Progress Is Real

In Beijing, talks focused on trade
Continue as both sides conveyed
That progress is real
With hopes for a deal
Increasing, or so it’s portrayed

Once again, the market is embracing the idea that a trade deal is coming and coming soon. Talks in Beijing have restarted and while yesterday President Trump indicated he would not be meeting Chinese President Xi by month’s end, as had been suggested last week, this morning, Mr Trump expressed a desire to meet with him “very soon”. Investors have taken this to mean that while a deal may not be completed by the initial March 1st deadline, there will be an extension of the truce and no tariff increases at that time. It should be no surprise that the equity market has taken this news well, with Asian stocks generally rallying (Nikkei +2.6%, Shanghai +0.7%), European stocks following suit (DAX + 1.3%, CAC + 1.1%) and US equity futures pointing higher (DJIA + 0.8%, S&P + 0.7%). Adding to the bullishness has been the news that there is a tentative deal in Congress to avoid a second government shutdown. So, all the stars have aligned for the bulls today.

And yet, the data continues to be lackluster with limited prospect to improve in the short run. A random sampling of recent releases shows that UK growth (as mentioned yesterday) was the weakest in six years and shows no signs of picking up ahead of Brexit. But also, Norwegian inflation is sinking along with Mexican IP and the Australian housing market. South African Unemployment remains near a record 27.5% and even the NFIB Survey here at home has fallen to its lowest level since November 2016 (Trump’s election), although it remains much closer to its historic highs than its lows. The point is that despite soothing words from central bank officials that recent weaker data is temporary, it is looking nothing of the sort. I’m not sure when temporary morphs into long-term, but we are now pushing into our fifth consecutive month of slowing global data and the trend shows no signs of abating.

So, what is an investor or a hedger to conclude from all this? Is the trade deal more important? Or is it the ongoing data story? While both of those may have short-term impacts, the reality remains that it is still the central banks that exert the most influence on markets. The Fed’s complete conversion from hawk to dove in six weeks has been THE dominant force in markets since December. Not only has that conversion helped the US markets, but it has dramatically reduced pressure on other nations to maintain their own hawkishness. This can be seen in the BOE, where earlier talk of needing to hike rates in the event of Brexit has abated. It can be seen in the ECB where the conversation has changed from raising rates in the autumn to what other measures of stimulus can they provide given the current negative rates and bloated balance sheet. (TLTRO’s will absolutely be rolled over.) In Scandinavia, both Norway and Sweden have seen inflation data decline and are now seen as far more likely to leave rates on hold rather than raising them as had been expected just a few months ago. And not to be outdone, the PBOC, which had been in the midst of a two-year program to reduce excess leverage in China, has handily turned far more dovish, injecting significant liquidity and ‘encouraging’ banks to make loans to SME’s there. So, in the end, while the trade story may garner headlines for a few more weeks, it remains a central bank controlled world.

As to today, the dollar is dipping slightly after a continued solid rally during yesterday’s session. This has been more evident in the EMG space than in G10. For example, MXN (+0.4%) and BRL (+0.95%) are leading the way in LATAM while INR (+0.7%) and CNY (+0.3%) have benefitted from the dollar’s lackluster performance. And of course, the dovish turn by the Fed has had an especially beneficial impact on EMG currencies since so many companies located there borrow in dollars. The idea that US rates have stopped rising has been one of the biggest changes we have seen.

However, it is important to remember that on a relative basis, US policy remains tighter than that anywhere else in the world, and as it becomes clearer that other central banks will turn more dovish, the dollar should retain its footing.

We have already seen the NFIB data print weaker than expected, and the only other data point today is the JOLT’s Jobs report (exp 6.90M), however, we do hear from Chairman Powell at 12:45 this afternoon, so all eyes will be on him. The thing is, given the data we have seen since the Fed changed course has continue to be weak, I would argue the only surprise can be dovish. In other words, comments hinting that the Fed will end the balance sheet roll-off, or a reevaluation of the neutral rate lower would be the type of thing to start a big rally. In the event that something like that were to occur, look for equities to rocket and the dollar to fall. But given the sudden increase in stories about prices rising in consumer products (yesterday’s WSJ talking about cat litter and detergent, today’s about Whole Foods raising prices), it seems hard to believe that a more dovish tone is likely.

