So Ended the Equity Slump

There once was a president, Trump
Who sought a great stock market jump
He reached out to Xi
Who seemed to agree
So ended the equity slump

The story of a single phone call between Presidents Trump and Xi was all it took to change global investor sentiment. Last evening it was reported that Trump and Xi spoke at length over the phone, discussing the trade situation and North Korea. According to the Trump, things went very well, so much so that he requested several cabinet departments to start putting together a draft trade agreement with the idea that something could be signed at the G20 meeting later this month in Buenos Aires. (As an aside, if something is agreed there it will be the first time something useful ever came out of a G20 meeting!) The market response was swift and sure; buy everything. Equity markets exploded in Asia, with Shanghai rallying 2.7% and the Hang Seng up over 4%. In Europe the rally is not quite as robust, but still a bit more than 1% on average across the board, and US futures are pointing higher as well, with both S&P and Dow futures higher by just under 1% as I type.

I guess this answers the question about what was driving the malaise in equity markets seen throughout October. Apparently it was all about trade. And yet, there are still many other things that might be of concern. For example, amid a slowdown in global growth, which has become more evident every day, we continue to see increases in debt outstanding. So more leverage driving less growth is a major long-term concern. In addition, the rise of populist leadership throughout the world is another concern as historically, populists don’t make the best long-term economic decisions, rather they are focused on the here and now. Just take a look at Venezuela if you want to get an idea of what the end game may look like. My point is that while a resolution of the US-China trade dispute would be an unalloyed positive, it is not the only thing that matters when it comes to the global economy and the value of currencies.

Speaking of currencies lets take a look at just how well they have performed vs. the dollar in the past twenty-four hours. Starting with the euro, since the market close on October 31, it has rallied 1.2% despite the fact that the data released in the interim has all been weaker than expected. Today’s Manufacturing PMI data showed that Germany and France both slowed more than expected while Italy actually contracted. And yet the euro is higher by 0.45% this morning. It strikes me that Signor Draghi will have an increasingly difficult time describing the risks to the Eurozone economy as “balanced” if the data continues to print like today’s PMI data. I would argue the risks are clearly to the downside. But none of that was enough to stop the euro bulls.

Meanwhile, the pound has rallied more than 2% over the same timeline, although here the story is quite clear. As hopes for a Brexit deal increase, the pound will continue to outperform its G10 brethren, and there was nothing today to offset those hopes.

Highlighting the breadth of the sentiment change, AUD is higher by more than 2.5% since the close on Halloween as a combination of rebounding base metal prices and the trade story have been more than sufficient to get the bulls running. If the US and China do bury the hatchet on trade, then Australia may well be the country set to benefit most. Reduced trade tensions should help the Chinese economy find its footing again and given Australia’s economy is so dependent on exports to China, it stands to reason that Australia will see a positive response as well.

But the story is far more than a G10 story, EMG currencies have exploded higher as well. CNY, for example is higher by 0.85% this morning and more than 1.6% in the new month. Certainly discussion of breeching 7.00 has been set to the back burner for now, although I continue to believe it will be the eventual outcome. We’ve also seen impressive response in Mexico, where the peso has rallied 1.2% overnight and more than 2% this month. And this is despite AMLO’s decision to cancel the biggest infrastructure project in the country, the new Mexico City airport.

Other big EMG winners overnight include INR (+1.3%), KRW (+1.1%), IDR (+1.1%), TRY (+0.8%) and ZAR (+0.5%). The point is that the dollar is under universal pressure this morning as we await today’s payroll report. Now arguably, this pressure is simply a partial retracement of what has been very steady dollar strength that we’ve seen over the past several months.

