Tag Archives: #Powell

If Things Go Astray

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The jobs report Friday was great
Which served to confuse the debate
Is growth on the rise?
Or will it downsize?
And how will the Fed acclimate?

The first indication from Jay
Is data continues to say
While growth seems robust
We’ll surely adjust
Our actions, if things go astray

In what can only be described as remarkable, despite the strongest jobs report in nearly a year, handily beating the most optimistic expectations for both job growth and wages, Fed Chairman Jay Powell told the market that the Fed could easily slow the pace of policy tightening if needed. While this may seem incongruous based on the data, it was really a response to several weeks of market gyrations that have been explicitly blamed on the Fed’s ongoing policy normalization procedure. A key concern over this sequence of events is that the data of ‘data dependence’ is actually market indices rather than economic ones. For every analyst and economist who had been looking for Powell to break the cycle of kowtowing to the stock market, Friday was a dark day. For the stock market, however, it was anything but, with the S&P 500 rising 3.4% and the NASDAQ an even more impressive 4.25%. The Fed ‘put’ seems alive and well after a three month hiatus.

So what can we expect going forward? The futures market has removed all pricing for the Fed to raise rates further in 2019, and in fact, has priced in a 50% probability of a 25bp rate cut before the year is over! Think about that. Two weeks ago, the market was priced for two 25bp rate hikes! This is a very large, and rapid, change of opinion. The upshot is that the dollar has come under significant pressure as both traders and investors abandon the view of continued cyclical dominance and start to focus on the US’ structural issues (growing twin deficits). In that scenario, the dollar has much further to fall, with a 10% decline this year well within reason. Equity markets around the world, however, have seen a short-term revival as not only did Powell blink, but also the Chinese continue to aggressively add to their monetary policy ease. And one final positive note was heard from the US-China trade talks in Beijing, where Chinese Vice-Premier, Liu He, President Xi’s top economic official, made a surprise visit to the talks. This was seen as a demonstration of just how much the Chinese want to get a deal done, and are likely willing to offer up more concessions than previously expected to do so. The ongoing weak data from China is clearly starting to have a real impact there.

It is situations like this that make forecasting such a fraught exercise. Based on the information we had available on December 31, none of these market movements seemed possible, let alone likely. But that’s the thing about predictions; they are especially hard when they focus on the future.

As to markets today, while Asian equity markets followed Friday’s US price action higher, the same has not been true in Europe, where the Stoxx 600 is lower by 0.4%. Weighing on the activity in Europe has been weaker than expected German Factory Order data (-1.0%) as well as the re-emergence of the gilets jaunes protests in France, where some 50,000 protestors, at least, made their presence felt over the weekend.

Turning to the dollar, it is down broadly, with every G10 currency stronger vs. the greenback and most EMG currencies as well. If the market is correct in its revised expectations regarding the Fed, then the dollar will remain under pressure in the short run. Of course, if the Fed stops tightening policy, and we continue to see Eurozone malaise, you can be certain that the ECB is going to be backing away from any rate rises this year. I have maintained that the ECB would not actually raise interest rates until 2020 at the earliest, and I see no reason to change that view. With oil prices hovering well below year ago levels, headline inflation has no reason to rise. At the same time, despite Signor Draghi’s false hope regarding eventual wage inflation, core CPI in the Eurozone seems pegged at 1.0%. As long as this remains the case, it will be extremely difficult for Draghi, or his successor, to consider raising rates there. As that becomes clearer to the market, the euro will likely begin to suffer. However, until then, I can see the euro grinding back toward 1.18 or so.

One last thing to remember is that despite the Christmas hiatus, the Brexit situation remains front and center in the UK, with Parliament scheduled to vote on the current deal early next week. At this time, there is no indication that PM May is going to find the votes to carry the day, although as the clock ticks down, it is entirely possible that some nays turn into yeas in order to prevent the economic catastrophe that is being predicted by so many. The pound remains beholden to this situation, but I believe the likely outcomes are quite asymmetric with a 2-3% rally all we will see if the deal passes, while an 8% decline is quite viable in the event the UK exits the EU with no deal.

As to data this week, it will not be nearly as exciting as last week, but we see both the FOMC Minutes on Wednesday and CPI on Friday. In addition, we hear from seven Fed speakers across nine speeches, including Chairman Powell again, as well as vice-Chairman Clarida.

Today ISM non-Manufacturing 59.0
Tomorrow NFIB Small Business Optimism 105.0
  JOLT’s Job Openings 7.063M
Wednesday FOMC Minutes  
Thursday Initial Claims 225K
Friday CPI -0.1% (1.9% Y/Y)
  -ex food & energy 0.2% (2.2% Y/Y)

All in all, it seems that the current market narrative is focused solely on the Fed changing its tune while the rest of the central banking community is ignored. As long as this is the case, look for a rebound in equity markets and the dollar to remain under pressure. But you can be certain that if the Fed needs to hold rates going forward because of weakening economic data, the rest of the world will be in even more dire straits, and central banks elsewhere will be back to easing policy as well. In the end, while there may be short-term weakness, I continue to like the dollar’s chances throughout the year as the US continues to lead the global economy.

Good luck
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If Job Numbers Swoon

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For Powell, the data he’s viewing
Shows weakness is palpably brewing
Will he change his tune
If job numbers swoon?
If not, it could prove his undoing!

The admonition that markets will remain volatile in 2019 certainly has held true to form thus far. After a significant sell-off in global equity markets yesterday, two pieces of news have now helped a partial rebound. First was the story that vice-ministerial trade talks are now scheduled to be held between the US and China next Monday and Tuesday. The market has taken this as a sign that the trade conflict is abating and that there will be a deal forthcoming shortly. While that would certainly be great news, it seems a bit premature. Nonetheless, it was clearly seen as a market positive overnight.

The second bit of news comes from China, where the PBOC has announced a 1.0% cut in the RRR for all Chinese banks, half to be implemented next week and half two weeks later. As opposed to the very targeted efforts announced earlier in the week, this is a broad-based easing of monetary policy, the first since 2016, and appears to be a direct response to the fact that the Manufacturing PMI data is alluding to contraction in the Chinese economy. As I have written before, China will be forced to continue to ease monetary policy this year due to slowing growth, and it is for that reason that I expect the renminbi to gradually decline all year.

