Rates as of 05:00 GMT



 Long AUD/JPY  Not that I expect the world situation to improve, just that after Friday’s sharp move, some mean reversion is likely.
• Buy USD/CAD  The resilience of CAD despite the plunge in oil prices over the last two days can’t last. Trade worries may also creep in here.
• Buy gold  Although there may be some mean reversion in FX, I think the fear factor is there and precious metals are likely to continue to appreciate


Market Recap

A risk-off day with a difference:  usually (about 60% of the time), the dollar tends to gain on risk-off, but Friday it was the big loser. Even the “risk on” currencies, such as AUD, gained vs USD.

That’s probably because this last move of Trump’s was just one mistake too far: by imposing tariffs on imports from Mexico, he’s shooting the US in the foot. The US economy will inevitably be hurt. Mexico is the US’ second-biggest source of imports, after China (or third, if you consider the EU or the Eurozone as one unit). In particular, much of what the US imports from Mexico is automobiles and parts ($93bn of the $347bn total in imports). If the maximum threatened tariff of 25% were imposed, that would mean something like a $23bn burden for the struggling US auto industry.

One wonders if these tariffs will actually go into effect, given that if Trump loses Michigan in 2020 he’ll have a hard time winning the Presidency again. But just the fact that he would take the chance sends an important signal to the market.

The impact of the tariffs on sentiment is probably more important than their direct economic effect. Imposing these tariffs on one of the US’ top trading partners just when the US is escalating the US-China trade dispute sends the signal that the Administration doesn’t care about the effects of trade policy on the economy and financial markets, nor even on US politics – or at least that the Administration believes the tariffs won’t lose voter support even if they do impose an economic burden. That tells the market that it may be more difficult for the US and China to reach an agreement than was previously assumed. That’s negative for global growth and negative for the US economy.


Commitments of Traders report

Not so many big moves this week. Notice that speculators are increasing their GBP short positions, but they’re still relatively small historically. Plenty of room to go shorter!

Also notice that MXN longs, although down a bit, are still historically very high. Long and wrong, the phrase is. Also RUB and WTI longs too, even as oil collapses. For that matter, CAD shorts are by no means overextended, either.


Today’s market

The global manufacturing purchasing managers’ indices (PMIs) come out today, including the final versions for the EU and US. The focus will be on Britain, where the manufacturing PMI is expected to fall substantially (in contrast to the services and construction PMIs, which come out later and are expected to be more or less unchanged – both at 50.6, which is why you can only see one dot on the graph). Although the forecast then would be for the composite UK PMI to be more or less unchanged, the market does tend to focus on the manufacturing PMI as the most cyclical, and therefore this would probably be negative for GBP.

The US Institute of Supply Management (ISM) manufacturing PMI is expected to be up slightly, as is the closely watched prices paid index, considered to be a good indicator of future inflation.

The small rise in the ISM PMI would be in contrast to the steep fall in the Markit version of this measure and could therefore change some peoples’ views on the US economy. I think it would therefore be USD positive, although since the survey was taken before the Trump administration’s latest debacle, it may be considered out of date already.

Overnight, the Reserve Bank of Australia (RBA) meets. It’s assumed they’re going to cut rates: the market is pricing in a 99.4% likelihood of a rate cut.

Note in this graph the sharp jump on April 24th of expectations of two rate cuts this year and the plunge in expectations of no rate cut.

That’s the day that the March consumer price index (CPI) data came out, showing inflation trending even further below the RBA’s target range. After that, the only question is, would they cut once this year or twice?

RBA Gov. Lowe basically confirmed the market’s expectations recently when he said in a speech that “we will consider the case for lower interest rates” at Tuesday’s meeting. As Lowe explained it, the RBA has changed its mind about how low unemployment can get before inflation starts rising. Apparently they had thought that the nonaccelerating inflation rate of unemployment (NAIRU) was around 5%, but now they think it’s even lower. That means they’ll have to get the unemployment rate down further if they want to see inflation back in their target range. 

The question then is whether the next rate cut after that will depend on the data, as central banks often say, or will they just repeat the last phrase from the May statement that “the Board will be paying close attention to developments in the labour market at its upcoming meetings.” The use of “meetings” in the plural implies that as long as the unemployment rate is above their new NAIRU level and inflation is below target, they see no problem in cutting rates further. Thus the market may start to discount a rate cut at the July meeting too, which would be negative for AUD.


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Marshall Gittler

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