QE We’ll Bestow

The data continue to show
That growth is unhealthily slow
The pressure’s on Jay
To cut rates and say
No sweat, more QE we’ll bestow

The market narrative right now is about slowing growth everywhere around the world. Tuesday’s ISM data really spooked equity markets and then that was followed with yesterday’s weaker than expected ADP employment data (135K + a revision of -38K to last month) and pretty awful auto sales in the US which added to the equity gloom. This morning, Eurozone PMI data was putrid, with Germany’s Services and Composite data (51.4 and 48.5 respectively) both missing forecasts by a point, while French data was almost as bad and the Eurozone Composite reading falling to stagnation at 50.1. In other words, the data continues to point to a European recession on the immediate horizon.

The interesting thing about this is that the euro is holding up remarkably well. For example, yesterday in the NY session it actually rallied 0.45% as the market began to evaluate the situation and price in more FOMC rate cutting. Certainly it was not a response to positive news! And this morning, despite gloomy data as well as negative comments from ECB Vice-President Luis de Guindos (“level of economic activity in the euro area remains disappointingly low”), the euro has maintained yesterday’s gains and is unchanged on the session. At this point, the only thing supporting the euro is the threat (hope?) that the Fed will cut rates more aggressively going forward than had recently been priced into the market. Speaking of those probabilities, this morning there is a 75% probability of a Fed cut at the end of this month. That is up from 60% on Tuesday and just 40% on Monday, hence the euro’s modest strength.

Looking elsewhere, the pound has also been holding its own after yesterday’s 0.5% rally in the NY session. While I think the bulk of this movement must be attributed to the rate story, the ongoing Brexit situation seems to be coming to a head. In fact, I am surprised the pound is not higher this morning given the EU’s reasonably positive response to Boris’s proposal. Not only did the EU not dismiss the proposal out of hand, but they see it as a viable starting point for further negotiations. One need only look at the EU growth story to recognize that a hard Brexit will cause a significant downward shock to the EU economy and realize that Michel Barnier and Jean-Claude Juncker have painted themselves into a corner. Nothing has changed my view that the EU will blink, that a fudged deal will be announced and that the pound will rebound sharply, up towards 1.35.

Beyond those stories, the penumbra of economic gloom has cast its shadow on everything else as well. Government bond yields continue to decline with Treasury, Bund and JGB yields all having fallen 3bps overnight. In the equity markets, the Nikkei followed the US lead last night and closed lower by 2.0%. But in Europe, after two weak sessions, markets have taken a breather and are actually higher at the margin. It seems that this is a trade story as follows: the WTO ruled in the US favor regarding a long-standing suit that the EU gave $7.5 billion in illegal subsidies to Airbus and that the US could impose that amount of tariffs on EU goods. But the White House, quite surprisingly, opted to impose less than that so a number of European companies that were expected to be hit (luxury goods and spirits exporters) find themselves in a slightly better position this morning. However, with the ISM Non-Manufacturing data on tap this morning, there has to be concern that the overall global growth story could be even weaker than currently expected.

A quick survey of the rest of the FX market shows the only outlier movement coming from the South African rand, which is higher this morning by 0.9%. The story seems to be that after three consecutive weeks of declines, with the rand falling more than 6% in that run, there is a seed of hope that the government may actually implement some positive economic policies to help shore up growth in the economy. That was all that was needed to get short positions to cover, and here we are. But away from that story, nothing else moved more than 0.3%. One thing that has been consistent lately has been weakness in the Swiss franc as the market continues to price in yet more policy ease after their inflation data was so dismal. I think this story may have further legs and it would not surprise me to see the franc continue to decline vs. both the dollar and the euro for a while yet.

On the data front, this morning we see Initial Claims (exp 215K) and then the ISM Non-Manufacturing data (55.0) followed by Factory Orders (-0.2%) at 10:00. The ISM data will get all the press, and rightly so. Given how weak the European and UK data was, all eyes will be straining to see if the US continues to hold up, or if it, too, is starting to roll over.

