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GBP up on Tory hopes; RBA speech, Richmond Fed index

Rates as of 06:30 GMT

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Market Recap

It should be a “risk on” day, as the news about US-China trade negotiations is basically good (albeit not that significant) and most stock markets are up slightly in Asia today. But AUD/JPY is barely moved and indeed slightly lower.

The big move of the day was in GBP, which apparently is gaining on increasing confidence that the Conservative Party will win a majority in its own right in the upcoming election – or at least that it will beat Labour. “Sterling was on track for its first one-day gain in a week as Boris Johnson’s Conservatives consolidated their lead in the opinion polls at the halfway point of the UK’s general election campaign,” said the Financial Times. The Telegraph agreed: “General election 2019: Tories on course for 80 seat majority as Boris Johnson warns Corbyn would cause financial crash” “Boris Johnson’s Tories have established their biggest lead over Labour for two years, a monthly poll of polls has revealed,  as the Prime Minister issued fresh warnings about a financial crash under Labour,” said the right-leaning paper.

But other papers disagreed. “Support for the Tories has slipped in a new election opinion poll released after the party’s official manifesto launch,” said Metro News. “The Survation poll put the prime minister’s party one point down on its previous result, with 41% of respondents saying they would vote Conservative compared with 30% for Labour.” “The gulf between the Tories and Labour has narrowed to just seven points with the general election three weeks away, according to the latest Britain Elect poll,” said The Evening Standard.

The BBC and The Economist have websites where you can track the development of polls. The BBC is at https://www.bbc.com/news/uk-politics-49798197 while The Economist is at https://projects.economist.com/uk-elections/poll-tracker/ The Economist page has some neat other graphs where you can see the breakdown of voting intentions by age, occupation, region etc.

Economist summary of polls

Both charts show the same story: Conservatives and Labour gaining, while Liberal Democrats and others decline. The LibDems are the main “Remain” party, so it means less support for rejecting Brexit outright. Labour have promised a referendum if elected. But the way things are going, it looks like the Conservatives are likely to get a majority on their own, in which case it’s bye-bye Europe on 31 January. Note though that that doesn’t mean the end of Brexit; it only means the end of the beginning of Brexit. Then the hard work of negotiating the trade agreement and the future arrangement between Britain and the EU begins.

Elsewhere, EUR was a bit lower after the Ifo survey came in slightly weaker than expected. It tried to rally during the US day but got hit again when the Dallas Fed survey came out better than expected. Surprising to me, because the Dallas Fed survey is the least significant of all five regional Fed surveys – in fact it has no statistical significance in explaining the ISM manufacturing index and I don’t even bother following it. On the other hand, today’s Richmond Fed index is the most important one, statistically speaking (see below). It may be that the timing was a coincidence and the fall in EUR/USD around then was caused by something else. In any case, it looks like the gap in expectations for the US and European economy is driving EUR/USD somewhat now. The gap was closing but in recent days it’s started to widen again, driving EUR/USD lower.

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Today’s market

The day starts out with the last gasp from the Australian day, namely a speech by Reserve Bank of Australia (RBA) Gov. Lowe onUnconventional Policy: Some Lessons From Overseas.” I think this is an important speech, of course for those interested in the AUD but also for everyone else too. That’s because a decade after the Global Financial Crisis, central banks around the world are grappling with questions about the efficacy of the “extraordinary measures” that were “temporarily” put in place then – and are still being used now. Are Quantitative Easing (QE) and negative interest rates really effective, and even if they are, is there a limit to them? Where is the “reversal rate,” the rate at which negative rates start cutting into banks’ profitability so much that they make banks less likely to lend, not more, and negative rates become counterproductive? The latest FOMC minutes for example showed that the staff economists’ evaluation was that “although the evidence so far suggested that this tool had provided accommodation in jurisdictions where it had been employed, there were also indications of possible adverse side effects.” Moreover, all the Committee members agreed that “negative interest rates currently did not appear to be an attractive monetary policy tool” for the US.

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The speech is of course particularly important for AUD. It will probably lay out the likely path that the RBA will take if it has to loosen policy further. You can watch it live if you want – the RBA will be livestreaming it here!

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As you can see, the market doesn’t expect the RBA to have to resort to unconventional policy measures any time soon. It sees only a 26% chance of two or more rate cuts by December next year, and to break that down further, it’s a 21% chance of two cuts to 0.25% and only a 5% chance of three cuts to zero. So the chance of four cuts to -0.25%? It’s not on anyone’s radar screen yet. But one thing we’ve learned in the last few years is “never say never.”

