Tag Archives: #trade war

Will Not Be Quelled

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Both sides in the trade war appear
To want nothing more than to steer
The narrative toward
A place where each scored
Political points, crystal clear
 
But markets, which yesterday felt
The problems would soon, away, melt
Are nervous today
And cannot allay
Their fear losses will not be quelled

 

It is becoming more difficult to discuss markets writ large as we have seen some historic relationships fall apart over the past 6 months.  For instance, the idea that both gold (and all precious metals) and the dollar would rise simultaneously is hard for old-timers like me to understand.  In ordinary times, the two had a very different relationship as gold was, essentially, just another currency.  If you look at the two charts below from tradingeconomics.com, you can see a longer-term chart that demonstrates, at best, independent behavior, and while the magnitudes of the movements are somewhat different, you can see that as the dollar peaked in late 2022, gold was bottoming and there is a general inverse correlation.

However, over the past month, that story is completely different as evidenced by this chart (which is based on percentage moves):

The other day I mentioned the debasement trade, the idea that investors were scooping up gold and bitcoin because they didn’t want to hold dollars.  However, it is harder to make that case about dollars, although fiat in general may be a different story.

I highlight this because I use the term ‘markets’ all the time as a generic concept, but lately, I need more specificity, I think.  So, Friday, when there appeared to be a sudden escalation in the trade war between China and the US, equity markets fell sharply, precious metals rallied, and bonds rallied while the dollar edged lower.  Yesterday, with the bond market closed, and a concerted effort by both sides to claim nothing had changed and that Presidents Trump and Xi would still be meeting at the ASEAN conference in two weeks, equity markets rebounded sharply, precious metals continued to rally, and the dollar rebounded.  Bringing us up to date now, equity markets are back under pressure (it appears that the trade situation is still an issue), precious metals are still rallying alongside the dollar, and as the bond market reopens, it, too, is rallying with yields slipping -3bps to 4.00%.

Some of this doesn’t make much sense, but I will try to address things, at least broadly speaking.  The constant across these moves has been precious metals rallying and I believe there are two stories working together here.  There is a fundamental story where central banks and, increasingly, individual investors are buying gold as they are seeking safe havens in an increasingly uncertain world.  Silver and platinum both benefit from this, as well as ongoing industrial demand, especially from the technology sphere.  But there is also a serious short squeeze unfolding in both the gold and silver markets as there is a mismatch between inventories held on exchanges and demand for physical metal.  

In the leadup to Liberation Day, you may remember the story of a huge inflow of gold and silver to the COMEX in the US ahead of feared tariffs on precious metals imports, although those tariffs never materialized.  However, all that metal sits in COMEX vaults today and is likely hedged with short futures contracts.  Meanwhile, London has a shortage of available metal and owners of LME contracts are seeking delivery, thus pushing the shorts to buy back at ever higher prices.  My friend JJ (Market Vibes on Substack) made the point there is a big difference between a bubble and a short squeeze, and a squeeze can go on much longer depending on the size of the short relative to the market’s overall size.  I think that’s what we are currently witnessing in both gold and silver.

As to the debasement trade idea, there are two things that call this theory into question, the dollar’s continued rebound and the bond market’s rally driving yields lower.  Arguably, the key concern in debasement is a dramatic increase in inflation, something I also fear.  But if that is the fear, how is it that bond yields, which are entirely reliant on pricing future inflation, are declining.  And that is what they have been doing since the beginning of the year, with 10-year yields falling ~80bps, and in truth, having gone nowhere since late 2022.

Source: tradingeconomics.com

Meanwhile, the dollar, which did decline in the first half of the year, looks very much like it is forming a base here.  It is certainly not in a serious decline as evidenced by the chart below.

Source: tradingeconomics.com

What about equity markets?  Well, they have much that goes on away from macroeconomic issues, such as company earnings and more sector specific events, although the macro can have an impact.  We all know the AI story has been THE driver of the equity rally this year, really the past 2+ years, pushing everything else aside.  However, the trade tiff between China and the US, and growing around the world (the Netherlands just expropriated a Chinese owned chip company!) is highly focused on the AI story, and if trade is severely impacted, especially in chips and technology, that does not bode well for the drivers of the equity rally.  Whether that results in a rotation into other companies or a wholesale liquidation is far less clear.  

This morning, for instance, all European bourses are lower (DAX -1.6%, CAC -1.3%, FTSE 100 -0.6%, IBEX -0.6%) and overnight we saw significant weakness on Japan’s reopening (-2.6%) as well as China (-1.2%) and HK (-1.7%).  Too, US futures are lower across the board at this hour (7:15) by -1.0% or so.  The indication is that a rotation is not the story, rather a reduction of risk.  Of course, we could easily see more comments from both China and the White House (who are meeting at the IMF meetings in Washington right now) that things have de-escalated and turn the whole ship back around.  It should be no surprise that the VIX is rallying.

As to bonds, European sovereign yields have fallen by between -3bps and -4bps across the continent while UK gilts (-7bps) have fallen further after employment data there showed the Unemployment Rate ticked up to 4.8% unexpectedly while there were job losses as well.  In fact, looking at the chart below of Payroll Changes over the past three years, the trend seems pretty clear!

Source: tradingeconomics.com

Those UK employment figures also weighed on the pound (-0.45%) which is declining in line with most of the G10 bloc (NOK -1.1%, AUD -0.9%, NZD -0.5%) although the yen (+0.25%) is bucking the trend, perhaps because of its haven status.  NOK is suffering from oil’s (-2.2%) sharp decline after the IEA, once again, said there would be a supply surplus, although their forecasts have been wrong, and consistently overestimating supply and underestimating demand, for the past decade.  

As to the EMG bloc, despite the rally in precious metals, both ZAR (-0.9%) and MXN (-0.8%) are under pressure as is KRW (-0.6%) after the story that China is imposing restrictions on Korean ship builders in the US that are helping America try to reverse the decimation of our shipbuilding industry.  

Trying to recap all that is happening, fear is pervasive across investors of all stripes.  The hunt for havens continues and absent a more lasting trade truce between the US and China, something I think will be very difficult to achieve, volatility is likely to be the dominant feature in all markets.  In the end, though, there is no evidence that the dollar is being ‘dumped’ in any manner and while gold and precious metals may continue to rally, given 2 Fed rate cuts are already priced in for the rest of the year, we will need something completely outside the box to see the dollar fall in any meaningful manner, I believe.  For hedgers, markets like these are why you remain hedged!

