Make Boris Bend

As Parliament seeks to extend
The timeline, and make Boris bend
The market’s decided
The deal he provided
Will ultimately pass in the end

Well, Brexit is still the number one topic in markets, although after a quiet Friday on the trade front, we got more discussion there as well. As to Brexit, Boris lost his fight to get a clean vote on the newly renegotiated deal on Saturday. Instead, Parliament voted to force a request for an extension, which at this moment the EU is considering. Interestingly, in the EU there are a number of countries that seem ready to be done with the process and no longer care if the UK exits. However, as sweet as that would be for the Brexiteers, in the end that would require courage by the country(ies) who voted no. And courage is something in short supply at the top of European (and most) governments. At any rate, given the speed with which this story changes, this morning the word is that Johnson has found the votes necessary to get his deal through Parliament, but it means that he has to get another vote. The roadblock there is in the form of John Bercow, the Speaker of the House of Commons, who has proven himself to be a virulent Bremainer, and wants nothing more than to see Boris fail.

With that as background, one might have thought the pound would have suffered, but the market has looked through all the permutations and decided that a deal is forthcoming in the near-term, or perhaps more accurately, that the odds of a no-deal Brexit have been significantly reduced. This is evident in the fact that as I type, the pound is essentially unchanged since Friday’s optimistic close at 1.2980, and has traded above 1.30 earlier in the session for the first time since May (the month, not the former PM).

However, I think the euro’s performance has been far more interesting lately. Consider that despite an ongoing run of generally awful data, showing neither growth nor inflationary impulse, the single currency continues to climb slowly. A part of this is likely a result of what has been mild dollar weakness amid increasing risk appetite. But I think that the market has also begun to recognize that a Brexit deal will remove uncertainty on the continent and the euro will benefit accordingly. From the time of the referendum in 2016 I have made it clear that Brexit was not just a British pound story, but a euro one as well. And this slow appreciation (EUR is higher by 2.7% this month, about 0.7% more than the dollar index) is a belated reaction to the fact that a Brexit deal is a benefit there as well. At any rate, much of this story is yet to be written, and a successful outcome will almost certainly result in further GBP outperformance, but the euro is likely to continue this grind higher as well.

On the trade front, comments from Chinese vice-premier Liu He explaining China would work with the US to address each other’s core concerns and that ending the trade war would be good for everyone were seen as quite positive by equity and other risk markets. In fact, the combination of optimism on the two big issues of the day, trade and Brexit has led to a clear, if modest, risk-on session. Equity markets in Asia performed well (Nikkei +0.25%, CSI 300 +0.3%), and we are seeing modest gains throughout Europe as well (DAX +0.7%, CAC +0.15%). It is certainly a positive that the trade dialog continues, but I fear we remain a very long way from a broad deal.

Another weekend event was the World Bank / IMF meetings in Washington with the commentary exactly what you would expect. Namely, everyone derided the trade war and explained it would be better if it ended. Everyone derided Brexit and said it would be better if it didn’t happen. And everyone explained that it’s time for fiscal policy to step up to the plate to help central banks. What has become very clear is that central banks are truly running out of room to help support their respective economies but it is impolitic to say so. This results in exhortations for fiscal policy pushes by those who can afford it. However, Germany remains resolute in their belief that there is no reason to implement a supplementary budget of any kind and that continuing to run a budget surplus is the best thing for the nation. Look for pressure to continue to build, but unless growth really starts to crater there, I don’t expect them to change their views, or policies.

A look around the rest of the FX market shows that the biggest gainer this weekend was KRW, rising 0.8% on optimism that a trade deal between the US and China was closer. Certainly it was not the terrible data from South Korea that helped the won rally, as exports in October have fallen nearly 20%, making eleven consecutive monthly declines in that statistic. Otherwise, the mild risk-on atmosphere has helped most EMG currencies edge higher. On the G10 front, NOK is the big winner, rising 0.55%, although that simply looks like a reaction to its sharp declines over the past two weeks.

On the data front it is extremely quiet this week as follows:

Tuesday Existing Home Sales 5.45M
Thursday Initial Claims 215K
  Durable Goods -0.7%
  -ex Transport -0.3%
  New Home Sales 701K
Friday Michigan Sentiment 96.0

Source: Bloomberg

Arguably, Durable Goods is the most interesting number of the bunch. And after a two-week deluge of Fed speakers, they have gone into their quiet period ahead of next Wednesday’s meeting. The final comments by Kaplan and Clarida were similar to the previous comments we heard, namely that the economy is in a “good place” and that they are essentially going to play it by ear on the next rate decision. As of this morning, the market is still pricing in an 89.5% probability of a rate cut.

Speaking of low rates, Signor Draghi presides over his last ECB meeting this week and while there are no new policies expected, it is universally anticipated that he will renew his call for fiscal stimulus to help the Eurozone economic outlook. Quite frankly, I think it is abundantly clear that the ECB has completely run out of ammunition to fight any further weakness, and that Madame Lagarde, when she takes the seat on November 1, will feel more like Old Mother Hubbard than anything else.

For the day, I see no reason for the risk-on attitude to change, and if anything, I imagine we can see more positive news from the UK which will only help drive things further in that direction. While in the end, I still see the dollar performing well, for now, it is on its back foot and likely to stay there for a little while longer.

Good luck
Adf

Lost Their Zeal

While yesterday Brexit seemed real
As both sides looked close to a deal
This morning we hear
A deal’s not so near
As Ireland’s North lost their zeal

Meanwhile from the Far East, the news
Is that China just might refuse
To buy pork and grain
Unless we refrain
From publicly airing our views

While the same two stories remain atop the leaderboard, the score has clearly changed. This morning, much of yesterday’s Brexit optimism has dissipated as the DUP, Boris Johnson’s key Northern Irish ally in Parliament, explained they could not support the deal that Johnson has been furiously negotiating over the past few days. Remember, DUP stands for Democratic Unionist Party, and the Union of which they speak is that of Northern Ireland and the rest of the UK. As such, they cannot countenance the idea of a soft border in the Irish Sea between Northern Ireland and the rest of the UK. They want to be treated exactly the same. At the same time, they don’t want a hard border between themselves and the Republic of Ireland, so it seems that they are the ones that need to make up their collective mind. As time is very clearly running out, the conversation has reached a very delicate phase. Remember, the Benn Act requires PM Johnson to request an extension by this Saturday if there is no deal agreed, and of course, Boris has said he “would rather be dead in a ditch” than request such an extension.

