Naught But Fool’s Gold

There once was a story, oft told
That growth round the world would be bold
But data of late
Has shown that the fate
Of that tale was naught but fool’s gold

Instead round the world what we see
Are signs that the future will be
Somewhat less robust
Than had been discussed
Since money is no longer free!

The dollar is strong this morning, rising vs. essentially every other currency after a series of weak data points from China and the EU reinforced the idea that global growth is slowing. As I type my last note of the year, the euro is lower by 0.65%, the pound -0.7% and Aussie has fallen -0.9%. In the emerging market space, the damage is generally less severe, with both CNY and BRL falling -0.4% while MXN and INR have both slipped -0.3%. There are two notable exceptions to this, however, as ZAAR has tumbled 1.5% and KRW fallen -0.8%. In other words, the dollar is in the ascendant today.

What, you may ask, is driving this movement? It started early last evening when China released some closely watched economic indicators, all of which disappointed and indicated further slowing of the economy there. Fixed Asset Investment rose just 5.9%, IP rose just 5.4% and Retail Sales rose just 8.1%. As Chinese data continue to fall below estimates, it increases the odds that the PBOC will ease monetary policy further, thus undermining the renminbi somewhat. But the knock on effect of weakening Chinese growth is that the rest of Asia, which relies on China as a key market for their exports, will also suffer. Hence the sharp decline in AUD and NZD (-1.0%), along with KRW and the rest of the APAC currencies. It certainly appears as though the trade tensions with the US are having a deleterious effect on the Chinese economy, and that may well be the reason that we have heard of more concessions on their part in the discussions. Today’s story is that corn purchases will be restarting in January, yet another rollback of Chinese trade barriers.

But it was not just China that undermined the global growth story; Eurozone data was equally dismal in the form of PMI releases. In this case, Germany’s Manufacturing PMI printed at 51.5, France at 49.7 and the Eurozone as a whole at 51.4. Each of these was substantially below expectations and point to Q4 growth in the Eurozone slowing further. While the French story is directly related to the ongoing gilets jaune protests, Germany is a bigger issue. If you recall, Q3 growth there was negative (-0.2%) but was explained away as a one-off problem related to retooling auto plants for emissions changes in regulations. However, the data thus far in Q4 have not shown any substantive improvement and now call into question the idea that a Q4 rebound will even occur, let alone offset the weak Q3 data.

Adding to the Eurozone questions is the fact that the ECB yesterday confirmed it was ending QE this month, although it has explained that it will be maintaining the size of the balance sheet for “an extended period of time” after its first interest rate rise. Currently, the market is pricing in an ECB rate hike for September 2019, but I am very skeptical. The fact that Signor Draghi characterized economic risks as to the downside rather than balanced should come as no surprise (they are) but calls into question why they ended QE. Adding to the confusion is the fact that the ECB reduced its forecasts for both growth and inflation for 2018 and 2019, hardly the backdrop to be tightening policy. In the end, much of this was expected, although Draghi’s tone at the press conference was clearly more dovish than had been anticipated, and the euro fell all day yesterday and has continued on this morning in the wake of the weak data. And this doesn’t even include the Italian budget mess where Italy’s latest figures show a smaller deficit despite no adjustments in either spending or taxes. Magical thinking for sure!

Meanwhile, the UK continues to hurtle toward a hard Brexit as PM May was rebuffed by the EU in her attempts to gain some conciliatory language to bring back to her Parliament. While I don’t believe in the apocalyptic projections being made about the UK economy come April 1st next year, I do believe that the market will severely punish the pound when it becomes clear there will be no deal, which is likely to be some time in January.

As to the US-China trade situation, this morning there is more fear of tariffs by the US, but the negotiation is ongoing. Funnily enough, my reading of the signs is that China is, in fact, blinking here and beginning to make some concessions. The last thing President Xi can afford is for the Chinese economy to slow sharply and put millions of young men out of work. Historically, excessive unemployed youth can lead to revolution, a situation he will seek to avoid at all costs. If it means he must spin some concessions to the US into a story of strengthening the Chinese economy, that is what he will do. It would certainly be ironic if President Trump’s hardball negotiating tactics turned out to be successful in opening up the Chinese economy and broadly pushing forward a more internationalist agenda, but arguably, it cannot be ruled out. Consider the ramifications on the political debate in the US if that were to be the case!! As to the market implications, I would expect that risk would be quickly embraced, equity markets would rally sharply as would the dollar, while expectations for the Fed would revert to tighter policy in 2019 and beyond. Treasuries, on the other hand, would fall sharply and yields on the 10-year would likely test their highs from early November. We shall see.

