A New Endeavor

A trend that is growing worldwide
Shows policy’s been modified
From lower forever
To a new endeavor
That tapering must be applied

But what if the jobless report
Frustrates and the number falls short?
Will traders respond
By buying the bond?
Or will sellers keep holding court?

While today is a summer Friday, which typically holds little excitement except for the anticipation of the weekend, there is a bit more at stake this morning with the release of the July NFP report at 8:30.  Given that we appear to be reaching an inflection point in policymaking circles, today’s data could either cement the changes that seem to be coming, or it could throw cold water on the entire process and take us back to square one.

The one thing that we have heard consistently over the past several weeks is that there is a growing desire by a widening array of FOMC members to begin tapering asset purchases.  While Chairman Powell has not yet indicated he is ready, and a key lieutenant, Governor Lael Brainerd, was forceful in her views that it was way too early to do so, at least six or seven other members are ready to roll, with the latest being vice-chair Clarida and SF President Daly.  But all of this tightening talk is predicated on the idea that not only has the inflation part of their mandate been achieved (gotten out of hand really), but that they have made progress on the employment part.

This brings us to today’s report.  Since December, when the number was negative amid the second wave of the Covid outbreak, we have seen the following numbers: 233K, 536K, 785K, 269K, 583K, 850K. Historically, all of those numbers would be seen as strong, but obviously, given the 20 million job losses at the beginning of the lockdown last year, those numbers represent a very different situation now.  A rudimentary look at the pattern would have you believe that today’s print, expected at 858K, is more likely to come at a much lower number, something like 250K-300K.  Frankly, the thing that has me concerned is that the monthly survey is taken during the week that contains the 15th of the month.  A quick look back at the weekly Initial Claims data for that week in July shows it was a surprisingly high 424K, a relatively high level given the prior trend.  So, it could well be that a quirk in the data may result in a disappointing headline number.  Remember, too, that the ADP Employment number was a MUCH weaker than expected 330K, so another potential sign of impending weakness.  My point is that there is a very real opportunity for a negative surprise this morning.

The question is; if we do get a negative surprise, will markets ignore it?  Or will they reevaluate their current belief set that tapering is on the way?  As it happens, there are no Fed speakers scheduled for today, so it is not obvious that anyone will be able to clarify things in that situation.

Ahead of the number, markets continue to demonstrate their belief that tighter monetary policy is coming to the US.  This is made evident by the dollar’s continuing strength, with the euro (-0.25%) testing the 1.18 level and stronger vs. all of its G10 and most of its EMG counterparts.  It is evident in the continued backing up in Treasury yields, which after trading as low as 1.1275% Wednesday ahead of the Clarida comments, are now higher by 3.3 basis points this morning and trading back at 1.26%.  While this is hardly “high” in a broad sense, the recent movement does demonstrate a clear trend

Equity markets seem to be somewhat less concerned, as yesterday, once again, US markets traded to new all-time highs.  European markets are all modestly in the green this morning and only China, which continues to attack its own companies (the latest being Moutai, the food delivery service that is mooted to be fined >$1 billion for no apparent reason), has seen any real weakness in this space.  But equity investors will continue to claim TINA until yields have really made a comeback.  And despite the modest declines we have seen in bond prices today, we have actually seen negative yielding debt rise further, to $16.9 trillion, as of yesterday, hardly a sign of tighter policy.

So, overall, we are mostly given mixed signals by markets and policymakers and need to sort things out for ourselves.  The first thing to do is look at what is expected this morning

Nonfarm Payrolls 858K
Private Payrolls 709K
Manufacturing Payrolls 26K
Unemployment Rate 5.7%
Average Hourly Earnings 0.3% (3.9% Y/Y)
Average Weekly Hours 34.7
Participation Rate 61.7%
Consumer Credit $23.0B

Source: Bloomberg

Between the widening spread of the delta variant, which is clearly disrupting supply chains around the world as well as causing more lockdowns and thus slowing economic activity, and the statistical noise and patterns, I have a feeling we are going to get a pretty bad number.  A print below 500K, which is my guess, is likely to force at least some rethinking of the timing for tapering.  Remember, while the Fed has admitted that some progress toward their goals has been achieved, their standard of “substantial further progress” remains “a ways away” according to Chairman Powell’s last comments.  A low print today will certainly delay the tapering talk.

