Open and Shut

Kashakari, on Friday, explained
For US growth to be sustained
The case for a cut
Was open and shut
Since then, talk of fifty has gained

As the new week begins, last week’s late trends remain in place, i.e. limited equity market movement as uncertainty over the outcome of the Trump-Xi meeting continues, continued demand for yield as investors’ collective belief grows that more monetary ease is on the way around the world, and a softening dollar vs. other currencies and commodities, as the prevailing assumption is that the US has far more room to ease policy than any other central bank. Certainly, the last statement is true as US rates remain the highest in the developed world, so simply cutting them back to the zero bound will add much more than the stray 20bps that the ECB, which is already mired in negative territory, can possibly add.

It is this concept which has adjusted my shorter-term view on the dollar, along with the view of most dollar bulls. However, as I have discussed repeatedly, at some point, the dollar will have adjusted, especially since the rest of the world will need to get increasingly aggressive if the dollar starts to really decline. As RBA Governor Lowe mentioned in a speech, one of the key methods of policy ease transmission by any country is by having the local currency decline relative to its peers, but if everyone is easing simultaneously, then that transmission channel is not likely to be as effective. In other words, this is yet another central bank head calling for fiscal policy stimulus as he admits the limits that exist in monetary policy at this time. Alas, the herd mentality is strong in the central bank community, and so I anticipate that all of them will continue down the same path with a minimal ultimate impact.

What we do know as of last week is there are at least two FOMC members who believe rates should be lower now, Bullard and Kashkari, and I suspect that there are a number more who don’t have to be pushed that hard to go along, notably Chairman Powell himself. Remember, if markets start to decline sharply, he will want to avoid as much of the blame as possible, so if the Fed is cutting rates, he covers himself. And quite frankly, I expect that almost regardless of how the data prints in the near-term, we are going to see policy ease across the board. Every central bank is too committed at this point to stop.

The upshot of all this is that this week is likely to play out almost exactly like Friday. This means a choppy equity market with no trend, a slowly softening dollar and rising bond markets, as all eyes turn toward Osaka, Japan, where the G20 is to meet on Friday and Saturday. Much to their chagrin, it is not the G20 statement of leaders that is of concern, rather it is the outcome of the Trump-Xi meeting that matters. In fact, that is pretty much the only thing that investors are watching this week, especially since the data releases are so uninteresting.

At this point, we can only speculate on how things will play out, but what is interesting is that we have continued to hear a hard line from the Chinese press. Declaring that they will fight “to the end” regarding the trade situation, as well as warning the US on doing anything regarding the ongoing protests in Hong Kong. Look for more bombast before the two leaders meet, but I think the odds favor a more benign resolution, at least at this point.

Turning to the data situation, the only notable data overnight was German Ifo, which fell to 97.4, its lowest level since November 2014, and continuing the ongoing trend of weak Eurozone data. However, the euro continues to rally on the overwhelming belief that the US is set to ease policy further, and this morning is higher by 0.25%, and back to its highest point in 3 months. As to the rest of the week, here’s what to look forward to:

Tuesday Case-Hiller Home Prices 2.6%
  Consumer Confidence 131.2
  New Home Sales 680K
Wednesday Durable Goods -0.1%
  -ex transport 0.1%
Thursday Initial Claims 220K
  Q1GDP 3.2%
Friday Personal Income 0.3%
  Personal Spending 0.4%
  Core PCE 0.2% (1.6% Y/Y)
  Chicago PMI 53.1
  Michigan Sentiment 98.0

Arguably, the most important point is the PCE data on Friday, but of more importance is the fact that we are going to hear from four more Fed speakers early this week, notably Chairman Powell on Tuesday afternoon. And while the Fed sounded dovish last week, with the subsequent news that Kashkari was aggressively so, all eyes will be looking to see if he is persuading others. We will need to see remarkably strong data to change this narrative going forward. And that just seems so unlikely right now.

In the end, as I said at the beginning, this week is likely to shape up like Friday, with limited movement, and anxiety building as we all await the Trump-Xi meeting. And that means the dollar is likely to continue to slide all week.

Good luck
Adf

Oy Vey!

The jobs report was quite the dud
And traders began smelling blood
If Powell and friends
Would not make amends
Then stocks would be dragged through the mud

Then later, down Mexico’s way
The tariff dispute went away
At least for the moment
Though Trump could still foment
More problems by tweeting, oy vey!

This morning, despite the confusion
The outcome’s a foregone conclusion
Stock markets will rise
While bonds scrutinize
The data, and fight the illusion

I’m not even sure where to start this morning. Friday’s market activity was largely as I had forecast given the weak payrolls report, just a 75K rise in NFP along with weaker earnings numbers, leading to a massive increase in speculation that the Fed is going to cut, and cut soon. In fact, the probability for a June cut of 25bps is now about 50/50, with a full cut priced in for the July meeting and a total of 70bps of cuts priced in for the rest of 2019. Equity markets worldwide have rallied on the weak data as a new narrative has developed as follows: weaker US growth will force the Fed to ease policy sooner than previously forecast and every other central bank will be forced to follow suit and ease policy as well. And since the reaction function for equity markets has nothing to do with economic activity, being entirely dependent on central bank largesse, it should be no surprise that stock markets are higher everywhere. Adding to the euphoria was the announcement by the Trump administration that those potential Mexican tariffs have been suspended indefinitely after progress was made with respect to the ongoing immigration issues at the US southern border.

This combination of news and data was all that was needed to reverse the Treasury market rally from earlier in the week, with 10-year yields higher by 5bps this morning, and the dollar, which had fallen broadly on Friday, down about 0.6% across the board after the payroll report, has rebounded against most of its counterpart currencies. The one outlier here is the Mexican peso, which after the tariff threat had fallen by nearly 3%, has rebounded and is 2.0% higher vs. the dollar this morning.

