Dreams All Come True

The Minutes explained that the Fed
Was actively looking ahead
Twixt yield curve control
And guidance, their goal
Might not be achieved, so they said

This morning, though, payrolls are due
And traders, expressing a view
Continue to buy
Risk assets on high
Here’s hoping their dreams all come true!

In the end, it can be no surprise that the Fed spent the bulk of their time in June discussing what to do next. After all, they had to be exhausted from implementing the nine programs already in place and it is certainly reasonable for them to see just how effective these programs have been before taking the next step. Arguably, the best news from the Minutes was that there was virtually no discussion about negative interest rates. NIRP continues to be a remarkable drag on the economies of those countries currently caught in its grasp. We can only hope it never appears on our shores.

Instead, the two policies that got all the attention were forward guidance and yield curve control (YCC). Of course, the former is already part of the active toolkit, but the discussion focused on whether to add an outcome-based aspect to their statements, rather than the more vague, ‘as long as is necessary to achieve our goals of stable prices and full employment.’ The discussion centered on adding a contingency, such as; until inflation reaches a certain level, or Unemployment falls to a certain level; or a time-based contingency such as; rates will remain low until 2023. Some would argue they already have that time-based contingency in place, (through 2022), but perhaps they were leading up to the idea it will be longer than that.

The YCC discussion focused on research done by their staff on the three most well-known instances in recent history; the Fed itself from 1942-1951, where they capped all rates, the BOJ, which has maintained 10-year JGB yields at 0.0% +/- 0.20%, and the RBA, which starting this past March has maintained 3-year Australian yields at 0.25%. As I mentioned last week in “A New Paradigm” however, the Fed is essentially already controlling the yield curve, at least the front end, where movement out to the 5-year maturities has been de minimis for months. Arguably, if they are going to do something here, it will need to be in the 10-year or longer space, and the tone of the Minutes demonstrated some discomfort with that idea.

In the end, my read of the Minutes is that when the FOMC meets next, on July 29, we are going to get a more formalized forward guidance with a contingency added. My guess is it will be an Unemployment rate contingency, not a time contingency, but I expect that we will learn more from the next set of Fed speakers.

Turning to today, as the market awaits the latest payroll report, risk assets continue to be on fire. The destruction in so many areas of the economy, both in the US and around the world, is essentially being completely ignored by investors as they continue to add risk to their portfolios amid abundant central bank provided liquidity. Here are the latest median forecasts as compiled by Bloomberg for today’s data:

Nonfarm Payrolls 3.06M
Private Payrolls 3.0M
Manufacturing Payrolls 438K
Unemployment Rate 12.5%
Average Hourly Earnings -0.7% (5.3% Y/Y)
Average Weekly Hours 34.5
Participation Rate 61.2%
Initial Claims 1.25M
Continuing Claims 19.0M
Trade Balance -$53.2B
Factory Orders 8.7%
Durable Goods 15.8%
-ex Transport 6.5%

Because of the Federal (although not bank) holiday tomorrow, the report is being released this morning. It will be interesting to see if the market responds to the more timely Initial Claims data rather than the NFP report if they offer different messages. Remember, too, that last month’s Unemployment rate has been under much scrutiny because of the misclassification of a large subset of workers which ultimately painted a better picture than it might otherwise have done. Will the BLS be able to correct for this, and more importantly, if they do, how will the market interpret any changes. This is one reason why the Initial and Continuing Claims data may be more important anyway.

But leading up to the release, it is full speed ahead to buy equities as yesterday’s mixed US session was followed by strength throughout Asia (Nikkei +0.1%, Hang Seng +2.85%, Shanghai +2.1%) and in Europe (DAX +1.6%, CAC +1.3%, FTSE 100 +0.6%). US futures are also higher, between 0.4%-0.8%, to complete the virtuous circle. Interestingly, once again bond yields are not trading true to form on this risk-on day, as yields in the US are flat while throughout Europe, bond yields are declining.

But bonds are the outlier here as the commodity space is seeing strength in oil and metals markets and the dollar is under almost universal pressure. For example, in the G10, NZD is the leading gainer, up 0.6%, as its status as a high beta currency has fostered buying interest from the speculative crowd betting on the recovery. But we are also seeing NOK and SEK (both +0.5%) performing well while the euro (+0.3%) and the pound (+0.3%) are just behind them. The UK story seems to be about the great reopening that is due to occur starting Saturday, when pubs and restaurants as well as hotels are to be allowed to reopen their doors to customers. The fear, of course, is that this will foster a second wave of infections. But there is no doubt there is a significant amount of pent up demand for a drink at the local pub.

In the EMG bloc, the ruble is today’s winner, rising 1.2% on the back of oil’s continued rebound. It is interesting, though, as there is a story that Saudi Arabia is having a fight with some other OPEC members, and is close to relaunching a full-scale price war again. It has been the Saudis who have done the lion’s share of production cutting, so if they turn on the taps, oil has a long way to fall. Elsewhere in the space, INR (+0.8%) and ZAR (+0.75%) are having solid days on the back of that commodity strength and recovery hopes. While the bulk of the space is higher, IDR has had a rough session, in fact a rough week, as it has fallen another 0.65% overnight which takes its loss in the past week near 2.0%. Infection rates continue to climb in the country and investors are becoming uncomfortable as equity sales are growing as well.

So, this morning will be a tale of the tape. All eyes will be on the data at 8:30 with the odds stacked for a strong risk session regardless of the outcome. If the data shows the recovery is clearly strengthening, then buying stocks makes sense. On the other hand, if the data is disappointing, and points to a reversal of the early recovery, the working assumption is the Fed will come to the rescue quite quickly, so buying stocks makes sense. In this worldview, the dollar is not seen as critical, so further dollar weakness could well be in our future.

