Weakness They’d Block

The PBOC’s taken stock
Of how their maneuvers did rock
Most markets worldwide
Which helped them decide
More currency weakness they’d block

The Chinese renminbi remains the number one story and concern in all financial markets as investors and traders try to decipher the meaning of yesterday’s move to allow a much weaker currency, but more importantly how those actions will help drive future activities.

As always, there are two sides to every coin, in this case both figuratively and literally. From the perspective of China’s manufacturing and production capabilities it is very clear that a weaker renminbi is a benefit for its exporters. Chinese goods are that much cheaper this morning than they were Friday afternoon. This, of course, is why there is so much concern over any nation weakening their currency purposely in order to gain an advantage in trade. This is the ‘beggar thy neighbor’ policy that is decried in both textbooks and political circles. It is this idea that animates President Trump’s complaints about a too strong dollar hindering US manufacturing exports, and it is true, as far as it goes.

But it is not the whole story by a long shot. There are two potentially significant negative consequences to having a weaker currency, both of which can have significant political as well as economic impacts. The first, and most widely considered is rising inflation. Remember, if a nation’s currency weakens then all its imports are, relatively speaking, more expensive for its citizens. While small fluctuations in price may be absorbed by businesses, ultimately a steadily weakening currency will result in rising prices and increases in measured inflation. This is one of the key things that BOE Governor Carney worries about in the event of a hard Brexit, and the only reason he tries to make the case that interest rates may need to rise after Brexit. (p.s., they won’t!)

However, the other issue is generally less considered but often far more destructive to a nation. This is the problem of repayment of foreign currency debt. Remember, the US capital markets are far and away the largest, deepest and most liquid in the world, and thus companies and countries around the world all raise funding in USD. Even though US rates are high relative to the rest of the G10, that available liquidity is something that is not replicable anywhere else in the world and offers real value for borrowers. And of course, compared to many emerging markets, US rates are lower to begin with, making borrowing in dollars that much more attractive. But when another country’s currency weakens, that puts additional pressure on all the businesses that have borrowed in USD to fund themselves (and the country itself if it has borrowed in USD).

For example, according to the BIS, Chinese companies had outstanding USD debt totaling more than $1 trillion as of the end of 2018, and that number has only grown. As the renminbi weakens, that means it takes that much more local currency to repay those dollars. China has already seen a significant uptick in local bankruptcies this year, with CNY bond defaults totaling nearly $6 billion equivalent and the pace increasing. And that is in the local currency. When it comes to repaying USD debt, a weaker CNY will just exacerbate the situation. The PBOC is well aware of this problem. In fact, this issue is what will prevent the PBOC from allowing the renminbi to simply fall and find a new market clearing price. Instead, they will continue to carefully manage any further devaluation to the best of their ability. The problem they have is that despite their seemingly tight control of the market, they have created an offshore version, the quickly growing CNH market, which is far more costly to manage. In other words, there is a real opportunity for leakage of funds from China and an uncontrolled decline in the currency, or at least a much larger decline than planned. We are only beginning to see the impact of this move by the PBOC and do not be surprise if things get more volatile going forward.

But this morning, the PBOC remains in control. They fixed the onshore CNY at 6.9683, stronger than expected and in the FX market CNY has regained about 0.3% of yesterday’s losses. This stabilization has allowed a respite in yesterday’s panic and the result was that Asian equity markets rebounded in the afternoon sessions, still closing lower but well off session lows. And in Europe, the main markets are all marginally higher as I type. It should be no surprise that US futures are pointing to a modest uptick on the opening as well.

In the bond markets, Treasury prices have fallen slightly, with yields backing up 2bps. The same movement has been seen in Japan, with JGB’s 2bps higher, but actually, in Germany, yields continue to decline, down a further 3bps to yet another new record low of -0.54% as German data continues to exhibit weakness implying the Eurozone is going to fall into a recession sooner rather than later.

