Not Been Tested

From Germany data suggested
The slowdown in growth’s been arrested
If true, that’s good news
But still there are views
The hypothesis, null’s, not been tested

There seems to be an inordinate amount of positivity surrounding a single data point this morning, German Factory Orders, which printed at +1.3% in September versus expectations of a 0.1% rise. And while this is certainly good news, two things to keep in mind are that the Y/Y rate of growth is -5.4%, (that’s right a significant decline) and that the other German data out this morning showed that October PMI’s printed at 48.9 on a composite level. In other words, all signs still point to a German recession on the basis of negative GDP growth in both Q3 and Q4. This will be confirmed next week when the official data is released. And remember, a negative print will be the third subzero outcome there in the past five quarters. My point is that Germany continues to drag on the Eurozone as a whole, and until the global trade situation improves, it is likely to continue to do so.

Yet, despite a spate of positive sounding articles about the nadir in Eurozone growth having been reached, the markets have taken a much less enthusiastic approach to things this morning. Yes, the euro is higher as I type, alas, by just 0.1%, and that is after a 0.6% decline yesterday. In other words, it is difficult to describe the FX market as jumping on board this narrative. What about equities you may ask? Well, the DAX is up by 0.15%, but again, this doesn’t seem to warrant much hype. In fact, looking at the Eurozone as a whole, we see a mixture of small gains (Germany, France, and Italy) and losses (Spain, Portugal and Austria) and a net of not much movement. In other words, it appears the press is far more excited than the investment community.

Perhaps a more interesting story has been the indication that Germany may be ready to allow more Eurozone banking integration by finally embracing allowing joint European deposit insurance. Recall that northern European nations, those that run surpluses, are loathe to bail out Italian and Spanish (and Greek and Cypriot, etc.) banks when they eventually go bust. However, it seems that Chancellor Merkel, whose power has been slipping away by the day, has decided that in order to maintain her grip she needed to do something to encourage her Social Democrat partners, and this is the latest wheeze. That said, if Germany and the rest of the north do sign off on this, it will be an unmitigated positive for the continent and, likely, for the euro. As is often the case with issues like this, there is a long way to go before an agreement is reached, but this is the first positive movement on the subject since the euro’s creation twenty years ago. In fact, success here is likely to permanently improve the euro’s value going forward.

Elsewhere in markets things have been pretty quiet. The rest of the G10 has seen modest movement with only Sweden’s krona rallying smartly, +0.45%, after the Minutes of the latest Riksbank meeting confirmed that they are working feverishly to figure out a way to exit the negative interest rate trap. At this point the market is pricing in a better than 60% probability of a rate hike at the December meeting, taking the base rate back to 0.00%. But away from that, the G10 is completely uninteresting.

In the EMG space, India’s rupee was the worst performer, falling 0.45% after weaker than expected PMI data (Services 49.2, Composite 49.6) indicated that the growth impulse in India remains absent and that further policy ease is likely from the RBI. Elsewhere, the Bank of Thailand, which has been trying to slow the baht’s steady appreciation, +8.5% in the past twelve months, cut its base rate by 25bps and relaxed some currency controls in an effort to release some pressure on the currency. However, given the economy’s ongoing relative strength, this seems unlikely to have a long term impact. In the end, the baht has declined 0.4% overnight, but hardly seems like it is getting ready to tumble.

And in truth, that’s really all that has been going on overnight. Yesterday we heard from a few more Fed speakers, Barkin, Kaplan and Kashkari, and the message remains consistent; i.e. the US economy is strong and monetary policy is appropriate, although the balance of risks still seem tilted toward the downside. In the end, Chairman Powell and his minions have done an excellent job of getting the markets to accept that there will be no further rate movement for the foreseeable future barring some catastrophic data.

Speaking of data, yesterday showed the Trade Balance shrunk to -$52.5B as imports fell sharply, and that the services sector in the US remains robust with ISM Non-manufacturing rising to 54.7. This morning we await Nonfarm Productivity (exp 0.9%) and Unit Labor Costs (2.2%), neither of which is likely to move the needle, and we hear from three more Fed speakers; Evans, Williams and Harker, none of whom are likely to deviate from the current mantra.

