Tag Archives: #tariffs

Little Fear

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Much to all Free Traders’ chagrin
More tariffs are set to begin
But markets appear
To have little fear
This madness will cause a tailspin

As NY walks in this morning, there has been very limited movement in the dollar overall. While yesterday saw a modicum of dollar weakness, at least against the G10 currencies, we remain range bound with no immediate prospects for a breakout. It does appear that US data is turning more mixed than clearly bullish, as evidenced by yesterday’s Empire Manufacturing Survey data, which printed at 19, still solid but down from last month’s reading of 25.6 as well as below expectations of 23.0. A quick look at the recent history of this indicator shows that it appears to be rolling over from its recent high levels, perhaps signaling that peak growth is behind us.

At this point, it is fair to question what is causing this change in tone. During the summer, US data was unambiguously strong, with most releases beating expectations, but lately that dynamic has changed. The most obvious catalyst is the ongoing trade situation, which if anything worsened yesterday when President Trump announced that the US would be imposing 10% tariffs on an additional $200 billion of Chinese imports. In addition, these are set to rise to 25% in January if there is no further progress in the trade negotiations. As well, Trump threatened to impose tariffs on an additional $267 billion of goods, meaning that everything imported from China would be impacted. As we have heard from several Fed speakers, this process has grown to be the largest source of uncertainty for the US economy, and by extension for financial markets.

Yet financial markets seem to be quite complacent with regard to the potential damage that the trade war can inflict on the economy and growth. As evidence I point to the modest declines in US equities yesterday, but more importantly, to the rally in Asian equities overnight. While it is fair to say that the impact of this tariff war will not be directly felt in earnings results for at least another quarter or two, it is still surprising that the market is not pricing the potential negative consequences more severely. This implies one of two things; either the market has already priced in this scenario and the risks are seen as minimal, or that the rise in passive investing, which has exploded to nearly 45% of equity market activity, has reduced the stock market’s historic role as a leading indicator of economic activity. If it is the former, my concern is that actual results will underperform current expectations and drive market declines later. However, I fear the latter situation is closer to the truth, which implies that one of the long-time functions of the equity market, anticipating and discounting future economic activity, is changing. The risk here is that policymakers will lose an important signal as to expectations, weakening their collective hands further. And let’s face it, they need all the help they can get!

Turning back to the dollar, not only has the G10 has been dull, but EMG currencies are generally benign as well. In fact, the only substantive movement has come from everybody’s favorite whipping boy, TRY. This morning it is back under pressure, down 1.3% and has now erased all the gains it made in the wake of last week’s surprising 625bp rate hike. But in truth, beyond that, I can’t find an important emerging market currency that has moved more than 20bps. There are two key central bank meetings this week, Brazil tomorrow and South Africa on Thursday. Right now, expectations are for both to stand pat, leaving interest rates in both nations at 6.50%. However, the whisper campaign is brewing that South Africa may raise rates, which has undoubtedly helped the rand over the past two weeks as it has rallied some 4.5% during that time. We will know more by Thursday.

This overall lack of activity implies that traders are waiting the next important catalyst for movement, which may well be next Wednesday’s FOMC meeting! That is a very long time in the market for treading water, however, given the US data the rest of this week is second tier, and the trade situation is widely understood at this time, it is a challenge to see what else will matter until we hear from the Fed. And remember, the market has already priced in a 100% probability that they will raise rates by 25bps, so this is really all about updated forecasts, the dot plot and the press conference. But until then, my sense is that we are in for a decided lack of movement in the FX world.

Good luck
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A Charade

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The news there was movement on trade
Twixt China and us helped persuade
Investors to buy
Though prices are high
And it could well be a charade

We also learned wholesale inflation
Was lower across the whole nation
Thus fears that the Fed
Might still move ahead
Aggressively lost their foundation

The dollar is little changed overall this morning, although there are a few outlier moves to note. However, the big picture is that we remain range bound as traders and investors try to determine what the path forward is going to look like. Yesterday’s clues were twofold. First was the story that Treasury Secretary Mnuchin has reached out to his Chinese counterpart, Liu He, and requested a ministerial level meeting in the coming weeks to discuss the trade situation more actively ahead of the potential imposition of tariffs on $200 billion of Chinese imports. This apparent thawing in the trade story was extremely well received by markets, pushing most equity prices higher around the world as well as sapping a portion of dollar strength in the FX markets. Remember, the cycle of higher tariffs leading to higher inflation and therefore higher US interest rates has been one of the factors underpinning the dollar’s broad strength.

But the other piece of news that seemed to impact the dollar was a bit more surprising, PPI. Generally, this is not a data point that FX traders care about, but given the overall focus on inflation and the fact that it printed lower than expected (-0.1%, 2.8% Y/Y for the headline number and -0.1%, 2.3% Y/Y for the core number) it encouraged traders to believe that this morning’s CPI data would be softer than expected and therefore reduce some of the Fed’s hawkishness. However, it is important to understand that PPI and CPI measure very different things in somewhat different manners and are actually not that tightly correlated. In fact, the BLS has an entire discussion about the differences on their website (https://www.bls.gov/ppi/ppicpippi.htm). The point is that PPI’s surprising decline is unlikely to be mirrored by CPI today. Nonetheless, upon the release, the dollar softened across the board.

