Uncertainty Reigns

Concerns over trade still remain,
For bullish investors, a bane
They want to believe
That Trump will achieve
His goals, so investments can gain

But right now uncertainty reigns
Resulting in stock market pains
When risk is reduced
Then bonds get a boost
While euros and pounds feel the strains

The one thing we know for sure is that the trade situation continues to be a major topic on investor minds, whether those investors are of the equity or fixed income persuasion. Despite the ostensible good news that Chinese vice-premier Liu He would still be coming to Washington later this week to continue the trade talks with Mnuchin and Lighthizer, it seems the market has become a bit less convinced that a deal is coming soon. As I have written several times over the past few weeks, it seems clear the market had fully priced in a successful completion of the trade talks and an (eventual) end to tariffs. But the President’s tweets on Sunday has caused a serious reconsideration of that pricing. Arguably, the 2% decline we have seen in US equity indices over the past two sessions is not nearly enough to offset the full risk, but it is a start. Ironically, I think the constant reiteration by financial heavyweights like Christine Lagarde and Mario Draghi, of how important it is to avoid a trade war, has set up a situation where in the event no deal is reached, the market reaction will be worse than if they had never piped up in the first place.

At any rate, the increased tensions have certainly reduced risk appetites across the board. Not only have equity markets suffered (Nikkei -1.5%, Shanghai -1.1% after yesterday’s US declines) but Treasury yields continue to fall. This morning 10-year Treasury yields have fallen to 2.43%, their lowest since late March and essentially flat to the 3-month T-Bill. Expect to hear more discussion about an inverted yield curve and the omens of a recession in the near future.

Away from the trade situation, it seems most other market stories are treading water. For example, the Brexit situation has been back page news for the past two weeks. PM May continues to negotiate with opposition leader Jeremy Corbyn, but there is no consistency to the reports of progress. Labour wants to join the customs union which is something the pro-Brexiteers are fiercely against. Depending on the source of the article you read, a deal is either imminent or increasingly unlikely, which tells me that nobody really knows anything. The pound, which had seen some strength last week, especially on Friday when rumors of a deal were rife, has fallen a further 0.45% this morning and is back near the 1.30 level. It seems increasingly likely to me there will be no solution before the EU elections, and that there will be no solution before the October 31 deadline. Parliament remains riven and leadership there has been completely absent. I expect this to be exhibit A in the long tradition of muddling through by European nations.

Elsewhere in the FX markets, the RBNZ did cut rates last night by 25bps, unlike their Australian brethren who stayed on hold. Kiwi is softer by 0.25% this morning on the back of the news and has helped drag the Aussie with it. Of course, part of the malaise in these currencies is the ongoing uncertainty over the trade talks, as well as the suspect Chinese data.

Speaking of that data, last night China released much worse than expected trade results with exports falling 2.7% and imports rising just 4.0% resulting in a trade surplus of ‘just’ $13.8B, well below expectations. It seems that the tariffs are starting to have a real impact now that inventories need to be replenished. Aside from the impact on the Shanghai exchange noted above, the renminbi also drifted modestly lower, -0.1%, and continues to push toward levels last seen in January. One thing of which I am confident is that if the trade talks fall apart completely, CNY will weaken sharply and test the 7.00 level in short order. Part of the recent stability in the currency has been due to a general malaise in the FX market as evidenced by the extremely low volatility across the board. But part of it, no doubt, is the result of the PBOC managing the currency and absorbing any significant selling in order to demonstrate they are not manipulating the currency lower to enhance their trade. But that will surely end if the talks end unsuccessfully.

Away from those stories it is much more about a modest risk-off scenario today with both JPY and CHF stronger by 0.2%, while EMG currencies are suffering (MXN -0.4%, TRY -0.5%). However, the overall market tone is, not unlike the Fed, one of patience for the next catalyst to arrive. Given the dearth of important data until Friday’s CPI, that should be no real surprise.

In fact, this morning there are no data releases in the US although we do hear from Fed Governor Lael Brainerd at 8:30. Yesterday’s comments from Governor Clarida were generally unenlightening, toeing the line that waiting was the best idea for now and that there were no preconceived notions as to the next rate move. As such, I expect Brainerd to be on the same page, and the FX market to continue to tread water at least until Friday’s CPI.