Turning to the data, here are current expectations for today:

Nonfarm Payrolls 190K
Private Payrolls 183K
Manufacturing Payrolls 15K
Unemployment Rate 3.7%
Average Hourly Earnings (AHE) 0.2% (3.1% Y/Y)
Average Weekly Hours 34.5
Trade Balance -$53.6B
Factory Orders 0.5%

I continue to expect that the AHE number is the one that will gain the most scrutiny, as it will be seen as the best indicator of the ongoing inflation debate. A strong print there could easily derail the equity rally as traders increase expectations that the Fed will tighten even faster, or at least for a longer time. But absent that type of result, I expect that the market’s euphoria is pretty clear today, so further USD weakness will accompany equity strength and bond market declines.

Good luck and good weekend
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New Standard-Bearers

The largest of all Latin nations
This weekend confirmed its frustrations
Electing a man
Whose stated game plan
Is changing the country’s foundations

Meanwhile in a key German state
Frau Merkel and friends felt the weight
Of policy errors
So new standard-bearers
Like AfD now resonate

This weekend brought two key elections internationally, with Brazil voting in Jair Bolsonaro, the right-wing firebrand and nationalist who has promised to clean up the corruption rampant in the country. Not unlike New Jersey and Illinois, Brazil has several former politicians imprisoned for corruption. Bolsonaro represented a change from the status quo of the past fifteen years, and in similar fashion to people throughout the Western world, Brazilians were willing to take a chance to see a change. Markets have been cheering Bolsonaro on, as he has a free-market oriented FinMin in mind, and both Brazilian equities and the real have rallied more than 10% during the past month. The early price action this morning has BRL rising by another 1.65%, continuing its recent rally, and that seems likely to continue until Bolsonaro changes tack to a more populist stance, something I imagine we will see within the first year of his presidency.

Just prior to those results, the German elections in the state of Hesse, one of the wealthiest states in Germany and the home of Frankfurt and the financial industry, showed disdain for the ruling coalition of Chancellor Merkel’s CDU and the Social Democrats, with their combined share of the vote falling to just 39%, from well above 50% at the last election. The big winners were the far left Green Party and the far right AfD, both of whom saw significant gains in the state house there, and both of whom will make it difficult to find a ruling coalition. But more importantly, it is yet another sign that Frau Merkel may be on her last legs. This was confirmed this morning when Merkel announced she was stepping down as leader of her party, the CDU, but claimed she will serve out her term as Chancellor, which runs until 2021.

One other Eurozone story came out Friday afternoon as Standard & Poors released their updated ratings on Italy’s sovereign debt, leaving the rating intact but cutting the outlook to negative. This was slightly better than expected as there were many who worried that S&P would follow Moody’s and cut the rating as well. Italian debt markets rallied on the opening with 10-year yields falling 10bps and the spread with German Bunds narrowing accordingly. So net, there was a euro negative, with Merkel stepping down, and a euro positive, from S&P, and not surprisingly, the euro wound up little changed so far, although that reflects a rebound from the early price action. My concern is that the positive story was really the absence of a more negative story, and one that could well be simply a timing delay, rather than an endorsement of the current situation in Italy. The budget situation remains uncertain there, and if the government chooses to ignore the EU and implement their proposed budget, I expect there will be more pressure on the euro. After all, what good are rules if they are ignored by those required to follow them? None of this bodes well for the euro going forward.

Two other key stories have impacted markets, first from Mexico, the government canceled the construction of a new airport for Mexico City. This was part of the departing administration’s infrastructure program, but, not surprisingly, it has seen its cost explode over time and the incoming president has determined the money is better spent elsewhere. The upshot is that the peso has fallen a bit more than 1% on the news, and I would be wary going forward as we approach AMLO’s inauguration. By cutting the investment spending, not only will the country’s infrastructure remain substandard, but its growth potential will suffer as well. I think this is a very negative sign for the peso.

The other story comes from China, where early Q4 data continues to show the economy slowing further. The government there, ever willing to do anything necessary to achieve their growth target, has proposed a 50% cut in auto sales taxes in order to spur the market. Auto sales are on track for their first annual decline ever this year, as growth slows throughout the country. Interestingly, the market impact was seen by rallies in auto shares throughout Europe and the US, but Chinese equity markets continued to slide, with the Shanghai Index falling another 2.2% overnight. This also has put further pressure on the renminbi with CNY falling another 0.2% early in the session before recently paring some of those losses. USDCNY continues to hover just below 7.00, the level deemed critical by the PBOC as they struggle to prevent an increase in capital outflows. The last time the currency traded at this level, it cost China more than $1 trillion to staunch the outflow, so they are really working to prevent that from happening again.

