Economy

Highlights Differences of opinion are what make a market, and we’ve got a big one when it comes to the Fed: The money market says the fed funds rate goes no higher than 2.75%; BCA says 3.5% by the end of 2019, and possibly 4% sometime in 2020. We are confident in our assessment of the economy’s underlying strength, … : Fiscal stimulus will keep the economy growing above trend in 2019, and the unemployment rate will almost certainly continue to grind lower. ... even if many commentators are accentuating the negative: The experts quoted in Barron’s found abundant fault with the November employment situation report, and the yield curve is out-trending all of the Kardashians combined. Amidst all the uncertainty, we’re sticking with an investment strategy that is more cautious than our outlook: The monetary backdrop is still too accommodative to spell the end of the equity bull market, but we are waiting for a better entry point to put our cash overweight to work. Feature Dear Client, This is our last report of 2018. Our regular publishing schedule will resume on Monday, January 7th. We wish you a happy, healthy and prosperous new year. Best regards, Doug Peta, Senior Vice President U.S. Investment Strategy   We have often remarked how we feel that we are watching a different game than the money market when it comes to the gap in our respective terminal fed funds rate expectations. Both we and the market expect a 25-basis-point (“bps”) hike to 2.5% at the conclusion of the FOMC’s two-day meeting on Wednesday, but from there our paths diverge sharply. The market grudgingly allows that one more hike, to 2.75%, is possible, though it is by no means certain. It sees about a 60% chance that the Fed will make that additional rate hike toward the end of 2019, but then proceeds to price that hike out by the end of 2020 (Chart 1). Chart 1Mind The Gap The terminal rate’s ultimate destination, and the path it follows along the way, is not just an academic matter. Once the fed funds rate crosses above the equilibrium fed funds rate (r-star, in economics-speak), monetary policy will become restrictive for the first time since the crisis began to break. We expect the shift to a restrictive policy setting will herald the end of the expansion. Most importantly for investors, it will mark the point when asset allocation should become considerably more defensive. Getting the Fed right, then, is of the utmost importance, and we need to get to the bottom of our differences with the market. We suspect they come down to disparate assessments of the state of the economy and the state of policy. The money market seems to believe that the economy is weaker than we perceive, and that the fed funds rate is currently much closer to equilibrium than we realize. In both cases, we are vulnerable if it is later in the cycle than we think, because we are not positioned for an imminent inflection. Is The Business Cycle Closer To Ending Than We Think? Real GDP growth will slow in 2019, just as one would expect when 60 bps of fiscal thrust is taken away from an economy that was already operating at its full 2-2.25% capacity (Chart 2). Per the IMF’s fiscal estimates, 2020 shapes up as the real challenge for the economy, especially once the Fed crosses the equilibrium-rate Rubicon. In October and November, however, financial markets acted as if they feared the beginning of the recession was considerably nearer (Chart 3). Our clients’ concerns seemed to coalesce around the implications of a slowdown in housing. Chart 2Lessened Thrust, Lessened Growth   Chart 3Growth Scare We do not worry about residential investment pulling down the economy,1 but we do pay close attention to nonfarm payrolls. Employment may be a coincident indicator, but it is powerfully self-reinforcing, and the sub-NAIRU2 unemployment rate looms large in the Fed’s policy calculus. Payrolls growth is robust, and our model projects that it will continue to be over the near term (Chart 4, top panel), as all of its components are in fine fettle, especially initial jobless claims (Chart 4, second panel), and small businesses’ hiring intentions (Chart 4, bottom panel). Chart 4Payrolls Should Keep Growing, ... As we have noted before, it only takes about 110,000 net new jobs every month to keep unemployment at a steady state. Even if our model turns out to be overly optimistic, the unemployment rate appears to be several months away from bottoming, unless the participation rate rises enough to materially increase the size of the labor force. Demographics argue against that, as the baby boomers, ages 54 to 72, exit the work world in a nearly interminable conga line. The participation rate has done well to stabilize in the face of the boomer headwind (Chart 5), but there’s a limit to how much more it can close the gap when businesses are already lamenting the difficulty of finding qualified