Tag Archives: #NAFTA

Compromising

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It cannot be very surprising
That Canada is compromising
Their views about trade
Thus now they have made
A deal markets find stabilizing

This morning, as the fourth quarter begins, arguably the biggest story is that Canada and the US have agreed terms to the trade pact designed to replace NAFTA. Canada held out to the last possible moment, but in the end, it was always clear that they are far too reliant on trade with the US to actually allow NAFTA to disintegrate without a replacement. The upshot is that there will be a new pact, awkwardly named the US-Mexico-Canada Agreement (USMCA) which is expected to be ratified by both Canada and Mexico quite easily, but must still run the gauntlet of the US Congress. In the end, it would be shocking if the US did not ratify this treaty, and I expect it will be completed with current estimates that it will be signed early next year. The market impact is entirely predictable and consistent with the obvious benefits that will accrue to both Canada and Mexico; namely both of those currencies have rallied sharply this morning with each higher by approximately 0.9%. I expect that both of these currencies will maintain a stronger tone vs. the dollar than others as the ending of trade concerns here will be a definite positive.

There is another trade related story this morning, although it does not entail a new trade pact. Rather, Chinese PMI data was released over the weekend with both the official number (50.8) and the Caixin small business number (50.0) falling far more sharply than expected. The implication is that the trade situation is beginning to have a real impact on the Chinese economy. This puts the Chinese government and the PBOC (no hint of independent central banking here) in a difficult position.

Much of China’s recent growth has been fueled by significant increases in leverage. Last year, the PBOC unveiled a campaign to seek to reduce this leverage, changing regulations and even beginning to tighten monetary policy. But now they are caught between a desire to add stability to the system by reducing leverage further (needing to tighten monetary policy); and a desire to address a slowing domestic economy starting to feel the pinch of the trade war with the US (needing to loosen monetary policy). It is abundantly clear that they will loosen policy further as the political imperative is to insure that GDP growth does not slow too rapidly during President Xi’s reign. The problem with this choice is that it will build up further instabilities in the economy with almost certain future problems in store. Of course, there is no way to know when these problems will manifest themselves, and so they will likely not receive much attention until such time as they explode. A perfect analogy would be the sub-prime mortgage crisis here ten years ago, where leading up to the collapse; every official described the potential problem as too small to matter. We all know how that worked out! At any rate, while the CNY has barely moved this morning, and in fact has remained remarkably stable since the PBOC stepped in six weeks ago to halt its weakening trend, it only makes sense that they will allow it to fall further as a pressure release valve for the economy.

Away from those two stories though, the FX market has been fairly dull. PMI data throughout the Eurozone was softer than expected, but not hugely so, and even though there are ongoing questions about the Italian budget situation, the euro is essentially unchanged this morning. In the past week, the single currency is down just under 2%, but my feeling is we will need to see something new to push us away from the 1.16 level, either a break in the Italy story or some new data or comments to alter views. The next big data print is Friday’s payroll report, but I expect we might learn a few things before then.

In the UK, while the Brexit deadline swiftly approaches, all eyes are now focused on the Tory party conference this week to see if there is a leadership challenge to PM May. Given that the PM’s ‘Chequers’ proposal has been dismissed by both the EU and half the Tory party, it seems they will need to find another way to move forward. While the best guess remains there will be some sort of fudge agreed to before the date, I am growing more concerned that the UK is going to exit with no deal in place. If that is what happens, the pound will be much lower in six-months’ time. But for today, UK Manufacturing PMI data was actually a surprising positive, rising to 53.8, and so the signals from the UK economy continue to be that it is not yet collapsing.

Away from those stories, though, I am hard pressed to find new and exciting news. As this is the first week of the month, there is a raft of data coming our way.

Today ISM Manufacturing 60.1
  ISM Prices Paid 71.0
  Construction Spending 0.4%
Wednesday ADP Employment 185K
  ISM Non-Manufacturing 58.0
Thursday Initial Claims 213K
  Factory Orders 2.0%
Friday Nonfarm Payroll 185K
  Private Payroll 183K
  Manufacturing Payroll 11K
  Unemployment Rate 3.8%
  Average Hourly Earnings 0.3% (2.8% Y/Y)
  Average Weekly Hours 34.5
  Trade Balance -$53.5B

On top of the payroll data, we hear from eight Fed speakers this week, including more comments from Chairman Powell tomorrow. At this point, however, there is no reason to believe that anything is going to change. The Fed remains in tightening mode and will raise rates again in December. The rest of the world continues to lag the US with respect to growth, and trade issues are likely to remain top of mind. While the USMCA is definitely a positive, its benefits will only accrue to Mexico and Canada as far as the currency markets are concerned. We will need to see some significant changes in the data stream or the commentary in order to alter the dollar’s trend. Until then, the dollar should maintain an underlying strong tone.