This morning, however, the dollar has edged slightly higher, essentially unwinding yesterday’s weakness. As the market awaits news from three key central banks, ECB, BOE and Bank of Turkey, traders have played things pretty close to the vest. Expectations are that neither the BOE or the ECB will change policy in any manner, and in fact, the BOE doesn’t even have a press conference scheduled so there is likely to be very little there. As to Draghi’s presser at 8:30, assuming there is no new guidance as expected, questions will almost certainly focus on the fact that the ECB staff economists have reduced their GDP growth forecasts and how that is likely to impact policy going forward. It will be very interesting to hear Draghi dance around the idea that softer growth still requires tighter policy.

But certainly the most interesting meeting will be from Istanbul, where current economist forecasts are for a 325bp rate rise to 22.0% in order to stem the decline of the lira as well as try to address rampant inflation. The problem is that President Erdogan was out this morning lambasting higher interest rates as he was implementing new domestic rules on FX. In the past, many transactions in Turkey were denominated in either USD or EUR (things like building leases) as the financing was in those currencies, and so landlords were pushing the FX risk onto the tenants. But Erdogan decreed that transactions like that are now illegal, everything must be priced in lira, and that existing contracts need to be converted within 30 days at an agreed upon rate. All this means is that if the currency continues to weaken, the landlords will go bust, not the tenants. But it will still be a problem.

Elsewhere, momentum for a Brexit fudge deal seems to be building, although there is also talk of a rebellion in the Tory party amongst Brexit hardliners and an incipient vote of no confidence for PM May to be held next month. Certainly, if she is ousted it would throw the negotiations into turmoil and likely drive the pound significantly lower. But that is all speculation as of now, and the market is ascribing a relatively low probability to that outcome.

FLASH! In the meantime, the BOE left rates on hold, in, as expected, a unanimous vote, and the Bank of Turkey surprised one and all, raising rates 525bps to 24.0%, apparently willing to suffer the wrath of Erdogan. And TRY has rallied more than 5% on the news, and is now trading just around 6.00, its strongest level since late August. While it is early days, perhaps this will be enough to help stabilize the lira. However, history points to this as likely being a short reprieve unless other policies are enacted that will help stabilize the economy. And that seems a much more daunting task with Erdogan at the helm.

Elsewhere in the EMG bloc we have seen both RUB and ZAR continue their recent hot streaks with the former clearly rising on the back of rising oil prices while the latter is responding to a report from Moody’s that they are unlikely to cut South Africa to a junk rating, thus averting the prospect of wholesale debt liquidation by foreign investors.

As mentioned before, this morning brings us CPI (exp 0.3%, 2.8% Y/Y for headline, 0.2%, 2.4% Y/Y for core). Certainly, anything on the high side is likely to have a strong impact on markets, unwinding yesterday’s mild dollar weakness as well as equity market strength. This morning we hear from Fed governor Randy Quarles, but he is likely to focus on regulation not policy. Meanwhile, yesterday we heard from Lael Brainerd and she was quite clear that the Fed was on the correct path and that two more rate hikes this year were appropriate, as well as at least two more next year with the possibility of more than that. So Brainerd, who had been one of the most dovish members for a long time, has turned hawkish.

All in all, traders will be focused on two things at 8:30, CPI and Draghi, with both of them important enough to move markets if they surprise. However, the big picture remains one where the Fed is the central bank with the highest probability of tightening faster than anticipated, while the ECB, given the slowing data from Europe, seems like the one most likely to falter. All that adds up to continued dollar strength over time.

Good luck
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Opted To Stay

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The BOE banker named Mark
Whose bite pales compared to his bark
Has opted to stay
To help PM May
Get through a time sure to be stark

It has been a relatively docile FX market in the overnight session with traders awaiting new information on which to take positions. With that in mind, arguably the most interesting news has been that BOE Governor, Mark Carney, has agreed to extend his term in office for a second time, establishing a new exit date of January 2020. This is a relief to Chancellor Phillip Hammond, who really didn’t want to have a new Governor during what could turn out to be a very turbulent time immediately in the wake of the actuality of Brexit, which occurs on March 31, 2019. This is actually Carney’s second extension of his term, as he agreed to extend it originally by one year in the immediate wake of the Brexit vote in 2016. The market response was positive, with the pound bouncing about 0.5% upon the news, but just around 7:00am, it has started to cede those gains and is now actually down 0.3% on the session.

Away from the Carney news, there is precious little new to discuss. Eurozone data was generally softer than expected with IP there falling a worse than expected -0.8% in July. This resulted in the Y/Y figure actually turning negative as well, indicating that growth on the Continent is starting to suffer. In fact, there is another story that explains the ECB economists (not the governing council) have lowered their growth forecasts for the Eurozone during the next three years on the basis of increased trade frictions, emerging market malaise and higher US interest rates driving the global cycle. It will be interesting to see how Signor Draghi handles this news, and whether it will force the council to rethink their current plan to reduce QE starting next month and ending it in December. We will get to find out his thoughts tomorrow morning at the 8:30am press conference following their meeting. If pressed, I would expect that Draghi will be reluctant to change policy, but the increasing dangers to the economy, especially those posed by the escalating trade tensions between the US and China, will be front and center in the discussion. In the end, the euro has fallen slightly on the day, down 0.2%.

