Times of Trouble

In times of trouble
The yen continues to be
Mighty like an oak

Pop quiz! What percentage of the workforce is working at their primary site vs. home or an alternate site? Please respond with where you’re working and your guesstimates. Will publish results of this (completely unscientific) survey on Monday, March 16.

As markets around the world continue to melt down, investors everywhere are looking for a haven to retain capital. For the past 100 years, US Treasuries have been the number one destination in markets. Interestingly, the past two days saw Treasuries sell off aggressively. I think the move was initially based on the relief rally seen on Tuesday, but at this point, the fact that Treasury prices fell alongside yesterday’s stock rout can only be explained by the idea that institutions that need cash are selling the only liquid assets they have, and Treasuries remain quite liquid. And to be clear, 10-year yields are lower by 18bps this morning as that bout of selling seems to have passed and the haven demand has returned in spades.

But since the financial crisis, the second most powerful haven asset has been the Japanese yen. Despite the fact that the nation has basically been in an economic funk for two decades, it continues to run a significant current account surplus. As a consequence, Japanese external investment is huge and when fear is in the air, that money comes running back home. The evolution of the coronavirus spread can be seen in the yen’s movement as in the middle of February, when Japan itself was dealing with the growth in infections, the yen weakened to a point not seen in nearly a year. Since then, however, the yen has strengthened 7.5% (with a peak gain of 9.8% seen Monday) as flows have been decidedly one way. This morning the yen has appreciated 0.7% from yesterday’s close and quite frankly, until the pandemic starts to ebb, I see no reason for it to stop appreciating. Par will pose a short-term psychological support for the dollar, but if this goes on for another two months, 95 is in the cards. With that in mind, though, for all yen receivables hedgers, zero premium collars are looking awfully good here. Let’s talk, at the very least you should be apprised of the pricing.

Interestingly, the Swiss franc has had a somewhat less impressive performance despite its historic haven characteristics. While it has appreciated 4.5% in the same time frame, it has been having much more trouble during the latest equity market decline. And I think that is the reason why. Famously, the Swiss National Bank has 20% of its balance sheet invested in individual equities. This is a very different investment philosophy than virtually every other central bank. The genesis of this came about when the SNB was intervening on a daily basis while trying to cap the franc and ultimately needed a place to put the dollars and euros they were buying. I guess the view was stocks only go up, so let’s make some money too. Whatever the reason, as of December 31 the USD value of their equity portfolio was about $97.6 billion. I’m pretty confident that number is a lot lower today, and perhaps the idea about Swiss franc strength is being called into question. The franc is unchanged today and has been generally unimpressive for the past week.

Meanwhile, all eyes this morning are on Madame Lagarde and the ECB who will be announcing their latest policy initiatives shortly. While it is clearly expected they will do something, other than a 10bp cut in the deposit rate, to -0.60%, there is a great deal of uncertainty. Expectations range from expanding the TLTRO program with much more aggressive rates, as low as -2.00%, to a significant increase in QE to capping government bond yields. All of that would be remarkably dramatic and likely have a short-term positive impact on markets. But will it last? My sense is that until the Fed announces next week, and at this point I think they cut 100bps, markets will still be on edge. After all, the world continues to revolve around USD funding, and in times of crisis, foreign entities need access to USD liquidity. Look for more repo, more swap lines and maybe even a lending scheme although I don’t think the Fed can do something like that within their mandate.

Overall, the dollar is performing as the number two currency haven, after the yen, and has rallied sharply against commodity currencies in both the G10 and EMG spaces. For example, with oil down 5% this morning, NOK has fallen 3.6%, but both AUD and SEK are lower by 1.5% as well. In the emerging markets, Mexican peso continues to be the market’s whipping boy, falling a further 3.2% as I type, which takes its decline since the beginning of the month to 12.2%. meanwhile, the RUB is in similarly dire straits (-2.75% today, -11.5% in March) and we are seeing every single EMG currency lower vs. the dollar today. These are the nations that are desperate for USD liquidity and you can expect their currencies to continue to decline for the foreseeable future.

At this point, data is an afterthought, but it is still being released. Yesterday saw CPI rise a tick more than expected but the more interesting data point was Mortgage Applications, which jumped 55.4% as mortgage rates collapse alongside Treasury yields. This morning brings Initial Claims (exp 220K) and PPI (1.8%, 1.7% core) with far more interest in the former than the latter. Consider, given the enormous economic disruptions, it would be easy to see that number jump substantially, which would just be another signal for the Fed to act as aggressively as possible.

At this point, as the equity meltdown continues, the dollar should remain well supported vs. everything except the yen.

Good luck
Adf

Set For Stagnation

When thinking of every great nation
Regarding its growth expectation
The US alone
Is like to have grown
While others seem set for stagnation

The upshot of these circumstances
Is regular dollar advances
Within the G10
It’s euros and yen
That suffer on policy stances

Another day, another dollar rally. This simple sentiment pretty well sums up what we have been seeing for the past several weeks. And while there may be a multitude of catalysts driving individual currency movements, the reality is they all point in the same direction, a stronger dollar. Broadly speaking, data from around the world, excluding the US, has been consistently weaker than expected while the US continues to hum along nicely. Now, if China’s economy remains in its current catatonic state for another month, one has to believe that US numbers are going to suffer, if only for supply chain reasons. But right now, it is difficult for anyone to make the case that another currency is better placed than the dollar.

