Under Stress

The week that just passed was a mess
With both bulls and bears under stress
As equities fell
Most bonds performed well
And dollars? A roaring success

Pundits have been searching for adjectives to describe the week that is ending today. Tumultuous strikes me as an accurate reflection, but then stormy, tempestuous and volatile all work as well. In the end though, the broad trends have not changed at all. Equities continue to retreat from their mid-summer highs, bonds continue to rally sharply while yield curves around the world flatten and the dollar continues to march higher.

So what is driving all this volatility? It seems the bulk of the blame is laid at the feet of President Trump as his flipping and flopping on trade policy have left investors and traders completely confused. After all, late last week he declared tariffs would be imposed on the rest of Chinese imports not already subject to them, then after market declines he decided that a portion of those tariffs would be delayed from September until December. But then the Chinese struck back saying they would retaliate and now the President has highlighted he will be speaking directly with President Xi quite soon. On the one hand, it is easy to see given the numerous changes in stance, why markets have been so volatile. However, it beggars belief that a complex negotiation like this could possibly be completed on any short timeline, and almost by definition will take many more months, if not years. There is certainly no indication that either side is ready to capitulate on any of the outstanding issues. So the real question is, why are markets responding to every single tweet or comment? To quote William Shakespeare, “It is a tale told by an idiot, full of sound and fury signifying nothing.” Alas, there is every indication that this investor and trader behavior is going to continue for a while yet.

This morning we are back in happy mode, with the idea that the Presidents, Trump and Xi, are going to speak soon deemed a market positive. Equity markets around the world are higher (DAX +1.0%, CAC +1.0%, Nikkei +0.5%); bond markets have been a bit more mixed with Treasuries (+2bps) and Gilts (+4.5bps) selling off a bit but we continue to see Bunds (-1.5bps) rally. In fact we are at new all-time lows for Bund yields with the 10-year now yielding -0.73%!

As to the dollar, it is still in favor, with only the pound showing any real life in the G10 space, having rallied 0.65% this morning with the market continuing to be impressed with yesterday’s Retail Sales data there. In fact, if we look over the past week, the pound is the only G10 currency to outperform the dollar, having rallied more than 1.0%. On the flip side, the Skandies are this week’s biggest losers with both SEK and NOK down by 1.35% closely followed by the euro’s 1.1% decline, of which 0.3% has happened overnight.

The FX market continues to track the newest thoughts regarding relative central bank policy changes and that is clearly driving the euro. For example, yesterday, St Louis Fed President Bullard, likely the most dovish FOMC member (although Kashkari gives him a run), sounded almost reticent to continue cutting rates, and ruled out the idea that an intermeeting cut was necessary. While he supported the July cut, and will likely vote for September, he again ruled out 50bps and didn’t sound like more made sense. At the same time, Finnish central bank president Ollie Rehn, a key ECB member, explained that come September, the ECB would act very aggressively in order to get the most bang for the buck (euro?). The indication was not only will they cut rates, and possibly more than the 10bps expected, but QE would be restarted and expanded, and he did not rule out movement into other products (equities anyone?) as well. In the end, the market sees that the ECB is going to basically do everything else they can right away as they watch the Eurozone economy sink into recession. Meanwhile, most US data continues to point to a much more robust growth situation.

Let’s look at yesterday’s US data where Retail Sales were very strong (0.7%, 1.0% ex autos) and Productivity, Empire Manufacturing and Philly Fed all beat expectations. Of course, confusingly, IP was a weaker than expected -0.2% and Capacity Utilization fell to 77.5%. Adding to the overall confusion is this morning’s Housing data where Starts fell to 1191K although Permits rose to 1336K. In the end, there is more data that is better than worse which helps explain the 2.1% growth trajectory in the US, which compares quite favorably with the 0.8% GDP trajectory on the continent. As long as this remains the case, look for the dollar to continue to outperform.

Oh and one more thing, given the problems in the Eurozone, do you really believe the EU will sit by and watch the UK exit without changing their tune? Me either!

Next week brings the Fed’s Jackson Hole symposium and key speeches, notably by Chairman Powell. As to today, there is no reason to expect the dollar to do anything but continue its gradual appreciation.

Good luck and good weekend
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Fears Have Been Slaked

For several days markets have quaked
As muck about trade has been raked
But Wednesday’s retracement
And China’s emplacement
Of yuan means some fears have been slaked

Yesterday was a session for those with strong stomachs. Equities plummeted (DJIA -589) early as did bond yields (10-year Treasury yields fell to 1.59%) with both markets pointing to an imminent recession. But then, as sometimes happens, things turned around inexplicably. There was no data to drive the change, as there was really no data yesterday. The only Fed comments were from Chicago’s Evans, a known dove, who said that the recent escalation in trade tensions could well warrant further rate cuts. But we already knew that and had heard it on Tuesday from two other Fed speakers.

