Fed Chair Powell to the rescue

Okay, very good morning. Monday, 7th of January. Hope everyone had a fantastic new year. Welcome back. Um, give you a flavor of what I'm going to cover this morning. Really going to focus much more on the news side of things. It's going to give you a bit of a recap of some major headlines, not just from the weekend, but just generally what we had at the end of last year, and a few things to be aware of going forward for the, for the week ahead. We'll submit a weekly strategy report a bit later on, which will include some more technical analysis from the main man, Sam North. But just having a look then this morning, here is the, the euro currency is what I'm looking at here, and we've had a bit of an uptick. But if you look at really the performance of the major currency pairs, there's a bit of a narrative of a weaker dollar. The dollar index down about 3/10 of 1% this morning, and we're going to have a look at a little bit of the reasoning behind that. So dollar weakness does come after we saw a very strong rally on Wall Street to end last week. Obviously, market conditions the first couple of days, kind of that 2nd of Jan, 2nd, 3rd, 4th, pretty light, so you tend to see some pretty volatile swings in the market, and you can see that by the, the kind of percentage increment changes that we were seeing towards the back end of last year. It was pretty crazy really, which is obviously fantastic if you're trying to take advantage of short-term intraday moves. But the point being here on Friday is that all 3 major US stock indices gained more than 3%. You can see here, well, obviously that did occurred a few times recently, but generally speaking, this is far up high on the, the upper bound of price activity when all three majors see such a large coordinated move. So the back of that, the main reason is, as is always with market direction, uh, really it's monetary policy being the, the real key driver. And that's because the Fed chair spoke alongside some of his predecessors. So I think it was a conference that had Yellen and Bernanke, and he was talking, and he basically was looking at the Fed's balance sheet policy, added context to the comment that its wind-down was on autopilot. That kind of spooked the market a little bit, where economic activity in, in the last couple of weeks of December was noticeably slowing in the US, and people were looking for potential dovish tones, if you remember, from that December Fed meeting when they hiked for the final time. And that didn't really materialize, but he's kind of been a little bit more flexible on that commentary now to alleviate some of those negative tensions that were certainly mounting towards the end of last year. So Powell said the Fed will be flexible on policy and is in no hurry to raise interest rates. So this is what you call, I guess, verbal intervention, just giving the, the general downside that the US equity market in particular was seeing towards the back end of last year. The Fed kind of just soothing market sentiment by sounding a little bit more dovish, irrespective of the fact that obviously their dot plot and their forecast of 2 rate hikes still remains in play at the moment. Now, what's been quite interesting is actually if you start looking at the, the short end in the federal funds rate futures, you can see here we do actually have a Fed meeting at the end of the month. There is actually a very, very small amount of the market pricing an interest rate cut from the Fed at the end of the month. I can pretty much tell you now that's not going to happen, not unless something black swan event occurs between now and the 30th of January as highly unlikely. As you can see here, overwhelming market pricing here, almost 100%, is for a hold. Remember, the key ones here— well, a distinguished or key thing to be aware of that makes things very different in 2019 is that every Fed conference now, or every Fed meeting, has a press conference. Jerome Powell. This was not the case in 2018 and does bring about a prospect that some will believe that every meeting now could be deemed as a live one because he has the ability to add some further clarity and transparency to their communication. But January's— we're not expecting too much here. So really, the summary of economic projections still is on the quarterly basis, so March, June, SEP, DEC. So if you start bre— Bringing this out to March, still very much so. Now, just given some of the developments and commentary from the Fed and the economic data, still looking at a hold. We go out to June, well, actually it starts to become a little bit more mixed then as to market opinion, because we've got 5% basically anticipating a cut of 25 basis points. There's a 5% looking for a hike of 25 basis points, because don't forget the Fed at this point at least are still saying that they're going to deliver to, but the market at the moment is looking at, well, look, at least the first 6 months of the year the Fed's got to be on hold. You start getting out to September, well, look, there's even people looking for 2 rate cuts by September, very small percentages, mind. So this is obviously way more dovishly priced than what the, the Fed's official, um, line is at the moment with that rate hike trajectory. However, Powell's comments have come to kind of save the day in some respect at the moment. What has that meant? Well, a lot of the big banks have been out and kind of