Tag Archives: #NFP

Hitting Home

Posted on by

The current Fed Chairman, Jerome
Initially’d taken the tone
That interest rate hiking
Was to the Fed’s liking
Until hikes began hitting home

Then stock markets round the world crashed
And policymakers’ teeth gnashed
He then changed his mind
And now he’s outlined
His new plan where tightening’s trashed

It’s interesting that despite the fact that the employment report was seen as quite positive, the weekend discussion continued to focus on the Fed’s U-turn last Wednesday. And rightly so. Given how important the Fed has been to every part of the market narrative, equities, bonds and the dollar, if they changed their reaction function, which they clearly have, then it will be the focus of most serious commentary for a while.

But let’s deconstruct that employment report for a moment. While there is no doubt that the NFP number was great (304K, nearly twice expectations, although after a sharply reduced December number), something that has gotten a lot less press is the Unemployment Rate, which rose to 4.0%, still quite low but now 0.3% above the bottom seen most recently in November. The question at hand is, is this a new and concerning trend? If the unemployment rate continues to rise, then the Fed was likely right to stop tightening policy. Yet, most analysts, like politicians, want their cake and the ability to eat it as well. If the Fed has finished tightening because growth is slowing, is that really the outcome desired? It seems to me I would rather have faster growth and tighter policy, a much better mix all around. Now it is too early to say that Unemployment has definitely bottomed, but another month or two of rises will certainly force that to creep into the narrative. And you can bet that will include all the reasons that the Fed better start cutting rates again! Remember, too, if the Fed is turning from tightening to easing, I assure you that the idea the ECB might raise rates is absurd.

Now, with the Fed decision behind us, as well as widely applauded, and the payroll report past, what do we have to look forward to? After all, Brexit is still grinding forward to a denouement in late March, although we will certainly hear of more trials and tribulations before then. I was particularly amused by the idea that the British government has developed plans for the Queen to be evacuated in the event of a hard Brexit. WWII wasn’t enough to evacuate royalty, but Brexit will be? Not unlike Y2K (for those of you who remember that) while a hard Brexit will almost certainly be disruptive in the short run, I am highly confident that the UK will continue to function going forward. The fear-mongering that is ongoing by the British government is actually quite irresponsible.

And of course, there are the US-China trade talks. Except that this week is Chinese New Year and all of China (along with much of Asia) is on holiday. So, there are no current discussions ongoing. But markets have taken heart from the view that President’s Xi and Trump will be meeting in a few weeks, and that they will come to an agreement of some sort. The problem I see is that the big issues are not about restrictions as much as about protection of IP and forced technology transfer. And since the Chinese have consistently denied that both of those things occur, it is not clear to me how they can credibly agree to stop them. The market remains sanguine about the prospects for a trade reconciliation, but I fear the probability of a successful outcome is less than currently priced. While this will not dominate the discussion for another two weeks, be careful when it surfaces again.

Looking ahead to this week, while US data is in short supply, really just trade, we do see more central bank meetings led by the BOE (no change expected), Banxico (no change expected) and Banco do Brazil (no change expected). The biggest risk seems to be in Mexico where some analysts are calling for a 25bp rate cut to 8.00%. We also hear from six Fed speakers, including Chairman Powell again, although at this point, it seems the market has heard all it wants. After all, given Friday’s payroll report, it seems impossible to believe that any Fed member can discuss cutting rates. Not raising them is the best they’ve got for now.

Tuesday ISM Non-Manufacturing 57.1
Wednesday Trade Balance -$54.0B
  Unit Labor Costs 1.7%
  Nonfarm Productivity 1.7%
Thursday Initial Claims 220K
  Consumer Credit $17.0B

So, markets are in a holding pattern while they await the next important catalyst. The stories that have driven things lately, the Fed, Brexit and trade talks are all absent this week. That leads to the idea that the dollar will be impacted by equity and bond markets.

We all know that equity markets had a stellar January and the question is, can that continue? With bond markets also rallying, they seem to be telling us different stories. Equities are looking to continued strength in the economy, while bonds see the opposite. I have to admit, based on the data we continue to see around the world, it appears that the bond market may have it right. As such, despite my concerns over the dollar’s future given the Fed’s pivot, a reversal in equities leading to a risk off scenario would likely underpin the dollar. While it is very modestly higher this morning, it is fair to call it little changed. I think the bias will be for a softer dollar unless things turn ugly. If that does happen, make sure your exposures are hedged as the dollar will benefit.

Good luck
Adf

If Things Go Astray

Posted on by

The jobs report Friday was great
Which served to confuse the debate
Is growth on the rise?
Or will it downsize?
And how will the Fed acclimate?

The first indication from Jay
Is data continues to say
While growth seems robust
We’ll surely adjust
Our actions, if things go astray

In what can only be described as remarkable, despite the strongest jobs report in nearly a year, handily beating the most optimistic expectations for both job growth and wages, Fed Chairman Jay Powell told the market that the Fed could easily slow the pace of policy tightening if needed. While this may seem incongruous based on the data, it was really a response to several weeks of market gyrations that have been explicitly blamed on the Fed’s ongoing policy normalization procedure. A key concern over this sequence of events is that the data of ‘data dependence’ is actually market indices rather than economic ones. For every analyst and economist who had been looking for Powell to break the cycle of kowtowing to the stock market, Friday was a dark day. For the stock market, however, it was anything but, with the S&P 500 rising 3.4% and the NASDAQ an even more impressive 4.25%. The Fed ‘put’ seems alive and well after a three month hiatus.