Good luck

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Off to the Races

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Though headlines describe the new cases
Of Covid, in so many places
The market’s real fear
Is later this year
The trade war is off to the races

Risk is under pressure today as, once again, concerns grow that increased trade tensions will derail the rebound from the Covid inspired global recession. You may recall yesterday’s fireworks in Asia after Peter Navarro seemed to describe the phase one trade deal as over. (Remember, too, President Trump quickly remedied that via Twitter.) This morning has seen a somewhat less dramatic market impact, although it has shown more staying power, after the Trump Administration explained that it was targeting $3.1 billion of European and UK goods for tariffs in a WTO sanctioned response to the EU’s illegal Airbus subsidies. Of course, the fact that they are sanctioned does not make them any less damaging to the economic rebound. Pretty much the last thing the global economy needs right now is something else to impede the flow of business. According to reports, the targeted goods will be luxury goods and high-end liquors, so the cost of that Hendricks and Tonic just might be going up soon. Naturally, the EU immediately responded that they would have to retaliate, although they have not released a list of their targets.

Needless to say, even the unbridled optimism over a central bank induced recovery was dented by these announcements as they are a direct attack on the idea that growth will rebound to previous levels quickly. Now, those tariffs are not yet in place, and the US has said they are interested in negotiating a better solution, but investors and traders (and most importantly, algorithms) are programmed to read tariffs as a negative and sell stocks. And so, what we have seen this morning is a solid decline across European bourses led by the DAX (-2.1%) and FTSE 100 (-2.3%) although the rest of the continent is looking at declines between of 1.25% and 1.75%. It is a bit surprising that the bond market has not seen things in quite the same light, with 10-year Treasury yields almost unchanged at this hour, as are German bund yields, and only Italian BTP’s seeing any real movement as yields there rise (prices fall) by 2bps. Of course, we recognize that BTP’s are more akin to stocks than bonds these days.

In the background, though, we continue to hear of a resurgence in Covid cases in many places throughout the world. In the US, newly reported infections are rising in many of the states that are going through a slow reopening process. There are also numerous reports of cases popping up in places that had seemed to have eliminated the virus, like Hong Kong, China and Japan. And then, there are areas, notably LATAM nations, that are seeing significant growth in the caseload and are clearly struggling to effectively mitigate the impact. The major market risk to this story is that economies around the world will be forced to stage a second shutdown with all the ensuing economic and financial problems that would entail. Remember, too, that if a second shutdown is in our future, governments, which have already spent $trillions they don’t have, will need to find $trillions more. At some point, that is also likely to become a major problem, with emerging market economies likely to be impacted more severely than developed nations.

So, with those unappetizing prospects in store, let us turn our attention to this morning’s markets. As I mentioned, risk is clearly under pressure and that has manifest itself in the foreign exchange markets as modest dollar strength. In the G10 space, NZD is the laggard, falling 0.9% after the RBNZ, while leaving policy on hold, promised to do more to support the economy (ease further via QE) if necessary. Apparently, the market believes it will be necessary, hence the kiwi’s weakness. But away from that, the dollar’s strength has been far more muted, with gains on the order of 0.2%-0.3% against the higher beta currencies (SEK, AUD and CAD) while the euro, yen and pound are virtually unchanged on the day.

In the EMG bloc, it has been a tale of two sessions with APAC currencies mostly gaining overnight led by KRW (+0.8%), which seemed to be responding to yesterday’s news of sunshine, lollipops and roses modestly improving economic data leading toward an end to the global recession. Alas, all those who bought KRW and its brethren APAC currencies will be feeling a bit less comfited now that the trade war appears to be heating up again. This is made evident by the fact that the CE4 currencies are all lower this morning, led by HUF (-0.6%) and CZK (-0.4%). In no uncertain terms, increased trade tensions between the US and Europe will be bad for that entire bloc of economies, so weaker currencies make a great deal of sense. As to LATAM, they too are under pressure, with MXN (-0.5%) the only one open right now, but all indications for further weakness amid the combination of the spreading virus and the trade tensions.

On the data front, we did see German IFO data print mildly better than expected, notably the Expectations number which rose to 91.4 from last month’s reading of 80.1. But for context, it is important to understand that prior to the onset of Covid-19, these readings were routinely between 105 and 110, so we are still a long way from ‘normal’. The euro has not responded to the data, although the trade story is likely far more important right now.

In the US we have no data of note today, and just two Fed speakers, Chicago’s Evans and St Louis’ Bullard. However, as I have pointed out in the recent past, every Fed speaker says the same thing; the current situation is unprecedented and awful but the future is likely to see a sharp rebound and in the meantime, the Fed will continue to expand their balance sheet and add monetary support to the economy.

And that’s really all there is today. US futures are pointing lower, on the order of 0.75% as I type, so it seems to be a question of watching and waiting. Retail equity investors continue to pile into the stock market driving it higher, so based on recent history, they will see the current decline as another opportunity to buy. I see no reason for the dollar to strengthen much further barring yet another trade announcement from the White House, and if my suspicions about the stock market rebounding are correct, a weaker dollar by the end of the day is likely in store.

Good luck and stay safe
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The UK Wants to Shun

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This morning as part of his plan
For Brexit, the PM began
A series of talks,
Before Britain walks,
With Angela as middleman

Alas, when the phone call was done
The odds of a deal approached none
The EU made clear
The (Northern) Irish adhere
To rules the UK wants to shun

The pound is suffering this morning, down 0.5%, after news that a phone call between Boris and Angela resulted in Johnson explaining that a Brexit deal is “essentially impossible” at the current time. If you recall, Boris’s plan was for Northern Ireland to adhere to EU rules on manufactured goods and agricultural products while customs activities would take place a number of miles from the actual border. Finally, Northern Ireland would be allowed to vote every four years to determine if they were happy with that situation. The EU view is that Northern Ireland must remain a part of the customs union in perpetuity, something that would essentially split them from the rest of the UK. It is no surprise that both Boris and Northern Ireland rejected that outcome, and so the Johnson government has increased preparations for a hard Brexit.