But the bad news is not restricted to China, we have also seen weaker data from both the US and Europe. Yesterday’s ISM Manufacturing data printed at 54.1, significantly lower than expectations and its weakest print November 2016, and while still in expansionary territory is indicative of slowing growth ahead. Meanwhile, inflation data from the Eurozone showed that price pressures continue to recede there on the back of sharply declining oil prices with the area wide CPI rising only 1.6% and the core reading remaining at 1.0%. It appears that the mooted inflation pressures Signor Draghi has been dreaming about remain only in his dreams.

Bond market reaction to this data was very much as would be expected, with 10-year Treasury yields falling to 2.57%, their lowest level since last January, while Bund yields have fallen back to 0.15%, levels not seen since April 2017. In fact, the futures market in the US is now beginning to bet on a rate cut by the Fed before the end of 2019. If you recall, at the December FOMC meeting, the dot plot indicated a median expectation of two more rate hikes this year.

What we can safely say is that there is a great deal of uncertainty in markets right now, and many disparate opinions as to how the economy will perform going forward, and to how the Fed and its central banking brethren will respond. And that uncertainty is not likely to dissipate any time soon. In fact, my fear is that when it does start to fade, it will be because the data is pointing to a much slower growth trajectory, or a recession on a widespread basis. At that point, uncertainty will diminish, but so will asset values!

And how, you may ask, is all this affecting the dollar? Well, yesterday’s price action was of the risk off variety, where the yen was the leader, but the dollar outperformed most emerging market currencies, as well as Aussie and Kiwi, but was slightly softer vs. the rest of its G10 counterparts. This morning, however, on the strength of the trade talk news and policy ease by China, risk is being tentatively embraced and so the yen has fallen a bit, -0.35%, and the dollar has ceded most of its recent gains vs. the EMG space. For example, ZAR (+1.3%), RUB (+1.0%), TRY (+1.1%), and IDR (+1.0%) have all managed to rally sharply alongside a rebound in commodity prices. As well, the market is still enamored of newly installed President Bolsonaro in Brazil with the real higher by a further 0.9% this morning, taking the YTD gain up to 3.0%.

As for the G10, AUD has benefitted from the Chinese news, rising 0.55%, while CAD and NOK are both higher by 0.5% on the back of the rebound in oil prices. This move was a reaction to OPEC output falling sharply. As to the euro, it is higher by just 0.2% although it has recouped about half its losses from Wednesday now. And finally, the pound has bounced as well after its PMI data was actually a positive surprise. That said, it remains within a few percent of its post Brexit vote lows, and until there is a resolution there, will be hard-pressed to gain much ground. Of course, if there is no deal, the pound is likely to move sharply lower. The UK Parliament is due to vote on the current deal next week, although recent news from PM May’s political allies, the Northern Irish DUP, indicates they are unhappy with the deal and cannot support it yet. With less than three months to go before Brexit is upon us, it is increasingly looking like there will be no deal beforehand, and that the pound has further to fall. For hedgers, I cannot exhort you enough to consider increasing your hedges there. I think the risks are highly asymmetric, with a deal resulting in a modest rally of perhaps 2-3%, while a no-deal outcome could easily see an 8% decline.

For today, the NFP report is on tap with expectations as follows:

Nonfarm Payrolls 177K
Private Payrolls 175K
Manufacturing Payrolls 20K
Unemployment Rate 3.7%
Average Hourly Earnings 0.3% (3.0% Y/Y)
Average Weekly Hours 34.5

We also hear from Chairman Powell at 10:15, where the market will be parsing every word to try to get a better understanding of the Fed’s data reaction function, and perhaps to see which data points they deem most important. At this point, strong NFP data ought lead to declining Treasury prices and rising stock prices although I expect the dollar would remain under pressure based on the risk-on feeling. If the data is weak, however, look for stock futures to reverse course (currently they are higher by ~1.0%) and Treasuries to find support. As to the dollar then, broadly stronger, although I expect the yen will be the best performer overall.

Good luck
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A Statement, Acute

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The company named for a fruit
Explained in a statement, acute
Though services grew
Its gross revenue
Was destined, not to follow suit

The impact ‘cross markets was vast
As traders, most havens, amassed
Thus Treasuries jumped
The dollar was dumped
While yen demand was unsurpassed

Happy New Year to all my readers. I hope it is a successful and prosperous 2019 for everyone.

But boy, has it gotten off to a rough start! Since I last wrote on December 14, volatility across markets has done nothing but increase as fear continues to pervade both the investor and trader communities. While some pundits point to the trade war and/or the US government shutdown, what has been apparent to me for the past several months is that central banking efforts around the world to normalize policy have begun to take their toll on economic activity and by extension on markets that have become completely dependent on that monetary buffer.

Ten years of extraordinary monetary support by central banks around the world has changed the way markets behave at a fundamental level. The dramatic increase in computer driven, algorithmic trading across markets, as well as passive investing and implicitly short volatility strategies has relegated fundamental analysis to the dust heap of history. Or so it seems. The problem with this situation is that when conditions change, meaning liquidity is no longer being continually added to markets, all those strategies suffer. It will be interesting to watch just how long the world’s central banks, who are desperately trying to normalize monetary policy before the next economic downturn, are able to continue on their present path before the pressure of slowing growth forces a reversion to ‘free’ money for all. (Despite all their claims of independence, I expect that before the summer comes, tighter monetary policy will be a historical footnote.)

In the meantime, last night’s volatility was triggered when a certain mega cap consumer electronics firm explained to investors that its sales in China would be much weaker than previously forecast. Blaming the outcome on a slowing Chinese economy, management tried to highlight growth elsewhere, but all for naught. The market response was immediate, with equity markets falling sharply, including futures in both Europe and the US, and the FX markets picking up where last year’s volatility left off. Notably, with Tokyo still on holiday, the yen exploded more 3.5% vs. the dollar during the twilight hours between New York’s close and Singapore’s open, trading to levels not seen since last March. While it has given back a large portion of those gains, it remains higher by 1.2% in the session, and is more than 5% stronger than when I last wrote. If ever there was a signal that fear continues to pervade markets, the yen’s performance over the past three weeks is surely that signal.

