Lost Traction

The tea leaves that everyone’s reading
‘bout trade talks claim risk is receding
Since Donald and Xi
Are desperate anxious to see
A deal that shows both sides succeeding

The equity market reaction
Has been one of great satisfaction
But bonds and the buck
Have had much less luck
As growth on both sides has lost traction

This morning is all about trade. Headlines blaring everywhere indicate that the US and China are close to ironing out their differences and that Chinese President Xi, after a trip through parts of Europe later this month, will visit the US at the end of March to sign a deal. It should be no surprise that global equity markets have jumped on the news. The Nikkei rose 1.0%, Shanghai was up 1.1% while the Hang Seng in Hong Kong rallied 0.5%. We have seen strength in Europe as well, (FTSE +0.5%, CAC +0.5%) although the German DAX is little changed on the day. And finally, US futures are pointing to a continuation of the rally here with both S&P and Dow futures currently trading higher by 0.25%.

However, beyond the equity markets, there has been much less movement in prices. Treasuries have barely edged higher and the dollar, overall, is little changed. It is pretty common for equity market reactions to be outsized compared to other markets, and this appears to be one of those cases. In fact, I would caution everyone about one of the oldest trading aphorisms there is, “buy the rumor, sell the news.” A dispassionate analysis of the trade situation, one which has evolved over the course of two decades, would indicate that a few months hardly seems enough time to solve some extremely difficult issues. The issue of IP (whether stolen or forced to be shared in order to do business) and state subsidies for state-owned firms remains up in the air and given that both these issues are intrinsic to the Chinese economic model, will be extremely difficult to alter. It is much easier for China to say they will purchase more stuff (the latest offer being $23 billion of LNG) or that they will prevent the currency from weakening, than for them to change the fundamentals of their business model. While positive trade sentiment has clearly been today’s driver, I would recommend caution over the long-term impacts of any deal. Remember, the political imperatives on both sides remain quite clear and strong, with both Presidents needing a deal to quiet criticism. But political expediency has rarely, if ever, been a harbinger of good policy, especially when it comes to economics.

Of course, one of the reasons that a deal is so important to both sides is the slowing economic picture around the world and the belief that a trade deal can reverse that process. Certainly, Friday’s US data was unimpressive with Personal Spending falling -0.5% in December (corroborating the weak Retail Sales data), while after a series of one-off events in December pumped up the Personal Income data, that too declined in January by -0.1%. The ISM numbers were softer than expected (54.2 vs. the 55.5 expected) and Consumer Confidence slumped (Michigan Sentiment falling to 93.7). All in all, not a stellar set of data.

This has set up a week where we hear from three key central banks (RBA tonight, Bank of Canada on Wednesday and ECB on Thursday) with previous thoughts of policy normalization continuing to slip away. Economic data in all three economic spheres has been retreating for the past several months, to the point where it is difficult to blame it all on the US-China trade situation. While there is no doubt that has had a global impact (look at Germany’s poor performance of late), it seems abundantly clear that there are problems beyond that.

History shows that most things have cyclical tendencies. This is especially true of economics, where the boom-bust cycle has been a fact of life since civilization began. However, these days, cycles are no longer politically convenient for those in power, as they tend to lose their jobs (as opposed to their heads a few hundred years ago) when things turn down. This explains the extraordinary effort that even dictators like President Xi put into making sure the economy never has a soft patch. Alas, the ongoing efforts to mitigate that cycle are likely to have much greater negative consequences over time. The law of diminishing returns virtually insures that every extra dollar or euro or yuan spent today to prevent a downturn will have a smaller and smaller impact until at some point, it will have none at all. It is this process which drives my concern that the next recession will be significantly more painful than the last.

So, while a trade deal with China would be a great outcome, especially if it was robust and enforceable, US trade with China is not the only global concern. Remember that as the trade saga plays out.