Otherwise, it is hard to get overly excited about the market this morning. Emerging market currencies are having a mixed session with INR rebounding, finally, after indications that the RBI is going to address the ongoing rupee weakness with tighter policy and perhaps increased market intervention. TRY is firmer by about 0.9% this morning as the market awaits tomorrow’s central bank news. Current market expectations are for a 300bp rate hike to address both the weakening currency and sharply rising inflation. However, we cannot forget President Erdogan’s distaste for higher interest rates as well as his control over the economy. In fact, this morning he fired the entire governing board of the Turkish sovereign wealth fund and installed himself as Chairman. I am skeptical that the Bank of Turkey raises rates anywhere near as much as the market anticipates. Meanwhile, yesterday saw the Brazilian real fall 1.6% as the presidential election polls show that the left wing candidates are gaining ground on Jair Bolsonaro, the market favorite. Given the virtual certainty there will be a second round vote, and the fact that Bolsonaro, who leads the polls right now, is shown by every poll to lose in the second round, it seems the market is coming to grips with the idea that the politics in Brazil are going to move away from investor friendliness into a more populist scenario. I fear the real may have quite a bit further to fall over time. 5.00 anyone?

Beyond these stories, nothing else is really noteworthy. Looking ahead to today’s US data shows that PPI will be released at 8:30 with the headline number expected at +0.2%, 3.2% Y/Y, and the core +0.2%, 2.7% Y/Y. We hear from two Fed speakers, uberdove Bullard and dovish leaning Brainerd, and then at 2:00pm comes the Fed’s Beige Book.

In the end, the dollar remains strongly linked to Fed policy, and there is no evidence that Fed policy is going to change from its current trajectory. In fact, if anything, it seems more likely that policy tightening quickens rather than slows. Consider the fact that the mooted tariffs of $200 billion of Chinese goods will impact a significant portion of consumer products, and if tariffs on an additional $267 billion are in play, then virtually everything that comes from China will be higher in price. I assure you that inflation will be higher in that event, and that the Fed will be forced to raise rates even more aggressively if that is the case. My point is that the dollar is still going to be the big beneficiary of this process, and my view that it will continue to strengthen remains intact.

Good luck
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Mostly At Peace

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Ahead of the payroll release
The market is mostly at peace
But there is no sign
The recent decline
In values is set to decrease

While I apologize for the double negative, this morning’s price action is a story of consolidation of recent losses across emerging market currencies and their respective equity markets. In fact, the biggest gainers in the FX markets today are some of the currencies that have been suffering the most recently. For example, the South African rand is higher by 1.4% on the day, but still down nearly 3.0% this week. Meanwhile in Brazil, in the wake of the assassination attempt on Brazilian presidential candidate Jair Bolsonaro, the real has rebounded 1.75%, essentially recouping the week’s losses, although is still down almost 8.0% this month. The story here is that Bolsonaro, who was leading in the polls and is favored by markets due to his free-market leanings, is expected to receive a sympathy vote along with more press coverage, and has increased his odds of winning the election next month. And of course, everyone’s favorite pair of losers, TRY and ARS, are both firmer this morning as well, by 3.5% and 2.75% respectively, but both remain down substantially in the past month. And there is no sign that policy is going to change sufficiently to have any positive impact in the short term. In other words, while many EMG currencies have performed well overnight, there is little reason to believe that the unfolding crisis in the space has ended.

Turning to the biggest news of the day, the payroll report is due with the following expectations:

Nonfarm Payrolls 191K
Private Payrolls 190K
Manufacturing Payrolls 24K
Unemployment Rate 3.8%
Average Hourly Earnings 0.2% (2.7% Y/Y)
Average Weekly Hours 34.5

If forecasts are on the mark, it will simply represent a continuation of the current US expansion and cement the case for two more rate hikes by the Fed this year. In fact, we would need to see substantially weaker numbers to derail that process on a domestic basis. And given yesterday’s Initial Claims data of 203K, the lowest print since 1969, it seems highly unlikely that this data will be weak.

A second factor reinforcing the view that the Fed will remain on their current rate-raising path was a comment by NY Fed President John Williams. Yesterday, after a speech in Buffalo, he said that he would not be deterred from raising rates simply because it might drive the yield curve into an inversion. This is quite a turn of events for Williams who had historically leaned more dovish when he was at the San Francisco Fed. In addition, it is exactly the opposite from what we have recently heard from two separate Fed presidents, Atlanta’s Bostic and St Louis’ Bullard, both of who were explicit in saying they would not vote for a rate hike if that would cause an inversion. Of course, neither of them is a voter right now while Williams is, so his voice is even more important.