There are two interesting tidbits ongoing as well, both of which bode ill for a deal. First is that Irish Taoiseach Leo Varadkar is terrified that he and his nation will be blamed if no deal is reached. And when I say terrified, it means that he is afraid that a no-deal Brexit will result in a significant (~5%) hit to Ireland’s economy and that he will be tossed from office because of that. Remember, every politician’s number one priority during any situation is to be reelected, hence his terror. His response has to increase the rhetoric about how Boris is the problem, further poisoning the well. The second interesting thing is that a survey in the EU by Kantar (a European polling company) showed that between 47% and 66% of citizens in six EU nations (France, Germany, the Netherlands, Ireland, Spain and Poland) believe the EU should not extend the Brexit deadline, with a solid majority in all nations except the Netherlands. Perhaps Boris will get his wish that Europe won’t offer an extension or agree to one if asked. It appears that this saga is reaching its denouement. And despite all of this, I continue to see a strong possibility that the EU blinks as they figure out Boris is serious. My impression is that Merkel and the EU continue to believe that the UK will come begging, hat in hand, for another extension and that a new vote will lead to the end of this process with the UK revoking Article 50. And so they continue to believe they are dealing from a position of strength. We shall see.

Of course, the reason we care so much about this is not just for the impact on the British pound, but actually the impact on the global economy. Consider that the global economy has been slowing steadily for the past eighteen months under pressure from the ongoing trade war between the US and China and the uncertainty that has engendered. If the estimates of the economic impact of a hard Brexit are even halfway correct, we are looking at a sharp decline in economic activity in the UK, Ireland, Germany, France and the Netherlands, ranging between 0.5% and 5.0%. I assure you that will not help the global growth situation. It will also result in immediate additional policy ease by the world’s central banks, notably the Fed. The impact on equity markets will be significant, bond markets will rally sharply as will haven currencies. In other words, it could easily be the catalyst required to bring on that recession on the horizon.

Beyond Brexit, the other big story overnight was on trade as the US put 28 Chinese firms on an export blacklist under the guise of those companies helping in repression of Muslim minorities in northwest China. Not surprisingly, the Chinese were not amused and ‘instructed’ the US to correct its mistake. They also told the world to “stay tuned” for any retaliation that will be forthcoming. Fortunately, this has not changed the plans for the trade talks to be held on Thursday and Friday in Washington with Vice-premier Liu He, at least not yet. But that remains a huge concern, that He will not make the trip and that the trade impasse will harden. At this point it has become pretty clear that a big trade deal is not in the offing. The Chinese appear to be betting that President Trump will lose the election and so are waiting him out. However, this is the one area where the President truly has bipartisan support so it is not clear to me that a President Warren, Biden or Sanders would be any more inclined to come to an agreement that didn’t meet hurdles regarding IP theft and state subsidies.

The combination of these two events has served to undermine equity markets in Europe with virtually every major index having fallen by more than 1% this morning. While Asian equity markets performed well (Nikkei +1.0%, KOSPI +1.2%, Shanghai +0.25%) that was before the Boris-Angela call. US futures have turned lower in the past hour with all three exchanges now pointing to 0.5% declines on the opening. Meanwhile, Treasury yields continue to fall with the 10-year at 1.52%, down 4bps and Bunds are following with yields there down 1.5bps.
As to the dollar, it is no surprise the yen (+0.4%) and Swiss franc (+0.35%) have rallied, but a bit more surprising that aside from the pound, most other G10 currencies are firmer. That said, the movement has not been that large and if we see a true risk-off session in the US, I would expect the dollar to strengthen. In the EMG space, ZAR is the biggest loser today, falling 0.65%, after Renaissance Capital put out a report that the country’s debt would be downgraded to junk status next month. Given their recent track record, correctly calling 8 of the past 9 ratings moves, it is being given some credence. After that, RUB has fallen 0.5% on the back or weaker oil prices, which are down 1.3% this morning and more than 11% from before the attack on the Saudi oil facility in the middle of September.

As to data today, NFIB was already released at a slightly weaker than expected 101.8. While that remains at the high end of its historic readings, it is clear that this series has rolled over and is heading lower. We also get PPI (exp 1.8%, 2.3% ex food & energy) at 8:30 but most folks ignore that and are looking for CPI on Thursday. Chairman Powell speaks again today at 2:30 this afternoon, so all eyes will be focused on Denver to see how he responds to the most recent gyrations in the big stories.

Overall, it feels like a day of uncertainty and risk reduction. Look for further yen and Swiss franc strength as well as for the dollar to regain its footing against the rest of its counterparts.

Good luck
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Not Making Hay

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In China, despite what they say
The ‘conomy’s not making hay
Their exports are lagging
With industry gagging
On stuff manufactured each day

The upshot’s the PBOC
Released billions of renminbi
Reserve rates are shrinking
And everyone’s thinking
They’ll shrink further ere ought twenty

Long before trading started last evening, Chinese trade data set the tone for the markets as exports there shrank by 1.0% in USD terms, a clear indication that the trade war is starting to bite. Imports fell further (5.6%), but overall, the trade surplus was significantly smaller than expected. In the current market environment, it cannot be a surprise that the response was for a rally in Asian equity markets as the weak data presages further policy ease by the Chinese. In fact, there are numerous articles discussing just what options they have. Friday afternoon they cut the reserve ratio by a full percentage point, and analysts all over are expecting at least one more cut before the end of the year. As to direct interest rate cuts, that is far less clear given the still problematic bubble tendencies in the Chinese real estate market. The PBOC is quite concerned over allowing that bubble to blow up further, so any reductions in the benchmark rate are likely to be modest…at least until the renminbi starts to strengthen again.

Speaking of the currency, while it has remained quite stable overall, -0.2% this morning, +0.65% in the past week, it remains one of the easiest tools for the PBOC to utilize. The government there has also sought to stimulate via fiscal policy, with significant tax cuts proposed and some implemented, but thus far, those have not been effective in supporting economic growth. While I am confident that when the next GDP number prints in mid-October it will be above 6.0%, there are an increasing number of independent reports showing that growth there is much slower than that, with some estimates more in line with the US at 3.0%. At any rate, equity markets continue to believe that a trade deal will happen sooner rather than later, and as long as talks continue, look for a more positive risk attitude across markets.