And those are the big stories from the weekend. Overall, the dollar is actually little changed as you can see that there have been individual issues across specific currencies rather than a broad dollar theme today. Looking ahead to the US session, we get the first of a number of important data points this morning with the full list here:

Today Personal Income 0.4%
  Personal Spending 0.4%
  PCE 0.1% (2.2% Y/Y)
  Core PCE 0.1% (2.0% Y/Y)
Tuesday Case-Shlller Home Prices 5.8%
Wednesday ADP Employment 189K
  Chicago PMI 60.0
Thursday Initial Claims 213K
  Nonfarm Productivity 2.2%
  Unit Labor Costs 1.1%
  ISM Manufacturing 59.0
  ISM Prices Paid 65.0
  Construction Spending 0.1%
Friday Nonfarm Payrolls 190K
  Private Payrolls 184K
  Manufacturing Payrolls 15K
  Unemployment Rate 3.7%
  Average Hourly Earnings 0.2% (3.1% Y/Y)
  Average Weekly Hours 34.5
  Trade Balance -$53.6B
  Factory Orders 0.4%

So there is a ton of data upcoming, with this morning’s PCE and Friday’s Payrolls the key numbers. Last week’s GDP data had a better than expected headline print but the entire weekend press was a discussion as to why the harbingers of weaker future growth were evident. And one other thing we have seen is the equity market dismiss better than expected Q3 earnings data from many companies, selling those stocks after the release, as the benefits from the tax cut at the beginning of the year are starting to get priced out of the future.

The market structure is changing, that much is clear. The combination of central bank actions to reduce accommodation, and an expansion that is exceedingly long in the tooth, as well as increased political uncertainty throughout the world has made investors nervous. It is these investors who will continue to support US Treasuries, the dollar, the yen and perhaps, gold,; the traditional safe havens. At this point, there is nothing evident that will change that theme.

Good luck
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Still Under Stress

As traders are forced to assess
A bond market still under stress
Today’s jobs report
Might be of the sort
That causes some further regress

Global bond markets are still reeling after the past several sessions have seen yields explode higher. The proximate cause seems to have been the much stronger data released Wednesday in the US, where the ADP Employment and ISM Non-Manufacturing reports were stellar. Adding to the mix were comments by Fed Chairman Powell that continue to sing the praises of the US economy, and giving every indication that the Fed was going to continue to raise rates steadily for the next year. In fact, the Fed funds futures market finally got the message and has now priced in about 60bps of rate hikes for next year, on top of the 25bps more for this year. So in the past few sessions, that market has added essentially one full hike into their calculations. It can be no surprise that bond markets sold off, or that what started in the US led to a global impact. After all, despite efforts by some pundits to declare that the ECB was the critical global central bank as they continue their QE process, the reality is that the Fed remains top of the heap, and what they do will impact everybody else around the world.

Which of course brings us to this morning’s jobs data. Despite the strong data on Wednesday, there has been no meaningful change in the current analyst expectations, which are as follows:

Nonfarm Payrolls 185K
Private Payrolls 180K
Manufacturing Payrolls 12K
Unemployment Rate 3.8%
Participation Rate 62.7%
Average Hourly Earnings (AHE) 0.3% (2.8% Y/Y)
Average Weekly Hours 34.5
Trade Balance -$53.5B

The market risk appears to be that the release will show better than expected numbers today, which would encourage further selling in Treasuries and continuation of the cycle that has driven markets this week. What is becoming abundantly clear is that the Treasury market has become the pre-eminent driver of global markets for now. Based on the data we have seen lately, there is no reason to suspect that today’s releases will be weak. In fact, I suspect that we are going to see much better than expected numbers, with a chance for AHE to touch 3.0%. Any outcome like that should be met with another sharp decline in Treasuries as well as equities, while the dollar finds further support.

