Just Let It Go

Said Brussels to Italy, No
Your budget is not apropos
Go fix it and then
Come back here again
Said Italy, just let it go

In England, meanwhile, PM May
Is finding she can’t get her way
A challenge is forming
With more Tories warming
Up to the thought she shouldn’t stay

The world seems to be getting messier by the day. Despite the ongoing vitriol in the US election process, the dollar continues to benefit from the fact that problems elsewhere seem to be worse. For example, the euro is under pressure this morning with two key stories driving the market. First, in an unprecedented move, the EU rejected Italy’s draft budget by claiming that it’s deficit targets were not in line with EU directives of reducing debt. Not surprisingly, the populist government in Italy simply said that fiscal stimulus was required to get the economy growing again, and they were going to enact it anyway. There are two issues here impacting the euro, the first being that markets are likely to drive Italian interest rates higher and add significant pressure to the Italian economy, notably the banking sector, which is tightly tied to those rates. The second is that if a major country is willing to ignore EU guidance on an important issue like this, what does that say about the credibility of the entire EU construct and the euro by default.

The other key issue was the release of much weaker than expected Flash PMI data for Germany, France and the entire Eurozone. Remember yesterday the Bundesbank indicated that GDP growth in Q3 would be flat in Germany, undermining markets there. Well, today, we learned that growth in Q4 isn’t exactly shining either, with the Manufacturing PMI printing at 52.3, its lowest level since early 2016. This data added to the pressure on the euro, which has fallen 0.6% on the day and is now touching 1.1400 for the first time since mid-August. It appears that regardless of the ongoing structural concerns in the US, the cyclical growth and interest rate story remains the market’s driver for now.

Turning to the UK, yesterday saw a rally in the pound after a story circulated that the EU was going to offer a compromise on how to treat the UK after Brexit, allowing them to stay within the customs union. However, this morning, there appears to be a growing insurgency within the Tory party and a challenge to PM May appears to be coming. If she were ousted, that would become quite problematic with regards to the ongoing negotiations as Cabinet members would change, and policy direction would likely as well. Given the late date, just five months left before the split is finalized, it would speak to a much higher probability of a hard Brexit with no deal, and a much lower pound. With this in mind, it is not surprising that the pound has ceded yesterday’s gains and is down 0.6% as well this morning.

Away from those two stories, the dollar is generally, but not universally, stronger. It is noteworthy that USDCNY is higher by 0.2%, pushing back to the top of its recent range just above 6.95, and starting to move into the area where many are counting on the PBOC to intervene. There are a number of analysts who continue to believe that a move above 7.00 will lead to a significant increase in capital outflows from China, and a much bigger risk-off movement. This is something about which the Chinese are extremely concerned. However, looking around APAC currencies overnight, both INR (+0.5%) and KRW (+0.25%), arguably the next most important ones, showed strength vs. the dollar as yesterday’s sharp decline in oil prices was seen as a positive for both of these large oil importers.

On the rate front, the Riksbank in Stockholm left interest rates on hold, as expected, but basically promised to raise them in either December or February. SEK is modestly weaker vs. the dollar, but almost unchanged vs. the euro, perhaps a better measure of the impact. This morning, the Bank of Canada will also announce its rate decision with expectations nearly universal that they will raise rates by 25bps to 1.75%. Ahead of the announcement, the Loonie is flat.

And those are really the FX stories of the day. Equity markets around the world seem to be rebounding from yesterday’s US led sell-off, although US equity futures are still pointing lower as I type. Treasury yields have fallen from yesterday’s closing levels, but remain in the vicinity of 3.15%. As mentioned, oil prices tumbled yesterday by more than 4% after Saudi Arabia indicated they would make up for any reduction in Iranian crude exports due to the US sanctions that are to begin in earnest next week. And gold, the traditional safe haven, is basically flat on the day, although about 1% lower than the peak of $1240/oz it reached during the nadir of yesterday’s equity market movement.

