Dying To See

Said Trump, it’s not me it’s the Fed
Preventing us moving ahead
While China and Xi
Are dying to see
A deal where all tariffs are dead

It should be no surprise that President Trump was at the center of the action yesterday, that is the place he most covets. In a speech at the Economic Club of New York, he discussed pretty much what we all expected; the economy is doing great (low unemployment, low inflation and solid growth); the Fed is holding the economy back from doing even better (give us negative rates like Europe and Japan, we deserve it) and the Chinese are dying to do a deal but the US is not going to cave in and remove tariffs without ironclad assurances that the Chinese will stop their bad behavior. After all, this has been the essence of his economically focused comments for the past year. Why would they change now? But a funny thing happened yesterday, the market did not embrace all this is good news, and we started to see a little bit of risk aversion seeping into equity prices and filter down to the bond and currency markets.

For example, although the Dow Jones Industrial Average closed yesterday just 0.3% from the all-time high set last Thursday, there has been no follow-through in markets elsewhere in the world, and, in fact, US futures are pointing lower. Now arguably, this is not entirely a result of Trump’s comments, after all there are plenty of problems elsewhere in the world. But global markets have proven to be quite vulnerable to the perception of bad news on the US-China trade negotiations front, and the fact that there is no deal clearly set to be signed is weighing on investors’ collective minds. So last night, we saw Asian markets suffer (Nikkei -0.85%, Hang Seng -1.8%, KOSPI -0.85%, Shanghai -0.35%) and this morning European markets are also under pressure (DAX -0.75%, CAC -0.45%, FTSE -0.55%, Spain’s IBEX -1.65%, Italy’s MIB -1.3%). In other words, things look pretty bad worldwide, at least from a risk perspective.

Now some of this is idiosyncratic, like Hong Kong, where the protests are becoming more violent and more entrenched and have demonstrably had a negative impact on the local economy. Of even more concern is the growing possibility that China decides to intervene directly to quell the situation, something that would likely have significant negative consequences for global markets. Too, Germany is sliding into recession (we will get confirmation with tomorrow’s Q3 GDP release) and so the engine of Europe is slowing growth throughout the EU, and the Eurozone in particular. And we cannot forget Spain, where the fourth election in four years did nothing to bring people together, and where the Socialist Party is desperately trying to cobble together a coalition to get back in power, but cannot find enough partners, even though they have begun to climb down from initial comments about certain other parties, namely Podemos, and consider them. The point is, President Trump is not the only reason that investors have become a bit skeptical about the future.

In global bond markets, we are also seeing risk aversion manifest itself, notably this morning with 10-year Treasury yields falling more than 6bps, and other havens like Bunds (-4bps) and Gilts (-5bps) following suit. There has been a great deal of ink spilled over the recent bond market price action with two factions completely at odds. There continue to be a large number of pundits and investors who see the long-term trend of interest rates still heading lower and see the recent pullback in bond prices as a great opportunity to add to their long bond positions. Similarly, there is a growing contingent who believe that we have seen the lows in yields, that inflation is beginning to percolate higher and that 10-year yields above 3.00% are going to be the reality over the course of the next year. This tension is evident when one looks at the price action where since early September, we have seen a 40bp yield rally followed by a 35bp decline in the span of five weeks. Since then, we have recouped all the losses, and then some, although we continue to see weeks where there are 15bp movements, something that is historically quite unusual. Remember, bonds have historically been a dull trading vehicle, with very limited price activity and interest generated solely for their interest-bearing qualities. These days, they are more volatile than stocks! And today, there is significant demand, indicating risk aversion is high.

