Incumbents Were Tossed

In Europe, Italian elections
Had voters express their objections
Incumbents were tossed
And centrists all lost
Look out for more market corrections

The big weekend news was, of course, the European electoral situation. In what can be no surprise, the German SPD caved and joined the ‘grand coalition’ again, despite the fact that the party is drifting into irrelevance largely because of these coalitions. As I wrote Friday, the aphrodisiac of power was far more compelling than any alleged principals they claimed to hold. While this outcome was foreseen, it simply highlights that the center of German politics is losing its grip. Unless they make some big changes in policy, and they are not discussing anything of the sort, my take is that at the next election, putting together a governing coalition will be far more difficult than this time, and remember, it took an unprecedentedly long six months this time!

Meanwhile, Italy went to the polls and elected…nobody. Well, that’s not really fair, what they did was split the vote pretty significantly, with the anti-establishment 5 Star Movement winning the largest number of votes, capturing 32%. However, that remains far below the estimated 40% required to manage an effective government there. The right-wing grouping of Forza Italia and Lega Norda, won 37%, although that too, seems unlikely to be able to rule. Finally, the incumbent Democratic Party saw its support fall to just 19%. So there is no obvious solution as to how a government will be formed there, and it is entirely possible that a new vote will be held after a few months of futility. But none of this seemed to matter to markets, at least FX markets. In truth, Italian share prices are down 1% this morning, although the rest of Europe is marginally firmer.

In fact, the subject that still gathers the most attention is the tariff announcements made last week by President Trump.

Trump said that the problem with trade
Is everyone’s been so afraid
To call out the cheating
Which is why he’s tweeting
America won’t be betrayed!

Let me start by saying that any escalation in this adventure will be a distinct negative for every economy and global markets as well. The foundation of global growth over the past fifty years has arguably been the ongoing globalization of manufacturing where comparative advantage has demonstrated that prosperity could be widespread. However, the reason insurgent political parties and candidates, (e.g. Trump, Brexit, AfD, 5 Star Movement, etc.) have had so much success is because it turns out that the benefits of this growth have been very unevenly distributed. And those who have been missing the gains have found their collective political voice. Ultimately, this is a very difficult problem, and one that is unlikely to simply disappear. Rather, I expect that we will see an ongoing increase in insurgent support. And that is not likely to bode well for growth anywhere in the world. But that is a long-term process, so will be background noise more often than not, except when we have elections that explicitly show how the previous system and assumptions continue to slowly unravel. And while that is a somewhat dark view, I fear it is the most likely outcome.

With that as background, let’s pivot to the markets this morning. The dollar is little changed, slightly stronger vs. the euro, slightly weaker vs. the pound and yen, and mixed around the world. In addition to the elections in Europe, we saw PMI data released at softer than expected outcomes. While the growth trajectory there remains quite positive, it is very possible that we have seen the peak already, and that the Euozone is going to head back to its long-run sustainable rate of growth which is estimated at somewhere between 1.5%-2.0%, well below the most recent readings of 2.5% or so. At the same time, UK Services PMI data surprised on the high side, printing at 54.5, well above the expected 53.3 level, and indicating that despite the uncertainty of Brexit, the economy there is continuing to muddle through. Also helping the pound, which is higher by just 0.1%, is the fact that the market seems to believe that PM May is about to cave on the Brexit negotiations thus insuring a soft Brexit and less economic impact. If that is the case, I have a feeling PM May just may lose her office with PM Corbyn entirely feasible. Quite frankly, that would be similar to a President Sanders here, and a situation where the pound, in my estimation, would suffer greatly.

In the emerging markets, the situation is one of general dollar strength. For example, MXN is weaker by 0.6%, with RUB not far behind it. KRW is under pressure, as is the CE4, although interestingly, ZAR is actually a bit firmer. The latter, however, is likely due to the solid performance of gold (+0.9% overnight). One other notable mover is CNY, which is weaker by 0.2% after Caixin PMI data released overnight showed a further slowdown in growth there. This is of a piece with the Chinese National Party Congress, where last night Premier Li Kiquang laid out plans for GDP growth this year of 6.5%, down from 6.9% in 2017, while they continue to try to force further deleveraging of sectors like real estate and local government. The point is the picture today is mixed, with no broad theme.

On the data front, this week brings a great deal of new and important information, culminating in Friday’s payroll report:

Today ISM Non-Manufacturing 58.8
Tuesday Factory Orders -1.2%
Wednesday ADP Employment 203K
  Trade Balance -$55.1B
  Fed’s Beige Book  
Thursday ECB Rate Announcement -0.40%
  Initial Claims 220K
  BOJ Rate Announcement -0.1%
Friday Nonfarm Payrolls 205K
  Private Payrolls 195K
  Manufacturing Payrolls 17K
  Unemployment Rate 4.0%
  Average Hourly Earnings 0.2% (2.9% Y/Y)
  Average Weekly Hours 34.4

So plenty of new information to help us determine the next steps in the ongoing saga of markets. Signor Draghi may have been helped by the recent softening trend in PMI data in the Eurozone as he continues to want to leave policy alone despite many calls by the hawks to finally end QE. It will also be interesting to hear what Kuroda-san has to say given his comments last week about an exit to QQE there. My gut tells me that neither will be aggressively hawkish and will do everything they can to keep things on an even keel.

As for today, it depends on if there is further information regarding the tariff situation, which in its purest form is clearly inflationary. However, barring that, I think the market is likely to have a nondescript session, with the dollar waffling along with equity and bond markets.

Good luck