This morning we see our first real data of the week, with New Home Sales expected to print at 625K. We also get the Fed’s Beige Book at 2:00pm. Speaking of the Fed, yesterday Atlanta Fed President Bostic reiterated that the Fed was on the right path and that gradual rate increases were appropriate. Today we hear from Bullard, Mester and Bostic again. While the housing data has softened lately, and even some of the earnings data has been a bit softer than expected, there is no strong rationale for any of these regional presidents to change their views. In fact the one thing I would mention about earnings is how many companies are raising prices to cover increased materials costs or tariff impacts. If anything, that sounds pretty inflationary to me, and I would guess to the Fed as well.

If US equity markets follow through on the opening and continue to decline, the dollar should remain well bid overall. But my sense is that we are going to see some bargain hunters coming in here, help the stock markets bounce and see the dollar decline by the time NY goes home.

Good luck
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Change Can Come Fast

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

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

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

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

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

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

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

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

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

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

Good luck
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A Collective Bronx Cheer

Some currencies, so far, this year
Received a collective Bronx cheer
Now in the last week
They saw a small peak
But forecasts continue severe

Recent pressure on the dollar has manifested itself against not only the G10 currencies, but also against some of the hardest hit currencies this year. Argentine pesos, Turkish Lira, Brazilian Real and Indian rupee all had received a modest reprieve during the dollar’s recent weakening spell. But that price action has faded into history as all of those currencies have come under renewed pressure during the past two sessions as the dollar seems to have found its footing. Each one seems to have its own domestic reason for distress, but the overarching theme remains that tighter Fed policy and the ensuing reduction in the available USD liquidity in global markets has undermined domestic conditions in these nations and exacerbated weakness in these currencies.

A quick recap shows that in Turkey, significant concerns remain over the central banks unwillingness to address quickly rising inflation by the ordinary method of raising interest rates. That lack of action has resulted in TRY declining by 7.5% in the past two sessions. In Brazil, the real has fallen 2% in the past two sessions as renewed concerns over the upcoming presidential election have arisen, with traders worried about a sharp turn left and a much less favorable investment environment. In India, we have seen a 1.5% decline in the rupee, which has generally been a much less volatile currency of late, as inflation concerns continue to plague the RBI despite its recent action to raise interest rates by 25bps, its second consecutive move and taking rates back to late 2016 levels. Finally, the Argentine economy continues to slow into recession while inflation remains rampant despite 45% interest rates as confidence in the Macri administration becomes more fragile. So every nation has its own problems, but most of these problems are not that new. They have been laid bare, however, by the change in Fed policy. When the Fed allowed USD liquidity to slosh all around the world, it hid many sins that existed.

As to the G10 space, it seems that my sense of continued dollar weakness was misplaced. Rather, what we have seen is a halt to the dollar’s recent slide and consolidation of those moves. For example, after touching a more than one month high at 1.1733 yesterday, the euro has drifted back to 1.1665 as I type, despite a distinct lack of data. Price action resembles that of positions being unwound ahead of the holiday weekend more than anything else.

Actually, within this space, two currencies stand out for their weakness today, AUD and SEK. The former has reacted to the ongoing dichotomy between the RBA’s cash rate, which remains at historic lows of 1.50%, and news that Westpac, one of the big four Australian banks, raised mortgage rates by 14bps in response to the fact that their funding costs continue to rise due to Federal Reserve policy in the US. Once again, the Fed’s actions are having unexpected ramifications around the world.

Sweden, however, has a different issue, and that is domestic politics. It is the latest nation where the establishment political parties have lost significant support, and in the mold of much of Eastern Europe, Italy, the UK and even the US, Sweden has seen the rise of a nationalist focused group, the Sweden Democrats, that is set to become the largest party in Parliament at next week’s election. This has generated significant concern within the marketplace that Sweden’s recent robust economic performance will be negatively impacted and that the Riksbank will refrain from raising interest rates as previously expected. The upshot is that while today’s decline is just 0.3% vs. the dollar, the big move has been vs. the euro, where the krone has been falling steadily for the past two months, lopping 5% from its value.

This morning’s data showed that Q2 growth in the US was actually revised higher to 4.2% amid improvements in investment by businesses. However, the dollar has shown little reaction to the numbers, maintaining its overnight gains but not extending them. Treasury prices, however, have fallen in the wake of the print and are now showing 10-year yields higher by 3bps. For the rest of the day, there is little in the way of news expected that is likely to move markets, so my best guess is that we will continue to see the dollar consolidate.