Aside from the three central bank meetings, we also get a bunch of important data this week, culminating in Friday’s payroll report:

Today Construction Spending 0.1%
Tuesday New Home Sales 590K
  ISM Non-Manufacturing 57.2
Wednesday Trade Balance -$49.3B
  ADP Employment 190K
  Fed’s Beige Book  
Thursday Initial Claims 225K
  Nonfarm Productivity 1.7%
  Unit Labor Costs 1.6%
Friday Nonfarm Payrolls 180K
  Private Payrolls 170K
  Manufacturing Payrolls 10K
  Unemployment Rate 3.9%
  Average Hourly Earnings 0.3% (3.3% Y/Y)

In addition to all this, we hear from four more Fed speakers, including Chairman Powell on Friday. It seems increasingly clear that Q1 growth has ebbed worldwide compared to the end of last year, and at this point, questions are being raised as to how the rest of the year will play out. Reading those tea leaves is always difficult, but equity markets would have you believe, based on their recent performance, that this is a temporary slowdown. So too, would every central banker in the world. While that would be a wonderful outcome, I am not so sanguine. In the end, slowing global growth, which I continue to anticipate, will result in all those central bankers following the Fed’s lead and changing their tune from policy normalization to continued monetary support. And that will continue to leave the dollar, despite President Trump’s latest concerns over its strength, the best place to be.

Good luck
Adf

Really Quite Splendid

For traders, the month that just ended
Turned out to be really quite splendid
The stock market soared
As risks were ignored
Just like Chairman Powell intended

The problem is data last night
Showed growth’s in a terrible plight
Both Europe and China
Can lead to angina
If policymakers sit tight

Now that all is right with the world regarding the Fed, which has clearly capitulated in its efforts to normalize policy, the question is what will be the driving forces going forward. Will economic data matter again? Possibly, assuming it weakens further, as that could quickly prompt actual policy ease rather than simply remaining on hold. But reading between the lines of Powell’s comments, it appears that stronger than expected data will result in virtually zero impetus to consider reinstating policy tightening. We have seen the top in Fed funds for many years to come. Remember, you read it here first. So, we are now faced with an asymmetric reaction function: strong data = do nothing; weak data = ease.

Let’s, then, recap the most recent data. Last night the Caixin Manufacturing PMI data from China was released at a lower than expected 48.3, its lowest point in three years. That is simply further evidence that the Chinese economy remains under significant pressure and that President Xi is incented to agree to a trade deal with the US. Interestingly, the Chinee yuan fell 0.6% on the news, perhaps the first time in months that the currency responded in what would be considered an appropriate manner to the data. That said, the yuan remains nearly 2% stronger than it began the year. We also saw PMI data from Europe with Germany (49.7) and Italy (47.8) both underperforming expectations, as well as the 50.0 level deemed so crucial, while France (51.2) rebounded and Spain (52.4) continued to perform well. Overall, the Eurozone data slid to 50.5, down a full point and drifting dangerously close to contraction. And yet, Signor Draghi contends that this is all just temporary. He will soon be forced to change his tune, count on it. The euro, however, has held its own despite the data, edging higher by 0.2% so far this morning. Remember, though, with the Fed having changed its tune, for now, I expect the default movement in the dollar to be weakness.

In the UK, the PMI data fell to 52.8, well below expectations, as concerns over the Brexit situation continue to weigh on the economy there. The pound has fallen on the back of the news, down 0.3%, but remains within its recent trading range as there is far more attention being paid to each item of the Brexit saga than on the monthly data. Speaking of which, the latest story is that PM May is courting a number of Labour MP’s to see if they will break from the party direction and support the deal as written. It is quite clear that we have two more months of this process and stories, although I would estimate that the broad expectation is of a short delay in the process beyond March and then an acceptance of the deal. I think the Europeans are starting to realize that despite all their tough talk, they really don’t want a hard Brexit either, so look for some movement on the nature of the backstop before this is all done.