In the end, the dollar has had a good run over the past two weeks. If that is ending, it is entirely reasonable, but don’t look for a collapse.

Good luck
Adf

Really Quite Splendid

For traders, the month that just ended
Turned out to be really quite splendid
The stock market soared
As risks were ignored
Just like Chairman Powell intended

The problem is data last night
Showed growth’s in a terrible plight
Both Europe and China
Can lead to angina
If policymakers sit tight

Now that all is right with the world regarding the Fed, which has clearly capitulated in its efforts to normalize policy, the question is what will be the driving forces going forward. Will economic data matter again? Possibly, assuming it weakens further, as that could quickly prompt actual policy ease rather than simply remaining on hold. But reading between the lines of Powell’s comments, it appears that stronger than expected data will result in virtually zero impetus to consider reinstating policy tightening. We have seen the top in Fed funds for many years to come. Remember, you read it here first. So, we are now faced with an asymmetric reaction function: strong data = do nothing; weak data = ease.

Let’s, then, recap the most recent data. Last night the Caixin Manufacturing PMI data from China was released at a lower than expected 48.3, its lowest point in three years. That is simply further evidence that the Chinese economy remains under significant pressure and that President Xi is incented to agree to a trade deal with the US. Interestingly, the Chinee yuan fell 0.6% on the news, perhaps the first time in months that the currency responded in what would be considered an appropriate manner to the data. That said, the yuan remains nearly 2% stronger than it began the year. We also saw PMI data from Europe with Germany (49.7) and Italy (47.8) both underperforming expectations, as well as the 50.0 level deemed so crucial, while France (51.2) rebounded and Spain (52.4) continued to perform well. Overall, the Eurozone data slid to 50.5, down a full point and drifting dangerously close to contraction. And yet, Signor Draghi contends that this is all just temporary. He will soon be forced to change his tune, count on it. The euro, however, has held its own despite the data, edging higher by 0.2% so far this morning. Remember, though, with the Fed having changed its tune, for now, I expect the default movement in the dollar to be weakness.

In the UK, the PMI data fell to 52.8, well below expectations, as concerns over the Brexit situation continue to weigh on the economy there. The pound has fallen on the back of the news, down 0.3%, but remains within its recent trading range as there is far more attention being paid to each item of the Brexit saga than on the monthly data. Speaking of which, the latest story is that PM May is courting a number of Labour MP’s to see if they will break from the party direction and support the deal as written. It is quite clear that we have two more months of this process and stories, although I would estimate that the broad expectation is of a short delay in the process beyond March and then an acceptance of the deal. I think the Europeans are starting to realize that despite all their tough talk, they really don’t want a hard Brexit either, so look for some movement on the nature of the backstop before this is all done.

Finally, the trade talks wrapped up in Washington yesterday amid positive signs that progress was made, although no deal is imminent. Apparently, President’s Trump and Xi will be meeting sometime later this month to see if they can get to finality. However, it still seems the most likely outcome is a delay to raising tariffs as both sides continue the talks. The key issues of IP theft, forced technology transfer and ongoing state subsidies have been important pillars of Chinese growth over the past two decades and will not be easily changed. However, as long as there appears to be goodwill on both sides, then there are likely to be few negative market impacts.

Turning to this morning’s data, it is payroll day with the following expectations:

Nonfarm Payrolls 165K
Private Payrolls 170K
Manufacturing Payrolls 17K
Unemployment Rate 3.9%
Average Hourly Earnings 0.3% (3.2% Y/Y)
Average Weekly Hours 34.5
ISM Manufacturing 54.2
Michigan Sentiment 90.8

Clearly, the payroll data will dominate, especially after last month’s huge upside surprise (312K). Many analysts are looking for a reversion to the mean with much lower calls around 100K. Also, yesterday’s Initial Claims data was a surprisingly high 253K, well above expectations, although given seasonalities and the potential impacts from the Federal government shutdown, it is hard to make too big a deal over it. But as I highlighted in the beginning, the new bias is for easier monetary policy regardless of the data, so strong data will simply underpin a stock market rally, while weak data will underpin a stock market rally on the basis of easier money coming back. In either case, the dollar will remain under pressure.