In that event, how can we expect markets to respond?  Well, as the equity market sees all news as good news, it will clearly rally under the guise of easy money for longer.  Bond markets are also likely to push higher with yields slipping as concerns over a taper in the near-term dissipate.  But arguably, the biggest mover will be the dollar, which I believe has rallied sharply on the tapering talk, and if/when that fades, the short-term case for being long dollars will fade with it.

If I am wrong, and we get a strong number then the taper talk will intensify.  This should lead to further bond weakness (higher yields), a dollar rally and likely test of the key euro support at 1.1704, and … an equity rally since that is what stocks seem to do.

Good luck, good weekend and stay safe
Adf

Dire Straits

The Vice-Chair explained he foresees
A time when the Fed, by degrees
Will taper their buying
Of bonds while they’re trying
To offset the spread of disease

Soon after they finish that deed
Most members already agreed
To raise interest rates
Unless dire straits
In markets don’t let them succeed

Fed Vice-Chair Richard Clarida certainly surprised markets yesterday with his speech as he laid out his reasoning that the tapering of the Fed’s current QE purchases will occur sooner than many had previously expected.  While he started out with the caveat that the Fed will not be responding to forecasts, but rather to actual economic outcomes, he then proceeded to forecast the exact sequence of events that will occur and create the proper environment for the Fed to first, taper bond purchases and second, eventually raise interest rates.  The market response was immediate, with the bond market selling off sharply, the dollar rallying and equity markets ceding early gains alongside most commodity prices.  After all, a tighter Fed is not nearly as supportive of risk assets, but neither does it imply lower interest rates.  It is also worth noting that coincident with the release of the text of his speech was the release of the ISM Services number which printed at a much higher than expected, and record level, 64.1.  So, a positive data print and a hawkish Fed speaker were sufficient to change a lot of opinions.

But not this author’s, at least not yet.  My baseline view continues to be that the Fed remains in an extremely difficult position where inflation continues at much higher levels than which they expected or with which they are comfortable, but the employment market remains far away from their restated goal of maximum employment.  As well, as Clarida noted yesterday, and as has been repeated by numerous other Fed speakers, they promise they are not going to move on forecasts or survey data, but instead wait for actual numbers (read the NFP data and core PCE) to achieve their preferred levels before altering policy.  This means that tomorrow’s NFP data will be scrutinized even more closely than usual, as Clarida’s comments yesterday imply that even more FOMC members are ready to move.

One problem with the early taper thesis is that the data may not meet the FOMC’s requirements, at least not in the near term.  For instance, yesterday’s ADP Employment release printed at 330K, less than half the expected 690K and basically one-third of the forecasts for NFP tomorrow.  While the month to month correlation between the two data points is not perfect (0.784 over the past 5 years) it is certainly high enough to imply a strong relationship between the two.  The point is that if tomorrow’s NFP number disappoints, which cannot be ruled out, and assuming that the Fed is true to their word regarding waiting for actual data to reach their preferred levels, it would certainly suggest a delay to the tapering story.  Keep in mind, as well, that the Citi Economic Surprise Index, which measures actual releases vs. forecasts, remains in negative territory, implying that the economy is slowing further rather than extending gains seen earlier in the year.  In fact, after the much worse than expected GDP print last week, it appears that growth is already slipping back toward pre-Covid trends of 1.5% – 2.0%.  Oh yeah, none of this includes the impact of the delta variant, which has resulted in numerous lockdowns around the world and augers still slower growth.