Finally, the trade talks wrapped up in Washington yesterday amid positive signs that progress was made, although no deal is imminent. Apparently, President’s Trump and Xi will be meeting sometime later this month to see if they can get to finality. However, it still seems the most likely outcome is a delay to raising tariffs as both sides continue the talks. The key issues of IP theft, forced technology transfer and ongoing state subsidies have been important pillars of Chinese growth over the past two decades and will not be easily changed. However, as long as there appears to be goodwill on both sides, then there are likely to be few negative market impacts.

Turning to this morning’s data, it is payroll day with the following expectations:

Nonfarm Payrolls 165K
Private Payrolls 170K
Manufacturing Payrolls 17K
Unemployment Rate 3.9%
Average Hourly Earnings 0.3% (3.2% Y/Y)
Average Weekly Hours 34.5
ISM Manufacturing 54.2
Michigan Sentiment 90.8

Clearly, the payroll data will dominate, especially after last month’s huge upside surprise (312K). Many analysts are looking for a reversion to the mean with much lower calls around 100K. Also, yesterday’s Initial Claims data was a surprisingly high 253K, well above expectations, although given seasonalities and the potential impacts from the Federal government shutdown, it is hard to make too big a deal over it. But as I highlighted in the beginning, the new bias is for easier monetary policy regardless of the data, so strong data will simply underpin a stock market rally, while weak data will underpin a stock market rally on the basis of easier money coming back. In either case, the dollar will remain under pressure.

Good luck and good weekend
Adf

If Job Numbers Swoon

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

More Concern

The tide is beginning to turn
As hawks at the Fed slowly learn
Their earlier view
No longer rings true
So they’ve now expressed more concern

These days there are three key drivers of the market narrative as follows:

The Fed – There is no question that the tone of commentary from Fed speakers has softened over the past two weeks, certainly from the way it sounded two months ago. Back then Chairman Powell explained that the Fed Funds rate was “a long way” from neutral, implying numerous further interest rate hikes. Equity markets responded by selling off sharply and talk of a yield curve inversion leading to a recession was nonstop. Meanwhile, the dollar rose nicely vs. most of its counterparties. A funny thing happened, though, on the way to that next rate hike due next week; economic data started to soften.

Softer housing data as well as declines in production numbers and survey data like the ISM have resulted in a more cautionary stance by these same Fed members. While the doves (Kashkari, Bullard and Brainerd) had always shown some concern over the pace of rate hikes given the absence of measured inflation, the rest of the Fed were happy to hew to the Phillips curve model and assume that the exceptionally low unemployment rate would lead to much higher inflation. This latter view encouraged them to gradually raise rates in order to prevent a failure on that part of their mandate.

But whether it is a result of the sharp declines seen in equity prices, the ongoing bashing from President Trump or simply the fact that the growth picture is slowing (I certainly hope it is the last of these!), the tone from this august group is definitely less aggressive. And while yesterday Chairman Powell reiterated that the economy was “very strong” on many measures, he was also clear to indicate that there was much more uncertainty over what the future would bring. This change of tone has been well received by the punditry, and quite frankly, by markets, which saw a sharp late day equity rally sufficient to reduce early session losses to nearly flat.

The Fed’s problem is that they created a monster with Forward Guidance, which was great when it helped them to further their easing bias, but is not well suited to changes in policy. Futures markets are now pricing less than one rate hike in 2019, down from nearly three hikes just a month ago. Transitions are always the hardest times for any market and for all policymakers. It is no surprise that we have seen increased volatility across markets lately, and I expect it will continue.

