Tag Archives: #ratecuts

Urgent Action

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Said Madame Lagarde urgent action
Is needed if we’re to gain traction
In putting a lid
On spreading Covid
Or we’ll have an ‘08 contraction

No sooner were those words reported
Than Governor Carney supported
A 50bp cut
(More than scuttlebutt!)
Thus, hoping recession is thwarted

Another day and another raft of new and important news driving markets. So far this morning, the biggest news has been the BOE’s surprise emergency rate cut of 0.50%, taking the base rate back down to 0.25%, its all-time low first reached during the financial crisis. Governor Carney, in his last official act, as he steps down on Sunday, explained that the idea behind the early cut (after all, the BOE has its regularly scheduled meeting in two weeks) was to show coordination with the government which will be releasing its budget for the new fiscal year later today. In addition, he explained, and was seconded by incoming Governor Andrew Bailey, that the BOE still had plenty of tools available to ease policy further if necessary.

In addition to the rate cut, they also restarted a targeted lending scheme that is designed to support bank lending to SME’s. As I type, we have not yet heard the nature of the budget package, but expectations are for a significant increase in spending focused on the National Health Service and small businesses. The market response has been positive for equities (FTSE 100 +0.8%), although Gilt yields have edged higher by 5bps. In the FX market, the pound’s initial reaction on the rate cut was to fall sharply, more than a penny, but it has since recouped all of that and then some and is currently higher by 0.2%.

Turning to Europe, Madame Lagarde led a conference call of EU leaders this morning and explained that if they don’t respond quickly and aggressively, the situation could devolve into the same type of financial crisis that the 2008 mortgage and credit crisis engendered with an equally deep recession. At the same time, Italian PM Conte is trying to get the rest of the EU to allow him to break the spending limits in order to rescue his country. With the entire nation on lockdown, economic activity is screeching grinding to a halt and the impact on individuals, who will not be able to get paid and therefore pay their bills, as well as small companies will be devastating. But remarkably, the EU has not yet endorsed the package, which is set to be as much as €25 billion. In the end, there is no question the package will be implemented even if the Germans are dragged along kicking and screaming. Italian stocks rallied on the announcement, +0.9%, while Italian BTP’s (their treasury bonds) rallied sharply with yields falling 16bps. The euro has also benefitted this morning, currently higher by 0.4%, although I think a lot of that is simply a rebound from yesterday’s sharp decline. After all, the single currency fell 1.5% yesterday.

Turning to the dollar itself, broadly speaking it is weaker overall, albeit not universally so. Versus its G10 counterparts, the dollar is on the back foot, which seems to reflect the fact that we are hearing of every other G10 country taking concrete action to fight Covid-19, while the US remains a little behind the curve. The $8 billion package passed last week is small beer in this economy, but the administration’s calls for a reduction in payroll taxes and federally supported sick leave pay has fallen on deaf ears in Congress. With Congress due to go on a one-week recess starting Thursday, it is hard to believe they will come up with something before they leave. This policy uncertainty is weighing on US assets with equity futures pointing lower as I type, on the order of 1.7%, and Treasuries rallying again with the 10-year yield falling by 10bps.

At this point, all eyes are on the Fed with market expectations still fully baked in for a 50bp rate cut one week from today. What is interesting is the number of pundits who are pointing to a speech given last summer by NY Fed President Williams, where he highlighted research showing that when policy space is limited (i.e. rates are already low), a central bank should be more aggressive to get an impact from their actions, rather than trying to hold onto what limited ammunition they have left. This has a number of economists around Wall Street calling for a 1.00% rate cut next week by the Fed, which would truly be a shock and awe move, at least initially. The problem for the Fed is that they don’t have the structure to create targeted lending facilities the way other central banks do, and they can only buy securities issued or guaranteed by the US government, so Treasuries and mortgages. While that law can be changed, it will not be done either quickly or without controversy. In other words, the Fed may find it has a more limited toolkit than they need in the short run. At this point, a 0.50% cut to Fed funds next week will not do very much, but more than that is likely to have a big market impact. In fact, I’m leaning toward the idea that they cut 1.00% next week to see if they can get a positive response and force the government to step up.

