Tag Archives: #Powell

The Question at Hand

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There is an old banker named Jay
Who’ll cut Fed Funds later today
The question at hand
Is, are more cuts planned?
Or is this the last one he’ll weigh?

Well, no one can describe the current market situation as dull, that’s for sure! The front burner is full of stories but let’s start with the biggest, the FOMC announcement and Chairman Powell’s press conference this afternoon. As of now, futures markets are fully pricing in a 25bp cut this afternoon, with a small probability (~18%) of a 50bp cut. They are also pricing in a 50% chance of a cut at the October meeting, so despite the hawkish rhetoric and relatively strong data we have seen lately, the doves are keeping the faith. In fact, it would be shocking if they don’t cut by 25bps, although I also expect the two regional Fed presidents (George and Rosengren) who dissented last time to do so again. What has become clear is that there is no overriding view on the committee. The dot plot can be interesting as well, as given there are only two meetings left this year, it will give a much better view of policy preferences. My guess is it will be split pretty evenly between one more cut and no more cuts.

Then it’s all on Chairman Jay to explain the policy thinking of the FOMC in such a way that the market accepts the outcome as reasonable, which translates into no large moves in equity or bond markets during or after the press conference. While, when he was appointed I had great hopes for his plain spoken comments, I am far less confident he will deliver the goods on this issue. Of course, I have no idea which way he will lean, so cannot even guess how the market will react.

But there’s another issue at the Fed, one that is being described as technical in nature and not policy driven. Yesterday saw a surge in the price of overnight money in the repo market which forced the Fed to execute $53 billion of repurchase agreements to inject cash into the system. It turns out that the combination of corporate tax payments in September (removing excess funds from the banking system and sending them to the Treasury) and the significant net new Treasury issuance last week that settles this week, also in excess of $50 billion, removed all the excess cash reserves from the banking system. As banks sought to continue to manage their ordinary business and transactions, they were forced to pay up significantly (the repo rate touched 10% at one point) for those funds. This forced the Fed to execute those repos, although it did not go off smoothly as their first attempt resulted in a broken system. However, they fixed things and injected the funds, and then promised to inject up to another $75 billion this morning through a second repo transaction.

It seems that the Fed’s attempt at normalizing their balance sheet (you remember the run-off) resulted in a significant drawdown in bank excess reserves, which are estimated to have fallen from $2.8 trillion at their peak, to ‘just’ $1.0 trillion now. There are a number of economists who are now expecting the Fed to begin growing the balance sheet again, as a way to prevent something like this happening again in the future. Of course, the question is, will this be considered a restarting of QE, regardless of how the Fed tries to spin the decision? Certainly I expect the market doves and equity bulls to try to spin it that way!

Ultimately, I think this just shows that the Fed and, truly, all central banks are losing control of a process they once felt they owned. As I have written before, at some point the market is going to start ignoring their actions, or even moving against them. Last week the market showed that the ECB has run out of ammunition. Can the same be said about Powell and friends?

Moving on to other key stories, oil prices tumbled ~6% yesterday as Saudi Arabia announced that 41% of their production was back on line and they expected full recovery by the end of the month. While oil is still higher than before the attacks, I anticipate it will drift lower as traders there turn their collective focus back toward shrinking growth and the potential for a global recession. Chinese data continues to look awful, Eurozone data remains ‘meh’ and last night Tokyo informed us that their trade statistics continued to deteriorate as well, with exports falling 8.2%, extending a nearly year-long trend of shrinking exports. The point is, if the global economy continues to slow, demand for oil will slow as well, reducing price pressures quite handily. In a direct response to the declining oil price we have seen NOK fall 0.5% this morning, although other traditional petrocurrencies (MXN, RUB) have shown much less movement.

On the Brexit story, Boris met with European Commission President, Jean-Claude Juncker on Monday, and while he spun the meeting as positive, Juncker was a little less optimistic. His quote was the risk of a no-deal Brexit was now “palpable” while the EU’s chief Brexit negotiator, Michel Barnier, said, “nobody should underestimate the damage of a no-deal Brexit.” It should be no surprise the pound fell after these comments, but that is a very different tone to yesterday’s NY session. Yesterday, we saw the pound rally more than a penny after word got out that the UK Supreme Court justices were ostensibly very skeptical toward the government’s argument and sympathetic to the plaintiffs. The market perception seems to be that a ruling against the government will essentially take a no-deal Brexit off the table, hence the rally, but that is certainly not this morning’s tale. In the end, the pound remains binary, with a deal of any sort resulting in a sharp rally, and a hard Brexit on Halloween, causing just the opposite. The UK hearings continue through tomorrow, and there is no official timeline as to when an opinion will be released. I expect the market will continue to follow these tidbits until the announcement is made. (And for what it’s worth, my sense is the Supremes will rule against the government as based on their biographies, they all voted remain!)

Finally, a look at the overnight data shows that UK inflation fell to its lowest level, 1.7%, since December 2016. With the BOE on tap for tomorrow, it beggars belief they will do anything, especially with Brexit uncertainty so high. At the same time, Eurozone inflation was confirmed at 1.0% (0.9% core), another blow to Signor Draghi’s attempts to boost that pesky number. As such, the euro, too, is under some pressure this morning, falling 0.25% after yesterday’s broad dollar sell-off. In fact, vs. the G10, the dollar is higher across the board, although vs. its EMG counterparts it is a much more mixed picture.