On the flip side, though, is the fact that we have seen an increasing number of FOMC members start to accept the idea that tapering will soon be appropriate.  In addition to Clarida, yesterday we also heard from SF Fed President Daly, an avowed dove, who said, “Fed will do something on asset purchases end ’21 / early ’22.”  By my count, that makes at least six different FOMC members who have indicated tapering is coming soon.  Of this group, Clarida is by far the most important, but if even the doves like Daly are coming round to that view, tapering cannot be ruled out.

To taper or not remains the $64 trillion question for all markets, and while the recent trend of the narrative seems to be pushing in that direction, without support from ongoing improvements in employment data (after all, inflation is well through their target), it will still come to naught.

One last thing on inflation.  As the Fed tries to retake the narrative from the market, be prepared for a new description of inflation.  No longer will it be transitory, but rather, perhaps, tolerable.  In other words, they will accept that it is running hotter than their target and make the excuse that it is far more important to get the nation back to work first, at which point they can use those vaunted tools they frequently mention to address rapidly rising prices.

With all this in mind, the next question is, how will these changes impact the markets?  Yesterday’s price action is likely to be a very good case study if the data continues to support an early tapering of purchases.  Any interruption in the flow of money into the capital markets will be felt by both equities and bonds in the same way, they will fall in price, while the dollar is very likely to find a lot of support vs. both G10 and EMG counterparts.  As to commodities, my inclination is that the past year’s rally will pause, at the very least, but given they remain massively undervalued vs. other asset classes, they likely still have some upside.

On to today.  Overnight price action was mixed with the Nikkei (+0.5%) rising somewhat while Chinese shares (Hang Seng -0.8%, Shanghai -0.3%) were under pressure as stories about the next sectors to feel the wrath of regulators (sin stocks) were rampant with those falling and dragging the indices with them.  fortunately, they represent a much smaller portion of the market than the tech sector, so will have a smaller negative impact if that is, indeed, the situation.  Europe is mixed this morning (DAX +0.1%, CAC +0.35%, FTSE 100 -0.2%) as the morning data was inconclusive and investors there are far more concerned with the Fed than anything else.  As to US futures, they are all modestly higher this morning, about 0.2%.

Bond markets are showing the difference between central bank policy this morning with Treasuries consolidating yesterday’s declines and unchanged on the day, while European sovereigns (Bunds -1.0bps, OATs -1.2bps) continue to see support from an ECB that is nowhere near tightening policy.  Gilts (+2.0bps) on the other hand, are selling off a bit as the BOE meeting, just ending, revealed several things.  First, they are prepared to go to negative interest rates if they need to.  Second, they will continue their current QE pace of £3.4 billion per week, and third, that they expect inflation to reach 4.0% in Q4 of this year.  They did, however, explain that if things proceed as expected, some tightening, read higher interest rates, may be appropriate.  while the initial move in the GBP was a sharp jump higher, it has already retraced those steps and at +0.2% is only modestly up on the day.

Commodity prices are mixed with oil consolidating after yesterday’s rout and unchanged on the day.  In fact, the same is true of precious and most base metals, as traders are trying to figure out their next move, so likely waiting for tomorrow’s data.

And the dollar, interestingly, is modestly softer vs. the G10 this morning, but that is after a strong rally yesterday in the wake of the Clarida speech.  The commodity bloc is leading the way (AUD +0.35%, NOK +0.3%, NZD +0.25%) despite the lack of commodity price action.  And this also sems to ignore the 6th lockdown in Melbourne since the pandemic began last year, as the delta variant continues to wreak havoc around the world.  The rest of the G10 though, has seen much less movement.  In the emerging markets, PHP (-1.0%) was by far the worst performer overnight as the covid caseload soared to record numbers and concerns over growth expanded.  After that, TRY (-0.6%) is the next worst, as President Erdogan came out with calls for a rate cut despite rampant inflation.  However, away from those two currencies, movement has been on the order of +/- 0.2%, indicating nothing very special.  Essentially, these markets have ignored Clarida.  One last thing to note here is yesterday, the central bank of Brazil raised its SELIC rate by 1.0% to 5.25%, as inflation is exploding there.  However while BRL has been modestly stronger over the past several sessions, this was widely priced in so there was no big movement.

