Tag Archives: #tariffs

Truly Surreal

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Said Lagarde, now are options are few
To complete what you’ve asked us to do
Though growth is “resilient”
It’s clearly not brilliant
And we’ve no more tools in the queue

Meanwhile tales from China reveal
The pain they’re beginning to feel
As tariffs they cut
And more ports are shut
Life there now is truly surreal

Poor Christine Lagarde. Amidst great pomp and circumstance she is named President of the ECB, clearly a step up from Managing Director of the IMF, but finds when she finally sits down that there is precious little to do in the job. Signor Draghi created and used all the tools the institution had in his effort to carry out its mission of achieving an inflation rate of “close to, but below 2.0%”. And he failed dismally in reaching that goal. In fairness, he did save the euro from collapse in 2012 with his famous “whatever it takes” remark, and arguably that saved the ECB from complete irrelevance. (After all, if the euro broke up, what would have been the purpose of maintaining a Eurozone central bank?) But in the end, the Eurozone continues to muddle through with desultory growth and almost no inflation impulse whatsoever. And Madame Lagarde is reduced to giving speeches exhorting governments to spend more money, while an army of economics PhD’s tries to come up with some other way to make the ECB relevant.

This morning this problem was on full display as she explained, yet again, to the European Parliament that the ECB has limited scope to act given the current policy stance. Yet it seems that despite the easiest monetary policy in its history, the positive impact is still missing. This was made clear when Germany reported that Factory Orders for December fell 2.1%, taking the annual decline to -8.7%, its lowest level since the financial crisis in 2009. Fortunately for European equity investors, things like economic growth no longer matter to equity markets, but for the poor folks of Germany, the future continues to look pretty grim. The euro, which had initially edged up by 0.15% ahead of the data release on this broader optimism, has since turned tail and given up those modest gains to sit right on the 1.10 level, unchanged on the day.

The thing is, in the short run, the economic fundamentals seem to point to the dollar continuing its recent strength, although longer term, as long as the Fed continues with QE, I expect the dollar to decline. But the market technicians are looking hard at this 1.0950-1.1000 level as critical support for the single currency, with a break of 1.0950 likely to open the door to a move to, and through, October’s lows of 1.0865.

But while things in Europe may not be looking that great, fortunately the rest of the world has decided that the coronavirus is no longer a relevant issue for investors and equity markets, and thus risk appetite, worldwide continue to make new highs. Yes, the number of confirmed deaths has risen to 562 and the number of infections has grown past 28,000, but the narrative is now incorporating a possible breakthrough in a treatment and vaccine to stop this infection in its tracks. And that would be extraordinary given the usual amount of time it takes to find, and test a cure for some disease.

Meanwhile, as more and more countries restrict travel to and from China, President Xi Jinping gets angrier and angrier that they are fomenting panic. Arguably, they are trying to prevent said panic, but I’m sure that is cold comfort for the Chinese. Of more importance economically is the fact that CNOOC, one of China’s major oil companies, declared force majeure to break a contract to take in a LNG cargo. It seems that the virus has led to a situation where there aren’t enough people available to work the LNG terminals, so there is nothing they can do with the gas. Again, my view is the market is taking this outbreak less seriously than it should, but of course, my view incorporates the idea that central banks cannot prop things up forever.

But for the time being, my view remains in the minority. Equity markets around the world continue to rally sharply, especially after China announced they would be cutting tariffs in half on $75 billion worth of imports as they attempt to live up to the phase one deal. Asian markets led the way overnight (Nikkei +2.4%, Hang Seng +2.6%, Shanghai +1.7%) and European markets didn’t want to miss out with both the CAC and DAX higher by 0.7% this morning while the UK’s FTSE 100 is up 0.4%. And US futures are pointing in the same direction, each up between 0.3% and 0.4%. In fairness, we did see much better than expected data yesterday here in NY, with ADP Employment blowing out at 291K while ISM Non-Manufacturing printed a better than expected 55.5.

All this has led to a growing risk appetite in the FX markets as well as equities. Last night’s best performer was KRW, rallying 1.0% as traders and investors have taken to heart the worst of the coronavirus fears are behind us and Chinese growth should rebound and help South Korea accordingly. Away from the won, however, there has been less movement in the EMG space, with an interesting mix of gainers and losers. It appears THB is suffering from yesterday’s rate cut today, having fallen 0.4%, but despite oil’s continued rebound, the RUB is weaker today by 0.3%. On the plus side, it seems commodity exporters BRL and IDR are the other big winners, rallying 0.5% and 0.4% respectively.

In the G10, the pound is the only currency that has moved more than 0.1% today, falling 0.25%, as talk about the difficulties of the UK-EU trade negotiations continue to garner attention. Otherwise, nada.

This morning’s data brings Initial Claims (exp 215K), Nonfarm Productivity (1.6%) and Unit Labor Costs (1.3%) none of which are likely to excite, especially with tomorrow’s payroll data on the horizon. Instead, FX remains beholden to the broad risk sentiment, which implies higher yield currencies should continue to do well, while those with low rates are likely to suffer.

Good luck
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Removal of Tariffs

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According to some in Beijing
Removal of tariffs’ the thing
That ought to diminish
And fin’lly help finish
The problems the trade war did bring

Another day, another story about progress in the trade talks. Given the complete lack of movement actually seen, a cynic might conclude that both sides have realized just talking about progress is probably as effective as making progress, maybe more so. After all, making progress requires both sides to make actual decisions. Talking about progress just hints that those decisions are being made. And let’s face it; the one thing at which politicians have proven especially inept is making decisions. At any rate, the news early this morning was that part of the elusive phase one deal would be simultaneous rollbacks of the current tariff schedules. If true, that is a great leap forward from simply delaying the imposition of new tariffs. But the key is, if true. At this point, it has become difficult to recognize the difference between actual progress and trial balloons. The one thing going for this story is it was put out by the Chinese, not President Trump. Of course, that could simply be a negotiating tactic trying to force Trump’s hand.

