Tag Archives: #Italy

Toadies Galore

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There once was a time in the past
When jobs like PM were a blast
With toadies galore
And laws you’d ignore
While scheming, all foes, to outlast

But these days when leading a nation
The role has outgrown bloviation
Consider Ms. May
Who just yesterday
Was subject to near ruination

Well, Brexit managed to not be the headline story for the several days between the time the current deal was tentatively agreed with the rest of the EU and the scheduled vote by the House of Commons to approve said deal. During that period, PM May made the rounds to try to sell her deal to the people of the UK. Alas, apparently she’s not a very good saleswoman. Under extreme duress, yesterday she indefinitely delayed the vote that was originally to be held this evening. Amid jeering from the floor of the House of Commons, she tried to make her case, but was singularly unable to do so. As has been the problem all along, the Irish border issue remains intractable with the opposing goals of separating the two nations legally and, more importantly, for customs purposes, while not installing a border between the two. As it currently stands, I will argue there is no compromise solution that is viable. One side is going to have to accept the other side’s demands and frankly, that doesn’t seem very likely. The upshot is that the market has once again begun to assume a no-deal Brexit with all the hyperbolic consequences that entails. And the pound? It was not a happy day if you were long as it fell 2% at its worst point, although only closed down by about 1.5%. This morning, it has regained a further 0.4%, but remains near its weakest levels since April 2017. Unless you believe in miracles (and in fairness there is no better time to do so than this time of year), my strong belief is the UK is going to exit the EU with nothing in place. The pound has further to fall, so hedgers beware.

Let’s pivot to the euro for a moment and discuss all the benefits of the single currency. First, there is the prospect of its third largest trading partner, the UK, leaving the fold and suddenly imposing tariffs on those exports. Next we have France literally on fire, as the gilets jaunes continue to run riot throughout the country while protesting President Macron’s mooted fuel tax increase. In the end, that seems to have been pulled and now he is offering tax cuts! Fiscal probity has been tossed aside in the name of political expediency. Thirdly, we have the ongoing Italian opera over the budget. The antiestablishment coalition government remains adamant that it is going to inject fiscal stimulus to the country, which is slipping into recession as we speak, but the EU powers-that-be are chuffed by the fact that the Italian budget doesn’t meet their criteria. In fact, those same powers continue down the road of seeking to impose fines on Italy for the audacity of trying to manage their own country. (Will someone please explain to me why when the French make outlandish promises that will expand their budget deficit, the EU remains mum, but when the Italians do so, it is an international crisis?)

At the same time as all of this is ongoing, the ECB is bound and determined to end QE this month and keeps talking about starting to normalize interest rates next autumn. Whistling past the graveyard anyone? When three of the four biggest nations in the EU are under significant duress, it seems impossible to consider that owning the euro is the best position. While it is clear that the situation in the US is not nearly as robust as had been believed just a month ago, and the Fed seems to be responding to that by softening their tone; at some point, the ECB is going to recognize that things in the Eurozone are also much worse, and that talk of tightening policy is going to fade from the scene. Rather, the discussion will be how large to make the new TLTRO loan program and what else can the ECB do to help support the economy since cutting rates seems out of the question given the starting point. None of that is priced into the market right now, and so as that unfolds, the euro will fall. However, in today’s session, the euro has recouped about half its losses from yesterday, rebounding by 0.4% after a more than 0.8% decline Monday. As much as there is a building discussion over the impending collapse of the dollar, it continues to seem to me that there are much bigger problems elsewhere in the world, which will help the dollar retain its haven status.

Away from those two stories, I would be remiss if I did not mention that the Reserve Bank of India’s widely respected governor, Urjit Patel, resigned suddenly Monday evening leading to a 1.5% decline in the rupee and a sharp fall in Indian equity markets Tuesday. But then, results from recent local elections seemed to shift toward the ruling BJP, instilling a bit more confidence that PM Modi will be able to be reelected next year. Given the perception of his market/business friendliness, that change precipitated a sharp reversal in markets with the rupee actually rallying 0.9% and Indian equity markets closing higher by 0.6%.

In fact, despite my warnings above, the dollar is under pressure across the board this morning while global equity markets are looking up. It seems there was a call between the US and China restarting the trade negotiation process, which was taken by investors as a sign that all would be well going forward. And while that is certainly encouraging, it seems a leap to believe a solution is at hand. However, there is no question the market is responding to that news as equity markets in Europe are all higher by between 1.0% and 2.0%, US equity futures are pointing to a 1% gain on the open, government bonds are softer across the board and the dollar is down. Even commodities are playing nice today with most rallying between 0.5%-1.0%. So everyone, RISK IS ON!!

Turning to the data story, first let me say that the euro has been helped by a better than expected German ZEW Index (-17.5 vs. exp -25), while the pound has benefitted from a modestly better than expected employment report, with Average earnings rising 3.3% and the Employment Change jumping 79K. At the same time, the NFIB Small Business Optimism Index was just released at a worse than expected 104.8, indicating that the peak may well be behind us in the US economy. At 8:30 we see PPI data (exp 2.5%, 2.6% core) however, that tends not to be a significant market mover. Rather, today is shaping up as a risk-on day and unless there is a change in the tone of the trade talks, there is no reason to believe that will change. Accordingly, for hedgers, take advantage of the pop in currencies as the big picture continues to point toward eventual further dollar strength.

Good luck
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There Is No Plan B

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Said Europe, “there is no Plan B”
This deal is the best that you’ll see
Opponents keep saying
The deal is dismaying
Because it cedes full sovereignty

It turns out last week was quite a difficult one in markets, with equity prices around the world under significant pressure as concerns continue to grow regarding growth prospects everywhere. In fact, for the first time we heard Fed Chair Jay Powell moderate his description of the US economy’s growth trajectory. It seems that the clear slowing in the housing sector combined with less positive IP and Durable Goods data has been enough to alert the Fed to the possibility that all may not be right with the world. While there is no indication that the Fed will delay its December rate hike, questions about 2019’s rate path have certainly been debated more aggressively with the consensus now believing that we can see a pause before just two more rate hikes next year. With the Powell Fed indicating that they are truly data dependent (as opposed to the Yellen Fed which liked the term, but not the reality), if we continue to see slowing US growth, then it is quite reasonable to expect a shallower trajectory of rate hikes in the US.

