Too many themes have caught my attention recently, so I’ll stick with some points on markets this week, leaving my more discursive thoughts for later. I think two things currently are serving to make sure that markets resemble deer caught in the headlights. For starters, Mr. Trump’s Twitter feed is keeping everyone on edge, whether they like it not. Markets clearly are moving as he tweets—no matter how crazy the statements—and to the extent that the president is using his executive powers to affect policy, he is liable to announce it on Twitter, even if he does decide not to go ahead. This makes Trump’s twitter feed a bit like nonfarm payrolls. Everyone knows that it is a lagging indicator, that it is heavily revised, and notoriously volatile due to seasonal adjustment and sampling issues. Still, knowing the headline in advance can make you a lot of money. In short; traders have to stay alert to Mr. Trump’s volatile ramblings. Secondly, markets are waiting for the decisions by the Fed and the ECB later this month. Further easing is all but guaranteed from both central banks, but expectations are elevated, increasing the risk of a disappointment. In any case, it is fair to say that whatever they actually do this month, the guidance from messieurs Powell and Draghi will be just as important as the actual actions taken by the FOMC and ECB.
Read MoreMy pre-holiday missive that FX volatility is making a comeback. Mr. Trump’s threat to slam tariffs on Chinese consumer goods earlier this month prompted the PBoC to step back and “allow” USDCNY to breach 7.0. This, in turn, drove the U.S. to label China as a currency manipulator. Markets now have to consider that the trade war are morphing into currency wars. This is significant for two reasons. First, it confirms what most punters already knew; the CNY is inclined to go lower if left alone by the PBoC. Secondly, it has brought us one step closer to the revelation of how far Mr. Trump is willing to go. The problem for the U.S. president is simple. He can bully his main trading partners with tariffs, “winning” the trade wars, but he is losing the currency wars in so far as goes as his desire for a weaker dollar. The veiled threat to print dollars and buy RMB assets, as part of the move to identify China as a manipulator, is a loose threat. Just to make it clear; it would involve the Fed printing dollars and buying Chinese government debt and/or stakes in SOEs, which would probably be politically contentious. Moreover, the PBoC could respond in kind; in fact, it probably would.
Read MoreI said my peace on what I consider to be the big market stories last week, so I won’t belabour bonds and equities too much this week. FX markets, however, could well be the driver of the NarrativeTM in the next few months, at least judging by the rustling of the grapevine. This story starts with the notion of the “global Fed,” which is not a new idea at all. Fed watchers tend to pivot between two extremes in their analysis of, and forecasts, for U.S. monetary policy. In one end, Fed conducts itself according to the reality of a relatively closed U.S. economy, without regard to the impact of its policy on the rest of the world, and the value of the dollar. At the other end, the Fed acts according to its role as a warden of the global reserve currency, taking into account the impact of its policy on the rest of the world. A more cynical version of this story is the idea that the Fed, in a world of free capital mobility, is constrained by the fact that other major central banks, in economies with large external surpluses, are stuck at the zero bound. This could happen in practice as tighter monetary policy in the U.S. drives the value of the dollar higher and/or leads to an increase in capital inflows. Both likely would drive up the external deficit, which would probably be counterproductive in an environment when the Fed would otherwise want to raise rates to curb inflation pressures.
Read MoreFriday’s initial price action in response to the June U.S. payroll report provides a nice microcosm for investors’ mood and short-term expectations. The data themselves were so-so. The unemployment rate increased slightly, due mainly to a lower labour force participation rate, and wage growth slipped, albeit marginally. Markets, however, homed in on the above-consensus increase in headline payrolls, a 224K jump relative to expectations of a 160K gain, and immediately started selling equities and bonds. Running the risk of skipping several important steps in the argument, I reckon the story is relatively simple. Markets have been angling for a 50bp cut by the Fed in July, a position that was washed out, at least for the time being, by Friday’s above-consensus NFP print. Even if this interpretation is right—and it might not be—it doesn’t change the main thrust of the story, which I have been trying to describe on these pages in recent months. Markets have made their bet on further easing by monetary policymakers, and they’re now expecting central banks to deliver. Friday’s session suggests that the consensus is easily spooked, though as I type, Spoos are virtually flat on the day, and EDZ9 is still pricing-in two-to-three cuts between now and year-end.
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