Tag Archives: #UK

A Few Tweaks

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Ms May explained that her Plan B
Was really a wonder, you see
She’d get a few tweaks
And then in ten weeks
The UK would finally be free!

The way I see it, Plan B is essentially a game of chicken. To date, the EU has said that they are firm and will not cede any more ground than that already outlined in the deal on the table. However, with ten weeks to go, the reality that the UK could exit with no deal is starting to hit home. Regardless of what they have said to date, a hard Brexit is going to have real negative impacts on the EU, especially Germany, the Netherlands and France, as they are the biggest trading partners of the UK. So, PM May went back to Parliament and explained that she would go back to the EU and explain that there needed to be some changes or else it was no deal. The first cracks appeared on the EU side with Poland discussing a 5-year transition period as a possibility, although so far, no other EU nation has piped up.

But consider the situation for the ECB. Signor Draghi is desperate to move further down the road of reducing the extraordinary monetary ease that the ECB has implemented. Stopping QE was to be the beginning of the process with the next steps to be slow and steady rate increases. Now, it is already looking like a questionable call, and a hard Brexit will definitely result in even slower Eurozone growth, thus ratcheting up the pressure on Draghi to do something. Remember, this is the man who did ‘whatever it took’ to save the euro during the sovereign debt crisis in 2012. But interest rates are already negative, and they just ended QE last month. Will they really start it up again in a few months’ time? There is significant pressure building on the EU to blink, although whether or not they do is still unclear.

Yesterday I discussed the idea that Parliament would try to take matters into its own hands given its dissatisfaction with PM May’s deal, but that would be an extraordinary outcome, and is in no way certain to be achieved. This morning, the pound has edged higher (just 0.2%) after surprisingly good employment data with the Unemployment Rate falling to 4.0%. Sterling continues to trade well above the lows seen in December though well below most economist estimates of ‘fair value.’ The thing is, given the possibility that there is no Brexit, which would arguably result in a very sharp Sterling rally, as well as the possibility there is a hard Brexit, which would result in a very sharp decline, maybe the pound is in the right place after all. And for hedgers, 50/50 is the best I can offer. If pressed, I would say the odds of no Brexit have increased, but there is still no way to know at this point in time.

Other than this story, however, there is precious little new news of interest to the FX world. The trade situation continues to percolate, as does the US government shutdown, but neither one has seen any change of note overnight. In both cases, there doesn’t appear to be a deal in the near future.

Broadly speaking, risk is off today, with the dollar modestly higher against most counterparts, equity markets softening somewhat along with commodities and Treasury and Bund yields declining slightly. There are still many problems extant in the world, it’s just that none of them are acute right now. However, the odds of another significant disruption appear to be increasing, hence the risk reduction we are witnessing today.

This morning’s data is Existing Home Sales (exp 5.25M), which is unlikely to impact the dollar very much unless it misses by a lot. Otherwise, the market is likely to continue this modest risk aversion unless we hear something about either Trade or the shutdown. In other words, look for a quiet FX session today.

Good luck
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Ill at Ease

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The nation that once ruled the seas
Has lately been brought to its knees
The Minister, Prime
Has run out of time
And Parliament’s still ill at ease

In ten days, some votes will be held
As MP’s there all feel compelled
To take more control
Around the black hole
Of Brexit, so fears might be quelled

There continue to be two main stories driving markets, Brexit and the trade war between the US and China. Everything else has faded into the background amid moderating global growth and concerns of worse to come.

Starting with Brexit, in a week and a half (it’s actually 11 days, but that didn’t fit into the limerick), Parliament will be holding a series of votes to try to wrest control of the process from the government and to explain their demands on behalf of the ‘people’. Alas, what is clear is that there is no consensus on how to proceed, with a large number not wanting to go through with it at all, while others seek a hard Brexit. PM May has insisted that the vote was for leaving the EU, and that is exactly what the UK is going to do. Currently, the best idea that anybody seems to have is to seek to delay the official date for up to a year in order to come up with more support for any action at all. There is talk of holding a second referendum, talk of a snap election to help PM May win a mandate on how to proceed, and talk of a hard Brexit. The one thing that is clear is that the deal on the table will not be the roadmap, at least not as currently written.

