Inflation in England is easing
Which most people there find quite pleasing
But Brexit remains
A source of great strains
As Europe continues its squeezing
Yesterday’s broad equity market rally brought relief to most investors as it allayed concerns that the end was nigh. While many continue to be bullish, there is no doubt that there is rising concern about the idea that the good times will eventually end. In the wake of yesterday’s rally, however, fears have abated somewhat and market chatter is now focused on more mundane things like data and the FOMC Minutes.
With that in mind, the most noteworthy data overnight was the UK Inflation report that showed that CPI rose only 2.4%, well below expectations of a 2.6% rise, and seemingly indicating that earlier fears of stagflation in the UK economy were widely overblown. In fact, both sides of that equation, GDP growth and inflation are moving in the preferred direction, with GDP outperforming while CPI is underperforming. This situation will reduce pressure on the Old Lady with regards to policy moves as the necessity of hiking rates in an environment where price rises are moderating is quite limited. Thus it should be no surprise that the pound is under modest pressure today, falling 0.3% in the wake of the data release. However, in the broad scheme of things, the pound remains little changed from its level back in June and July.
Ultimately, while the monthly data releases are important, all eyes remain on the Brexit situation and estimates of how and when things there will be settled. The latest news is that the currently mooted plan, essentially splitting Northern Ireland from the rest of the UK, at least from a commerce perspective, does not have support in Parliament. At the same time, the Europeans believe they retain the upper hand in the negotiation as EU President Donald Tusk has called for PM May to come forward with some new creative solutions, implying it is her problem, not theirs. It is almost as though the EU doesn’t want to work at solving the problem at all. There is a big EU meeting today and tomorrow but right now, there doesn’t appear to be anything new to discuss, and while negotiations are ongoing, the issue is likely insoluble. After all, the competing demands are to prevent any visible customs border between Ireland and Northern Ireland while insuring that customs and duties are charged for all products that cross that border. As I have written many times, I expect there will be a fudge solution that doesn’t solve the problem but more likely kicks the can down the road for a few years. However, each day that passes increases the probability that there is no solution and the result is short-term chaos in markets and a much weaker pound. The risk/reward in the pound argues to maintain a net short position, as any potential gains are likely to be small relative to any potential losses depending on the actual outcome.
Away from the Brexit story, however, there is precious little else happening in the G10 bloc. Eurozone CPI was released right on the money, with the headline confirmed at 2.1%, but core remains a full percentage point below that. There is no indication that the ECB is going to change their policy stance at this point, and so look for QE to end in December while interest rates remain unchanged for at least another nine months following that. The euro has edged lower in recent trading, but the 0.2% decline is hardly enough to change any opinions, and as I mentioned yesterday, the bigger picture shows that it has barely budged over the course of the past five months. As to other currencies in the bloc, the RBA Minutes highlighted that low interest rates were likely to be maintained for another few years as the Unemployment Rate drifts lower, but there is, as yet, no evidence of rising wage pressures. Aussie seems likely to remain under broad pressure, especially as the US continues to tighten policy.
Turning to the EMG bloc, Chinese data last night showed that the money supply was continuing its steady 8.3% growth and that far from austerity, new loans continue to be made at a solid clip. It is quite clear that the PBOC is easing policy while trying to use regulatory tools to prevent additional liquidity moving into real estate where they continue to try to deflate a bubble. So far, it has been working for them. In the meantime, the renminbi continues to trade around 6.92, making no move toward the feared 7.00 level, but also not showing signs of strength. It is becoming quite clear, however, that outbound capital flows are starting to increase as for the third month running, China’s holdings of US Treasuries have fallen, this time by about $6 billion. Ignore all that you hear about China using Treasuries as a weapon; they have no alternative place to park their cash. Rather, the most likely explanation for a reduction in holdings is that they have been selling dollars in the FX market and need to sell Treasuries to get those dollars to deliver.
And those are really the big stories of the day. Yesterday’s US data was solid with IP growing 0.3% and Capacity Utilization running at 78.1%, largely as expected. This morning brings Housing Starts (exp 1.22M) and Building Permits (1.278M), and then this afternoon at 2:00 we see the FOMC Minutes. Given how much we have already heard from Fed speakers since the meeting, it strikes me that there is very little new information likely to appear. However, there are those who are looking for more clarity on the ongoing discussion about the neutral rate and where it is, as well as how important a policy tool it can be.
Equity futures have turned lower as I type, now down 0.2% while Treasury yields seem to have found a new home in the 3.15%-3.20% range. Arguably, today’s big risk is that the equity market resumes last week’s sharp declines and risk is jettisoned. However, that doesn’t appear that likely to me, rather a modest decline and limited impact on the FX market seems more viable for today.