Finally, in the rest of the FX market, we are seeing a modest reversal of some of yesterday’s significant moves. For example, USDMXN is softer by 0.2% this morning after the peso fell nearly 2.0% yesterday. We are seeing similar activity in USDBRL, and USDKRW. These examples are just that, indications that an uncontrolled collapse is not in the cards, but that this process has not yet played itself out. In the G10 space, the RBA left rates on hold at 1.00% last night, as universally expected, and Aussie has rallied 0.4% this morning. Interestingly, one of the reasons they felt able to pause was the fact that the AUD had fallen more than 3% in the past month, easing financial conditions slightly and helping in their quest to push inflation back to their target. The other reversal this morning has been USDJPY which is higher by 0.4% after having traded to its lowest level (strongest JPY) yesterday since March 2018. As yen remains a key haven asset, it remains an excellent proxy for risk appetite, which today is recovering.

There were actually a few Fed speakers yesterday with both SF President Daly and Governor Brainerd expressing a wait and see attitude as to the impact of the escalation of trade tensions, although a clear bias in both cases to cut rates. Meanwhile, the futures market is pricing in a 100% chance of a 25bp cut in September and a 40% chance of a 50bp cut. It seems like the Fed has a lot of work to do in order to clarify their message.

With no data of note today, the FX market is likely to continue to consolidate yesterday’s moves, and awaits comments from James Bullard, St Louis Fed President and noted dove. In the end, my sense is that the Fed has lost control of the situation and that we are going to see more rate cuts than they had anticipated going forward. The question is more the timing than the actuality. In the meantime, the dollar is likely to be dichotomous, continuing to rise vs. the EMG bloc, but faring less well vs. much of the G10.

Good luck
Adf

More Doubt He Is Sowing

In Beijing, the Chinese yuan
Fell sharply as it’s now been drawn
Into the trade fight
Much to the delight
Of bears, who had shorts layered on

For President Xi, though, the risk
Is money there exits the fisc
With growth there still slowing
More doubt he is sowing
So capital flight could be brisk

Things changed overnight as the PBOC fixed the renminbi below 6.90, much weaker than expected and then the currency fell sharply in subsequent trading in both the on-shore and offshore markets. As you will have no doubt seen, USDCNY is trading somewhere in the vicinity of 7.08 this morning, although the price has been quite volatile. While that represents a decline of more than 1.5% compared to Friday’s closing levels, the more important questions revolve around the PBOC’s new strategy going forward.

Recall, one of the reasons that there was a strong market belief in the sanctity of the 7.00 level was that four years ago, when the PBOC surprised markets with a mini-devaluation, locals took their cash and ran for the hills. Capital outflows were so great, in excess of $1 trillion, that the PBOC needed to institute strict new rules preventing further flight. That was a distinct loss of face for an institution that was trying to modernize and prove that it could manage things like G10 countries where capital flows more freely. Ever since, the assumption was that the Chinese population would get nervous if the renminbi weakened beyond that level and correspondingly, the PBOC would not allow that outcome to occur.

But that was then, in the days when trade was simply a talking point rather than the focus of policy. As the trade war intensifies, the Chinese have fewer tools with which to fight given the massive imbalance that exists. The result of this is that increases in US tariffs cannot be matched and so other weapons must be used, with changes in the exchange rate the most obvious. While the PBOC claims they can continue to manage the currency and maintain its stability, the one thing I have learned throughout my career is that markets have a way of abusing claims of that nature, at least for a while. Back in January I forecast USDCNY to reach 7.40 by the end of this year and, as of this morning, that seems quite realistic.

But the impact on markets is far greater than simply the USDCNY exchange rate. This has been the catalyst for a significant amount of risk-off behavior with equity markets throughout Asia (Nikkei -1.75%, Shanghai -1.6%, Hang Seng -2.85%) and Europe (DAX -1.85%, CAC -2.25%, FTSE -2.25%) sharply lower; Treasury (1.76%) and Bund (-0.51%) yields sharply lower, the Japanese yen (+0.6%) and Swiss franc (+0.75%) both sharply higher and most emerging market currencies (e.g. MXN -1.5%, INR -1.4%, ZAR -1.2%, KRW -0.9%) falling alongside the renminbi. It should be no surprise that gold is higher by 1.0%, to a 6-year high, as well this morning and oil prices (-1.1%) are falling amid concerns of waning demand from the slowing global growth story.