workers (Chart 6). Chart 5... But The Part Rate Probably Won't   Chart 6Good Help Is Hard To Find A robust labor market suggests that households in the aggregate will have the means to support consumption. Now that payrolls have expanded for a record 98 straight months, the lowest-income households are finally in line to capture some of the benefits. Those households have the highest marginal propensity to consume, which may provide spending with an additional fillip. With the savings rate now back to its late-‘90s levels, better-heeled households are also in a position to do their part to keep consumption humming (Chart 7). Chart 7Plenty Of Dry Powder For Spending The near-term consumption outlook is additionally supported by the expectations component of the Conference Board’s consumer confidence survey, which has been a reliable coincident indicator throughout its entire history (Chart 8). The unusual divergence between the two series suggests that consumers may have more of an appetite to spend than they’ve demonstrated so far. Employment gains and real consumption also have a well-established history of traveling together (Chart 9). Chart 8Consumers' Optimism Points To More Spending ...\   Chart 9... And So Do Solid Employment Gains Bottom Line: We find it hard to believe the economy is set to weaken in a worrisome way when the labor market still has plenty of momentum, and consumption is well supported on multiple fronts. Is The Fed Funds Rate Cycle Further Along Than We Realize? The Real Economy Our equilibrium fed funds rate model continues to suggest that the target fed funds rate is well below its equilibrium level and will not exceed it until late next year.3 Equilibrium is only a concept, however, so we actively seek out objective data that may confirm or disprove our assessment. Our approach is to trust our modeled estimate of a concept, but verify it with as much real-time evidence as we can muster. Based on the current level of activity, housing seems to be the only major segment that is experiencing some indigestion from higher rates. Corporate investment may not have lived up to the most optimistic post-tax-cut estimates, but there is no evidence that corporations are holding back because of higher rates. A back-of-the-envelope proxy, calculating the difference between the S&P 500’s return on capital and the after-tax interest rate on BBB-rated corporate bonds, suggests that prospective returns to borrowing are near their best level in 30 years, even with the reduction in the debt tax shield4 (Chart 10). Through December 14th, the Atlanta Fed’s GDPNow model was projecting an increase of 3.8% in fourth-quarter final domestic demand, forcefully pushing back against the notion that r-star is at hand. Chart 10Higher Rates Aren't Biting Yet The ongoing application of fiscal thrust to an economy already operating at capacity argues for a higher equilibrium rate than would otherwise apply. The equilibrium rate is also higher because the unemployment rate is well below NAIRU (4.5%, per the dots), suggesting that the Fed will have to push harder against the economy than it otherwise would to keep it from overheating. Tepid post-crisis investment, mixed with unnecessary fiscal stimulus, and combined with a red-hot labor market, is a recipe for inflation pressures that can only be neutralized by a higher r-star. Financial Conditions As last week’s Google Trends chart of yield-curve searches made clear, investors have developed something of an obsession with an inverted yield curve. The yield curve’s ability to flag overly tight monetary policy in real time has made it a reliable leading indicator of recessions, and it is a key input into our simple recession indicator. The curve has flattened over the last five-plus weeks as the 10-year Treasury yield has melted, stoking recession fears. Before they get too worked up, however, investors should bear in mind that the depressed term premium has the potential to distort its signal in this cycle. The term premium is the yield differential between a Treasury note or bond, and a strip of T-bills, laddered to match the note or bond’s maturity. In line with its name, the term premium is typically positive, as investors have typically demanded compensation for bearing the increased interest-rate volatility embedded in longer-maturity instruments. That volatility may well have been restrained by the Fed’s large-scale asset purchase program, along with long yields themselves, though the entire matter of QE’s impact is subject to spirited debate. Whatever the mechanism, the term premium is considerably lower than it has been across the five decades that the yield curve has had a nearly perfect record of calling recessions (Chart 11). If the term premium were in line with its historical mean value, the yield curve would be nowhere near inverting. We continue to trust