Speaking of slowing Chinese growth, the recent PMI data from China printed below that critical 50.0 level at a weaker than expected 49.4, simply confirming the fears of many. What has become quite clear is that thus far, the trade dispute is having a much more measurable negative impact on China’s economy than on the US economy. This has prompted the PBOC to ease policy further overnight, expanding the definition of a small company to encourage more lending to that sector. Banks there that increase their loans to SME’s will see their reserve requirements reduced by up to a full percentage point going forward. (One thing that is very clear is there is no pretense of independence by the PBOC, it is a wholly owned operation of the Chinese government and President Xi!) I guess China is the first central bank to back away from policy normalization as the PBOC’s previous efforts to wring excess leverage out of the system are now overwhelmed by trying to add back that leverage! Look for the ECB to crack soon, and the Fed not far behind.

And while the rest of the FX market saw some pretty fair activity, this was clearly the key story driving activity. The funny thing about the euro is that there are mixed views as to whether the euro or the dollar is a better safe haven, which means that in risk-off scenarios like we saw last night, EURUSD tends not to move very far. Arguably, its future will be determined by which of the two central banks capitulates to weaker data first. (My money continues to be on the ECB).

This week is a short one, but we still have much data to come, including the NFP report tomorrow. So here is a quick update of what to expect today and tomorrow:

Today ADP Employment 178K
  Initial Claims 220K
  ISM Manufacturing 57.9
  ISM Prices Paid 58.0
Friday Nonfarm Payrolls 177K
  Private Payrolls 175K
  Manufacturing Payrolls 20K
  Unemployment Rate 3.7%
  Average Hourly Earnings 0.3% (3.0% Y/Y)
  Average Weekly Hours 34.5

Tomorrow we also hear from Fed Chair Powell, as well as two other speakers (Bullard and Barkin) and then Saturday, Philly Fed President Harker speaks. At this point, all eyes will be on the Chairman tomorrow as market participants are desperate to understand if the Fed’s reaction function to data is set to change, or if they remain committed to their current policy course. One thing that is certain is if the Fed slows or stops the balance sheet shrinkage, equity markets around the world will rally sharply, the dollar and the yen will fall and risky assets, in general, should all benefit with havens under pressure. At least initially. But don’t be surprised if the central banks have lost the ability to drive markets in their preferred long-term direction, even when explicitly trying to do so!

Good luck
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A Year So Dreary

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(With apologies to Edgar Allen Poe)

‘Eighteen was a year so dreary, traders studied hara-kiri
As they pondered every theory, algorithm and z-score.
Interest rates were slowly rising, growth no longer synchronizing,
Brexit’s failures mesmerizing, plus we got a real trade war
Italy, meanwhile explained that budget limits were a bore
Europe looked aghast and swore.

Thus instead of markets booming, (which most pundits were assuming)
What we got was all consuming angst too great to just ignore
Equities reduced to rubble, high-yield bonds saw their spreads double
As the Fed inspired bubble sprung a leak through the back door
Balance sheet adjustment proved to be more harsh than heretofore
Stock investors cussed and swore.

But the New Year’s now commencing, with the markets’, trouble, sensing
Thus predictions I’m dispensing might not be what you wished for
Life’s not likely to get better, ‘specially for the leveraged debtor
Who ought write an open letter to Chair Powell and implore
Him to stop his raising rates so assets grow just like before
Would that he would raise no more.

Pundits far and wide all wonder if Chair Powell’s made a blunder
Or if he will knuckle under to entreaties from offshore
Sadly for mainstream investors, lest our growth decays and festers
Powell will ignore protestors though they’ll raise a great uproar
Thus far he has made it clear that neutral’s what he’s shooting for
Jay, I fear, sees two hikes more.

At the same time Signor Draghi, who’s EU is weak and groggy
Using words in no way foggy, told us QE’s dead, he swore!
Plus he strongly recommended that when summer, this year, ended
Raising rates would be just splendid for those nations at the core
Even though the PIGS keep struggling, this he’s willing to ignore
Higher rates might be in store.

Lately, though, are growing rumors, that six billion world consumers
Are no longer in good humors, thus are buying less, not more
This result should be concerning for those bankers who are yearning
Rates to tighten, overturning years when rates were on the floor
Could it be what we will see is QE4 as an encore?
Maybe low rates are called for.

What about the budget shortfall, in the States that’s sure to snowball
If our growth rate has a pratfall like it’s done ten times before?
While this would be problematic, growth elsewhere would crash to static
Thus it would be quite pragmatic to assume the buck will soar
Don’t believe those euro bulls that think rate hikes there are in store
Christmas next we’re One-Oh-Four.

Now to Britain where the story of its Brexit’s been so gory
Leaving Labour and the Tories in an all out civic war
Though the deal that’s on the table, has its flaws, it would help cable
But when PM May’s unable to find votes here’s what’s in store
Look for cable to go tumbling well below its lows of yore
Next December, One-One-Four.

Time to focus on the East, where China’s growth just might have ceased
Or slowed quite sharply at the least, from damage due to Trump’s trade war
Xi, however’s not fainthearted, and more ease he has imparted
Trying to get growth restarted, which is really quite a chore
But with leverage so extended, how much more can they pay for?
Not as much as days of yore.

With growth there now clearly slowing, public cash is freely flowing,
Banks are told, be easygoing, toward the Chinese firms onshore
But the outcome’s not conclusive, and the only thing conducive
To success for Xi is use of weakness in the yuan offshore
I expect a steady drift much lower to Seven point Four
Only this and nothing more.

Now it’s time for analyzing, ten-year yields, so tantalizing
With inflation hawks advising that those yields will jump once more
But inflation doves are banking that commodities keep tanking
Helping bonds and Bunds when ranking outcomes, if you’re keeping score
Here the doves have better guidance and the price of bonds will soar
At what yields will they sell for?