It should be no surprise that the market reacted quite positively to the story, with equity markets in Asia turning around from early losses to close higher on the day. While the Nikkei just clawed back to +0.1%, the Hang Seng finished higher by 0.6% and Australia’s ASX 200 gained 1.0% on the day. Europe has followed the trend with the DAX leading the way, +0.75%, and the rest of the Continent showing gains of between 0.2% (CAC) and 0.6% (IBEX). And of course, US futures turned higher on the news, now showing gains of approximately 0.5% across all three.

So risk is in vogue once again. Treasuries and Bunds have both sold off sharply, with yields in the 10-year space higher by roughly 6bps in both markets. And the dollar, as would be expected, is under further pressure this morning.

A trade truce cannot come soon enough for Germany, which once again released worse than expected data. This morning’s miss was IP, which fell 0.6% in September, and is down 4.3% Y/Y. So while yesterday’s Factory Orders seemed positive, they also seem like the outlier, not the trend. However, given the dollar’s overall performance this morning, it should be no surprise that the euro has edged higher, rising 0.1% as I type. But a step back for some perspective shows that the euro has actually done essentially nothing for the past month, trading within a range barely exceeding 1.0%. It will take more than just the occasional positive or negative economic print to change this story.

And perhaps there is a story brewing that will do just that. Several weeks ago there was a Bloomberg article about inflation in the Eurozone, specifically in Spain, that highlighted the dichotomy between the low rate of measured inflation, which in Spain is running at 1.0%, and the fact that the cost of home ownership and rent is rising at a double digit pace. It turns out that the European CPI measurements have rent as just 6.5% of the index and don’t even include the costs of home ownership. In contrast, those represent more than 30% of the US CPI measurement! And housing costs throughout Europe are rising at a much faster rate, something on the order of 3.0%+ over the past five years. In other words, a CPI basket constructed to include what Europeans actually spend their money on, rather than on some theoretical construct, would almost certainly have resulted in higher CPI readings and potentially would have prevented the poisonous negative interest rate conundrum.

With this in mind, and considering Madame Lagarde’s review of ECB policy, there is a chance, albeit a small one, that the ECB will consider changing the metric, and with a change in the metric, the need for further QE and NIRP will diminish greatly. That would be hugely euro positive! This is something to watch for going forward.

The other big news that just hit the tape was from the Bank of England, where while rates were left unchanged, two members of the MPC voted to cut rates by 25bps in a complete surprise. Apparently, there is growing concern inside the Old Lady that the recent weakening data portends further problems regardless of the election outcome. Of course, regarding the election, the fact that both the Tories and Labour are promising huge new spending plans, the need for low rates is clear. After all, it is much easier to borrow if interest rates are 0.5% than 5.0%! The pound, which had been trading modestly higher before the news quickly fell 0.4% and is now back toward the lower end of its recent trading range. Sometimes I think central banks do things simply to prove that they matter to the markets, but in this case, given the ongoing economic malaise in the UK, it does seem likely that a rate cut is in the offing.

As to the rest of the market, some of the biggest gainers this morning are directly related to the US-China trade story, with the offshore renminbi trading higher by 0.6% and back to its strongest level in three months’ time. In addition we have seen NOK rally 0.85%, which seems to be on the back of stronger oil and the fact that easing trade tensions are likely to further support the price of crude. Combining this with the fact that the krone has been mysteriously weak given its fundamentals, relatively strong economic growth and positive interest rates, it looks like a lot of short positions are getting squeezed out.

Finally, I would be remiss if I didn’t mention the Brazilian real, which yesterday tumbled 2.0% after a widely anticipated auction of off-shore oil drilling rights turned into a flop, raising just $17 billion, far less than the $26 billion expected. In fact, two of the three parcels had no bids, and no oil majors were involved. While they will certainly put them up for auction again, the market’s disappointment was clear. It should also be no surprise that the real is rebounding a bit on the open, currently higher by 0.5%.

On the data front this morning the only thing of note is Initial Claims (exp 215K) and there are two more Fed speakers on the agenda, Kaplan and Bostic. However, the plethora of speakers we have heard this week have all remained on message, things are good and policy is appropriate, but if needed we will do more.

And that’s really it. I expect we will continue to hear more about the trade talks and perhaps get a bit more clarity on the proposed tariff rollbacks. But it will take a lot to turn the risk story around, and as such, I expect the dollar will continue to be under pressure as the session progresses.

Good luck
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Shocked and Surprised

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Delivering just twenty-five
Did not satisfy Donald’s drive
To boost US growth
So he made an oath
That tariffs he’d quickly revive

Investors were shocked and surprised
As trade talks had seemed civilized
Thus stocks quickly fell
And yields did as well
Seems risk assets are now despised

Just when you thought it was safe to go back in the water…

Obviously, the big news yesterday was President Trump’s decision to impose a 10% tariff on the remaining $300 billion of Chinese imports starting September 1st. Arguably, this was driven by two things; first was the fact that he has been increasingly frustrated with the Chinese slow-walking the trade discussions and wants to push that along faster. Second is he realizes that if he escalates the trade threats, the Fed may be forced to cut rates further and more quickly. After all, one of their stated reasons for cutting rates Wednesday was the uncertainty over global growth and trade. That situation just got more uncertain. So in President Trump’s calculation, he addresses two key issues with one action.