Data-wise, today brings Initial Claims (exp 383K), Continuing Claims (3255K) and the Trade Balance (-$74.2B), none of which seem likely to change any opinions.  Rather, at this point, all eyes are on tomorrow’s NFP data.  We also hear from two Fed speakers, Governor Waller and Minneapolis President KashKari, who is arguably the most dovish of all.  certainly if he starts talking taper, then the die is cast.  We shall see.

As I said, if tapering is on the cards, the dollar will likely test its highs from March/April, so be prepared.

Good luck and stay safe
Adf

Some Water to Tread

The quickening pace of the spread
Of delta means looking ahead
The prospects for both
Inflation and growth
Seem likely, some water, to tread

The upshot is central bank staff
Will trot out some chart or some graph
Highlighting that rates
In all nation states
Should once more be cut, least in half

The talk of the markets is the pace of the spread of the delta variant of Covid and how the latest wave of lockdowns and other measures has reduced growth forecasts for the second half of the year.  This is especially true throughout Asia as nations that had seemingly weathered the initial wave of Covid with aplomb find themselves woefully unprepared for the current situation.  A combination of less widespread vaccinations and less effective health infrastructure has resulted in the fast spreading virus wreaking havoc.  China, for instance, finds itself in this position as half of its 32 provinces are reporting cases and officials there have closed major tourist destinations because of the spread.  This is a far cry from their earlier claims of having controlled the virus better than anyone else.  But the same situation exists throughout Europe and the Americas as the delta variant runs its course.

The clearest market response to this situation has been from bond markets where yields continue to fall around the world on the weaker prospects for growth.  The amount of negative yielding debt worldwide has risen back to $16.7 trillion, up from $12.9 trillion at the end of June, although still below the $18.3 trillion reached in December of last year.  However, the trajectory of this move, which is approaching vertical, offers the possibility that we could easily take out those old highs in the next week or two.

The problem is that rapidly declining bond yields do not accord easily with higher inflation or inflation expectations.  Yet higher inflation continues to be present and inflation expectations continue to rise.  This is the great conundrum in markets right now.  How can markets be anticipating slower growth while inflation measures continue to rise?  Shouldn’t slower growth lead to lower inflation?

In ordinary economic environments, there has certainly been a strong relationship between growth and inflation, but I challenge anyone to describe this economic situation as ordinary.  Rather, as a result of collective government responses to the pandemic, with whole swaths of various economies around the world being closed, along with massive fiscal and monetary stimulus being added to those same economies, a series of supply shocks have been created.  Thus, when the artificially stoked demand (from the stimulus) meets the constrained supply (from the lockdowns) the natural response is for prices to rise in order to achieve a new equilibrium.  The point is that the supply constraints continue to drive much of the pricing behavior, and therefore the inflation story, while the central banks can only really affect the demand side of the equation.  After all, while they may be able to print lots of money, they cannot print chickens, toilet paper or semiconductors, all things that have seen supply reduced.

A large part of the central banks’ transitory inflation theme stems from the fact that their models tell them that supply will be replenished and therefore prices will ease.  Alas, there has been little indication that the real world is paying attention to central bank models, as we continue to see shipping delays, manufacturing delays and higher raw materials prices as the supply infrastructure remains under significant strain.

Perhaps the most telling feature regarding the current views on inflation, even more than the rise in economic statistics, is the growth in the number of stories in the mainstream media regarding why different ordinary products and services have become more expensive.  Just this morning, the WSJ explained why both vacations and patio furniture are more expensive, and a quick Google trends search shows the term “more expensive” is being searched at near peak levels virtually daily.  The central bank community has put themselves in a significant bind, and while some nations are beginning to respond, the big 3, Fed, ECB and BOJ, show absolutely no signs of changing their behavior in the near term.  As such, the outlook is for more printed money, the same or few available goods and higher prices across the board.