Ahead of the FOMC at 2:00 we see Housing Starts (exp 1250K) and Building Permits (1300K), but they will not excite with the Fed on tap. Equity markets are modestly higher in Europe though US futures are pointing slightly lower. Overall, barring something from the UK ahead of the Fed, I expect limited activity and then…

Good luck
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Run Off The Rails

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In England and Scotland and Wales
The saga has run off the rails
So Boris is gambling
A vote will keep scrambling
Dissent and extend his coattails

Meanwhile market focus has turned
To data, where much will be learned
When payrolls are shown
And if they have grown
Watch stocks rise as havens are spurned

The Brexit story remains front page news as the latest twists and turns create further uncertainty over the outcome. Boris is pushing for an election to be held on October 15 so that he can demonstrate he has a sufficient majority to exit with no deal when the EU next meets on October 17-18, thus forcing the EU’s hand. However, parliament continues to do what they can to prevent a no-deal Brexit and have passed a bill directing the PM to seek an extension if there is no deal agreed by the current Halloween deadline. With that in hand, they will agree to a vote on October 29, thus not allowing sufficient time for a new government to do anything ahead of the deadline.

But Boris, being Boris, has intimated that despite the extension bill, he may opt not to seek that extension and simply let the UK leave. That would really sow chaos in the UK as it would call into question many constitutional issues; but based on the current agreement with the EU, that action may not be able to be changed. After all, even if the EU offers the extension, the UK must accept it, which seemingly Boris has indicated he won’t. Needless to say, there is no clarity whatsoever on how things will play out at this time, so market participants remain timid. The recent news has encouraged the view that there will be no hard Brexit and has helped the pound recoup 2.0% this week. However, this morning it is slipping back a bit, -0.3%, as traders and investors are just not sure what to believe anymore. Nothing has changed my view that the EU will seek a deal and cave-in on the Irish backstop issue, especially given the continuous stream of terrible European data.

To that point, German IP was released at a much worse than expected -0.6% this morning, with the Y/Y outcome a -4.2% decline. I know that Weidmann and Lautenschlager are ECB hawks, but it is starting to feel like they are willing to sacrifice their own nation’s health on the altar of economic fundamentalism. The ECB meeting next Thursday will be keenly watched and everything Signor Draghi says at the press conference that follows will be parsed. But we have a couple of things coming before that meeting which will divert attention. And that doesn’t even count this morning’s surprise announcement by the PBOC that they were cutting the RRR by 0.5% starting September 16 in an effort to ease policy further without stoking the real estate bubble there.

So let’s look at today’s festivities, where the US payroll report is released at 8:30 and then Chairman Powell will be our last Fed speaker ahead of the quiet period and September 18 FOMC meeting. Here are the current expectations:

Nonfarm Payrolls 160K
Private Payrolls 150K
Manufacturing Payrolls 5K
Unemployment Rate 3.7%
Average Hourly Earnings 0.3% (3.0% Y/Y)
Average Weekly Hours 34.4

Yesterday’s ADP number was much stronger than expected at 195K, but the employment data from the ISM surveys has been much weaker so there is a wide range of estimates this month. In addition, the government has been hiring census workers, and it is not clear how that will impact the headline numbers and the overall data. I think the market might be a little schizophrenic on this number as a good number could serve to reinforce that the economy is performing well enough and so drive earning expectations, and stocks with them, higher. But a good number could detract from the ongoing Fed ease story which, on the surface, would likely be a stock market negative. In a funny way, I think Powell’s 12:30 comments may be more important as market participants will take it as the clear direction the Fed is leaning. Remember, futures are pricing in certainty that the Fed cuts 25bps at the meeting, with an 11% probability they cut 50bps! And the comments we have heard from recent Fed speakers have shown a gamut of viewpoints exist on the FOMC. Interesting times indeed! At this point, I don’t think the Fed has the gumption to stand up to the market and remain on hold, so 25bps remains the most likely outcome.

As to the rest of the world, next week’s ECB meeting will also be highly scrutinized, but lately there has been substantial pushback on market and analyst expectations of a big easing package. Futures are currently pricing in a 10bp cut with a 46% chance of a 20bp cut. Despite comments from a number of hawks regarding the lack of appetite for more QE, the majority of analysts are calling for a reinstitution of the asset purchase program as soon as October. As to the euro, while it has edged higher this week, just 0.35%, it remains in a long-term downtrend and has fallen 1.6% this month. The ECB will need to be quite surprisingly hawkish to do anything to change the trend, and I just don’t see that happening. Signor Draghi is an avowed dove, as is Madame Lagarde who takes over on November 1. Look for the rate cuts and the start of QE, and look for the euro to continue its decline.

Overall, though, today has seen a mixed picture in the FX market with both gainers and losers in G10 and EMG currencies. Some of those movements have been significant, with ZAR, for example, rallying 0.75% as investment continues to flow into the country, while CHF has fallen 0.6% as haven assets are shed in the current environment. Speaking of shedding havens, how about the 10-year Treasury, which has seen yields rebound 15bps in two days, a truly impressive squeeze on overdone buyers. But for now, things remain generally quiet ahead of the data.

Given it is Friday, and traders will want to be lightening up any positions outstanding, I expect that this week’s dollar weakness may well see a modest reversal before we go home. Of course, a surprise in the data means all bets are off. And if Powell sounds remotely hawkish? Well then watch out for a much sharper dollar rally.