For example, last night we saw Australian Unemployment unexpectedly rise to 5.3% as the first measured impacts of Covid-19 make themselves felt Down Under. Traders wasted no time in selling Aussie and here we are this morning with the currency lower by 0.75%, trading to new lows for the move and touching its lowest level since March 2009. Perhaps the Lucky Country has run out of luck.

The yen keeps falling
Like ash from Fujiyama
Is an end in sight?

At this point in the session, the yen has seen its largest two-day decline since November 2016, in the immediate wake of President Trump’s election, and has now fallen more than 2.0% since Tuesday morning. It has broken through a key technical level at 111.02, which represented a very long-term downtrend line. This has encouraged short-term traders to add to what is believed to be significant outflows from Japanese investors, notably insurance companies. One of the other interesting things is that Japanese exporters, who are typically sellers of USDJPY, seem to be sitting this move out, having filled orders at the 110 level, and are now apparently waiting for 115. While it is unlikely that we will see the yen continue to decline 1% each day, I have to admit that 115 seems quite realistic by the end of the Japanese fiscal year next month.

And those are just two of the many stories that seem to be coming together simultaneously to encourage dollar buying. Other candidates are ongoing weak Eurozone economic data (Eurozone Construction output falling and reduced forecasts for tomorrow’s flash PMI data), rate cuts by EMG central banks (Indonesia cut by 25bps last night), and more confusion from China regarding Covid-19 and its spread. Last night, they changed the way they count infections for the second time in a week, and shockingly the result was a lower number indicating the spread of the disease is slowing. However, at this point, the virus count seems to be having less of a market impact than little things like the announcement that Hubei province is keeping all factories shuttered until at least March 10. Now I don’t know about you, but that hardly seems like the type of thing that indicates things are getting better there.

There is a new tacit contest in the market as well, trying to determine just how big a hit the Chinese economy is going to take in Q1. If you recall two weeks ago, the initial estimates were that GDP would grow at a 4%-5% rate in Q1. At this point 0.0% seems a given with a number of analysts penciling in negative growth for the quarter. And folks, I don’t know why anyone would think there is going to be a V-shaped recovery there. It is going to take a long time to get things anywhere near normal, and there has already been a lot of permanent demand destruction. On top of that, one of the things I had discussed last week, the idea that even if companies aren’t generating revenue, they still need to pay interest on their debt, is starting to be seen more publicly. The news overnight that HNA Group, a massively indebted conglomerate that had acquired trophy assets all around the world (stakes in Hilton Hotels and Deutsche Bank amongst others) is unable to pay interest on its debt and seems to be moving under state control. While the PBOC cut rates slightly overnight, the one-year loan prime rate is down to 4.05% from 4.15% previously, it appears that the Chinese government is going to be fighting the Covid-19 fight with more fiscal measures than monetary ones. That said, the renminbi has been falling along with all other currencies and has traded back through 7.00 to the dollar after a further 0.35% decline overnight.

The point is that you can essentially look at any currency right now and it is weaker vs. the dollar. Each may have its own story to tell, but they all point in the same direction.

I would be remiss to ignore other markets, which show that other than Chinese equity markets (Shanghai +1.85%), which rallied last night after news of further stimulus measures, risk is mostly on its back foot today. European equity markets are generally lower (DAX -0.1%, CAC -0.1%) although not by much. US futures are pointing lower by 0.2% across the board, again, not significant, but directionally the same message. Treasury yields continue to fall, down another 2bps this morning to 1.54%, and gold continues to rally, up another 0.3% this morning.

Yesterday’s FOMC Minutes explained that the Fed was pretty happy with current policy settings, something we already knew, and that they are still unsure how to change their ways to try to be more effective with respect to achieving their inflation target as well as insuring that there are no more funding crises. On the data front, yesterday’s PPI data was much firmer than expected, although most people pretty much ignore those numbers. Today we see Philly Fed (exp 11.0), Initial Claims (210K) and Leading Indicators (0.4%). Monday’s Empire Mfg data was stronger than expected and the forecasts for Philly Fed are for a solid increase. Yet again, the data picture points to a better outcome in the US than elsewhere, which in the current environment will only encourage further USD buying. For now, don’t get in front of this train, but if you need to hedge receivables, sooner is better than later as I think we could see this run for a while.

Good luck
Adf

Fears Melt

As Covid fears melt
Like the snowpack during spring
The yen, too, recedes

Remember when there was a universal idea that if the world’s second largest economy, and its fastest growing one at that, essentially shut down due to complications from an exogenous force (Covid-19), it would force investors to show concern over their risk allocations and seek out haven assets? Me neither! Remarkably, equity investors have become so convinced that central banks collectively have their “backs” that there is virtually no interest in limiting positions. This is certainly true across all equity markets, where after a mere twenty-four hours of modest concern over the fact that Q1 iPhone sales would be negatively impacted by Covid-19, the all clear signal was given. This time that signal took the form of the Chinese government announcing that they would be supporting the domestic airline industry, either encouraging takeovers of smaller airlines in financial trouble by their larger brethren, or via direct capital injections into companies. My sense is we will see both of those actions in order to be certain that no airlines go under.