in the yield curve’s propensity to sense danger, but concede that the anomalously low term premium may render it somewhat less timely now. Given the preponderance of evidence to the contrary, we are not concerned that it is signaling that r-star is materially closer than our equilibrium fed funds rate model estimates. Chart 11The Bar For Inversion Is A Lot Lower In This Cycle QE raises one more issue for our equilibrium fed funds rate model, which does not account for any tightening of monetary conditions occasioned by the unwinding of the Fed’s balance sheet. We assume that such tightening occurs only at the margin, but it could delay our recognition that policy has shifted from accommodative to restrictive. Attempting to isolate the impact of balance sheet reduction on monetary conditions would be more trouble than it’s worth, however, and we simply assume that it will cause the confidence interval around our equilibrium estimate to widen a little. Bottom Line: Our equilibrium fed funds rate model projects that policy is not nearing restrictive territory, and our interpretation of the whole of the real-time data supports that view. We think that the Fed is still several hikes away from reaching r-star. Investment Implications As we noted in last week’s 2019 outlook, the view that the economy is strong enough to overheat undergirds all of our recommendations. The potential for overheating is what will impel the Fed to hike aggressively through 2019 and possibly beyond. Investors should therefore underweight Treasuries in balanced portfolios, while maintaining below-benchmark duration. The idea that the economy will gather more momentum on its way to overheating keeps us constructive on equities. We do not believe the bull market is over, and are therefore keeping an eye out for an opportunity to overweight the S&P 500 before it makes new highs. We are confident that the unemployment rate will continue to decline, but must concede that the key outcome for Fed policy – higher wages – has been slow to materialize. Several investors have become impatient with waiting for the Phillips Curve to assert itself, and we cannot blame them. Shorn of its fancy trappings, though, the Phillips Curve is just a supply-and-demand story, and we have always found it hard to argue against supply-and-demand stories’ plain logic. The action in the 10-year Treasury nonetheless has us reviewing our call closely in search of anything that we may be missing. It appears that the decline in yields is better explained by the unwinding of lopsided positioning and sentiment (Chart 12), than by anything connected to economic growth. We are acutely conscious of how a worsening of U.S.-China trade tensions could impair global growth and subvert our constructive take on risk assets. U.S. equities may shine on a relative basis in the worst-case scenario, but absolute losses would be assured. We remain in wait-and-see mode, open to deploying our cash overweight if the opportunity presents itself, but happy to have it for ballast and insurance in the meantime. Chart 12Stretched Rubber Bands Snap Back   Doug Peta, Senior Vice President U.S. Investment Strategy dougp@bcaresearch.com   Footnotes 1 Please see the U.S. Investment Strategy Special Reports, “Housing: Past, Present And (Near) Future,” and “Housing Seminar,” published November 19 and December 3, 2018, respectively, at usis.bcaresearch.com. 2 NAIRU, the non-accelerating-inflation rate of unemployment (also known as the natural rate of unemployment), is the unemployment rate that can be sustained over time without causing the economy to overheat. 3 Our model estimates that equilibrium fed funds is currently around 3%, will be around 3.25% by the middle of 2019, and will settle near 3⅜% at year end. 4 Before the 2017 tax reform act, corporations faced a top marginal rate of 35%, and could deduct interest expense without limit. After-tax interest expense for large corporations amounted to (1-.35), or 65% of the pre-tax expense. Now that the top marginal rate is 21%, after-tax interest expense is (1-.21), or 79% of pre-tax expense.

Highlights A progressing Sino-U.S. trade truce, rallying commodities and EM FX as well as improving Swedish economic activity point to a respite in the global growth slowdown. This should support commodity currencies and cause a correction in the dollar – moves we would fade. Ultimately, tightening U.S. policy and a rising Chinese marginal propensity to save point to both slower growth and a stronger dollar over the coming six to nine months. The European Central Bank is extremely data dependent, and in our view, our outlook on global growth will compromise the ECB’s ability to lift rates in September 2019. A tactical trade: Sell EUR/GBP. Feature Glimmers of hope are emerging for dollar bears and EM bulls. The Sino-U.S. trade truce seems to be progressing: Meng Wanzhou, the