Good luck
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Badly Maligned

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The Chinese, now, have it in mind
That they have been badly maligned
So tariffs they hiked
Which markets disliked
Though they have not yet been enshrined

Then Powell explained pretty well
That interest rates hadn’t yet fell
As far as they might
But if we sit tight
Most things ought to turn out just swell

And after the markets had closed
The President quickly imposed
More tariffs to thwart
The Chinese report
While showing he’s just as hard-nosed

It is truly difficult to keep abreast of the pace of change in market information these days. Like so many, I yearn for the good old days when a surprising data release would change trader views and result in a market move but comments and headlines typically had limited impact. These days, by far the most important newsfeed to watch is Twitter, given President Trump’s penchant for tweeting new policy initiatives. This weekend was a perfect example of just how uncertainty has grown in markets.

A quick recap of Friday shows that the Chinese decided to respond to numerous trade provocations and announced they would be raising tariffs further on $75 billion of US imports. Not surprisingly, risk assets responded negatively and we saw equity markets around the world decline while bonds, gold and the yen all rallied. Then we heard Chairman Powell’s long-awaited speech, where he explained that while the economy is in a pretty good place, given the ongoing global weakness and uncertainties engendered by the current trade war, the Fed stood ready to ease policy further. That was enough to encourage the risk-takers and we saw equity markets rebound and bonds give up most of their gains. But just as the market was getting set to close, the President tweeted that he would be raising tariffs further in response to the Chinese action, lamenting that he hadn’t acted more aggressively initially. This, of course, turned things back around and risk was quickly jettisoned into the close, resulting in equity markets ending down more than 2.4% in the US while bonds rebounded and the dollar fell. Whew!!

But that is all old news now as the weekend’s G7 meeting in Biarritz, France, resulted in more surprises all around. The first surprise was that the US and Japan have announced they have reached a trade deal “in principal” which should open Japanese markets to US agricultural imports and prevent the imposition of further tariffs on Japanese autos. Clearly a positive. But that was not enough to turn markets around and Asian sessions started off quite negatively, following the US close and understanding that the US-China trade war was getting hotter. However, an early morning Trump tweet announced that China had called the US and asked to get back to the negotiating table, something that was neither confirmed nor denied by the Chinese, but enough information to reverse markets again. So while Asian equity markets all suffered badly (Nikkei -2.2%, Hang Seng -1.9%) Europe went from down 1% to up 0.5% pretty much across the board (UK markets are closed for a holiday, the late-August banking holiday). We also saw US futures reverse course, from -1.4% to +0.5%, and Treasuries, which had traded to new low yields for the move at 1.44%, reversed course and are now back up (prices lower) to 1.52%. However, that is still lower than Friday’s close. As well, while early on there was a brief 1bp 2yr-10-yr inversion; that has now reversed to a 1bp positive slope.

And what about the dollar through all this? Well, G10 currencies are broadly softer vs. the dollar this morning, with losses ranging from -0.2% for EUR, GBP and CAD all the way to -0.8% for SEK. Even the yen is weaker, -0.45% on the day having reversed some early session (pre-tweet) gains to levels not seen since November 2016.

Of more interest, though, is the fact that CNH has fallen to new historic lows since its creation in August 2010, touching 7.1925 before bouncing slightly, and still down nearly 1% on the day. The Chinese are potentially playing with fire as stories of capital flight increase amid the renminbi’s recent declines. Obviously, 7.00 is no longer an issue, but the key unknown is at what level will money start to leak more fiercely, something nobody knows. I must admit, I did not expect to see this type of movement so quickly, but at this point, one cannot rule out even more aggressive weakness here. Certainly the options markets are telling us that is the case with implied vols rising sharply overnight (1mo +0.6 vol) and heading back toward levels seen after the 2015 ‘mini devaluation’. In fact, not surprisingly, implied volatility is higher pretty much across the board this morning as late summer illiquidity adds to the remarkable uncertainty in markets. There’s probably a bit more boost available in implied vols, at least until the next tweet changes the situation again.

Turning to this week’s calendar, there is a fair amount of data to absorb as follows:

Today Durable Goods 1.2%
  -ex transport 0.0%
Tuesday Case Shiller Home Prices 2.30%
  Consumer Confidence 129.0
Thursday Initial Claims 215K
  Q2 GDP 2.0% (2.1% prior)
Friday Personal Income 0.3%
  Personal Spending 0.5%
  PCE 0.2% (1.4% Y/Y)
  Core PCE 0.2% (1.6% Y/Y)
  Chicago PMI 47.7
  Michigan Sentiment 92.3

Clearly, all eyes will be on Friday’s PCE data as that is the number the Fed watches most carefully. Remember, we have seen two successive surprising upticks in CPI inflation, so a high surprise here could have consequences regarding the future path of interest rates. At least that’s the way things used to be, these days I’m not so sure. Wednesday we hear from two Fed speakers, Barkin and Daly, but it seems unlikely either of them will swerve far from Powell’s comments as neither is particularly hawkish. Speaking of data, we did see one piece this morning, Germany’s IFO Indices with all three pieces falling much further than expected, underscoring just how weak the economy is there. My money is on a stimulus package before Brexit, but also on a hard Brexit being averted.

Recapping, barring any further twitter activity, markets are set to open optimistically, but unless we hear confirmation from the Chinese that talks are, indeed, back on, I would not be surprised to see risk ebb lower as the day progresses. This means a stronger yen, and right now, a softer dollar, at least against the G10. Versus the EMG bloc, the dollar has further room to run.

