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The US dollar finally finds some friends

The US dollar finally finds some friends

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The US dollar rallied strongly versus the major currencies overnight, notably against the Japanese yen, which weakened by over 1.20%, USD/JPY closing at 105.80 on Friday. That said, I cannot find one piece of news to explain the sudden rally. What is notable is that a bullish USD/JPY outside reversal day was traced out. Today, USD/JPY spiked above 106.00 before returning to 105.80, likely on stop-loss buyers and thin early morning liquidity. USD/JPY should target a return to 106.60 initially.

In a volatile session, the dollar index rose o.53% to 93.46, narrowly avoiding tracing out a bullish outside reversal day itself. The dollar index is unchanged in Asia after spiking higher in early trade but is targeting a return to 94.00 before we reassess direction.

EUR/USD touched 1.1900 before sellers emerged, pushing the single currency back to 1.1775. Sterling also rallied, reaching 1.3170 before falling to an unchanged 1.3070. Selling in the EUR/GBP cross appears to have exaggerated the euro’s fall while limiting the damage on sterling. From a technical perspective, both seem poised to retreat further, with initial targets at 1.1700 and 1.3000 respectively.

A stronger US dollar and Covid-19 fears have torpedoed the Australian dollar, dragging the New Zealand dollar with it. The AUD/USD has formed a formidable top at 0.7200, as has the NZD/USD at 0.6700. Both look likely to ease further in the first half of the week.

Regional currencies, having only bought into the US dollar rotation late in the day, has outperformed as a result. Across Asia, having eased only slightly on Friday, Asian currencies are almost unchanged today. It appears that a dollar correction will fall heaviest on the G-10 family.

Overall, the underlying reasons for the US dollar sell-off remain firmly intact. However, nothing moves in a linear fashion forever, and this week seems likely to feature more dollar strength than last. A weak Non-Farm Payrolls print on Friday could extend the dollar strength into next week on haven flows.

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Hedge Fund CIO: How Will The Fed Do QT? Each Crisis Has Increased Markets’ Dependency On Fed Liquidity

Hedge Fund CIO: How Will The Fed Do QT? Each Crisis Has Increased Markets’ Dependency On Fed Liquidity

By Eric Peters, CIO of One River Asset…

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Hedge Fund CIO: How Will The Fed Do QT? Each Crisis Has Increased Markets' Dependency On Fed Liquidity

By Eric Peters, CIO of One River Asset Management

“The Fed is “all in” on re-establishing price stability,” Fed Governor Waller pronounced in pleasantly direct language. “Experience has shown that markets need time to adjust to a turn from accommodation to tightening.”

In response to questions, Waller spoke with blunt determination: “I don’t care what’s causing inflation, it’s too high, it’s my job to get it down. The higher rates and the path that we’re putting them on, it’s going to put downward pressure on demand across all sectors.”

Powell offered his own sober message, “A soft landing is our goal. It is going to be very challenging. It has been made significantly more challenging by the events of the last few months – thinking of the war and of commodities prices and further problems with supply chains.”

New York Fed economists provide a bit more precision, arguing that “the chances of a hard landing are about 80%,” starting in Q4 2022.

Something will break. Something always does.

Digital did and the regulatory landgrab has started in full force. Lagarde, with plenty of serious policy decisions ahead, observed that “crypto assets and DeFi have the potential to pose real risk to financial stability.”

Spain’s Minister of Finance, Montero, announced digital asset owners would need to declare holdings and trading “in anticipation of regulations that would soon be carried out throughout the European Union.”

The East-West divide is clear in policy focus. President Xi is focused on growth, vowing to “strengthen macro-policy adjustment and adopt more effective measures to strive to meet the social and economic development targets for 2022 and minimize the impacts of Covid-19.”

Strains in emerging markets are being managed from within. Sri Lanka’s 22mm people are in the most severe economic crisis in nearly a century and India’s Foreign Secretary Kwatra underlined, “India stands ready to help Sri Lanka through promoting investments, connectivity and strengthening economic linkages,” beyond the $4bln aid already provided.

The East-West center of gravity between global war and peace sits in Kaliningrad, a tiny Russian province pressed between NATO countries. Lithuanian President Nauseda offered that “Russia cannot be stopped by persuasion, cooperation, appeasement or concessions.”