Not surprisingly, given the shocking nature of the move, something that not a single analyst had been forecasting, there was a significant market reaction. Risk was quickly jettisoned as US equity markets turned around and fell 1% on the day after having been higher by a similar amount in the morning. Asian equity markets saw falls of between 1.5% and 2.0% and Europe is being hit even harder, with a number of markets (DAX, CAC) down more than 2.5%. But even more impressive was the decline in Treasury yields, which saw a 12bp fall in the 10-year and a 14bp fall in the 2-year. Those are the largest single day declines since May 2018, and the 10-year is now at its lowest level since October 2016. Of course, it wasn’t just Treasuries that rallied. Bund yields fell to a new record low of -0.498%, and we have seen similar declines throughout the developed markets. For example, Swiss 10-year yields are now -0.90%, having fallen 9bps and are the lowest in the world by far! In fact, the entire Swiss government yield curve is negative!

And in the FX market, haven number one, JPY rallied sharply. After weakening early in the session, it rebounded 1.7% yesterday and is stronger by a further 0.5% this morning. This has taken the yen back to its strongest level since April last year. Not surprisingly the Swiss franc saw similar price action and is now more than 1.0% stronger than yesterday. However, those are not the only currencies that saw movement, not by a long shot. For example, CNY has fallen 0.9% since the announcement and is now within spitting distance of the key 7.00 level. Significant concern remains in the market about that level as the last time the renminbi was that weak, it led to significant capital outflows and forced the PBOC to adjust policy and impose restrictions. However, there are many analysts who believe it is seen as less of a concern right now, and of course, a weaker renminbi will help offset the impact of US tariffs.

Commodity prices were also jolted, with oil tumbling 7% and oil related currencies feeling the brunt of that move. For example, RUB is lower by 1.2% this morning after a 0.5% fall yesterday. MXN is lower by a further 0.3% this morning after a 0.6% decline yesterday and even NOK, despite its G10 status, is lower by 1.0% since the tariff story hit the tape. In fact, looking at the broad dollar, it is actually little changed as there has been significant movement in both directions as traders and investors adjust their risk profiles.

With that as a prelude, we get one more key piece of data this morning, the payroll report. Current expectations are as follows:

Nonfarm Payrolls 164K
Private Payrolls 160K
Manufacturing Payrolls 5K
Unemployment Rate 3.6%
Average Hourly Earnings 0.2% (3.1% Y/Y)
Average Weekly Hours 34.4
Trade Balance -$54.6B
Michigan Sentiment 90.3

You can see the bind in which the Fed finds itself. The employment situation remains quite robust, with the Unemployment Rate expected to tick back to 50-year lows and steady growth in employment. This is hardly a classic set of statistics to drive a rate cut. But with the escalation of the trade situation, something they specifically highlighted on Wednesday, they are going to need to address that or lose even more credibility (although it’s not clear how much they have left to lose!) In a funny way, I would wager that Chairman Powell is secretly rooting for a weak number this morning which would allow further justification for rate cuts and correspondingly allow him to save some face.

In the end, the key to remember is that markets are beholden to many different forces with the data merely one of those, and increasingly a less and less important one. While historically, the US has generally allowed most market activity without interference, there has clearly been a change of heart since President Trump’s election. His increased focus on both the stock market and the dollar are something new, and we still don’t know the extent of the impact this will have over time. While volatility overall has been relatively low, it appears that is set to change with this increased focus. Hedgers keep that in mind as programs are implemented. All of this untested monetary policy is almost certainly building up problems for the future, and those problems will not be easily addressed by the central banks. So, my sense is that we could see a lot more volatility ahead.

In the meantime, today has the sense of a ‘bad news is good’ for stocks and vice versa as equity investors will be looking for confirmation that more rate cuts are on the way. As to the dollar, bad news will be bad!

Good luck and good weekend
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Stopped at the Border

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On Friday the President tweeted
Unless immigration, unneeded,
Is stopped at the border
I will give the order
To raise tariffs til it’s defeated

Friday’s big market news was President Trump’s threat of new tariffs, this time on Mexico, if they don’t address the illegal immigration issue domestically. This is a novel approach to a non-economic problem, but given the President’s embrace of the tariff process, perhaps it is not that surprising. The impact across markets, however, was substantial, with equities suffering while haven assets, notably Treasuries and Bunds, both rallied sharply. In fact, those moves have continued through the overnight session and we now see the 10-year US Treasury yielding just 2.10%, its lowest since September 2017, while 10-year Bunds are yielding a record low -0.21%! In other words, fear is rife that the future is going to be less amenable to investors than the recent past.

Meanwhile, equity markets have also suffered with Friday’s global sell-off continuing this morning in Europe after a mostly negative day in Asia. As to the dollar, it has been a bit more mixed, falling sharply against the yen (JPY +1.1% Friday, flat today), rising sharply against emerging market currencies (MXN -2.5% Friday, -0.3% today), but actually sliding slightly vs. its other G10 counterparts.

It is instructive to consider why the dollar is not maintaining its full status as a haven. Ultimately, the reason is that expectations for aggressive rate cuts by the Fed are becoming the default market expectation. This compares to a much less aggressive adjustment by other central banks, and so the relative forecasts point to a narrowing interest rate differential. Consider that the futures market has now priced in three rate cuts by Q1 2020 in Fed funds. Six months ago, they were pricing in three rate hikes! That is a huge sentiment change, and yet the dollar is actually stronger today than it was at the beginning of the year by about 2%. The point is that while recent economic estimates in the US continue to be downgraded, estimates for the rest of the world are being downgraded equally. In fact, there is substantially greater concern that China’s GDP growth could slow far more than that of the US adding to knock-on effects elsewhere in the world.