CFO of Huawei, was released on bail this week, and U.S. President Donald Trump suggested he would lean in her favor; China dropped its tariffs on U.S. auto imports to 15%; and the communication channels between China and the U.S. are clearly open. Green shoots for global growth have also emerged, with commodity prices staging a bit of a rebound, and data in some small, open economies very levered to global growth showing improvement. These developments can easily help risk assets temporarily rebound, lifting EM currencies and G-10 commodity currencies in the process while hurting the greenback for a month or two. However, we remain doubtful that these glimmers of hope for global growth will morph into a sustained rebound in global industrial activity. Consequently, we are inclined to use any weakness in the greenback to buy the dollar, and any rebound in EM and commodity currencies to sell them in anticipation of deeper lows. A Set Up For Some Dollar Weakness… The continued warming up in Sino-U.S. relations is encouraging, but as we argued last week, a more important consideration is whether global growth is finding a floor.1 In recent weeks, a few market signals have offered some hope. The growth-sensitive CRB Raw Industrials index has been firming, and the Baltic Dry index has recouped 40% of its loss from August to November (Chart I-1). Chart I-1Green Shoots In The Commodity Space... EM FX has also staged a bit of a rebound, led by the Turkish lira. The most positive development on this front has been the recent gains in the yuan. Its rebound keeps at bay a large deflationary shock for the global economy, and the stability in EM FX means that EM financial conditions are not deteriorating further (Chart I-2). Chart I-2...Green Shoots In EM FX... In our view, the greatest source of optimism comes from the Swedish economy. Sweden is a small, open economy where industrial and intermediate goods account for 25% of exports, or 11% of GDP. Its manufacturing PMI have been rebounding – a phenomenon repeated across multiple data sets. In fact, our diffusion index of 15 Swedish economic variables has been recovering. Based on history, the current recovery in the Swedish economic advance/decline line points to an upcoming rebound in EM exports growth, and to a temporary stabilization in the Global Leading Economic Indicator (Chart I-3). Chart I-3...And Green Shoots In Sweden As Well! Any sign of stabilization in global economic activity will generate a period of weakness in the dollar, a traditionally countercyclical currency, which has now been made more vulnerable to good global growth by extended long speculative positioning. However, before bailing on the greenback, we need to see if this period of respite for the world will prove durable. Bottom Line: Indications that the Sino-U.S. trade truce has staying power for now, coupled with signs from both financial market prices and from Sweden – one of the G-10’s most growth sensitive economies – are likely to prompt a dollar correction over the next month or two. Short-term traders are likely to be able to take advantage of this move. ...But Not For A Cyclical Top… Even the most ferocious dollar bull markets can be punctuated by periods of weakness. This was the case throughout the first half of the 1980s and the second half of the 1990s. There is no reason why this rally will prove different. Thus, a period of stabilization in global growth prompting a dollar correction should not come as a surprise. However, at this juncture, the global policy set up still favors remaining long the dollar and using any correction to build up bigger long-dollar bets. Today, our BCA central bank monitor continues to point to the need of tightening U.S. monetary policy. However, the same cannot be said about the rest of the G-10 in aggregate. We estimated the performance of G-10 currency pairs versus the dollar when, like today, the BCA central bank monitors showed a greater need for policy tightening in the U.S. than in the rest of the world. What we found was during the past 26 years, this kind of environment is associated with depreciations versus the U.S. dollar in the euro, the yen, the Australian dollar, the Canadian dollar, the Swiss franc and the Scandinavian currencies (Chart I-4). Interestingly, the GBP and the NZD seem to buck this trend. Chart I-4The Current Currency Setup Is Dollar Bullish The EUR/USD pair is of particular interest, as it accounts for 58% of the DXY dollar index and is often the preferred vehicle for investors to bet on the dollar’s trend. Right now, in sharp contrast with the U.S., the euro area central bank monitor points to a need for easing policy in Europe (Chart I-5). Chart I-5Economic Conditions Warrant More Hikes In The U.S., But Not In Europe... We expect our monitors to continue to point toward the need for tighter U.S. than European monetary