It All Went to Hell

First Mario cooed like a dove
Then trade data gave things a shove
It all went to hell
As stock markets fell
While folks showed the dollar some love

It was a rocky day in markets yesterday as risk appetite was severely impaired. The ECB wound up being more dovish than many had expected by extending the guidance on interest rates and definitively rolling over the TLTRO program. And yet, this morning many analysts are complaining they didn’t do enough! The details are that interest rates will now remain where they are (-0.4% deposit rate) until at least the end of the year, well past “through the summer” as the guidance had been previously. Of course, for some time now, my own view has been that rates will remain unchanged well into 2020. In addition, the ECB said that there would be a new round of TLTRO’s initiated in September, but that the maturity of these new loans would only be two years, and the terms are not yet decided, with some indications they may not be as favorable as the current crop.

All of this followed in the wake of the ECB revising lower their 2019 GDP growth forecast from 1.7% to 1.1%. But remember, the OECD is looking for even slower growth at just 1.0%. “We never thought we were behind the curve,” said Signor Draghi, and “in any event today we are not behind the curve, for sure.” These comments are not nearly as impactful as “whatever it takes” from 2012, that’s the only thing for sure! Several other ECB members were quick to express that there was no expectation of a recession this year, but the market seems to have a less positive view. The market response to the surprisingly increased dovishness was negative across the board, with equity markets selling off in Europe (~-0.6%) and the US (-0.8%) while government bonds rallied (Treasuries -4.5bps) and the dollar strengthened materially, rising 1.2% vs. the euro.

But wait, there’s more! Overnight, Chinese trade data was released, and it turns out that exports fell -20.7% from a year ago! Now, in fairness, part of this has to do with the timing of the Chinese New Year, which was earlier this year than last, but even when stripped out of the data, the underlying trend showed a -4.7% decline. It appears that the US tariffs are really starting to bite.

Adding to the negative China sentiment were two more things. First, comments by Terry Branstad, the US ambassador to China, indicated that a trade deal was not so close (shocking!) and that the mooted meeting between President’s Trump and Xi later this month may well be postponed further. Second, in a huge surprise to Chinese investors, China Citic Securities issued a sell rating on one of the most popular stocks in the market there. The immediate response was for that particular stock, People’s Insurance Company (Group) of China, a state-owned insurer, to fall the daily 10% limit. This led the way for the Shanghai Index to fall 4.4% as investors now believe that the Chinese government is not merely willing to see equity markets fall, but actually interested in having it occur as they try to deflate the bubble that blew up during the past several months.

Needless to say, this information did not help assuage investor feelings anywhere, with the rest of Asia suffering on the day (Nikkei -2.0%, Hang Seng -1.9%) while Europe is also going down that road with the Stoxx 600 currently lower by -0.8%. And US futures? They too are under pressure, -0.4% as I type following yesterday’s -0.8% declines. [As an aside, can someone please explain to me why global index purveyors like MSCI are willing to include Chinese shares in their indices? Given the clear government market manipulation that exists there, as well as the foreign investment restrictions, the idea that they represent a true valuation of a company is laughable.]

So that is the backdrop as we head into the US session with employment data the first thing we’ll see. Expectations are currently as follows:

Nonfarm Payrolls 180K
Private Payrolls 170K
Manufacturing Payrolls 11K
Unemployment Rate 3.9%
Average Hourly Earnings 0.3% (3.3% Y/Y)
Average Weekly Hours 34.5
Housing Starts 1.197M
Building Permits 1.289M

The data of late has pretty consistently shown the US economy holding its own relative to everywhere else in the world. Meeting expectations today would simply reinforce that view. Now, Fed speakers this week (Brainerd, Williams and Clarida) have been consistent in their comments that given the current situation and outlook, there is no need to raise rates further. And yet, that is still relatively hawkish compared to the ECB who has actually added more stimulus. Chairman Powell speaks this afternoon as well, but it would be remarkable if he were to change the message. In the end, the relative story remains the same; the US is still the best performing economy (although it is showing signs of slowing) and the dollar is likely to continue to benefit from that reality.