Headlines like the following: “Chinese Companies Say They Can’t Afford to Pay Workers Now” from a Bloomberg story are seen as irrelevant and have no impact on risk assessment. Apparently the idea that the Chinese private sector, which accounts for two-thirds of GDP growth and 90% of new jobs, has basically been shuttered is not relevant in the calculations made by equity investors. Let me just say that the idea of risk has certainly evolved lately.

But this is the story. Equity investors are convinced that central banks will never allow stock markets to decline again and will do everything in their power to prevent any such decline. And while that may be true with regard to central bank efforts, there is a potential flaw in the theory. Central bank power, just like virtually everything else, is subject to the law of diminishing returns, and we are already seeing that situation in Europe and Japan. So even though central bankers may try to stop all declines, do not be surprised when a situation arises where they cannot do so.

Interestingly, bond market investors have a somewhat different view of the landscape as we continue to see interest in Treasuries and bunds with yields in both instruments continuing to grind slowly lower. However, for now, the equity markets are in the spotlight and driving the narrative.

So, with this in mind, it is easier to understand that Asian markets mostly rallied last night (Nikkei +0.9%, Hang Seng +0.5) although Shanghai edged lower by -0.15%. European markets are rocking this morning with the DAX (+0.55%), CAC (+0.7%) and FTSE100 (+0.8%) leading the way higher despite news that Adidas and Puma have seen sales collapse to virtually zero in China. US futures are also pointing higher, on the order of 0.3% as we would not want to be left out of the action here.

Treasury yields continue to sink, however, with the 10-year down to 1.56% while German bunds have fallen to -0.42%. So there is clearly some demand for haven assets, perhaps just not as much as we would expect. And finally, in the FX market, havens have lost their appeal. Most notably, the yen has tumbled 0.5% this morning, trading well back through 110 and touching its weakest point since last May. Clearly, there is no fear in FX traders’ collective minds. Funnily enough, gold prices continue to rally, having closed above $1600/oz yesterday for the first time since March 2013, and are higher by a further 0.5% this morning.

With this as a backdrop, it is very difficult to paint a coherent picture of the markets today, at least the FX markets. In the G10 space, we have already discussed the yen’s decline, marking it as the worst performing major currency today. On the flip side, NOK is the big winner, +0.5% as oil prices rebound on the news that Chinese airlines are not all going to disappear. CAD is the second best performer, also on the back of the oil news, although it has only managed a 0.25% gain. And other than those three currencies, nothing else has moved more than 10 basis points from last night’s closing levels. On the data front overseas, UK CPI was released a tick higher than expected at 1.8%, although the pound has seen exactly zero movement on the back of the data. If nothing else, new BOE Governor Andrew Bailey must be happy that the road to 2% inflation is not quite as steep as previously expected.

In the EMG space, movement has been even more muted with the biggest gainers ZAR (+0.3%) and RUB (+0.25%) on the back stronger commodity and oil prices while the biggest decliners have been HUF (-0.3%) and TRY (-0.25%) with the former seeing profit taking after a nearly 2% rally in the wake of central bank discussions of tighter policy to fight inflation there, while the lira is responding to a rate cut of 50 bps as the central bank seeks to unwind the drastic tightening it implemented in mid-2018 amid major inflationary pressures. And while I wish there were some more interesting stories, the reality is the big narrative of central banks preventing risk sell-offs remains the only theme in the market.

Looking at this morning’s data we see Housing Starts (exp 1428K), Building Permits (1450K) and PPI (1.6%, 1.3% ex food & energy). Then at 2:00 we get a look at the FOMC Minutes from January’s meeting. Fed watchers are focusing on any discussion regarding the balance sheet and repo as it remains clear there is not going to be any interest rate change anytime soon.

So that’s what we have for today. Arguably, the dollar is ever so slightly on its back foot, but the movement has been infinitesimal. While I continue to believe that ultimately the Fed will ease policy further, for now, the dollar remains the brightest bulb in the box, and so should continue to attract buyers.

Good luck
Adf

 

A Dangerous Game

In ‘Nineteen the story was trade
As Presidents Trump and Xi played
A dangerous game
While seeking to blame
The other for why growth decayed

But ‘Twenty has seen both adjust
Their attitudes and learn to trust
That working together,
Like birds of a feather,
Results in an outcome, robust

In a very quiet market, the bulk of the discussion overnight has been about the upcoming signing ceremony in the East Room of the White House tomorrow, where the US and China will agree the phase one piece of a trade deal. Despite the fact that this has been widely expected for a while, it seems to be having a further positive impact on risk assets. Today’s wrinkle in the saga has been the US’ removal of China from the Treasury list of currency manipulators. Back in August, in a bit of a surprise, the US added China to that list formally, rather than merely indicating the Chinese were on notice, as President Trump sought to apply maximum pressure during the trade negotiations. Now that the deal is set to be signed, apparently the Chinese have made “enforceable commitments” not to devalue the yuan going forward, which satisfied the President and led to the change in status. The upshot is that the ongoing positive risk framework remains in place thus supporting equity markets while undermining haven assets. In other words, just another day where the politicians seek to anesthetize market behavior, and have been successful doing so.

