Tag Archives: #tariffs

For How Long?

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The US economy’s strong
Denial of this would be wrong
It’s not too surprising
That rates will be rising
The question is just, for how long?

Despite the Trump administration’s recent discussion of imposing 25% tariffs on $200 billion of Chinese imports, rather than the 10% initially mooted, the Fed looked at the economic landscape and concluded that things continue apace. While they didn’t adjust rates yesterday, as was universally expected, the policy statement was quite positive, highlighting the strength in both economic growth and the labor market, while pointing out that inflation is at their objective of 2.0%. Market expectations for a September rate hike increased slightly, with futures traders now pricing in a nearly 90% probability. More interestingly, despite the increased trade rhetoric, those same traders have increased their expectations for a December hike as well, with that number now hovering near 70%. At this point, despite President Trump’s swipe at higher rates last week, it appears that the Fed is continuing to blaze its rate-hiking path undeterred.

The consequences of the Fed’s stance are starting to play out more clearly now, with the dollar once again benefitting from expectations of higher short term rates, and equity markets around the world, but especially in APAC, feeling the heat. The chain of events continues in the following manner. Higher US rates have led to a stronger US dollar, especially vs. many emerging market currencies. The companies in those countries impacted are those that borrowed heavily in USD over the past ten years when US rates were near zero. They now find themselves struggling to repay and refinance that debt. Repayment is impacted because their local revenues buy fewer dollars while refinancing is impacted by the fact that US rates are that much higher. With this cycle in mind, it should not be surprising that equity markets elsewhere in the world are struggling. And those struggles don’t even include the potential knock-on effects of further US tariff increases. Quite frankly, it appears that this trend has further to run.

Meanwhile, the week’s central bank meetings are coming to a close with this morning’s BOE decision, where they are widely touted to raise the Base rate by 25bps, up to 0.75%. It is actually quite amusing to read some of the UK headlines talking about the BOE raising rates to the ‘highest in a decade’, which while strictly true, seems to imply so much more than the reality of still exceptionally low interest rates. However, given the ongoing uncertainty due to the Brexit situation, I continue to believe that Governor Carney is extremely unlikely to raise rates again this year, and if we are headed to a ‘no-deal’ Brexit, which I believe is increasingly likely, UK rates will head back lower again. Early this morning the UK Construction PMI data printed at a better than expected 55.8, its highest since late 2016, but despite the strong data and rate expectations, the pound has fallen 0.35% on the day.

Other currency movement has been similar, with the euro down 0.35%, Aussie and Kiwi both falling more than 0.5% and every other G10 currency, save the yen declining. The yen has rallied slightly, 0.2%, as interest rates in Japan continue to respond to Tuesday’s BOJ policy tweaks. JGB’s seem to have quickly found a new home above the old 0.10% ceiling, and there is now a growing expectation that as the 10-year yield there approaches the new 0.2% cap, the longer end of the JGB curve will rise with it taking the 30-year JGB to 1.00%. While that may not seem like much to the naked eye, when considering the nature of international flows, it is potentially quite important. The reason stems from the fact that Japanese institutional investors tend to hedge the FX exposure that comes from foreign fixed income purchases thus reducing their net yield from the higher rates received overseas to something on the order of 1.0%. And if the Japanese 30-year reaches that 1.0% threshold (it is currently yielding 0.83%), there is a growing expectation that those same investors will sell Treasuries and other bonds and bring the money home. That will have two impacts. First, I would be far less concerned over an inverting yield curve in the US as yields across the back end of the US curve would rise on those sales, and second, the dollar would likely rally overall on higher rates, but decline further against the yen. These are the type of background flows that impact the FX market, but may not be obvious to most hedgers.

Turning to the emerging markets, the dollar is firmer against virtually all of these currencies as well. One of the biggest movers has been CNY, falling 0.5% and now trading at its weakest level since May 2017. The renminbi’s decline has been impressive since mid-April, clocking in at nearly 9%, and clearly offsetting some of the impact of the recent tariffs. But remember, the renminbi’s decline began well before any tariffs were in place, and has as much to do with a slowing Chinese economy forcing monetary policy ease in China as with the recent trade spat. At this point, capital outflows have not yet become a problem there, but if history is any guide, as we get closer to 7.00, we are likely to see more pressure on the system as both individuals and companies seek to get their money out of China and into a stronger currency. I expect that there are more fireworks in store here.

Aside from China, the usual suspects continue to fall, with TRY having blasted through 5.00 overnight and now down 1.5% on the day. But we have also seen significant weakness in ZAR (-1.75%), KRW (-1.15%), and MXN (-0.75%). Even INR is down 0.5% despite the RBI having raised rates 0.25% overnight to try to rein in rising inflation pressures there. So today’ story is clear, the dollar remains in the ascendancy on the back of optimism in the US vs. increasing pessimism elsewhere in the world.

