New Brexit Day

In Britain and in the EU
They finally made a breakthrough
Three months from Thursday
Is New Brexit Day
Will England, at last, bid adieu?

So French President Macron finally agreed what we all knew he would agree, that the UK will get another three-month Brexit extension. The question now is whether or not the UK will be able to figure out how to end this saga. It is abundantly clear that Labour leader, Jeremy Corbyn, is terrified of a general election because he knows he and his party will be decimated, and he is likely to lose his role. However, it is also abundantly clear that Parliament, as currently constructed, is completely unable to finalize this process. Later today we will know if Boris will be able to convince two-thirds of the current Parliament to vote with him and prepare the ground for an election. Already, the Scottish National Party and Lib-Dems are on board, but that will not get the job done, Labour has to agree.

Throughout all these machinations, FX traders find themselves constantly searching for a clue as to the outcome but the big picture remains the same. A hard Brexit is still seen as resulting in a very sharp decline in the pound. Meanwhile, a smooth Brexit transition, where the negotiated deal is put in place, is likely to add a few cents more to the pound’s current value, at least in the short run. Finally, in the event that an election led to a Parliament that not only voted against the deal, but decided to withdraw Article 50, something not getting very much attention at all, then the pound would very likely head back north of 1.40. Of the three, my money is still on a negotiated withdrawal, but stranger things have happened. At any rate, we ought to no more before the end of the day when Parliament will have ostensibly voted on whether or not to hold the new election.

Moving on to the other stories in the market, there really aren’t very many at all! In fact, markets around the world seem to be biding their time for the next big catalyst. If pressed, I would point to Wednesday’s FOMC meeting as the next big thing.

On Wednesday the FOMC
Will issue their latest decree
While Fed Funds will fall
They don’t seem in thrall
To more cuts, lest growth soon falls free

As of this writing, the probability of the Fed cutting rates 25bps on Wednesday, at least according to futures market pricing, is 91%. This is a pretty good indication that the Fed is going to cut for a third time in a row, despite the fact that they keep exclaiming what a “good place” the economy is in. One of the interesting things about this is that both the Brexit situation and the trade situation seem to have improved substantially since the September meeting, which seemingly would have reduced the need for added stimulus. However, since the stock market continues to rely on the idea of ongoing stimulus for its performance, and since the performance of the stock market continues to be the real driver of Fed policy, I see no reason for them to hold back. However, inquiring minds want to know if Wednesday’s cut will be the last, or if they will continue down this slippery slope.

According to Fed funds Futures markets, expectations for another cut beyond this one have diminished significantly, such that there is only a 50% probability of the next cut coming by March 2020. And, after all, given the reduction in global tensions and uncertainty, as well as the recent hints from CPI that inflation may finally be starting to pick up, it seems that none of their conditions for cutting rates would be met. However, if Chairman Jay sounds hawkish in his press conference, and the result is that equity markets retreat, do not be surprised if those probabilities change in favor of another cut in December. So, we have much to look forward to this Wednesday.

Ahead of that, and after the UK parliament vote later today, though, I think we will rely on Wednesday morning’s data for the next opportunity for excitement. Here’s the full slate:

Tuesday Case Shiller Home Prices 2.10%
  Consumer Confidence 128.0
Wednesday ADP Employment 110K
  GDP 3Q 1.6%
  FOMC Decision 1.75% (-0.25%)
Thursday Initial Claims 215K
  Personal Income 0.3%
  Personal Spending 0.3%
  Core PCE 0.1% (1.7% Y/Y)
  Chicago PMI 48.0
Friday Nonfarm Payrolls 85K
  Private Payrolls 80K
  Manufacturing Payrolls -55K (GM Strike)
  Unemployment Rate 3.6%
  Average Hourly Earnings 0.3% (3.0% Y/Y)
  Average Weekly Hours 34.4
  Participation Rate 63.1%
  ISM Manufacturing 49.0
  ISM Prices paid 50.0

Source: Bloomberg

So, the back half of the week can certainly produce some excitement. Remember, the employment data will have been significantly impacted by the General Motors strike, which has since been settled. Expect to see a lot of analysis as to what the numbers would have been like absent the strike. But still, the Fed remains the dominant theme of the week. And then, since the press conference never seems to be enough, we will hear from four Fed speakers on Friday to try to explain what they really meant.