Good luck
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Investor Frustrations

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There once was a wide group of nations
Whose growth was built on weak foundations
Their policy actions
Are seen as subtractions
Increasing investor frustrations

Boy, I go away for a few days and world virtually collapses!!!

Needless to say, a lot has happened since I last wrote on Thursday, with a number of emerging market currencies and their respective equity markets really coming under pressure. It was the usual suspects; Turkey, Argentina, Indonesia, Brazil, Mexico, Russia and China, all of whom had felt significant pressure at various times during the year. But this new wave seems a bit more stressful in that prior to the past few days, each one had experienced a problem of its own, but since Friday, markets have pummeled them all together. This appears to be the contagion that had been feared by both investors and policymakers. The thing is, the unifying theme to pretty much all these markets is the stronger dollar. As the dollar resumes its strengthening trend, both companies and governments in those nations are finding it increasingly difficult to handle their debt loads. And given the near certainty that the Fed is going to continue its steady policy tightening alongside consistently stronger US economic data, the dollar strengthening trend seems likely to remain in tact for a while yet.

Could this be one of the ‘unexpected’ consequences of ten years of QE, ZIRP and NIRP? Apparently, despite assurances from esteemed central bankers like Ben Bernanke, Janet Yellen and Mario Draghi (as dovish a triumvirate as has ever been seen), there ARE negative consequences to dramatically changing the way monetary policy is handled, massively expanding balance sheets and driving real interest rates to significant negative levels. While there is no doubt that developed economy stock markets have benefitted generally, it seems like some of those risks are becoming more apparent.

These risks include things like the central bankers’ loss of control over markets. After all, markets around the world have basically danced to the tune of free money for the past decade. As that tune changes, investor behavior is sure to change as well. Another systemic risk has been the increasing inability of investors to adequately diversify their portfolios. If every market rises due to exogenous variables, like zero interest rates, then how can prudent investors manage their risk? Many took comfort in the fact that market volatility had declined so significantly, implying that systemic risk was reduced on net. However, what we have observed in 2018 is that volatility is not, in fact, dead, but had merely been anaesthetized by that free money.

The worrying thing is there is no reason to believe that this process is going to end soon. Rather, I fear that it may just be beginning. There are a significant number of excesses to wring out of the markets, and however much central bankers around the world try to prevent that from happening, they cannot hold back the tide forever. At some point, and it could be coming sooner than you think, markets are going adjust despite all the efforts of Powell, Draghi, Carney, Kuroda and their brethren. Never forget that the market is far bigger than any one nation.

We are already seeing how this can play out in some of the above-mentioned countries. Argentina, for example, has short-term interest rates of 60%, inflation of ‘only’ 31%, and therefore real interest rates are now +29%! But the economy is back in recession, having shrunk 6.7% last quarter, and the current account deficit remains a significant problem. So despite jacking rates to 60%, the currency has fallen 22% this week and 120% this year! And they are following orthodox monetary policy. Turkey, on the other hand, has been unwilling to bend to orthodoxy (when it comes to monetary policy) and has kept rates low such that real interest rates are near zero and heading negative as inflation continues its climb (17.9% in September) while rates remain on hold. So the fact that the lira is down 9% this week and 95% this year should be less surprising.

The point is that the market is losing its taste for discrimination and is beginning to treat all currencies under the rubric ‘emerging markets’ as the same. And they are selling them all. As long as the Fed continues its grind higher in rates, there is no reason to believe that this will end. And if these declines are steady, rather than sharp crashes, it will go on for a while. Chairman Powell will have no reason to stop if a few random EMG markets trend lower. If, however, the S&P 500 starts to suffer, that may be a different story, and one we will all watch with great interest!

In the meantime, turning to G10 currencies, the dollar is stronger here as well this morning, although it has fallen back from its best levels of the morning. In fact, while the pound has been consistently undermined (-0.3% today, -1.5% since Thursday) by what seems to be a worsening saga regarding Brexit, the euro has stabilized for now, although it is down about 1% since Thursday as well. Apparently, CAD is not taking the ongoing NAFTA negotiations that well, as it has fallen 2% since Thursday amid pressure on PM Trudeau to cave into US demands. The BOC meets today and while there had been previous expectations that they may raise rates, that has been pushed back to October now in view of the NAFTA process. This is despite the fact that inflation in Canada is running at 2.9%, well above target.