Finally, the dollar continues to benefit against most of its counterparts in both the G10 and EMG blocs, at least since I last wrote on Friday. In fact, there are four G10 currencies that have performed well since then, each with a very valid reason. First, given risk aversion, it should be no surprise that both the yen and Swiss franc have strengthened in this period. Looking further, the pound got a major fillip yesterday when Nigel Farage said that his Brexit party would not contest any of the 317 seats the Tories held going into the election, thus seeming to give a boost to Boris Johnson’s electoral plans, and therefore a boost toward the end of the Brexit saga with a deal in hand. Finally, last night the RBNZ surprised almost the entire market by leaving rates on hold at 1.0%, rather than cutting 25bps as had been widely expected. The reaction was immediate with kiwi jumping 1.0% and yields in New Zealand rallying between 10 and 15 bps across the curve.

Turning to the Emerging markets, the big mover has been, of course, the Chilean peso, the erstwhile star of LATAM which has fallen more than 5.0% since Friday in the wake of the government’s decision to change the constitution in an effort to address the ongoing social unrest. But this has dragged the rest of the currencies in the region down as well, with Colombia (-2%) and Mexico (-1.7%) also feeling the effects of this action. The removal of Peruvian president, Evo Morales, has further undermined the concept of democracy in the region, and investors are turning tail pretty quickly. Meanwhile, APAC currencies have also broadly suffered, with India’s rupee the worst performer in the bunch, down 1.1% since Friday, as concerns about slowing growth there are combining with higher than expected inflation to form a terrible mix. But most of the region is under pressure due to the ongoing growth and trade concerns, with KRW (-0.9%) and PHP (-0.7%) also feeling strains on the trade story. The story is no different in EEMEA, with the bulk of the bloc lower by between 0.5% and 0.85% during the timeframe in question.

Turning to this morning, we see our first important data of the week, CPI (exp 0.3%, 0.2% core) for the month and (1.7%, 2.4% core) on an annual basis. But perhaps more importantly Chairman Powell speaks to Congress today, and everybody is trying to figure out what it is he is going to say. Most pundits believe he is going to try to maintain the message from the FOMC meeting, and one that has been reinforced constantly by his minions on the committee, namely that the economy is in a good place, that rates are appropriately set and that they will respond if they deem it necessary. And really, what else can he say?

However, overall, risk remains on the back foot today, and unless Powell is suddenly very dovish, I expect that to remain the case. As such, look for the dollar to continue to edge higher in the short term, as well as the yen, the Swiss franc and Treasuries.

Good luck
Adf

 

Badly Maligned

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

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

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

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

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

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

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

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

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

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

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

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

Good luck
Adf

Absent Deceit

Two presidents are set to meet
From nations that fiercely compete
The issue at hand
Is how to expand
The trade twixt them absent deceit

For markets, this issue is key
And so far, today, what we see
Is traders complacent
A deal is now nascent
So buyers have been on a spree

The upcoming meeting between President’s Trump and Xi, due to be held on Saturday, has drawn the most focus amid financial markets in the past twenty-four hours. Yesterday we heard Treasury Secretary Mnuchin express confidence a deal could be completed and that “we were about 90% of the way there…” prior to the abrupt end of discussions last month. If you recall, the US claimed China reneged on their willingness to enshrine the deal details into their canon of law, which the US demanded to insure the deal was followed. However, shortly thereafter, President Trump, in a Fox News interview, talked about raising tariffs if necessary and seemed quite unconcerned over the talks falling apart. In fact, he turned his ire on India and Vietnam for adding to trade troubles. While Asian markets all rallied as the vibes seemed to be improving, a short time ago China announced they would have a set of conditions to present to Mr Trump in order to reach a deal. These include an end to the ban on Huawei products and purchases as well as an immediate end to all tariffs.

Given the importance of reaching a deal for both sides, my take is these comments and terms are simply being used to establish the baseline for the negotiations between the two men, and that some middle ground will be reached. However, markets (wisely I think) took the Chinese demands as a sign that a deal is far less certain than optimists believe, and European equities, as well as US futures, have sold off since their release. I have maintained throughout this process that a deal was always going to be extremely difficult to achieve given the fundamental problem that the Chinese have yet to admit to IP theft or forced technology transfers while the US sees those as critical issues. In addition, the question of enshrinement of terms into local law describes one of the fundamental differences between the two nations. After all, the US is a nation based on its laws, while China is a nation entirely in thrall to one man. Quite frankly, I think the odds of completing a deal are 50:50 at best, and if the luncheon between the two men does not result in the resumption of talks, be prepared for a pretty significant risk-off event.