Away from the payroll data, there have been other noteworthy things ongoing around the world, so lets touch on a few here. First, there is growing optimism that with the Tory Party conference now past, and PM May still in control, that now a Brexit deal will be hashed out. One thing that speaks to this possibility is the recent recognition by Brussels that the $125 trillion worth of derivatives contracts that are cleared in London might become a problem if there is no Brexit deal, with payment issues needing to be sorted, and have a quite deleterious impact on all EU economies. As I have maintained, a fudge deal was always the most likely outcome, but it is by no means certain. However, today the market is feeling better about things and the pound has responded by rallying more than a penny. The idea is that with a deal in place, the BOE will have the leeway to continue raising rates thus supporting the pound.

Meanwhile, stronger than expected German Factory orders have helped the euro recoup some of its recent losses with a 0.25% gain since yesterday’s close. But the G10 has not been all rosy as the commodity bloc (AUD, NZD and CAD) are all weaker this morning by roughly 0.4%. Other currencies under stress include INR (-0.6%) after the RBI failed to raise interest rates as expected, although they explained there would be “calibrated tightening” going forward. I assume that means slow and steady, but sounds better. We have also seen further pressure on RUB (-1.3%) as revelations about Russian hacking efforts draw increased scrutiny and the idea of yet more sanctions on the Russian economy make the rounds. ZAR (-0.75%) and TRY (-2.0%) remain under pressure, as do IDR (-0.7%) and TWD (-0.5%), all of which are suffering from a combination of broad dollar strength and domestic issues, notably weak financial situations and current account deficits. However, there is one currency that has been on a roll lately, other than the dollar, and that is BRL, which is higher by 3.4% in the past week and 8.0% since the middle of September. This story is all about the presidential election there, where vast uncertainty has slowly morphed into a compelling lead for Jair Bolsonaro, a right-wing firebrand who is attacking the pervasive corruption in the country, and also has University of Chicago trained economists as his financial advisors. The market sees his election as the best hope for market-friendly policies going forward.

But for today, it is all about payrolls. Based on what we have heard from Chairman Powell lately, there is no reason to believe that the Fed is going to adjust its policy trajectory any time soon, and if they do, it is likely only because they need to move tighter, faster. Today’s data could be a step in that direction. All of this points to continued strength in the dollar.

Good luck and good weekend
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Goldilocks Ain’t Dead Yet

The Chairman said, no need to fret
Our low unemployment’s no threat
To driving up prices
And so my advice is
Relax, Goldilocks ain’t dead yet

Chairman Powell’s message yesterday was that things were pretty much as good as anyone could possibly hope. The current situation of unemployment remaining below every estimate of NAIRU while inflation remains contained is a terrific outcome. Not only that, there are virtually no forecasts for inflation to rise meaningfully beyond the 2.0% target, despite the fact that historically, unemployment levels this low have always led to sharper rises in inflation. In essence, he nearly dislocated his shoulder while patting himself on the back.

But as things stand now, he is not incorrect. Measured inflationary pressures remain muted despite consistently strong employment data. Perhaps that will change on Friday, when the September employment report is released, but consensus forecasts call for the recent trend to be maintained. Last evening’s news that Amazon was raising its minimum wage to $15/hour will almost certainly have an impact at the margin given the size of its workforce (>575,000), but the impact will be muted unless other companies feel compelled to match them, and then raise prices to cover the cost. It will take some time for that process to play out, so I imagine we won’t really know the impact until December at the earliest. In the meantime, the Goldilocks economy of modest inflation and strong growth continues apace. And with it, the Fed’s trajectory of rate hikes remains on track. The impact on the dollar should also remain on track, with the US economy clearly still outpacing those of most others around the world, and with the Fed remaining in the vanguard of tightening policy, there is no good reason for the dollar to suffer, at least in the short run.

