Weakness Worldwide

The Fed followed through on their pledge
To cut rates, as they try to hedge
‘Gainst weakness worldwide
But Jay clarified
It’s not a trend as some allege

The market response was quite swift
With equities given short shrift
Commodities fell
While bonds did excel
In FX, the buck got a lift

Something has really begun to bother me lately, and that is the remarkable inconsistency over the benefits/detriments of a currency’s value. For example, the dollar has been relatively strong lately, and as you are all aware, I believe will continue on that path overall. The key rationales for the dollar’s strength lie in two factors; first, despite yesterday’s cut, US interest rates remain much higher than every other G10 country, in most cases by more than 100bps, and so the relative benefit of holding dollars vs. other currencies continues. The second reason is that the US economy is the strongest, by far, of the G10, as recent GDP data demonstrated, and while there are certain sectors of weakness, notably housing and autos, things look reasonably good. This compares quite favorably to Europe, Japan and Oceania, where growth is slowing to the point that recession is a likely outcome. The thing is, article after article by varying analysts points to the dollar’s strength as a major problem. While President Trump rightly points out that a strong dollar can hinder US exports, and as a secondary effect corporate earnings, remember that trade represents a small portion of the US economy, just 12% as of the latest data.

Contrast this widespread and significant concern over a strong currency with the angst over the British pound’s recent performance as it continues to decline. Sterling is falling not only because the dollar is strong, but also because the market is repricing its estimates of the likelihood of a no-deal Brexit. Ever since the Brexit vote the pound has been under pressure. Remember that the evening of the vote, when the first returns pointed to a Remain win, the pound touched 1.50. However, once the final results were in, the pound sold off sharply, losing as much as 20% of its value within four months of the vote. However, since then, during the negotiation phase, the pound actually rallied back as high as 1.4340 when it looked like a deal would get done and agreed. Alas, that never occurred and now that no-deal is not only back on the table, but growing as a probability, the pound is back near its lows. And this is decried as a terrible outcome! So, can someone please explain why a strong currency is bad but a weak currency is also bad? You can’t have it both ways. Arguably, every complaint over the pound’s weakness is a political statement clothed in an economic argument. And the same is true as to the dollar’s strength, with the difference there being that the President makes no bones about the politics.

In the end, the beauty of a floating currency regime is that the market adjusts based on actual and expected flows, not on political whims. If there is concern over a currency’s value, that implies that broader policy adjustments need to be considered. In fact, one of the most frightening things we have heard of late is the idea that the US may intervene directly to weaken the dollar. Intervention has a long and troubled history of failure, especially when undertaken solo rather than as part of a globally integrated plan a la the Plaza Accord in the 1980’s. An unsolicited piece of advice to the President would be as follows: if you want the strongest economy in the world, be prepared for a strong currency to accompany that situation. It is only natural.

With that out of the way, there is no real point in rehashing the FOMC yesterday as there are myriad stories already available. In brief, they cut 25bps, but explained it as an insurance cut because of global uncertainties. Weak sauce if you ask me. The telling thing is that during the press conference, when Powell explained that this was not the beginning of a new cycle and the stock market sold off sharply, he quickly backtracked and said more cuts could come as soon as he heard about the selloff. It gets harder and harder to believe that the Fed sees their mandate as anything other than boosting the stock market.

This morning brings the final central bank meeting of the week with the BOE on the docket at 7:00am. At this point, with rates still near historic lows and Brexit on the horizon, the BOE is firmly in the wait and see camp. Concerns have to be building as more economic indicators point to a slump, with today’s PMI data (48.0) posting its third consecutive month below the 50.0 level. I think it is clear that a hard Brexit will have a short-term negative impact on the UK economy, likely making things worse before they get better, but I also believe that the market has already priced in a great deal of that weakness. And in the end, I continue to believe that the EU will blink as they cannot afford to drive Europe into a recession just to spite the UK. So there will be no policy change here.