In the EMG bloc, only ZAR (-0.7%) and MXN (-0.65%) are under any real pressure this morning as both feel the weight of sinking commodity prices. While some others here are soft, the moves are modest (RUB -0.3%). On the positive side, INR is the leader, rising 0.7% in a catch-up move as the country was on holiday yesterday during the rally by other Asian currencies.

But as we look ahead to today, unless we get new news from the US administration, my sense is the dollar will remain under pressure overall. There is data upcoming as CPI will print at 8:30 (exp 2.2%, 2.3% core), but I don’t think anybody is paying attention. The market is still completely driven by comments and official actions, with longer term views sidelined.

Good luck
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Potency Waning

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There once was a time in the past
When central banks tried to forecast
When signals were flashing
That rates needed slashing
‘Cause growth wasn’t growing so fast

But now that so many have found
Their rates near the real lower bound
The tools they’ve remaining
See potency waning
Unable to turn things around

Another day, another rate cut to mention. This time Peru cut rates 25bps responding to slowing growth both domestically and in their export markets as well as muted inflation pressures. Boy, we’ve heard that story a lot lately, haven’t we? But that’s the thing, if every central bank cut rates, then it’s like none of them have done so. Remember, FX markets thrive on the differential between policy regimes, with higher interest rates both drawing capital while reducing demand for loans, and correspondingly growth. So, if you can recall the time when there were economies that were growing rapidly, raising rates was the preferred method to prevent overheating.

But it’s been more than a decade since that has been a concern of any central bank, anywhere in the world. Instead, we are in the midst of a ‘race to the bottom’ of interest rates. Every country is trying to stimulate their economy and cutting interest rates has always been the preferred method of doing so, at least from a monetary perspective. (Fiscal stimulus is often far more powerful but given the massive debt loads that so many countries currently carry, it has become much harder to implement and fund.) One of the key transmission mechanisms for pumping up growth, especially for smaller nations with active trade policies, was the weakening in their currency that was a byproduct of cutting rates. But with everybody cutting rates at the same time (remember, we have had six central banks cut rates in the past week!) that mechanism is no longer working. And this is one of the key reasons that no country has been able to set themselves apart and halt their waning growth momentum.

A perfect example of this is the UK, where Q2 GDP figures released this morning printed at -0.2% for the quarter taking the Y/Y figure down to 1.0%. Obviously, the Brits have other issues, with just 84 days left before the Brexit deadline, but it is also clear that the global slowdown is having an impact. And the problem for the BOE is the base rate is just 0.75%, not much room to cut if the UK enters a recession. In fact, that is largely true around the world, there’s just not much room to cut rates at this point.

The upshot is that markets continue to demonstrate increasing volatility. In the FX markets there has been a growing dichotomy with the dollar showing solid strength against virtually the entire emerging market bloc but having a much more muted reaction vs. the rest of the G10. Of course, since the financial crisis, the yen (+0.3% today) has been seen as a safe haven and has benefitted in times of turmoil. So too, the Swiss franc (+0.2%), although not quite to the same extent given the much smaller size of the economy.

But perhaps the most interesting thing of late is that the euro has not fallen further, especially given the ongoing internal struggles it is having. Italy, for example, looks about set to dissolve its government and have new elections with all the polls showing Matteo Salvini, the League party’s firebrand leader set to win a majority. He has been pushing to cut taxes, spend on infrastructure and allow the Italian budget deficit to grow. That is directly at odds with the EU’s stability policy, and while both Italian stocks (-2.25%) and bonds (+25bps) have suffered today on the news, the euro itself has held up well, actually rallying 0.25% and recouping yesterday afternoon’s losses. Given the ongoing awful data out of the Eurozone (German Exports -0.1%, French IP -2.3%) it is becoming increasingly clear that the ECB is going to ease policy further next month. In fact, between Europe’s upcoming recession and Italy’s existential threat to the euro, I would expect it to have fallen further. Arguably, the rumor that the German government may increase spending has been crucial in supporting the single currency today, but if they don’t, I think we are going to see further weakness there as well.

