Open and Shut

Kashakari, on Friday, explained
For US growth to be sustained
The case for a cut
Was open and shut
Since then, talk of fifty has gained

As the new week begins, last week’s late trends remain in place, i.e. limited equity market movement as uncertainty over the outcome of the Trump-Xi meeting continues, continued demand for yield as investors’ collective belief grows that more monetary ease is on the way around the world, and a softening dollar vs. other currencies and commodities, as the prevailing assumption is that the US has far more room to ease policy than any other central bank. Certainly, the last statement is true as US rates remain the highest in the developed world, so simply cutting them back to the zero bound will add much more than the stray 20bps that the ECB, which is already mired in negative territory, can possibly add.

It is this concept which has adjusted my shorter-term view on the dollar, along with the view of most dollar bulls. However, as I have discussed repeatedly, at some point, the dollar will have adjusted, especially since the rest of the world will need to get increasingly aggressive if the dollar starts to really decline. As RBA Governor Lowe mentioned in a speech, one of the key methods of policy ease transmission by any country is by having the local currency decline relative to its peers, but if everyone is easing simultaneously, then that transmission channel is not likely to be as effective. In other words, this is yet another central bank head calling for fiscal policy stimulus as he admits the limits that exist in monetary policy at this time. Alas, the herd mentality is strong in the central bank community, and so I anticipate that all of them will continue down the same path with a minimal ultimate impact.

What we do know as of last week is there are at least two FOMC members who believe rates should be lower now, Bullard and Kashkari, and I suspect that there are a number more who don’t have to be pushed that hard to go along, notably Chairman Powell himself. Remember, if markets start to decline sharply, he will want to avoid as much of the blame as possible, so if the Fed is cutting rates, he covers himself. And quite frankly, I expect that almost regardless of how the data prints in the near-term, we are going to see policy ease across the board. Every central bank is too committed at this point to stop.

The upshot of all this is that this week is likely to play out almost exactly like Friday. This means a choppy equity market with no trend, a slowly softening dollar and rising bond markets, as all eyes turn toward Osaka, Japan, where the G20 is to meet on Friday and Saturday. Much to their chagrin, it is not the G20 statement of leaders that is of concern, rather it is the outcome of the Trump-Xi meeting that matters. In fact, that is pretty much the only thing that investors are watching this week, especially since the data releases are so uninteresting.

At this point, we can only speculate on how things will play out, but what is interesting is that we have continued to hear a hard line from the Chinese press. Declaring that they will fight “to the end” regarding the trade situation, as well as warning the US on doing anything regarding the ongoing protests in Hong Kong. Look for more bombast before the two leaders meet, but I think the odds favor a more benign resolution, at least at this point.

Turning to the data situation, the only notable data overnight was German Ifo, which fell to 97.4, its lowest level since November 2014, and continuing the ongoing trend of weak Eurozone data. However, the euro continues to rally on the overwhelming belief that the US is set to ease policy further, and this morning is higher by 0.25%, and back to its highest point in 3 months. As to the rest of the week, here’s what to look forward to:

Tuesday Case-Hiller Home Prices 2.6%
  Consumer Confidence 131.2
  New Home Sales 680K
Wednesday Durable Goods -0.1%
  -ex transport 0.1%
Thursday Initial Claims 220K
  Q1GDP 3.2%
Friday Personal Income 0.3%
  Personal Spending 0.4%
  Core PCE 0.2% (1.6% Y/Y)
  Chicago PMI 53.1
  Michigan Sentiment 98.0

Arguably, the most important point is the PCE data on Friday, but of more importance is the fact that we are going to hear from four more Fed speakers early this week, notably Chairman Powell on Tuesday afternoon. And while the Fed sounded dovish last week, with the subsequent news that Kashkari was aggressively so, all eyes will be looking to see if he is persuading others. We will need to see remarkably strong data to change this narrative going forward. And that just seems so unlikely right now.