So what can we expect going forward? The futures market has removed all pricing for the Fed to raise rates further in 2019, and in fact, has priced in a 50% probability of a 25bp rate cut before the year is over! Think about that. Two weeks ago, the market was priced for two 25bp rate hikes! This is a very large, and rapid, change of opinion. The upshot is that the dollar has come under significant pressure as both traders and investors abandon the view of continued cyclical dominance and start to focus on the US’ structural issues (growing twin deficits). In that scenario, the dollar has much further to fall, with a 10% decline this year well within reason. Equity markets around the world, however, have seen a short-term revival as not only did Powell blink, but also the Chinese continue to aggressively add to their monetary policy ease. And one final positive note was heard from the US-China trade talks in Beijing, where Chinese Vice-Premier, Liu He, President Xi’s top economic official, made a surprise visit to the talks. This was seen as a demonstration of just how much the Chinese want to get a deal done, and are likely willing to offer up more concessions than previously expected to do so. The ongoing weak data from China is clearly starting to have a real impact there.

It is situations like this that make forecasting such a fraught exercise. Based on the information we had available on December 31, none of these market movements seemed possible, let alone likely. But that’s the thing about predictions; they are especially hard when they focus on the future.

As to markets today, while Asian equity markets followed Friday’s US price action higher, the same has not been true in Europe, where the Stoxx 600 is lower by 0.4%. Weighing on the activity in Europe has been weaker than expected German Factory Order data (-1.0%) as well as the re-emergence of the gilets jaunes protests in France, where some 50,000 protestors, at least, made their presence felt over the weekend.

Turning to the dollar, it is down broadly, with every G10 currency stronger vs. the greenback and most EMG currencies as well. If the market is correct in its revised expectations regarding the Fed, then the dollar will remain under pressure in the short run. Of course, if the Fed stops tightening policy, and we continue to see Eurozone malaise, you can be certain that the ECB is going to be backing away from any rate rises this year. I have maintained that the ECB would not actually raise interest rates until 2020 at the earliest, and I see no reason to change that view. With oil prices hovering well below year ago levels, headline inflation has no reason to rise. At the same time, despite Signor Draghi’s false hope regarding eventual wage inflation, core CPI in the Eurozone seems pegged at 1.0%. As long as this remains the case, it will be extremely difficult for Draghi, or his successor, to consider raising rates there. As that becomes clearer to the market, the euro will likely begin to suffer. However, until then, I can see the euro grinding back toward 1.18 or so.

One last thing to remember is that despite the Christmas hiatus, the Brexit situation remains front and center in the UK, with Parliament scheduled to vote on the current deal early next week. At this time, there is no indication that PM May is going to find the votes to carry the day, although as the clock ticks down, it is entirely possible that some nays turn into yeas in order to prevent the economic catastrophe that is being predicted by so many. The pound remains beholden to this situation, but I believe the likely outcomes are quite asymmetric with a 2-3% rally all we will see if the deal passes, while an 8% decline is quite viable in the event the UK exits the EU with no deal.

As to data this week, it will not be nearly as exciting as last week, but we see both the FOMC Minutes on Wednesday and CPI on Friday. In addition, we hear from seven Fed speakers across nine speeches, including Chairman Powell again, as well as vice-Chairman Clarida.

Today ISM non-Manufacturing 59.0
Tomorrow NFIB Small Business Optimism 105.0
  JOLT’s Job Openings 7.063M
Wednesday FOMC Minutes  
Thursday Initial Claims 225K
Friday CPI -0.1% (1.9% Y/Y)
  -ex food & energy 0.2% (2.2% Y/Y)

All in all, it seems that the current market narrative is focused solely on the Fed changing its tune while the rest of the central banking community is ignored. As long as this is the case, look for a rebound in equity markets and the dollar to remain under pressure. But you can be certain that if the Fed needs to hold rates going forward because of weakening economic data, the rest of the world will be in even more dire straits, and central banks elsewhere will be back to easing policy as well. In the end, while there may be short-term weakness, I continue to like the dollar’s chances throughout the year as the US continues to lead the global economy.

Good luck
Adf

If Job Numbers Swoon

Posted on by

For Powell, the data he’s viewing
Shows weakness is palpably brewing
Will he change his tune
If job numbers swoon?
If not, it could prove his undoing!

The admonition that markets will remain volatile in 2019 certainly has held true to form thus far. After a significant sell-off in global equity markets yesterday, two pieces of news have now helped a partial rebound. First was the story that vice-ministerial trade talks are now scheduled to be held between the US and China next Monday and Tuesday. The market has taken this as a sign that the trade conflict is abating and that there will be a deal forthcoming shortly. While that would certainly be great news, it seems a bit premature. Nonetheless, it was clearly seen as a market positive overnight.

The second bit of news comes from China, where the PBOC has announced a 1.0% cut in the RRR for all Chinese banks, half to be implemented next week and half two weeks later. As opposed to the very targeted efforts announced earlier in the week, this is a broad-based easing of monetary policy, the first since 2016, and appears to be a direct response to the fact that the Manufacturing PMI data is alluding to contraction in the Chinese economy. As I have written before, China will be forced to continue to ease monetary policy this year due to slowing growth, and it is for that reason that I expect the renminbi to gradually decline all year.

But the bad news is not restricted to China, we have also seen weaker data from both the US and Europe. Yesterday’s ISM Manufacturing data printed at 54.1, significantly lower than expectations and its weakest print November 2016, and while still in expansionary territory is indicative of slowing growth ahead. Meanwhile, inflation data from the Eurozone showed that price pressures continue to recede there on the back of sharply declining oil prices with the area wide CPI rising only 1.6% and the core reading remaining at 1.0%. It appears that the mooted inflation pressures Signor Draghi has been dreaming about remain only in his dreams.