For now, though, quiet is the most likely outcome. Investors are not likely to get aggressive ahead of the Fed, and though short positions remain elevated in both euros and pounds, they have not been increasing of late. Overall, the dollar is little changed on the day, and I see little reason for it to move in either direction. Quiet markets are beneficial for hedgers, so don’t be afraid to take advantage.

Good luck
Adf

Kind of a Treat

For Boris, what looked like defeat
Is actually kind of a treat
For later today
His bill makes its way
Through Parliament, it to complete

The Brexit drama continues today, but it has become clear that Boris is moving toward a win, politically at least. The schedule today is for Parliament to debate and then hold its first vote on the actual legislation that would put Brexit into law. When Speaker of the House Bercow would not allow a second vote on the broad idea of accepting the new terms, it forced the PM to set out the new law’s details for a vote. And that is exactly what he has done. The goal is to get final approval by Thursday evening in the House of Commons, at which point it will go to the House of Lords for final approval. While the Lords have not been supportive of Brexit overall (after all, they have all benefitted greatly from the current situation) if it passes the House of Commons, it is expected to pass there as well. It is unquestionable that if this schedule holds up, the EU will pass the bill as well, and Brexit will be complete.

While there are still many potential pitfalls, the market has become pretty clear that they no longer believe in the idea of a no-deal Brexit. That is why we remain hovering around the 1.30 level instead of the 1.22 level we saw for most of the summer, when it seemed that all Boris wanted was to leave, and he was willing to leave without a deal. But even if there is a delay, it seems to me that Boris has the upper hand in any election that comes. He has done what he promised, negotiated a new treaty with a substantially better outcome than former PM May’s Irish backstop. The new bill puts the power of remaining tied to the EU in the hands of Northern Ireland, not the EU. There may yet be a second referendum, and there will almost certainly be an election before the end of the year, but at this point, Boris outflanked all the opposition. I strongly believe that a negotiated Brexit is coming to a screen near you before the year ends, and that the pound is going to have an opportunity to rally much further. At this point, a move to between 1.35-1.40 seems quite probable, although eventually I expect the dollar to reassert itself globally.

However, this is all speculation about the future, albeit the near future. For today, though, FX markets have continued to digest the news and the pound has been trading either side of yesterday’s closing levels. Currently, it is unchanged on the day, although there is an opportunity for movement this afternoon as the bill wends its way through Parliament’s byzantine process. At approximately 2:00pm, a vote is expected which will determine if the new bill has a chance to get passed. I think a ‘no’ vote will have a temporary negative impact on the pound, but am hard pressed to see Sterling sink below 1.28. If the vote is yes, then look for the pound to start to appreciate further as the market anticipates a conclusion to the process soon.

Away from Brexit, President Trump hinted that the ongoing trade talks are moving in the right direction and the market has assumed that the “initial phase” deal will be signed at the APEC meeting in Chile next month when presidents Trump and Xi are scheduled to meet.

So combined with the positive Brexit vibes, it appears two of the key geopolitical issues that have been hindering the global economy may be coming to a positive resolution. That certainly bodes well for economic growth, but it is unclear if it will be enough to turn the tide. First, neither one is actually complete yet, so this is all anticipation; and second, we have seen a significant slowdown in global manufacturing that will not simply rebound instantly. Even if business confidence improves sharply, it still takes time to formulate and implement new plans for business expansion. This implies that the current monetary policy framework is not going to be reversed any time soon.

Speaking of monetary policy, Thursday Signor Draghi presides over his last meeting as ECB president. After last month’s rate cut and restarting of QE, there are no expectations for further actions at this meeting. The one thing of which you can be sure is that he will complain about the lack of fiscal stimulus being implemented by the nations that can afford it (read Germany). But you can also be sure that the Germans are not about to change their plans.

