Propense to Inveigh

The Minutes released yesterday
Had not very much new to say
Rates will keep on rising
And assets downsizing
Despite Trump’s propense to inveigh

The market reaction was swift
With 10-years receiving short shrift
The stock market fell
(Was this its death knell?)
While dollars received quite a lift!

And here I thought the FOMC Minutes would be dull and boring with limited market impact. I couldn’t have been more wrong. While the text itself was as dry as usual, it seems the market read between the lines and gleaned the following: interest rates are going to go higher for a while yet, a longer time than previously considered.

Arguably the biggest change in the September FOMC statement was the removal of the sentence regarding policy being accommodative. Chairman Powell focused on this at the ensuing press conference, and has commented on it since then as well. The gist of his message has been that since the dividing line between accommodative and not accommodative is so uncertain (r* is immeasurable) and that it is not likely to be stationary either, there is no way the Fed can be certain they have reached that target. Given that premise, describing their policy as accommodative seemed to express too much precision in something that is extremely uncertain.

However, the compilation of views from the Minutes seemingly showed a larger group of members sounding hawkish. In the end, the market read this to mean that the Fed was going to be raising rates at least another 100bps before they stop. Consider that if they act every quarter through the end of 2019, raising rates 25bps each time, Fed Funds is going to be in a range of 3.25%-3.50% at the end of next year. And while that is still low on a historic basis, it is much higher than markets have seen in more than a decade. Based on what we have heard from the ECB and BOJ, it is also much higher than their cash rates are going to be at that time. In fact, it is quite possible that in both those cases, cash rates will still be 0.00% or negative at the end of next year.

If you play out that scenario, it cannot be very surprising that the dollar was a beneficiary of the release of the Minutes. So yesterday’s 0.6% decline in the euro makes a great deal of sense. In fact, the dollar index performed in exactly the same manner, rising 0.6% on the day. And one thing to keep in mind is that Fed funds futures markets are still pricing in only a 25% probability that rates will be that high at the end of next year. If the Fed stays the course, and there is no reason yet to believe they won’t, that market will need to adjust, and other markets will adjust accordingly.

So a quick recap of the G10 currencies showed that the dollar performed will against all of them yesterday, but has since ceded some of that ground in what appears to be a short-term trading effect. So this morning’s 0.15% rise in the euro, or 0.1% rise in the pound hardly seems compelling.

But there was another story of note yesterday as well, the US Treasury issued its semiannual report on currencies and, once again, did not find China a currency manipulator by its legal definition. This cannot be a real surprise because despite the President’s constant complaints, according to the law, a country can only be designated a manipulator if three conditions are met; consistent currency intervention, running a large trade surplus with the US and running a large current account surplus overall. In fact, China has not been actively intervening on a net basis in the FX markets, and its overall current account surplus has actually fallen to near flat, although obviously it continues to run a large surplus with the US.

Recent price action in USDCNY had been extremely stable, with the PBOC seeking to maintain very modest volatility and expressly saying that they would not be using the exchange rate as a ‘weapon’ in trade. But interestingly, last night, after the release of the Treasury report, the PBOC fixed CNY at its weakest level in nearly two years and the renminbi fell 0.25%. As well, Chinese stock markets continued their recent declines, with Shanghai falling another 2.9% and now trading at its lowest point since December 2014. Concerns are growing that the Chinese economy may be slowing faster than anticipated and this is also being reflected in commodity prices, where base metals have been falling along with oil. (Oil also suffered because of the ongoing inventory build in the US, which when combined with fears over slowing global growth have been sufficient to add a little caution to all those claims that $100 oil was returning soon.)

And those were the big stories yesterday. The US data was surprisingly weak, with both Housing Starts and Building Permits falling and coming in well short of expectations. But this market is far more focused on the Fed and its perceived intentions than on a piece of data. That tells me that this morning’s Initial Claims (exp 212K) and Philly Fed (20.0) are unlikely to move markets. Of more interest may be speeches by two Fed speakers, Bullard and Quarles, especially if they delve into more detail of their policy expectations.

Equity futures are pointing lower, and Treasury yields have maintained yesterday’s gains and are back at 3.20%. My sense is that risk is being reduced across the board here, thus driving both stocks and bonds lower at the same time. If that is true, then look for further commodity price weakness and the dollar to retain its recent gains.