Overall, it has been a mixed session so far with no real direction and at this point, there is nothing obvious that is likely to change that mood. Look for a quiet one as the market seeks out its next big thing, maybe confirmation that the trade deal is going to be signed, but until then, hedgers should take advantage of the quiet market to execute.

Good luck
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A Currency Pact

The market is focused on trade
And hoping that progress is made
There’s news China’s backed
A currency pact
If tariff boosts can be delayed

Activity overnight was considerably more volatile than usual as conflicting stories regarding the US-China trade talks hit the tape. Risk was quickly jettisoned after a story from the South China Morning Post indicated that the talks, starting this morning in Washington, would be cut short. Shortly thereafter, the White House denied that report encouraging traders to buy back their stocks and sell bonds. Then Fox Business reiterated the original report less than a half hour later and the sell-off happened all over again. Finally, two positive reports helped equity markets recoup all of their overnight losses and took the shine off bonds. The first of those was that the currency pact that had been agreed between the US and China back in May (when chances of a big deal seemed realistic) was being dusted off and likely would be part of a mini-deal with the US agreeing to delay the imposition of new tariffs next Tuesday. And finally, President Trump has allowed US firms to sell non-critical technology to Huawei again, which was seen as additional thawing of the trade situation.

Of course, all this means is that we are back where we started, the trade talks are due to begin this morning and the Chinese delegation is scheduled to leave tomorrow evening. Arguably, the story that both sides are willing to agree on a currency pact as part of this round, and the indications that there are low level things that can be agreed, bode well for the rest of the week. But make no mistake, the major issues; IP theft, forced technology transfer and state subsidies are nowhere near being solved, and quite frankly, given they are integral to China’s economic model, seem unlikely ever to be solved. But for equity bulls, at least, hope springs eternal.

The FX impact in the end has been for a much softer dollar pretty much across the board. The idea is that if risk is to be embraced again, the higher yields available in Emerging Markets, as well as developed markets on a swapped basis, are the place to be. While the biggest mover overnight has been SEK, that is actually due to a surprising CPI report, with the annual pace of price increases rising to 1.5%, above the 1.3% expectation and a boon for the Riksbank who has been trying to normalize monetary policy by raising rates back to, and above, zero again. This report has given the market reason to believe that at their next meeting, in two weeks, while they won’t hike, they will continue to give guidance that a hike is coming before the end of the year. As such, SEK has rallied a solid 1.4%, although arguably, the trend is still for a weaker krone.

But the rest of the G10 has performed as well, with AUD, NZD and NOK all higher by 0.6% and the euro, despite disappointing data from both Germany and France, higher by 0.5%. Even the pound is higher this morning, up 0.35%, as the market awaits word on the outcome of a lunch meeting between Boris and Irish PM Leo Varadkar as they try to find a compromise. It seems to make the most sense that Varadkar is representing the EU given Ireland will be the nation most negatively impacted by a hard Brexit. My sense is we should start to hear about the outcome of this lunch around the time that US CPI is released, although I would read a delay as quite positive. The longer it takes; it seems the more likely that they are making headway on a compromise which would be very bullish for the pound. But until we actually see the news, the broad dollar trend is all we have.

In the EMG bloc we have also seen broad based strength paced this morning by HUF’s 0.7% rally. While much of this move is simply on the back of the euro’s rise, Hungary did have a quite successful auction of 5yr-15yr bonds which encouraged additional forint buying. Otherwise, the rest of the CE4 have moved directly in line with the euro and gains throughout Asia were only on the order of 0.2%. Of course, those markets closed before all the trade news had been released, so assuming nothing changes on that front (a difficult assumption) APAC currencies are likely to perform well tonight.

