Tariffs Can Wait

Said Trump, for now tariffs can wait
Since talks with the Chinese are great
When this news emerged
The stock market surged
While dollars and bonds did deflate

In what cannot be a very great surprise, last evening President Trump announced that there has been substantial progress in the trade negotiations with China and that the mooted tariff increases on March 2nd are going to be delayed indefinitely while the talks continue. It was pretty clear that neither side really wanted to see tariffs rise again, but if the reports are accurate, there has been some real movement in terms of the negotiations. Given the focus by all markets on this story, the reactions cannot be a great surprise. That said, the fact that Shanghai closed higher by 5.6% and other global markets are higher by just 0.2%-0.4% hints at just how much more important this issue is for China than for the US.

But in fairness, there was another driver for Chinese stocks, the ‘official’ end of the deleveraging campaign of the past two years. Despite the fact that Chinese debt levels have barely slowed their growth, the fact that the economy has clearly been under pressure from slowing global growth, and the fact that the trade situation has clearly hampered recovery attempts has led to a decision to open the credit spigots again. Two years ago, the Chinese recognized that their financial structure was wobbling due to significant growth in off balance sheet leverage. After a two-year effort to reduce those risks, the imperative of supporting the broad economy is now far more important than worrying about some arcane financial statistics. In the end, every government, whether liberal or totalitarian, can only address structural issues for short periods of time before the pressure grows too great to support growth in any way they can. As to the renminbi, it has strengthened a bit further, rising 0.3% and now trading at its strongest levels since last July. If, as has been reported, the trade deal includes a currency portion, it seems appropriate to look for the renminbi to trade back toward the 6.20 level, another 5%-7% stronger, over time.

Though wily, Prime Minister May
Might soon find she’s nothing to say
‘bout any new terms
As Parliament firms
Support for a Brexit delay

Of the other two stories that have been market drivers, let’s discuss Brexit first. PM May met with other EU leaders in Egypt over the weekend and there are now two competing theories as to what might happen. May has postponed the vote on her deal until March 12, basically daring Parliament to vote no and cause a no-deal Brexit. At the same time, while talk in Parliament has been about voting for a three-month extension, the EU has now discussed a 21-month extension as the only alternative under the theory that three months is not enough time to get anything done. Of course, for the pro-Brexit forces, 21 months is unpalatable as well since that would give enough time to hold a second referendum, which based on all the recent polling, would result in a remain vote. The pound has drifted higher by 0.2% this morning, back to the high end of its recent trading range, but until there is more clarity on the outcome, it will remain locked in a fairly narrow range. For the past seven months, the pound has traded in a range of 1.25-1.32. It seems unlikely to break out until a more definitive outcome is clear with Brexit.

Finally, regarding the third major market driver, the Fed, there were several stories in the WSJ over the weekend about how the Fed is now reevaluating its inflation target. It seems that they have become increasingly unhappy with their inability to achieve the 2.0% target, as measured by PCE. The prevailing view is that because they have been so successful at moderating inflation, people’s inflation expectations have now fallen so much that inflation cannot rise. That feels a little self-serving to me, especially since the ‘feel’ of inflation appears much higher than what is measured. At least in my world. Ask yourself if it feels like inflation is running at 1.8%, as you consider things like education, the cost of health insurance and property taxes. The point, however, is that they seem to be laying the ground to maintain easier monetary policy for a much longer period. If they are not constrained by inflation rising above their target, then rates can stay lower for longer. Frighteningly, this seems to be the Fed’s attempt to embrace MMT. In the end, if the Fed modifies their policy targets in this manner, it will be a decided dollar negative. In fact, I will need to reevaluate the premises underlying my market views. Unless, of course, all the other major central banks do the same thing, which is a fair bet.

At any rate, with the trade discussion today’s biggest story, risk appetite has returned, and we are seeing higher equity markets along with a weaker dollar and falling bonds. That said, the dollar’s decline is not substantial, on the order of 0.2% overall, although it has fallen against most of its counterparts. Turning to the data story, this week brings a fair amount of information, as well as Congressional Testimony by Chairman Powell and a number of other Fed speakers:

Tuesday Housing Starts 1.25M
  Building Permits 1.29M
  Case-Shiller Home Prices 4.5%
  Consumer Confidence 124.7
Wednesday Factory Orders 0.5%
Thursday Initial Claims 220K
  Q4 GDP 2.3%
  Chicago PMI 57.0
Friday Personal Income 0.3%
  Personal Spending -0.2%
  PCE 0.0% (1.7% Y/Y)
  Core PCE 0.2% (1.9% Y/Y)
  ISM Manufacturing 55.5
  Michigan Sentiment 95.7

In addition to Powell’s testimony, he speaks again Thursday morning, and is joined by five other Fed speakers throughout the week. Unless the data is extraordinarily strong, it is clear that there will be no discussion of further rate hikes. In fact, given this new focus on the inflation target, I expect that will be the topic of note amongst the group of them. And as all signs point to this being yet another way to justify easy money, look for a consensus to quickly build. If I am correct about the Fed’s turn regarding how they view inflation, the dollar will suffer going forward. This will force me to change my longer term views, so this week will be quite important to my mind. For today, however, it seems evident that risk appetite will help push the dollar somewhat lower from here.

Good luck