In the end, as I said at the beginning, this week is likely to shape up like Friday, with limited movement, and anxiety building as we all await the Trump-Xi meeting. And that means the dollar is likely to continue to slide all week.

Good luck
Adf

QE Will Soon Have Returned

The ECB started the trend
Which helped the bond market ascend
Then yesterday Jay
Was happy to say
A rate cut he’d clearly portend

Last night from Japan we all learned
Kuroda-san was not concerned
That yields there keep falling
And if growth is stalling
Then QE will soon have returned

This morning on Threadneedle Street
The Governor and his staff meet
Of late, they’ve implied
That rates have upside
But frankly, that tune’s obsolete

This morning, every story is the same story, interest rates are going lower. Tuesday, Signor Draghi told us so. Yesterday Chairman Jay reiterated the idea, and last night, Kuroda-san jumped on the bandwagon. This morning, Governor Carney left policy unchanged, although he continues to maintain that interest rates in the UK could rise if there is a smooth exit from the EU. Gilt markets, however, clearly don’t believe Carney as yields there fall and futures markets are pricing in a 25bp rate cut by the end of the year.

But it is not just those banks that are looking to ease policy. Remember, several weeks ago the RBA cut rates to a new record low at 1.25%, and last night, Governor Lowe indicated another cut was quite realistic. Bank Indonesia cut the reserve requirement by 0.50% last night and strongly hinted that an interest rate cut was on its way. While Bangko Sentral ng Pilipanas surprised most analysts by leaving rates on hold due to an uptick in inflation, that appears to be a temporary outcome. And adding to the Asian pressure is the growing belief that the RBNZ is also set to cut rates right before Australia does so.

In fact, looking around the world, there is only one place that is bucking this trend, Norway, which actually increased interest rates this morning by 25bp to a rate of 1.25%. In fairness, Norway continues to grow strongly, estimated 2.6% GDP growth this year, and inflation there is running above the 2.0% target and forecast to continue to increase. And it should be no surprise that the Norwegian krone is this morning’s best performing currency, rallying 1.0% vs. the euro and 1.5% vs. the dollar.

But in the end, save Norway, every story is still the same story. Global GDP growth is slowing amid increased trade concerns while inflationary pressures are generally absent almost everywhere. And in that environment, policy rates are going to continue to fall.

The market impacts ought not be too surprising either. Equity investors everywhere are giddy over the thought of still lower interest rates to help boost the economy. Or if not boosting the economy, at least allowing corporations to continue to issue more debt at extremely low levels and resume the stock repurchase schemes that have been underpinning equity market performance. Meanwhile, bond market investors are pushing the central banks even further, with new low yield levels in many countries. For example, in the 10-year space, German bunds are at -0.31%; Japanese JGB’s are at -0.18%; UK Gilts yield 0.81%; and Treasuries, here at home, have fallen to 2.01% right now, after touching 1.97% yesterday. It is abundantly clear that the market believes policy rates are going to continue to fall, and that QE is going to be reinstated soon.

As to the FX markets, yesterday saw the beginning of a sharp decline in the dollar with the euro up nearly 1.0% since the FOMC announcement, the pound +0.5% and the yen +0.6%. This makes sense as given the global rate structure, it remains clear that the Fed has the most room to ease from current settings, and thus the dollar is likely to suffer the most in the short term. However, as those changes take effect, I expect that the dollar’s decline will slow down, and we will find a new short-term equilibrium. I had suggested a 3%-5% decline before settling, and that still seems reasonable. After all, despite the fall yesterday, the dollar is simply back to where it was a week ago, before all the central bank fireworks.

With the BOE out of the way, the rest of the morning brings us two data releases, Initial Claims (exp 220K) and Philly Fed (11.0). For the former, there is still real scrutiny there given the weak NFP number earlier this month, and estimates have been creeping slightly higher. A big miss on the high side will likely see rates fall further and the dollar with them. As to the latter, given the huge miss by the Empire Manufacturing print on Monday, there will be wariness there as well. A big miss here will become the second piece of news that indicates a more acute slowing of the US economy, and that will also likely see rates fall further.

