have heard of more concessions on their part in the discussions. Today’s story is that corn purchases will be restarting in January, yet another rollback of Chinese trade barriers.

But it was not just China that undermined the global growth story; Eurozone data was equally dismal in the form of PMI releases. In this case, Germany’s Manufacturing PMI printed at 51.5, France at 49.7 and the Eurozone as a whole at 51.4. Each of these was substantially below expectations and point to Q4 growth in the Eurozone slowing further. While the French story is directly related to the ongoing gilets jaune protests, Germany is a bigger issue. If you recall, Q3 growth there was negative (-0.2%) but was explained away as a one-off problem related to retooling auto plants for emissions changes in regulations. However, the data thus far in Q4 have not shown any substantive improvement and now call into question the idea that a Q4 rebound will even occur, let alone offset the weak Q3 data.

Adding to the Eurozone questions is the fact that the ECB yesterday confirmed it was ending QE this month, although it has explained that it will be maintaining the size of the balance sheet for “an extended period of time” after its first interest rate rise. Currently, the market is pricing in an ECB rate hike for September 2019, but I am very skeptical. The fact that Signor Draghi characterized economic risks as to the downside rather than balanced should come as no surprise (they are) but calls into question why they ended QE. Adding to the confusion is the fact that the ECB reduced its forecasts for both growth and inflation for 2018 and 2019, hardly the backdrop to be tightening policy. In the end, much of this was expected, although Draghi’s tone at the press conference was clearly more dovish than had been anticipated, and the euro fell all day yesterday and has continued on this morning in the wake of the weak data. And this doesn’t even include the Italian budget mess where Italy’s latest figures show a smaller deficit despite no adjustments in either spending or taxes. Magical thinking for sure!

Meanwhile, the UK continues to hurtle toward a hard Brexit as PM May was rebuffed by the EU in her attempts to gain some conciliatory language to bring back to her Parliament. While I don’t believe in the apocalyptic projections being made about the UK economy come April 1st next year, I do believe that the market will severely punish the pound when it becomes clear there will be no deal, which is likely to be some time in January.

As to the US-China trade situation, this morning there is more fear of tariffs by the US, but the negotiation is ongoing. Funnily enough, my reading of the signs is that China is, in fact, blinking here and beginning to make some concessions. The last thing President Xi can afford is for the Chinese economy to slow sharply and put millions of young men out of work. Historically, excessive unemployed youth can lead to revolution, a situation he will seek to avoid at all costs. If it means he must spin some concessions to the US into a story of strengthening the Chinese economy, that is what he will do. It would certainly be ironic if President Trump’s hardball negotiating tactics turned out to be successful in opening up the Chinese economy and broadly pushing forward a more internationalist agenda, but arguably, it cannot be ruled out. Consider the ramifications on the political debate in the US if that were to be the case!! As to the market implications, I would expect that risk would be quickly embraced, equity markets would rally sharply as would the dollar, while expectations for the Fed would revert to tighter policy in 2019 and beyond. Treasuries, on the other hand, would fall sharply and yields on the 10-year would likely test their highs from early November. We shall see.

This morning brings Retail Sales (exp 0.2%, ex autos 0.2%), IP (0.3%) and Capacity Utilization (78.6%). Data that continues to show the US growing, especially in the wake of the weakness seen elsewhere in the world, should continue to underpin the dollar going forward. While I understand the structural issues like the massive budget and current account deficits should lead to dollar weakness, we are still in a cyclical phase of the market, and the US remains the best place to be for investment, so it remains premature to write off further dollar strength.

Good luck, good weekend and happy holidays to you all.

FX Poetry will return on January 2nd with forecasts for next year, and in regular format starting January 3rd.

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