However, that does not mean it won’t fall periodically, and today is one of those days. After a weeklong rally, the dollar appears to be consolidating those gains. The euro has been one of today’s beneficiaries as news that the Italian government is backing off its threats of destroying EU budget rules has been seen as a great relief. You may recall yesterday’s euro weakness was driven by news that the Italians would present a budget that forecast a 2.4% deficit, well above the previously agreed 1.9% target. The new government needs to spend a lot of money to cut taxes and increase benefits simultaneously. But this morning, after feeling a great deal of pressure, it seems they have backed off those deficit forecasts for 2020 and 2021, reducing those and looking to receive approval. In addition, Claudio Borghi, the man who yesterday said Italy would be better off without the euro, backed away from those comments. The upshot is that despite continued weakening PMI data (this time services data printed modestly weaker than expected across most of the Eurozone) the euro managed to rally 0.35% early on. Although in the past few minutes, it has given up those gains and is now flat on the day.

Elsewhere the picture is mixed, with the pound edging lower as ongoing Brexit concerns continue to weigh on the currency. The Tory party conference has made no headway and time is slipping away for a deal. Both Aussie and Kiwi are softer this morning as traders continue to focus on the interest rate story. Both nations have essentially promised to maintain their current interest rate regimes for at least the next year and so as the Fed continues raising rates, that interest rate differential keeps moving in the USD’s favor. It is easy to see these two currencies continuing their decline going forward.

In the emerging markets, Turkish inflation data was released at a horrific 24.5% in September, much higher than even the most bearish forecast, and TRY has fallen another 1.2% on the back of the news. Away from that, the only other currency with a significant decline is INR, which has fallen 0.65% after a large non-bank lender, IL&FS, had its entire board and management team replaced by the government as it struggles to manage its >$12 billion of debt. But away from those two, there has been only modest movement seen in the currency space.

One of the interesting things that is ongoing right now is the fact that crude oil prices have been rallying alongside the dollar’s rebound. Historically, this is an inverse relationship and given the pressure that so many emerging market economies have felt from the rising dollar already, for those that are energy importers, this pain is now being doubled. If this process continues, look for even more anxiety in some sectors and further pressure on a series of EMG currencies, particularly EEMEA, where they are net oil importers.

Keeping all this in mind, it appears that today is shaping up to be a day of consolidation, where without some significant new news, the dollar will remain in its recent trading range as we all wait for Friday’s NFP data. Speaking of data, this morning brings ADP Employment (exp 185K) and ISM Non-Manufacturing (58.0), along with speeches by Fed members Lael Brainerd, Loretta Mester and Chairman Powell again. However, there is no evidence that the Fed is prepared to change its tune. Overall, it doesn’t appear that US news is likely to move markets. So unless something changes with either Brexit or Italy, I expect a pretty dull day.

Good luck
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Compromising

It cannot be very surprising
That Canada is compromising
Their views about trade
Thus now they have made
A deal markets find stabilizing

This morning, as the fourth quarter begins, arguably the biggest story is that Canada and the US have agreed terms to the trade pact designed to replace NAFTA. Canada held out to the last possible moment, but in the end, it was always clear that they are far too reliant on trade with the US to actually allow NAFTA to disintegrate without a replacement. The upshot is that there will be a new pact, awkwardly named the US-Mexico-Canada Agreement (USMCA) which is expected to be ratified by both Canada and Mexico quite easily, but must still run the gauntlet of the US Congress. In the end, it would be shocking if the US did not ratify this treaty, and I expect it will be completed with current estimates that it will be signed early next year. The market impact is entirely predictable and consistent with the obvious benefits that will accrue to both Canada and Mexico; namely both of those currencies have rallied sharply this morning with each higher by approximately 0.9%. I expect that both of these currencies will maintain a stronger tone vs. the dollar than others as the ending of trade concerns here will be a definite positive.

