Pundits Maligned

Phase one of the trade deal’s been signed
And though many pundits maligned
The outcome, it’s clear
That in the, term, near
Its impact on trading’s been kind

Amid a great deal of hoopla yesterday morning, President Trump signed the long-awaited phase one trade deal with China. The upshot is that the US has promised to roll back the tariffs imposed last September by 50%, as well as delay the mooted December tariffs indefinitely while the Chinese have promised to purchase upwards of $95 billion in US agricultural products over the next two years as well as agreeing to crack down on IP theft. In addition, the Chinese have committed to preventing excess weakness in the renminbi, and in fact CNY has been strengthening steadily for the past month as the negotiations came to an end. For example, this morning CNY is firmer by 0.15% and since mid-December it has rallied nearly 2.0%. Clearly there are larger trade issues outstanding between the two nations, notably forced technology transfer as well as numerous non-tariff barriers, but something is better than nothing.

Taking a step back, though, the bilateral nature of the deal is what has many pundits and economists unhappy. Certainly the economic theories I was taught, and that have been prevalent since David Ricardo first developed the theory of comparative advantage in 1817, indicate that multilateral trade is a better outcome for all concerned. Alas, the current political backdrop, where populism has exploded in response to the unequal outcomes from the globalization phenomenon of the past sixty years, has tarred multilateralism with a very bad reputation. And while it is far outside the purview of this commentary to dissect the issues, it is important to understand they exist and how they may impact markets. Given that the relative value of a nation’s currency is an important driver of trade outcomes, we cannot ignore it completely. Ultimately, as things currently stand, the market has seen this deal as a positive outcome, and risk appetite remains strong. As such, haven assets like the yen, dollar and Swiss franc are likely to remain on the back foot for the time being.

Beside the trade story, there has been scant new information on which to base trading decisions. Important data remains limited with the only notable print being German CPI at 1.5%, exactly as expected, although EU Car registrations bucked the trend and rose sharply, 21.7%, perhaps indicating we have seen a bottom on the Continent. But in reality, the market is now looking for the next big thing, and quite frankly, nobody really knows what that is. After all, the Fed has promised it is on hold, as are the ECB and BOJ, at least for the time being. Perhaps it is the BOE’s meeting in two weeks’ time, where the market continues to price in a growing probability of a rate cut. Of course, if the market is pricing it in, it is not likely to be that big a surprise, is it?

So in an uninspiring market, let’s look at what is coming up in today’s session. On the data front we see Initial Claims (exp 218K) and then Retail Sales (0.3%, 0.5% ex autos) as well as Philly Fed (3.8). Arguably, of just as much importance for the global economic outlook is tonight’s Chinese data where we will see; GDP (6.0%), Fixed Asset Investment (5.2%), Retail Sales (7.9%) and IP (5.9%). Remember, 6.0% growth has been President Xi’s target, and given the recent trajectory lower, any weaker than expected data is likely to be a risk-off sign, although it is likely to see a PBOC response in short order as well. Meanwhile, the US consumer continues to play its supporting role in the global economy, so any downside in this morning’s data is also likely to be a stock market negative.

On the speaker front, there are no Fed speakers today, although Philly’s Patrick Harker will regale us tomorrow. Later this afternoon ECB President Lagarde will be on the tape, and given she is still learning how much impact her words have on markets, there is always a chance of some unintentional excitement. Finally, yesterday, for the first time, we heard a Fed speaker explain that even though not-QE is not QE, the market may still consider it to be QE and the resulting rise in the price of risk assets may well be excessive. Dallas Fed President Kaplan is the first Fed member to publically admit that they may need to address this issue going forward. Certainly, the fact that the short-term repo program continues to be extended, and is now expected to run through April, rather than the original February completion, is an indication that the Fed still does not have control over the money markets. It is this last point which holds the potential to drive more significant market moves in the event of a communication or policy error. Just not today.

The dollar is mildly softer overall this morning, while we are seeing a very modest bias higher in equity markets around the world. Treasury yields are unchanged, just below 1.78%, and the previous narratives regarding recession probabilities and curve inversions as well as ongoing QE activities have just faded into the background. It all adds up to what is likely to be another quiet day in the FX markets, with no compelling story to drive movement.