To say that we live in a looking glass world where up is down and down is up may not quite capture the extent of the overall market confusion. One thing is certain though, and that is we are likely to continue to see market volatility increase going forward.

Let’s unpack the Fed portion of the story, as I believe it will be most helpful in trying to anticipate how things will play out going forward. President Trump’s threats against Mexico really shook up the market but had an even bigger impact on the Fed. Consider, we have not heard the word ‘patient’ from a Fed speaker since Cleveland Fed President Loretta Mester used the word on May 3rd. When the FOMC minutes were released on May 22, the term was rampant, but the world had changed by then. In the interim, we had seen the US-China trade talks fall apart and an increase in tariffs by both sides, as well as threats of additional actions, notably the banning of Huawei products in the US and the restriction of rare earth metals sales by China. At this point, the trade situation is referred to as a war by both sides and most pundits. We have also seen weaker US economic activity, with Retail Sales and Housing data suffering, along with manufacturing and production. While no one is claiming we are in recession yet, the probabilities of one arriving are seen as much higher.

The result of all this weak data and trade angst was a pretty sharp sell-off in the equity markets, which as we all know, seems to be the only thing that causes the Fed to react. And it did so again, with the Fed speakers over the past two weeks highlighting the weakening data and lack of inflation and some even acknowledging that a rate cut would be appropriate (Bullard and Evans.) This drove full on speculation that the Fed was about to ease policy and futures markets have now gone all-in on the idea. It would actually be disconcerting if the Fed acted after a single poor data point, so June still seems only a remote possibility, but when they meet next week, look for a much more dovish statement and for Chairman Powell to be equally dovish in the press conference afterward.

And remember, if the Fed is turning the page on ‘normalization’ there is essentially no chance that any other major central bank will be able to normalize policy either. In fact, what we have heard from both the ECB’s Draghi and BOJ’s Kuroda-san lately are defenses of the many tools they still have left to utilize in their efforts to raise inflation and inflationary expectations. But really, all they have are the same tools they’ve used already. So, look for interest rates to fall further, even where they are already negative, as well as more targeted loans and more QE. And the new versions of QE will include purchases that go far beyond government bonds. We will see much more central bank buying of equities and corporate bonds, and probably mortgages and municipals before it is all over.

Ultimately, the world has become addicted to central bank policy largesse, and I fear the only way this cycle will be broken is by a crisis, where really big changes are made (think debt jubilee), as more of the same is not going to get the job done. And that will be an environment where havens will remain in demand, so dollars, yen, Treasuries and Bunds, and probably gold will all do quite well. Maybe not immediately, but that is where we are headed.

Enough doom and gloom. Let’s pivot to the data story this week, which is actually pretty important:

Today JOLTs Jobs Report 7.479M
Tuesday NFIB Small Biz 102.3
  PPI 0.1% (2.0% Y/Y)
  -ex food & energy 0.2% (2.3% Y/Y)
Wednesday CPI 0.1% (1.9% Y/Y)
  -ex food & energy 0.2% (2.1% Y/Y)
Thursday Initial Claims 216K
Friday Retail Sales 0.7%
  -ex autos 0.3%
  IP 0.1%
  Capacity Utilization 78.7%
  Michigan Sentiment 98.1

Clearly CPI will be closely watched, with any weakness just fanning the flames for rate cuts sooner. Also, after the weak NFP report Friday, I expect closer scrutiny for the Initial Claims data. This has been quite steady at low levels for some time, but many pundits will be watching for an uptick here as confirmation that the jobs market is starting to soften. Finally, Retail Sales will also be seen as important, especially given the poor outcome last month, which surprised one and all.

Mercifully, the Fed is in its quiet period ahead of their meeting next week, so we won’t be hearing from them. Right now, however, the momentum for a rate cut continues to build and stories in the media are more about potential weakness in the economy than in the strength that we had seen several months ago. If the focus remains on US economic activity softening, the dollar should come under pressure, but once we see that spread to other areas, notably the UK and Europe, where they had soft data this morning, I expect those pressures to equalize. For today, though, I feel like the dollar is still vulnerable.

Good luck
Adf

Soon On the Way

While Powell did not actually say
That rate cuts were soon on the way
He hinted as much
So traders did clutch
The idea and quickly made hay

If there was ever any doubt as to what is driving the equity markets, it was put to rest yesterday morning. Chairman Powell, during his discussion of the economy and any potential challenges said the following, “We are closely monitoring the implications of these developments for the U.S. economic outlook and, as always, we will act as appropriate to sustain the expansion.” Nowhere in that comment does he actually talk about cutting rates, but the market belief is that ‘appropriate action’ is just that. The result was a powerful equity market rally (DJIA and S&P +2.1%, NASDAQ +2.6%), a modest Treasury sell-off and further weakness in the dollar. At this point, Wall Street analysts are competing to define the terms of the Fed’s next easing cycle with most now looking for at least two rate cuts this year, but nobody expecting a move later this month. And don’t forget the futures market, where traders are pricing in 60bps of rate cuts before the end of the year, so two cuts and a 40% probability of a third.

All of this is ongoing in the face of continuing bombastic trade rhetoric by both the US and China, and with President Trump seemingly quite comfortable with the current situation. While it appears that he views these as negotiating tactics, it seems clear that the strategy is risky and could potentially spiral into a much more deeply entrenched trade war. However, with that in mind, the one thing we all should have learned in the past two plus years is that forecasting the actions of this President is a mug’s game.

Instead, let’s try to consider potential outcomes for various actions that might be taken.