A quick peek at today’s data shows that aside from the weekly Initial Claims (exp 220K) we see only Factory Orders (0.7%). Yesterday’s ADP Employment data was quite strong, rising 219K, while the ISM Manufacturing report fell to a still robust 58.1, albeit a larger fall than expected. However, given the Fed’s upbeat outlook, the market was able to shake off the news. At this point, however, I expect that eyes are turning toward tomorrow’s NFP report, which will be seen as taking a much more accurate reading on the economy. All in all, I see no reason for the dollar to give back its recent gains, and in fact, expect that modest further strength is in the cards.

Good luck
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Percent Twenty-Five

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The story, once more’s about trade
As Trump, a new threat, has conveyed
Percent twenty-five
This fall may arrive
Lest progress in trade talks is made

President Trump shook things up yesterday by threatening 25% tariffs on $200 billion of Chinese imports unless a trade deal can be reached. This is up from the initial discussion of a 10% tariff on those goods, and would almost certainly have a larger negative impact on GDP growth while pushing inflation higher in both the US and China, and by extension the rest of the world. It appears that the combination of strong US growth and already weakening Chinese growth, has led the President to believe he is in a stronger position to obtain a better deal. Not surprisingly the Chinese weren’t amused, loudly claiming they would not be blackmailed. In the background, it appears that efforts to restart trade talks between the two nations have thus far been unsuccessful, although those efforts continue.

Clearly, this is not good news for the global economy, nor is it good news for financial markets, which have no way to determine just how big an impact trade ructions are going to have on equities, currencies, commodities and interest rates. In other words, things are likely more uncertain now than in more ‘normal’ times. And that means that market volatility across markets is likely to increase. After all, not only is there the potential for greater surprises, but the uncertainty prevailing has reduced liquidity overall as many investors and traders hew to the sidelines until they have a better idea of what to do. And, of course, it is August 1st, a period where summer vacations leave trading desks with reduced staffing levels and so liquidity is generally less robust in any event.

Moving past trade brings us straight to the central bank story, where the relative hawkishness or dovishnes of yesterday’s BOJ announcement continues to be debated. There are those who believe it was a stealth tightening, allowing higher 10-year yields (JGB yields rose 8bps last night to their highest level in more than 18 months) and cutting in half the amount of reserves subject to earning -0.10%. And there are those who believe the increased flexibility and addition of forward guidance are signals that the BOJ is keen to ease further. Yesterday’s price action in USDJPY clearly favored the doves, as the yen fell a solid 0.8% in the session. But there has been no follow-through this morning.

As to the other G10 currencies, the dollar is modestly firmer against most of them this morning in the wake of PMI data from around the world showing that the overall growth picture remains mixed, but more troubling, the trend appears to be continuing toward slower growth.

The emerging market picture is similar, with the dollar performing reasonably well this morning, although, here too, there are few outliers. The most notable is KRW, which has fallen 0.75% overnight despite strong trade data as inflation unexpectedly fell and views of an additional rate hike by the BOK dimmed. However, beyond that, modest dollar strength was the general rule.

At this point in the session, the focus will turn to some US data including; ADP Employment (exp 185K), ISM Manufacturing (59.5) and its Prices Paid indicator (75.8), before the 2:00pm release of the FOMC statement as the Fed concludes its two day meeting. As there is no press conference, and the Fed has not made any changes to policy without a press conference following the meeting in years, I think it is safe to say there is a vanishingly small probability that anything new will come from the meeting. The statement will be heavily parsed, but given that we heard from Chairman Powell just two weeks ago, and the biggest data point, Q2 GDP, was released right on expectations, it seems unlikely that they will make any substantive changes.

It feels far more likely that this meeting will have been focused on technical questions about how future Fed policies will be enacted. Consider that QE has completely warped the old framework, where the Fed would actually adjust reserves in order to drive interest rates. Now, however, given the trillions of dollars of excess reserves, they can no longer use that strategy. The question that has been raised is will they try to go back to the old way, or is the new, much larger balance sheet going to remain with us forever. For hard money advocates, I fear the answer will not be to their liking, as it appears increasingly likely that QE is with us to stay. Of course, since this is a global phenomenon, I expect the impact on the relative value of any one currency is likely to be muted. After all, if everybody has changed the way they manage their economy in the same manner, then relative values are unlikely to change.

Flash, ADP Employment prints at a better than expected 219K, but the initial dollar impact is limited. Friday’s NFP report is of far more interest, but for today, all eyes will wait for the Fed. I expect very limited movement in the dollar ahead of then, and afterwards to be truthful.

Good luck
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Is That Despair?