However, the fear that was rampant at the opening (gold exploded through $1500/oz, USDJPY traded below 105.50) just as quickly dissipated and through the rest of the session, equities rallied back to flat, Treasury prices fell such that yields actually closed the day higher than the day before, and both the dollar and yen reversed early gains and settled slightly lower on the day. Gold, however, maintained most of its gains.

Price action like that, which can be quite unsettling, tends to be indicative of a great deal of uncertainty in markets. In fact, that is what markets do best, with bulls and bears fighting it out for supremacy. But the ultimate conclusion has to be that recent market trends are being questioned. As I wrote yesterday, and has been widely mentioned elsewhere as well, there is a fundamental difference of opinion between the stock and bond markets, where bonds investors see a much gloomier economic future than stock investors. In fact, it is fair to say, that stock investors are so fixated on the potential benefits of lower interest rates that they seem to be forgetting why those lower rates are being contemplated, slowing growth. At some point, this conundrum will be resolved, either as Treasury yields rebound amid stronger growth indications, or with lower stock prices as the economic data defines a worse economic situation than currently expected. While my view, alas, remains the latter is more likely, it is still an open question as to how things play out.

The end result, however, is that as I have written frequently in the past, volatility in markets is going to be with us for some time to come. Today, though, it is not as evident as it was yesterday. Equity markets around the world have shown modest gains, generally on the order of 0.5%, while bond prices have been fairly stable along with the dollar. In fact, the dollar has done very little overall.

There has been much made of the fact that the PBOC fixed USDCNY at 7.0039, above the 7.00 level and its weakest fix since 2008. However, market expectations were for a fix at an even higher level, ~7.0130, so despite the optics on the surface, this was seen as an attempt to mitigate the recent anxiety. Ultimately, the PBOC is likely to allow a very gradual depreciation of the yuan going forward as they find themselves caught between competing problems. On the one hand, slowing growth indicates the need for a weaker yuan to help support exporters. However, the flip side is that the huge increase in USD borrowings by Chinese companies, especially in the local property sector, means that a weaker yuan will crimp their ability to service and repay that debt, potentially leading to larger systemic issues. Clearly the PBOC wants to avoid anything like that, so slow and steady seems the most likely outcome.

And in fact, that is probably what we are going to see in a number of currencies as the impacts of the growing trade conflict widens around the world. The dollar will continue to be a key destination for investment as long as the US economy, even if it is slowing somewhat, remains stronger than economies elsewhere. Yesterday we saw the aggressive actions of three Asian central banks, and last night the Philippines cut rates by 25bps as well. Markets are pricing in cuts pretty much everywhere in the world so the fact that the Fed is likely to produce at least two more cuts is hardly a reason to avoid the dollar. In fact, US rates continue to trade above every other developed market rate and, as such, remain attractive to foreign investors. There is no evidence that situation will change in the near-term, and so support for the dollar is likely to remain firm.

A quick look at today’s price action shows what I would describe as consolidation of recent moves. Looking across the board, the dollar has had a strong week against most currencies. The two exceptions have been the yen, which has rallied 1.25% on increased market fears, and the euro, which surprisingly has rallied about 1.0% this week. But otherwise, the dollar has been ascendant vs. virtually everything else. As long as economic uncertainty remains the driving force in markets, and that seems like a pretty good bet, the dollar should continue to perform well.

On the data front, the only thing to be released is Initial Claims (exp 215K) and there are no Fed speakers on the calendar. That implies that the FX market will take its cues from elsewhere, with equities the leading candidate. In the current framework, stronger equities means less risk and less reason to hold dollars, so given Europe’s modest rebound and US futures pointing higher, that seems like a reasonable expectation for today, a modestly softer buck.

Good luck
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Shocked and Surprised

Delivering just twenty-five
Did not satisfy Donald’s drive
To boost US growth
So he made an oath
That tariffs he’d quickly revive

Investors were shocked and surprised
As trade talks had seemed civilized
Thus stocks quickly fell
And yields did as well
Seems risk assets are now despised

Just when you thought it was safe to go back in the water…

Obviously, the big news yesterday was President Trump’s decision to impose a 10% tariff on the remaining $300 billion of Chinese imports starting September 1st. Arguably, this was driven by two things; first was the fact that he has been increasingly frustrated with the Chinese slow-walking the trade discussions and wants to push that along faster. Second is he realizes that if he escalates the trade threats, the Fed may be forced to cut rates further and more quickly. After all, one of their stated reasons for cutting rates Wednesday was the uncertainty over global growth and trade. That situation just got more uncertain. So in President Trump’s calculation, he addresses two key issues with one action.