The other big news this morning is from the UK, where British PM Boris Johnson met with his Irish counterpart, Taoiseach Leo Varadkar, to discuss how to overcome the Irish backstop conundrum. It is interesting to see the two attitudes; Boris quite positive, Leo just the opposite, but in the end, nothing was agreed. In this instance, Ireland is at far more risk than the UK as its much smaller economy is far more dependent on free access to the UK than vice versa. But thus far, Varadkar is holding his ground. Another Tory cabinet member, Amber Rudd, quit Saturday night, but Boris is unmoved. There was an interesting article over the weekend describing a possible way for Boris to get his election; he can call for a no-confidence vote in his government, arguably losing, and paving the way for the election before the Brexit deadline. Certainly it seems this would put parliament in an untenable position, support him to prevent the election, but that would imply they support his program, or defeat him and have the election he wants.

Of course, while all this is ongoing, the currency market is looking at the pound and trying to decide the ultimate outcome. For the past two weeks, it is clear that a belief is growing there will be no Brexit at all as the pound continues to rally. This morning it is higher by 0.6% and back to its highest level in over a month. Part of that, no doubt, was the UK GDP data, which surprised one and all by showing a 0.3% gain in July, which virtually insures there will be no technical recession yet. But the pound is a solid 3.5% from its lows seen earlier this month. I continue to believe that the EU will blink and a deal will be cobbled together with the pound rebounding much further.

Elsewhere, the dollar is softer in most cases. The continuation of last week’s risk rally has reduced the desire to hold dollars and we continue to see yields edge higher as well. Beyond the pound’s rally, which is the largest in the G10 space, AUD and NZD have pushed back up by about 0.3% on the China stimulus story, but the rest of G10 is quite dull. In the EMG bloc, ZAR is today’s big winner, +0.8%, as hopes for more global stimulus increase the relative attractiveness of high yielding ZAR denominated bonds. But otherwise, here too, things are uninteresting.

Looking to the data this week, it is an Inflation and Retail Sales week with no Fed speak as they are now in their quiet period ahead of next week’s meeting.

Today Consumer Credit $16.0B
Tuesday NFIB Small Biz Optimism 103.5
  JOLT’s Job Openings 7.311M
Wednesday PPI 0.0% (1.7% Y/Y)
  -ex food & energy 0.2% (2.2% Y/Y)
Thursday Initial claims 215K
  CPI 0.1% (1.8% Y/Y)
  -ex food & energy 0.2% (2.3% Y/Y)
Friday Retail Sales 0.2%
  -ex autos 0.1%
  Michigan Sentiment 90.5

Aside from this, we hear from both the ECB and BOJ this Thursday with expectations for a rate cut and potentially more QE by Signor Draghi, while there are some thoughts that Kuroda-san will be cutting rates in Japan as well. Ultimately, nothing has changed the broad sweep of central bank policy ease. As long as everybody is easing, the relative impact of monetary policy on the currency market will be diminished. And that means that funds will continue to flow to the best performing economies with the best prospects. Despite everything ongoing, the US remains the choice, and the dollar should remain supported overall.

Good luck
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The Optimists Reign

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This morning the optimists reign
As China was keen to explain
They felt it unwise
That tariffs should rise
They’d rather start talking again

Equity bulls are on the rampage this morning as all the negative stories have been overwhelmed by positive sentiment from two areas, China and Italy. From China last night we heard that despite President Trumps’ latest decision to increase tariffs further on Chinese imports, the nation would not escalate the situation, and instead wanted to maintain the dialog and seek common ground. Spokesman Gao Feng said that while China is protesting, they are not responding. He also confirmed that ongoing communications would likely lead to another face-to-face meeting in Washington in September. We heard confirmation from Treasury Secretary Mnuchin that a meeting in Washington was to take place in September, although the final details have not yet been decided.

However, this was more than enough for the bulls to stampede as once again they seem willing to believe that a solution is close at hand. One need only look at the timeline of every other trade negotiation in history to recognize that these things take a very long time to come to agreement. And of course, as I have written before, there are fundamental issues that seem unlikely to ever be addressed to the satisfaction of both sides. For example, while a key issue for the US is the theft of IP by Chinese companies, the Chinese won’t even acknowledge that takes place and therefore cannot agree to stop something they don’t believe is happening. Recall, as well, the issue when talks broke down in late spring, that the issue was the US was seeking the agreement be enshrined in law, as is the case in the US and every Western nation, but the Chinese refused claiming that was an infringement of their sovereignty and that they would simply make rules that would be followed. These are very big canyons to cross and will take a long time to do so. While it is certainly good news that the Chinese are not escalating things, and in fact, are making efforts to reduce market tensions via their CNY fixing activities, we are still a long way from a deal.

The upshot of the China story is that Asian equity markets rebounded from their lows to close near unchanged while European markets are all higher on the order of 1.0%. Treasury yields have edged up slightly as have yields in most sovereign bond markets, and the two main haven currencies, yen and Swiss francs, have both weakened slightly.

The other story that has the bulls on the move is from Rome, where Italian President, Sergio Mattarella has given the nod to the coalition of 5-Star and the Democratic Party (known as the PD and which, contrary to yesterday’s comment, is actually a center left party) to try to form a government. The thing that makes this so surprising, and bodes ill for any government’s longevity, is that 5-Star came to power by constantly attacking the PD as corrupt and the major problem in the country. But their combined fear of an election, where the League is likely to win an outright majority at this time, has pushed these unlikely bedfellows together. The market, however, loves it with Italian equities higher by 1.9% and Italian BTP’s (their sovereign bonds) rallying nearly a full point driving the 10-year yield down to a new historic low of 0.96%. Think about that for a moment, Italian 10-year yields are more than 50bps lower than US yields!

All in all, it is clearly a risk-on type of day. Looking at the FX markets shows a mixed bag of results although the theme is really modest movement. For example, in the G10, the biggest mover has been NOK, which is lower by 0.25%, while the biggest gainer is AUD, up just 0.2%. The latter has been helped by the China story, while the former is suffering after weaker than expected GDP data showed Q2 growth at just 0.3% in the quarter, well below expectations of a 0.5% rebound from last quarter’s negative print.

It should be no surprise that EMG currencies have a slightly larger range, but still, the biggest mover is ZAR, which has gained 0.5% while the weakest currency is TRY, falling 0.4%. From South Africa we learned that price pressures are less acute than anticipated as PPI actually fell in July engendering hope that the SARB can encourage more growth by maintaining the rate structure rather than raising rates. Meanwhile, Turkey continues to see erosion in both the number of incoming tourists, a key industry and source of hard currency, and incoming investment, where foreigners were net sellers of both stocks and bonds last week.