This morning brings Retail Sales (exp 0.2%, ex autos 0.2%), IP (0.3%) and Capacity Utilization (78.6%). Data that continues to show the US growing, especially in the wake of the weakness seen elsewhere in the world, should continue to underpin the dollar going forward. While I understand the structural issues like the massive budget and current account deficits should lead to dollar weakness, we are still in a cyclical phase of the market, and the US remains the best place to be for investment, so it remains premature to write off further dollar strength.

Good luck, good weekend and happy holidays to you all.

FX Poetry will return on January 2nd with forecasts for next year, and in regular format starting January 3rd.

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Twixt Trade Adversaries

A fortnight from now we will know
How Brexit is going to go
Can Minister May
Still carry the day?
Or will the vote, chaos, bestow?

Meanwhile, this week, in Buenos Aires
A meeting twixt trade adversaries
Has hopes running high
We’ll soon wave goodbye
To tariffs and their corollaries

The first thing you notice this morning in the FX markets is that the pound is under more pressure. As I type, it is lower by 0.7% as the flow of news from London is that the Brexit deal is destined to fail in Parliament. Perhaps the most damning words were from the DUP (the small Northern Irish party helping support PM May’s government), which indicated that they would not support the deal as constructed under any circumstances. At the same time, numerous Tories have been saying the same thing, and the general feeling is that there is only a small chance that PM May will be able to prevail. We have discussed the market reaction in the event of no deal, and nothing has changed in my view. In other words, if the Brexit deal is defeated in parliament in two weeks’ time, look for the pound to fall much further. In fact, it is reasonable to consider a move toward 1.20 in the very short term. Between now and the vote, I expect that the pound will be subject to every headline which discusses the potential vote outcome, but unless some of those headlines start to point to a yes vote, the pound is going to remain under pressure consistently.

Beyond Brexit, there are two other things that have the markets’ collective attention, Fed Chairman Powell’s speech tomorrow, and the meeting between Presidents Trump and Xi on Friday in Buenos Aires at the G20 gathering.

As to the first, the market narrative has evolved to the point where expectations for the Fed to raise rates at their December meeting remain quite high, but there are now many questions about the 2019 rate path. If you recall, after the September FOMC meeting, the consensus was moving toward four rate hikes next year. However, since then, the data has been somewhat less robust, with both production and inflation numbers moderating. Notably, the housing market has been faltering despite the lowest unemployment rate in more than 40 years. Ignoring the President’s periodic complaints about the Fed raising rates, the data story has clearly started to plateau, at least, if not roll over, and the Fed is quite aware of this fact. (Anecdotally, the fact that GM is shuttering 5 plants and laying off 15,000 workers is also not going to help the Fed’s view on the economy.) This is why all eyes will be on Powell tomorrow, to see if he softens his stance on the Fed’s expectations. Already the futures market has priced out one full rate hike for next year, and given there is still more than two weeks before the Fed meets again, Powell’s comments tomorrow, along with vice chairman Clarida today and NY Fed President Williams on Friday are going to be seen as quite critical in gauging the current Fed outlook. Any more dovishness will almost certainly be followed by a weakening dollar and rising equity markets. But if the tone comes across as hawkish, look for the current broad trends of equity weakness and dollar strength to continue.

And finally, we must give a nod to the other elephant in the room, the meeting between President Trump and Chinese President Xi at this weekend’s G20 meeting. Hopes are running high that the two of them will be able to agree to enough common ground to allow more formal trade talks to move ahead while delaying any further tariff implementation. The problem is that the latest comments from Trump have indicated he is going to be raising the tariff rate to 25% come January, as well as seek to implement tariffs on the rest of Chinese imports to the US. It seems that the President believes the Chinese are feeling greater pressure as their economy continues to slow, and they will be forced to concede to US demands sooner rather than later. And there is no question the Chinese economy is slowing, but it is not clear to me that Xi will risk losing face in order to prevent any further economic disorder. I think it is extremely difficult to handicap this particular meeting and the potential outcomes given the personalities involved. However, I expect that sometime in the next year this trade dispute will be resolved, as Trump will want to show that his tactics resulted in a better deal for the US as part of his reelection campaign.