While it is not clear whether Chairman Powell is of a like mind on this subject, there is certainly no evidence that Powell is going to be deterred from his current belief set that further gradual rate hikes are necessary and appropriate. The one thing that is very clear is that the current Fed is focused almost entirely on the US economy, to the exclusion of much of the rest of the world. And this focus reduces the chance that Powell will respond to further emerging market instability unless it reaches a point where the US economy is likely to be impacted. As far as I can tell, the Fed’s focus remains on the impact of the recent increase in fiscal stimulus and how that might impact the inflation situation.

There is one other thing to keep in mind today, and going forward, and that is that yesterday was the last day of comment period on President Trump’s mooted tariff increase on a further $200 Billion of Chinese imports. If he does follow through by implementing these tariffs, look for significant market impact with the dollar resuming its climb and a much bigger negative impact on equity markets as investors try to determine the impact on company results. Also look for commodity prices to decline on the news.

But that is really it for the day. Ahead of the data there is little reason for much of a move. However, even after the data, assuming the forecasts are reasonably accurate, I would expect the dollar’s consolidation to continue. In the end, though, all signs still point to a stronger dollar over time.

Good luck
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A deal Has Been Made

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The story is once again trade
As news that a deal has been made
Twixt Mex and DC
Helped traders agree
The dollar would slowly degrade

Right now, there are two essential stories that the market is following; the Fed and US trade negotiations. While Friday’s news was all about the Fed (with a small dose of PBOC), yesterday we turned back to trade as the key market driver. The announcement that a tentative agreement had been reached between the US and Mexico regarding NAFTA negotiations was hailed in, most quarters, as a positive event. It is beyond the scope of this discussion to opine on the merits of the actual negotiation, only on its market impact. And that was unambiguous. Equity markets rallied everywhere while the dollar continued its recent decline. In fact, the dollar has now fallen for seven of the past eight sessions and is trading back at levels not seen in four weeks. So much for my thesis that continued tighter policy by the Fed would support the buck.

But I think it is worth examining why things are moving the way they are, and more importantly, if they are likely to continue the recent trend, or more likely to revert to the longer run story.

Earlier this year, as the narrative evolved from synchronous global growth to the US leading the way and policy divergence, buying dollars became a favored trade, especially in the hedge fund community. In fact, it grew to be so favored that positioning, at least based on CFTC figures, showed that it was near record levels. And while the dollar continued to rally right up until early last week, everybody carrying that position was happy. This was not only because their view was correct, but also because the current interest rate market paid them to maintain the position, a true win-win situation.

In the meantime, another situation was playing out at the same time; the increasingly bombastic trade rhetoric, notably between the US and China, but also between the US and Mexico, Canada and Europe. With the imposition of tariffs on $50 billion of Chinese imports by the US, and the reciprocal tariffs by China, the situation was seen as quite precarious. While there was a mild reprieve when the US delayed imposing tariffs on imported European autos last month, a key issue had continued to be the ongoing NAFTA renegotiations. These stories, when highlighted in the press, typically led to risk-off market reactions, one of which included further USD strength.

So between the two stories, higher US rates and increasing risk on the trade front, there were two good reasons to remain long dollars. However, one of the oft-mentioned consequences of the stronger dollar has been the pressure it applies to EMG economies that were heavy dollar borrowers over the past ten years. Suddenly, their prospects dimmed greatly because they felt the double whammy of less inward investment (as USD investments became more attractive due to higher US rates) and a weaker currency eating up a greater proportion of local currency revenues needed to repay dollar debt and its interest. This led to increasing angst over the Fed’s stated views that gradual rate hikes were appropriate regardless of the international repercussions. This also led to significant underperformance by EMG equity markets as well as their currencies, forced the hands of several EMG central banks to raise rates to protect their currencies, and completely decimated a few places, notably Argentina and Turkey.

But that all started to change in earnest last Friday. While the dollar had been retracing some of its recent gains prior to the Jackson Hole meeting, when Chairman Powell hinted that he saw no reason that inflation would continue much beyond the Fed’s target level (although without the benefit of a rationale for that view), the market interpreted that as the Fed ‘s rate hiking trajectory would be shallower than previously thought, and that four rate hikes this year was no longer a given. In fact there are those who now believe that September may be the last rate hike for several quarters (I am not in the group!) Now adding to that the positive news regarding trade with Mexico, with the implication that there is an opportunity to avoid a truly damaging trade war, all of those long dollar positions are feeling far less confident and slowly unwinding. And my sense is that will continue for a bit longer, continuing to add pressure to the dollar. What is interesting to me is that the euro, for example, has retraced back above 1.17 so quickly (remember, it was trading at 1.13 just two weeks ago) and it is not clear that many positions have been cleared out. That implies that we could see further dollar weakness ahead as long as there is no other risk-off catalyst that arises.

The thing is, I don’t think this has changed the long run picture for the dollar, which I think will continue to outperform over time, as while the Fed may slow its trajectory, it is not stopping any time soon. And the reality is that the ECB is still well over a year away from raising rates, with Japan further behind than that. Meanwhile, the PBOC is actively easing as the Chinese economy continues to slow. In the end, the dollar remains the best bet in the medium term. But in the short run, I think the euro could well trade toward 1.19 before stalling, with other currencies moving a similar amount.