Chinese trade data released last night was quite interesting on two fronts; first that the Chinese trade surplus with the US shrank 11%, exactly what the President was seeking, and second, that the Chinese found many substitute markets in which to sell their wares as their overall trade surplus rose to $425 billion from 2018’s $351 billion. And another positive for the global growth watch was that both exports (+7.6%) and imports (+17.7%) grew nicely, implying that economic growth in the Middle Kingdom seems to be stabilizing. As to the yuan, it has been on a tear lately, rising 1.4% this year and nearly 4.5% since early September right after the US labeled China a currency manipulator. So, here too, President Trump seems to have gotten his way with the Chinese currency having regained almost all its losses since the November 2016 election. Quite frankly, it seems likely that the yuan has further to climb as prospects for Chinese growth brightened modestly and investors continue to hunt for yield and growth opportunities.

But away from the trade story there is precious little else to discuss. The pound remains under pressure (and under 1.30) as the idea of a BOE rate cut at the end of the month gains credence. Currently the market is pricing in a 47% probability of a rate cut, which is up from 23% on Friday. After yesterday’s weak GDP data, all eyes are focused on tomorrow’s UK CPI data as well as Friday’s Retail Sales where any weakness in either one is likely to see the market push those probabilities up even further.

As haven assets are shed, the Japanese yen has finally breached the 110 level for the first time since May and quite frankly there doesn’t appear to be any reason for the yen to stop declining, albeit slowly. Barring some type of major risk-off event, which is always possible, the near term portents are for further weakness. However, as the year progresses, ongoing Fed QE should serve to reverse this movement.

Even the Emerging markets have been dull overnight, with no currency moving more than 0.3%, which in some cases is nearly the bid-ask spread. For now, most market participants have become quite comfortable that no disasters are looming and that, with the US-China trade deal about to be completed, there is less likelihood of any near-term angst on that front. While a phase two deal has been mooted, given the issues that the US has indicated are important (forced technology transfer, state subsidies), and the fact that they are essentially non-starters in China, it seems highly improbable that there will be any progress on that issue this year.

On the data front, this morning brings the first US data of the week, where NFIB Small Business Optimism actually disappointed at 102.7 and the market is now awaiting December CPI data (exp 2.4%, 2.3% ex food & energy) at 8:30. The headline forecast represents a pretty big uptick from November, but that is directly related to oil’s price rally last month. The core, however, remains unchanged and well above the 2.0% Fed target. Of course that target is based on PCE, something that is designed to print lower, and there has been abundant evidence that the Fed’s idea of the target is to miss it convincingly on the high side. In other words, don’t look for the Fed to even consider a tighter policy stance unless CPI has a 3 handle.

And that’s really it for the session. Equity futures are pointing slightly higher as European equity indices are edging in that direction as well. Treasury yields are hovering just above 1.80%, little changed on the day and showing no directional bias for the past several weeks. If anything, the dollar is slightly higher this morning, but I would be surprised if this move extends much further at all.

Good luck
Adf

Growth Can Be Spurred

In England this morning we heard
From Vlieghe, the BOE’s third
Incumbent to say
That given his way
He’d cut rates so growth can be spurred

The pound is under pressure this morning after Gertjan Vlieghe became the third MPC member in the past week, after Carney and Tenreyo, to explain that a rate cut may be just the ticket at this point in time. Adding these three to the two members who had previously voted to cut rates, Haskel and Saunders, brings the number of doves to five, a majority on the committee. It can be no surprise that the pound has suffered, nor that interest rate markets have increased the probability of a 25bp rate cut at the January 30 meeting from below 25% last week to 50% now. Adding to the story was the release of worse than expected November IP (-1.2%) and GDP (-0.3%) data, essentially emphasizing the concerns that the UK economy has a long way to go to recover from the Brexit uncertainty.

However, before you turn too negative on the UK economy, remember that this is backward-looking data, as November was more than 6 weeks ago, and in the interim we have had the benefit of the resounding electoral victory by Boris Johnson. This is not to say that the UK economy cannot deteriorate further, just that there has been a palpable change in the tone of commentary in the UK as Brexit uncertainty has receded. Granted, the question of the trade deal with the EU, which is allegedly supposed to be signed by the end of 2020, remains open. But it is very difficult for market participants to look that far ahead and try to anticipate the outcome. And if anything, Boris has the fact that he was able to renegotiate the original Brexit deal in just six weeks’ time working in his favor. While previous assumptions had been that trade deals take years and years to negotiate, it is clear that Boris doesn’t subscribe to that theory. Personally, I wouldn’t bet against him getting it done.

But for now, the pound is the worst performer of the session, and given today’s news, that should be no surprise. However, I maintain my view that current levels represent an excellent opportunity for payables hedgers to add to hedges.

The other mover of note in the G10 space is the yen, which has fallen 0.4% after traders were able to take advantage of a Japanese holiday last night (Coming-of-age Day) and the associated reduced liquidity to push the dollar above a key technical resistance point at 109.72. Stop-loss orders at that level led to a quick jump at 4:00 this morning, and given the broad risk-on attitude in markets (equity markets worldwide continue to rebound from concerns over further Middle East flare ups), it certainly feels like traders are going to push the dollar up to 110, a level not seen since May. However, the other eight currencies in the G10 have been unable to generate any excitement whatsoever and are very close to unchanged this morning.