policy. Today, European growth has decelerated, and the slowdown in euro area M1 money supply indicates that continental growth will slow further before finding a bottom (Chart I-6, top panel). The European Central Bank is not immune to growth risks. Chart I-6...And This Is Not About To Change Meanwhile, the Federal Reserve is fixated on inflationary developments, especially those emanating from the labor market. While U.S. core PCE has disappointed, U.S. wages, as measured by average hourly earnings and the Atlanta Fed Wage Tracker, are all trending higher (Chart I-6, middle panel). Moreover, while there has been a concerning slowdown in the U.S. housing sector, mortgage applications are beginning to regain some vigor (Chart I-6, bottom panel). The Fed may thus pause in March, but we do not think it is done hiking for the remainder of 2019, as markets currently expect. As a result, we anticipate one-year-ahead policy differentials between the U.S. and the DXY-weighted G-10 central banks to widen, lifting the dollar in the process (Chart I-7). Therefore, any dollar correction should be short-lived. Investors with longer investment horizons than three months should ride the volatility and remain long the dollar. Chart I-7More Dollar Upside Bottom Line: BCA’s Fed monitor is pointing to the need for further U.S. rate hikes. Meanwhile, outside the U.S., G-10 policy should remain easy. Historically, this set-up is associated with dollar strength. The dichotomy between slowing European growth and growing U.S. wages suggests expected policy differentials will remain negative for EUR/USD. Stay long the dollar. ...Especially As China Remains Challenged China is now such an important diver of the global industrial cycle that it could nullify any of the conclusions noted above. However, at this point, Chinese economic dynamics seem to reinforce the dollar-bullish outcome, not weaken it. Chinese policy rates have collapsed, and the People’s Bank of China has cut the Reserve Requirement Ratio to 14.5%, injecting RMB 750 billion into the interbank market. This apparent easing in policy lifted hopes that we would see a significant rebound in the credit number in November. However, as Chart I-8 illustrates, total social financing excluding equity issuance has not picked up and continues to crawl along at a 16-year low. Moreover, the shadow-banking sector remains weak. Chart I-8Despite Stimulus, Chinese Credit Is Still Slowing Why is the Chinese economy not responding to what seems like an easing in liquidity conditions? First, it is far from clear that Beijing has abandoned its desire to limit the growth of indebtedness in China. As a result, bankers remain reluctant to open the lending taps aggressively. Second, Chinese borrowers themselves have curtailed their appetite for credit. After binging on easy credit, state-owned enterprises have misallocated vast amounts of capital and are now unable to generate sufficient returns on assets to cover their costs of borrowing (Chart I-9). Meanwhile, the private sector is also reluctant to borrow aggressively amid uncertainty regarding the Chinese growth outlook. Chart I-9Too Much Debt Leads To Misallocated Capital The result is a sharp rise in the Chinese marginal propensity to save (MPS). We can approximate China’s MPS by looking at the growth of M2 money supply relative to M1. The difference between the two monetary aggregates are savings deposits. If M2 grows faster than M1, Chinese economic agents are parking their funds in savings deposits faster than they are adding to their checking accounts, despite low interest rates. This suggests a greater desire to save. This means it will take much more stimulus than what has so far been injected into the Chinese economy to put a floor under growth. Indeed, this proxy for China’s MPS has historically been a reliable leading indicator of Chinese economic activity, announcing turning points in the Li Keqiang index (Chart I-10, top panel). The rising MPS is currently signaling a further deceleration in Chinese import volumes growth (Chart I-10, second panel), which is reflected in a call for greater downside to global export growth (Chart I-10, third panel). Finally, China’s MPS also forewarns that global industrial activity, as measured by our nowcast, will slow more (Chart I-10, bottom panel). In aggregate, China’s rising marginal propensity to save clearly points toward further global growth weakness. Chart I-10China's Rising Marginal Propensity To Save Hurts Global Growth As we have shown many times, slowing global growth is good for the dollar, as it has a more negative impact on economic activity outside the U.S. than inside.2 Additionally, when global growth decelerates in response to slowing Chinese economic activity, Chinese interest rates also normally fall relative to U.S. ones, as China is forced to ease policy vis-a-vis the U.S. This