Good luck
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A Source of Great Strains

Inflation in England is easing
Which most people there find quite pleasing
But Brexit remains
A source of great strains
As Europe continues its squeezing

Yesterday’s broad equity market rally brought relief to most investors as it allayed concerns that the end was nigh. While many continue to be bullish, there is no doubt that there is rising concern about the idea that the good times will eventually end. In the wake of yesterday’s rally, however, fears have abated somewhat and market chatter is now focused on more mundane things like data and the FOMC Minutes.

With that in mind, the most noteworthy data overnight was the UK Inflation report that showed that CPI rose only 2.4%, well below expectations of a 2.6% rise, and seemingly indicating that earlier fears of stagflation in the UK economy were widely overblown. In fact, both sides of that equation, GDP growth and inflation are moving in the preferred direction, with GDP outperforming while CPI is underperforming. This situation will reduce pressure on the Old Lady with regards to policy moves as the necessity of hiking rates in an environment where price rises are moderating is quite limited. Thus it should be no surprise that the pound is under modest pressure today, falling 0.3% in the wake of the data release. However, in the broad scheme of things, the pound remains little changed from its level back in June and July.

Ultimately, while the monthly data releases are important, all eyes remain on the Brexit situation and estimates of how and when things there will be settled. The latest news is that the currently mooted plan, essentially splitting Northern Ireland from the rest of the UK, at least from a commerce perspective, does not have support in Parliament. At the same time, the Europeans believe they retain the upper hand in the negotiation as EU President Donald Tusk has called for PM May to come forward with some new creative solutions, implying it is her problem, not theirs. It is almost as though the EU doesn’t want to work at solving the problem at all. There is a big EU meeting today and tomorrow but right now, there doesn’t appear to be anything new to discuss, and while negotiations are ongoing, the issue is likely insoluble. After all, the competing demands are to prevent any visible customs border between Ireland and Northern Ireland while insuring that customs and duties are charged for all products that cross that border. As I have written many times, I expect there will be a fudge solution that doesn’t solve the problem but more likely kicks the can down the road for a few years. However, each day that passes increases the probability that there is no solution and the result is short-term chaos in markets and a much weaker pound. The risk/reward in the pound argues to maintain a net short position, as any potential gains are likely to be small relative to any potential losses depending on the actual outcome.

Away from the Brexit story, however, there is precious little else happening in the G10 bloc. Eurozone CPI was released right on the money, with the headline confirmed at 2.1%, but core remains a full percentage point below that. There is no indication that the ECB is going to change their policy stance at this point, and so look for QE to end in December while interest rates remain unchanged for at least another nine months following that. The euro has edged lower in recent trading, but the 0.2% decline is hardly enough to change any opinions, and as I mentioned yesterday, the bigger picture shows that it has barely budged over the course of the past five months. As to other currencies in the bloc, the RBA Minutes highlighted that low interest rates were likely to be maintained for another few years as the Unemployment Rate drifts lower, but there is, as yet, no evidence of rising wage pressures. Aussie seems likely to remain under broad pressure, especially as the US continues to tighten policy.

Turning to the EMG bloc, Chinese data last night showed that the money supply was continuing its steady 8.3% growth and that far from austerity, new loans continue to be made at a solid clip. It is quite clear that the PBOC is easing policy while trying to use regulatory tools to prevent additional liquidity moving into real estate where they continue to try to deflate a bubble. So far, it has been working for them. In the meantime, the renminbi continues to trade around 6.92, making no move toward the feared 7.00 level, but also not showing signs of strength. It is becoming quite clear, however, that outbound capital flows are starting to increase as for the third month running, China’s holdings of US Treasuries have fallen, this time by about $6 billion. Ignore all that you hear about China using Treasuries as a weapon; they have no alternative place to park their cash. Rather, the most likely explanation for a reduction in holdings is that they have been selling dollars in the FX market and need to sell Treasuries to get those dollars to deliver.

And those are really the big stories of the day. Yesterday’s US data was solid with IP growing 0.3% and Capacity Utilization running at 78.1%, largely as expected. This morning brings Housing Starts (exp 1.22M) and Building Permits (1.278M), and then this afternoon at 2:00 we see the FOMC Minutes. Given how much we have already heard from Fed speakers since the meeting, it strikes me that there is very little new information likely to appear. However, there are those who are looking for more clarity on the ongoing discussion about the neutral rate and where it is, as well as how important a policy tool it can be.

Equity futures have turned lower as I type, now down 0.2% while Treasury yields seem to have found a new home in the 3.15%-3.20% range. Arguably, today’s big risk is that the equity market resumes last week’s sharp declines and risk is jettisoned. However, that doesn’t appear that likely to me, rather a modest decline and limited impact on the FX market seems more viable for today.