Elevated rhetoric continued when Russia’s Foreign Minister Lavrov drew comparison to Hitler’s war against the Soviet Union. “The EU and NATO are bringing together a contemporary coalition to fight and, to a large extent, wage war against Russia.”

* * *

Liquidity Unknowns I: How much QT is too much QT? We don’t know. There is no tidy math formula, no general equilibrium model, no linear approximation that will tell you. The trouble is, in a world of false precision, everyone wants a number. And policymakers have a hard time saying, “we don’t know,” especially when it’s true. Through the week ending June 22, balances with Federal Reserve Banks – previously known as ‘excess reserves’ – stood at $3.115trln. Powell guided the market that the end point for the Fed balance sheet would shrink another $2.5trln to $3trln. How does that math work?

Unknowns II: Yet again new tools were needed in this cycle. To make sure rates didn’t fall below the Fed’s floor, they needed a broader mechanism to absorb excess liquidity. That mechanism was private sector access to the reverse repo facility. Remember the 2018 period of QT. Excess reserves were $1.9trln before liquidity conditions started to bite in September. Private sector reverse repos were basically zero. Today? $2.5trln. The Fed’s liabilities are acting as the riskless asset to private money funds in a way. The Fed clearly thinks reverse repos will decline. We don’t know. Behavior could drive it up if everyone wants liquidity and wants to face the Fed. As reverse repos rise, excess reserves decline. QT has more liquidity plumbing risk today – tools can turn into weapons.

Unknown III: The risks are different but the strategy with QT is the same – start small, increase gradually, and then let it run. It isn’t the obvious choice. Reducing the pace as liquidity is withdrawn is a more natural path – you typically slow as you approach a stop sign, after all. We will know when the tightening – both in liquidity and interest rates – has gone too far. Weak links will break. Digital plays the role of EM in this cycle – big enough to be noticed, not enough to get policy to stop. Asset deflation, a USD credit crunch, and risks from maturity transformation has led to capital controls with 11 digital intermediaries. As in the Asia Crisis, the ecosystem will respond to gain independence and resilience.

Unknown IV: Digital is the warning sign, not the circuit-breaker. Typical candidates – a rapid rise in the US dollar, EM currency and debt crisis, and banking strain – are just not applicable. After each crisis is a response, and those responses act like a vaccine against future ‘shocks.’ Emerging markets have insulated themselves with large holdings in the US dollar. Currency depreciation forced EM central banks into more orthodox positions well ahead of the Fed, ECB, and BOJ. Banks don’t have the space to make the mistakes of the GFC, with leverage financing pushed to capital markets. But markets have not been weaned from liquidity. To the contrary, each crisis has increased dependency on Fed liquidity.

Unknown V: The adjustment in broader markets is orderly. How else would it be? Disorder is how it ends, not how it starts. “It is like jumping from the 100th floor of a building and saying, ‘so far, so good’ halfway into the drop,” a prolific investor remarked when confronted with “contained” language head of the GFC. Liquidity transformation in traditional markets, the driver of digital weakness, is everywhere. And it is a so-far, so-good story. ETF discounts make the point emphatically. An illiquidity pocket means that ETFs would clear the way closed-end funds do – hunting for a price where a buyer is willing to absorb the liquidity risk. Mortgage ETFs are down 9.7% for the year and trade exactly on net asset value. So far, so good.

Unknown VI: What we can see is rarely the problem. The grandest mismatch resides in private markets. “Prior to the pandemic, many had already grown concerned about public market valuations and were exploring private capital markets in the hopes of addressing lower return projections for their traditional 60/40 portfolios.” Pronouncements like these became the norm. A generation of “J-curve” investors – the pattern of private investments to draw capital and then deliver rapid returns – was born. Everyone wants a liquidity buffer. Nobody has one. And in the everything bubble, to get one you are selling assets in the hole. You sell what you can. You promise never again, even if enticed by the Fed toolkit. Until it happens again.