But that was last week’s news and as the new week begins, the biggest story is that the EU has agreed the terms of the Brexit negotiations that were just completed two weeks ago. The entire process now moves on to the next stage, where all 28 parliaments need to approve the deal. Given the terms of the deal, which has the opportunity to lock the UK into the EU’s customs union with no say in its evolution, it would be surprising if any of the other 27 members reject the deal. However, it remains unclear that the deal will be accepted by the UK parliament, where PM May does not hold a majority and rules because of a deal with the Northern Irish DUP. Of course the irony here is that Northern Ireland is the area of greatest contention in the deal, given the competing desires of, on the one hand, no hard border between Ireland and Northern Ireland, and on the other hand, the desire to be able to separate the two entities for tariff and immigration purposes.

At this stage, it seems there is at best a fifty-fifty chance that the deal makes it through the UK parliament, as the opposition Labour Party has lambasted the deal (albeit for different reasons) in the same manner as the hard-line Brexiteers. But political outcomes rarely follow sound logic, and so at this point, all we can do is wait until the vote, which is expected to be on December 12. What we do know is that the FX market is not sold on the deal’s prospects as despite the announcement by the EU, the pound has managed to rally just 0.25% today and remains, at 1.2850, much closer to the bottom of its recent trading range than the top. I continue to believe that a no vote will be tantamount to a hard Brexit and that the pound will suffer further from here in that event. However, if parliament accepts the deal, I would expect the pound to rally to around1.35 initially, although its future beyond that move is likely to be lower anyway.

Last week’s risk-off behavior led to broad-based dollar strength, with the greenback rallying on the order of 1.0% against both its G10 and major EMG counterparts. While that movement pales in comparison to the rout in equity markets seen last week, it was a consistent one nonetheless. This morning, though, the dollar is under a modicum of pressure as the fear evident last week has abated.

For example, despite softer than expected German IFO data (102.0 vs. exp 102.3), the euro has rallied 0.25% alongside the pound. A big part of this story seems to be that the Italians have made several comments about a willingness to work with a slightly smaller budget deficit in 2019 than the 2.4% first estimated. While the euro has clearly benefitted from this sentiment, the real winner has been Italian debt (where 10-year BTP’s are 17bps lower) and Italian stocks, where the MIB is higher by 2.7%. In fact, that equity sentiment has spread throughout the continent as virtually every European market is higher by 1% or more. We also saw strength in APAC equity markets (Nikkei +0.75%, Hang Seng +1.75%) although Shanghai didn’t join in the fun, slipping a modest 0.15%. The point is that market sentiment this morning is clearly far better than what was seen last week.

Looking ahead to the data this week, the latest PCE data is due as well as the FOMC Minutes, and we have a number of Fed speakers, including Chairman Powell on Wednesday.

Tuesday Case-Shiller Home Prices 5.3%
  Consumer Confidence 135.5
Wednesday Q3 GDP 3.5%
  New Home Sales 578K
Thursday Initial Claims 219K
  Personal Income 0.4%
  Personal Spending 0.4%
  PCE 0.2% (2.1% Y/Y)
  Core PCE 0.2% (1.9% Y/Y)
Friday Chicago PMI 58.3

In addition to Powell, we hear from NY Fed President Williams as well as Vice-Chairman Richard Clarida, both of whom will be closely watched. Given the recent change in tone to both the US data (slightly softer) and the comments from Fed speakers (slightly less hawkish), I think the key this week will be the Minutes and the speeches. Investors will be extremely focused on how the evolution in the Fed’s thinking is progressing. But it is not just the Fed. Remember, the ECB has promised to end QE come December despite the fact that recent data has shown slowing growth in the Eurozone.

The greatest fear central bankers currently have is that their economy rolls into a recession while interest rates are already at “emergency” levels and monetary policy remains extremely loose. After all, if rates are negative, what can they do to stimulate growth? This has been one of the forces driving central bankers to hew to a more hawkish line lately as they are all keen to get ahead of the curve. The problem they face collectively is that the data is already beginning to show the first indications of slowing down more broadly despite the continuation of ultra easy monetary policy. In the event that the global economy slows more rapidly than currently forecast, there is likely to be a significant increase in market volatility across equities, bonds and currencies. In this case, I am not using the term volatility as a euphemism for declines, rather I mean look for much more intraday movement and much more uncertainty in expectations. It is this scenario that fosters the need for hedgers to maintain their hedge programs at all times. Having been in the markets for quite a long time, I assure you things can get much worse before they get better.

But for today, there is no reason to believe that will be the case, rather the dollar seems likely to drift slightly lower as traders position for the important stuff later this week.

Good luck
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Into the Tank

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The German economy shrank
Japan’s heading into the tank
Italians declared
The budget prepared
Is gospel, and oil just sank

There are a number of stories this morning competing for market attention as investors and traders continue to try to get a reading on growth prospects going forward. Perhaps the most surprising story is that German GDP, which had been expected to print at 0.0% in Q3, actually fell -0.2%, significantly worse than expected. While every pundit and economist has highlighted that it was a confluence of one-time events that drove the data and that expectations for Q4 are far more robust, the fact remains that Q3 growth in Germany, and the whole of Europe, has been much weaker than anticipated. The euro has not benefitted from the news, falling 0.25%, and broadly continuing its recent downtrend.

Adding to the single currency’s woes is the ongoing Italian budget opera, where the EU huffed and puffed and demanded the Italians change their plans. The Italians, formally, told the EU to pound salt yesterday evening, and now the EU is at a crossroads. Either the emperor has no clothes (EU does nothing and loses its fiscal oversight capability) or is in fact well dressed and willing to flaunt it (initiates procedures to sanction and fine Italy). The problem with the former is obvious, but the problem with the latter is the potential impact on EU Parliamentary elections to be held in the spring. Attacking Italy could easily result in a far more antiestablishment parliament with many of the current leadership finding themselves in the minority. (And the one thing we absolutely know is that incumbency is THE most important aspect of leadership, right?) The point is that there are ample reasons for the euro to remain under pressure going forward.