In fact, that is the theme for now, everything will be an excuse for rates to fall until the meeting between President’s Trump and Xi next week, with all eyes looking for signs that the trade situation will improve. And one other thing to remember is that tensions in the Middle East are increasing after Iran claimed to have shot down a US drone. Both oil and gold prices are much higher this morning, and I assure you, Treasuries are a beneficiary of this story as well.

So, for the dollar, things look dim in the short and medium term, however, I see no reason for a prolonged decline. Hedgers should take advantage of the weakness in the buck to add to hedges over the next few weeks.

Good luck
Adf

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
Adf

 

Constant Hyperbole

On Wednesday the FOMC
Will offer their latest decree
Will Fed funds be pared?
Or will Jay be scared
By Trump’s constant hyperbole?

The one thing that’s patently clear
Is rates will go lower this year
And lately some clues
Show Powell’s new views
Imply NIRP he’ll soon engineer

Once again, market movement overnight has been muted as traders and investors look ahead to Wednesday’s FOMC meeting and Chairman Powell’s press conference afterwards. Current expectations are for the removal of the word ‘patient’ from the statement and some verbiage that implies rates will be adjusted as necessary to maintain the US growth trajectory. Futures markets are pricing just a 25% probability of a rate cut on Wednesday, but a virtual certainty of one at the July meeting in six weeks’ time. With that said, there are several bank analysts calling for a cut today, or a 50bp cut in July. The one thing that seems abundantly clear is that interest rates in the US have reached their short-term peak, with the next move lower.

However, in the Mariner Eccles building, they have another dilemma, the fact that Fed funds are just 2.50%, the lowest cyclical peak in history. It has been widely recounted that the average amount of rate cutting by the Fed when fighting a recession has been a bit more than 500bps, which given the current rate, results in two possibilities: either they will have to quickly move to use other policy tools, like QE; or interest rates in the US are going to go negative before long! And quite frankly, I expect that it will be a combination of both.

Consider, while the Fed did purchase some $3.5 trillion of assets starting with QE1 in 2009, the Fed balance sheet still represents just 19% of US GDP. This compares quite favorably with the ECB (45%) and the BOJ (103%), but still represents a huge increase from its level prior to the financial crisis. Funnily enough, while there was a great deal of carping in Congress about QE by the (dwindling) hard-money set of Republicans, if the choice comes down to NIRP (Negative Interest Rate Policy) or a larger balance sheet, I assure you the politicians will opt for a larger balance sheet. The thing is, if the economy truly begins to slow, it won’t be a choice, it will be a combination of both, NIRP and QE, as the Fed pulls out all the stops in an effort to prevent a downturn.

And NIRP, in the US, will require an entirely new communications effort because, as in Europe and Japan, investors will find themselves on the wrong side of the curve when looking for short term investments. Money market funds are going to get crushed, and corporate treasuries are going to have to find new places to invest. It will truly change the landscape, and it is not clear it will do so in a net positive way. But regardless, NIRP is coming to a screen near you once the Fed starts cutting, although we are still a number of months away from that.

With that in mind, the obvious next question is how it will impact other markets. I expect that the initial reaction will be for a sharp equity rally, as that is still the default response to rate cuts. However, if the Fed is looking ahead and sees trouble on the horizon, that cannot be a long-term positive for equities. It implies that earnings numbers are going to decline, and no matter how ‘bullish’ interest rate cuts may seem, declining earnings are hard to overcome.

Bonds, on the other hand, are easy to forecast, with a massive rally in Treasuries, a lagging rally in corporates, as spreads widen into a weakening economy, but for high-yield bonds, I would expect significant underperformance. Remember, during the financial crisis, junk bond yield spreads rose to 20.0% over Treasuries. In another economic slowdown, I would look for at least the same, which compares to the current level of about 5.50%.