And those are the big stories today. There are two data points this morning, Case-Shiller House Prices (exp 5.3%) and Consumer Confidence (135.9), but neither seems likely to have an impact on the FX market. However, as mentioned above, Fed vice-chairman Richard Clarida speaks first thing this morning, and his tone will be watched carefully for clues about how the Fed will behave going forward. My take here is that we are likely to hear a much more moderate viewpoint from the Fed given the recent data flow, and that is likely to keep modest pressure on the dollar.

Good luck
Adf

 

That Might Be Obtuse

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

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

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

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

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

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

Here is the data for the abbreviated week:

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

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

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

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

Until then, good luck and have a wonderful holiday
Adf

QE He’ll Dismember

The head of the Fed, Chairman Jay
Implied there might be a delay
In how far the Fed
Will push rates ahead
Lest policy does go astray

Meanwhile, his Euro counterpart,
Herr Draghi’s had no change of heart
He claims, come December
QE he’ll dismember
Despite slower growth in Stuttgart

In what can only be seen as quite a twist on the recent storylines, Wednesday’s US CPI data was soft enough to give pause to Chairman Powell as in two consecutive speeches he highlighted the fact that the US economy is facing some headwinds now, and that may well change the rate trajectory of the Fed. While there was no indication of any change coming in December, where a 25bp rate hike is baked in, there is much more discussion about only two rate hikes next year, rather than the at least three that had been penciled in by the Fed itself back in September. Powell mentioned the slowing growth story internationally, as well as the winding down of fiscal stimulus as two potential changes to the narrative. Finally, given that the Fed has already raised rates seven times, he recognized that the lagged effects of the Fed’s own policies may well lead to slower growth. The dollar has had difficulty maintaining its bid from the past several weeks, and this is clearly the primary story driving that change of heart.

At the same time, Signor Draghi, in a speech this morning, reiterated that the risks to growth in the Eurozone were “balanced”, his code word to reassure the market that though recent data was soft, the ECB is going to end QE in December, and as of now, raise rates next September. Now, there is a long time between now and next September, and it is not hard to come up with some scenarios whereby the Eurozone economy slows much more rapidly. For example, the combination of a hard Brexit and increased US tariffs on China could easily have a significant negative impact on the Eurozone economy, undermining the recent growth story as well as the recent (alleged) inflation story. For now, Draghi insists that all is well, but at some point, if the data doesn’t cooperate, then the ECB will be forced to change its tune. His comments have helped support the euro modestly today, but the euro’s value is a scant 0.1% higher than its close yesterday.

Adding to the anxiety in the market overall is the quickening collapse of the Brexit situation, where it seems the math is getting much harder for PM May to get the just agreed deal through Parliament. Yesterday’s sharp decline in the pound, more than 1.5%, has been followed by a modest rebound, but that seems far more likely to be a trading event rather than a change of heart on the fundamentals. In my view, there are many more potential negatives than positives likely to occur in the UK at this point. A hard Brexit, a Tory rebellion ousting May, and even snap elections with the chance for a PM Corbyn all would seem to have negative overtones for the pound. The only thing, at this time, that can support the currency is if May somehow gets her deal agreed in Parliament. It feels like a low probability outcome, and that implies that the pound will be subject to more sharp declines over time.

Pivoting to the Emerging markets, the trade story with China continues to drive equity markets, or at least all the rumors about the trade story do that. While it seems that there are mid-level conversations between the two nations ahead of the scheduled meeting between Trump and Xi later this month, we continue to hear from numerous peanut gallery members about whether tariffs are going to be delayed or increased in size. This morning’s story is no deal is coming and 25% tariffs are on their way come January 1. It is no surprise that equity futures are pointing lower in the US. Look for CNY to soften as well, albeit not significantly so. The movement we saw last week was truly unusual.

Other EMG stories show that Mexico, the Philippines and Indonesia all raised base rates yesterday, although the currency impacts were mixed. Mexico’s was widely anticipated, so the 0.5% decline this morning seems to be a “sell the news” reaction. The Philippines surprised traders, however, and their peso was rewarded with a 0.5% rally. Interestingly, Bank Indonesia was not widely expected to move, but the rupiah has actually suffered a little after the rate hike. Go figure.

Yesterday’s US data arguably leaned to the strong side with only the Philly Fed number disappointing while Empire State and Retail Sales were both quite strong. This morning brings IP (exp 0.2%) and Capacity Utilization (78.2%), although these data points typically don’t impact the FX market.