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

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

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

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

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

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

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

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

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

Good luck
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No Tariffs For Now

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Herr Juncker and Trump had their meeting
And what they both claimed bears repeating
No tariffs for now
As both sides allow
The current regime with no cheating

Whew! That pretty much sums up the market reaction to yesterday afternoon’s hastily arranged press conference with President Trump and European Commission President Jean-Claude Juncker. Both were all smiles as they announced that there would be no tariffs imposed at this time while the US and EU begin more serious trade negotiations with an eye toward reducing trade friction in manufactured goods. In addition, Europe would be seeking to purchase more US soybeans and LNG in a good faith effort to reduce the current trade imbalance. And finally, they would be addressing the current US tariffs on steel and aluminum imports from Europe. It can be no surprise that the market reacted quite positively to this news, with equities in the US finishing higher and European markets all performing well this morning. It should also not be that surprising that the euro jumped immediately upon the news, rising 0.25%, although this morning it has given back those gains after both French and German Consumer Confidence data extended their trend declines amid disappointing outcomes.

While it is still anybody’s guess how this will ultimately play out, the news is certainly an encouraging sign that there can be movement in a positive direction on the trade front. The same appears to be true regarding NAFTA negotiations with both Canada and Mexico reconfirming that a trilateral deal is the goal, and apparently making headway toward achieving those aims.

However, the same optimism is nowhere to be found regarding trade relations between China and the US, with no indication that the situation has shown any positive movement. In the meantime, China continues to respond to signs of weakening growth on the mainland, this time by further reducing capital requirements for banks’ lending to SME’s. While the PBOC has not specifically cut rates, generally seen as a broad monetary policy step, these targeted capital requirement and reserve ratio cuts can be very powerful tools for the targeted recipients, allowing them to expand their loan books and driving profits in the banking sector. But no matter how the easing of monetary policy is implemented, it is still easing of monetary policy and will have an impact on both Chinese equity markets and the renminbi’s exchange rate. While the currency weakened, as would be expected, falling 0.5% overnight, the Shanghai composite fell as well, which is somewhat surprising. Although, in fairness, the Shanghai exchange has rallied nearly 8% over the past two weeks, so this could simply be a case of “selling the news.” In the end, especially if the trade situation between the US and China remains fraught, I expect that USDCNY has further to run, and 7.00 remains on the radar.

The other big story this morning is the anticipation of the ECB meeting results, not so much in terms of policy changes, as none are expected, but in terms of the follow-on press conference where Signor Draghi will be asked about the timing of interest rate increases and the meaning of the term “through the summer” which was inserted into the last statement. Analysts have been debating if that means rates could be raised in August or September of next year, or if it implies a longer wait before a rate move. The futures market doesn’t have a full 10bp rate hike priced in until January 2020, significantly past the summer. The other question of note is how the ECB will handle reinvestment of their current portfolio, and whether they will seek to smooth the reinvestment program or simply wait until debt matures before purchasing more. The reason this matters is that their portfolio has a very uneven distribution of maturities, which could lead to more volatility in European Government bond markets if they choose the latter path.

In the end, given that Eurozone data continues to disappoint on a regular basis, it seems that whatever path they choose for rate hikes and reinvestment, it will seek to maintain as much support as possible for now. Other than the Germans, there does not appear to be a strong constituency to aggressively tighten monetary policy, and there are nations, like Italy and Greece, which would much prefer to see policy remain ultra accommodative for the foreseeable future. While the euro has been range trading for the past two months between 1.15 and 1.18, I continue to look for a break lower eventually.

Away from those stories, things have been less interesting. Most of the G10 is trading in a fairly narrow range, with Aussie the laggard, -0.4%, on the back of weaker metals prices. EMG currencies have similarly been fairly quiet with limited movement overall.

Yesterday’s US data showed that the housing market is starting to suffer a bit more consistently as New Home Sales fell to 631K, well below expectations and the lowest level since last October. Adding this to the miss in Existing Home Sales on Monday shows that the combination of still rising house prices and rising mortgage rates is starting to have a more substantial impact on the sector. This morning we see Durable Goods data (exp 3.0%, 0.5% -ex Transport) and the weekly Initial Claims data (215K), which continues to show the strength of the job market. However, regarding US data, all eyes remain on tomorrow’s first look at Q2 GDP, where the range of expectations is broad, from 3.8% to 5.2%, and traders will be trying to parse how the data will impact the Fed’s activities.

In the meantime, US equity futures are mixed this morning with the NASDAQ pointing lower after some weaker than expected earnings guidance from a FANG member, while Dow futures are pointing higher on the back of relief over the trade situation. As to the dollar, I expect that it will see modest weakness overall as positions continue to be adjusted ahead of tomorrow’s key GDP release.

Good luck
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Twixt Juncker and Trump

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The meeting today in DC
Twixt Juncker and Trump will be key
In helping determine
If cars that are German
Are hit with a new import fee

Markets overnight have been relatively muted as today’s big story revolves around EU President Jean-Claude Juncker’s meeting with President Tump in Washington. The agenda is focused on tariffs and trade as Juncker seeks to de-escalate the current trade policy differences. At this point, while most market participants would love to see signs that the US is backing off its recent threats, and that progress is made in adjusting the terms of trade, I don’t sense that there is a lot of optimism that will be the case. Remarkably, the US equity market has been able to virtually ignore the trade story, with only a few individual companies suffering due to direct impacts from the situation (or poor quarterly numbers), but that has not been true elsewhere in the world. Other equity markets have fared far worse in the wake of the trade battle, and I see no reason for those prospects to improve until there is a resolution. At the same time, while the dollar has fallen from its highs seen early last week, it remains significantly stronger than it was three months ago. In fact, during the recent escalation in Presidential rhetoric, while we saw a reaction last Friday, the reality is that there has been little overall movement.

