Loosen the Screws

Said President Trump, come next week
That he and Xi are set to speak
Meanwhile he complains
The euro remains
Too weak, and a boost there he’ll seek

But that was all yesterday’s news
Today Jay will offer his views
On whether the Fed
Is ready to shred
Its old plans and loosen the screws

ECB President Draghi once again proved his mettle yesterday by managing to surprise the market with an even more dovish set of comments when he spoke at the ECB gathering in Sintra, Portugal. Essentially, the market now believes he promised to cut interest rates further and restart QE soon, despite the fact that rates in the Eurozone remain negative and that the ECB has run up against their self-imposed limits regarding percentage of ownership of Eurozone government bonds. In other words, once again, Draghi will change the rules to allow him to go deeper down the rabbit hole otherwise, these days, known as monetary policy.

Markets were Europhoric, on the news, with equities on the Continent all rising 1.5% or so, while government bond yields fell to new lows. German Bund yields touched a new, all-time, low at -0.326%, but we also saw French OAT yields fall to a record low of 0.00% in the 10-year space. In fact, all Eurozone government bonds saw sharp declines in yields. For Draghi, I’m sure the most gratifying result was that the 5 year/5 year inflation swap contract rebounded from 1.18%, up to 1.23%, still massively below the target of “close to, but below, 2.0%”, but at least it stopped falling. In addition, the euro fell, closing the day lower by 0.2% and back below the 1.12 level, and we also saw gold add to its recent gains, as lower interest rates traditionally support precious metals prices.

US markets also had a big day yesterday with both equity and bond markets continuing the recent rally. Clearly, the idea that the ECB was ready to add further stimulus was a key driver of the move, but that news also whetted appetites for today’s FOMC meeting and what they will do and say. Adding fuel to the equity fire was President Trump’s announcement that he would be meeting with Chinese President Xi at the G20 next week, with plans for an “extended meeting” there. This has created the following idea for traders and investors; global monetary policy is set to get much easier while the trade war is soon coming to an end. The combination will remove both of the current drags on global economic growth, so buy risky assets. Of course, the flaw in this theory is that if Trump and Xi come to terms, then the trade war, which has universally been blamed for the world’s economic troubles, will no longer be weakening the economy and so easier monetary policy won’t be necessary. But those are just details relative to the main narrative. And the narrative is now, easy money is coming to a central bank near you, and that means stocks will rally!

Let’s analyze that narrative for a moment. There is a growing suspicion that this is a coordinated attempt by central bankers to rebuild confidence by all of them easing policy at the same time, thus allowing a broad-based economic benefit without specific currency impacts. After all, if the ECB eases, and so does the Fed, and the BOJ tonight, and even the BOE tomorrow, the relative benefits (read declines) to any major currency will be limited. The problem I have with the theory is that coordination is extremely difficult to achieve out in the open, let alone as a series of back room deals. However, it does seem pretty clear that the data set of late is looking much less robust than had been the case earlier this year, so central bank responses are not surprising.

And remember, too, that BOE Governor Carney keeps trying to insist that UK rates could rise in the event of a smooth Brexit, although this morning’s CPI data printed right on their target of 2.0%, with pipeline pressures looking quite subdued. This has resulted in futures markets pricing in rate cuts despite Carney’s threats. This has also helped undermine the pound’s performance, which continues to be a laggard, even with yesterday’s euro declines. The fact that markets are ignoring Carney sets a dangerous precedent for the central banking community as well, because if markets begin to ignore their words, they may soon find all their decisions marginalized.

So, all in all, the market is ready for a Fed easing party, although this morning’s price action has been very quiet ahead of the actual news at 2:00 this afternoon. Futures markets are currently pricing a 23% chance of a rate cut today and an 85% chance of one in July. One thing I don’t understand is why nobody is talking about ending QT this month, rather than waiting until September. After all, the balance sheet run-off has been blamed for undermining the economy just as much as the interest rate increases. An early stop there would be seen as quite dovish without needing to promise to change rates. Just a thought.

And really, these are the stories that matter today. If possible, this Fed meeting is even more important than usual, which means that the likelihood of large movement before the 2:00pm announcement is extremely small. There is no other data today, and overall, the dollar is ever so slightly softer going into the announcement. This is a reflection of the anticipated easing bias, but obviously, it all depends on what the Chairman says to anticipate the next move.