Finally, the dollar becomes a difficult question. Given the Fed has far more room to ease policy than does the ECB, the BOJ, the BOE or the BOC, it certainly seems as though the first move would be lower in the buck. However, if the Fed is easing policy that aggressively, you can be sure that every other central bank is going to quickly follow. Net I expect that we could see a pretty sharp initial decline, maybe 5%-7%, but that once the rest of the world gets into gear, the dollar will find plenty of support.

A quick look at markets overnight shows that the dollar is little changed overall, with some currencies slightly firmer and others slightly softer. However, there is no trend today, nor likely until we hear from the Fed on Wednesday.

Looking at data this week, it is much less interesting than last week’s and unlikely to sway views.

Today Empire Manufacturing 10.0
Tuesday Housing Starts 1.239M
  Building Permits 1.296M
Wednesday FOMC Rates 2.50% (unchanged)
Thursday BOJ Rates -0.10% (unchanged)
  Initial Claims 220K
  Philly Fed 11.0
  Leading Indicators 0.1%
Friday Existing Home Sales 5.25M

As I said, not too interesting. And of course, once the Fed meeting is done, we will get to hear more from the various Fed members, with two speakers on Friday afternoon (Brainard and Mester) likely to be the beginning of a new onslaught.

Yes, the trade situation still matters, but there is little chance of any change there until the G20 meeting next week, and that assumes President’s Trump and Xi agree to meet. So, for now, it is all about the Fed. One last thing, the ECB has their Sintra meeting (their answer to Jackson Hole) this week, and it is likely that we will hear more about their thinking when it comes to easing policy further given their current policy settings include NIRP and a much larger balance sheet already. Any hint that new policies are coming soon will certainly undermine the single currency. Look for that beginning on Wednesday as well.

Good luck
Adf

Powell’s Fixation

The latest release on inflation
Revealed, despite Powell’s fixation,
That prices have yet
To pose a real threat
So, look for more accommodation

Much to the Fed’s chagrin, yesterday’s inflation data was disappointing, with CPI rising just 1.8% in May, below both expectations and their target. Of course, they don’t target CPI, but PCE instead, however, history has shown that PCE typically runs about 0.3%-0.4% below CPI. Regardless of the statistic they view, what is abundantly clear is that price pressures, at least as measured by the both the Labor and Commerce departments, remain well below the level the Fed believes is consistent with a healthy economy. And it is this outcome which continues to animate the investment community.

If we ignore the comments from the White House and simply focus on the economic data, it is pretty easy to see why expectations of a rate cut are growing rapidly. The employment situation seems to have peaked and started to reverse, price pressures remain quiescent and every Q2 GDP forecast is for a pretty significant slowdown relative to Q1’s 3.1% rate. Given what appears to be a weakening trajectory in the US economy (not even considering the possibility of bigger issues driven by a full-blown trade war) and given that the Fed has implicitly assumed the responsibility to manage economic growth, a rate cut might seem pretty tempting at this point. While next week’s meeting seems quite aggressive for this line of thought, July, where the market is pricing in nearly a 100% probability, makes sense barring a sudden upturn in the data.

One of the things that has been weighing on the inflation data has been the sharp decline in oil prices over the past two months. Even with today’s 3.5% rally on the news of two oil tanker attacks in the Persian Gulf, WTI is lower by more than 20% since the third week of April. And the oil data continues to point to softening demand and growing supplies. Slowing global growth is sapping that demand, but producers continue to drill as quickly as possible. So, the central bank logic continues to be; lower interest rates will help sustain economic growth which will push up demand for energy (read oil prices) and help inflation get back to their comfort zone. Alas, that has been shown to be a pretty tenuous path for central banks to achieve their desired results and there is limited reason to believe it will work this time. In the end, it is becoming abundantly clear that we are about to embark on the next round of monetary ease, even in those nations which never tightened from the last round.