Scenario 1: status quo, meaning tariffs remain in place but don’t grow on either side and trade talks don’t restart. If the current frosty relationship continues, then markets will become that much more reliant on Fed largesse in order to maintain YTD gains, let alone rally. Global growth is slowing, as is growth in trade (the IMF just reduced forecasts for 2019 again!), and earnings data is going to suffer. In this case, the market will be pining for ‘appropriate action’ and counting on the Fed to cut rates to support the economy. While rate cuts will initially support equities, there will need to be more concrete fiscal action to extend any gains. Treasuries are likely to continue to see yields grind lower with 2.00% for the 10-year quite viable, and the dollar is likely to continue to suffer in this context as expectations for US rate cuts will move ahead of those for the rest of the world. Certainly, a 2% decline in the dollar is viable to begin with. However, remember that if the economic situation in the US requires monetary ease, you can be sure that the same will be true elsewhere in the world, and when that starts to become the base case, the dollar should bottom.

Scenario 2: happy days, meaning both President’s Xi and Trump meet at the G20, agree that any deal is better than no deal and instruct their respective teams to get back to it. There will be fudging on both sides so neither loses face domestically, but the threat of an all-out trade war dissipates quickly. Markets respond enthusiastically as earnings estimates get raised, and while things won’t revert to the 2016 trade situation, tariffs will be removed, and optimism returns. In this case, without any ‘need’ for Fed rate cuts, the dollar will likely soar, as once again, the US economic situation will be seen as the most robust in the world, and any latent Fed dovishness is likely to be removed. Treasury prices are sure to fall as risk as quickly embraced and 2.50%-2.75% 10-year Treasuries seems reasonable. After all, the 10-year was at 2.50% just one month ago.

Scenario 3: apocalypse, the trade war escalates as both Presidents decide the domestic political benefits outweigh the potential economic costs and everything traded between the two nations is subject to significant tariffs. Earnings estimates throughout the world tumble, confidence ebbs quickly and equity markets globally suffer. While this will trigger another bout of central bank easing globally, the impact on equity markets will be delayed with fear running rampant and risk rejected. Treasury yields will fall sharply; 1.50% anyone? The dollar, however, will outperform along with the yen, as haven currencies will be aggressively sought.

Obviously, there are many subtle gradations of what can occur, but I feel like these three descriptions offer a good baseline from which to work. For now, the status quo is our best bet, with the chance of happy days coming soon pretty low, although apocalypse is even more remote. Just don’t rule it out.

As to the markets, the dollar has largely stabilized this morning after falling about 1% earlier in the week. Eurozone Services PMI data printed ever so slightly higher than expected but is still pointing to sluggish growth. The ECB is anticipated to announce the terms of the newest round of TLTRO’s tomorrow, with consensus moving toward low rates (-0.4% for banks to borrow) but terms of just two years rather than the previous package’s terms of four years. Given the complete lack of inflationary pulse in the Eurozone and the ongoing manufacturing malaise, it is still very hard for me to get excited about the euro rallying on its own.

This morning brings ADP Employment data (exp 185K) as well as ISM Non-Manufacturing (55.5) and then the Fed’s Beige Book is released at 2:00. We hear from three more Fed speakers, Clarida, Bostic and Bowman, so it will be interesting to see if there is more emphasis on the willingness to respond to weak markets activity. One thing to note, the word patience has not been uttered by a single Fed member in a number of days. Perhaps that is the telling signal that a rate cut is coming sooner than they previously thought.

Good luck
Adf

 

Completely Dissolved

The last time the FOMC
Sat down to discuss policy
The trade talks were purring
While folks were concurring
A hard Brexit never could be

But since then the world has evolved
And good will completely dissolved
So what they discussed
They now must adjust
If problems are e’er to be solved

It wasn’t too long ago that the Fed was the single most important topic in markets. Everything they said or did had immediate ramifications on stocks, bonds and currencies. In some circles, the Fed, and their brethren central banks, were seen as omnipotent, able to maintain growth by simply willing it higher. A natural consequence of that narrative was that the FOMC Minutes especially, but generally those of all the major central banks, were always seen as crucial in helping to better understand the policy stance, as well as its potential future. But that time has passed, at least for now. Yesterday’s FOMC Minutes were, at best, the third most important story of the day mostly because they opened the window on views that are decidedly out of date. Way back then, three weeks ago, the backdrop was of a slowly resolving trade dispute between the US and China with a deal seeming imminent, growing confidence that a no-deal Brexit was out of the picture, and an equity market that was trading at all-time highs. My how quickly things can change!

To summarize, the Minutes expressed strong belief amongst most members that patience remained the proper stance for now, although a few were concerned about too low inflation becoming more ingrained in the public mind. And then there was a technical discussion of how to manage the balance sheet regarding the tenors of Treasury securities to hold going forward, whether they should be focused in the front end, or spread across the curve. However, no decisions were close to being made. It should be no surprise that the release had limited impact on markets.

The thing is, over the past few sessions we have heard an evolution in some FOMC members’ stance on things, specifically with Bullard and Evans discussing the possibility of cutting rates, although as of now, they are the only two. However, we have heard even some of the more hawkish members willing to imply that rate cuts could be appropriate if the ‘temporary’ lull in the growth and inflation data proves more long-lasting. As has been said elsewhere, while the bar for cutting rates is high, the bar for raising rates is much, much higher. The next move is almost certainly lower.

And what has caused this evolution in thought since the last FOMC meeting? Well, the obvious answers are, first, the sharp escalation in the trade war, with the US raising tariffs on $200B of Chinese imports from 10% to 25% as well as threatening to impose that level of tariffs on the other $325B of Chinese imports. And second, the fact that the Brexit story has spiraled out of control, with further cabinet resignations (today Andrea Leadsom, erstwhile leader of the Tories in the House of Commons quit the Cabinet) adding to pressure on PM May to resign and opening up the potential for a hardline Boris Johnson to become the next PM and simply pull the UK out of the EU with no deal.