Good luck and stay safe
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Feeling the Heat

As tensions continue to flare
Twixt China and Uncle Sam’s heir
The positive feelings
In equity dealings
Could easily turn to a bear

Meanwhile down on Threadneedle Street
The Old Lady’s fairly downbeat
Thus negative rates
Are now on their plates
With bank stocks there feeling the heat

A yoyo may be the best metaphor for market price action thus far in May as we have seen a nearly equal number of up and down days with the pattern nearly perfect of gains followed by losses and vice versa. Today is no different as equity markets are on their back foot, after yesterday’s gains, in response to increasing tensions between Presidents Trump and Xi. Realistically, this is all political, and largely for each President’s domestic audience, but it has taken the form of a blame game, with each nation blaming the other for the instance and severity of the Covid-19 outbreak. What is a bit different this time is that President Trump, who had been quick to condemn China in the past, had also been scrupulous in maintaining that he and President Xi had an excellent working relationship. However, last night’s Twitter tirade included direct attacks on Mr Xi, a new tactic and one over which markets have now shown concern.

Thus, equity markets around the world are lower this morning with modest losses seen in Asia (Nikkei -0.2%, Hang Seng and Shanghai -0.5%) and slightly larger losses throughout the Continent (DAX -1.6%, CAC -1.1%, FTSE 100 -1.0%). US futures are pointing in the same direction with all three indices currently down about 0.7%. Has anything really changed? Arguably not. After all, both broad economic data and corporate earnings numbers remain awful, yet equity market prices, despite today’s dour mood, remain within sight of all-time highs. And of course, the bond market continues to point to a very different future as 10-year Treasury yields (-1bp today) continue to trade near historically low levels. To reiterate, the conundrum between a bond market that is implying extremely slow economic activity for the next decade, with no concomitant inflation seems an odd companion to an equity market where the median P/E ratio has once again moved above 20, well above its long-term average. This dichotomy continues to be a key topic of conversation in the market, and one which history has shown cannot last forever. The trillion-dollar question is, which market adjusts most?

With the increasing dissent between the US and China as a background, we also learned of the specter of the next country to move toward a negative interest rate stance, the UK. When Mark Carney was governor there, he categorically ruled out negative interest rates as an effective tool to help support the economy. He got to closely observe the experiment throughout Europe and concluded the detriments to the banking community outweighed any potential economic positives. (This is something that is gaining more credence within the Eurozone as well although the ECB continues to insist NIRP has been good for the Eurozone.) However, Carney is no longer governor, Andrew Bailey now holds the chair. And he has just informed Parliament, “I have changed my position a bit,” on the subject, and is now willing to consider negative rates after all. This is in concert with other members of the MPC, which implies that NIRP is likely soon to be reality in the UK. It should be no surprise that UK banking stocks are suffering after these comments as banks are the second victims of the process. (Individual savers are the first victims as their savings no longer offer any income, and in extreme cases decline.)

The other natural victim of NIRP is the currency. As discussed earlier this week, there is a pretty solid correlation between negative real rates and a currency’s relative value. Now granted, if real rates are negative everywhere, then we are simply back to the relative amount of negativity that exists, but regardless, this potential policy shift is clearly new, and one would expect the pound to suffer accordingly. Surprisingly, it is little changed this morning, down less than 0.1% amid a modest trading range overnight. However, it certainly raises the question of the future path of the pound.

When the Eurozone first mooted negative interest rates, in 2014, the dollar was already in the midst of a strong rally based on the view that the Fed was getting set to start to raise interest rates at that time. Thus, separating the impact of NIRP from that of expected higher US rates on the EUR/USD exchange rate is no easy task. However, there is no question that the euro’s value has suffered from NIRP as there is limited incentive for fixed income investment by foreigners. It should therefore be expected that the pound will be weaker going forward as foreign investment interest will diminish in the UK. Whether negative rates will help encourage foreign direct investment is another story entirely, and one which we will not understand fully for many years to come. With all this in mind, though, the damage to the pound is not likely to be too great. After all, given the fact that negative real rates are widespread, and already the situation in the UK, a base-rate cut from 0.1% to -0.1% doesn’t seem like that big a deal overall. We shall see how the market behaves.

As to the session today, FX markets have been as quiet as we have seen in several months. In the G10 space, Aussie and Kiwi are the underperformers, but both are lower by a mere 0.35%, quite a small move relative to recent activity, and simply a modest unwind of yesterday’s much more powerful rally in both. But away from those two, the rest of the bloc is less than 0.2% different from the close with both gainers (EUR, DKK) and losers (GBP, JPY) equidistant from those levels.

On the EMG side, there is a bit more constructive performance with oil’s continued rally (+2%) helping RUB (+0.4%) while the CE4 are also modestly firmer simply following the euro higher. APAC currencies seem a bit worse for wear after the Twitter spat between Trump and China, but the losses are miniscule.

Data this morning showed the preliminary PMI data from Europe is still dire, but not quite as bad as last month’s showing. In the US today we see Initial Claims (exp 2.4M), Continuing Claims (24.25M) and Existing Home Sales (4.22M). But as I have been writing all month, at this point data is assumed to be dreadful and only policy decisions seem to have an impact on the market. Yesterday we saw the Minutes of the Fed’s April 29 meeting, where there was a great deal of discussion about the economy’s problems and how they can continue to support it. Ideas floated were firmer forward guidance, attaching rate moves to numeric economic targets, and yield curve control, where the Fed determines to keep the interest rate on a particular tenor of Treasury bonds at a specific level. Both Japan and Australia are currently executing this, and the Fed has done so in its history, keeping long-term yields at 2.50% during WWII. My money is on the 10-year being pegged at 0.25% for as long as necessary. But that is a discussion for another day. For today, the dollar seems more likely to rebound a bit rather than decline, but that, too, is one man’s view.