interest rate differential has already narrowed considerably. If the correlation of the past 12 years is any guide, this means the recent rebound in the CNY is to be faded, and that USD/CNY has significant upside in the upcoming six to nine months (Chart I-11). This is deflationary for the global economy. Chart I-11Chinese Rates Will Further Lag U.S. Ones, The Yuan Will Follow The impact of falling Chinese interest rates relative to the U.S. is not limited to the USD/CNY. As Chart I-12 shows, when U.S. one-year rates rise relative to China, the DXY also strengthens. This is again because U.S. rates overtake Chinese rates in an environment where global growth is slowing. Today, U.S. 12-month rates are higher than Chinese rates, and the differential will widen as Chinese policymakers are forced to continue stimulating. Hence, any correction in the USD should prove transitory. Chart I-12When U.S. Rates Rise Relative To China, The DXY Appreciates The impact of these dynamics is most evident in the currencies of the economies most exposed to the Chinese business cycle. As Chart I-13 shows, when Chinese 12-month interest rates fall relative to U.S. 12-month rates, EM FX and G-10 commodity currencies depreciate significantly. A further drop in the Sino-U.S. spread, a consequence of a high and rising MPS hurting Chinese growth, will lead to further weakness in EM FX, the AUD, the NZD, the CAD, and the NOK against the dollar. Thus, it seems any respite these currencies may currently enjoy will prove temporary. Chart I-13Falling Sino-U.S. Spreads Will Hurt EM FX And Commodity Currencies Bottom Line: Despite injections of stimulus, China’s credit growth is not rising because the Chinese marginal propensity to save has risen significantly. It will take much more stimulus before credit growth rises anew. Thus, Chinese and global growth will not find a durable bottom for at least two more quarters. This implies that rate differentials between China and the U.S. will fall further, and hence USD/CNY and the DXY have more upside on a six- to nine-month basis, even if they weaken in the coming weeks. Meanwhile, EM FX and commodity currencies have a lot more downside in their future. ECB: The End Of An Era Yesterday, the ECB announced the well-anticipated end of its asset purchase program, but couched its discussion in rather hedged terms. The ECB focused on the importance of forward guidance and is open to adding to the TLTRO program if need be. The first rate hike being through the summer of 2019 is clearly conditional on economic circumstances. In this regard, the ECB downgraded its growth forecast for 2018 and 2019 to 1.9% from 2% and to 1.7% from 1.8%, respectively. The inflation forecast was revised up to 1.8% from 1.7% in 2018 and was revised down to 1.6% from 1.7% in 2019. Additionally, ECB President Mario Draghi highlighted that risks to the forecasts are balanced, but downside risk is growing. Not only do we agree that downside risk is growing, we also agree on the source of this risk: foreign growth and global protectionism. However, on this front, we are more pessimist than the ECB as we expect a greater deterioration in EM conditions and global trade. As a result, we think that risks are very significant that the ECB will find it difficult to implement a first rate hike in September 2019, yet markets are currently pricing in a 10 basis-point move that month. Hence, we expect that if our view on global growth is correct, the ECB will guide markets to price in the first hike later than September 2019, a process that will weigh on the euro, especially as investors already take a dim view on the capacity of the Fed to lift rates next year. Bottom Line: The ECB is ending its asset purchase program, but it remains committed to supporting growth in the euro area. The ECB is now heavily leaning on forward guidance, and any policy tightening is conditional on economic circumstances. BCA’s view on global growth suggests that it will be hard for the ECB to lift rates in September 2019. Short-Term Trade: Sell EUR/GBP This week’s political survival of Prime Minister Theresa May means that for another year, the hard Brexiters cannot challenge her for leadership of the Conservative Party. While it does not mean that the Brexit saga is over, it does mean that the probability of a Hard, No-Deal Brexit has fallen even further. As such, this implies that the politically driven rally in EUR/GBP since mid November is likely to reverse (Chart I-14). Chart I-14Tactical Trade: Sell EUR/GBP Additionally, the outperformance of British wages relative to the euro area should also support the pound in the short term (Chart I-15). A lower risk of a crash Brexit together with an ECB displaying a somewhat dovish side should cause an upgrade by investors in the expected path of monetary policy in the U.K. relative to the euro area. Moreover, while the euro area current account surplus has rolled over, the U.K.’s is steadily improving, making the pound progressively less dependent on international flows. Chart I-15Relative Wages Favor BoE Hikes Versus ECB Hikes As such, we are opening a tactical trade: selling EUR/GBP with a tight stop at 0.9100 and a target at 0.8700.   