While problems in China persist
And risk is still on the blacklist
More talk is now turning
To Powell concerning
Tomorrow’s FOMC tryst
The coronavirus remains the primary topic of conversation amongst the economic and financial community as analysts and pundits everywhere are trying to estimate how large the impact of this spreading disease will be on economic output and growth. The statistics on the ground continue to worsen with more than 100 confirmed deaths from a population of over 4500 confirmed cases. I fear these numbers will get much worse before they plateau. And while I know that science and technology are remarkable these days, the idea that a treatment can be found in a matter of weeks seems extremely improbable. Ultimately, this is going to run its course before there is any medication available to address the virus. It is this last idea which highlights the importance of China’s actions to prevent travel in the population thus reducing the probability of spreading. Unfortunately, the fact that some 5 million people left the epicenter in the past weeks, before the problem became clear, is going to make it extremely difficult to really stop its spread. Today’s news highlights how Hong Kong and Macau are closing their borders with China, and that there are now confirmed cases in France, Germany, Canada, Australia and the US as well as many Asian nations.
With this ongoing, it is no surprise that risk appetite, in general, remains limited. So the Asian stock markets that were open last night, Nikkei (-0.6%), KOSPI (-3.1%), ASX 200 (-1.35%) all suffered. However, European markets, having sold off sharply yesterday, have found some short term stability with the DAX unchanged, CAC +0.15% and FTSE 100 +0.2%. As to US futures, they are pointing higher at this hour, looking at 0.2%ish gains across the three main indices.
Of more interest is the ongoing rush into Treasury bonds with the 10-year yield now down to 1.57%, a further 3bp decline after yesterday’s 7bp decline. In fact, since the beginning of the year, the US 10-year yield has declined by nearly 40bps. That is hardly the sign of strong growth in the underlying economy. Rather, it has forced many analysts to continue to look under the rocks to determine what is wrong in the economy. It is also a key feature in the equity market rally that we have seen year-to-date, as lower yields continue to be seen as a driver of the TINA mentality.
But as I alluded to in my opening, tomorrow’s FOMC meeting is beginning to garner a great deal of attention. The first thing to note is that the futures market is now pricing in a full 25bp rate cut by September, in from November earlier this month, with the rationale seeming to be the slowing growth as a result of the coronavirus’s spread will require further monetary stimulus. But what really has tongues wagging is the comments that may come out regarding the Fed’s review of policy and how they may adjust their policy toolkit going forward in a world of permanently lower interest rates and inflation.
One interesting hint is that seven of the seventeen FOMC members have forecast higher than target inflation in two years’ time, with even the most hawkish member, Loretta Mester, admitting that her concerns over incipient inflation on the back of a tight labor market may have been misplaced, and that she is willing to let things run hotter for longer. If Mester has turned dovish, the end is nigh! The other topic that is likely to continue to get a lot of press is the balance sheet, as the Fed continues to insist that purchasing $60 billion / month of T-bills and expanding the balance sheet is not QE. The problem they have is that whatever they want to call it, the market writ large considers balance sheet expansion to be QE. This is evident in the virtual direct relationship between the growth in the size of the balance sheet and the rally in the equity markets, as well as the fact that the Fed feels compelled to keep explaining that it is not QE. (For my money, it is having the exact same impact as QE, therefore it is QE.) In the end, we will learn more tomorrow afternoon at the press conference.
Turning to the FX markets this morning, the dollar continues to be the top overall performer, albeit with today’s movement not quite as substantial as what we saw yesterday. The pound is the weakest currency in the G10 space after CBI Retailing Reported Sales disappointed with a zero reading and reignited discussion as to whether Governor Carney will cut rates at his last meeting on Thursday. My view remains that they stay on the sidelines as aside from this data point, the recent numbers have been pretty positive, and given the current level of the base rate at 0.75%, the BOE just doesn’t have much room to move. But that was actually the only piece of data we saw overnight.
Beyond the pound, the rest of the G10 is very little changed vs. the dollar overnight. In the EMG bloc, we saw some weakness in APAC currencies last night with both KRW and MYR falling 0.5%, completely in sync with the equity weakness in the region. On the positive side this morning, both CLP and RUB have rallied 0.5%, with the latter benefitting on expectations Retail Sales there rose while the Chilean peso appears to be seeing some profit taking after a gap weakening yesterday morning.
Yesterday’s New Home Sales data was disappointing, falling back below 700K despite falling mortgage rates. This morning we see Durable Goods (exp 0.4%, -ex Transport 0.3%), Case Shiller Home Prices (2.40%) and Consumer Confidence (128.0). At this stage of the economic cycle, I think the confidence number will have more to tell us than Durable Goods. Remarkably, Confidence remains quite close to the all-time highs seen during the tech bubble. But it bodes well for the idea that any slowdown in growth in the US economy is likely to be muted. In the end, while the US economy continues to motor along reasonably well, nothing has changed my view that not-QE is going to undermine the value of the dollar as the year progresses.