Not surprisingly, given the shocking nature of the move, something that not a single analyst had been forecasting, there was a significant market reaction. Risk was quickly jettisoned as US equity markets turned around and fell 1% on the day after having been higher by a similar amount in the morning. Asian equity markets saw falls of between 1.5% and 2.0% and Europe is being hit even harder, with a number of markets (DAX, CAC) down more than 2.5%. But even more impressive was the decline in Treasury yields, which saw a 12bp fall in the 10-year and a 14bp fall in the 2-year. Those are the largest single day declines since May 2018, and the 10-year is now at its lowest level since October 2016. Of course, it wasn’t just Treasuries that rallied. Bund yields fell to a new record low of -0.498%, and we have seen similar declines throughout the developed markets. For example, Swiss 10-year yields are now -0.90%, having fallen 9bps and are the lowest in the world by far! In fact, the entire Swiss government yield curve is negative!

And in the FX market, haven number one, JPY rallied sharply. After weakening early in the session, it rebounded 1.7% yesterday and is stronger by a further 0.5% this morning. This has taken the yen back to its strongest level since April last year. Not surprisingly the Swiss franc saw similar price action and is now more than 1.0% stronger than yesterday. However, those are not the only currencies that saw movement, not by a long shot. For example, CNY has fallen 0.9% since the announcement and is now within spitting distance of the key 7.00 level. Significant concern remains in the market about that level as the last time the renminbi was that weak, it led to significant capital outflows and forced the PBOC to adjust policy and impose restrictions. However, there are many analysts who believe it is seen as less of a concern right now, and of course, a weaker renminbi will help offset the impact of US tariffs.

Commodity prices were also jolted, with oil tumbling 7% and oil related currencies feeling the brunt of that move. For example, RUB is lower by 1.2% this morning after a 0.5% fall yesterday. MXN is lower by a further 0.3% this morning after a 0.6% decline yesterday and even NOK, despite its G10 status, is lower by 1.0% since the tariff story hit the tape. In fact, looking at the broad dollar, it is actually little changed as there has been significant movement in both directions as traders and investors adjust their risk profiles.

With that as a prelude, we get one more key piece of data this morning, the payroll report. Current expectations are as follows:

Nonfarm Payrolls 164K
Private Payrolls 160K
Manufacturing Payrolls 5K
Unemployment Rate 3.6%
Average Hourly Earnings 0.2% (3.1% Y/Y)
Average Weekly Hours 34.4
Trade Balance -$54.6B
Michigan Sentiment 90.3

You can see the bind in which the Fed finds itself. The employment situation remains quite robust, with the Unemployment Rate expected to tick back to 50-year lows and steady growth in employment. This is hardly a classic set of statistics to drive a rate cut. But with the escalation of the trade situation, something they specifically highlighted on Wednesday, they are going to need to address that or lose even more credibility (although it’s not clear how much they have left to lose!) In a funny way, I would wager that Chairman Powell is secretly rooting for a weak number this morning which would allow further justification for rate cuts and correspondingly allow him to save some face.

In the end, the key to remember is that markets are beholden to many different forces with the data merely one of those, and increasingly a less and less important one. While historically, the US has generally allowed most market activity without interference, there has clearly been a change of heart since President Trump’s election. His increased focus on both the stock market and the dollar are something new, and we still don’t know the extent of the impact this will have over time. While volatility overall has been relatively low, it appears that is set to change with this increased focus. Hedgers keep that in mind as programs are implemented. All of this untested monetary policy is almost certainly building up problems for the future, and those problems will not be easily addressed by the central banks. So, my sense is that we could see a lot more volatility ahead.

In the meantime, today has the sense of a ‘bad news is good’ for stocks and vice versa as equity investors will be looking for confirmation that more rate cuts are on the way. As to the dollar, bad news will be bad!

Good luck and good weekend
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10%’s Not Enough

Said Trump, 10%’s not enough
It’s time that we really get tough
So starting next week
A quarter we’ll seek
Believe me, this ain’t just a bluff

If there was any question as to whether or not markets had fully priced in a successful conclusion of the US-China trade talks, last night’s price action should have answered it in full. President Trump is clearly feeling his oats, as his approval rating rises alongside the stock market and the economy, and so he changed the landscape once again. With Chinese Vice-premier Liu He, the chief negotiator in the trade talks, scheduled to arrive in the US later this week to continue, and in the market’s view conclude, those discussions, the President, last night, threatened to increase tariffs on $200 billion of goods to 25% from the current 10%, and to impose 25% tariffs on another $325 billion of goods, which is essentially everything else the US imports from China. In a heartbeat, views changed from rainbows and unicorns to Armageddon. Equity markets around the world plunged, commodity prices tumbled and the dollar and yen both rallied. Interestingly, Treasury prices have not moved much yet, although with the UK and Japan on holiday, overseas Treasury markets are extremely thin, so it could be there just hasn’t been any trading. Of course, it also could be that Treasury prices had already incorporated a less rosy future than equity markets, and so have less need to adjust.

