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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Completely Dissolved

The last time the FOMC
Sat down to discuss policy
The trade talks were purring
While folks were concurring
A hard Brexit never could be

But since then the world has evolved
And good will completely dissolved
So what they discussed
They now must adjust
If problems are e’er to be solved

It wasn’t too long ago that the Fed was the single most important topic in markets. Everything they said or did had immediate ramifications on stocks, bonds and currencies. In some circles, the Fed, and their brethren central banks, were seen as omnipotent, able to maintain growth by simply willing it higher. A natural consequence of that narrative was that the FOMC Minutes especially, but generally those of all the major central banks, were always seen as crucial in helping to better understand the policy stance, as well as its potential future. But that time has passed, at least for now. Yesterday’s FOMC Minutes were, at best, the third most important story of the day mostly because they opened the window on views that are decidedly out of date. Way back then, three weeks ago, the backdrop was of a slowly resolving trade dispute between the US and China with a deal seeming imminent, growing confidence that a no-deal Brexit was out of the picture, and an equity market that was trading at all-time highs. My how quickly things can change!

To summarize, the Minutes expressed strong belief amongst most members that patience remained the proper stance for now, although a few were concerned about too low inflation becoming more ingrained in the public mind. And then there was a technical discussion of how to manage the balance sheet regarding the tenors of Treasury securities to hold going forward, whether they should be focused in the front end, or spread across the curve. However, no decisions were close to being made. It should be no surprise that the release had limited impact on markets.

The thing is, over the past few sessions we have heard an evolution in some FOMC members’ stance on things, specifically with Bullard and Evans discussing the possibility of cutting rates, although as of now, they are the only two. However, we have heard even some of the more hawkish members willing to imply that rate cuts could be appropriate if the ‘temporary’ lull in the growth and inflation data proves more long-lasting. As has been said elsewhere, while the bar for cutting rates is high, the bar for raising rates is much, much higher. The next move is almost certainly lower.

And what has caused this evolution in thought since the last FOMC meeting? Well, the obvious answers are, first, the sharp escalation in the trade war, with the US raising tariffs on $200B of Chinese imports from 10% to 25% as well as threatening to impose that level of tariffs on the other $325B of Chinese imports. And second, the fact that the Brexit story has spiraled out of control, with further cabinet resignations (today Andrea Leadsom, erstwhile leader of the Tories in the House of Commons quit the Cabinet) adding to pressure on PM May to resign and opening up the potential for a hardline Boris Johnson to become the next PM and simply pull the UK out of the EU with no deal.

In fact, while I have written consistently on both topics over the past several months, the Fed remained the top driver previously. But now, these events are clearly completely outside the control of monetary officials and markets are going to respond to them as they unfold. In other words, look for more volatility, not less going forward.

With that as a backdrop, it can be no surprise that risk is being jettisoned across the board this morning. Equity markets are down around the world (Shanghai -1.4%, Nikkei -0.6%, DAX -1.75%, FTSE -1.4%, DJIA futures -0.9%, Nasdaq futures -1.25%); Treasuries (2.35%) and Bunds (-0.11%) are both in demand with yields falling; and the dollar is back on top of the world, with the yen along for the ride. A quick survey of G10 currencies shows the euro -0.15% and back to its lowest level since May 2017, the pound -0.2% extending its losing streak to 13 consecutive down days, while Aussie and Canada are both lower by 0.25%.

In the emerging markets, despite the fact that the PBOC continues to fix the renminbi stronger than expected, and still below 6.90, the market will have none of it and CNY is lower by a further 0.2% this morning and back above 6.94. Despite higher oil prices RUB and MXN are both softer by 0.6% and 0.4% respectively. CE4 currencies are under pressure with HUF leading the way, -0.4%, but the rest down a solid 0.25%-0.3%. In other words, there is no place to hide.

The hardest thing for risk managers to deal with is that these events are completely unpredictable as they are now driven by emotions rather than logical economic considerations. As such, the next several months are likely to see a lot of sharp movement on each new headline until there is some resolution on one of these issues. Traders and investors will be quite relieved when that happens, alas I fear it will be mid-summer at the earliest before anything concrete is decided. Until then, rumors and stories will drive prices.

Turning to today’s session we see a bit of US data; Initial Claims (exp 215K) and New Home Sales (675K). Tuesday’s Existing Home Sales disappointed and represented the 14th consecutive month of year-on-year declines. Of more interest, we have four Fed speakers (Kaplan, Barkin, Bostic and Daly) at an event and given what I detect is the beginnings of a change in view, these words will be finely parsed. So, at this point the question is will the fear factor outweigh the possible beginning of a more dovish Fed narrative. Unless all four talk about the possibility of cutting rates as insurance, I think fear still reigns. That means the dollar’s recent climb has not ended.