There is another trade related story this morning, although it does not entail a new trade pact. Rather, Chinese PMI data was released over the weekend with both the official number (50.8) and the Caixin small business number (50.0) falling far more sharply than expected. The implication is that the trade situation is beginning to have a real impact on the Chinese economy. This puts the Chinese government and the PBOC (no hint of independent central banking here) in a difficult position.

Much of China’s recent growth has been fueled by significant increases in leverage. Last year, the PBOC unveiled a campaign to seek to reduce this leverage, changing regulations and even beginning to tighten monetary policy. But now they are caught between a desire to add stability to the system by reducing leverage further (needing to tighten monetary policy); and a desire to address a slowing domestic economy starting to feel the pinch of the trade war with the US (needing to loosen monetary policy). It is abundantly clear that they will loosen policy further as the political imperative is to insure that GDP growth does not slow too rapidly during President Xi’s reign. The problem with this choice is that it will build up further instabilities in the economy with almost certain future problems in store. Of course, there is no way to know when these problems will manifest themselves, and so they will likely not receive much attention until such time as they explode. A perfect analogy would be the sub-prime mortgage crisis here ten years ago, where leading up to the collapse; every official described the potential problem as too small to matter. We all know how that worked out! At any rate, while the CNY has barely moved this morning, and in fact has remained remarkably stable since the PBOC stepped in six weeks ago to halt its weakening trend, it only makes sense that they will allow it to fall further as a pressure release valve for the economy.

Away from those two stories though, the FX market has been fairly dull. PMI data throughout the Eurozone was softer than expected, but not hugely so, and even though there are ongoing questions about the Italian budget situation, the euro is essentially unchanged this morning. In the past week, the single currency is down just under 2%, but my feeling is we will need to see something new to push us away from the 1.16 level, either a break in the Italy story or some new data or comments to alter views. The next big data print is Friday’s payroll report, but I expect we might learn a few things before then.

In the UK, while the Brexit deadline swiftly approaches, all eyes are now focused on the Tory party conference this week to see if there is a leadership challenge to PM May. Given that the PM’s ‘Chequers’ proposal has been dismissed by both the EU and half the Tory party, it seems they will need to find another way to move forward. While the best guess remains there will be some sort of fudge agreed to before the date, I am growing more concerned that the UK is going to exit with no deal in place. If that is what happens, the pound will be much lower in six-months’ time. But for today, UK Manufacturing PMI data was actually a surprising positive, rising to 53.8, and so the signals from the UK economy continue to be that it is not yet collapsing.

Away from those stories, though, I am hard pressed to find new and exciting news. As this is the first week of the month, there is a raft of data coming our way.

Today ISM Manufacturing 60.1
  ISM Prices Paid 71.0
  Construction Spending 0.4%
Wednesday ADP Employment 185K
  ISM Non-Manufacturing 58.0
Thursday Initial Claims 213K
  Factory Orders 2.0%
Friday Nonfarm Payroll 185K
  Private Payroll 183K
  Manufacturing Payroll 11K
  Unemployment Rate 3.8%
  Average Hourly Earnings 0.3% (2.8% Y/Y)
  Average Weekly Hours 34.5
  Trade Balance -$53.5B

On top of the payroll data, we hear from eight Fed speakers this week, including more comments from Chairman Powell tomorrow. At this point, however, there is no reason to believe that anything is going to change. The Fed remains in tightening mode and will raise rates again in December. The rest of the world continues to lag the US with respect to growth, and trade issues are likely to remain top of mind. While the USMCA is definitely a positive, its benefits will only accrue to Mexico and Canada as far as the currency markets are concerned. We will need to see some significant changes in the data stream or the commentary in order to alter the dollar’s trend. Until then, the dollar should maintain an underlying strong tone.