Turning to markets, all that money continues to be a positive for equity investors as a great deal of that liquidity keeps finding its way into equity markets.  While Japan (Nikkei -0.2%) lagged last night, the rest of Asia rebounded with both the Hang Seng and Shanghai indices rising 0.9%.  Europe, too, continues to perform well with the DAX (+0.8%), CAC (+0.4%) and FTSE 100 (+0.4%) all in the green after PMI Services indices were released.  While all of those data points were strong, they all missed expectations and were slightly softer than last month.  In other words, the trajectory continues to be lower, although the absolute readings remain strong.  Perhaps despite what Timbuk 3 explained, you won’t need shades for the future after all.

As to the bond market, we continue to see demand as yields are lower almost everywhere.  Treasury yields have fallen 1 basis point, with European sovereigns even stronger (Bunds -1.7bps, OATs -2.0bps, Gilts -1.3bps).  In fact, the only bond market to sell off overnight was in New Zealand (+5bps) as comments from the central bank indicated they are likely to raise rates next week, and as many as 3 times by the end of the year as inflation continues to rise while the unemployment rate fell to a surprisingly low 4.0%.

Commodity prices continue to lack direction, although the negativity on the economy has impacted oil prices which are down 1.1% this morning.  However, gold (+0.4%) is looking up, as are agricultural prices with the big three products all higher by between 0.3%-0.6%.  Base metals, though, are under pressure (Cu -0.4%, Sn -0.3%) which given the evolving economic sentiment makes some sense.

Finally, the dollar is ever so slightly softer this morning with only NZD (+0.7%) showing real movement and dragging AUD (+0.3%) along with it.  Otherwise, the rest of the G10 is +/- 0.1% from yesterday’s closing levels.  The EMG picture is a bit more mixed with gainers and losers on the order of 0.4%, although even that is only a few currencies.  The leader today is KRW (+0.4%) which responded to increased expectations that the BOK would be raising interest rates soon, perhaps later this month, with some analysts even floating the idea for a 50bp hike.  We have seen a similar gain in HUF (0.4%) as the market continues to digest hawkish commentary from the central bank there, but after those two, gainers have been far less impressive.  On the downside, TRY (-0.4%) is the laggard du jour as the market grows increasingly concerned that the central bank will not be able to keep up with rising inflation there.  Elsewhere, THB (-0.35%) fell on weakening growth prospects and the rest of the space was less interesting.

Two notable data points are to be released today with ADP Employment (exp 683K) early and then the ISM Services (60.5) index released at 10:00. The ADP number will be seen by many as a harbinger of Friday’s NFP, so could well have a big impact if it surprises in either direction.

Interestingly, the dollar continues to hold its own lately despite declining yields as it appears investors are buying dollars to buy Treasuries.  After all, as more and more debt turns into negative yields, Treasuries look that much more attractive.  At least until the Fed admits that inflation is going to be more persistent than previously discussed.

Good luck and stay safe
Adf

Down in Flames

The nation that built the Great Wall
Has lately begun to blackball
Its best and its brightest
For even the slightest
Concerns, causing prices to fall

Last night it was TenCent’s new games
Which suffered some unfounded claims
Concerns have now grown
They’ll need to atone
So their stock price went down in flames

The hits keep coming from China where last night, once again we were witness to a government sanctioned hit on a large private company, in this case Tencent.  In fact, Tencent is was the largest company in China by market cap but has since fallen to number two, after an article in an official paper, Xinhua News Agency’s “The Economic Information Daily” wrote about online gaming and how it has become “spiritual opium” for young people there.  While the government did not actually impose any restrictions, the warning shot’s meaning was abundantly clear.  Tencent’s stock fell 6.5% and Asian equity markets overall fell (Nikkei -0.5%, Hang Seng -0.2%, Shanghai -0.5%) as investors continue to fret over President Xi’s almost nightly attacks on what had been considered some of the greatest success stories in the country.  Apparently, that has been the problem; when companies are considered a greater success than the government (read communist party) they cease to serve their purpose.  It seems that capitalism with Chinese characteristics is undergoing some changes.

