Another Cut’s Quite Apropos

The Chair said, ‘inflation’s too low
And there’s something you all need to know
Lest prices soon rise
We’ll not compromise
Thus another cut’s quite apropos

There are a number of discussion topics in the market this morning so let’s get right to it.

First the Fed surprised exactly nobody yesterday afternoon by leaving policy unchanged, (except for a ‘technical’ adjustment to IOER, which they raised by the expected 5bps). However, the talk this morning is all about the tone of the statement and the ensuing press conference. In the end, it appears that the Fed is leaning slightly more dovish than they had seemed to be previously, with a still greater focus on inflation. Powell and friends appear to be increasingly concerned that inflation expectations are still declining, and are terrified of an ultimate outcome similar to the past two decades in Japan. As such, it appears they are getting set to move from an inflation target to a price level target. This means that if inflation runs below target for a period of time, as it has been doing ever since it was officially announced in 2012, they will be comfortable allowing it to run above target in order to make up ground. The conclusion is that the bar to raising rates is now impossibly high, at least assuming prices don’t follow the lead of Argentina or Venezuela. And if anything, especially with the impact of the coronavirus still just being discussed and modeled, the likelihood is for more rate cuts before the end of the year.

Speaking of the coronavirus, the WHO has suddenly figured out what the rest of the world has known for a week, this is a serious problem that is spreading quickly. The death toll is over 170 and the number of cases is quickly approaching 8000. The economic impact is growing as more and more companies halt activity in China, more flights are canceled to and from all cities in China, and fear spreads further. Last night, Taiwan’s stock market reopened for the first time in a week and fell 5.75%. Meanwhile the Taiwan dollar fell 1.0%. And the renminbi? Well onshore markets are still closed, and will be so through Monday, at least, but the CNH traded below 7.00 (dollar higher) in London early this morning and remains within basis points of that level as NY walks in. As I wrote on Monday, this will be the best indicator of sentiment as it is the only thing that can actively trade that reflects opinions on the mainland. It should be no surprise that the other Asian equity markets that were open also fell sharply (Nikkei -1.7%, Hang Seng -3.1%, KOSPI -1.7%) as investors just don’t know what to do at this stage. Fear remains the key driver, and will continue to be until there is some sense that the infection rate is slowing down. To date, that has not been the case.

And finally, the Old Lady just announced no change in the base rate, which according to the futures market had been a 50:50 chance. The pound’s response was an immediate pop and it is now higher by 0.4% on the day, making it the best performing G10 currency. Data early in the month prompted a number of dovish comments from three BOE members, including Governor Carney himself, but the data we have seen recently has shown much more positive momentum in the wake of PM Johnson’s December electoral victory. Clearly, a number of fears have receded and tomorrow is the big day, when the UK officially leaves the EU. The EU Parliament voted overwhelmingly to approve the deal, as the UK’s Parliament did last week. So the UK has reclaimed its total sovereignty and now must make its own way in the world. As I have said all along, while there is a risk that no trade deal is agreed by year end, I think the odds are vanishingly small that Boris will risk his current political strength by pushing things to that level. Come summer, a short delay will be agreed and eventually a deal will be signed. Meanwhile, the US will be seeking a deal as well. Overall, I like the pound throughout the year on the twin features of an increasingly weaker USD (QE related) and the positivity of the situation on the ground there.

And those are the three big stories of the morning. We did get some data, notably the German employment report which showed the Unemployment Rate remained unchanged at 5.0%, while the number of people unemployed fell by…2k. This was better than the expected 5k increase in unemployment, but can we step back for a moment and consider what this actually means. Do you know how many people are employed in Germany? I didn’t think so. But the answer is 41.73 million. So, this morning’s data, showing a net change of 7k vs. expectations represents exactly a 0.0167% improvement. In other words, IT DOESN’T MATTER. And I think we need to consider this issue on a regular basis. So much is made of a number being better or worse than expected when most of the time it is well within the margin of error of any estimate. Nonetheless, the euro has edged higher this morning, by just 0.15%, but my goodness it has been stable of late. And quite frankly, in the short term, barring a massive uptick in coronavirus cases which changes broad risk sentiment, I see no reason for it to do much. Ultimately, I still like the single currency to edge higher throughout the year on the back of my weaker dollar call.