Mathieu Savary, Vice President Foreign Exchange Strategy mathieu@bcaresearch.com Footnotes 1  Please see Foreign Exchange Strategy Weekly Report, titled “Waiting For A Real Deal”, dated December 7, 2018, available at fes.bcaresearch.com 2 Please see Foreign Exchange Strategy Weekly Report, titled “Appetite For Destruction? FX Investing For Slowing Global Growth And Inflation”, dated November 23, 2018, as well as the Foreign Exchange Strategy Weekly Report, titled “The Dollar And Risk Assets Are Beholden To China’s Stimulus”, dated August 3, 2018. Both are available at fes.bcaresearch.com Currencies U.S. Dollar Chart II-1USD Technicals 1 Chart II-2USD Technicals 2 Recent data in the U.S. has been mixed: Core inflation came in line with expectations at 2.2%. This measure also increased from last month’s reading. Meanwhile, the JOLTS job openings outperformed expectations, coming in at 7.079 million However, while nonfarm payrolls underperformed expectations, coming in at 155 thousand, U.S. average hourly earnings remains solid DXY has risen by 0.5% this past week. We continue to be bullish on the U.S. dollar. The current environment of falling global growth and inflation has historically been very positive for this currency. Moreover, the market has already priced out any Fed hikes beyond December. This means that the risk for U.S. rates vis-à-vis the rest of the world remains to the upside. Report Links: Waiting For A Real Deal - December 7, 2018 2019 Key Views: The Xs And The Currency Market - December 7, 2018 Six Questions From The Road - November 16, 2018 The Euro Chart II-3EUR Technicals 1 Chart II-4EUR Technicals 2 Recent data in the euro area has been mixed: Industrial production yearly growth surprised to the upside, coming in at 1.2%. However, the Sentix Investor Confidence index surprised negatively, coming in at -0.3. Finally, Gross domestic product yearly growth underperformed expectations coming in at 1.6%. EUR/USD has been flat this week. Yesterday, the ECB downgraded its 2018 and 2019 growth forecasts. Moreover ECB president Mario Draghi hinted at increasing caution, as he remarked that downside risks where growing. We believe that EUR/USD has further downside, towards the 1.08-1.05 range, as the ECB will be unable to tighten monetary policy in the current environment of slowing global growth. Report Links: 2019 Key Views: The Xs And The Currency Market - December 7, 2018 Six Questions From The Road - November 16, 2018 Evaluating The ECB’s Options In December - November 6, 2018 The Yen Chart II-5JPY Technicals 1 Chart II-6JPY Technicals 2 Recent data in Japan has been negative: Machinery orders yearly growth underperformed expectations, coming in at 4.5%. Moreover, the final revisions to GDP annualized growth also surprised downside, coming in at -2.5%. Finally, the leading economic index also surprised negatively, coming in at 100.5. USD/JPY has risen by 0.8% this week. We are positive on the yen for the first quarter of 2019, especially on its crosses. The current risk off environment should be positive for safe havens like the yen. We are particularly negative on EUR/JPY, as this cross is very well correlated with bond yields, which have possess short-term downside. Report Links: 2019 Key Views: The Xs And The Currency Market - December 7, 2018 Updating Our Intermediate Timing Models - November 2, 2018 Will Rising Wages Cause An Imminent Change In Policy Direction In Europe And Japan? - October 5, 2018 British Pound Chart II-7GBP Technicals 1 Chart II-8GBP Technicals 2 Recent data in the U.K. has been mixed: Industrial production yearly growth underperformed expectations, coming in at -0.8%. Moreover, the claimant count change also surprised negatively, coming in at 21.9 thousand. However, average hourly earnings excluding and including bonus both outperformed expectations, coming in at 3.3%. GBP/USD has fallen by 1.2% this week on political risks. However, on Wednesday PM Theresa May survived a vote of no confidence that would have removed her from the leadership of the tory party. With this win, Prime Minister May is now protected from intra-party challenges for at least a year, strengthening her ability to fend-off demands by hard-brexiters. This event has created a tactical opportunity to sell EUR/GBP. Report Links: Six Questions From The Road - November 16, 2018 Updating Our Intermediate Timing Models - November 2, 2018 Clashing Forces: The Fed And EM Financial Conditions - October 19, 2018 Australian Dollar Chart II-9AUD Technicals 1 Chart II-10AUD Technicals 2 Recent data