Bond market reaction to this data was very much as would be expected, with 10-year Treasury yields falling to 2.57%, their lowest level since last January, while Bund yields have fallen back to 0.15%, levels not seen since April 2017. In fact, the futures market in the US is now beginning to bet on a rate cut by the Fed before the end of 2019. If you recall, at the December FOMC meeting, the dot plot indicated a median expectation of two more rate hikes this year.

What we can safely say is that there is a great deal of uncertainty in markets right now, and many disparate opinions as to how the economy will perform going forward, and to how the Fed and its central banking brethren will respond. And that uncertainty is not likely to dissipate any time soon. In fact, my fear is that when it does start to fade, it will be because the data is pointing to a much slower growth trajectory, or a recession on a widespread basis. At that point, uncertainty will diminish, but so will asset values!

And how, you may ask, is all this affecting the dollar? Well, yesterday’s price action was of the risk off variety, where the yen was the leader, but the dollar outperformed most emerging market currencies, as well as Aussie and Kiwi, but was slightly softer vs. the rest of its G10 counterparts. This morning, however, on the strength of the trade talk news and policy ease by China, risk is being tentatively embraced and so the yen has fallen a bit, -0.35%, and the dollar has ceded most of its recent gains vs. the EMG space. For example, ZAR (+1.3%), RUB (+1.0%), TRY (+1.1%), and IDR (+1.0%) have all managed to rally sharply alongside a rebound in commodity prices. As well, the market is still enamored of newly installed President Bolsonaro in Brazil with the real higher by a further 0.9% this morning, taking the YTD gain up to 3.0%.

As for the G10, AUD has benefitted from the Chinese news, rising 0.55%, while CAD and NOK are both higher by 0.5% on the back of the rebound in oil prices. This move was a reaction to OPEC output falling sharply. As to the euro, it is higher by just 0.2% although it has recouped about half its losses from Wednesday now. And finally, the pound has bounced as well after its PMI data was actually a positive surprise. That said, it remains within a few percent of its post Brexit vote lows, and until there is a resolution there, will be hard-pressed to gain much ground. Of course, if there is no deal, the pound is likely to move sharply lower. The UK Parliament is due to vote on the current deal next week, although recent news from PM May’s political allies, the Northern Irish DUP, indicates they are unhappy with the deal and cannot support it yet. With less than three months to go before Brexit is upon us, it is increasingly looking like there will be no deal beforehand, and that the pound has further to fall. For hedgers, I cannot exhort you enough to consider increasing your hedges there. I think the risks are highly asymmetric, with a deal resulting in a modest rally of perhaps 2-3%, while a no-deal outcome could easily see an 8% decline.

For today, the NFP report is on tap with expectations as follows:

Nonfarm Payrolls 177K
Private Payrolls 175K
Manufacturing Payrolls 20K
Unemployment Rate 3.7%
Average Hourly Earnings 0.3% (3.0% Y/Y)
Average Weekly Hours 34.5

We also hear from Chairman Powell at 10:15, where the market will be parsing every word to try to get a better understanding of the Fed’s data reaction function, and perhaps to see which data points they deem most important. At this point, strong NFP data ought lead to declining Treasury prices and rising stock prices although I expect the dollar would remain under pressure based on the risk-on feeling. If the data is weak, however, look for stock futures to reverse course (currently they are higher by ~1.0%) and Treasuries to find support. As to the dollar then, broadly stronger, although I expect the yen will be the best performer overall.

Good luck
Adf

Mostly At Peace

Posted on by

Ahead of the payroll release
The market is mostly at peace
But there is no sign
The recent decline
In values is set to decrease

While I apologize for the double negative, this morning’s price action is a story of consolidation of recent losses across emerging market currencies and their respective equity markets. In fact, the biggest gainers in the FX markets today are some of the currencies that have been suffering the most recently. For example, the South African rand is higher by 1.4% on the day, but still down nearly 3.0% this week. Meanwhile in Brazil, in the wake of the assassination attempt on Brazilian presidential candidate Jair Bolsonaro, the real has rebounded 1.75%, essentially recouping the week’s losses, although is still down almost 8.0% this month. The story here is that Bolsonaro, who was leading in the polls and is favored by markets due to his free-market leanings, is expected to receive a sympathy vote along with more press coverage, and has increased his odds of winning the election next month. And of course, everyone’s favorite pair of losers, TRY and ARS, are both firmer this morning as well, by 3.5% and 2.75% respectively, but both remain down substantially in the past month. And there is no sign that policy is going to change sufficiently to have any positive impact in the short term. In other words, while many EMG currencies have performed well overnight, there is little reason to believe that the unfolding crisis in the space has ended.

Turning to the biggest news of the day, the payroll report is due with the following expectations:

Nonfarm Payrolls 191K
Private Payrolls 190K
Manufacturing Payrolls 24K
Unemployment Rate 3.8%
Average Hourly Earnings 0.2% (2.7% Y/Y)
Average Weekly Hours 34.5

If forecasts are on the mark, it will simply represent a continuation of the current US expansion and cement the case for two more rate hikes by the Fed this year. In fact, we would need to see substantially weaker numbers to derail that process on a domestic basis. And given yesterday’s Initial Claims data of 203K, the lowest print since 1969, it seems highly unlikely that this data will be weak.

A second factor reinforcing the view that the Fed will remain on their current rate-raising path was a comment by NY Fed President John Williams. Yesterday, after a speech in Buffalo, he said that he would not be deterred from raising rates simply because it might drive the yield curve into an inversion. This is quite a turn of events for Williams who had historically leaned more dovish when he was at the San Francisco Fed. In addition, it is exactly the opposite from what we have recently heard from two separate Fed presidents, Atlanta’s Bostic and St Louis’ Bullard, both of who were explicit in saying they would not vote for a rate hike if that would cause an inversion. Of course, neither of them is a voter right now while Williams is, so his voice is even more important.

