Mixed news from the east overnight, Chinese PMI’s showed an uptick for March which comfortably exceeded expectations and the data for February. Other business activity surveys also turned out positively in China, with signs that property sales are perking up again. So much so that some of the data is the best since as far back as October 2014. Despite this the export side of the economy still looks fragile, and the fact that it’s real estate doing well makes you immediately wonder if the government is adding some sort of stimulus. Whatever it is, it’s encouraging to have some positive economic news coming out of China, it feels like it’s been a while! Japanese data was a slightly different affair though, not so good news, with the Tankan describing business leaders as gloomy about prospects for the land of the rising sun. While the survey still considers conditions to be good for business, there is far less optimism in Japan than one might have hoped for, given the conducive monetary conditions. Perhaps negative interest rates aren’t a panacea after all.

Later on today we get the US labour market report, non-farm payrolls. Economists are forecasting a continuation of robust labour market growth, with 205,000 new jobs expected. In a way this might be the least anticipated report in some time, given Chairwoman Yellen’s comments earlier on in the week. It is clear that the Federal Reserve is retreating from the idea that the US economy as at or close to full employment. I must admit when I initially heard her comments, I thought it was a fudge to justify a more cautious approach to the hiking cycle. But perhaps it isn’t. After all we are seeing the same phenomenon in other advanced economies, not least the UK. Wage growth is anaemic despite very low unemployment rates and it is likely that globalisation is the root cause of it. Workers no longer have the bargaining power they once did and this might enable the economy to operate at much higher levels of employment before workers can feel confident that demands for better pay will be met. As of right now, a company like Procter and Gamble or Nestle, can juggle production amongst a myriad of manufacturing sites around the world. What distinction do they make between an employee in the United States, Mexico or South Africa?

Anyway what does all this mean for currencies? I suspect it might take a bigger positive data surprise to lift the dollar from here. Don’t get me wrong, interest rate differentials should still make the greenback a more attractive bet than holding euros or yen, but betting on a widening of that interest rate spread is becoming a more complicated business. As for the pound sterling, it exists in its own Brexit world at the moment, and bear in mind, the reasons to be more cautious about the dollar also apply to the pound. It is notable that the UK current account deficit data showed a deterioration yesterday despite the weaker pound, in fact the papers report that the deficit is now at a postwar high. If you weren’t already aware of how dependent the UK economy is on foreign capital that should tell you all you need to know! I’m not sure this Brexit debate could be happening at worse time.

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A potential new element of systemic risk has been introduced to the market according the Financial Times (they didn’t characterise it in that way, that’s me). The Hong Kong affiliate of China’s 8^th largest investment bank, Guosen Securities, has defaulted on a renminbi denominated bond (dim sum bond) traded in Hong Kong. The assumption has always been that there is an implicit guarantee from state owned enterprises (SOE’s). This is now open to question and could affect funding for all SOE backed dim sum bonds, and the matter is made worse by the seeming health of the parent company. Are we to distrust appearances now? It wouldn’t surprise me if the yield required by dim sum investors rises after this incident. It would certainly not be unreasonable to demand more return to take the risk in future. This might not sound like a big deal, maybe it isn’t but if investors become reluctant to hold dim sum bonds, we don’t know what the implications could be on the funding prospects of mainland Chinese companies. Just bear in mind that problems with loans started appearing like this in 2007 before the Global Financial Crisis. Not saying it’s the same thing, its noteworthy though, and we know there has been a massive debt build up in China, much of it, not so good…

Still on China, the Asian Development Bank published its Outlook for 2016 yesterday. A slowing China is one of the key risks identified with their forecast for Chinese GDP growth at the low end of the range (6.5%) that the government itself is expecting. A rate rise in the United States is another scenario which could add further downside. Gloom gloom gloom…

The British pound left to its own devices continues to struggle to hold its level. I observed during the brief dollar selloff that whereas EUR/USD had made a new month to date high in the wake of Yellen’s comments, GBP/USD was unable to break its mid-month high, and today it is already trading weaker while other major currencies are roughly flat against the dollar. This all points to a continuation of the pound sterling weakness we have already identified. It is noteworthy that the Japanese yen is also looking a bit fragile at the moment, and some chartists are looking for a new period of substantial yen weakness, with new multi-year highs.