Tyler Durden Sun, 06/26/2022 - 21:13

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Government

40,000 National Guard Troops Face Unemployment As Vaccine Deadline Imminent

40,000 National Guard Troops Face Unemployment As Vaccine Deadline Imminent

Up to 40,000 Army National Guard troops – around 13% of the force…

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40,000 National Guard Troops Face Unemployment As Vaccine Deadline Imminent

Up to 40,000 Army National Guard troops - around 13% of the force - could be fired for not getting the mandated COVID-19 vaccine (which has limited efficacy against Omicron, doesn't stop transmission, has been linked to elevated heart problems, and has been mandated for a healthy demographic that rarely dies of the disease).

Michigan Army National Guard Sgt. Mark Abbott administers a COVID-19 vaccine

Guard soldiers have until Thursday to get the jab, according to the Associated Press, which notes that between 20% and 30% of Guard soldiers in six states remain unvaccinated.

"We’re going to give every soldier every opportunity to get vaccinated and continue their military career. Every soldier that is pending an exemption, we will continue to support them through their process," Lt. Gen. Jon Jensen, director of the Army National Guard, told AP. "We’re not giving up on anybody until the separation paperwork is signed and completed. There’s still time."

Last year, Defense Secretary Lloyd Austin ordered all service members to get the vaccine, with different branches maintaining different deadlines for the jab. The Army National Guard was given the maximum amount of time, largely because its roughly 330,000 soldiers are scattered throughout the country, including remote locations.

The Army Guard’s vaccine percentage is the lowest among the U.S. military — with all the active-duty Army, Navy, Air Force and Marine Corps at 97% or greater and the Air Guard at about 94%. The Army reported Friday that 90% of Army Reserve forces were partially or completely vaccinated.

The Pentagon has said that after June 30, Guard members won’t be paid by the federal government when they are activated on federal status, which includes their monthly drill weekends and their two-week annual training period. Guard troops mobilized on federal status and assigned to the southern border or on COVID-19 missions in various states also would have to be vaccinated or they would not be allowed to participate or be paid. -AP

Complicating matters is a rule that Guard soldiers deployed on state active duty may not require a vaccination, depending on state-level mandates. 

According to the report, at least seven governors have asked Austin to reconsider, or drop, the vaccine mandate for National Guard members - with some having filed or joined lawsuits to that end.

Austin, apparently following his own special brand of science, told them to pound sand, saying that Covid-19 "takes our service members out of the fight, temporarily or permanently, and jeopardizes our ability to meet mission requirements," adding that troops will either need to get vaccinated or lose their Guard status.

"When you’re looking at, 40,000 soldiers that potentially are in that unvaccinated category, absolutely there’s readiness implications on that and concerns associated with that," said Jenson, adding "That's a significant chunk." 

AP reports that around 85% of Army Guard soldiers are fully vaccinated, while 87% are at least partially vaccinated.

Tyler Durden Sun, 06/26/2022 - 18:00

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Government

The End Game Approaches

The pendulum of market sentiment swings dramatically.  It has swung from nearly everyone and their sister complaining that the Federal Reserve was lagging…

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The pendulum of market sentiment swings dramatically.  It has swung from nearly everyone and their sister complaining that the Federal Reserve was lagging behind the surge in prices to fear of a recession.  On June 15, at the conclusion of the last FOMC meeting, the swaps market priced in a 4.60% terminal Fed funds rate.  That seemed like a stretch, given the headwinds the economy faces that include fiscal policy and an energy and food price shock on top of monetary policy tightening. It is now seen closer to 3.5%.  It is lower now than it was on when the FOMC meeting concluded on May 4 with a 50 bp hike.  

In addition to the tightening of monetary policy and the roughly halving of the federal budget deficit, the inventory cycle, we argued was mature and would not be the tailwind it was in Q4. While we recognized that the labor market was strong, with around 2.3 mln jobs created in the first five month, we noted the four-week moving average of weekly jobless claims have been rising for more than two months.  In the week to June 17, the four-week moving average stood at 223k.  It is a 30% increase from the lows seen in April.  It is approaching the four-week average at the end of 2019 (238k), which itself was a two-year high.  In addition, we saw late-cycle behavior with households borrowing from the past (drawing down savings and monetizing their house appreciation) and from the future (record credit card use in March and April).  