From what I have read, it appears that the soft border would be time limited, and so in the end, I think the pressure on the DUP will be too great to bear and they will cave in. After all, they also don’t want to be the ones responsible for the failure of reaching a deal. The pound, after having traded as high as 1.2800 yesterday, has been extremely volatile this morning, trading in a more than 1.0% range and having touched both the highs at 1.2790 and the lows near 1.2660 twice each. As I write, the pound is lower by 0.3% on the day, but at this point, it is entirely headline driven. The one thing that is clear is that many of the short positions that had been built up over the past year have been reduced or eliminated completely.

Turning to China, the story is about Beijing’s anger over two bills passed by the House of Representatives in support of the pro-democracy protests in Hong Kong. The Chinese are adamant that anything that happens in Hong Kong is a domestic affair and that everybody else, especially the US, should keep their noses out of the discussion. In fairness, it is a Chinese territory legally, unlike the situation in Taiwan where they claim ‘ownership’ with less of a legal claim. Nonetheless, they are quite serious and are threatening retaliation if any law addressing Hong Kong is passed by the US. Now a bill passing the House is a far cry from enacting a law, but this does seem to be something where there is bipartisan support. Remember, too, that the standoff with China is one of the few things where the Democrats and President Trump see eye to eye.

At the same time, somewhat behind the scenes, the PBOC injected CNY 200 billion into its money markets last night, surprising everyone, as a measure of further policy ease. Thursday night the Chinese will release their Q2 GDP data and while the median forecast is for a 6.1% annualized outcome, there are a number of forecasts with a 5 handle. That would be the slowest GDP growth since at least 1992 when records started to be kept there. At any rate, the cash injection helped weaken the renminbi with CNY falling 0.3% in the overnight session. One thing to remember here is that part of the ostensible trade deal is the currency pact, but if that deal falls apart because of the Hong Kong issue, it opens the door for CNY to weaken a bit more.

It ought not be surprising that the change in tone on those two stories has dampened overall market enthusiasm and this morning can clearly be described as a risk-off session. In the G10, the dollar is stronger against everything except the yen and Swiss franc (both higher by 0.1%). In fact, both NOK (-0.9%) and NZD (-0.7%) lead the way lower with the former responding to oil’s ongoing weakness as well as the potential negative impact of a hard Brexit. Meanwhile, the kiwi has suffered after the RBNZ reiterated that lower rates were likely still in store despite CPI printing a tick higher than expected last night at 1.5%.

In the EMG space, things have been less dramatic with ZAR today’s weakest component, falling 0.5% after news that the troubled utility, Eskom, will be forced to create rolling blackouts, further highlighting its tenuous financial position and putting more pressure on the government to do something (read spend money they don’t have) to fix things. Without a solution to this issue, which has been hanging over the economy for several years, look for the rand to continue its broad move lower. While at 14.97, it is well off the lows seen in August, the trend remains for the rand to continue falling. Otherwise, this space has been far less interesting with KRW dipping just 0.25% overnight after the BOK cut rates by 25bps. The thing is, comments from BOK members indicated a reluctance to cut rates much further, thus limiting the downward movement.

This morning brings us Retail Sales (exp 0.3%; -ex autos 0.2%) and Business Inventories (0.2%). Then, at 2:00 the Fed’s Beige Book is released with analysts set to look for clues about economic activity to drive the Fed’s next activity. We also hear from three Fed speakers, Evans, Kaplan and Brainard, who all lean to the dovish side of the spectrum. With European equities under pressure and US futures pointing lower, it seems that risk will remain out of favor, unless there is a change of heart in the UK. But for now, think risk-off as a guide to today’s activity.

Good luck
Adf

Talks Remain Tough

In Brussels they’re starting to say
A soft Brexit’s soon on the way
Though talks remain tough
There could be enough
To reach an agreement today!

Nothing has changed with regard to which stories are market drivers, although on the equity front we now get to add Q3 earnings to the mix. But as far as FX is concerned, Brexit and trade still dominate the discussion. Regarding Brexit, the rumblings from Brussels have been far more positive this morning, with the EU’s chief negotiator, Michel Barnier, explaining that a deal was still possible before the EU Summit on Thursday, but difficult. Apparently, the UK has submitted detailed plans of how they would like to address the Irish border situation, and there is serious consideration although negotiations continue. From Parliament, the word is that the votes will be there to pass any deal agreed by PM Johnson, as the Tories and Brexiteers recognize that Boris was a Brexiteer from the get-go. The Summit begins in two days, and I continue to expect that a deal, ‘in principal’ will be agreed beforehand. It should be no surprise that the pound has rallied on the news, after giving up some of Friday’s gains during the European session yesterday. This morning, Sterling is higher by 0.4%, although since we closed Friday, it is actually lower by 0.2%. Nonetheless, I continue to see scope for significant advancement here upon the news that deal has been reached.

As to the trade story, Friday also proved to be something of a false dawn as the Chinese backed away from the idea that a deal has been struck and are seeking continued discussions. This morning, however, there seems to be a bit more upbeat tone, even with the Chinese, as it is clear that talks will continue over the next few weeks at both mid-level and high-level (Mnuchin, Lighthizer and Liu He) conference calls. The Chinese have also figured out that they need to import a LOT if pork and that is something of which the US possesses a great deal. Overnight, Chinese data showed PPI falling 1.2%, meaning factories continue to lose pricing power, but CPI rose 3.0%, above expectations and starting to put pressure on the government. As part of that CPI rise, pork prices rose 69%! African swine fever is clearly taking its toll on the Chinese swine herd. This morning, the Chinese offered to remove tariffs on $50 billion of agricultural products if the US would remove a similar amount. While no decision has been made, I expect that there will be agreement on this subject as for President Trump, the demographics of the beneficiaries of this action would be his biggest supporters. Despite broad dollar strength since Friday, we continue to see the renminbi (+0.2% since Friday) perform well, a testimony to the PBOC’s efforts to prevent the currency from weakening, but also in response, I think, to the idea that there is positive movement on the trade front.