In the end, as long as the Fed continues along its recent path, expect market volatility to increase further, with more and more dominoes likely to fall.

As to today, the only noteworthy data is the Balance of Trade, where expectations are for a $50.3B outcome, not exactly what the president is hoping for, I’m sure. And as far as the dollar goes, there is no reason to believe that its recent strength is going to turn around anytime soon.

Good luck
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Still No Solution

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On Wednesday it suddenly seemed
That Brexiteers might be redeemed
The EU’d just hinted
A deal could be printed
Like nothing initially dreamed

But subsequent comments made clear
No breakthrough was actually near
There’s still no solution
(Just feared retribution)
On solving the Irish frontier

Yesterday saw the British pound rocket around 10:00am when EU Brexit negotiator, Michel Barnier, hinted that there was a chance for a deal with the UK that was different than EU deals with its other near neighbors. The market heard this as the first real attempt at a compromise on the EU side, and so within minutes, the pound was 1.2% higher and back above 1.30 for the first time in almost a month. Certainly, if this is true, it marks a serious breakthrough in the talks and is quite positive. Everything we have heard from the UK so far is that they are willing to adhere to EU rules regarding the trade in goods, but are looking for a different deal in services. Prior to the Barnier comments, the EU had been firm in their stance that it was an all or none decision. Suddenly, it seemed like a deal could occur. On that basis, the pound’s rally certainly makes sense, as the prospects for a no-deal Brexit had lately been clearly weighing on the pound. Alas, subsequent comments by the EU have poured cold water on this thought process as Barnier has reiterated there is no ability to cherry-pick the preferred parts of EU policy. Interestingly, the pound has barely given back any of the gains it managed in the wake of the first statement, as it is actually down less than 0.1% as I type.

Given the data released earlier this morning, which was not all that positive (Consumer Credit declined more than expected, Mortgage Lending declined much more than expected and Mortgage Approvals fell more than expected) it seems hard to justify the ongoing strength of the pound. Two possible explanations are 1) the market had built up significant short positions in the pound and while yesterday’s sharp rally forced covering, nobody has looked to reinstate them yet, or 2) investors and traders continue to believe that the UK will get a special deal and so further weakness in the pound is not warranted. Occam’s Razor would suggest that the first explanation is the correct one, as the second one would seem to require magical thinking. And while there is plenty of magical thinking going around, financial markets are one place where it is difficult to retain those thoughts and survive. My gut tells me that once the Labor Day holiday has passed, we will see the pound start to sell off once again.

The other noteworthy story this morning is that there is even more stress in those emerging market currencies that have been feeling stressed during the past month. Today it is Argentina’s turn to lead the way lower, with the peso falling an impressive 7.5% after President Macri announced that he had asked the IMF to speed up disbursements of the $50 billion credit line. The market saw that as desperation, which is probably correct despite strenuous denials by the Argentine government. Meanwhile, the Turkish lira is down by 3.5% because…well just because. After all, nothing has changed there and until the central bank starts to focus monetary policy on solving the nation’s problems, TRY will continue to fall. Overnight we saw INR fall to a new historic low, down 0.4% and now pushing to 71.00, albeit not quite there yet. ZAR is under pressure this morning, down nearly 2% as its current account deficit situation is seen as a significant weight. And despite the positive of completing NAFTA negotiations with the US, MXN has fallen 0.5%. So while the dollar is generally little changed vs. its G10 counterparts, the stress in the EMG bloc remains palpable. Ultimately, I expect the dollar to resume its uptrend, but not until next week, after the holiday.

As to this morning’s data, after yesterday’s upward revision of Q2 GDP, all eyes are on the PCE data this morning. Expectations run as follows: Initial Claims (214K); Personal Income (0.3%); Personal Spending (0.4%); PCE (0.1%, 2.2% Y/Y); and Core PCE (0.2%, 2.0% Y/Y). Again, the biggest market reaction is likely to be caused by an unexpected outturn in Core PCE, which is the number most Fed members seem to regard as the key. A high print should support the dollar, as the implication will be the Fed may be forced to tighten more aggressively, while a low print should undermine the buck as traders back off on their estimates of how quickly the Fed acts. Remember, many traders and investors took Powell’s Jackson Hole speech as dovish, although I’m not so sure that is an accurate take.

At any rate, that pretty much sums up the day. I will be on vacation starting tomorrow and thus there will be no poetry until September 5th.