While the value of the dollar clearly has an impact on trade, historically the reverse has been far less clear. In other words, although there have been knee-jerk reactions to a particular trade number that missed expectations, or similar to Friday’s movement, knee-jerk reactions to political statements about trade policy, generally speaking, trade’s impact on the dollar has been very hard to discern. Several months ago I highlighted the tension between short-term and long-term drivers of the dollar. On the short-term side, which is what I believe has been dominant this year, is monetary policy and interest rate differentials. These have clearly been moving aggressively in the dollar’s favor. On the long-term side is the US’ fiscal account, namely its current account deficit and trade deficit. Economic theory tells us that a country that runs significant deficits in these accounts will see its currency decline over time in order to help balance things. In fact, this has been the crux of the view that the dollar will fall in the long run. However, given the US’ unique situation as the global reserve currency, and the fact that so much global trade is priced in dollars as opposed to other currencies, there remains an underlying demand for dollars that is not likely to disappear anytime soon.

The point here is that if the current trade situation deteriorates further, with additional tariffs imposed on all sides, and growth slows correspondingly, it is still not clear to me that the dollar will suffer. In fact, most other countries will seek to weaken their own currencies in order to offset the tariffs, which means the dollar will likely continue to outperform. In other words, in addition to the US monetary policy benefit, it seems likely that the dollar will be the beneficiary of policy adjustments elsewhere designed to weaken other currencies. And ironically, in the current political situation, that is only likely to generate even more Presidential rhetoric on the subject. Quite frankly, I feel the dollar has potentially much further to climb as long as trade is the topic du jour.

Of course, that doesn’t mean it will rally ever day. In fact, today the dollar is very modestly softer vs. most of its counterparts. The biggest gainer has been CNY, which is firmer by 0.55% overnight, as China appears very interested in calming things down. But away from that move, most currency gains have been on the order of 0.1% or so. The most notable data overnight was the German IFO report, which declined for the eighth consecutive month and is now back to levels last seen in March 2017. While the ECB continues to look ahead to the ending of their extraordinary monetary policy, the economy does not seem to be cooperating with their views of a sustainable recovery. While I think there is very little chance that the ECB changes its stance on bond buying, meaning come December, they will be done, it remains an open question as to when they might start to raise rates. This is especially true given the potential for an escalating trade conflict between the US and the EU resulting in slower growth on both sides of the Atlantic. If that is the case, the ECB will have a much harder time normalizing policy. At this time, however, it is still way too early to make any determinations, and I suspect that tomorrow’s ECB meeting will give us very little new information.

Meanwhile, the market is still extremely focused on the BOJ meeting early next week, with varying views as to the potential for any policy shifts there. What does seem clear is there has at least been discussion of the timing of ending QE, but no decisions have been made. The problem for the BOJ is that after more than five years of aggressive bond buying, not only have they broken the JGB market, but they have not been able to achieve anywhere near the results they had sought. Given that the BOJ balance sheet is now essentially the same size as the Japanese economy (for comparison, in the US despite its remarkable growth during QE, it remains ~20% of the US economy), there are growing concerns that current policy may be doing more harm than good. Apparently there are limits to just how much a central bank can do to address inflation. As to the yen, if the market perception turns to the BOJ stepping back from constant injections of funds, it is very likely that the yen will find itself in great demand and USDJPY will fall steadily. I maintain my view that 100.00 is a viable target for the end of the year.

Today brings just New Home Sales data (exp 670K, a 2.8% decline from last month) but this is generally not a key figure for markets. Rather, today’s price action will be dependent on the outcome of the Trump-Juncker meeting and whatever comments follow at the press conference. A conciliatory tone by President Trump would almost certainly result in a stock market rally and modest dollar strength. Continued combativeness is likely to see stocks under pressure and the dollar, at least initially, falling as well.

Good luck
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Trump’s Latest Tirade

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There once was a time when men thought
That trade wars should never be fought
But that was back then
And now those same men
Think trade wars can help votes be bought

However, attacking free trade
By building a tariff blockade
Can open the doors
To currency wars
Just like in Trump’s latest tirade

Jerome Powell’s job got a LOT tougher on Friday, when President Trump not only reiterated his concern over the Fed raising rates and the impact it would have on the economy, (i.e. tapping on the brakes), but on the impact Fed policy is having on the dollar as it continues to rise. The President then called out China, Europe and Japan for manipulating their currencies lower and calling it unfair and a serious problem.