One interesting outcome since the Fed action yesterday was how many other central banks quickly cut interest rates as well. Brazil cut the Selic rate by 50bps, to a record low 6.00% as they had room from the Fed move and then highlighted the fact that a key pension reform bill seemed to have overwhelming support and was due to become law. This would greatly alleviate government spending pressures and allow for even more policy ease. As well, the Middle East saw rate cuts by Saudi Arabia, the UAE, Qatar and Bahrain all cut rates by 25bps as well. In fact, the only bank that does not seem likely to respond is the PBOC, where they have been trying to use other tools, rather than interest rate policy, to help bolster the economy there.

This morning sees the dollar broadly higher with both the euro and pound down by ~0.40%, and similar weakness in a number of EMG currencies like MXN and INR. Even the yen has weakened this morning by 0.2%, implying this is not so much a risk-off event as a dollar strength event. Data today brings Initial Claims (exp 212K) and ISM Manufacturing (52.0). Regarding the ISM data, yesterday saw an extremely weak Chicago PMI print of just 44.4, its lowest since December 2015. Given how poor the European and Chinese PMI data were overnight and this morning, I wouldn’t be surprised to see a weak outcome there. However, I don’t think that will be enough to weaken the dollar much as the Fed just gave the market its marching orders. We will need to see a very weak payroll report tomorrow to change any opinions, but for today, the dollar remains in the ascendancy.

Good luck
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Boris is Fumbling

The British pound Sterling is tumbling
As traders think Boris is fumbling
His chance to succeed
By forcing, at speed
Hard Brexit with some Tories grumbling

It’s official, the only story of note in the FX markets today is Brexit. Despite central bank meetings and key data, the number one discussion is about how far the pound will fall in the event of a hard Brexit and how high the likelihood of a hard Brexit has become. Since Friday morning, the pound is down by 2.5% and there doesn’t appear to be a floor in the near term. It seems that traders have finally decided that BoJo was being serious when he said the UK would leave the EU with or without a deal come October 31. As such, today’s favorite analyst pastime is to guess how low the pound can fall with a hard Brexit. So far, there has been one estimate of parity with the dollar, although most estimates talk about 1.10 or so. The thing is, while Brexit will clearly be economically disruptive, it seems to me that the warnings of economic activity halting are vastly overstated for political reasons. After all, if you voted Remain, and you are in the media (which was largely the case) then painting as ugly a picture as possible suits your cause, whether or not it is based on factual analysis or fantasy.

But let’s discuss something else regarding the potential effects of a hard Brexit; the fears of a weaker currency and higher inflation. Are these really problems? Is not every developed country (and plenty of emerging ones) in the world seeking to weaken their currency through easier monetary policy in order to gain a competitive advantage in trade? Is not every developed country in the world complaining that inflation is too low and that lowered inflation expectations will hinder central bank capabilities? Obviously, the answer to both these questions is a resounding ‘YES’. And yet, the prospects of a weaker pound and higher inflation are seen as devastatingly bad for the UK.

Is that just jealousy? Or is that a demonstration of central bank concern when things happen beyond their control. After all, for the past decade, central banks have basically controlled the global economy. Methinks they have gotten a bit too comfortable with all that power. At any rate, apocalyptic scenarios rarely come to pass, and in fact, my sense is that while the pound can certainly fall further in the short run, we are far more likely to see the EU figure out that they don’t want a hard Brexit after all, and come back to the table. While a final agreement will never be finished in time, there will be real movement and Brexit in name only as the final details are hashed out over the ensuing months. And the pound will rebound sharply. But that move is still a few months away.

Away from Brexit, there has been other news. For example, the BOJ met last night and left policy rates on hold, as universally expected, but lowered their inflation forecast for 2019 to 1.0%, which is a stretch given it’s currently running at 0.5%. And their 2.0% target is increasingly distant as even through 2022 they see inflation only at 1.6%. At the same time, they indicated they will move quickly to ease further if necessary. The problem is they really don’t have much left to do. After all, they already own half the JGB market, and have bought both corporate bonds and equities. Certainly, they could cut rates further, but as we have learned over the past ten years, ZIRP and NIRP have not been all that effective. With all that said, the yen’s response was to rise modestly, 0.15%, but basically, the yen has traded between 107-109 for the past two months and shows no signs of breaking out.

