Concerns about trade have matured
With markets now more reassured
That all the trade bluster
Was just meant to muster
Both nations while deals are secured
One has to be impressed with the ability of investors to change their collective mind in a hurry. When I wrote yesterday morning, it felt as though the world economy was about to hit a very big roadblock toward future growth as the trade rhetoric between the US and China got quite heated. But by the middle of the day, after comments from Commerce Secretary Ross and new National Economic Advisor, Larry Kudlow, as well as from some Chinese counterparts, it became clear that all the huffing and puffing was simply the first part of a more substantial negotiation on the trade relationship between the two nations. And the market breathed a huge sigh of relief, with equities rebounding some 2.5% from their intraday lows and Treasuries giving up their early gains as the risk-off meme reversed into a risk-on day.
The dollar, meanwhile, regained all its lost ground and then some against the yen, ultimately rallying 0.2% on the day, which was a solid 0.7% from early yesterday morning. The other big mover of note during yesterday’s session was the Mexican peso, which rallied more than 1% from its early morning lows on the back of both the changing perception in the US-China trade spat and increasing confidence that the NAFTA negotiations are going to be concluded successfully. One other thing has helped the peso lately and that was the announcement two days ago by AMLO (the leading, far-left presidential candidate) that he was not considering renationalizing strategic companies if he is elected. This had been a great fear amongst investors and so relieves additional pressure on the economy and currency.
So if trade is moving to the back burner (although I imagine there will be periodic comments and tweets that can have market moving effects), we are back to looking for the next big thing. Or perhaps more accurately, we are back to looking at the previous big thing, central bank activity. Remember, prior to the escalated trade dialog, global central bank activity had been the primary driver of markets. So has anything changed in the past few days? Not really.
In the US, the data continue to point to a robust labor market, with yesterday’s ADP Employment figure printing at a higher than expected 241K with particular growth in the manufacturing sector. At the same time, the ISM non-manufacturing index slipped a bit more than expected to a still robust 58.8. We also saw Factory Orders rebound less than expected, growing only 1.2%, not the 1.7% forecast by economists. In fact, this pattern mirrors what we are seeing throughout the developed world, with economic activity seeming to have slowed from its Q4 peak around the world, although employment continues to ramp up. Now this is not unusual given the fact that employment data has always been a lagging indicator, meaning that it essentially looks back to where the economy has been rather than ahead to where it is going. So while politicians love to crow about their policies driving employment, and despite the fact that the market reacts more forcefully to the NFP report than virtually any other, arguably, it doesn’t tell us much about the future. In fact, the entire purpose of the ISM data (PMI data elsewhere in the world) is to get a read on the potential future activity, which is arguably much more important for policymakers. And it is why I highlight the fact that the forward-looking growth data is beginning to trend lower, because that is going to impact central bank thinking. In addition, the forward looking price data is continuing to trend higher, which implies that measured inflation is going to continue to increase as the year progresses. It is also why I am far more concerned about a recession before the end of 2018 than are most pundits.
But the market continues to rationalize the data in the following manner; ongoing strong employment data implies growth remains strong and even though the ‘soft’ indicators like ISM are starting to roll over, they remain quite high on a historic basis, and therefore are not indicative of weakening future growth. At least that’s what I can determine based on the fact that despite still high valuations in markets, there appears to be little concern that a further correction in asset prices can come along.
So all of this takes us to the dollar and its future. Given the fact that there has been no real change in the underlying fundamentals, it should be no surprise that my views haven’t changed. Yesterday’s Fed speakers offered little new information, with Cleveland’s Mester not even discussing policy in her speech about increasing diversity in economics while St Louis’s Bullard, a confirmed dove, said he thought policy right now was sufficiently tight and didn’t need any additional action based on his view of the economy. In other words, despite the fact that the Fed seems set to raise rates at least twice more this year, he sees no reason for the action. But as a dove, that is to be expected. In the end, I believe that not only is the market anxiously awaiting tomorrow’s payroll report, but so is the Fed, as they keep a close eye on potential wage gains. It is why I continue to believe that the AHE number tomorrow is the key feature of the report.
At the same time, we have not heard anything new from any of the Fed’s brethren central bankers, with the policy trajectories for the ECB, BOJ, BOE and PBOC all unchanged from before the trade story. As to data elsewhere, in the Eurozone this morning, the PMI Services and Composite data was a touch softer than expected, again pointing to the slowing growth momentum. We saw the same outcome in the UK, and we have seen that in both Japan and China in the past week as well. The difference is that the inflationary impulse that is quite clear in the US, with CPI already above 2.0% and PCE fast approaching the target, is not evident in either the Eurozone or Japan, especially at the core level. It is this lack of inflation, plus the fact that the Unemployment rate in Europe, which at 8.5% is at its lowest level in more than a decade, is still quite high, that continues to inform my view that the ECB is just not going to be as aggressive tightening policy as the current narrative suggests. And it is why I think the euro is toppish here and has far more downside than upside.
As to today, there are two data points of note, Initial Claims (exp 230K) and the Trade Balance (-$56.7B). Given the current trade rhetoric, the latter number could lead to some inflammatory comments, but my take is that will continue to be posturing. We also hear from Atlanta’s Rafael Bostic this afternoon. However, tomorrow is really the key day because not only do we get the payroll report, but Chairman Powell speaks at 1:30pm, so all ears will be attuned to his comments then. For the rest of the day, with equity markets continuing yesterday’s afternoon rally, my take is that the dollar, which is broadly stronger this morning, will actually give back a bit. But with so much news set for tomorrow, I don’t imagine today’s price action will be significant.