No Progress Was Made

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

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

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

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

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

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

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

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

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

Good luck
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Twixt Juncker and Trump

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

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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The Fed’s Fallen Short

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

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

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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