Lost Traction

The tea leaves that everyone’s reading
‘bout trade talks claim risk is receding
Since Donald and Xi
Are desperate anxious to see
A deal that shows both sides succeeding

The equity market reaction
Has been one of great satisfaction
But bonds and the buck
Have had much less luck
As growth on both sides has lost traction

This morning is all about trade. Headlines blaring everywhere indicate that the US and China are close to ironing out their differences and that Chinese President Xi, after a trip through parts of Europe later this month, will visit the US at the end of March to sign a deal. It should be no surprise that global equity markets have jumped on the news. The Nikkei rose 1.0%, Shanghai was up 1.1% while the Hang Seng in Hong Kong rallied 0.5%. We have seen strength in Europe as well, (FTSE +0.5%, CAC +0.5%) although the German DAX is little changed on the day. And finally, US futures are pointing to a continuation of the rally here with both S&P and Dow futures currently trading higher by 0.25%.

However, beyond the equity markets, there has been much less movement in prices. Treasuries have barely edged higher and the dollar, overall, is little changed. It is pretty common for equity market reactions to be outsized compared to other markets, and this appears to be one of those cases. In fact, I would caution everyone about one of the oldest trading aphorisms there is, “buy the rumor, sell the news.” A dispassionate analysis of the trade situation, one which has evolved over the course of two decades, would indicate that a few months hardly seems enough time to solve some extremely difficult issues. The issue of IP (whether stolen or forced to be shared in order to do business) and state subsidies for state-owned firms remains up in the air and given that both these issues are intrinsic to the Chinese economic model, will be extremely difficult to alter. It is much easier for China to say they will purchase more stuff (the latest offer being $23 billion of LNG) or that they will prevent the currency from weakening, than for them to change the fundamentals of their business model. While positive trade sentiment has clearly been today’s driver, I would recommend caution over the long-term impacts of any deal. Remember, the political imperatives on both sides remain quite clear and strong, with both Presidents needing a deal to quiet criticism. But political expediency has rarely, if ever, been a harbinger of good policy, especially when it comes to economics.

Of course, one of the reasons that a deal is so important to both sides is the slowing economic picture around the world and the belief that a trade deal can reverse that process. Certainly, Friday’s US data was unimpressive with Personal Spending falling -0.5% in December (corroborating the weak Retail Sales data), while after a series of one-off events in December pumped up the Personal Income data, that too declined in January by -0.1%. The ISM numbers were softer than expected (54.2 vs. the 55.5 expected) and Consumer Confidence slumped (Michigan Sentiment falling to 93.7). All in all, not a stellar set of data.

This has set up a week where we hear from three key central banks (RBA tonight, Bank of Canada on Wednesday and ECB on Thursday) with previous thoughts of policy normalization continuing to slip away. Economic data in all three economic spheres has been retreating for the past several months, to the point where it is difficult to blame it all on the US-China trade situation. While there is no doubt that has had a global impact (look at Germany’s poor performance of late), it seems abundantly clear that there are problems beyond that.

History shows that most things have cyclical tendencies. This is especially true of economics, where the boom-bust cycle has been a fact of life since civilization began. However, these days, cycles are no longer politically convenient for those in power, as they tend to lose their jobs (as opposed to their heads a few hundred years ago) when things turn down. This explains the extraordinary effort that even dictators like President Xi put into making sure the economy never has a soft patch. Alas, the ongoing efforts to mitigate that cycle are likely to have much greater negative consequences over time. The law of diminishing returns virtually insures that every extra dollar or euro or yuan spent today to prevent a downturn will have a smaller and smaller impact until at some point, it will have none at all. It is this process which drives my concern that the next recession will be significantly more painful than the last.

So, while a trade deal with China would be a great outcome, especially if it was robust and enforceable, US trade with China is not the only global concern. Remember that as the trade saga plays out.

Aside from the three central bank meetings, we also get a bunch of important data this week, culminating in Friday’s payroll report:

Today Construction Spending 0.1%
Tuesday New Home Sales 590K
  ISM Non-Manufacturing 57.2
Wednesday Trade Balance -$49.3B
  ADP Employment 190K
  Fed’s Beige Book  
Thursday Initial Claims 225K
  Nonfarm Productivity 1.7%
  Unit Labor Costs 1.6%
Friday Nonfarm Payrolls 180K
  Private Payrolls 170K
  Manufacturing Payrolls 10K
  Unemployment Rate 3.9%
  Average Hourly Earnings 0.3% (3.3% Y/Y)

In addition to all this, we hear from four more Fed speakers, including Chairman Powell on Friday. It seems increasingly clear that Q1 growth has ebbed worldwide compared to the end of last year, and at this point, questions are being raised as to how the rest of the year will play out. Reading those tea leaves is always difficult, but equity markets would have you believe, based on their recent performance, that this is a temporary slowdown. So too, would every central banker in the world. While that would be a wonderful outcome, I am not so sanguine. In the end, slowing global growth, which I continue to anticipate, will result in all those central bankers following the Fed’s lead and changing their tune from policy normalization to continued monetary support. And that will continue to leave the dollar, despite President Trump’s latest concerns over its strength, the best place to be.

