In Germany, GDP’s easing
An outcome that’s surely displeasing
A recent assessment
Of Chinese investment
Highlights global growth could be wheezing
The synchronous global growth story took a few more body blows today as both Chinese Retail Sales (actual 9.4%, exp 10.0%) and Fixed Investment (actual 7.0%, exp 7.4%) disappointed markets. In fairness, IP rose a more than expected 7.0%, but the net outcome was a depiction of an economy that is being slowed by the government’s efforts to reduce leverage. And while that is no bad thing, it still results in slowing economic activity. In fact, the slowdown in investment points to a continued future slowing in economic activity in China. A little while later, Germany reported that Q1 GDP actually rose only 0.3% (1.3% annualized), half the rate of Q4 and lower than the 0.4% expected. This has variously been attributed to extreme cold weather in March, a flu epidemic and a series of IG Metal strikes during their wage negotiations. These explanations are an effort to highlight that this was a temporary phenomenon, rather than the beginning of a trend. And perhaps they are correct, although the April data thus far have not borne out that case. And it was not only Germany that came up short, but also both the Netherlands and Portugal failed to meet expectations. The point here is that thus far in Q2, the data have not indicated that Q1 was a temporary blip. Now it may well be that things have improved significantly and that will start to show up in the data soon, but to date, the evidence is scant.
It can be no surprise that the dollar has held its own in the wake of these releases, with the euro edging lower on the day while the renminbi has fallen 0.25%. Yesterday’s price action was a bit more volatile as the euro made a run at 1.20 in NY’s morning session (remember the Villeroy comments), but then declined steadily all afternoon essentially closing unchanged on the day. One of the themes I have seen lately is that the dollar’s recent strength can be entirely attributed to a short squeeze in positioning. I agree that the large outstanding short positions played a role, in fact I wrote about it several times in the past month. But despite the fact that there are long-term structural issues affecting the dollar, my read is that the short-term cyclical factors remain the dominant driver for now. With 10-year yields trading back above 3.0% this morning, and the data stream continuing to point to ongoing US growth vs. slowing growth elsewhere in the world, it is hard for me to make the case that the cyclical story is over. It is why I continue to look for the dollar to perform well in the near term.
Adding to the dollar’s overall luster is the fact that the problematic emerging market currencies are just getting more problematic. Both Turkey and Argentina have fallen to new historic lows this morning as their local situations deteriorate. In Turkey, President Erdogan has explained to the market that after the election next month, he expects to take more direct control over the economy, which implies that he will be cutting interest rates there. That is certainly not the traditional policy for a nation with rising inflation and a weakening currency, but in this case, I expect he is a man of his word. TRY has further to fall. In Argentina, there are essentially no bids for the peso, which fell another 7.5% yesterday as the central bank has stopped wasting reserves in an effort to slow the decline. Right now, the only hope is that the IMF stand-by loan of $30-$40 billion is agreed soon and investors are willing to believe that it will stabilize the situation. We’ll see. But it is not just those two currencies that are suffering. BRL fell more than 2 big figures yesterday, (0.6%) and is steadily marching toward 4.00 as the presidential election process there heats up. A mixed data picture in Brazil shows the consumer still hanging in there, but production data slipping. Certainly not the best of circumstances. And India has also been suffering lately, falling another 0.5% overnight after inflation data highlighted that the RBI likely needs to be a bit more aggressive in raising rates. And while the rupee has not yet traded to new historic lows, it is a scant 1% from those levels.
My point is that it feels premature to dismiss the dollar rally at this stage. This is especially so in view of the fact that there is zero evidence that the Fed is going to change its strategy of tightening policy via both interest rate increases and a reduced balance sheet. And so I won’t do so. Rather I remain confident that the ongoing data situation will point to the dollar continuing its rally for now. With that said, all eyes will be on Mario Draghi tomorrow morning when he speaks, as if he has turned hawkish at all, that would signal that the ECB is ready to actually change policy, something I don’t believe will occur, but something that would clearly underpin a less bearish case for the euro.
This morning brings arguably the most important US data of the week in Retail Sales (exp 0.3%, -ex autos 0.5%). We also see Empire Manufacturing (15.5) at the same time, but the sales data should dominate.
One other thing, the politics of trade policy has almost certainly had a market impact, even beyond the potential for it to drive inflation higher. The recent turn on the Chinese phone company ZTE, where the administration is now working to reduce the draconian sanctions imposed earlier has been taken by some as a sign that the trade negotiations with China may be moving forward. As there were many who expected the dollar to weaken in the event that the US became significantly more protectionist, this is likely a mild benefit as well. In fact, it is hard to point to something that is a clear dollar negative right now. Granted, weak US data would help to turn the tide, but it would need to be quite consistent in order to do so. In the end, based on the current evidence, I see no reason to alter my views. And for today, I think all signs point to a bit more dollar strength.