reevaluated their calls. Goldman Sachs issued a note at the, uh, on, on Saturday actually, following the speech from Powell on Friday and basically said the dollar is poised to decline. Uh, they said that Powell's comments on Friday boosted the chances that the central bank will pause interest rate increases. Um, Powell cited events of 2016, and anyone who was in the market then, you'll remember there was kind of two real things that were happening at that time. That was when the Fed hiked in December 2015 and said they would deliver four in 2016. And the unexpected fears of a hard landing in China, and then the unexpected result of the EU referendum meant that they weren't able to hike during that Q1, Q2, and Q3 period, and they only did 1 out of 4 that they promised. And so they're kind of looking at it potentially then, the fact that Powell cited those events previously as a, as a sign of much more flexibility rather than just being strict to stay the course of the, the party line that they've communicated officially. That as well, and they note that combined with softer or net softer US data. Now with that in mind, this was one thing that if you weren't in the market last week, you probably would have missed, and this was the ISM Manufacturing PMI. Now this was really interesting because as you can see on the chart here there was a, a collapse in manufacturing PMI in the US. It was the weakest since November 2016. It missed expectations by a large margin. So it was 54.1 was the print, it was expected at 57.9. One of the most worrying parts of this though is obviously ISM, that's the headline figure, it's made of constituents, one of which when forward-looking indicators, like whether it's leading indicators itself and economic data, or this inversion of the yield curve that's been happening, indicative of a slowdown in the future and an impending recession. Well, the one thing that people look at in the ISM reading is the new orders constituent. Now, we had the largest monthly drop since October 2008 as growth in new orders, production, and employment slowed sharply. So you know, sizable drops that haven't been seen since the global financial crisis. And that new order level getting ever so close to, um, the 50 kind of lower bound level, which makes people nervous that going forward, uh, people are already hesitant in putting those new orders into action, thinking that the economy is going to slow, which can be a forward-looking indicator as to the economic environment in the future. So this kind of weak data with the Fed and the Powell comments actually has had quite a meaningful response in the, in the equity market. I was looking at the S&P this morning and you can see from where we were— well, let's just quickly measure it from that low that we printed in December. Just give me one second. I just want to see how much percentage-wise that we've bounced. I mean, from that low We've bounced, you know, almost 10%, albeit it's a, it's a long way off seeing a full retracement of the entire move that we had. I mean, let's just have a look from the all-time high that was right at the beginning of October to that low. So there's a couple of points here, I guess, of technical interest. As we've come higher, you can see the market has responded somewhat to the, the initial dip that was seen in early part of April. You've also got the 38% retracement of the entire move from the all-time high to the, uh, the bottom of the rout that was seen in December, which comes at pretty much the same level. So you can see here the market has responded, having hit that and then pulled back, and we're kind of locked within that band now between that price point and then what was the previous lows of 2018 before that December breach that were in February. And so you're kind of looking at that price range now between $25,000, $30,000, and $52,000, some of the near-term going forward for the, for the coming days. As we move further higher though, if we are to see a more meaningful recovery going ahead this week or beyond, then I'd say there's some pretty key— there's a key area as well of, I guess, potential resistance for the market, and that would be if we do get our heads above this 52 area, then it starts to come in around the kind of 93 to the 2600 mark. So kind of around here, that being just previous areas where the market has responded on multiple times before. So certainly a dovish Fed, but with economic data not collapsing could now start to be actually a positive for markets. By that, what I mean is if Powell was not dovish but was remaining quite neutral and the economic data was faltering but the Fed were committed to remaining on track to tightening, that's what creates that equity weakness. But now Powell's changed tact and become a little bit more dovish Well, then good data actually then will come as well. Is that going back into this kind of Goldilocks scenario where the Fed are going to be backing off quite slow and gradual, but the economy actually is not as bad as we may have anticipated? Now, with that being in mind, what came to the, uh, on Friday as well was non-farm payrolls. And non-farm payrolls, uh, absolutely knocked it out the park. We had a headline reading of 312 thousand. Market expectations were for 177,000. So yeah, absolutely blew out the forecasts. And you can see here, we've not printed really that high going back to almost right at the beginning of, of 2018. Job gains: healthcare, food