Good luck
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Constant Hyperbole

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Good luck
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Contrite

More stock market records were smashed
And bulls remain quite unabashed
The future is bright
With Powell contrite
As prior rate hikes are now trashed

The world is a fabulous place this morning, or at least the US is, if we are judging by the financial markets. Both the S&P 500 and NASDAQ indices made new all-time highs yesterday, with the Dow Jones scant points away from its own new record. The dollar is back to its highest point since mid-December and looks poised to rally toward levels not seen since mid 2017. Meanwhile, Treasuries remain in demand, despite all this risk appetite, as yields actually dipped yesterday and continue to hover around 2.50%. And the remarkable thing is the fact that there is no reason to believe these trends will end in the near future. After all, as we move into the heart of earnings season, the data shows that 80% of the 105 companies that have so far reported have beaten their (much reduced) estimates. Even though actual earnings growth is sparse, the fact that expectations have been reduced sufficiently to allow a no-growth result to seem bullish is the fuel for market bulls.

Beyond the earnings story, we have had a bit more positive US data, with New Home Sales rising 4.5%, instead of the expected decline. Last week we also saw strong Retail Sales data, and even though broadly speaking, the housing market seems a bit shaky, (Housing Starts and Existing Home Sales were both soft), there has been enough positive news overall to keep up momentum. And when compared to the Eurozone, where Germany’s Ifo fell to 99.2, below expectations and French Business Confidence fell to 101, its lowest point in three years, it is even clearer why the US is in favor.

Of course, there is one other reason that the US is a favored investment spot right now, the Fed. Over the course of the first four months of 2019, we have seen the Fed turn from a clear hawkish view to uber-doves. At this point, if there are two FOMC members who think a rate hike is in the cards for the rest of the year, it would be a lot. The market is still pricing in a chance of a rate cut, despite the ongoing data releases indicating things are pretty good in the US, and of course, President Trump and his staff have been consistent in their view that rates should be lower, and QE restarted. Funnily enough, given the global central bank desire to pump up inflation, and their total inability to do so for the past decade, do not be surprised to see further policy ease from the US this year. In fact, despite all the angst over Modern Monetary Theory (MMT) I would wager that before long, some mainstream economists are going to be touting the idea as reasonable and that it is going to make its way into policy circles soon thereafter.

In fact, one of the things I have discussed in the past, a debt jubilee, where debt is completely written off, seems almost inevitable. Consider how much government debt is owned by various nations’ central banks. The Fed owns $2.2 trillion, the BOJ owns ¥465 trillion (roughly $4.5 trillion) while the ECB owns €2.55 trillion (roughly $2.85 trillion). Arguably, each could make a book entry and simply destroy the outstanding debt, or some portion of it, without changing anything about the economy directly. While in the past that would have been anathema to economists, these days, I’m not so sure. And if it was done in a coordinated fashion, odds are the market response would be pretty benign. In fact, you could make the case that it would be hyper bullish, as the reduction in debt/GDP ratios would allow for significant additional policy stimulus as well as increased demand for the remaining securities outstanding. We continue to get warnings from official quarters (yesterday the IMF’s new chief economist was the latest to explain there is no free lunch) but politicians will continue to hear the siren song of MMT and will almost certainly be unable to resist the temptation.

Anyway, turning back to the FX market, the dollar has proven to be quite resilient over the past several sessions. This morning, after a rally yesterday, it is higher by another 0.2% vs. the euro. As to the pound, it has fallen steadily during the past week, a bit more than 1.2%, and though unchanged this morning, is now trading well below 1.30. Aussie fell sharply last night after inflation data disappointed on the low side and calls for rate cuts were reaffirmed. This morning, it is down 0.95% and pushing back to 0.7000, which has been a long-term support line. However, if rate cuts are coming, and China remains in the doldrums, it is hard to see that support continuing to hold.

This is not just a G10 phenomenon though, with EMG currencies also on the back foot. For instance, KRW fell 0.75% overnight and broke through key support with the dollar trading back to its highest level since mid-2017. RUB, ZAR and TRY are all lower by ~0.7% and LATAM currencies are under pressure as well.

The point is that as I have been explaining for the past months, whatever issues might exist within the US, they pale in comparison to the issues elsewhere. And looking at the economic growth momentum around the world, the US continues to lead the pack. We will get another reading on that come Friday, but until then, the data is sparse, with nothing at all released today.

I see no reason for current market trends to falter, so expect equities to rally with the dollar alongside them as international investors buy dollars in order to buy stocks. We will need something remarkably different to change this narrative, and it just doesn’t seem like there is anything on the horizon to make that happen.