In the EMG space, Indonesia’s rupiah is once again the leader in the clubhouse, rising a further 0.7% after the central bank reiterated it would allow the currency to appreciate and following an announcement by the UAE that it would make a large investment in the nation’s (Indonesia’s) sovereign wealth fund. The resultant rally, to the rupiah’s strongest level in almost a year, has been impressive, but there is no reason to believe that it cannot continue for another 5% before finding a new home. This is especially true if we continue to hear good things regarding the US-China trade situation. Trade has also underpinned the second-best performer of the day in this space, KRW, which has rallied 0.5%, on the trade story.

While those are the key stories thus far this session, we do have a full week’s worth of data to anticipate, led by CPI, Retail Sales and Housing data.

Tuesday NFIB Small Biz Optimism 104.9
  CPI 0.3% (2.4% Y/Y)
  -ex food & energy 0.2% (2.3% Y/Y)
Wednesday PPI 0.2% (1.3% Y/Y)
  -ex food & energy 0.2% (1.3% Y/Y)
  Empire Manufacturing 3.5
  Fed’s Beige Book  
Thursday Initial Claims 218K
  Philly Fed 3.0
  Retail Sales 0.3%
  -ex autos 0.5%
  Business Inventories -0.1%
Friday Housing Starts 1380K
  Building Permits 1460K
  IP -0.1%
  Capacity Utilization 77.0%
  Michigan Sentiment 99.3
  JOLTS Job Openings 7.264M

Source: Bloomberg

So clearly there is plenty on the docket with an opportunity to move markets, and we also hear from another six Fed speakers. While you and I may be concerned about rising prices, it has become abundantly clear that the Fed is desperate to see them rise further, so the only possible reaction to a CPI miss would be on the weak side, which would likely see an equity rally on the assumption that even more stimulus is coming. Otherwise, I think Retail Sales will be the data point of choice for the market, with weakness here also leading to further equity strength on the assumption that the Fed will add to their current policy.

And it is hard to come up with a good reason for any Fed speaker to waver from the current mantra of no rate cuts, but ongoing support for the repo market and a growing balance sheet. And of course, that underlies my thesis that the dollar will eventually fall. Just not today it seems!

Good luck
Adf

More Doubt He Is Sowing

In Beijing, the Chinese yuan
Fell sharply as it’s now been drawn
Into the trade fight
Much to the delight
Of bears, who had shorts layered on

For President Xi, though, the risk
Is money there exits the fisc
With growth there still slowing
More doubt he is sowing
So capital flight could be brisk

Things changed overnight as the PBOC fixed the renminbi below 6.90, much weaker than expected and then the currency fell sharply in subsequent trading in both the on-shore and offshore markets. As you will have no doubt seen, USDCNY is trading somewhere in the vicinity of 7.08 this morning, although the price has been quite volatile. While that represents a decline of more than 1.5% compared to Friday’s closing levels, the more important questions revolve around the PBOC’s new strategy going forward.

Recall, one of the reasons that there was a strong market belief in the sanctity of the 7.00 level was that four years ago, when the PBOC surprised markets with a mini-devaluation, locals took their cash and ran for the hills. Capital outflows were so great, in excess of $1 trillion, that the PBOC needed to institute strict new rules preventing further flight. That was a distinct loss of face for an institution that was trying to modernize and prove that it could manage things like G10 countries where capital flows more freely. Ever since, the assumption was that the Chinese population would get nervous if the renminbi weakened beyond that level and correspondingly, the PBOC would not allow that outcome to occur.

But that was then, in the days when trade was simply a talking point rather than the focus of policy. As the trade war intensifies, the Chinese have fewer tools with which to fight given the massive imbalance that exists. The result of this is that increases in US tariffs cannot be matched and so other weapons must be used, with changes in the exchange rate the most obvious. While the PBOC claims they can continue to manage the currency and maintain its stability, the one thing I have learned throughout my career is that markets have a way of abusing claims of that nature, at least for a while. Back in January I forecast USDCNY to reach 7.40 by the end of this year and, as of this morning, that seems quite realistic.

But the impact on markets is far greater than simply the USDCNY exchange rate. This has been the catalyst for a significant amount of risk-off behavior with equity markets throughout Asia (Nikkei -1.75%, Shanghai -1.6%, Hang Seng -2.85%) and Europe (DAX -1.85%, CAC -2.25%, FTSE -2.25%) sharply lower; Treasury (1.76%) and Bund (-0.51%) yields sharply lower, the Japanese yen (+0.6%) and Swiss franc (+0.75%) both sharply higher and most emerging market currencies (e.g. MXN -1.5%, INR -1.4%, ZAR -1.2%, KRW -0.9%) falling alongside the renminbi. It should be no surprise that gold is higher by 1.0%, to a 6-year high, as well this morning and oil prices (-1.1%) are falling amid concerns of waning demand from the slowing global growth story.

So, what’s a hedger to do? The first thing to consider is whether these moves are temporary fluctuations that will quickly be reversed, or the start of longer-term trends. Given the imbalances that have been building within markets for the past decade and given that central banks have a greatly reduced set of monetary tools with which to manage things, despite their comments otherwise, this could well be the tipping point where markets start to unwind significant positions. After all, the one thing that truly underpinned gains in both equity and bond markets, especially corporate and high-yield bond markets, was confidence that regardless of fiscal policy failures, the central banks would be able to maintain a level of stability.