As the week comes to a close, it appears the dollar is going to remain under some pressure on the back of the newly evolving Fed narrative regarding a less aggressive monetary policy. However, if we see a return of more severe equity market weakness, the dollar remains the haven of choice, and a reversal of the overnight moves can be expected.

Good luck and good weekend
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Troubles Anew

Though yesterday all seemed okay
Today, poor Prime Minister May
Has troubles anew
As two from her crew
Of cabinet ministers stray

As I wrote yesterday, it seemed odd to me that despite the headline news of a Brexit deal being reached, and ostensibly signed off by PM May’s cabinet, the market response was tepid, at best. Given that the Brexit story has been THE key driver of the pound for the past eighteen months, how was it that one of the biggest developments in the entire saga was met with a collective yawn by the market? One would have expected a sharp rally in the pound on the news of a Brexit deal being agreed. Instead, what we got was a pound that fell slightly after the announcement, seeming to respond to modestly softer inflation data rather than to the Brexit story.

Well, today we learned the answer to that question. The news this morning is that Brexit Minister, Dominic Raab, as well as Pensions Secretary Esther McVey, both resigned from the cabinet citing the PM’s Brexit deal. Both indicated that they could not support the deal in its current form given the relatively high probability that it will result in different treatment for Northern Ireland than for the rest of the UK, a de facto sovereign rift within the UK. While May remains in office, and there has not, as yet, been any official effort to dethrone her, it is also clear that the probability of this deal being passed by Parliament has fallen sharply. And along side that probability falling, so too has the pound fallen sharply, down 1.5% as I type. In truth, this outcome can be no real surprise given the intractable nature of the underlying problem. A nation is defined by its borders. Insisting that there be no border and yet two distinct nations has been an inherent dilemma during the entire Brexit process. One side has to concede something, and thus far neither side is willing to do so. It remains to be seen if one side does cave in. For now, however, the pound is likely to remain under pressure.

The other story on which FX traders have focused was the speech by Chairman Powell last evening, where in a subtle change in tone, he recognized potential headwinds to the US growth story. These include, slowing growth elsewhere in the world, trade friction and the lagged impact of the Fed’s own policy changes, as well as the diminishing impact of this year’s fiscal stimulus. While none of this is ‘new’ information, what is new is the communication that the Fed is paying close attention. It had seemed to some pundits that the Fed was on autopilot and ignoring the changes that were ongoing in the global economy. By his remarks, Powell made it very clear that was not the case. The market impact, however, is a belated recognition of that fact, and instead will respond to the information that they see. If financial conditions tighten sufficiently because the underlying growth situation is weaker, the Fed has made it clear they will adjust policy accordingly.

The result of these comments was a very mild softening in the dollar as traders and investors implicitly reduce the probability of further policy tightening. However, the movement has not been very significant. Since Monday’s dollar peak, it has drifted lower by about 1% in a relatively smooth manner. Certainly, yesterday’s US CPI data didn’t help the dollar as it printed slightly softer than expected. Combining that with the Powell comments has been plenty to help stop the dollar’s recent rally. The question, of course, is how will upcoming data and information impact things. At this time, the market is following a completely logical pattern whereby strong US data results in a stronger dollar and weak data the opposite. With that in mind, I would suggest that this morning’s data will be of some real importance to the FX market.

Here are expectations for today:

Initial Claims 212K
Philly Fed 20.0
Empire State Manufacturing 20.0
Retail Sales 0.5%
-ex autos 0.5%
Business Inventories 0.3%

In addition, Chairman Powell speaks again at 11:00 this morning, although it would be hard to believe that he will have something new to say versus his comments yesterday. In all, if today’s data shows signs of faltering US growth, I expect the dollar will slide a little further, whereas strong data should see the dollar retraces some of yesterday’s losses. As to the pound, absent another resignation, it has likely found a new home for now. However, it will be increasingly difficult for the pound to rally unless a new idea is formulated, or we hear soothing words from the EU. At this time, neither of those seems very likely.

Good luck
Adf

Into the Tank

The German economy shrank
Japan’s heading into the tank
Italians declared
The budget prepared
Is gospel, and oil just sank

There are a number of stories this morning competing for market attention as investors and traders continue to try to get a reading on growth prospects going forward. Perhaps the most surprising story is that German GDP, which had been expected to print at 0.0% in Q3, actually fell -0.2%, significantly worse than expected. While every pundit and economist has highlighted that it was a confluence of one-time events that drove the data and that expectations for Q4 are far more robust, the fact remains that Q3 growth in Germany, and the whole of Europe, has been much weaker than anticipated. The euro has not benefitted from the news, falling 0.25%, and broadly continuing its recent downtrend.