As to today’s session, there has been a decided lack of data from either Asia or Europe, and nothing really on the cards for the US. We remain in a lackluster holiday week, as US trading desks remain lightly staffed ahead of the Labor Day holiday next Monday. So to me, momentum is pointing to continued dollar weakness for now, and I expect that is what we will see for the rest of the week.

Good luck
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And what has happened as that angst has grown, and fears of a repeat of the EMG crisis of 1998-9 were raised?

 

No Progress Was Made

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In Washington, talks about trade
Twixt us and the Chinese decayed
Both sides pitched their views
But couldn’t enthuse
The other. No progress was made

Today, though, the Fed Chairman Jay
Will speak and might seek to convey
How high rates may rise
Or how he’ll devise
A plan to keep prices at bay

Two key themes dominate the FX markets this morning, yesterday’s failure of low-level trade talks between the US and China to make any progress and the beginning of the Kansas City Fed’s Jackson Hole conference.

Starting with trade, last evening, the talks ended with no progress of note. Both sides explained that they had expressed their views, but there was no indication that there was movement on either side toward a compromise. Obviously, politics will play a huge role in this process, and so it becomes extremely difficult to forecast how things will evolve. However, as the day progressed yesterday, it seemed increasingly likely that nothing beneficial would occur, and so the dollar regained its footing. In fact, it had its best day (+0.6%) since it reached its recent peak early last week and reversed course lower. Interestingly, this morning the dollar has given back some of that ground, but net remains higher than when I wrote yesterday morning. It has become clearer to me that the market presumption is more trade angst will lead to a firmer dollar, which is simply an additional catalyst for dollar strength in the near and medium term. But we will need to watch the trade situation carefully, as any indication that progress is being made is likely to result in a dollar retreat.

But that was yesterday’s story, and at this point is virtually ancient history. Today is all about the Fed symposium in Jackson Hole, Wyoming, specifically about Chairman Powell’s speech at 10:00am EDT. Analysts and traders are waiting to hear his latest thoughts on monetary policy and how he sees it evolving. Yesterday we heard from two regional Fed presidents, Dallas’s Richard Kaplan and KC’s Esther George, both of whom said that the committee was entirely focused on its Congressional mandates of price stability and maximum employment, and that they would not be swayed by comments from the President. And incidentally, both said they see at least four more rate hikes between now and the end of next year. In fact Ms George is in the camp leaning toward six more over that time frame. Of course, this is all dependent on the evolution of the US economy. As long as it continues to grow in the current manner, it seems there will be no dissuading the Fed from removing accommodation. That said, Mr. Powell’s speech this morning is seen as critical in helping define exactly how much tightening is on the way. The funny thing about those expectations is that Powell is probably the last person who is likely to set expectations in that manner. He is all about pragmatism and reacting to the data as it evolves. Certainly, if the US economy continues to grow quickly, he will be leading the charge for higher rates. But if cracks start to show, or the trade situation causes deterioration in the economic data, I expect he will be perfectly happy to pause.

Speaking of cracks in the data, yesterday brought us New Home Sales, which disappointed by rising only 627K in July, down 1.7% from June’s level and back to the lowest since last October. This followed softer than expected Existing Home Sales data on Wednesday and seems to indicate that the housing market may have peaked for now. Given its importance to the overall economy, that is a somewhat worrying sign, especially given the state of employment here. If the best employment data in decades cannot help perk up housing, it may well be ripe for a more substantial correction. Following that line of reasoning further, it is an open question as to whether we have seen the peak in US growth and just how rapidly the situation here might change. Food for thought, but it is still early days for this idea.

A quick survey of FX market movement overnight shows that the dollar’s decline is pretty uniform. The G10 leader higher is AUD (+0.8%), which has shown a positive reaction to the changing of PM’s there, with Malcolm Turnbull out and Scott Morrison, the previous Treasurer, now the PM. But the euro and pound are both firmer by about 0.4% despite lackluster UK mortgage data and Eurozone data that merely met expectations. As I said, today’s dollar weakness appears more a response to the trade story than data.

In the EMG bloc, ZAR is firmer by 1.1% as traders decided that comments by President Trump regarding South African land reform were actually not that relevant and would not impact policy. But we have also seen CNY rocket higher by nearly 1.0%, (post trade talk reaction?), RUB jump 1.0% on the back of higher oil prices and even TRY has found its footing, at least temporarily, rising 0.4%.

But in the end, it would be surprising to see much market movement between now and Powell’s speech. Rather, I expect that the market will absorb the Durable Goods data (exp -0.5%, +0.5% ex Transport) with aplomb and be right here when he starts. After that it is dependent on what he says. If pressed, I expect that he will subtly reaffirm the Fed’s independence, talk up the economy, and indicate monetary policy is on the right trajectory for now, in other words, US rates have plenty further to rise this year and next, at least. And as rates rise, so goes the dollar.