Good luck
Adf

Great Apprehensions

In England the rate of inflation
Has fallen despite expectation
By Carney and friends
That recent price trends
Would offer rate hike validation

But markets have turned their attentions
To news of two likely extensions
The deadline on trade
And Brexit charade
Have tempered some great apprehensions

Two key data points lead the morning news with UK inflation falling below the BOE’s 2.0% target for the first time since the Brexit vote while Eurozone IP fell far more sharply than expected. Headline CPI in the UK declined to 1.8% while core remained at 1.9%, with both printing lower than market expectations. Given the slowing economic picture in the UK (remember the slowest growth in six years was reported for Q4 and 2018 as a whole), this cannot be that much of a surprise. Except, perhaps, to Governor Carney and his BOE brethren. Carney continues to insist that the BOE may need to raise rates in the event of a hard Brexit given the possibility of an inflation spike. Certainly, there is no indication that is likely at the present time, but I guess anything is possible. Granted he has explained that nothing would be done until the “fog of Brexit” has lifted but given the overall global growth trajectory (lower) and the potential for disruption, it seems far more likely that the next BOE move is down, not up. The pound originally sold off on the news but has since reversed course and is higher by 0.3% as I type. Overriding the data seems to be a growing belief that both sides will blink in the Brexit negotiations resulting in a tentative agreement of a slightly modified deal with a few extra months made available to ratify everything. That’s probably not a bad bet, but it is by no means certain.

On the Continent, the data story was also lackluster, with Eurozone IP falling a much worse than expected -0.9% in December and -4.2% Y/Y. It is abundantly clear that Germany’s problems are not unique and that the probability of a Eurozone recession in 2019 is growing. After all, Italy is already there, and France has seen its survey data plummet in the wake of the ongoing Gilets Jaunes protests. However, despite this data, the euro has held onto yesterday’s modest gains and is little changed on the day. The thing is, I still cannot figure out a scenario where the ECB actually raises rates given the economic situation. Even ECB President Draghi has recognized that the risks are to the downside for the bloc’s economy, and yet he is fiercely holding onto the idea that the next move will be higher rates. It won’t be higher rates. The next move is to roll over the TLTRO’s and interest rates will remain negative for as far as the eye can see. There is a growing belief in the market that because the Fed has halted its policy tightening, the dollar will fall. But since every other central bank is in the same boat, the relative impact still seems to favor the US.

Away from those stories, the market continues to believe that a US-China trade deal is almost done. At least, that’s the way equity markets are trading. President Trump’s comment that he would consider extending the March 1 tariff deadline if there was sufficient progress and it looked like a deal was in the offing certainly helped sentiment. But as with the Brexit issue, where the Irish border situation does not offer a simple compromise, the US requests for ending forced technology transfer and IP theft as well as the reduction of non-tariff barriers strike at the heart of the Chinese economic model and will not be easily overcome. It seems that the most likely outcome will be a delay of some sort and then a deal that will have limited long-term impact but will get played up by both sides as win-win. In the meantime, the PBOC will continue to add stimulus to the economy, as will the fiscal authorities, as they seek to slow the rate of decline. And you can be sure that no matter how the economy actually performs, the GDP data will be firmly above expectations.

And those are the big stories. The dollar has had a mixed performance overnight with two currencies making substantial gains, NZD +1.25% and SEK +0.6%, both of which responded to surprises by their respective central banks. The RBNZ left rates on hold, as universally expected, but instead of offering signs of further rate cuts, simply explained that rates would remain on hold for two years before likely rising. This was taken as hawkish and the currency responded accordingly. Similarly, the Riksbank in Stockholm explained that they still see the need for rates to rise later this year despite the current slowing growth patterns throughout Europe. As I had written yesterday, expectations were growing that they would back away from any policy tightening, so the krone’s rally should be no real surprise. But beyond those two stories, movement has been much less substantial in both the G10 and EMG blocs.