Adding to the single currency’s woes is the ongoing Italian budget opera, where the EU huffed and puffed and demanded the Italians change their plans. The Italians, formally, told the EU to pound salt yesterday evening, and now the EU is at a crossroads. Either the emperor has no clothes (EU does nothing and loses its fiscal oversight capability) or is in fact well dressed and willing to flaunt it (initiates procedures to sanction and fine Italy). The problem with the former is obvious, but the problem with the latter is the potential impact on EU Parliamentary elections to be held in the spring. Attacking Italy could easily result in a far more antiestablishment parliament with many of the current leadership finding themselves in the minority. (And the one thing we absolutely know is that incumbency is THE most important aspect of leadership, right?) The point is that there are ample reasons for the euro to remain under pressure going forward.

At the same time, Japanese economic data continues to disappoint, with IP declining -2.5% Y/Y in September and Capacity Utilization falling 1.5%. At the same time, we find out that the BOJ’s balance sheet is now officially larger than the Japanese economy! Think about that, Japan’s debt/GDP ratio has long been over 200%, but now the BOJ has printed money and bought assets equivalent to the entire annual output of the nation. And despite the extraordinary efforts that the BOJ has made, growth remains lackluster and inflation nonexistent meaning the BOJ has failed to achieve either of its key aims. At some point in time, and it appears to be approaching sooner rather than later, central banks around the world will completely lose the ability to adjust market behavior through either words or action. And while it is not clear which central bank will lose that power first, the BOJ has to be the frontrunner, although the ECB is certainly trying to make a run at the title.

Meanwhile, from Merry Olde Englande we have news that a draft Brexit deal has been agreed between PM May and the EU. The problem remains that her cabinet has not yet seen nor signed off on it, and there is the little matter of getting the deal through Parliament, which will be dicey no matter what. On the one hand, it is not wholly surprising that some type of agreement was reached, but as is often the case in a situation as fraught as Brexit, nobody is satisfied, and quite frankly, it is not clear that it will gather sufficient support from either the UK Parliament, or the EU’s other nations. This is made evident by the fact that the pound has actually fallen today, -0.2%, despite the announcement. I maintain that a Brexit deal will clearly help the pound’s value, so the market does not yet believe the story. At the same time, UK inflation data was released at a softer than expected 2.4% in October, thus reducing potential pressure on the BOE to consider raising rates, even if a Brexit deal is agreed. After all, if inflation falls to 2.0%, their concerns will be much allayed.

One other story getting a lot of press has been the sharp decline in the price of oil, which yesterday fell 7.1% in the US, and is now down more than 26% since its high in the beginning of October, just six weeks ago. There is clearly a relationship between commodity prices and the dollar given the fact that most commodities are priced in dollars, and that relationship is consistently an inverse one. The question, that I have yet to seen answered effectively, is the direction of the causality. Does a stronger dollar lead to weaker commodity prices? Or do weaker commodity prices drive the dollar higher? While I am inclined to believe in the first scenario, there are arguments on both sides and no research has yet been able to answer the question effectively. However, it should be no surprise that the dollar continues to rally coincidentally with the decline in oil, and other commodity, prices.

I didn’t even get a chance to discuss the ongoing slowdown in Chinese economic growth, but we can touch on that tomorrow. As for today’s session, this morning we see the latest CPI readings (exp 0.3%, 2.5% Y/Y headline, 0.2% 2.2% core) and then as the FX market gets set to go home, Chairman Powell speaks, although it is hard to believe that his views on anything will have changed that much. In the end, the big picture remains that the dollar should continue to benefit from the Fed’s ongoing monetary policy activities as well as the self-inflicted wounds of both the euro and the yen.

Good luck
Adf

A Too Bitter Pill

Three stories today are of note
First, Italy’s rocking the boat
Next Brexit is still
A too bitter pill
While OPEC, a cut soon may vote

The outcome in all of these cases
Has been that the market embraces
The dollar once more
(It’s starting to soar)
And quite clearly off to the races

On this Veteran’s Day holiday in the US, where bond markets will be closed although equity markets will not, the dollar has shown consistent strength across the board. Interestingly, there have been several noteworthy stories this morning, but each one of them has served to reinforce the idea that the dollar’s oft-forecast demise remains somewhere well into the future.