Good luck
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A Dangerous Game

In ‘Nineteen the story was trade
As Presidents Trump and Xi played
A dangerous game
While seeking to blame
The other for why growth decayed

But ‘Twenty has seen both adjust
Their attitudes and learn to trust
That working together,
Like birds of a feather,
Results in an outcome, robust

In a very quiet market, the bulk of the discussion overnight has been about the upcoming signing ceremony in the East Room of the White House tomorrow, where the US and China will agree the phase one piece of a trade deal. Despite the fact that this has been widely expected for a while, it seems to be having a further positive impact on risk assets. Today’s wrinkle in the saga has been the US’ removal of China from the Treasury list of currency manipulators. Back in August, in a bit of a surprise, the US added China to that list formally, rather than merely indicating the Chinese were on notice, as President Trump sought to apply maximum pressure during the trade negotiations. Now that the deal is set to be signed, apparently the Chinese have made “enforceable commitments” not to devalue the yuan going forward, which satisfied the President and led to the change in status. The upshot is that the ongoing positive risk framework remains in place thus supporting equity markets while undermining haven assets. In other words, just another day where the politicians seek to anesthetize market behavior, and have been successful doing so.

Chinese trade data released last night was quite interesting on two fronts; first that the Chinese trade surplus with the US shrank 11%, exactly what the President was seeking, and second, that the Chinese found many substitute markets in which to sell their wares as their overall trade surplus rose to $425 billion from 2018’s $351 billion. And another positive for the global growth watch was that both exports (+7.6%) and imports (+17.7%) grew nicely, implying that economic growth in the Middle Kingdom seems to be stabilizing. As to the yuan, it has been on a tear lately, rising 1.4% this year and nearly 4.5% since early September right after the US labeled China a currency manipulator. So, here too, President Trump seems to have gotten his way with the Chinese currency having regained almost all its losses since the November 2016 election. Quite frankly, it seems likely that the yuan has further to climb as prospects for Chinese growth brightened modestly and investors continue to hunt for yield and growth opportunities.

But away from the trade story there is precious little else to discuss. The pound remains under pressure (and under 1.30) as the idea of a BOE rate cut at the end of the month gains credence. Currently the market is pricing in a 47% probability of a rate cut, which is up from 23% on Friday. After yesterday’s weak GDP data, all eyes are focused on tomorrow’s UK CPI data as well as Friday’s Retail Sales where any weakness in either one is likely to see the market push those probabilities up even further.

As haven assets are shed, the Japanese yen has finally breached the 110 level for the first time since May and quite frankly there doesn’t appear to be any reason for the yen to stop declining, albeit slowly. Barring some type of major risk-off event, which is always possible, the near term portents are for further weakness. However, as the year progresses, ongoing Fed QE should serve to reverse this movement.

Even the Emerging markets have been dull overnight, with no currency moving more than 0.3%, which in some cases is nearly the bid-ask spread. For now, most market participants have become quite comfortable that no disasters are looming and that, with the US-China trade deal about to be completed, there is less likelihood of any near-term angst on that front. While a phase two deal has been mooted, given the issues that the US has indicated are important (forced technology transfer, state subsidies), and the fact that they are essentially non-starters in China, it seems highly improbable that there will be any progress on that issue this year.

On the data front, this morning brings the first US data of the week, where NFIB Small Business Optimism actually disappointed at 102.7 and the market is now awaiting December CPI data (exp 2.4%, 2.3% ex food & energy) at 8:30. The headline forecast represents a pretty big uptick from November, but that is directly related to oil’s price rally last month. The core, however, remains unchanged and well above the 2.0% Fed target. Of course that target is based on PCE, something that is designed to print lower, and there has been abundant evidence that the Fed’s idea of the target is to miss it convincingly on the high side. In other words, don’t look for the Fed to even consider a tighter policy stance unless CPI has a 3 handle.