Good luck and good weekend
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Mario’s Turn

It’s Mario’s turn to explain
Why rates should start rising again
His problem, of course
Is he can’t endorse
A rise if it leads to more pain

Markets have been quiet overnight as traders and investors await the ECB’s policy statement, and then perhaps more importantly, Signor Draghi’s press conference to be held at 8:30 this morning. The word filtering out from the ECB is that the TLTRO discussion has moved beyond the stage of IF they need to be rolled over to the stage of HOW exactly they should construct the process. Yesterday’s OECD downgrade of Eurozone growth is likely the last straw for the more hawkish ECB members, notably Germany, Austria and the Netherlands. This is especially so given the OECD slashed their forecasts for German growth by 0.8%! As it happens, Eurozone GDP data was released this morning, and it did nothing to help the monetary hawks’ cause with Q4’s estimate revised lower to 1.1% Y/Y. While the FX market has shown little overall movement ahead of the ECB meeting, European government bonds have been rallying with Italy, the country likely to take up the largest share of the new TLTRO’s, seeing the biggest gains (yield declines) of all.

Once again, the juxtaposition of the strength of the US economy and the ongoing weakness in the Eurozone continues to argue for further gradual strength in the dollar. That US strength was reaffirmed yesterday by the much higher than expected trade deficit (lots more imports due to strong demand) as well as the ADP Employment report, which not only saw its monthly number meet expectations, but showed a massive revision to the previous month, up to 300K from the initial 213K reported. So, for all the dollar bears out there, please explain the drivers for a weaker dollar. While the Fed has definitely turned far less hawkish, so has every other central bank. FX continues to be a two-sided game with relative changes the key drivers. A more dovish ECB, and that is almost certainly what we are going to see this morning, is more than sufficient to undermine any long-term strength in the euro.

Beyond the ECB meeting, however, the storylines remain largely the same, and there has been little movement in any of the major ones. For example, the Brexit deadline is drawing ever closer without any indication that a solution is at hand. Word from the EU is that they are reluctant to compromise because they don’t believe it will be sufficient to get a deal over the line. As to PM May, she is becoming more explicit with her internal threats that if the euroskeptics don’t support her deal, they will be much less pleased with the ultimate outcome as she presupposes another referendum that will vote to Remain. The pound continues to struggle in the wake of this uncertainty, falling another 0.25% overnight which simply indicates that despite all the talk of the horror of a no-deal Brexit, there is a growing probability it may just turn out that way.

Looking at the US-China trade talks, there has been no word since Sunday night’s WSJ story that said the two sides were moving closer to a deal. The trade data released yesterday morning was certainly significant but is really a reflection of the current global macroeconomic situation, namely that the US economy continues to be the strongest in the world and continues to absorb a significant amount of imports. At the same time, weakness elsewhere has manifested itself in reduced demand for US exports. In addition, there was probably some impact from US importers stuffing the channel ahead of worries over increased tariffs. With that concern now dismissed after the US officially stated there would be no further tariff increases for now, channel stuffing is likely to end, or at least slow significantly. Given the lack of information regarding the status of the trade talks, there is no way to evaluate their progress. The political imperatives on both sides remain strong, but there are some very difficult issues that have yet to be addressed adequately. In the meantime, the reniminbi has been biding its time having stabilized over the past two weeks after a 3.0% rally during the previous three months. That stability was evident overnight as it is essentially unchanged on the day.

Beyond those stories there is precious little to discuss today. There is a bit of US data with Initial Claims (exp 225K) along with Nonfarm Productivity (+1.6%) and Unit Labor Costs (+1.6%) all released this morning. In addition, we hear from Fed governor Brainerd (a known dove) early this afternoon. But those things don’t seem likely to be FX drivers today. Rather, it is all about Signor Draghi and his comments. The one other thing to note is that risk appetite in markets, in general, has been ebbing of late. US Equities have fallen in six of the past eight sessions and futures are pointing lower again. The same has largely been true throughout Europe, where markets are lower this morning by roughly 0.4%. fear is a growing factor in markets overall, and as we all know by now, both the dollar and the yen are the main FX beneficiaries in that scenario. It feels like the dollar has room to edge higher today, unless Draghi is quite hawkish. And that is a low probability outcome!

Good luck
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A Lack of Pizzazz

This week, central banks, numb’ring three
Released information that we
Interpreted as
A lack of pizzazz
So, don’t look for tight policy