Trade – The trade situation is extremely difficult to describe. In the course of a week, market sentiment has gone from euphoria over the reopening of talks between the US and China on Monday, to outright fear after the US had the CFO of one of China’s largest companies, Huawei, arrested in Canada regarding the breech of sanctions on Iran. There are two concerns over the trade issue that need to be addressed when considering its impact on markets. First is the impact on prices. Tariffs will unambiguously raise prices to someone as long as they are in place. The question is who will feel the pain. For importers, their choices are pass on the cost by raising prices, eat the cost by reducing margins or have their vendors eat the cost by renegotiating their prices. In the first case, it is a direct impact on inflation data, something that has not yet been evident. In the second case, it is a direct hit to profitability, also something that has not yet been evident, but it has been discussed by a number of CEO’s as they get asked about their business. In the third case, the US makes out well, with neither of the potential problems coming home to roost.

The second, knock-on impact is on growth. Higher prices will reduce demand and lower margins will reduce available cash flow, and correspondingly reduce the ability of companies to invest and grow. In other words, there are no short term positives to be had from the tariffs. However, if negative behavior can be changed because of their imposition, such that IP is protected and an agreement can help reduce all trade barriers, including non-tariff ones, then the ends may justify the means. Alas, I am not confident that will be the case. Looking at the market impact, theory would dictate the dollar should rise on the idea that other currencies will depreciate sufficiently to offset the tariffs and reestablish equilibrium. We have seen that in USDCNY, which has fallen about 8% from its peak in spring, nearly offsetting the 10% tariffs. Looking ahead though, if the tariff rate rises to 25%, it is harder to believe the Chinese will allow the yuan to fall that much further. For the past decade they have been fearful of allowing their currency to fall to quickly as it has led to significant capital flight, so it would be premature to expect a decline anywhere near that magnitude.

Oil – Oil prices have moved back to the top of the market’s play list as a combination of factors has lately driven significant volatility. It wasn’t that long ago that there was talk of oil getting back to $100/bbl, especially with the US sanctions on Iran being reimposed. But then political pressure from the US on Saudi Arabia resulted in a significant increase in production there, which alongside continuing growth in US production, turned fears of a shortage into an absolute oil glut. This resulted in a 33% decline in the price in less than two months’ time, with ensuing impact on petrocurrencies like CAD, RUB and MXN, as well as a significant change in sentiment regarding inflation. With global growth continuing to show signs of slowing further, it is hard to believe that oil prices will rebound anytime soon. As such, one needs to consider that those same currencies will remain under pressure going forward.

All of this leads us to today’s session where the primary focus will be on the employment report. Expectations are as follows:

Nonfarm Payrolls 200K
Private Payrolls 200K
Manufacturing Payrolls 20K
Unemployment Rate 3.7%
Average Hourly Earnings 0.3% (3.1% Y/Y)
Average Weekly Hours 34.5
Michigan Sentiment 97.0

It feels like the market is more concerned over a strong number, which might put the Fed on alert for further rate hikes. In fact, it seems like we have moved into a good news is bad situation again, at least for equities. For the dollar, though, strong data is likely to lead to support. My view is that we may start to see a softer tone from the data, which would lead to further softening in the dollar, but a rebound in stocks.

Good luck and good weekend
Adf

Soared Like a Jet

On Friday the jobs report showed
More money, to more people flowed
Earnings per hour
Has gained firepower
So interest rate hikes won’t be slowed

The market response, though, was bleak
With equity prices quite weak
However the buck
Had much better luck
And soared like a jet, so to speak

As the week begins, we have seen the dollar cede some of the gains it made in Friday’s session. That move was a direct result of the payroll data, where not only did NFP beat expectations at 201K, but the Average Hourly Earnings number printed at 0.4% for the month and 2.9% annualized. That result was the fastest pace of wage growth since 2009 and significantly higher than the market anticipated. It should be no surprise that the market response was higher interest rates and a concurrently stronger dollar. Overall, the dollar was higher by a solid 0.5% and 10-year Treasury yields jumped 5bps on the day.