While it is not clear whether Chairman Powell is of a like mind on this subject, there is certainly no evidence that Powell is going to be deterred from his current belief set that further gradual rate hikes are necessary and appropriate. The one thing that is very clear is that the current Fed is focused almost entirely on the US economy, to the exclusion of much of the rest of the world. And this focus reduces the chance that Powell will respond to further emerging market instability unless it reaches a point where the US economy is likely to be impacted. As far as I can tell, the Fed’s focus remains on the impact of the recent increase in fiscal stimulus and how that might impact the inflation situation.

There is one other thing to keep in mind today, and going forward, and that is that yesterday was the last day of comment period on President Trump’s mooted tariff increase on a further $200 Billion of Chinese imports. If he does follow through by implementing these tariffs, look for significant market impact with the dollar resuming its climb and a much bigger negative impact on equity markets as investors try to determine the impact on company results. Also look for commodity prices to decline on the news.

But that is really it for the day. Ahead of the data there is little reason for much of a move. However, even after the data, assuming the forecasts are reasonably accurate, I would expect the dollar’s consolidation to continue. In the end, though, all signs still point to a stronger dollar over time.

Good luck
Adf

Uncomfortably High

Posted on by

Said Carney, exhaling a sigh
The odds are “uncomfortably high”
More pain will we feel
If there is no deal
When England waves Europe bye-bye

Yesterday the BOE, in a unanimous decision, raised its base rate by 25bps. This outcome was widely expected by the markets and resulted in a very short-term boost for the pound. However, after the meeting, Governor Carney described the odds of the UK leaving the EU next March with no transition deal in hand as “uncomfortably high.” That was enough to spook markets and the pound sold off pretty aggressively afterwards, closing the day lower by 0.9%. And this morning, it has continued that trend, falling a further 0.2% and is now trading back below 1.30 again.

By this time, you are all well aware that I believe there will be no deal, and that the market response, as that becomes increasingly clear, will be to drive the pound still lower. In the months after the Brexit vote, January 2017 to be precise, the pound touched a low of 1.1986, but had risen fairly steadily since then until it peaked well above 1.40 in April of this year. However, we have been falling back since that time, as the prospects for a deal seem to have receded. The thing is, there is no evidence that points to any willingness to compromise among the Tory faithful and so it appears increasingly likely that no deal will be agreed by next March. Carney put the odds at 20%, personally I see them as at least 50% and probably higher than that. In the meantime, the combination of ongoing tightening by the Fed and Brexit uncertainty impacting the UK economy points to the pound falling further. Do not be surprised if we test those lows below 1.20 seen eighteen months ago.

This morning also brought news about the continuing slowdown in Eurozone growth as PMI data was released slightly softer than expected. French, German and therefore, not surprisingly, Eurozone Services data was all softer than expected, and in each case has continued the trend in evidence all year long. It is very clear that Eurozone growth peaked in Q4 2017 and despite Signor Draghi’s confidence that steady growth will lead inflation to rise to the ECB target of just below 2.0%, the evidence is pointing in the opposite direction. While the ECB may well stop QE by the end of the year, it appears that there will be no ability to raise rates at all in 2019, and if the current growth trajectory continues, perhaps in 2020 as well. Yesterday saw the euro decline 0.7%, amid a broad-based dollar rally. So far this morning, after an early extension of that move, it has rebounded slightly and now sits +0.1% on the day. But in the end, the euro, too, will remain under pressure from the combination of tighter Fed policy and a decreasing probability of the ECB ever matching that activity. We remain in the 1.1500-1.1800 trading range, which has existed since April, but as we push toward the lower end of that range, be prepared for a breakout.

Finally, the other mover of note overnight was CNY, with the renminbi falling to new lows for the move and testing 6.90. The currency has declined more than 8% since the middle of June as it has become increasingly clear that the PBOC is willing to allow it to adjust along with most other emerging market currencies. While the movement has been steady, it has not been disorderly, and as yet, there is no evidence that capital outflows are ramping up quickly, so it is hard to make the case the PBOC will step in anytime soon. And that is really the key; increases in capital outflows will be the issue that triggers any intervention. But while many pundits point to 7.00 as the level where that is expected to occur, given the still restrictive capital controls that exist there, it may take a much bigger decline to drive the process. With the Chinese economy slowing as well (last night’s Caixin Services PMI fell to 52.8, below expectations and continuing the declining trend this year) a weaker yuan remains one of China’s most important and effective policy tools. There is no reason for this trend to end soon and accordingly, I believe 7.50 is reasonable as a target in the medium term.

Turning to this morning’s payroll report, here are the current expectations:

Nonfarm Payrolls 190K
Private Payrolls 189K
Manufacturing Payrolls 22K
Unemployment Rate 3.9%
Average Hourly Earnings (AHE) 0.3% (2.7% Y/Y)
Average Weekly Hours 34.5
Trade Balance -$46.5B
ISM Non-Manufacturing 58.6

Wednesday’s ADP number was much stronger than expected at 213K, and the whisper number is now 205K for this morning. As long as this data set continues to show a strong labor market, and there is every indication it will do so, the only question regarding the Fed is how quickly they will be raising rates. All of this points to continued dollar strength going forward as the divergence between the US economy and the rest of the world continues. While increasing angst over trade may have a modest impact, we will need to see an actual increase in tariffs, like the mooted 25% on $200 billion in Chinese imports, to really affect the economy and perhaps change the Fed’s thinking. Until then, it is still a green light for dollar buyers.

Good luck and good weekend
Adf

For How Long?

Posted on by

The US economy’s strong
Denial of this would be wrong
It’s not too surprising
That rates will be rising
The question is just, for how long?