At the same time, Japanese economic data continues to disappoint, with IP declining -2.5% Y/Y in September and Capacity Utilization falling 1.5%. At the same time, we find out that the BOJ’s balance sheet is now officially larger than the Japanese economy! Think about that, Japan’s debt/GDP ratio has long been over 200%, but now the BOJ has printed money and bought assets equivalent to the entire annual output of the nation. And despite the extraordinary efforts that the BOJ has made, growth remains lackluster and inflation nonexistent meaning the BOJ has failed to achieve either of its key aims. At some point in time, and it appears to be approaching sooner rather than later, central banks around the world will completely lose the ability to adjust market behavior through either words or action. And while it is not clear which central bank will lose that power first, the BOJ has to be the frontrunner, although the ECB is certainly trying to make a run at the title.

Meanwhile, from Merry Olde Englande we have news that a draft Brexit deal has been agreed between PM May and the EU. The problem remains that her cabinet has not yet seen nor signed off on it, and there is the little matter of getting the deal through Parliament, which will be dicey no matter what. On the one hand, it is not wholly surprising that some type of agreement was reached, but as is often the case in a situation as fraught as Brexit, nobody is satisfied, and quite frankly, it is not clear that it will gather sufficient support from either the UK Parliament, or the EU’s other nations. This is made evident by the fact that the pound has actually fallen today, -0.2%, despite the announcement. I maintain that a Brexit deal will clearly help the pound’s value, so the market does not yet believe the story. At the same time, UK inflation data was released at a softer than expected 2.4% in October, thus reducing potential pressure on the BOE to consider raising rates, even if a Brexit deal is agreed. After all, if inflation falls to 2.0%, their concerns will be much allayed.

One other story getting a lot of press has been the sharp decline in the price of oil, which yesterday fell 7.1% in the US, and is now down more than 26% since its high in the beginning of October, just six weeks ago. There is clearly a relationship between commodity prices and the dollar given the fact that most commodities are priced in dollars, and that relationship is consistently an inverse one. The question, that I have yet to seen answered effectively, is the direction of the causality. Does a stronger dollar lead to weaker commodity prices? Or do weaker commodity prices drive the dollar higher? While I am inclined to believe in the first scenario, there are arguments on both sides and no research has yet been able to answer the question effectively. However, it should be no surprise that the dollar continues to rally coincidentally with the decline in oil, and other commodity, prices.

I didn’t even get a chance to discuss the ongoing slowdown in Chinese economic growth, but we can touch on that tomorrow. As for today’s session, this morning we see the latest CPI readings (exp 0.3%, 2.5% Y/Y headline, 0.2% 2.2% core) and then as the FX market gets set to go home, Chairman Powell speaks, although it is hard to believe that his views on anything will have changed that much. In the end, the big picture remains that the dollar should continue to benefit from the Fed’s ongoing monetary policy activities as well as the self-inflicted wounds of both the euro and the yen.

Good luck
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A Too Bitter Pill

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Three stories today are of note
First, Italy’s rocking the boat
Next Brexit is still
A too bitter pill
While OPEC, a cut soon may vote

The outcome in all of these cases
Has been that the market embraces
The dollar once more
(It’s starting to soar)
And quite clearly off to the races

On this Veteran’s Day holiday in the US, where bond markets will be closed although equity markets will not, the dollar has shown consistent strength across the board. Interestingly, there have been several noteworthy stories this morning, but each one of them has served to reinforce the idea that the dollar’s oft-forecast demise remains somewhere well into the future.

Starting with Italy, the current government has shown every indication that they are not going to change their budget structure or forecasts despite the EU’s rejection of these assumptions when the budget was first submitted several weeks ago. This sets up the following situation: the EU can hold firm to its fiscal discipline strategy and begin the procedure to sanction Italy and impose a fine for breaking the rules, or the EU can soften its stance and find some compromise that tries to allow both sides to save face, or at least the EU to do so.

The problem with the first strategy is the EU Commission’s fear that it will increase the attraction of antiestablishment parties in the Parliamentary elections due in May. After all, the Italian coalition was elected by blaming all of Italy’s woes on the EU and its policies. The last thing the Commission wants is a more unruly Parliament, especially as the current leadership may find themselves on the sidelines. The problem with the second strategy is that if they don’t uphold their fiscal probity it will be clear, once and for all, that EU fiscal rules are there in name only and have no teeth. This means that going forward, while certain countries will follow them because they think it is proper to do so, many will decide they represent conditions too difficult with which to adhere. Over time, the second option would almost certainly result in the eventual dissolution of the euro, as the problems from having such dramatically different fiscal policies would eventually become too difficult for the ECB to manage.

With this in mind, it is no surprise that the euro is softer again today, down 0.6% and now trading at its lowest level since June 2017. In less than a week it has fallen by more than 2.0% and it looks as though this trend will continue for a while yet. We need to see the Fed soften its stance or something else to change in order to stop this move.

Turning to the UK, the clock to make a deal seems to be ticking ever faster and there is no indication that PM May is going to get one. Over the weekend, there was no progress made regarding the Irish border issue, but we did hear from several important constituents that the PM’s current deal will fail in Parliament. If Labour won’t support it and the DUP won’t support it and the hard-line Brexiteers won’t support it, there is no deal to be had. With this in mind it is no surprise that the pound has suffered greatly this morning, down 1.4% and back well below 1.30. You may recall that around Halloween, the market started to anticipate a Brexit deal and the pound rallied 3.7% in the course of a week. Well, it has since ceded 2.7% of that gain and based on the distinct lack of progress on the talks, it certainly appears that the pound has further to fall. Do not be surprised if the pound trades below its recent lows of 1.2700 and goes on to test the post-Brexit vote lows of 1.1900.

The third story of note is regarding OPEC and oil prices, which have fallen nearly 20% during the past six weeks as US production and inventories continue to climb while the price impact of sanctions on Iran turned out to be much less then expected. This has encouraged speculation that OPEC may cut its production quotas, although the news from various members is mixed. Adding to oil’s woes (and in truth all commodity prices) has been the fact that global growth has been slowing as well, thus reducing underlying demand. In fact, the biggest concern for the market has been the slow down in China, which continues apace and where stories of further policy ease by the PBOC, including interest rate cuts, are starting to be heard. Two things to note are first, the typical inverse correlation between the dollar and commodity prices such that when the dollar rises, commodity prices tend to fall, and second, in line with the dollar’s broad strength, the Chinese yuan has fallen further today, down 0.3%, and pushing back to the levels that inspired calls for a move beyond 7.00 despite concerns over increased capital outflows.