Good luck and stay safe
Adf

A Bright Line

In Europe there is a bright line
Twixt nations, those strong, those supine
The Germans and Dutch
Refuse to give much
While Italy wilts on the vine

Once again, the EU has failed to accomplish a crucial task and once again, market pundits are calling for the bloc’s demise. The key story this morning highlights the failure of EU FinMins, after a 16-hour meeting yesterday, to reach a support deal for the whole of Europe. The mooted amount was to be €500 billion, but as always in this group, the question of who would ultimately pick up the tab could not be agreed. And that is because, there are only three nations, Germany, Austria and the Netherlands, who are in a net financial position to do so. Meanwhile, the other twenty-four nations all have their collective hands out. (And you wonder why the UK voted to leave!) Ultimately, the talks foundered on the desire by the majority of nations to mutualize the costs of the support (i.e. issue Eurobonds backed by the full faith and credit of the entire EU), while the Germans, Dutch and Austrians would not agree. Realistically, it is understandable why they would not agree, because in the end, the obligation will fall on those three nations to pick up the tab. But the outcome does not bode well for either the present or the future.

In the current moment, the lack of significant fiscal support is going to hamstring every EU nation, other than those three, in their attempts to mitigate the impacts of shutting down economies to halt the spread of Covid-19. But in the future, this issue is the latest manifestation of the fundamental flaw in the EU itself.

That flaw can be described as follows: the EU is a group of fiercely competitive nations masquerading as a coherent whole. When the broad situation is benign, like it is most of the time, and there is positive economic growth and markets are behaving well, the EU makes a great show of how much they do together and all the things on which they agree. However, when the sh*t hits the fan, it is every nation for themselves and woe betide any attempt by one member to collaborate with another on a solution. This makes perfect sense because, despite the fact that they have constructed a number of institutions that sound like they are democratically elected representatives of each nation, the reality is in tough times, each nation’s political class is concerned first and foremost with its own citizenry, and only when that group is safeguarded, will they consider helping others. At this point, in the virus crisis, no nation feels its own citizens are safe, so it would be political suicide to offer help to others. (Asking for help is an entirely different matter, that’s just fine.) In the end, I am confident that this group will make an announcement of some sort that will describe the fantastic cooperation and all they are going to do to support the continent. But I am also confident that it will not include a willingness by the Teutonic three to pay for the PIGS.

The initial market impact of this failure was exactly as expected, the euro (-0.5%) declined along with the other European currencies (SEK -0.75%, NOK -1.25%) and European equity markets gave back some of their recent gains with the DAX and CAC both falling around 1.5%. Meanwhile, European government bonds saw Italian, Spanish and Greek yields all rise, as hoped for support has yet to come. However, the EU is nothing, if not persistent, and the comments that have come out since then continue to suggest that they will arrive at a plan by the end of the week. This has been enough to moderate those early moves and at 7:00, as New York walks in the door, we see markets with relatively modest changes compared to yesterday’s closing levels.

In the G10 currencies, while the dollar remains broadly stronger, its gains are far less than seen earlier. For example, NOK is the current laggard, down 0.35%, while SEK (-0.3%) and EUR (-0.2%) are next in line. The pound has actually edged higher this morning, but its 0.1% gain is hardly groundbreaking. However, it is interesting to note that the non-EU currencies are outperforming those in the EU.

Emerging market currencies have also broadly fallen, with just a few exceptions. The worst performer today is INR (-0.9%), which seems to be responding to the growth in the number of coronavirus cases there, now over 5,000. But we are also seeing weakness, albeit not as much, from EU members CZK (-0.35%), BGN (-0.3%) and the rest of the CE4. The one notable gainer today is ZAR (+0.5%) which seems to be benefitting from a much smaller than expected decline in a key Business Confidence indicator. However, I would not take much solace in that as the data is certain to get worse there (and everywhere) before it gets better.

Overall, though, the market picture is somewhat mixed today. The FX market implies some risk mitigation, which is what we are seeing in the European equity space as well. However, US equity futures are all pointing slightly higher, about 0.5% as I type, and oil prices are actually firmer along with most commodities. In other words, there is no clear direction right now as market participants await the next piece of news.

The only data point we see today in the US is the FOMC Minutes, but I don’t see them as being that interesting given both how much the Fed has already done, thus leaving less things to do, and the fact they have gone out of their way to explain why they are doing each thing. So I fear today will be dependent on the periodic reports of virus progression. At the beginning of the week, it seemed as though the narrative was trying to shift to a peak in infections and better data ahead. Alas, that momentum has not been maintained and we have seen a weries of reports where deaths are increasing, e.g. in Spain and New York to name two, where just Monday it was thought things had peaked. Something tells me that the virus will not cooperate with a smooth curve of progress, and that more volatility in the narrative, and thus markets, lays ahead. We are not yet near the end of this crisis, so hedgers, you need to keep that in mind as you plan.

Good luck
Adf

No Rapprochement

The topic du jour is Iran
Where threats, to and fro, carry on
Risk appetite’s fallen
And bears are now all in
That this time there’s no rapprochement

The rhetoric between the US and Iran over the weekend has escalated with both sides threatening retaliation for anything the other side does. Stories of cyber-attacks on the US as well as an attack on a base in Kenya where three Americans were killed seem to be the first steps, but with the US deploying reinforcements to the Middle East, and President Trump promising disproportionate responses to any further actions, the situation has become fraught with danger.

Not surprisingly, financial markets are stressing with risk appetites throughout the world dissipating and haven assets in demand. So, for a second day we have seen equity markets fall around the world (Nikkei -1.9%, Hang Seng -0.8%, DAX -1.6%, CAC -1.1%, FTSE -1.0%) and US futures are following along with all three indices currently lower by approximately 0.8%. Treasuries and German bunds have rallied, albeit Friday’s price action was far greater than this morning’s movement which has seen yields on each fall just one more basis point. Gold has soared to its highest level since April 2013 and is now pressing up toward $1600/oz. Oil continues to rise on supply fears, up another 1.0% this morning and nearly 6.0% since Friday morning. But recall that prior to the US action against Soleimani, oil was up more than 20% since October.