Slowing growth and growing fear will help them both throughout the year
And so it’s not too cavalier to look for lower yields in store
Treasuries will keep on rising, and for now what I’m surmising
Is a yield of Two point Five is likely come Aught Twenty’s door
Bunds will see their yields retreat to Zero, that’s right, to the floor
Lower ten-year yields, look for.

In a world where growth is slowing, earnings data won’t be glowing
Red ink will, for sure, be flowing which investors can’t ignore
P/E ratios will suffer, and most firms will lack a buffer
Which means things will just get tougher for investors than before
What of central banks? Won’t they be able, prices, to restore?
Not this time, not like before.

In the States what I foresee is that the large cap S&P
Can fall to Seventeen Fifty by year end next, if not before
Europe’s like to see the same, the Stoxx 600 getting maimed
Two Fifty is where I proclaim that index will next year explore
Large percentage falls in both are what investors all abhor
But its what I see in store.

Oil’s price of late’s been tumbling, which for drillers has been humbling
OPEC meanwhile keeps on fumbling, each chance to, its strength, restore
But with global growth now slowing, storage tanks are overflowing
Meanwhile tankers, oceangoing, keep on pumping ship to shore
And more drilling in the States means lower prices are in store
Forty bucks I now call for.

One more thing I ought consider, Bitcoin, which had folks on Twitter
Posting many Tweets quite bitter as it tumbled ever more
Does this coin have true potential? Will it become influential?
In debates quite consequential ‘bout where assets you may store?
While the blockchain is important, Hodlers better learn the score
Bitcoin… folks won’t pay much for

So instead come winter next, Bitcoin Hodlers will be vexed
As it suffers from effects of slowing growth they can’t ignore
While it might be worth Two Grand, the end result is that demand
For Bitcoin will not soon expand, instead its like to shrink some more
Don’t be fooled in thinking you’ll soon use it at the grocery store
Bitcoin… folks won’t pay much for

Fin’lly here’s an admonition, if these views do reach fruition
Every single politician will blame someone else for sure
I’m not hoping for this outcome, I just fear the depths we might plumb
Will result in falling income and recession we’ll explore
So if risk you’re managing, more hedging now is what’s called for
Fear and risk are what will soar!

For you folks who’ve reached the end, please know I seek not to offend
But rather try to comprehend the state of markets and some more
If you read my thoughts last year, I tried to make it very clear
That economic trouble’s near, and so that caution is called for
Mostly though I hope the time invested has not made you sore
For you, my readers, I adore!

Have a very happy, healthy and prosperous New Year
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A More Dovish Muse

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The Chair of the Federal Reserve
For months has displayed steady nerve(s)
He’s gradually lifted
Fed Funds as he’s sifted
The data Fed members observe

But Friday brought more iffy news
And many now look for some clues
That Powell may soon
Abandon his tune
And search for a more dovish muse

Meanwhile o’er in Frankfurt they claim
That QE will end all the same
Though growth there is fading
There is no persuading
The Germans they’ll soon take the blame

The dollar started the Asian session on its back foot as market participants have jumped on the idea that softer employment data on Friday is going to prevent the Fed from maintaining their aggressive stance on monetary policy. And in fairness, we have already heard the first cracks in that story, as a number of Fed speakers were quite willing to admit that if the data slowed, they would not be as aggressive. However, the Fed is now in their blackout period, which means that we will not hear anything from them until they release their statement a week from Wednesday. In this market, that is an eternity with the ability for so much to happen and markets to move extraordinary distances.

As far as selling the dollar is concerned, I certainly understand the impulse given the clearly weaker US data and mildly more dovish tone of the latest comments last week. But the key thing to remember in the FX market is that everything is relative. And while US data is not as robust as it was just a few months ago, the same is true of both Eurozone and Japanese data, as well as Chinese and most EMG data. In fact, while the majority of participants continue to believe that the ECB is going to end QE on December 31st, and confirm that stance this week, there is a very big question mark regarding future European growth, especially in the event of a hard Brexit. Will the ECB have the guts ability to restart QE when inflation data suddenly starts to slide while Q4 GDP disappoints? And so while policy ease may be the proper response, having just ended their program they will be desperate to retain any credibility that they have left. At the end of the day, while the US economy appears to be slowing, it remains significantly brighter than the rest of the world. And that, eventually, is going to underpin the dollar. However, apparently not today.

Arguably, the biggest story this morning is the European Court of Justice’s ruling that the UK can unilaterally withdraw their Section 50 letter (the one where they officially declared they were leaving the EU). The upshot is the Bremainers feel there is new life and they can prevent the disastrous outcome of a hard Brexit. The one thing that seems clear, however, is that the Brexit deal, as currently negotiated, is likely to go down to defeat in the House of Commons in any vote. While that vote had been scheduled to occur tomorrow evening, just moments ago PM May took it off the agenda, with no alternative time scheduled. At the same time, her government reiterated that the UK is going through with Brexit as that was the result requested by the nation during the referendum. The FX market response to the latest histrionics has been to sell the pound. As I type, Sterling is lower by -0.45%, although that is also partially due to the fact that UK data was quite weak as well. For example, Construction Orders fell -30.7% in Q3, its worst performance since the depths of the great recession in 2009. IP fell -0.8% and GDP continues to edge along at a mere 0.1% monthly rate, having grown just 1.5% in the past year. It is becoming ever more clear that Brexit uncertainty is having a negative impact on the UK and by extension on the pound.

Away from the pound’s decline, though, the dollar is generally under pressure in the G10. For example, the euro has rallied 0.3% after modestly positive German trade and Italian IP data, although quite frankly, it seems more of a dollar negative than euro positive story. Bearing out the dollar weakness theme are the commodity currencies, with all three (AUD, CAD and NZD) firmer this morning despite declines across the board in energy, metals and agricultural prices.