In the meantime, the global economic picture continues to fade as data releases point to slowing growth everywhere. Yesterday’s Durable Goods numbers were much worse than expected at -1.3%, although that was largely due to the reduction in aircraft orders on the back of the ongoing travails of Boeing’s 737 Max jet. But even absent transport, the 0.3% increase, while better than expected, is hardly the stuff of a strong expansion. In fact, economists have begun adjusting their GDP forecasts lower due to the absence of manufacturing production. Yesterday I highlighted the sharp decline in all of the regional Fed manufacturing surveys, so the Durables data should be no real surprise. But surprise or not, it bodes ill for GDP growth in Q2 and Q3.

Of course, the US is not alone in seeing weaker data. For example, this morning the Eurozone published its monthly Confidence indices with Business Confidence falling to 0.17, the lowest level in five years, while Economic Sentiment fell to 103.3 (different type of scale), its lowest level in three years and continuing the steep trend lower since a recent peak in the autumn of last year. Economists have been watching the ongoing deterioration in Eurozone data and have adjusted their forecasts for the ECB’s future policy initiatives as follows: 10bp rate cut in September and December as well as a 50% probability of restarting QE. The latter is more difficult as that requires the ECB to change their self-imposed rules regarding ownership of government debt and the appearance of the ECB financing Eurozone governments directly. Naturally, it is the Germans who are most concerned over this issue, with lawsuits ongoing over the last series of QE. However, I think its quaint that politicians try to believe that central banks haven’t been directly funding governments for the past ten years!

So, what has all this done for the FX markets? Frankly, not much. The dollar is little changed across the board this morning, with nary a currency having moved even 0.20% in either direction. The issue in FX is that the competing problems (trade, weakening growth, central bank policy adjustments) are pulling traders in different directions with no clarity as to longer term trends. Lately, a common theme emerging has been that the dollar’s bull run is over, with a number of large speculators (read hedge funds) starting to establish short dollar positions against numerous currencies. This is based on the idea that the Fed will be forced to begin easing policy and that they have far more room to do so than any other central bank. As such, the dollar’s interest rate advantage will quickly disappear, and the dollar will fall accordingly. While I agree that will be a short-term impact, I remain unconvinced that the longer-term trend is turning. After all, there is scant evidence that things are getting better elsewhere in the world. Remember, the ongoing twin deficits in the US are hardly unique. Governments continue to spend far more than they receive in tax revenues and that is unlikely to stop anytime soon. Rather, ultimately, we are going to see more and more discussion on MMT, with the idea that printing money is without risk. And in a world of deflating currencies and halting growth, the US will still be the place where capital is best treated, thus drawing investment and dollar demand.

This morning brings some more data as follows: Initial Claims (exp 220K) and the third look at Q1 GDP (3.1%). Later, we also see our 6th regional Fed manufacturing index, this time from KC and while there is no official consensus view, given the trend we have seen, one has to believe it will fall sharply from last month’s reading of 2.0. There are no Fed speakers on the docket, so FX markets ought to take their cues from the equity and bond markets, which as the morning progressed, are starting to point to a bit of risk aversion.