This morning brings two more data points in the US, with Initial Claims (exp 215K) and Q4 GDP (2.0%) released at 8:30. However, unless the GDP number is significantly different from expectations, the market focus will remain on the coronavirus issue. Equity markets in Europe are under pressure (DAX -1.1%, CAC -1.4%) and US futures are pointing in the same direction, with all 3 indices leaning about 0.75% lower. Meanwhile, Treasury yields continue to fall with the 10-year now at 1.56%, its lowest level in three months. With no Fed speakers on the docket, today is a risk day, and that arrow is pointing lower. Look for EMG currencies to suffer, while the yen benefits.

Good luck
Adf

Truly a Curse

In China, it’s gotten much worse
This virus that’s truly a curse
How fast will it spread?
And how many dead?
Ere treatment helps it to disperse.

Despite the fact that we have two important central bank meetings this week, the Fed and the BOE, the market is focused on one thing only, 2019-nCoV, aka the coronavirus. The weekend saw the number of confirmed infections rise to more than 2800, with 81 deaths as of this moment. In the US, there are 5 confirmed cases, but the key concern is the news that prior to the city of Wuhan (the epicenter of the outbreak) #fom locked down, more than 5 million people left town at the beginning of the Lunar New Year holiday. While I am not an epidemiologist, I feel confident in saying that this will seem worse before things finally settle down.

And it’s important to remember that the reason the markets are responding has nothing to do with the human tragedy, per se, but rather that the economic impact has the potential to be quite significant. At this point, risk is decidedly off with every haven asset well bid (JPY +0.35%, 10-year Treasury yields -7bps, gold +0.8%) while risk assets have been quickly repriced lower (Nikkei -2.0%, DAX -2.0%, CAC -2.1%, FTSE 100 -2.1%, DJIA futures -1.4%, SPX futures -1.4%, WTI -3.0%).

Economists and analysts are feverishly trying to model the size of the impact to economic activity. However, that is a Sisyphean task at this point given the combination of the recency of the onset of the disease as well as the timing, at the very beginning of the Lunar New year, one of the most active commercial times in China. The Chinese government has extended the holiday to February 2nd (it had been slated to end on January 30th), and they are advising businesses in China not to reopen until February 9th. And remember, China was struggling to overcome a serious slowdown before all this happened.

It should be no surprise that one of the worst performing currencies this morning is the off-shore renminbi, which has fallen 0.8% as of 7:00am. In fact, I think this will be a key indicator of what is happening in China as it is the closest thing to a real time barometer of sentiment there given the fact that the rest of the Chinese financial system is closed. CNH is typically a very low volatility currency, so a movement of this magnitude is quite significant. In fact, if it continues to fall sharply, I would not be surprised if the PBOC decided to intervene in order to prevent what it is likely to believe is a short-term problem. There has been no sign yet, but we will watch carefully.

And in truth, this is today’s story, the potential ramifications to the global economy of the spreading infection. With that in mind, though, we should not forget some other featured news. The weekend brought a modestly surprising outcome from Italian regional elections, where Matteo Salvini, the populist leader of the League, could not overcome the history of center-left strength in Emilia-Romagna and so the current coalition government got a reprieve from potential collapse. Salvini leads in the national polls there, and the belief was if his party could win the weekend, it would force the governing coalition to collapse and new elections to be held ushering in Salvini as the new PM. However, that was not to be. The market response has been for Italian BTP’s (their government bonds) to rally sharply, with 10-year yields tumbling 18bps. This has not been enough to offset the risk-off mentality in equity markets there, but still a ray of hope.

We also saw German IFO data significantly underperform expectations (Business Climate 95.9, Expectations 92.9) with both readings lower than the December data. This is merely a reminder that things in Germany, while perhaps not accelerating lower, are certainly not accelerating higher. The euro, however, is unchanged on the day, as market participants are having a difficult time determining which currency they want to hold as a haven, the dollar or the euro. Elsewhere in the G10, it should be no surprise that AUD and NZD are the laggards (-0.85% and -0.65% respectively) as both are reliant on the Chinese economy for economic activity. Remember, China is the largest export destination for both nations, as well as the source of a significant amount of inbound tourism. But the dollar remains strong throughout the space.