With all that in mind, the FX market is starting to vote, and they are coming around to the idea that there will be no Brexit at all. At least that is my take on the fact that the pound has been rising steadily since the beginning of the year. While it is actually slightly softer this morning (-0.35%) on the back of weaker than expected Retail Sales figures (-0.9% in Dec), it is higher by 3.5% since January 2nd. My view that a hard Brexit will result in a much lower pound is universal, while a deal would clearly help the pound’s value. But no Brexit at all might open up a very significant rally. Remember, before the vote, the pound was trading around 1.45-1.50. Price action indicates to me that there are more and more traders and speculators who are betting on no Brexit and a sharp rebound. I will say that if there is a decision to hold a second referendum, look for the pound to rally very sharply, easily another 5%-8%, and to do so quickly. I just don’t think there will be another referendum.

As to the trade spat, the WSJ published an article of rumors and innuendo about the idea that the US is contemplating removing tariffs as a sign of good faith and a spur to help an agreement be reached. What was interesting was that at the very end of the article, it was mentioned that all of this talk was in the context of how to move the talks forward, and not an agreed plan of action. But equity markets around the world continue to look for positive catalysts and the end of the trade war would definitely fit that bill. Given the story was published late yesterday afternoon, it is no surprise that equity markets around the world have rallied, with Asia (Nikkei +1.3%, Shanghai +1.4%) and Europe (+1.0%-1.5% across the board) both performing quite well while US futures are pointing higher as well, albeit not quite as robustly (+0.4%). But the dollar has seen very little impact from this news as aside from the pound’s modest decline, it is doing very little overall.

Beyond those stories, much less of note is happening. Next week the ECB meets, and we are starting to see analysts discuss the prospects for the previously expected rate hikes later this year. Given the ongoing softness in Eurozone data, it remains hard to believe that the ECB is going to think that raising rates is the correct move. Rather, more likely will be an extension of the TLTRO’s and interest rates remaining right where they are for an extended period from here. All eyes will be on Signor Draghi’s characterization of the economy, as to whether risks are tilted to the downside or things are balanced, but even if he claims balance, the reality is the data is pointing lower. At some point, that will be acknowledged, and it will be clearer to all that policy will not tighten further in Europe for many years. In fact, it is much easier to believe that the next move will be for easier policy than tighter. And as I have continued to explain, I believe that will help the dollar overall.

As to this morning’s data, we see IP (exp 0.2%), Capacity Utilization (78.5%) and Michigan Sentiment (97.0). Canadian Inflation is also on the docket (1.7%), which hardly seems a reason to expect higher rates there. Looking ahead, there are no more Fed speakers until the meeting on the 30th as they have entered their quiet period. But the message we have received is quite clear, patience is a virtue and there will be no rate hike in either January or March. After that, if the data supports the idea that growth and inflation are picking up, I think they will move, but unfortunately, given the overall tone of data, that seems unlikely. As to the tone for today, it is hard to get too excited about the FX market without further specific news. It wouldn’t surprise to see the pound drift a bit lower as there will be some profit taking on the recent move, but for now, the dollar is likely to remain under very modest pressure overall. Especially if equities in the US perform like those elsewhere.

Good luck and good weekend
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Disgraced

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Prime Minister May was disgraced
As Parliament calmly laid waste
To hopes that her deal
With Europe could heal
The schism that Brexit emplaced

Yesterday’s Parliamentary vote on the Brexit deal negotiated between PM May’s government and the EU resulted in a resounding rejection. While the UK remains fairly evenly divided on the absolute concept of Brexit, what was made clear was that the terms proposed were unacceptable to all sides. As I have maintained, the Irish border issue is an intractable one, where one side or the other simply must cede ground. There is no middle way. At this time, neither side is willing to do so, and quite frankly, unless Northern Ireland is willing to reunite with Ireland, (which seems highly unlikely any time soon), there can be no deal that will be acceptable to both sides. This leaves three potential outcomes; the UK could leave the EU with no deal in hand and go back to WTO tariff rules; the UK could opt not to leave at all (based on the European Court of Justice ruling from November); or there is a small possibility that the deadline could be delayed a number of months in order to reopen negotiations.

Let’s unpack those three choices.
1. In a no-deal Brexit, pretty much every published analysis by economists has forecast a nearly apocalyptic result for the UK economy, with a deep recession followed by much slower growth. Or course, every one of those economists likely voted to remain as the demographics of the vote showed professionals, especially financial industry professionals, overwhelmingly voted to remain. In other words, they are talking their book. Will the UK suffer? Almost certainly. Will the UK collapse into a depression? Absolutely not. The UK was a strong and viable nation before the EU came into existence and will certainly continue to be so going forward. The market impact of this outcome is likely to be quite negative in the short term, however, with both the pound and UK equity markets falling sharply if it becomes clear this will be the outcome. While both will recover eventually, the timing on that is unclear.

