October Monthly

Trade,  central bank policy, and Brexit dominated the
investment climate in September.
The US-Chinese trade conflict stopped
escalating.  Although face-to-face talks
are planned in October and the list of exemptions from the punitive tariffs has
increased (US soy and pork, for example, are now exempt as are 10 components of
Apple’s Mac Book Pro from China), the tensions remain high.  The conflict is more than about more than trade.  It is also about market access, unfair
subsidies, and intellectual property rights. 

The October 1 increase in US
tariffs has been delayed until October 15. 

Another round is to be initiated on December 15.  A key metric of the success of the
negotiations will be whether these dates can be extended, if not
suspended.  More broadly, a limited US-Japanese
deal was struck, and work is said to continue toward a more comprehensive
deal.  Japan essentially granted the US
similar terms as what was struck at the Trans-Pacific Partnership after the US
withdrew. In exchange, the US dropped tariffs on some consumer products and
machine tools.  Perhaps the agreement on
digital trade is an element that can be a model for future trade agreements The
US and India are moving to a short-term agreement.  There is risk that US attention turns to
Europe with WTO-approval for retaliatory measures to compensate for improper
subsidies to Airbus.  A decision on US
auto tariffs is required by the middle of November.  There is some risk that the short-run limited
agreements violate WTO principles and may be challenged. 

The Federal Reserve and the ECB
eased policy in September as had been widely expected.
  The Fed retains the “midcourse correction”
framing of its challenge, while the ECB’s measures are trying to arrest a
slowdown as it appears the German engine continues to sputter.  It seems that the economy contracted for
the second consecutive quarter.  Fiscal
support appears to be too little and too late. 
On the other hand, the stronger housing activity the US has reported and
consumption are what would be expected if a decline in interest rates were to
support the economy. 

The strain at the very short-end of
the curve means that these operational issues will remain important ahead of
the FOMC meeting at the end of the month

We expect that to help investors keep separate the plumbing issues from
the conduct of monetary policy proper by announcing its policy on meeting the
apparent reserve needs of the banking system at the end of October.   That, coupled with the better data, an
acceleration in inflation, and a strong dollar can buy the Fed time.  We expect another 25 bp cut at the December
11 FOMC meeting. 

The UK departure from the EU has
been a torturous process. 
The EU Summit
in the middle of October is event ahead of the month-end deadline.  If no agreement has been struck by then,
Parliament has instructed the Prime Minister to request a three-month delay.  We expect that the UK will continue to be
part of the EU come November 1 and anticipate elections before the end of the


One of the reasons why the dollar performed better in September was that there
was a marked adjustment in expectations of the trajectory of Fed policy.  The implied yield of the January 2020 fed
funds futures rose about five basis points despite the Fed’s 25 bp cut and a
plurality of Fed officials thinking that one more cut this year will likely be
appropriate.  Market expectations have
converged our understanding of the reference to midcourse correction.  Greenspan’s use in the 1990s, as Powell
briefly referred to in his press conference, signaled three rate cuts.  We are still concerned about the dollar’s
longer-term cyclical advance for reasons we have previously discussed.  However, developments in Europe, Japan, and
China do not exactly boost the attractiveness of the alternatives. 

Europe is in poor shape.  Imagine that Germany
appears to have contracted in Q3, the second consecutive quarter despite its
entire yield curve being below zero. 
While fiscal policy seems to be the obvious lever to boost aggregate
demand, the Stability and Growth Pact set limits.  That said, the new European Commission
appears somewhat more sympathetic than the predecessor.  A weaker euro works in the same direction,
which is one of the things that distinguish this big dollar rally from the
Reagan-Volcker and Clinton-Rubin rallies. 
The euro’s weakness is not problematic for Europe now.   A new ECB President and a new European
Commission have their work cut out.  Trade
tensions with the US will likely intensify in Q4. 

(previous in parenthesis, end of
July indicative levels

Spot: $1.0900
$1.0982)      Median Bloomberg
Forecast $1.0965 (

forward $1.0935 (
$1.1010)      One-month
implied vol  5.8%

Yen: The
yen was the weakest of the major currencies against the dollar in September,
falling about 1.3%.  The decline in
global yields would have been expected to favor the yen.  The equity markets were firmer, and that is
typically associated with a weaker yen, even though the Topix return of more
than 7% was easily the best performer in the G20.  The economy appears to have lost some
momentum as Q3 wound down and ahead of the controversial sales tax increase at
the start of October (from 8% to 10%). 
Although the economic justification and fiscal need are not so clear,
especially given the debt servicing costs, it appears to have taken on a
political life of its own.  The BOJ meets
at the end of the month.  Should the economy
show adverse effects from the sales tax, we suspect the central bank will cut its
deposit rate.