One of the most common themes espoused lately has been the remarkable decline in asset price volatility this year, with measures in equities, bonds and currencies all pushing to cyclical lows. While there is a contingent of analysts (present company included) who believes that this is the calm before the storm, it is also true that market activity has been unidirectional since January, with that direction higher.

With respect to volatility, nothing has yet changed regarding the view that volatility increases when prices fall in both equity and bond markets although the relationship between volatility and the dollar is far less structured. In fact, there has been a significant increase in the amount of short volatility bets being made in the market, similar to the situation we saw at the beginning of 2018. Of course, I’m sure we all remember the disintegration of the XIV ETF (really it was an ETN), when a spike in volatility reduced its value by more than 85% in two days. Well, currently, records show that there is an even larger short volatility position now than there was last February when things went pear-shaped. The point is it is worthwhile to be careful in the current environment.

As to the dollar, historically volatility has increased in both rising and declining dollar environments depending on the circumstances. Given the dollar’s overall strength lately has been accompanies by a decline in volatility, it seems a fair bet to assume that if the dollar were to reverse lower, it would do so in a volatile manner rather than as a steady adjustment. Remember, too, currencies tend to overshoot when large moves occur. However, at this point, I would expect that fear in other markets will continue to support the dollar, and hence keep volatility at bay.

A recap of price movement overnight shows that the Shanghai Composite fell 5.5% and the Hang Seng fell 2.9% (the Nikkei was closed). Europe is currently trading with both the DAX and CAC falling 2.0% (FTSE is also closed) and US futures are pointing to nearly 2.0% losses on the open as well.

Meanwhile, the dollar is broadly higher. It has rallied 0.5% vs. the pound, offsetting a large part of Friday’s GBP rally that was based on the rumor PM May and Labour leader Corbyn were soon going to announce agreement on a Brexit deal. While nothing has come of it yet, that does explain the pound’s sharp Friday movement. AUD and NZD are both lower by 0.5% as the market looks to this evening’s RBA meeting with a 50% probability of a rate cut priced and the belief that the RBNZ will need to match that tomorrow if it occurs. Aussie is back below 0.70, and my sense is it has further to fall, especially if the trade situation deteriorates. Elsewhere in the G10, the euro is little changed after slightly better than expected PMI data seems to have been enough to offset trade concerns. And finally, the yen, as would be expected of a haven asset, is higher by 0.25%.

Versus emerging market currencies, the dollar has had an even stronger performance. It should be no surprise that CNY has fallen sharply (-0.75%) especially since the PBOC cut the RRR for small and medium sized banks by another 1.0% in an effort to stabilize markets. Elsewhere in Asia both INR and KRW fell 0.65% with other currencies having a slightly less negative result. EEMEA has seen ZAR fall 1.0% and TRY -1.20% although the latter has more to do with the possibility that the recent election in Istanbul, where President Erdogan’s party lost, would be overturned and a new one held thus undermining the concept of democracy in Turkey even further. Finally, LATAM markets are waking up under modest pressure, but have not yet fallen sharply.

Turning to this week’s data, there is not much overall, but we do see CPI data Friday.

Tuesday JOLTs Job Openings 7.24M
Thursday Initial Claims 220K
  Trade Balance -$50.2B
  PPI 0.2% (2.3% Y/Y)
  -ex food & energy 0.2% (2.5% Y/Y)
Friday CPI 0.4% (2.1% Y/Y)
  -ex food & energy 0.2% (2.1% Y/Y)

We also will hear a lot of Fed speaking, with eleven speeches from eight different FOMC members including Chairman Powell on Thursday. This week’s talks could well be market moving as last week’s press conference was not as smooth as it might have been. Look for lots of nuance as to what the Fed is looking at and why they think it is appropriate to be patient. As of now, it doesn’t seem that there is any leaning toward an “insurance” rate cut in the near term, but, especially if Friday’s CPI data is softer than expected, that theme could well change. As such, for now, I don’t see a good policy reason for the dollar to retreat, and if the trade situation deteriorates, it should help the buck, but given the mercurial dynamics of the President’s negotiating tactics, I wouldn’t rule out a complete reversal of things before long.

Good luck
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