The data that China reported
Showed growth there somewhat less supported
Meanwhile in Hong Kong
The protesting throng
Has bullish views totally thwarted
Once again, risk is under pressure this morning as the litany of potential economic and financial problems continues to grow rather than recede. The latest concerns began last night when China reported slowing Investment (5.6%, below 6.1% expected) and IP (5.0%, weakest since 2002) data (although Retail Sales held up) which led to further concerns over the growth trajectory in the Middle Kingdom. PBOC Governor Yi Gang assures us that China has significant firepower left to address further weakness, but traders are a little less comforted. Adding to concerns are the ongoing protests in Hong Kong over potential new legislation which would allow extradition, to mainland China, of people accused of fomenting trouble in Hong Kong. That is a far cry from the separation that has been key in allowing Hong Kong’s financial markets and economy to flourish despite its close ties to Beijing.
The upshot is that stocks in Hong Kong (-0.65%) and Beijing (-1.0%) fell again, while interest rates in Hong Kong pushed even higher. This has resulted in a liquidity shortage in Hong Kong which is supporting the HKD (+0.2% this week and finally pushing away from the HKMA’s floor). The renminbi, meanwhile, has gone the other way, softening slightly since the protests began. Other signs of pressure were evident by the weakness in AUD and NZD, both of which rely heavily on the Chinese market as their primary export destinations.
Risk is also evident in the energy markets where there has been an escalation in the rhetoric between the US and Iran after the tanker attacks yesterday. This morning the US is claiming it has video proof that Iran was behind the attacks, although it has not been widely accepted as such. Oil prices, which rose sharply yesterday, have maintained those gains, although on the other side of the oil equation is the slowing economy sapping demand. In fact, the IEA is out with a report this morning that next year, production increases in the US, Canada and Brazil will significantly outweigh anemic increases in demand, further pressuring OPEC and likely oil prices overall. However, for the moment, the market concerns are focused on the increased tension in the Gulf with the possibility of a conflict there seeming to rise daily. Remember, risk assets tend to suffer greatly in situations like this.
Aside from the weaker Aussie (-0.25%) and Kiwi (-0.55%), we have also seen strength in the yen (+0.2%), a huge rally in Treasuries (10-year yield down 4.5bps), gold pushing higher (+1% and back to its highest level in three years) and the dollar, overall performing well. The latter is evidenced by the decline in the euro (-0.2%), the pound (-0.3%) and basically the rest of the G10 with similar declines.
This is the market backdrop as we await the last major piece of data before the FOMC meeting next week, this morning’s Retail Sales numbers. Current expectations are for a 0.6% increase, with the ex-autos number printing at 0.3%. But recall, last month economists were forecasting a significant gain and instead the headline number was negative. A similar result this morning would certainly add more pressure on Chairman Powell and friends next week. And that is really the big underlying story across all markets, just how soon are we likely to see the Fed or the ECB or the BOJ turn clearly dovish and ease policy.
It has become abundantly clear that inflation is the only data point that the big central banks are focusing on these days. And given their fixation on achieving a, far too precise, level of 2.0%, they are all failing by their own metrics. Wednesday’s US CPI data was softer than expected leading to reduced expectations for the PCE data coming at the end of the month. In the Eurozone, 5y/5y inflation swaps, one of the ECB’s key metrics for inflation sentiment, has fallen below 1.20% and is now at its lowest level since the contract began in 2003. And in Japan, CPI remains pegged just below 1.0%, nowhere near the target level. It is this set of circumstances, more than any questions on growth or employment, that will continue to drive monetary policy. With this in mind, one can only conclude that money is going to get easier going forward. I still don’t think the Fed moves next week, but I could easily see a 50bp cut in July. Regardless, markets are going to continue to pressure all central banks until policy rates are lowered, mark my words.
Regarding the impact of these actions on the dollar, it becomes a question of timing more than anything else. As I have consistently maintained, if the Fed starts to ease aggressively, you can be sure that the ECB and BOJ, as well as a host of other central banks, will be doing so as well. And in an environment of global weakness, I expect the dollar will remain the favored place to maintain assets.
As for today, a weak Retail Sales print is likely to see an initial sell-off in the dollar but look for it to reverse as traders focus on the impacts likely to be felt elsewhere.
Good luck and good weekend