The PMI data last night
From China highlighted their plight
More trouble is brewing
While Xi keeps pursuing
The policies to get things right
Any questions about whether the trade conflict between the US and China was having an impact on the Chinese economy were answered last night when the latest PMI readings were released. The Manufacturing PMI fell to 50.2, it’s lowest level in more than two years and barely above the expansion/contraction level of 50.0. Even more disconcertingly for the Chinese, a number of the sub-indices notably export sales and employment, fell further below that 50.0 level (to 46.9 and 48.1 respectively), pointing to a limited probability of a rebound any time soon. At the same time, the Services PMI was also released lower than expected, falling to 53.9, its lowest level since last summer. Here, too, export orders and employment numbers fell (to 47.8 and 48.9 respectively), indicating that the economic weakness is quite broad based.
Summing up, it seems safe to say that growth in China continues to slow. One question I have is how is it possible that when the Chinese release their GDP estimates, the quarter-to-quarter movement is restricted to 0.1% increments? After all, elsewhere in the world, despite much lower headline numbers (remember China is allegedly growing at 6.5% while Europe is growing at 2.0% and the US at 3.5%), the month-to-month variability is much greater. Simple probability would anticipate that the variance in China’s data would be higher than in the rest of the world. My point is that, as in most things to do with China, we don’t really know what is happening there other than what they tell us and that is like relying on a pharmaceutical salesman to prescribe your medicine. There are several independent attempts ongoing to get a more accurate reading of GDP growth in China, with measures of electricity utilization or copper imports seen as key data that is difficult to manipulate, but they all remain incomplete. And it seems highly unlikely that President Xi, who has been focused on improving the economic lot of his country, will ever admit that the growth figures are being manipulated. But I remain skeptical of pretty much all the data that they provide.
At any rate, the impact on the renminbi continues to be modestly negative, with the dollar touching another new high for the move, just below 6.9800, in the overnight session. This very gradual weakening trend seems to be the PBOC’s plan for now, perhaps in order to make a move through 7.00 appear less frightening if it happens very slowly. I expect that it will continue for the foreseeable future especially as long as the Fed remains on track to tighten policy further while the PBOC searches for more ways to ease policy without actually cutting interest rates. Look for another reserve requirement ratio cut before the end of the year as well as a 7 handle on USDCNY.
Turning to the euro, data this morning showed that Signor Draghi has a bit of a challenge ahead of him. Eurozone inflation rose to 2.2% with the core reading rising to 1.1%, both slightly firmer than expected. The difference continues to be driven by energy prices, but the concern comes from the fact that GDP growth in the Eurozone slowed more than expected last quarter. Facing a situation where growth is slowing and inflation rising is every central banker’s nightmare scenario, as the traditional remedies for each are exactly opposite policies. And while the fluctuations are hardly the stuff of a disaster, the implication is that Europe may be reaching its growth potential at a time when interest rates remain negative and QE is still extant. The risk is that the removal of those policies will drive the Eurozone back into a much slower growth scenario, if not a recession, while inflation continues to creep higher. It is data of this nature, as well as the ongoing political dramas, that inform my views that the ECB will maintain easier policy for far longer than the market currently believes. And this is why I remain bearish on the euro.
Yesterday the pound managed to trade to its lowest level since the post-Brexit vote period, but it has bounced a bit this morning, +0.35%. That said, the trend remains lower for the pound. We are now exactly five months away from Brexit and there is still no resolution for the Irish border issue. Every day that passes increases the risk that there will be no deal, which will certainly have a decidedly negative impact on the UK economy and the pound by extension. Remember, too, that even if the negotiators agree a deal, it still must be ratified by 28 separate parliaments, which will be no easy task in the space of a few months. As long as this is the trajectory, the risk of a sharp decline in the pound remains quite real. Hedgers take note.
Elsewhere, the BOJ met last night and left policy unchanged as they remain no closer to achieving their 2.0% inflation goal today than they were five years ago when they started this process. However, the market has become quite accustomed to the process and as such, the yen is unchanged this morning. At this time, yen movement will be dictated by the interplay between risk scenarios and the Fed’s rate hike trajectory. Yen remains a haven asset, and in periods of extreme market stress is likely to perform well, but at the same time, as the interest rate differential increasingly favors the dollar, yen strength is likely to be moderated. In other words, it is hard to make a case for a large move in either direction in the near term.
Away from those three currencies, the dollar appears generally firmer, but movement has not been large. Turning to the data front, yesterday’s releases showed that home prices continue to ebb slightly in the US while Consumer Confidence remains high. This morning brings the first inklings of the employment situation with the ADP report (exp 189K) and then Chicago PMI (60.0) coming at 9:45. Equity futures are pointing higher as the market looks to build on yesterday’s modest rally. All the talk remains about how October has been the worst month in equity markets all year, but in the broad scheme of things, I would contend that, at least in the US, prices remain elevated compared to traditional valuation benchmarks like P/E ratios. At any rate, it seems unlikely that either of today’s data points will drive much FX activity, meaning that the big trend of a higher dollar is likely to dominate, albeit in a gradual fashion.