Away from those stories, we continue to see weak Eurozone growth data, with the German ZEW Survey falling to -22.8, slightly better than expected but still miles below its longer term average of +12.8. On top of that, a survey of 53 economists by Bloomberg has forecast that German GDP will shrink 0.1% in Q3, defining a technical recession in the country, and weighing further on the entire Eurozone. As I have repeatedly pointed out, the EU cannot afford a hard Brexit and are highly incented to reach an agreement this week. The euro, which had been holding its own of late has given up 0.2% this morning and a bit more since Friday and is back at the 1.1000 level, although that is in the upper half of performers in the G10 space. The biggest loser is NZD, which is down 1.1% since Friday after the RBNZ bid for bonds, which traders read as a form of QE, and which is tracking Aussie lower after remarks from the RBA indicate that further easing is on the way.

The other big loser this morning is the Norwegian krone, which has fallen 0.8% since Friday following oil prices’ downward trajectory. The latter is due to a combination of concerns over slowing global growth reducing demand for oil, while inventories continue to rise.

In the EMG space, INR is today’s largest mover, sliding 0.75% after CPI data was released at a higher than expected 3.99% in September. The rupee had been a beneficiary of inward investment based on the idea that quiescent inflation would allow further RBI rate cuts and enhanced growth and equity market performance. However, if inflation has bottomed, it seems that investors are likely to be a little more circumspect. Overnight there was clear selling of Indian bonds by international investors leading to the currency’s decline. However, beyond that movement, the EMG bloc had more losers than gainers, but none with a significant move or story.

On the data front this week, we see a bunch of middle tier data with the highlight arguably Retail Sales.

Wednesday Retail Sales 0.3%
  -ex autos 0.2%
  Business Inventories 0.2%
  Fed’s Beige Book  
Thursday Initial Claims 215K
  Housing Starts 1320K
  Building Permits 1350K
  Philly Fed 8.0
  IP -0.2%
  Capacity Utilization 77.7%
Friday Leading Indicators 0.1%

In addition to the data, we hear from a total of ten Fed speakers this week, ranging from the uber-dove James Bullard to the uber-hawk Esther George and every spot along the spectrum in between. Overall, the Fed message has been that they feel the economy is in a ‘good’ place, but they won’t hesitate to ease further if the data turns downward. Of course, their message was also that buying $60 billion / month of T-bills to help ease reserve conditions was in no way more QE. That is a much tougher circle to square.

Looking ahead, the market remains headline driven so care needs to be taken. There is no clear risk view this morning with both equity futures and Treasuries higher, and the dollar is mixed, again clouding any view. My expectation is that the market will likely tread water ahead of the next piece of news. And my money remains on that being a positive Brexit story.

Good luck
Adf

Time’s Crunch

When Boris and Leo had lunch
No panties were balled in a bunch
The signals showed promise
And no doubting Thomas
Appeared, as both sides felt time’s crunch

Meanwhile, though there’s been no bombshell
The trade talks have gone “very well”
Today Trump meets He
And then we will see
If a deal betwixt sides can now gel

And finally from the Mideast
The story ‘bout risk has increased
A tanker attack
Had market blowback
With crude a buck higher at least

There is no shortage of important stories today so let’s jump right in. Starting with Brexit, yesterday’s lunch meeting between Boris Johnson and Leo Varadkar, the Irish PM, turned into something pretty good. While the comments have been very general, even EU president Donald Tusk as said there were “promising signals.” It is crunch time with the deadline now less than three weeks away. Apparently, the rest of the EU is beginning to believe that Boris will walk with no deal, despite the Benn Act requiring him to ask for an extension if there is no deal in place. At the same time, everybody is tired of this process and the EU has many other problems, notably a declining economy, to address. And so, I remain confident that we will soon hear, probably early next week, about a ‘deal in principle’ which will be ratified by Parliament as well as the EU. Though all the details will not have been completed, there will be enough assurances on both sides to get it through. Remember, Boris has Parliament on his side based on the deal he showed them. I’m pretty sure that his conversation with Leo yesterday used that as the starting point.

When that news hit the tape yesterday morning a little past 10:00, the pound started a significant rally, ultimately gaining 2% yesterday and it is higher by a further 1.0% this morning after more promising comments from both sides of the table. Remember, too, that the market remains extremely short pound Sterling and has been so for quite a while. If I am correct, then we could see the pound well above 1.30 as early as next week. Of course, if it does fall apart, then a quick trip back to 1.20 is on the cards. As I have said, my money is on a deal. One other thing to note here is what happened in the FX options market. For most of the past twelve years, the risk reversal (the price the market pays for 25 delta puts vs. 25 delta calls) has traded with puts at a premium. In fact earlier this year, the 1mo version was trading at a 2.5 vol premium for puts. Well, yesterday, the risk reversal flipped positive (bid for calls) and is now bid more than 1.0 vol for GBP calls. This is a huge move in this segment of the market, and also seen as quite an indicator that expectations for further pound strength abound.

Regarding the trade talks, risk assets have taken a very positive view of the comments that have come from both sides, notably President Trump describing things as going “very well” and agreeing to meet with Chinese Vice-premier Liu He this afternoon before he (He) returns to Beijing. The information that has come out points to the following aspects of a deal; a currency pact to insure the Chinese do not weaken the renminbi for competitive advantage; increased Chinese purchases of grains and pork; a US promise not to increase tariffs going forward as the broader negotiations continue; and the lifting of more sanctions on Chinese companies like Huawei and COSCO, the Chinese shipping behemoth. Clearly, all of that is positive and it is no surprise that equity markets globally have responded with solid gains. It is also no surprise that Treasury and Bund yields are much higher this morning than their respective levels ahead of the talks. In fact, Treasuries, which are just 1bp higher this morning, are up by more than 15bps since Tuesday. For Bunds, today’s price action shows no change in yields, but a 12bp move (less negative rates) since then. The idea is a trade deal helps global economic growth pick back up and quashes talk of deflation.

