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The Fed announced a quarter point cut yesterday at the conclusion of its two-day policy meeting. While the cut was expected the vote was not unanimous with three Fed members voting against. The prospect of a divided Fed has lowered the probability of additional cuts this year and spurred a stronger dollar (fewer future rate cuts increases the incentive to hold USD assets). Characterizing yesterday’s rate action as a ‘hawkish cut’ seems appropriate, the Icy-Hot version of the FOMC.

The stronger dollar has led to reduced holdings in the traditional ‘risk’ currencies and weakening the BRL (-0.71%), AUD (-0.38%), SGD (-0.23%), KRW (-0.20%), and NZD (-0.16%). Conversely the CHF (+0.49%) and JPY (+0.42%) are stronger in today’s session as the markets tilt towards safety.

For the third consecutive day the Fed has injected liquidity into the overnight funding market (repo). Funding shortages on Monday and Tuesday for one-day loans backed by treasuries led to a spike in rates to as high as 10%, or four times higher than rates seen just last week. Liquidity operations such as this by the Fed typically occur in periods just prior to a financial crisis. So we will add the repo market volatility to the list of worrying symptoms for the global economy.

BREXIT: Today is the final day of hearings before the U.K. Supreme Court on whether Prime Minister Johnson abused his authority when he suspended Parliament until mid-October. The GBPUSD is trading within an increasingly tighter range leading up to the court’s verdict.

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The currency markets have been quiet overnight and early in today’s U.S. trading session ahead of the FOMC’s rate announcement later this afternoon. The Fed is widely expected to cut rates by 25bps, but worth noting that the market has priced in a 17.2% probability of a 50bps cut. The policy announcement is scheduled for 2PM Eastern.

The pound sterling dropped early in the day after EU commission president Juncker stated that ‘the risk of a no-deal is very real’. The pound has strengthened by 4.76% (vs. the USD) since September 3^rd when PM Johnson’s government lost control of the Parliamentary agenda. GBPUSD: support 1.2375, resistance 1.2550.

As the U.K.’s new Prime Minister, Boris Johnson’s government has been stymied at every turn in its effort to deliver Brexit by the 31 October 2019 deadline. Below is a recap of the near daily actions by government opposition to prevent a no-deal Brexit following the announcement of Johnson’s suspension of Parliament on 28 August.

·         28 Aug - PM Johnson announces suspension of Parliament for five weeks

·         3 Sept - Tory rebels and opposition MP’s were granted an emergency debate and vote to take control of Parliament’s agenda from Johnson’s government

·         3 Sept - Government opposition wins vote (328-321) to take control of Parliament’s agenda.

o        4 Sept - PM Johnson’s call for snap election is blocked

·         4 Sept - With control of the agenda, Opposition and Conservative MP’s passed a bill (327-299) outlawing a no-deal Brexit

·         6 Sept - Bill outlawing no-deal Brexit wins final approval

·         9 Sept - Motion passed (311-302) ordering Johnson’s government to release internal private communications between the PM’s top advisors about Brexit plans/strategy

·         9 Sept - PM Johnson’s second attempt to trigger snap election is defeated (needed 434, got 293)

·         17 Sept – Three days of scheduled hearings begin at U.K. Supreme Court challenging the legality of Parliament’s suspension by PM Johnson

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The FOMC starts its 2-day policy meeting today and is expected to cut the Federal Funds rate by 25 basis points to a target range of 1.75%-2% (from the current 2%-2.25%) at tomorrow’s policy announcement. The probability of a rate cut is firmly at 100%, comprised of a 92.9% chance of a 25bps cut and a 7.1% chance of a 50bps cut.

Economic data released since the Fed’s last policy meeting show developing challenges in the U.S. labor market, most notably in the Nonfarm Payroll report for August which was reported at +130K, well below the estimated +160K. And July’s payroll report was revised to 159K from 164K. The labor market had been the most resilient sector of the slowing economy but is now showing vulnerability.

U.K. Prime Minister Boris Johnson’s suspension of parliament, announced on August 28^th, is being challenged today at the U.K.’s Supreme Court. The hearings are scheduled to last three days. If the court determines Johnson overstepped his authority he could be forced to recall Parliament, giving Brexit opponents additional time to maneuver before the October 31^st Brexit deadline.

The dollar is mixed today with moderate gains against the CAD, AUD, CHF, MXN, NZD and JPY, but losses against the EUR and GBP.

Oil prices are lower today by 4.82% on reports that Saudi Arabia would soon be able to resume 70% of lost capacity following last week’s drone attack.

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The pound sterling continues to rebound from its Brexit crisis low last week when the GBPUSD traded as low as 1.1957 (Tuesday, September 3^rd). The combination UK Parliament’s successful vote to assume control of the parliamentary agenda and Prime Minister Johnson’s failure to reach the 2/3 majority needed to initiate an early general election have lessened the likelihood of a no-deal Brexit at the October 31 deadline. Having lost the momentum for a no-deal departure from the EU, PM Johnson has indicated that his government will now work for a revamped deal with the EU, picking up right where former PM May left off before her resignation.

The GBPUSD has broken above short-term trendline resistance at 1.2250 and is now targeting 1.2400 in the near-term and has room to move as high as 1.2550.

As U.S./China trade tensions have subsided the appetite for risk has returned, leading to a stronger ZAR (+2.59%/week), MXN (+2.02%/week), and BRL (+1.04%/week). The ‘safety’ currencies have declined with the JPY -1.26%/week and the CHF -0.36%/week.