From the Fed we hear from five more FOMC members (Evans, Quarles, Mester, Kaplan and Clarida), adding to the cacophony from earlier this week. We already know Mester is a hawk, so if she starts to hedge her hawkishness, look for bonds to rally further and the dollar to suffer. As to the rest of the crew, Evans spoke earlier this week and explained he had an open mind regarding whether or not another rate cut made sense. He also said that he saw the US avoiding a recession. And ultimately, that’s the big issue. If the US looks like a recession is imminent, you can be sure the Fed will become much more aggressive, but until then, I imagine few FOMC members will want to tip their hand. (Bullard and Kashkari already have.)

Until the data prints, I expect limited activity, but once it is released, look for a normal reaction, strong data = strong dollar and vice versa.

Good luck
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It’s Now or Never

Like Elvis said, it’s now or never
For Boris’s Brexit endeavor
The Irish are chuffed
As Coveney huffed
He’s not, but he thinks he’s so clever

Around 7:00 this morning, PM Boris Johnson will be addressing the Tory party at their annual convention and the key focus will be on his plan to ensure a smooth Brexit. The early details call for customs checks several miles away from the border on both sides with a time limit of about four years to allow for technology to do the job more effectively. However, he maintains that the whole of the UK will be out of the EU and that there will be no special deal for Northern Ireland. His supporters in Northern Ireland, the DUP, appear to have his back. In addition, he is reportedly going to demand that an agreement be reached by October 11 so that it can be agreed in Parliament as well as throughout the EU.

Interestingly, the Irish are still playing tough, at least according to Foreign Minister Simon Coveney, who said that the leaked details formed “no basis for an agreement.” Of course, as in everything to do with this process, there are other views in Ireland with Irish PM Varadkar seemingly far more willing to use this as a basis for discussion. His problem is the Fianna Fail party, a key coalition member, is unhappy with the terms. I say this is interesting because in the event of a no-deal Brexit, Ireland’s economy will be the one most severely impacted, with estimates of 4%-5% declines in GDP in 2020.

With respect to the market, it is difficult to untangle the effect of the latest Brexit news from the dreadful economic data that continues to be released. This morning’s UK Construction PMI fell to 43.3, within ticks of the lows seen during the financial crisis in 2009. The pound has suffered, down 0.4% as I type, although it was even softer earlier in the session. The FTSE 100 is also weak, -1.8%, although that is very much in line with the rest of the European equity markets (CAC -1.6%, DAX -1.3%) and is in synch with the sharp declines seen yesterday in the US and overnight in Asia.

Speaking of yesterday’s price action, it was pretty clear what drove activity; the remarkably weak ISM Manufacturing print at 47.8. This was far worse than forecast and the lowest print since June 2009. It seems pretty clear at this point that there is a global manufacturing recession ongoing and the question that remains is, will it be isolated to manufacturing, or will it spill over into the broader economy. Remember, manufacturing in the US represents only about 11.6% of GDP, so if unemployment remains contained and services can hold up, there is no need for the US economy to slip into recession. But it certainly doesn’t help the situation. However, elsewhere in the world, manufacturing represents a much larger piece of the pie (e.g. Germany 21%, China 40%, UK 18%) and so the impact of weak manufacturing is much larger on those economies as a whole.

It is this ongoing uncertainty that keeps weighing on sentiment, if not actually driving investors to sell their holdings. And perhaps of most interest is that despite the sharp equity market declines yesterday, it was not, by any means, a classic risk-off session. I say this because the yen barely budged, the dollar actually fell and Treasuries, while responding to the ISM print at 10:00am by rallying more than half a point (yields -7bps), could find no further support and have not moved overnight. If I had to describe market consensus right now, it would be that everyone is unsure of what is coming next. Will there be positive or negative trade news? Will the impeachment process truly move forward and will it be seen as a threat to the Administration’s plans? Will Brexit be soft, hard or non-existent? As you well know, it is extremely difficult to plan with so many potential pitfalls and so little clarity on how both consumers and markets will react to any of this news. I would contend that in situations like this, owning options make a great deal of sense as a hedge. This is especially so given the relatively low implied volatilities that continue to trade in the market.