We also saw some Eurozone data with French GDP disappointing in Q2, down to 0.2% vs. 0.3% expected, and Eurozone Confidence indicators were all weaker than expected, noticeably Business Confidence which fell to -0.12 from last month’s +0.17 and well below the +0.08 expected. This was the weakest reading in six years and simply highlights the spreading weakness on the continent. Once again I ask, do you really think the EU is willing to accept a hard Brexit with all the disruption that will entail? As to the euro, it is essentially unchanged on the day. Longer term, however, the euro remains in a very clear downtrend and I see nothing that will stop that in the near term. If anything, if Draghi and friends manage to be uber-uber dovish in September, it could accelerate the weakness.

Away from the big three, we are seeing weakness in the Scandies, down about 0.5%, as well as Aussie and Kiwi, both lower by about 0.25%. Interestingly, the EMG bloc has been much less active with almost no significant movement anywhere. It appears that traders are unwilling to do anything ahead of tomorrow’s FOMC statement and Powell’s press conference.

On the data front this morning we see Personal Income (exp 0.4%), Personal Spending (0.3%), Core PCE (0.2%, 1.7% Y/Y), Case-Shiller Home Prices (2.4%) and Consumer Confidence (125.0). Arguably, the PCE data is most important as that is what the Fed watches. Also, given that recent CPI data came in a tick higher than expected, if the same thing happens here, what will that do to the insurance cut narrative? The point is that the data of late has not warranted talk of a rate cut, at least not the US data. But will that stop Powell and company? The controlling narrative has become the Fed must cut to help the rest of the world. But that narrative will not depreciate the dollar very much. As such, I remain generally bullish the dollar for the foreseeable future.

Good luck
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More Clear

The contrast could not be more clear
Twixt growth over there and right here
While Europe is slowing
The US is growing
So how come a rate cut is near?

It seems likely that by the time markets close Friday afternoon, investors and traders will have changed some of their opinions on the future given the extraordinary amount of data and the number of policy statements that will be released this week. Three major central banks meet, starting with the BOJ tonight, the Fed tomorrow and Wednesday and then the BOE on Thursday. And then there’s the data download, which includes Eurozone growth and inflation, Chinese PMI and concludes with US payrolls on Friday morning. And those are just the highlights. The point is that this week offers the opportunity for some significant changes of view if things don’t happen as currently forecast.

But before we talk about what is upcoming, perhaps the question at hand is what is driving the Fed to cut rates Wednesday despite a run of better than expected US economic data? The last that we heard from Fed members was a combination of slowing global growth and business uncertainty due to trade friction has been seen as a negative for future US activity. Granted, US GDP grew more slowly in Q2 at 2.1%, than Q1’s 3.1%, but Friday’s data was still better than expected. The reduction was caused by a combination of inventory reduction and a widening trade gap, with consumption maintaining its Q1 pace and even speeding up a bit. The point is that things in the US are hardly collapsing. But there is no doubt that growth elsewhere in the world is slowing down and that prospects for a quick rebound seem limited. And apparently, that is now the driving force. The Fed, which had been described as the world’s central bank in the past, seems to have officially taken on that mantle now.

One fear of this action is that it will essentially synchronize all major economies’ growth cycles, which means that the amplitude of those cycles will increase. In other words, look for higher highs and lower lows over time. Alas, it appears that the first step of that cycle is lower which means that the depths of the next recession will be wider and worse than currently expected. (And likely worse than the last one, which as we all remember was pretty bad.) And it is this prognosis that is driving global rates to zero and below. Phenomenally, more than 25% of all developed market government bonds outstanding now have negative yields, something over $13.4 Trillion worth. And that number is going to continue to grow, especially given the fact that we are about to enter an entirely new rate cutting cycle despite not having finished the last one! It is a strange world indeed!

Looking at markets this morning, ahead of the data onslaught, shows that the dollar continues its winning ways, with the pound the worst performer as more and more traders and investors begin bracing for a no-deal Brexit. As I type, Sterling is lower by 0.55%, taking it near 1.23 and its lowest point since January 2017. As long as PM BoJo continues to approach the EU with a hard-line stance, I expect the pound to remain under pressure. However, I think that at some point the Irish are going to start to scream much louder about just how negative things will be in Ireland if there is no deal, and the EU will buckle. At that point, look for the pound to turn around, but until then, it feels like it can easily breech the 1.20 level before summer’s out.