Turning to today’s session, we see our most important data of the week with CPI (exp 1.8%, 2.4% ex food & energy) as well as the usual Initial Claims data (220K). Regarding the former, Tuesday’s PPI report was surprisingly soft, with the headline number printing at -0.3% on the month and dragging the annual number down to just 1.4%. While there have been no forecast shifts amongst economists, there is still some lingering concern (hope?) amongst market participants that we could see a soft number here as well. The issue is a soft number would seem to open the door for the Fed to be far more aggressive in their rate cutting. Remember, Chairman Powell has repeated several times lately that the committee is watching the data closely and will do what they need to do in order to maintain the expansion while achieving their twin goals of stable prices and maximum employment. Obviously, with the Unemployment Rate at 3.5%, there is not much concern there. But falling inflation will ring alarm bells.

One last thing, though, regarding employment. The Initial Claims data is often a very good leading indicator of the overall employment situation, starting to rise well before the nonfarm numbers start to decline. Since the financial crisis, Initial Claims have tumbled from a peak of 665K in March 2009 to the low 200’s that we have seen for the past year. But recently, it appears that the number is beginning to creep higher again, with the 210k-215k readings that we had been seeing regularly now edging toward 220K and beyond. And while I know that seems extremely subtle, I merely caution that Initial Claims is a measure of job cuts, so if they are actually growing, that bodes ill for the economy’s future performance.

As to today, unless and until we hear more from the Trade talks or Boris, don’t look for much movement. But certainly the bias is to add risk for the day meaning the dollar should remain under pressure.

Good luck
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No Longer Afraid

This morning twixt Brexit and trade
The market’s no longer afraid
More talks are now set
Though there’s no deal yet
And Parliament’s built a blockade

Yesterday saw a risk grab after the situation in Hong Kong moved toward a positive outcome. This morning has seen a continuation of that risk rally after two more key stories moved away from the abyss. First, both the US and China have confirmed that trade talks will resume in the coming weeks, expected sometime in early October, when Vice-premier Liu He and his team visit Washington. While the current tariff schedules remain in place, and there is no certainty that either side will compromise on the outstanding issues, it is certainly better that the talks continue than that all the news is in the form of dueling tweets.

It should be no surprise that Asian equity markets rallied on the news, (Nikkei +2.1%, Shanghai +1.0%), nor that European markets are following in their footsteps (DAX +0.85%, CAC +0.9%). It should also not be surprising that Treasury yields are higher (+5bps) as are Bund yields (+5bps); that the yen and dollar have suffered (JPY -0.2%, DXY -0.25%) and that gold prices are lower (-0.7%).

Of course, the other big story is Brexit, where yesterday PM Boris Johnson suffered twin defeats in his strategy of ending the mess once and for all. Parliament passed a bill that prevents the government from leaving the EU without a deal and requires the PM to ask for a delay if no deal is agreed by mid-October. Then in a follow-up vote, they rejected the call for a snap election as Labour’s Jeremy Corbyn would not support the opportunity to become PM himself. While Boris plots his next move, the market is reducing the probability of a hard Brexit in the pound’s price thus it has rallied further this morning, +0.7%, and is now higher by more than 2% since Tuesday morning.

However, while the news on both fronts is positive right now, remember nothing is concluded and both stories are subject to reversal at any time. In other words, hedgers must remain vigilant.

Turning to the rest of the market, there have been two central bank surprises in the past twenty-four hours, both of which were more hawkish than expected. First, the Bank of Canada yesterday left rates on hold despite the market having priced in a 25bp rate cut. They pointed to still solid growth and inflation near their target levels as reason enough to dissent from the market viewpoint. The market response was an immediate 0.5% rise in the Loonie with a much slower pace of ascent since then. However, all told, CAD is stronger by a bit over 1.1% since before the meeting. If you recall, analysts were less convinced than the market that a cut was coming, but they still have one penciled in by the end of the year. Meanwhile, the market is now 50/50 they will cut in October and about 65% certain it will happen by December.

The other hawkish surprise came from Stockholm this morning, where the Riksbank left rates on hold, as expected, but reiterated their view that a hike was still appropriate this year and that they expected to get rates back to positive before too long (currently the rate is -0.25%). While analysts don’t believe they will be able to follow through on this commitment, the FX market responded immediately and SEK is today’s top performer in the G10 space, rallying 0.9%.