The difference this time is that markets do not seem to be embracing that as a panacea for all their troubles. While equity markets are modestly higher this morning, that follows two lackluster sessions with small losses. We continue to hear pundits highlighting a Fed cut as an important driver, but slowing global growth, especially the continued weakness in China, means that earnings estimates continue to slide and with them, expected equity gains. Add to this mix the unraveling of a few stories (Tesla, government pressure on tech companies) and suddenly the future is not so bright. We have also seen continued concern registered via the Treasury market, where 10-year yields have edged lower again today, trading at 2.11% as I type. While this is a few bps higher than the recent lows, it remains more than 50bps below where we started 2019 and the trend remains firmly downward. And rightly so if inflation is going to continue to decline.

The FX market has weighed all this evidence and remains…confused. While the dollar remains stronger overall in 2019, it has given back some of its gains during the past several weeks, at least against most G10 currencies. Today is a perfect example of the mixed view we’ve seen lately with the euro and the pound within 0.05% of yesterday’s closing levels, albeit the euro is higher and the pound lower. We see Aussie down 0.3% but CHF up 0.3%. You get the picture, there is little in the way of a trend. And quite frankly, that is likely to remain the case until we actually see the Fed (or ECB or BOJ or BOE) actually change policy. Broadly, there is little evidence that global growth is going to improve in the short run, and so FX movement is going to be based on the relative rate of weakness we see in economic data and the corresponding interest rate assumptions that will follow.

Looking at this morning’s data, we really only see Initial Claims (exp 216K), which is generally not a market mover. However, given the heightened sensitivity to the employment situation based on last Friday’s weak NFP report, any uptick here (above, say 230K) might have an outsized impact. Arguably, tonight’s Chinese data in Retail Sales and IP is likely to have a much bigger impact. And that’s really the day. Once again it looks like limited activity and correspondingly, limited movement in markets.

Good luck
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Soon On the Way

While Powell did not actually say
That rate cuts were soon on the way
He hinted as much
So traders did clutch
The idea and quickly made hay

If there was ever any doubt as to what is driving the equity markets, it was put to rest yesterday morning. Chairman Powell, during his discussion of the economy and any potential challenges said the following, “We are closely monitoring the implications of these developments for the U.S. economic outlook and, as always, we will act as appropriate to sustain the expansion.” Nowhere in that comment does he actually talk about cutting rates, but the market belief is that ‘appropriate action’ is just that. The result was a powerful equity market rally (DJIA and S&P +2.1%, NASDAQ +2.6%), a modest Treasury sell-off and further weakness in the dollar. At this point, Wall Street analysts are competing to define the terms of the Fed’s next easing cycle with most now looking for at least two rate cuts this year, but nobody expecting a move later this month. And don’t forget the futures market, where traders are pricing in 60bps of rate cuts before the end of the year, so two cuts and a 40% probability of a third.

All of this is ongoing in the face of continuing bombastic trade rhetoric by both the US and China, and with President Trump seemingly quite comfortable with the current situation. While it appears that he views these as negotiating tactics, it seems clear that the strategy is risky and could potentially spiral into a much more deeply entrenched trade war. However, with that in mind, the one thing we all should have learned in the past two plus years is that forecasting the actions of this President is a mug’s game.

Instead, let’s try to consider potential outcomes for various actions that might be taken.

Scenario 1: status quo, meaning tariffs remain in place but don’t grow on either side and trade talks don’t restart. If the current frosty relationship continues, then markets will become that much more reliant on Fed largesse in order to maintain YTD gains, let alone rally. Global growth is slowing, as is growth in trade (the IMF just reduced forecasts for 2019 again!), and earnings data is going to suffer. In this case, the market will be pining for ‘appropriate action’ and counting on the Fed to cut rates to support the economy. While rate cuts will initially support equities, there will need to be more concrete fiscal action to extend any gains. Treasuries are likely to continue to see yields grind lower with 2.00% for the 10-year quite viable, and the dollar is likely to continue to suffer in this context as expectations for US rate cuts will move ahead of those for the rest of the world. Certainly, a 2% decline in the dollar is viable to begin with. However, remember that if the economic situation in the US requires monetary ease, you can be sure that the same will be true elsewhere in the world, and when that starts to become the base case, the dollar should bottom.