The last big story of the morning comes from the Persian Gulf, where an Iranian oil tanker, carrying about 1 million barrels of oil, was attacked by missiles near the Saudi port of Jeddah. At first the Iranians blamed the Saudis, but they have since retracted that statement. It should be no surprise that oil prices jumped on the news, with WTI futures quickly rallying more than a dollar and maintaining those gains since then. One of the key depressants of oil prices has been the global economic malaise, which does not yet look like it is over. However, if the trade truce is signed and positive vibes continue to come from that area, I expect that oil prices will benefit greatly as well.

As to the FX market per se, the dollar is overall under pressure. Of course, the pound has been the biggest mover in the G10 space, but AUD has gained 0.55% and the rest of the block is higher by roughly 0.3%. The only exceptions here are the yen (-0.3%) and Swiss franc (-0.1%) as haven assets are unloaded.

Turning to the EMG bloc, ZAR is today’s big winner, rallying more than 1.1% on two features; first the general euphoria on trade discussed above and second on the news that former President Jacob Zuma must face corruption charges. The latter is important because it demonstrates that the rule of law may be coming back into favor there, always a benefit for an emerging market. But most of the space is firmer this morning, with many currencies higher by between 0.5% and 0.6% (RUB, KRW, PLN, HUF, MXN, etc.) In fact, the only loser this morning is TRY (-0.4%), which remains under pressure as President Erdogan presses his military campaign against the Kurds in Syria.

On the data front, the only US news is Michigan Sentiment (exp 92.0) but we also get the Canadian employment picture (exp 7500 new jobs and a 5.7% Unemployment Rate). Three more Fed speakers, Kashkari, Rosengren and Kaplan, are on the slate, but so far, the only clarity of message we have received this week is that everybody is watching the data and will respond as they see fit. Hawks are still hawks and doves are still doves.

I see no reason for the dollar to regain ground today assuming the good news from Trade and Brexit continue. So look for a further decline into the holiday weekend.

Good luck and good weekend
Adf

PS. While typing, the pound jumped another 1.0%.

A Currency Pact

The market is focused on trade
And hoping that progress is made
There’s news China’s backed
A currency pact
If tariff boosts can be delayed

Activity overnight was considerably more volatile than usual as conflicting stories regarding the US-China trade talks hit the tape. Risk was quickly jettisoned after a story from the South China Morning Post indicated that the talks, starting this morning in Washington, would be cut short. Shortly thereafter, the White House denied that report encouraging traders to buy back their stocks and sell bonds. Then Fox Business reiterated the original report less than a half hour later and the sell-off happened all over again. Finally, two positive reports helped equity markets recoup all of their overnight losses and took the shine off bonds. The first of those was that the currency pact that had been agreed between the US and China back in May (when chances of a big deal seemed realistic) was being dusted off and likely would be part of a mini-deal with the US agreeing to delay the imposition of new tariffs next Tuesday. And finally, President Trump has allowed US firms to sell non-critical technology to Huawei again, which was seen as additional thawing of the trade situation.

Of course, all this means is that we are back where we started, the trade talks are due to begin this morning and the Chinese delegation is scheduled to leave tomorrow evening. Arguably, the story that both sides are willing to agree on a currency pact as part of this round, and the indications that there are low level things that can be agreed, bode well for the rest of the week. But make no mistake, the major issues; IP theft, forced technology transfer and state subsidies are nowhere near being solved, and quite frankly, given they are integral to China’s economic model, seem unlikely ever to be solved. But for equity bulls, at least, hope springs eternal.

The FX impact in the end has been for a much softer dollar pretty much across the board. The idea is that if risk is to be embraced again, the higher yields available in Emerging Markets, as well as developed markets on a swapped basis, are the place to be. While the biggest mover overnight has been SEK, that is actually due to a surprising CPI report, with the annual pace of price increases rising to 1.5%, above the 1.3% expectation and a boon for the Riksbank who has been trying to normalize monetary policy by raising rates back to, and above, zero again. This report has given the market reason to believe that at their next meeting, in two weeks, while they won’t hike, they will continue to give guidance that a hike is coming before the end of the year. As such, SEK has rallied a solid 1.4%, although arguably, the trend is still for a weaker krone.

But the rest of the G10 has performed as well, with AUD, NZD and NOK all higher by 0.6% and the euro, despite disappointing data from both Germany and France, higher by 0.5%. Even the pound is higher this morning, up 0.35%, as the market awaits word on the outcome of a lunch meeting between Boris and Irish PM Leo Varadkar as they try to find a compromise. It seems to make the most sense that Varadkar is representing the EU given Ireland will be the nation most negatively impacted by a hard Brexit. My sense is we should start to hear about the outcome of this lunch around the time that US CPI is released, although I would read a delay as quite positive. The longer it takes; it seems the more likely that they are making headway on a compromise which would be very bullish for the pound. But until we actually see the news, the broad dollar trend is all we have.

In the EMG bloc we have also seen broad based strength paced this morning by HUF’s 0.7% rally. While much of this move is simply on the back of the euro’s rise, Hungary did have a quite successful auction of 5yr-15yr bonds which encouraged additional forint buying. Otherwise, the rest of the CE4 have moved directly in line with the euro and gains throughout Asia were only on the order of 0.2%. Of course, those markets closed before all the trade news had been released, so assuming nothing changes on that front (a difficult assumption) APAC currencies are likely to perform well tonight.

Turning to today’s session, we see our most important data of the week with CPI (exp 1.8%, 2.4% ex food & energy) as well as the usual Initial Claims data (220K). Regarding the former, Tuesday’s PPI report was surprisingly soft, with the headline number printing at -0.3% on the month and dragging the annual number down to just 1.4%. While there have been no forecast shifts amongst economists, there is still some lingering concern (hope?) amongst market participants that we could see a soft number here as well. The issue is a soft number would seem to open the door for the Fed to be far more aggressive in their rate cutting. Remember, Chairman Powell has repeated several times lately that the committee is watching the data closely and will do what they need to do in order to maintain the expansion while achieving their twin goals of stable prices and maximum employment. Obviously, with the Unemployment Rate at 3.5%, there is not much concern there. But falling inflation will ring alarm bells.