Turning to the rest of the session, a big surprise has been the weakness in the Swiss franc, which has fallen 0.6% this morning despite risk concerns. However, the Swiss released CPI data and it was softer than expected at -0.1% (+0.1% Y/Y) which has encouraged traders to look for further policy ease by the SNB, or at least intervention to weaken the currency. But just as the dollar was broadly weaker yesterday, it has largely recouped those losses today vs. its G10 counterparts. Only the yen, which is up a scant 0.15%, has managed to show strength vs. the greenback. In the EMG space, KRW has been the biggest mover, falling 0.55% overnight after North Korea fired another missile into the sea last night, heightening tensions on the peninsula there. Of course, given the negative data (negative CPI and sharply declining exports) there is also a strong case being made for the BOK to ease policy further, thus weakening the won. Beyond that, however, the EMG currency movement has been mixed and modest, with no other currency moving more than 25bps.

This morning after Boris’s speech, all eyes will turn to the ADP employment data (exp 140K) and then we have three more Fed speakers this morning, Barkin, Harker and Williams. Yesterday, we heard from Chicago Fed president Charles Evans, who explained that he felt the economy was still growing nicely and that the two rate cuts so far this year were appropriate. He did not, however, give much of a hint as to whether he thought the Fed needed to do more. Reading what I could of the text, it did not really seem to be the case. My impression is that his ‘dot’ was one of the five looking for one more cut before the September meeting.

And that’s what we have for today. Barring something remarkable from Boris, it appears that if ADP is in line with expectations, the dollar is likely to consolidate this morning’s gains. A strong print will help boost the buck, while a weak print, something on the order of 50K, could well see the dollar cede everything it has gained today and then some.

Good luck
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Still Writing Obits

The Germans, the Chinese and Brits
Have seen manufacturing hits
But in the US
There’s been more success
Though bears are still writing obits

It is fair to say that the global economic growth rate continues to slow. We have seen weaker data as the norm, whether in manufacturing, housing or agriculture; we have seen a never-ending stream of central bankers expressing concern over this slowing growth and promising to respond appropriately; and we continue to see equity markets trade to new highs. Something seems amiss.

Yesterday was a perfect example of this phenomenon with an ISM print of 51.7, its fourth consecutive decline and the weakest reading since October 2016. In fairness, it was better than consensus estimates of 51.0, and the US was the only major economy to show continued expansion in the sector, but the trend is foreboding. The new orders component was exceptionally weak, and highlights those concerns going forward. And yet, equity prices traded to new highs yesterday afternoon, before ceding some ground into the close.

There has been a pretty complete disconnect between the fundamentals of stock valuation (at least the theories we learned in finance class about discounted future cash flows) and the actual price of stocks. And this is a global phenomenon, not merely a US outlier.

Of course, the missing link in this puzzle is central bank activities. Markets have become entirely dependent on central bank largesse to justify their valuations. Central bankers, after a decade of ZIRP and NIRP led to a huge increase in the financialization of the global economy, are now beholden to markets when they make decisions. This was made plain in January, when the Fed pivoted after equity markets plummeted following their last rate increase. They literally could not stand the pressure for even two weeks before reversing course.

So, the question becomes, will equity markets now dictate every central bank action going forward? While rhetorical, it is not hard to believe that the answer is yes. Despite all the current conversation regarding an uncomfortably low inflation rate as the driver for policy ease, it is abundantly clear that the only data point on which every central bank focuses, is their domestic stock market. I fear this is a situation that will result in extremely negative outcomes at some point in the future. However, there is no way to determine, ex ante, when those negative outcomes will manifest themselves. That is why bulls are happy, they buy every dip and have been rewarded, and why bears are miserable, because despite their certainty they are correct, thus far the central banks have been able to delay the pain.