In the meantime, the dollar is starting to pick up against a variety of EMG currencies this morning with MXN falling 0.4%, INR 0.6% and CNY 0.15%. Also, under the risk-off ledger we are seeing equity markets suffer this morning with both Germany (-1.25%) and France (-1.0%) suffering alongside Italy and US futures pointing to -0.6% declines on the open. It is not clear to me why the market so quickly dismissed their concerns over the escalating trade war by Tuesday, after Monday’s sharp devaluation of the CNY. This is a long-term affair and just because the renminbi didn’t continue to collapse doesn’t mean that things are better. They are going to get worse and risk will be reduced accordingly, mark my words.

As to this morning’s data we see PPI here at home (exp 1.7%, 2.4% core) and Canadian Employment Data where the Unemployment Rate is forecast to remain unchanged at 5.5%. Earnings data in the US continues to be mixed, at best, with Uber the latest big-name tech company to disappoint driving its stock price lower after the close yesterday.

I’m sorry, I just cannot see the appeal of risky assets at this time. Global growth is continuing to slow, trade activity is falling rapidly and there are a number of possible catalysts for major disruption, (e.g. hard Brexit, Italian intransigence, and Persian Gulf military escalations). Safety is the order of the day which means that the yen, Swiss franc and dollar, in that order, should be the beneficiaries. And don’t forget gold, which looks for all the world like it is heading up to $1600/oz.

Good luck and good weekend
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Demand, More, to Whet

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In Asia three central banks met
And all three explained that the threat
Of trade tensions rising
Required revising
Their pathway, demand, more, to whet

The RBNZ cut rates 50bps last night, surprising markets and analysts, all of whom were expecting a 25bp rate cut. The rationale was weakening global growth and increased uncertainty over the escalation of the trade fight between the US and China were sufficient cause to attempt to get ahead of the problem. They seem to be following NY Fed President Williams’ dictum that when rates are low, cutting rates aggressively is the best central bank policy. It should be no surprise that the NZD fell sharply on the news, and this morning it is lower by 1.4% and back to levels not seen since the beginning of 2016.

The Bank of Thailand cut rates 25bps last night, surprising markets and analysts, none of whom were expecting any rate cut at all. The rationale was … (see bold type above). The initial FX move was for a 0.9% decline in THB, although it has since recouped two-thirds of those losses and currently sits just 0.3% lower than yesterday’s close. THB has been the best performing currency in Asia this year as the Thai economy has done a remarkable job of skating past many of the trade related problems affecting other nations there. However, the central bank indicated it would respond as necessary going forward, implying more rate cuts could come if deemed appropriate.

The RBI cut rates 35bps last night, surprising markets and analysts, most of whom were expecting a 25bp rate cut. The rationale was… (see bold type above). The accompanying policy statement was clearly dovish and indicted that future rate cuts are on the table if the economic path does not improve. However, this morning INR is actually stronger by 0.3% as there was a whiff of ‘buy the rumor, sell the news’ attached to this move. The rupee had already weakened 3% this week, so clearly market anticipation, if not analysts’ views, was for an even more dovish outcome.

These are not the last interest rate moves we are going to see, and we are going to see them from a widening group of central banks. You can be sure, given last night’s activity, that the Philippine central bank is going to be cutting rates when they meet this evening and now the question is, will they cut only the 25bps analysts are currently expecting, or will they take their cues from last night’s activity and cut 50bps to get ahead of the curve? Last night the peso fell 0.4% and is down 2.5% in the past week. It feels to me like the market is pricing in a bigger cut than 25bps. We shall see.

This central bank activity seems contra to the fact that equity markets are stabilizing quickly from Monday’s sell-off. The idea that because the PBOC didn’t allow another sharp move lower last night in the renminbi is an indication that there is no prospect for further weakness in the currency is ridiculous. (After all, CNY did fall 0.4% overnight). The global rate cutting cycle is starting to pick up steam, and as more central banks respond, it will force the others to do the same. The market has now priced in a 100% probability of a 25bp Fed cut at the September meeting. Comments from Fed members Daly and Bullard were explicit that the increased trade tensions have thrown a spanner into their models and that some preemption may be warranted.