But the dollar is generally performing well everywhere, albeit not quite to the same extent. Rather we are seeing continued modest strength, on the order of 0.1%-0.2% against most other currencies. This has been the pattern for the past several weeks and it is starting to add up to real movement overall. It is no wonder that the White House has been complaining about currency manipulation elsewhere, but I have to say that doesn’t appear to be the case. Rather, I think despite the international community’s general dislike of President Trump, at least according to the press, investors continue to see the US as the destination with the most profit opportunity and best prospects overall. And that will continue to drive dollar based investment and strengthen the buck.

Away from the FX markets, we have seen pretty inconsequential movement in most equity markets with two exceptions (FTSE +1.50% on the weak pound and KOSPI -1.8% on increasing trade issues and correspondingly weaker growth in South Korea). As to US futures markets, they are pointing to essentially flat openings here this morning, although the earnings data will continue to drive things. And bond markets have seen similarly modest movement with most yields within a basis point or two of Friday’s levels. Consider two bonds in Europe in particular; Italian 10-year BTP’s yield 1.54%, more than 50bps less than Treasuries, and this despite the fact that the government coalition is on the rocks and the country’s fiscal situation continues to deteriorate amid a recession with no ability to cut rates directly; and Greek 10-year yields are 2.05% vs. 2.08% for US Treasuries! Yes, Greek yields are lower than those in the US, despite having defaulted on their debt just 7 years ago! It is a strange world indeed.

A look at the data this week shows a huge amount of information is coming our way as follows:

Tuesday BOJ Rate Decision -0.10% (unchanged)
  Personal Income 0.4%
  Personal Spending 0.3%
  Core PCE 1.7%
  Case-Shiller Home Prices 2.4%
  Consumer Confidence 125.0
Wednesday ADP Employment 150K
  Chicago PMI 50.5
  FOMC Rate Decision 2.25% (-25bps)
Thursday BOE Rate Decision 0.75% (unchanged)
  Initial Claims 214K
  ISM Manufacturing 52.0
  ISM Prices Paid 49.6
  Construction Spending 0.3%
Friday Trade Balance -$54.6B
  Nonfarm Payrolls 165K
  Private Payrolls 160K
  Manufacturing Payrolls 5K
  Unemployment Rate 3.6%
  Average Hourly Earnings 0.2% (3.2% Y/Y)
  Average Weekly Hours 34.4
  Factory Orders 0.8%
  Michigan Sentiment 98.5

And on top of that we see Chinese PMI data Tuesday night, Eurozone GDP and Inflation on Wednesday and a host of other Eurozone and Asian data releases. The point is it is quite possible that the current view of the world changes if the data shows a trend, especially if that trend is faster growth. Right now, the default view is global growth is slowing with the question just how quickly. However, a series of strong prints could well stop that narrative in its tracks. And ironically, that is likely the best opportunity for the dollar to stop what has been an inexorable, if slow, climb higher. However, the prospects of weak data elsewhere are likely to see an acceleration of central bank easing around the world with the dollar benefitting accordingly.

In sum, there is an awful lot happening this week, so be prepared for potentially sharp moves on missed expectations. But unless the data all points to faster growth away from the US while the US is slowing, the dollar’s path of least resistance remains higher.

Good luck
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Sans Details

In England and Scotland and Wales
A new PM finally hails
With Boris the man
We know the game plan
Is Brexit, as yet sans details

As of 7:05 this morning, it was finally official that Boris Johnson was elected as the new leader of the UK’s Conservative and Unionist Party (aka the Tories) by a substantial margin. By all rights, as of tomorrow, he will be the new Prime Minister of the UK. Congratulations Boris!