One of the things I have consistently maintained is that a slowdown in the US will not happen in isolation, and if the US is slowing, so will be the rest of the world. This means there is virtually no probability that the Fed will cut rates without essentially every other country easing policy as well, and that all important (at least for FX traders) interest rate differential is not likely to shrink nearly as much as reflected by simply looking at the Fed’s activities. A perfect example is Australia, where tomorrow’s RBA meeting is expected to see a 25bp rate cut, with the market pricing between two and three more during the next several quarters. Aussie has been suffering lately and is likely to continue to do so going forward, especially as pressure remains on China’s economy.

The Fed’s done a year-long review
Of policies they might turn to
They’re hoping to find
A new frame of mind
In order to reach a breakthrough

The other story about which you will hear a great deal this week is the gathering at the Chicago Fed of the FOMC and academics as they try to find a better way to effect policy. The positive aspect of this process is that they recognize they are not really doing a very good job. The negative aspect is that they continue to believe inflation remains too low and are extremely frustrated by their impotence to change the situation. We have already heard a number of the ideas; ranging from choosing a higher inflation target to allowing inflation to run hot (if it ever gets there based on their measurements). Alas, there seems little chance that the fundamental issue, the fact that their models are no longer reasonable representations of the real world, will be addressed. To a (wo)man, they all continue to strongly believe in a Keynesian world where more stimulus equals more economic activity. I would contend that, not dissimilar to the differences between Newtonian physics and particle physics, interest rates at the zero bound (and below) no longer have the same impact as they do at higher levels. And it is this failure by all central bankers to recognize the non-linearity of results which will prevent a viable solution from being found until a crisis materializes. And even then I’m not optimistic.

Turning to this weeks’ data dump, there is a ton of stuff coming, culminating in Friday’s NFP report:

Today ISM Manufacturing 53.0
  ISM Prices Paid 52.0
  Construction Spending 0.4%
Tuesday Factory Orders -0.9%
Wednesday ADP Employment 185K
  ISM Non-Manufacturing 55.5
  Fed’s Beige Book  
Thursday Initial Claims 215K
  Trade Balance -$50.7B
  Nonfarm Productivity 3.5%
  Unit Labor Costs -0.8%
Friday Nonfarm Payrolls 183K
  Private Payrolls 175K
  Manufacturing Payrolls 4k
  Unemployment Rate 3.6%
  Average Hourly Earnings 0.3% (3.2% Y/Y)
  Average Weekly Hours 34.5

There are also eleven Fed speakers including Chairman Powell on Tuesday morning as well as the aforementioned Fed conclave regarding new policy tools. In other words, there is plenty available to move markets this week. And that doesn’t even take into consideration the ongoing trade situation, where fears are extremely high, but both China and Mexico have said they want to sit down and discuss things again.

At this point, given how much new information will be added to the mix, it is impossible to say how markets will perform. However, with that in mind, we will need to see some extraordinarily weak US data to change the idea that the US is still the ‘cleanest dirty shirt in the laundry’, to use a terrible metaphor. As well, do not be surprised to see Mexico, at least, agree to implement new policies to address the immigration issue and reduce pressure on the peso. In the end, I continue to look for the dollar to maintain its overall strength, but a modest drift lower against G10 counterparts is well within reason.

Good luck
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Caused by the Other

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With tariffs now firmly in place
The market’s been keen to embrace
The idea that Xi
And Trump will agree
To terms when they meet face-to-face

But rhetoric lately has shown
That both Trump and Xi will condone
A slowdown in trade
That both men portrayed
As caused by the other, alone

Risk is, once again, in tatters as the fallout from the US increase in tariffs starts to feed through the market. As of midnight last Thursday, US tariffs on $200 billion of goods rose to 25%. This morning, a list of the other $325 billion of goods that may be subject to tariffs will be published with a target date of 30-days before imposition. Meanwhile, China continues to try to figure out how best to respond. Their problem, in this scenario, is they don’t import that much stuff from the US, and so trying to determine what is an ‘equal’ offset is complicated. However, I am confident that within the next day or two, they will publish their response. Markets around the world have felt the fallout, with equity prices everywhere under pressure, EMG currencies, especially, feeling the heat, and Treasury bonds and German bunds remaining in vogue.

As of now, it appears the situation is unlikely to improve in the short-term. The US remains miffed that the Chinese seemingly reneged on previously agreed terms. Meanwhile, the Chinese are adamant that they will not kowtow to the US and be forced to legislate the agreed changes, instead insisting that administrative guidance is all that is needed to insure compliance with any terms. They deem this desire for a legislated outcome as impinging on their sovereignty. Once again, the issue falls back to the idea that while the US consistently accused the Chinese of IP theft and forced technology transfer, the Chinese don’t see it that way, and as such, don’t believe they need to change laws that don’t exist. Whatever the merits of either sides views, the end result is that it seems far less clear that a trade deal between the two is going to be signed anytime soon.

The markets question is just how much of this year’s global equity market rally has been driven by the assumption that trade issues would disappear and how much was based on a response to easier central bank policies. The risk for markets is not only that growth is negatively impacted, but that inflation starts to rise due to the tariffs. This would put the central banks in a tough spot, trying to determine which problem to address first. Famously, in 1979, when Paul Volcker was appointed Fed Chairman, he immediately took on inflation, raising short term interest rates significantly to slay that demon, but taking the US (and global) economy into recession as a result. It strikes me that today’s crop of central bank heads does not have the wherewithal to attack that problem in the same manner as Volcker. Rather, the much easier, and politically expedient, response will be to try to revive the economy while allowing inflation to run hot. This is especially the case since we continue to see serious discussions as to whether inflation is ‘dead’. FWIW, inflation is not dead!