One last thing, though, regarding employment. The Initial Claims data is often a very good leading indicator of the overall employment situation, starting to rise well before the nonfarm numbers start to decline. Since the financial crisis, Initial Claims have tumbled from a peak of 665K in March 2009 to the low 200’s that we have seen for the past year. But recently, it appears that the number is beginning to creep higher again, with the 210k-215k readings that we had been seeing regularly now edging toward 220K and beyond. And while I know that seems extremely subtle, I merely caution that Initial Claims is a measure of job cuts, so if they are actually growing, that bodes ill for the economy’s future performance.

As to today, unless and until we hear more from the Trade talks or Boris, don’t look for much movement. But certainly the bias is to add risk for the day meaning the dollar should remain under pressure.

Good luck
Adf

 

No Longer Afraid

This morning twixt Brexit and trade
The market’s no longer afraid
More talks are now set
Though there’s no deal yet
And Parliament’s built a blockade

Yesterday saw a risk grab after the situation in Hong Kong moved toward a positive outcome. This morning has seen a continuation of that risk rally after two more key stories moved away from the abyss. First, both the US and China have confirmed that trade talks will resume in the coming weeks, expected sometime in early October, when Vice-premier Liu He and his team visit Washington. While the current tariff schedules remain in place, and there is no certainty that either side will compromise on the outstanding issues, it is certainly better that the talks continue than that all the news is in the form of dueling tweets.

It should be no surprise that Asian equity markets rallied on the news, (Nikkei +2.1%, Shanghai +1.0%), nor that European markets are following in their footsteps (DAX +0.85%, CAC +0.9%). It should also not be surprising that Treasury yields are higher (+5bps) as are Bund yields (+5bps); that the yen and dollar have suffered (JPY -0.2%, DXY -0.25%) and that gold prices are lower (-0.7%).

Of course, the other big story is Brexit, where yesterday PM Boris Johnson suffered twin defeats in his strategy of ending the mess once and for all. Parliament passed a bill that prevents the government from leaving the EU without a deal and requires the PM to ask for a delay if no deal is agreed by mid-October. Then in a follow-up vote, they rejected the call for a snap election as Labour’s Jeremy Corbyn would not support the opportunity to become PM himself. While Boris plots his next move, the market is reducing the probability of a hard Brexit in the pound’s price thus it has rallied further this morning, +0.7%, and is now higher by more than 2% since Tuesday morning.

However, while the news on both fronts is positive right now, remember nothing is concluded and both stories are subject to reversal at any time. In other words, hedgers must remain vigilant.

Turning to the rest of the market, there have been two central bank surprises in the past twenty-four hours, both of which were more hawkish than expected. First, the Bank of Canada yesterday left rates on hold despite the market having priced in a 25bp rate cut. They pointed to still solid growth and inflation near their target levels as reason enough to dissent from the market viewpoint. The market response was an immediate 0.5% rise in the Loonie with a much slower pace of ascent since then. However, all told, CAD is stronger by a bit over 1.1% since before the meeting. If you recall, analysts were less convinced than the market that a cut was coming, but they still have one penciled in by the end of the year. Meanwhile, the market is now 50/50 they will cut in October and about 65% certain it will happen by December.

The other hawkish surprise came from Stockholm this morning, where the Riksbank left rates on hold, as expected, but reiterated their view that a hike was still appropriate this year and that they expected to get rates back to positive before too long (currently the rate is -0.25%). While analysts don’t believe they will be able to follow through on this commitment, the FX market responded immediately and SEK is today’s top performer in the G10 space, rallying 0.9%.

The only data we have seen today was a much weaker than expected Factory Orders print from Germany (-2.7%), simply reinforcing the fact that the country is heading into a recession. That said, general dollar weakness on the risk grab has the euro higher by 0.25% as I type.

In the EMG space, we continue to see traders and investors piling into positions in their ongoing hunt for yield now that overall risk sentiment has improved. In the past two sessions we have seen LATAM, in particular, outperform with BRL higher by 1.8%, MXN up 1.65% and COP up 1.35%. But it is not just LATAM, ZAR is higher by 2.0% in that time frame, and KRW is up 1.3%. In fact, if you remove ARS from the equation (which obviously has its own major problems), every other EMG currency is higher since Tuesday’s close.

On the data front, yesterday’s US Trade deficit was a touch worse than expected at -$54.0B, but still an improvement on June’s data. This morning we see a number of things including ADP Employment (exp 148K), Initial Claims (215K), Nonfarm Productivity (2.2%), Unit Labor Costs (2.4%), Durable Goods orders (2.1%, -0.4% ex transport) and finally ISM Non-manufacturing (54.0). So there’s plenty of updated information to help ascertain just how the US economy is handling the stresses of the trade war and the global slowdown. As to Fed speak, there is nobody scheduled for today although we heard from several FOMC members yesterday with a range of views; from uber-dove Bullard’s call for a 50bp cut, to Dallas’s Kaplan discussing all the reasons that a cut is not necessary right now.

Despite the data dump today, I think all eyes will be on tomorrow where we not only get the payroll report, but Chairman Powell speaks at lunchtime. As such, there is no reason, barring a White House tweet, for the current risk on view to change and so I expect the dollar will continue to soften right up until tomorrow’s data. Then it will depend on that outcome.

Good luck
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Under Stress

The week that just passed was a mess
With both bulls and bears under stress
As equities fell
Most bonds performed well
And dollars? A roaring success

Pundits have been searching for adjectives to describe the week that is ending today. Tumultuous strikes me as an accurate reflection, but then stormy, tempestuous and volatile all work as well. In the end though, the broad trends have not changed at all. Equities continue to retreat from their mid-summer highs, bonds continue to rally sharply while yield curves around the world flatten and the dollar continues to march higher.