However, this morning that belief seems a little less secure. It will not take much for investors to decide that, ‘it’s been a good run and now might be a good time to take some money off the table’, at least figuratively. Last week saw equity markets suffer their worst week of the year and this week is not starting any better. Yes, the Fed has room to cut rates further, but will 200bps be enough to stop a global recession? Arguably, that’s the question that needs to be answered. From where I sit, that answer is no, but then I am a cynic. Of course, that cynicism is born of a long career in financial markets.

Thus, my take is that there is further to run in most of these currencies, and that assuming a quick reversion would be a mistake. While option prices are clearly higher this morning than last week, they remain low by historic standards and should be considered for their value in uncertain times. Just sayin’.

What else does this week have to offer? Well, the US data set is not that substantial, but we do hear from a number of Fed speakers, which given last week’s confusion will be extremely important and closely watched. There are also a number of foreign central bank meetings that will be interesting regarding their rate maneuvers.

Today ISM Non-Manufacturing 55.5
Tuesday JOLT’s Job Openings 7.317M
Wednesday RBNZ Rate Decision 1.25% (25bp cut)
  RBI Rate Decision 5.50% (25bpcut)
  Consumer Credit $16.0B
Thursday Philippine Rate Decision 4.25% (25bp cut)
  Initial Claims 215K
Friday PPI 0.2% (1.7% Y/Y)
  -ex food & energy 0.2% (2.4% Y/Y)

We also hear from three dovish Fed speakers; Brainerd, Bullard and Evans, who are likely to give more reasons for further rate cuts, especially if markets continue to fall. As to the three central banks with decisions to make, they find themselves in a difficult place. All three are extremely concerned about their currencies’ value and don’t want to exert further downward pressure on them, yet all three are facing slowing economies and need to do something to boost demand. In fact, this is going to be the central bank conundrum for some time to come across both developing and G10 countries as they try to continually manage the impossible trilateral of exchange rates, interest rates and growth.

All of this adds up to yet more reasons for higher volatility across all asset classes in the near future. It appears that these are the first cracks in the old economic order, and there is no way to know how everything will play out going forward. As long as risk is being jettisoned though, Treasuries, the yen, the Swiss franc and the dollar will see demand. Keep that in mind as you manage your risks.

Good luck
Adf

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
Adf

A Bad Dream

According to pundits’ new theme
December was just a bad dream
Though Europe’s a mess
And China feels stress
The fallout was way too extreme

The thing is, the data of late
Worldwide has not really been great
The only thing growing
Is debt which is sowing
The seeds of a troubled debate

The dollar has been edging higher over the past several sessions which actually seems a bit incongruous based on other market movements. Equity investors continue to see a glass not half full, but overflowing. Bond yields are edging higher in sync with those moves as risk is being acquired ‘before it’s too late’. But the dollar, despite the Fed’s virtual assurance that we have seen the last of the rate hikes, has been climbing against most counterparts for the past two sessions.

Some of this is clearly because we are getting consistently bad economic data from other countries. For example, last night saw Services PMI data from around the world. In France, the index fell to 47.8, its worst showing in five years. German data printed a slightly worse than expected 53.0, while the Eurozone as a whole remained unchanged at 51.2 It should be no surprise that Italy, which is currently in recession, saw its number fall below 50 as well, down to 49.7. Thus, while Brexit swirls on in the background, the Eurozone economy is showing every sign of sliding toward ever slower growth and inflation. As I have been repeating for months, the ECB will not be tightening policy further. And as the Brexit deadline approaches, you can be sure that the EU will begin to make more concessions given the growing domestic pressure that already exists due to the weakening economy. Net, the euro has decline 0.2% this morning, and is ebbing back to the level seen before the Fed capitulated.

Speaking of Brexit, the UK Services PMI data fell to 50.1, its worst showing in two- and one-half years, simply highlighting the issues extant there. PM May’s strategy continues to consist of trying to renegotiate based on Parliament’s direction, but the EU continues to insist it cannot be done. While very few seem to want a hard Brexit, there has been very little accomplished of late that seems likely to prevent it. And the pound? It has fallen a further 0.2% and is trading back just above 1.30, its lowest level in two weeks and indicative of the fact that the certainty about a deal getting done, or at the very least a delay in any decision, is starting to erode.

With the Lunar New Year continuing in Asia, there is no new news on the trade front, just the ongoing impact of the tariffs playing out in earnings releases and economic reports. But this story is likely to be static until the mooted meeting between the two presidents later this month. My observation is that the market has priced in a great deal of certainty that a deal will be agreed and that the tariff regime will end. Quite frankly, that seems very optimistic to me, and I think there is a very real chance that things deteriorate further, despite the incentives on both sides to solve the problem. The issue is that the US’s trade concerns strike at the very heart of the Chinese economic model, and those will not be easily changed.

Elsewhere, the yen has been falling modestly of late, which is not surprising given the recent risk-on sentiment in markets, but the Japanese economy has not shown any signs that the key concern over inflation, or lack thereof, has been addressed. During December’s equity meltdown, the yen rallied ~4.5%. Since then, it has rebound about half way, and in truth, since equity markets stabilized in the middle of January, the yen has been in a tight trading range. At this point, given the complete lack of ability by the BOJ to impact its value based on monetary policy settings, and given the strong belief that it represents a safe haven in times of trouble (which is certainly true for Japanese investors), the yen is completely beholden to the market risk narrative going forward. As long as risk is embraced, the yen is likely to edge lower. But on risk off days, look for it to rebound sharply.