And finally, the dollar this morning is…lower. At least mostly that’s the case. In some ways this is quite surprising as the dollar tends to be a haven in its own right, but markets have been known to be fickle prior to today. In the G10 space, the pound is leading the way higher overnight, up 0.5%, which may well be a response to modestly better than expected UK data (New Car Registrations +3.4%, Services PMI 50.0) rather than to the geopolitical risks. Of course, PMI at 50.0 is hardly cause for celebration, but I guess that’s better than further sub-50 readings. The euro has also benefitted this morning, +0.35%, after PMI data across the region was also modestly better than the flash numbers from the week before last. However, based on the latest data, according to most econometric models, GDP for Q1 in the Eurozone is still running at just 0.1%, or less than 0.5% annualized. Again, it’s hard to get too excited about the situation yet.

And then there is the yen, which is essentially unchanged on the day, perhaps the biggest surprise of all. This is because even when the dollar has not run true to course on a risk basis, the yen has been extremely consistent. Granted, since New Year’s Eve, the yen has been the top G10 performer but its 0.5% rally in that time is hardly inspirational. My take is that even heightened rhetoric from either side is likely to see the yen gain further, but remember there are market technicals involved in the trade, with 108.00 having demonstrated strong support since early October. It appears we will need a bit more of a ‘kinetic’ action in Iraq/Iran before the yen takes its next steps higher.

In the EMG bloc, the situation is a bit different, with EEMEA currencies all trading in a tightly linked manner to the euro, and so higher by about 0.35%, but modest weakness seen across most of the APAC region. As to LATAM, CLP is opening much lower (-1.75%) as the central bank backed away from its USD sale program. The bank announced this morning that it would not be selling the $150mm in the spot market it has been executing every day since last autumn. If nothing else, this should be a good indication for hedgers of just how little liquidity exists within that market.

Turning to Friday’s FOMC Minutes, it can be no surprise that the Fed nearly twisted their own arm, patting themselves on the back, for setting policy at just the right place. And then there was the American Economic Association conference this past weekend where the Fed loomed large in the paper production. Former Fed chairs Bernanke and Yellen once again explained that things beyond their control (demographics and technology) were the reason that they could not achieve their policy targets, but both assured us that more of the same policies that have been ineffective for the economy (but great for the stock market) would get the job done! Meanwhile, current Fed members all expressed satisfaction with the current settings, although it is clear there is far more concern over economic weakness than rising price pressures. What is clear is that higher prices are coming to a store (every store) near you.

As to this week, the data parade starts tomorrow and runs through Friday’s payroll report as follows:

Tuesday Trade Balance -$43.9B
  ISM Non-Manufacturing 54.5
  Factory Orders -0.7%
Wednesday ADP Employment 160K
  Consumer Credit $15.8B
Thursday Initial Claims 220K
Friday Nonfarm Payrolls 162K
  Private Payrolls 152K
  Manufacturing Payrolls 5K
  Unemployment Rate 3.5%
  Average Hourly Earnings 0.3% (3.1% Y/Y)
  Average Weekly Hours 34.4

Source: Bloomberg

In addition, we hear from five more Fed speakers, with many more doves than hawks slated to discuss their views. In truth, I think it would be more effective if they would simply shut up rather than constantly reiterate their opinion that they have done a great job and will continue to do so unless things change. However, with the reduced risk appetite due to the Iran situation, I guess they feel the need to try to support stock prices at all costs.

In the medium term, I think the dollar will continue to come under pressure. In the short term, I think it is much harder to have a view given the highly volatile nature of the current situation in the Middle East. This is why you hedge; to prevent significant problems, but take care in executing those hedges, markets are skittish on the opening, and market depth may be a bit less robust than normal.

Good luck
Adf

Unease In Iraq

While yesterday, risk basked in glory
This morning risk-off is the story
Unease in Iraq
Had markets give back
The gains seen in each category

Well, this is probably not the way most of us anticipated the year to begin, with a retaliatory strike against Iran inside Iraq, but that’s what makes markets interesting. So yesterday’s bright beginning, where the PBOC reduced its reserve requirement ratio (RRR) by 0.50% to add further liquidity to the Chinese economy which led to broad based positive risk sentiment has been completely reversed this morning. Briefly recapping yesterday’s activity, equity markets around the world soared on the news of further central bank easy money, but interestingly, Treasury bonds rallied (yields declined) and gold rallied as did the dollar. This is a pretty unusual combination of market movements, as generally, at least one of that group would sell off in a given session. Perhaps it speaks to the amount of spare cash on the sidelines looking for investment opportunities to start the year.

However, that was soooo yesterday. At about 7:45 last night the news hit the tape that a senior Iranian general from the QUDS force had been killed by a US drone attack near Baghdad airport. When this was confirmed all of the positive sentiment that had been permeating markets disappeared in an instant. Equity prices went from a strong opening in Asia to closing with declines. The dollar and the yen both rallied sharply as did gold and oil. And not to be left out, Treasury yields have plummeted along with Bund and Gilt yields. In other words, today is a classic risk-off session.

So a quick look at markets as NY starts to walk in shows European equity markets under pressure (DAX -1.65%, CAC -0.5%, FTSE -0.5%) and US futures similarly falling (DJIA -1.2%, Nasdaq 1.5%, SPY -1.3%). In the bond market, Treasury yields are down 7.5bps to 1.80% while German Bunds are down 7bps to -0.30%. Gold prices have rallied a further 1.4% and are back to the highs touched in September at $1550/oz, a level which had not been seen since early 2013 prior to that. Oil prices have rocketed higher, up 3.9%, as fears of supply interruptions make the rounds. Of course, given that the US shale producers have essentially become the swing producers in the market, my sense is that we are not likely to see a permanently higher price level here. Remember, when Iran attacked Saudi oil facilities last September, the oil price spike was extremely short-lived, lasting just a couple of days before settling right back down.

And finally, the dollar has rallied sharply this morning against virtually all its counterparts except, naturally, the yen. During the last week of 2019, the dollar sold off broadly, losing about 2.0% against a wide range of currencies as investors and traders seemed to be preparing for a scenario of continued low US interest rates supporting stocks while undermining the dollar’s value. Of course, my view of ‘not QE’ having a significant impact on the dollar has not changed, and although the US economy continues to outperform its G10 peers and US interest rates remain higher than pretty much every other country in that bloc, the history of QE is that it will undermine the dollar this year.