Good luck and good weekend
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As Patient As Needed

More rate hikes? The Fed said, ‘no way!’
With growth slowing elsewhere we’ll stay
As patient as needed
Since now we’ve conceded
Our hawkishness led us astray

If you needed proof that central bankers are highly political rather than strictly focused on the economics and financial issues, how about this:

Dateline January 24, 2019. ECB President Mario Draghi characterizes the Eurozone economy as slowing more than expected yet continues to support the idea that interest rates will be rising later this year as policy tightening needs to continue.

Dateline January 30, 2019. Federal Reserve Chairman Jay Powell characterizes the US economy as solid with strong employment yet explains that there is no need to consider raising rates further at this time, and that the ongoing balance sheet reduction program, which had been on “autopilot” is to be reevaluated and could well slow or end sooner than previously expected.

These are certainly confusing actions when compared to the comments attached. Why would Draghi insist that policy tightening is still in the cards if the Eurozone economy is clearly slowing? Ongoing pressure from the monetary hawks of northern Europe, notably Germany’s Bundesbank, continues to force Draghi to hew a more hawkish line than the data might indicate. As to the Fed, it is quite clear that despite the Fed’s description of a strong economy, Powell has succumbed to the pressure to support the equity market, with most of that pressure coming from the President. And yet central bankers consistently try to maintain that they are above politics and cherish their independence. There hasn’t been an independent central banker since Paul Volcker was Fed Chair from 1979-1987.

Nonetheless, this is where we are. The Fed’s dovishness was applauded by the markets with equities rallying briskly in the US (1.5%-2.2% across the indices) and following in Asia (Nikkei and Hang Seng both +1.1%) although Europe has shown less pluck. But Europe has, as described above, a slowing growth problem. This is best characterized by Italy, whose Q4 GDP release this morning (-0.2%) has shown the nation to be back in recession, their third in the past five years! It should be no surprise that Italy’s stock market is lower (-0.6%) nor that it is weighing on all the European indices.

Not surprisingly, government bond yields around the world are largely lower as well. This reaction is in a piece with market behavior in 2017 through the first three quarters of 2018, where both stocks and bonds rallied consistently on the back of monetary policy actions. I guess if easy money is coming back, and as long as there is no sign of inflation, there is no reason not to own them both. Certainly, the idea that 10-year Treasury yields are going to start to break higher seems to be fading into the background. The rally to 3.25% seen last November may well mark a long term high.

And what about the dollar? Well, if this is the new normal, then my views on the dollar are going to need to change as well. Consider this, given that the Fed has tightened more than any other central bank, the dollar has benefitted the most. We saw that last year as the dollar rallied some 7%-8% across the board. But now, the Fed has the most room to ease policy in comparison to every other G10 central bank, and so if the next direction is easy money, the dollar is certain to suffer the most. Certainly, that was the story yesterday afternoon in NY, where the dollar gave up ground across the board after the FOMC statement. Against the euro, the initial move saw the dollar sink 0.75% in minutes. Since then, it has traded back and forth but is little changed on the day, today, with the euro higher by just an additional 0.1%. We saw a similar move in the yen, rallying 0.7% immediately, although it has continued to strengthen and is higher by another 0.35% this morning. Even the pound, which continues to suffer from Brexit anxiety, rallied on the Fed news and has continued higher this morning as well, up another 0.2%. The point is, if the Fed is done tightening, the dollar is likely done rallying for now.

Other stories have not disappeared though, with the Brexit saga ongoing as it appears more and more likely to come down to a game of brinksmanship in late March. The EU is adamant they won’t budge, and the UK insists they must. I have a feeling that nothing is going to change until late March, just ahead of the deadline, as this game of chicken is going to play out until the end.