Good luck
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Realistic

As far as the market’s concerned
The mood out of Brussels has turned
They’re quite optimistic
A deal is “realistic”
By early November, we’ve learned

Michel Barnier, the EU negotiator for Brexit has lately changed his tune. Last month, ostensibly at the direction of his political masters, he was playing hardball, shooting down every UK proposal as inadequate and saying there was no negotiating room on the EU’s positions. Not surprisingly, the pound came under pressure during this period, trading to its lowest level in more than a year and approaching the post-vote lows. But a funny thing happened during the past week, Europe suddenly figured out they didn’t really want a no-deal Brexit. The first inkling came from comments by German officials who indicated that compromises were available. That changed the tone of the negotiations and suddenly, as I mentioned last week, it seemed that a deal was more likely. Those comments last week helped the pound rally more than 1%. Then yesterday morning Barnier explained that a deal is both “realistic” and “possible” within 6-8 weeks. It should be no surprise that the pound rallied yet again on the news, jumping another 1% during the US session and maintaining those gains ever since.

Regular readers will know that I have been quite bearish on the pound for two reasons; first is the fact that I continue to see the dollar strengthening over the medium term as the Fed’s tighter monetary policy leads all developed nations and will continue to do so. But the other reason was that I have been quite skeptical that a Brexit deal would be agreed and that the initial concern over damage to the UK economy would undermine the currency. However, this change in tone by the EU over Brexit is almost certainly going to have a significant positive impact on the pound’s value vs. both the euro and the dollar. And even though any deal is likely to be short on details, I expect that we will see the pound outperform the euro for the next several months at least. So any dollar strength will be less reflected vs. the pound than the euro, while any dollar weakness should see the pound as the top performer. The thing is, the details of the deal still matter a great deal, and at some point in the future, the UK and the EU are going to need to figure out how they are going to deal with the Irish border situation, even if they have kicked that particular can further down the road for now.

While on the topic of the UK, I would be remiss if I didn’t mention that the employment situation there remains robust. Unemployment data was released this morning showing the Unemployment Rate remained at 4.0%, the lowest level since 1975, while wage growth accelerated to 2.9%. The latter potentially presages further inflation, as measured productivity in the UK remains quite soft at 1.5% per annum. If this continues, higher wages amid low productivity, the BOE may find itself forced to raise rates regardless of the Brexit situation. Yet another positive for the beleaguered pound. Perhaps the bottom is in after all.

However, away from yesterday’s news on the pound, the FX markets have been quite uninteresting in the past twenty-four hours. Arguably, the dollar is a touch stronger, but the movement has been minute. Even the emerging market bloc has been less active with perhaps the most notable feature the fact that INR continues to trade to new historic lows (dollar highs) every day. As to the group of currencies that has led the turmoil, TRY, ARS and ZAR, all of them are slightly firmer this morning as they continue to consolidate their losses over the past month. In addition, we hear from the central banks of both Argentina (today) and Turkey (tomorrow), with more attention focused on the latter than the former. Recall that Argentine interest rates are already the world’s highest at 60% and no move is anticipated. However, Turkey’s meeting is anxiously awaited as the market is looking for a 300bp rate hike to help stem rising inflation and the currency’s weakness. The problem is that Turkish President Erdogan has been quite adamant that he is strongly against higher interest rates and given his apparent control over the central bank, it is by no means assured that they will act according to the market’s expectations. Be prepared for another leg lower in the lira if the Bank of Turkey disappoints.

As to today’s session, the NFIB Small Business Index was released at 108.8, stronger than expected and a new record high for the release. Despite the trade concerns and the political circus in Washington, small businesses have never been more confident in their future. I will admit that this almost seems like whistling past the graveyard, but for now everything is great. Later this morning we see the JOLTs Job report (exp 6.68M), which should simply reconfirm that the employment situation in the US remains robust.

And that’s really it for today. Equity futures are flat although the 10-year Treasury is continuing its recent trend lower (higher yields), albeit at a slow rate. There is certainly no evidence that the Fed is going to change its path, but for today, it seems unlikely that we will see much movement in either direction beyond what has already occurred. Barring, of course, any surprising new comments.