Thanks and have a good holiday weekend
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A deal Has Been Made

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The story is once again trade
As news that a deal has been made
Twixt Mex and DC
Helped traders agree
The dollar would slowly degrade

Right now, there are two essential stories that the market is following; the Fed and US trade negotiations. While Friday’s news was all about the Fed (with a small dose of PBOC), yesterday we turned back to trade as the key market driver. The announcement that a tentative agreement had been reached between the US and Mexico regarding NAFTA negotiations was hailed in, most quarters, as a positive event. It is beyond the scope of this discussion to opine on the merits of the actual negotiation, only on its market impact. And that was unambiguous. Equity markets rallied everywhere while the dollar continued its recent decline. In fact, the dollar has now fallen for seven of the past eight sessions and is trading back at levels not seen in four weeks. So much for my thesis that continued tighter policy by the Fed would support the buck.

But I think it is worth examining why things are moving the way they are, and more importantly, if they are likely to continue the recent trend, or more likely to revert to the longer run story.

Earlier this year, as the narrative evolved from synchronous global growth to the US leading the way and policy divergence, buying dollars became a favored trade, especially in the hedge fund community. In fact, it grew to be so favored that positioning, at least based on CFTC figures, showed that it was near record levels. And while the dollar continued to rally right up until early last week, everybody carrying that position was happy. This was not only because their view was correct, but also because the current interest rate market paid them to maintain the position, a true win-win situation.

In the meantime, another situation was playing out at the same time; the increasingly bombastic trade rhetoric, notably between the US and China, but also between the US and Mexico, Canada and Europe. With the imposition of tariffs on $50 billion of Chinese imports by the US, and the reciprocal tariffs by China, the situation was seen as quite precarious. While there was a mild reprieve when the US delayed imposing tariffs on imported European autos last month, a key issue had continued to be the ongoing NAFTA renegotiations. These stories, when highlighted in the press, typically led to risk-off market reactions, one of which included further USD strength.

So between the two stories, higher US rates and increasing risk on the trade front, there were two good reasons to remain long dollars. However, one of the oft-mentioned consequences of the stronger dollar has been the pressure it applies to EMG economies that were heavy dollar borrowers over the past ten years. Suddenly, their prospects dimmed greatly because they felt the double whammy of less inward investment (as USD investments became more attractive due to higher US rates) and a weaker currency eating up a greater proportion of local currency revenues needed to repay dollar debt and its interest. This led to increasing angst over the Fed’s stated views that gradual rate hikes were appropriate regardless of the international repercussions. This also led to significant underperformance by EMG equity markets as well as their currencies, forced the hands of several EMG central banks to raise rates to protect their currencies, and completely decimated a few places, notably Argentina and Turkey.

But that all started to change in earnest last Friday. While the dollar had been retracing some of its recent gains prior to the Jackson Hole meeting, when Chairman Powell hinted that he saw no reason that inflation would continue much beyond the Fed’s target level (although without the benefit of a rationale for that view), the market interpreted that as the Fed ‘s rate hiking trajectory would be shallower than previously thought, and that four rate hikes this year was no longer a given. In fact there are those who now believe that September may be the last rate hike for several quarters (I am not in the group!) Now adding to that the positive news regarding trade with Mexico, with the implication that there is an opportunity to avoid a truly damaging trade war, all of those long dollar positions are feeling far less confident and slowly unwinding. And my sense is that will continue for a bit longer, continuing to add pressure to the dollar. What is interesting to me is that the euro, for example, has retraced back above 1.17 so quickly (remember, it was trading at 1.13 just two weeks ago) and it is not clear that many positions have been cleared out. That implies that we could see further dollar weakness ahead as long as there is no other risk-off catalyst that arises.

The thing is, I don’t think this has changed the long run picture for the dollar, which I think will continue to outperform over time, as while the Fed may slow its trajectory, it is not stopping any time soon. And the reality is that the ECB is still well over a year away from raising rates, with Japan further behind than that. Meanwhile, the PBOC is actively easing as the Chinese economy continues to slow. In the end, the dollar remains the best bet in the medium term. But in the short run, I think the euro could well trade toward 1.19 before stalling, with other currencies moving a similar amount.

As to today’s session, there has been a decided lack of data from either Asia or Europe, and nothing really on the cards for the US. We remain in a lackluster holiday week, as US trading desks remain lightly staffed ahead of the Labor Day holiday next Monday. So to me, momentum is pointing to continued dollar weakness for now, and I expect that is what we will see for the rest of the week.

Good luck
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And what has happened as that angst has grown, and fears of a repeat of the EMG crisis of 1998-9 were raised?