Scenario 2: happy days, meaning both President’s Xi and Trump meet at the G20, agree that any deal is better than no deal and instruct their respective teams to get back to it. There will be fudging on both sides so neither loses face domestically, but the threat of an all-out trade war dissipates quickly. Markets respond enthusiastically as earnings estimates get raised, and while things won’t revert to the 2016 trade situation, tariffs will be removed, and optimism returns. In this case, without any ‘need’ for Fed rate cuts, the dollar will likely soar, as once again, the US economic situation will be seen as the most robust in the world, and any latent Fed dovishness is likely to be removed. Treasury prices are sure to fall as risk as quickly embraced and 2.50%-2.75% 10-year Treasuries seems reasonable. After all, the 10-year was at 2.50% just one month ago.

Scenario 3: apocalypse, the trade war escalates as both Presidents decide the domestic political benefits outweigh the potential economic costs and everything traded between the two nations is subject to significant tariffs. Earnings estimates throughout the world tumble, confidence ebbs quickly and equity markets globally suffer. While this will trigger another bout of central bank easing globally, the impact on equity markets will be delayed with fear running rampant and risk rejected. Treasury yields will fall sharply; 1.50% anyone? The dollar, however, will outperform along with the yen, as haven currencies will be aggressively sought.

Obviously, there are many subtle gradations of what can occur, but I feel like these three descriptions offer a good baseline from which to work. For now, the status quo is our best bet, with the chance of happy days coming soon pretty low, although apocalypse is even more remote. Just don’t rule it out.

As to the markets, the dollar has largely stabilized this morning after falling about 1% earlier in the week. Eurozone Services PMI data printed ever so slightly higher than expected but is still pointing to sluggish growth. The ECB is anticipated to announce the terms of the newest round of TLTRO’s tomorrow, with consensus moving toward low rates (-0.4% for banks to borrow) but terms of just two years rather than the previous package’s terms of four years. Given the complete lack of inflationary pulse in the Eurozone and the ongoing manufacturing malaise, it is still very hard for me to get excited about the euro rallying on its own.

This morning brings ADP Employment data (exp 185K) as well as ISM Non-Manufacturing (55.5) and then the Fed’s Beige Book is released at 2:00. We hear from three more Fed speakers, Clarida, Bostic and Bowman, so it will be interesting to see if there is more emphasis on the willingness to respond to weak markets activity. One thing to note, the word patience has not been uttered by a single Fed member in a number of days. Perhaps that is the telling signal that a rate cut is coming sooner than they previously thought.

Good luck
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10%’s Not Enough

Said Trump, 10%’s not enough
It’s time that we really get tough
So starting next week
A quarter we’ll seek
Believe me, this ain’t just a bluff

If there was any question as to whether or not markets had fully priced in a successful conclusion of the US-China trade talks, last night’s price action should have answered it in full. President Trump is clearly feeling his oats, as his approval rating rises alongside the stock market and the economy, and so he changed the landscape once again. With Chinese Vice-premier Liu He, the chief negotiator in the trade talks, scheduled to arrive in the US later this week to continue, and in the market’s view conclude, those discussions, the President, last night, threatened to increase tariffs on $200 billion of goods to 25% from the current 10%, and to impose 25% tariffs on another $325 billion of goods, which is essentially everything else the US imports from China. In a heartbeat, views changed from rainbows and unicorns to Armageddon. Equity markets around the world plunged, commodity prices tumbled and the dollar and yen both rallied. Interestingly, Treasury prices have not moved much yet, although with the UK and Japan on holiday, overseas Treasury markets are extremely thin, so it could be there just hasn’t been any trading. Of course, it also could be that Treasury prices had already incorporated a less rosy future than equity markets, and so have less need to adjust.

One of the most common themes espoused lately has been the remarkable decline in asset price volatility this year, with measures in equities, bonds and currencies all pushing to cyclical lows. While there is a contingent of analysts (present company included) who believes that this is the calm before the storm, it is also true that market activity has been unidirectional since January, with that direction higher.