And frankly, those are the stories of note. The dollar is higher vs. pretty much every other currency today, G10 and EMG alike, with no distinction and few other stories that are newsworthy. Looking at the data this week, there are two key releases, CPI and Retail Sales along with a bit of other stuff.

Tuesday NFIB Biz Confidence 108.0
  Monthly Budget -$98.0B
Wednesday CPI 0.3% (2.5% Y/Y)
  -ex food & energy 0.2% (2.2% Y/Y)
Thursday Initial Claims 215K
  Philly Fed 20.2
  Empire State 20.0
  Retail Sales 0.5%
  -ex Autos 0.5%
Friday IP 0.2%
  Capacity Utilization 78.2%

Overall, the data continues to support the Fed’s thesis that tighter monetary policy remains the proper course of action. In addition to the data we will hear from three Fed speakers including Chairman Powell on Wednesday. It seems hard to believe that he will have cause to change his tune, so I expect that as long as the rest of the world exhibits more short-term problems like we are seeing today, the dollar will remain quite strong.

Good luck
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Powell’s Fixation

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Though spending by business has slowed
(And debt from the government growed)
There’s no indication
That Powell’s fixation
On raising rates soon will erode

The Fed left rates on hold yesterday, as universally expected. The policy statement was largely unchanged although it did tweak the wording regarding business investment, which previously had been quite strong but is now slowing somewhat. That said, there is absolutely no indication that the Fed is going to slow its trajectory of rate increases anytime soon. With the meeting now out of the way, I expect that the Fedspeak we hear going forward will reinforce that view, with only Kashkari and Bullard seeking to slow the pace, and neither of them is yet a voting member. The market response was actually mildly surprising in that equities sold off somewhat after the news (and have fallen sharply in Asia and Europe) despite the fact that this was the expected outcome. Meanwhile the dollar has continued to rebound from its recent lows touched on Wednesday, with the euro having declined 0.2% further this morning and 1.4% from its peak.

As an aside, I am constantly amazed at the idea that the Fed, especially as overseen by Jay Powell, is more than mildly interested in the happenings in the stock market. The Fed mandate is clear, maximum employment and stable prices, notably lacking any discussion of rising equity markets. Alas, ever since the Maestro himself, Alan Greenspan, was Fed Chair, it seems that the default reaction has been to instantly add liquidity to the market if there was any stock market decline. The result is we have seen three massive bubbles blown in markets, two of which have burst (tech stocks and real estate) with the third ongoing as we speak. If you understand nothing else about the current Fed chairman, it is abundantly clear that he is unconcerned with the day-to-day wobbles in financial markets. I am confident that if there is a significant change in the economic situation, and markets respond by declining sharply, the current Fed will address the economic situation, not the markets, and that, in my view, is the way policy should be handled.

But back to today’s discussion. I fully admit that I did not understand the market response to the election results, specifically why the dollar would have declined on the news. After all, a split Congress is not going to suddenly change policies that are already in place, especially since the Republican majority in the Senate expanded. And as the Fed made clear yesterday, they don’t care about the politics and are going to continue to raise rates for quite a while yet. Certainly, we haven’t seen data elsewhere in the world which is indicative of a significant uptick in growth that would draw investment away from the US, and so the dollar story will continue to be the tension between the short-term cyclical factors (faster US growth and tighter monetary policy) vs. the long-term structural factors (rising budget deficits and questionable fiscal sustainability). Cyclical data points to a stronger dollar; structural data to a weaker one, and for now, the cyclical story is still the market driver. I think it is worth keeping that in mind as one observes the market.

Regarding other FX related stories, the Brexit situation is coming to a head in the UK as PM May is trying to get her cabinet to sign off on what appears to be quite a bad deal, where the Irish border situation results in the UK being forced to abide by EU rules without being part of the EU and thus having no input to their formation. This is exactly what the Brexiteers wanted to avoid, and would seemingly be the type of thing that could result in a leadership challenge to May, and perhaps even new elections, scant months before Brexit. While I have assumed a fudge deal would be agreed, I am losing confidence in that outcome, and see an increasing chance that the pound falls sharply. Its recent rally has been based entirely on the idea that a deal would get done. For the pound, it is still a binary outcome.

The Italian budget story continues to play out with not only Brussels upset but actually the backers of the League as well. While I am no expert on Italian politics, it looks increasingly likely that there could be yet another election soon, with the League coming out on top, five star relegated to the backbenches, and more turmoil within the Eurozone. However, in that event, I think it highly improbable that the League is interested in leaving the euro, so it might well end up being a euro positive net.

So the week is ending on a positive note for the dollar, and I expect to see that continue throughout the session. This morning’s PPI data was much firmer than expected with the headline print at 2.9% and the core at 2.6%, indicating that there is no real moderation in the US inflation story. This data is likely tariff related, but that is no comfort given that there is no indication that the tariff situation is going to change soon. And if it does, it will only get worse. So look for the dollar to continue its rebound as the weekend approaches.

Good luck and good weekend
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A Narrative Challenge

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From Europe, the data released
Showed growth there has clearly decreased
For Draghi this poses
(What everyone knows is)
A narrative challenge, at least

Once upon a time there was a group of nations that came together in an effort to reap the theoretical benefits of closely adhering to the same types of economic policies. They believed that by linking together, they would create a much larger ‘domestic’ market, and therefore would be able to compete more effectively on the global stage. They even threw away their own currencies and created a single currency on which to depend. Under the guidance of their largest and most successful member, this currency was managed by a completely independent central bank, so they could never be accused of printing money recklessly. And after a few initial hiccups, this group generally thrived.

But then one day, clouds arose on the horizon, where from across the great ocean, a storm (now known as the Great financial crisis) blew in from the west. At first it appeared that this group of nations would weather the storm pretty well. But quickly these nations found out that their own banks had substantial exposure to the key problem that precipitated the storm, real estate investment in the US. Suddenly they were dragged into the maelstrom and their economies all weakened dramatically. The after effects of this included questions about whether a number of these countries would be able to continue to repay their outstanding debt. This precipitated the next crisis, where the weakest members of the club, the PIIGS, all saw their financing costs skyrocket as investors no longer wanted to accept the risk of repayment. This had the added detriment of weakening those nations’ banks further, as they had allocated a significant portion of their own balance sheets to buying home country debt. (The very debt investors were loath to own because of the repayment risks.)