Good luck
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Lest Bubbles They Stoke

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There is a fine fellow named Jay
Who not too much later today
Will take to the stage
And help us to gauge
How quickly Fed funds will decay

This week several Fed members spoke
And all of them sought to invoke
That growth is still fine
Thus they’ve drawn the line
On more cuts, lest bubbles they stoke

It is quite remarkable that despite ongoing unrest in Hong Kong, with the temperature there rising each week, as well as the countdown to Brexit getting shorter and shorter, the only thing that matters right now is Jay Powell’s speech this morning from Jackson Hole. It is the defining theme of today’s market activity.

Let me set the stage to begin: interest rate markets are pricing in a rate cut in September, another in October and then a chance of one in December with “certainty” of that third cut by March 2020. Given that GDP growth in the US is running at 2.1% annually, Retail Sales have consistently beaten expectations and are up more than 4% in the past year and the Unemployment Rate, at 3.7%, is a tick away from its post-WWII lows, three cuts seem like a lot of monetary stimulus. After all, despite the fact that the Fed watches the PCE Deflator as their inflation gauge of choice, we all know that inflation is running higher than its current reading of 1.4%. The government’s own evidence is from CPI readings which most recently showed prices rising at a 1.8% level, with the core reading there at 2.1%. And ask yourself if even that conveys the feel of inflation. My guess is: Not. Even. Close.

At any rate, that’s what the market is pricing. As NY walks in this morning, equity markets around the world have shown modest gains (US futures included), bonds are falling with 10-year Treasury yields back up to 1.64% and the dollar is stronger almost across the board. Arguably, expectations are for Powell to confirm that July was not a ‘one and done’ rate cut but rather the beginning of several insurance cuts. The fly in that ointment comes from the comments we heard yesterday from a series of regional Fed Presidents, all of whom said that they saw little reason to cut rates further at this time. Effectively their argument was that growth is solid, unemployment low and inflation pretty close to target. While all paid heed to the fact that the Fed funds rate was above the 10-year yield, they were unwilling to buy into the idea that the curve inversion was presaging a recession at this time. There is just not enough evidence to them.

With the Fed’s hawks in full flight, it will certainly be tricky for Powell to describe anything about the FOMC as coordinated. Remember, the Minutes showed us members who didn’t want to cut at all as well as members wanting to cut by 50bps. That’s a pretty wide dispersion of thought. All told, he has a pretty tough job today if he doesn’t want to spook the markets.

As I have no idea what he will say, let’s game out two different views; first he manages to surprise dovishly and second, more likely in my opinion, he disappoints and sounds more hawkish than the market (and President) wants.

Dovish Surprise – If he confirms the markets current pricing and, for example, doubles down saying QE is an effective tool and they will use it again, look for a sharp equity rally to begin with, as well as a bond rally and dollar weakness. Certainly that would be the initial price action. However, it is not clear how long that would last. After all, if the current claim is growth is solid, what is the reason for all the ‘insurance’? At some point, market participants will ask that very question, as well as, what does the Fed know that we don’t? The result would be a reversal of equity gains, although bonds would likely still rally. And the dollar? I think a rebound would be in order as well as strength in the yen and Swiss franc. However, even if he does manage to sound dovish, I don’t see the dollar falling more than 2%-3% before finding a floor. At this point, I cannot paint a scenario where the dollar enters a longer term downtrend. Overall, my unscientific odds on this outcome are less than 25%.

Hawkish Disappointment – This seems far more likely to be the outcome, if only because to my eyes, the market has really gotten ahead of itself with regard to rate cuts. Essentially, if Powell doesn’t confirm that July’s cut was the beginning of a new rate-cutting cycle, the market is going to be disappointed. If he pushes back at all, sounding more like Esther George or Eric Rosengren, the two dissenters, than James Bullard or Neel Kashkari, the 50bp advocates, the market will be REALLY disappointed.

In the first case, I expect we will see equity markets fall a percent or a bit more today, with Europe giving up its early gains and the US quite weak. Bonds are a tougher call here, although I expect that the initial price action would be for further weakness. Remember, despite the fact that yields are 15bps from the low point seen two weeks ago, they are still down 37bps this month. There is plenty of room to fall. As to the dollar, that will rally further against everything, the yen included. I would expect the euro to finally test, and break, 1.10, and we could easily see 1% weakness and more throughout the emerging markets.

If he pushes back, well today may be remembered in market history as PB (Powell’s black) Friday. Equity markets would see significant losses as all the bets on further easy policy would be shed immediately. Bonds, too, would fall sharply as the idea that the Fed would no longer need to cut rates would change the entire sentiment there. And finally, the dollar would explode higher. Any ideas that the Fed has further room to cut rates than virtually all its counterparties, a key dollar bearish thesis, would be swept away and the dollar would really appreciate sharply. Think about EUR at 1.08; GBP at 1.20 (and that’s without the Brexit story); and the yen back to 108.00. However, given the risk of this type of market disruption, I do not believe this is at all likely either. In the end, a mild disappointment seems the most likely outcome, so look for stocks to close the week on a low note and the dollar on a high note.

Before he speaks at 10:00 this morning, we do see New Home Sales (exp 647K), but quite frankly, nobody cares about that today. It is all Powell, all the time.

