A Terrible Sight

The data from China last night
Described their economy’s plight
With trade talks ongoing
Their growth is still slowing.
For Xi, it’s a terrible sight

While the Martin Luther King holiday in the US will close markets and keep things quiet here, the rest of the world continues to be active. Equity markets in Europe are weak on the back of disappointing data from China. In fact, that has been the story of the day. Chinese GDP in Q4 was reported at 6.4% higher than Q4 2018, its slowest pace of growth since the financial crisis in 2009. And when considered on an annual basis, the 6.6% growth in calendar 2018 was the slowest pace of growth since 1990. Retail Sales and Industrial Production also continued their long-term downtrends, with no sign that things are set to reverse anytime soon. While the trade situation with the US is clearly weighing on the Chinese economy, they are also reaping the ‘benefits’ of the decades of increased leverage needed to achieve previous growth targets. The telling statistic I’ve seen is that ten years ago, one dollar of leverage bought $0.80 worth of additional growth. Today that number is ~$0.15 of additional growth for each new dollar of leverage. That is not the recipe for long term success!

In the meantime, despite the comments on Friday about China proposing a path to reduce the US trade deficit to zero over six years, it seems that substantive talks on protecting IP and preventing its forced transfer to local Chinese partners have gone nowhere. (In addition, the idea that reducing that trade deficit to zero would be net beneficial is not actually clear. (This article by Mike Ashton, @inflation_guy (https://mikeashton.wordpress.com/author/mikeashton/)  does an excellent job of describing potential outcomes.) At any rate, Friday’s good vibes are not nearly as apparent this morning.

Of course, the other storyline that has been nonstop is Brexit, with today the deadline for PM May to put forth her Plan B. It remains unclear as to what she can actually change to get Parliament to agree, but she will try for something. An interesting analysis I saw this weekend actually made the case that the risk of a no-deal Brexit was actually vanishingly small. The idea is that Parliament will vote to make that outcome illegal, meaning the government cannot accept that as an outcome. (Remember, Parliament and the government are not the same institution, similar to our legislative and executive branches in the US.) The alternatives are to delay the deadline in order to get a new referendum put together, or to unilaterally decide not to leave. The problem I have with that idea is that it seems a bit like Parliament declaring that recessions are illegal. As much as they would like to avoid having them, it is not clear they control the situation. Certainly, the FX market is coming around to that view as the pound has been rallying for five weeks (although there was virtually no movement overnight), but it seems to me that there is still a significant risk of a no-deal outcome, which given the recent rally, will almost certainly result in a sharp fall in the pound.

Away from those two stories, things remain remarkably dull in the FX world. The ongoing government shutdown in the US has had limited impact (arguably just that some data has not been released), while within the Eurozone, data continues to ebb and the political will to make changes of substance remains absent. Japan remains in stasis and there is virtually no possibility, in my view, that either the ECB or the BOJ tightens policy at all in 2019. In fact, I continue to believe that they will both seek to ease further at the margins.

What about the emerging market you may ask? Again, the story remains one of limited new news, at least news that is sufficient to drive market movement. Overall, investors and traders are wedded to the big picture stories like trade and Brexit, and we continue to see broad based moves accordingly.

The data story this week is unimpressive (largely due to the shutdown) with just two data points coming, tomorrow’s Existing Home Sales (exp 5.24M) and Thursday’s Initial Claims (218K). With the Fed meeting next week, they are now in their quiet period so there are no speakers on the docket. Arguably, the ECB meeting on Thursday is the biggest FX news of the week, but there is no expectation for anything new. I imagine the press conference will focus on the previous comments about tightening later this year in the context of the ongoing economic slowdown there, but we have a few days before we have to worry about that. In the end, the dollar is modestly higher this morning, but I expect it to see very limited movement in the holiday market.

Good luck


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