Though Bond Prices Tumbled

There once was a time when the buck
Reacted when bonds came unstuck
If fear was seen rising
It wasn’t surprising
If traders would back up the truck

But lately though bond prices tumbled
The dollar just hasn’t been humbled
Instead of declining
Investors are pining
For dollars as other cash crumbled

First, a moment of silence to remember the horrific events of 18 years ago this morning…

As the market awaits tomorrow’s ECB meeting, it is not surprising that FX markets have remained pretty benign. In fact, looking across both G10 and EMG currencies, the largest mover overnight was the Hungarian forint, which has fallen 0.4%, a moderately exaggerated move relative to the shallow rally in the dollar. Arguably, yesterday’s modestly lower than expected CPI print has reduced some of the pressure on the central bank there to keep policy firm, hence the selloff. But otherwise, there are really no stories of direct currency interest today and no data of note overnight.

As such, I thought it would be interesting to take a look at government bond yields and their gyrations lately. It was just eight days ago when 10-year Treasury yields were trading at 1.45% as expectations for further coordinated policy ease by the major central banks became the meme du jour. Economic data appeared to be rolling over (ISM at 49.1, German GDP -0.1%, Eurozone CPI 0.9%, etc.) which inspired thoughts of massive policy ease by the big 3 central banks. The market narrative evolved into the ECB cutting rates by 0.20% and restarting QE to the tune of €35 billion / month while the Fed cut 0.50% and the BOJ cut rates by 0.10% and pumped up QE further. It seemed as though analysts were simply trying to outdo one another’s forecasts so they could be heard above the din. And after all, we had seen central banks all around the world cutting rates during the previous two months (Australia, New Zealand, Philippines, South Korea, India et al.) so it seemed natural to expect the biggest would be acting soon.

During this time, the FX market responded as might be expected during a pretty clear risk-off scenario, the dollar and the yen rallied while other currencies suffered. In fact, we have seen several currencies trade near historic lows lately (CLP, COP, BRL, INR, PHP to name a few). Equity markets were caught between fear and the idea that central bank ease would support stock prices, and while there were certainly wobbles, in the end greed won out.

But then a funny thing happened to the narrative; a combination of data and commentary started to turn the tide (sorry for the mixed metaphor). We heard from a variety of central bank speakers, notably from the ECB, who were clearly pushing back on the narrative. Weidmann, Lautenschlager, Knot and Villeroy were all adamant that there was no reason for the ECB to consider restarting QE. At the same time, just before the quiet period we heard from a number of Fed members (Rosengren, George, Kaplan, Barkin) who were quite clear they didn’t see the need for an aggressive rate cutting stance, and then Chairman Powell, in the last words before the quiet period, basically stuck to the party line of the current stance being a modest mid-cycle adjustment as they closely monitored the data.

It cannot be a surprise that the market has adjusted its views ahead of the first of the three central bank meetings tomorrow. But boy, what an adjustment. 10-year Treasury yields have rallied 27bps, 10-year Bunds are higher by 19bps and 10-year JGB yields are up 8.5bps (there’s a lot less activity there as the BOJ already owns so many bonds there is very little ability to trade.) However, this is not a risk-on move despite the movement in yields. This has been a massive position unwinding. A couple of things highlight the lack of risk appetite. First, the dollar continues to move higher overall. While individual currencies may have good days periodically, nothing has changed the long-term trend of dollar strength. And history shows that when risk is sought, dollars are sold. Equity markets have also been underwhelming lately, with very choppy price action but no direction. Granted, stocks are not falling, but they are certainly not rallying like risk is being ignored. And finally, gold, which had been performing admirably during the fear period, has ceded some of its recent gains as positions there are also unwound.

The point is that in the current market environment, it is very difficult to draw lessons from the price movement. Market moves lately have been all about position adjustments and very little about either market fundamentals (data) or monetary policy. While this is not the first time markets have behaved in this manner, in the past these periods have tended to be pretty short. The ECB meeting tomorrow will allow views to crystalize regarding future monetary policy there, and my sense is that we will go back to the previous market driver of the policy narrative. In fact, it is arguably quite healthy that we have seen this correction as it allows markets a fresh(er) start with new information. However, there is still nothing I see on the horizon which will weaken the dollar overall.