And so, the Brexit story now takes a new turn as Boris was instrumental in campaigning for the vote three years ago, and has been a vocal supporter ever since, unlike his predecessor, Theresa May. He has been abundantly clear that if the EU does not reopen the negotiations, he will take the UK out of the EU without a deal. Yet to date, the EU has been adamant that the only deal available is the one they have already tabled. Since the beginning, I have maintained that while the UK will certainly be negatively impacted by a no-deal Brexit, the EU will also feel significant pain. This is especially true in northern Europe, with Germany, France and the Netherlands amongst the biggest exporters to the UK. Thus, we are now involved in the biggest game of chicken seen in the global economy in a very long time. (While the politicians describe this as brinksmanship, I think chicken is a better label.) At this point, it is anybody’s guess how things will turn out, but what we do know is that if there really is a no-deal Brexit, the pound will fall much further, the euro will decline, and global growth will slow further.

As it happens, we are already seeing the UK economy slip, with the latest evidence being this morning’s CBI report which printed at a much worse than expected -34, its lowest since the immediate wake of the Brexit vote in 2016. And not surprisingly, the pound remains under pressure, down 0.1% as I type, which makes 2.1% during the past month. In addition, we heard from BOE member Saunders, who confirmed that the BOE default assumption of a smooth Brexit may not be the outcome, and that monetary policy will need to adjust to the new realities in that case. While he continues to fear a stagflationary outcome, there remains little case for the BOE to raise rates anytime soon. The evidence is abundantly clear that in a global rates environment that is declining, there is virtually no chance the UK would tighten policy in any way. Despite the fact that the US has far more room to cut rates than the UK, the problems attendant to Brexit, at least initially, are going to continue to weigh on the pound going forward.

Away from the Brexit story, all eyes are turning toward the ECB meeting to be held in two days’ time in Frankfurt. While most analysts around the world are convinced that Signor Draghi is going to use this meeting to set the table for more action in September, the market is moving toward my view that a rate cut is coming Thursday. OIS markets are pricing in a 40% probability of a 10bp cut, and there are a few outlier analysts who are even calling for 20 bps right away. After all, if you consider what NY Fed president Williams said last week about how, when rates are low, acting aggressively right away is a better strategy than a slow decline in rates, that would argue for 20 bps on Thursday. The other question is whether they will introduce some sort of tiering into the program to allow the European banks, which have been getting killed by the negative rate charges, to exempt some portion of their excess reserves from the penalty rates. That is actually a huge deal, and one where there is very little clarity. In the meantime, despite the fact that the market is certain the Fed is going to cut rates by 25 bps next week, I think the euro has room to fall further in the interim. It is lower by 0.25% this morning, and I expect a move toward 1.10, especially as I believe they will cut Thursday.

As to the rest of the G10, the dollar is broadly stronger, but the magnitude of change remains very modest, on the order of 0.10%-0.20%. In the EMG space, the dollar has also seen broad strength, although here, too, the size of the movement remains muted, with the biggest losers falling just 0.3% (PLN, HUF, IDR). It should be no surprise that markets continue to bide their time as we await the official news from the ECB as well as Friday’s US GDP data, which will clearly play into the FOMC decision next week.

And that’s pretty much today’s story. Equity earnings continue to be released, and it seems that most are beating the lowered expectations that are out there. This has been enough to prevent further equity market damage but has not led to significant gains. On the rate front, Treasuries have been stagnant for the past few sessions with 10-year yields standing at 2.03%, well off the highs seen two weeks ago in a technical sell-off, but certainly with plenty of room to decline from here, especially in the event the Fed does cut 50. We get one piece of data, Existing Home Sales (exp 5.33M), but that seems unlikely to change many views regardless of the outcome. So, my view remains that the dollar’s slow drift higher is still the most likely outcome for now.

Good luck
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Lingering Issues

Some pundits now have the impression
That we will soon be in recession
The data of late
Has spurred the debate
And could remove Powell’s discretion

Meanwhile, we just heard from Herr Draghi
That “lingering” issues made foggy
The future of growth
So he and Jay both
Will soon ease ere things turn too quaggy

Some days, there is far more to discuss than others, and today is one of those days. Markets are trying to digest all of the following information: weaker US data, weaker Eurozone data, dovish comments from Signor Draghi, confirmation the RBA is likely to cut rates again, increased likelihood that Boris Johnson will be the next PM in the UK, and increased tensions in the Middle East.