So, what’s a hedger to do? The first thing to consider is whether these moves are temporary fluctuations that will quickly be reversed, or the start of longer-term trends. Given the imbalances that have been building within markets for the past decade and given that central banks have a greatly reduced set of monetary tools with which to manage things, despite their comments otherwise, this could well be the tipping point where markets start to unwind significant positions. After all, the one thing that truly underpinned gains in both equity and bond markets, especially corporate and high-yield bond markets, was confidence that regardless of fiscal policy failures, the central banks would be able to maintain a level of stability.

However, this morning that belief seems a little less secure. It will not take much for investors to decide that, ‘it’s been a good run and now might be a good time to take some money off the table’, at least figuratively. Last week saw equity markets suffer their worst week of the year and this week is not starting any better. Yes, the Fed has room to cut rates further, but will 200bps be enough to stop a global recession? Arguably, that’s the question that needs to be answered. From where I sit, that answer is no, but then I am a cynic. Of course, that cynicism is born of a long career in financial markets.

Thus, my take is that there is further to run in most of these currencies, and that assuming a quick reversion would be a mistake. While option prices are clearly higher this morning than last week, they remain low by historic standards and should be considered for their value in uncertain times. Just sayin’.

What else does this week have to offer? Well, the US data set is not that substantial, but we do hear from a number of Fed speakers, which given last week’s confusion will be extremely important and closely watched. There are also a number of foreign central bank meetings that will be interesting regarding their rate maneuvers.

Today ISM Non-Manufacturing 55.5
Tuesday JOLT’s Job Openings 7.317M
Wednesday RBNZ Rate Decision 1.25% (25bp cut)
  RBI Rate Decision 5.50% (25bpcut)
  Consumer Credit $16.0B
Thursday Philippine Rate Decision 4.25% (25bp cut)
  Initial Claims 215K
Friday PPI 0.2% (1.7% Y/Y)
  -ex food & energy 0.2% (2.4% Y/Y)

We also hear from three dovish Fed speakers; Brainerd, Bullard and Evans, who are likely to give more reasons for further rate cuts, especially if markets continue to fall. As to the three central banks with decisions to make, they find themselves in a difficult place. All three are extremely concerned about their currencies’ value and don’t want to exert further downward pressure on them, yet all three are facing slowing economies and need to do something to boost demand. In fact, this is going to be the central bank conundrum for some time to come across both developing and G10 countries as they try to continually manage the impossible trilateral of exchange rates, interest rates and growth.

All of this adds up to yet more reasons for higher volatility across all asset classes in the near future. It appears that these are the first cracks in the old economic order, and there is no way to know how everything will play out going forward. As long as risk is being jettisoned though, Treasuries, the yen, the Swiss franc and the dollar will see demand. Keep that in mind as you manage your risks.

Good luck
Adf

Akin to Caffeine

There once was a time in the past
Where weakness in growth, if forecast
Resulted in prices
That forewarned a crisis
And traders sold what they’d amassed

But nowadays weakness is seen
As something akin to caffeine
‘Cause central bank measures
Will add to their treasures
It’s like a brand new cash machine

Chinese growth data was weak last night, falling to its lowest quarterly rate in the twenty-seven years that China has measured growth on a quarterly basis. The outcome of 6.2%, while expected, confirms that the ongoing trade situation with the US is having an increasingly negative impact on GDP worldwide. Naturally, not unlike Pavlov’s dogs, the market response was to rally on the theory that the PBOC would be adding more stimulus soon. After all, every other central bank in the world (save Norway’s) is preparing to ease policy further as growth worldwide continues to slow down. And so far, the Pavlovian response of buying stocks on bad news continues to be working as evidenced by the fact that equity markets throughout Asia rose. However, the magnitude of that rise has been quite limited, with gains of between 0.2% and 0.4% the norm. in fact, that market response is actually a bad sign for the central banks, because it demonstrates that the effectiveness of their policies is expected to be much less than in the past. Diminishing returns is a normal outcome for the repeated use of anything, and monetary policy is no different. The implication of this outcome is that despite the growing certainty that the Fed, ECB, BOJ, PBOC, BOE and more are going to ease policy further, equity markets seem unlikely to benefit as much as they have in the past. And if when a recession finally arrives, look for a change of heart in the equity community. But in the meantime, party hearty!

