Still Some Doubt

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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Heavy-Handed

There once was a large bloc of nations
That gathered to foster relations
On how they should trade
That they might dissuade
A conflict midst trade accusations

But slowly their mission expanded
As rules on more things they demanded
One nation resented
These unprecedented
Requests which they thought heavy-handed

This nation expressed their dissention
By voting to leave that convention
But three years have passed
And no deal’s amassed
Support so they need an extension

I apologize for the length of this morning’s ditty, but sometimes it takes more than one stanza to tell the story.

Brexit is once again the top story today, although the FOMC meeting and US-China trade talks are still in the news. With just nine days left before the UK is due to leave the EU, there is still no agreed upon deal between the two sides of the negotiation. Today, the EU has a council meeting of all its leaders and PM May will be making a speech and asking for an extension. The question has been, how long would she request? At this time, it appears it will be short, just three months, as she is seeking to get the negotiated text voted on in Parliament one more time. However, there has been pushback by several other EU members concerned that three months won’t be enough time to change anything. In fact, some EU members want a much longer delay in order to push for a second Brexit vote; you know, to get the ‘right’ answer this time. At any rate, Brexit continues to be a slow-motion train wreck and all are fascinated to watch, if not to live through its consequences.

As an aside, a conversation I had yesterday with a local who has become more engaged in politics there, indicated that there is an abject fear of leaving without a deal, and that despite the many bad things about PM May’s deal, there will be many MP’s who vote for it rather than allowing a hard Brexit. Certainly that is what May is counting on. We shall see. The FX market continues to react to the ebbs and flows of the conversation and this morning is ebbing. The pound is down 0.3% as it seems some traders are losing confidence in the outcome. As I have repeatedly said, despite the fears of a no-deal outcome, the law remains for the UK to leave next Friday whether there is a deal in place or not, and that is a non-zero probability. If that is the case, the pound will suffer greatly, especially because that is clearly not the current expectation. Hedgers be ready.

On to the FOMC, which will release their policy statement at 2:00 this afternoon, along with their latest economic projections (expected to see GDP growth lowered slightly) and the infamous dot plot. Chairman Powell had made an effort, prior to the quiet period, to minimize the importance of the dots as those projections do not contain error bars showing the level of uncertainty attached to the forecasts. But the market is still talking about them non-stop. I guess six years of harping on the importance of forward guidance, BY THE FED, has trained market participants to pay attention to forward guidance. My money remains on the idea that the median dot will be at no more rate increases this year, and a more pronounced reduction in the long-term neutral rate. However, there are a number of analysts who are warning that the dot plot could look much more hawkish, highlighting another rate hike this year and one more next year. if that is the case, I expect equity markets to suffer, as it is pretty clear the market has priced out any further rate hikes.

In addition, we cannot forget the balance sheet story, where I remain convinced that the balance sheet roll-off will be slated to end by June, and that the composition will be focused on shorter term securities. The idea that shortening the maturity profile now will result in more ammunition for fighting the next economic downturn will prove quite appealing. After all, a big fear of the Fed is the howls of protest from the Austrian school (read Congressional monetary hawks) if they restart QE during the next recession. Shortening the average maturity of holdings now will allow them to maintain the size of the balance sheet while still adding stimulus in the next downturn by extending the maturity then.

And finally, on the trade front, despite a story yesterday indicating the Chinese were backing away from earlier agreements on IP security, the US delegation of Lighthizer and Mnuchin are heading to Beijing this week, with the Chinese delegation expected to come back here the week after in the final push for a deal. Certainly, equity markets have priced in a successful deal here, and probably so has the dollar. Interestingly, Treasury markets continue to look at the world with a very different view of much slower growth now, and in the future. It appears there is a bit more skepticism by bond traders on the successful outcome of a trade deal, than that of equity traders.

Overall, the dollar is marginally firmer this morning, but as we have seen the last several days, individual currency movements have been muted. The Indian rupee continues to perform well as an equity market rally in Mumbai has drawn in foreign investment and the market increasingly prices in a Modi victory in the upcoming election, which is seen as the most economic friendly outcome available. But even there, the rupee has only rallied 0.3% this morning. Throughout the G10, movement continues to be extremely limited, with 0.1% being the extent of today’s activity (the pound excepted).

Ahead of the FOMC meeting, there is no data to be released today, and equity futures are basically flat, pointing to very modest 0.1% declines on the open. Look for very little movement until the FOMC announcement and the following press conference. And then, it will all depend on the outcome.