2. If the May government opted to remain in the EU, essentially repudiating the results of the referendum, I fear it would lead to riots in the streets, certainly in the Midlands which led the vote to leave. In fact, I could see an alliance between the French gilets jaune and the Brexiteers as both will be taking to the streets in an effort to change the government. A unilateral decision not to leave would have much deeper consequences with regard to the political system within the UK, as there would be whole swathes of the nation that would cease to trust the government entirely. I actually think this is the least likely scenario, although in the event it occurred, I would expect both the pound and the FTSE to rally sharply initially, but as the consequences of that act became clearer, I imagine both would suffer greatly.

3. Delaying the deadline seems like the best fudge available to both sides at this point, although the initial comments by EU officials followed the line that, given the depth of the defeat of the already negotiated deal, there seems little chance to make small changes and get a new result. This will also require unanimous approval by the remaining 27 members of the EU, which sounds daunting, although if there it was believed there was a serious chance of coming up with a better deal would get done. Here, too, the market response will be for a rally in the pound, and probably the FTSE, as investors would likely take the stance that the delay presages a deal.

However, for the time being, PM May’s first course of business is to fight off the no-confidence motion brought by Labour Leader Jeremy Corbyn in his attempt to bring down the government and force a general election. Pundits believe that while the deal was unacceptable, May will hold on. The problem is, she has no ideas as to how to move the process forward. Certainly, the probability of a no-deal Brexit has increased somewhat after the vote. Interestingly, the FX markets have not really priced for that outcome. In fact, since the original vote date, December 11, when May pulled the bill to try to garner more support, the pound has rallied pretty steadily and is nearly 3% higher over the past month. It would seem that FX traders believe a deal will be found.

The other story of note is that the Chinese government is now set to cut taxes in an effort to add fiscal stimulus to their ongoing monetary stimulus efforts. Remember, they have already cut bank reserve requirements by another 1% this year, adding to 2% cuts from last year, and they have created a loan targeting policy for SME’s. Now income tax cuts are to be included as well. This highlights just how poorly the Chinese economy is performing right now, and how critical President Xi believes it is to continue publishing GDP growth above 6%. While the FX market has shown little response to these actions, they have had a much more positive impact on equity markets, with yesterday’s rallies easily attributed to the announcement. The one thing that is certain is that Xi will continue to do whatever he things is necessary to support economic growth in the short run, regardless of the potential longer-term negative consequences. After all, despite being President for life, he is still a politician!

Pivoting to the data story, yesterday Germany reported 2018 GDP growth of just 1.5%, its weakest performance in 5 years, although there was no report on Q4 growth. Given the surprise decline in Q3, pundits were watching to see if Germany had entered a technical recession, although it appears not to be the case. However, it is clear that growth in the engine of Europe is continuing to slow which doesn’t bode well for the entire Eurozone. Nor does it bode well for the ECB’s nascent attempts to remove policy accommodation. In fact, their biggest fear has to be that growth slows further there and they have basically no monetary tools left to combat the situation. This morning’s data has shown that inflation continues to ebb in Europe (France 1.6%, Germany 1.7%, Spain 1.2%, Italy 1.1%), and the UK (2.1%) as well, which reduces pressure to tighten policy at all. While US inflation is also softening, it continues to puzzle me that there is any belief the ECB (or the BOE for that matter) will consider raising interest rates any time soon. So even if the Fed is more dovish (and given remarks from the always hawkish KC President Esther George yesterday, it is clear that there is no rate hike in the near future in the US), the idea that any other central bank is going to be tightening policy is absurd.

In fact, I would argue that the dollar’s recent weakness has been predicated solely on the idea that the Fed will back off on previously forecast rate hikes. But if the Fed is stopping, you can be 100% certain that any thoughts of tighter policy elsewhere are also out the window, and so relatively speaking, the US remains the tightest policy around. I still like the dollar for that reason.

Good luck
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Trumped

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A great nation in the Far East
Is seeing its growth rate decreased
Their trade has been ‘Trumped’
As exports have slumped
According to data released

There are two stories of note this morning as follows:

1. Chinese Trade data
2. Brexit vote tomorrow

While both of these stories have knock-on effects, they are the conversation drivers today.

Starting with China, last night’s data showed that both exports (-4.4%) and imports (-7.6%) fell much further than forecast with the resulting Trade balance expanding to a $57 billion surplus. Adding to the concerns was a -13% decline in vehicle sales there, so a trifecta of poor data. The short-term response has been for equity markets to sell off as concerns over slowing global growth mount. In Asia the Hang Seng fell -1.4% while Shanghai fell -0.7%. European equities are also suffering, with the Stoxx 600 down -0.8% amid universal weakness there, and US futures are pointing toward opening declines on the order of -0.8%.