Starting at the top, yesterday’s Empire State Manufacturing survey printed at a much worse than expected -8.6, which represented a 26.4-point decline from May’s survey and the largest fall on record. It was a uniformly awful report, with every sub-index weak. While by itself, this report is generally second tier data, it is adding to the case that the US economy is slowing more rapidly than had previously been expected and is increasing market expectations that the Fed will act sooner rather than later. We will see how that turns out tomorrow.

Then this morning, the German ZEW Survey was released at -21.1, a 19-point decline and significantly worse than expected. This is seen as a potential harbinger of further weakness in the German economy adding to what has been a run of quite weak manufacturing data. Although auto registrations in the Eurozone ticked ever so slightly higher in May (by 0.04%), the trend there also remains sharply downward. All in all, there has been very little encouraging of late from the Continent.

Then Signor Draghi got is turn at the mike in Sintra, Portugal, where the ECB is holding its annual summer festivities, and as usual, he did not disappoint. He explained the ECB has plenty of tools left to address “lingering” risks in the economy and hinted that action may be coming soon. He expressly described the ability for the ECB to cut rates further as well as commit to keep rates lower for even longer. And he indicated that QE is still available as the only rules that could restrict it are self-imposed, and easily changed. Arguably, this had the biggest impact of the morning as Eurozone equities rocketed on the prospect of lower rates, bouncing back from early losses and now higher by more than 1.0% on the day across the board. German bunds have plumbed new yield depths, touching -0.30% while the euro, to nobody’s surprise, has weakened further, ceding modest early gains to now sit lower by -0.3%. This is proof positive of my contention that the Fed will not be easing policy in isolation, and that if they start easing, you can be sure that the rest of the world will be close behind. Or perhaps even ahead!

Adding to the news cycle were the RBA minutes, which essentially confirmed that the next move there will be lower, and that two more rate cuts this year are well within reason as Governor Lowe tries to drive unemployment Down Under to just 4.5% from its current 5.2% level. Aussie has continued its underperformance on the news, falling a further 0.1% this morning and is now back to lows last touched in January 2016. And it has further to fall, mark my words.

Then there is the poor old pound, which has been falling sharply for the past week (-1.75%) as the market begins to price in an increased chance of a no-deal Brexit. This is due to the fact that Boris Johnson is consolidating his lead in the race to be the next PM and he has explicitly said that come October 31, the UK will be exiting the EU, deal or no deal. Given the EU’s position that the deal on the table is not open for renegotiation, that implies trouble ahead. One thing to watch here is the performance of Rory Stewart, a dark horse candidate who is gaining support as a compromise vs. Johnson’s more hardline stance. The point is that any indication that Johnson may not win is likely to see the pound quickly reverse its recent losses.

And finally, the Middle East continues to see increased tensions as Iran announced they were about to breach the limits on uranium production imposed by the ill-fated six-nation accord while the US committed to increase troop deployment to the area by 1000 in the wake of last week’s tanker attacks. Interestingly, oil is having difficulty gaining any traction which is indicative of just how much market participants are anticipating a global economic slowdown. OPEC, too, has come out talking about production cuts and oil still cannot rally.

To recap, bond, currency and commodity markets are all forecasting a significant slowdown in economic activity, but remarkably, global stock markets are still optimistic. At this point, I think the stock jockeys are on the wrong side of the trade.

As to today, we are set to see Housing Starts (exp 1.239M) and Building Permits (1.296M) at 8:30. Strong data is likely to have little impact on anybody’s thinking right now, but weakness will start to drive home the idea that the Fed could act tomorrow. Overall, the doves are in the ascendancy worldwide, and rightly so given the slowing global growth trajectory. Look for more cooing tomorrow and then on Thursday when both the BOJ and BOE meet.

Good luck
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Doves There Held Sway

It seems that a day cannot pass
When one country ‘steps on the gas’
Twas China today
Where doves there held sway
With funding for projects en masse

If I didn’t know better, I would suspect the world’s central banks of a secret accord, where each week one of them is designated as the ‘dove du jour’ and makes some statement or announcement that will serve to goose stock prices higher. Whether it is Fed speakers turning from patience to insurance, the ECB promising more of ‘whatever it takes’ or actual rate cuts a la the RBA, the central banks have apparently realized that the only place they continue to hold sway is in global stock markets. And so, they are going to keep on pushing them for as long as they can.