Good luck
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Soared Like a Jet

On Friday the jobs report showed
More money, to more people flowed
Earnings per hour
Has gained firepower
So interest rate hikes won’t be slowed

The market response, though, was bleak
With equity prices quite weak
However the buck
Had much better luck
And soared like a jet, so to speak

As the week begins, we have seen the dollar cede some of the gains it made in Friday’s session. That move was a direct result of the payroll data, where not only did NFP beat expectations at 201K, but the Average Hourly Earnings number printed at 0.4% for the month and 2.9% annualized. That result was the fastest pace of wage growth since 2009 and significantly higher than the market anticipated. It should be no surprise that the market response was higher interest rates and a concurrently stronger dollar. Overall, the dollar was higher by a solid 0.5% and 10-year Treasury yields jumped 5bps on the day.

Wage growth has been the key missing ingredient from the economic data for the past several years as economists continue to try to figure out why record low unemployment has not been able to drive wages higher. The Fed reaction function has always been predicated on the idea that once unemployment declines past NAIRU (Non-accelerating inflation rate of unemployment), more frequently known as the natural rate of unemployment, that wages will rise based on increased demand for a shrinking supply of workers. Yet the Fed’s models have been unable to explain the situation this cycle, where unemployment has fallen to 50 year lows without the expected wage inflation. And of course, the one thing every politician wants (and Fed members are clearly politicians regardless of what they say) is for the population to make more money. So, if Friday’s data is an indication that wage growth is finally starting to pick up, it will encourage Powell and friends to continue hiking rates.

This was made clear on Friday by Boston Fed President Eric Rosengren, who had been a reliable dovish voice for a long time, when he explained to the WSJ that the Fed’s current pace of quarterly rate hikes was clearly appropriate and that there need to be at least four more before they start to consider any policy changes. There was no discussion of inverting the yield curve, nor did he speak about the trade situation. It should not be surprising that the Fed Funds futures market responded by bidding up the probability of a December rate hike to 81% with the September hike already a virtual certainty.

But that was then and this is now. This morning has seen a much less exciting session with the dollar edging slightly lower overall, although still showing strength against its emerging market counterparts. Looking at the G10, the picture is mixed, with the euro and pound both firmer by 0.15% or so. The former looks to be a trading response to Friday’s decline, while the latter is benefitting, ever so slightly, from better than expected GDP data with July’s print at 0.3% and the 3-month rate at 0.6%. We’ve also seen AUD rally 0.25%, as firmer commodity prices seem to be underpinning the currency today. However, both CHF and JPY are softer this morning, with the Swiss franc the weakest of the bunch, down 0.65%.

In the EMG space, however, the picture is quite different, with INR making yet another new historic low as the market continues to respond to Friday’s worse than expected current account deficit. The rupee has fallen a further 0.85% on the day. We’ve also seen weakness in CNY (-0.25%), RUB (-0.45%) and MXN (-0.2%). But some of the biggest decliners of recent vintage, TRY and ZAR, have rebounded from their worst levels, although they are still off significantly this year.

Looking ahead to this week, the data is fairly light with just CPI and Retail Sales in the back half of the week, although we also get the Fed’s Beige Book on Wednesday.

Tuesday NFIB Business Optimism 108.2
  JOLT’s Job Openings 6.68M
Wednesday PPI 0.2% (3.2% Y/Y)
  -ex food & energy 0.2% (2.8% Y/Y)
  Beige Book  
Thursday Initial Claims 210K
  CPI 0.3% (2.8% (Y/Y)
  -ex food & energy 0.2% (2.4% Y/Y)
Friday Retail Sales 0.4%
  -ex autos 0.5%
  IP 0.3%
  Capacity Utilization 78.4%
  Michigan Sentiment 96.9

There are also a number of Fed speakers this week, but I have to say that it seems increasingly unlikely that there will be any new views coming from them. The doves have already made their case, and the hawks continue to be in the ascendancy.

Net, I see no reason to believe that anything in the market has really changed for now. Rate expectations remain for higher US rates, and growth elsewhere continues to be okay but not great. Ultimately, things still point to a higher dollar in my view. Not forever, but for now.

Good luck
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