Good luck
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A Major Mistake

There once was a pundit named Fately
Who asked, is Fed policy lately
A major mistake
Or did Yellen break
The mold? If she did t’was sedately

Please sanction my poetic license by listing Janet Yellen as the primary suspect in my inquiry; it was simply that her name fit within the rhyme scheme better than her fellow central bankers, all of whom acted in the same manner. Of course, I am really discussing the group of Bernanke, Draghi, Kuroda and Carney as well as Yellen, the cabal that decided ZIRP (zero interest rate policy), NIRP (negative interest rate policy) and QE (quantitative easing) made sense.

Recently, there has been a decided uptick in warnings from pundits about how current Fed Chair, Jay Powell, is on the verge of a catastrophic policy mistake by raising interest rates consistently. There are complaints about his plainspoken manner lacking the subtleties necessary to ‘guide’ the market to the correct outcome. In this case, the correct outcome does not mean sustainable economic growth and valuation but rather ever higher equity prices. There are complaints that his autonomic methodology (which if you recall was actually instituted by Yellen herself and simply has been followed by Powell), does not take into account other key issues such as wiggles in the data, or more importantly the ongoing rout in non-US equity markets. And of course, there is the constant complaint from the current denizen of the White House that Powell is undermining the economy, and by extension the stock market, by raising rates. You may have noticed a pattern about all the complaints coming back to the fact that Powell’s policy actions are no longer supporting the stock markets around the world. Curious, no?

But I think it is fair to ask if Powell’s policies are the mistake, or if perhaps, those policies he is unwinding, namely QE and ZIRP, were the mistakes. After all, in the scope of history, today’s interest rates remain exceedingly low, somewhere in the bottom decile of all time as can be seen in Chart 1 below.

5000 yr interest rate chart

So maybe the mistake was that the illustrious group of central bankers mentioned above chose to maintain these extraordinary monetary policies for nearly a decade, rather than begin the unwinding process when growth had recovered several years after the recession ended. As the second chart shows, the Fed waited seven years into a recovery before beginning the process of slowly unwinding what had been declared emergency policy measures. Was it really still an emergency in 2015, six years after the end of the recession amid 2.0% GDP growth, which caused the Fed to maintain a policy stance designed to address a severe recession?

Chart 2

real gdp growth

My point is simply that any analysis of the current stance of the Federal Reserve and its current policy trajectory must be seen in the broader context of not only where it is heading, but from whence it came. Ten years of extraordinarily easy monetary policy has served to build up significant imbalances and excesses throughout financial markets. Consider the growth in leveraged loans, especially covenant lite ones, corporate debt or government debt, all of which are now at record levels, as key indicators of the current excesses. The history of economics is replete with examples of excesses leading to shakeouts throughout the world. The boom and bust cycle is the very essence of Schumpeterian capitalism, and as long as we maintain a capitalist economy, those cycles will be with us.

The simple fact is that every central bank is ‘owned’ by its government, and has been for the past thirty years at least. (Paul Volcker is likely the last truly independent Fed Chair we have had, although Chairman Powell is starting to make a name for himself.) And because of that ownership, every central bank has sought to keep rates as low as possible for as long as possible to goose growth above trend. In the past, although that led to excesses, the downturns tended to be fairly short, and the rebounds quite robust. However, the advent of financial engineering has resulted in greater and greater leverage throughout the economy and correspondingly bigger potential problems in the next downturn. The financial crisis was a doozy, but I fear the next one, given the massive growth in debt outstanding, will be much worse.

At that point, I assure you that the first person who will be named as the culprit for ‘causing’ the recession will be Jay Powell. My point here is that, those fingers need to be pointed at Bernanke, Yellen, Draghi, Carney and Kuroda, as it was their actions that led to the current significantly imbalanced economy. The next recession will have us longing for the good old days of 2008 right after Lehman Brothers went bankrupt, and the political upheaval that will accompany it, or perhaps follow immediately afterwards, is likely to make what we are seeing now seem mild. While my crystal ball does not give me a date, it is becoming abundantly clear that the date is approaching far faster than most appreciate.

Be careful out there. Markets and politics are going to become much more volatile over the next several years.

One poet’s view!

Trembling With Fear

The one thing increasingly clear
Is markets are trembling with fear
As stock markets tumble
Most central banks fumble
Their message, then get a Bronx cheer

Being a central banker has become much more difficult recently, especially in the wake of yesterday’s global equity market rout. It seems that policies that they have collectively promulgated, QE and ZIRP/NIRP are now quite long in the tooth, and no longer having the positive impact desired. Let’s recap quickly.