Good luck
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Change Can Come Fast

There once was a market that soared
With tech stocks quite widely adored
The Fed, for eight years
Suppressed any fears
And made sure that rates were kept floored

But nothing, forever, can last
Now ZIRP and QE’s time has passed
Investors are frightened
‘Cause Powell has tightened
Beware because change can come fast!

Many of you will have noticed that equity markets sold off sharply in the past twenty-four hours, and that as of now, it appears there is more room to run in this correction. The question in situations like these is always, what was the catalyst? And while sometimes it is very clear (think Brexit or the Lehman bankruptcy) at other times movements of this nature are simply natural manifestations of a very complex system. In other words, sometimes, and this appears to be one of them, markets simply move because a confluence of seemingly minor events all occur at the same time. Trying to ascribe the movement to yesterday’s PPI reading, or comments from the IMF meetings, or any other specific piece of information is unlikely to be satisfying and so all I will say is that sometimes, markets move further than you expect.

Consider, though, that by many measures equity prices, especially in the US, are extremely richly valued. Things like the Shiller CAPE, or the Buffet idea of total market cap/GDP both show recent equity market levels at or near historic highs. And while the tax cuts passed into law for 2018 have clearly helped profitability this year, 2019 comparisons will simply be that much tougher to meet. There are other situations regarding the market that are also likely having an impact, like the increase in algorithmic trading, the dramatic increase in passive indexing and the advent of risk parity strategies. All of these tended to lead to buying interest in the same group of equities, notably the tech sector, which has been the leading driver of the stock market’s performance. If these strategies are forced to sell due to investor withdrawals, they will do so with abandon (after all, they tend to be managed by computer programs not people, and there is no emotion involved at all) and we could see a substantial further decline. Something to keep in mind.

But how, you may ask, is this impacting the FX markets? Interestingly, the dollar is not showing any of its risk-off tendencies through this move. In fact, it has fallen against almost all counterpart currencies. And while in some cases, there is a valid story that has nothing to do with the dollar per se, in many cases, it appears that this is simply dollar weakness. For example, the euro has rallied 0.5% this morning, after a 0.25% gain yesterday. Part of this has been driven by modestly higher than expected inflation data from several Eurozone countries (Spain and Ireland) while there is likely also a benefit from the story that the Brexit negotiations seem to be moving to a conclusion. However, despite the positive Brexit vibe, the pound has only managed a 0.15% rise this morning. The big winner in the G10 space has been Sweden, where the krone has rallied 1.5% after it also released higher than expected CPI data (2.5%) and the market has priced in further tightening by the Riksbank.

Looking at the EMG space, the dollar has fallen very consistently here, albeit not universally. We haven’t paid much attention to TRY lately, but it has rallied 1.4% today, and 5.5% in the past month. While yesterday they did claim to create some measures to help address the rising inflation there, they appear fairly toothless and I suspect the lira’s recent strength has more to do with the market correcting a massive decline than investor appetite for the currency. But all of the CE4 are rallying today, albeit in line with the euro’s 0.5% move, and there have been no stories of note from the region.

Looking to APAC, the movement has actually been far less pronounced with THB the best performer, rising 0.7% but the rest of the space largely trading within 0.2% of yesterday’s close. In other words, there is no evidence that, despite a significant decline in equity markets throughout the region, that risk-off sentiment has reached dramatic proportions. Now, if equity markets continue their sharp decline today, my best guess is that we will see a bit more activity in the currency markets, likely with the dollar the beneficiary.

Finally, LATAM currencies have had a mixed performance, with MXN rising 0.5% this morning, but BRL having fallen more than 1% on news that the mooted finance minister for Jair Bolsonaro (assuming he wins the second round election) is being investigated for corruption.

Turning to this morning’s session, the key data point of the week is released, with CPI expected to have declined to 2.4% in September (from 2.7%) and the core rate to have risen to 2.3%, up from August’s reading of 2.2%. With every comment from a Fed speaker focused on the idea of continuing to increase Fed Funds until they reach neutral, this data has the opportunity to have a real impact. If the release is firmer than expected, look for bonds to suffer, equities to suffer more and the dollar to find support. However, if this data is weak, then I would expect that the dollar could fall further, maybe back toward the bottom of its recent range, while the equity market finds some support as fears of an overly tight Fed dissipate.

So there is every opportunity for some more market fireworks today. As I believe that inflation remains likely to continue rising, especially based on the anecdotal evidence of rises in wages, I continue to see the dollar finding support. Of course, that doesn’t speak well of how the equity market is likely to perform if I am correct.