Speaking of further policy ease, it seems the market is chomping at the bit for next week’s ECB meeting, where there are two schools of thought. The conservative view is that Signor Draghi will sound quite dovish and indicate a 10bp cut is coming in September. But that is not nearly as exciting a view as the more aggressive analysts are discussing, which is a 20bp cut next week and the introduction of QE2 in September. Interestingly, despite all this certitude about ECB rate cuts, the euro is actually slightly higher this morning (albeit just 0.1%). It appears that traders are betting on the fact that if Draghi is aggressive, the Fed will have the opportunity the following week to match and outperform the ECB. Remember, the Fed has 250bps of rate cuts before it reaches ZIRP while the ECB is already negative. Despite the recent academic work explaining that negative rates are just fine and helping the situation, it still seems unlikely that we are going to see -2.0% anywhere in the world anytime soon. Ergo, the relative policy stance implies the Fed will ease more and the dollar will suffer accordingly. Just not today. Rather, today, the dollar is little changed overall, with some gains and some losses, but few large moves.

And those have been the real stories of note over what was a very quiet weekend. This week we see a fair amount of data, including Retail Sales, but more importantly, we hear from five more Fed speakers, including Chairman Powell tomorrow, in a total of nine speeches.

 

Today Empire Manufacturing 2.0
Tuesday Retail Sales 0.2%
  -ex autos 0.2%
  IP 0.2%
  Capacity Utilization 78.2%
  Business Inventories 0.3%
Wednesday Housing Starts 1.262M
  Building Permits 1.30M
  Fed’s Beige Book  
Thursday Initial Claims 216K
  Philly Fed 5.0
  Leading Indicators 0.1%
Friday Michigan Sentiment 98.5

Given the importance of the consumer to the US economy, the Retail Sales data is probably the most important data point. Certainly, a weak outcome will result in rate cut euphoria, but it will be interesting to see what happens if there is a strong print. But otherwise, this seems more like a week where Fed speakers will dominate, as we hear from NY’s John Williams twice, as well as a mix of other governors and regional presidents. In the end, though, Powell’s comments are key, as I expect he will be looking to fine tune his message from last week’s congressional testimony.

It remains clear that the Fed has the most room to ease policy, and as long as that is the case, the dollar should remain under pressure. However, given the fact that the US economy continues to outperform the rest of the developed world, I don’t anticipate the dollar’s decline to be extreme, a few percent at most.

For today, there is precious little else to really drive things, so look for more of the recent choppiness that we have observed in markets, with no real directional bias.

Good luck
Adf

Plan B

As PM May turns to ‘Plan B’
The choices are not one, but three
Will Brexit be hard?
Or will she discard
The vote so Bremainers feel glee

The third choice is seek a delay
From Europe so that the UK
Can head to the polls
To sort out their goals
And maybe this time choose to stay

Once again Brexit remains the topic du jour as the ongoing political maelstrom in the UK is both riveting and agonizing at the same time. The latest news is that PM May survived the no-confidence vote. Her next step was to reach out to all opposition parties to try to determine what they wanted to see in Brexit as a prelude to going back to the EU with more demands requests. But the market has dismissed that idea as a non-starter (which I think is correct) and instead is clearly expecting that the decision will be for the UK to seek an extension of several months so that the UK can organize a second referendum on the question. At that point, the result would be binary, either stay in the EU or accept a hard Brexit. At least, that seems to be the current thinking amongst market participants and pundits. The pound has continued its slow recovery from the December lows as investors and traders start to assume that there will be no Brexit after all, and that the only reason the pound trades at its current levels is because of the prospect of leaving the EU. I cannot handicap how a second referendum would turn out, but it does appear that any result would be extremely close in either direction. Like many of you, I am ready for this saga to end, but I fear we will be hearing about it for another six months. In the meantime, the pound will remain hostage to the latest thoughts on the outcome, with Brexit still resulting in a significant decline, while confidence in Bremain will result in sterling strength.

