Still Great Disorder

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
Adf

 

Sans Reason or Rhyme

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
Adf

More Concern

The tide is beginning to turn
As hawks at the Fed slowly learn
Their earlier view
No longer rings true
So they’ve now expressed more concern

These days there are three key drivers of the market narrative as follows:

The Fed – There is no question that the tone of commentary from Fed speakers has softened over the past two weeks, certainly from the way it sounded two months ago. Back then Chairman Powell explained that the Fed Funds rate was “a long way” from neutral, implying numerous further interest rate hikes. Equity markets responded by selling off sharply and talk of a yield curve inversion leading to a recession was nonstop. Meanwhile, the dollar rose nicely vs. most of its counterparties. A funny thing happened, though, on the way to that next rate hike due next week; economic data started to soften.

Softer housing data as well as declines in production numbers and survey data like the ISM have resulted in a more cautionary stance by these same Fed members. While the doves (Kashkari, Bullard and Brainerd) had always shown some concern over the pace of rate hikes given the absence of measured inflation, the rest of the Fed were happy to hew to the Phillips curve model and assume that the exceptionally low unemployment rate would lead to much higher inflation. This latter view encouraged them to gradually raise rates in order to prevent a failure on that part of their mandate.

But whether it is a result of the sharp declines seen in equity prices, the ongoing bashing from President Trump or simply the fact that the growth picture is slowing (I certainly hope it is the last of these!), the tone from this august group is definitely less aggressive. And while yesterday Chairman Powell reiterated that the economy was “very strong” on many measures, he was also clear to indicate that there was much more uncertainty over what the future would bring. This change of tone has been well received by the punditry, and quite frankly, by markets, which saw a sharp late day equity rally sufficient to reduce early session losses to nearly flat.

The Fed’s problem is that they created a monster with Forward Guidance, which was great when it helped them to further their easing bias, but is not well suited to changes in policy. Futures markets are now pricing less than one rate hike in 2019, down from nearly three hikes just a month ago. Transitions are always the hardest times for any market and for all policymakers. It is no surprise that we have seen increased volatility across markets lately, and I expect it will continue.

Trade – The trade situation is extremely difficult to describe. In the course of a week, market sentiment has gone from euphoria over the reopening of talks between the US and China on Monday, to outright fear after the US had the CFO of one of China’s largest companies, Huawei, arrested in Canada regarding the breech of sanctions on Iran. There are two concerns over the trade issue that need to be addressed when considering its impact on markets. First is the impact on prices. Tariffs will unambiguously raise prices to someone as long as they are in place. The question is who will feel the pain. For importers, their choices are pass on the cost by raising prices, eat the cost by reducing margins or have their vendors eat the cost by renegotiating their prices. In the first case, it is a direct impact on inflation data, something that has not yet been evident. In the second case, it is a direct hit to profitability, also something that has not yet been evident, but it has been discussed by a number of CEO’s as they get asked about their business. In the third case, the US makes out well, with neither of the potential problems coming home to roost.

The second, knock-on impact is on growth. Higher prices will reduce demand and lower margins will reduce available cash flow, and correspondingly reduce the ability of companies to invest and grow. In other words, there are no short term positives to be had from the tariffs. However, if negative behavior can be changed because of their imposition, such that IP is protected and an agreement can help reduce all trade barriers, including non-tariff ones, then the ends may justify the means. Alas, I am not confident that will be the case. Looking at the market impact, theory would dictate the dollar should rise on the idea that other currencies will depreciate sufficiently to offset the tariffs and reestablish equilibrium. We have seen that in USDCNY, which has fallen about 8% from its peak in spring, nearly offsetting the 10% tariffs. Looking ahead though, if the tariff rate rises to 25%, it is harder to believe the Chinese will allow the yuan to fall that much further. For the past decade they have been fearful of allowing their currency to fall to quickly as it has led to significant capital flight, so it would be premature to expect a decline anywhere near that magnitude.

Oil – Oil prices have moved back to the top of the market’s play list as a combination of factors has lately driven significant volatility. It wasn’t that long ago that there was talk of oil getting back to $100/bbl, especially with the US sanctions on Iran being reimposed. But then political pressure from the US on Saudi Arabia resulted in a significant increase in production there, which alongside continuing growth in US production, turned fears of a shortage into an absolute oil glut. This resulted in a 33% decline in the price in less than two months’ time, with ensuing impact on petrocurrencies like CAD, RUB and MXN, as well as a significant change in sentiment regarding inflation. With global growth continuing to show signs of slowing further, it is hard to believe that oil prices will rebound anytime soon. As such, one needs to consider that those same currencies will remain under pressure going forward.