Good luck
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The Next Year Or So

Said Williams, “the next year or so”
Should see rates reach neutral, you know
At that point we’ll see
If our GDP
Is humming or soon set to slow

The dollar is under very modest pressure this morning, although in reality it is simply continuing to consolidate its recent gains. While there have been individual currency stories, the big picture continues apace.

As I write, the IMF is holding its annual meeting in Indonesia and so we are hearing much commentary from key financial officials around the world. Yesterday, IMF Managing Director Lagarde told us that the ongoing trade tensions were set to slow global growth. Overnight, we heard from NY Fed President John Williams, who said that the US economy continued to be strong and that while there is no preset course, it seemed likely that the Fed would continue to adjust policy until rates reached ‘neutral’. Of course, as nobody knows exactly where neutral is, there was no way to determine just how high rates might go. However, there was no indication that the Fed was going to pause anytime soon. Dallas Fed President Robert Kaplan, who said that he foresaw three more rate hikes before any pause, corroborated this idea. According to the dot plot, 3.00% seems to be the current thinking of where the neutral rate lies as long as inflation doesn’t push significantly higher than currently expected. All this points to the idea that the Fed remains on course to continued policy tightening, with the risks seemingly that if inflation rises more than expected, they will respond accordingly.

The other truly noteworthy news was from the UK, where it appears that a compromise is in sight for the Brexit negotiations. As expected, there is some fudge involved, with semantic definitions of the difference between customs and regulatory checks, but in the end, this cannot be a great surprise. The impetus for change came from Germany, who has lately become more concerned that a no-deal Brexit would severely impact their export industries, and by extension their economy. The currency impact was just as would be expected with the pound jumping one penny on the report and having continued to drift higher from there. This seems an appropriate response as no deal is yet signed, but at least it appears things are moving in the right direction. In the meantime, UK data showed that Q3 GDP growth is on track for a slightly better than expected outcome of 0.7% for the quarter (not an annualized figure).

As to the other ongoing story, there has been no change in the tone of rhetoric from the Italian government regarding its budget, but there are still five days before they have to actually submit it to their EU masters. It remains to be seen how this plays out. As I type, the euro has edged up 0.15% from yesterday’s close, but taking a step back, it is essentially unchanged for the past week. If you recall, back in August there was a great deal of discussion about how the dollar had peaked and that its decline at that time portended a more significant fall going forward. At this point, after the dollar recouped all those losses, that line of discussion has been moved to the back pages.

Turning to the emerging markets, Brazil remains a hot topic with investors piling into the real in expectations (hopes?) of a Bolsonaro win in the runoff election. That reflected itself in yet another 1.5% rise in the currency, which is now higher by more than 10% over the past month. The China story remains one where the renminbi seems to be on the cusp of a dangerous level, but has not yet fallen below. Equity markets there took a breather from recent sharp declines, ending the session essentially flat, but there is still great concern that further weakness in the CNY could lead to a sharp rise in capital outflows, or correspondingly, more draconian measures by the PBOC to prevent capital movement.

But after those two stories, it is harder to find something that has had a significant impact on markets. While Pakistan just reached out to the IMF for a $12 billion loan, the Pakistani rupee is not a relevant currency unless you live there. However, this issue is emblematic of the problems faced by many emerging economies as the Fed continues to tighten policy. Excessive dollar borrowing when rates were low has come back to haunt many of these countries, and there is no reason to think this process will end soon. Continue to look for the dollar to strengthen vs. the EMG bloc as a whole.

This morning brings our first real data of the week, PPI (exp 2.8%, 2.5% ex food & energy). However, PPI is typically not a market mover. Tomorrow’s CPI data, on the other hand, will be closely watched for signs that inflation is starting to test the Fed’s patience. But for now, other than the Brexit news, which is the first truly positive non-dollar news we have seen in a while, my money is on a quiet session with limited FX movement. The only caveat is if we see significant equity market movement, whereby a dollar reaction would be normal. This is especially so if equities fall and so risk mitigation leads to further dollar buying.

Good luck
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Too Arcane

The Fed took the time to explain
Why ‘Neutral’ they’ll never attain
Though theories suppose
O’er that rate, growth slows
Its measurement is too arcane

If one needed proof that Fed watching was an arcane pastime, there is no need to look beyond yesterday’s activities. As universally expected, the FOMC raised the Fed funds rate by 25bps to a range of 2.00% – 2.25%. But in the accompanying statement, they left out the sentence that described their policy as ‘accommodative’. Initially this was seen as both surprising and dovish as it implied the Fed thought that rates were now neutral and therefore wouldn’t need to be raised much further. However, that was not at all their intention, as Chairman Powell made clear at the press conference. Instead, because there is an ongoing debate about where the neutral rate actually lies, he wanted to remove the concept from the Fed’s communications.