Yesterday’s release of the ECB Minutes from their January meeting didn’t garner nearly as much press as the FOMC Minutes on Wednesday. However, they are still important. The topic du jour was the analysis necessary to help them determine if rolling over the TLTRO’s was the appropriate policy going forward. Not surprisingly, the hawks on the committee, like Austria’s Ewald Nowotny, said there is no hurry and a decision doesn’t need to be taken until June when the first of these loans fall below twelve months in their remaining term. I am pretty sure that he is against adding any more stimulus at all. At the same time, given the recession in Italy and slowing growth picture throughout Germany and France, and given that Italian and French banks had been the first and third most active users of the financing, in the end, the ECB cannot afford to let them lapse. I remain 100% convinced that these loans will be rolled over in an effort to ‘avoid tightening financial conditions’, not in order to ease them further. However, the market impact of the Minutes was muted at best, as has been this morning’s data releases; one confirming that German GDP was flat in Q4, and more importantly, the decline in the Ifo Business Climate indicator to 98.5, its lowest level in four years. Meanwhile, Eurozone inflation remains absent from the discussion with January’s data confirmed to have declined to a 1.4% Y/Y rise. Nothing in this data indicates the ECB will tighten policy in 2019, and quite frankly, I would be shocked to see them move in 2020 as well.

The other central bank information of note was the Bank of Canada, where Governor Poloz spoke in Montreal and explained that while the current policy setting (base rates are 1.75%) remain below their range of estimates of the neutral rate (2.5%-3.5%), current conditions dictate that there is no hurry to tighten further, especially with the ongoing uncertainty emanating from the US and the overall global trade situation. So here is another central bank that had been talking up the tightening process and has now backed away.

In virtually every case, the central banks continue to hang their hats on the employment market’s strength, and the idea that a tight jobs market will lead to higher wages, and thus higher inflation. The thing is, this Phillips Curve model has two flaws; first it only relates lower unemployment to higher wages, not higher general inflation; and second, it is based on an analysis of the UK from 1861-1957, which may not actually be a relevant timeline compared to the global economy in 2019. And one other thing to remember is that employment is a lagging indicator with respect to economic signals. This means that it is backward looking and has been demonstrated to have limited predictive power. My point is that despite a clearly strong employment situation, it is still entirely possible that global growth can slow much further and much more quickly than policymakers would have you believe.

Back to the currency markets, the upshot of all the new information was that traders have essentially left both the euro and the Loonie unchanged for the past two days. In fact, they have left most currencies that way. This morning’s largest G10 mover is the pound, which just recently has extended its losses to -0.40% after it became clear that the EU was NOT going to make any concessions regarding the backstop issue as had been believed just yesterday. The latest story is that the UK is going to ask for a three-month extension, which is likely to be granted. The thing is, the problem is not going to get any easier to solve in three months’ time than it is now. This will simply extend the time of uncertainty.

Of course, the other story is the trade talks and the positive spin that we continue to hear despite the information that there remain wide differences on key issues like enforcement of any deals as well as the speed with which the Chinese are willing to open up their markets. It is all well and good for the Chinese to say they will buy more corn, or more soybeans or more oil, but while nice, those pledges don’t address the question of IP protection and state subsidies. I remain concerned that any deal, if it is brokered, will be much less impactful than is claimed. And it is quite possible that the US will not remove any of the current tariffs until they have validation that the Chinese have upheld their side of any deal. I feel like the market is far too optimistic on this subject, but then again, I am a cynic.

While FX markets have been slow to respond to these stories, we continue to see equity markets wholeheartedly embrace the idea that a deal is coming soon and there is no reason to worry. Last night, Chinese equity markets rallied sharply (Shanghai +1.9%), although the Nikkei actually slipped -0.2%. European markets this morning are higher by around 0.4%-0.5%, as they, too, seem bullish on the trade picture. Certainly, it is not based on the economic picture in the Eurozone.

But as we have seen for the past several weeks, central banks, Brexit and trade are the only stories that matter. Right now, investors and traders are giving mixed signals, with the equity markets feeling positive, but currency and bond markets much less so. My money is on the bond market vs. the stock market as having correctly analyzed the situation.

Good luck and good weekend
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More Frustration

In Europe, the dominant nation
Is starting to feel more frustration
As data implies
They’ll soon demonize
The Chinese US for their degradation

The story in Europe continues to be one of diminishing growth across the board. Early this morning, German Factory Order data was released showing orders unexpectedly fell -1.6% in December after a downwardly revised -0.2% decline in November. Weakness was seen in every sector as both domestic and foreign demand shrank. There is no way to paint this as anything other than a sign of ongoing economic malaise. Once again, I will point out that there is a vanishingly small probability that the ECB will consider raising interest rates later this year, with a far more likely scenario being that further policy ease is on the way. The immediate impact of this data was to see the euro continue its recent decline, having fallen a further 0.2% this morning and now trading back below the 1.14 level.