But let us discuss one of the key problems in the Eurozone for a moment, the inconsistency between fiscal dogma and political will. While it is now de rigeur to claim that nations need to turn on the fiscal pumps, the European Commission has sent letters to Italy, France, Spain, Belgium and Portugal telling them not to spend so much money next year. In other words, despite desperate pleas to increase spending, they are going to prevent five nations seeking to do so, from accomplishing their goals. If you ever wondered why there is such fundamental bearishness on the euro and its construction, this situation could not be more informative. It is a key reason I believe the long term prospects for the single currency point lower.

To markets: FX has had another generally dull session overnight with the dollar just slightly firmer against most counterparts, but with movements generally less than 0.20%. In other words, there is little if any information in the price movement, which is likely a response to recent dollar weakness. Equity markets in Asia flourished after the US rally yesterday, but in Europe they can only be described as mixed. Meanwhile, US futures are pointing slightly lower, although not enough to imply very much. Treasury yields are a few bps lower, as are Bund yields, but the reality is that they have been pretty stable for the past two weeks and traders seem to be looking for the next real catalyst (FOMC anyone?).

Yesterday’s Canadian election had little impact on the Loonie, although PM Trudeau is returning with a weakened mandate in a minority government. That said, north of the border the economy has been performing pretty well, certainly well enough such that there seems to be no reason for the BOC to follow the Fed and cut rates next week alongside the Fed.

As to data this morning, Existing Home Sales (exp 5.45M) are unlikely to quicken any pulses, and with the Fed in its quiet period, quite frankly, I see a very quiet session until this afternoon, when the results of the first Brexit votes in parliament have an opportunity to spice things up a bit.

Good luck
Adf

 

Time’s Crunch

When Boris and Leo had lunch
No panties were balled in a bunch
The signals showed promise
And no doubting Thomas
Appeared, as both sides felt time’s crunch

Meanwhile, though there’s been no bombshell
The trade talks have gone “very well”
Today Trump meets He
And then we will see
If a deal betwixt sides can now gel

And finally from the Mideast
The story ‘bout risk has increased
A tanker attack
Had market blowback
With crude a buck higher at least

There is no shortage of important stories today so let’s jump right in. Starting with Brexit, yesterday’s lunch meeting between Boris Johnson and Leo Varadkar, the Irish PM, turned into something pretty good. While the comments have been very general, even EU president Donald Tusk as said there were “promising signals.” It is crunch time with the deadline now less than three weeks away. Apparently, the rest of the EU is beginning to believe that Boris will walk with no deal, despite the Benn Act requiring him to ask for an extension if there is no deal in place. At the same time, everybody is tired of this process and the EU has many other problems, notably a declining economy, to address. And so, I remain confident that we will soon hear, probably early next week, about a ‘deal in principle’ which will be ratified by Parliament as well as the EU. Though all the details will not have been completed, there will be enough assurances on both sides to get it through. Remember, Boris has Parliament on his side based on the deal he showed them. I’m pretty sure that his conversation with Leo yesterday used that as the starting point.

When that news hit the tape yesterday morning a little past 10:00, the pound started a significant rally, ultimately gaining 2% yesterday and it is higher by a further 1.0% this morning after more promising comments from both sides of the table. Remember, too, that the market remains extremely short pound Sterling and has been so for quite a while. If I am correct, then we could see the pound well above 1.30 as early as next week. Of course, if it does fall apart, then a quick trip back to 1.20 is on the cards. As I have said, my money is on a deal. One other thing to note here is what happened in the FX options market. For most of the past twelve years, the risk reversal (the price the market pays for 25 delta puts vs. 25 delta calls) has traded with puts at a premium. In fact earlier this year, the 1mo version was trading at a 2.5 vol premium for puts. Well, yesterday, the risk reversal flipped positive (bid for calls) and is now bid more than 1.0 vol for GBP calls. This is a huge move in this segment of the market, and also seen as quite an indicator that expectations for further pound strength abound.