Despite the Trump administration’s recent discussion of imposing 25% tariffs on $200 billion of Chinese imports, rather than the 10% initially mooted, the Fed looked at the economic landscape and concluded that things continue apace. While they didn’t adjust rates yesterday, as was universally expected, the policy statement was quite positive, highlighting the strength in both economic growth and the labor market, while pointing out that inflation is at their objective of 2.0%. Market expectations for a September rate hike increased slightly, with futures traders now pricing in a nearly 90% probability. More interestingly, despite the increased trade rhetoric, those same traders have increased their expectations for a December hike as well, with that number now hovering near 70%. At this point, despite President Trump’s swipe at higher rates last week, it appears that the Fed is continuing to blaze its rate-hiking path undeterred.

The consequences of the Fed’s stance are starting to play out more clearly now, with the dollar once again benefitting from expectations of higher short term rates, and equity markets around the world, but especially in APAC, feeling the heat. The chain of events continues in the following manner. Higher US rates have led to a stronger US dollar, especially vs. many emerging market currencies. The companies in those countries impacted are those that borrowed heavily in USD over the past ten years when US rates were near zero. They now find themselves struggling to repay and refinance that debt. Repayment is impacted because their local revenues buy fewer dollars while refinancing is impacted by the fact that US rates are that much higher. With this cycle in mind, it should not be surprising that equity markets elsewhere in the world are struggling. And those struggles don’t even include the potential knock-on effects of further US tariff increases. Quite frankly, it appears that this trend has further to run.

Meanwhile, the week’s central bank meetings are coming to a close with this morning’s BOE decision, where they are widely touted to raise the Base rate by 25bps, up to 0.75%. It is actually quite amusing to read some of the UK headlines talking about the BOE raising rates to the ‘highest in a decade’, which while strictly true, seems to imply so much more than the reality of still exceptionally low interest rates. However, given the ongoing uncertainty due to the Brexit situation, I continue to believe that Governor Carney is extremely unlikely to raise rates again this year, and if we are headed to a ‘no-deal’ Brexit, which I believe is increasingly likely, UK rates will head back lower again. Early this morning the UK Construction PMI data printed at a better than expected 55.8, its highest since late 2016, but despite the strong data and rate expectations, the pound has fallen 0.35% on the day.

Other currency movement has been similar, with the euro down 0.35%, Aussie and Kiwi both falling more than 0.5% and every other G10 currency, save the yen declining. The yen has rallied slightly, 0.2%, as interest rates in Japan continue to respond to Tuesday’s BOJ policy tweaks. JGB’s seem to have quickly found a new home above the old 0.10% ceiling, and there is now a growing expectation that as the 10-year yield there approaches the new 0.2% cap, the longer end of the JGB curve will rise with it taking the 30-year JGB to 1.00%. While that may not seem like much to the naked eye, when considering the nature of international flows, it is potentially quite important. The reason stems from the fact that Japanese institutional investors tend to hedge the FX exposure that comes from foreign fixed income purchases thus reducing their net yield from the higher rates received overseas to something on the order of 1.0%. And if the Japanese 30-year reaches that 1.0% threshold (it is currently yielding 0.83%), there is a growing expectation that those same investors will sell Treasuries and other bonds and bring the money home. That will have two impacts. First, I would be far less concerned over an inverting yield curve in the US as yields across the back end of the US curve would rise on those sales, and second, the dollar would likely rally overall on higher rates, but decline further against the yen. These are the type of background flows that impact the FX market, but may not be obvious to most hedgers.

Turning to the emerging markets, the dollar is firmer against virtually all of these currencies as well. One of the biggest movers has been CNY, falling 0.5% and now trading at its weakest level since May 2017. The renminbi’s decline has been impressive since mid-April, clocking in at nearly 9%, and clearly offsetting some of the impact of the recent tariffs. But remember, the renminbi’s decline began well before any tariffs were in place, and has as much to do with a slowing Chinese economy forcing monetary policy ease in China as with the recent trade spat. At this point, capital outflows have not yet become a problem there, but if history is any guide, as we get closer to 7.00, we are likely to see more pressure on the system as both individuals and companies seek to get their money out of China and into a stronger currency. I expect that there are more fireworks in store here.

Aside from China, the usual suspects continue to fall, with TRY having blasted through 5.00 overnight and now down 1.5% on the day. But we have also seen significant weakness in ZAR (-1.75%), KRW (-1.15%), and MXN (-0.75%). Even INR is down 0.5% despite the RBI having raised rates 0.25% overnight to try to rein in rising inflation pressures there. So today’ story is clear, the dollar remains in the ascendancy on the back of optimism in the US vs. increasing pessimism elsewhere in the world.

A quick peek at today’s data shows that aside from the weekly Initial Claims (exp 220K) we see only Factory Orders (0.7%). Yesterday’s ADP Employment data was quite strong, rising 219K, while the ISM Manufacturing report fell to a still robust 58.1, albeit a larger fall than expected. However, given the Fed’s upbeat outlook, the market was able to shake off the news. At this point, however, I expect that eyes are turning toward tomorrow’s NFP report, which will be seen as taking a much more accurate reading on the economy. All in all, I see no reason for the dollar to give back its recent gains, and in fact, expect that modest further strength is in the cards.

Good luck
Adf

 

Percent Twenty-Five

Posted on by

The story, once more’s about trade
As Trump, a new threat, has conveyed
Percent twenty-five
This fall may arrive
Lest progress in trade talks is made

President Trump shook things up yesterday by threatening 25% tariffs on $200 billion of Chinese imports unless a trade deal can be reached. This is up from the initial discussion of a 10% tariff on those goods, and would almost certainly have a larger negative impact on GDP growth while pushing inflation higher in both the US and China, and by extension the rest of the world. It appears that the combination of strong US growth and already weakening Chinese growth, has led the President to believe he is in a stronger position to obtain a better deal. Not surprisingly the Chinese weren’t amused, loudly claiming they would not be blackmailed. In the background, it appears that efforts to restart trade talks between the two nations have thus far been unsuccessful, although those efforts continue.