Highlighting the risk sell off, Treasury yields have fallen 3bps, oil prices are down 1.5% and gold has climbed 0.6%. Finally, in the FX market, the yen is today’s leader, rising 0.45% as I type. However, while that describes today’s market movement, the narrative seems to be shifting slightly, toward the idea that a resolution of the trade conflict between the US and China is coming sooner than previously thought. Certainly, if growth in China is slowing more rapidly than expected, President Xi will be motivated to get a deal done, and with the ongoing tribulations in Washington, President Trump would love nothing more than to trumpet a victory on trade. So, it certainly makes sense that both sides will find a solution, but it must be remembered that there are a number of very difficult issues to address, notably the question of IP theft and forced technology transfer, which will not be easy to fudge. With that said, it is clear that a resolution to the trade fight will result in a significant risk-on atmosphere in global markets.

The other story is the imminent vote in the UK Parliament regarding PM May’s Brexit deal. As should be expected in any compromise, nobody is happy with the deal. However, in this case, given May’s weak underlying support (remember she is leading a minority government), it appears that the deal has extremely limited support, even from her own party. It is no longer a question of whether the vote will go against the government, (it will), but by how many votes will it lose. Apparently, anything on the order of 40-50 votes could be seen as close enough for PM May to go back to the EU and seek some minor tweaks in order to get the deal done. However, it is increasingly looking like the loss will be catastrophic, on the order of 100 votes, which will remove any possibility of a Brexit deal.

A ‘No’ vote will leave two possible outcomes, either a no-deal Brexit, something that is greatly feared by markets and politicians alike, or no Brexit at all! The second choice seems quite confusing, given the referendum results in 2016, but several months ago, the European Court of Justice ruled that the UK could unilaterally decide to remain in the EU. Of course, if that is the decision it seems likely to ignite an extraordinary political firestorm within the UK, given that a legal referendum called for Brexit. So, all eyes will be on London tomorrow, but for right now, traders seem to be falling into the no Brexit camp as the pound has rallied 0.3% this morning. I would argue, however, that a no Brexit outcome would see major government upheaval and have quite a negative impact on the UK economy and the pound in the short run.

Away from those stories, there is not much interesting discussion. Overall, the dollar is mixed this morning, with both AUD (-0.3%) and CNY (-0.15%) falling after the Chinese trade data, RUB (-0.45%) and CAD (-0.15%) softer on weakening oil prices and TRY (-1.10%) suffering the slings and arrows of US threats in the event the Turks attack the US-backed Kurds in Syria. On the plus side, it has mostly been the yen and the pound as described above. Net, the dollar is little changed on the day.

Turning to this week’s data, there is a decent amount highlighted by the Fed’s Beige Book on Wednesday.

Tuesday PPI -0.1% (2.5% Y/Y)
  -ex food & energy 0.2% (2.9% Y/Y)
  Empire Manufacturing 11.25
Wednesday Fed’s Beige Book  
Thursday Initial Claims 220K
  Philly Fed 10
Friday Capacity Utilization 78.5%
  IP 0.2%
  Michigan Sentiment 97.0

In addition, we hear from four more Fed speakers, including uber-dove Kashkari and NY Fed President Williams. However, the Fed speak is unlikely to have changed from the onslaught last week, meaning there will still be a dovish bias perceived by the market.

As for today, while risk has been reduced, it does not feel like a major rout, but rather a modest adjustment to positions. My sense is that the Brexit vote tomorrow will be the big story for the market, and we will likely bide our time for the rest of the day, at least in FX markets. As long as the narrative continues to focus on a dovish Fed, the dollar will remain under pressure, that is unless the focus turns to more disruptive possible outcomes, when fear really blossoms. However, I don’t see a good reason for that to occur in the short run, so the dollar is apt to stay soft for now.

Good luck
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Greater Clarity

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Last year rate hikes had regularity
But now the Fed seeks greater clarity
‘Bout whether our nation
Is feeling inflation
Or some other source of disparity

Investors exhaled a great sigh
And quickly realized they must buy
Those assets with risk
To burnish their fisc
Else soon prices would be too high

The December FOMC Minutes were received quite positively by markets yesterday as it appears despite raising rates for the fourth time in 2018, it was becoming clearer to all involved that there was no hurry to continue at the same pace going forward. The lack of measured inflation and the financial market ructions were two key features that gave pause to the FOMC. While the statement in December didn’t seem to reflect that discussion, we have certainly heard that tune consistently since then. Just yesterday, two more Fed regional presidents described the need for greater clarity on the economic situation before seeing the necessity to raise rates again. And after all, given the Fed has raised rates 225bps since they began in December 2015, it is not unreasonable to pause and see the total impact.

