The dollar is nearing the highs for the year once again. Rising interest rates in the US have bolstered the dollar this year as other major central banks are not near the same part of the cycle as the US. The BOJ came out last night lowering inflation forecasts in a sign that rates and asset purchases will still be a part of the picture in Japan. The Euro and Pound outlooks for rate increases look murky from the threat of a hard Brexit and political and fiscal divisions across Euro member countries.

The only shorter term catalysts that could substantially move the Dollar lower would be heightened trade war rhetoric or signs that the language is starting to affect the overall economy (through corporate earnings or otherwise). These factors seem to be longer term trends that will take time to develop which means in the mean time, expect the dollar to remain strong going into the 4th quarter.

Stocks are making a comeback this morning after Italy concerns wane, but the initial shock of the announcement that Angela Merkel will not seek reelection in 2020 pulled down the Euro. Since the announcement that too has recovered to trade about flat. This change in the Christian Democrats chair could be good for the country, where taking a stance on issues such as immigration and European integration need to be dealt with to stop the populist rise in the country. The silver lining of this transition is that Merkel will now be able to take decisive action without the need to tip toe around political sensitive issues.

Elections in Brazil were looked at approvingly by the markets too, boosting EM stocks in European trading. The country is looking at the newly elected president, Bolsonaro, as good for the economy by being pro business. These changes in themselves do not make much of an impact to the markets but will be important factors in managing the economy as markets start to wobble.

About a quarter into earnings season and the data is showing a very strong 3rd quarter. The markets took the news and dropped the S&P almost 9% this month. A lot of analysts are scratching their heads over this conundrum and why the data isn't raising as rosy of a picture as in the past. There are three major thoughts on why earnings don't matter, two of them justify the correction, while one of them leaves a lot more to worry about in the coming months. 

Overestimated earnings:
The estimate cycle usually goes in its downward revising fashion as the estimate date comes near. This is a classic example of people overestimating near term future conditions. This year something different has happened, estimates went up as a result of the tax cuts that came into effect. This caused the markets to rally on the news and the optimistic estimates before the actual results came out. Therefore no stock prices are shocked or unprepared for these higher numbers.

Outlook: 
In relation to the earnings story, a lot of companies forward guidance was a cause for concern. Admitting to the one time boost from these tax cuts and concerns over the tightening of the rate cycle, the markets could be pricing in modest earnings growth in the future. Companies have come out in their earnings calls mentioning the tougher climate that is ahead and headwinds to their industries, or the economy as a whole. While this is not good for companies' stock prices it is a factor that can be measured, as a result, so will the market correction.

Macro factors:
This is the big question mark in terms of how much the market has to drop. Earnings and outlook stories will understandably see an adjustment in the markets to take into account the new realities. The big "if" factor is whether the trade wars with China escalate, sanctions on the middle east de-stabilize the region and the oil market, or Italy and the Euro countries come to a budget resolution. These issues are more frightening to the markets because there is no estimate to how bad they can get. As escalation in the trade war deepens, you can see earnings consistently erode beyond even the lowest estimates. Sharp spikes in oil prices can negate any wage growth Americans have seen, and curb spending. These are the concerns to watch in terms of how much the market may still have to go. As time goes on you will see these negative factors start to fade, or be priced into earnings forecasts. It will be in a couple quarters that the macro factors start to become an earnings story. 

The Euro came off its lows after the news that Italy wanted to start discussions over their budget with the European Commission. While coming off the recent lows, many market participants are not sure this will be the end of the volatility in the Euro or any other currency in the near term. Taking a look at the bigger picture we can see that, while the headline news certainly does affect there markets, the increase in volatility is nothing new. 

Since the start of the crisis, major central banks lowered their interest rates to historic lows to stem the crisis and stimulate the economy. After the initial shock of the market turmoil this brought volatility down since interest rate differentials were the only measures to use and no country looked ready to start a rate increase cycle any time soon (The ECB tried it to their detriment). With the announcement of QE across central banks, volatility increased as the balance sheets of the major central banks started to swell. 

Now we are starting to see the volatility decrease as the US starts to shrink its balance sheet. Europe is expected to follow suit with the end of their QE program this year and the start of higher rates in the middle of 2019. Barring the current threats of Italy the removal of the ECB in open market operations will bring down the volatility of the Euro. At that point we will be back to pricing the Euro based on interest rate differentials and this is where the importance of the Eurozone unity will come in. The level at which the euro is set will be dependent on several interest rates as opposed to just the ECB rate. It will be at this time the that spreads concerning the markets today will truly have an impact on the currency.

As results come in from the Bavarian election in Germany, the Christian Social Union (CSU) is forecast to have taken a hit. The CSU is set to take about 39% of the seats, with the far right Alternative for Deutschland (AfD) projected around 11%. This will give the far right group seats in Bavaria for the first time.

Why this matters to the markets is in how it will shape the ability of Germany to play a role outside the country. With the need for deeper integration between European counties to stabilize the currency longer term having a inward, nationalistic, shift will make this more difficult. Macron of France came into office on the premise that he would be able to better integrate Euro countries in a tighter union. With his domestic policy running into problems his ability to influence other countries into this union is becoming more difficult. 

Italian markets dropped and bond yields increased as the government created a budget outside the agreed upon fiscal policy measures. This will no doubt cause tensions between the EU and Italy in the coming month when they have to submit the finalized budget. How this gets resolved will be important to watch as a gauge of the political unity within the Eurozone.

Political concerns are creeping up all over Europe with Brexit and populism growing in traditionally stable countries like Germany. The immediate fallout from the Italian budget getting passed will not be severe, but it would show the willingness of other Euro countries to enforce agreed upon measures with a new government. Failure to do wo would empower far right groups elsewhere to push for more nationalistic economic measures. Should this happen the fiscal issues that are isolated to Italy could be factored into markets on a country by country basis. 

The Euro countries see this and will most likely try to contain the measures that Italy is proposing. By rejecting their plan they will show there is a 'penalty' for not agreeing to historical agreements. This is bad news for Italy and expect more volatility in the month ahead.