services, drinking places, construction, manufacturing, retail trade. So job— decent, strong job performance there. in the US. And then on the back of this, you actually had quite a, a strong number as well of average hourly earnings, which you can see here moved back up to the— towards, uh, a repeat of the highest levels of 2018. It was printed in the summer, in August, uh, that lifted the annual increase in wages to 3.2%, matching the fastest pace since 2009, seen in October. So hence the reason why at the moment the Fed still have those, those 2 rate hikes kind of baked in. Um, okay, let's have a look at a few other things because I want to take too much of your, your time this morning because I know some of you were in the market from last week. But this was another major headline. The market's kind of got over this at the moment, but it's certainly something to be aware of because we did see quite an extreme down day when this did come out. This was going back to, uh, kind of the literally the new year. And this was because Apple fell about 8.5% after market, uh, and it dragged the entire Wall Street lower the following day. And this was because Apple came out with a sudden warning to investors, basically lowering its first quarter revenue guidance. And it's the first time that's happened in a long time. And they were kind of pinpointing that weakness on the back of the slowdown in China in particular. And that being said, that's the other factor to be aware of to really get you up to speed of what's been going on if you have been away over the Christmas New Year break, is the Chinese PMIs of course have fallen now into contractionary territory, which certainly also heightens this, this concern about global economic growth. So we were certainly in quite a negative setup as the new year got underway, but Jerome Powell kind of rode in with his white horse and has saved the day and certainly helped prop things up. And we saw a big rally on, on Friday. Okay, other things are, and this is the week ahead because then we can start looking at some other key things like Brexit we've not even mentioned as yet. But looking at the schedule for today, so for Monday we've already had German factory orders. And in fact, if I quickly jump over to here, German factory orders were particularly disappointing this morning. Industrial orders dropped 1% month on month, worse than market estimates, and it was the first decline in factory orders since July. But as you've seen, markets have largely brushed that aside because they're still kind of taking the baton from the positive Asia-Pacific performance, but following on from that stellar rally on Wall Street we had at the end of last week. The other thing to be aware of as well from overnight is that not only those Powell comments, but we've had some news from China where the People's Bank of China cut the reserve, or the required reserves for banks, so helping add some liquidity to the system. And this fits that narrative since really November of 2018, where the Chinese central bank and government have been pretty clear that they're willing to do everything and anything in order to, to quell the kind of, um, the negativity in their markets throughout what we were seeing in 2018. I did see an interesting headline this morning in the FT, and this is how China rolls, is they've just outlined a new $125 billion railway project that they're gonna now decide that they want to do. You know, this is, this is the way that China deals with an economic downturn. It just opens up the wallet and starts spending, which is certainly what they've done in the past. As long as that continues to happen, they remain committed to that, and the central bank remains also committed to doing these, um, kind of, let's say, mechanical measures to help support the economy, then that should help eliminate some of those growing concerns about global growth because China is obviously really critical to that equation. One thing then, talking about China, that really has been fairly quiet but certainly you need to be mindful of through Monday and Tuesday, and that's trade delegation from the US travel to China today, and that continues tomorrow. Um, now the trade war obviously is one of the key risks for, um, Q1, given the end and lapse of that 90-day kind of temporary truce where obviously Trump was backing off, um, changing the tariff percentage levels of certain goods for from 10 to 25%, he kind of delayed that. And so there's still yet to be a concrete resolution found. However, another thing that really does help sharpen the mind in order to progress a negotiation is an economic fallout. If the economy in China and the US starts to suffer bad enough, well, no surprise he starts to see progression in talks between Trump and Xi Jinping happen awfully quickly, and they have been making some positive noises over the last week. So looking out for any comments from that. Otherwise, for the rest of today, not too much coming out. US ISM non-manufacturing, that will be this afternoon. Tuesday, a couple of things. German, well, industrial production. We've had some of the data, factory orders from this morning has been a little bit weak. But I guess as a theme throughout this week, you're going to get some, a little bit of evidence about the economic health of Europe. So that does need to be, to be monitored. Otherwise, Tuesday is fairly slow in terms of major data. Wednesday, it starts