As we mentioned earlier on in the week, we get big data tomorrow, with the US labour market report, non-farm payrolls. But there’s also some interesting data today, in the UK we get an updated Q4 GDP number, and also Eurozone CPI data.

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The focus of today’s blog is exclusively about a market moving speech made by the Chairwoman of the Federal Reserve, Janet Yellen, at the Economic Club of New York. Let’s make no bones about it, the speech was dovish, she seemed to highlight every case doves are likely to make about the US and global economies. It is likely, after this speech that interest rate rises in April are off the table and perhaps even the peak level of interest rates at the end of this hiking cycle might be in question. The bottom line is that the dollar sold off heavily and equity markets rallied. This was unquestionably a boon for risk markets and even the most unloved emerging market currencies like the Russian rouble and Brazilian real have profited at the dollars expense. This is such a broad based rally that its effects are likely to be lasting. Over the coming days we will re-assess our views and the key technical levels we have been monitoring, this could be that important.

Here are some of the key points Janet Yellen made:

• Federal Reserve will proceed cautiously in lifting interest rates
• Fed’s estimate of longer term rate of unemployment might be too high – if this is the case then the US labour market is not as tight as policy makers think, and the risk of wage inflation is less. Basically the current low level of unemployment should not be used as a justification for a rate hike
• Inflation outlook has become more uncertain since the start of the year – while core inflation looks to be creeping higher, inflation indicators are falling. And furthermore there is still no sign of wage inflation. Which supports cautiousness regarding rate hikes
• Weaker than expected overseas growth – the Chinese economy and the oil & gas sector remain big concerns for US policy makers. Both represent potentially significant negative shocks to the US economy, which would justify caution regarding interest rate hikes.

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A very interesting article from the IMF questions the often mooted benefits of lower oil prices on the global economy in the current environment (IMF article). It’s worth a read and they may well have a good point, which is that the disinflationary impact of lower oil prices normally gives scope for interest rate cuts, but that’s not the case in a zero interest rate world.

I heard a disturbing story over the weekend which illustrates one of the less talked about human consequences of negative interest rates. Apparently pensioners in Japan are increasingly taking to a life of crime as living on the income of fixed interest products is not so easy in a negative interest rate world. Someone has figured out that it makes more sense for these pensioners to commit crimes and then be incarcerated as they’ll be looked after by the state once they’re in prison. What a terrible terrible choice!

Let’s get back to currencies though. In the UK we’ve just had the Easter break so Monday was a public holiday. This didn’t stop sterling from moving significantly yesterday as weaker than expected inflation numbers in the United States left traders selling the greenback. GBP/USD jumped about 100pips yesterday but already today we are seeing the dollar claw back some of its losses. It’s worth noting that sterling wasn’t alone, as EUR/USD also bounced, but the extent of the GBP/USD bounce was much greater and might provide some insight into positioning in sterling at the currently. The market might be quite short of it at the moment.

This Friday, being the first of the month, is non-farm payrolls day in the United States. The labour market report remains the single most important data point every month, barring interest rate decisions from major central banks. Economists are forecasting a fairly healthy 205,000 new jobs were added in March. As usual this data will be monitored closely by investors and central banks alike to determine the likely impact on interest rates. Perhaps we should start paying closer attention to all the inflation data we are getting which is looking decidedly mixed at the moment. Even in the event that we would still be talking about a less aggressive rate hiking environment in the United States versus almost every other major economy where rate cuts are more likely to be on the agenda. The case for a stronger dollar remains…

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Already this morning the dollar has made new highs for the week versus the euro, Japanese yen and British pound, as clear a sign of trend as you’re likely to get. Whether it’s a re-repricing of potential rate hikes in the United States later this year or supply demand factors, it’s happening, and we have to deal with it. It actually makes sense when you consider the recent comments of Charles Evans an FOMC member and a known dove, “Two rate increases not at all unreasonable”. That’s where the Fed is right now, 2 rate hikes forecast for 2016. So what does it mean when one of the most dovish decision makers is suggesting that that’s the least they should do? I’m guessing it implies that not only are those two hikes a near certainty but they might not actually be enough. As I mentioned in a recent blog, core inflation in the United States has actually been creeping higher, and so it was interesting that the last FOMC statement appeared to disregard any significant inflationary threat. Is it possible that the Federal Reserve might end up behind the curve on inflation this year? That’s probably not as farfetched as it might seem, let’s not forget that the labour market continues to tighten. One could almost feel sorry for them, considering the tough decisions they’ll have to make.