Turning to the Emerging markets, the story is a little less anti-dollar as INR has fallen -0.7% after local elections added pressure to PM Modi’s political standing and called into question his ability to be reelected next year. In a more normal reaction to weaker commodity prices, both ZAR (-0.55%) and IDR (-0.5%) are suffering. At the same time, ongoing tensions regarding the US-China trade situation continue to weigh on KRW (-0.7%) and, not surprisingly, CNY (-0.5%). But away from those stories, the broad EMG theme is actually one of modest currency strength. Overall, it has been a mixed picture in the FX space.

Looking ahead to the data this week, with the UK vote now pulled from the calendar and Fed speakers absent, the market will look toward inflation data and Retail Sales for the latest clues on the economy.

Today JOLT’s Jobs Report 6.995M
Tuesday NFIB Small Biz Optimism 107.3
  PPI 0.0% (2.5% Y/Y)
  -ex food & energy 0.1% (2.6% Y/Y)
Wednesday CPI 0.0% (2.2% Y/Y)
  -ex food & energy 0.2% (2.2% Y/Y)
Thursday Initial Claims 225K
Friday Retail Sales 0.2%
  -ex autos 0.2%
  IP 0.3%
  Capacity Utilization 78.5%
  Business Inventories 0.5%

While the inflation data is important, the one thing that seems abundantly clear from recent Fed commentary is that they are unconcerned over the potential for inflation to run much higher. Instead, my sense is that they are going to be very focused on the potential first harbingers of a slowdown in the employment situation, where Initial Claims have ended their decade long decline and actually have started to rise. This is often seen as an early sign of potential economic weakness. But in the end, with the Fed quiet this week, I expect that we are going to be subject to much more foreign influence, with the ongoing Brexit situation driving the pound, the potential for a surprise from the ECB (which meets Thursday) and of course, the ongoing trade melee. In addition, we cannot forget the influence of equity markets, which continue to decline this morning after an abysmal week last week. In other words, there is plenty to drive markets this week, even absent the Fed, and for now, the dollar seems to be under pressure.

Good luck
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Making Its Case

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The market is making its case
The Fed should be slowing the pace
Of interest rate hikes
That nobody likes
As growth has begun to retrace

The emerging narrative is that the Fed needs to stop raising rates before it is too late, or else the global economy is going to sink into a recession. Funnily enough, I think this is one area where many of the glitterati agree with President Trump; Chairman Powell is doing the wrong thing. Certainly, recent equity market activity has been pretty bad, with the overnight sessions showing sharp declines again (Shanghai -1.7%, Nikkei -1.9%, DAX -2.4%, FTSE -2.5%) and US futures pointing to a -1.75% fall on the opening. While the proximate cause of today’s move may be the surprising arrest of the CFO of Chinese telecoms manufacturer Huawei, the reality is that there are plenty of issues that are generating concerns these days.

Clearly the primary concern continues to be the trade situation between the US and China. Monday’s relief rally was based on the fact that there seemed to be a truce. Tuesday’s sharp decline was based on the fact that there were disputes to that message. This morning’s declines have been a reflection of growing concern that the above-mentioned arrest will undermine any chance at trade progress between the two nations. But in addition to the trade story, the background narrative has been that the Fed is raising rates despite growing evidence that the US economy is slowing rapidly. Exhibit A in that story is the housing market, which has seen a particularly weak run of construction and sales over the past six months. Then there is the auto sector, where sales have fallen back from the remarkable heights seen last year. These two industries make up a significant portion of the market’s perception of the economy because virtually everybody has a house and a car, and is aware of what prices are doing there. They have always been seen as a harbinger of future economic activity, so if they are slowing, that bodes ill for the economy at large.

And this is where the dissatisfaction with Powell arises, because he continues to raise rates based on the idea that inflation, while remaining subdued, has the potential to rise sharply unless the Fed tightens policy. They continue to look at the Unemployment Rate of 3.7%, a rate well below any estimates of the Natural Rate of Unemployment, and expect that inflation is going to jump soon. And it might, but so far, that has just not been evident. In fact, the past couple of readings have shown a softer inflation bias, which further adds to the pundit’s angst over Powell.

This commentator is not going to opine on whether the Fed is right or wrong at this time, but I will say that my fear is that all the tools that the Fed (and every other economist) are using to forecast future economic activity are likely not up to the task. There have been massive structural changes to both the economy in general (ongoing improvements in automation across industries) but more specifically, to the way monetary policy works. The aftermath of the financial crisis has fundamentally changed the way the Fed and every other central bank oversees their respective economies. No longer do they adjust reserves to achieve a desired interest rate at a clearing price. Now they simply tell us where rates are and use their powers of suasion to keep them there. And ten years on, the market has built up structures that are now reliant on the new process, so reverting to the old one is no longer an option. My strong concern about this is that these changes are not reflected in the way econometric models are built, and therefore those models do not produce results that are coherent with the current reality.

With that as background, it is easier to understand why there is so much confusion and concern in markets in general. If the Fed is using outdated tools to manage the economy, odds are they won’t work very well. Perhaps this is what the equity markets are pointing out, and have been doing pretty much all year outside the US.

Pivoting to FX, the question is, how will this narrative impact the dollar? Generally speaking, what we have seen is an ongoing risk-off scenario throughout markets, and that has historically been quite beneficial for the greenback. Last night was no exception with Asian currencies experiencing significant declines (AUD -0.9%, NZD -0.5%, CNY -0.6%) while the yen, the other chief beneficiary of risk reduction, rallied 0.4%. We have also seen weakness in CAD (-0.6%), MXN (-0.5%) and BRL (-0.8%). Granted, the CAD story has more to do with the BOC walking back their recent hawkish views, and behaving the way the market wants the Fed to behave. But as long as the Fed seems certain to raise rates come December, and the rest of the world is crumbling, the dollar will find support.

Perhaps we will hear a new tone from the Fed today and tomorrow, as Chairman Powell testifies to Congress today and we hear from both Williams and Bostic with Governor Brainerd speaking tomorrow. The risk is that each of them starts to walk back the hawkish views that have predominated, and reconsider future rate hikes. In that case, look for equity markets to rocket higher, while the market prices out a December rate hike and the yield curve steepens. Also in that case, watch for the dollar to decline sharply. But in the event they maintain their current tone, I see no reason for the dollar to backpedal.