This morning the only thing of note on the calendar is PPI (exp 1.7%, 2.2% core). It is hard to believe that it will change any views. At this point, look for continued position adjustments (arguably modest further declines in bond prices but no direction in the dollar) as we all await Signor Draghi and the ECB tomorrow morning.

Good luck
Adf

Appetite’s Whet

Both Powell and Kaplan agreed
That lower rates are what we need
The table’s now set
And appetite’s whet
For more cuts to soon be decreed

If there was any uncertainty, prior to yesterday, about a rate cut by the Fed at the end of this month, it should be completely eliminated now. Not only did Chairman Jay reiterate that the Fed was “carefully monitoring” the situation (shouldn’t that always be the case?) and that the Fed would use all its available tools to maintain the expansion, but we heard from Dallas Fed President Robert Kaplan that he was turning in favor of a ‘risk management’ cut in order to be sure that things don’t start to turn down soon. Given the integration in the global economy over the past years and given the fact that the US still represents 24% of global GDP, it should be no surprise that things occurring elsewhere in the world have an impact on the US and vice versa. As such, it is not unreasonable for the Fed to try to take the global economic situation into account when determining US monetary policy. And one thing that is clear is that global GDP growth is falling. So folks, we have seen the top in interest rates around the world and the only question is just how quickly they will fall in different jurisdictions.

In a nutshell, that is the FX story. Historically, relative monetary policy has been one of the prime drivers of FX rates, with currencies attached to tight policy appreciating vs. those attached to loose policy. This has been the basis of the carry trade, and arguably, nothing about this process has changed. It’s just that for the first time in memory, pretty much every nation is driving policy in the same direction, in this case looser. This leads to a probable outcome where currency values remain largely stable. After all, if everybody cuts by 25bps, aren’t we all still in the same place?

The irony is that, as discussed by RBA Governor Lowe several weeks ago, if every central bank is cutting rates at the same time, the effectiveness of those rate cuts will be severely diminished. Remember, one of the key transmission mechanisms of rate cuts is to reduce the currency’s value in order to help support trade, and eventually growth. But if everybody cuts, that mechanism will be severely impaired, and so the central banks will be forced to find new tools. And while they are actively looking for new ways to ease policy, in the end, monetary policy is simply some combination of interest rates and money supply. Until now, central banks have focused on managing interest rates. But this is why MMT, or something like it, is a growing possibility. When thoughts turn to money supply as the only other thing to adjust, and as ‘new’ thinking permeates the political class, MMT is going to become increasingly attractive. I’m not sure which nation will be the first to publicly embrace the idea of debt monetization (my money’s on Japan though), but you can be sure that whichever it is will see its currency depreciate sharply, at least until other nations follow their lead. Only time will tell, but that is not a positive future.

With that as a somewhat depressing backdrop, let’s look at market activity. Generally speaking, the dollar has done little this morning after yesterday’s rally. Or perhaps yesterday’s rally was more a function of other currency weakness. Remember, the pound’s decline was all about Brexit, not the US. The euro’s decline was all about weakening economic sentiment in the Eurozone and the idea that the ECB would be acting sooner rather than later. Yesterday also saw the Mexican peso fall sharply, more than 1%, after President Trump tweeted about reimposing tariffs on China. It seems that traders are still nervous over more tariffs, and with the ongoing border situation between the US and Mexico, see any tariff threats as potentially applying to Mexico as well.

But this morning, the biggest movers are RUB and TRY, both recouping about 0.4% of yesterday’s losses. The G10 currencies are within 0.10% of yesterday’s levels and show no sign of breaking out in the near term. Of course, that is subject to another Brexit announcement or comments from central bankers, however, nothing is scheduled on those fronts. Equity markets, too, have had little direction as investors await the next shoe to drop. Interest rate markets remain fully priced for a 25bp rate cut by the Fed in two weeks, while there remains some uncertainty as to just what Signor Draghi will announce next week. I will say that if he did announce a 10bp rate cut, it would have a pretty big impact on the single currency, and not in a positive manner.

As to bonds, both Treasuries and Bunds remain 10-15bps from their recent lows but show no signs of selling off further (higher yields). Rather, those markets are demonstrating all the behavior of a consolidation after a large unwinding move. Given the strong trend lower in central bank policy rates, it seems highly unlikely that yields in the government space, and by extension elsewhere, have anywhere to go but down.

