The Result Europe’s Fearing

The dollar, like art and fine wine
Continues, its peers, to outshine
Like Veblen explained
The more it has gained
The more buyers want to say, “Mine!”

Has the dollar become a Veblen Good? Given its recent performance and the underlying drivers of dollar strength, it certainly seems to behave like one, even if the rationale behind the dollar demand is not quite what Thorstein Veblen imagined in 1899. For those unfamiliar with the term, a Veblen Good is one where demand increases as its price rises, completely opposite to most items. It was defined by Dr Veblen in his 1899 book; The Theory of the Leisure Class, explaining that certain items saw increased demand based on the idea of exclusivity, thus the higher the price the more demand shown.

Now, the dollar is certainly not a rare item given the trillions of them that are currently circulating around the globe. Yet the price of dollars, at least in terms of other currencies, continues to climb despite the numerous studies that demonstrate it is overvalued at current levels. This behavior leads to the question of why, if the dollar is so overvalued, is demand increasing? At this point it seems pretty clear that the rationale is twofold. First is the fact that the financial markets definition of a safe haven begins with US Treasury paper and to buy Treasuries one needs to first buy dollars. So in the current environment, where uncertainty over trade policy, politics and Brexit are constant headlines, havens are in great demand. In fact, the more concern there is, the more demand regardless of the price of the dollar. The second issue is that because the dollar is the funding currency of choice globally, given the deepest and most liquid capital markets exist in the US, there has been a significant amount of issuance by non-US entities, both companies and foreign governments, in USD. As the dollar rises, these borrowers are forced to scramble to obtain as many dollars as they can in order to repay their loans. This simply adds to the demand for dollars, actually increasing that demand the higher the price of the buck. In the end, almost regardless of the relative interest rate structures in different countries, the dollar is destined, for now, to continue rising. Hedgers need to keep that in mind.

In England a showdown is nearing
Which Brexiteers are loudly cheering
By later today
If Boris holds sway
Look for the result Europe’s fearing

In more specific news, the pound has plumbed new depths for the move, trading below 1.20 for the first time since the flash crash in October 2016, as Parliament returns from their summer holiday. Bremainers are trying to pass legislation that takes the Brexit decision out of PM Johnson’s hands and requires a deal to be in place before leaving. Meanwhile, Boris is adamant that he has to have the ability to ‘threaten’ a no-deal in order to win any concessions. In fact, Johnson has said he will call for an election on October 14 if the legislation passes. This would prevent any further parliamentary activity, although negotiations would be ongoing.

Of course, one of the market’s key concerns is an election could wind up with a PM Jeremy Corbyn, the socialist leader of the Labour party , and someone greatly feared by financial markets given his stated desire to nationalize entire swathes of the economy. At this point, there appear to be three possible outcomes; Boris stays in power and despite best efforts oversees a no-deal Brexit; an election where Corbyn becomes the new PM; or the EU caves on the Irish backstop and a deal is verbalized so the hard edges are removed. Arguably in either of the first two situations the pound has further to fall, while clearly the last situation will result in a sharp rebound of the pound, and the euro. My money remains on a deal as the EU cannot look at their economic situation and believe they can withstand the stress of a hard Brexit right now. Consider this, if the EU holds firm and the economy suffers greatly, politicians throughout the EU will find themselves under huge pressure, and likely many will lose their next elections, because of this decision. And that is probably the only thing about which politicians really care.

So with that as a backdrop, what else do we have to look forward to this week? The China trade talks have still not even agreed on a date, so that remains on the back burner for now, although every day without some concrete positive news indicates a longer and longer time before anything positive can happen. Meanwhile, new tariffs were imposed on $115 billion of Chinese imports starting Sunday. Hong Kong is still simmering with the Chinese claiming they can invoke emergency powers (read martial law) if necessary. Argentina is on the cusp, having imposed very strict capital controls last Friday to try to husband whatever hard currency they still have. And sentiment around the world continues to move toward a recessionary outcome.

Looking ahead to this week, there is much Fedspeak and some quite important data, culminating in the payroll report on Friday.

Today ISM Manufacturing 51.3
  ISM Prices Paid 46.8
  Construction Spending 0.3%
Wednesday Trade Balance -$53.4B
  Fed’s Beige Book  
Thursday ADP Employment 149K
  Initial Claims 215K
  Nonfarm Productivity 2.2%
  Unit Labor Costs 2.4%
  Factory Orders 1.0%
  Durable Goods 2.1%
  -ex Transport -0.4%
  Ism Non-Manufacturing 54.0
Friday Nonfarm Payrolls 160K
  Private Payrolls 150K
  Manufacturing Payrolls 5K
  Unemployment Rate 3.7%
  Average Hourly Earnings 0.3% (3.0% Y/Y)
  Average Weekly Hours 34.4

So obviously, everyone will be waiting for Friday’s payroll report, but before then we hear from five speakers and Chairman Powell speaks Friday at 12:30pm.

The RBA left rates on hold last night, as expected but further cuts are coming, especially as China’s economy slows further. That said, AUD is the top G10 performer overnight. Meanwhile, the other piece of positive news we saw was South African GDP rising at 3.1% in Q2, much better than expected and enough to help the rand rally 0.7%. Other than those two pieces of news though, it has really been all about Brexit and the pound. For now, that makes sense as the market awaits the outcome of this afternoon’s parliamentary vote. Until then, risk is under pressure and havens will likely perform well.

Good luck