And what of the trade talks between the US and China? Well, so far there is no word of a breakthrough, and the only hints have been that the two sides remain far apart on some key issues. Do not be surprised to see another round of talks announced before the March 2 tariff deadline, or an agreement to postpone the raising of tariffs at that time as long as talks continue. Meanwhile, Chinese data released overnight showed Manufacturing PMI a better than expected (though still weak) 49.5 while Non-Manufacturing PMI actually rose to 54.7, its best reading since September, although still seeming to trend lower. However, the market there applauded, and the renminbi continues to perform well, maintaining its gains from the last week where it has rallied ~1.5%.

The US data picture continues to be confused from the government shutdown, but this morning we are due to receive Initial Claims (exp 215K and look for a revision higher from last week’s suspect 199K) as well as New Home Sales (569K). Yesterday’s ADP Employment number was much better than expected at 213K, and of course, tomorrow, we get the payroll report. Given the Fed’s hyper focus on data now, that could be scrutinized more closely than usual for guesstimates of how the Fed might react to a surprise.

In the end, the market tone has changed to mirror the Fed with a more dovish nature, and given that, the prospects for the dollar seem to have diminished. For now, it seems it has further to fall.

Good luck
Adf

 

Will We Understand?

The current Fed Chairman named Jay
Will speak to us later today
The question at hand
Will we understand
The message that he will relay?

Meanwhile, nearby trade talks resume
Midst fears that a failure spells doom
For Trump and for Xi
They need victory
To help both economies boom

Three main stories continue to dominate the headlines; Brexit, the Fed and US-China trade talks. Given that all three remain unsettled, it should not be surprising that markets have shown little direction of late. This is evidenced by the fact that, once again, the dollar is little changed this morning against the bulk of its counterparts while both Treasury yields and equity prices remain rangebound.

Starting with the Fed, this afternoon at 2:00 the policy statement is released and then at 2:30 Chairman Powell holds his first of eight press conferences this year. We all know about the change in tone from Fed speakers since the December meeting where the Fed funds rate was raised 25bps to 2.50%. Since then, we have seen every Fed speaker back away from the previous narrative of slow and steady rate hikes to the new watchword, ‘patience’. In other words, previous expectations of two or three rate hikes this year have been moderated and will only occur if the data supports them. At this point, it seems pretty clear that the Fed will not raise rates in March, and likely not in June either, unless the data between now and then brightens significantly. As to the second half of the year, based on the slowing trajectory of global growth, it is becoming harder to believe they will push rates higher at all this year.

This is a significant change of expectations and will certainly impact other markets, notably the dollar. Given the view that any dollar strength was predicated on tighter Fed policy, the absence of such tightening should negatively impact the buck. But as I frequently point out, the dollar is a two-sided coin, and if the Fed is tightening less than expected, you can be certain that so is every other central bank, with the possibility of easing elsewhere coming into play. On a relative basis, I continue to see the dollar being the beneficiary of the tightest monetary policy around.

Moving to the trade talks, while hopes remain high, it seems expectations need to be moderated. The US is seeking major structural changes from China, including the reduction of subsidies for SOE’s and changes in terms for partnerships between US and Chinese firms. China built its economic model on those terms and seems unlikely to give them up. And that doesn’t include the IP theft issue, which the Chinese deny while the US continues to maintain is the reality. I think the best case scenario is that the talks continue and that any tariff increases remain on hold for another 90 days to try to achieve a settlement. But I would not rule out the chance that the talks break down and that higher tariffs are put into place come March 2nd. If the former occurs, I expect equity markets to rally on hope, while the dollar comes under modest pressure. However, if they break down, equities will suffer around the world and I expect to see safe havens, including the dollar, rally.