At any rate, for now, the trade story is going to be the key story in every market, and the upshot is that the odds of any central bank turning more hawkish have diminished even further.

Looking at overnight activity, there was virtually no data to absorb with just Norwegian GDP growth printing slightly softer than expected, although not enough to change views that the Norgesbank is going to be raising rates next month. Broadly speaking, the dollar is quite firm, with the biggest loser being the Chinese yuan, down 0.9%, and that movement dragging down AUD (-0.45%) as a G10 proxy. But while other G10 currencies have seen more limited movement, the EMG bloc is really under pressure. For instance, MXN has fallen 0.6%, INR 0.75%, RUB, 0.5% and KRW 1.2%. All of this is trade related and is likely just the beginning of the fallout. Once China publishes its list of retaliatory efforts, I would expect further weakness in this space.

Equity markets are suffering everywhere, with Shanghai (-1.2%) and the Nikkei (-0.7%) starting the process, the DAX (-0.8%) and CAC (-0.6%) following in their footsteps and US futures pointing lower as well (both Dow and S&P futures -1.3%). Treasury yields have fallen to 2.43% and are now flat with 3-month Treasury bill rates, reigniting concerns over future US growth, and commodity prices are feeling the strain as well on overall growth concerns.

Turning to the data this week, there is a modicum of news, with Retail Sales likely to be seen as the most important:

Tuesday NFIB Business Optimism 102.3
Wednesday Retail Sales 0.2%
  -ex autos 0.7%
  Capacity Utilization 78.7%
  IP 0.1%
  Empire State Mfg 8.5
Thursday Initial Claims 220K
  Housing Starts 1.205M
  Building Permits 1.29M
  Philly Fed 9.0
Friday Michigan Sentiment 97.5

We also see the housing story and hear from another five Fed speakers across seven speeches this week. However, as we learned last week, pretty much the entire Fed is comfortable with their patient stance in the belief that growth is solid and inflation will eventually head to their target of 2.0%.

Add it all up and there is no reason to believe that the trends from last week will change, namely further pressure on equity markets and commodities, with the dollar and Treasuries the beneficiaries.

Good luck
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Things Changed

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The reason the stock market fell-a
Is Goldi (locks) turned to Cinderella
At Midnight things changed
as tariffs arranged
By Trump, forced stock owners to sell-a

Please forgive my poetic license, but it is, after all, just a poem!

Waiting to See

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At midnight the US imposed
The tariffs that Trump had disclosed
We’re waiting to see
How President Xi
Responds, or if China’s now hosed

It’s all about the tariffs this morning as the US increased the tariff rate on $200 billion of Chinese imports to 25% as of midnight last night. China has promised to retaliate but has not yet announced what they will do. One of the problems they have is they don’t import that much stuff from the US, so they cannot match it exactly. There was an unintentionally humorous article in Bloomberg this morning that tried to outline the ‘powerful’ tools China has to respond; namely selling US Treasuries, allowing the CNY to weaken further, or stop buying US soybeans. The humor stemmed from the fact that they basically destroyed their own arguments on the first two, leaving just the soybean restriction as potentially viable and even that is problematic.

Consider the Treasury sales first. As the Chinese own ~$1.1 trillion, if they sold a significant chunk, they would almost certainly drive US yields higher as Treasury prices fell. But two problems with this are; they would undermine the value of whatever bonds they retained and more problematically, what else would they do with the dollars? After all, the Treasury market is pretty much the only one that is large enough to handle that type of volume on a low risk basis. I guess they could convert the dollars to euros and buy Italian BTP’s (there are a lot of those outstanding) but their risk profile would get significantly worse. And of course, selling all those dollars would certainly weaken the dollar, which would not help the Chinese economy one bit.

On the flip side, allowing the renminbi to weaken sharply presents an entirely different problem, the fact that the Chinese are terrified that they would lose control of the capital flow situation if it weakened too far. Remember in 2015, when the Chinese created a mini-devaluation of just 1.5%, it triggered a massive outflow as USDCNY approached 7.00. The Chinese people have no interest in holding their assets in a sharply depreciating currency, and so were quick to sell as much as they could. The resultant capital flows cost China $1 trillion in FX reserves to prevent further weakness in the currency. Given we are only 2% below that level in the dollar right now, it seems to me the Chinese will either need to accept massive outflows and a destabilizing weakening in the renminbi, or more likely, look for another response.

The final thought was to further restrict soybean imports from the US. While the Chinese can certainly stop that trade instantly, the problems here are twofold. First, they need to find replacement supplies, as they need the soybeans regardless of where they are sourced, and second, given the Swine virus that has decimated the pig herds in China, they need to find more sources of protein for their people, not fewer. So, no pork and less soybeans is not a winning combination for Xi. The point is, while US consumers will likely feel the pressure from increased tariff rates via higher prices, the Chinese don’t have many easy responses.

And let’s talk about US prices for a moment. Shouldn’t the Fed be ecstatic to see something driving prices higher? After all, they have been castigating themselves for ‘too low’ inflation for the past seven years. They should be cheering on the President at this stage! But seriously, yesterday’s PPI data was released softer than expected (2.2%, 2.4% core) and as much as both Fed speakers and analysts try to convince us that recently declining measured inflation is transitory, the market continues to price rate cuts into the futures curve. This morning brings the CPI data (exp 2.1%, 2.1% core) but based on data we have seen consistently from around the world, aside from the oil price rally, there is scant evidence that inflation is rising. The only true exceptions are Norway, where the oil driven economy is benefitting greatly from higher oil prices, and the disasters of Argentina and Turkey, both of which have tipped into classic demand-pull inflation, where too much money is chasing too few goods.