Regarding the trade talks, risk assets have taken a very positive view of the comments that have come from both sides, notably President Trump describing things as going “very well” and agreeing to meet with Chinese Vice-premier Liu He this afternoon before he (He) returns to Beijing. The information that has come out points to the following aspects of a deal; a currency pact to insure the Chinese do not weaken the renminbi for competitive advantage; increased Chinese purchases of grains and pork; a US promise not to increase tariffs going forward as the broader negotiations continue; and the lifting of more sanctions on Chinese companies like Huawei and COSCO, the Chinese shipping behemoth. Clearly, all of that is positive and it is no surprise that equity markets globally have responded with solid gains. It is also no surprise that Treasury and Bund yields are much higher this morning than their respective levels ahead of the talks. In fact, Treasuries, which are just 1bp higher this morning, are up by more than 15bps since Tuesday. For Bunds, today’s price action shows no change in yields, but a 12bp move (less negative rates) since then. The idea is a trade deal helps global economic growth pick back up and quashes talk of deflation.

The last big story of the morning comes from the Persian Gulf, where an Iranian oil tanker, carrying about 1 million barrels of oil, was attacked by missiles near the Saudi port of Jeddah. At first the Iranians blamed the Saudis, but they have since retracted that statement. It should be no surprise that oil prices jumped on the news, with WTI futures quickly rallying more than a dollar and maintaining those gains since then. One of the key depressants of oil prices has been the global economic malaise, which does not yet look like it is over. However, if the trade truce is signed and positive vibes continue to come from that area, I expect that oil prices will benefit greatly as well.

As to the FX market per se, the dollar is overall under pressure. Of course, the pound has been the biggest mover in the G10 space, but AUD has gained 0.55% and the rest of the block is higher by roughly 0.3%. The only exceptions here are the yen (-0.3%) and Swiss franc (-0.1%) as haven assets are unloaded.

Turning to the EMG bloc, ZAR is today’s big winner, rallying more than 1.1% on two features; first the general euphoria on trade discussed above and second on the news that former President Jacob Zuma must face corruption charges. The latter is important because it demonstrates that the rule of law may be coming back into favor there, always a benefit for an emerging market. But most of the space is firmer this morning, with many currencies higher by between 0.5% and 0.6% (RUB, KRW, PLN, HUF, MXN, etc.) In fact, the only loser this morning is TRY (-0.4%), which remains under pressure as President Erdogan presses his military campaign against the Kurds in Syria.

On the data front, the only US news is Michigan Sentiment (exp 92.0) but we also get the Canadian employment picture (exp 7500 new jobs and a 5.7% Unemployment Rate). Three more Fed speakers, Kashkari, Rosengren and Kaplan, are on the slate, but so far, the only clarity of message we have received this week is that everybody is watching the data and will respond as they see fit. Hawks are still hawks and doves are still doves.

I see no reason for the dollar to regain ground today assuming the good news from Trade and Brexit continue. So look for a further decline into the holiday weekend.

Good luck and good weekend
Adf

PS. While typing, the pound jumped another 1.0%.

What He’s Wrought

The High Court within the UK
Explained in a ruling today
That Boris cannot
Complete what he’s wrought
A win for those who want to stay

As I wrote last Tuesday, the Supreme Court ruling in the UK cannot be a surprise to anyone. The issue was that twelve justices who were appointed to their seats from lives of privilege and wealth, and who almost certainly each voted to Remain two years ago, were going to decide whether Boris Johnson, a rebel in every conceivable way, would be allowed to lead the UK out of the EU against their personal views. These are folks who have greatly benefitted from the UK being within the EU, and they were not about to derail that gravy train. Thus, this morning’s ruling should have been the default case in everyone’s mind.