Finally, to Brexit, where yesterday Parliament voted to have PM May go back and reopen negotiations but did not vote to prevent a no-deal Brexit. This is what May wanted, but it is not clear it will solve any problems. The EU has been adamant that they will not reopen negotiations on the deal, although they seem willing to discuss the ‘political’ issues like the nature and timing of the backstop deal regarding Ireland. At this point, it seems May is playing chicken with her own party, as well as Labour, and trying to force them to vote for the current deal as the best they can get. But with time running out and the requirement that a unanimous vote of the EU is needed in order to delay the timeline, the chance of a no-deal Brexit is certainly increasing. The pound suffered yesterday after the vote, falling about 1%, although this morning it has bounced 0.25% from those levels. It is very clear that the market has ascribed a diminishing probability to a no-deal Brexit, but hedgers need to be careful. That probability is definitely not zero! And if it does come about, the pound will fall very sharply very quickly. A 10% decline is not unreasonable under those circumstances.

Away from those stories, this morning brings us the ADP Employment report (exp 178K) and we cannot forget that NFP comes on Friday. Eurozone data was generally soft, as was Japanese data, but that has all become part of the new narrative of a temporary lull in the global economy before things pick up again when the big issues (trade and Brexit) are behind us. The risk is those issues don’t resolve in a positive manner, and the slowdown is not as temporary as hoped. If global growth keeps deteriorating, all ideas on monetary policy will need to be reconsidered, which will have a direct impact on views of the future of the dollar, equity markets and bonds. So far, things haven’t changed enough to bring that about, but beware a situation where economic data continues to slide.

Good luck
Adf

If Things Go Very Wrong

Last year he thought growth would be strong
This year, “if things go very wrong”
It seems Signor Draghi
Just might restart QE
And rate hikes? They’ll ne’er come along!

Markets continue to bide their time ahead of tomorrow’s FOMC statement and the press conference by Chairman Powell. In addition, the Brexit saga continues with a series of votes scheduled today in Parliament that may help determine the next steps in that messy process. And of course, the next round of US-Chinese trade talks are set to begin tomorrow. So, there is plenty of potential news on the near-term horizon. But before I touch on those subjects, I wanted to highlight comments from ECB President Draghi yesterday speaking to EU lawmakers in Brussels. From the Bloomberg article this morning:

        The president of the European Central Bank blamed “softer external demand and some country and sector-specific factors” for the slowdown, but indicated he still has some confidence in the underlying strength of the economy.
       “If things go very wrong, we can still resume other instruments in our toolbox. There is nothing objecting to that possibility,” he told lawmakers in Brussels in response to a question on whether net asset purchases could be restarted. “The only point is under what contingency are we going to do this. And at this point in time, we don’t see such contingency as likely to materialize, certainly this year.”

Basically, he opened the door to reinstate QE, something which just two months ago would never have been considered. And while he tried to downplay the problems, it is clear there is growing concern in Frankfurt about Eurozone growth. Surprisingly, to me, the euro barely budged on the report, as I would have anticipated a sell-off. However, given the Fed is due to make its comments tomorrow, it appears that traders are waiting to see where Powell comes out on the hawkish-dovish spectrum. Because to me, Draghi’s comments were quite dovish. But essentially, the euro has been unchanged since trading opened in Asia yesterday, so clearly the market doesn’t see these comments as newsworthy.

Now, looking at the other three stories, there has been virtually no new information released since last week. Regarding the Fed, yesterday’s WSJ had an article that looked like a Fed plant discussing how unimportant the balance sheet issue was, and how the Fed sees no evidence that shrinking the balance sheet is having any impact on markets. That assessment is quite controversial as many investors and pundits see the balance sheet as a key issue driving recent market volatility. I expect we will hear more on Wednesday from Powell, but I also expect that now that Powell has shown he cannot withstand pressure from a declining stock market, that the pace of balance sheet reduction is going to slow. I wouldn’t be surprised to see it cut in half with a corresponding rally in both stocks and bonds on the news. In this event, the dollar should come under pressure as well.