In fact, while I have written consistently on both topics over the past several months, the Fed remained the top driver previously. But now, these events are clearly completely outside the control of monetary officials and markets are going to respond to them as they unfold. In other words, look for more volatility, not less going forward.

With that as a backdrop, it can be no surprise that risk is being jettisoned across the board this morning. Equity markets are down around the world (Shanghai -1.4%, Nikkei -0.6%, DAX -1.75%, FTSE -1.4%, DJIA futures -0.9%, Nasdaq futures -1.25%); Treasuries (2.35%) and Bunds (-0.11%) are both in demand with yields falling; and the dollar is back on top of the world, with the yen along for the ride. A quick survey of G10 currencies shows the euro -0.15% and back to its lowest level since May 2017, the pound -0.2% extending its losing streak to 13 consecutive down days, while Aussie and Canada are both lower by 0.25%.

In the emerging markets, despite the fact that the PBOC continues to fix the renminbi stronger than expected, and still below 6.90, the market will have none of it and CNY is lower by a further 0.2% this morning and back above 6.94. Despite higher oil prices RUB and MXN are both softer by 0.6% and 0.4% respectively. CE4 currencies are under pressure with HUF leading the way, -0.4%, but the rest down a solid 0.25%-0.3%. In other words, there is no place to hide.

The hardest thing for risk managers to deal with is that these events are completely unpredictable as they are now driven by emotions rather than logical economic considerations. As such, the next several months are likely to see a lot of sharp movement on each new headline until there is some resolution on one of these issues. Traders and investors will be quite relieved when that happens, alas I fear it will be mid-summer at the earliest before anything concrete is decided. Until then, rumors and stories will drive prices.

Turning to today’s session we see a bit of US data; Initial Claims (exp 215K) and New Home Sales (675K). Tuesday’s Existing Home Sales disappointed and represented the 14th consecutive month of year-on-year declines. Of more interest, we have four Fed speakers (Kaplan, Barkin, Bostic and Daly) at an event and given what I detect is the beginnings of a change in view, these words will be finely parsed. So, at this point the question is will the fear factor outweigh the possible beginning of a more dovish Fed narrative. Unless all four talk about the possibility of cutting rates as insurance, I think fear still reigns. That means the dollar’s recent climb has not ended.

Good luck
Adf

 

Mostly Mayhem

There once was a female PM
Whose task was the fallout, to stem,
From Brexit, alas
What then came to pass
Was discord and mostly mayhem

And so, because progress has lumbered
Theresa May’s days are now numbered
The market’s concern
Is Boris can’t learn
The problems with which he’s encumbered

In the battle for headline supremacy, at least in the FX market’s eyes, Brexit has once again topped the trade war today. The news from the UK is that PM May has now negotiated her own exit which will be shortly after the fourth vote on her much-despised Brexit bill in Parliament. The current timing is for the first week of June, although given how fluid everything seems to be there, as well as a politician’s preternatural attempts to retain power, it may take a little longer. However, there seems to be virtually no possibility that the legislation passes, and Theresa May’s tumultuous time as PM seems set to end shortly.

Of course, that begs the question, who’s next? And that is the market’s (along with the EU’s) great fear. It appears that erstwhile London Mayor, Boris Johnson, is a prime candidate to win the leadership election, and his views on Brexit remain very clear…get the UK out! In the lead up to the original March 31 deadline, you may recall I had been particularly skeptical of the growing sentiment at the time that a hard Brexit had been taken off the table. In the end, the law of the land is still for the UK to leave the EU, deal or no deal, now by October 31, 2019. It beggars belief that the EU will readily reopen negotiations with the UK, especially a PM Johnson, and so I think it is time to reassess the odds of the outcome. Here is one pundit’s view:

  May 16, 2019 May 17, 2019
Soft Brexit 50% 20%
Vote to Remain 30% 35%
Hard Brexit 20% 45%

Given this change in the landscape, it can be no surprise that the pound continues to fall. This morning sees the beleaguered currency lower by a further 0.3% taking the move this month to 3.2%. And the thing is, given the nature of this move, which has been very steady (lower in 9 of the past 10 sessions with the 10th unchanged), there is every reason to believe that this has further room to run. Very large single day moves tend to be reversed quickly, but this, my friends is what a market repricing future probability looks like. The most recent lows, near 1.25 in December look a likely target at this time.

Of course, the fact that the market seems more focused on Brexit than trade doesn’t mean the trade story has died. In fact, equity markets in Asia suffered, as have European ones, on the back of comments from the Chinese Commerce Ministry that no further talks are currently scheduled, and that the Chinese no longer believe the US is negotiating in good faith. As such, risk is clearly being reduced across the board this morning with not merely equity weakness, but haven strength. Treasury (2.37%) and Bund (-0.11%) yields continue to fall while the yen (+0.2%) rallies alongside the dollar.

In FX markets, the Chinese yuan has fallen again (-0.3%) and is now trading at 6.95, quite close to the supposed critical support (dollar resistance) level of 7.00. There continues to be a strong belief in the market, along with the analyst community, that the PBOC won’t allow the renminbi to weaken past that level. This stems from market activity in 2015, when the Chinese surprised everyone with a ‘mini-devaluation’ of 1.5% one evening in early August of that year. The ensuing rush for the exits by Chinese nationals trying to save their wealth cost the PBOC $1 trillion in FX reserves as they tried to moderate the renminbi’s decline. Finally, when it reached 6.98 in late December 2016, they changed the capital flow regulations and added significant verbal suasion to their message that they would not allow the currency to fall any further.