The only data we have seen today was a much weaker than expected Factory Orders print from Germany (-2.7%), simply reinforcing the fact that the country is heading into a recession. That said, general dollar weakness on the risk grab has the euro higher by 0.25% as I type.

In the EMG space, we continue to see traders and investors piling into positions in their ongoing hunt for yield now that overall risk sentiment has improved. In the past two sessions we have seen LATAM, in particular, outperform with BRL higher by 1.8%, MXN up 1.65% and COP up 1.35%. But it is not just LATAM, ZAR is higher by 2.0% in that time frame, and KRW is up 1.3%. In fact, if you remove ARS from the equation (which obviously has its own major problems), every other EMG currency is higher since Tuesday’s close.

On the data front, yesterday’s US Trade deficit was a touch worse than expected at -$54.0B, but still an improvement on June’s data. This morning we see a number of things including ADP Employment (exp 148K), Initial Claims (215K), Nonfarm Productivity (2.2%), Unit Labor Costs (2.4%), Durable Goods orders (2.1%, -0.4% ex transport) and finally ISM Non-manufacturing (54.0). So there’s plenty of updated information to help ascertain just how the US economy is handling the stresses of the trade war and the global slowdown. As to Fed speak, there is nobody scheduled for today although we heard from several FOMC members yesterday with a range of views; from uber-dove Bullard’s call for a 50bp cut, to Dallas’s Kaplan discussing all the reasons that a cut is not necessary right now.

Despite the data dump today, I think all eyes will be on tomorrow where we not only get the payroll report, but Chairman Powell speaks at lunchtime. As such, there is no reason, barring a White House tweet, for the current risk on view to change and so I expect the dollar will continue to soften right up until tomorrow’s data. Then it will depend on that outcome.

Good luck
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Both Driver and Bane

Though Brexit and China remain
For markets, both driver and bane
The rest of the globe
Is worth a quick probe
Since some things are clearly germane

The markets are beginning to demonstrate Brexit fatigue as each day’s anxieties are no longer reflected in price movements. Broadly, a hard Brexit is still going to be bad and result in a significant decline in the pound, and a signed deal should see the pound rally somewhat, but the political machinations are just getting annoying at this point. Yesterday’s news was the House of Commons voted to seek a delay, although there has been no definition of how long that delay should be. It seems PM May is going to bring her deal to the floor one more time to see if she can get it passed this time:

Although her rep’s suffered much harm
The PM has rung the alarm
It’s time to get real
And vote for her deal
Perhaps the third time is the charm

The threat to the Brexiteers is a long delay opens the way for a reversal of the process, so this deal is better than that outcome. Of course, as I have written before, a delay requires unanimity from the rest of the EU and given the uncertainty of what can be gained by a delay at this time, it still appears there is a real risk of a hard Brexit, despite Parliament’s vote yesterday.

The latest news is a delay
In Brexit is what’s on the way
But will that resolve
The issues involved
Don’t count on it in any way

As to the pound, yesterday it fell, today it is rallying, but in general, it is still stuck. For the past three plus weeks it has traded between 1.30 and 1.33, albeit visiting both sides several times. Let’s move on.

The China trade story continues in slow motion as hopes of a late March meeting between President’s Xi and Trump have now faded to late April. Of note overnight was a new law passed by the Chinese government that alleges to address IP theft and international investment. While that certainly appears to be in response to US concerns, the lack of an enforcement mechanism remains a significant obstacle to concluding the process. However, it does appear to be a tacit admission that IP theft has been a part of the program in the past, despite vehement protestations on the part of the Chinese. But for now, this issue is headed to the back burner and will only matter to markets again when a deal seems imminent, or the talks collapse.

So what else is happening in the world? Well, global growth remains under pressure with data around the world indicating a slowdown is essentially universal. German production, US housing, Japanese inflation, you name it and the data is weaker than expected, and weaker than targeted. What this means is that pretty much every central bank around the world, at least in the developed world, has stopped thinking about policy normalization and is back on the easy money bus.