But for right now, long-term structural issues are taking a back seat to the immediacy of growing concern over escalating tensions in Iraq and the Middle East. If a larger conflict erupts, then we are far more likely to see protracted USD and JPY strength alongside weaker equity markets, higher prices for gold and oil and lower Treasury yields. And the thing to remember right now is that traders were establishing short USD positions for the last several weeks, so this sudden reversal could well have further to run on position squaring alone. Markets remain less liquid than normal as most trading desks will not be fully staffed until Monday. So keep that in mind if some hedging needs to be executed today.

With that as an introduction, what else can we anticipate today? Well, we do get a bit of US data, ISM Manufacturing (exp 49.0) and ISM Prices Paid (47.8) as well as Construction Spending (0.4%) and then at 2:00 the FOMC Minutes from the December meeting will be released. Those have garnered a great deal of interest as even though Chairman Powell has essentially told us all that rates are on hold for a long time, all eyes will be searching for further discussion of the repo issue and how the Fed plans to handle it going forward. While they were able to prevent any untoward movement for the year-end turn, they are still buying $60 billion / month of T-bills and the balance sheet has grown more than $400 billion since October. Not coincidentally, equity prices have rallied sharply since October as well. The point is that the Fed remains on a path where they have promised to re-inflate the balance sheet until at least late Spring, and given the direct relationship between the Fed’s balance sheet and equity prices, as well as the demonstrated fear the Fed has shown with respect to doing anything that could be blamed for causing the stock market to decline, it seems awfully likely that ‘not QE’ is going to continue for a very long time. And that is going to weigh on the dollar going forward…just not today.

One more thing to look for this afternoon is a series of comments from a bevy of Fed doves (Brainard, Daly, Evans and Kaplan) who are attending a conference in San Diego. Do not be surprised to hear comments that continue to raise the bar for any possible rate hikes, but allow the idea of rate cuts to filter into the discussion. However, this too, is unlikely to undermine the dollar during a risk-off session. The theme here is that payables hedgers need to consider taking advantage of this short-term dollar strength.

Good luck
Adf

 

Well Calibrated

Our policy’s “well calibrated”
Though some of us are still frustrated
It’s time to resort
To fiscal support
Since our balance sheet’s so inflated

While market activity has been relatively benign this morning, there are two stories that have consistently been part of the conversation; the FOMC Minutes and the latest trade information. Regarding the former, it seems there was a bit more dissent than expected regarding the Fed’s last rate cut, as while there were only two actual dissenters, others were reluctant rate cutters. With that said, the term “well calibrated” has been bandied about by more than one Fed member as a description of where they see policy right now. And this aligns perfectly with the idea that the Fed is done for a while which is what Powell signaled at the press conference and what essentially every Fed speaker since has confirmed. Regarding the balance of risks, despite what has been a clear uptick in investor sentiment over the past month, the Fed continues to point to asymmetry with the downside risks being of more concern. Recall, the futures markets are not looking for any policy adjustments at the December meeting, and in fact, are pricing just a 50% chance of a cut by next June. One final thing, the feeling was unanimous on the committee that there was no place for negative interest rates in the US. If (when) the economic situation deteriorates that much, they were far more likely to utilize policies like yield curve control (we know how well that worked for Japan) and forward guidance rather than taking the leap to negative rates.

Ultimately, the market read the Minutes and decided that while the Fed is on hold, the next move is far likelier to be a rate cut than a rate hike and thus yesterday’s early risk-off attitude was largely moderated by the end of the day. In fact, this morning, we are seeing a nascent risk-on view, although given how modest movement has been in any market; I am hesitant to describe it in that manner.

The other story that reinserted itself was the US-China trade negotiations, where Chinese vice –premier Liu He, the chief negotiator, explained that he was “cautiously optimistic” about progress and that he invited Messr’s Mnuchin and Lighthizer to Beijing next week to continue the dialog. While he admitted that he was confused about US demands, it does appear that the Chinese are pretty keen to get a deal done.

One other wrinkle is the fact that the Hong Kong support bill in Congress has been approved virtually unanimously, and all indications are that President Trump is going to sign it. While it is clear the Chinese are not happy about that, it seems a bit of an overreaction. After all, the bill simply says that Hong Kong’s special economic status will be reviewed annually, and that any direct military intervention would be met with sanctions. I have to believe that if the PLA did intervene directly to quell the unrest, even without this law in place, the US would respond in some manner that would make the Chinese unhappy. As to an annual review, the onus is actually on the US, although it could certainly add a new pressure point on China in the event they decide to convert from ‘one country, two systems’, to ‘one country, one system’. My take on the entire process is the Chinese are feeling more and more pressure on the economy because of the current tariff situation, and realize that they need to change that situation, hence the new invitation to continue the talks.

With that as our backdrop, a look at markets this morning shows the dollar is very modestly softer pretty much across the board. The largest gainer overnight has been the South African rand, which has rallied 0.5% ahead of the SARB meeting. While markets are generally expecting no policy changes, yesterday’s surprisingly low CPI data (3.7%, exp 3.9%) has some thinking the SARB may cut rates from their current 6.5% level and help foster further investment. On the flip side, South Korea’s won has been the big loser, falling 0.7% overnight after export data showed a twelfth consecutive month of declines and implied prospects for a pickup are limited. Arguably South Korea has been the nation most impacted by the US-China trade war. And one last thing, the Chilean peso, which has been under significant pressure for the past two weeks, is once again opening weaker, down 0.4% to start the day. In the past two weeks the peso has tumbled nearly 7%, and this despite the fact that the Chilean government has been extremely responsive to the protest movement, agreeing to rewrite the constitution to address many of the concerns that have come to light.