Clearly, this is not good news for the global economy, nor is it good news for financial markets, which have no way to determine just how big an impact trade ructions are going to have on equities, currencies, commodities and interest rates. In other words, things are likely more uncertain now than in more ‘normal’ times. And that means that market volatility across markets is likely to increase. After all, not only is there the potential for greater surprises, but the uncertainty prevailing has reduced liquidity overall as many investors and traders hew to the sidelines until they have a better idea of what to do. And, of course, it is August 1st, a period where summer vacations leave trading desks with reduced staffing levels and so liquidity is generally less robust in any event.

Moving past trade brings us straight to the central bank story, where the relative hawkishness or dovishnes of yesterday’s BOJ announcement continues to be debated. There are those who believe it was a stealth tightening, allowing higher 10-year yields (JGB yields rose 8bps last night to their highest level in more than 18 months) and cutting in half the amount of reserves subject to earning -0.10%. And there are those who believe the increased flexibility and addition of forward guidance are signals that the BOJ is keen to ease further. Yesterday’s price action in USDJPY clearly favored the doves, as the yen fell a solid 0.8% in the session. But there has been no follow-through this morning.

As to the other G10 currencies, the dollar is modestly firmer against most of them this morning in the wake of PMI data from around the world showing that the overall growth picture remains mixed, but more troubling, the trend appears to be continuing toward slower growth.

The emerging market picture is similar, with the dollar performing reasonably well this morning, although, here too, there are few outliers. The most notable is KRW, which has fallen 0.75% overnight despite strong trade data as inflation unexpectedly fell and views of an additional rate hike by the BOK dimmed. However, beyond that, modest dollar strength was the general rule.

At this point in the session, the focus will turn to some US data including; ADP Employment (exp 185K), ISM Manufacturing (59.5) and its Prices Paid indicator (75.8), before the 2:00pm release of the FOMC statement as the Fed concludes its two day meeting. As there is no press conference, and the Fed has not made any changes to policy without a press conference following the meeting in years, I think it is safe to say there is a vanishingly small probability that anything new will come from the meeting. The statement will be heavily parsed, but given that we heard from Chairman Powell just two weeks ago, and the biggest data point, Q2 GDP, was released right on expectations, it seems unlikely that they will make any substantive changes.

It feels far more likely that this meeting will have been focused on technical questions about how future Fed policies will be enacted. Consider that QE has completely warped the old framework, where the Fed would actually adjust reserves in order to drive interest rates. Now, however, given the trillions of dollars of excess reserves, they can no longer use that strategy. The question that has been raised is will they try to go back to the old way, or is the new, much larger balance sheet going to remain with us forever. For hard money advocates, I fear the answer will not be to their liking, as it appears increasingly likely that QE is with us to stay. Of course, since this is a global phenomenon, I expect the impact on the relative value of any one currency is likely to be muted. After all, if everybody has changed the way they manage their economy in the same manner, then relative values are unlikely to change.

Flash, ADP Employment prints at a better than expected 219K, but the initial dollar impact is limited. Friday’s NFP report is of far more interest, but for today, all eyes will wait for the Fed. I expect very limited movement in the dollar ahead of then, and afterwards to be truthful.

Good luck
Adf

 

Is That Despair?

Posted on by

Forward guidance is
Kuroda-san’s newest hope
Or is that despair?

The BOJ has committed to keep the current extremely low levels for short- and long-term interest rates for an “extended period of time.” Many of you will recognize this phrase as Ben Bernanke’s iteration of forward guidance. This is the effort by central banks to explain to the market that even though rates cannot seemingly go any lower, they promise to prevent them from going higher for the foreseeable future. Alas, forward guidance is akin to Hotel California, from which, as The Eagles famously sang back in 1976, “you can check out but you can never leave.” As the Fed found out, and the ECB will learn once they finally end QE (assuming they actually do so), changing tack once you have promised zero rates forever can have market ramifications. The first indication that forward guidance might be a problem came with the ‘taper tantrum’ in 2013, but I’m confident it won’t be the last.

However, for the BOJ, now trumps the future, and they needed to do something now. But forward guidance was not the only thing they added last night. It was the cover for their attempts to adjust policy without actually tightening. So, yield curve control now has a +/- 20bp range around 0.0% for the 10-year JGB, double the previous level, and thus somewhat more flexible. And they reduced the amount of reserves subject to the -0.10% deposit rate in order to alleviate some of the local banks’ profit issues. In the end, their commitment to maintaining zero interest rates for that extended period of time was sufficient for FX traders to sell the yen (it fell -0.40%), and JGB yields actually fell a few bps, closing at 0.065%, which is down from 0.11% ahead of the meeting. All in all, I guess the BOJ did a good job last night.

There is, however, one other thing to mention, and that is they reduced their own inflation forecasts (to 1.1% in 2019, 1.5% in 2020 and 1.6% in 2021) for the next three years, indicating that even they don’t expect to achieve that elusive 2.0% target before 2022 at the earliest. In the end, the BOJ will continue to buy JGB’s and equity ETF’s and unless there is a substantial acceleration in global growth, (something which seems increasingly unlikely) they will continue to miss their inflation target for a very long time. As to the yen, I expect that while it fell a bit last night, it is still likely to drift higher over time.