Good luck
Adf

 

Not So Fast

While everyone thought it was nifty
The Fed was about to cut fifty
Said Jay, not so fast
We’ll not be harassed
A quarter’s enough of a gift-y

Once again, Chairman Powell had a significant impact on the markets when he explained that the Fed is fiercely independent, will not be bullied by the White House, and will only cut rates if they deem it necessary because of slowing growth or, more importantly, financial instability. Specifically, he said the Fed is concerned about and carefully watching for signs of “a loss of confidence or financial market reaction.” In this context, “financial market reaction” is a euphemism for falling stock prices. If ever there was a question about the existence of the Fed put, it was laid to rest yesterday. Cutting to the chase, Powell said that the Fed’s primary concern, at least right now, is the stock market. If it falls too far, too fast, we will cut rates as quickly as we can. Later in his speech, he gave a shout out to the fact that low inflation seems not to be a temporary phenomenon, but that was simply thinly veiled cover for the first part, a financial market reaction.

There are two things to note about these comments. First, the Fed, and really every major central bank, continues to believe they are in complete control of both their respective economies and the financial markets therein. And while it is absolutely true this has been the case since the GFC ended, at least with respect to the financial markets, it is also absolutely true that the law of diminishing returns is at work, meaning it takes much more effort and stimulus to get the same result as achieved ten years ago. At some point, probably in the not too distant future, markets are going to begin to decline and regardless of what those central banks say or do, will not be deterred from actually clearing. It will not be pretty. And second, the ongoing myth of central banks being proactive, rather than reactive, is so ingrained in the central bank zeitgeist that there is no possibility they will recognize the fact that all of their actions are, as the axiom has it, a day late and a dollar short.

But for now, they are still in command. Yesterday’s price action was informed by the fact that despite the weakest Consumer Confidence data in two years and weaker than expected New Home Sales, Powell did not affirm a 50bp cut was on its way in July. Since the market has been counting on that outcome, the result was a mild risk off session. Equity prices suffered in the US and continued to do so around the world last night and Treasuries settled below 2.00%. However, gold prices, which have been rocking lately, gave up early gains when Powell nixed the idea of a 50bp cut. And the dollar? Well, it remains mixed at best. It did rally slightly yesterday but continues to be broadly lower than before the FOMC meeting last week.

We also heard from two other Fed speakers yesterday, Bullard and Barkin, with mixed results. Bullard, the lone dissenter from the meeting made clear that he thought a 25bp reduction was all that was needed, a clear reference to Minneapolis Fed President Kashkari’s essay published on Friday calling for a 50bp cut. However, Thomas Barkin, from the Richmond Fed, sounded far less certain that the time was right for a rate cut. He sounds like he is one of the dots looking for no change this year.

And the thing is, that’s really all the market cares about right now, is what the Fed and its brethren central banks are planning. Data is a sidelight, used to embellish an idea if it suits, and ignored if it doesn’t. The trade story, of course, still matters, and given the increasingly hardened rhetoric from both sides, it appears the market is far less certain of a positive outcome. That portends the opportunity for a significant move on Monday after the Trump-Xi meeting. And based on the way things have played out for the past two years, my money is on a resumption of the dialog and some soothing words, as that will help underpin stocks in both NY and Shanghai, something both leaders clearly want. But until then, I expect a general lack of direction as investors make their bets on the outcome.

One little mentioned thing on the data front is that we have seen every regional Fed manufacturing survey thus far released show significantly more weakness than expected. Philly, Empire State, Chicago, Richmond and Dallas have all fallen sharply. That does not bode well for economic growth in either Q2 or Q3, which, in a twisted way, will play right into the President’s hands as the Fed will be forced to cut rates as a response. Strange times indeed.

This morning, two data points are released; Durable Goods (exp -0.1%, +0.1% ex transports) and the Goods Trade Balance (-$71.8B). Look for weakness in these numbers to help perk of the equity market as anticipation will grow that more rate cutting is in the offing. And look for the dollar to suffer for the same reason.