As to the G10, there is nothing to discuss. Movement has been extremely modest and data has been limited. Perhaps the one interesting item is that Jeremy Corbyn has released the Labour manifesto for the election and it focuses on raising taxes in numerous different ways and on numerous different parties. Certainly in the US that is typically not the path that wins elections, but perhaps in the UK it is different. At any rate, the market seems to think that this will hurt Corbyn’s chances, something it really likes, and the pound has edged up 0.25% this morning.

On the data front, this morning brings Initial Claims (exp 218K), Philly Fed (6.0), Leading Indicators (-0.1%) and finally Existing Home Sales (5.49M). Of this group, I expect that Philly Fed is the most likely to have an impact, but keep an eye on the claims data. Remember, last week it jumped to 225K, its highest since June, and another high print may start to indicate that the labor market, one of the key pillars of economic support, is starting to strain a little. We also hear from two Fed speakers, the hawkish Loretta Mester and the dovish Neal Kashkari, but again, it feels like the Fed is pretty comfortably on hold at this point.

Lacking a catalyst, it seems to me that the dollar is likely to have a rather dull session. Equity futures are pointing ever so slightly lower, but are arguably unchanged at this point. My sense is that this afternoon, markets will be almost exactly where they are now…unchanged.

Good luck
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The Senate’s Blackball

Near China, an island quite small
Has led to the latest downfall
In equity prices
Because of their crisis
As well as the Senate’s blackball

Risk is decidedly off this morning as equity markets around the world are under pressure and bond markets rally strongly. Adding to the mix is a stronger dollar and Japanese yen as well as an uptick in gold prices. The proximate cause of this angst was the unanimous voice vote in the Senate last night to pass legislation requiring an annual review of Hong Kong’s special trade status with the US, something that was heretofore permanently granted in 1992. The new legislation requires Hong Kong to remain “sufficiently autonomous” in order to maintain that status, which is arguably quite a nebulous phrase. Nonetheless, the Chinese response was immediate, threatening unspecified retaliation if the bill becomes law and calling it illegal and an intrusion in domestic Chinese affairs. While the bill must still be reconciled with a similar House version, that seems likely to be fairly easy. The real question is how the president will manage the situation given the fragility of the ongoing trade talks. Thus far, he has not made his views known, but they would appear to be in sympathy with the legislation. And given the unanimity of voting in both chambers, even a presidential veto would likely be overturned.

Given this turn of events, it should be no surprise that risk is under pressure this morning. After all, the promise of a trade deal has been supporting equity and other risk markets for the past six weeks. This is the first thing that could clearly be seen to cause a complete breakdown in the discussions. And if the trade negotiations go into hibernation, you can be sure that risk assets have much further to fall. You can also be sure that the developing narrative that European weakness is bottoming will also disappear, as any increase in US tariffs, something that is still scheduled for the middle of next month, would deal a devastating blow to any nascent recovery in Europe, especially Germany. The point is, until yesterday, the trade story was seen as a positive catalyst for risk assets. Its potential unwinding will be seen as a clear negative with all the risk-off consequences that one would expect.

Beyond the newly fraught trade situation, other market movers include, as usual, Brexit and the Fed. In the case of the former, last night saw a debate between PM Johnson and Labour’s Jeremy Corbyn where Boris focused on reelection and conclusion of the Brexit deal he renegotiated. Meanwhile, Jeremy asked for support so that he could renegotiate, yet again, the deal and then put the results to a referendum in six months’ time. The snap polls after the debate called it a draw, but the overall polls continue to favor Boris and the Tories. However, the outcome was enough to unnerve Sterling traders who pushed the pound lower all day yesterday and have continued the process today such that we are currently 0.6% below yesterday’s highs at 1.2970. It seems pretty clear that in the event of an upset victory by Corbyn, the pound would take a tumble, at least initially. Investors will definitely run from a country with a government promising a wave of nationalization of private assets. Remember what happened in Brazil when Lula was elected, Mexico with AMLO and Argentina with Fernandez a few months ago. This would be no different, although perhaps not quite as dramatic.

As to the Fed, all eyes today are on the release of the FOMC Minutes from the November meeting where they cut rates by 25bps and essentially told us that was the end of the ‘mid-cycle adjustment’. And, since then, we have heard from a plethora of Fed speakers, all explaining that they were comfortable with the current rate situation relative to the economy’s status, and that while they will respond if necessary to any weakening, they don’t believe that is a concern in the near or medium term. In fact, given how much we have heard from Fed speakers recently, it is hard to believe that the Minutes will matter at all.

So reviewing market activity, G10 currencies are all lower, save the yen, which is basically unchanged. The weakest link is NOK, which is suffering on the combination of risk aversion and weak oil prices (+0.4% today but -4.0% this week). But the weakness is solid elsewhere, between 0.2% and 0.5%. In the EMG bloc, CLP is once again leading the way lower, down 1.0% this morning after a 2.0% decline yesterday, with spot pushing back toward that psychological 800 level (currently 795). But pretty much every other currency in the bloc is lower as well, somewhere between 0.2% and 0.4%, with just a few scattered currencies essentially unchanged on the day.

And that really describes what we have seen thus far today. With only the FOMC Minutes on the docket, and no other Fed speakers, my take is the FX market will take its cues from the broader risk sentiment, and the dollar is in a position to reverse its losses of the past week. Barring a shocking change of view by Congress, look for a test of 1.10 in the euro by the end of the week.

Good luck
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Digging In Heels

In Europe they’re digging in heels
Ignoring all UK appeals.
So, Brexit is looming
With Boris assuming
They’ll blink, ratifying his deal

Brexit and the Trade Wars sounds more like a punk rock band than a description of the key features in today’s markets, but once again, it is those two stories that are driving sentiment.

Regarding the former, the news today is less positive that a deal will be agreed. A wide group of EU leaders have said Boris’s latest offering is unacceptable and that they are not willing to budge off their principles (who knew they had principles?). It appears the biggest sticking point is that the proposal allows Northern Ireland to be the final arbiter of approval over the workings of the deal, voting every four years to determine if they want to remain aligned with the EU’s rules on manufactured goods, livestock and agricultural products. This, of course, would take control of the process out of the EU’s hands, something which they are unwilling to countenance.