to get a little bit more interesting because after the Christmas recess, of course, parliamentary members return to the lower house of Commons to start their debate over Theresa May's Brexit plan. Now, let's have a look at that and what's in store. This was some of the headlines. So if anyone watches the Andrew Marr Show, at the weekend Theresa May appeared and she really didn't say anything new at all. Obviously all the questions are, "What are you gonna do when your vote fails?" which is still the baseline kind of expectation at the moment. Now just to give you an update, what happens is they're going to be debating her Brexit plan from Wednesday, so Wednesday, Thursday, Friday, and actually the BBC have reported this morning that UK government are to hold the meaningful vote itself itself next week on the 15th, which I believe then would be the Tuesday. So that's the current schedule, but I would say be ready for that to probably change. Now, one of the headlines here Bloomberg are running is UK lawmakers ratchet up the campaign to avert a no-deal Brexit. The point being here is that there are various options now that we can look at. And of all of these options, I think one of the most— one of the one things that all parties can agree on is really the aversion of a no deal. And this is really what this is, this is talking about. But that does leave other options then of where do we go from here. A couple other headlines though to be aware of on the Brexit situation. This was in The Telegraph. This was talking about Theresa May is poised to to play for time by further postponing a final vote on her Brexit deal next week. So again, just to be aware of, I think if you are trading the pound, then obviously volatility is going to continue. We're at a real key moment in time for the prospects for the pound on whether or not we come to the, um, you know, through this this vote period into March 29th is going to be critical whether we see either quite a strong move lower or a real meaningful recovery and relief if we are— if we do manage to move into that transition period. So a delay of the vote could be something to be looking out for. And this was the other thing, uh, that the Times were reporting at the weekend: an all-party group of senior MPs will launch an audacious attempt to derail no-deal Brexit this week by starving the government of cash, creating a Donald Trump-style shutdown. So yeah, you start to— I mean, there's a vote basically happening on Tuesday. They'll vote on two amendments to the finance bill that would lead to a gridlock in Whitehall. So you basically try to leverage this against the Prime Minister to force her into then making concessions and so on. All of this then in an aversion of a no deal. Now, ING did a really good graphic. I did send this out to you in your morning research, so I'll also put it in the chat room afterwards. But I thought this was quite good because it just kind of summarizes the various different options. I'm not going to go into this in too much detail because you can read in your own time. But the options being PM May's deal is approved, a second referendum. Now obviously a second referendum is not the baseline scenario but has been an option or a potential that's been growing. One of the things here is I was doing a little bit of research on this last week and I came across this, and this was basically the really thorough analysis done for the Institute for Government. And basically it was looking at— my question was, well, if there's going to be a second referendum, then how quickly can that happen? And this is obviously— there's many other issues with a second referendum that we discussed before, such as what would the question be. But as timing goes, basically there needs to be a legislation period of where it needs to be brought forward that they want a second referendum. It then needs to be asked, what is the question? That then needs to be reviewed and voted upon. That needs to then go through the House of Commons and the House of Lords bill stages. It then needs to go into a campaigning period where political parties must apply to the Electoral Commission. Then there's a campaigning period. it's actually quite a long process if that was going to happen. And even with the best will, the minimum period needed for a second referendum— granted, we've not even got to that point yet— would be 21 weeks. That's well beyond then, Article 50, and we'd need to delay that, push it out. But one would think that Europe would agree if then there has been a parliamentary vote that that is indeed the way going forward. The EU referendum in 2016, obviously David Cameron's pledge, that actually took 56 weeks to get the referendum sorted to have the vote. So obviously this could be, this could be a meaningful delay to the entire process if that was going to happen. Norway-style deal, snap elections, no deal. So I'll let you have a look at this in your own time. What would this mean for pound? Well, I mean, everyone's kind of waiting at the moment. I mean, you can see even from the end of last year— let me just remove some of these lines because I'm just going to pinpoint these two price points here for no other reason than I just want to show you the extremity of the price movements. You've gone from 25 to almost a 29 handle, and it kind of shows the state of what really is going to be increased volatility for sterling as we go through these real important