Good luck
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Diminished

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There is a small nation called Greece
Which eight years ago had to cease
Expending their cash
Which led to a crash
And caused GDP to decrease

Today is important due to
The fact that austerity’s through
The bailout is finished
Though Greece is diminished
While people there barely make do

Even though all eyes are on emerging markets these days, and rightly so in many cases, I thought it was worthwhile to note that the Greek sovereign debt crisis is ‘officially’ over as of today. While the situation in Greece doesn’t seem to have improved that much overall, today is the day that the bailouts officially end and Greece returns to the group of nations that are fully independent-ish. In fact, the Troika still controls much of what Greece is allowed to do with respect to spending priorities and budget discipline, and the nation remains a basket case in most ways. But reality on the ground could never dissuade the Troika from touting that their programs were a huge success and that everybody will live happily ever after. At any rate, it is probably a good thing that this chapter in Europe’s history has finally closed, but I would wager that if you surveyed the Greek people, not many would find good things to say about the future, let alone the past. In the end, though, Greece remains a tiny nation within the Eurozone, and what happens there impacts markets through sentiment changes, not through financial ones.

At the same time, there is a much bigger problem brewing in Italy, with many of the same issues surfacing there as occurred in Greece, and fears that the recently elected, anti-establishment government may make decisions inconsistent with the EU’s wishes. But Italy is not a small country. It is the third largest in the Eurozone and carries the largest amount of debt, €2.3 trillion worth. The one thing of which I am confident is that we have not seen the last problems to emanate from the Eurozone, and correspondingly, with the euro itself.

Reverting to emerging markets, while everyone recognizes the wreck that is Venezuela, on Friday night they made some major adjustments to their currency regime, devaluing the official bolivar by 95% (now approaching the black market rate) and redenominating the currency by removing 5 zeroes from its value. But in the end, the currency is just a symptom of their problems, not the cause, and it will remain the basket case that it has become over the past twenty years until there is a new government in place.

Moving on to more frequently discussed EMG currencies, like TRY (-2.2%), INR (+0.3%) and RUB (-0.2%), things are far less interesting. Remarkably, a 2% decline in the Turkish lira seems like a good day after recent gyrations, and the rest of the FX world seems to be on vacation, with very little substantive movement overnight. As we are coming to the end of August, it should be no real surprise that markets are getting quiet as there are more and more traders on holiday, and unless there is a specific story on which to trade, those that are manning the desks seem likely to play things close to the vest.

Meanwhile, there was virtually no data of note released overnight, and no commentary from any officials. The US-China trade situation seems like it might be moving toward a better place, with ongoing negotiations designed to arrive at an outcome in November, but there is still a long time to go before anything truly positive arrives. And in the meantime, Thursday we are due to see new tariffs imposed on $16 billion more of Chinese goods. Otherwise, there’s just not that much happening.

And the calendar this week is underwhelming as well, although the KC Fed’s Jackson Hole Symposium does kick off on Friday with Chairman Powell starting the festivities Friday morning.

Wednesday Existing Home Sales 5.4M
  FOMC Minutes  
Thursday Initial Claims 215K
  New Home Sales 645K
Friday Durable Goods -0.5%
  -ex Transport 0.5%

So the reality is that Wednesday’s FOMC Minutes will be carefully scrutinized for any sign that there is growing concern over the trade issue, and then Friday’s Powell speech is the next thing that will really matter. My sense is that we are looking forward to a very quiet week, with modest gyrations in the dollar, but no trend extension likely.

Good luck
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Decidedly Bleak

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The view turned decidedly bleak
For EMG nations this week
Though Turkey was worst
Some others were cursed
As well, since more funding they seek

The Argies are feeling put out
The rand had an actual rout
In LATAM they all
Enjoyed (?) quite a fall
But China, more weakness, did flout!

In truth, this morning things are rather dull in the FX markets, although I’m pretty sure that most traders are relieved. It has been an extremely difficult week for emerging market currencies and volatility remains pretty high. As an example, this week saw the South African rand fall nearly 6%, with 1% coming overnight. In LATAM, while the Argentine peso fell nearly 6% that was not the only casualty. Brazil felt the sting with the real falling 2.75%; Chile saw its peso down 3.5% while the Colombian version fell 2.7%. In fact, the best performing peso was Mexico’s, falling only 1% this week.

Of course, given that the Turkish lira was where all this started; we cannot ignore its movement. If you recall, last week it collapsed, falling nearly 40% at its weakest. Then, in response to several moves by the central bank restricting liquidity and stealthily hiking interest rates, it recouped nearly half that loss. However, this morning, the lira is once again falling, down about 5% as I type. The only thing we know for sure is that this volatility is unlikely to end soon as the market will continue to test the central bank, as well as President Erdogan’s ability to continue his policies of folly.

Finally, a quick look at APAC currencies shows INR as the only one with significant movement, falling 2% and breeching the 70.00 level for the first time ever. But the rest of this space, though it definitely saw volatility, wound up little changed on the week. And despite a great deal of anxiety about the renminbi, it is essentially exactly where it started on Monday.

The message that can be gleaned from this movement is that there are a great many countries which have fiscal imbalances, and whose prospects for future growth are being impacted by a combination of two US policies. First, as the Fed continues to raise rates and withdraw liquidity from markets via shrinking its balance sheet, those nations that relied on cheap dollar funding for their recent growth are finding themselves under pressure. And, of course, the second US policy impacting these nations is the reintroduction of tariffs on trade. Most emerging markets are heavily reliant on exports, with the US as a major destination. Slowing trade growth is also going to negatively impact these economies, and force a re-evaluation of the level of their currencies. As long as these two policies continue, and there is absolutely no sign they are going to change any time soon, every emerging market currency will be living under its own Sword of Damocles.