As to Brexit, there still seems to be this disconnect between the UK and the EU in that the UK continues to believe that if Parliament votes to renegotiate parts of the deal, the EU will do so. Thus far, the EU has been pretty consistent that they like the deal the way it is and that there is not enough time to make changes. But from what I have seen this morning, it seems the most likely outcome is the ‘Malthouse proposal’ which will essentially do just that. Get support from Parliament to go back and change the Irish backstop arrangement. While I know that there is no desire for a hard Brexit, it strikes me that one cannot yet be ruled out.

Finally, on to the trade talks, we continue to get conflicting information from the US side as to where things stand, but ultimately the key issue is much more likely to be enforcement of any deal, rather than the deal itself. There is a great wariness that the Chinese will agree to something, and then ignore the details and go back to business as usual. Or perhaps create new and different non-tariff barriers to maintain their advantages. While the equity market continues to be positive on the process, I don’t see things quite so rosily. I think a deal would be great, but I don’t ascribe more than a 50% chance to getting one. However, I do expect that any tariff increases will be postponed for another round of talks to be enabled.

Beyond those stories, not too much of note is happening, which is evident by the fact that there has been almost no movement in the FX market, or any market for that matter. The G10 currencies are within pips of yesterday’s closing levels, and even EMG currencies are generally little changed. One exception is BRL, which has fallen -0.6% as ongoing news regarding the mining disaster and its impact on CRDV, a huge Brazilian mining conglomerate, seems to be generating a little angst. But otherwise, even this bloc of currencies is little changed. Equity markets are close to flat, as are bond and commodity markets. In other words, investors and traders are looking to the horizon and waiting for the big stories to play out. First in line is the Brexit voting, so perhaps later this afternoon we will see some movement, but I suspect that the FOMC is actually THE story of note for most people right now.

Good luck
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Animal Spirits Were Stirred

All week from the Fed we have heard
That patience is their new watchword
The market’s reaction
Implied satisfaction
And animal spirits were stirred!

While it may be a new day, nothing has really changed. Yesterday we heard from both Chairman Powell and vice-Chairman Clarida and both said essentially the same thing: the Fed is watching both the economy and markets closely, and given where policy rates currently stand, they can afford to be patient before acting next. On the subject of the Fed’s balance sheet, neither indicated there was cause for a policy change, but Powell, when asked, remarked that if they thought the shrinking balance sheet was becoming a problem, they would not hesitate to adjust policy. The market interpretation was: the Fed is not going to raise rates anytime soon so we better buy stocks as quickly as we can. The result was yet another rally in equities with all three US market indices rising about 0.5% on the day. At this point, even the Fed must recognize that they have gotten their message across.

The next key story that remains ongoing is the trade situation between the US and China. There was no specific news on the subject and no comments from either side. The market view is that there was clearly some progress made during the initial discussions earlier this week and many people are optimistic that the next round of talks, which will include more senior representatives from both sides, can lead to a permanent resolution. As long as that remains the collective mindset, it is one less pressure point for global equity markets. However, it must be remembered that the US is seeking significant changes in the structure of the Chinese economy, and so a complete resolution will not be easy to achieve, especially in the accelerated timeline currently extant. I expect an extension of the timeline as the first concrete result.

The third key story has been Brexit, which continues to be a complete mess. Next week’s Parliamentary vote looks destined to fail, and now there is a growing movement for the deadline to be extended three months to the end of June. While that requires a unanimous vote to do so, comments from European members seem to be heading in that direction. The pound has benefitted from the discussion, as traders believe that the extra three months will help alleviate the risk of a no-deal Brexit and the forecast consequences on both the economy and the currency in that event. However, the Irish border remains unchanged and there has been no indication that the UK will accept an effective walling off of Northern Ireland for the sake of the deal. We shall see.

Two other stories are also gaining in their importance, the rebound in oil prices and further weakness in the Eurozone economy. As to the first, the OPEC agreement to cut production by 1.2 million barrels/day has served to remove fears of an oil glut and recent inventory figures have backed that up. As well, while WTI has traded back above $50/bbl, there is a growing belief that the US fracking community is not going to be able to produce as much oil as previously thought, especially if prices slip back below that $50 level. Oil prices have rallied for nine consecutive days but remain far below levels seen just last October. Historically, rising commodity prices have gone hand in hand with a declining dollar, and for right now, that correlation has been holding.