There is, perhaps, another lesson that we can learn from the ongoing purge of private sector success in China, that it has far less impact on global risk opinion than the activities in other geographies, namely the US.  While China has grown to the second largest economy in the world and is widely tipped to become the largest in the next decade or two, its capital markets remain significantly smaller on the world stage than those elsewhere.  So, when idiotic idiosyncratic situations arise like we have seen lately, with ideological attacks on successful companies, investors may reduce risk in China, but not necessarily everywhere else.  This is evident this morning where we see gains throughout Europe (DAX +0.15%, CAC +0.9%, FTE 100 +0.4%) as well as in the US futures markets (DOW and SPX +0.4%, NASDAQ +0.2%).  Despite last night’s poor performance in Asia, risk remains in vogue elsewhere in the world.

Away from the ongoing theatrics in China, last night we also heard from the RBA, who not only left policy on hold, as universally expected, but explained that they remain on track to begin tapering their QE purchases, down from A$ 5 billion/week to $A 4 billion/week, come September, despite the recent Covid lockdowns in response to the spread of the delta variant.  They see enough positive news and incipient credit demand to believe that tapering remains the proper course of action.  While there were no expectations of a policy change currently, many pundits were expecting the lockdowns to force a delay in tapering and the result was a nice little rally in the Aussie dollar, rising 0.5% overnight.

But, as we have just entered August, the month where vacations are prominent and government activity slows to a crawl, there were few other interesting tidbits overnight.  At this point, markets are looking ahead to Thursday’s BOE meeting, where there is some thought that tapering will be on the agenda, as well as Friday’s NFP report.  One final story that is gaining interest is the US financing situation with the debt ceiling back in place as of last Saturday.  Congress is on its summer recess, and Treasury Secretary Yellen has been forced to adjust certain cash outlays in order to continue to honor the government’s debt obligations.  As it stands right now, Treasury cannot issue new debt, although it can roll over existing debt.  However, that will not be enough to pay the bills come October.  There is no reason to believe this will come to a messy conclusion, but stranger things have happened.

As to the rest of the markets, bonds are under a bit of pressure today with Treasury yields rising 1.5bps, and similar size moves throughout Europe.  Of course, this is in the wake of yesterday’s powerful bond rally where yields fell 5bps after ISM data once again missed estimates.  In fact, we continue to see a pattern of good data that fails to match forecasts which is a strong indication that we have seen the peak in economic growth, and it is all downhill from here.  Trend GDP growth prior to Covid was in the 1.5%-1.7% range, and I fear we will soon be right back at those levels with the unhappy consequence of higher inflation alongside.  It is an outcome of this nature that will put the most stress on the Fed as the policy prescriptions for weak growth and high inflation are opposite in nature.  And it is this reason that allowing inflation to run hot on the transitory story is likely to come back to haunt every member of the FOMC.

Commodity markets today are offering less clarity in their risk signals as while oil prices are higher, (WTI +0.5%), we are seeing weakness throughout the rest of the space with precious metals (Au -0.2%), base metals (Cu -0.85%, Al -0.5%) and agriculturals (Soybeans -0.7%, Corn -0.9%, Wheat -0.5%) all under pressure today.