Just when things reached their nadir, and the very weakest piggy looked like it was about to leave the group, a knight in shining armor rode to the rescue, promising to do “whatever it takes” to prevent the system from collapsing and the currency from breaking up. Being a knight in good standing, he lived up to those words and used every monetary policy trick known to mankind in order to save the day. These included cutting interest rates not just to zero, but below; force-feeding interest-free loans to the banks so that that they could on lend that money to companies throughout the group; and finally buying up as much sovereign, and then corporate, debt as they could, regardless of the price.

Time passed (five years) and that shining knight was still doing all those same things which helped avoid the worst possible outcomes, but didn’t really get the group’s economy growing as much as hoped. In fact, it seems that last year was the best it was going to get, where growth reached 2.5%. But now there are new storm clouds brewing, both from the West as well as from within, and the growth narrative has changed. And it appears this new narrative may not have a happy ending.

Data released this morning showed that GDP growth in Italy was nil, matching Germany’s performance, and helping to drag Eurozone growth down to 0.2% for Q3, half the expected rate. French growth, while weaker than expected at 0.4%, was at least positive. In addition, a series of confidence and sentiment indicators all demonstrated weakness describing a situation where not only has the recent performance been slipping, but expectations for the future are weakening as well. It can be no surprise that the euro has slipped further on the news, down 0.2% this morning and continuing its recent trend. During the month of October, the single currency has fallen more than 2.2%, and quite frankly, there doesn’t appear to be any reason in the short run for that to change.

What may change, though, is Signor Draghi’s tune if Eurozone growth data continues to weaken. It will be increasingly difficult for Draghi to justify ending QE and eventually raising rates if the economy is truly slowing. Right now, most analysts are saying this is a temporary thing, and that growth will rebound in Q4, but with the ongoing trade fight between the US and China weakening the Chinese economy, as well as the Fed continuing to raise interest rates and reduce dollar liquidity in global markets, it is quite realistic to believe that there will be no reprieve. And none of that includes the still fragile Italian budget situation as well as the potential for a ‘hard’ Brexit, both of which are likely to negatively impact the euro. And don’t get me started about German politics and how the end of the Merkel era could be an even bigger problem.

The point is, there is still no good reason to believe the dollar’s rally has ended. Speaking of Brexit, the pound is under pressure this morning, down -0.35%, as the market absorbs the most recent UK budget, where austerity has ended while growth is slowing. Of course, everything in the UK is still subject to change depending on the Brexit outcome, but as yet, there has been no breakthrough on the Irish border issue.

As to the rest of the G10, Aussie and Kiwi both benefitted from a bounce in the Chinese stock market, at least that’s what people are talking about. However, it makes little sense to me that a tiny bounce there would have such a big impact. Rather, I expect that both currencies will cede at least some of those gains before the day is done. Meanwhile, the yen has softened, which has been attributed to a risk-on sentiment there, and in fairness, Treasury yields have risen as well, but the rest of the risk clues are far less clear.

Speaking of China, the PBOC fixed the renminbi at a new low for the move, 6.9724, which promptly saw it trade even closer to 7.00, although it is now essentially unchanged on the day. The market talk is that traders are waiting for the meeting between Presidents Trump and Xi, later this mornth, to see if a further trade war can be averted. If tensions ease in the wake of the meeting, look for USDCNY to slowly head lower, but if there is no breakthrough, a move through 7.00 would seem imminent.

And that’s really it for this morning. Yesterday’s US data showed PCE right at 2.0% for both headline and core, while Personal Spending rose 0.4%, as expected. Today’s data brings only the Case-Shiller Home Price Index (exp 5.8%) and Consumer Confidence (136.0), neither of which is likely to move markets. In addition, the Fed is now in its quiet period, so no more Fed speak until the meeting next week. Equity futures are pointing slightly higher, but that is no guarantee of how the day proceeds. In the end, it is hard to make a case for a weaker dollar quite yet.

Good luck
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New Standard-Bearers

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The largest of all Latin nations
This weekend confirmed its frustrations
Electing a man
Whose stated game plan
Is changing the country’s foundations

Meanwhile in a key German state
Frau Merkel and friends felt the weight
Of policy errors
So new standard-bearers
Like AfD now resonate

This weekend brought two key elections internationally, with Brazil voting in Jair Bolsonaro, the right-wing firebrand and nationalist who has promised to clean up the corruption rampant in the country. Not unlike New Jersey and Illinois, Brazil has several former politicians imprisoned for corruption. Bolsonaro represented a change from the status quo of the past fifteen years, and in similar fashion to people throughout the Western world, Brazilians were willing to take a chance to see a change. Markets have been cheering Bolsonaro on, as he has a free-market oriented FinMin in mind, and both Brazilian equities and the real have rallied more than 10% during the past month. The early price action this morning has BRL rising by another 1.65%, continuing its recent rally, and that seems likely to continue until Bolsonaro changes tack to a more populist stance, something I imagine we will see within the first year of his presidency.

Just prior to those results, the German elections in the state of Hesse, one of the wealthiest states in Germany and the home of Frankfurt and the financial industry, showed disdain for the ruling coalition of Chancellor Merkel’s CDU and the Social Democrats, with their combined share of the vote falling to just 39%, from well above 50% at the last election. The big winners were the far left Green Party and the far right AfD, both of whom saw significant gains in the state house there, and both of whom will make it difficult to find a ruling coalition. But more importantly, it is yet another sign that Frau Merkel may be on her last legs. This was confirmed this morning when Merkel announced she was stepping down as leader of her party, the CDU, but claimed she will serve out her term as Chancellor, which runs until 2021.

