Tag Archives: #Powell

If Things Go Very Wrong

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

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

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

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

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

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

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

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

Good luck
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Animal Spirits Were Stirred

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

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

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

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

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

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

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

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

Good luck and good weekend
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Greater Clarity

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

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

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

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

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

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

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

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

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

Good luck
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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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