Good luck and good weekend
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Not a Clue

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The thing that we learned from the Fed
Was they’ve not a clue what’s ahead
A few wanted fifty
But others more thrifty
Suggested a quarter instead

The thing that has Powell perplexed
Is what to do when they meet next
That’s why when he speaks
Near Jackson Hole’s peaks
Investors all fear some subtext

Once again the market has wandered aimlessly ahead of tomorrow’s Jackson Hole speech by Chairman Powell. Equity markets have generally edged lower (Hang Seng -0.85%, DAX -0.1%, FTSE -0.6%) although a few managed to scrape out a gain (Nikkei +0.05%, Shanghai +0.1%). Bond markets have also been mixed with most Asian markets rallying while Europe has seen small losses. I guess it’s only fitting that 10-year Treasuries are essentially unchanged on the day. Meanwhile, the dollar continues its broad winning ways with mostly modest gains against both G10 and EMG currencies.

At this point, all eyes are on tomorrow’s Powell speech to discern the Fed’s next move. Yesterday afternoon’s FOMC Minutes painted a picture of a group with significant differences in views. We know of the two dissenters, who didn’t want to cut rates at all, and it turns out that a “couple of participants” were looking for a fifty basis point cut. In the end, it is no surprise that twenty-five was the result, although the rationale, given their stated views that downside risks to the economy had diminished, seem shaky. The market response to the Minutes was, therefore, largely nonexistent, with almost no movement subsequent to their release in any market, which, given the proximity of the new information coming from Powell ought not be that surprising. In fact, it seems unlikely that today will bring too much activity either given that the important data has already been released (European PMI’s) and Initial Claims (exp 216K) and Leading Indicators (0.3%) are unlikely to change any opinions.

A quick look at those Eurozone PMI’s shows that they were marginally better than expected although continue to paint a picture of a weakening economy with no inflationary impulse. The biggest concern was that the new orders survey in Germany fell even further, a sign that there is no recovery in sight. At their release, the euro managed to rally about 0.35%, however it has given all of those gains back in the past four hours and seems more likely to wander aimlessly than take on a direction. The release of the ECB’s Minutes did nothing to change any views, merely confirming that they are preparing further easing for next month, with a growing chance of both an interest rate cut and the restarting of Large Scale Asset Purchases, better known as QE.

Other news of note comes from Djakarta, where Bank Indonesia (BI) surprised one and all and cut 25bps last night. However, the rupiah managed to eke out a small gain on the session as investors and traders seem more focused on the positive growth story, a true rarity these days, than on the interest rate situation. Most analysts are convinced that BI is done cutting unless the global economy really tanks, rather than merely continues its recent slowdown. In China we saw the renminbi soften some 0.3% and fall to levels not seen since 2008 in the onshore market. However, there has been no obvious further deterioration of the trade situation so I don’t anticipate a significant extension unless the PBOC acts more aggressively to ease policy. And arguing in favor of less movement is the fact that the 70th anniversary of the founding of the People’s Republic is coming up on October 1st. Historically, the PBOC will go out of their way to insure financial markets are stable during that celebration and frequently they start the process several months beforehand.

Brexit is the final story that seems to be having an impact as PM Johnson is visiting Paris today after meetings in Berlin yesterday. At this point the EU continues to talk tough, but nothing has changed regarding the desperate need for the EU to prevent a shock to a weakening economy. In fact, the pound is bucking today’s dollar trend, currently trading higher by 0.15%, as traders are beginning to read between the lines and realize that a deal is more likely than currently priced. I maintain that we will see something in October that will avoid a no-deal outcome and the pound will rally sharply as that becomes a reality.

And that’s really all for today. Bloomberg will be interviewing several FOMC members in Jackson Hole, so that should offer some background color, but at this point, it is all about Chairman Powell tomorrow. Until then, tight ranges are the most likely outcome.

Good luck
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They Just Might

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This afternoon traders will learn
About how the Fed did discern
A rate cut was right
And how they just might
Keep cutting despite no downturn

As we look forward to the first truly interesting information of the week, this afternoon’s release of the FOMC Minutes from the July meeting, markets have a better attitude this morning than they did yesterday. As has been the case for the past decade, all eyes remain on central bank activity with the Fed in the lead. If you recall, at the July meeting when the Fed cut the Fed funds rate by 25bps, there were two dissenting votes, Boston’s Rosengren and Kansas City’s George. Monday, Eric Rosengren reiterated that he saw no reason to cut rates given the recent economic data and the outlook for continued solid growth. At the same time, yesterday we heard from San Francisco Fed President Mary Daly, a non-voter, that the cut was the right thing to do despite the growth prospects as continued low inflation and the opportunity to improve the labor market further called for more action. Of course, Chairman Powell will be on the wires Friday morning from Jackson Hole and the market is quite anxious to hear what he has to say, but until then, this afternoon’s Minutes are the best thing available for the market to try to discern the FOMC’s overall attitude.

With that as a backdrop, this morning’s market activity can more readily be described as risk-on as opposed to yesterday’s risk-off flavor. At this point, though, all we have seen is a retracement of yesterday’s losses in equities and gains in the bond market. As to the dollar, it is modestly softer this morning, but that too is simply a retracement of yesterday’s price action.

Clearly it has not been the data which is fueling market movements as there was just not much to see overnight. The little bit released showed continued weakness in Japanese consumer activity (Department Store Sales -2.7%) while UK public finances were modestly less worrisome than forecast. But neither one of those was ever going to move the market. Instead the stories that are of most interest have included Germany’s failed 30-year bund auction, where only €824 million of the €2 billion offered were bought. The interesting thing here was that the coupon was set at 0.00% and the yield that cleared was -0.11%. So the question being asked is; have we reached a limit with respect to what bond investors are willing to buy? While I am surprised at the poor outcome, given my view, as well as the growing consensus, that the ECB is going to restart QE next month and absorb up to €50 billion per month of paper, I believe this will be seen as a temporary phenomenon, and that going forward, we will see far more interest at these levels and even lower yields.