Turning to today’s data, we see Housing Starts (exp 1.261M), Building Permits (1.3M) and then at 2:00 the Fed releases its Beige Book. But we have no more Fed speakers and it seems highly unlikely that any of that will be enough to change any views. One other thing happening this afternoon is the G7 FinMins are meeting in France, but those talks are highly focused on taxation of tech companies with monetary policy a sidelight. After all, everybody is already cutting rates, so what else can they say?

Alas, it appears to be another day with limited cause for FX movement, which for hedgers is great, but for traders, not so much.

Good luck
Adf

 

Worries ‘Bout Debt

In DC this weekend they met
The World Bank and IMF set
They bitched about Trump
Explained there’s no slump
But did express worries ‘bout debt

Markets are on the quiet side this morning as they consolidate the gains seen on Friday. Risk continues to be in vogue and so haven currencies; dollars, Swiss francs and Japanese yen, remain under modest pressure. That said, the FX market remains broadly range bound, at least within the G10 space.

The annual World Bank / IMF meetings were held this past weekend in Washington D.C. and all the global economic glitterati were present. Arguably there were three key themes; central bank independence is paramount to successful policy and there is great concern over President Trump’s ongoing, and increasingly strident, complaints about the Fed. Secondly there continues to be broad concern over the slowing growth trajectory that was highlighted by the IMF reducing their global growth forecast yet again last week, this time down to 3.3% in 2019 from their 3.7% estimate last October. Finally, there was evidence that the massive growth in debt around the world is starting to make a few policymakers more nervous.

Of course, the question is will policymakers actually change anything that they do given their concerns? As to the first, the only hope they have is to raise the issue frequently enough so that it gains a broad consensus amongst the non-economic set. Frankly, if you asked the proverbial man on the street who was Fed Chair, or the names of any of the other governors, I would wager less than one in ten people would know any of the answers. At the same time, with the President’s constant haranguing, the Fed remains an excellent scapegoat for any weakness in the US economy going forward. As much as it galls the establishment, there is no reason to believe that this behavior is going to change throughout the rest of the Trump presidency and probably well beyond that.

Regarding the second issue, slowing growth, once again given the current stance of virtually the entire global economic central bank community, it is unclear they have any ability to do anything else. After all, the whole group is already set at ultra-easy money, with limited ability to move any further. But perhaps more importantly, it is questionable whether the central banks are the actual drivers of economic growth, as much as they would like to think they are. Arguably, economic growth comes from a combination of consumer demand and production of those goods and services demanded. The last time I checked, the Fed neither consumed very much nor produced anything (other than hot air and paperwork). All I’m saying is that the ongoing belief that central banks control the economy might be faulty. What they do control is money and financial assets, but as we have seen during the past decade, a strong rally in financial assets does not necessarily translate into strong growth.

Finally, regarding the massive increase in debt that we have seen during the past decade, they are absolutely right to be concerned about this process. As Rogoff and Reinhart explained in their classic book, This Time is Different, excessive debt is the one thing that has consistently been shown to have a negative effect on economic growth. And while the definition of excessive may be uncertain, it is abundantly clear that debt/GDP ratios >100% is excessive.

Add it all up and it seems unlikely that there is going to be a surge in economic growth in the near future, or even the medium term. Thus, when comparing the situations across the globe, the current status is likely to remain the future status.

Turning to the upcoming week, we have a fair amount of data as well as another group of Fed speakers.

Today Empire Manufacturing 6.7
Tuesday IP 0.2%
  Capacity Utilization 79.1%
Wednesday Trade Balance -$53.5B
  Fed Beige Book  
Thursday Initial Claims 205K
  Philly Fed 10.4
  Retail Sales 0.9%
  -ex autos 0.7%
  Business Inventories 0.4%
Friday Housing Starts 1.23M
  Building Permits 1.30M

In addition to this, we hear from five more Fed speakers, although none of them are the big guns like Powell or Williams. And as I have repeatedly described, the Fed story is already well known and unlikely to change unless the data really starts to adjust. Add to this the fact that now Brexit is a back-burner issue and there remains scant information on the US-China trade talks and quite frankly, this week in FX is going to be all about US equity market earnings data. If the data is good and risk is embraced, the dollar will suffer and vice versa.

Good luck
Adf