We actually have a bunch of data today as yesterday’s data was delayed due to the day of mourning for President Bush. Today includes ADP Employment (exp 195K), Initial Claims (225K), Nonfarm Productivity (2.3%), Unit Labor Costs (1.1%), Trade Balance (-$54.9B), ISM Non-Manufacturing (59.2) and Factory Orders (-2.0%). It will be interesting to see if we start to get softer data from ISM but I really believe that the market will be far more focused on the Fedspeak and tomorrow’s payroll data than today’s data dump.

Good luck
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Problem’s Aplenty

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Two stories have traders’ attention
The first showed the Fed’s apprehension
That their preferred path
Was earning the wrath
Of markets, thus causing dissention

The other is that the G20
(According to the cognoscenti)
May let Xi explain
A trade war’s insane
Since both men have problems aplenty

Once again the market has narrowed its focus on two things only, in this case the Minutes from the November FOMC meeting and the upcoming dinner between Presidents Trump and Xi at the G20 meeting in Buenos Aires. It seems that traders in virtually every market are taking their cues from these stories.

Starting with the Minutes, it is clear that the Fed finds itself at an inflection point in their policymaking with the easy part now behind them. Up until September, it was evident that policy was extremely accommodative, and the Fed’s goal of gradually reducing that accommodation was easy to achieve, hence the steady pace of a 25bp rate hike every other meeting. However, despite the fact that nobody actually knows where the neutral rate of interest (also known as r*) is, it is apparent that the current Fed funds rate is much closer to that mythical rate than it used to be. Hence the dilemma. How much further should the Fed raise rates, and at what pace? The last thing they want is to raise rates sufficiently to slow the economy into a recession. But they also remain quite wary of policy settings that are too easy, since that could lead to financial instability (read bubbles) and higher inflation. This is why they get paid the big bucks!

Signals from the US economy lately have been mixed, with the housing market slowing along with auto sales, but general consumer confidence and spending remaining at very high levels. Underpinning the latter is the ongoing strength in the labor market, where the Unemployment rate remains near 50 year lows of 3.7%. There is a caveat with the labor market though, and that is the Initial Claims data, which had been trending lower consistently for the past nine years, but has suddenly started to tick higher over the past month. While this could simply be a temporary fluctuation based on changes in seasonal adjustments, it could also be the proverbial canary in the coalmine. We will have a better sense next Friday, when the November NFP report is released, but based on the recent Initial Claims data, a soft employment report is entirely within reason.

The upshot is that the Fed is no longer certain of its near term rate path which means that many of the investing memes of the past ten years, notably buy-the-dip, may no longer make sense. Instead, the volatility that we have seen lately across all markets is likely to be with us going forward. But remember, too, that volatility is a market’s natural habitat. It has been the extreme monetary policies of central banks that have moderated those natural movements. And as central banks back away from excessive monetary ease, we should all expect increased volatility.

The second story is the upcoming meeting between Presidents Trump and Xi tomorrow night. Signals from Trump going into the meeting have been mixed (aren’t all his signals mixed?) but my take is that sentiment is leaning toward at least a pause in any escalation of the trade war, with the true optimists expecting that concrete progress will be made toward ending the tariffs completely. Color me skeptical on the last part, but I wouldn’t be surprised if a temporary truce is called and negotiations restarted as both men are under increasing domestic pressure (China’s PMI just fell to 50.0 last night indicating the economy there is slowing even more rapidly than before) and so a deal here would play well both on a political level, as well as to markets in each country. And when the needs of both parties are aligned, that is when deals are made. I don’t think this will end the tension, but a reduction in the inflammatory rhetoric would be a welcome result in itself.

Recapping the impact of the two stories, the fact that the Fed is no longer inexorably marching interest rates higher has been seen as quite the positive for equities, and not surprisingly a modest negative for the dollar. Meanwhile, optimism that something positive will come from the Trump-Xi dinner tomorrow has equity bulls licking their collective chops to jump back into the market, while FX traders see that as a dollar negative. In other words, both of the key stories are pointing in the same direction. That implies that prices already reflect those views, and that any disappointment will have a more significant impact than confirmation of beliefs.

As it happens, the dollar is actually a bit firmer this morning, rallying vs. most of its G10 counterparts, but only on the order of 0.2%. The pound remains under pressure as traders continue to try to handicap the outcome of the Parliamentary vote on Brexit on December 11, and the signs don’t look great. Meanwhile, the euro has softened after weaker than expected CPI data (headline 2.0%, core 1.0%) and continued weak growth data are making Signor Draghi’s plans to end QE next month seem that much more out of touch.

This morning brings a single data point, Chicago PMI (exp 58.0) as well as a speech from NY Fed President John Williams. However, at this point, given we have heard from both the Chairman and vice-Chairman already this week, it seems unlikely that Williams will surprise us with any new views. Remember, too, that Powell testifies to Congress next week, so we will get to hear an even more detailed discussion on his thinking on Tuesday. Until then, it seems that the dollar will continue its recent range trading. The one caveat is if there truly is a breakthrough tomorrow night in Buenos Aires, we can expect the dollar to respond at the opening in Asia Sunday night. But for today, it doesn’t feel like much is on the cards.

Good luck and good weekend
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Yikes!

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Said Powell, we’re now “just below”
The neutral rate, thus we’ll forego
Too many more hikes
The market said yikes!
And saw all key price metrics grow

If you wonder why I focus on the Fed as much as I do, it is because the Fed continues to be the single most important player in global financial markets. This was reinforced yesterday when Chairman Powell indicated that the current Fed Funds rate, rather than being “…a long way from neutral at this point,” as he described things on October 3rd, are in fact, “…just below” the neutral rate of interest. The implication is that the Fed is much closer to the end of their rate hiking cycle than had previously been anticipated by most market participants. And the market response was immediate and significant. US equity markets exploded higher, with all three major indices rising more than 2.3%; Treasury yields continued their recent decline, with the 10-year yield falling 4.5bps to levels not seen since mid-September; and the dollar fell sharply across the board, with the euro jumping 1% at one point, although it has since given back about 0.3% of that move. But it wasn’t just the euro that rallied, overnight we saw IDR and INR, two of the worst performing EMG currencies, each rally more than 1.0% as a more dovish Fed will clearly bring relief to what has ailed economies throughout the emerging markets.