A quick survey of government bond yields shows that Treasuries are down 4bps to 1.66%, new lows for the move; Bunds are down 5.5bps to -0.59% and a new historic low; while JGB’s are down 3bps to -0.21%, below the BOJ’s target of -0.2% / +0.2% for the first time since they instituted their yield curve control process. Bond investors and stock investors seem to have very different views of the world right now, but there are more markets aligning with bonds than stocks.

For instance, gold prices are up another 1% overnight, to $1500/oz, their highest in six years and show no sign of slowing down. Oil prices are down just 0.2% overnight, but more than 8% in the past week, as demand indicators decline more than offsetting production declines.

And of course, economic data continues to demonstrate the ongoing economic malaise globally. Early this morning, June German IP fell 1.5%, much worse than expected and from a downwardly revised May number, indicating even further weakness. It is becoming abundantly clear that the Eurozone is heading into a recession and that the ECB is going to be forced into aggressive action next month. Not only do I expect a 20bp rate cut, down to -0.60%, but I expect that QE is going to be restarted right away and expanded to include a larger portion of corporate bonds. And don’t rule out equities!

So, for now we are seeing simultaneous risk-on (equity rally) and risk-off (bond, gold, yen rallies) on our screens. The equity investor belief in the benefits of lower interest rates is quite strong, although I believe we are reaching a point where lower rates are not the solution to the problem. The problem is economic uncertainty due to changes in international trade relations, it is not a lack of access to capital. But lowering rates is all the central banks can do.

Overall, the dollar is stronger this morning as only a handful of currencies, notably the yen as a haven and INR as described above, have managed to gain ground. I expect that this will continue to be the pattern unless the Fed does something truly surprising like a 50bp cut in September or even more unlikely, a surprise inter-meeting cut. They have done that before, but it doesn’t seem to be in Chairman Powell’s wheelhouse.

The only data today is Consumer Credit this afternoon (exp $16.0B) and we hear from Chicago Fed President Charles Evans, a known dove later today. But equity futures are pointing higher and for now, the idea that Monday’s sharp decline was an opportunity rather than a harbinger of the future remains front and center. However, despite the equity market, I have a feeling the dollar is likely to maintain its overnight gains and perhaps extend them as well.

Good luck
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A Rate Cut’s Assumed

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

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

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

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

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

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

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

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

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

Good luck
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Thus Far They’ve Failed

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The ECB meeting today
Is forcing its members to weigh
The costs if they wait
To cut the base rate
Vs. benefits if they delay

Their problem is as things now stand
Recovery should be at hand
But thus far they’ve failed
As growth’s been curtailed
From Sicily to the Rhineland

Today brings the first of three major central bank meetings in the next six days as the ECB is currently meeting and the market awaits the outcome. Next week we will hear from both the BOJ and then the Fed, but for now all eyes are turned toward Frankfurt.

Expectations, as measured by the futures market, have moved to a 48% probability of a 10bp rate cut by the ECB this morning, although most of the punditry believe that Signor Draghi will simply lay the groundwork for a cut in September at the next meeting. The arguments for waiting are as follows: given the expectations of a Fed rate cut, with some still holding out hope for 50bps, the market benefits of cutting today would be quickly offset, and one of the few arrows the ECB still has left in its quiver would be wasted. The key benefit they are seeking is a weaker euro, and the concern is that any weakness will be short-lived, especially in the event of a 50bp cut by Powell. Of course, one need only look at the chart to see that the euro has been trending steadily lower for the past year, falling nearly 5% since last July, although as we await the meeting outcome it remains unchanged on the day. It’s not clear to me why else they would wait. After all, the data continues to point to ongoing Eurozone weakness every day. This morning’s example was the German Ifo Business Climate Index, which fell to 95.7, its lowest point since April 2013. It is becoming abundantly clear that Germany is heading into a recession and given Germany’s status as the largest economy in the Eurozone, representing nearly one-third of the total, that bodes ill for the entire bloc.

I maintain that it makes no sense to wait if they know that they will cut next month. They are far better off cutting now, maybe even by 20bps, and using September to restart QE, which is also a foregone conclusion. The funny thing about appointing Madame Lagarde, the uber dove, as the next ECB president, is that she won’t have anything to do once she sits down given the fact that all the easing tools will have been used already. Well, perhaps that is not strictly correct. Lagarde will be able to expand QE to cover, first, bank bonds and then, eventually equities.