Good luck
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Doves Are in Flight

Our central bank’s doves are in flight
As this week the Fed will rewrite
Their previous view
That one hike or two
Was needed to make things alright

Instead as growth everywhere slows
More policy ease they’ll propose
Perhaps not QE
But all will agree
The balance sheet’s size reached its lows

If you were to throw a dart at a map of the world, whichever country you hit would almost certainly be in the midst of easing monetary policy (assuming of course you didn’t hit the ocean.) It is virtually unanimous now that the next move in interest rates is going to be lower. In fact, there are only two nations that are poised to go the other way, Norway and Hong Kong. The former because growth there continues to motor along and, uniquely in the world, inflation is above their target range, most recently printing at 2.6%. The latter is actually under a different kind of pressure, draining liquidity from its economy as there has been a huge inflow of funds driving rates down and pressuring the HKD to the bottom of its band. But aside from those two, its easy money everywhere. Last week the ECB surprised the market by announcing the implementation of a new round of TLTRO’s, rather than just talking about the idea. That was a much faster move than the market had anticipated.

This week it is the Feds turn, where new forecasts and a new dot plot are due. It is widely assumed that economic forecasts will be marked lower given the slowing data picture that has emerged in the US, with the most notable data point being the 20K rise in NFP last month, well below the 180K expected. As such, and given the change in rhetoric since the last dot plot was revealed in December, it is now assumed that the median expectation for FOMC members will be either zero or one rate hikes this year, down from two to three. My money is on zero, with only a few of the hawks (Mester and George) likely to still see even one rate hike in the future.

To me, however, the market surprise will come with regard to the balance sheet reduction that has been ongoing for the past two years. What was “paint drying” in October, and “on autopilot” in December is going to end by June! Mark my words. It is already clear that the Fed wants to stop tightening policy, and despite the claims that the slow shrinkage of the balance sheet would have a limited impact, it is also clear that the impact of reducing reserves has been more than limited. In a similar vein to the ECB acting instead of talking about TLTRO’s last week, look for the Fed to stop the shrinkage by June. There is no right answer to the question, how large should the Fed’s balance sheet be? Instead, it is always seen as a range. However, given the current desire to stop the tightening, why would they wait any longer? If I’m wrong it is because they could simply stop at the end of this month and be done with it, but that might send a panicky message, so June probably fits the bill a bit better.

This is going to hit the market in a very predictable way; a weaker dollar, stronger stocks and stronger bonds. The stock story is easy, as less tightening will continue to be perceived as a boon to earnings and eventually to the economy. Funnily enough, the message to the bond market is likely to be quite different. With 10-year yields already below 2.60% (2.58% this morning), news that the Fed is more concerned about growth is likely to drive inflows, and maybe even help the curve invert. Remember, short end rates are already 2.50%, so it won’t take much to get to an inversion. As to the dollar, while everybody is in easing mode, the new information that the Fed is taking another step will be read as quite dovish and force more long dollar positions to be covered. In the end, I maintain that the situation in the Eurozone remains worse than that in the US, but the timing of announcements and perception of surprise is going to drive the short-term price activity.

Elsewhere in markets, while the China trade talks remain a background story for now, Brexit is edging ever closer. There is still no clear outcome there, although PM May is apparently going to try to get her deal through Parliament again this week. You have to admire her tenacity, if not her success. But here’s an interesting tidbit that hasn’t been widely reported: the vote last week by Parliament to prevent a no-deal Brexit wasn’t binding! In other words, absent an agreed delay by the rest of the EU, Brexit is still going to happen at the end of the month, deal or no deal. Again, my point is that the probability of a no-deal Brexit remains distinctly non-zero, and the idea that the pound has reflected Brexit risk at its current level of 1.32 is laughable. If they can’t figure it out, the pound will go a LOT lower.

Of course, today, there is virtually nothing going on in the FX markets, with G10 currencies all within 0.1% of their closing levels on Friday. Even the EMG bloc has seen limited movement with the Indian rupee the only currency to have moved more than 0.5% all day. The rupee’s strength has been evident over the past three weeks as recent fiscal stimulus has attracted significant investment inflows. But beyond that, nothing.

Away from the Fed, this week is extremely quiet on the data front as well:

Tuesday Factory Orders 0.3%
Wednesday FOMC Interest Rate 2.50%
Thursday Initial Claims 225K
  Philly Fed 4.5
Friday Existing Home Sales 5.10M

And that’s it. After the Fed meeting, there is only one speech scheduled, Raphael Bostic on Friday, but given that Powell will be all over the air on Wednesday, it is unlikely to matter much. So this week shapes up as a waiting game, nothing until the FOMC on Wednesday, and then react to whatever they do. Look for quiet FX markets until then.

Good luck
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Incessant Whining

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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