Emerging markets are showing similar activity with weakness throughout the space led by the South African rand (-1.0%) on the back of concerns over the disposition of state-owned Eskom Holdings, the troubled utility, as well as the general macroeconomic concerns over the coronavirus outbreak and its ultimate impact on the South African economy. Meanwhile, the sharp decline in the price of oil has weighed on the Russian ruble, -0.9%.

As I mentioned above, we do have two key central bank meetings this week, as well as a significant amount of data as follows:

Today New Home Sales 730K
  Dallas Fed Manufacturing -1.8
Tuesday Durable Goods 0.5%
  -ex Transport 0.3%
  Case Shiller Home Prices 2.40%
  Consumer Confidence 128.0
Wednesday Advance Goods Trade Balance -$65.0B
  FOMC Rate Decision 1.75% (unchanged)
Thursday BOE Rate Decision 0.75% (unchanged)
  Initial Claims 215K
  GDP (Q4) 2.1%
Friday Personal Income 0.3%
  Personal Spending 0.3%
  Core PCE Deflator 1.6%
  Chicago PMI 49.0
  Michigan Sentiment 99.1

Source: Bloomberg
Regarding the BOE meeting, the futures market is back to pricing in a 60% probability of a rate cut, up from 47% on Friday, which seems to be based on the idea that the coronavirus is going to have a significant enough impact to require further monetary easing by central banks. As to the Fed, there is far more discussion about what they may be able to do in the future as they continue to review their policies, rather than what they will do on Wednesday. Looking at the spread of data this week, we should get a pretty good idea as to whether the pace of economic activity in the US has changed, although forecasts continue to be for 2.0%-2.5% GDP growth this year.

And that’s really it for the day. Until further notice, the growing epidemic in China remains the number one story for all players, and risk assets are likely to remain under pressure until there is some clarity as to when it may stop spreading.

Good luck
Adf

Cashiered!

In China, a virus appeared
That seems to be worse than first feared
It’s spreading so quickly
That markets turned sickly
And stock market bulls got cashiered!

Some of you may remember the SARS virus from the winter of 2002-3, when a respiratory illness, emanating from Guangdong in China, spread quickly around the world resulting in some 800 odd deaths, but more importantly from the market’s perspective, created a very real risk-off environment. As an example, from January through March of 2003, the Dow Jones fell more than 16%, largely on fears that the virus would continue to spread and ultimately reduce economic activity worldwide. Fortunately, that was not the case, as those diagnosed with the virus were isolated and the spread of the disease ended. Naturally, risk was reignited and all was right with the world…until 2008.

I remind everyone of this history as this morning, there is another coronavirus that has been discovered in central China, this time Wuhan seems to be ground zero, and has begun to spread rapidly from human to human. In just a few weeks, more than 200 cases have been reported with several deaths. However, the big concern is that the Lunar New Year celebration begins on Saturday and this is the heaviest travel time of the year within China and for Chinese people around the world. And if your goal was to spread a virus, there is no better way to do so than by getting infected people on airplanes and sending them around the world! Of course, this is nobody’s goal, however it is a very real potential consequence of the confluence of the new virus and the Lunar New Year. The market has reacted just as expected, with risk aversion seen across markets (equities lower, bonds higher) and specific stocks reacting to anticipated direct effects. For example, every Asian airline stock has been aggressively sold lower, while manufacturers of things like latex gloves and face masks have rallied sharply.

Now, while none of this should be surprising, a quick look at market levels shows us that the current impact of this virus has been widespread, at least from a market perspective. For example, equity markets have suffered across the board, although Asia was worst hit (Nikkei -0.9%, Hang Seng -2.8%, Shanghai -1.4%, DAX -0.25%, CAC -0.85%, FTSE -1.0%). Treasury yields have fallen 2bps, although bund yields are actually higher by 0.5bps this morning on the back of stronger than expected ZEW survey data.

And in the currency market, the dollar is broadly, although not universally, higher. It can be no surprise that APAC currencies are under the most pressure given the risk-off causality, with KRW -0.75% and CNY -0.55%, its largest daily decline since last August. But we are also seeing weakness throughout LATAM with both BRL (-0.45%) and MXN (-0.35%) among the day’s worst performers.