And that’s really it for the session. Equity futures are pointing slightly higher as European equity indices are edging in that direction as well. Treasury yields are hovering just above 1.80%, little changed on the day and showing no directional bias for the past several weeks. If anything, the dollar is slightly higher this morning, but I would be surprised if this move extends much further at all.

Good luck
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Wind At His Sails

In England and Scotland and Wales
Young Boris has wind at his sails
A thumping great win
To Labour’s chagrin
Has put Brexit back on the rails

As well, from the US, the news
Is bears need start singing the blues
The trade deal is done
At least for phase one
Thus more risk, investors did choose

An historic victory for PM Boris Johnson yesterday has heralded a new beginning for the UK. Historic in the sense that it is the largest majority in Parliament for either party since Margret Thatcher’s second term, and historic in the sense that the Labour party won the fewest seats since 1935. One can only conclude that Jeremy Corbyn’s vision of renationalization of industry and high taxes was not the direction in which the UK wants to head. Perhaps the only concern is the Scottish National Party winning 49 of the 58 seats available and will now be itching to rerun the Scottish independence referendum. But that is an issue for another day, and today is all about a huge relief rally in equities as the threat of a hard Brexit essentially disappears, while the pound has also benefitted tremendously, rising 1.7% from yesterday’s closing level and having traded almost a full percent higher than that in the early aftermath of the results. So here we are this morning at 1.3390, right at my forecast for the initial move in the event of a Johnson victory. The question of course, is where do we go from here?

Before I answer, I must also mention the other risk positive story, about which I’m sure you are already aware, the news that President Trump has signed off on terms of a phase one trade deal with China. The details thus far released indicate China has promised to buy $50 billion of agricultural products from the US, and will be more vigilant in protection of IP rights, while the US is set to reduce the tariff rates already imposed and delay, indefinitely, the tariffs that were due to come into effect this Sunday. Not surprisingly, equity markets around the world rallied sharply on this news as well while haven investments like Treasuries, Bunds and the yen (and the dollar) have all fallen.

So everyone is feeling good this morning and with good reason, as two of the major political uncertainties that have been hanging over the market have been resolved. With this in mind, we can now try to answer the question of what’s next in the FX markets.

History has shown that while macroeconomic factors have some impact on the relative value of currencies, that impact is driven by the corresponding interest rates in each nation. So a nation that has strong economic growth and relatively tighter monetary policy is likely to see a strong currency while the opposite is also true. Now this correlation is hardly perfect, and financial theory cannot be completely ignored regarding a country’s fiscal balances (current account, trade and budget), where deficits tend to lead to a weaker currency, at least in theory, and surpluses the opposite. Obviously, one need only look at the dollar these days to recognize that despite the US’s significant negative fiscal position, the dollar remains relatively quite strong.

But ever since the financial crisis, there has been another part of monetary policy that has had a significant impact on the FX market, namely QE. As I’ve written before, when the US was implementing QE’s 1, 2 and 3, the dollar fell markedly each time, by 22%, 25% and 17% over a period of 9 months, 11 months and 22 months respectively. Clearly that pattern demonstrates the law of diminishing returns, where a particular action has a weaker and weaker effect the more frequently it is used. Of course, in each of these cases, the Fed funds rate was at 0.00%, so QE was the only tool in the toolbox. This brings us to the current situation; positive interest rates but the beginning of QE4. I know that none of us think 1.5% is a robust return on our savings, but remember, US interest rates are the highest in the G10, by a lot. In addition, the economy seems to be doing pretty well with GDP ticking over above 2.0%, Unemployment at 50 year lows and wage gains solidly at 3.0% or higher. Equity markets in the US make new highs on a regular basis and measured inflation is running right around 2.0%. And yet…the Fed is clearly looking at QE despite all their protestations. Buying $60 billion per month of T-bills with the newly stated option of extending those purchases to coupons is clearly expanding the balance sheet and driving risk accumulation further. And that is QE!