In the end, though, the story on global growth remains one of a slowdown throughout the world. For all their largesse to date, central banks have not yet been able to reverse that trend.

With that out of the way, let’s see what those central bank activities have wrought in the FX markets. The first thing to note was that the dollar actually had an impressive day yesterday, rallying 0.7% vs. the euro and 0.5% vs. the pound after the ISM data. Given the better than expected print, market participants decided that the Fed may not be as aggressive cutting rates after all, and so the key recent driver of dollar weakness was reevaluated. Of course, one day’s reaction does not a trend make, and this morning, the dollar is backing off yesterday’s rally slightly.

Last night the RBA cut rates another 25bps, to a record low of 1.00%, and left the door open for further rate cuts in the future. Aussie, however, is higher by 0.4% this morning on a classic, sell the rumor, buy the news reaction. In the end, Australia remains entirely dependent on growth in China and as that economy slows, which is clearly happening, it will weigh on the Australian economy. While Australia managed to avoid ZIRP in the wake of the financial crisis, this time around I think it is inevitable, and we will see AUD resume its multiyear weakening trend.

Weighing on the pound further this morning were two data points, the Construction PMI at 43.1, its weakest in more than ten years, as well as the ongoing malaise in housing prices in the UK. Brexit continues to garner headlines locally, although it has not been front page news elsewhere in the world because of all the other concerns like trade, OPEC, North Korea, and in the US, the beginnings of the presidential campaigns.

But there is a very interesting change ongoing in the Brexit discussion. Throughout the process, the EU has appeared to have the upper hand in the negotiations, forcing their views on outgoing PM May. But with all signs pointing to a new PM, Boris Johnson, who has made clear he will leave with or without a deal, suddenly Ireland is finding itself under extreme pressure. A recent report by the central bank there indicated that a hard Brexit could result in a 4.0% decline in Irish GDP! That is HUGE. At the same time, the EU will require Ireland to uphold the border controls that are involved in the new separate relationship. This means they will need to perform any inspections necessary as well as arrange to collect tariffs to be charged. And the UK has made it clear that they will not contribute a penny to that process. Suddenly, Ireland is in a bad situation. In fact, it is entirely realistic that the EU needs to step in to delay the impact and cave to an interim deal that has nothing to do with PM May’s deal. At least that is the case if they want to maintain the integrity of their borders, something which has been given short shrift until now. My point is that there is still plenty of Brexit mischief ahead, and the pound is going to continue to react to all of it. In the end, I continue to believe that a hard Brexit will result in a weaker pound, but I am not so sure it will be as weak as I had previously believed. Maybe 1.20-1.25 is the right price.

In the US today there is no data to be released although we do hear from NY Fed president Williams and Cleveland Fed President Mester this morning. If the Fed is serious about staying on hold at the end of this month, rather than cutting the 25bps that the market has already priced, they better start to speak more aggressively about that fact. Otherwise, they are going to find themselves in a situation where a disappointed equity market sells off sharply, and the pressure ratchets even higher on them to respond. Food for thought as we hear from different Fed speakers during the month.

Good luck
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The Chaff from the Wheat

As markets await the report
On Payrolls they’re having to sort
The chaff from the wheat
From Threadneedle Street
As Carney, does rate hikes exhort

The gloom that had been permeating the analyst community (although certainly not the equity markets) earlier this year, seems to be lifting slightly. Recent data has shown a stabilization, at the very least, if not the beginnings of outright growth, from key regions around the world. The latest news was this morning’s surprising Eurozone inflation numbers, where CPI rose a more than expected 1.7% in April, while the core rate rose 1.2%, matching the highest level it has seen in the past two years. If this is truly a trend, then perhaps that long delayed normalization of monetary policy in the Eurozone may finally start to occur. Personally, I’m not holding my breath. Interestingly, the FX market has responded by selling the euro with the single currency down 0.2% this morning and 1.0% since Wednesday’s close. I guess that market doesn’t see the case for higher Eurozone rates yet.