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People who are interested in this speech need to know one important fact about Australia: mortgages there are generally tied to the level of short-term rates, not long-term rates as they are in the US. Monetary policy is therefore transmitted quite directly to the average home-owning citizen.

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The problem is that as interest rates approach zero, the banks have less and less room to cut mortgage rates. Cuts therefore become less and less effective.

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Britain has a similar mortgage system. The solution the Bank of England hit upon to get around this problem was called the “term funding scheme,” or TFS. Basically, the Bank of England would lend to banks participating in the TFS at bank rate if they increased their lending, but would add a surcharge to their rate if the banks’ loans outstanding fell. It’s possible that Lowe will refer to this system and talk about applying it to Australia.

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Aside from that technical matter, the real interest will be in what he has to say about QE and negative rates in the Australian context specifically and in the global context more generally. I expect he’ll say that they’re not necessary right now, but he won’t rule them out at some point in the future (why would he?) Negative rates would seem to be a better fit for Australia than QE, given borrowers’ greater exposure to the short end of the curve. That may worry the FX market and be negative for AUD.

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Speaking of British mortgages, the first European indicator today is UK Finance mortgage data. The market is forecasting a 0.4% drop in mortgage approvals from the previous month. This may be slightly GBP-negative if anyone is paying attention to anything besides the election polls. Frankly, I doubt it.

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After that, we have a boatload of US economic indicators coming out.

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The US advance goods trade balance is expected to show a slight widening of the US trade deficit. Interestingly enough, the market consensus forecast (-$71.2bn) is almost exactly the same number as what you’d need to keep the six-month moving average unchanged (-$70.91bn). Maybe you don’t need a PhD in economics to make these forecasts, just use the “goal seek” function on Excel. Net net this would be no change in the trend and therefore no implications for USD.

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By the way, notice how the forecast deficit compares with the deficit in January 2017, the month that Trump came into office (-\$66.2bn) (red bar). This after a trade war that has sent the global economy into a tailspin. So much winning! It’s true – as predicted, trade wars are easy to win, and we’re winning so much, we’re getting tired of winning!

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The Richmond Fed manufacturing index is coming out. That isn’t as closely watched as the Empire State and Philly Fed indices are, but that’s just because of the timing, I think. In fact the Richmond Fed index is by far the most statistically significant of the five regional Fed indices when it comes to explaining the movement of the ISM manufacturing index, so actually it should be the most important one. (The five indices together explain about 85% of the movement of the ISM manufacturing index.)

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The Richmond Fed index is expected to be down a bit, whereas the Empire State & Philly Fed indices were on average up (Empire State down a bit, Philly Fed up a lot). So this index could call into question the strength of the US recovery a bit, although following Friday’s better-than-expected Markit PMIs for the US, I doubt if it will cause much sharpening of pencils and reworking of forecasts. Slightly USD-negative

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US new home sales are expected to be up 1.0% mom. This is roughly in the same ballpark as the 1.9% mom rise in existing home sales that was announced last Thursday. It should therefore come as no surprise. USD neutral

The Conference Board consumer confidence index is expected to be up 0.9%, pretty much in line with the 1.4% increase that we saw in the U of Michigan consumer sentiment index on Friday. Both indices are pretty amazing, considering that there’s an impeachment hearing going on. I guess this proves that it’s the stock market and the job market, not the President, that affects sentiment. USD positive

Speaking of which, on Thursday when there are no US indicators to discuss, I’ll talk about Trump and his growing health problems, which are really the elephant in the room insofar as US politics are concerned.

Overnight, New Zealand announces its trade balance. The deficit is expected to narrow considerably. That would bring the 12m moving average up a little bit too (i.e., a slightly narrower deficit). Moreover, it’s expected to make it the good way: both imports and exports are forecast to rise, but exports are forecast to rise faster than imports. NZD positive

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DISCLAIMER

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The information and opinions in this report were prepared by Marshall Gittler. Though the information herein is believed to be reliable and has been obtained from public sources believed to be reliable, the author makes no representation as to its accuracy or completeness. This report is provided for informational purposes only and does not take into account the particular investment objectives, financial situations, or needs of individual traders. It is not an offer or a solicitation of an offer to buy or sell any financial instruments or to participate in any particular trading strategy.

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The author may hold positions in any of the currencies that he is writing about. He may also be holding debt or equity securities in any of the markets or issuers he writes on.

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Hyperlinks to third-party websites in this report are provided for reader convenience only. The author neither endorses the content nor is responsible for the accuracy or security controls of those websites.

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‘The key is not to predict the future, but to prepare for it.’ Pericles, 500 BCE

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