The Sensible Direction


MAKE UP YOUR MIND - Markets have been a tougher go over the past several months, with so much going on and everything waiting to happen. We've been held up on these external forces that are now working their way out of the system and everyone is trying to figure it out what it all means. The trouble is, with the opinions so strong on both sides, we've been left in a kind of directionless trade. While I recognize we have seen some big moves that might make this sound a little odd, I'm talking bigger picture. And even when you break the year of 2018 down, it was initially all headed one way in Q1, with the Dollar on the decline, before everything reversed in Q2 and Q3. We're into Q4 and things feel like they could get going again. My view is that they should get going in the opposite direction, back to what we were doing in Q1. That is what would make good sense to me. We're at the point where if it is going to happen and we are going to see things really start moving, it should happen over the coming days.

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POSTURING - As far as the Pound and Brexit go, I really have a hard time seeing this play out in a disaster scenario where there is no deal to be had. A lot of what is going on right now is about the hard negotiation process and knowing that time can be wasted making it all feel a lot worse than it actually is. But there is a danger here, and that danger is what happens when things sit back for too long without progress and what was initially nothing more than stubborn negotiation, all of a sudden turns into something more real that never was intended. A no deal Brexit is not a good thing for the UK and it isn't a good thing for the EU. We've seen a lot of this naturally play through the weaker Pound, but none of this would be good for the EU. And so, there is a deal out there somewhere and I believe it just might be one of those things that comes out of nowhere and jolts the Pound a good deal higher. But there are other things that need to start happening as well for all of these things to play out.

Looking for markets to get back to thinking like they did in Q1 2018.

Q2 - One of the big reasons the Dollar started to rally back in Q2 was because of the whole global trade turmoil. It wasn't yet about Fed policy and higher US yields. That initial Dollar recovery happened because of the retaliatory efforts of countries around the globe who did not want to see the US get its way with a soft Dollar trade policy. And so, there were countermeasures in response to US moves that scared the market enough to doubt the effectiveness of the US policy. After all, the market was already trying to figure out if US policy could even impact financial markets in the way that a central bank could. One of those countermeasures came from Mario Draghi and the ECB, with the central bank making the unorthodox decision to not even consider any rate increases until the summer of 2019. And what did this do? Well, with the Fed in normalization mode and the ECB now saying it wouldn't be moving along for a year or so, it shifted those yield differentials right back to the US Dollar.

Q3 - And so, we need to see the US getting back to pushing that policy which it is committed to doing, as I believe the next wave of US protectionist measures will not be followed up with nearly as much bite. The recovery that I'm looking for in the Pound on a medium term to longer term basis, which I also expect will benefit the Euro, needs to be a recovery that comes from the US Dollar side of the equation as well. And there is another Dollar bearish driver that will need to work its way back into the market too. That one is about what I alluded to earlier. That one is about why the Dollar rallied in Q3 of 2018. In Q3 it was all about Fed policy normalization and higher rates. The Fed continued to show a willingness to lean more hawkish than what risk market were wanting to see, and all of that had US yields pushing up. But if the risk liquidation continues, as I believe it will, we should see the Fed give in to President Trump's calls to ease up on the normalization. This of course will get those yields moving back out of the Dollar and into the Euro and Pound.


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