Now put yourself in Powell’s seat. Maintaining Fed independence, and any perceptions thereof is crucial. But so is managing monetary policy as he see’s fit. However, now that Trump has complained about rising US interest rates and the ongoing policy divergence we have seen over the past fifteen months, if the US economy slows and the Fed believes that a change in policy is appropriate, it may look like he is bending to the President’s will. At the same time, if he continues to raise rates because he believes that is appropriate, he will seemingly come under further pressure from the President. As I said, his job got a lot harder. One doesn’t have to be too cynical to believe that Powell and the Fed will continue to raise rates until the economy falters, at which point it will be clearly appropriate for the Fed to ease policy, and there will be no question of the Fed’s independence. Of course, purposely engineering a slowdown or recession doesn’t seem like such a wonderful idea either.

At the same time, the President has just created his fall guy for any bad outcomes in the economy. If things go bad, he blames the Fed and says, ‘I told you this would happen if they raised rates.’ And if everything continues with positive growth, he claims it’s his policies in spite of the Fed that is doing the job.

With that as the lay of the land, it should be no surprise that on the back of Trump’s discussion of currency manipulation, that the dollar fell sharply in Friday’s session. The dollar Index fell 0.75% with almost every major currency rallying. As the Asian session opens this evening, we are seeing some follow through in that price action, with the dollar index down a further 0.2%. JPY is leading the way higher, up 0.45%, but the movement remains widespread.

Interestingly, it appears that most of the punditry have decided that the dollar’s rally is now over. With the President now keen to see the dollar fall, that is what will happen. I, however, disagree with that assessment. At this point, as long as the interest rate divergence continues, I see no reason to believe that traders are going to change their tune. The carry available remains too great a temptation to ignore. In fact, I wouldn’t be surprised if we see the current level of dollar bullishness, as measured by open futures positions, rise over the next several weeks, as traders take advantage of the dollar’s short-term decline to add to positions at better levels. Until we start to see concrete changes in monetary policy (and there is no indication that any other country is going to tighten policy sooner than they otherwise would have), the dollar still holds all the cards. In fact, if the ongoing trade ructions lead to a more significant equity market correction, meaning risk is jettisoned, then the dollar will probably rise further. I will change my views when policy changes, but for now, I see this move as a temporary correction.

There is really no other story in the FX markets right now other than the evolution of the trade war into a currency war. While there will be some data this week, and the ECB meets Thursday, everything we hear will be in a response to Trump’s comments. The G20 arrived at no decisions, which can be no surprise, as they never do. However, all the talk is on the trade cum currency war that is brewing. At this point, given the ECB is not going to change anything, (perhaps they will refine their rate message more specifically, but I doubt it), it is headline roulette until the Fed meets next month. And even then, there is no expectation of a move until September, so really we are beholden to the headlines for now. I wish I could give more guidance than that, but let’s face it; nobody knows what will happen there.

Good luck
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I’m Not Thrilled

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Said President Trump, “I’m not thrilled”
With how Chairman Powell’s fulfilled
Both job and price mandates
By raising Fed Fund rates
‘Cause soon the Dow Jones could get killed

“I’m not thrilled. I don’t like all of this work that we’re putting into the economy and then I see rates going up. I am not happy about it. But at the same time I’m letting them do what they feel is best.” So said President Trump in an interview on CNBC yesterday afternoon. It should be no surprise that the FX market response was immediate, with the dollar reversing earlier gains.

While this is not the first time that a US president has tried to persuade the Federal Reserve to cut rates (they never want higher rates, I assure you!), it is the first time since George H.W. Bush pushed then Chairman Greenspan to reduce rates more quickly in 1992 (he didn’t). This is a situation fraught with serious consequences as the independence of a nation’s central bank is seen as one of the keys to a developed economy’s success. For instance, recall just several weeks ago when Turkey’s President Erdogan essentially took over making monetary policy there, and how the market has behaved since, with TRY already significantly weaker.

As long as the Fed remains on course to continue raising rates, and despite the Trump comments, Fed Funds futures showed no change in the probability for two more rate hikes this year, I see little reason to change my stance on the dollar’s future strength. However, the bigger problem is if the Fed, independently, decides that slowing the pace of rate hikes is justified by the data, it could still appear to be politically motivated, and so reduce whatever credibility the Fed still maintains. This will remain a background story, at the very least, for a while. So far, there is no indication that Chairman Powell is going to change his stance, which means that policy divergence remains the lay of the land.

In the meantime, the other big FX story comes from China. We discussed yuan weakness yesterday and in the overnight session, the PBOC fixed the onshore currency at its weakest point in more than a year, which in fairness is simply following the dollar’s overall strength, but then when USDCNY made new highs for the year above 6.83, a large Chinese state-owned bank was seen aggressively selling dollars. This tacit intervention helped to steady the market and worked to support the Shanghai Stock Exchange as well, which ultimately rose 2.0% on the day. It is, however, difficult to follow all the twists and turns in the US-China relationship these days, as literally minutes ago, President Trump raised the ante yet again, by saying that he is “ready to go” with regard to imposing tariffs on $500 billion of Chinese goods. That represents all Chinese exports to the US and is considerably larger than ever mentioned before.