(As an aside, for all you capitalists out there, the practice of central banks buying equities should cause great discomfort. After all, they can print as much money as they need to effectively buy ownership in all the public companies in an economy. And isn’t the definition of Socialism merely when the government owns the means of production? It seems to me that central bank equity purchases are a great leap down that slippery slope!)

At any rate, FX markets have largely been holding their breath awaiting the ECB outcome this morning. The same cannot be said of equity markets, where we continue to see records in the US, and markets in both Asia and Europe continue to rally on the idea that lower rates will continue to support stocks. At the same time, bond markets are also still on the march, with Bunds trading to yet another new low, touching -0.46% yesterday, and currently at -0.41%. Treasuries, too, remain bid, with the 10-year yield ticking slightly lower to 2.03%. And in the commodity space, oil prices are firmer after both a surprisingly large inventory draw and the ongoing issues in the Persian Gulf as the UK and Iran duke it out over captured tankers.

With the Brexit story now waiting for its next headlines, which will likely take at least a few days to arrive, and the US-China trade story awaiting next week’s meetings in Beijing, it is central banks all the way as the key market drivers for now. This morning’s Initial Claims (exp 219K) and Durable Goods (0.7%, 0.2% -ex transport) seem unlikely to be key movers.

So Mario, it’s all up to you today. How dovish Draghi sounds will be the key event for today, and likely the impetus behind movement until next Wednesday when Chairman Powell takes the spotlight. Personally, I think he will be far more dovish than the market is currently pricing and we will see the dollar rally further.

Good luck
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A Half Point’s Preferred

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

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

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

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

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

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

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

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

Good luck and good weekend
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Half Has Allure

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The Fed Reserve Chairman named Jay
Is tasked, market fears, to allay
He did it in spades
Explaining that trade
And Brexit, could possibly weigh

On growth in the US this year
And so he implied cuts were near
A quarter seems sure
But half has allure
Since price rises never appear

Every market story today is the same story; the Fed is going to cut rates at the end of the month. In fact, the only mystery at this point is whether it will be the 25bps that is currently fully priced in by the futures market, or if the Fed will jump in with a 50bp cut. Every market around the world has felt the impact of this story and will continue to do so until the actual cut arrives.

The knock-on effects have been largely what would be expected from a lower rate environment. For example, equity prices have risen almost everywhere, closing at new record highs in the US yesterday and trading in the green throughout Asia overnight and Europe today. The dollar has fallen back, much to President Trump’s delight I’m sure, giving up some of its recent gains with declines of 0.5% vs. the euro, 0.6% vs. the pound and 0.7% vs. the yen. Emerging market currencies have also rallied a bit with, for example, BRL rising 1.3%, ZAR 1.8% and KRW up 0.8%. Even CNY has rallied slightly, +0.25%, although as we already know, its volatility is managed to a much lower level than other currencies.

Bond markets, on the other hand, have not demonstrated the same exuberance as stocks, commodities (gold +2.0%) or currencies today as they had clearly anticipated the news last week. If you recall, Bunds had traded to new record lows last week, touching -0.41% before reversing course, and are now “up” to a yield of -0.31%. And 10-year Treasuries, after trading to 1.935% a week ago, have since reversed course, picking up nearly 12bps at one point, although have given back a tick this morning. In fact, many traders have been looking at the market technicals and see room for bond yields to trade higher in the short-term, although the long-term trend remains for lower yields.

But those are simply the market oriented knock-on effects. There will be other effects as well. For example, it is now patently clear that a new central bank easing cycle is unfolding. We already knew the ECB was preparing to cut, and you can be sure they will both cut rates and indicate a restarting of QE at their next meeting on July 25. Meanwhile, by that date, Boris Johnson is likely to be the new UK PM which means that the BOE is going to need to prepare for a hard Brexit in a few months’ time. Part of that preparation is going to be lower interest rates and possibly the restarting of QE there as well. In fact, this morning, Governor Carney was on the tape discussing the issues that will impact the UK in the event of a hard Brexit, including slowing growth, lower confidence and weakness in markets. Japan? Well, they never stopped easing, but are likely to feel a renewed sense of urgency to push harder on that string, especially if USDJPY starts to fall more substantially. And finally, of the major economies, China will also certainly be looking to ease monetary policy further as growth there continues to lag desired levels and the trade situation continues to weigh on sentiment. The biggest problem the PBOC has is they have no sure-fire way to cut rates without quickly reinflating the leverage bubble they have been working to reduce for the past three years.

