The important data this morning is US inflation, forecast a little lower than June (1.6%) or maybe a little higher (1.7%) but most forecasters seeing an average for the year at 1.3-1.4%, vs. 2.1% in 2016. Critically, core CPI is expected to remain the same 1.7% for the third month in a row. In other words, the Event could be a dud, leaving everyone scrambling to figure out how to trade. (Remember Rocky's Rule 3: When in doubt, sell dollars.)
A prime inflation mover is oil, but we are seeing that WTI crude can achieve $50 only briefly--it can't hold it.
Falling inflation removes justification for the Fed's rate hike this year, although the WSJ survey of 62 economists finds a majority, nearly 75%, see the Fed acting once more this year and three times in 2018. This means they agree with the Fed's own projections. They do expect the Sept meeting to deliver the announcement of contracting the balance sheet, which will be "relatively soon" after the July meeting. The crowd that trades Fed funds futures does not agree. The probability of a hike by year-end is now 42.5%, from 47.3% a month ago.
The WSJ survey also covers the likelihood of a government shut-down and budget crisis, running at 22%, with a 17% chance the government halts payments to its workers, contractors and entitlement beneficiaries (Social Security).
That's the one good thing about war—a budget would get done.
Probably possessing as much scare-power as Trump's intemperate words was the story that the Pentagon has prepared a plan for a preemptive strike against N. Korea. Announcing such a plan could be a tactic, but nobody doubts that such a plan exists. Most observers seem to think activation of such a plan would be a death-knell for the citizens of Seoul, which is 14 seconds away from 10,000 artillery guns, not to mention the 37,000 US soldiers, sailors and marines.
Secretary of Defense Mattis muddied the waters. On Wednesday, he had issued an ultimatum to North Korea to "cease any consideration of actions that would lead to the end of its regime and destruction of its people. The DPRK must choose to stop isolating itself and stand down its pursuit of nuclear weapons.... [The] "regime's actions will continue to be grossly overmatched by ours and would lose any arms race or conflict it initiates."
But then yesterday Mattis said a US-North Korea war would be "catastrophic. The American effort is diplomatically led, it has diplomatic traction, it is gaining diplomatic results and I want to stay right there right now. The tragedy of war is well-enough known it doesn't need another characterization beyond the fact that it would be catastrophic."
War is unthinkable but clearly some people in power are thinking about it.
Or are they? Maybe this is just another episode of "The Trump Show." You have to wonder if Trump is blowing up the Washington Post story on the Defense Intelligence Agency estimate that N. Korean nukes can now reach the US—in order to distract attention from something worse. The other big story these days is disclosure that two weeks ago the FBI raided the Manafort house for evidence, one day after Manafort testified to a Congressional committee. Maybe he took the Fifth and the FBI raid is the way around that. Note that there were no FBI raids in the entire Watergate case. Some analysts question the DIA story, which is still not affirmed by other intelligence agencies and has less credence since the DIA cried wolf once before in 2013.
It would be utterly despicable if Trump seized upon that DIA story to distract attention and is threatening war to avoid focus on the special counsel investigation into his campaign's collusion with Russian interference in the election. North Korea has been increasing its nuclear capability for decades. Why now? The distraction thesis is getting little attention because war is such a serious thing, but we buy it. We can just imagine Trump bragging a few months from now about how he avoided war—a war that he himself proposed. Trump is reported by his own staff to have a two-minute attention span. Since Trump projects himself on everyone else, he thinks the rest of us have a two-minute attention span, too. Alas, for the majority of citizens, he may well be right.
By now, after two forays into Iraq plus a number of other events, including Libya and Trump's own forays into Syria, we all know that while only Congress can declare war, the president has the constitutional authority to take any military action if he perceives the threat warrants it. There is a further distinction in the Constitution, at least according to some legal scholars—offensive military action requires the approval of Congress, but defensive military action does not.
Trump doesn't give a fig for the Constitution and will start a war if he darn well feels like it. Fortunately, he cares more about his image and public relations than about actual foreign affairs. If he wants a Nobel Peace Prize (for fixing the Middle East), he can't start war preemptively, at least not one with such a high civilian body count. Greater Seoul has almost 30 million citizens, not to mention those 37,000 American soldiers, sailors, and marines. Besides, would the generals convey his orders? The thought of mutiny is intriguing, if remote. Some Congressmen are contemplating new rules to cover Trump's war powers, but they are few and far between, and relatively toothless.
Markets are now thoroughly frightened. Let's assume Trump is not one bit serious about war. Or if he is serious, that "the generals" will talk him down. This whole thing could be over in a week. It would be helpful if N. Korea would just shut up and stop poking Trump's thin skin. Maybe China can help at least to that extent.
If the war story is just another of Trump's distraction ruses, we could be back to less abnormal conditions in very short order. But the damage to the dollar is permanent as long as he is in office. We trade on expectations as much as hard data and news. If our expectations cannot be captured within boundaries that define "normalcy," markets can go haywire all too easily. One place where a semblance of normalcy can be restored is the carry trade. The funding currencies, the yen and Swiss franc, would reverse from their current upmove. How fast is anyone's guess. Another beneficiary of the end of war talk, aside from the obvious (the Kospi), is emerging markets. If you are not busy stashing money in a safe haven, you are out seeking yield.
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This morning FX briefing is an information service, not a trading system. All trade recommendations are included in the afternoon report.