Finally, we continue to see weak economic data from the Eurozone, with this morning’s Italian IP data (-1.6% in Nov) the latest in a string that has shown Europe’s manufacturing sector is under increasing pressure. This story is the one that has received shortest shrift from the market overall. In fact, I would argue it has been completely ignored, certainly by FX traders. While everyone focuses intently on the Fed and the recent change of heart regarding future rate hikes, there has been almost no discussion with regard to the ECB and how, as economic growth continues to slow in the Eurozone, the idea that they will be tightening policy further come September is laughable. At some point, the market will realize that the Eurozone is in no position to normalize policy further, and that instead, the question will arise as to when they will seek to add more stimulus. My gut tells me that a change in forward guidance will be the first step as they extend the concept of rate hikes from; “not until the end of summer” to something along the lines of “when we deem appropriate based on the economic data”. In other words, the current negative rate regime will be indefinite, and if (when) the next recession arrives, look for a reintroduction of QE there. My point is that the euro has no business rallying in any substantive way.

With all of this as background, a quick tour of markets shows that while the dollar actually performed fairly well during the US session yesterday, it is giving back some of those gains this morning. For example, the euro, despite weak data, is higher by 0.3%. The pound, on the back of the renewed Brexit deal hope is higher by 0.5%. Firmer commodity prices have helped AUD (+0.6%), NZD (+0.9%) and CAD (+0.3%). But the biggest consistent winner of late has been CNY, which has rallied a further 0.65% overnight and is now up 1.6% this week. This is a far cry from the situation just a few weeks ago, when there were concerns the yuan might break through the 7.00 level. Two things come to mind here as to the cause. The first possibility is that there has been an increase in investment flows into the Chinese bond market, where yields remain higher than in much of the developed world, and the Chinese bond market is slowly being added to global bond indices requiring fund managers to add positions there. The second, slightly more conspiratorial idea is that the Chinese government is pushing the yuan higher during the trade negotiations with the US to insure that its value is not seen as an impediment to reaching any deal. Whatever you think of President Trump’s tactics, there is no question that the Chinese economy has come under increased pressure since the imposition of US tariffs on their exports. It is not hard to believe that the stronger yuan is a direct response to help reach an agreement as quickly as possible.

And that’s pretty much everything to watch today. This morning we get CPI data with expectations for headline to print at -0.1% (1.9% Y/Y) and ex food & energy to print at +0.2% (2.2% Y/Y). Thankfully there are no more Fed speakers, but I would say given the near unanimity of the message from the nine speakers this week, we have a pretty good idea of what they are thinking. Equity futures are pointing slightly lower following European markets, which are softer today. However, given that equity markets around the world have rallied steadily all week, it can be no real surprise that a little profit taking is happening on a Friday. As to the dollar, in the short term I think it remains under pressure, but over time, I continue to see more reasons to own it than to short it.

Good luck and good weekend
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Greater Clarity

Last year rate hikes had regularity
But now the Fed seeks greater clarity
‘Bout whether our nation
Is feeling inflation
Or some other source of disparity

Investors exhaled a great sigh
And quickly realized they must buy
Those assets with risk
To burnish their fisc
Else soon prices would be too high

The December FOMC Minutes were received quite positively by markets yesterday as it appears despite raising rates for the fourth time in 2018, it was becoming clearer to all involved that there was no hurry to continue at the same pace going forward. The lack of measured inflation and the financial market ructions were two key features that gave pause to the FOMC. While the statement in December didn’t seem to reflect that discussion, we have certainly heard that tune consistently since then. Just yesterday, two more Fed regional presidents described the need for greater clarity on the economic situation before seeing the necessity to raise rates again. And after all, given the Fed has raised rates 225bps since they began in December 2015, it is not unreasonable to pause and see the total impact.