And that’s really all we have for today. This evening’s State of the Union address by President Trump has the potential to move markets given the contentious nature of his current relationship with the House of Representatives. There is growing talk of another Federal government shutdown in two weeks’ time, although as far as the FX market was concerned, I would say the last one had little impact. Arguably, the dollar’s weakness during that period was directly a result of the change in Fed rhetoric, not a temporary interruption of government services.

At 10:00 this morning the ISM Non-Manufacturing data is released (exp 57.2), which while softer than last month remains considerably higher than its European and Chinese counterparts. Overall, as markets continue to reflect an optimistic attitude, I would expect that any further dollar strength is limited, but in the event that fear returns, the dollar should be in great demand. However, that doesn’t seem likely for today.

Good luck
Adf

A Statement, Acute

The company named for a fruit
Explained in a statement, acute
Though services grew
Its gross revenue
Was destined, not to follow suit

The impact ‘cross markets was vast
As traders, most havens, amassed
Thus Treasuries jumped
The dollar was dumped
While yen demand was unsurpassed

Happy New Year to all my readers. I hope it is a successful and prosperous 2019 for everyone.

But boy, has it gotten off to a rough start! Since I last wrote on December 14, volatility across markets has done nothing but increase as fear continues to pervade both the investor and trader communities. While some pundits point to the trade war and/or the US government shutdown, what has been apparent to me for the past several months is that central banking efforts around the world to normalize policy have begun to take their toll on economic activity and by extension on markets that have become completely dependent on that monetary buffer.

Ten years of extraordinary monetary support by central banks around the world has changed the way markets behave at a fundamental level. The dramatic increase in computer driven, algorithmic trading across markets, as well as passive investing and implicitly short volatility strategies has relegated fundamental analysis to the dust heap of history. Or so it seems. The problem with this situation is that when conditions change, meaning liquidity is no longer being continually added to markets, all those strategies suffer. It will be interesting to watch just how long the world’s central banks, who are desperately trying to normalize monetary policy before the next economic downturn, are able to continue on their present path before the pressure of slowing growth forces a reversion to ‘free’ money for all. (Despite all their claims of independence, I expect that before the summer comes, tighter monetary policy will be a historical footnote.)

In the meantime, last night’s volatility was triggered when a certain mega cap consumer electronics firm explained to investors that its sales in China would be much weaker than previously forecast. Blaming the outcome on a slowing Chinese economy, management tried to highlight growth elsewhere, but all for naught. The market response was immediate, with equity markets falling sharply, including futures in both Europe and the US, and the FX markets picking up where last year’s volatility left off. Notably, with Tokyo still on holiday, the yen exploded more 3.5% vs. the dollar during the twilight hours between New York’s close and Singapore’s open, trading to levels not seen since last March. While it has given back a large portion of those gains, it remains higher by 1.2% in the session, and is more than 5% stronger than when I last wrote. If ever there was a signal that fear continues to pervade markets, the yen’s performance over the past three weeks is surely that signal.

Speaking of slowing Chinese growth, the recent PMI data from China printed below that critical 50.0 level at a weaker than expected 49.4, simply confirming the fears of many. What has become quite clear is that thus far, the trade dispute is having a much more measurable negative impact on China’s economy than on the US economy. This has prompted the PBOC to ease policy further overnight, expanding the definition of a small company to encourage more lending to that sector. Banks there that increase their loans to SME’s will see their reserve requirements reduced by up to a full percentage point going forward. (One thing that is very clear is there is no pretense of independence by the PBOC, it is a wholly owned operation of the Chinese government and President Xi!) I guess China is the first central bank to back away from policy normalization as the PBOC’s previous efforts to wring excess leverage out of the system are now overwhelmed by trying to add back that leverage! Look for the ECB to crack soon, and the Fed not far behind.

And while the rest of the FX market saw some pretty fair activity, this was clearly the key story driving activity. The funny thing about the euro is that there are mixed views as to whether the euro or the dollar is a better safe haven, which means that in risk-off scenarios like we saw last night, EURUSD tends not to move very far. Arguably, its future will be determined by which of the two central banks capitulates to weaker data first. (My money continues to be on the ECB).

This week is a short one, but we still have much data to come, including the NFP report tomorrow. So here is a quick update of what to expect today and tomorrow:

Today ADP Employment 178K
  Initial Claims 220K
  ISM Manufacturing 57.9
  ISM Prices Paid 58.0
Friday Nonfarm Payrolls 177K
  Private Payrolls 175K
  Manufacturing Payrolls 20K
  Unemployment Rate 3.7%
  Average Hourly Earnings 0.3% (3.0% Y/Y)
  Average Weekly Hours 34.5

Tomorrow we also hear from Fed Chair Powell, as well as two other speakers (Bullard and Barkin) and then Saturday, Philly Fed President Harker speaks. At this point, all eyes will be on the Chairman tomorrow as market participants are desperate to understand if the Fed’s reaction function to data is set to change, or if they remain committed to their current policy course. One thing that is certain is if the Fed slows or stops the balance sheet shrinkage, equity markets around the world will rally sharply, the dollar and the yen will fall and risky assets, in general, should all benefit with havens under pressure. At least initially. But don’t be surprised if the central banks have lost the ability to drive markets in their preferred long-term direction, even when explicitly trying to do so!