In Europe the story is still
That growth there is starting to chill
The data last night
Did naught to delight
Poor Mario, testing his will

Beyond the BOJ, and ahead of the FOMC announcement tomorrow, the major news was from the Eurozone where GDP and Inflation data was released. What we learned was that, on the whole, growth continued to slow while inflation edged higher than expected. Eurozone GDP rose 0.3% in Q2, its slowest pace in a year, while headline inflation rose 2.1%, its fastest rate since early 2013. Of course the latter was predicated on higher energy prices with core CPI rising only 1.1%, still a long way from the ECB’s target. The point is that given the slowing growth trajectory in the Eurozone, it seems that Draghi’s confidence in faster growth causing inflation to pick up on the continent may be unwarranted. But that remains the official line, and it appears that the FX market has accepted it as gospel as the euro has traded higher for a third consecutive day (+0.3%) and is now back in the top half of its trading range. If Q3 growth continues the trajectory that Q2 has extended, it will call into question whether the ECB can stop buying bonds, or at the very least, just how long rates will remain at -0.4%, with those looking for a September 2019 rate hike sure to be disappointed.

There is one country in Europe, however, that is performing well, Sweden. GDP growth there surprised the market yesterday, rising 1.0% in Q2 and 3.3% Y/Y. This has encouraged speculation that the Riksbank will be raising rates fairly soon and supported the krone, which has rallied 1.0% since the announcement.

The final piece of news to discuss from last night was from China, where the PMI readings all fell below expectations. The official Manufacturing data was released at 51.2, down from last month’s 51.5 and the third consecutive monthly decline. The non-manufacturing number fell to 54.0, its weakest print since October 2016. These are the first data from China that include the impact of the US tariffs, and so are an indication that the Chinese economy is feeling some effects. I expect that the government there will add more stimulus to offset any more severe impact, but that will simply further complicate their efforts at reducing excess leverage in the economy. Meanwhile, the renminbi slid 0.25% overnight.

This morning’s data releases bring us Personal Income (exp 0.4%), Personal Spending (0.4%) and PCE (2.3% headline, 2.0% core), as well as the Case-Shiller Home price index (6.4%), Chicago PMI (62.0) and Consumer Confidence (126.0). In other words, there is much for us to learn about the economy. While I believe the PCE data could be market moving, especially if it is stronger than expected, I continue to believe that traders and investors remain far more focused on Friday’s payroll report than this data. Recent weakness in equity markets has some folks on edge, although futures this morning look benign. But if we do see that weakness continue, the chances of a full-blown risk off scenario materializing will grow substantially. And that means, the dollar has the potential to rally quite sharply. Keep that in mind as a tail risk, one where the tail grows fatter each day that equity markets disappoint.

Good luck
adf

Still At Its Peak

Posted on by

Three central bank meetings this week
Seem unlikely, havoc to wreak
When they all adjourn
Attention will turn
To joblessness, still at its peak

In the current central bank calendric cycle, the ECB meeting was the first to be completed, and last Thursday we learned virtually nothing new about Mario Draghi’s plans. The ECB is going to reduce QE further starting in October and is due to end it completely by year end. As to interest rates, ‘through summer’ remains the watchword, with markets forecasting a 10bp rate rise in either September or October of next year.

This week brings us the other three big central bank meetings, starting with the BOJ’s announcement tomorrow evening, then the FOMC on Wednesday and finally the BOE on Thursday. Going in reverse order, the market remains convinced that Governor Carney will raise rates 25bps, with a more than 80% probability priced in by futures traders. While I think it is a mistake, it does seem increasingly likely it will be the outcome. As to the Fed, there are no expectations of any policy adjustments at this meeting, and as there is no press conference following, I expect that the statement, when released Wednesday afternoon, will have little market impact.

This takes us to tomorrow evening’s BOJ meeting, which is the only one where there seems to be any real uncertainty. Last week I discussed the questions at hand which boil down to whether or not Kuroda and company have come to believe that QQE is not only ineffective, but actually beginning to have a detrimental impact on the Japanese economy. After all, they have been at it for the better part of five years and have still had zero success in achieving their 2.0% inflation goal. The three biggest problems are that Japanese banks have seen their business models decimated by increasingly narrow lending spreads; the ETF purchase program has had an increasingly large distortive impact on the Japanese stock markets as the BOJ now owns roughly 4% of all Japanese equities; and finally, the yield curve control plan has essentially broken the JGB market as evidenced by the fact that they continue to see sessions where there are actually no trades in the 10-year JGB. (Consider what would happen if there were no trades in 10-year Treasuries one day!)

With all of this as baggage, there has been increasing discussion that the BOJ may seek to tweak the program to try to make it more effective. However, they have painted themselves into a corner because if they reduce their activity in the JGB market, the market is likely to see it as a reduced commitment to QE and it is likely to result in higher yields there, which can easily lead to two separate but related outcomes. First, USDJPY is likely to fall further, as higher JGB yields lead to more interest for Japanese investors to bring their funds home. Given the disinflationary impact of a stronger currency, this would be a disaster. And second, if there is less support for JGB’s, given the fungibility of money and the open capital markets that exist, we are likely to see yields rise in US, UK, European and other developed markets. While Chairman Powell may welcome this as it will reduce concern over the Fed inverting the yield curve, the rest of the world, which retains far easier monetary policy, is likely to be somewhat less welcoming of that outcome. And this is all based on anonymous reports that the BOJ is going to make some technical adjustments to their program, not change the nature of what they are doing. So if you are looking for some fireworks this week, the BOJ is your best bet.