It is abundantly clear that a more dovish Fed will have significant consequences for markets around the world. In this event we can expect the recent equity market correction to come to an end, we can expect the dollar to give back some portion of its recent gains, and we can expect Treasury yields to level off, especially in the front end, with fears over a yield curve inversion dissipating rapidly. However, is the Fed really changing its tune? Or is yesterday’s market reaction significantly overdone? Unfortunately, it is far too soon to judge. In fact, this will add further significance to the FOMC Minutes from the October meeting, which will be released at 2:00pm today. Remember, that meeting was held nearly four weeks after Powell’s ‘long way from neutral’ comments, so would reflect much more updated thinking.

Something else to keep in mind regarding the potential future path of interest rates is that we continue to see evidence that key sectors of the US economy are slowing down. Yesterday’s New Home Sales data reinforced the idea that higher mortgage rates, a direct consequence of Fed actions during the past two years, continue to take a toll on the housing sector as the print was just 544K, well below expectations and indicative of a market that is flatlining, not growing. We have also seen the trade data deteriorate further despite the president’s strenuous efforts at reversing that trend. In other words, for a data dependent Fed, there is a growing segment of data showing that rates need not go higher. While Powell was clear that there is no preset path of interest rates, the market is now pricing in just two more hikes, one in December and one in March, and then nothing. If that turns out to be the case, the dollar may well come under pressure.

Of course, FX is really about interest rate differentials, not merely interest rates. And while changes in Fed expectations are crucial, so are changes in other central bank actions. For example, early this morning we saw that Eurozone Consumer Confidence fell for the 11th straight month; we saw that Swiss GDP shrank -0.2% unexpectedly in Q3; and we saw that Swedish GDP shrank -0.2% unexpectedly in Q3. The point is that the slowing growth scenario is not simply afflicting the US, but is actually widespread. If Eurozone growth has peaked and is slipping, it will be increasingly difficult for Signor Draghi and the ECB to begin to tighten policy, even if they do end QE next month. The Swedes, who are tipped to raise rates next month are likely to give that view another thought, and the Swiss are certain to maintain their ultra-easy policy. In other words, the interest rate differentials are not going to suddenly change in favor of other currencies, although they don’t seem likely to continue growing in the dollar’s favor. Perhaps we are soon to reach an equilibrium state. (LOL).

On Threadneedle Street there’s a bank
That raised interest rates to outflank
Rising inflation
But now fears stagnation
If they walk the Brexit gangplank

The only currency that has not benefitted from the Powell dovish tone has been the British pound, which has fallen 0.5% this morning back toward the bottom of its recent trading range. The Brexit debate continues apace there and despite analyses by both the government and the BOE regarding the potential negative consequences of a no-deal Brexit (worst case is GDP could be 10% smaller than it otherwise would be with the currently negotiated deal) it seems that PM May is having limited success in convincing a majority of MP’s that her deal is acceptable. Interestingly, the BOE forecast that in their worst-case scenario the pound could fall below parity with the dollar, although every other pundit (myself included) thinks that number is quite excessive. However, as I have maintained consistently for the past two years, a move toward 1.10-1.15 seems quite viable, and given the current political machinations ongoing, potentially quite realistic. All told, the pound remains completely beholden to the Brexit debate, and until the Parliamentary vote on December 11, will be subject to every comment, both positive and negative, that is released. However, the trend remains lower, and unless there is a sudden reversal of sentiment amongst the politicians there, it is feeling more and more like a hard Brexit is in our future. Hedgers beware!

Quickly, this morning’s data brings Initial Claims (exp 221K), Personal Income (0.4%), Personal Spending (0.4%), and the PCE data (Headline 2.0%, Core 1.9%) as well as the FOMC Minutes at 2:00. Unless the PCE data surprises sharply, I expect that markets will remain quiet until the Minutes. But if we see softer PCE prints, look for equities to rally and the dollar to suffer.

Good luck
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Headwinds Exist

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Of late from the Fed we have heard
That “gradual” is the watchword
Though headwinds exist
The Fed will persist
Their rate hikes just won’t be deferred

It appears there is a pattern developing amongst the world’s central bankers. Despite increasing evidence that economic activity is slowing down, every one of them is continuing to back the gradual increase of base interest rates. Last week, Signor Draghi was clear in his assessment that recent economic headwinds were likely temporary and would not deter the ECB from ending QE on schedule and starting to raise rates next year. This week, so far, we have been treated to Fed speakers Charles Evans and Richard Clarida both explaining that the gradual increase of interest rates was still the appropriate policy despite indications that economic activity in the US is slowing. While both acknowledged the recent softer data, both were clear that the current policy trajectory of gradual rate hikes remained appropriate. Later this morning we will hear from Chairman Powell, but his recent statements have been exactly in line with those of Evans and Clarida. And finally, the Swedish Riksbank remains on track to raise rates next month despite the fact that recent economic data shows slowing growth and declining consumer and business confidence.

Interestingly, the San Francisco Fed just released a research paper explaining that inflation was NOT likely to rise significantly and that the increases earlier this year, which have been ebbing lately, were the result of acyclical factors. The paper continued that as those factors revert to more normal, historical levels, inflation was likely to fall back below the Fed’s 2.0% target. But despite their own research, there is no indication that the Fed is going to change their tune. In fact, the conundrum I see is that Powell’s Fed has become extremely data focused, seemingly willing to respond to short term movement in the numbers despite the fact that monetary policy works with a lag at least on the order of 6-12 months. In other words, even though the Fed is completely aware that their actions don’t really impact the data for upwards of a year, they are moving in the direction of making policy based on the idiosyncrasies of monthly numbers.