French President Emmanuel Macron has indicated that if they cannot agree the framework for a deal by this Friday, October 11, there would be no chance to get a vote on a deal at the EU Summit to be held next week on October 17. It appears, at this point, that the EU is betting the Benn Act, the legislation recently passed requiring the PM to ask for an extension, will be enforced and that the UK will hold a general election later this year in an attempt to establish a majority opinion there. The risk, of course, is that the majority is to complete Brexit regardless and then the EU will find itself in a worse position. All of this presupposes that Boris actually does ask for the extension which would be a remarkable climb-down from his rhetoric since being elected.

Given all the weekend machinations, and the much more negative tone about the outcome, it is remarkable that the pound is little changed on the day. While it did open the London session down about 0.35%, it has since recouped those losses. As always, the pound remains a binary situation, with a hard Brexit likely to result in a sharp decline, something on the order of 10%, while a deal will result in a similar rally. However, in the event there is another extension, I expect the market will read that as a prelude to a deal and the pound should trade higher, just not that much, maybe 2%-3%.

Otherwise, the big story is the trade war and how the Chinese are narrowing the scope of the negotiations when vice-premier Liu He arrives on Thursday. They have made it quite clear that there will be no discussion on Chinese industrial policy or subsidies, key US objectives, and that all the talks will be about Chinese purchases of US agricultural and energy products as well as attempts to remove tariffs. It appears the Chinese believe that the impeachment inquiry that President Trump is facing will force him to back down on his demands. While anything is possible, especially in politics, based on all his actions to date, I don’t think that the President will change his tune on trade because of a domestic political tempest that he is bashing on a regular basis. The market seems to agree with that view as well, at least based on today’s price action which can best be described as modestly risk-off. Treasury and Bund yields are lower, albeit only between 1-2bps, the yen (+0.1%) and Swiss franc (+0.2%) have strengthened alongside the dollar and US equity futures are pointing to a decline of 0.2% to start the session. Ultimately, this story will remain a market driver based on headlines, but it would be surprising if we hear very much before the meetings begin on Thursday.

Looking ahead to the rest of the week, the FOMC Minutes will dominate conversation, but we also see CPI data:

Today Consumer Credit $15.0B
Tuesday NFIB Small Biz Optimism 102.0
  PPI 0.1% (1.8% Y/Y)
  -ex food & energy 0.2% (2.3% Y/Y)
Wednesday JOLTS Job Openings 7.25M
  FOMC Minutes  
Thursday Initial Claims 220K
  CPI 0.1% (1.8% Y/Y)
  -ex food & energy 0.2% (2.4% Y/Y)
Friday Michigan Sentiment 92.0

Source: Bloomberg

Over the weekend we heard from both Esther George and Eric Rosengren, the two FOMC members who dissented against the rate cuts. Both said they see no reason to cut rates again right now, but if the data do deteriorate, they have an open mind about it. Meanwhile, Friday Chairman Powell gave no hints that last week’s much weaker than expected data has changed his views either. This week brings seven more Fed speakers spread over ten different events, including Chairman Powell tomorrow.

At the same time, this morning saw German Factory Orders decline a more than expected 0.6%, which makes the twelfth consecutive Y/Y decline in that series. It is unambiguous that Germany is in a recession and the question is simply how long before the rest of Europe follows, and perhaps more importantly, will any country actually consider fiscal stimulus? As it stands right now, Germany remains steadfast in their belief it is unnecessary. Maybe a hard Brexit will change that tune!

The big picture remains intact, with the dollar being the beneficiary as the currency of the nation whose prospects outshine all others in the short run. As it appears highly unlikely a trade deal will materialize this week, I see no reason for the dollar to turn around. Perhaps the only place that is not true is if there is, in fact, a break though in the UK.

Good luck
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Not a Clue

The thing that we learned from the Fed
Was they’ve not a clue what’s ahead
A few wanted fifty
But others more thrifty
Suggested a quarter instead

The thing that has Powell perplexed
Is what to do when they meet next
That’s why when he speaks
Near Jackson Hole’s peaks
Investors all fear some subtext

Once again the market has wandered aimlessly ahead of tomorrow’s Jackson Hole speech by Chairman Powell. Equity markets have generally edged lower (Hang Seng -0.85%, DAX -0.1%, FTSE -0.6%) although a few managed to scrape out a gain (Nikkei +0.05%, Shanghai +0.1%). Bond markets have also been mixed with most Asian markets rallying while Europe has seen small losses. I guess it’s only fitting that 10-year Treasuries are essentially unchanged on the day. Meanwhile, the dollar continues its broad winning ways with mostly modest gains against both G10 and EMG currencies.

At this point, all eyes are on tomorrow’s Powell speech to discern the Fed’s next move. Yesterday afternoon’s FOMC Minutes painted a picture of a group with significant differences in views. We know of the two dissenters, who didn’t want to cut rates at all, and it turns out that a “couple of participants” were looking for a fifty basis point cut. In the end, it is no surprise that twenty-five was the result, although the rationale, given their stated views that downside risks to the economy had diminished, seem shaky. The market response to the Minutes was, therefore, largely nonexistent, with almost no movement subsequent to their release in any market, which, given the proximity of the new information coming from Powell ought not be that surprising. In fact, it seems unlikely that today will bring too much activity either given that the important data has already been released (European PMI’s) and Initial Claims (exp 216K) and Leading Indicators (0.3%) are unlikely to change any opinions.

A quick look at those Eurozone PMI’s shows that they were marginally better than expected although continue to paint a picture of a weakening economy with no inflationary impulse. The biggest concern was that the new orders survey in Germany fell even further, a sign that there is no recovery in sight. At their release, the euro managed to rally about 0.35%, however it has given all of those gains back in the past four hours and seems more likely to wander aimlessly than take on a direction. The release of the ECB’s Minutes did nothing to change any views, merely confirming that they are preparing further easing for next month, with a growing chance of both an interest rate cut and the restarting of Large Scale Asset Purchases, better known as QE.