While Chairman Powell takes the brunt of the criticism for his quick volte-face last December, we have seen it everywhere. ECB President Draghi will have spent eight years at the helm and only cut rates and added monetary stimulus, all to achieve average growth of a whopping 1.5% or so with inflation remaining well below the target of 2.0% throughout his tenure. And, as he vacates the seat, he will leave his successor with further ease ongoing (TLTRO’s) and no prospect of a rate hike for years to come. But hey, perpetual debt-fueled slow growth and negative interest rates should be great for the stock market! What could possibly go wrong?

Meanwhile, the BOJ finds itself in exactly the same place as the ECB, lackluster growth, virtually no inflation and monetary policy set at extreme ease. Last night, Kuroda-san and his friends left policy unchanged (although two BOJ members voted for further ease) and said that the 2.0% inflation target remained appropriate and they were on track to achieve it…eventually. Alas, unless anti-aging medicines are available soon, I don’t think any of us will ever see that outcome. The yen’s response was to sink slightly further, falling 0.2%, and it is trading near its weakest levels of the year. However, in the big scheme of things, it remains right in the middle of its long-term trading range. My point is that we will need a stronger catalyst than more of the same from Kuroda to change things.

Other noteworthy currency stories are the weakness in HKD, as a glut of cash pouring into the island territory has driven interest rates there down significantly and opened up a carry trade opportunity. The HKMA has already spent close to $1 billion supporting the currency at the floor of its band over the past two weeks and seems likely to spend another $5-$7 billion before markets are balanced again.

Sweden has watched its krone depreciate steadily as slowing growth has caused a change in the Riksbank’s tune. In December, it was assumed they would be raising rates and exiting NIRP given the growth trajectory, which led to some modest currency strength. However, the reality has been the growth has never appeared and now the market has priced out any rate hikes. At the same time, FX traders have all unwound those long krone positions and pushed down the SEK by more than 4% this year. While it has rallied 0.4% overnight, it remains the key underperformer in the G10 this year. in fact, there is talk that the Riksbank may need to intervene directly in FX markets if things get much worse, although given the lack of inflation, it seems to me that is excessive.

So you see, there is a world beyond Brexit! As to today’s session, we see a bit more data from the US including: Empire Manufacturing (exp 10.0); IP (0.4%); Capacity Utilization (7.4%); JOLT’s Job Openings (7.31M); and Michigan Sentiment (95.3). This is a nice array of data which can help give an overall assessment as to whether the economy is continuing to sag, or if there are some possible bright spots. But unless everything is extraordinarily strong, I imagine that it will have limited direct impact and the dollar, which has been broadly under pressure today (after a rally yesterday) will continue to slide a little. Right now, there is no strong directional view as traders await the next central bank pronouncements. With the Fed, that comes next week. Until then, look for range trading.

Good luck and good weekend
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Cause For Concern

Once more to Great Britain we turn
And so we ask, ‘what did we learn?’
May’s Deal lacks appeal
But No-Deal they feel
Is still quite a cause for concern

Where’s Howie Mandel when you need him to say, “Deal…or No Deal?”

In yet another loss for beleaguered British PM May, the House of Commons yesterday approved a bill ruling out a no-deal Brexit for the UK. Of course, the day before they defeated the only Brexit deal on the table. Like a spoiled child, they cannot figure out what they want, but they know they want something. The next step is to request an extension of the deadline, which is now just 15 days away. However, even on that subject there is no clarity. The length of that extension has been open to debate with many different answers. For the pro-Brexit crowd, those willing to see a no-deal outcome, they want as short a delay as possible. Anything beyond six months is likely to allow a second referendum, with the current polls showing that Bremain would be the winner. Naturally, those who want to remain are seeking the longest extension possible.