The Fed funds futures strip now sees the Fed's rate cycle ending in late Q1 23 or early Q2 23.  A cut is being priced into the last few months of next year.  This has knock-on effects on the dollar.  We suspect it is an important part of the process that forms a dollar peak.  There is still more wood to chop, as they say, and a constructive news stream from Europe and Japan is still lacking.  The sharp decline in Russian gas exports to Europe is purposely precipitating a crisis that Germany's Green Economic Minister, who reluctantly agreed to boost the use of coal (though not yet extend the life of Germany's remaining nuclear plants that are to go offline at the end of the year), warns could spark a Lehman-like event in the gas sector.  

At the low point last week, the US 10-year yield had declined by around 50 bp from the peak the day before the Fed delivered its 75 bp hike.  This eases a key pressure on the yen, and, at the same time, gives the BOJ some breathing space for the 0.25% cap on its 10-year bond.  A former Ministry of Finance official cited the possibility of unilateral interventionWhile we recognize this as another step up the intervention escalation ladder, it may not be credible.  First, it was a former official.  It would be considerably more important if it were a current official.  Second, by raising the possibility, it allowed some short-covering of the yen, which reduces the lopsided positioning and reduces the impact of intervention.  Third, on the margin, it undermines the surprise-value.  

Ultimately, the decline in the yen reflects fundamental considerations.  The widening of the divergence of monetary policy is not just that other G10 countries are tightening, but also that Japan is easing policy.  A couple of weeks ago, to defend its yield-curve-control, the BOJ bought around $80 bln in government bonds.  The odds of a successful intervention, besides the headline impact, is thought to be enhanced if it signals a change in policy and/or if it is coordinated (multilateral).  

There are a few high frequency data points that will grab attention in the coming days, but they are unlikely to shape the contours of the investment and business climate.  The key drivers are the pace that financial conditions are tightening, the extent that China's zero-Covid policy is disrupting its economy and global supply chains, and the uncertainty around where inflation will peak. 

Most of the high frequency data, like China's PMI and Japan's industrial production report and the quarterly Tankan survey results, and May US data are about fine-tuning the understanding of Q2 economic activity and the momentum at going into Q3.  They pose headline risk, perhaps, but may be of little consequence.  It is all about the inflation and inflation expectations: except in Japan. Tokyo's May CPI, released a few weeks before the national figures, is most unlikely to persuade the Bank of Japan that the rise in inflation will not be temporary.  

With fear of recession giving inflation a run for its money in terms of market angst, the dollar may be vulnerable to disappointing real sector data, though the disappointing preliminary PMI likely stole some thunder.  The Atlanta Fed's GDPNow says the US economy has stagnated in Q2, but this is not representative of expectations.  It does not mean it is wrong, but it is notable that the median in Bloomberg's survey is that the US economy is expanding by 3% at an annualized rate.  This seems as optimistic as the Atlanta Fed model is pessimistic.  May consumption and income figures will help fine-tune GDP forecasts, but the deflator may lose some appeal.  Even though the Fed targets the headline PCE deflator, Powell cited the CPI as the switch from 50 to 75 bp hike.  

In that light, the preliminary estimate of the eurozone's June CPI that comes at the end of next week might be the most important economic data point.  It comes ahead of the July 21 ECB meeting for which the first rate hike in 11 years has been all but promised.  Although ECB President Lagarde had seemed to make clear a 25 bp initial move was appropriate, the market thinks the hawks may continue to press and have about a 1-in-3 chance of a 50 bp move.  The risk of inflation is still on the upside and Lagarde has mentioned the higher wage settlements in Q2.  That said, the investors are becoming more concerned about a recession and expectations for the year-end policy rate have fallen by 30 bp (to about 0.90%) since mid-June.  

A couple of days before the CPI release the ECB hosts a conference on central banking in Sintra (June 27-June 29).  The topic of this year's event is "Challenges for monetary policy in a rapidly changing world," which seems apropos for almost any year.  The conventional narrative places much of the responsibility of the high inflation on central banks.  It is not so much the dramatic reaction to the Pandemic as being too slow to pullback.  In the US, some argue that the fiscal stimulus aggravated price pressures. On the face of it, the difference in fiscal policy between the US and the eurozone, for example, may not explain the difference between the US May CPI of 8.6% year-over-year and EMU's 8.1% increase, or Canada's 7.7% rise, or the UK's 9.1% pace.