The one other noteworthy move has been CNY, where the renminbi is firmer by 0.25% today after the PBOC very clearly indicated their interest in preventing a sharp decline. The fix overnight was significantly stronger than every forecast and that has helped squeeze the differential between the fix and the currency market back below 1.0%. It is worthwhile to keep an eye on this spread as it can be a harbinger of bigger problems to come if it expands. Remember, the current band is 2.0%, so actions to change that or allow a breech are clear policy statements.

This morning we finally get some useful data led by the second look at Q2 GDP (exp 2.0%) and Initial Claims (214K). Overnight we saw German state inflation data point to continued weakening growth with the national number due soon. We also heard from SF Fed president Daly yesterday who was clearly on board for another rate cut, while Richmond’s Patrick Harker was far less enthused. However, neither one is a voter, so they tend to be seen in a bit less important light.

There is no reason to think that the equity rally will fade, barring a tweet of some sort from the White House. As such, it seems the dollar will likely remain in its current holding pattern, with some gainers and some losers, until the next shoe drops.

Good luck
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No Solutions Are Near

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There is a group that’s quite elite
And every six months they all meet
In France this weekend
They tried to pretend
That problems, worldwide, they could treat

Alas what was really quite clear
Is that no solutions are near
The trade war remains
The source of most pains
And Brexit just adds to the fear

It has been a pretty dull session overnight with the dollar somewhat softer, Treasuries rallying and equities mixed. With the G7 meeting now over, the takeaways are that the US remains at odds with most members over most issues, but that those members are still largely reliant on the US as their major trade counterparty and overall security umbrella. In the end, there has been no agreement on any issue of substance and so things remain just as they were.

And exactly how are things? Well, the US economy continues to motor along with all the indications still pointing to GDP growth of 2.0% annualized or thereabouts in Q3, continuing the Q2 pace. This contrasts greatly with the Eurozone, for example, where German GDP was confirmed at -0.1% in Q2 this morning as slowing global trade continues to weigh on the economy there. Perhaps the most remarkable thing is that Jens Weidmann, the Bundesbank president, remains firm in his view that negative growth is no reason for easier monetary policy. While every other central bank in the world would be responsive to negative output, the Bundesbank truly does see things differently. As an aside, it is also interesting to see Weidmann revert to his old, uber-hawkish, self as opposed to the show of pragmatism he displayed when he was vying to become the next ECB President. You can be sure that Madame Lagarde will have a hard time convincing him that once the current mooted measures (cutting rates further and more QE) fail, extending policy to other asset purchases or other, as yet unconsidered, tools will be appropriate.

And the rest of Europe? Well, Italy continues to slide into recession as well while the country remains without a government. Ongoing talks between Five-Star and the center-left PD party remain stuck on all the things on which weird coalitions get stuck. But fear of another election, where League leader, Matteo Salvini, is almost certain to win a ruling majority will force them to find some compromise for a few months. None of this will help the economy there. Meanwhile, France is muddling along with an annualized growth rate below 1.0%, better than Germany and Italy, but still a problem. Despite the fact that the Fed has much more monetary leeway than the ECB, the problems extant in the Eurozone are such that buying the euro still seems quite a poor bet.

Turning to the UK, PM Johnson was quite the charmer at the G7, but with just over two months left before Brexit, there is still no indication a deal is in the offing. However, I remain convinced that given the dire straits in the Eurozone economic outlook, the willingness to allow a hard Brexit will fall to zero very quickly as the deadline approaches. A deal will be cut, whether a fudge or not is unclear, but it will change the tone completely. While the pound has edged higher this morning, +0.4%, it remains quite close to its post-vote lows at 1.2000 and there is ample room for a sharp rebound when the deal materializes. For hedgers, please keep that in mind.

The other story, of course, remains the trade war, where the PBOC is overseeing a steady deterioration in the renminbi while selectively looking for places to ease monetary policy and support the economy. Growth on the mainland has been slowing quite rapidly, and while I don’t expect reported data to surprise on the downside, indicators like commodity inventories and electricity usage point to a much weaker economy than one sporting a 6.0% growth handle. Of course, the G7 did produce a positive trade story, the in-principal agreement between the US and Japan on a new trade deal, but that just highlights the other pressure on the EU aside from Brexit, namely the need to make a deal with the US. Bloomberg pointed out the internal problem as to which constituency will be thrown under the bus; French farmers or German automakers. The US is seeking greater agricultural access, and appears willing to punish the auto companies if it is not achieved. (Once again, please explain to me how the EU can possibly allow a hard Brexit with this issue on the front burner).

And that is really today’s background news. The overnight session saw modest dollar weakness overall, and it would be easy to try to define sentiment as risk-off given the strength in the yen (+0.3%), gold (+0.2%) and Treasuries (-3bps). But equities are holding their own and there is no palpable sense in the market that fear has been elevated. Mostly, trading desks remain thinly staffed given the time of year, and I expect more meandering than trending in FX today. Of course, any tweet could change things quickly, but for now, yesterday’s modest dollar strength looks set to be replaced by today’s modest dollar weakness.

Good luck
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Badly Maligned

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The Chinese, now, have it in mind
That they have been badly maligned
So tariffs they hiked
Which markets disliked
Though they have not yet been enshrined

Then Powell explained pretty well
That interest rates hadn’t yet fell
As far as they might
But if we sit tight
Most things ought to turn out just swell

And after the markets had closed
The President quickly imposed
More tariffs to thwart
The Chinese report
While showing he’s just as hard-nosed

It is truly difficult to keep abreast of the pace of change in market information these days. Like so many, I yearn for the good old days when a surprising data release would change trader views and result in a market move but comments and headlines typically had limited impact. These days, by far the most important newsfeed to watch is Twitter, given President Trump’s penchant for tweeting new policy initiatives. This weekend was a perfect example of just how uncertainty has grown in markets.

A quick recap of Friday shows that the Chinese decided to respond to numerous trade provocations and announced they would be raising tariffs further on $75 billion of US imports. Not surprisingly, risk assets responded negatively and we saw equity markets around the world decline while bonds, gold and the yen all rallied. Then we heard Chairman Powell’s long-awaited speech, where he explained that while the economy is in a pretty good place, given the ongoing global weakness and uncertainties engendered by the current trade war, the Fed stood ready to ease policy further. That was enough to encourage the risk-takers and we saw equity markets rebound and bonds give up most of their gains. But just as the market was getting set to close, the President tweeted that he would be raising tariffs further in response to the Chinese action, lamenting that he hadn’t acted more aggressively initially. This, of course, turned things back around and risk was quickly jettisoned into the close, resulting in equity markets ending down more than 2.4% in the US while bonds rebounded and the dollar fell. Whew!!