In the G10 space, the results have been a bit more mixed, and actually seem more related to data than the general risk sentiment. For example, the pound is today’s big winner, +0.35% after UK Employment data was released with much better than expected results. While the Unemployment Rate remained unchanged at 3.8%, the 3M/3M Employment Change rose 208K, nearly double expectations and the first really good piece of data seen from the UK in two weeks (recall PMI data was a bit better than expected). This has resulted in some traders questioning whether the BOE will cut rates next week after all. Futures markets continue to price a 61% probability, although that is down from 70% on Friday.

Elsewhere, the euro reversed small early losses and now has small gains after the ZEW Expectations data (26.7 vs. 15.0 expected), while the yen has benefitted ever so slightly on two different fronts. First, the broad risk-off market flavor has helped keep the yen underpinned, but more importantly, the BOJ met last night, and although they left policy unchanged, as universally expected, there continues to be a growing belief that the next move there is going to be a tightening! This was reinforced by the BOJ raising its growth estimates for both 2019 (0.8%, up from 0.6%) and 2020 (0.9% up from 0.7%). Of course, offsetting that somewhat was the decline in the BOJ’s inflation forecast, down to 0.8% in 2020 from the previous expectation of 0.9%. In the end, it is difficult to get overly excited about the Japanese economy’s prospects, with a much greater likelihood of significant yen strength emanating from a more severe risk-off event.

Looking ahead to the week, not only is the Fed in its quiet period, but there is a very limited amount of US data set to be released.

Wednesday Existing Home Sales 5.43M
Thursday Initial Claims 214K
  Leading Indicators -0.2%

Source: Bloomberg

Of course, there are two other events this week that may have a market impact, although my personal belief is that neither one will do so. This morning the US Senate takes up the Articles of Impeachment for President Trump that were finally proffered by the House of Representatives. And while the politicos in Washington and the talking heads on TV are all atwitter over this situation, financial markets have collectively yawned throughout the entire process. I see no reason for that stance to change at this point.

The other event is the World Economic Forum in Davos, the annual get together of the rich and famous, as well as those who want to be so, to pontificate on all things they deem important. However, it beggars belief that anything said from this conference is going to change any investment theories, let alone any fiscal or monetary policies. This too, from the market’s perspective, is unlikely to have any impact at all.

And that’s really it for today. Lacking catalysts, I anticipate a quiet session overall. Short term, the dollar still seems to have some life. But longer term, I continue to look for a slow decline as the effects of the Fed’s QE begin to be felt more keenly.

Good luck
Adf

Just Dreams

Last night saw a rocket attack
On assets, US, in Iraq
The oil price surged
While stocks were submerged
’neath selling by bulls who cut back

This morning, however, it seems
Concerns about war were just dreams
The losses reversed
As traders still thirst
For assets now priced at extremes

What a difference a day makes…or does it? Yesterday saw market participants’ initial evaluation of the threat of escalation in Iran/Iraq as limited with the result that early price action favoring haven assets reversed and most markets closed within a few basis points of Monday’s prices. The one exception to that rule was the dollar, which maintained its bid all day long, actually extending its gains late into the session. Other than the idea that international investors are buying dollars so they can buy US stocks, it is hard to come up with a short term rationale for the dollar’s recent strength. If anything, news this morning that the Fed’s balance sheet has grown even further, to $4.17 trillion, would imply that a weaker dollar is in the offing.

Of course, last night, shortly after the US markets closed, came the news that Iran fired a number of missiles at two different military bases in Iraq that are jointly used by the US and Iraqi militaries. There was a great deal of huffing and puffing from Iran, they announced the attacks themselves on Iranian TV, but in the end, they were nothing more than damp squibs. There was no material damage and no personnel killed, or even severely wounded. (And that is a good thing!) But at the time the news hit the tape, this outcome was not clear and risk assets plunged while haven assets soared. Thus, overnight saw gold trade up to $1610/oz, WTI rise to $65.65 (Brent to $71.75), Treasury yields fall to 1.74% and the yen rise to 107.65 (0.75%). But that price action, and the fear driving it, was quite short-lived. Once it became clear that the Iranian retaliation was completely ineffective, and they announced they were not interested in a major conflict, essentially all of that movement was reversed. So this morning we see gold at $1579/oz, WTI at $62.60, Treasury yields back to 1.82% and the yen actually net weaker on the day, at 108.70 (-0.25%).

