Easier Terms

According to President Xi
The next steps from China we’ll see
Are easier terms
Giving foreign firms
The chance not to share their IP

Though no timeline did he announce
Most stock markets really did bounce
The dollar’s been steady
And bonds are already
Declining to larger discounts

Trade remains the primary focus of market participants as the ongoing comments and threats from both sides continue. Last night, however, Chinese President Xi Jinping spoke at the Boao Forum and struck a more diplomatic tone regarding the subject. In fact, he explained that Chinese markets would be opening for more imports of manufactured goods like autos, that foreign investment and activity in financial services and insurance would be allowed to increase and that respect for foreign IP would be reinforced. Of course, those are all terrific outcomes…if they come about. But there was no timeline attached to the discussion, not even a broad one like, ‘by the end of the year’ or ‘within X years’ so at this stage it is simply talk. And we all know the value of talk. That said, equity markets, which have been the ones most impacted by the ongoing trade concerns, have all rallied sharply, with Chinese and HK markets up 1.5%, while the Nikkei rallied a more subdued 0.5%. European markets have also rallied with the German DAX leading the way, up 1.0%, but the rest of the space more in the 0.5% range. Finally, US equity futures are pointing to a 1% rally at the opening.

It remains to be seen just how this plays out, but if pressed I would estimate that there will be some type of agreement reached that both sides will be able to point to domestically as victories. Will the Chinese actually open their markets further? History shows that only in areas where they feel they need something, or where they believe that the domestic industry is at such an advantage there will be limited value for foreign investment. The one thing on which we can count, however, is that this process has not ended, and that we are almost certainly going to hear about it regularly for a while yet. Another risk here is that investors and traders become inured to the discussion and something actually happens which results in real changes in the relationships (e.g. more tariffs or quotas) that has a real impact and requires a reassessment of valuations.

Moving on to the FX markets, we are in the midst of the monthly stretch where inflation data is printed all around the world. Although tomorrow we see both Chinese and US data, and next week brings UK, Eurozone aggregate and Japanese data, this morning we are seeing the first inklings of how things played out in March. For example, Dutch, Danish and Norwegian inflation all fell compared to last month and all were lower than expected. Now I grant that even combined, these nations are not large enough to have an impact on the global situation. However, the trend is clearly not one that Signor Draghi will be happy to see. We also continue to see softening economic growth from various Eurozone nations, with both Italian and Finnish IP falling last month. Once again my point is that the narrative continues to anticipate a more aggressively hawkish ECB going forward, and at this point, the data does not support that thesis.

The flip side of this story is in the US, where virtually every inflation-related piece of data has pointed to higher prices taking hold in the US. While Friday’s AHE data was seen as relatively benign, the underlying wage story continues to improve. Add to that the ongoing increase in oil prices and the cost of filling your tank, and it is well within reason that we see tomorrow’s CPI print higher than expected. Something else working to raise tomorrow’s CPI data is the removal of the cell phone data adjustment as that happened long enough ago to finally exit the data. So even though the reality is that inflation has been steadily rising and likely understated due to the idiosyncrasies of data collection, the optics are likely to look like there has been a sudden increase in the rate of inflation lately, and probably severe enough to cause the Fed to move. At this point, expectations are for headline and core CPI to print at 2.4% and 2.1% respectively, which represent 0.2% and 0.3% rises from last month. Those are already pretty big moves in this series. What if the numbers print at 2.6% and 2.2%? All I’m saying is that Goldilocks has been getting beaten up pretty regularly lately, and a high side surprise could well be enough to kill her.

If inflation is no longer benign and the Fed is forced to tighten even faster, a key part of the global growth story with low inflation is going to crumble, and with it, potentially, many market themes of the recent past. And of course one of those themes is the ever-weakening dollar. A more aggressive Fed combined with a more reluctant ECB is going to support the greenback almost no matter what else is ongoing. This has been part and parcel of my thesis on dollar strength, so it will be tested in stages, first tomorrow and then next Thursday when the ECB releases its CPI data.

A quick look at the dollar’s performance this year shows that while it fell in January as the narrative was strong, since then it has done almost nothing, albeit in a choppy fashion. Coincidentally, since then we have also seen the first inklings that last year’s synchronized global growth story with low inflation was coming undone, and the trade issues have merely reinforced that concern. If/when the market recognizes that inflation rates have started to diverge, I anticipate a lot more pain for those who are still invested in Goldilocks. Just sayin’.

As to today, the NFIB Small Business Index disappointed a short while ago, printing at 104.7, its lowest level since last October and perhaps indicative of a top in this series. We also have PPI at 8:30 (exp 0.1% and 0.2% core which translates into 2.9% and 2.6% Y/Y). This data will have to be shockingly different to move markets as investors focus on tomorrow’s CPI. So for now, despite the weaker NFIB data, equity futures continue to point toward a rebound. However, the equity movement has been insufficient to drive FX markets by itself. So lacking further trade related comments from the administration, I expect a quiet day for the dollar. However, tomorrow has some potential for movement.

Good luck

2 thoughts on “Easier Terms

  1. John Noonan had the best take on this:

    “Comments aren’t targeted at the United States, but rather the vast sweep of ASEAN countries who are in the midst of a tug-of-war between U.S. and Chinese influence.”

    • Entirely possible. After all, the Chinese are famous for their long term views. But as another friend said, it also appears that President Xi is expecting a more “normal” response from President Trump, similar to what US presidents have done since Nixon, however, there is nothing in Trump’s history as president, or before, that indicates he will behave in that manner. I think he wants the Chinese to change, and words will not be enough in this case.

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