Good luck
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Is That Despair?

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

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

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

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

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

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

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

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

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

Good luck
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A New Complication

Last Friday it seemed immigration
Had ceased as a cause of vexation
In Europe, but then
On Monday again
It suffered a new complication

The euro first rose, then declined
But now there’s a new deal designed
To finally forestall
For once and for all
The chance Merkel might have resigned

Remarkably, the immigration debate in Germany continues to dominate the news. Last night, German Interior Minister Horst Seehofer agreed to a new deal regarding the immigration situation and withdrew his threatened resignation. This led to a major sigh of relief in the markets as the fear of Frau Merkel’s coalition falling apart has once again receded. While Merkel clearly remains in a weakened state, if this deal can be signed by all the parties involved (a big if), the market may be able to move on to its next concerns. It should be no surprise that the euro has rebounded on the news, after all it has tracked the announcements extremely closely, but the rebound this morning, just 0.1%, has been somewhat lackluster after yesterday’s rout. Perhaps that has as much to do with the release of Eurozone Retail Sales data, which disappointed by printing at 0.0% in May, less than expected and yet another indication that growth in the Eurozone is on a slowing trajectory.

As an aside, if I were Mario Draghi, I might be starting to get a little more nervous given that the Eurozone economy is almost certainly trending toward slower growth and the ECB has very little ammunition available to counter that trend. Rates remain negative and QE is set to run its course by the end of the year. It is not clear what else the ECB can do to combat a more severe slowdown in the economy there.

But away from the daily immigration saga in Germany, the dollar has had a mostly softer session. This is primarily due to the fact that it had a particularly strong rally yesterday and we are seeing short-term profit taking.

China remains a key theme of the market as well, with the renminbi having fallen for twelve of the past thirteen sessions with a total decline of nearly 5.0%. While it has rebounded somewhat this morning (+0.35%), that is small beer relative to its recent movement. Last night, PBOC Governor Yi Gang was on the tape explaining that the bank would “keep the yuan exchange rate basically stable at a reasonable and balanced level.” That was sufficient for traders to stop their recent selling spree and begin to take profits. While there are some pundits who believe that the Chinese will allow the renminbi to decline more sharply, I believe there is still too much fear that a sharper decline will lead to more severe capital outflows and potential economic destabilization at home. As such, I expect to see the CNY decline managed in a steady and unthreatening manner going forward. But I remain pretty sure that it will continue to decline.

Other than those two stories, here’s what’s happening today. SEK has been the biggest winner in the G10, rising 1.25% after the Riksbank, although leaving rates on hold at -0.5%, virtually promised they would begin raising them by the end of the year. That is a faster pace than expected and so the currency reaction should be no surprise. However, keep in mind that Sweden is highly dependent on trade, and as trade rhetoric increases, they could well be collateral damage in that conflict. Aussie is the next biggest winner, having risen 0.7% after the RBA also left rates on hold, as expected, but the statement was seen as having a mildly hawkish tinge to it. But remember, AUD had fallen more than 4.5% in the past month, so on a day when the dollar is under pressure, it can be no surprise that the rebound is relatively large.

In the EMG space, MXN is today’s big winner, rallying 1.3% as the new story is that there are now more areas between the US and Mexico where President Trump and President-elect Obrador will be able to find common ground. Certainly both presidents are of the populist stripe, and so perhaps this is true. But my gut tells me that once AMLO and his Congress are sworn in (it doesn’t happen until December 1!) the market will recognize that the investment environment in Mexico is set to deteriorate, and so the currency will follow.

On the data front, yesterday’s ISM data was quite strong at 60.2, well above expectations and a further indication that the economic divergence theme remains alive and well. This morning we await only Factory Orders (exp -0.1%) and Vehicle Sales (17.0M), with the latter likely to be more interesting to market players than the former. Of course, tomorrow is July 4th, and so trading desks are on skeleton staff already. That means that liquidity is probably a bit sparse, and that interest in taking positions is extremely limited. Look for a lackluster session with the dollar probably edging a bit lower, but things to wind up early as everybody makes their escape.

Good luck
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