Tariffs and protectionism have a very poor history when it comes to enhancing any country’s economic situation, but it is very possible that this continuous ratcheting of pressure may actually be effective at achieving policy changes in this situation as China has plenty of domestically created economic problems already. Recall, President Xi has been on the warpath about excess leverage and the PBOC had been tightening policy in order to squeeze that out of the system. However, growth in China has suffered accordingly, and the recent data indicates that it may be slowing even more. With that in mind, a full-scale trade war with the US would likely be disastrous for China. The last thing they can afford is to see reduced production numbers, as well as loss of access to critical component and technology imports. It is not impossible that Xi blinks first, or that the two presidents recognize that a face-saving deal is in both their interests. It may take a little while, but I have a sense that could well be the outcome. However, until then, look for USDCNY to continue to rally sharply, with a move to 7.00 and beyond very viable. This morning, despite the intervention overnight, it has subsequently weakened 0.4% and shows no signs of stopping.

Finally, one last story has returned from the past to haunt markets, Italy. There appeared to be a push by Five-Star leader, Luigi di Maio, to have the Finmin, Giovanni Tria, removed from office. You may recall that back in May, things got very dicey in Italy before the current government was finally formed as President Mattarella rejected the first proposed cabinet because of the Euroskeptic proposed for the FinMin post. Tria was the compromise selection designed to calm markets down, and it worked. So, if he were forced out, and it has been denied by the Finance Ministry that is the situation, it could lead us right back into a euro area crisis. This is especially true since the populist coalition of the League and Five-Start has gained further strength in the interim. While Italian bond markets suffered on the news, it was not sufficient to impact the euro much. However, we need to keep an eye on this story as it could well resurface in a more malevolent manner.

And that is really today’s situation. Overall the dollar is mildly weaker, but given its performance all week, that has more to do with profit taking on a Friday than other news. Clearly the Trump comments undermined the dollar to some extent, but until policies are seen changing, I think that will only be a temporary situation. With no data due this morning, and no speakers on the agenda, it has all the feelings of a quiet day upcoming. It is, after all, a Friday in July, so the summer doldrums seem appropriate.

Good luck and good weekend
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The Fed’s Fallen Short

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This morning’s inflation report
Ought show that the Fed’s fallen short
In holding down prices
And so my advice is
It’s time, those short dollars, abort

Yesterday’s session was dominated by two key themes; the suddenly increased trade tensions after the announcement of a new list of $200 billion of Chinese tariff targets, and the sharp decline in oil prices (WTI – 5.0%) after Libya declared the end of force majeure with respect to shipments from its eastern port. The oil price decline, which occurred despite a surprisingly large drawdown of US inventories, was in sync with other commodity prices, notably copper which fell 2.5% and is now down more than 16% in the past month. Copper is generally seen as an important harbinger of future economic growth given its widespread use throughout different industries, and so falling demand for copper often leads to slower economic growth. And yet, despite the declining commodity price environment, yesterday’s PPI data (3.4% Y/Y) was the strongest in more than six years while expectations for today’s CPI are similarly elevated with consensus views looking for 0.2% monthly increases in both headline and core data which translates into 2.8% headline and 2.3% core on a Y/Y basis.

If those expectations are met, the Fed will certainly continue its hiking cycle, which ought to continue to support the dollar going forward. The other key dollar support has been risk aversion, which is where the trade story comes into play. As long as trade tensions remain front-page news, investors are likely to remain skittish which means they will be reducing risk and looking for safe places to invest. US Treasuries remain the global safe haven of choice, and so both Treasuries and the dollar should continue to benefit from this situation.

Yesterday I mentioned that there had been no indication that there were background talks ongoing between the US and China regarding trade, something I found surprising given the situation. However, this morning there is a story that such talks are, in fact, proceeding which implies to me that there will be some type of solution that arrives before the next round of tariffs are in place. Look for concessions on both sides as well as comments highlighting the strength of the Sino-US relationship, especially with regard to North Korea. At least that’s my view. But it will be several months before anything comes to fruition, and so we are likely to be subject to further volatility on the subject.

One of the impacts of the China trade story was yesterday’s very sharp decline in the renminbi (-1.1%), which resulted in the currency falling to its weakest level since last August. Some pundits see this as an attempt to adjust for the recent tariff impositions by the US, but a case can be made that since the dollar was so strong overall yesterday, (USDX +0.65%), the CNY move was not really out of character. And this morning, the renminbi has already retraced half of that movement, so I am inclined to give the Chinese the benefit of the doubt here and accept the broad dollar strength thesis. In fact, one of the things that continues to haunt the PBOC is their mini devaluation in 2015, which triggered significant capital outflows and forced the imposition of very strict capital controls in China. Regardless of the trade situation, I assure you the Chinese will do all they can to prevent a repeat of that outcome. However, steady depreciation of the renminbi going forward remains my base case.