All of this leads us to today’s session where the primary focus will be on the employment report. Expectations are as follows:

Nonfarm Payrolls 200K
Private Payrolls 200K
Manufacturing Payrolls 20K
Unemployment Rate 3.7%
Average Hourly Earnings 0.3% (3.1% Y/Y)
Average Weekly Hours 34.5
Michigan Sentiment 97.0

It feels like the market is more concerned over a strong number, which might put the Fed on alert for further rate hikes. In fact, it seems like we have moved into a good news is bad situation again, at least for equities. For the dollar, though, strong data is likely to lead to support. My view is that we may start to see a softer tone from the data, which would lead to further softening in the dollar, but a rebound in stocks.

Good luck and good weekend
Adf

Most Are Afraid

Since pundits have often asserted
A yield curve that’s truly inverted
Will lead to recession
The recent compression
Of rates has investors alerted

Meanwhile the concerns over trade
Have not really started to fade
Twixt trade and those yields
Investors need shields
Explaining why most are afraid

It got ugly in the equity markets yesterday, with significant declines in the US followed by weakness overnight in Asia and continuing into today’s European session. With US markets closed today in observance of a day of mourning for ex-president George Herbert Walker Bush, the news cycle has the potential to increase recent volatility. Driving the market activity were two key stories, ongoing uncertainty over the US-China trade situation and, more importantly, further flattening of the US yield curve toward inversion.

At this point, unless you have been hiding under a rock for the past year (although given market activity, that may not have been a bad idea!) you are aware of the relationship between the shape of the US yield curve and the potential for a recession in the US. Every recession since 1975 has been preceded by an inverted yield curve (one where short-term rates are higher than long-term ones). In each of those cases, the driving force raising short-term rates was the Fed, which is no different than today’s situation. What is different is both the level of yields, on both a nominal and real basis, and the size of the Fed’s balance sheet.

From 1963 up to the Financial Crisis, the average of nominal 10-year Treasury yields had been 7.11%. Since the crisis, that number has fallen to 2.62%! Of course that was driven by the Fed’s policy actions of ZIRP and QE, the second of which was explicitly designed to drive longer-term rates lower. Clearly they were successful on that score. However, ten years on from the crisis, rates remain exceptionally low on a historical basis, despite the fact that the economy has been expanding since the middle of 2009. The reasons for this are twofold; first the Fed had maintained ZIRP for an exceptionally long time, and while they have been raising rates since December 2015, the pace at which they have done so has been extremely slow by historical standards. Secondly, although the Fed has begun to reduce the size of their balance sheet, it remains significantly larger, relative to the size of the economy, than it was prior to the crisis. This means that there is less supply of bonds available for other investors, and so prices continue to be artificially high.

This combination of the Fed’s rate hikes, as slow as they have been, and their ownership of a significant portion of available Treasuries has resulted in a much flatter yield curve. Adding to this mixture is the fact that the economy’s performance is now beginning to show signs of slowing down. This has been evident in the recent weakness in both the housing market and the auto sector. Meanwhile, falling equity prices have encouraged more demand for the safety of Treasuries. Put it all together and you have a recipe for a yield curve inversion, which will simply help fulfill the prophesy of an inverted yield curve leading to recession.

The other pressure point in markets has been the ongoing trade drama between the US and China. The weekend’s G20 news was quickly embraced by investors everywhere in the hope that further tariffs had been avoided and the current ones might be reduced or removed. However, China’s interpretation of the weekend discussions and those of President Trump appear to be somewhat different, and now there is concern that the delay in tariff increases may not result in their eventual removal.

Recapping the two stories, fears over a resumption of the trade war have helped undermine views of future economic growth. This has led investors to seek safety in longer dated Treasury securities helping to flatten the US yield curve. That signal is seen as a harbinger of future recession, which has led investors to sell equities, further increasing demand for Treasuries. It is easy to see how this cycle can get out of hand, and may well lead to much weaker equity prices, lower US yields and slower US growth.

That trifecta would be a cogent reason for the dollar to suffer. But remember, the FX market is a relative one, not an absolute one. And if the US is seeing declining growth, you can be certain that the rest of the world is suffering from the same affliction. In fact, the data from Europe this morning showed that Eurozone Services PMI fell to 52.7, its lowest level since September 2016 and further evidence that the Eurozone economy is quickly slowing. While Italy has garnered the headlines, and appears set to enter yet another recession, the data from Germany has also been soft, which bodes ill for the future. If the slowdown in the Eurozone economy continues its recent trend, it will be that much harder for Signor Draghi to begin tightening policy. So once again, despite the fact that the Fed may be slowing down, signs are pointing to the fact that the ECB will be in the same boat. In that case, the euro is unlikely to be seen as terribly attractive, and the dollar still has potential to rise, despite the recent US softness.

The point is that although the long-term structural issues remain quite concerning in the US, the short-term cyclical factors continue to favor the dollar over its G10 and EMG counterparts. We will need to see wholesale changes within the policy mixes around the world for this to change.