This begs the question of how to consider this new potential risk going forward. The first rule of an exogenous market risk is the law of diminishing returns. In other words, even if there is another attack of some sort, you can be sure that the haven rally will be smaller and risk assets will not decline as much as the first time. And since this entire affair is occurring in a locale that, other than oil production, has almost no impact on the global economy, the impact is likely to be even smaller. Now I waved off oil production as though it is not important, but there is no question that the remarkable rise of US oil production has significantly altered the global politics of oil. When the Middle East was responsible for more than 50% of global production, OPEC ruled the roost, and anything that happened there had a global impact. But as oil production elsewhere in the world has grown and OPEC’s market share sinks below 40% (remember, the US is the world’s largest oil producer now), the impact of Middle Eastern conflagrations has fallen dramatically. The point is that short of a major attack by Iran on Saudi oil facilities or attempts to close the Persian Gulf, this situation has probably driven all the market excitement it is going to. In other words, we need to look elsewhere for market catalysts.

With that in mind, if we turn to the ongoing data releases, we find that German Factory Orders once again missed the mark, falling 6.5% Y/Y in November, highlighting that the industrial malaise in the engine of Europe continues. French Consumer Confidence fell more than expected, and Eurozone Confidence indices were almost uniformly worse than expected. It is difficult to look at this data and conclude that the situation in Europe is improving, at least yet. I guess, given this situation it should be no surprise that the euro is lower again this morning, down 0.3%, and actually trading at its lowest point this year (a little unfair, but the lowest level in two weeks). But the dollar’s strength is evident elsewhere in the G10 as the pound remains under pressure, -0.1% today and 0.45% this week. And the same is true pretty much throughout the space.

In the EMG bloc, the results have been a bit more mixed overnight with THB the worst performer (-0.5%) after comments from the central bank decrying the baht’s strength and implying they may do something about it. Remember, too, that APAC currencies, in general, saw weakness on the fear story, which dissipated after those markets closed. On the flip side, ZAR is the day’s biggest gainer, +0.6%, completely recouping its early-session Middle East related losses, as investors apparently focused on the incipient US-China trade deal and how it will benefit the global economy and South African interests.

On the US data front, yesterday saw a smaller than expected Trade Deficit and better than expected ISM data (55.0 vs. 54.5 exp). This morning we are awaiting the ADP Employment numbers (exp 160K) and Consumer Credit ($16.0B) this afternoon. We also hear from Fed Governor Lael Brainerd this morning, but it doesn’t appear as though she will focus on monetary policy as part of her discussion on the Community Reinvestment Act.

In the end, US data has continued to perform well, which thus far has been enough to offset the early impact of the Fed’s (not) QE. However, as the Fed balance sheet continues to grow, I continue to look for the dollar to decline throughout the year. As such, payables receivers should consider taking advantage of the dollar’s early year strength.

Good luck
Adf

 

No Rapprochement

The topic du jour is Iran
Where threats, to and fro, carry on
Risk appetite’s fallen
And bears are now all in
That this time there’s no rapprochement

The rhetoric between the US and Iran over the weekend has escalated with both sides threatening retaliation for anything the other side does. Stories of cyber-attacks on the US as well as an attack on a base in Kenya where three Americans were killed seem to be the first steps, but with the US deploying reinforcements to the Middle East, and President Trump promising disproportionate responses to any further actions, the situation has become fraught with danger.

Not surprisingly, financial markets are stressing with risk appetites throughout the world dissipating and haven assets in demand. So, for a second day we have seen equity markets fall around the world (Nikkei -1.9%, Hang Seng -0.8%, DAX -1.6%, CAC -1.1%, FTSE -1.0%) and US futures are following along with all three indices currently lower by approximately 0.8%. Treasuries and German bunds have rallied, albeit Friday’s price action was far greater than this morning’s movement which has seen yields on each fall just one more basis point. Gold has soared to its highest level since April 2013 and is now pressing up toward $1600/oz. Oil continues to rise on supply fears, up another 1.0% this morning and nearly 6.0% since Friday morning. But recall that prior to the US action against Soleimani, oil was up more than 20% since October.