The Great recession in 2008 called for an extraordinary monetary response by central banks around the world, and rightly so. The deepest recession since the Great Depression saw liquidity across many markets completely dry up. Even FX, arguably the most liquid market of them all, had structural problems. So the combination of QE and USD swap lines offered by the Fed to the rest of the world’s central banks was an appropriate response to help untangle the mess. Alas, fiscal policy never chipped in to the recovery and central banks took it upon themselves to do all the lifting, thus relieving governments of the need to make hard decisions. In hindsight, this was a key mistake!

Fast forward ten years to today and the situation, remarkably, is that most of that extraordinary monetary stimulus is still sloshing around the world as other than the Fed and the Bank of Canada (who raised rates yesterday and indicated they would be quickening the pace of doing so in the future), no other major central bank has done anything of note. The ECB, the BOJ and the PBOC are all still adding liquidity to their systems, while the BOE has raised rates just 25bps, net, from the lows established after the crisis. And the same is true of peripheral nations like Switzerland, Sweden and Australia, where interest rates remain at their post crisis nadirs (-0.75%, -0.50% and 1.50% respectively).

The problem for these central banks is that growth is starting to slow on a global basis. Whether it is the increased trade friction between the US and China, concerns over Brexit or simply that the US recovery (which still arguably drives most of the global economy) is now the longest on record and due to end, the situation is increasingly fraught. And that’s the rub. If interest rates are already negative, what can central banks do to stimulate the economy in the event of a recession? The answer, of course, is not much. More QE and even deeper negative interest rates are unlikely to have the same positive impact the first efforts had, in fact they could have the opposite effect by generating greater concern amongst investors and causing a more severe sell-off in markets. But politically, no central bank will be able to sit by and do nothing if a recession does appear. As I said, central banking has become much more difficult lately.

That is all a preamble to discuss what is going on in markets right now. FX is a backburner issue with equities front and center around the world. While European markets have stabilized at this time, one session of stability is not sufficient to declare an end to the rout. In the end, markets remain beholden to broad sentiment, the narrative if you will, and for the past ten years that narrative was that continued low inflation combined with steady growth would allow the central banks to maintain ultra easy monetary policy with no negative side effects. But in the past year, the cracks in that narrative have grown to the point where it is no longer seen as viable. First, inflation has begun to creep higher in certain areas around the world, notably the US and China. At the same time, growth data appears to have peaked last quarter. Tomorrow we will see the first estimate of Q3 GDP growth in the US (exp 3.3%), which is already considerably lower than Q2. In addition, we have seen Chinese growth slow more than expected and German growth fall to 0.0% in Q3. The combination of rising inflation and slower growth has put central banks in a bind forcing them to choose which issue to address first. The problem is by addressing one they are likely to exacerbate the other. So as the Fed fights threats of higher inflation, it impedes growth. Meanwhile, China has opted to support growth, thus feeding faster inflation. In the end, as the next recession looms closer, central banks will find themselves with fewer policy arrows in their quiver.

But this is an FX note, so let’s take a quick look at the market this morning. The dollar is a touch softer, with both the euro and the pound higher by 0.15% while we are seeing similar moves in most emerging market currencies. Activity in the market seems muted relative to the excitement in equities, but my sense is this will not last. Rather, if the equity sell-off continues, the dollar should find itself in a much stronger position. As to the stories that have been driving things in FX, the Italian budget, Brexit, central bank policies, there have been no real changes in the past twenty-four hours. The possible exception is that the interest rate futures market in the US has removed one price hike from the Fed’s expected path as concern grows that a continues slide in the stock market will lead to weaker growth and less need to keep driving rates higher. It seems that the Fed realizes that it began its tightening process far too late (thank you Chair Yellen!) and is now desperately trying to catch up so they can respond to the next downturn. But hey, the ECB is MUCH further behind.

Looking forward to today’s session, we start with the ECB meeting, where they announced no change in policy rates, but we still await Signor Draghi’s press conference at 8:30. It will be interesting if he continues to characterize the Eurozone economy risks as balanced, or if the downside risks are now elevated. If the latter, look for the euro to decline sharply! We also get US data including Durable Goods (exp -1.0%, ex transport +0.5%) and the Goods Trade Balance (-$74.9B). Yesterday’s New Home Sales data was awful, just 553K, well below expectations, and another sign that parts of the economy here are rolling over. I still don’t believe that the data turn has been enough to change the Fed’s mind about a December rate hike, but if numbers start to fall, watch out. Tomorrow’s GDP print will be quite important to the market. But today, I think the ECB dominates the story.