As I write, GBP/USD is within a few pips of breaking the key level I mentioned a few days ago. While I wouldn’t go so far as to say that it confirms the bearish trend, it does greatly increase the probability that we will indeed see new lows for cable in the weeks ahead. But where cable is concerned it’s important to realise that the move is as much to do with sterling weakness as dollar strength. You only have to look at EUR/GBP which continues to power higher. 0.80 doesn’t seem far away at all now, and we could be there even at some time today!

Elsewhere the Nigerian government looks set to approve a huge budget. You would think that collapsed fiscal revenues could spur belt tightening, but the opposite seems to be true. While I agree with one of the rationales, that Nigeria will never rid itself of its dependence on oil without building the infrastructure required to sustain a non-oil economy, I’m not convinced that a coherent plan has been put in place to achieve that objective. Nor do I have any faith in any government anywhere setting the agenda in terms of industrial policy. It is not yet clear to me what these investments the government wants to undertake are, so I’ll withhold judgment until more facts are available. We only need to focus on trying to understand how the excess government expenditure will be paid for. As things stand we are told that there have been discussions with the IMF and World Bank for loans, but the sums in the budget are so large that surely there’ll have to be other sources of funds as well? Watch this space, we’ll report as we find out, it could have a significant effect on the trajectory of the currency which has been doing reasonably well (relatively!) in recent days.

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A few days ago, I voiced concern about the dynamics of the market potentially making it difficult for the dollar to continue rallying in the short term. It seems that no sooner had I said that the market turned! This is the way of markets, they tests your convictions to the maximum, forcing you to doubt your view, and then it moves, and probably in a way that minimises your profit making potential. Still there is nothing definitive about the current move, we would expect to see key levels taken out before the short term trend can be confirmed.

Here’s the level in cable (GBP/USD). We need to see a break to the downside of 1.4053:

And 1.1058 for EUR/USD:

Yesterday, UK inflation was published, holding steady at +0.3% year on year to February despite forecasts of a modest increase. As some economists observed, inflation is not going anywhere fast in the UK. The markets have now pushed the timing of rate rise expectations back into 2019! So it was no surprise at all that sterling reacted negatively to the news, it fell substantially against a basket of currencies and indeed, EUR/GBP is now testing year to date highs and could easily surpass those levels to make new 12 month highs. As we’ve pointed out many times there is a case to be made for a considerably weaker pound in the coming months, Brexit or no. On the plus side, weaker inflation should give consumers more spending power, but as some economists have also pointed out, this seems to be giving employers the excuse not to raise wages.

Economic realities appear to be catching up with the Central Bank of Nigeria. The weakening of the naira in such an import dependent economy has undoubtedly stoked inflationary pressures, which was confirmed by the higher than expected inflation rate for February published about a week ago. At 11.4% it was the highest level for the measure in about 4 years. With the economy now growing at the slowest rate in well over a decade, it would have been too much of a risk to social stability for the central bank to ignore the difficulties facing the ordinary Nigerian consumer, with poor employment prospects and their disposable income getting eroded by higher inflation. This is probably an attempt of some sort to bolster the level of the naira, or at least defend the official rate, but with demand for dollars vastly outstripping supply in an environment where the central bank is trying to keep hold of reserves, it is unlikely to do much to safeguard the level of the naira in the only market that counts… the parallel market. That said, we have seen some stability come into the parallel market in recent weeks, with USD/NGN, staying in a 320 – 330 range (chart below).

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The equity market rally continues to strengthen and year to date the S&P 500 is now trading in positive territory which is quite impressive all things considered. A month ago some pundits seemed convinced another great recession was beginning. There are key levels that will need to be taken out in order for me to be convinced about the short term sustainability of this rally, not least the reaction highs of December 30^th 2015, but that’s not too far away. It is clear that financial conditions are starting to ease again, so it is perhaps not too surprising that some Fed policy makers, notably Bullard are feeling more freedom to express hawkish views. In a speech on Friday he said “Prudent policy suggests edging the policy rate and the balance sheet towards more normal levels”. It’s quite a tight rope monetary officials will have to walk in the United States, as the reason the equity markets are rallying now is largely due to the belief that rate hikes are less likely. In my view the only thing that changes this is if the data in the United States improves. It’s not been that great recently, with sentiment indicators and PMI’s tailing off. We might start to see a rather perverse situation where strong data frightens the markets!