Good luck
Adf

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

Markets Are Waiting

For right now most markets are waiting
To see if key risks are abating
Next week it’s the Fed
Then looking ahead
The G20 is captivating

The question is what we will learn
When Powell and friends next adjourn
The bond market’s sure
A cut has allure
To help them avoid a downturn

Markets this morning are pretty uninteresting as trader and investor focus turns to the two key upcoming events, next week’s FOMC meeting and the G20 meeting at the end of the month. At this point, it is fair to say that the market is pricing in renewed monetary ease throughout most of the world. While the Fed is in their quiet period, the last comments we heard were that they would act appropriately in the event economic growth weakened. Futures markets are pricing in a 50% chance of a cut next week, and a virtually 100% chance of a cut in July, with two more after that before the end of the year. While that seems aggressive to many economists, who don’t believe that the US economy is in danger of slowing too rapidly, the futures market’s track record is pretty good, and thus cannot be ignored.

But it’s not just the US where markets are pushing toward further rate cuts, we are seeing the same elsewhere. For example, last week Signor Draghi indicated that the ECB is ready to act if necessary, and if you recall, extended their rate guidance further into the future, assuring no rate changes until the middle of next year. Eurozone futures markets are pricing in a 10bp rate cut, to -0.50%, for next June. This morning we also heard from Banque de France President, and ECB Council member, Francois Villeroy that they have plenty of tools available to address slowing growth if necessary. A key pressure point in Europe is the 5year/5year inflation contract which is now pricing inflation at 1.18%, a record low, and far below the target of, “close to, but below, 2.0%”. In other words, inflation expectations seem to be declining in the Eurozone, something which has the ECB quite nervous.

Of course, adding to the picture was the news Monday night that the PBOC is loosening credit conditions further, targeting infrastructure spending. We also heard last week from PBOC Governor Yi Gang that the PBOC has plenty of tools available to fight slowing economic output. In fact, traveling around the world, it is easy to highlight dovishness at many central banks; Australia, Canada, Chile, India, Indonesia, New Zealand and Switzerland quickly come to mind as countries that have recently cut rates or discussed the possibility of doing so.

Once again, this plays to my constant discussion of the relative nature of the FX market. If every country is dovish, it becomes harder to discern which is the most hawkish dove. In the end, it generally winds up being a case of which nation has the highest interest rates, even if they are falling. As of now, the US continues to hold that position, and thus the dollar is likely to continue to be supported.

While the Fed meeting is obvious as to its importance, the G20 has now become the focal point of the ongoing trade situation with optimists looking for a meeting between Presidents Trump and Xi to help cool off the recent inflammation, but thus far, no word that Xi is ready to meet. There are many domestic political calculations that are part of this process and I have read arguments as to why Xi either will or won’t meet. Quite frankly, it is outside the scope of this note to make that call. However, what I can highlight is that news that a meeting is scheduled will be seen as a significant positive step by markets with an ensuing risk-on reaction, meaning stronger equities and a sell-off in the bond market, the dollar and the yen. Equally, any indication that no meeting will take place is likely to see a strong risk-off reaction with the opposite impacts.

Looking at the overnight data, there have been few releases with the most notable, arguably, Chinese in nature. Vehicle Sales in China fell 16.4%, their 11th consecutive monthly decline, which when combined with slowing monthly loan growth paints a picture of an economy that is clearly feeling some pain. The only other data point was Spanish Inflation, which printed at 0.8%, clearly demonstrating the lack of inflationary impulse in the Eurozone, even in one of the economies that is growing fastest. Neither of these data points indicates a change in the easing bias of central banks.

In the US this morning we see CPI data which is expected to print at 1.9% with the ex food& energy print at 2.1%. Yesterday’s PPI data was on the soft side, so there is some concern that we might see a lower print, especially given how rapidly oil prices have fallen of late. In the end, it is shaping up as another quiet day. Equity markets around the world have been slightly softer, but that is following a weeklong run of gains, and US futures are pointing to 0.3% declines at this point. Treasury yields are off their lowest point but still just 2.12% and well below overnight rates. And the dollar is modestly higher this morning, although I don’t see a currency that has moved more than 0.2%, indicating just how quiet things have been. Look for more of the same until at least next Wednesday’s FOMC announcement.

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