 

No Tariffs For Now

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Herr Juncker and Trump had their meeting
And what they both claimed bears repeating
No tariffs for now
As both sides allow
The current regime with no cheating

Whew! That pretty much sums up the market reaction to yesterday afternoon’s hastily arranged press conference with President Trump and European Commission President Jean-Claude Juncker. Both were all smiles as they announced that there would be no tariffs imposed at this time while the US and EU begin more serious trade negotiations with an eye toward reducing trade friction in manufactured goods. In addition, Europe would be seeking to purchase more US soybeans and LNG in a good faith effort to reduce the current trade imbalance. And finally, they would be addressing the current US tariffs on steel and aluminum imports from Europe. It can be no surprise that the market reacted quite positively to this news, with equities in the US finishing higher and European markets all performing well this morning. It should also not be that surprising that the euro jumped immediately upon the news, rising 0.25%, although this morning it has given back those gains after both French and German Consumer Confidence data extended their trend declines amid disappointing outcomes.

While it is still anybody’s guess how this will ultimately play out, the news is certainly an encouraging sign that there can be movement in a positive direction on the trade front. The same appears to be true regarding NAFTA negotiations with both Canada and Mexico reconfirming that a trilateral deal is the goal, and apparently making headway toward achieving those aims.

However, the same optimism is nowhere to be found regarding trade relations between China and the US, with no indication that the situation has shown any positive movement. In the meantime, China continues to respond to signs of weakening growth on the mainland, this time by further reducing capital requirements for banks’ lending to SME’s. While the PBOC has not specifically cut rates, generally seen as a broad monetary policy step, these targeted capital requirement and reserve ratio cuts can be very powerful tools for the targeted recipients, allowing them to expand their loan books and driving profits in the banking sector. But no matter how the easing of monetary policy is implemented, it is still easing of monetary policy and will have an impact on both Chinese equity markets and the renminbi’s exchange rate. While the currency weakened, as would be expected, falling 0.5% overnight, the Shanghai composite fell as well, which is somewhat surprising. Although, in fairness, the Shanghai exchange has rallied nearly 8% over the past two weeks, so this could simply be a case of “selling the news.” In the end, especially if the trade situation between the US and China remains fraught, I expect that USDCNY has further to run, and 7.00 remains on the radar.

The other big story this morning is the anticipation of the ECB meeting results, not so much in terms of policy changes, as none are expected, but in terms of the follow-on press conference where Signor Draghi will be asked about the timing of interest rate increases and the meaning of the term “through the summer” which was inserted into the last statement. Analysts have been debating if that means rates could be raised in August or September of next year, or if it implies a longer wait before a rate move. The futures market doesn’t have a full 10bp rate hike priced in until January 2020, significantly past the summer. The other question of note is how the ECB will handle reinvestment of their current portfolio, and whether they will seek to smooth the reinvestment program or simply wait until debt matures before purchasing more. The reason this matters is that their portfolio has a very uneven distribution of maturities, which could lead to more volatility in European Government bond markets if they choose the latter path.

In the end, given that Eurozone data continues to disappoint on a regular basis, it seems that whatever path they choose for rate hikes and reinvestment, it will seek to maintain as much support as possible for now. Other than the Germans, there does not appear to be a strong constituency to aggressively tighten monetary policy, and there are nations, like Italy and Greece, which would much prefer to see policy remain ultra accommodative for the foreseeable future. While the euro has been range trading for the past two months between 1.15 and 1.18, I continue to look for a break lower eventually.

Away from those stories, things have been less interesting. Most of the G10 is trading in a fairly narrow range, with Aussie the laggard, -0.4%, on the back of weaker metals prices. EMG currencies have similarly been fairly quiet with limited movement overall.

Yesterday’s US data showed that the housing market is starting to suffer a bit more consistently as New Home Sales fell to 631K, well below expectations and the lowest level since last October. Adding this to the miss in Existing Home Sales on Monday shows that the combination of still rising house prices and rising mortgage rates is starting to have a more substantial impact on the sector. This morning we see Durable Goods data (exp 3.0%, 0.5% -ex Transport) and the weekly Initial Claims data (215K), which continues to show the strength of the job market. However, regarding US data, all eyes remain on tomorrow’s first look at Q2 GDP, where the range of expectations is broad, from 3.8% to 5.2%, and traders will be trying to parse how the data will impact the Fed’s activities.

In the meantime, US equity futures are mixed this morning with the NASDAQ pointing lower after some weaker than expected earnings guidance from a FANG member, while Dow futures are pointing higher on the back of relief over the trade situation. As to the dollar, I expect that it will see modest weakness overall as positions continue to be adjusted ahead of tomorrow’s key GDP release.

Good luck
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