In the meantime, the market continues to consider BOE Governor Carney’s comments in the wake of yesterday’s meeting, where he tried to convince one and all that the tendency for UK rates will be higher once Brexit is finalized (and assuming a smooth transition). And perhaps, if there truly is a global recovery trend and policy normalization becomes a reality elsewhere, that will be the case. But here, too, the market does not seem to believe him as evidenced by the pound’s ongoing weakness (-0.3% and back below 1.30) and the fact that interest rate futures continue to price in virtually no chance of rate hikes in the UK before 2021.

While we are discussing the pound, there is one other thing that continues to confuse me, the very fact that it is still trading either side of 1.30. If you believe the narrative, the UK cannot leave the EU without a deal, so there is no chance of a hard Brexit. After all, isn’t that what Parliament voted for? In addition, according to the OECD, the pound at 1.30 is undervalued by 12% or so. Combining these two themes, no chance of a hard Brexit and a massively undervalued pound, with the fact that the Fed has seemingly turned dovish would lead one to believe that the pound should be trading closer to 1.40 than 1.30. And yet, here we are. My take is that the market is not yet convinced that a hard Brexit is off the table or else the pound would be much higher. And frankly, in this case, I agree. It is still not clear to me that a hard Brexit is off the table which means that any true resolution to the situation should result in a sharp rally in the pound.

Pivoting to the rest of the FX market, the dollar is stronger pretty much across the board this morning, and this is after a solid performance yesterday. US data yesterday showed a significant jump in Nonfarm Productivity (+3.6%) along with a decline in Unit Labor Costs (-0.9%), thus implying that corporate activity was quite robust and the growth picture in the US enhanced. We also continue to see US earnings data that is generally beating (quite low) expectations and helping to underpin the equity market’s recent gains. Granted the past two days have seen modest declines, but overall, stocks remain much higher on the year. In the end, it continues to appear that despite all the angst over trade, and current US policies regarding energy, climate and everything else, the US remains a very attractive place to invest and dollars continue to be in demand.

Regarding this morning’s data, not only do we see the payroll report, but also the ISM Non-manufacturing number comes at 10:00.

Nonfarm Payrolls 185K
Private Payrolls 180K
Manufacturing Payrolls 10K
Unemployment Rate 3.8%
Participation Rate 62.9%
Average Hourly Earnings 0.3% (3.3% Y/Y)
Average Weekly Hours 34.5
ISM Non-Manufacturing 57.0

One cannot help but be impressed with the labor market in the US, where for the last 102 months, the average NFP number has been 200K. It certainly doesn’t appear that this trend is going to change today. In fact, after Wednesday’s blowout ADP number, the whisper is for something north of 200K. However, Wednesday’s ISM Manufacturing number was disappointingly weak, so there will be a great deal of scrutiny on today’s non-manufacturing view.

Adding to the mix, starting at 10:15 we will hear from a total of five Fed speakers (Evans, Clarida, Williams, Bowman, Bullard) before we go to bed. While Bullard’s speech is after the markets close, the other four will get to recount their personal views on the economy and future policy path with markets still open. However, given that we just heard from Chairman Powell at his press conference, and that the vote to leave rates was unanimous, it seems unlikely we will learn too much new information from these talks.

Summing up, heading into the payroll report the dollar is firm and shows no signs of retreating. My take is a good number will support the buck, while a weak one will get people thinking about that insurance rate cut again, and likely undermine its recent strength. My money is on a better number today, something like 230K, and a continuation of the last two days of dollar strength.

Good luck and good weekend
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