But that is all old news now as the weekend’s G7 meeting in Biarritz, France, resulted in more surprises all around. The first surprise was that the US and Japan have announced they have reached a trade deal “in principal” which should open Japanese markets to US agricultural imports and prevent the imposition of further tariffs on Japanese autos. Clearly a positive. But that was not enough to turn markets around and Asian sessions started off quite negatively, following the US close and understanding that the US-China trade war was getting hotter. However, an early morning Trump tweet announced that China had called the US and asked to get back to the negotiating table, something that was neither confirmed nor denied by the Chinese, but enough information to reverse markets again. So while Asian equity markets all suffered badly (Nikkei -2.2%, Hang Seng -1.9%) Europe went from down 1% to up 0.5% pretty much across the board (UK markets are closed for a holiday, the late-August banking holiday). We also saw US futures reverse course, from -1.4% to +0.5%, and Treasuries, which had traded to new low yields for the move at 1.44%, reversed course and are now back up (prices lower) to 1.52%. However, that is still lower than Friday’s close. As well, while early on there was a brief 1bp 2yr-10-yr inversion; that has now reversed to a 1bp positive slope.

And what about the dollar through all this? Well, G10 currencies are broadly softer vs. the dollar this morning, with losses ranging from -0.2% for EUR, GBP and CAD all the way to -0.8% for SEK. Even the yen is weaker, -0.45% on the day having reversed some early session (pre-tweet) gains to levels not seen since November 2016.

Of more interest, though, is the fact that CNH has fallen to new historic lows since its creation in August 2010, touching 7.1925 before bouncing slightly, and still down nearly 1% on the day. The Chinese are potentially playing with fire as stories of capital flight increase amid the renminbi’s recent declines. Obviously, 7.00 is no longer an issue, but the key unknown is at what level will money start to leak more fiercely, something nobody knows. I must admit, I did not expect to see this type of movement so quickly, but at this point, one cannot rule out even more aggressive weakness here. Certainly the options markets are telling us that is the case with implied vols rising sharply overnight (1mo +0.6 vol) and heading back toward levels seen after the 2015 ‘mini devaluation’. In fact, not surprisingly, implied volatility is higher pretty much across the board this morning as late summer illiquidity adds to the remarkable uncertainty in markets. There’s probably a bit more boost available in implied vols, at least until the next tweet changes the situation again.

Turning to this week’s calendar, there is a fair amount of data to absorb as follows:

Today Durable Goods 1.2%
  -ex transport 0.0%
Tuesday Case Shiller Home Prices 2.30%
  Consumer Confidence 129.0
Thursday Initial Claims 215K
  Q2 GDP 2.0% (2.1% prior)
Friday Personal Income 0.3%
  Personal Spending 0.5%
  PCE 0.2% (1.4% Y/Y)
  Core PCE 0.2% (1.6% Y/Y)
  Chicago PMI 47.7
  Michigan Sentiment 92.3

Clearly, all eyes will be on Friday’s PCE data as that is the number the Fed watches most carefully. Remember, we have seen two successive surprising upticks in CPI inflation, so a high surprise here could have consequences regarding the future path of interest rates. At least that’s the way things used to be, these days I’m not so sure. Wednesday we hear from two Fed speakers, Barkin and Daly, but it seems unlikely either of them will swerve far from Powell’s comments as neither is particularly hawkish. Speaking of data, we did see one piece this morning, Germany’s IFO Indices with all three pieces falling much further than expected, underscoring just how weak the economy is there. My money is on a stimulus package before Brexit, but also on a hard Brexit being averted.

Recapping, barring any further twitter activity, markets are set to open optimistically, but unless we hear confirmation from the Chinese that talks are, indeed, back on, I would not be surprised to see risk ebb lower as the day progresses. This means a stronger yen, and right now, a softer dollar, at least against the G10. Versus the EMG bloc, the dollar has further room to run.

Good luck
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More Doubt He Is Sowing

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In Beijing, the Chinese yuan
Fell sharply as it’s now been drawn
Into the trade fight
Much to the delight
Of bears, who had shorts layered on

For President Xi, though, the risk
Is money there exits the fisc
With growth there still slowing
More doubt he is sowing
So capital flight could be brisk

Things changed overnight as the PBOC fixed the renminbi below 6.90, much weaker than expected and then the currency fell sharply in subsequent trading in both the on-shore and offshore markets. As you will have no doubt seen, USDCNY is trading somewhere in the vicinity of 7.08 this morning, although the price has been quite volatile. While that represents a decline of more than 1.5% compared to Friday’s closing levels, the more important questions revolve around the PBOC’s new strategy going forward.

Recall, one of the reasons that there was a strong market belief in the sanctity of the 7.00 level was that four years ago, when the PBOC surprised markets with a mini-devaluation, locals took their cash and ran for the hills. Capital outflows were so great, in excess of $1 trillion, that the PBOC needed to institute strict new rules preventing further flight. That was a distinct loss of face for an institution that was trying to modernize and prove that it could manage things like G10 countries where capital flows more freely. Ever since, the assumption was that the Chinese population would get nervous if the renminbi weakened beyond that level and correspondingly, the PBOC would not allow that outcome to occur.

But that was then, in the days when trade was simply a talking point rather than the focus of policy. As the trade war intensifies, the Chinese have fewer tools with which to fight given the massive imbalance that exists. The result of this is that increases in US tariffs cannot be matched and so other weapons must be used, with changes in the exchange rate the most obvious. While the PBOC claims they can continue to manage the currency and maintain its stability, the one thing I have learned throughout my career is that markets have a way of abusing claims of that nature, at least for a while. Back in January I forecast USDCNY to reach 7.40 by the end of this year and, as of this morning, that seems quite realistic.