This week’s champion is the PBOC, which last night eased restrictions further on infrastructure investment by local governments, allowing more issuance of ‘special bonds’ and encouraging banks to lend more for these projects. At the same time, the CNY fix was its strongest in a month, back below the 6.90 level, as the PBOC makes clear that for the time being, it is not going to allow the yuan to display any unruly behavior. True to form, Chinese equity markets roared higher led by construction and cement companies, and once again we see global equity markets in the green.

While in the short run, investors remain happy, the problem is that in the medium and longer term, it is unclear that the central banking community has sufficient ammunition left to really help economic activity. After all, how much lower is the ECB going to cut rates from their current -0.4% level? And will that really help the economy? How many more JGB’s can the BOJ buy given they already own about 50% of the market? In truth, the Fed and the PBOC are the only two banks with any real leeway to ease policy enough to have a real economic impact, rather than just a financial markets impact. And for a world that has grown completely reliant on central bank activity to maintain economic growth, that is a real problem.

Adding to these woes is the ongoing trade war situation which seems to change daily. The latest news on this front is that if President Xi won’t sit down with President Trump at the G20 meeting in Japan later this month, then the US will impose tariffs on all Chinese imports. However, it seems the market is becoming inured to statements like these as there has been precious little discussion on the subject, and the PBOC’s actions were clearly far more impactful.

The question is, how long can markets continue to ignore what is a clearly deteriorating global economic picture before responding? And the answer is, apparently, quite a long time. Or perhaps that question is aimed only at equity markets because bond markets clearly see a less rosy future. At some point, we are going to see a central bank announcement result in no positive impact, or perhaps even a negative one, and when that occurs, be prepared for a rockier ride.

Turning to the FX markets this morning, the dollar has had a mixed session, although is arguably a touch softer overall. So far this month, the euro, which is basically unchanged this morning, has rallied 1.4%, while the pound, which is a modest 0.15% higher this morning after better than expected wage data, is higher by just 0.5%. My point is that despite some recent angst in the analyst community that the dollar was due to come under significant pressure, the overall movements have been quite small.

In the EMG bloc, there has also been relatively little movement this month (and this morning) as epitomized by the Mexican peso, which fell nearly 3% last week after the threat of tariffs being imposed unless immigration changes were made by Mexico, and which has recouped essentially all of those losses now that the tariffs have been averted. China is another example of a bit of angst but no substantial movement. This morning, after the PBOC drove the dollar fix lower, the renminbi is within pips of where it began the month. Again, FX markets continue to fluctuate in relatively narrow ranges as other markets have seen far more activity.

Repeating what I have highlighted many times, FX is a relative market, and the value of one currency is always in comparison to another. So, if monetary policies are changing in the same direction around the world, then the relative impact on any currency is likely to be muted. It is why, despite the fact that the US has more room to ease policy than most other nations, I expect the dollar to quickly find its footing in the event the Fed gets more aggressive. Because we know that if the Fed is getting aggressive, so will every other central bank.

Data this morning has seen the NFIB Small Business Optimism Index rise to 105.0, indicating that things in the US are, perhaps, not yet so dire. This is certainly not the feeling one gets from the analyst community or the bond market, but it is important to note. We do see PPI as well this morning (exp 2.0%, 2.3% core) but this is always secondary to tomorrow’s CPI report. The Fed remains in its quiet period so there will be no speakers, and the stock market is already mildly euphoric over the perceived policy ease from China last night. Quite frankly, it is hard to get excited about much movement at all in the dollar today, barring any new commentary from the White House.