So with the knowledge that the Fed is engaged in QE4, and the history that shows the dollar has fallen pretty significantly during each previous QE policy, my view is that we are about to embark on a reasonable weakening of the US dollar for the next year or so. Now, clearly the initial conditions this time are different, with positive growth and interest rates, but while that will likely limit the dollar’s decline to some extent, it won’t prevent it. If pressed, I would say that we are likely to see the dollar fall by 10% or so over the next 12-18 months. And that is regardless of the outcome of the US elections next year. In the event that we were to see a President Warren or President Sanders, I think the dollar would suffer far more aggressively, but right now, removing the effect of the election still points to a slow decline in the buck. So for receivables hedgers, it is likely to be a situation where patience is a virtue.

Turning to the data story, last night we saw the Japanese Tankan report fall to 0, below expectations of 3 and down from its previous reading of 5. But the yen’s 0.35% decline overnight has more to do with risk appetite than that particular number. However, I’m sure PM Abe and BOJ Governor Kuroda are not thrilled with the implications for the economy. Otherwise, there has been precious little else of note released leaving us to ponder this morning’s Retail Sales data (exp 0.5%, 0.4% ex Autos) and wait to hear pearls of wisdom from NY Fed President Williams at 11:00. Of course, given the fact the Fed just finished meeting and there appears very little uncertainty over their immediate future course, my guess is the only thing he can try to defend is ‘not QE’ and how they are on top of the repo situation. But today is a risk on day, so while we may not extend these movements much further, I feel we are likely to maintain the gains vs. the dollar across the board.

In a final note, this will be the last poetry until January as I will be on vacation and then will return with my prognostications for 2020 to start things off.

Good luck, good weekend and happy holidays to all
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Most Concerning

While cities worldwide keep on burning
The news for which markets are yearning
Revolves around trade
Is phase one delayed?
If so, that would be most concerning

This morning it seems that everything is right with the world, at least based on market behavior. After all, equity markets are rallying, Treasury yields are rising and haven currencies are falling, the perfect description of a risk-on day. And what has everyone so optimistic this morning? Why, for the umpteenth time, the White House has indicated that the US and China are close to signing that elusive phase one trade deal. By all accounts, this deal is basically a swap of Chinese promises to purchase more agricultural products from the US, allegedly upwards of $50 billion worth, while the US will roll back the tariffs most recently put in place and will not impose new ones come December 15th. And don’t get me wrong, that would be great if it helped relieve some uncertainty in both markets and business planning. But I would conservatively estimate that this is the tenth time that optimism on a trade deal has led to increased risk appetite in the past three months, and we still don’t have a deal in place. My point is we’ve seen this movie before and we know how it ends…no deal and the opportunity to see it yet again in another few weeks’ time. I challenge anyone to show me evidence that this time is different!

And yet, it continues to be effective insofar as these constant announcements have helped maintain optimism in the market. The biggest risk is that the next story describes a complete breakdown in the trade talks and the chance of a deal, even a phase one deal, being completed disappears. Risk assets would not take that lightly. But another risk is that the deal is signed, and it is as modest as it appears to be. While that would be good news initially, it would remove one of the key market supports, the prospect of that deal. I fear we would see a classic sell the news outcome in that event as well. Something to keep in mind.

Meanwhile, the world is literally burning; at least a great number of large cities are besieged by mass protests with fire a constant result. Perhaps the best known situation is in Hong Kong, where things have gone from bad to worse, the protesters’ demands are being studiously ignored and the threat of China intervening directly grows by the day. Hong Kong’s economy has been severely impacted, falling into a recession in Q3, and the official forecast for GDP growth next year is now -1.3% by the Hong Kong government.

But Hong Kong is hardly alone. Santiago, Chile has been the sight of major demonstrations, with estimates of more than one million people turning out recently. That is more than 5% of the population! In the past week, in the wake of the news that the government wanted to scrap the current constitution and write a new one, the currency collapsed 12% and the local equity market fell 6%, taking its losses since mid-October to 15%. But this morning things are looking up there as Congress has come to an agreement on how to go about this process, with the evidence leaning toward a constitutional convention that will include many voices. When the FX market opened this morning, the CLP rebounded 2.5%. Of all the protests ongoing around the world, this may be the first where a solution is being created.