Turning to market performance, last night saw the Shanghai Composite rally 3.1% after the imposition of tariffs, which is an odd response until you understand that the government aggressively bought stocks to prevent a further decline. The rest of Asia was mixed with the Nikkei lower by a bit and the KOSPI higher by a bit. European shares are modestly higher this morning, on average about 0.5%, in what appears to be a ‘bad news is good’ scenario. After all, French IP fell more than expected (-0.9%) and Italian IP fell more than expected (-1.4%). Yes, German Trade data was solid, but there is still scant evidence that the Eurozone is pulling out of its recent malaise so weaker data encourages traders to believe further policy ease is coming.

In the FX market, there has been relatively little movement in any currency. The euro continues to trade either side of 1.12, the pound either side of 1.30 and the yen either side of 110.00. It is very difficult to get excited about the FX market given there is every indication that the big central banks are well ensconced in their current policy mix with no changes on the horizon. That means that both the Fed and the ECB are on hold (although we will be finding out about those TLTRO’s soon) while both the BOJ and PBOC continue to ease policy. In the end, it turns out the increased tariffs were not that much of a shock to the system, although if the US imposes tariffs on the rest of Chinese imports, I expect that would be a different story.

This morning we hear from Brainerd, Bostic and Williams, although at this point, patience in policy remains the story. The inflation data mentioned above is the only data we get (although Canadian employment data is released for those of you with exposures there), and while US equity futures are tilted slightly lower at this time, it feels like the market is going to remain in the doldrums through the weekend. That is, of course, unless there is a shocking outturn from the CPI data. Or a trade deal, but that seems pretty remote right now.

Good luck and good weekend
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So Ended the Equity Slump

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There once was a president, Trump
Who sought a great stock market jump
He reached out to Xi
Who seemed to agree
So ended the equity slump

The story of a single phone call between Presidents Trump and Xi was all it took to change global investor sentiment. Last evening it was reported that Trump and Xi spoke at length over the phone, discussing the trade situation and North Korea. According to the Trump, things went very well, so much so that he requested several cabinet departments to start putting together a draft trade agreement with the idea that something could be signed at the G20 meeting later this month in Buenos Aires. (As an aside, if something is agreed there it will be the first time something useful ever came out of a G20 meeting!) The market response was swift and sure; buy everything. Equity markets exploded in Asia, with Shanghai rallying 2.7% and the Hang Seng up over 4%. In Europe the rally is not quite as robust, but still a bit more than 1% on average across the board, and US futures are pointing higher as well, with both S&P and Dow futures higher by just under 1% as I type.

I guess this answers the question about what was driving the malaise in equity markets seen throughout October. Apparently it was all about trade. And yet, there are still many other things that might be of concern. For example, amid a slowdown in global growth, which has become more evident every day, we continue to see increases in debt outstanding. So more leverage driving less growth is a major long-term concern. In addition, the rise of populist leadership throughout the world is another concern as historically, populists don’t make the best long-term economic decisions, rather they are focused on the here and now. Just take a look at Venezuela if you want to get an idea of what the end game may look like. My point is that while a resolution of the US-China trade dispute would be an unalloyed positive, it is not the only thing that matters when it comes to the global economy and the value of currencies.

Speaking of currencies lets take a look at just how well they have performed vs. the dollar in the past twenty-four hours. Starting with the euro, since the market close on October 31, it has rallied 1.2% despite the fact that the data released in the interim has all been weaker than expected. Today’s Manufacturing PMI data showed that Germany and France both slowed more than expected while Italy actually contracted. And yet the euro is higher by 0.45% this morning. It strikes me that Signor Draghi will have an increasingly difficult time describing the risks to the Eurozone economy as “balanced” if the data continues to print like today’s PMI data. I would argue the risks are clearly to the downside. But none of that was enough to stop the euro bulls.

Meanwhile, the pound has rallied more than 2% over the same timeline, although here the story is quite clear. As hopes for a Brexit deal increase, the pound will continue to outperform its G10 brethren, and there was nothing today to offset those hopes.

Highlighting the breadth of the sentiment change, AUD is higher by more than 2.5% since the close on Halloween as a combination of rebounding base metal prices and the trade story have been more than sufficient to get the bulls running. If the US and China do bury the hatchet on trade, then Australia may well be the country set to benefit most. Reduced trade tensions should help the Chinese economy find its footing again and given Australia’s economy is so dependent on exports to China, it stands to reason that Australia will see a positive response as well.

But the story is far more than a G10 story, EMG currencies have exploded higher as well. CNY, for example is higher by 0.85% this morning and more than 1.6% in the new month. Certainly discussion of breeching 7.00 has been set to the back burner for now, although I continue to believe it will be the eventual outcome. We’ve also seen impressive response in Mexico, where the peso has rallied 1.2% overnight and more than 2% this month. And this is despite AMLO’s decision to cancel the biggest infrastructure project in the country, the new Mexico City airport.

Other big EMG winners overnight include INR (+1.3%), KRW (+1.1%), IDR (+1.1%), TRY (+0.8%) and ZAR (+0.5%). The point is that the dollar is under universal pressure this morning as we await today’s payroll report. Now arguably, this pressure is simply a partial retracement of what has been very steady dollar strength that we’ve seen over the past several months.