On a different note, Brexit has seen a little more headline activity as yesterday German Chancellor Merkel seemed to start the concessionary talk on behalf of the EU by explaining they need “practical solutions” to solve the Irish impasse. As soon as those words hit the tape the pound rebounded sharply from its lows rallying more than a penny and closed higher on the day by 0.3%. However, this morning, Irish Deputy PM Coveney complained that British PM Johnson was trying to ‘steamroll’ Ireland into accepting new terms and that the result of this was a hard Brexit was far more likely. Funnily enough I don’t remember the Irish complaining when the EU was ‘steamrolling’ former PM May into a completely unacceptable deal for the Brits. At any rate, the latest comments have taken a little steam out of the pound’s rally and it has given back yesterday’s gains. In the end though, I think Germany’s word is going to be far more important than Ireland’s and if Johnson and Merkel have a successful discussion today, the Irish are going to have to accept any deal that is brokered. If anything, yesterday’s commentary and price action have simply reinforced my view that the EU will blink and that the pound is destined to trade much higher before the end of the year.

And in truth, away from those stories it is hard to find anything of interest in the G10 space. In the emerging markets, this morning sees strength virtually across the board as risk appetite everywhere improves. ZAR is leading the way, up 1.1% after a better than expected CPI print of just 4.0%, well below the 4.3% market expectation encouraged inflows to the local bond market where 10-year yields have fallen by 10bps this morning (to a still robust 8.96%). But we have also seen a stronger RUB (+0.95%) on firmer oil prices; and KRW (+0.5%), as traders reduce long dollar positions despite weaker than expected trade data, where exports fell a troubling -13.3% in the first 20 days of the month.

It should be no surprise that European equity markets are firm (DAX and FTSE 100 +1.1%) and that US equity futures are firmer as well, with all three indices seeing gains on the order of 0.6%.

Ahead of the Minutes we will see Existing Home Sales (exp 5.39M) but remember this has been the one area of the economy that has suffered recently. Given the continued decline in yields, and correspondingly in mortgage rates, one would think the housing market would stabilize, but we shall see. And then it is a collective breath-holding until 2:00pm when the Minutes come out. Ahead of that I don’t anticipate much movement at all. After that…

Good luck
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Weakness Worldwide

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

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

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

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

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

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

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

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

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

Good luck
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A Rate Cut’s Assumed

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In Washington DC today
We’ll get to hear from Chairman Jay
A rate cut’s assumed
So, equities boomed
While dollar strength seems here to stay

Markets are on tenterhooks as the release of the FOMC statement approaches. That actually may be overstating the case. The market is highly confident that the Fed is going to cut the funds rate by 25 bps this afternoon as there has not been nearly enough change in the trajectory of the economic data over the past ten days to change any views. During this ‘quiet period’ we have seen solid, if unspectacular economic indicators. Certainly nothing indicating a severe slowdown, but also nothing indicating that the economy is overheating. As well, we have heard from several other central banks, notably the ECB and BOJ, that further policy ease is on the way and they are ready to move imminently. Finally, the whipped cream on this particular decision was released yesterday morning when core PCE data printed at 1.6%, a lower than expected outcome, and sufficient proof that inflation remains too quiescent for the Fed’s liking. At this point, it all seems anticlimactic.

Perhaps of more interest will be the press conference to be held at 2:30, when Chairman Powell will be able to explain more fully the rationale behind cutting rates with an economy running at potential, historically low unemployment and the easiest financial conditions seen in a decade. But hey, inflation is a few ticks low, so that is clearly justification. (As an aside, I find it remarkable that any central bank is so wedded, with precision, to a specific target inflation rate, and that not achieving that target is grounds for policy change. Let’s face it, monetary policy tools are blunt instruments and work with a significant lag. In fact, when a target is achieved, that seems to be more luck than skill. There are a number of central banks that aim for inflation to be within a range, and that seems to make far more sense than setting a 2.0% target and complaining when the rate is at 1.6%.)

In the meantime, there are still a few other things that are impacting markets today, notably the US-China trade talks and the ongoing Brexit story. Regarding the trade talks, the delegations met for two days in Shanghai and made approximately zero headway. The word is they are further apart now than when talks broke down three months ago. Suddenly it is dawning on a lot of people that these trade talks may not be concluded on a politically convenient schedule (meaning in time for the US election). The market impact was a decline in Asian equity indices with the Nikkei falling 0.9%, both Shanghai and Korea falling 0.7%, and the Hang Seng in Hong Kong down 1.3%. However, European indices have barely moved on the day and US futures are pointing higher after Apple beat earnings estimates following the close yesterday. The implication here is that US markets have moved on from the trade story while Asian ones are still beholden to every word. Quite frankly, that seems to be a realistic outcome given the fact that trade represents such a small part of the US economy as opposed to every Asian nation, where it is a major driver of economic activity.

Turning to the Brexit story, the pound plumbed new depths yesterday, trading close to 1.21 before a modest bounce this morning (+0.15%) as Boris continues to hold a hard line on talks. He is pushing very hard for the EU to reopen the existing, unratified deal and will not meet face-to-face with any EU counterparts until they do so. Thus far, the EU has been adamant that the deal is done, and they refuse to change it.