One other Eurozone story came out Friday afternoon as Standard & Poors released their updated ratings on Italy’s sovereign debt, leaving the rating intact but cutting the outlook to negative. This was slightly better than expected as there were many who worried that S&P would follow Moody’s and cut the rating as well. Italian debt markets rallied on the opening with 10-year yields falling 10bps and the spread with German Bunds narrowing accordingly. So net, there was a euro negative, with Merkel stepping down, and a euro positive, from S&P, and not surprisingly, the euro wound up little changed so far, although that reflects a rebound from the early price action. My concern is that the positive story was really the absence of a more negative story, and one that could well be simply a timing delay, rather than an endorsement of the current situation in Italy. The budget situation remains uncertain there, and if the government chooses to ignore the EU and implement their proposed budget, I expect there will be more pressure on the euro. After all, what good are rules if they are ignored by those required to follow them? None of this bodes well for the euro going forward.

Two other key stories have impacted markets, first from Mexico, the government canceled the construction of a new airport for Mexico City. This was part of the departing administration’s infrastructure program, but, not surprisingly, it has seen its cost explode over time and the incoming president has determined the money is better spent elsewhere. The upshot is that the peso has fallen a bit more than 1% on the news, and I would be wary going forward as we approach AMLO’s inauguration. By cutting the investment spending, not only will the country’s infrastructure remain substandard, but its growth potential will suffer as well. I think this is a very negative sign for the peso.

The other story comes from China, where early Q4 data continues to show the economy slowing further. The government there, ever willing to do anything necessary to achieve their growth target, has proposed a 50% cut in auto sales taxes in order to spur the market. Auto sales are on track for their first annual decline ever this year, as growth slows throughout the country. Interestingly, the market impact was seen by rallies in auto shares throughout Europe and the US, but Chinese equity markets continued to slide, with the Shanghai Index falling another 2.2% overnight. This also has put further pressure on the renminbi with CNY falling another 0.2% early in the session before recently paring some of those losses. USDCNY continues to hover just below 7.00, the level deemed critical by the PBOC as they struggle to prevent an increase in capital outflows. The last time the currency traded at this level, it cost China more than $1 trillion to staunch the outflow, so they are really working to prevent that from happening again.

And those are the big stories from the weekend. Overall, the dollar is actually little changed as you can see that there have been individual issues across specific currencies rather than a broad dollar theme today. Looking ahead to the US session, we get the first of a number of important data points this morning with the full list here:

Today Personal Income 0.4%
  Personal Spending 0.4%
  PCE 0.1% (2.2% Y/Y)
  Core PCE 0.1% (2.0% Y/Y)
Tuesday Case-Shlller Home Prices 5.8%
Wednesday ADP Employment 189K
  Chicago PMI 60.0
Thursday Initial Claims 213K
  Nonfarm Productivity 2.2%
  Unit Labor Costs 1.1%
  ISM Manufacturing 59.0
  ISM Prices Paid 65.0
  Construction Spending 0.1%
Friday Nonfarm Payrolls 190K
  Private Payrolls 184K
  Manufacturing Payrolls 15K
  Unemployment Rate 3.7%
  Average Hourly Earnings 0.2% (3.1% Y/Y)
  Average Weekly Hours 34.5
  Trade Balance -$53.6B
  Factory Orders 0.4%

So there is a ton of data upcoming, with this morning’s PCE and Friday’s Payrolls the key numbers. Last week’s GDP data had a better than expected headline print but the entire weekend press was a discussion as to why the harbingers of weaker future growth were evident. And one other thing we have seen is the equity market dismiss better than expected Q3 earnings data from many companies, selling those stocks after the release, as the benefits from the tax cut at the beginning of the year are starting to get priced out of the future.

The market structure is changing, that much is clear. The combination of central bank actions to reduce accommodation, and an expansion that is exceedingly long in the tooth, as well as increased political uncertainty throughout the world has made investors nervous. It is these investors who will continue to support US Treasuries, the dollar, the yen and perhaps, gold,; the traditional safe havens. At this point, there is nothing evident that will change that theme.

Good luck
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Just Let It Go

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Said Brussels to Italy, No
Your budget is not apropos
Go fix it and then
Come back here again
Said Italy, just let it go

In England, meanwhile, PM May
Is finding she can’t get her way
A challenge is forming
With more Tories warming
Up to the thought she shouldn’t stay

The world seems to be getting messier by the day. Despite the ongoing vitriol in the US election process, the dollar continues to benefit from the fact that problems elsewhere seem to be worse. For example, the euro is under pressure this morning with two key stories driving the market. First, in an unprecedented move, the EU rejected Italy’s draft budget by claiming that it’s deficit targets were not in line with EU directives of reducing debt. Not surprisingly, the populist government in Italy simply said that fiscal stimulus was required to get the economy growing again, and they were going to enact it anyway. There are two issues here impacting the euro, the first being that markets are likely to drive Italian interest rates higher and add significant pressure to the Italian economy, notably the banking sector, which is tightly tied to those rates. The second is that if a major country is willing to ignore EU guidance on an important issue like this, what does that say about the credibility of the entire EU construct and the euro by default.

The other key issue was the release of much weaker than expected Flash PMI data for Germany, France and the entire Eurozone. Remember yesterday the Bundesbank indicated that GDP growth in Q3 would be flat in Germany, undermining markets there. Well, today, we learned that growth in Q4 isn’t exactly shining either, with the Manufacturing PMI printing at 52.3, its lowest level since early 2016. This data added to the pressure on the euro, which has fallen 0.6% on the day and is now touching 1.1400 for the first time since mid-August. It appears that regardless of the ongoing structural concerns in the US, the cyclical growth and interest rate story remains the market’s driver for now.

Turning to the UK, yesterday saw a rally in the pound after a story circulated that the EU was going to offer a compromise on how to treat the UK after Brexit, allowing them to stay within the customs union. However, this morning, there appears to be a growing insurgency within the Tory party and a challenge to PM May appears to be coming. If she were ousted, that would become quite problematic with regards to the ongoing negotiations as Cabinet members would change, and policy direction would likely as well. Given the late date, just five months left before the split is finalized, it would speak to a much higher probability of a hard Brexit with no deal, and a much lower pound. With this in mind, it is not surprising that the pound has ceded yesterday’s gains and is down 0.6% as well this morning.