As an indication of just how remarkable the Brexit story has become, Fed activity has faded from the front pages. We continue to hear from Fed speakers and the consistent message is that the Fed is now in ‘wait-and-see’ mode, with no rate hikes likely in the near future unless economic data indicates that prices are rising sharply. It appears that the Fed is losing faith in its Phillips Curve models, and although there doesn’t seem to be a consensus on what should replace them, concerns over runaway inflation based on continued low Unemployment rates are diminishing.

Economic data from around the world continues to moderate, if not outright slow, and while recession remains in the future, it is arguably closer. The upshot is that no central banks are going to consider tightening policy further for quite a while, and the odds favor more policy ease from the big banks instead. As I have consistently written, the FX market remains entirely focused on the Fed without considering the fact that the ECB is in no position to think about raising interest rates later this year and is, in fact, more likely to have to reintroduce QE as the Eurozone economy slows. If the market is beginning to price in rate cuts by the Fed, which it is, then rate cuts by the ECB (or at least QE2) is a given. It is very difficult to see a path where the Fed eases and the ECB doesn’t follow suit, if not lead. This is not a positive outlook for the single currency.

Speaking of easing policy, the PBOC has been at it consistently as growth in China ebbs with no indication they will be reducing these efforts soon. While policy rates remain unchanged, the PBOC has continued to inject excess liquidity into the market there (so far this week they have injected CNY 1.169 Billion) in an effort to bring down short term financing costs for banks. The objective is to help the banks maintain their loan books, especially for those loans that are underperforming. As long as the renminbi remains relatively firm (and although weakening 0.3% overnight remains more than 3.0% from the 7.00 level that is seen as critical in preventing capital outflows), they will be able to continue this easing policy. However, at the point in time that the renminbi begins to weaken (and it will at some point), the PBOC will find its toolkit somewhat more restricted. Remember, despite the fact that so much has occurred in markets and policy circles recently, we are less than three weeks into 2019. There is plenty of time for trader and investor views to change if forecasted activities don’t materialize.

Once again, beyond those three stories, FX remains generally dull. Overall, the dollar is little changed this morning, rising against some currencies (CNY, NZD, RUB, MXN) and falling against others (JPY, EUR, GBP, BRL). The data releases were uninspiring with Eurozone inflation the most noteworthy release but coming in exactly as expected at 1.6% headline and 1.0% core. Those are not inflation rates that quicken the pulse. Yesterday’s Beige Book indicated an increase in uncertainty by a number of businesses but described ongoing decent economic activity. This morning we see Initial Claims (exp 220K) and Philly Fed (10.0), with the latter more likely to be interesting than the former. But for now, FX market attention continues to focus on Brexit first and then the Fed. And today that is not a recipe for excitement! I see little reason, at this point, for the dollar to do much of anything today.

Good luck
Adf

 

A Statement, Acute

The company named for a fruit
Explained in a statement, acute
Though services grew
Its gross revenue
Was destined, not to follow suit

The impact ‘cross markets was vast
As traders, most havens, amassed
Thus Treasuries jumped
The dollar was dumped
While yen demand was unsurpassed

Happy New Year to all my readers. I hope it is a successful and prosperous 2019 for everyone.

But boy, has it gotten off to a rough start! Since I last wrote on December 14, volatility across markets has done nothing but increase as fear continues to pervade both the investor and trader communities. While some pundits point to the trade war and/or the US government shutdown, what has been apparent to me for the past several months is that central banking efforts around the world to normalize policy have begun to take their toll on economic activity and by extension on markets that have become completely dependent on that monetary buffer.

Ten years of extraordinary monetary support by central banks around the world has changed the way markets behave at a fundamental level. The dramatic increase in computer driven, algorithmic trading across markets, as well as passive investing and implicitly short volatility strategies has relegated fundamental analysis to the dust heap of history. Or so it seems. The problem with this situation is that when conditions change, meaning liquidity is no longer being continually added to markets, all those strategies suffer. It will be interesting to watch just how long the world’s central banks, who are desperately trying to normalize monetary policy before the next economic downturn, are able to continue on their present path before the pressure of slowing growth forces a reversion to ‘free’ money for all. (Despite all their claims of independence, I expect that before the summer comes, tighter monetary policy will be a historical footnote.)