So what is driving all this volatility? It seems the bulk of the blame is laid at the feet of President Trump as his flipping and flopping on trade policy have left investors and traders completely confused. After all, late last week he declared tariffs would be imposed on the rest of Chinese imports not already subject to them, then after market declines he decided that a portion of those tariffs would be delayed from September until December. But then the Chinese struck back saying they would retaliate and now the President has highlighted he will be speaking directly with President Xi quite soon. On the one hand, it is easy to see given the numerous changes in stance, why markets have been so volatile. However, it beggars belief that a complex negotiation like this could possibly be completed on any short timeline, and almost by definition will take many more months, if not years. There is certainly no indication that either side is ready to capitulate on any of the outstanding issues. So the real question is, why are markets responding to every single tweet or comment? To quote William Shakespeare, “It is a tale told by an idiot, full of sound and fury signifying nothing.” Alas, there is every indication that this investor and trader behavior is going to continue for a while yet.

This morning we are back in happy mode, with the idea that the Presidents, Trump and Xi, are going to speak soon deemed a market positive. Equity markets around the world are higher (DAX +1.0%, CAC +1.0%, Nikkei +0.5%); bond markets have been a bit more mixed with Treasuries (+2bps) and Gilts (+4.5bps) selling off a bit but we continue to see Bunds (-1.5bps) rally. In fact we are at new all-time lows for Bund yields with the 10-year now yielding -0.73%!

As to the dollar, it is still in favor, with only the pound showing any real life in the G10 space, having rallied 0.65% this morning with the market continuing to be impressed with yesterday’s Retail Sales data there. In fact, if we look over the past week, the pound is the only G10 currency to outperform the dollar, having rallied more than 1.0%. On the flip side, the Skandies are this week’s biggest losers with both SEK and NOK down by 1.35% closely followed by the euro’s 1.1% decline, of which 0.3% has happened overnight.

The FX market continues to track the newest thoughts regarding relative central bank policy changes and that is clearly driving the euro. For example, yesterday, St Louis Fed President Bullard, likely the most dovish FOMC member (although Kashkari gives him a run), sounded almost reticent to continue cutting rates, and ruled out the idea that an intermeeting cut was necessary. While he supported the July cut, and will likely vote for September, he again ruled out 50bps and didn’t sound like more made sense. At the same time, Finnish central bank president Ollie Rehn, a key ECB member, explained that come September, the ECB would act very aggressively in order to get the most bang for the buck (euro?). The indication was not only will they cut rates, and possibly more than the 10bps expected, but QE would be restarted and expanded, and he did not rule out movement into other products (equities anyone?) as well. In the end, the market sees that the ECB is going to basically do everything else they can right away as they watch the Eurozone economy sink into recession. Meanwhile, most US data continues to point to a much more robust growth situation.

Let’s look at yesterday’s US data where Retail Sales were very strong (0.7%, 1.0% ex autos) and Productivity, Empire Manufacturing and Philly Fed all beat expectations. Of course, confusingly, IP was a weaker than expected -0.2% and Capacity Utilization fell to 77.5%. Adding to the overall confusion is this morning’s Housing data where Starts fell to 1191K although Permits rose to 1336K. In the end, there is more data that is better than worse which helps explain the 2.1% growth trajectory in the US, which compares quite favorably with the 0.8% GDP trajectory on the continent. As long as this remains the case, look for the dollar to continue to outperform.

Oh and one more thing, given the problems in the Eurozone, do you really believe the EU will sit by and watch the UK exit without changing their tune? Me either!

Next week brings the Fed’s Jackson Hole symposium and key speeches, notably by Chairman Powell. As to today, there is no reason to expect the dollar to do anything but continue its gradual appreciation.

Good luck and good weekend
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A Rate Cut’s Assumed

In Washington DC today
We’ll get to hear from Chairman Jay
A rate cut’s assumed
So, equities boomed
While dollar strength seems here to stay

Markets are on tenterhooks as the release of the FOMC statement approaches. That actually may be overstating the case. The market is highly confident that the Fed is going to cut the funds rate by 25 bps this afternoon as there has not been nearly enough change in the trajectory of the economic data over the past ten days to change any views. During this ‘quiet period’ we have seen solid, if unspectacular economic indicators. Certainly nothing indicating a severe slowdown, but also nothing indicating that the economy is overheating. As well, we have heard from several other central banks, notably the ECB and BOJ, that further policy ease is on the way and they are ready to move imminently. Finally, the whipped cream on this particular decision was released yesterday morning when core PCE data printed at 1.6%, a lower than expected outcome, and sufficient proof that inflation remains too quiescent for the Fed’s liking. At this point, it all seems anticlimactic.

Perhaps of more interest will be the press conference to be held at 2:30, when Chairman Powell will be able to explain more fully the rationale behind cutting rates with an economy running at potential, historically low unemployment and the easiest financial conditions seen in a decade. But hey, inflation is a few ticks low, so that is clearly justification. (As an aside, I find it remarkable that any central bank is so wedded, with precision, to a specific target inflation rate, and that not achieving that target is grounds for policy change. Let’s face it, monetary policy tools are blunt instruments and work with a significant lag. In fact, when a target is achieved, that seems to be more luck than skill. There are a number of central banks that aim for inflation to be within a range, and that seems to make far more sense than setting a 2.0% target and complaining when the rate is at 1.6%.)

In the meantime, there are still a few other things that are impacting markets today, notably the US-China trade talks and the ongoing Brexit story. Regarding the trade talks, the delegations met for two days in Shanghai and made approximately zero headway. The word is they are further apart now than when talks broke down three months ago. Suddenly it is dawning on a lot of people that these trade talks may not be concluded on a politically convenient schedule (meaning in time for the US election). The market impact was a decline in Asian equity indices with the Nikkei falling 0.9%, both Shanghai and Korea falling 0.7%, and the Hang Seng in Hong Kong down 1.3%. However, European indices have barely moved on the day and US futures are pointing higher after Apple beat earnings estimates following the close yesterday. The implication here is that US markets have moved on from the trade story while Asian ones are still beholden to every word. Quite frankly, that seems to be a realistic outcome given the fact that trade represents such a small part of the US economy as opposed to every Asian nation, where it is a major driver of economic activity.

Turning to the Brexit story, the pound plumbed new depths yesterday, trading close to 1.21 before a modest bounce this morning (+0.15%) as Boris continues to hold a hard line on talks. He is pushing very hard for the EU to reopen the existing, unratified deal and will not meet face-to-face with any EU counterparts until they do so. Thus far, the EU has been adamant that the deal is done, and they refuse to change it.