And for the most part, it worked for the next 15 months. However, clearly the situation has changed given the ongoing trade negotiations, and arguably given the deterioration in the relationship between the US and China. While the Chinese have pledged to avoid currency manipulation, it is not hard to argue that their current activities in maintaining yuan strength are just that, manipulation. Given the capital controls in place, meaning locals won’t be able to rush for the doors, it is entirely realistic to believe the PBOC could say something like, ‘we believe it is appropriate for the market to have a greater role in determining the value of the currency and are widening the band around the fix to accommodate those movements.’ A 5% band would certainly allow a much weaker renminbi while remaining within the broad context of their policy tools. In other words, I am not convinced that 7.00 is a magic line, perhaps more like a Maginot Line. If your hedging policy relies on 7.00 being sacrosanct, it is time to rethink your policy.

Overall, the dollar is firmer pretty much everywhere, with yesterday’s broad strength being modestly extended today. Yesterday’s US data was much better than expected as Housing starts grew 5.6% and Philly Fed printed at a higher than expected 16.6. Later this morning we see the last data of the week, Michigan Sentiment (exp 97.5). We also hear from two more Fed speakers, Clarida and Williams, although we have already heard from both of them earlier this week. Yesterday Governor Brainerd made an interesting series of comments regarding the Fed’s attempts to lift inflation, highlighting for the first time, that perhaps their models aren’t good descriptions of the economy any more. After a decade of inability to manage inflation risk, it’s about time they question something other than the market. While I am very happy to see them reflecting on their process, my fear is they will conclude that permanent easy money is the way of the future, a la Japan. If that is the direction in which the Fed is turning, it will have a grave impact on the FX markets, with the dollar likely to suffer the most as the US is, arguably, the furthest from that point right now. But that is a future concern, not one for today.

Good luck and good weekend
Adf

“Talks” Become “War”

At what point do “talks” become “war”?
And how long can traders ignore
The signs that a truce
Are, at best, abstruse?
It seems bulls don’t care any more

So, markets continue to shine
But something’s a bit out of line
If problems have past
Then why the forecast
By bonds of a further decline

I can’t help being struck this morning by the simultaneous rebound in equity markets alongside the strong rally in bond markets. They seem to be telling us conflicting stories or are perhaps simply focusing on different things.

After Monday’s equity market rout set nerves on edge, and not just among the investor set, but also in the White House, it was no surprise to hear a bit more conciliatory language from the President regarding the prospects of completing the trade negotiations successfully. That seemed to be enough to cool the bears’ collective ardor and brought bargain hunters dip buyers back into the market. (Are there any bargains left at these valuations?) This sequence of events led to a solid equity performance in Asia despite the fact that Chinese data released last night was, in a word, awful. Retail Sales there fell to 7.2%, the lowest in 16 years and well below forecasts of 8.6% growth. IP fell to 5.4%, significantly below the 6.5% forecast, let alone last month’s 8.5% outturn. And Fixed Asset Investment fell to 6.1%, another solid miss, with the result being that April’s economic performance in the Middle Kingdom was generally lousy. We have already seen a number of reductions in GDP forecasts for Q2 with new expectations centering on 6.2%.

But the market reaction was not as might have been expected as the Shanghai composite rose a solid 1.9%. It seems that China is moving into the ‘bad news is good’ scenario, where weak data drives expectations of further monetary stimulus thus supporting stock prices. The other interesting story has been the change in tone in the official Chinese media for domestic Chinese consumption, where they have become more stridently nationalist and are actively discussing a trade “war”, rather than trade “talks”. It seems the Chinese are girding for a more prolonged fight on the trade front and are marshaling all the resources they can. Of course, at the end of the day, they remain vulnerable to significant pain if the second set of tariffs proposed by the US is enacted.

One consequence of this process has been a weakening Chinese yuan, which has fallen 2.7% since its close on Friday May 3rd, and is now at its weakest point since mid-December. At 6.9150 it is also less than 2% from the 7.00 level that has been repeatedly touted by analysts as a no-go zone for the PBOC. This is due to concerns that the Chinese people would be far more active in their efforts to protect their capital by moving it offshore. This is also the reason there are such tight capital flow restrictions in China. It doesn’t help the trade talks that the yuan has been falling as that has been a favorite talking point of President Trump, China’s manipulation of their currency.

This process has also renewed pundit talk of the Chinese selling all their Treasury holdings, some $1.1 trillion, as retaliation to US tariffs. The last idea makes no sense whatsoever, as I have mentioned in the past, if only because the question of what they will do with $1.1 trillion in cash has yet to be answered. They will still need to own something and replacing Treasuries with other USD assets doesn’t achieve anything. Selling dollars to buy other currencies will simply weaken the dollar, which is the opposite of the idea they are trying to manipulate their currency to their advantage, so also makes no sense. And finally, given the huge bid for Treasuries, with yields on the 10-year below 2.40%, it seems there is plenty of demand elsewhere.

Speaking of the Treasury bid, it seems bond investors are looking ahead for weaker overall growth, hence the declining yields. But how does that square with equity investors bidding stocks back up on expectations that a trade solution will help boost the economy. This is a conundrum that will only be resolved when there is more clarity on the trade outcome.

(Here’s a conspiracy theory for you: what if President Trump is purposely sabotaging the talks for now, seeking a sharp enough equity market decline to force the Fed to ease policy further. At that point, he can turn around and agree a deal which would result in a monster rally, something for which we can be sure he would take credit. I’m not saying it’s true, just not out of the question!)