Good luck
Adf

Impugned

The continent east of the ‘pond’
Makes many things of which we’re fond
But data of late
Impugned their growth rate
Just when will Herr Draghi respond?

There is an ongoing dichotomy in the economic landscape that I continue to have difficulty understanding. Pretty much every day we see data that describes slowing economic activity from multiple places around the world. Sales are slowing, manufacturing is ebbing, or housing markets are backing away from their multiyear explosion higher. And all this is occurring while in the background, international trade agreements, that have underpinned the growth in global trade for the past forty years, are also under increasing pressure. And yet, equity markets around the world seemingly ignore every piece of bad news and, when there is a glimmer of hope, investors grab hold and markets rally sharply.

Arguably the best explanation is that the dramatic change in central bank policies have evolved from emergency measures to the baseline for activity. Following that line of thought and adding the recent central bank response to increased ‘volatility’ (read declines) as seen in December, it has become apparent that economic fundamentals no longer matter very much at all. While the central bankers all pay lip service to being data dependent, the only data that seems to matter is the latest stock market close. For someone who has spent a career trying to identify macroeconomic risks and determine the best way to manage them, I’m concerned that fewer and fewer investors view that as important. I fear that when the next downturn comes, and I remain highly confident there will be another economic downturn too large to ignore, we will be wistful for the good old days of 2008-09, when recession was ‘mild’.

Please excuse my little rant, but it continues to be increasingly difficult to justify market movements when looking at economic data. For example, last night we learned that PMI data throughout the Eurozone was confirmed to be abysmal in February (Germany 47.6, Italy 47.7, Spain 49.9, Eurozone overall 49.2) and has led to a reduced forecast for Eurozone GDP growth in Q1 of just 0.1%. Naturally, every equity market in Europe is higher on the news. Even the euro has edged higher, climbing 0.15% (albeit after falling 0.4% in yesterday’s session). Adding to the malaise, Eurozone core inflation unexpectedly fell to 1.0%, a long way from the ECB’s target of just below 2.0% and showing no signs of increasing any time soon.

With the March ECB meeting on the docket for next week, the discussion has focused on how Signor Draghi will justify his ongoing efforts to normalize monetary policy amid weakening growth. His problem is that he has downplayed economic weakness as temporary, but it has lingered far longer than anticipated. It is widely expected that the new economic forecasts will point to further slowing, and this will just make his task that much more difficult. Ultimately, the market is not pricing in any interest rate hikes until June 2020, and there is a rising expectation that TLTRO’s are going to be rolled over with an announcement possible as soon as April’s meeting. Draghi’s term as ECB president ends in October, and it is pretty clear that he will have never raised interest rates during his eight years at the helm. The question is, will his successor get a chance in the next eight years? Once again, I have looked at this information, compared it to the ongoing Fed discussion, and come out on the side of the euro having further to decline. We will need to see much stronger growth and inflation from Europe to change that view.

Other than that discussion, there is very little of real note happening today. Chinese Caixin PMI data was slightly better than expected at 49.9, which has been today’s argument for adding risk, but recall just yesterday how weak the official statistic was. As with everything from China, it is difficult to understand the underlying story as the data often has inconsistencies. But this has been enough to create a risk-on atmosphere with Treasuries falling (10-year yields +2bps) and JPY falling (-0.4%) while commodities and equities rally. Gold, naturally, is the exception to this rule as it has softened this morning.

Regarding trade, today’s news stories discuss documents being prepared for an eventual Trump-Xi summit later this month. If there really is a deal, that will be a global positive as it would not only clear up US-Chinese confusion, but it would bode well for all the other trade discussions that are about to begin (US-Japan, US-Europe). Hopefully, President Trump won’t feel the need to walk away from this deal.

Looking back at yesterday’s session, we saw Q4 GDP actually grew 2.6%, a bit stronger than expected, which arguably helped underpin the dollar’s performance. We also learned that the House Finance Committee is equally unconcerned over what the Fed is doing, as Chairman Powell’s testimony was a complete sleeper. So, with no oversight, the Fed will simply motor along. At this point, it would be remarkable if the Fed raised rates again in 2019, and unless Core PCE goes on an extended run higher, perhaps even in 2020. I have a feeling that we are going to see this flat yield curve for a long time.

This morning brings a bunch more data with both December and January numbers due. Looking at the January data, the only forecast I find is Personal Income (exp 0.3%) but Personal Spending, and PCE are both due as well. At 10:00 we see ISM Manufacturing (55.5) which is now biased higher after yesterday’s Chicago PMI printed at a robust 64.7, its strongest print in 18 months. With risk being embraced today, I think we are far more likely to see the dollar edge lower than not by the end of the day.

Good luck and good weekend
Adf