But here’s the first clue that things are going to change; the Bank of Ireland said that a hard Brexit will reduce GDP growth in 2020 to 0.7% from the currently expected 4.1% growth. As I mentioned before, Ireland is on the front lines and will feel the brunt of the early impacts. At some point, probably pretty soon, Taoiseach Leo Varadkar is going to prevail on the rest of the EU to reopen talks before Ireland is crushed. And remember, too, that a no-deal Brexit leaves the EU with a £39 billion hole in their budget as that was to be the UK’s parting alimony payment.

While the EU tries to convince one and all that they hold the upper hand, it is not clear to me that is the case. Working in Boris’s favor was today’s Q2 GDP data from the Eurozone showing growth falling to 0.2% in the quarter with Italy at 0.0%, Spain dipping to 0.5% and France having reported 0.2% yesterday. Germany doesn’t actually report until next month, but indications are 0.0% is the best they can expect. The euro remains under pressure, trading at the bottom of its recent 1.11-1.14 trading range and shows no signs of rebounding. And of course, the fact that the ECB is getting set to ease policy further is not helping the single currency at all. I maintain that despite the Fed’s actions today, unless Powell promises three more cuts soon, the dollar will remain bid.

And those are really today’s stories. Overall, the FX market is pretty benign today, with the largest mover being TRY, which rallied 0.45% as optimism is growing that the economy is stabilizing which means that the current high rates are quite attractive to investors. But away from that, movement has been on the order of 0.10%-0.20% in either direction. In other words, nothing is happening.

On the data front, remember this is payroll week as well, and today we see ADP Employment (exp 150K) and then Chicago PMI (50.6) before the FOMC this afternoon. As earnings season is still underway, I expect equities to respond to that data, but the dollar will likely bide its time until the Fed. After that, nothing has changed my broadly bullish view, although an uber-dovish Powell could clearly do so.

Good luck
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Beggar Thy Neighbor

A story that’s making the rounds
Although, it, so far, lacks real grounds
Is that the US
Might try to depress
The dollar ‘gainst euros and pounds

If so, that’s incredible news
And dollar bulls need change their views
But beggar thy neighbor
Does naught but belabor
The trade war, instead, it, defuse

The most interesting story that has started to gain traction is the idea that the Trump administration is considering direct intervention in the FX markets. While most pundits and investors focus on the Fed and how its monetary policy impacts the value of the dollar (which is completely appropriate), the legal framework in the US is that the Treasury is the department that has oversight of the currency. This means that dollar policy, such as it is beyond benign neglect, is formulated by the Secretary of the Treasury, not the FOMC. This is why the Treasury produces the report about other countries and currency manipulation every six months. Also, this is not a new situation, it has been the case since the abandonment of the Bretton Woods Agreement in 1971.

Since the Clinton Administration, the US policy has been a ‘strong dollar is in the US best interest’. This was made clear by then Treasury Secretary Robert Rubin and has been an accepted part of the monetary framework ever since. The issue with a strong dollar, of course, is that it can be an impediment for US exporters as their goods and services may become uncompetitively priced. Now, during the time when the US’s large trade deficits were not seen as problematic, the strong dollar was not seen as an issue. Clearly, earnings results from multinational corporations were impacted, but the government was not running policy with that as a priority. However, the current administration is far more mercantilist than the previous three or four, and as we have seen from the President’s Twitter feed, dollar strength has moved up the list of priorities.

It is this set of circumstances that has analysts and economists pondering the idea that the Treasury may direct the Fed to intervene directly in the FX market, selling dollars. History has shown that when a country intervenes by itself in the FX market, whether to prevent strength or weakness, it has generally been a failure. The only times when intervention has worked has been when there has been a general agreement amongst a large group of nations that a currency is either too strong or too weak and that intervention is appropriate. The best known examples are the Plaza Accord and the Louvre Accord from the mid-1980’s, where the G7 first agreed that the dollar was overvalued, then that it had reached an appropriate level. The initial announcement alone was able to drive the dollar lower by upwards of 10%, and the active intervention was worth another 5%. The result was a longer term weakening of nearly 40% before it was halted by the Louvre Accord. But other than those situations, for the large freely floating currencies, intervention has been effective at slowing a trend, but not reversing one. And the current dollar trend remains higher.

If the US does decide to intervene directly, this will have an enormous short-term impact on the FX market (and probably all markets) as it represents a significant policy reversal. However, in the end, macroeconomic fundamentals and relative monetary policy stances are still going to drive the value of every currency. With that in mind, it could be a long time before those influences become dominant again. Of course, the other thing is that the history of beggar-thy-neighbor FX policy is one of abject failure, with all nations seeking the same advantage, and none receiving any. Certainly, this is something to keep on your radar.

Away from that story, the dollar is actually stronger this morning, with the euro having breached 1.12, the pound tumbling toward 1.24 and most currencies, both G10 and EMG on the back foot. In fact, this is the problem for the Trump administration on this front, the growth situation elsewhere in the world continues to deteriorate more rapidly than in the US. Not only did Friday’s employment data help support the dollar, but this morning we saw very weak UK and Italian Retail Sales data to add to the economic malaise in those areas. In fact, economists are now forecasting negative GDP growth in the UK for Q2, and markets are pricing in a 25bp rate cut by the BOE before the end of the year. Meanwhile, in the Eurozone, all the talk is about how quickly the ECB is going to restart QE, with new estimates it could happen as soon as September with amounts up to €40 billion per month. While that seems to be a remarkably quick reversal (remember, they just ended QE six months ago), with the prospect of an ECB President Lagarde, who has lauded QE as an excellent policy tool, it cannot be ruled out.

Pivoting to the trade story, the latest news is that senior officials will be speaking by phone this week and the chances of a meeting, probably in Beijing in the next few weeks are rising. The problem is that there are still fundamental differences in world views and unless one side caves, which seems unlikely right now, I don’t see a short-term resolution. What is more remarkable is the fact that the lack of any discernible progress on trade is no longer seen as an issue by any markets. Or at least not a major one. While equity markets have softened over the past two sessions, the declines have been muted and, at least in the US, indices remain near record highs. Bond yields have risen a bit, implying the worst of the fear has passed, although in fairness, they remain incredibly low. But most importantly, the dialog has moved on, with trade no longer seen as the key fundamental factor it appeared to be just two months ago.