At any rate, nothing in the past several sessions has changed the view that the trade situation is going to continue to be one of the key drivers for market activity across all markets for the foreseeable future.

After that prolonged diatribe, let’s look at the other overnight data and developments. German GDP rose 0.4%, as expected, in Q1. This was a significant uptick from the second half of last year but appears to be the beneficiary of some one-off issues, with slower growth still forecast for the rest of the year. Given expectations were built in, the fact that the euro has softened a bit further, down 0.1% and back below 1.12, ought not be too surprising. Meanwhile, the pound is little changed on the day, but has drifted down to 1.2900 quietly over the past two sessions. Despite solid employment data yesterday, it seems that traders remain unconvinced that a viable solution will be found for Brexit. This morning the word is that PM May is going to bring her thrice-defeated Brexit deal to Parliament yet again in June. One can only imagine how well that will go.

Elsewhere in the G10 we have the what looks like a risk-off session. The dollar is modestly stronger against pretty much all of that bloc except for the yen (+0.2%) and the Swiss franc (+0.1%), the classic haven assets. So, bonds (Bund yields are -0.10%, their lowest since 2016) and currencies are shunning risk, while equity traders continue to lap it up. As I said, there is a conundrum.

This morning we finally get some US data led by Retail Sales (exp 0.2%, 0.7% ex autos) as well as Empire Manufacturing (8.5), IP (0.0%) and Capacity Utilization (78.7%) all at 8:30. Business Inventories (0.0%) are released at 10:00 and we also hear from two more Fed speakers, Governor Quarles and Richmond Fed President Barkin. However, it seems unlikely that, given the consistency of message we have heard from every Fed speaker since their last meeting, with Williams and George yesterday reinforcing the idea that there is no urgency for the Fed to change policy in the near term and politics is irrelevant to the decision process, that we will hear anything new from these two.

In the end, it feels like yesterday’s equity rebound was more dead-cat than a start of something new. Risks still abound and slowing economic growth remains the number one issue. As long as US data continues to outperform, the case for dollar weakness remains missing. For now, the path of least resistance is for a mildly firmer buck.

Good luck
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Caused by the Other

With tariffs now firmly in place
The market’s been keen to embrace
The idea that Xi
And Trump will agree
To terms when they meet face-to-face

But rhetoric lately has shown
That both Trump and Xi will condone
A slowdown in trade
That both men portrayed
As caused by the other, alone

Risk is, once again, in tatters as the fallout from the US increase in tariffs starts to feed through the market. As of midnight last Thursday, US tariffs on $200 billion of goods rose to 25%. This morning, a list of the other $325 billion of goods that may be subject to tariffs will be published with a target date of 30-days before imposition. Meanwhile, China continues to try to figure out how best to respond. Their problem, in this scenario, is they don’t import that much stuff from the US, and so trying to determine what is an ‘equal’ offset is complicated. However, I am confident that within the next day or two, they will publish their response. Markets around the world have felt the fallout, with equity prices everywhere under pressure, EMG currencies, especially, feeling the heat, and Treasury bonds and German bunds remaining in vogue.

As of now, it appears the situation is unlikely to improve in the short-term. The US remains miffed that the Chinese seemingly reneged on previously agreed terms. Meanwhile, the Chinese are adamant that they will not kowtow to the US and be forced to legislate the agreed changes, instead insisting that administrative guidance is all that is needed to insure compliance with any terms. They deem this desire for a legislated outcome as impinging on their sovereignty. Once again, the issue falls back to the idea that while the US consistently accused the Chinese of IP theft and forced technology transfer, the Chinese don’t see it that way, and as such, don’t believe they need to change laws that don’t exist. Whatever the merits of either sides views, the end result is that it seems far less clear that a trade deal between the two is going to be signed anytime soon.

The markets question is just how much of this year’s global equity market rally has been driven by the assumption that trade issues would disappear and how much was based on a response to easier central bank policies. The risk for markets is not only that growth is negatively impacted, but that inflation starts to rise due to the tariffs. This would put the central banks in a tough spot, trying to determine which problem to address first. Famously, in 1979, when Paul Volcker was appointed Fed Chairman, he immediately took on inflation, raising short term interest rates significantly to slay that demon, but taking the US (and global) economy into recession as a result. It strikes me that today’s crop of central bank heads does not have the wherewithal to attack that problem in the same manner as Volcker. Rather, the much easier, and politically expedient, response will be to try to revive the economy while allowing inflation to run hot. This is especially the case since we continue to see serious discussions as to whether inflation is ‘dead’. FWIW, inflation is not dead!

At any rate, for now, the trade story is going to be the key story in every market, and the upshot is that the odds of any central bank turning more hawkish have diminished even further.

Looking at overnight activity, there was virtually no data to absorb with just Norwegian GDP growth printing slightly softer than expected, although not enough to change views that the Norgesbank is going to be raising rates next month. Broadly speaking, the dollar is quite firm, with the biggest loser being the Chinese yuan, down 0.9%, and that movement dragging down AUD (-0.45%) as a G10 proxy. But while other G10 currencies have seen more limited movement, the EMG bloc is really under pressure. For instance, MXN has fallen 0.6%, INR 0.75%, RUB, 0.5% and KRW 1.2%. All of this is trade related and is likely just the beginning of the fallout. Once China publishes its list of retaliatory efforts, I would expect further weakness in this space.

Equity markets are suffering everywhere, with Shanghai (-1.2%) and the Nikkei (-0.7%) starting the process, the DAX (-0.8%) and CAC (-0.6%) following in their footsteps and US futures pointing lower as well (both Dow and S&P futures -1.3%). Treasury yields have fallen to 2.43% and are now flat with 3-month Treasury bill rates, reigniting concerns over future US growth, and commodity prices are feeling the strain as well on overall growth concerns.

