Into the Tank

The German economy shrank
Japan’s heading into the tank
Italians declared
The budget prepared
Is gospel, and oil just sank

There are a number of stories this morning competing for market attention as investors and traders continue to try to get a reading on growth prospects going forward. Perhaps the most surprising story is that German GDP, which had been expected to print at 0.0% in Q3, actually fell -0.2%, significantly worse than expected. While every pundit and economist has highlighted that it was a confluence of one-time events that drove the data and that expectations for Q4 are far more robust, the fact remains that Q3 growth in Germany, and the whole of Europe, has been much weaker than anticipated. The euro has not benefitted from the news, falling 0.25%, and broadly continuing its recent downtrend.

Adding to the single currency’s woes is the ongoing Italian budget opera, where the EU huffed and puffed and demanded the Italians change their plans. The Italians, formally, told the EU to pound salt yesterday evening, and now the EU is at a crossroads. Either the emperor has no clothes (EU does nothing and loses its fiscal oversight capability) or is in fact well dressed and willing to flaunt it (initiates procedures to sanction and fine Italy). The problem with the former is obvious, but the problem with the latter is the potential impact on EU Parliamentary elections to be held in the spring. Attacking Italy could easily result in a far more antiestablishment parliament with many of the current leadership finding themselves in the minority. (And the one thing we absolutely know is that incumbency is THE most important aspect of leadership, right?) The point is that there are ample reasons for the euro to remain under pressure going forward.

At the same time, Japanese economic data continues to disappoint, with IP declining -2.5% Y/Y in September and Capacity Utilization falling 1.5%. At the same time, we find out that the BOJ’s balance sheet is now officially larger than the Japanese economy! Think about that, Japan’s debt/GDP ratio has long been over 200%, but now the BOJ has printed money and bought assets equivalent to the entire annual output of the nation. And despite the extraordinary efforts that the BOJ has made, growth remains lackluster and inflation nonexistent meaning the BOJ has failed to achieve either of its key aims. At some point in time, and it appears to be approaching sooner rather than later, central banks around the world will completely lose the ability to adjust market behavior through either words or action. And while it is not clear which central bank will lose that power first, the BOJ has to be the frontrunner, although the ECB is certainly trying to make a run at the title.

Meanwhile, from Merry Olde Englande we have news that a draft Brexit deal has been agreed between PM May and the EU. The problem remains that her cabinet has not yet seen nor signed off on it, and there is the little matter of getting the deal through Parliament, which will be dicey no matter what. On the one hand, it is not wholly surprising that some type of agreement was reached, but as is often the case in a situation as fraught as Brexit, nobody is satisfied, and quite frankly, it is not clear that it will gather sufficient support from either the UK Parliament, or the EU’s other nations. This is made evident by the fact that the pound has actually fallen today, -0.2%, despite the announcement. I maintain that a Brexit deal will clearly help the pound’s value, so the market does not yet believe the story. At the same time, UK inflation data was released at a softer than expected 2.4% in October, thus reducing potential pressure on the BOE to consider raising rates, even if a Brexit deal is agreed. After all, if inflation falls to 2.0%, their concerns will be much allayed.

One other story getting a lot of press has been the sharp decline in the price of oil, which yesterday fell 7.1% in the US, and is now down more than 26% since its high in the beginning of October, just six weeks ago. There is clearly a relationship between commodity prices and the dollar given the fact that most commodities are priced in dollars, and that relationship is consistently an inverse one. The question, that I have yet to seen answered effectively, is the direction of the causality. Does a stronger dollar lead to weaker commodity prices? Or do weaker commodity prices drive the dollar higher? While I am inclined to believe in the first scenario, there are arguments on both sides and no research has yet been able to answer the question effectively. However, it should be no surprise that the dollar continues to rally coincidentally with the decline in oil, and other commodity, prices.

I didn’t even get a chance to discuss the ongoing slowdown in Chinese economic growth, but we can touch on that tomorrow. As for today’s session, this morning we see the latest CPI readings (exp 0.3%, 2.5% Y/Y headline, 0.2% 2.2% core) and then as the FX market gets set to go home, Chairman Powell speaks, although it is hard to believe that his views on anything will have changed that much. In the end, the big picture remains that the dollar should continue to benefit from the Fed’s ongoing monetary policy activities as well as the self-inflicted wounds of both the euro and the yen.

Good luck