These two are just the most well-known situations, but the gilets jaunes continue to protest in France more than a full year after they started. And a quick survey shows ongoing protests, a number of which are quite large and disruptive, in Peru, Indonesia, Lebanon, the Netherlands, Haiti and Israel. The point is there are a lot of very unhappy people in the world, and much of their collective angst seems to be driven by a sense of inherent unfairness in the way those (and most) countries’ are run. This is a background issue generally, but as can be seen on a daily basis in the US and the UK, these issues can have much broader impacts on economies as a whole. After all, one could argue that both the Brexit vote and the election of President Trump were protest votes as well. And certainly, the US-China trade war is a consequence of those outcomes. My point is that while most of these things may not have a daily impact, they are important to recognize as part of the fabric of the market background.

Turning to today’s markets, though, as I mentioned, rose-colored glasses are the order of the day. Equity markets are generally higher gains in Asia (Nikkei +0.7%, Australia +0.85% and South Korea +1.05%) although Shanghai actually fell 0.65% after the PBOC did not cut rates as many had hoped/expected in the wake of yesterday’s very weak data outturn. European indices are also generally doing well this morning (DAX +0.2%, CAC +0.4%) although the FTSE 100 in the UK is having a rough go, down 0.4%, because of a sharp decline in British Telecom which has fallen 2% after Jeremy Corbyn promised to nationalize the company and give everyone in the UK free broadband access. It is remarkable what politicians will say in an effort to get elected!

Bond markets have fared less well as risk has been acquired since havens are no longer needed. So Treasury yields have bounced 3bps with Bunds following suit. And in the FX market, haven currencies are also under pressure. Overall, the dollar is softer, as is the yen, which has fallen 0.3% and the Swiss franc, which has fallen 0.25%. On the positive side in G10 is NOK, which has rallied 0.65% after a stronger than expected Trade Balance helped burnish optimism that GDP growth would maintain its recent solid performance and the Norgesbank would not need to join most other central banks and ease policy. In the emerging markets, aside from CLP mentioned above, we have seen broad-based, but modest strength across most of the rest of the space, with no real stories to note.

Yesterday we heard from a whole bunch of Fed speakers and to a wo(man) they explained that the economy was in good shape (the star performer according to Powell) and that there was no need to adjust policy at this time. Data yesterday showed that Initial Claims jumped more than expected, to 225K, which is not concerning if it is a one-time situation, but needs to be carefully monitored as a precursor to a deterioration in the labor market.

This morning we see Empire Manufacturing (exp 6.0), Retail Sales (0.2%, ex autos 0.4%), IP (-0.4%) and Capacity Utilization (77.0%). All eyes will be on the Retail Sales data as last month’s surprising decline has some on edge that the US economy is starting to show some cracks. But assuming an in-line outcome, I expect the dollar to soften modestly through the rest of the day as risk is accumulated further.

Good luck and good weekend
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Get Out of My Face!

“The economy’s in a good place”
Which means we can slacken the pace
Of future rate cuts
No ifs, ands or buts
So Donald, ‘get out of my face’!

Reading between the lines of yesterday’s FOMC statement and the Powell press conference, it seems abundantly clear that Chairman Powell is feeling pretty good about himself and what the Fed has achieved. He was further bolstered by the data yesterday which showed GDP grew at a 1.9% clip in Q3, far better than the expected 1.6% pace and that inflation, as measured by the GDP deflator, rose 2.2%, also clearly around the levels that the Fed seeks. In other words, although he didn’t actually say, ‘mission accomplished’, it is clearly what he wants everybody to believe. The upshot is that he was able to convince the market that the Fed has no more reason to cut rates anytime soon. But more importantly from a market perspective, he explained at the press conference that the bar was quite high for the Fed to consider raising rates again. And that was all he needed to say for equity markets to launch to yet another new high, and for the dollar, which initially had rallied on the FOMC statement, to turn tail and fall pretty sharply. And the dollar remains under pressure this morning with the euro rising a further 0.15%, the pound a further 0.45% and the yen up 0.5%.