in Australia has been positive: The house price index yearly growth came in line with expectations, declining by -1.5%. Moreover, home loans growth outperformed expectations, coming in at 2.2%. AUD/USD has been flat this week. We believe that the AUD is the currency with the most potential downside in the G10. After all, Australia is the G-10 economy most leveraged to the Chinese industrial cycle, due to Australia’s high reliance on industrial metal and coal exports. This means that the continued tightening by Chinese authorities should be most toxic for this currency. Report Links: Waiting For A Real Deal - December 7, 2018 Updating Our Intermediate Timing Models - November 2, 2018 Policy Divergences Are Still The Name Of The Game - August 14, 2018 New Zealand Dollar Chart II-11NZD Technicals 1 Chart II-12NZD Technicals 2 NZD/USD has fallen by 0.5% this week. After being bullish in the NZD for a couple of months, we have recently turned bearish, as this currency is very likely to suffer in the current environment of declining inflation and global growth. said that being said, we remain bullish on the NZD relative to the AUD, given that the kiwi economy is less exposed to the Chinese industrial cycle than Australia’s. Report Links: Updating Our Intermediate Timing Models - November 2, 2018 Clashing Forces: The Fed And EM Financial Conditions - October 19, 2018 In Fall, Leaves Turn Red, The Dollar Turns Green - October 12, 2018 Canadian Dollar Chart II-13CAD Technicals 1 Chart II-14CAD Technicals 2 Recent data in Canada has been positive: Net change in employment surprised positively, coming in at 94.1 thousand. Moreover, the unemployment rate also surprised positively, coming in at 5.6%. Finally, housing starts growth also surprised to the upside, coming in at 216 thousand. After falling by nearly 1%, USD/CAD finished the week flat. While we are bearish on the Canadian dollar relative to the U.S. dollar, we are more positive on the CAD against the AUD. Renewed tightening in oil supply should serve as a support for global oil producers. Meanwhile, Chinese deleveraging will continue, hurting base metals in the process. This will cause oil to outperform base metals, which means that the CAD should have upside against currencies like the AUD. Finally, domestic economic conditions favor BoC hikes versus RBA hike, even after the recent pause flagged by the BoC. Report Links: Updating Our Intermediate Timing Models - November 2, 2018 Clashing Forces: The Fed And EM Financial Conditions - October 19, 2018 Updating Our Long-Term FX Fair Value Models - June 22, 2018 Swiss Franc Chart II-15CHF Technicals 1 Chart II-16CHF Technicals 2 EUR/CHF has been flat this week. Our bullish view on EUR/CHF is a high conviction view for the first part of 2019. This is because the recent strength in the franc is choking out any inflationary pressures in the Swiss economy. Thus, we are reaching the threshold at which the SNB is very likely to intervene in the currency market to prevent the franc’s strength from derailing the path toward the inflation target. In fact, the SNB even acknowledged this reality this week by downgrading its inflation outlook. Report Links: Waiting For A Real Deal - December 7, 2018 Updating Our Intermediate Timing Models - November 2, 2018 Updating Our Long-Term FX Fair Value Models - June 22, 2018 Norwegian Krone Chart II-17NOK Technicals 1 Chart II-18NOK Technicals 2 USD/NOK has risen by 0.7% this week. While we maintain a bearish stance toward the krone versus the U.S. dollar, we are short AUD/NOK, as a way to take advantage of stabilizing oil prices and a continued growth slowdown in China. Moreover, AUD/NOK is expensive in PPP terms, and is technically overbought. Finally, this currency is one of the most mean-reverting within the G10, which means that the recent surge in this cross is likely to reverse. Report Links: Waiting For A Real Deal - December 7, 2018 Updating Our Intermediate Timing Models - November 2, 2018 Clashing Forces: The Fed And EM Financial Conditions - October 19, 2018 Swedish Krona Chart II-19SEK Technicals 1 Chart II-20SEK Technicals 2 USD/SEK has risen by 0.9% this week. On a short-term basis, we are negative on the krona, given that this currency is very sensitive to global growth dynamics, which means that the continued tightening by both Chinese authorities and the Fed will create a headwind for any SEK rally. That being said, on a longer-term basis we are more positive on the krona, as the Riksbank has a lot of room to lift rates as the Swedish economy is increasingly displaying large internal imbalances that need to be addressed. Report Links: Updating Our Intermediate Timing Models - November 2, 2018 Updating Our Long-Term FX Fair Value Models - June 22, 2018 Updating Our Intermediate Timing Models - May 18, 2018 Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Closed Trades