And finally, the dollar this morning is…lower. At least mostly that’s the case. In some ways this is quite surprising as the dollar tends to be a haven in its own right, but markets have been known to be fickle prior to today. In the G10 space, the pound is leading the way higher overnight, up 0.5%, which may well be a response to modestly better than expected UK data (New Car Registrations +3.4%, Services PMI 50.0) rather than to the geopolitical risks. Of course, PMI at 50.0 is hardly cause for celebration, but I guess that’s better than further sub-50 readings. The euro has also benefitted this morning, +0.35%, after PMI data across the region was also modestly better than the flash numbers from the week before last. However, based on the latest data, according to most econometric models, GDP for Q1 in the Eurozone is still running at just 0.1%, or less than 0.5% annualized. Again, it’s hard to get too excited about the situation yet.

And then there is the yen, which is essentially unchanged on the day, perhaps the biggest surprise of all. This is because even when the dollar has not run true to course on a risk basis, the yen has been extremely consistent. Granted, since New Year’s Eve, the yen has been the top G10 performer but its 0.5% rally in that time is hardly inspirational. My take is that even heightened rhetoric from either side is likely to see the yen gain further, but remember there are market technicals involved in the trade, with 108.00 having demonstrated strong support since early October. It appears we will need a bit more of a ‘kinetic’ action in Iraq/Iran before the yen takes its next steps higher.

In the EMG bloc, the situation is a bit different, with EEMEA currencies all trading in a tightly linked manner to the euro, and so higher by about 0.35%, but modest weakness seen across most of the APAC region. As to LATAM, CLP is opening much lower (-1.75%) as the central bank backed away from its USD sale program. The bank announced this morning that it would not be selling the $150mm in the spot market it has been executing every day since last autumn. If nothing else, this should be a good indication for hedgers of just how little liquidity exists within that market.

Turning to Friday’s FOMC Minutes, it can be no surprise that the Fed nearly twisted their own arm, patting themselves on the back, for setting policy at just the right place. And then there was the American Economic Association conference this past weekend where the Fed loomed large in the paper production. Former Fed chairs Bernanke and Yellen once again explained that things beyond their control (demographics and technology) were the reason that they could not achieve their policy targets, but both assured us that more of the same policies that have been ineffective for the economy (but great for the stock market) would get the job done! Meanwhile, current Fed members all expressed satisfaction with the current settings, although it is clear there is far more concern over economic weakness than rising price pressures. What is clear is that higher prices are coming to a store (every store) near you.

As to this week, the data parade starts tomorrow and runs through Friday’s payroll report as follows:

Tuesday Trade Balance -$43.9B
  ISM Non-Manufacturing 54.5
  Factory Orders -0.7%
Wednesday ADP Employment 160K
  Consumer Credit $15.8B
Thursday Initial Claims 220K
Friday Nonfarm Payrolls 162K
  Private Payrolls 152K
  Manufacturing Payrolls 5K
  Unemployment Rate 3.5%
  Average Hourly Earnings 0.3% (3.1% Y/Y)
  Average Weekly Hours 34.4

Source: Bloomberg

In addition, we hear from five more Fed speakers, with many more doves than hawks slated to discuss their views. In truth, I think it would be more effective if they would simply shut up rather than constantly reiterate their opinion that they have done a great job and will continue to do so unless things change. However, with the reduced risk appetite due to the Iran situation, I guess they feel the need to try to support stock prices at all costs.

In the medium term, I think the dollar will continue to come under pressure. In the short term, I think it is much harder to have a view given the highly volatile nature of the current situation in the Middle East. This is why you hedge; to prevent significant problems, but take care in executing those hedges, markets are skittish on the opening, and market depth may be a bit less robust than normal.

Good luck
Adf

Unease In Iraq

While yesterday, risk basked in glory
This morning risk-off is the story
Unease in Iraq
Had markets give back
The gains seen in each category

Well, this is probably not the way most of us anticipated the year to begin, with a retaliatory strike against Iran inside Iraq, but that’s what makes markets interesting. So yesterday’s bright beginning, where the PBOC reduced its reserve requirement ratio (RRR) by 0.50% to add further liquidity to the Chinese economy which led to broad based positive risk sentiment has been completely reversed this morning. Briefly recapping yesterday’s activity, equity markets around the world soared on the news of further central bank easy money, but interestingly, Treasury bonds rallied (yields declined) and gold rallied as did the dollar. This is a pretty unusual combination of market movements, as generally, at least one of that group would sell off in a given session. Perhaps it speaks to the amount of spare cash on the sidelines looking for investment opportunities to start the year.