Good luck
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A New Race Begins

The die has now finally been cast
Prime Minister May’s time has past
A new race begins
With fears that who wins
Will push for a hard Brexit fast

June 7, 2019 is the day on which Theresa May will step down from her role as leader of the Conservative Party in the UK, and consequently Prime Minister. While she will remain in the chair as caretaker, she will no longer drive policy. Instead, we will get to hear about the ensuing political machinations of each of the MP’s who want to replace her. At this time, the leading candidate is Boris Johnson, who was Foreign Minister until he resigned about a year ago under protest of how May was conducting the Brexit negotiations. He is seen as quite committed to having the UK exit and is not afraid of a no-deal outcome. Also in the running is ex-Brexit Minister, Dominic Raab, who while clearly pushing for finality is not seen quite as hardline as Johnson.

The mechanics of the process are a bit arcane, especially for Americans unfamiliar with the Parliamentary process. Briefly, the PM is the leader of the party that wins the most seats in Parliament. The Conservative Party, while without a current majority, leads the government through a coalition with the Democratic Unionist Party of Northern Ireland. There are 120,000 members of the Conservative Party (active party members) who will vote to determine the new leader of the party. The current MP’s will have a series of polls to whittle potential successors down to just two candidates for that vote. The key to remember is that these 120K are the activist wing and are substantially more pro-Brexit than the party at large. As such, it is quite possible, if not likely, that the next PM makes an exit, deal or not, a requirement by the new deadline of October 31.

But politics is a funny thing, and as we have all learned over the past few years, what polls say and how people vote are not necessarily the same thing. At this time, the market has clearly been pricing in an increasing probability of a hard Brexit, although it is by no means fully priced. Last week I proffered a table showing my estimates of probabilities for each of three scenarios and will update it here:

  May 16, 2019 May 17, 2019 May 24, 2019
Soft Brexit 50% 20% 5%
Vote to Remain 30% 35% 40%
Hard Brexit 20% 45% 55%

It strikes me that the idea of a deal is going away. Given the EU’s position that they will not renegotiate, the choices have come down to stay or leave with no deal. Simply based on the fact that the pound has been falling for the past three weeks, my assumption is that preparations for a hard Brexit are moving apace. As it happens, this morning the pound has rallied slightly, +0.25%, but the trend remains quite clear and this was likely short-term profit taking into the long holiday weekend. The path of least resistance for the pound remains lower.

And actually, short-term profit taking seems to be the story of the day in the FX markets. The dollar is very modestly softer across the board after a week of steady strength. For instance, the euro, after a 0.4% jump on the back of weaker than expected New Home Sales yesterday morning has maintained that gain but been unable to rally further. We see AUD and NZD both having bounced (0.1% and 0.35% respectively) and CAD is firmer by 0.2%. Meanwhile, the yen, which has rallied 1% on its haven status during the past week, has edged down 0.1%.

Speaking of havens, after a pretty awful week in the equity markets, this morning Europe is bouncing, and US futures are pointing higher. At the same time, Treasury yields, which traded as low as 2.29% yesterday (their lowest since October 2017) have rebounded slightly to 2.32%. Bunds also dipped to their lowest level (-0.117%) since October 2016 yesterday. In other words, risk appetite has clearly been under pressure lately.

However, this morning, there is a little relief, at least on the trading front, and that can be seen in the EMG bloc as well. The CE4, most of APAC and LATAM’s opening are all showing very modest strength. The only currency moving more aggressively has been INR, where PM Modi’s surprisingly strong showing in the election, where he clearly won a strong mandate to continue his policies, has been seen as a huge boon for the Indian economy and helped the rupee gain 1.4% this week.

Turning to the data today, we get Durable Goods (exp -2.0%, +0.2% ex-Transport) as the final piece of the puzzle before the holiday weekend. After a spate of Fed speakers, there is nothing scheduled on that front either. On this subject, Dallas Fed President Kaplan yesterday reiterated the party line of patience, explaining that there was no compelling evidence right now to drive his decision on the next policy move. There are currently 15 members of the FOMC (two governor roles remain empty), and my tally is there are 3-4 who would be quick to cut rates with the remaining group firmly in the do-nothing camp. If upcoming data next week starts to point to a weakening trend, I would expect to see that ratio swing more dovish, but for now, there is no reason to believe that anything here is going to change. In other words, there are still more reasons for the dollar to rally than fall.

Good luck and have a great holiday weekend
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