Turning to this morning’s news, there is only one data point, JOLT’s Job Openings (exp 7.47M) but of much more importance we hear from Chairman Powell at 8:45 this morning, followed by Bullard, Bostic and Quarles later in the day. Powell begins his testimony to Congress tomorrow morning, but everyone will be listening carefully to see if he is going to try to walk back expectations for the July rate cut that is fully priced into the market. My money is on confirming the cut on the basis of continued low inflation readings. However, given that is the market expectation, there is no reason to believe the dollar will suffer on the news, unless he is hyper dovish. So, the current strong stance of the buck seems likely to continue for the rest of the day.

Good luck
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Cow’ring In Fear

Tis coming increasingly clear
That growth is at ebb tide this year
The PMI data
When looked at, pro rata
Shows industry cow’ring in fear

Meanwhile in Osaka, the meet
Twixt Trump and Xi lowered the heat
On tariffs and trade
Which most have portrayed
As bullish, though some are downbeat

With all the buildup about the meeting between President’s Trump and Xi, one might have thought that a cure for cancer was to be revealed. In the end, the outcome was what was widely hoped for, and largely expected, that the trade talks would resume between the two nations. Two addenda were part of the discussion, with Huawei no longer being shut out of US technology and the Chinese promising to buy significantly more US agricultural products. Perhaps it was the two addenda that have gotten the market so excited, but despite the results being largely in line with expectations, equity markets around the world have all exploded higher, with both Shanghai and Tokyo rallying more than 2.2%, Europe seeing strong gains, (DAX +1.35%, FTSE + 1.15%) and US futures pointing sharply higher (DJIA +1.1%, NASDAQ +1.75%). In other words, everybody’s happy! Oil prices spiked higher as well, with WTI back over $60 due to a combination of an extension of the OPEC+ production cuts and the boost from anticipated economic growth after the trade truce. Gold, on the other hand, is lower by 1.4% as haven assets have suffered. After all, if the apocalypse has been delayed, there is no need to seek shelter.

But a funny thing happened on the way to market salvation, Manufacturing PMI data was released, and not only was it worse than expected pretty much everywhere around the world, it was also below the 50 level pretty much everywhere around the world. Here are the data for the world’s major nations; China 49.4, Japan 49.3, Korea 47.5, Germany 45.0, and the UK 48.0. We are awaiting this morning’s US ISM report (exp 51.0), but remember, that Friday’s Chicago PMI, often seen as a harbinger of the national scene, printed at a disastrous 49.7, more than 3 points below expectations and down 4.5 points from last month.

Taking all this into account, the most important question becomes, what do you do if you are the Fed? After all, the Fed remains the single most important actor in financial markets, if not in the global economy. Markets are still pricing in a 25bp rate cut at the end of this month, and about 100bps of cuts by the end of the year. In the meantime, the most recent comments from Fed speakers indicate that they may not be that anxious to cut rates so soon. (see Richmond Fed President Thomas Barkin’s Friday WSJ interview.) If you recall, part of the July rate cut story was the collapse of the trade talks and the negative impact that would result accordingly. But they didn’t collapse. Now granted, the PMI data is pointing to widespread economic weakness, which may be enough to convince the Fed to cut rates anyway. But was some of that weakness attributable to the uncertainty over the trade situation? After all, if global trade is shrinking, and it is, then manufacturing plans are probably suffering as well, even without the threat of tariffs. All I’m saying is that now that there is a trade truce, will that be sufficient for the Fed to remain on hold?

Of course, there is plenty of other data for the Fed to study before their next meeting, perhaps most notably this Friday’s payroll report. And there is the fact that with the market still fully priced for a rate cut, it will be extremely difficult for the Fed to stand on the side as the equity market reaction would likely be quite negative. I have a feeling that the markets are going to drive the Fed’s activities, and quite frankly, that is not an enviable position. But we have a long time between now and the next meeting, and so much can, and likely will, change in the interim.

As to the FX market, the dollar has been a huge beneficiary of the trade truce, rallying nicely against most currencies, although the Chinese yuan has also performed well. As an example, we see the euro lower by 0.3%, the pound by 0.45% and the yen by 0.35%. In fact, all G10 currencies are weaker this morning, with the true outliers those most likely to benefit from lessening trade tensions, namely CNY and MXN, both of which have rallied by 0.35% vs. the dollar.

Turning to the data this week, there is plenty, culminating in Friday’s payrolls:

Today ISM Manufacturing 51.0
  ISM Prices Paid 53.0
Wednesday ADP Employment 140K
  Trade Balance -$54.0B
  Initial Claims 223K
  ISM Non-Manufacturing 55.9
  Factory Orders -0.5%
Friday Nonfarm Payrolls 160K
  Private Payrolls 153K
  Manufacturing Payrolls 0K
  Unemployment Rate 3.6%
  Average Hourly Earnings 0.3% (3.2% Y/Y)
  Average Weekly Hours 34.4

So, there will be lots to learn about the state of the economy, as well as the latest pearls of wisdom from Fed members Clarida, Williams and Mester in the first part of the week. And remember, with Thursday’s July 4th holiday, trading desks in every product are likely to be thinly staffed, especially Friday when payrolls hit. Also remember, last month’s payroll data was a massive disappointment, coming in at just 75K, well below expectations of 200K. This was one of the key themes underpinning the idea that the Fed was going to cut in July. Under the bad news is good framework, another weak data point will virtually guaranty that the Fed cuts rates, so look for an equity market rally in that event.

In the meantime, though, the evolving sentiment in the FX market is that the Fed is going to cut more aggressively than everywhere else, and that the dollar will suffer accordingly. I have been clear in my view that any dollar weakness will be limited as the rest of the world follows the Fed down the rate cutting path. Back in the beginning of the year, I was a non-consensus view of lower interest rates for 2019, calling for Treasuries at 2.40% and Bunds at 0.0% by December. And while we could still wind up there, certainly the consensus view is for much lower rates as we go forward. Things really have changed dramatically in the past six months. Don’t assume anything for the next six!

Good luck
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