The neutral rate, or r-star (r*) is the theoretical interest rate that neither supports nor impedes growth in an economy. And while it makes a great theory, and has been a linchpin of Fed models for the past decade at least, Chairman Powell takes a more pragmatic view of things. Namely, he recognizes that since r* cannot be observed or measured in anything like real-time, it is pretty useless as a policy tool. His point in removing the accommodative language was to say that they don’t really know if current policy is accommodative or not, at least with any precision. However, given that their published forecasts, the dot plot, showed an increase in the number of FOMC members that are looking for another rate hike this year and at least three rate hikes next year, it certainly doesn’t seem the Fed believes they have reached neutral.

The market response was pretty much as you would expect it to be. When the statement was released, and initially seen as dovish, the dollar suffered, stocks rallied and Treasury prices fell in a classic risk-on move. However, once Powell started speaking and explained the rationale for the change, the market reversed those moves and the dollar actually edged higher on the day, equity markets closed lower and Treasury yields fell as bids flooded the market.

In the end, there is no indication that the Fed is slowing down its current trajectory of policy tightening. While they have explicitly recognized the potential risks due to growing trade friction, they made clear that they have not seen any evidence in the data that it was yet having an impact. And given that things remain fluid in that arena, it would be a mistake to base policy on something that may not occur. All told, if anything, I would characterize the Fed message as leaning more hawkish than dovish.

So looking beyond the Fed, we need to look at everything else that is ongoing. Remember, the trade situation remains fraught, with the US and China still at loggerheads over how to proceed, Canada unwilling to accede to US demands, and the ongoing threat of US tariffs on European auto manufacturers still in the air. As well, oil prices have been rallying lately amid the belief that increased sanctions on Iran are going to reduce global supply. There is the ongoing Brexit situation, which appears no closer to resolution, although we did have French President Macron’s refreshingly honest comments that he believes the UK should suffer greatly in the process to insure that nobody else in the EU will even consider the same rash act as leaving the bloc. And the Italian budget spectacle remains an ongoing risk within the Eurozone as failure to present an acceptable budget could well trigger another bout of fear in Italian government bonds and put pressure on the ECB to back off their plans to remove accommodation. In other words, there is still plenty to watch, although none of it has been meaningful to markets for more than a brief period yet.

Keeping all that in mind, let’s take a look at the market. As I type (which by the way is much earlier than usual as I am currently in London) the dollar is showing some modest strength with the Dollar Index up about 0.25% at this point. The thing is, there has been no additional news of note since yesterday to drive things, which implies that either a large order is going through the market, or that short dollar positions are being covered. Quite frankly, I would expect the latter reason is more compelling. But stepping back, the euro has traded within a one big figure range since last Thursday, meaning that nothing is really going on. The same is true for most of the G10, as despite both data and the Fed, it is clear very few opinions have really changed. My take is that we are going to need to see material changes in the data stream in order to alter views, and that will take time.

In the emerging markets, we have two key interest rate decisions shortly, Indonesia is forecasts to raise their base rate by 25bps to 5.75% and the Philippines are expected to raise their base rate by 50bps to 4.50%. Both nations have seen their currencies remain under pressure due to the dollar’s overall strength and their own current account deficits. They have been two of the worst three performing APAC currencies this year, with India the other member of that ignominious group. Meanwhile, rising oil prices have lately helped the Russian ruble rebound with today’s 0.2% rally adding to the nearly 7% gains seen in the past two plus weeks. And look for the Argentine peso to have a solid day today after the IMF increased its assistance to $57 billion with faster disbursement times. Otherwise, it is tough to get very excited about this bloc either.

On the data front, this morning brings the weekly Initial Claims data (exp 210K), Durable Goods (2.0%, 0.5% ex transport) and our last look at Q2 GDP (4.2%). I think tomorrow’s PCE data will be of far more interest to the markets, although a big revision in GDP could have an impact. But overall, things remain on the same general trajectory, solid US growth, slightly softer growth elsewhere, and a Federal Reserve that is continually tightening monetary policy. I still believe they will go tighter than the market has priced, and that the dollar will benefit accordingly. But for now, we remain stuck with the opposing cyclical and structural issues offsetting. It will be a little while before the outcome of that battle is determined, and in the meantime, a drifting currency market is the most likely outcome.

Good luck
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