Good luck
Adf

More Trouble is Brewing

The PMI data last night
From China highlighted their plight
More trouble is brewing
While Xi keeps pursuing
The policies to get things right

Any questions about whether the trade conflict between the US and China was having an impact on the Chinese economy were answered last night when the latest PMI readings were released. The Manufacturing PMI fell to 50.2, it’s lowest level in more than two years and barely above the expansion/contraction level of 50.0. Even more disconcertingly for the Chinese, a number of the sub-indices notably export sales and employment, fell further below that 50.0 level (to 46.9 and 48.1 respectively), pointing to a limited probability of a rebound any time soon. At the same time, the Services PMI was also released lower than expected, falling to 53.9, its lowest level since last summer. Here, too, export orders and employment numbers fell (to 47.8 and 48.9 respectively), indicating that the economic weakness is quite broad based.

Summing up, it seems safe to say that growth in China continues to slow. One question I have is how is it possible that when the Chinese release their GDP estimates, the quarter-to-quarter movement is restricted to 0.1% increments? After all, elsewhere in the world, despite much lower headline numbers (remember China is allegedly growing at 6.5% while Europe is growing at 2.0% and the US at 3.5%), the month-to-month variability is much greater. Simple probability would anticipate that the variance in China’s data would be higher than in the rest of the world. My point is that, as in most things to do with China, we don’t really know what is happening there other than what they tell us and that is like relying on a pharmaceutical salesman to prescribe your medicine. There are several independent attempts ongoing to get a more accurate reading of GDP growth in China, with measures of electricity utilization or copper imports seen as key data that is difficult to manipulate, but they all remain incomplete. And it seems highly unlikely that President Xi, who has been focused on improving the economic lot of his country, will ever admit that the growth figures are being manipulated. But I remain skeptical of pretty much all the data that they provide.

At any rate, the impact on the renminbi continues to be modestly negative, with the dollar touching another new high for the move, just below 6.9800, in the overnight session. This very gradual weakening trend seems to be the PBOC’s plan for now, perhaps in order to make a move through 7.00 appear less frightening if it happens very slowly. I expect that it will continue for the foreseeable future especially as long as the Fed remains on track to tighten policy further while the PBOC searches for more ways to ease policy without actually cutting interest rates. Look for another reserve requirement ratio cut before the end of the year as well as a 7 handle on USDCNY.

Turning to the euro, data this morning showed that Signor Draghi has a bit of a challenge ahead of him. Eurozone inflation rose to 2.2% with the core reading rising to 1.1%, both slightly firmer than expected. The difference continues to be driven by energy prices, but the concern comes from the fact that GDP growth in the Eurozone slowed more than expected last quarter. Facing a situation where growth is slowing and inflation rising is every central banker’s nightmare scenario, as the traditional remedies for each are exactly opposite policies. And while the fluctuations are hardly the stuff of a disaster, the implication is that Europe may be reaching its growth potential at a time when interest rates remain negative and QE is still extant. The risk is that the removal of those policies will drive the Eurozone back into a much slower growth scenario, if not a recession, while inflation continues to creep higher. It is data of this nature, as well as the ongoing political dramas, that inform my views that the ECB will maintain easier policy for far longer than the market currently believes. And this is why I remain bearish on the euro.

Yesterday the pound managed to trade to its lowest level since the post-Brexit vote period, but it has bounced a bit this morning, +0.35%. That said, the trend remains lower for the pound. We are now exactly five months away from Brexit and there is still no resolution for the Irish border issue. Every day that passes increases the risk that there will be no deal, which will certainly have a decidedly negative impact on the UK economy and the pound by extension. Remember, too, that even if the negotiators agree a deal, it still must be ratified by 28 separate parliaments, which will be no easy task in the space of a few months. As long as this is the trajectory, the risk of a sharp decline in the pound remains quite real. Hedgers take note.

Elsewhere, the BOJ met last night and left policy unchanged as they remain no closer to achieving their 2.0% inflation goal today than they were five years ago when they started this process. However, the market has become quite accustomed to the process and as such, the yen is unchanged this morning. At this time, yen movement will be dictated by the interplay between risk scenarios and the Fed’s rate hike trajectory. Yen remains a haven asset, and in periods of extreme market stress is likely to perform well, but at the same time, as the interest rate differential increasingly favors the dollar, yen strength is likely to be moderated. In other words, it is hard to make a case for a large move in either direction in the near term.

Away from those three currencies, the dollar appears generally firmer, but movement has not been large. Turning to the data front, yesterday’s releases showed that home prices continue to ebb slightly in the US while Consumer Confidence remains high. This morning brings the first inklings of the employment situation with the ADP report (exp 189K) and then Chicago PMI (60.0) coming at 9:45. Equity futures are pointing higher as the market looks to build on yesterday’s modest rally. All the talk remains about how October has been the worst month in equity markets all year, but in the broad scheme of things, I would contend that, at least in the US, prices remain elevated compared to traditional valuation benchmarks like P/E ratios. At any rate, it seems unlikely that either of today’s data points will drive much FX activity, meaning that the big trend of a higher dollar is likely to dominate, albeit in a gradual fashion.

Good luck
Adf