Finally, the dollar is falling versus virtually all its main counterparts today, with the entire G10 space firmer and the bulk of the EMG bloc as well.  NOK (+0.75%) leads the G10 group as oil’s rally bolsters the currency along with general dollar weakness.  Otherwise, NZD (+0.6%) and AUD (+0.5%) have benefitted from the RBA’s relative hawkishness.  The rest of the bloc is also higher, but by much lesser amounts.  I do want to give a shout out to JPY (+0.1% today, +2.3% in the past month) as it seems to be performing well despite the risk preferences being displayed in the market.  something unusual seems to be happening in Japan, and I have not yet been able to determine the underlying causes.  However, I also must note that last night, exactly zero 10-year JGB’s traded in the market, despite a JGB auction.  If you were wondering what a dysfunctional market looked like, JGB’s are exhibit A.  The BOJ owns 50% of the outstanding issuance, and the idea that there is a true market price of interest rates is laughable.

As to emerging markets, we are seeing strength throughout all three regional blocs led by ZAR (+0.8%), HUF (+0.7%) and PHP (+0.6%), with the story in all places the sharp decline in US rates leading to investors seeking additional carry.  While BRL is not yet open, it rallied 0.7% yesterday as the market is beginning to believe the central bank may hike rates by 100 bps tomorrow, a shockingly large move in the current environment, but one that is being driven by rapidly rising inflation in the country.

Data today brings Factory Orders (exp 1.0%) and Vehicle Sales (15.25M), neither of which is likely to distract us from Friday’s payroll report.  We also hear from one Fed speaker, governor Bowman, who appears to be slightly dovish, but has not make public her opinions on the tapering question as of yet.

Yesterday saw modest dollar strength despite lower interest rates.  Today that strength is being unwound, but net, we are not really going anywhere.  And that seems to be the best bet, not much direction overall, but continued choppy trading.

Good luck and stay safe
Adf

Jay Powell’s Story

This weekend the Chinese reported
That PMI growth has been thwarted
This likely implies
They’ll increase the size
Of stimulus, when all is sorted

Meanwhile, as the week doth progress
Investors will need to assess
If Jay Powell’s story
About transitory
Inflation means more joblessness

The conventional five-day work week clearly does not apply to China.  On a regular basis, economic data is released outside of traditional working hours as was the case this past weekend when both sets of PMI data, official and Caixin (targeting small companies), were reported.  And, as it happens, the picture was not very pretty.  In fact, it becomes easier to understand why the PBOC reduced the reserve requirement for banks several weeks ago as growth on the mainland is quite evidently slowing.  The damage can be seen not only in the headline manufacturing numbers (PMI 50.4, Caixin 50.3) but also in the underlying pieces which showed, for example, new export orders fell to 47.7, well below the expansion/contraction line.

While it is one of Xi’s key goals to wean China from the dominance of exports as an economic driver, the reality is that goal has come nowhere near being met.  China remains a mercantilist, export focused economy, where growth is defined by its export sector.  The fact that manufacturing is slowing and export orders shrinking does not bode well for China’s economy in the second half of the year.  To the extent that the delta variant of Covid is responsible for slowing growth elsewhere in the world, apparently, China has not escaped the impact as they claim.

However, in today’s upside-down world, weakening Chinese growth is seen as a positive for risk assets.  The ongoing ‘bad news is good’ meme continues to drive markets and this weaker Chinese data was no exception.  Clearly, investors believe that the Chinese are going to add more stimulus, whether fiscal or monetary being irrelevant, and have responded by snapping up risk assets.  The result was higher equity prices in Asia (Nikkei +1.8%, Hang Seng +1.1%, Shanghai +2.0%) as well as throughout Europe (CAC +0.8%, FTSE 100 +0.95%, DAX +0.1%) with the DAX having the most trouble this morning.  And don’t worry, US futures are all higher by around 0.5% as I type.

But it was not just Chinese equities that benefitted last night, investors snapped up Chinese 10-year bonds as well, driving yields lower by 5bps as expectations of further policy ease are widespread in the investment community there. That performance is juxtaposed versus what we are witnessing in developed market bonds, where yields are actually slightly firmer, although by less than 1 basis point, as the risk-on attitude encourages investors to shift from fixed income to equity weightings.