Otherwise, in G10 space the Bank of Canada raised rates by 25bps, as expected, which helped the Loonie temporarily, but in the end, it seems that weaker oil prices overwhelmed the rate hike and CAD fell 0.75% on the day. However, the BOC continues to sound upbeat on the economy for now and is positioned to continue to track the Fed’s policy for the next year or two.

From the UK, this morning, we received PM May’s latest Brexit position paper which is seeking to have the UK track EU goods regulations, but simultaneously looking for the UK to go completely its own way regarding services and seek trade agreements around the world on that basis. While it is an interesting idea, and one with merit given that services represent ~80% of the UK economy, with less than nine months before the Brexit date, it feels like they may not be able to complete much of the process in time. However, the BOE appears completely ready to raise rates next month with the market pricing an 80% probability of the event and Governor Carney commenting that growth in the UK continues to perform as the BOE expected in its rebound from Q1. The pound, however, has added a small 0.1% decline this morning to yesterday’s 0.5% slide.

Beyond these stories, nothing of note to the FX markets has really been evident. Given the strength of yesterday’s dollar move, it would be no real surprise if there was a small retracement, but in fact, I have a feeling that we are going to see high side surprises in the CPI data which will only serve to increase Fed expectations and support the dollar. So my money is on the dollar continuing its strengthening trend of the week and closing yet higher today.

Good luck
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Both Sides Will Lose

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The trade story’s back in the news
With stock markets singing the blues
Two hundred bill more
Confirms the Trade War
Will happen, and both sides will lose

The Trump administration’s announcement last evening that they are targeting another $200 billion of Chinese imports for tariffs, this time 10% across the board, has interrupted the markets recent sense of calm. In fact, the immediate response was for equity markets around the world to fall sharply and the dollar to regain its footing. Investors had come to believe that the initial salvo of tariffs on $34 billion by each nation would be the extent of things, and that negotiations would soon begin. However, assuming things with this administration is a fraught activity as unpredictability has been Trump’s hallmark since his election.

It is interesting to consider the market ramifications of this growing trade war between the US and China. For instance, since March 22, the day the first tariffs were announced, the Shanghai Index is down more than 15% while the S&P 500 is higher by a bit more than 3.0%. While economists have ridiculed Trump’s statement that “trade wars are easy to win”, it certainly seems that the US has so far come out ahead, at least on this measure. At the same time, the Chinese renminbi has fallen ~5.6% over the same period, which could mean that investors are more confident that the US will come out ahead…or it could mean that the PBOC has simply forced guided the currency lower in an effort to offset the impact of the tariffs.

However, the one thing that I take away from this process is that neither side is going to back down anytime soon. As Trump is leading the charge, he is unlikely to back off without having won some major concessions from the Chinese. At the same time, Chinese President Xi, who has spent the past five years consolidating his power, cannot afford to look weak to the home crowd. So my advice is to prepare for higher prices on lots of things that you buy, because this is likely to drag on for a long time.

As an aside, while the politics may favor Xi, I think given the nature of the imbalance, where the Chinese not only have far more items that can be taxed, but that they remain a largely mercantilist economy depending on exports for growth, it means that China’s economic situation is likely to deteriorate far more than that of the US. However, it is not clear to me that I would call that ‘winning’!

At any rate, the one thing that seems almost certain is that the dollar is going to be a major beneficiary of this process. Not only are other currencies going to suffer as their nations’ exports are reduced and growth impaired, but the ensuing inflationary impact of tariffs on the US is going to encourage the Fed to be more aggressive. Given the dollar’s positive response to the tightening of Fed policy already, as well as the growing divergence between the US economy and the rest of the world, the brewing trade war has simply increased my dollar bullishness.

Pivoting to the overnight markets, the dollar has rallied for a second straight day, showing strength against all its G10 counterparts and most EMG currencies. There continues to be a dearth of data on which to base trading outcomes and it seems most likely that the dollar’s recent strength, while receiving a catalyst from the trade situation, is a continuation of its rebound from last week’s decline. In the end, the dollar is still largely range bound and has been so since its rally ended in mid May. I continue to believe we will need new data of note to encourage a breakout, with the next real opportunity tomorrow’s CPI print. A surprisingly high print will get tongues wagging over the Fed picking up the pace, and likely support the dollar. However, I don’t believe the opposite is true. A weaker than expected print will simply confirm that the Fed will stay on its current trajectory, which may not help the dollar much, but should not undermine it.

The other potential driver is going to be the general risk tone in markets. It is very clear that the dollar has regained its status as a safe haven, and with every escalation in the trade war, risk aversion will lead to further dollar strength. This is especially true given that the other potential havens, JPY and CHF, continue to offer negative interest rates and so are far less attractive to investors looking for a short-term home for their assets. To me, all the evidence still points to the dollar’s next leg being a move up potentially testing the levels seen back in the beginning of 2017 over time.