Turning to the data this week, there is a modicum of news, with Retail Sales likely to be seen as the most important:

Tuesday NFIB Business Optimism 102.3
Wednesday Retail Sales 0.2%
  -ex autos 0.7%
  Capacity Utilization 78.7%
  IP 0.1%
  Empire State Mfg 8.5
Thursday Initial Claims 220K
  Housing Starts 1.205M
  Building Permits 1.29M
  Philly Fed 9.0
Friday Michigan Sentiment 97.5

We also see the housing story and hear from another five Fed speakers across seven speeches this week. However, as we learned last week, pretty much the entire Fed is comfortable with their patient stance in the belief that growth is solid and inflation will eventually head to their target of 2.0%.

Add it all up and there is no reason to believe that the trends from last week will change, namely further pressure on equity markets and commodities, with the dollar and Treasuries the beneficiaries.

Good luck
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10%’s Not Enough

Said Trump, 10%’s not enough
It’s time that we really get tough
So starting next week
A quarter we’ll seek
Believe me, this ain’t just a bluff

If there was any question as to whether or not markets had fully priced in a successful conclusion of the US-China trade talks, last night’s price action should have answered it in full. President Trump is clearly feeling his oats, as his approval rating rises alongside the stock market and the economy, and so he changed the landscape once again. With Chinese Vice-premier Liu He, the chief negotiator in the trade talks, scheduled to arrive in the US later this week to continue, and in the market’s view conclude, those discussions, the President, last night, threatened to increase tariffs on $200 billion of goods to 25% from the current 10%, and to impose 25% tariffs on another $325 billion of goods, which is essentially everything else the US imports from China. In a heartbeat, views changed from rainbows and unicorns to Armageddon. Equity markets around the world plunged, commodity prices tumbled and the dollar and yen both rallied. Interestingly, Treasury prices have not moved much yet, although with the UK and Japan on holiday, overseas Treasury markets are extremely thin, so it could be there just hasn’t been any trading. Of course, it also could be that Treasury prices had already incorporated a less rosy future than equity markets, and so have less need to adjust.

One of the most common themes espoused lately has been the remarkable decline in asset price volatility this year, with measures in equities, bonds and currencies all pushing to cyclical lows. While there is a contingent of analysts (present company included) who believes that this is the calm before the storm, it is also true that market activity has been unidirectional since January, with that direction higher.

With respect to volatility, nothing has yet changed regarding the view that volatility increases when prices fall in both equity and bond markets although the relationship between volatility and the dollar is far less structured. In fact, there has been a significant increase in the amount of short volatility bets being made in the market, similar to the situation we saw at the beginning of 2018. Of course, I’m sure we all remember the disintegration of the XIV ETF (really it was an ETN), when a spike in volatility reduced its value by more than 85% in two days. Well, currently, records show that there is an even larger short volatility position now than there was last February when things went pear-shaped. The point is it is worthwhile to be careful in the current environment.

As to the dollar, historically volatility has increased in both rising and declining dollar environments depending on the circumstances. Given the dollar’s overall strength lately has been accompanies by a decline in volatility, it seems a fair bet to assume that if the dollar were to reverse lower, it would do so in a volatile manner rather than as a steady adjustment. Remember, too, currencies tend to overshoot when large moves occur. However, at this point, I would expect that fear in other markets will continue to support the dollar, and hence keep volatility at bay.

A recap of price movement overnight shows that the Shanghai Composite fell 5.5% and the Hang Seng fell 2.9% (the Nikkei was closed). Europe is currently trading with both the DAX and CAC falling 2.0% (FTSE is also closed) and US futures are pointing to nearly 2.0% losses on the open as well.

Meanwhile, the dollar is broadly higher. It has rallied 0.5% vs. the pound, offsetting a large part of Friday’s GBP rally that was based on the rumor PM May and Labour leader Corbyn were soon going to announce agreement on a Brexit deal. While nothing has come of it yet, that does explain the pound’s sharp Friday movement. AUD and NZD are both lower by 0.5% as the market looks to this evening’s RBA meeting with a 50% probability of a rate cut priced and the belief that the RBNZ will need to match that tomorrow if it occurs. Aussie is back below 0.70, and my sense is it has further to fall, especially if the trade situation deteriorates. Elsewhere in the G10, the euro is little changed after slightly better than expected PMI data seems to have been enough to offset trade concerns. And finally, the yen, as would be expected of a haven asset, is higher by 0.25%.

Versus emerging market currencies, the dollar has had an even stronger performance. It should be no surprise that CNY has fallen sharply (-0.75%) especially since the PBOC cut the RRR for small and medium sized banks by another 1.0% in an effort to stabilize markets. Elsewhere in Asia both INR and KRW fell 0.65% with other currencies having a slightly less negative result. EEMEA has seen ZAR fall 1.0% and TRY -1.20% although the latter has more to do with the possibility that the recent election in Istanbul, where President Erdogan’s party lost, would be overturned and a new one held thus undermining the concept of democracy in Turkey even further. Finally, LATAM markets are waking up under modest pressure, but have not yet fallen sharply.

Turning to this week’s data, there is not much overall, but we do see CPI data Friday.