And of course, away from the major central banks, you can be sure that we are going to see easier monetary policy pretty much everywhere else in the world. This is especially true throughout the emerging markets, the countries that have suffered the most from the combination of higher US rates and a stronger dollar.

The irony of all this is that, as RBA Governor Lowe pointed out two weeks ago when they cut rates, if everybody cuts rates at the same time, one of the key transmission mechanisms, a weaker currency, is likely to have far less impact because the relative rate structure will remain the same. This is the reason that the dollar is likely to come under pressure in the short-run, because the Fed has more room to cut rates than most other central banks. But in the end, if everybody reaches ZIRP, currency valuations will need to be decided on other criteria with macroeconomic performance likely to be a key driver. And in the end, the dollar still comes up looking like the best bet.

And that’s really it. Every story is about the Fed cutting rates and how it will impact some other country, market, company, policy, etc.. Brexit is hanging out there, but until the new PM is named, nothing is going to change. The trade talks have restarted, but there is no conclusion in sight. Granted, several individual currencies have suffered of their own accord lately, notably MXN which fell more than 2.0% on Monday after the FinMin resigned due to philosophical differences with President AMLO, and TRY, which fell a similar amount at the end of last Friday after President Erdogan fired the central bank president and replaced him with someone more likely to cut rates. But those are special situations, and in truth, a good deal of those losses have been mitigated by the Fed story. As I said, it is all one story today.

Looking ahead to today’s market, we see our only important data point of the week, CPI (exp 1.6%, 2.0% core) and we also get Initial Claims (223K). But Chairman Powell testifies in front of the Senate today, and we hear from Williams, Bostic, Barkin, Kashkari and Quarles before the day is through as well. Given the Minutes released yesterday indicated a majority of FOMC members were ready to cut this month, it will be interesting to see how dovish this particular group sounds today, especially in the wake of the Chairman’s comments yesterday. Overall, I think the bias will be more dovish, and that the dollar probably has a bit further to fall before it is all over.

Good luck
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Loosen the Screws

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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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Oy Vey!

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The jobs report was quite the dud
And traders began smelling blood
If Powell and friends
Would not make amends
Then stocks would be dragged through the mud

Then later, down Mexico’s way
The tariff dispute went away
At least for the moment
Though Trump could still foment
More problems by tweeting, oy vey!

This morning, despite the confusion
The outcome’s a foregone conclusion
Stock markets will rise
While bonds scrutinize
The data, and fight the illusion

I’m not even sure where to start this morning. Friday’s market activity was largely as I had forecast given the weak payrolls report, just a 75K rise in NFP along with weaker earnings numbers, leading to a massive increase in speculation that the Fed is going to cut, and cut soon. In fact, the probability for a June cut of 25bps is now about 50/50, with a full cut priced in for the July meeting and a total of 70bps of cuts priced in for the rest of 2019. Equity markets worldwide have rallied on the weak data as a new narrative has developed as follows: weaker US growth will force the Fed to ease policy sooner than previously forecast and every other central bank will be forced to follow suit and ease policy as well. And since the reaction function for equity markets has nothing to do with economic activity, being entirely dependent on central bank largesse, it should be no surprise that stock markets are higher everywhere. Adding to the euphoria was the announcement by the Trump administration that those potential Mexican tariffs have been suspended indefinitely after progress was made with respect to the ongoing immigration issues at the US southern border.

This combination of news and data was all that was needed to reverse the Treasury market rally from earlier in the week, with 10-year yields higher by 5bps this morning, and the dollar, which had fallen broadly on Friday, down about 0.6% across the board after the payroll report, has rebounded against most of its counterpart currencies. The one outlier here is the Mexican peso, which after the tariff threat had fallen by nearly 3%, has rebounded and is 2.0% higher vs. the dollar this morning.