There is a case to be made that we are still too close to the pandemic to put the experience in a broader context. This may also be true because the effects are still rippling through the economies.  In the big picture, central banks, leaving aside the BOJ, appear to have responded quicker this time than after the Great Financial Crisis in pulling back on the throttle, even if they could have acted sooner.  Some of the price pressures may be a result of some of the changes wrought by the virus.  For example, a recent research paper found that over half of the nearly 24% rise in US house prices since the end of 2019 can be explained by the shift to working remotely, for example. 

The rise in gasoline prices in the US reflect not only the rise in oil prices, but also the loss of refining capacity. The pandemic disruptions saw around 500k barrels a day of refining capacity shutdown.  Another roughly 500k of day of refining capacity shifted to biofuels.  ESG considerations, and pressure on shale producers to boost returns to shareholders after years of disappointment have also discouraged investment into the sector.  The surge in commodity prices from energy and metals to semiconductors to lumber are difficult to link to monetary or fiscal policies.  

Such an explanation would also suggest that contrary to some suggestions, the US is not exporting inflation.  Instead, most countries are wrestling with similar supply-driven challenges and disruptions.  That said, consider that US core CPI has risen 6% in the year through May, while the ECB's core rate is up 3.8%, and rising. The US core rate has fallen for two months after peaking at 6.5%.  The UK's core CPI was up 5.9% in May, its first slowing (from 6.2%) since last September.  Japan's CPI stood at 2.5% in May, but the measure excluding fresh food and energy has risen a benign 0.8% over the past 12 months.  

Consider Sweden.  The Riksbank meets on June 30.  May CPI accelerated to 7.3% year-over-year.  The underlying rate, which uses a fixed interested rate, and is the rate the central bank has targeted for five years is at 7.2%.  The underlying rate excluding energy is still up 5.4% year-over-year, more than doubling since January.  The policy rate sits at 0.25%, having been hiked from zero in April.  The economy is strong.  The May composite PMI was a robust 64.4.  The economy appears to be growing around a 3% year-over-year clip.  Unemployment, however, remains elevated at 8.5%, up from 6.4% at the end of last year.  The swaps market has a 50 bp hike fully discounted and about a 1-in-3 chance of a 75 bp hike.  The next Riksbank meeting is not until September 20, and the market is getting close to pricing in a 100 bp hike.  Year-to-date, the krona has depreciated 11% against the dollar and about 3% against the euro.  

In addition to macroeconomic developments, geopolitics gets the limelight in the coming days.  The G7 summit is June 26-28.  Coordinating sanctions on Russia will likely dominate the agenda and as the low-hanging fruit has been picked, it will be increasingly challenging to extend them to new areas.  

At least two important issues will go unspoken and they arise from domestic US political considerations.  Although President Biden has recommended a three-month gas tax holiday, he needs Congress to do it.  That is unlikely.  Inflation, and in particular gasoline prices are a critical drag on the administration and the Democrats more broadly, who look set to lose both houses.  And the Senate and Congressional Republicans are not inclined to soften the blow.  Talk of renewing an export ban on gasoline and/oil appears to be picking up. The American president has more discretion here. This type of protectionism needs to be resisted because could it be a slippery slope. 

The other issue is the global corporate tax reform.  Although many countries, most recently Poland, have been won over, it looks increasingly likely that the US Senate will not approve it.  Biden and Yellen championed it, but the votes are not there now, and it seems even less likely they will be there in the next two years.  The particulars are new, but the pattern is not.  The US has not ratified the Law of the Seas nor is it a member of the International Court of Justice. Some push back and say that the US acts as if it were.  That argument will be less persuasive on the corporate tax reform.  

NATO meets on June 29-30.  For the first time, Japan, Australia, New Zealand, and South Korea will be attending.  Clearly, the signal is that Russia's invasion of Ukraine is not distracting from China. Most recently, China pressed its case that the Taiwan Strait is not international waters.  Some in Europe, including France, do not want to dilute NATO's mission by extending its core interest to the Asia Pacific area and distracting from European challenges. NATO is to publish a new long-term strategy paper.  Consider that the last one was in 2010 and did not mention Beijing and said it would seek a strategic partnership with Russia.  Putin's actions broke the logjam in Sweden and Finland, and both now want to join NATO, but Turkey is holding it up.  


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