But it is important to remember that the other 27 members of the EU need to approve the extension unanimously, which when it comes to EU activities is certainly the exception, not the rule. For example, what if Hungary, which is currently at odds with the EU over other issues, decides to vote against an extension simply to tweak the rest of the bloc’s collective nose? My point is that an extension, while pretty likely, is hardly guaranteed. And we have already heard from a number of different EU members on the importance of a rationale for an extension. Ultimately, now that Parliament has taken control of the process from PM May, they have to decide what they want to do, not merely what they want to avoid. And thus far, that information has been lacking.

Turning to the market reaction, the pound rallied sharply yesterday, a full 2.0%, as traders and investors gained confidence that the UK would not be crashing out of the EU without a deal. Of course, given the current lack of alternatives, that remains a fraught situation. This morning, it has ceded about 0.65% of those gains between profit-taking and a dawning realization that just because they voted not to leave without a deal, that hasn’t actually solved the problem. In the end, there is much more to this process and this story, with the potential for both a bigger rally, if somehow the UK comes up with a viable solution, or a much bigger decline, if the delay doesn’t help solve the problem.

The other noteworthy news has been the postponement of a meeting between President’s Xi and Trump to sign any trade deal. While there had been recent indications that progress was being made, apparently it has not been enough progress to schedule a meeting. In the end, as I have written repeatedly, it is difficult for China to agree to not steal IP and force technology transfers when they have maintained, all along, that they don’t do that to begin with. In addition, yesterday President Trump indicated he was in “no hurry” to sign a deal, so this cloud is likely to hang over the global economy for a while yet.

As evidence of that cloud, Chinese data last night pointed to further slowing in the economy there as IP fell to a 5.3% growth rate, the slowest since 2002! While Retail Sales remained unchanged at 8.2%, auto sales continue to decline, falling -2.8% in the January-February period from year ago levels. (The Chinese statistics agency combines Jan and Feb every year to try to smooth the impact of the Chinese New Year, which typically floats in that period.) Interestingly, the combination of these two stories, trade disappointment and weak data, has led to the renminbi slipping 0.5% this morning, a pretty big move for the currency.

Away from those two stories, we continue to see signs of slowing growth around the developed world with rising Swedish Unemployment (6.6% vs. 6.3% previously) and a continued lack of inflationary pressure from both Germany (1.5%) and France (1.3%). This has helped reverse the euro’s recent modest strength with the single currency lower by 0.25% this morning.

In fact, the dollar is having a strong day virtually everywhere, with Aussie and Kiwi both falling more than 0.5% after the weak Chinese data raised concerns over their key export market. Meanwhile, even the yen is lower by 0.45%, as the economic story there continues to point to slowing growth and the possibility of yet more monetary policy ease. The problem for Kuroda-san is there are precious few things left to do. After all, he already has negative interest rates and owns 43% of the JGB market, as well as 10% of the equity market, all while maintaining a cap on the yield of the 10-year JGB. Barring explicit monetization of the debt, meaning relieving the Japanese government of the obligation to repay the debt on their balance sheet, the list is short. However, if they do go to explicit monetization, you can be sure the yen will fall sharply.

Equity markets, however, remain oblivious of all the potential problems that exist and continue to focus on a single thing, easy money. Slowing growth and weaker profitability are meaningless in the new world. The only thing that matters is free cash. My observation on this phenomenon is that it has diminishing returns. And despite ongoing efforts to prop up the economy by central banks everywhere, equity markets, while well off the lows seen in December, have not been able to take the next step higher. To my untrained eye, it appears that the top has been put in, and that lower is the most likely direction over time. But perhaps not today, where equities continue to hang in there and US futures are pointing slightly higher.

Today’s data is just Initial Claims (exp 225K) and New Home Sales (620K), neither of which is likely to have a significant impact. With no Fed speakers, the market is going to be focused on the UK, with their next vote to extend the Brexit deadline, but away from that, has no obvious catalysts. Given the dollar’s decline yesterday, and the rebound thus far today, my money is on a modest continuation of the rebound, at least for the rest of the day.