But the impact on markets is far greater than simply the USDCNY exchange rate. This has been the catalyst for a significant amount of risk-off behavior with equity markets throughout Asia (Nikkei -1.75%, Shanghai -1.6%, Hang Seng -2.85%) and Europe (DAX -1.85%, CAC -2.25%, FTSE -2.25%) sharply lower; Treasury (1.76%) and Bund (-0.51%) yields sharply lower, the Japanese yen (+0.6%) and Swiss franc (+0.75%) both sharply higher and most emerging market currencies (e.g. MXN -1.5%, INR -1.4%, ZAR -1.2%, KRW -0.9%) falling alongside the renminbi. It should be no surprise that gold is higher by 1.0%, to a 6-year high, as well this morning and oil prices (-1.1%) are falling amid concerns of waning demand from the slowing global growth story.

So, what’s a hedger to do? The first thing to consider is whether these moves are temporary fluctuations that will quickly be reversed, or the start of longer-term trends. Given the imbalances that have been building within markets for the past decade and given that central banks have a greatly reduced set of monetary tools with which to manage things, despite their comments otherwise, this could well be the tipping point where markets start to unwind significant positions. After all, the one thing that truly underpinned gains in both equity and bond markets, especially corporate and high-yield bond markets, was confidence that regardless of fiscal policy failures, the central banks would be able to maintain a level of stability.

However, this morning that belief seems a little less secure. It will not take much for investors to decide that, ‘it’s been a good run and now might be a good time to take some money off the table’, at least figuratively. Last week saw equity markets suffer their worst week of the year and this week is not starting any better. Yes, the Fed has room to cut rates further, but will 200bps be enough to stop a global recession? Arguably, that’s the question that needs to be answered. From where I sit, that answer is no, but then I am a cynic. Of course, that cynicism is born of a long career in financial markets.

Thus, my take is that there is further to run in most of these currencies, and that assuming a quick reversion would be a mistake. While option prices are clearly higher this morning than last week, they remain low by historic standards and should be considered for their value in uncertain times. Just sayin’.

What else does this week have to offer? Well, the US data set is not that substantial, but we do hear from a number of Fed speakers, which given last week’s confusion will be extremely important and closely watched. There are also a number of foreign central bank meetings that will be interesting regarding their rate maneuvers.

Today ISM Non-Manufacturing 55.5
Tuesday JOLT’s Job Openings 7.317M
Wednesday RBNZ Rate Decision 1.25% (25bp cut)
  RBI Rate Decision 5.50% (25bpcut)
  Consumer Credit $16.0B
Thursday Philippine Rate Decision 4.25% (25bp cut)
  Initial Claims 215K
Friday PPI 0.2% (1.7% Y/Y)
  -ex food & energy 0.2% (2.4% Y/Y)

We also hear from three dovish Fed speakers; Brainerd, Bullard and Evans, who are likely to give more reasons for further rate cuts, especially if markets continue to fall. As to the three central banks with decisions to make, they find themselves in a difficult place. All three are extremely concerned about their currencies’ value and don’t want to exert further downward pressure on them, yet all three are facing slowing economies and need to do something to boost demand. In fact, this is going to be the central bank conundrum for some time to come across both developing and G10 countries as they try to continually manage the impossible trilateral of exchange rates, interest rates and growth.

All of this adds up to yet more reasons for higher volatility across all asset classes in the near future. It appears that these are the first cracks in the old economic order, and there is no way to know how everything will play out going forward. As long as risk is being jettisoned though, Treasuries, the yen, the Swiss franc and the dollar will see demand. Keep that in mind as you manage your risks.

Good luck
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Still Great Disorder

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While PM May fought off defeat
The Brexit debate’s incomplete
There’s still great disorder
O’er the Irish border
And angst for the man in the street

Was it much ado about nothing? In the end, PM May won the no-confidence vote, but in a singularly unimpressive manner with more than one-third of the Conservative MP’s voting against her. The upshot is that while she cannot be challenged again for another year, it clarified the strength of the opposition to her handling of the Brexit negotiations. At the same time, the EU has reiterated that the deal, as negotiated, represents all they are willing to offer. May’s strategy now seems to be to delay any vote until such time that the choice is clearly binary; accept the deal or exit with no deal. Despite the increasingly dire warnings that have come from the BOE and some private forecasters, I have lost my faith in the idea that a deal would be agreed. If this is the case, the impact on the pound is going to be quite negative for some time. Over the past two days, the pound has rallied 1.3% although it remains quite close to its post vote lows. However, in the event of a hard Brexit, look for the pound to test its historic lows from 1985, when it traded at approximately 1.05.

As to the rest of the market, it is central bank day in Europe with the Norgebank leaving rates on hold but promising to raise them in Q1; the Swiss National Bank leaving rates on hold and describing the necessity of maintaining a negative interest rate spread vs. the euro as the Swiss economy slows and inflation along with it; and, finally, the market awaits the ECB decision, where Signor Draghi is universally expected to confirm the end of QE this month. One of the interesting things about Draghi’s actions is that he is set to end QE despite his own internal forecasts, which, according to ‘sources’ are going to be reduced for both growth and inflation in 2019. How, you may ask, can a central banker remove policy accommodation despite weakening data? Arguably the answer is that the ECB fears the consequences of going back on its word more than the consequences of implementing the wrong policy. In any event, look for Draghi to speak of transient and temporary causes to the reduced forecasts, but express optimism that going forward, Eurozone growth is strong and will be maintained as inflation edges toward their target of just below 2.0%.

Of greater consequence for the euro this morning, which has rallied a modest 0.1%, is the news from Italy that they have adjusted their budget forecasts to expect a very precise 2.04% deficit in 2019, down from the previous budget deficit forecast of 2.4%. Personally I question the changes other than the actual decimal place on the forecast, but the market has accepted them at face value and we have seen Italian assets rally, notably 10-year BTP’s where yields have fallen 10bps and the spread with German bunds has fallen a similar amount. While the situation in France does not seem to have improved very much, the market is clearly of the view that things in Europe are better than they were last week. However, caution is required in accepting that all the issues have been adequately addressed. They have not.

In the end, though, despite these important issues, risk sentiment continues to be broadly driven by the trade situation between the US and China. Helping that sentiment this morning has been the news that China just purchased several million tons of US soybeans for the first time since the trade tussle began. That has encouraged investors to believe that a truce is coming, and with it, a resumption of the previous regime of steadily increasing global growth. Caution is required here, as well, given the still nascent level of discussions and the fact that the US negotiators, LIghthizer and Navarro, are known trade hawks. While it would certainly be better for all involved if an agreement is reached, it is far from certain that will be the case.