Away from those two stories, the dollar is generally, but not universally, stronger. It is noteworthy that USDCNY is higher by 0.2%, pushing back to the top of its recent range just above 6.95, and starting to move into the area where many are counting on the PBOC to intervene. There are a number of analysts who continue to believe that a move above 7.00 will lead to a significant increase in capital outflows from China, and a much bigger risk-off movement. This is something about which the Chinese are extremely concerned. However, looking around APAC currencies overnight, both INR (+0.5%) and KRW (+0.25%), arguably the next most important ones, showed strength vs. the dollar as yesterday’s sharp decline in oil prices was seen as a positive for both of these large oil importers.

On the rate front, the Riksbank in Stockholm left interest rates on hold, as expected, but basically promised to raise them in either December or February. SEK is modestly weaker vs. the dollar, but almost unchanged vs. the euro, perhaps a better measure of the impact. This morning, the Bank of Canada will also announce its rate decision with expectations nearly universal that they will raise rates by 25bps to 1.75%. Ahead of the announcement, the Loonie is flat.

And those are really the FX stories of the day. Equity markets around the world seem to be rebounding from yesterday’s US led sell-off, although US equity futures are still pointing lower as I type. Treasury yields have fallen from yesterday’s closing levels, but remain in the vicinity of 3.15%. As mentioned, oil prices tumbled yesterday by more than 4% after Saudi Arabia indicated they would make up for any reduction in Iranian crude exports due to the US sanctions that are to begin in earnest next week. And gold, the traditional safe haven, is basically flat on the day, although about 1% lower than the peak of $1240/oz it reached during the nadir of yesterday’s equity market movement.

This morning we see our first real data of the week, with New Home Sales expected to print at 625K. We also get the Fed’s Beige Book at 2:00pm. Speaking of the Fed, yesterday Atlanta Fed President Bostic reiterated that the Fed was on the right path and that gradual rate increases were appropriate. Today we hear from Bullard, Mester and Bostic again. While the housing data has softened lately, and even some of the earnings data has been a bit softer than expected, there is no strong rationale for any of these regional presidents to change their views. In fact the one thing I would mention about earnings is how many companies are raising prices to cover increased materials costs or tariff impacts. If anything, that sounds pretty inflationary to me, and I would guess to the Fed as well.

If US equity markets follow through on the opening and continue to decline, the dollar should remain well bid overall. But my sense is that we are going to see some bargain hunters coming in here, help the stock markets bounce and see the dollar decline by the time NY goes home.

Good luck
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Some Whiplash

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It seems that the pumping of cash
By China was good for a flash
Of higher stock prices
But there’s still a crisis
So traders there felt some whiplash

In Europe, the same might be said
As traders, Italian debt fled
The EU today
Rome’s budget will weigh
With portents of more strife ahead

Remember how the officially induced rally in the Chinese equity market was going to stabilize markets? Yeah, me neither. It seems that, last night, despite lots more talk and promises of more funding, investors in those equity markets were decidedly unimpressed with the prospects and have resumed their active share selling. Overnight saw the Shanghai composite decline 2.25% and drag the rest of Asian markets lower alongside (Nikkei -2.7%, Hang Seng -2.9%). The impact on the CNY was very much as would be expected, a modest decline of 0.25% as traders test the PBOC resolve of preventing a move to 7.00.

This has also impacted European markets, which are lower across the board, none more so than Germany’s DAX which has fallen 2.0%. Given the ongoing angst over the Italian budget situation, one might have expected the Italian markets to be the worst performers, but Germany revealed its own little secret this morning, Q3 GDP growth there is expected to be 0.0%! That’s right, Europe’s strongest economy is going to suffer a stagnant quarter, and so equity markets have responded accordingly. This is not to imply that all is rosy in Rome, just that the Germans had a bigger surprise today.

Before moving on to the Italian story, let me note that the situation in China needs to be watched carefully going forward for another reason. For the past ten years, central banks around the world have controlled the price action in markets. Whether it was the first QE implementation by Benny the Beard, or Signor Draghi’s “whatever it takes” comments, when central bankers spoke, markets responded as the bankers desired. But lately, those same central banks seem to have lost a little bit of their mojo, as comments they make in an effort to sway markets have a shorter and shorter half-life. The fact that despite a concerted effort by every senior financial official in China, including President Xi, to talk up equity markets, and by reference the health of the Chinese economy, has had such a short lived impact, may well imply that the meme of central banks controlling markets is coming to an end.

And to my mind, that would be a good thing. Ten years of unprecedented monetary policy actions have dramatically distorted price signals in virtually every market. Whether it is the abnormally low spread between high-yield debt and government bonds, or the idea that P/E ratios of 100 are the signs of a good investment, markets no longer offer price discovery. Or perhaps they no longer offer the opportunity to discern value in a price. Keep in mind that there are still more than €5 trillion of debt outstanding that have negative interest rates. But while I may see this as a positive step toward markets regaining their functionality, the central banks are likely to feel very differently. If their words are no longer effective tools to manage markets, they will be forced to enact actual policies, some of which may be contrary to fiscal considerations. ‘Forward guidance’ is much easier to implement (and comes with much less political fallout) than actual policy changes. Just remember, if this thesis is correct, market volatility in every market is going to increase going forward.

Now back to our regularly scheduled programming. The Italian budget continues to be topic number one in terms of current risks to market stability. Thus far the Italian government has been unwilling to change its plans and the EU is studying them closely to determine if the budget breaks the rules. The problem for the EU is that if they crack down hard, reject the budget and tell Rome what to do, it is likely to further inflame the anti-establishment forces in Italy, and potentially have a bigger detrimental impact on the European Parliament elections to be held early next year. However, if they do nothing, the risk is that Italy finds itself in a situation where it has increased difficulty in refinancing its debt, and that could stress the entire Eurozone project. It was much easier for the EU to act tough with Greece, whose economy was so tiny. Italy has the third largest economy in the Eurozone , and if they have financing troubles it could quickly lead to problems throughout the continent, and directly impact the euro. In other words, there is no good answer.

The market impact of this ongoing situation has been a gradual erosion in the euro’s value, which fell about 0.7% yesterday, although it has stabilized this morning. While the German GDP story is obviously a negative for the currency, the reality is that the euro, for now, is beholden to the Italian budget story. If Italy remains recalcitrant, look for further weakness. Meanwhile, the pound, too, suffered yesterday, falling a penny alongside the euro, as the ongoing Brexit story continues to weigh on the currency. Consider that there are essentially five months left to find a compromise and that the problem has not gotten any easier. Despite the lack of progress, I still expect some sort of face-saving deal at the end of the process, but the risk situation is highly skewed. If there is no deal, look for the pound to fall very sharply, maybe another 5% right away, whereas any deal will likely only see a relief rally of 2% or so. Hedgers beware.