Turning to the data, here are current expectations for today:

Nonfarm Payrolls 190K
Private Payrolls 183K
Manufacturing Payrolls 15K
Unemployment Rate 3.7%
Average Hourly Earnings (AHE) 0.2% (3.1% Y/Y)
Average Weekly Hours 34.5
Trade Balance -$53.6B
Factory Orders 0.5%

I continue to expect that the AHE number is the one that will gain the most scrutiny, as it will be seen as the best indicator of the ongoing inflation debate. A strong print there could easily derail the equity rally as traders increase expectations that the Fed will tighten even faster, or at least for a longer time. But absent that type of result, I expect that the market’s euphoria is pretty clear today, so further USD weakness will accompany equity strength and bond market declines.

Good luck and good weekend
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More Trouble is Brewing

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The PMI data last night
From China highlighted their plight
More trouble is brewing
While Xi keeps pursuing
The policies to get things right

Any questions about whether the trade conflict between the US and China was having an impact on the Chinese economy were answered last night when the latest PMI readings were released. The Manufacturing PMI fell to 50.2, it’s lowest level in more than two years and barely above the expansion/contraction level of 50.0. Even more disconcertingly for the Chinese, a number of the sub-indices notably export sales and employment, fell further below that 50.0 level (to 46.9 and 48.1 respectively), pointing to a limited probability of a rebound any time soon. At the same time, the Services PMI was also released lower than expected, falling to 53.9, its lowest level since last summer. Here, too, export orders and employment numbers fell (to 47.8 and 48.9 respectively), indicating that the economic weakness is quite broad based.

Summing up, it seems safe to say that growth in China continues to slow. One question I have is how is it possible that when the Chinese release their GDP estimates, the quarter-to-quarter movement is restricted to 0.1% increments? After all, elsewhere in the world, despite much lower headline numbers (remember China is allegedly growing at 6.5% while Europe is growing at 2.0% and the US at 3.5%), the month-to-month variability is much greater. Simple probability would anticipate that the variance in China’s data would be higher than in the rest of the world. My point is that, as in most things to do with China, we don’t really know what is happening there other than what they tell us and that is like relying on a pharmaceutical salesman to prescribe your medicine. There are several independent attempts ongoing to get a more accurate reading of GDP growth in China, with measures of electricity utilization or copper imports seen as key data that is difficult to manipulate, but they all remain incomplete. And it seems highly unlikely that President Xi, who has been focused on improving the economic lot of his country, will ever admit that the growth figures are being manipulated. But I remain skeptical of pretty much all the data that they provide.

At any rate, the impact on the renminbi continues to be modestly negative, with the dollar touching another new high for the move, just below 6.9800, in the overnight session. This very gradual weakening trend seems to be the PBOC’s plan for now, perhaps in order to make a move through 7.00 appear less frightening if it happens very slowly. I expect that it will continue for the foreseeable future especially as long as the Fed remains on track to tighten policy further while the PBOC searches for more ways to ease policy without actually cutting interest rates. Look for another reserve requirement ratio cut before the end of the year as well as a 7 handle on USDCNY.

Turning to the euro, data this morning showed that Signor Draghi has a bit of a challenge ahead of him. Eurozone inflation rose to 2.2% with the core reading rising to 1.1%, both slightly firmer than expected. The difference continues to be driven by energy prices, but the concern comes from the fact that GDP growth in the Eurozone slowed more than expected last quarter. Facing a situation where growth is slowing and inflation rising is every central banker’s nightmare scenario, as the traditional remedies for each are exactly opposite policies. And while the fluctuations are hardly the stuff of a disaster, the implication is that Europe may be reaching its growth potential at a time when interest rates remain negative and QE is still extant. The risk is that the removal of those policies will drive the Eurozone back into a much slower growth scenario, if not a recession, while inflation continues to creep higher. It is data of this nature, as well as the ongoing political dramas, that inform my views that the ECB will maintain easier policy for far longer than the market currently believes. And this is why I remain bearish on the euro.

Yesterday the pound managed to trade to its lowest level since the post-Brexit vote period, but it has bounced a bit this morning, +0.35%. That said, the trend remains lower for the pound. We are now exactly five months away from Brexit and there is still no resolution for the Irish border issue. Every day that passes increases the risk that there will be no deal, which will certainly have a decidedly negative impact on the UK economy and the pound by extension. Remember, too, that even if the negotiators agree a deal, it still must be ratified by 28 separate parliaments, which will be no easy task in the space of a few months. As long as this is the trajectory, the risk of a sharp decline in the pound remains quite real. Hedgers take note.

Elsewhere, the BOJ met last night and left policy unchanged as they remain no closer to achieving their 2.0% inflation goal today than they were five years ago when they started this process. However, the market has become quite accustomed to the process and as such, the yen is unchanged this morning. At this time, yen movement will be dictated by the interplay between risk scenarios and the Fed’s rate hike trajectory. Yen remains a haven asset, and in periods of extreme market stress is likely to perform well, but at the same time, as the interest rate differential increasingly favors the dollar, yen strength is likely to be moderated. In other words, it is hard to make a case for a large move in either direction in the near term.

Away from those three currencies, the dollar appears generally firmer, but movement has not been large. Turning to the data front, yesterday’s releases showed that home prices continue to ebb slightly in the US while Consumer Confidence remains high. This morning brings the first inklings of the employment situation with the ADP report (exp 189K) and then Chicago PMI (60.0) coming at 9:45. Equity futures are pointing higher as the market looks to build on yesterday’s modest rally. All the talk remains about how October has been the worst month in equity markets all year, but in the broad scheme of things, I would contend that, at least in the US, prices remain elevated compared to traditional valuation benchmarks like P/E ratios. At any rate, it seems unlikely that either of today’s data points will drive much FX activity, meaning that the big trend of a higher dollar is likely to dominate, albeit in a gradual fashion.