This morning’s data brings CPI (exp 1.5% headline, 2.1% core) which will be closely watched by all markets. Any further weakness will likely see another leg higher in equity markets as it will cement the case for the Fed having reached the end of the tightening cycle. A surprise on the high side ought to have the opposite impact, as concerns the Fed might not yet be done will resurface. There are also three Fed speakers, but for now, that message of Fed on hold seems pretty unanimous across the FOMC.

Absent a surprise, my money is on a directionless day today. The dollar’s recent rally has stalled and without a new catalyst will have a hard time restarting. However, there is no good reason to think things have gotten worse for the buck either.

Good luck
Adf

 

Up To New Tricks

The nation that first tried to fix
Its price target’s up to new tricks
Last night it explained
That rates would remain
Unchanged til growth, up, finally ticks

You know it has been a relatively uneventful session when the most interesting story is about New Zealand! For those with a bent toward history, it was then-RBNZ Governor Donald Brash, who in 1988 set the first inflation target for a nation, 3.0% at that time, and who was able to maintain the RBNZ’s independence from government meddling ( a new philosophy then) to help achieve that target and eventually bring interest rates down from more than 15% to low single digits. Well, last night when the RBNZ met, they left rates on hold at a record low level of 1.75%, as was universally expected, but they added a sentence to their policy statement “…that rates will remain at this level through 2019 and into 2020”, adding forward guidance to the mix and surprising markets completely. The result was that the NZD fell a bit more than 1% instantly and has continued lower to currently trade down 1.4% on the session and back to its lowest level since March 2016.

This action simply underscores the policy divergence that we have seen over the past two and a half years. Since the Fed’s first, tentative steps towards tightening in December 2015, it has been clear that the US remains ahead of the global growth cycle. And now we find ourselves in a world where several countries are trending higher (US, Canada, India, Sweden) in growth and inflation, while others are seeing the opposite outcome (China, New Zealand, Australia). Of course there are those who are in between, like the Eurozone and Japan, where they want to believe that things are getting better so they can normalize policy, but just don’t quite have the confidence yet. Maybe soon. And it is these policy differences, as well as expectations for their evolution, that will continue to be the key drivers of currencies going forward.

However, away from New Zealand, the G10 has been a dull affair. There has been limited data released and currency movement has been extremely modest, generally less than 0.1% since yesterday’s closing levels.

Emerging markets, though, have been a different story, with several of them really taking a tumble. Starting with Turkey, which has, of course, been under pressure for the past several months, last night saw yet another significant decline of 2.2%, which makes 6.5% this week and more than 50% in the past year. Additional US sanctions driven by the arrest of a US pastor in Turkey have been the recent catalyst, but the reality is that there is an increasing sense of doom attached to President Erdogan’s economic management theories, which include the idea that high interest rates cause inflation; they don’t fight it. But high inflation is what they have there, with the annual rate now running above 16% and rising. The lira has further to fall, mark my words.

Next on the list is the Russian ruble, which has recovered as I write to only be down by 0.6%, after having been lower by as much as 1.3% earlier in the session. However, this week it is lower by 4.2% and nearly 7% this month. The story here is a combination of both new US sanctions as the latest response to the poisoning of an ex Russian agent in the UK earlier this year, as well as the sharp decline in oil prices yesterday, WTI fell 3.2% after storage data indicated there was much more oil and products around than expected. The Russian economy is definitely feeling the squeeze of US sanctions and I expect that the ruble will continue to be pressured lower for a while yet.

But once we get past those currencies, there is precious little to discuss in this space as well. Which takes us to the upcoming data releases. This morning we see Initial Claims (exp 220K) and PPI (3.4%, 2.8% core) at 8:30 and then we hear from Chicago Fed president Evans at 9:30. Evans is a known dove, so the only possibility of a newsworthy event would be if he sounded hawkish. Yesterday, Richmond Fed president Barkin said it was time to get rates back to ‘normal’ and that two more hikes this year seem reasonable. While the futures market is not yet pricing in great confidence in a December move by the Fed, it seems a foregone conclusion to me.

In the end, nothing has happened to alter my views that the Fed will continue to lead the way in tighter monetary policy and that the dollar will be the main beneficiary of that action.

Good luck
Adf