Of course, the pound has its own drivers these days as the UK gears up for its election on December 12. According to the most recent polls, the Tories lead the race with 34%, while Labour is at 26%, the Lib-Dems at 19% and the Brexit party at 12%. After that there are smaller parties like the DUP from Northern Ireland and the Scottish National Party. The most interesting news is that the Brexit party is allegedly considering withdrawing from a number of races in order to allow the Tories to win and get Brexit completed. And after all, once Brexit has been executed, there really is no need for the Brexit party, and so its voting bloc will have to find a home elsewhere.

Something that has been quite interesting recently is the change in tone from analysts regarding the pound’s future depending on the election. While on the surface it seems that the odds of a no-deal Brexit have greatly receded, there are a number of analysts who point out that a strong showing by the Brexit party, especially if Boris cannot manage a majority on his own, could lead to a much more difficult transition period and bring that no-deal situation back to life. As well, on the other side of the coin, a strong Lib-Dem showing, who have been entirely anti-Brexit and want it canceled, could result in a much stronger pound, something I have pointed out several times in the past. Ultimately, though, from my seat 3500 miles away from the action, I sense that Boris will complete his takeover of the UK government, complete Brexit and return to domestic issues. And the pound will benefit to the tune of another 2%-3% in that scenario.

The recent trade talks, called ‘phase one’
According to both sides are done
But China’s now said
That looking ahead
A broad deal fails in the long run

A headline early this morning turned the tide on markets, which were getting pretty comfortable with the idea that although the Fed may not be cutting any more, they had completely ruled out raising rates. But the Chinese rained on that parade as numerous sources indicated that they had almost no hope for a broader long-term trade deal with the US as they were not about to change their economic model. Of course, it cannot be a surprise this is the case, given the success they have had in the past twenty years and the fact that they believe they have the ability to withstand the inevitable economic slowdown that will continue absent a new trading arrangement. Last night, the Chinese PMI data released was much worse than expected with Manufacturing falling to 49.3 while Services fell to 52.8, both of which missed market estimates. However, the latest trade news implies that President Xi, while he needs to be able to feed his people, so is willing to import more agricultural products from the US, is also willing to allow the Chinese economy to slow substantially further. Interestingly, the renminbi has been a modest beneficiary of this news rallying 0.15% on shore, which takes its appreciation over the past two months to 2.1%. Eventually, I expect to see the renminbi weaken further, but it appears that for now, until phase one is complete, the PBOC is sticking to its plan to keep the currency stable.

Finally, last night the BOJ left policy unchanged, however, in their policy statement they explicitly mentioned that they may lower rates if the prospect of reaching their 2% inflation goal remained elusive. This is the first time they have talked about lowering rates from their current historically low levels (-0.1%) although the market response has been somewhat surprising. I think it speaks to the belief that the BOJ has run out of room with monetary policy and that the market is pricing in more deflation, hence a stronger currency. Of course, part of this move is related to the dollar’s weakness, but I expect that the yen has further to climb regardless of the dollar’s future direction.

In the EMG bloc there were two moves of note yesterday, both sharp declines. First Chile’s peso fell 1.5% after President Sebastian Pinera canceled the APEC summit that was to be held in mid-November due to the ongoing unrest in the country. Remember, Chile is one of the dozen nations where there are significant demonstrations ongoing. The other big loser was South Africa’s rand, which fell 2.9% yesterday after the government there outlined just how big a problem Eskom, the major utility, is going to be for the nation’s finances (hint: really big!). And that move is not yet finished as earlier this morning the rand had fallen another 1.1%, although it has since recouped a portion of the day’s losses.

On the data front, after yesterday’s solid GDP numbers, this morning we see Personal Income (exp 0.3%); Personal Spending (0.3%); Core PCE (0.1%, 1.7% Y/Y); Initial Claims (215K) and Chicago PMI (48.0). And of course, tomorrow is payroll day with all that brings to the table. For now, the dollar is under pressure and as there are no Fed speakers on the docket, it appears traders are either unwinding old long dollar positions, or getting set for the next wave of weakness. All told, it is hard to make a case for much dollar strength today, although strong data is likely to prevent any further weakness.

Good luck
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