Spot: JPY108.10
 (JPY106.28)      Median Bloomberg
Forecast JPY107.00 (

forward  JPY107.80 (
JPY106.05)   One-month implied
 6.6%  (8.1%) 

The UK Prime Minister Johnson insists that the UK is leaving the EU on October
31, no matter what.  The issue is with or
without an agreement.  Before it was
illegally suspended (ruled by the UK Supreme Court), Parliament passed a motion
instructing the Prime Minister to request a three-month delay in the exit if no
deal had been found.  The Prime Minister
has indicated he will not follow Parliament’s advice, setting the stage for a constitutional
struggle.  PredictIt.Org indicates a swing
in sentiment.  At the end of August, an
October 31 departure was seen a little more likely than not (58%-42%).  It swung hard against in September and
finished the month with a nearly a delay being the 4-to-1 favorite.  An extension would not so much lift the
uncertainty that is weighing on the economy but would replace one uncertainty
for another. After a delay is granted, elections and no party will likely get a
majority.  Sterling appreciated for the
first three weeks of August and peaked near $1.2580 before reversing lower.  It managed to hold on to about a 1.5% gain to
lead the major currencies. 

Spot: $1.2290
($1.2156)   Median
Bloomberg Forecast $1.2300

 $1.2305 ($1.2172)    One-month
implied vol 11.1%  (

  The Bank of Canada remains neutral in the face of US
rate cuts and the Canadian dollar has remained softer than expected in this
context.  The Canadian dollar drew little
comfort from the greater risk appetites reflected in rising equity prices
(S&P 500) in 

September.  National elections will be
held on October 21.  The polls have
tightened in recent weeks, but Prime Minister Trudeau holds a modest lead.  A robust labor market and low-interest rates
are underpinning the Canadian economy. 
When adjusted for the 1.8%-2.1% headline and core CPI, real interest
rates are below zero in Canada.  The
market has pushed out rate cut expectations from Q4 19 and into Q1 20. 

CAD 1.3245 (CAD1.3311)     Median Bloomberg Forecast CAD1.3225

forward CAD1.3240 (
CAD1.3305)    One-month
implied vol  5.4% (

Australian Dollar:  The
October 1 rate cut, the third since April, coupled with the tax cuts, and
currency depreciation provide the needed stimulus for the Australian economy.  The Australian dollar has fallen in eight of
the last ten weeks and depreciated by about 3.65% against the US dollar in Q3.  This overstates the stimulative effect as the
Australian dollar fared better on a trade-weighted basis.  It was mostly steady against the Chinese
yuan and euro, about 3% stronger than the New Zealand dollar in Q3.   The
The Australian dollar gained about 0.5% against the dollar in September. 

Spot: $0.6750
($0.6845)      Median Bloomberg Forecast $0.6770 ($0.6750)  

 $0.6760 ($0.6740)     One-month
implied vol
 7.2% (7.8%)   

Mexican Peso:   With the beginning of an easing cycle in
Mexico, the US dollar appears to have entered a new and higher range against
the peso.  The MXN19.40 area was the
upper-end of range earlier this year, and now that appears to be the lower end
of the new range.  It is not clear, yet
the upper end, but the dollar briefly traded above MXN20.20 in late
August.  The peso will likely be
sensitive to data that fans expectations for further rate cuts, especially.  At the same time, its function as a proxy for
emerging market currencies broadly, the peso is also vulnerable to global
growth concerns and risk appetites.

Spot: MXN19.7330
MXN20.06)   Median Bloomberg Forecast MXN19.74 (MXN

forward  MXN19.8660 (
MXN20.17)     One-month
implied vol 9.4% (

Chinese Yuan:  The yuan
gained about 0.5% in September but ended the month under pressure.  Although trade negotiations between China and
the US will resume, the next set of tariff increases have already been
postponed once and are now scheduled for October 15.  News that the US is contemplated curbs
portfolio flows to China and is conceived as separate from trade highlights
hurdles to a meaningful deal.  China’s
purchases of US soy and pork are necessary and not so much a sign of goodwill
any more than the US exemptions on ten of fifteen Apple requests were
kindness to Beijing.  The risks seem
asymmetrically biased toward a weaker yuan in the month ahead. 

Spot: CNY7.1483
(CNY7.1560)       Median Bloomberg Forecast CNY7.17

 CNY7.1235 (CNY7.1470)    One-month implied vol 5.3%


Share this post

Share on facebook
Share on google
Share on twitter
Share on linkedin
Share on pinterest
Share on print
Share on email