In the meantime, last night’s volatility was triggered when a certain mega cap consumer electronics firm explained to investors that its sales in China would be much weaker than previously forecast. Blaming the outcome on a slowing Chinese economy, management tried to highlight growth elsewhere, but all for naught. The market response was immediate, with equity markets falling sharply, including futures in both Europe and the US, and the FX markets picking up where last year’s volatility left off. Notably, with Tokyo still on holiday, the yen exploded more 3.5% vs. the dollar during the twilight hours between New York’s close and Singapore’s open, trading to levels not seen since last March. While it has given back a large portion of those gains, it remains higher by 1.2% in the session, and is more than 5% stronger than when I last wrote. If ever there was a signal that fear continues to pervade markets, the yen’s performance over the past three weeks is surely that signal.

Speaking of slowing Chinese growth, the recent PMI data from China printed below that critical 50.0 level at a weaker than expected 49.4, simply confirming the fears of many. What has become quite clear is that thus far, the trade dispute is having a much more measurable negative impact on China’s economy than on the US economy. This has prompted the PBOC to ease policy further overnight, expanding the definition of a small company to encourage more lending to that sector. Banks there that increase their loans to SME’s will see their reserve requirements reduced by up to a full percentage point going forward. (One thing that is very clear is there is no pretense of independence by the PBOC, it is a wholly owned operation of the Chinese government and President Xi!) I guess China is the first central bank to back away from policy normalization as the PBOC’s previous efforts to wring excess leverage out of the system are now overwhelmed by trying to add back that leverage! Look for the ECB to crack soon, and the Fed not far behind.

And while the rest of the FX market saw some pretty fair activity, this was clearly the key story driving activity. The funny thing about the euro is that there are mixed views as to whether the euro or the dollar is a better safe haven, which means that in risk-off scenarios like we saw last night, EURUSD tends not to move very far. Arguably, its future will be determined by which of the two central banks capitulates to weaker data first. (My money continues to be on the ECB).

This week is a short one, but we still have much data to come, including the NFP report tomorrow. So here is a quick update of what to expect today and tomorrow:

Today ADP Employment 178K
  Initial Claims 220K
  ISM Manufacturing 57.9
  ISM Prices Paid 58.0
Friday 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

Tomorrow we also hear from Fed Chair Powell, as well as two other speakers (Bullard and Barkin) and then Saturday, Philly Fed President Harker speaks. At this point, all eyes will be on the Chairman tomorrow as market participants are desperate to understand if the Fed’s reaction function to data is set to change, or if they remain committed to their current policy course. One thing that is certain is if the Fed slows or stops the balance sheet shrinkage, equity markets around the world will rally sharply, the dollar and the yen will fall and risky assets, in general, should all benefit with havens under pressure. At least initially. But don’t be surprised if the central banks have lost the ability to drive markets in their preferred long-term direction, even when explicitly trying to do so!

Good luck
Adf

A Weakening Buck

Said Powell, we’ve had quite some luck
Inflation’s apparently stuck
Right at two percent
So I won’t lament
If we see a weakening buck

You likely noticed the dollar’s sharp decline on Friday, which actually began shortly before Chairman Powell spoke in Jackson Hole. For that, you can thank the PBOC who reinstated their Countercyclical Factor (CCF). The CCF was the fudge the PBOC created in January of last year to help them regain control of the USDCNY fixing each day. Prior to that, the goal had been to slowly allow the FX market establish the fixing rate in their efforts to internationalize the yuan. But then, market turmoil upset the apple cart and they were no longer pleased with the yuan’s direction. In fact, that was the last time USDCNY made a move toward 7.00. But once they instituted the CCF, which is claimed to include market parameters, they essentially resumed command of the currency and at that time, simply walked it higher over the course of the ensuing year. At that point, they felt things were under control, and early this year they abandoned the CCF as unnecessary. Until Friday, when after the yuan made yet another attempt at 7.00, they decided it was time to reestablish control of the currency. And so, Friday, the yuan rallied in excess of 1.5% and has now stabilized, at least temporarily, around 6.80. With the PBOC’s thumb on the scale, I expect that we are going to see a reduction in CNY volatility, and arguably, a very mild appreciation over time.