Wage growth has been the key missing ingredient from the economic data for the past several years as economists continue to try to figure out why record low unemployment has not been able to drive wages higher. The Fed reaction function has always been predicated on the idea that once unemployment declines past NAIRU (Non-accelerating inflation rate of unemployment), more frequently known as the natural rate of unemployment, that wages will rise based on increased demand for a shrinking supply of workers. Yet the Fed’s models have been unable to explain the situation this cycle, where unemployment has fallen to 50 year lows without the expected wage inflation. And of course, the one thing every politician wants (and Fed members are clearly politicians regardless of what they say) is for the population to make more money. So, if Friday’s data is an indication that wage growth is finally starting to pick up, it will encourage Powell and friends to continue hiking rates.

This was made clear on Friday by Boston Fed President Eric Rosengren, who had been a reliable dovish voice for a long time, when he explained to the WSJ that the Fed’s current pace of quarterly rate hikes was clearly appropriate and that there need to be at least four more before they start to consider any policy changes. There was no discussion of inverting the yield curve, nor did he speak about the trade situation. It should not be surprising that the Fed Funds futures market responded by bidding up the probability of a December rate hike to 81% with the September hike already a virtual certainty.

But that was then and this is now. This morning has seen a much less exciting session with the dollar edging slightly lower overall, although still showing strength against its emerging market counterparts. Looking at the G10, the picture is mixed, with the euro and pound both firmer by 0.15% or so. The former looks to be a trading response to Friday’s decline, while the latter is benefitting, ever so slightly, from better than expected GDP data with July’s print at 0.3% and the 3-month rate at 0.6%. We’ve also seen AUD rally 0.25%, as firmer commodity prices seem to be underpinning the currency today. However, both CHF and JPY are softer this morning, with the Swiss franc the weakest of the bunch, down 0.65%.

In the EMG space, however, the picture is quite different, with INR making yet another new historic low as the market continues to respond to Friday’s worse than expected current account deficit. The rupee has fallen a further 0.85% on the day. We’ve also seen weakness in CNY (-0.25%), RUB (-0.45%) and MXN (-0.2%). But some of the biggest decliners of recent vintage, TRY and ZAR, have rebounded from their worst levels, although they are still off significantly this year.

Looking ahead to this week, the data is fairly light with just CPI and Retail Sales in the back half of the week, although we also get the Fed’s Beige Book on Wednesday.

Tuesday NFIB Business Optimism 108.2
  JOLT’s Job Openings 6.68M
Wednesday PPI 0.2% (3.2% Y/Y)
  -ex food & energy 0.2% (2.8% Y/Y)
  Beige Book  
Thursday Initial Claims 210K
  CPI 0.3% (2.8% (Y/Y)
  -ex food & energy 0.2% (2.4% Y/Y)
Friday Retail Sales 0.4%
  -ex autos 0.5%
  IP 0.3%
  Capacity Utilization 78.4%
  Michigan Sentiment 96.9

There are also a number of Fed speakers this week, but I have to say that it seems increasingly unlikely that there will be any new views coming from them. The doves have already made their case, and the hawks continue to be in the ascendancy.

Net, I see no reason to believe that anything in the market has really changed for now. Rate expectations remain for higher US rates, and growth elsewhere continues to be okay but not great. Ultimately, things still point to a higher dollar in my view. Not forever, but for now.

Good luck
Adf

Lighthearted

At this point one must be impressed
Investors have not become stressed
A trade war has started
Yet they are lighthearted
With willingness still to invest

On top of that word from the Fed
Is they will keep pushing ahead
With rate hikes until
Our growth starts to chill
Or when markets start to bleed red

There has certainly been a lot to digest in the past twenty-four hours. Arguably the biggest story is the imposition of tariffs by the US on $34 billion worth of Chinese goods, which began at midnight last night. China is responding in kind and the Trump administration is determining whether they want to up the ante by an additional $200 billion. Now that the trade war is ‘officially’ underway, the key questions are just how far it will go and how long it will last. While there has been nothing in the press indicating that background negotiations are ongoing and that things can be resolved soon, based on the US equity market’s insouciance, it certainly seems that many investors feel that is the case. I hope they are correct, and soon, because otherwise I expect that we will see a more substantial correction in stocks. As to the dollar in this case, I expect that it will continue to benefit from its safe haven status in a time of market turmoil.