Interestingly, the ruling went far beyond simply the legality of the prorogation, but included a call for Parliament to reconvene immediately. Naturally, John Bercow, the speaker of the House of Commons, and an alleged non-partisan player, called on both sides of the aisle to get back to work post haste. Given that prorogation was nothing new in Parliament, having occurred on a fairly regular basis since 1628 when King Charles I first did so, and since there is no written constitution in the UK by which to compare laws to a basic canon, it will be interesting in the future when another PM seeks prorogation at a time less fraught than the current Brexit induced mania, whether or not they have the ability to do so.

Nonetheless, we can expect Parliament to reconvene shortly and try to do more things to insure that Boris cannot unilaterally ignore the current law requiring the PM to ask for an extension if there is no deal agreed at the deadline. In other words, there is still plenty of action left in this process, with just 37 days left until the current deadline.

And what of Sterling you ask? When the announcement hit the tape at 5:30 this morning, it jumped a quick 0.4% to just below 1.2500. That move had all the hallmarks of short covering by day traders, and we have since removed half of that gain. Interestingly, Boris is currently at the UN session in NY meeting with his EU counterparts and trying to get a deal in place. In the end, I still believe that the EU is ready to relent on some issues to pave the way for a deal of some sort. As European economic data continues to melt down (German IFO Expectations fell to 90.8, well below forecasts and the lowest in more than a decade), there is a growing sense of urgency that the EU leadership cannot afford to allow a hard Brexit. Combining that view with the fact that everybody over there is simply tired of the process and wants it to end means that a deal remains far more likely than not. As such, I remain pretty confident that we will see a deal before the deadline, or at least agreement on the key Irish backstop issue, and that the pound will rebound sharply.

Away from that story, however, things are far less exciting and impactful. On the trade front, news that China has allowed exemptions from soybean tariffs for a number of Chinese importers has been met with jubilation in the farm belt, and has imparted a positive spin to the equity market. Last week’s trepidations over the canceling of the Chinese delegation’s trip to Montana and Nebraska is ancient history. The narrative is back to progress is being made and a deal will happen sooner or later. Equity markets have stabilized over the past two days, although in order to see real gains based on the trade situation we will need to see more definitive progress.

Bond prices continue to focus on the global industrial malaise that is essentially made evident every day by a new data release. Yesterday it was PMI, today IFO and later this week, on Thursday, we will see Eurozone confidence indicators for Industry, Services and Consumers. All three of these have been trending lower since the winter of 2017 and there is no reason to expect that trend to have changed. As such, it is no surprise that we continue to see government bond yields slide with Treasuries down a further 3bps this morning as are JGB’s. Bunds, however, have seen less buying interest and have seen yields fall just 1bp. The story with Bunds is more about the increasing calls for fiscal stimulus in the Eurozone. Signor Draghi has tried his best but the Teutons remain stoic in the face of all his pressure. But Draghi is an economist. Incoming ECB President Christine Lagarde is a politician and may well be the best choice for the role after all. If she has the political nous to change Merkel’s views, that will be enough to open the taps, arguably support growth in the EU and reduce the need for further monetary ease. However, that is a BIG if.

One other story out of China describes comments from PBOC Governor Yi Gang that essentially said there was no reason for them to ease policy aggressively at this time, although they have plenty of tools available if they need to do so in the future. It is clear they are still quite concerned over inflating a housing bubble and will do all they can to prevent any further excess leverage in the real estate sector. It should not be surprising that the renminbi benefitted from these comments as it is 0.25% stronger than yesterday. The combination of a slightly more hawkish PBOC and the positive trade news was all it took.

Turning to this morning’s session, things are pretty quiet at this time. There are only two minor pieces of data, Case Shiller House Prices (exp 2.90%) and Consumer Confidence (133.0). On the speaker front, nobody is scheduled today although yesterday we heard from a number of doves, Bullard, Daly and Williams, all of whom agreed with the recent rate cut. With the day’s big news out of the way, I anticipate a relatively uneventful session. Overall the dollar is slightly softer on the day, and it seems reasonable to believe that trend will stay in place so look for a modest decline as the day progresses.

Good luck
Adf

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
Adf

 

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
Adf

 

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
Adf