Great Apprehensions

In England the rate of inflation
Has fallen despite expectation
By Carney and friends
That recent price trends
Would offer rate hike validation

But markets have turned their attentions
To news of two likely extensions
The deadline on trade
And Brexit charade
Have tempered some great apprehensions

Two key data points lead the morning news with UK inflation falling below the BOE’s 2.0% target for the first time since the Brexit vote while Eurozone IP fell far more sharply than expected. Headline CPI in the UK declined to 1.8% while core remained at 1.9%, with both printing lower than market expectations. Given the slowing economic picture in the UK (remember the slowest growth in six years was reported for Q4 and 2018 as a whole), this cannot be that much of a surprise. Except, perhaps, to Governor Carney and his BOE brethren. Carney continues to insist that the BOE may need to raise rates in the event of a hard Brexit given the possibility of an inflation spike. Certainly, there is no indication that is likely at the present time, but I guess anything is possible. Granted he has explained that nothing would be done until the “fog of Brexit” has lifted but given the overall global growth trajectory (lower) and the potential for disruption, it seems far more likely that the next BOE move is down, not up. The pound originally sold off on the news but has since reversed course and is higher by 0.3% as I type. Overriding the data seems to be a growing belief that both sides will blink in the Brexit negotiations resulting in a tentative agreement of a slightly modified deal with a few extra months made available to ratify everything. That’s probably not a bad bet, but it is by no means certain.

On the Continent, the data story was also lackluster, with Eurozone IP falling a much worse than expected -0.9% in December and -4.2% Y/Y. It is abundantly clear that Germany’s problems are not unique and that the probability of a Eurozone recession in 2019 is growing. After all, Italy is already there, and France has seen its survey data plummet in the wake of the ongoing Gilets Jaunes protests. However, despite this data, the euro has held onto yesterday’s modest gains and is little changed on the day. The thing is, I still cannot figure out a scenario where the ECB actually raises rates given the economic situation. Even ECB President Draghi has recognized that the risks are to the downside for the bloc’s economy, and yet he is fiercely holding onto the idea that the next move will be higher rates. It won’t be higher rates. The next move is to roll over the TLTRO’s and interest rates will remain negative for as far as the eye can see. There is a growing belief in the market that because the Fed has halted its policy tightening, the dollar will fall. But since every other central bank is in the same boat, the relative impact still seems to favor the US.

Away from those stories, the market continues to believe that a US-China trade deal is almost done. At least, that’s the way equity markets are trading. President Trump’s comment that he would consider extending the March 1 tariff deadline if there was sufficient progress and it looked like a deal was in the offing certainly helped sentiment. But as with the Brexit issue, where the Irish border situation does not offer a simple compromise, the US requests for ending forced technology transfer and IP theft as well as the reduction of non-tariff barriers strike at the heart of the Chinese economic model and will not be easily overcome. It seems that the most likely outcome will be a delay of some sort and then a deal that will have limited long-term impact but will get played up by both sides as win-win. In the meantime, the PBOC will continue to add stimulus to the economy, as will the fiscal authorities, as they seek to slow the rate of decline. And you can be sure that no matter how the economy actually performs, the GDP data will be firmly above expectations.

And those are the big stories. The dollar has had a mixed performance overnight with two currencies making substantial gains, NZD +1.25% and SEK +0.6%, both of which responded to surprises by their respective central banks. The RBNZ left rates on hold, as universally expected, but instead of offering signs of further rate cuts, simply explained that rates would remain on hold for two years before likely rising. This was taken as hawkish and the currency responded accordingly. Similarly, the Riksbank in Stockholm explained that they still see the need for rates to rise later this year despite the current slowing growth patterns throughout Europe. As I had written yesterday, expectations were growing that they would back away from any policy tightening, so the krone’s rally should be no real surprise. But beyond those two stories, movement has been much less substantial in both the G10 and EMG blocs.

This morning’s data brings CPI (exp 1.5% headline, 2.1% core) which will be closely watched by all markets. Any further weakness will likely see another leg higher in equity markets as it will cement the case for the Fed having reached the end of the tightening cycle. A surprise on the high side ought to have the opposite impact, as concerns the Fed might not yet be done will resurface. There are also three Fed speakers, but for now, that message of Fed on hold seems pretty unanimous across the FOMC.

Absent a surprise, my money is on a directionless day today. The dollar’s recent rally has stalled and without a new catalyst will have a hard time restarting. However, there is no good reason to think things have gotten worse for the buck either.

Good luck
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