A second fear for equity investors has to be the Fed, which explained in yesterday’s release of the June meeting minutes, that while the trade situation could well become a concern in the future, for now they are much more focused on the potential for the US economy to overheat. The upshot is that the Fed is bound and determined to continue normalizing policy by gradually raising rates and by allowing the balance sheet to continue to gradually shrink. Speaking of the balance sheet, starting this month, they are going to allow $40 billion per month to roll off, and then beginning in October, it will be $50 billion per month until they reach whatever size they determine is appropriate. That means that $270 billion of bids for Treasury’s are going missing for the rest of the year. As the Fed continues to drain liquidity from the economy, I expect that the dollar will continue to benefit across the board, and that the US equity market will face additional headwinds. After all, QE was effective in its goal of forcing investors further out the risk curve and driving equity prices around the world higher as central banks everywhere hoovered up government bonds. Well, with yields rising and central banks backing away from the market (all while equity prices remain robustly valued) it seems there is ample opportunity for a substantial correction in stocks.

You may have noticed I said exactly the same thing when discussing the trade war situation. My point is that we are starting to see multiple catalysts align for a potential change in tone. A higher dollar and lower US (and likely global) equity prices seem like an increasingly possible outcome. Be prepared.

This leaves us at our third big story for the day, the payroll report this morning. Yesterday’s ADP Employment number was a mild disappointment, rising 177K rather than the 190K expected, but the reason appeared to be a lack of available workers rather than a lack of demand for hiring. In other words, the labor market in the US remains extremely strong. Or so it seems. Here are this morning’s expectations:

Nonfarm Payrolls 195K
Private Payrolls 190K
Manufacturing Payrolls 18K
Unemployment Rate 3.8%
Average Hourly Earnings 0.3% (2.8% Y/Y)
Average Weekly Hours 34.5
Trade Balance -$43.7B

It strikes me that this is a potential third catalyst that will line up with the trade war and Fed story in that a strong print today will encourage the Fed to continue or even accelerate their activities; it will encourage the administration that they can outlast the Chinese in this war of attrition, and so the dollar is likely to firm up while equity markets suffer. In the event payrolls disappoint, I think we could see the dollar’s modest correction lower continue and I expect that equity markets will be fine, at least in the US.

Remarkably, I don’t have space to more fully discuss what appears to be a euro positive, where Chancellor Merkel has averted disaster in Germany by getting the third coalition partner, the SPD, to agree to her immigration reforms thus keeping her government intact. As long as this internal truce lasts, there should be no further impact on the euro, but if the problem arises again (and I’m pretty sure it will soon) the euro is likely to suffer. At the same time, the pound is on tenterhooks as PM May is meeting with her cabinet today to finalize a negotiating stance regarding Brexit. If she cannot get the cabinet to agree, I expect the pound will feel the heat as concern over the fall of the May government will rise and an election campaign just nine months before the deadline for leaving the EU cannot be seen as a positive, especially with the chance that Jeremy Corbyn, the far-left Labour Party leader could become the next PM. Investors will not appreciate him in that seat, at least not at first.

As to the overnight session, the dollar is slightly softer and equity markets are under modest pressure, including US futures, as the market awaits the labor situation report. Remember, too, that many trading desks remain lightly staffed because of the holiday, and so liquidity is going to be a bit less robust than normal. If pressed my thought is that NFP will print near consensus, around 200K. I just wonder if the Unemployment Rate doesn’t tick even lower. And keep an eye on AHE, where my gut tells me it will be 0.4% enough to get Fed tongues wagging again. Net, I like the dollar to end the week on a strong note.

Good luck and good weekend
Adf