Which leads us to discuss the other catalyst for dollar weakness on Friday, Chairman Powell’s speech. In it, he basically said that although inflation has reached their 2.0% target, there is limited reason to expect it to continue to go higher. The market’s take on those comments was that the Fed was likely to slow the trajectory of rate hikes, thereby undermining the dollar. The broad dollar index fell about 0.6% during the speech and has retained those losses since. One of the interesting things is that nobody has accused Powell of succumbing to pressure from Trump with regard to changing his tone. But economists around the world are clearly happier.

Their joy stems from the following sequence of events. In the decade since the financial crisis, when interest rates were pushed to zero or below by developed country central banks, there was a huge expansion of US dollar debt taken on by EMG countries and companies within them. As long as rates were low, and the dollar remained on the soft side, those borrowers had limited issues when it came to rolling over the debt and paying the interest. But once the Fed started to tighten policy, both raising rates and shrinking the available number of dollars in the global system, the dollar rebounded. This was a double whammy for those EMG borrowers because refinancing became more expensive on a rate basis, and it took more local currency to pay the interest, hurting their local currency cash flows as well. This has been a key underlying issue for numerous EMG nations like Argentina, Turkey, Brazil, Indonesia and India. It has exacerbated their currency weakness and expanded their current account deficits.

So now, if Powell and the Fed are going to slow down their efforts on the basis of the idea that inflation is not going to continue to rise, it will reduce the pressure on all of those nations and more. Hence the joy from economists. I guess the only thing that can derail this is if inflation doesn’t actually slow down. Remember, despite the fact that the Fed follows PCE, CPI has been rising sharply lately, and they cannot ignore that fact. If that trend continues, and there is a fair chance that it will, look for PCE to follow and for Powell to have to walk back those comments. I guess we shall see.

As to the overnight session, the dollar is little changed from Friday’s closes as we begin the week leading up to the Labor Day holiday in the US. We actually saw our first substantive data release in more than a week overnight, with the German IFO index rising for the first time in nine months to a much better than expected 103.8. But the euro has been unable to take advantage of the news and is essentially unchanged on the day, along with everything else. As to the US data calendar, it remains on the quiet side, although we do see the latest reading of the aforementioned PCE data.

Tuesday Case-Shiller Home Prices 6.5%
  Goods Trade Balance -$68.6B
Wednesday Q2 GDP 2nd Est 4.0%
Thursday Initial Claims 214K
  Personal Income 0.3%
  Personal Spending 0.4%
  PCE 0.1% (2.2% Y/Y)
  Core PCE 0.2% (2.0% Y/Y)
Friday Chicago PMI 63.0
  Michigan Sentiment 95.5

I expect that unless something remarkable happens to the GDP data on Wednesday, that all eyes will be on the Income and Spending data on Thursday. But in the end, there is a new tone to the market, one which is decidedly less dollar bullish, and given the number of dollar long positions that remain in place, I expect that we may see the dollar nursing its wounds for quite a while. This is a plus for receivables hedgers, as it does appear the dollar has stopped rallying for now. Just don’t get greedy!

Good luck
Adf

Tired

Speculation’s rife
Kuroda is tired of
JGB support

For the fifth consecutive session, the Japanese yen is rising amid growing speculation that the BOJ, when it meets next Monday and Tuesday, is going to adjust monetary policy tighter. During that run, which also included President Trump’s harangues on currency manipulation around the world, the yen has strengthened nearly 2%. My point is that the dollar has suffered somewhat overall during that period, so this movement is not entirely due to the BOJ story. But, as the meeting approaches, that is becoming the hottest topic in the market.