With markets closed today, there is no US data to be released, and I expect a subdued session overall. However, nothing has changed my medium term view of dollar strength.

Good luck
Adf

Progress Was Made

The Presidents, Trump and Xi, met
Attempting, trade talks, to reset
Some progress was made
Though China downplayed
Reductions in tariffs as yet

Risk is back! At least it is for today, with the news that there has been a truce, if not an end, to the trade war between the US and China seen as a huge positive for risky assets. And rightly so, given that the trade contretemps has been one of the key drivers of recent investor anxiety. In addition, the G20 managed to release a statement endorsed by all parties, albeit one that was a shadow of its former self. There remain significant disagreements on the value of the G20 with the Trump administration still convinced that these gatherings seek to institutionalize rules and regulations that are contra to the US best interests.

At any rate, equity markets around the world have rallied sharply with Shanghai jumping 2.5%, the Nikkei up 1.25% and the South Korean KOSPI rising by 1.75%. In Europe, the FTSE is higher by 1.75%, the DAX by 2.2% and the CAC, despite ongoing riots in Paris and throughout France, higher by 1.0%. Ahead of the opening here, futures are pointing to an opening on the order of 2.0% higher as well. It should be no surprise that Treasury bonds have fallen somewhat, although the 2bp rise in 10-year yields is dwarfed relative to the equity movements. And finally, the dollar is lower, not quite across the board, but against many of its counterparts. Today, EMG currencies are leading the way, with CNY rising 0.9%, MXN rising 1.7% and RUB up 0.75% indicative of the type of price movement we have seen.

However, the trade story is not the only market driver today, with news in the oil market impacting currencies as well. The story that OPEC and Russia have agreed to extend production cuts into 2019, as well as the news that Alberta’s Premier has ordered a reduction of production, and finally, the news that Qatar is leaving OPEC all combining to help oil jump by more than 3% this morning. The FX impact from oil, however, was mixed. While the RUB and MXN both rallied sharply, as did CAD (+0.9%) and BRL (+0.9%), those nations that are major energy importers, notably India (INR -1.1%), have seen their currencies suffer. I would be remiss not to mention the fact that the euro, which is a large energy importer, has actually moved very little as the two main stories, trade war truce and oil price rise, have offsetting impacts in FX terms on the Continent.

But through it all, there is one currency that is universally underperforming, the British pound, which has fallen 0.3% vs. the dollar and much further against most others. Brexit continues to cast a long shadow over the pound with today’s story that the DUP, the small Northern Irish party that has been key for PM May’s ability to run a coalition government, is very unhappy with the Brexit deal and prepared to not only vote against it in Parliament next week, but to agree a vote of no confidence against PM May as well. This news was far too much for the pound, overwhelming even much better than expected Manufacturing PMI data from the UK (53.1 vs. exp 51.5). So the poor pound is likely to remain under pressure until that vote has been recorded next Tuesday. As of now, it continues to appear that the Brexit deal will fail in its current form, and that the UK will be leaving the EU with no framework for the future in place. This has been the market’s collective fear since the beginning of this process, and the pound will almost certainly suffer further in the event Parliament votes down the deal.

While all this has been fun, the week ahead brings us much more news and
information, as it is Payrolls week in the US.

Today ISM Manufacturing 57.6
  ISM Prices Paid 70.0
  Construction Spending 0.4%
Wednesday ADP Employment 197K
  Nonfarm Productivity 2.3%
  Unit Labor Costs 1.2%
  ISM Non-Manufacturing 59.2
  Fed’s Beige Book  
Thursday Initial Claims 220K
  Trade Balance -$54.9B
  Factory Orders -2.0%
Friday Nonfarm Payrolls 200K
  Private Payrolls 200K
  Manufacturing Payrolls 19K
  Unemployment Rate 3.7%
  Average Hourly Earnings 0.3% (3.1% Y/Y)
  Average Weekly Hours 34.5
  Michigan Sentiment 97.0

So a lot of data, and even more Fed speakers, with a total of 11 speeches, including congressional testimony by Chairman Powell on Wednesday, from six different Fed Governors and Presidents. Now we have heard an awful lot from the Fed lately and it has been interpreted as being somewhat less hawkish than the commentary from September and October. In fact, Minneapolis President Kashkari was out on Friday calling for an end to rate hikes, although he is arguably the most dovish member of the FOMC. Interestingly, the trade truce is likely to lead to one less problem the Fed has highlighted as an economic headwind, and may result in some more hawkish commentary, but my guess is that the current mindset at the Eccles Building is one of moderation. I continue to believe that a December hike is a done deal, but I challenge anyone who claims they have a good idea for what 2019 will bring. The arguments on both sides are viable, and the proponents are fierce in their defense. While the Fed continues to be a key driver of FX activity, my sense is that longer term FX views are much less certain these days, and will continue down to be that way as the Fed strives to remove Forward Guidance from the tool kit. Or at least put it away for a while. I still like the dollar, but I will admit my conviction is a bit less robust than before.