Bullard, wasn’t the only important policy maker talking in recent days. Germany’s Weidmann, a senior ECB policy maker, is widely known to be a sceptic of the extraordinary policies undertaken in recent times by the European Central Bank. He commented, “Monetary policy is not a panacea, doesn’t replace the necessary reforms in individual countries and won’t solve all of Europe’s growth problems.” I have a lot of sympathy for that view, particularly when you consider that Eurozone banks have been unable to deleverage significantly over the last few years, which is a pretty sorry state of affairs to be honest.

In the UK, the resignation of Ian Duncan Smith, a former Tory party leader, from his ministerial job could see an internal civil war amongst the ranks of the Conservative Party. Whether it affects the government’s ability to properly present the case for Britain staying in the EU is an open question and it is clear that the currency markets see it as damaging. The pound is relatively soft this morning.

China’s central bank governor has voiced his concerns at the high corporate debt levels in China, and how this makes the economy more vulnerable to macroeconomic risk. This is something this blog has mentioned a number of times over the past year as one of the bigger risks facing the global economy in 2016 and beyond. Indeed the BIS (Bank for International Settlements) added its voice earlier this month when it suggested that the steep rise in private and corporate debt emerging market economies was “eerily reminiscent” of situation in advanced economies prior to the global financial crisis. It is right to raise this issue, although it is almost impossible to determine at what point, if ever, this over leveraging issue turns into a full blow financial crisis. One thing is certain, the global economy in its current state isn’t strong enough to cope.

That’s quite a lot of stuff going on, and the key question has to be, what does it all mean for the currency markets? Well it seems to me that the dynamic driving positive risk sentiment also means that the dollar is less likely to strengthen significantly in the near term. Surely only a return to strongly positive US economic data is the only scenario where equity markets and the dollar can rally together at the moment? This doesn’t not mean that the bigger picture case for a stronger dollar has been dumped in the trash heap, merely that shorter term dynamics are now more confusing. Data becomes that bit more important to follow.

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As expected there was no rate change following the FOMC meeting, but that was never what anyone was looking out for, it was always about the statement. It was an interesting statement, The Federal Reserve has retreated from its more hawkish view on the US economy somewhat, and is now only forecasting two hikes this year. For me, the really interesting thing is the fact that core CPI in the United States has now risen to its highest level in 4 years and with labour markets continuing to tighten the statement was actually more dovish than I and many others expected. So much so that the dollar weakened significantly in the aftermath and stocks and bonds rallied. You have to ask yourself, given the markets recovery rally from the start of the year that we’ve seen over the last month, and the fact that the macro data has been supportive of the ‘US is recovering robustly’ case, why be so cautious on the outlook? I can only conclude that there is a genuine concern over the state of the global economy and the Fed has elected to take a wait and see approach. Whatever the reason is, the market looks to be calling the Federal Reserve’s bluff. Despite the fact the FOMC moved closer to the market’s estimation of future US rate hikes the market became even more dovish on future prospects post the announcement.

What does this mean for the dollar? Well… in my view, when the dust settles it still comes down to relative growth prospects and interest rate differentials. The dollar remains the only game in town as far as I can see. As financial conditions continue to ease in the wake of a continuing equity market rally, the Federal Reserve will be given the room to re-assess again. Ask yourself this…where else are you going to deposit your cash? JPY… get ready to pay for the privilege as negative rates erode your capital! EUR… same. GBP… with Brexit hanging over your head? No.. the dollar is it right now. I continue to view these dollar selloffs as the liquidations of short term traders caught offside by negative data. The bullish case for the dollar seems largely intact, if only because the greenback retains the best chance of preserving your capital. That said I am keeping a close eye on certain key levels like 1.44.37 in GBP/USD. Above that and I would have to re-assess the status of the dollar trend.