With respect to volatility, nothing has yet changed regarding the view that volatility increases when prices fall in both equity and bond markets although the relationship between volatility and the dollar is far less structured. In fact, there has been a significant increase in the amount of short volatility bets being made in the market, similar to the situation we saw at the beginning of 2018. Of course, I’m sure we all remember the disintegration of the XIV ETF (really it was an ETN), when a spike in volatility reduced its value by more than 85% in two days. Well, currently, records show that there is an even larger short volatility position now than there was last February when things went pear-shaped. The point is it is worthwhile to be careful in the current environment.

As to the dollar, historically volatility has increased in both rising and declining dollar environments depending on the circumstances. Given the dollar’s overall strength lately has been accompanies by a decline in volatility, it seems a fair bet to assume that if the dollar were to reverse lower, it would do so in a volatile manner rather than as a steady adjustment. Remember, too, currencies tend to overshoot when large moves occur. However, at this point, I would expect that fear in other markets will continue to support the dollar, and hence keep volatility at bay.

A recap of price movement overnight shows that the Shanghai Composite fell 5.5% and the Hang Seng fell 2.9% (the Nikkei was closed). Europe is currently trading with both the DAX and CAC falling 2.0% (FTSE is also closed) and US futures are pointing to nearly 2.0% losses on the open as well.

Meanwhile, the dollar is broadly higher. It has rallied 0.5% vs. the pound, offsetting a large part of Friday’s GBP rally that was based on the rumor PM May and Labour leader Corbyn were soon going to announce agreement on a Brexit deal. While nothing has come of it yet, that does explain the pound’s sharp Friday movement. AUD and NZD are both lower by 0.5% as the market looks to this evening’s RBA meeting with a 50% probability of a rate cut priced and the belief that the RBNZ will need to match that tomorrow if it occurs. Aussie is back below 0.70, and my sense is it has further to fall, especially if the trade situation deteriorates. Elsewhere in the G10, the euro is little changed after slightly better than expected PMI data seems to have been enough to offset trade concerns. And finally, the yen, as would be expected of a haven asset, is higher by 0.25%.

Versus emerging market currencies, the dollar has had an even stronger performance. It should be no surprise that CNY has fallen sharply (-0.75%) especially since the PBOC cut the RRR for small and medium sized banks by another 1.0% in an effort to stabilize markets. Elsewhere in Asia both INR and KRW fell 0.65% with other currencies having a slightly less negative result. EEMEA has seen ZAR fall 1.0% and TRY -1.20% although the latter has more to do with the possibility that the recent election in Istanbul, where President Erdogan’s party lost, would be overturned and a new one held thus undermining the concept of democracy in Turkey even further. Finally, LATAM markets are waking up under modest pressure, but have not yet fallen sharply.

Turning to this week’s data, there is not much overall, but we do see CPI data Friday.

Tuesday JOLTs Job Openings 7.24M
Thursday Initial Claims 220K
  Trade Balance -$50.2B
  PPI 0.2% (2.3% Y/Y)
  -ex food & energy 0.2% (2.5% Y/Y)
Friday CPI 0.4% (2.1% Y/Y)
  -ex food & energy 0.2% (2.1% Y/Y)

We also will hear a lot of Fed speaking, with eleven speeches from eight different FOMC members including Chairman Powell on Thursday. This week’s talks could well be market moving as last week’s press conference was not as smooth as it might have been. Look for lots of nuance as to what the Fed is looking at and why they think it is appropriate to be patient. As of now, it doesn’t seem that there is any leaning toward an “insurance” rate cut in the near term, but, especially if Friday’s CPI data is softer than expected, that theme could well change. As such, for now, I don’t see a good policy reason for the dollar to retreat, and if the trade situation deteriorates, it should help the buck, but given the mercurial dynamics of the President’s negotiating tactics, I wouldn’t rule out a complete reversal of things before long.

Good luck
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