However, that was soooo yesterday. At about 7:45 last night the news hit the tape that a senior Iranian general from the QUDS force had been killed by a US drone attack near Baghdad airport. When this was confirmed all of the positive sentiment that had been permeating markets disappeared in an instant. Equity prices went from a strong opening in Asia to closing with declines. The dollar and the yen both rallied sharply as did gold and oil. And not to be left out, Treasury yields have plummeted along with Bund and Gilt yields. In other words, today is a classic risk-off session.

So a quick look at markets as NY starts to walk in shows European equity markets under pressure (DAX -1.65%, CAC -0.5%, FTSE -0.5%) and US futures similarly falling (DJIA -1.2%, Nasdaq 1.5%, SPY -1.3%). In the bond market, Treasury yields are down 7.5bps to 1.80% while German Bunds are down 7bps to -0.30%. Gold prices have rallied a further 1.4% and are back to the highs touched in September at $1550/oz, a level which had not been seen since early 2013 prior to that. Oil prices have rocketed higher, up 3.9%, as fears of supply interruptions make the rounds. Of course, given that the US shale producers have essentially become the swing producers in the market, my sense is that we are not likely to see a permanently higher price level here. Remember, when Iran attacked Saudi oil facilities last September, the oil price spike was extremely short-lived, lasting just a couple of days before settling right back down.

And finally, the dollar has rallied sharply this morning against virtually all its counterparts except, naturally, the yen. During the last week of 2019, the dollar sold off broadly, losing about 2.0% against a wide range of currencies as investors and traders seemed to be preparing for a scenario of continued low US interest rates supporting stocks while undermining the dollar’s value. Of course, my view of ‘not QE’ having a significant impact on the dollar has not changed, and although the US economy continues to outperform its G10 peers and US interest rates remain higher than pretty much every other country in that bloc, the history of QE is that it will undermine the dollar this year.

But for right now, long-term structural issues are taking a back seat to the immediacy of growing concern over escalating tensions in Iraq and the Middle East. If a larger conflict erupts, then we are far more likely to see protracted USD and JPY strength alongside weaker equity markets, higher prices for gold and oil and lower Treasury yields. And the thing to remember right now is that traders were establishing short USD positions for the last several weeks, so this sudden reversal could well have further to run on position squaring alone. Markets remain less liquid than normal as most trading desks will not be fully staffed until Monday. So keep that in mind if some hedging needs to be executed today.

With that as an introduction, what else can we anticipate today? Well, we do get a bit of US data, ISM Manufacturing (exp 49.0) and ISM Prices Paid (47.8) as well as Construction Spending (0.4%) and then at 2:00 the FOMC Minutes from the December meeting will be released. Those have garnered a great deal of interest as even though Chairman Powell has essentially told us all that rates are on hold for a long time, all eyes will be searching for further discussion of the repo issue and how the Fed plans to handle it going forward. While they were able to prevent any untoward movement for the year-end turn, they are still buying $60 billion / month of T-bills and the balance sheet has grown more than $400 billion since October. Not coincidentally, equity prices have rallied sharply since October as well. The point is that the Fed remains on a path where they have promised to re-inflate the balance sheet until at least late Spring, and given the direct relationship between the Fed’s balance sheet and equity prices, as well as the demonstrated fear the Fed has shown with respect to doing anything that could be blamed for causing the stock market to decline, it seems awfully likely that ‘not QE’ is going to continue for a very long time. And that is going to weigh on the dollar going forward…just not today.

One more thing to look for this afternoon is a series of comments from a bevy of Fed doves (Brainard, Daly, Evans and Kaplan) who are attending a conference in San Diego. Do not be surprised to hear comments that continue to raise the bar for any possible rate hikes, but allow the idea of rate cuts to filter into the discussion. However, this too, is unlikely to undermine the dollar during a risk-off session. The theme here is that payables hedgers need to consider taking advantage of this short-term dollar strength.

Good luck
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Started To Fade

On Monday, the data released
Showed growth in the US decreased
As well, hope ‘bout trade
Has started to fade
And snow overwhelmed the Northeast

In a word, yesterday sucked. At least that’s the case if you were bullish on essentially any US asset when the session started. Early equity market gains were quickly reversed when the ISM data printed at substantially worse than expected levels. Not only did the headline release (48.1) miss expectations, which was biased toward a modest improvement over the October readings, but all of the sub-indices along with the headline number actually fell further from October. Arguably the biggest concern came from the New Orders Index which printed its lowest level (47.2) since the financial crisis. Granted, this was the manufacturing sector and manufacturing represents only about 12% of the US economy, but still, it was a rout. The juxtaposition with the green shoots from Europe was not lost on the FX market either as the dollar fell sharply across the board. In fact, the euro had its best day since early September, rallying 0.6%.