And those are really the only stories that matter today. There is a great deal of discussion regarding the US midterm elections, and how any given result may impact markets, but that is well beyond the purview of this note. Generally, risk was tossed overboard yesterday as 10-year Treasury yields fell 5bps, gold rallied and so did the dollar, the yen and the Swiss franc. This morning, there has been less movement in that group of havens, although risk assets remain under pressure. My sense is that given the absence of any US data, the broad risk profile will drive the dollar. To me, all signs point to further equity weakness and therefore more haven buying. I like the dollar in that scenario.

Good luck
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Unwavering

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Said Xi, our support is “unwavering”
For stocks, which of late have been quavering
A rally ensued
The result, which imbued
A feeling the bulls have been savoring

Make no mistake about it, while President Xi Jinping is ‘president-for-life’ in China, and the most powerful leader since Deng Xiaoping, it turns out that the stock market is more powerful still. Despite last night’s 4% rally by the Shanghai Index, the market remains 25% lower than the highs seen in January. On Friday, we heard from a number of Chinese financial officials, each of them explaining how the government would support the market, and saw quasi-official purchases by Chinese brokerage firms. Over the weekend, President Xi, in a speech, promised a cut in personal income taxes as well as “unwavering” support for state owned enterprises. In other words, the combination of the trade spat with the US and the government’s previous efforts to deflate the real estate bubble by tightening liquidity and cracking down on non-bank financing seems to have been too much for Xi to bear. The equity market there has become too important to Chinese consumer sentiment to be ignored by the government, and a nearly 30% decline during the past nine months has really increased the pressure on Xi and his comrades. Since a key underpinning of Xi’s power is continued strong economic growth, the market signals had become too great to ignore. Hence the weekend actions, which also included promises of further tax cuts in the VAT rate, and the all-out effort to not merely halt the equity market decline, but reverse it.

For the moment, it has worked, with global equity markets responding favorably to the Chinese lead and risk being more warmly embraced by traders, if not long-term investors. European equity markets are higher, Treasury prices are falling, except in Italy (a truly high risk asset these days) where yields on the 10-year BTP have fallen 17bps today. Meanwhile, the dollar is little changed, having been slightly softer earlier in the session but now showing signs of life. The renminbi is also little changed this morning, continuing to hover near 6.94, while the PBOC looks on nervously. It has become increasingly apparent that regardless of the trade situation, there is very limited appetite to allow USDCNY to trade to 7.00 or beyond right now, as the fear of an uptick in capital outflows remains palpable. Although, eventually, I think that is exactly what will happen, it appears that the PBOC is going to allow only a very slow movement in that direction.

Away from China, the other ‘good’ news of the day was from Italy, where Moody’s cut the sovereign debt rating one notch to Baa3, its lowest investment grade, and adjusted the outlook to stable. This downgrade had been widely expected, but fears had been growing that it could actually be a two notch downgrade, into junk status, which would have resulted in forced selling of Italian debt by funds with mandates to only invest in investment grade bonds. The confirmation of a stable outlook has resulted in widespread relief by the market, although Standard & Poors will release their newest report next week, also slated to be a downgrade, but also expected (hoped?) to be a single notch and to remain in investment grade territory. For now, the result has been a huge rally in Italian bonds, with yields falling 14bps to 3.44% and the spread over German bunds declining to 298bps, its first time below 300 in two weeks. The thing is, there has been no indication that the Italians are going to alter their budget to meet EU requirements, and that is what started this latest round of problems.

Elsewhere in Europe Brexit remains the biggest unknown, with a deal still far from concluded. The key issue is still the Ireland situation and the competing demands for no hard Irish/Northern Irish border vs. the willingness to allow Northern Ireland to have a completely different set of trading rules than the rest of the UK. Over the weekend, PM May seemed to signal some willingness to move toward an EU suggested solution, but that is likely to imperil her tenure as PM given the strong resistance by hard-line Brexiteers. The pound is the worst performing G10 currency this morning, down 0.3%, but my sense is that for a substantive move to occur we will need to get a clear signal one way or the other, and that does not look imminent.

Another issue, which is in the background right now, but will start to become more interesting as we head into 2019, is the funding status of Eurozone banks that took advantage of the TLTRO financing during the Eurozone bond crisis. That cheap funding is set to mature beginning next year, and given the ECB’s stated goals of ending QE and eventually returning interest rates back to a more normal level, it means that bank funding costs throughout Europe are set to rise, and rise sharply. This will impact regulatory issues enacted in the wake of the financial crisis, as once those loans have less than 1-year remaining in them, they no longer count as long term capital. The point is that while the Eurozone economy has been recovering, a sharp rise in bank financing costs could easily undermine recent strength and force the ECB to reconsider the trajectory of tighter policy. Easier than expected ECB monetary policy would definitely weaken the single currency. This is not an issue for today, but we need to keep an eye out for potential concerns going forward.

Turning to the data story, this week doesn’t have much, but it does include the first look of Q3 GDP growth in the US, which could be critical for both markets and the upcoming elections. We also see New Home Sales, the last of the housing data, which thus far, has been quite weak.

Wednesday New Home Sales 625K
  Fed’s Beige Book  
Thursday Initial Claims 214K
  Durable Goods -1.0%
  -ex Transport +0.5%
  Goods Trade Balance -$74.9B
Friday Q3 GDP 3.3%
  Michigan Sentiment 99

On top of the GDP we have six Fed speakers, but there seems to be a pretty uniform set of expectations that they are on the right path with gradual rate increases the correct policy for now. In other words, don’t look for any new information there.

That sets us up for a week dependent on any changes in several ongoing stories, notably the Brexit negotiations, the Italian budget situation and Chinese market intervention. For now the signs are that the Chinese will continue to support things while Brexit will go nowhere. In the end, Italy has the best chance to rock the boat further, although I doubt that will occur this week. So look for a fairly quiet FX market, with the dollar remaining in its trading range waiting the next catalyst of note.

Good luck
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