All this sounds like a recipe for some policy mistakes going forward. However, as I wrote two weeks ago, current attempts to normalize policy are very likely simply addressing previous policy mistakes. After all, the fact that pretty much every central bank in the G20 is seeking to ‘normalize’ monetary policy despite recent growth hiccups is indicative of the fact that they all realize their policies are in the wrong place for the end of the economic cycle. Belatedly, it seems they are beginning to understand that they will have very limited ability to address the next economic downturn, which I fear will occur much sooner than most pundits currently predict.

The reason I focus on the central banks is because of their outsized impact on the currency markets. After all, as I have written many times, the cyclical factor of relative interest rates continues to be one of the main drivers of FX movements. So as long as central banks are telling us that they are on a mission to raise rates, the real question becomes the relative speed with which they are adjusting policy and how much of that adjustment is already priced into the market. The reason that yesterday’s comments from Evans and Clarida are so important is that the market had begun pricing out rate hikes for 2019, with not quite two currently expected. However, if the Fed maintains its hawkish tone that implies the dollar has further room to rise.

Speaking of the dollar, despite the risk-on sentiment that has been evident in equity markets the past two sessions, the dollar continues to perform well. That sentiment seems to be driven by the idea that the Trump-Xi meeting on Saturday will produce some type of compromise and restart the trade talks. I am unwilling to handicap that outcome as forecasting this president’s actions has proven to be extremely difficult. We shall see.

Pivoting to the market today, the dollar is actually little changed this morning, with the largest G10 movement being a modest 0.3% rally in the pound Sterling. There are numerous articles describing the ongoing machinations in Parliament in the UK regarding the upcoming Brexit vote, and today’s view seems to be that something will pass. However, away from the pound, the G10 is trading within 10bps of yesterday’s close, although yesterday did see the dollar rally some 0.4% across the board. Yesterday’s US data showed that consumer confidence was slipping from record highs and that house prices were rising less rapidly than forecast, although still at a 5.1% clip. This morning brings the second look at Q3 GDP (exp 3.5%) as well as New Home Sales (575K) and the Goods Trade Balance (-$76.7B). However, Chairman Powell speaks at noon, and that should garner the bulk of the market’s attention. Until then, I anticipate very little price action in the FX markets, and truthfully in any market.

Good luck
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Twixt Trade Adversaries

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A fortnight from now we will know
How Brexit is going to go
Can Minister May
Still carry the day?
Or will the vote, chaos, bestow?

Meanwhile, this week, in Buenos Aires
A meeting twixt trade adversaries
Has hopes running high
We’ll soon wave goodbye
To tariffs and their corollaries

The first thing you notice this morning in the FX markets is that the pound is under more pressure. As I type, it is lower by 0.7% as the flow of news from London is that the Brexit deal is destined to fail in Parliament. Perhaps the most damning words were from the DUP (the small Northern Irish party helping support PM May’s government), which indicated that they would not support the deal as constructed under any circumstances. At the same time, numerous Tories have been saying the same thing, and the general feeling is that there is only a small chance that PM May will be able to prevail. We have discussed the market reaction in the event of no deal, and nothing has changed in my view. In other words, if the Brexit deal is defeated in parliament in two weeks’ time, look for the pound to fall much further. In fact, it is reasonable to consider a move toward 1.20 in the very short term. Between now and the vote, I expect that the pound will be subject to every headline which discusses the potential vote outcome, but unless some of those headlines start to point to a yes vote, the pound is going to remain under pressure consistently.

Beyond Brexit, there are two other things that have the markets’ collective attention, Fed Chairman Powell’s speech tomorrow, and the meeting between Presidents Trump and Xi on Friday in Buenos Aires at the G20 gathering.

As to the first, the market narrative has evolved to the point where expectations for the Fed to raise rates at their December meeting remain quite high, but there are now many questions about the 2019 rate path. If you recall, after the September FOMC meeting, the consensus was moving toward four rate hikes next year. However, since then, the data has been somewhat less robust, with both production and inflation numbers moderating. Notably, the housing market has been faltering despite the lowest unemployment rate in more than 40 years. Ignoring the President’s periodic complaints about the Fed raising rates, the data story has clearly started to plateau, at least, if not roll over, and the Fed is quite aware of this fact. (Anecdotally, the fact that GM is shuttering 5 plants and laying off 15,000 workers is also not going to help the Fed’s view on the economy.) This is why all eyes will be on Powell tomorrow, to see if he softens his stance on the Fed’s expectations. Already the futures market has priced out one full rate hike for next year, and given there is still more than two weeks before the Fed meets again, Powell’s comments tomorrow, along with vice chairman Clarida today and NY Fed President Williams on Friday are going to be seen as quite critical in gauging the current Fed outlook. Any more dovishness will almost certainly be followed by a weakening dollar and rising equity markets. But if the tone comes across as hawkish, look for the current broad trends of equity weakness and dollar strength to continue.

And finally, we must give a nod to the other elephant in the room, the meeting between President Trump and Chinese President Xi at this weekend’s G20 meeting. Hopes are running high that the two of them will be able to agree to enough common ground to allow more formal trade talks to move ahead while delaying any further tariff implementation. The problem is that the latest comments from Trump have indicated he is going to be raising the tariff rate to 25% come January, as well as seek to implement tariffs on the rest of Chinese imports to the US. It seems that the President believes the Chinese are feeling greater pressure as their economy continues to slow, and they will be forced to concede to US demands sooner rather than later. And there is no question the Chinese economy is slowing, but it is not clear to me that Xi will risk losing face in order to prevent any further economic disorder. I think it is extremely difficult to handicap this particular meeting and the potential outcomes given the personalities involved. However, I expect that sometime in the next year this trade dispute will be resolved, as Trump will want to show that his tactics resulted in a better deal for the US as part of his reelection campaign.

And those are the big stories today. There are two data points this morning, Case-Shiller House Prices (exp 5.3%) and Consumer Confidence (135.9), but neither seems likely to have an impact on the FX market. However, as mentioned above, Fed vice-chairman Richard Clarida speaks first thing this morning, and his tone will be watched carefully for clues about how the Fed will behave going forward. My take here is that we are likely to hear a much more moderate viewpoint from the Fed given the recent data flow, and that is likely to keep modest pressure on the dollar.

Good luck
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