pivot points in the Brexit process. The lower bound, obviously there's, there's a real critical area down here, the kind of just sub the 25 handle which was that 3rd of Jan low that we had in very thin trading conditions. But on the upside, obviously, if we did manage— if she somehow manages to go through all of this— and one of the things has been is if the meaningful vote fails, it's not a case of really that Theresa May is going to step aside. A lot of the reports at the weekend were suggesting she could come back as many as 30 times. To basically go back, try again with Europe, come back, go again, come back. But obviously time is of the essence here because at the moment we are still due to have a no deal on March 29th as things stand at the moment. So something will need to give in the interim period. Okay. Finally, just wrapping up the headlines, Trump— this whole impasse over his funding for the border wall goes on. We thought we were kind of over this last week, but what he's basically saying, and this is the kind of the quite unique thing about the political structure in America, is that the president holds the power in certain situations where if it is declared a a national emergency, i.e., he could basically say that the country is under threat, so then he could basically veto any decision that comes out of Congress and go ahead and basically turn around decisions that their Parliament makes. So Donald Trump has edged closer towards a radical move to fund his border wall after the prospects of a deal with the Democrats to reopen government dimmed and the president's political leverage appeared to dissipate. So on Sunday, he renewed his threat to bypass negotiations with Democrats and instead declare a national emergency on the southern border with Mexico, according to people familiar with the matter. So again, this— if that is the case, you know, just political more noises out of Washington. I think the market's largely over this. Because ultimately, as far as— as long as government is funded and running, that's what they care about. This kind of Trump shenanigans is kind of business as usual, I would say. And then this was another graphic I just wanted to show you. Let me just make my screenshot a bit smaller so you can see what I'm talking about. This is— if I switch it back over— something that I saw over the Christmas period, and this is looking at basically 5-year default probability of 3 countries. And this is really looking not so much for today but going forward for Q1. What we've got here is a yellow line which is France, the green line which is Italy, and the blue line which is Germany. As you can see here, Germany— I know it's quite difficult to see, but it has risen through the period of Q4, certainly as big question marks have been asked about Deutsche Bank. And just given how relevant and systemically important that institution is, then it's increased by net default, uh, the, the prospects then of the cost of insurance, if you like, for potential German 5-year default. But the interesting one here is the convergence of the green and the yellows. Now, the green was the most, I guess, consistent story of much of 2018. That, of course, was of the hung parliament in Italy, which led to the formation of a government which had quite radical social reform proposals which required heavy amounts of additional debt burdens, which by net default then raises the prospects of them not being able to, to service their, um, their obligations. Now from that you can see then, uh, we had big spikes up in the, the Italian 5-year default probability. However, that came off quite dramatically as headway was made between European Commission and Italy falling in line. The more worrying one, and I think the one that still needs watching over the coming weeks, is this one, which is France. And following on from the, um, the very violent protests that had been seen in France at the end of last year, which kind of forced Macron into making several concessions of his own social reforms, which come at a cost which then actually puts them in a worse, um, kind of situation in terms of their, their fiscal side of things. Well, then actually you've seen their default risk rising and almost coming in very close proximity to a level of which would be akin to Italy. So this is definitely a story, um, we talked about this in our 2019 outlook, um, the economic anticipated slowdown in Europe as defined in the ECB's own projections, as well as economic data we've been seeing in Europe in, um, localized PMI data, uncertainty in politics emanating particularly from France and Italy, uh, and this all coming at the end of quantitative easing from the ECB does bring about some really interesting, um, period for European assets going forward. Okay, finally, quick look back at the week here. So we talked about Wednesday is when those Brexit talks recommence. Thursday, I've highlighted down here, you've got Fed's Powell is speaking. You do also have the— this week you've got the FOMC minutes on Wednesday. You've also got the ECB minutes on Thursday. So just to be aware of. And then on Friday, you've got things like US CPI, which could be quite interesting as well to watch, just given the focus on— renewed focus on economic data. All right, gonna leave it at that and wish you guys a good day. Welcome back, good to be back, and we'll have the weekly strategy issue issued to you in the next hour or so. Have a good one.