Good luck
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Some Other Soul

It seems like Prime Minister May
Is quickly approaching the day
When some other soul
Will try to control
The mess Brexit’s caused the UK

Once again, the pound is the lead story as the slow motion train wreck, also known as the Brexit process, continues to unfold. Yesterday, you may recall, PM May was promising to present her much reviled Brexit deal to Parliament for a fourth time, with new promises that if it was passed, the UK would hold a second referendum on the subject. However, not only did the opposition Labour party trash the idea, so did most of her own Conservative party, as well as the Democratic Unionist Party from Northern Ireland, which is the group that has helped her maintain control for the past two years. At this point, her previous idea of having one more vote the first week of June and then stepping down seems to be dead. The latest news is the pressure from her own cabinet is mounting quickly enough to force her to step down as soon as this week. Meanwhile, Boris Johnson, who was a key cheerleader for Brexit in the run-up to the initial vote and spent time as Foreign Minister in PM May’s government, is the favorite to move into Number 10 Downing Street. He has made it clear that he is quite willing to simply walk away from the EU with no deal.

With that as the political backdrop, it should be no surprise that the pound continues to suffer. This morning it is lower by 0.3% and is now trading less than a penny from its 2019 lows, which were established back on January 2nd. It is very difficult to create a scenario where the pound rebounds in the short term. Unless there is a massive shift in thinking in Parliament, or the EU decides that they will concede to UK demands regarding the Irish backstop (remember that?), the market is going to continue to price in the probability of a hard Brexit ever so slowly. The post-Brexit vote low of 1.1906, back in October 2016 is on the radar in my view. That said, it will take a while to reach it unless Boris becomes PM and summarily exits the EU. At that point, the pound will fall much faster.

Ironically, the economic data from the UK continues to show an economy that, while having some difficulty, is outperforming many other areas. This morning’s CPI data showed inflation at 2.1%, a tick below expectations and essentially right at the BOE’s target. I am constantly amused by Governor Carney’s comments that he will need to raise rates due to a potential inflation shock. At this point, that seems like an extremely low risk. Granted, given the openness of the UK economy, if the pound were to collapse in the wake of a hard Brexit, inflation would almost certainly rise initially. The question, I think, is whether that would be seen as a temporary shock, or the beginning of a trend. Arguably, the former would be more likely.

Away from the UK, the FX market has been reevaluating its views on EMG currencies and thus far, the verdict is…they suck! While I have highlighted the weakness seen in the Chinese yuan while the trade war brews, I have been less focused on other currencies which have been collateral damage to that war. But there has been significant damage in all three EMG areas. For example, even excluding the Argentine peso, which has all kind of domestic issues unrelated to trade and has fallen nearly 6% this month and more than 26% this year, LATAM currencies have suffered significantly this month. For example, USDBRL is trading back above 4.00 for the first time since last October and is down by 3.0% in May. We have seen similar weakness in both the Colombian and Chilean pesos, down 5% and 4% respectively. In fact, the Mexican peso is the region’s top performer, down just 0.5% this month although it had been weaker earlier in May. It seems that the trade war is acting as a benefit on the assumption that supply chains are going to find their way from China to Mexico in order to supply the US.

It ought not be surprising that many APAC currencies have also performed quite poorly this month led by KRW’s 4% decline and IDR’s 3.2% fall. Even the Taiwan dollar, historically one of the least volatile currencies is feeling the pressure, especially since the Huawei sanctions, and has fallen more than 1.2% in the past week, and for the month overall. Granted, these moves may not seem as large as the LATAM currencies, but historically, APAC currencies are more tightly controlled and thus less volatile. And there is one exception to this, the Indian rupee, which is basically unchanged on the month. This relative strength has a twofold explanation; first India is poised to benefit as a supplier to the US in the wake of the trade war, and second, the surprisingly strong showing of PM Narendra Modi in the recent election was taken as a positive given his pro-business platform.

Finally, a look at EEMEA shows weakness across the board here as well, albeit not quite as drastically. For example, TRY has fallen 4.5% this month, although the cause seems self-inflicted rather than from outside events. The ongoing political turmoil and inability of the central bank to tighten policy given President Erdogan’s clear opposition to that has encouraged foreign investors to flee. But we have also seen HUF fall 2.5%, and weakness in the Scandies with both NOK and SEK down more than 2.0% this month.

All in all, you can see that the dollar has been ascendant this month as a combination of slowing global growth, trade concerns and the relative outperformance of the US economy continues to draw inflows.

Looking at the data picture, the only US release is the FOMC Minutes at 2:00 this afternoon. Analysts are going to be parsing the comments to see if they can determine if there is building sentiment regarding an ‘insurance’ rate cut. Certainly, some members are willing to go down that road as we heard from St Louis Fed President Bullard yesterday saying just that. There are a number of other speakers today, and in truth, it does seem as though there is an evolution in the FOMC’s thinking. Remember, the market is pricing a cut before the end of the year, and if we continue to see mixed economic data and inflation’s dip proves more than ‘transitory’, I think we will see a consensus build in that direction. While in the very short run, a decision like that could be a dollar negative, my sense is that if the Fed starts to cut, we will see the rest of the world’s central banks ease further thus offsetting the negative impact.

Good luck
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