Good luck
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Percent Twenty-Five

The story, once more’s about trade
As Trump, a new threat, has conveyed
Percent twenty-five
This fall may arrive
Lest progress in trade talks is made

President Trump shook things up yesterday by threatening 25% tariffs on $200 billion of Chinese imports unless a trade deal can be reached. This is up from the initial discussion of a 10% tariff on those goods, and would almost certainly have a larger negative impact on GDP growth while pushing inflation higher in both the US and China, and by extension the rest of the world. It appears that the combination of strong US growth and already weakening Chinese growth, has led the President to believe he is in a stronger position to obtain a better deal. Not surprisingly the Chinese weren’t amused, loudly claiming they would not be blackmailed. In the background, it appears that efforts to restart trade talks between the two nations have thus far been unsuccessful, although those efforts continue.

Clearly, this is not good news for the global economy, nor is it good news for financial markets, which have no way to determine just how big an impact trade ructions are going to have on equities, currencies, commodities and interest rates. In other words, things are likely more uncertain now than in more ‘normal’ times. And that means that market volatility across markets is likely to increase. After all, not only is there the potential for greater surprises, but the uncertainty prevailing has reduced liquidity overall as many investors and traders hew to the sidelines until they have a better idea of what to do. And, of course, it is August 1st, a period where summer vacations leave trading desks with reduced staffing levels and so liquidity is generally less robust in any event.

Moving past trade brings us straight to the central bank story, where the relative hawkishness or dovishnes of yesterday’s BOJ announcement continues to be debated. There are those who believe it was a stealth tightening, allowing higher 10-year yields (JGB yields rose 8bps last night to their highest level in more than 18 months) and cutting in half the amount of reserves subject to earning -0.10%. And there are those who believe the increased flexibility and addition of forward guidance are signals that the BOJ is keen to ease further. Yesterday’s price action in USDJPY clearly favored the doves, as the yen fell a solid 0.8% in the session. But there has been no follow-through this morning.

As to the other G10 currencies, the dollar is modestly firmer against most of them this morning in the wake of PMI data from around the world showing that the overall growth picture remains mixed, but more troubling, the trend appears to be continuing toward slower growth.

The emerging market picture is similar, with the dollar performing reasonably well this morning, although, here too, there are few outliers. The most notable is KRW, which has fallen 0.75% overnight despite strong trade data as inflation unexpectedly fell and views of an additional rate hike by the BOK dimmed. However, beyond that, modest dollar strength was the general rule.

At this point in the session, the focus will turn to some US data including; ADP Employment (exp 185K), ISM Manufacturing (59.5) and its Prices Paid indicator (75.8), before the 2:00pm release of the FOMC statement as the Fed concludes its two day meeting. As there is no press conference, and the Fed has not made any changes to policy without a press conference following the meeting in years, I think it is safe to say there is a vanishingly small probability that anything new will come from the meeting. The statement will be heavily parsed, but given that we heard from Chairman Powell just two weeks ago, and the biggest data point, Q2 GDP, was released right on expectations, it seems unlikely that they will make any substantive changes.

It feels far more likely that this meeting will have been focused on technical questions about how future Fed policies will be enacted. Consider that QE has completely warped the old framework, where the Fed would actually adjust reserves in order to drive interest rates. Now, however, given the trillions of dollars of excess reserves, they can no longer use that strategy. The question that has been raised is will they try to go back to the old way, or is the new, much larger balance sheet going to remain with us forever. For hard money advocates, I fear the answer will not be to their liking, as it appears increasingly likely that QE is with us to stay. Of course, since this is a global phenomenon, I expect the impact on the relative value of any one currency is likely to be muted. After all, if everybody has changed the way they manage their economy in the same manner, then relative values are unlikely to change.

Flash, ADP Employment prints at a better than expected 219K, but the initial dollar impact is limited. Friday’s NFP report is of far more interest, but for today, all eyes will wait for the Fed. I expect very limited movement in the dollar ahead of then, and afterwards to be truthful.

Good luck
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Is That Despair?

Forward guidance is
Kuroda-san’s newest hope
Or is that despair?