Good luck
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A Narrative Challenge

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From Europe, the data released
Showed growth there has clearly decreased
For Draghi this poses
(What everyone knows is)
A narrative challenge, at least

Once upon a time there was a group of nations that came together in an effort to reap the theoretical benefits of closely adhering to the same types of economic policies. They believed that by linking together, they would create a much larger ‘domestic’ market, and therefore would be able to compete more effectively on the global stage. They even threw away their own currencies and created a single currency on which to depend. Under the guidance of their largest and most successful member, this currency was managed by a completely independent central bank, so they could never be accused of printing money recklessly. And after a few initial hiccups, this group generally thrived.

But then one day, clouds arose on the horizon, where from across the great ocean, a storm (now known as the Great financial crisis) blew in from the west. At first it appeared that this group of nations would weather the storm pretty well. But quickly these nations found out that their own banks had substantial exposure to the key problem that precipitated the storm, real estate investment in the US. Suddenly they were dragged into the maelstrom and their economies all weakened dramatically. The after effects of this included questions about whether a number of these countries would be able to continue to repay their outstanding debt. This precipitated the next crisis, where the weakest members of the club, the PIIGS, all saw their financing costs skyrocket as investors no longer wanted to accept the risk of repayment. This had the added detriment of weakening those nations’ banks further, as they had allocated a significant portion of their own balance sheets to buying home country debt. (The very debt investors were loath to own because of the repayment risks.)

Just when things reached their nadir, and the very weakest piggy looked like it was about to leave the group, a knight in shining armor rode to the rescue, promising to do “whatever it takes” to prevent the system from collapsing and the currency from breaking up. Being a knight in good standing, he lived up to those words and used every monetary policy trick known to mankind in order to save the day. These included cutting interest rates not just to zero, but below; force-feeding interest-free loans to the banks so that that they could on lend that money to companies throughout the group; and finally buying up as much sovereign, and then corporate, debt as they could, regardless of the price.

Time passed (five years) and that shining knight was still doing all those same things which helped avoid the worst possible outcomes, but didn’t really get the group’s economy growing as much as hoped. In fact, it seems that last year was the best it was going to get, where growth reached 2.5%. But now there are new storm clouds brewing, both from the West as well as from within, and the growth narrative has changed. And it appears this new narrative may not have a happy ending.

Data released this morning showed that GDP growth in Italy was nil, matching Germany’s performance, and helping to drag Eurozone growth down to 0.2% for Q3, half the expected rate. French growth, while weaker than expected at 0.4%, was at least positive. In addition, a series of confidence and sentiment indicators all demonstrated weakness describing a situation where not only has the recent performance been slipping, but expectations for the future are weakening as well. It can be no surprise that the euro has slipped further on the news, down 0.2% this morning and continuing its recent trend. During the month of October, the single currency has fallen more than 2.2%, and quite frankly, there doesn’t appear to be any reason in the short run for that to change.

What may change, though, is Signor Draghi’s tune if Eurozone growth data continues to weaken. It will be increasingly difficult for Draghi to justify ending QE and eventually raising rates if the economy is truly slowing. Right now, most analysts are saying this is a temporary thing, and that growth will rebound in Q4, but with the ongoing trade fight between the US and China weakening the Chinese economy, as well as the Fed continuing to raise interest rates and reduce dollar liquidity in global markets, it is quite realistic to believe that there will be no reprieve. And none of that includes the still fragile Italian budget situation as well as the potential for a ‘hard’ Brexit, both of which are likely to negatively impact the euro. And don’t get me started about German politics and how the end of the Merkel era could be an even bigger problem.

The point is, there is still no good reason to believe the dollar’s rally has ended. Speaking of Brexit, the pound is under pressure this morning, down -0.35%, as the market absorbs the most recent UK budget, where austerity has ended while growth is slowing. Of course, everything in the UK is still subject to change depending on the Brexit outcome, but as yet, there has been no breakthrough on the Irish border issue.

As to the rest of the G10, Aussie and Kiwi both benefitted from a bounce in the Chinese stock market, at least that’s what people are talking about. However, it makes little sense to me that a tiny bounce there would have such a big impact. Rather, I expect that both currencies will cede at least some of those gains before the day is done. Meanwhile, the yen has softened, which has been attributed to a risk-on sentiment there, and in fairness, Treasury yields have risen as well, but the rest of the risk clues are far less clear.

Speaking of China, the PBOC fixed the renminbi at a new low for the move, 6.9724, which promptly saw it trade even closer to 7.00, although it is now essentially unchanged on the day. The market talk is that traders are waiting for the meeting between Presidents Trump and Xi, later this mornth, to see if a further trade war can be averted. If tensions ease in the wake of the meeting, look for USDCNY to slowly head lower, but if there is no breakthrough, a move through 7.00 would seem imminent.

And that’s really it for this morning. Yesterday’s US data showed PCE right at 2.0% for both headline and core, while Personal Spending rose 0.4%, as expected. Today’s data brings only the Case-Shiller Home Price Index (exp 5.8%) and Consumer Confidence (136.0), neither of which is likely to move markets. In addition, the Fed is now in its quiet period, so no more Fed speak until the meeting next week. Equity futures are pointing slightly higher, but that is no guarantee of how the day proceeds. In the end, it is hard to make a case for a weaker dollar quite yet.

Good luck
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