But here’s the first clue that things are going to change; the Bank of Ireland said that a hard Brexit will reduce GDP growth in 2020 to 0.7% from the currently expected 4.1% growth. As I mentioned before, Ireland is on the front lines and will feel the brunt of the early impacts. At some point, probably pretty soon, Taoiseach Leo Varadkar is going to prevail on the rest of the EU to reopen talks before Ireland is crushed. And remember, too, that a no-deal Brexit leaves the EU with a £39 billion hole in their budget as that was to be the UK’s parting alimony payment.

While the EU tries to convince one and all that they hold the upper hand, it is not clear to me that is the case. Working in Boris’s favor was today’s Q2 GDP data from the Eurozone showing growth falling to 0.2% in the quarter with Italy at 0.0%, Spain dipping to 0.5% and France having reported 0.2% yesterday. Germany doesn’t actually report until next month, but indications are 0.0% is the best they can expect. The euro remains under pressure, trading at the bottom of its recent 1.11-1.14 trading range and shows no signs of rebounding. And of course, the fact that the ECB is getting set to ease policy further is not helping the single currency at all. I maintain that despite the Fed’s actions today, unless Powell promises three more cuts soon, the dollar will remain bid.

And those are really today’s stories. Overall, the FX market is pretty benign today, with the largest mover being TRY, which rallied 0.45% as optimism is growing that the economy is stabilizing which means that the current high rates are quite attractive to investors. But away from that, movement has been on the order of 0.10%-0.20% in either direction. In other words, nothing is happening.

On the data front, remember this is payroll week as well, and today we see ADP Employment (exp 150K) and then Chicago PMI (50.6) before the FOMC this afternoon. As earnings season is still underway, I expect equities to respond to that data, but the dollar will likely bide its time until the Fed. After that, nothing has changed my broadly bullish view, although an uber-dovish Powell could clearly do so.

Good luck
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A Half Point’s Preferred

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Said Williams, the Fed must be swift
When acting if growth is adrift
The market inferred
A half point’s preferred
Which gave all stock markets a lift

If there was any doubt that markets are still entirely beholden to the Fed, they should have been removed after yesterday’s price action. First, recall that a number of emerging market central banks cut interest rates, some in a complete market surprise (South Korea), while others were anticipated (Indonesia, South Africa, Ukraine) and yet all of those currencies strengthened on the day. It is always curious to me when a situation like that occurs, as it forces a deeper investigation as to the market drivers. But this investigation was pretty short as all the evidence pointed in one direction; the Fed. Yesterday afternoon, NY Fed President John Williams gave an, ostensibly, academic speech about how central banks should respond to economic weakness and highlighted that they should act quickly and aggressively in such cases. Notably, he said, “take swift action when faced with adverse economic conditions” and “keep interest rates lower for longer.” The market interpretation of those comments was an increased expectation for a 50bp rate cut by the Fed at the end of the month. Stocks reversed early losses, bonds rallied, with yields falling 4bps and the dollar fell as much as 0.5%. While a spokesperson for the NY Fed made a statement later trying to explain that Williams’ speech was not about policy, just academic research, the market remained convinced that 50bps is coming to a screen near you on July 31! We shall see.

The problem with the 50bp theme is that the economic data of late has actually been generally, although not universally, better than expected. Consider that last week, both core CPI (2.1%) and PPI (2.3%) printed a tick higher than expectations; Retail Sales were substantially stronger at 0.4% vs. the 0.1% expected; and both the Empire State and Philly Fed indices printed stronger than expected at 4.3 and 21.8 respectively. Also, the jobs report at the beginning of the month was much stronger than expected. Of course, there have been negatives as well, with IP (0.0%), Housing Starts (-0.9%) and Building Permits (-6.1%) all underperforming. In addition, we cannot forget the situation elsewhere in the world, where China printed Q2 GDP at 6.2%, its lowest print in the 27 years they have been releasing quarterly data, while Eurozone data continues to suffer as well. The implication is that if you assume there is a case for a rate cut at all, the case for a 50bp rate cut relies on much thinner gruel.

At this point, even if we continue to see stronger than expected US data, I believe that Powell and company are locked into a rate cut. Given that futures markets have fully priced that in, as well as the fact that the equity markets are unquestionably counting on that cut, disappointment would serve to truly disrupt markets, potentially impinging on financial conditions and certainly draw the ire of the White House. None of these consequences seem worthwhile for the potential benefit of leaving 25bps of dry powder in the magazine. Add to this the fact that we have heard from several Fed members; Bostic, Kaplan and George, none of whom are enthused about a rate cut at all. Now, of those three, only Esther George is a current voter, but one dissenting vote will not be enough to sway a clearly dovish FOMC. Add it all up and I think we see 25bps when the dust settles. Of course, if that’s the case, it is entirely realistic to see equity prices ‘sell the news’ unless Powell is hyper dovish in the press conference.

And in truth, that is the entire story today. Virtually every story in the financial press focuses on rate cuts, whether the question about the Fed, or the discussion of all the other central banks that have already acted. There is an ongoing argument about whether the ECB actually cuts rates next week, or if they simply prepare the market for a cut in September and the reinstitution of QE in January. Most analysts are opting for the latter, believing that Signor Draghi will wait and see, but if they know they are going to cut, why wait? I think there is a much better chance of immediate action than is being priced into the market.

On the Brexit front, the voting by Tory members continues, and by all accounts, Boris is still in the lead and due to be the next PM. That will continue to pressure the pound, as unless there is further movement by the EU, the chances of a no-deal Brexit will continue to rise. In fact, next week will be quite momentous as we hear from the ECB and get the UK voting results on Thursday.