The BOJ has committed to keep the current extremely low levels for short- and long-term interest rates for an “extended period of time.” Many of you will recognize this phrase as Ben Bernanke’s iteration of forward guidance. This is the effort by central banks to explain to the market that even though rates cannot seemingly go any lower, they promise to prevent them from going higher for the foreseeable future. Alas, forward guidance is akin to Hotel California, from which, as The Eagles famously sang back in 1976, “you can check out but you can never leave.” As the Fed found out, and the ECB will learn once they finally end QE (assuming they actually do so), changing tack once you have promised zero rates forever can have market ramifications. The first indication that forward guidance might be a problem came with the ‘taper tantrum’ in 2013, but I’m confident it won’t be the last.

However, for the BOJ, now trumps the future, and they needed to do something now. But forward guidance was not the only thing they added last night. It was the cover for their attempts to adjust policy without actually tightening. So, yield curve control now has a +/- 20bp range around 0.0% for the 10-year JGB, double the previous level, and thus somewhat more flexible. And they reduced the amount of reserves subject to the -0.10% deposit rate in order to alleviate some of the local banks’ profit issues. In the end, their commitment to maintaining zero interest rates for that extended period of time was sufficient for FX traders to sell the yen (it fell -0.40%), and JGB yields actually fell a few bps, closing at 0.065%, which is down from 0.11% ahead of the meeting. All in all, I guess the BOJ did a good job last night.

There is, however, one other thing to mention, and that is they reduced their own inflation forecasts (to 1.1% in 2019, 1.5% in 2020 and 1.6% in 2021) for the next three years, indicating that even they don’t expect to achieve that elusive 2.0% target before 2022 at the earliest. In the end, the BOJ will continue to buy JGB’s and equity ETF’s and unless there is a substantial acceleration in global growth, (something which seems increasingly unlikely) they will continue to miss their inflation target for a very long time. As to the yen, I expect that while it fell a bit last night, it is still likely to drift higher over time.

In Europe the story is still
That growth there is starting to chill
The data last night
Did naught to delight
Poor Mario, testing his will

Beyond the BOJ, and ahead of the FOMC announcement tomorrow, the major news was from the Eurozone where GDP and Inflation data was released. What we learned was that, on the whole, growth continued to slow while inflation edged higher than expected. Eurozone GDP rose 0.3% in Q2, its slowest pace in a year, while headline inflation rose 2.1%, its fastest rate since early 2013. Of course the latter was predicated on higher energy prices with core CPI rising only 1.1%, still a long way from the ECB’s target. The point is that given the slowing growth trajectory in the Eurozone, it seems that Draghi’s confidence in faster growth causing inflation to pick up on the continent may be unwarranted. But that remains the official line, and it appears that the FX market has accepted it as gospel as the euro has traded higher for a third consecutive day (+0.3%) and is now back in the top half of its trading range. If Q3 growth continues the trajectory that Q2 has extended, it will call into question whether the ECB can stop buying bonds, or at the very least, just how long rates will remain at -0.4%, with those looking for a September 2019 rate hike sure to be disappointed.

There is one country in Europe, however, that is performing well, Sweden. GDP growth there surprised the market yesterday, rising 1.0% in Q2 and 3.3% Y/Y. This has encouraged speculation that the Riksbank will be raising rates fairly soon and supported the krone, which has rallied 1.0% since the announcement.

The final piece of news to discuss from last night was from China, where the PMI readings all fell below expectations. The official Manufacturing data was released at 51.2, down from last month’s 51.5 and the third consecutive monthly decline. The non-manufacturing number fell to 54.0, its weakest print since October 2016. These are the first data from China that include the impact of the US tariffs, and so are an indication that the Chinese economy is feeling some effects. I expect that the government there will add more stimulus to offset any more severe impact, but that will simply further complicate their efforts at reducing excess leverage in the economy. Meanwhile, the renminbi slid 0.25% overnight.

This morning’s data releases bring us Personal Income (exp 0.4%), Personal Spending (0.4%) and PCE (2.3% headline, 2.0% core), as well as the Case-Shiller Home price index (6.4%), Chicago PMI (62.0) and Consumer Confidence (126.0). In other words, there is much for us to learn about the economy. While I believe the PCE data could be market moving, especially if it is stronger than expected, I continue to believe that traders and investors remain far more focused on Friday’s payroll report than this data. Recent weakness in equity markets has some folks on edge, although futures this morning look benign. But if we do see that weakness continue, the chances of a full-blown risk off scenario materializing will grow substantially. And that means, the dollar has the potential to rally quite sharply. Keep that in mind as a tail risk, one where the tail grows fatter each day that equity markets disappoint.

Good luck
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