Recapping, the dollar has been under pressure this morning on the basis of a broad view of a better risk environment across markets. These include PM May’s retaining her seat, movement on the Italian budget issue and positive signs from the US-China trade conflict. And yet the dollar is only softer by some 0.1% or so, on average. Nothing has changed my view that the underlying fundamentals continue to favor the greenback.

Pivoting to the emerging markets, INR has performed well again, rallying 0.3% overnight which makes more than 1% this week while nearly erasing the losses over the past month. It appears that investors have taken a new view on the necessity of an independent central bank. Recall that the RBI governor stepped down on Monday as he was at odds with the government about the path of future policy, with ex-governor Patel seeking to maintain tighter money and address excess leverage and non-performing loans, while the government wanted easy money and fast growth in order to be reelected. The replacement is a government hack that will clearly do PM Modi’s bidding and likely cut rates next. Yet, market participants are rewarding this action as evidenced not only by the rupee’s rally, but also by the performance of the Indian stock market, which has led APAC markets higher lately. To this observer, it appears that this short term gain will be overwhelmed by longer term losses in both equities and the currency, if monetary policy falls under the government’s thumb. But right now, that is not the case, and I wouldn’t be surprised to see movement in this direction elsewhere as governments try to maintain economic growth at all costs. This is a dangerous precedent, but one that is ongoing nonetheless.

Yesterday’s CPI data was right in line with expectations at 2.2% for both headline and core, and the market had limited response. This morning brings only Initial Claims (exp 225K) and then the monthly Budget Figures are released this afternoon (exp -$188B). In other words, there is limited new information due once we hear from Signor Draghi. As long as there is a broad risk-on consensus, which appears to be the case, look for the dollar to remain under pressure. But I continue to see this as a short-term phenomenon. At some point, the market will recognize that the rest of the world is going to halt any efforts at tightening policy as global growth slows, and that will help support the dollar.

Good luck
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Sans Reason or Rhyme

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In England, the Minister Prime
Is serving, now, on borrowed time
No confidence reigns
As Brexit remains
The issue sans reason or rhyme

The biggest headline early this morning was the collection of a sufficient number of letters of no-confidence in PM May to force a vote in Parliament on the issue. Thus, later today, that vote will be held as the UK holds its breath. If she wins, it will likely strengthen her standing there, and potentially help her push through the Brexit deal that is currently on the table, despite its many flaws. If she loses, a leadership contest will begin and though she will remain PM, it will be only in an acting capacity without any power to move the agenda forward. One potential consequence of the latter outcome is that the probability of the UK leaving the EU with no deal will grow substantially.

With that in mind, the two best indicators of the likely outcome of the vote are the bookie market in the UK and the price of the pound. According to Ladbrokes, one of the largest betting shops in the UK, she is a 2:7 favorite to win the vote after starring at even money. In the FX market, the pound, after having fallen below 1.25 yesterday afternoon has rebounded by 0.4% thus far this morning. In other words, market sentiment is in her favor. Of course, if you recall, market sentiment was clearly of the opinion that Brexit would never occur, or that President Trump would never be president, so these measures are hardly perfect. At any rate, the vote is due to be completed by 3:00pm in NY, and results released shortly thereafter, so we won’t have long to wait. If she wins, look for the pound to continue this morning’s rally, with another 1% well within reason. However, a May victory in no way guaranties that the Brexit deal gets through Parliament. If she loses the vote, however, I expect that the pound will sell off pretty sharply, and that 1.20 could well be in the cards before the end of the year. It will be seen as a decided negative.

Away from the UK, the other big market news is the renewed enthusiasm over prospects for a US-China trade deal being achieved. Equity markets continue to rally on the back of a single phone call between the two nations that ostensibly discussed China purchasing more US soybeans and cutting tariffs on US made cars from 40% to 15%. While both of those are obviously good outcomes, neither addresses the issues of IP theft and Chinese subsidies to SOE’s. It feels a little premature to be celebrating an end to the trade conflict after the first phone call, but nobody ever claimed markets were rational. (Or perhaps they did, Professor Fama, and were just mistaken!) At any rate, after a volatile session yesterday, equities in Asia and Europe have all rallied on the trade news and US futures are pointing higher as well.

Meanwhile, the litany of other global concerns continues to exist. For example, there has been no resolution of the Italian budget issue, which has become even more fraught now that French President Macron has decided to expand the deficit in France in order to try to buy off the gilets jaunes protesters. This begs the question as to why it is acceptable for the French to break the budget guidelines, but not for the Italians to do so. Methinks there is plenty more drama left in this particular issue, and likely not to the euro’s benefit. However, the broad risk-on sentiment generated by the trade discussion has lifted the euro by 0.2% this morning, although it remains much closer to recent lows than highs. It would be hard to describe the market as having enthusiasm over the euro’s near-term prospects. And don’t forget that tomorrow the ECB will meet and ostensibly end QE. There is much discussion about how this will play out and what they will do going forward, but we will cover that tomorrow.

In India, the new RBI governor is a long-time Treasury bureaucrat, Shaktikanta Das, which calls into question the independence of that institution going forward. After all, the reason that the former head, Urjit Patel, quit was because he was coming under significant government pressure to act in a manner he thought unwise for the nation, but beneficial to the government’s electoral prospects. It is hardly comforting that a long time government minister is now in the seat. That said, the rupee continued yesterday’s modest rally and is higher by a further 0.4% this morning.

And those are really the big FX market stories for the day. Overall, the dollar’s performance today could be characterized as mixed. While modestly weaker vs. the euro and pound, it is stronger vs. NZD and SEK, with the latter down by 0.7%. As to the rest of the G10, they are little changed. In the EMG space, the dollar is modestly softer vs. LATAM names, but vs. APAC, aside from INR, it has shown modest strength. In other words, there is little uniform direction evident today as I believe traders are awaiting the big news events. So the UK vote and the ECB tomorrow are set to have more significant impacts.

On the data front, this morning brings CPI (exp 2.2% for headline and core), where a miss in either direction could have a market impact. At this time, Fed funds futures are pricing a ~78% chance that the Fed raises rates 25bps next week, but there is less than one rate hike priced in for 2019. My take continues to be that the market is overestimating the amount of tightening we will see from the ECB going forward, and as that becomes clearer, the euro will start its next leg lower. But for the rest of the day, I expect limited movement at least until the UK vote results are announced this afternoon.

Good luck
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