To say that we live in a looking glass world where up is down and down is up may not quite capture the extent of the overall market confusion. One thing is certain though, and that is we are likely to continue to see market volatility increase going forward.

Let’s unpack the Fed portion of the story, as I believe it will be most helpful in trying to anticipate how things will play out going forward. President Trump’s threats against Mexico really shook up the market but had an even bigger impact on the Fed. Consider, we have not heard the word ‘patient’ from a Fed speaker since Cleveland Fed President Loretta Mester used the word on May 3rd. When the FOMC minutes were released on May 22, the term was rampant, but the world had changed by then. In the interim, we had seen the US-China trade talks fall apart and an increase in tariffs by both sides, as well as threats of additional actions, notably the banning of Huawei products in the US and the restriction of rare earth metals sales by China. At this point, the trade situation is referred to as a war by both sides and most pundits. We have also seen weaker US economic activity, with Retail Sales and Housing data suffering, along with manufacturing and production. While no one is claiming we are in recession yet, the probabilities of one arriving are seen as much higher.

The result of all this weak data and trade angst was a pretty sharp sell-off in the equity markets, which as we all know, seems to be the only thing that causes the Fed to react. And it did so again, with the Fed speakers over the past two weeks highlighting the weakening data and lack of inflation and some even acknowledging that a rate cut would be appropriate (Bullard and Evans.) This drove full on speculation that the Fed was about to ease policy and futures markets have now gone all-in on the idea. It would actually be disconcerting if the Fed acted after a single poor data point, so June still seems only a remote possibility, but when they meet next week, look for a much more dovish statement and for Chairman Powell to be equally dovish in the press conference afterward.

And remember, if the Fed is turning the page on ‘normalization’ there is essentially no chance that any other major central bank will be able to normalize policy either. In fact, what we have heard from both the ECB’s Draghi and BOJ’s Kuroda-san lately are defenses of the many tools they still have left to utilize in their efforts to raise inflation and inflationary expectations. But really, all they have are the same tools they’ve used already. So, look for interest rates to fall further, even where they are already negative, as well as more targeted loans and more QE. And the new versions of QE will include purchases that go far beyond government bonds. We will see much more central bank buying of equities and corporate bonds, and probably mortgages and municipals before it is all over.

Ultimately, the world has become addicted to central bank policy largesse, and I fear the only way this cycle will be broken is by a crisis, where really big changes are made (think debt jubilee), as more of the same is not going to get the job done. And that will be an environment where havens will remain in demand, so dollars, yen, Treasuries and Bunds, and probably gold will all do quite well. Maybe not immediately, but that is where we are headed.

Enough doom and gloom. Let’s pivot to the data story this week, which is actually pretty important:

Today JOLTs Jobs Report 7.479M
Tuesday NFIB Small Biz 102.3
  PPI 0.1% (2.0% Y/Y)
  -ex food & energy 0.2% (2.3% Y/Y)
Wednesday CPI 0.1% (1.9% Y/Y)
  -ex food & energy 0.2% (2.1% Y/Y)
Thursday Initial Claims 216K
Friday Retail Sales 0.7%
  -ex autos 0.3%
  IP 0.1%
  Capacity Utilization 78.7%
  Michigan Sentiment 98.1

Clearly CPI will be closely watched, with any weakness just fanning the flames for rate cuts sooner. Also, after the weak NFP report Friday, I expect closer scrutiny for the Initial Claims data. This has been quite steady at low levels for some time, but many pundits will be watching for an uptick here as confirmation that the jobs market is starting to soften. Finally, Retail Sales will also be seen as important, especially given the poor outcome last month, which surprised one and all.

Mercifully, the Fed is in its quiet period ahead of their meeting next week, so we won’t be hearing from them. Right now, however, the momentum for a rate cut continues to build and stories in the media are more about potential weakness in the economy than in the strength that we had seen several months ago. If the focus remains on US economic activity softening, the dollar should come under pressure, but once we see that spread to other areas, notably the UK and Europe, where they had soft data this morning, I expect those pressures to equalize. For today, though, I feel like the dollar is still vulnerable.

Good luck
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