However, beyond the central banks, the market will turn its attention to Friday’s employment report here in the US. Last Friday saw a robust GDP report, as widely expected, and further proof of the divergence between the US and the rest of the global economy. This Friday could simply add to that impression. Here is the full listing of this week’s data, which is quite robust:

Tuesday BOJ Rate Decision -0.10% (unchanged)
  Personal Income 0.4%
  Personal Spending 0.4%
  PCE 0.1% (2.3% Y/Y)
  Core PCE 0.1% (2.0% Y/Y)
  Case-Shiller Home Prices 6.4%
  Chicago PMI 62.0
Wednesday ADP Employment 185K
  ISM Manufacturing 59.5
  ISM Prices Paid 75.8
  FOMC Rate Decision 2.00% (unchanged)
Thursday BOE Rate Decision 0.75% (+0.25%)
  Initial Claims 221K
  Factory Orders 0.7%
Friday Nonfarm Payrolls 190K
  Private Payrolls 185K
  Manufacturing Payrolls 22K
  Unemployment Rate 3.9%
  Average Hourly Earnings 0.3% (2.7% Y/Y)
  Average Weekly Hours 34.5
  Trade Balance -$46.2B
  ISM Non-Manufacturing 58.7

So, as you can see there is much to be learned this week. With the focus on the central banks and Friday’s payroll data, don’t lose sight of tomorrow’s PCE report, because remember, that is the Fed’s go-to number on inflation. Overall, looking at forecasts, things remain remarkably strong in the US economy this long into an expansion, which is something that has many folks concerned. We also continue to see important corporate earnings releases this week for Q2, which given the high profile misses we had last week, could well impact markets beyond individual equity names.

As to the dollar through all this, it is a touch softer this morning, but remains on the strong side of its recent trading range. While I still like it higher, there is so much potential new information coming this week, it is probably wisest to remain as neutral as possible for now. For hedgers, that means the 50% rule is in effect.

Good luck
Adf

The Winsome Ms. May

Posted on by

The lady who leads the UK
Last night had a terrible day
Dave Davis resigned
And strongly maligned
The PM, the winsome Ms. May

Arguably the biggest news over the weekend was the sudden resignation last night of the UK Brexit Minister, David Davis, who decided he couldn’t countenance the outcome of Friday’s Cabinet meeting. The crux of that agreement was that the UK would continue to abide by EU food and manufacturing regulations after Brexit becomes final in March. Davis, who had campaigned for Brexit and was always seen as more of a hard-liner, thought this was too much of a concession, and heeded PM May’s general call to leave if he couldn’t get on board. While Dominic Raab, another pro-Brexit voice, quickly replaced him, the resignation has simply highlighted the ongoing uncertainties within the UK on the subject.

Markets, however, have remained surprisingly subdued on the news. It appears that traders are far more focused on how the BOE responds to the Brexit story than on the Brexit story’s daily twists and turns. And as of now, there has been no change in the view that the Old Lady is going to raise rates next month come hell or high water. Futures markets continue to price a more than 80% probability of that occurring. So in the end, despite a key political shakeup, the pound has actually rallied 0.45% and is now more than 2.2% clear of the nadir reached at the end of June. Perhaps the mindset is that PM May now has greater control over the cabinet and so is in a stronger position going forward which means that a soft Brexit will be the outcome. At least, that’s the best I can come up with for now.

Otherwise, the weekend has been extremely quiet. With that in mind I think a recap of Friday’s events is in order. The employment report was probably as good as it gets, at least from the Fed’s perspective. NFP increased a better than expected 213K and last month’s number was revised higher to 244K. The Unemployment Rate actually ticked higher to 4.0%, but that was because the Participation Rate rose as well, up to 62.9%, which while better than last month remains well below the longer-term historical trend. But for now, it demonstrates to the Fed that there is still some slack in the labor market, which means there is less concern that wage increases are going to spur much higher inflation. And the AHE data proved that out, rising 2.7% Y/Y, in line with both expectations and recent history. It seems the Fed is going to continue to focus on the shape of the yield curve rather than rising inflation, at least for now. If, however, we start to see some sharply higher inflation data (CPI is released this Thursday), that may begin to change some thinking there.

The other data Friday showed that the Trade deficit shrank to -$43.1B, it’s smallest gap since October 2016. This is somewhat ironic given that Friday was also the day that the US imposed tariffs on $34 billion of Chinese goods. It is too early to determine exactly how the trade situation will play out, although virtually every economist has forecast it will be a disaster for the US, and if it expands potentially for the world. That said, the equity markets have clearly spoken as Chinese stocks have fallen more than 20% in the past months, while US stocks have edged slightly higher. This story, however, has much further to go with there likely being many new twists and turns going forward.

Here in the middle of the summer, it is a light data week, with Thursday’s CPI clearly the highlight.

Today Consumer Credit $12.7B
Tuesday NFIB Small Biz Optimism 105.6
  JOLT’s Job Openings 6.583M
Wednesday PPI 0.2% (3.2% Y/Y)
  -ex food & energy 0.2% (2.6% Y/Y)
Thursday CPI 0.2% (2.9% Y/Y)
  -ex food & energy 0.2% (2.3% Y/Y)
Friday Michigan Sentiment 98.2

We also hear from four Fed speakers and we are at the point between meetings where there has been enough data for some views to have changed. However, my sense is there will be more discussion of the yield curve than of the economy as that has once again become a hot topic amongst a number of the regional Presidents.

Broadly the dollar has been under pressure overnight, continuing last week’s corrective price action. There has been some indication that data elsewhere in the world, especially in the Eurozone, has started to pick up again. If that trend continues, then I expect that the dollar will remain on its back foot. After all, its recent strength had been predicated on the idea that the US was continuing to show economic strength, diverging from the rest of the world’s near-term prospects. A change in that narrative will clearly change the FX story. However, it is not a foregone conclusion that is the outcome. I remain convinced that the dollar is likely to be the leader for quite a while yet.

Good luck
Adf