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Later today the Federal Reserve of the United States will have its Open Market Committee meeting to determine interest rate policy. It is widely expected that rates will be left unchanged at 0.5%, but what will the FOMC statement say? It was always going to be key, but now it’s even more interesting because the excellent retail sales data we saw in the United States in January has now been revised from a surprise +0.2% to -0.4%, putting the resilience of the US consumer to the question. While we should expect the statement to provide us with a more cautious outlook on the US economy, it’s unlikely that the Fed will be as downbeat as some watchers believe. Indeed the recovery in the equity market gives the FOMC cover to present a more hawkish tone if the truth be told, and let’s not forget that the labour market continues to strengthen. In fact recent data shows that lower income groups in the United States are starting to feel more bullish about consuming as increasing job security gives them more breathing room. Don’t forget that lower income groups have a higher propensity to spend their disposable income than the rich. Some Fed watchers think that there is a battle going on within the FOMC between the hawks and the doves, and the hawks have support from influential economists on the outside. The concern is that persistently looser policies are storing up longer term problems for the Federal Reserve so why not bite the bullet now and act? I have a lot of sympathy with this viewpoint, as I’m sure you know. For now I suspect the pressure from the doves will mean continued caution, and there’s nothing wrong with this, the market turbulence at the start of the year means that financial conditions are probably still tighter now than they were in December. The bottom line is that the FOMC will probably need to guide us towards a more hawkish tone before the next move in rates anyway, which probably means that we won’t see further hikes until later in the summer.

It seems that there’s more turbulence ahead for South Africa. You’ll recall in December the government saw three finance ministers in less than a week, not really what you want to see when the economy has stalled and rating agencies are hovering with the risk of the sovereign debt being downgraded to junk! Now there is a new political crisis with the new Finance Minister Gordhan front and centre. His actions in a previous role are being challenged by a special unit of the police. Not surprisingly the rand suffered yesterday, falling 3%. You can’t make this stuff up.

The other giant African economy, Nigeria, is not faring much better. Not surprisingly the inflation data has worsened, with 11.4% in February a 3 year high. This is hardly a surprise given the difficulties facing the naira, and the import dependence of the economy. Here’s a great article from Bloomberg for those who are interested http://www.bloomberg.com/news/articles/2016-03-15/nigerian-february-inflation-soars-to-three-year-high-of-11-4?

In the UK the Chancellor announces the budget just after noon today. It’s going to be tough for Mr Osborne as the outlook has deteriorated a bit. Labour market growth is decelerating, business surveys are stalling and wage growth is anaemic. This will make reducing the deficit that much more difficult, and let’s not forget that there are big political stakes for the Chancellor, his main rival for the premiership, Boris Johnson has set his stall out as the darling of the Brexit MP’s, so Mr Osborne has to use his position to bolster his own claims.

In front of the FOMC meeting later on today, the dollar is inching ahead. As you recall we expressed confidence that there was still a good chance for EUR/USD and GBP/USD to make new lows, the announcement tonight will be key in determining whether this happens or not.

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The full extent of the impact of ECB President Draghi’s post meeting speech has been revealed by the price action of the markets. If there is one lesson to be learnt for future central bankers, it is this… don’t perform an action and hint immediately that it will be the last time that you do so. That’s like not performing the action in the first place! If I seem clear as mud, let me elaborate. The ECB cut rates further into negative territory last week, but in the post monetary policy meeting announcement, Mr Draghi hinted that the ECB was unlikely to make further cuts. In an instant, what should have been remembered as a dovish policy meeting took on a hawkish tone. EUR/USD is still trading above pre-meeting levels, surely this must be counter to the aims of the ECB. I can imagine some northern Eurozone board members frowning at the quantitative easing, shaking their heads at the negative rates, but a lower euro? There would only have been smirks there surely? Not now!

One thing is certainly different in this post-meeting world, and that’s the equity markets. They are unquestionably higher and look to have taken out key technical levels. Further highs look inevitable and possibly a re-test of 2015 levels. The bottom line is that we are back in a risk positive, or if you like.. ‘risk on’ environment. What we don’t yet know is whether the markets can tolerate another slump in oil prices. While technicians I respect are bullish commodities, I remain sceptical of the ability of oil to sustain the current rally. Should the black gold turn again, can the broader market ignore it? Presumably one of the concerns in the recent bout of market turbulence has been fears of some systemic risks brought on by failing loans in the Shale industry in the United States.

If the dollar rally is to continue, this is roughly where I would expect the turn to begin. I remain more comfortable regarding the bearish case for GBP/USD than EUR/USD from looking at the charts. Thematically the case for a continuation in the rally of emerging market currencies looks strong, and I suspect that this will be linked to the sustainability of the equity market rally. Of course there will country specific narratives that might negate the general positive tone. In the case of the naira, the Nigerian currency appears to have stabilised, although as I warned at the start of the year, at a level comfortably above 300. This appears to be the new normal now.

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