Other news of note comes from Djakarta, where Bank Indonesia (BI) surprised one and all and cut 25bps last night. However, the rupiah managed to eke out a small gain on the session as investors and traders seem more focused on the positive growth story, a true rarity these days, than on the interest rate situation. Most analysts are convinced that BI is done cutting unless the global economy really tanks, rather than merely continues its recent slowdown. In China we saw the renminbi soften some 0.3% and fall to levels not seen since 2008 in the onshore market. However, there has been no obvious further deterioration of the trade situation so I don’t anticipate a significant extension unless the PBOC acts more aggressively to ease policy. And arguing in favor of less movement is the fact that the 70th anniversary of the founding of the People’s Republic is coming up on October 1st. Historically, the PBOC will go out of their way to insure financial markets are stable during that celebration and frequently they start the process several months beforehand.

Brexit is the final story that seems to be having an impact as PM Johnson is visiting Paris today after meetings in Berlin yesterday. At this point the EU continues to talk tough, but nothing has changed regarding the desperate need for the EU to prevent a shock to a weakening economy. In fact, the pound is bucking today’s dollar trend, currently trading higher by 0.15%, as traders are beginning to read between the lines and realize that a deal is more likely than currently priced. I maintain that we will see something in October that will avoid a no-deal outcome and the pound will rally sharply as that becomes a reality.

And that’s really all for today. Bloomberg will be interviewing several FOMC members in Jackson Hole, so that should offer some background color, but at this point, it is all about Chairman Powell tomorrow. Until then, tight ranges are the most likely outcome.

Good luck
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They Just Might

This afternoon traders will learn
About how the Fed did discern
A rate cut was right
And how they just might
Keep cutting despite no downturn

As we look forward to the first truly interesting information of the week, this afternoon’s release of the FOMC Minutes from the July meeting, markets have a better attitude this morning than they did yesterday. As has been the case for the past decade, all eyes remain on central bank activity with the Fed in the lead. If you recall, at the July meeting when the Fed cut the Fed funds rate by 25bps, there were two dissenting votes, Boston’s Rosengren and Kansas City’s George. Monday, Eric Rosengren reiterated that he saw no reason to cut rates given the recent economic data and the outlook for continued solid growth. At the same time, yesterday we heard from San Francisco Fed President Mary Daly, a non-voter, that the cut was the right thing to do despite the growth prospects as continued low inflation and the opportunity to improve the labor market further called for more action. Of course, Chairman Powell will be on the wires Friday morning from Jackson Hole and the market is quite anxious to hear what he has to say, but until then, this afternoon’s Minutes are the best thing available for the market to try to discern the FOMC’s overall attitude.

With that as a backdrop, this morning’s market activity can more readily be described as risk-on as opposed to yesterday’s risk-off flavor. At this point, though, all we have seen is a retracement of yesterday’s losses in equities and gains in the bond market. As to the dollar, it is modestly softer this morning, but that too is simply a retracement of yesterday’s price action.

Clearly it has not been the data which is fueling market movements as there was just not much to see overnight. The little bit released showed continued weakness in Japanese consumer activity (Department Store Sales -2.7%) while UK public finances were modestly less worrisome than forecast. But neither one of those was ever going to move the market. Instead the stories that are of most interest have included Germany’s failed 30-year bund auction, where only €824 million of the €2 billion offered were bought. The interesting thing here was that the coupon was set at 0.00% and the yield that cleared was -0.11%. So the question being asked is; have we reached a limit with respect to what bond investors are willing to buy? While I am surprised at the poor outcome, given my view, as well as the growing consensus, that the ECB is going to restart QE next month and absorb up to €50 billion per month of paper, I believe this will be seen as a temporary phenomenon, and that going forward, we will see far more interest at these levels and even lower yields.

On a different note, Brexit has seen a little more headline activity as yesterday German Chancellor Merkel seemed to start the concessionary talk on behalf of the EU by explaining they need “practical solutions” to solve the Irish impasse. As soon as those words hit the tape the pound rebounded sharply from its lows rallying more than a penny and closed higher on the day by 0.3%. However, this morning, Irish Deputy PM Coveney complained that British PM Johnson was trying to ‘steamroll’ Ireland into accepting new terms and that the result of this was a hard Brexit was far more likely. Funnily enough I don’t remember the Irish complaining when the EU was ‘steamrolling’ former PM May into a completely unacceptable deal for the Brits. At any rate, the latest comments have taken a little steam out of the pound’s rally and it has given back yesterday’s gains. In the end though, I think Germany’s word is going to be far more important than Ireland’s and if Johnson and Merkel have a successful discussion today, the Irish are going to have to accept any deal that is brokered. If anything, yesterday’s commentary and price action have simply reinforced my view that the EU will blink and that the pound is destined to trade much higher before the end of the year.

And in truth, away from those stories it is hard to find anything of interest in the G10 space. In the emerging markets, this morning sees strength virtually across the board as risk appetite everywhere improves. ZAR is leading the way, up 1.1% after a better than expected CPI print of just 4.0%, well below the 4.3% market expectation encouraged inflows to the local bond market where 10-year yields have fallen by 10bps this morning (to a still robust 8.96%). But we have also seen a stronger RUB (+0.95%) on firmer oil prices; and KRW (+0.5%), as traders reduce long dollar positions despite weaker than expected trade data, where exports fell a troubling -13.3% in the first 20 days of the month.

It should be no surprise that European equity markets are firm (DAX and FTSE 100 +1.1%) and that US equity futures are firmer as well, with all three indices seeing gains on the order of 0.6%.

Ahead of the Minutes we will see Existing Home Sales (exp 5.39M) but remember this has been the one area of the economy that has suffered recently. Given the continued decline in yields, and correspondingly in mortgage rates, one would think the housing market would stabilize, but we shall see. And then it is a collective breath-holding until 2:00pm when the Minutes come out. Ahead of that I don’t anticipate much movement at all. After that…

Good luck
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