The sixty-one days of Q1
Resulted in somewhat less fun
Than all of last year
And there’s a real fear
This craziness isn’t near done
So looking ahead to Q2
The question is what should you do?
Where hawks see inflation
Most doves fear stagnation
It just rests on your point of view
Easter Monday is a holiday throughout Europe and equity markets there are closed across the board. While banks are open, trading staffs are skeletal and FX price action has been quite muted. If pushed, I would say the dollar is slightly softer, but there has really been very little to discuss. The biggest news overnight was the Japanese Tankan Survey, which mildly disappointed by printing at 24, but remains near its highest level in more than a decade. So perhaps growth in Japan has plateaued, but there is no strong evidence it is beginning to decline. Meanwhile, the impact on the FX market was virtually nil, as USDJPY has rallied just 4 pips. We also got Caixin PMI data from China, which was a disappointing 51.0 (exp 51.8) with the renminbi sliding 0.1% in the wake of the data. As I said, there was very little of note overnight.
So now seems like a good time to discuss bigger picture views of the market as we begin the second quarter. As always, there are many pieces of the story that appear contradictory and the question becomes which ones capture the market’s fancy at any point in time. It has been said many times, nothing matters until it Matters. In other words, while information may be available, until it becomes the focus of the market, it is merely background noise.
Historically, from a policy perspective, the best way to strengthen a currency is to run tight monetary and loose fiscal policy. The opposite is also true, loose monetary and tight fiscal policy will weaken a currency. So when looking around the world today, what do we see?
I would argue that the US is running the tightest monetary policy of all developed nations and arguably the loosest fiscal policy. Consider, the Fed has raised rates six times in this cycle while reducing the size of its balance sheet some $60 billion since October and seems set to continue both processes with three more rate hikes this year and probably another $150-$200 billion in balance sheet reduction. At the same time, the ECB continues to add to their QE to the tune of €30 billion per month and will be doing so through September at which point they are likely to reduce the purchase amount and maybe even stop buying completely, but certainly not sell any back! And rate hikes? It will be at least eighteen months before they go there. What about the BOJ, you may ask. Well they, too, are continuing to expand their balance sheet, buying JGB’s, and equity ETF’s to the tune of ¥6 trillion per year. Short-term rates in both places remain negative and the prospects of the BOJ raising rates also seem quite remote in the near future, as inflation there remains anchored below 1%. While both the BOE and BOC have raised rates in the past year, the pace has been much slower than the Fed (once in the UK, twice in Canada) and expectations remain that they will continue to lag the US in this policy adjustment. As to China, the PBOC has raised rates slightly, but also at a much slower pace than the Fed and they continue to be reactive rather than proactive in this process. China does have its own domestic struggles regarding excess leverage and the PBOC is trying to wring that out of the system via macro prudential policy adjustments without crashing things, so overall monetary policy there is probably the second tightest around. But I think it is clear that the US is running the tightest monetary policy in the world right now.
So let’s look at fiscal policy. Well, we all know that the US not only cut taxes massively, but also just signed an omnibus spending bill that will increase deficits by $300 billion (at least) over the next two years. That, my friends, is loose fiscal policy. A quick peek at the Eurozone shows the largest economy, Germany, running a 1.5% budget surplus! While throughout the Eurozone different countries have different situations, the net is an area running a basically balanced budget while every discussion on taxes has been about raising them (3% tax on tech company revenues anyone?). In other words, no one would accuse the Europeans of running loose fiscal policy right now. Japan? The Japanese continue to run budget deficits as they continue to try to prime the pump of the economy. They also have the fastest aging population in the world and are paying increasing sums for pensions and healthcare, so it is hard to call their fiscal policy tight. But is it looser than in the US? Debatable, and arguably since the US has just adjusted its policy, the impacts remain in the future as opposed to the Japanese who have been in this policy position for years. Elsewhere fiscal policy is loosening somewhat, but not nearly to the extent we have seen here in the US.
Add it all up and I would argue that the dollar ought to be the beneficiary of the policy settings. Of course, markets are forward looking and the argument that all these policies are already priced in is a valid one. But as I have maintained all year, it appears to me that the market is overestimating the future monetary policy moves elsewhere, although it might have finally caught up to the Fed.
Of course there are other issues that impact the dollar’s value with a recent favorite topic being trade. There is no question the US’s recent more protectionist bent on trade is having an impact. In the previous two periods where the US imposed tariffs on specific products, steel in 2001 and autos in the 1980’s, the dollar did suffer, falling about 8% each time. But monetary and fiscal policy settings were quite different then, so it is not really an apples-to-apples comparison. However, as I wrote above, nothing matters until it matters and apparently, the market is keenly focused on the FX impact of tariffs right now. At least that is one explanation for the dollar’s weakness and it may be the best we have.
Another factor is prospects for future growth. While the synchronized global growth story continues to be a popular meme, I am starting to wonder how much longer it will continue. My concern stems from the fact that we have seen a series of data releases that not only missed forecasts but also have actually turned lower. Last night’s Tankan is a perfect example, but so too is the PMI data we have seen in Q1 throughout the world, as well as US Retail Sales data and a host of other factors. It is entirely possible that Q4 represented the pinnacle of this cycle’s growth and that we are going to see a reduced rate going forward. If that is the case, then the relative timing of those changes will drive the FX market. For example, if the US data starts slowing appreciably faster than that of the Eurozone, I would expect a weaker dollar and vice versa. As I have written before, one of my key concerns is that virtually the entire economist community is so sanguine about the prospects for a recession by the end of this year, with mid 2019 seen as the earliest opportunity. Again, my observation is that when all agree an event will occur in the distant future, it tends to occur sooner than expected. So a recession before 2018 ends would not shock me, but it would shock markets. Depending on how it evolved, the dollar could clearly suffer in that scenario, but it could just as well rally if the US seemed set to weather it best.
What is surprising is that for those carrying short USD positions, the negative carry is becoming quite significant as LIBOR rates continue to rise almost daily. The point is that it is a painful position to hold if it is not working, and for the past several weeks, the dollar has been relatively stable. That is costing the shorts a lot ofmoney. At some point for a negative carry position, not falling is the same as rising, although I don’t know at what point that will occur now.
Other issues that pundits have mentioned are concerns over the volatility in the US administration, with a lot of turnover in the White House, but I don’t think that markets really see that is a critical day-to-day issue. There is much more concern with policy action rather than with personalities, at least in my view.
So add it all up and I still see the rationale for the dollar to rebound as the year progresses unless we see significant changes in policy elsewhere. And as it stands right now, that doesn’t seem to be likely.
Before I finish, we do have a lot of important data this week, culminating in Friday’s payroll report.
|Average Hourly Earnings||2.7%|
|Average Weekly Hours||34.5|
So we should get our first idea as to how Q1 is shaping up and as to whether the Fed is going to be on further alert. Last week, the PCE data on Thursday did print higher than expected with the core at 1.6%. Continued strength in the AHE number will certainly be a keen focus. Imagine, if you will, a 3.0% print there on Friday. That would cause some fireworks in both the bond and equity markets! In addition, we hear from five more Fed speakers, with a chance for the first nuance from the new data. In the end, I fear we will continue to see pressure on the equity markets this week as we have reached the good news is bad scenario, and if Friday’s data is strong, it will simply feed the process. While today is likely to be benign given the holiday hangover, the rest of the week could well be quite interesting.