However, regarding the continued shrinking of the balance sheet, the Fed showed no concern at this point that it was having any detrimental effect on either the economy or markets. Personally I think they are mistaken in this view when I look at the significant rise in LIBOR beyond the Fed funds rate over the past year, where Fed Funds has risen 125 bps while LIBOR is up 187bps. But the market, especially the equity market, remains focused on the Fed funds path, not on the balance sheet, and so breathed a collective sigh of relief yesterday.

Given this turn of events, it should also not be surprising that the dollar suffered pretty significantly in the wake of the Minutes’ release. In the moments following the release, the euro jumped 0.7% and continued subsequently to close the day nearly 1% stronger. One of the underpinnings of dollar strength has been the idea that the Fed was going to continue to tighten policy in 2019, but the combination of a continuous stream of comments from Fed speakers and recognition that even back in December the Fed was discussing a pause in rate hikes has served to alter that mindset. Now, not only is the market no longer pricing in rate hikes this year, but also analysts are backing away from calling for further rate hikes. In other words, the mood regarding the Fed has turned quite dovish, and the dollar is likely to remain under pressure as long as this is the case.

Of course, the other story of note has been the trade talks between the US and China which ended yesterday. During the talks, market participants had a generally upbeat view of the potential to reach a deal, however, this morning that optimism seems to be fading slightly. Equity markets around the world have given back some of their recent gains and US futures are also pointing lower. As I mentioned yesterday, while it is certainly good news that the talks seemed to address some key issues, there is still no clarity on whether a more far-reaching agreement can be finalized in any near term timeline. And while there has been no mention of tariffs by the President lately, a single random Tweet on the subject is likely enough to undo much of the positive sentiment recently built.

The overnight data, however, seems to tell a different story. It started off when Chinese inflation data surprised on the low side, rising just 1.9% in December, much lower than expected and another red flag regarding Chinese economic growth. It seems abundantly clear that growth there is slowing with the only real question just how much. Forecasts for 2019 GDP growth have fallen to 6.2%, but I wouldn’t be surprised to see them lowered going forward. On the other hand, the yuan has actually rallied sharply overnight, up 0.5%, despite the prospects for further monetary ease from Beijing. It seems that there is a significant inflow into Chinese bond markets from offshore which has been driving the currency higher despite (because of?) those economic prospects. In fact, the yuan is at its strongest level since last August and seemingly trending higher. However, I continue to see this as a short-term move, with the larger macroeconomic trends destined to weaken the currency over time.

As to the G10 currencies, they have stabilized after yesterday’s rally with the euro virtually unchanged and the pound ceding 0.25%. Two data points from the Eurozone were mixed, with French IP slipping to a worse than expected -1.3% while Italian Retail Sales surprised higher at +0.7% back in November. While there was no UK data, the Brexit story continues to be the key driver as PM May lost yet another Parliamentary procedural vote this morning and seems to be losing complete control of the process. The thing I don’t understand about Brexit is if Parliament votes against the current deal next week, which seems highly likely at this stage, what can they do to prevent a no-deal Brexit. Certainly the Europeans have not been willing to concede anything else, and with just 79 days left before the deadline, there is no time to renegotiate a new deal, so it seems a fait accompli that the UK will leave with nothing. I would welcome an explanation as to why that will not be the case.

Turning to this morning’s activity, the only data point is Initial Claims (exp 225K), but that is hardly a market moving number. However, we hear from three regional Fed presidents and at 12:45 Chairman Powell speaks again, so all eyes will be focused on any further nuance he may bring to the discussion. At this point, it seems hard to believe that there will be any change in the message, which if I had to summarize would be, ‘no rate changes until we see a strong reason to do so, either because inflation jumps sharply or other data is so compelling that it forces us to reconsider our current policy of wait and see.’ One thing to keep in mind, though, about the FX markets is that it requires two sets of policies to give a complete picture, and while right now all eyes are on the Fed, as ECB, BOJ, BOE and other central bank policies evolve, those will have an impact as well. If global growth is truly slowing, and the current evidence points in that direction, then those banks will start to sound more dovish and their currencies will likely see plenty of selling pressure accordingly. But probably not today.

Good luck
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