Away from these stories, most things fall into the background. For example, China Minsheng Group, a major Chinese conglomerate, is defaulting on a $500 million bond repayment due in August. Clearly, this is not a positive event, but more importantly speaks to two specific issues, the lack of US dollar liquidity available in emerging markets as well as the true nature of the slowdown in the Chinese economy. This will be used as further ammunition for the camp that believes the Chinese significantly overstate their economic data.

Turning to this morning’s activity, the only data point is the Michigan Sentiment data (exp 98.5) and we get one more Fed speech, from uber-dove James Bullard. The dollar is stronger today, after yesterday’s afternoon selloff, having risen 0.35% vs. the euro and with gains also against the yen (0.3%), Aussie (0.25%) and most emerging market currencies (MXN 0.3%, ZAR 0.6%, CNY 0.1%). My sense is that yesterday afternoon’s price action was a bit overdone on the dollar, and so we will see more of that unwound ahead of the weekend. Look for modest further USD strength.

Good luck and good weekend
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Appetite’s Whet

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Both Powell and Kaplan agreed
That lower rates are what we need
The table’s now set
And appetite’s whet
For more cuts to soon be decreed

If there was any uncertainty, prior to yesterday, about a rate cut by the Fed at the end of this month, it should be completely eliminated now. Not only did Chairman Jay reiterate that the Fed was “carefully monitoring” the situation (shouldn’t that always be the case?) and that the Fed would use all its available tools to maintain the expansion, but we heard from Dallas Fed President Robert Kaplan that he was turning in favor of a ‘risk management’ cut in order to be sure that things don’t start to turn down soon. Given the integration in the global economy over the past years and given the fact that the US still represents 24% of global GDP, it should be no surprise that things occurring elsewhere in the world have an impact on the US and vice versa. As such, it is not unreasonable for the Fed to try to take the global economic situation into account when determining US monetary policy. And one thing that is clear is that global GDP growth is falling. So folks, we have seen the top in interest rates around the world and the only question is just how quickly they will fall in different jurisdictions.

In a nutshell, that is the FX story. Historically, relative monetary policy has been one of the prime drivers of FX rates, with currencies attached to tight policy appreciating vs. those attached to loose policy. This has been the basis of the carry trade, and arguably, nothing about this process has changed. It’s just that for the first time in memory, pretty much every nation is driving policy in the same direction, in this case looser. This leads to a probable outcome where currency values remain largely stable. After all, if everybody cuts by 25bps, aren’t we all still in the same place?

The irony is that, as discussed by RBA Governor Lowe several weeks ago, if every central bank is cutting rates at the same time, the effectiveness of those rate cuts will be severely diminished. Remember, one of the key transmission mechanisms of rate cuts is to reduce the currency’s value in order to help support trade, and eventually growth. But if everybody cuts, that mechanism will be severely impaired, and so the central banks will be forced to find new tools. And while they are actively looking for new ways to ease policy, in the end, monetary policy is simply some combination of interest rates and money supply. Until now, central banks have focused on managing interest rates. But this is why MMT, or something like it, is a growing possibility. When thoughts turn to money supply as the only other thing to adjust, and as ‘new’ thinking permeates the political class, MMT is going to become increasingly attractive. I’m not sure which nation will be the first to publicly embrace the idea of debt monetization (my money’s on Japan though), but you can be sure that whichever it is will see its currency depreciate sharply, at least until other nations follow their lead. Only time will tell, but that is not a positive future.

With that as a somewhat depressing backdrop, let’s look at market activity. Generally speaking, the dollar has done little this morning after yesterday’s rally. Or perhaps yesterday’s rally was more a function of other currency weakness. Remember, the pound’s decline was all about Brexit, not the US. The euro’s decline was all about weakening economic sentiment in the Eurozone and the idea that the ECB would be acting sooner rather than later. Yesterday also saw the Mexican peso fall sharply, more than 1%, after President Trump tweeted about reimposing tariffs on China. It seems that traders are still nervous over more tariffs, and with the ongoing border situation between the US and Mexico, see any tariff threats as potentially applying to Mexico as well.

But this morning, the biggest movers are RUB and TRY, both recouping about 0.4% of yesterday’s losses. The G10 currencies are within 0.10% of yesterday’s levels and show no sign of breaking out in the near term. Of course, that is subject to another Brexit announcement or comments from central bankers, however, nothing is scheduled on those fronts. Equity markets, too, have had little direction as investors await the next shoe to drop. Interest rate markets remain fully priced for a 25bp rate cut by the Fed in two weeks, while there remains some uncertainty as to just what Signor Draghi will announce next week. I will say that if he did announce a 10bp rate cut, it would have a pretty big impact on the single currency, and not in a positive manner.

As to bonds, both Treasuries and Bunds remain 10-15bps from their recent lows but show no signs of selling off further (higher yields). Rather, those markets are demonstrating all the behavior of a consolidation after a large unwinding move. Given the strong trend lower in central bank policy rates, it seems highly unlikely that yields in the government space, and by extension elsewhere, have anywhere to go but down.

Turning to today’s data, we see Housing Starts (exp 1.261M), Building Permits (1.3M) and then at 2:00 the Fed releases its Beige Book. But we have no more Fed speakers and it seems highly unlikely that any of that will be enough to change any views. One other thing happening this afternoon is the G7 FinMins are meeting in France, but those talks are highly focused on taxation of tech companies with monetary policy a sidelight. After all, everybody is already cutting rates, so what else can they say?

Alas, it appears to be another day with limited cause for FX movement, which for hedgers is great, but for traders, not so much.

Good luck
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