Might Cause Dismay

The CPI data today
Could very well show us the way
The market will move
As things here improve
So strong data might cause dismay

It is remarkable to me that the CPI print today has garnered as much press as it has. For the past three decades, this attention has pretty much been entirely reserved for the payroll report. So perhaps this is a healthy turn of events, one signaling that investors are going to look more carefully at the entire economic data set rather than a single proxy. Of course, it’s early days to be making that claim, but one can be hopeful! At any rate, most markets have basically tread water for the past two sessions in anticipation of the print.

To reiterate, expectations are as follows: CPI (0.3%, 2.0% Y/Y) and CPI ex food & energy (0.2%, 1.7% Y/Y). One thing that is important to understand is that not all 0.3% rises are the same. While the release only has one decimal place showing, the actual calculation pushes to the second decimal place, so 0.26% and 0.34% both print at 0.3%. Street economists and analysts will be closely watching the more precise figure and markets will respond to that number. And there is one other thing to remember, CPI is an annual number, so it is comparing the current price index to last year’s data. If you recall, it was last February when the cell phone companies changed their pricing for unlimited data, which drove the March inflation number much lower. So starting next month, the comparisons are going to be with those lower numbers, therefore we are almost assured of higher numbers this year beginning in March. Of course, that says nothing about today. While I don’t know where this data is going to print, what seems quite likely is that any print on the high side of 0.3%, let alone a 0.4% print, will be seen as confirmation that the FOMC is going to pick up the pace of rate hikes, and is likely to see another wave of equity market turmoil.

Oh and there is one more thing about the Fed, a story this morning that the White House is considering Loretta Mester, currently Cleveland Fed president and one of the more hawkish members of the FOMC, for the role of Fed Vice-Chair. She is a well-respected economist, and if she becomes the highest-ranking economist on the Fed, I expect that the tone from the FOMC will turn even more hawkish. That, my friends, will have an immediate impact on markets if it is announced. In the end, what we are seeing is the ongoing dismantling of the ultra easy monetary policy of the past nine years. As that progresses, expect both equity and bond markets to underperform and volatility to head back toward more historic levels, which despite the past week’s activity, are still higher than currently seen.

How will the dollar fare through all this? For the past two sessions, it has clearly been under some pressure, albeit not excessively so. One interesting conundrum has been the yen, which is stronger again this morning by 0.4%. Despite the fact that equity markets have stabilized, and there are many calls that last week’s decline was overdone, a stronger yen has historically been a sign of removing risk. So the modestly higher equity prices this week don’t really fit with a much stronger yen. Now, it’s possible that FX traders were responding to the Japanese GDP data last night, which showed Q4 growth at a slower than expected 0.5% Y/Y. The Nikkei underperformed, falling 0.4%, but in a classic chicken and egg question, I’m not sure whether the weak data and Nikkei, in the guise of risk reduction, caused the yen to strengthen, or if the strong yen caused the Nikkei to weaken. What I do know is that there are more stories that PM Abe is set to reappoint Kuroda-san as BOJ Governor, which some take as proof that the BOJ is going to maintain its hyper aggressive monetary stance. But even he has questioned just how much more QQE (Japan’s terms for QE) can help the economy there. And there is one other thing to note. Japan’s population is actually shrinking, as well as aging rapidly. So any growth at all on a gross basis implies a much better rate of per capita growth. Quite frankly, I think Japan has been doing quite well, and I continue to expect the yen to strengthen further despite my views on the Fed. Par remains my year-end target.

Pivoting to Europe shows that Q4 GDP was released at the expected (0.6%, 2.7% Y/Y) level, with Germany and Italy coming in a bit weaker than expected, while the Netherlands, France and Spain all looked a bit better. However, given the overall pace of growth, traders continue to preach the narrative that the ECB is going to exit QE faster than Signor Draghi is willing to admit. While the euro is virtually unchanged overnight, it has been edging higher during the past week. Here, I continue to put more faith in the Fed to turn the tables and drive the dollar higher. Today will be a key input in that process I think.

In the emerging markets, once again South Africa remains the place with the most noise as the ANC voted to remove President Zuma, but he has not yet vacated the post. This vote, however, has been enough to encourage further active rand buying, and it is higher by another 1% this morning. The risk here is that given the delays in this transition, the economy remains under stress and there is no budget in place. Moody’s is on the cusp of downgrading South Africa to junk rating which would trigger a significant outflow by bond investors, and correspondingly, likely have a pretty negative impact on the rand. For those with hedging needs here, it is something to keep in mind.

Elsewhere in the EMG bloc, APAC currencies have been the best performers, following the yen higher with KRW higher by 0.65%, MYR by 0.5% and both INR and TWD by 0.3%. Overall, a strong performance ahead of a key US data point. But it appears that investors are getting set to shake off last week’s market action and dive back in to risk. Again, the conundrum is the yen showing strength while other markets seem to be embracing risk. One of these processes is going to change soon, so beware.

Alongside the CPI data we also get Retail Sales this morning (exp 0.3%, 0.5% ex autos) although with the focus on CPI, it will have to be a really big outlier to matter. There are no Fed speakers and no other news on the docket. With that in mind, it will be all about that CPI print. A strong number should lead to equity market declines alongside bond market declines and the dollar rallying. A weak number should see the opposite, and if it is right in line, I expect that we are likely to see a continued tentative rebound from last week’s price action.

Good luck
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