Of course, all this price action continues to reflect the fact that the Fed, last week, was not nearly as hawkish as many had expected with the tapering question remaining wide open, and no timetable whatsoever with regard to rate movement.  And that brings us to the month’s most important data point, Non-farm Payrolls, which will be released this Friday.  At this early point in the week, the median forecast, according to Bloomberg, is 900K with the Unemployment Rate falling to 5.7%.

Given we appear to be at an inflection point in some FOMC members’ thinking, I believe Friday’s number may have more importance than an August release would ordinarily demand.  Recall, the recent trend of US data has been good, but below expectations.  Another below expectations outcome here would almost certainly result in a strong equity and bond rally as investors would conclude that the tapering story was fading.  After all, the Fed seems highly unlikely to begin tapering into a softening economy.  Last week’s GDP data (6.5%, exp 8.5%) and core PCE (3.5%, exp 3.7%) are just the two latest examples of a slowing growth impulse in the US.  That is not the time when the Fed would historically tighten policy, and I don’t believe this time will be different.

There is, however, a lot of time between now and Friday, with the opportunity for many new things to occur.  Granted, it is the beginning of August, a time when most of Europe goes on vacation along with a good portion of the Wall Street crowd and investment community as a whole, so the odds of very little happening are high.  But recall that market liquidity tends to be much less robust during August as well, so any new information could well lead to an outsized impact.  And finally, historically, August is one of the worst month for US equities, with an average decline of 0.12% over the past 50 years.

Keeping this in mind, what else has occurred overnight?  While bad news may be good for stock prices, as it implies lower rates for even longer, slowing growth is not an energy positive as evidenced by WTI’s (-1.8%) sharp decline.  Interestingly, gold (-0.25%) is not benefitting either, as arguably the reduced inflation story implies less negative real yields.  More surprisingly, copper (+0.7%) and Aluminum (+0.6%) are both firmer this morning, which is a bit incongruous on a weaker growth story.

As to the dollar, it is broadly weaker, albeit not by much, with G10 moves all less than 0.2% although we have seen some much larger gains in the EMG space.  On top of that list sits ZAR (+1.15%) and TRY (+1.1).  The former is quite surprising given the PMI data fell by a record amount to 43.5, 14 points below last month’s reading as rioting in the wake of the Zuma arrest had a huge negative impact on business sentiment and expectations.  Turkey, on the other hand, showed a solid gain in PMI data, which bodes well for the economy amid slowing growth in many other places.  After those two, the gains were far more modest with HUF (+0.5%) and RUB (+0.35%) the next best performers with both the forint and the ruble benefitting from more hawkish central bank comments.

Obviously, it is a big data week as follows:

Today ISM Manufacturing 60.9
ISM Prices Paid 88.0
Construction Spending 0.5%
Tuesday Factory Orders 1.0%
Wednesday ADP Employment 650K
ISM Services 60.5
Thursday Initial Claims 382K
Coninuing Claims 3260K
Trade Balance -$74.0B
Friday Nonfarm Payrolls 900K
Private Payrolls 750K
Manufacturing Payrolls 28K
Unemployment Rate 5.7%
Average Hourly Earnings 0.3% (3.9% Y/Y)
Average Weekly Hours 34.7
Participation Rate 61.7%
Consumer Credit $22.0B

Source: Bloomberg

Beyond the data, surprisingly, we only hear from three Fed speakers as many must be on holiday.  But at this point, the market is pretty sure that it is only a matter of time before the Fed starts to taper, so unless they want to really change that message, which I don’t believe is the case, they can sit on the sidelines for now.  of course, that doesn’t mean they are going to taper, just that the market expects it.

While the dollar is opening the week on its back foot, I don’t expect much follow through weakness, although neither do I expect much strength.  I suspect many participants will be biding their time ahead of Friday’s report unless there is some exogenous signal received.

Good luck and stay safe
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