Tuesday JOLTs Job Openings 7.24M
Thursday Initial Claims 220K
  Trade Balance -$50.2B
  PPI 0.2% (2.3% Y/Y)
  -ex food & energy 0.2% (2.5% Y/Y)
Friday CPI 0.4% (2.1% Y/Y)
  -ex food & energy 0.2% (2.1% Y/Y)

We also will hear a lot of Fed speaking, with eleven speeches from eight different FOMC members including Chairman Powell on Thursday. This week’s talks could well be market moving as last week’s press conference was not as smooth as it might have been. Look for lots of nuance as to what the Fed is looking at and why they think it is appropriate to be patient. As of now, it doesn’t seem that there is any leaning toward an “insurance” rate cut in the near term, but, especially if Friday’s CPI data is softer than expected, that theme could well change. As such, for now, I don’t see a good policy reason for the dollar to retreat, and if the trade situation deteriorates, it should help the buck, but given the mercurial dynamics of the President’s negotiating tactics, I wouldn’t rule out a complete reversal of things before long.

Good luck
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It All Went to Hell

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

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

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

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

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

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

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

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

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

Good luck and good weekend
Adf

Quite the Sensation

Economists’ latest creation
Called MMT’s quite the sensation
It claims there’s no risk
To nation or fisc
From vast monetary dilation

So, here’s the deal…apparently it doesn’t matter if economic growth is slowing around the world. It doesn’t matter if politics has fractured on both sides of the Atlantic and it doesn’t matter if the US and China remain at loggerheads over how to continue to trade with each other. None of this matters because…MMT is the new savior! Modern Monetary Theory (MMT) is the newest output from our central banking saviors and their minions in the academic economic community. In a nutshell, it boils down to this; printing unlimited amounts of money and running massive budget deficits is just fine and will have no long-term negative consequences. This theory is based on the data from the past ten years, when central banks have done just that (printed enormous amounts of money) and governments have done just that (run huge deficits) and nothing bad happened. Therefore, these policymakers theorize, that nothing bad will happen if they keep it up.

Markets love this because hyper monetary and fiscal stimulus is perceived as an unambiguous positive for asset prices, especially equities, and so why would anybody argue to change things. After all, THIS TIME IS DIFFERENT he said with tongue firmly in cheek. This time is never different, and my greatest concern is that the continuing efforts to prevent any slowing of economic growth is going to lead to a situation that results in a massive correction at some point in the (probably) not too distant future. And the problem will be that central banks will have lost their ability to maintain stability as their policy tools will no longer be effective, while governments will have limited ability to add fiscal stimulus given their budget situations. But clearly, that day is not today as evidenced by the ongoing positivity evident from rising equity markets and an increasing risk appetite. Just something to keep in the back of your mind.

Said Mario after his meeting
‘This weakness should really be fleeting’
But traders believe
His view is naïve
Explains, which, why rates are retreating

It can be no surprise that the euro declined further yesterday (-0.8%), although this morning it has regained a small bit (+0.25% as I type). Not only did the PMI data disappoint completely, but Signor Draghi appears to be starting to recognize that things may not be as rosy as he had hoped. While he still held out hope that rates may rise later this year, that stance is becoming increasingly lonely. At this point, the earliest that any economist or analyst on the Street is willing to consider for that initial rate hike is December 2019 with the majority talking 2020. And of course, my view is that there will be no rate rise at all.

The problem they face is that that with rates already negative, when if the Eurozone slips into recession by the end of the year, what else can he do. Fortunately, Mario explained that the ECB still has many options in front of them, “We have lots of instruments and we stand ready to adjust them or use them according to the contingency that is produced.” The thing is, he was talking about forward guidance, more QE and TLTRO’s, all policies that are long in the tooth and appear to have lost a significant portion of their efficacy. As I have written before, Draghi will be happy to vacate his seat given the problems that are on the horizon. Though he certainly had to deal with a series of difficult issues (Eurozone debt crisis, Greek insolvency), at least he still had a full toolkit with which to work. His successor will have an empty cupboard. One last nail in the growth coffin was this morning’s Ifo data, which printed at its worst level in three years, 99.1, much lower than the expected 100.9. I would love to hear the euro bullish case, because I don’t see much there.

Away from that story, Brexit remains an ongoing market uncertainty, although it certainly appears, based on the pound’s recent trajectory, that more and more traders and investors have decided that there will be no Brexit at all. At least that’s the only thing I can figure based on what is happening in the market. On the one hand, I guess it is reasonable to assume that given all the tooth-gnashing and garment rending that we have seen, the belief is that Brexit will be so toxic as to be unthinkable. And we have begun to see some of the rest of the Eurozone members get nervous, notably Ireland which is adamant about preventing a hard border between themselves and Northern Ireland. Alas there is still no resolution as to how to police the border in the event the UK leaves. (And based on the ongoing US discussion, we know that any type of border barrier will be a waste of money!) It is not clear to me that it is viable to rule out a hard Brexit, but that is clearly what investors are beginning to do.

As to the US-China trade story, despite President Trump’s professed optimism that a deal will be done, Commerce Secretary Wilbur Ross, indicated that we are still “miles and miles” away from a deal. And though it certainly appears that both sides are incented to solve this problem, especially given the slowing growth trajectory in both nations, it is by no means clear that will be the outcome. At least not before there is another rise in tariffs. And yet, markets are generally sanguine about the prospects of the talks failing.

So, despite potential problems, risk is in the ascendancy this morning with equity markets rising, commodities and Treasuries stable and the dollar under pressure. It is almost as if there is fatigue over the myriad potential problems and given that none of them have actually created a difficulty of note yet, investors are willing to ignore them. At least that’s my best guess.

A tour around the FX markets shows the dollar softer against most of its G10 counterparts, with JPY the only exception, further adding to the risk-on narrative, while it remains mixed vs. EMG currencies. However, overall, the tone is definitely of the dollar on its back foot. Given the ongoing US government shutdown, there is no data scheduled to be released and the Fed remains in quiet mode ahead of next week’s meeting, so unless something happens regarding trade, my money is on continued dollar weakness in today’s session as more and more investors whistle that happy tune.

Good luck and good weekend
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