A quick look at the Japanese economy shows that inflation remains quiescent, with the latest core reading just 0.2%, a far cry from the 2.0% target the BOJ has been aiming for during the past five years. In addition, last night’s PMI data, (printing at 51.6, well below expectations of 53.2) has to give Kuroda and company pause as well. In other words, while Japan is not cratering, it doesn’t seem like there is any danger of overheating there either. However, with the Fed actively tightening, the BOE widely expected to raise rates in early August and the ECB highlighting its plans to end QE this year with interest rate increases to follow next year, the BOJ is clearly feeling somewhat left out of the mix. Apparently groupthink is a strong emotion for central bankers.

At any rate, whether justified or not, the story that is getting play is that they are going to tweak their operations, perhaps allowing (encouraging?) the long end of the JGB yield curve to see higher yields, although they will likely keep control of the 10-year space and below. But all the market needed to hear was that QE was going to be reduced and the reaction was immediate. JGB yields in the 10-year space jumped from 0.03% to 0.09%, at which point the BOJ stopped the movement by stepping in with an unlimited bid for bonds. Remember, they already own 42% of all outstanding JGB’s, and liquidity in that market is so thin that there have already been six days this year where there were absolutely zero trades in the 10-year JGB. The FX market was not going to be left out and seeing the prospect for less QE immediately added to the yen’s recent gains. It remains to be seen whether Kuroda-san will be able to actually implement any policy changes given the combination of slackening growth and still low inflation, especially with the prospects of a trade war having an even more deleterious impact on the economy. However, the market loves this story and is going to continue to run with it, at least until the BOJ announcement next Tuesday. So I would look for the yen to continue to trade slowly higher during that period.

The other big story overnight was the PBOC injection of CNY502 billion of liquidity into the market as part of their ongoing policy adjustments. It is becoming increasingly clear that the Chinese economy is having trouble dealing with the simultaneous deleveraging demanded by President Xi for the past two years and the increased trade issues that have arisen quite rapidly of late. Of course, the PBOC is no wallflower when it comes to taking action, and so having already cut reserve requirements three times this year; they decided that direct injection of funds into the market was a better method of achieving their goals. In addition the government created tax incentives for R&D, encouraged more state infrastructure spending and told banks to offer more credit to small firms. The market impact of these measures was immediate with the Shanghai Stock Exchange rallying 1.6% while the renminbi fell as much as 0.6% early, before retracing somewhat and now standing just 0.2% lower on the day.

When considering the CNY, the opposing forces are that a weaker yuan will certainly help support short-term growth due to the still significant reliance on exports by the Chinese economy. However, there is a feared tipping point at which a weak yuan may encourage significant capital outflows, thus destabilizing the Chinese economy and Chinese markets. We saw this play out three years ago, shortly after the PBOC surprised markets with its mini (2%) devaluation of the yuan. The ensuing global market sell-off was significant enough to prevent then Fed Chair Yellen to hold off on raising rates, despite having signaled that the Fed was ready to do so. However, it is not clear to me that Chairman Powell sees the world the same way as Yellen, and my take is that he would not be dissuaded from continuing the Fed’s current trajectory despite some increased global volatility. Of course, the Chinese instituted strict capital controls in the wake of the 2015 situation, so it is also not clear that the contagion can even occur this time. In the end, though, this is simply further evidence of the diverging monetary policies between the US and China, and continues to underpin my views of USDCNY moving to 7.00 and beyond before the year ends.

Away from those two stories, the dollar is modestly softer this morning despite mixed to weaker Eurozone PMI data (Germany strong, France weak, Eurozone weak), and US Treasury yields that gained nearly 10bps yesterday after the BOJ story broke. Yesterday saw weaker than expected Existing Home Sales (5.38M), which is the third consecutive monthly decline. While there is no important data today, we do see the critical first look at Q2 GDP on Friday, and of course, the ECB meets Thursday, so there is ample opportunity for more opinion changing information to come to market. But right now, the dollar remains largely trapped between the positive monetary policy story and the negative political story, and so I don’t anticipate it will be breaking out in either direction in the short run. However, as long as US monetary policy continues on its current trajectory, I believe the dollar has further to run. We have not yet evolved to a point where other issues are more important, although that time may well come in the future.

Good luck
Adf