This morning, the situation hasn’t improved either, as one of the other key bullish stories for equity sentiment, completion of the phase one trade deal with China, was dealt a blow when President Trump explained that he was in no hurry to complete the deal and would only do so when he was ready. In fact, he mused that it might be better to wait until after the 2020 elections before agreeing a deal with China, something that is clearly not priced into the market. When those comments hit the tape, US equity futures turned around from small gains to losses on the order of 0.3%. Bullishness is no fun yet.

Perhaps it’s worth a few moments to consider the essence of the bullish US case and determine if it still holds water. Basically, the broad consensus has been that despite its sluggish pace, growth in the US has been more robust than anywhere else in the developed world and that with the FOMC having added additional stimulus via 75 bps of interest rate cuts and, to date, $340 billion in non-QE QE, prospects for continued solid growth seemed strong. In addition, the tantalizing proximity of that phase one trade deal, which many had assumed would be done by now or certainly by year end, and would include a reduction in some tariffs, was seen as a turbocharger to add to the growth story.

Now, there is no doubt that we have seen some very positive data from the US, with Q3 GDP being revised higher, the housing market showing some life and Retail Sales still solid. In fact, last week’s data releases were uniformly positive. At the same time, the story from Europe, the UK, China and most of the rest of the world was of slowing or non-existent growth with central banks having run out of ammunition to help support those economies and a protracted period of subpar growth on the horizon. With this as a backdrop, it is no surprise that US assets performed well, and that the dollar was a key beneficiary.

However, if that narrative is going to change, then there is a lot of price adjustment likely to be seen in the markets, which arguably are priced for perfection on the equity side. The real question in the FX markets is, at what point will a risk-off scenario driven by US weakness convert from selling US assets, and dollars by extension, to buying US dollars in order to buy US Treasuries in a flight to safety? (There is a great irony in the fact that even when the US is the source of risk and uncertainty, investors seek the safety of US Treasury assets.) At this point, there is no way to know the answer to that question, however, what remains clear this morning is that we are still in the sell USD phase of the process.

With that in mind, let’s look at the various currency markets. Starting with the G10, Aussie is one of the winners after the RBA left rates on hold, as widely expected, but sounded less dovish (“global risks have lessened”) than anticipated in their accompanying statement. Aussie responded by rallying as much as 0.65% initially, and is still higher by 0.35% on the day. And that is adding to yesterday’s 0.85% gain taking the currency higher by 1.2% since the beginning of the week. While the longer term trend remains lower, it would not be a surprise to see a push toward 0.70 in the next week or so.

The other major winner this morning is the British pound, currently trading about 0.4% higher after the latest election poll, by Kantar, showed the Tories with a 12 point lead with just nine days left. Adding to the positive vibe was a modestly better than expected Construction PMI (45.3 vs. 44.5 expected) perhaps implying that the worst is over.

Elsewhere in the G10, things have been far less interesting with the euro maintaining, but not adding to yesterday’s gains, and most other currencies +/- a few bps on the day. In the EMG bloc, the noteworthy currency is the South African rand, which has fallen 0.55% after a much worse than expected Q3 GDP release (-0.6% Q/Q; 0.1% Y/Y). The other two losing currencies this morning are KRW and CNY, both of which have suffered on the back of the Trump trade comments. On the plus side, BRL has rallied 0.4% after its Q3 GDP release was better than expected at +0.6% Q/Q. At least these moves all make sense with economic fundamentals seeming to be today’s driver.

And that’s really it for the day. There is no US data this morning, although we get plenty the rest of the week culminating in Friday’s payroll report. Given the lack of economic catalysts, it feels like the dollar will remain under general pressure for the time being. The short term narrative is that things in the US are not as good as previously had been thought which is likely to weigh on the buck. But for receivables hedgers, this is an opportunity to add to your hedges at better levels in quiet markets. Take advantage!

Good luck
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