Speaking of potential further easing of ECB monetary policy, the discussion regarding TLTRO’s is starting to heat up. These (Targeted Long-Term Refinancing Operations) were one of the several ways the ECB expanded their balance sheet during the Eurobond crisis several years ago. The idea was that the ECB made cheap (or even negative rate) liquidity available to Eurozone banks that wanted to fund an increase in their loan books. If the loans qualified (based on the recipients) banks actually got paid to borrow the money from the ECB. So, it was a pretty sweet deal for them, getting paid on both sides of the transaction. Because these loans had initial terms of four and five years, they also counted toward banks’ capital ratios and thus helped reduce their overall cost of funding.

But starting in June, the first of these loans will fall under twelve months until repayment is due, and thus will no longer be able to be counted as long-term capital. As I have written before, there are two possible scenarios: this financing rolls off and banks are forced to fund their outstanding loans in the markets at a much higher price. The result of this will be either slimmer profit margins for the banks, undermining their balance sheets, or they will be forced to raise rates or call in those outstanding loans, neither of which will help the growth story in Europe. The other, far more likely, choice is for the ECB to roll the TLTRO’s over, allowing the banks to maintain their interest rate margins and insuring that there is no tightening of monetary policy in the Eurozone. Given the ongoing weakness in data, which do you think is going to happen? Exactly, they will be rolled over, despite the fact that the ECB is unwilling to commit to that right now. It would be shocking if that is not the outcome!

But the euro is not the only currency to decline this morning, in fact, dollar strength has been pretty widespread. For example, AUD has fallen -1.45% after RBA Governor Lowe explained that the balance of risks for the Australian economy had tilted lower. The market has understood that as a ‘promise’ that future rate hikes have been delayed indefinitely. Aussie’s fall helped drag Kiwi lower as well, with NZD down -0.65%. Meanwhile, the ongoing decline in oil prices, most recently on the back of rising US inventories, has undermined CAD (-0.6%), NOK (-0.4%), MXN (-0.5%) and RUB (-0.4%). Interestingly, the pound, which had been lower earlier, is the one G10 currency that has held its own this morning. Of course, it has been declining steadily for more than two weeks, ever since the last big Parliamentary vote. What appears to be happening is that traders grew to believe that with Parliament taking charge of the negotiations, a deal would be reached, and the risk of a hard Brexit diminished. But funnily enough, Parliament is learning that despite their distaste for the Irish border solution proposed by PM May, there is no obvious better way to address that intractable problem. Traders are starting to lose their confidence that the outcome will be a deal, as despite a universal claim that a hard Brexit should not and cannot happen, it just might happen.

Turning to emerging markets, we have seen weakness across the board there as well. One of the big changes that the Fed has wrought by changing its stance from ongoing hawkishness to apparent dovishness is that many APAC central banks, that had been raising rates steadily alongside the Fed last year, are now backing away from those policies. Last night Bank of Thailand left rates on hold and later this week we will hear from both the Philippines (no change expected) and India (possible 25bp rate cut). Both mark a change from recent policy direction. So, while the dollar suffered in the wake of the Fed’s change, as that sentiment propagates around the world, I expect that the dollar will find its footing. After all, if every central bank is easing policy, the forces driving the FX market will need to be non-monetary. And for now, the US remains the best economy around, despite recent signs of slowing here.

One other story I need to mention is an article in Bloomberg (https://www.bloomberg.com/news/articles/2019-02-06/imf-staff-floats-dual-money-to-allow-much-deeper-negative-rates?srnd=markets-vp) that talks about a paper written at the IMF suggesting the creation of e-money to be issued alongside current cash. E-money would have negative interest rates and an exchange rate with cash which would drive the value of cash lower over time (effectively creating a negative interest rate for holding cash). Given my current role as Chief Strategist at 9th Gear Technologies, I have a particular interest in the concept of e-money, as I do believe cash will become scarcer and scarcer over time. I have also been vocal in my concerns that e-money will result in permanent negative interest rates, and that was before the IMF weighed in with that exact view.

Turning to this morning’s data releases, US Trade data is due (exp -$54.0B) at 8:30, and then we hear from the Fed’s Randall Quarles this afternoon. However, his focus continues to be on regulation, so I don’t anticipate any new monetary policy information. If the news from Asia is the new trend, then expect to see talk of easier money from all around the world, with the Fed, once again becoming the tightest policy around, thus supporting the dollar. I don’t imagine it will happen all at once, as there are still those harping on the Fed’s U-turn, but eventually, the news will be other banks easing while the Fed stands pat.

Good luck
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