Good luck
Adf

That Might Be Obtuse

For those who are hoping next week
The meeting where Trump and Xi speak
Will end with a truce
That might be obtuse
As progress this weekend was bleak

The holiday week opens with a mixed picture in the currency markets and limited movement in both equity and bond markets. This past weekend saw an APEC meeting end with no communiqué, adding to the recent trend of a lack of ability for current trading partners to find common ground amongst themselves. In this case, it seems that the Chinese were unwilling to accept a particular sentence in the final draft as follows: “We agreed to fight protectionism including all unfair trade practices.” It is not clear if the problem was the term protectionism, or the reference to unfair trade, but the twenty members aside from China, including the US, were all comfortable with the phrase. What is clear, however, is that there has been very little movement toward consensus on how trade issues should be handled and what actually constitutes free and fair trade.

The immediate impact was that APAC currencies, including AUD and NZD, were broadly weaker on the day, with Kiwi actually falling the furthest, -0.8%. It seems that all the nations in the region are going to continue to have to tiptoe around the trade situation between the US and China, which given that every one of them has built their economy based on trade with China and security from the US military, has become a very difficult balancing act. Until the US-China trade issues are resolved, it seems likely that these currencies will underperform their peers.

The other impact from this situation is that it now seems increasingly unlikely that the meeting between Presidents Trump and Xi, scheduled for next week at the G20 conference in Buenos Aires, will be able to find enough common ground between the two to prevent a further escalation in the trade war. If you recall, President Trump has indicated that tariffs on Chinese exports would be increased to 25% in January from the current 10% level, and that the administration would open comments on attaching tariffs to the other $257 billion of Chinese imports not already affected. Both businesses and market participants have been counting on the fact that Trump and Xi would halt this negative spiral, but after this weekend, it seems somewhat less likely that will be the result. Of course, anything is possible, especially in the case of political negotiations, so all is not lost yet.

Otherwise, things have been pretty dull. In the UK, both Brexiteers and Bremainers have been trying to muster their troops for the upcoming internal battle. The Europeans have said that the deal on the table is the best that is coming and there will be no further changes. However, M. Barnier also tried to spin things by indicating that the deal, as it stands, does not mean the UK would be beholden to EU rules forever. Meanwhile, the machinations in the UK parliament are ongoing, where allegedly 42 MP’s have written letters seeking a no confidence vote in PM May, just six less than the 48 required to call such a vote. In the event a vote is called and PM May loses, it is not clear how things will play out. A new PM could be elected, or there might be an entirely new national vote. However, in either case, it would delay the UK process and that is a big problem given that there are now just over four months remaining before Brexit is official. While I had always assumed that some fudge deal would be completed, I have to say that the odds of that are perhaps no better than 50:50 now. In the end, traders who had been somewhat optimistic at the end of last week are less so this morning with the pound having fallen 0.25%. Absent a big change in sentiment, it appears that the pound has further to fall.

And really, those are the only two stories of note this morning. The Italian budget opera remains ongoing, but has not garnered any headlines lately as we are in the midst of reviews, although it seems certain that the EU will take the next step and propose sanctions. Aside from the APEC trade story, there is nothing else specific from China, and as this is a holiday week, there is limited data due. One thing that may be changing, however, is that the Fed may be softening its stance as recent data in certain segments of the economy, notably housing, has been less robust. While a rate hike next month seems certain, the trajectory for 2019 seems less clear than it did back in September. If that is the case, my dollar bullishness is likely to be tempered.

Here is the data for the abbreviated week:

Tuesday Housing Starts 1.23M
  Building Permits 1.27M
Wednesday Initial Claims 214K
  Durable Goods -1.2%
  -ex transport 0.3%
  Michigan Sentiment 98.3
  Existing Home Sales 5.2M

While each data point represents further information for the FOMC, it is not clear that any one of these will stand out on its own. As to Fed speakers, there is only one this week, NY Fed President Williams speaks this morning, but after that it appears the FOMC is taking the Thanksgiving week off.

It seems unlikely that either today’s session, or the rest of the week will be too exciting. The one exception would be if there is a ‘no-confidence’ vote in the UK, where the outcome would have a direct impact on the pound. If PM May holds on, I would look for the pound to rally sharply as that implies that she will have sufficient support to push through the Brexit deal, however if she loses, it will be very cheap to go to London for Christmas!

Taking my cue from the Fed, I will not be writing a letter until next Monday, November 26th.

Until then, good luck and have a wonderful holiday
Adf

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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