Meanwhile, in the G10 space, things are decidedly less interesting. While the euro did manage to trade to new lows for the move earlier this week, it has been able to reverse those losses and is now essentially flat since last Friday. The same can be said for most of the space, with the early week panic having dissipated, and very little information to drive currency movement otherwise. The weekly data was very much as expected, showing that the Eurozone and the UK are both rebounding from a very weak Q1, but hardly exploding higher. Rather, both continue to lag US growth numbers, and while the BOE did hike rates two weeks ago, and the ECB continues to slowly wind down QE, neither seems likely to increase the pace of their policy tightening, and so change the near term outlook for their respective currencies. And remember that Brexit continues to hang over the pound (its very own Sword of Damocles), with a distinct lack of movement on that front, other than the calendar which now shows just over seven months to come to a deal.

As to the US, data this week was somewhat mixed with some quite positive results (Retail Sales and Productivity) and some weaker data (Housing Starts and Philly Fed). All told, the weakness was not nearly enough to change the Fed’s trajectory, of that I am certain. And so, in the end, there is no reason to change any views with regard to the dollar; as the Fed continues to tighten policy, the dollar will continue to rise, albeit slowly.

Good luck
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More Concerned

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More pressure has lately been felt
In China, despite Road and Belt
As growth there is slowing
And Xi Jinping’s knowing
He must change the cards he’s been dealt

So last night, the news that we learned
Was both sides have grown more concerned
Thus trade talks would start
While traders took heart
And short-sellers of yuan got burned

While the Turkey situation has not disappeared completely, the central bank there appears to be regaining some control over the lira through surreptitious rate hikes. Cagily, they have stopped offering one-week liquidity, which theoretically could be had for ‘just’ 17.75% and instead are forcing banks to fund at the more expensive overnight window. This amounts to an effective 300bp rate rise and has been a key reason, along with yesterday’s announced moves regarding short positions, as to why the Turkish lira has rebounded so sharply from its worst levels. This hasn’t changed the macroeconomic picture, nor can it address the ongoing political row between the US and Turkey, but it has been effective in cooling the ardor of traders to short the lira. We will continue to monitor the situation, but it appears, that for now, TRY will no longer be the primary topic in FX markets.

Which allows us to turn our attention to China, where last night it was announced that low level trade talks between the US and China would start later this month in Washington. That is clearly the best news we have heard on the trade front in months, and although the process for further tariffs continues apace in the US, and it seems highly likely that next weeks imposition of tariffs on $16 billion of Chinese goods would go ahead, traders took the news very positively. The FX response was to reverse the renminbi’s recent decline, which prior to the news had seen it trade above 6.95 and perilously close to the 7.00 level many analysts have targeted as critical in PBOC deliberations. But this morning, USDCNY has fallen 0.75%, quite a large move for the currency pair, as fears of further escalation in the trade war seem to have abated slightly. There is certainly no guarantee that these talks will amount to anything or bring about further discussions, let alone a solution, but for now, they have been extremely well received by markets. Not only did the yuan rally, but also the Shanghai Composite reversed its early weakness, having fallen 1.8% at the open, and closed lower by only 0.65%. Hong Kong shares, too, rebounded from early weakness to close only marginally lower. It is important to remember that one of the drivers of the Shanghai market had been much weaker than expected earnings from Tencent, the Chinese internet firm that owns WeChat, China’s answer to Facebook. But there is no question that the news about trade talks was a critical factor in the rebound.

With these two stories as the lead, it is not surprising that the dollar has ceded some of its recent gains and is a touch softer overall this morning. Other EMG currencies that had seen significant pressure like ZAR (+0.1%), MXN (+0.5%), and RUB (+0.3%) have at least stabilized, if not reversed course. Fear of contagion remains rampant amongst emerging market investors and I expect that they will only return to markets slowly. And of course, it is entirely possible that the measures taken by the various authorities will turn out to be insufficient to address what in many cases are structural problems, and the currency rout will resume. But for now, it feels like a modicum of calm has been restored.

Meanwhile, G10 currencies are also mildly firmer this morning, although the dollar remains near its recent highs. For example, while the euro is higher by 0.3%, it is still trading with a 1.13 handle. There has been very little Eurozone data to drive markets, but there have been several articles discussing the ongoing trauma in Italy and how concerns over the new government’s fiscal policies may still turn disastrous.

Looking toward the UK, Retail Sales data there was quite strong, rising 0.7% in July, well above expectations for a 0.2% rise. However, the benefit to the pound has been minimal, with it rising just 0.1% on the news. Brexit remains a huge cloud over the currency (and the economy) and every day there is no positive news means that there is that much less time to create a solution. You all know I foresee a hard Brexit, not so much on principle as much as because I fear the May government simply cannot decide how to proceed and is not strong enough to impose a decision.