Good luck
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Quite Sublime

The markets are biding their time
Awaiting a new paradigm
On trade and on growth
While hoping that both
Instill attitudes quite sublime

The dollar has rebounded this morning as most of the news from elsewhere in the world continues to point to worsening economic activity. For example, the German ZEW survey printed at -13.4, which while marginally better than the expected -13.6, remains some 35 points below its long-term average of +22. So, while things could always be worse, there is limited indication that the German economy is rebounding from its stagnation in H2 2018. Meanwhile, Italian Industrial Orders fell to -1.8%, well below the +0.5% expectation, and highlighting the overall slowing tenor of growth in the Eurozone. As I have mentioned over the past several days, we continue to hear a stream of ECB members talking about adding stimulus as they slowly recognize that their previous views of growth had been overestimated. With all this in mind, it should be no surprise the euro is lower by 0.25% this morning, giving back all of yesterday’s gains.

At the same time, Swedish inflation data showed a clear decrease in the headline rate, from 2.2%, down to the Riksbank’s 2.0% target. This is a blow to the Riksbank as they had been laying the groundwork to raise rates later this year in an effort to end ZIRP. Alas, slowing growth and inflation have put paid to that idea for now, and the currency suffered accordingly with the krone falling 1.5% on the release, and remaining there since then. Despite very real intentions by European central bankers to normalize policy, all the indications are that the economy there is not yet ready to cooperate by demonstrating solid growth.

The last data point of note overnight was UK employment, where the Unemployment rate remained at a 40 year low of 4.0% and the number of workers grew by 167K, a better than expected outcome. In addition, average earnings continue to climb at a 3.4% pace, which remains the highest pace since 2008. Absent the Brexit debate, and based on previous comments, it is clear that the BOE would feel the need to raise rates in this situation. But the Brexit debate is ongoing and uncertainty reigns which means there will be no rate hikes anytime soon. The latest news is that Honda is closing a factory in Swindon, although they say the driving impulse is not Brexit per se, but weaker overall demand. Nonetheless, the 4500 jobs lost will be a blow to that city and to the UK overall. Meanwhile, the internal politics remain just as jumbled as ever, and the political infighting on both sides of the aisle there may just result in the hard Brexit that nobody seems to want. Basically, every MP is far more concerned about their own political future than about the good of the nation. And that short-sightedness is exactly how mistakes are made. As it happens, the strong UK data has supported the pound relative to other currencies, although it is unchanged vs. the dollar this morning.

Pivoting to the EMG bloc, the dollar is generally, but not universally higher. Part of that is because much of the dollar’s strength has been in the wake of European data well after Asian markets were closed. And part of that is because today’s stories are not really dollar focused, but rather currency specific. Where the dollar has outperformed, the movement has been modest (INR +0.2%, KRW +0.2%, ZAR +0.4%), but it has fallen against others as well (BRL -0.2%, PHP -0.2%). In the end, there is little of note ongoing here.

Turning to the news cycle, US-China trade talks are resuming in Washington this week, but the unbridled optimism that seemed to surround them last week has dissipated somewhat. This can be seen in equity markets which are flat to lower today, with US futures pointing to a -0.2% decline on the opening while European stocks are weaker by between -0.4% and -0.6% at this point in the morning. On top of that, Treasury yields are creeping down, with the 10-year now at 2.66% and 10-year Bunds at 0.10%, as there is the feeling of a modest risk-off sentiment developing.

At this point, the key market drivers seem to be on hold, and until we receive new information, I expect limited activity. So, tomorrow’s FOMC Minutes and Thursday’s ECB Minutes will both be parsed carefully to try to determine the level of concern regarding growth in the US and Europe. And of course, any news on either trade or Brexit will have an impact, although neither seems very likely today. With all that in mind, today is shaping up to be a dull affair in the FX markets, with limited reason for the dollar to extend its early morning gains, nor to give them back. There is no US data and just one speaker, Cleveland’s Loretta Mester, who while generally hawkish has backed off her aggressive stance from late last year. Given that she speaks at 9:00 this morning, it may be the highlight of the session.

Good luck
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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
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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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