Starting with Italy, the current government has shown every indication that they are not going to change their budget structure or forecasts despite the EU’s rejection of these assumptions when the budget was first submitted several weeks ago. This sets up the following situation: the EU can hold firm to its fiscal discipline strategy and begin the procedure to sanction Italy and impose a fine for breaking the rules, or the EU can soften its stance and find some compromise that tries to allow both sides to save face, or at least the EU to do so.

The problem with the first strategy is the EU Commission’s fear that it will increase the attraction of antiestablishment parties in the Parliamentary elections due in May. After all, the Italian coalition was elected by blaming all of Italy’s woes on the EU and its policies. The last thing the Commission wants is a more unruly Parliament, especially as the current leadership may find themselves on the sidelines. The problem with the second strategy is that if they don’t uphold their fiscal probity it will be clear, once and for all, that EU fiscal rules are there in name only and have no teeth. This means that going forward, while certain countries will follow them because they think it is proper to do so, many will decide they represent conditions too difficult with which to adhere. Over time, the second option would almost certainly result in the eventual dissolution of the euro, as the problems from having such dramatically different fiscal policies would eventually become too difficult for the ECB to manage.

With this in mind, it is no surprise that the euro is softer again today, down 0.6% and now trading at its lowest level since June 2017. In less than a week it has fallen by more than 2.0% and it looks as though this trend will continue for a while yet. We need to see the Fed soften its stance or something else to change in order to stop this move.

Turning to the UK, the clock to make a deal seems to be ticking ever faster and there is no indication that PM May is going to get one. Over the weekend, there was no progress made regarding the Irish border issue, but we did hear from several important constituents that the PM’s current deal will fail in Parliament. If Labour won’t support it and the DUP won’t support it and the hard-line Brexiteers won’t support it, there is no deal to be had. With this in mind it is no surprise that the pound has suffered greatly this morning, down 1.4% and back well below 1.30. You may recall that around Halloween, the market started to anticipate a Brexit deal and the pound rallied 3.7% in the course of a week. Well, it has since ceded 2.7% of that gain and based on the distinct lack of progress on the talks, it certainly appears that the pound has further to fall. Do not be surprised if the pound trades below its recent lows of 1.2700 and goes on to test the post-Brexit vote lows of 1.1900.

The third story of note is regarding OPEC and oil prices, which have fallen nearly 20% during the past six weeks as US production and inventories continue to climb while the price impact of sanctions on Iran turned out to be much less then expected. This has encouraged speculation that OPEC may cut its production quotas, although the news from various members is mixed. Adding to oil’s woes (and in truth all commodity prices) has been the fact that global growth has been slowing as well, thus reducing underlying demand. In fact, the biggest concern for the market has been the slow down in China, which continues apace and where stories of further policy ease by the PBOC, including interest rate cuts, are starting to be heard. Two things to note are first, the typical inverse correlation between the dollar and commodity prices such that when the dollar rises, commodity prices tend to fall, and second, in line with the dollar’s broad strength, the Chinese yuan has fallen further today, down 0.3%, and pushing back to the levels that inspired calls for a move beyond 7.00 despite concerns over increased capital outflows.

And frankly, those are the stories of note. The dollar is higher vs. pretty much every other currency today, G10 and EMG alike, with no distinction and few other stories that are newsworthy. Looking at the data this week, there are two key releases, CPI and Retail Sales along with a bit of other stuff.

Tuesday NFIB Biz Confidence 108.0
  Monthly Budget -$98.0B
Wednesday CPI 0.3% (2.5% Y/Y)
  -ex food & energy 0.2% (2.2% Y/Y)
Thursday Initial Claims 215K
  Philly Fed 20.2
  Empire State 20.0
  Retail Sales 0.5%
  -ex Autos 0.5%
Friday IP 0.2%
  Capacity Utilization 78.2%

Overall, the data continues to support the Fed’s thesis that tighter monetary policy remains the proper course of action. In addition to the data we will hear from three Fed speakers including Chairman Powell on Wednesday. It seems hard to believe that he will have cause to change his tune, so I expect that as long as the rest of the world exhibits more short-term problems like we are seeing today, the dollar will remain quite strong.

Good luck
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