Asian currencies have advanced as U.S./China tariff rhetoric has softened the last few days. Over the last week the AUD has gained 1.35%, NZD +1.17%, KRW +1.87%, SGD + 0.72, and TWD +0.66%.

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Political maneuvering is in full swing today as Brexit opponents in the UK Parliament have applied for an emergency debate. If the debate is granted the opposition could spend the time instead voting to take control of Parliament away from the government. Prime Minister Boris Johnson has vowed to trigger a snap election on October 14th if his government loses control of Parliament, which could happen as early as today.

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There were mixed signals from China today on its trade dispute with the U.S., first stating that it ‘has no choice but to take necessary measures to retaliate’ (in response to the recent round of tariffs announced by the Trump administration). This was followed shortly by a comment from China’s foreign ministry that ‘we hope the U.S. side will meet China half-way’ by implementing a trade plan discussed in Osaka at the end of June.

China’s one-two punch of hard line followed by conciliatory statements seems to be from the same playbook being used to address the current unrest in Hong Kong, where a no-compromise message is fed to the state-run media while conciliatory remarks are censored.

China’s comments created some volatility in the FX markets, most notably in the USDJPY which has traded in a 1.02% range between today’s high and low.

Mexico rate decision out later today. The expectation is for a 25bps cut to 8%, with the intention to ease monetary conditions with the U.S. while keeping economic policy tight. The policy statement is expected to keep a cautious tone and neutral bias.

The Australian dollar has gained today following the release of stronger than expected jobs data overnight. The AUDUSD is currently +0.49% in today’s session.

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Will it be like 2007 all over again? This is what the markets are wondering after US 10-year treasury yields briefly dipped below 2-year treasury yields earlier today, the first time since 2007. This type of yield curve is the ominous ‘inverted yield curve’ and an inverted 2Y10Y is considered THE reliable warning signal for a possible recession. Only time will tell but months/years from now we may be looking back to today as the day the signal first flashed.

Coincidentally the UK’s 2-year/10-year yield curve inverted today as well, the first time since August of 2008.

And one final piece of history for today is that the US 30-year treasury yield reached an all-time low at 2.0139.

The dollar is mixed today, declining vs. JPY and CHF (safety) but gaining against the ZAR, MXN, and BRL (risk currencies) and the NOK, SEK, AUD, CAD, and NZD (commodity currencies).

The NZD and CAD are trading at one-week lows as commodities remain under pressure. NZDUSD is trading on the low side of a long-term sideways range and has a bias towards lower levels. The pair is currently trading near 0.6400 support, a level last traded in October of last year. Resistance is seen at 0.7000. Next support is near 0.6300. The RBNZ recently cut the key policy rate by a surprise 50 bps (a 25bps cut was expected) to 1% and has said that it could cut the rate to minus 0.35% in case of crisis. The RBNZ is one of several global central banks to have adopted a rate cut bias to spur lagging inflation and to support labor markets. The probability of another 25bps rate cut increases to 83% by February of next year. This alone will prevent the NZD from strengthening beyond near-term resistance levels.

Ongoing uncertainty over US/China trade relations will continue to weigh on the global economic outlook, stoking fears of recession and driving flows into the safe-haven JPY, CHF, and USD.

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After allowing its currency to drop to an 11-year low yesterday, China’s central bank targeted a somewhat weaker yuan today, which helped to allay fears that China was manipulating its currency in response to the recent escalation of trade tensions with the US. The USDCNY traded as high as 7.0575 yesterday, the highest level since March of 2008. A weaker yuan makes Chinese goods less expensive in the US, and US goods more expensive in China… the recipe for an increasing trade imbalance.

In trading today, the JPY and CHF have declined by 0.50% vs. the dollar while the AUD, MXN, GBP have gained ~0.40%. And the US dollar index is higher by 0.23% today following three consecutive daily declines.

Factory order data for the EU released earlier today was reported at +2.5% MoM, well above the +0.5% estimate and the previous the -2.2%.

Overnight New Zealand reported a jobless rate of 3.9%, the lowest level in 11 years, and a significant improvement from the previous reading of 4.2%. The RBNZ is expected to lower the official rate to 1.25% tomorrow despite the improving labor market and increasing wages.

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No sooner had Fed Chairman Powell said that ‘trade policy tensions… now appear to have returned to a simmer’ at last week’s FOMC rate policy decision than President Trump announced a new 10% tariff on $300bio of Chinese goods on Thursday. The new tariffs, set to go into effect September 1^st, simultaneously (1) apply pressure on China to address the trade conflict with the US and (2) attempt to steer an uncooperative US Federal Reserve towards more aggressive rate cuts.

The currency markets have swiftly adjusted to a defensive stand, lifting the JPY by 2.49% and the CHF by 1.97% since Wednesday’s close. Traditional risk currencies have taken the brunt of the shifting global risk sentiment with the ZAR, BRL, KRW, and MXN declining over 2% vs. the dollar, and the AUD, NOK, and NZD with losses over 1% against the dollar.

The probability of a follow-up 25bps cut at the FOMC’s mid-September meeting has climbed from 62.7% last Wednesday to 100% today, reflecting the market’s downgraded expectations for the global economy.

In light of the recent swings in the currency markets it seems appropriate to review how a handful of the major currencies have performed vs. the USD YTD: KRW and SEK have declined over 8%; GBP and AUD are down over 4%; and the ZAR, NOK, NZD, TWD, EUR, and DKK have declined over 2%. The JPY and CAD have gained over 3%, and the CHF and MXN are about unchanged.