On the data front, this morning brings PPI (exp 0.2% for both headline and core) but all eyes will be on tomorrow’s CPI, not today’s number. We also hear from NY Fed President Williams late this afternoon. Given both the timing, some four weeks since the last FOMC meeting, and his elevated role, it is possible that he could create some volatility by adding new information to the mix. However, my read is that the data trajectory has remained quite steady, and although he will almost certainly mention the trade situation and its potential to upend the economy, I doubt there will be new information forthcoming. So in the end, I like the dollar to continue to grind higher as the day progresses.

Good luck
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Lighthearted

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At this point one must be impressed
Investors have not become stressed
A trade war has started
Yet they are lighthearted
With willingness still to invest

On top of that word from the Fed
Is they will keep pushing ahead
With rate hikes until
Our growth starts to chill
Or when markets start to bleed red

There has certainly been a lot to digest in the past twenty-four hours. Arguably the biggest story is the imposition of tariffs by the US on $34 billion worth of Chinese goods, which began at midnight last night. China is responding in kind and the Trump administration is determining whether they want to up the ante by an additional $200 billion. Now that the trade war is ‘officially’ underway, the key questions are just how far it will go and how long it will last. While there has been nothing in the press indicating that background negotiations are ongoing and that things can be resolved soon, based on the US equity market’s insouciance, it certainly seems that many investors feel that is the case. I hope they are correct, and soon, because otherwise I expect that we will see a more substantial correction in stocks. As to the dollar in this case, I expect that it will continue to benefit from its safe haven status in a time of market turmoil.

A second fear for equity investors has to be the Fed, which explained in yesterday’s release of the June meeting minutes, that while the trade situation could well become a concern in the future, for now they are much more focused on the potential for the US economy to overheat. The upshot is that the Fed is bound and determined to continue normalizing policy by gradually raising rates and by allowing the balance sheet to continue to gradually shrink. Speaking of the balance sheet, starting this month, they are going to allow $40 billion per month to roll off, and then beginning in October, it will be $50 billion per month until they reach whatever size they determine is appropriate. That means that $270 billion of bids for Treasury’s are going missing for the rest of the year. As the Fed continues to drain liquidity from the economy, I expect that the dollar will continue to benefit across the board, and that the US equity market will face additional headwinds. After all, QE was effective in its goal of forcing investors further out the risk curve and driving equity prices around the world higher as central banks everywhere hoovered up government bonds. Well, with yields rising and central banks backing away from the market (all while equity prices remain robustly valued) it seems there is ample opportunity for a substantial correction in stocks.

You may have noticed I said exactly the same thing when discussing the trade war situation. My point is that we are starting to see multiple catalysts align for a potential change in tone. A higher dollar and lower US (and likely global) equity prices seem like an increasingly possible outcome. Be prepared.

This leaves us at our third big story for the day, the payroll report this morning. Yesterday’s ADP Employment number was a mild disappointment, rising 177K rather than the 190K expected, but the reason appeared to be a lack of available workers rather than a lack of demand for hiring. In other words, the labor market in the US remains extremely strong. Or so it seems. Here are this morning’s expectations:

Nonfarm Payrolls 195K
Private Payrolls 190K
Manufacturing Payrolls 18K
Unemployment Rate 3.8%
Average Hourly Earnings 0.3% (2.8% Y/Y)
Average Weekly Hours 34.5
Trade Balance -$43.7B

It strikes me that this is a potential third catalyst that will line up with the trade war and Fed story in that a strong print today will encourage the Fed to continue or even accelerate their activities; it will encourage the administration that they can outlast the Chinese in this war of attrition, and so the dollar is likely to firm up while equity markets suffer. In the event payrolls disappoint, I think we could see the dollar’s modest correction lower continue and I expect that equity markets will be fine, at least in the US.

Remarkably, I don’t have space to more fully discuss what appears to be a euro positive, where Chancellor Merkel has averted disaster in Germany by getting the third coalition partner, the SPD, to agree to her immigration reforms thus keeping her government intact. As long as this internal truce lasts, there should be no further impact on the euro, but if the problem arises again (and I’m pretty sure it will soon) the euro is likely to suffer. At the same time, the pound is on tenterhooks as PM May is meeting with her cabinet today to finalize a negotiating stance regarding Brexit. If she cannot get the cabinet to agree, I expect the pound will feel the heat as concern over the fall of the May government will rise and an election campaign just nine months before the deadline for leaving the EU cannot be seen as a positive, especially with the chance that Jeremy Corbyn, the far-left Labour Party leader could become the next PM. Investors will not appreciate him in that seat, at least not at first.

As to the overnight session, the dollar is slightly softer and equity markets are under modest pressure, including US futures, as the market awaits the labor situation report. Remember, too, that many trading desks remain lightly staffed because of the holiday, and so liquidity is going to be a bit less robust than normal. If pressed my thought is that NFP will print near consensus, around 200K. I just wonder if the Unemployment Rate doesn’t tick even lower. And keep an eye on AHE, where my gut tells me it will be 0.4% enough to get Fed tongues wagging again. Net, I like the dollar to end the week on a strong note.

Good luck and good weekend
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