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Wednesday, April 19, 2017

Skepticism about US reflation and geopolitical fears spread to Japan,10-year JGB yield fell below zero for the first time

The dollar index tumbled Tuesday alongside the 10-year yield, which closed at the lowest since before the November election. The 2-year, supposedly most attuned to Fed policy changes, fell to 1.16% . The CME FedWatch tool now shows the probability of a hike in June at 42.4% from 46.6% the day before (and over 50% last week). The market is giving up on dreams of Trumpian fiscal stimulus as well as worried about the absence of a coherent foreign policy. Trump lying about sending an aircraft carrier to Korea worsened geopolitical jitters.

The other factor behind the dollar collapse is a rise in other currencies for their own reasons, chiefly sterling. PM May’s announcement of a snap election drove the pound upward from 1.2513 to 1.2906 over nine hours, although it’s consolidating below yesterday’s highs ever since. May is assumed to gain some 20 additional seats from the hapless Labourites and strengthen her hand in Brexit talks. Pushing out the 2020 election also removes an obstacle to negotiating strength. Ironically, the strong pound was bad for the FTSE 100, which is now down year-to-date. SEE CHART BELOW:

Skepticism about US reflation and geopolitical fears spread to Japan, where the 10-year JGB yield fell below zero for the first time since mid-November. The FT reports it was as low as -0.004% overnight, from 0.116% in early Feb. 

• The Atlanta Fed kept its Q1 forecast for GDP at the same 0.5% as last time, based on residential investment growth (a little higher) and inventories (a little lower).

• In the eurozone, the CPI final is the same 1.5% y/y as the flash. The Feb trade balance moved back into surplus (€17.8 billion) from a deficit in Jan (€600 million).


The euro made a breakout move to the upside and closed above the 20-day moving average. Anyone doubting the efficacy of the linear regression channel should look at how useful it has been since the beginning of the year. WE can more clearly see two higher lows and two higher highs. If we get a third higher high, it will have to be above 1.0906 from March 27 and likely to 1.0977, the 62% retracement of the previous big move down that started last August (not visible off the left-hand side of the chart).

Something worth repeating: Yesterday SocGen’s Juckes said “The medium-term case for the euro to usurp the dollar as strongest of the major currencies grows steadily even if European political uncertainty holds it back in the short term.’’ Juckes is always to be heeded.

The Main Event The Reuters 10-year yield index closed at 2.179% from 2.252% the day before and below the 200-day moving average. The yield is now the lowest since Nov 10, before the election. Today we see 2/210%, but a die has been cast, maybe.

The Bund yield is quoted at 0.201% from 0.178% yesterday morning.


We get the EIA crude oil stocks report today plus the Beige Book. These are secondary considerations given more of the Monday FT interview with TreasSec Mnuchin, the looming showdown with N. Korea and the (arguably) deteriorating US economy.

TreasSec Mnuchin told the FT on Monday that Trump was not trying to talk the dollar down, merely commenting that in the short-term the dollar was getting too strong, while in the long run, the US favors a strong dollar. Today the FT has more of its interview with Mnuchin, this time saying more vehemently that Trump was “absolutely not, absolutely not” trying to talk the dollar down.

Mnuchin’s effort at damage control is undone, we think, by the addition of the stance that it’s not manipulation if it’s in the US favor. He said "To manipulate a currency you have to be doing it to disadvantage the United States. To the extent you manipulate a currency that advantages the United States, it’s not currency manipulation." Mnuchin explains that this is how the law defines “manipulation” for the Treasury’s twice-yearly report on currency manipulation. But he didn’t have to point it out. We have been following the report for years and never knew about that definition. It takes a Trumpian worldview to emphasize it.

It’s a very bad definition, basically saying the ends justify the means. The G7 and G20 position is that any and all currency manipulation is bad and to be avoided whatever the outcome. Presumably Mnuchin has one eye on the World Bank/IMF meetings, along with G20, in Washington this week. But the high mucky-mucks of these organizations will not be shy about criticizing the US for stupidity and incoherence.

 The Mnuchin interview is very long. He does not acquit himself well. If Rubin got an A+, Mnuchin gets a D. He couldn’t remember some acronyms, says Greece is a European issue (avoiding the question of whether the IMF should return to the table), and several other sub-par answers to softball questions.

Trump and Mnuchin are dollar-negatives. Another dollar negative is a possible showdown between the US and Pyongyang as early as April, 25, the date of the founding of the Korean military. A military display is expected. The question is whether N. Korea tries to lob another missile into the Sea of Japan and whether the US tries to shoot it down. We don’t know whether the US was able to sabotage the last missile electronically. We wonder at what point Japan gets tired of strange and unconvincing statements from the US and starts taking some initiatives….

But the bigger determinant of the dollar’s downfall is the state of the economy and how the bond market views it

The CME puts the probability of a June hike at 42.4% from 60%+ in March. Bloomberg has 44%, but never mind—it back under 50%. Bloomberg also notes that the 2-year breakeven spread (TIPS vs. the 2-year notional yield) has fallen from the high this year at 2.19% to 1.37% this week, meaning traders do not believe the Fed will get its 2% inflation target. Moreover, the spread of the 2-year over Fed funds is down to 16 bp from 44 at the start of the year.

One bond manager told Bloomberg we will get another hike this year, but not more. “The strength of the U.S. economy has been exaggerated, especially after Trump’s election. Things may get worse.” And bond market prices are behaving weirdly. See the chart from Deutsche Bank, courtesy of the Daily Shot. We have no idea how to interpret this thing.

Inflation data and inflation expectations are behind a lot of the bond market action. While inflation may be falling back in the US, it’s falling back in the eurozone, too. In fact, the only place where inflation seems truly likely is the UK, and even there the new sterling rally should put a dent in imported inflation.

Finally, what about the French election that is supposed to drive the euro down on unbearable uncertainty? The Daily Shot offers this cute graphic from Monday (next page). France is still at risk. Maybe by tomorrow or Friday fear will get a grip again. But in FX, we are not getting the usual pullback after a giant move. A little consolidation, but where’s the big profit-taking? The dog that isn’t barking is as big a worry as any of the data.

Politics: Trump tried one of his bluffs, saying an aircraft carrier was headed for N. Korea—only to have the Navy say it wasn’t. The story ran around the internet all day and hit the front page of the major newspapers this morning, not because Trump lied—we’re used to that--but because he lied to an ally in a crisis. The implications are vast. A S. Korean presidential candidate said his country can never trust Trump again unless he admits he made a mistake. Trump was ridiculed in China, which already calls him a paper tiger. A state-approved blogger wrote that bluster without a real resolve to use military force will keep “Fatty the Third” away from the table permanently. A Japanese professor military strategy said disinformation is for wartime. To use it in peacetime just harms US credibility.

Trump fans think it’s exciting to make up tactics on the fly, but anyone with a grain of common sense knows that it’s stupid and dangerous. And what’s with the Navy calling the commander in chief either a liar or mistaken? We still don’t know whether the Army used the MOAB bomb without presidential approval. A military coup in the US is unthinkable but a mutiny is not. Some general or admiral is all too likely to refuse a really bad Trump order.

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