The last noteworthy piece of news in this space comes from Oslo, where the Norgesbank left rates on hold, as expected, but also essentially cemented the idea that they will be raising rates in September, joining the growing list of countries that are beginning to remove the excess accommodation put in place as a response to the financial crisis. After all, the tenth anniversary of the Lehman bankruptcy, the time many hold as the starting point to the crisis, is coming up in less than a month!

This morning’s US data brings Housing Starts (exp 1.2M), Building Permits (1.28M), Initial Claims (217K) and Philly Fed (22). Yesterday’s data was pretty strong, with the Empire Mfg print higher than expected and productivity growth showing its highest outcome since Q1 2015. In all, there is nothing in the data that suggests the Fed is going to change its tune, and if the trade situation eases, it is even more likely the Fed remains steady. All in all, despite modest softness this morning, the dollar remains the best bet going forward.

Good luck
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Uncomfortably High

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Said Carney, exhaling a sigh
The odds are “uncomfortably high”
More pain will we feel
If there is no deal
When England waves Europe bye-bye

Yesterday the BOE, in a unanimous decision, raised its base rate by 25bps. This outcome was widely expected by the markets and resulted in a very short-term boost for the pound. However, after the meeting, Governor Carney described the odds of the UK leaving the EU next March with no transition deal in hand as “uncomfortably high.” That was enough to spook markets and the pound sold off pretty aggressively afterwards, closing the day lower by 0.9%. And this morning, it has continued that trend, falling a further 0.2% and is now trading back below 1.30 again.

By this time, you are all well aware that I believe there will be no deal, and that the market response, as that becomes increasingly clear, will be to drive the pound still lower. In the months after the Brexit vote, January 2017 to be precise, the pound touched a low of 1.1986, but had risen fairly steadily since then until it peaked well above 1.40 in April of this year. However, we have been falling back since that time, as the prospects for a deal seem to have receded. The thing is, there is no evidence that points to any willingness to compromise among the Tory faithful and so it appears increasingly likely that no deal will be agreed by next March. Carney put the odds at 20%, personally I see them as at least 50% and probably higher than that. In the meantime, the combination of ongoing tightening by the Fed and Brexit uncertainty impacting the UK economy points to the pound falling further. Do not be surprised if we test those lows below 1.20 seen eighteen months ago.

This morning also brought news about the continuing slowdown in Eurozone growth as PMI data was released slightly softer than expected. French, German and therefore, not surprisingly, Eurozone Services data was all softer than expected, and in each case has continued the trend in evidence all year long. It is very clear that Eurozone growth peaked in Q4 2017 and despite Signor Draghi’s confidence that steady growth will lead inflation to rise to the ECB target of just below 2.0%, the evidence is pointing in the opposite direction. While the ECB may well stop QE by the end of the year, it appears that there will be no ability to raise rates at all in 2019, and if the current growth trajectory continues, perhaps in 2020 as well. Yesterday saw the euro decline 0.7%, amid a broad-based dollar rally. So far this morning, after an early extension of that move, it has rebounded slightly and now sits +0.1% on the day. But in the end, the euro, too, will remain under pressure from the combination of tighter Fed policy and a decreasing probability of the ECB ever matching that activity. We remain in the 1.1500-1.1800 trading range, which has existed since April, but as we push toward the lower end of that range, be prepared for a breakout.

Finally, the other mover of note overnight was CNY, with the renminbi falling to new lows for the move and testing 6.90. The currency has declined more than 8% since the middle of June as it has become increasingly clear that the PBOC is willing to allow it to adjust along with most other emerging market currencies. While the movement has been steady, it has not been disorderly, and as yet, there is no evidence that capital outflows are ramping up quickly, so it is hard to make the case the PBOC will step in anytime soon. And that is really the key; increases in capital outflows will be the issue that triggers any intervention. But while many pundits point to 7.00 as the level where that is expected to occur, given the still restrictive capital controls that exist there, it may take a much bigger decline to drive the process. With the Chinese economy slowing as well (last night’s Caixin Services PMI fell to 52.8, below expectations and continuing the declining trend this year) a weaker yuan remains one of China’s most important and effective policy tools. There is no reason for this trend to end soon and accordingly, I believe 7.50 is reasonable as a target in the medium term.

Turning to this morning’s payroll report, here are the current expectations:

Nonfarm Payrolls 190K
Private Payrolls 189K
Manufacturing Payrolls 22K
Unemployment Rate 3.9%
Average Hourly Earnings (AHE) 0.3% (2.7% Y/Y)
Average Weekly Hours 34.5
Trade Balance -$46.5B
ISM Non-Manufacturing 58.6

Wednesday’s ADP number was much stronger than expected at 213K, and the whisper number is now 205K for this morning. As long as this data set continues to show a strong labor market, and there is every indication it will do so, the only question regarding the Fed is how quickly they will be raising rates. All of this points to continued dollar strength going forward as the divergence between the US economy and the rest of the world continues. While increasing angst over trade may have a modest impact, we will need to see an actual increase in tariffs, like the mooted 25% on $200 billion in Chinese imports, to really affect the economy and perhaps change the Fed’s thinking. Until then, it is still a green light for dollar buyers.

Good luck and good weekend
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