However, regarding the continued shrinking of the balance sheet, the Fed showed no concern at this point that it was having any detrimental effect on either the economy or markets. Personally I think they are mistaken in this view when I look at the significant rise in LIBOR beyond the Fed funds rate over the past year, where Fed Funds has risen 125 bps while LIBOR is up 187bps. But the market, especially the equity market, remains focused on the Fed funds path, not on the balance sheet, and so breathed a collective sigh of relief yesterday.

Given this turn of events, it should also not be surprising that the dollar suffered pretty significantly in the wake of the Minutes’ release. In the moments following the release, the euro jumped 0.7% and continued subsequently to close the day nearly 1% stronger. One of the underpinnings of dollar strength has been the idea that the Fed was going to continue to tighten policy in 2019, but the combination of a continuous stream of comments from Fed speakers and recognition that even back in December the Fed was discussing a pause in rate hikes has served to alter that mindset. Now, not only is the market no longer pricing in rate hikes this year, but also analysts are backing away from calling for further rate hikes. In other words, the mood regarding the Fed has turned quite dovish, and the dollar is likely to remain under pressure as long as this is the case.

Of course, the other story of note has been the trade talks between the US and China which ended yesterday. During the talks, market participants had a generally upbeat view of the potential to reach a deal, however, this morning that optimism seems to be fading slightly. Equity markets around the world have given back some of their recent gains and US futures are also pointing lower. As I mentioned yesterday, while it is certainly good news that the talks seemed to address some key issues, there is still no clarity on whether a more far-reaching agreement can be finalized in any near term timeline. And while there has been no mention of tariffs by the President lately, a single random Tweet on the subject is likely enough to undo much of the positive sentiment recently built.

The overnight data, however, seems to tell a different story. It started off when Chinese inflation data surprised on the low side, rising just 1.9% in December, much lower than expected and another red flag regarding Chinese economic growth. It seems abundantly clear that growth there is slowing with the only real question just how much. Forecasts for 2019 GDP growth have fallen to 6.2%, but I wouldn’t be surprised to see them lowered going forward. On the other hand, the yuan has actually rallied sharply overnight, up 0.5%, despite the prospects for further monetary ease from Beijing. It seems that there is a significant inflow into Chinese bond markets from offshore which has been driving the currency higher despite (because of?) those economic prospects. In fact, the yuan is at its strongest level since last August and seemingly trending higher. However, I continue to see this as a short-term move, with the larger macroeconomic trends destined to weaken the currency over time.

As to the G10 currencies, they have stabilized after yesterday’s rally with the euro virtually unchanged and the pound ceding 0.25%. Two data points from the Eurozone were mixed, with French IP slipping to a worse than expected -1.3% while Italian Retail Sales surprised higher at +0.7% back in November. While there was no UK data, the Brexit story continues to be the key driver as PM May lost yet another Parliamentary procedural vote this morning and seems to be losing complete control of the process. The thing I don’t understand about Brexit is if Parliament votes against the current deal next week, which seems highly likely at this stage, what can they do to prevent a no-deal Brexit. Certainly the Europeans have not been willing to concede anything else, and with just 79 days left before the deadline, there is no time to renegotiate a new deal, so it seems a fait accompli that the UK will leave with nothing. I would welcome an explanation as to why that will not be the case.

Turning to this morning’s activity, the only data point is Initial Claims (exp 225K), but that is hardly a market moving number. However, we hear from three regional Fed presidents and at 12:45 Chairman Powell speaks again, so all eyes will be focused on any further nuance he may bring to the discussion. At this point, it seems hard to believe that there will be any change in the message, which if I had to summarize would be, ‘no rate changes until we see a strong reason to do so, either because inflation jumps sharply or other data is so compelling that it forces us to reconsider our current policy of wait and see.’ One thing to keep in mind, though, about the FX markets is that it requires two sets of policies to give a complete picture, and while right now all eyes are on the Fed, as ECB, BOJ, BOE and other central bank policies evolve, those will have an impact as well. If global growth is truly slowing, and the current evidence points in that direction, then those banks will start to sound more dovish and their currencies will likely see plenty of selling pressure accordingly. But probably not today.

Good luck
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Naught But Fool’s Gold

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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

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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
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That Might Be Obtuse

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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
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QE He’ll Dismember

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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

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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
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