The narrative that we’ve been fed
Explains a soft landing’s ahead
With CPI falling
And job growth enthralling
The equity bulls lack all dread

But part of this thesis entails
That Chinese expansion prevails
Alas for that view
The data that’s new
Shows Xi’s had a series of fails

Pop quiz: what do you call an economy that demonstrates anemic economic output with relatively high inflation yet relatively low unemployment?  The future.  In truth, I don’t think economists have come up with a new descriptor for the situation to where we are headed.  Stagflation may be appropriate, but the key outlier in this scenario is the low unemployment situation.  To help better understand how a recession is defined in the US (as opposed to the shorthand view of 2 consecutive quarters of negative real GDP growth), here is an excerpt directly from the NBER’s website describing the things they consider [emphasis added]:

“Because a recession must influence the economy broadly and not be confined to one sector, the committee emphasizes economy-wide measures of economic activity. The determination of the months of peaks and troughs is based on a range of monthly measures of aggregate real economic activity published by the federal statistical agencies. These include real personal income less transfers, nonfarm payroll employment, employment as measured by the household survey, real personal consumption expenditures, wholesale-retail sales adjusted for price changes, and industrial production. There is no fixed rule about what measures contribute information to the process or how they are weighted in our decisions. In recent decades, the two measures we have put the most weight on are real personal income less transfers and nonfarm payroll employment.”

Based on this description, if the unemployment rate remains low, recession is not on the cards.  Now, politically, the current administration will spend a lot of time during the current election cycle touting their achievements, but will this situation, where inflation continues to plague the economy amid very slow growth, really feel like times are good?  The employment situation appears to be a structural change with a large reduction in the workforce in the wake of the pandemic and related policies.  While this seems likely to keep unemployment low, it will also keep upward pressure on inflation.  This will be good for the nation’s fiscal stance, as high nominal activity along with high inflation (exactly the situation I foresee) will do wonders for reducing the real value of the outstanding debt.  However, it is not clear it will do much for the nation’s psyche.  

One of the key features of the soft landing scenario is that economic activity will be widespread.  Now, we know that Europe and the UK are both struggling, but of equal, if not greater importance, is the stituaiton in China.  There has been a near universal view that the post zero-Covid economy in China would revive quickly and that growth there would be sufficient to support the entire world.  Last night, though, we got some bad news on that front as Chinese data was generally weaker than expected, specifically the GDP result where growth rose just 0.8% on the quarter (5.5% Y/Y) far below economists’ forecasts.  It seems that the China reopening is not nearly as impressive as previously expected.  Property investment continues to fall (-7.9%), Retail Sales continue to slide (3.1%) and IP remains far below historic levels.  Oh yeah, while the Surveyed Jobless Rate remained unchanged at 5.2%, youth unemployment (people between ages 16-24) rose still further to 21.3%!  This is not the sign of an expanding economy.

It seems that the combination of slowing world activity and ongoing trade wars is starting to really take a toll.  Exports fell last month, and apparently, the Chinese consumer is not picking up the slack.  Now, the latter should be no surprise as there was precious little fiscal policy support for the Chinese people by the Xi government during covid, and their largest source of savings, housing, has been collapsing for at least 2 years, so it is not clear why anyone should expect an uptick in activity.  The Chinese people just don’t have the money for it.  Despite Xi’s earnest desire to have the economy pivot away from export-led growth to consumption led growth, it just ain’t gonna happen real soon.  And if Chinese economic activity remains in the doldrums, we could be in for a longer period of overall slow growth around the world.  That will not help the soft-landing scenario at all.  

Maybe things will be much better, but I cannot get over the view that the worst of this economic cycle is yet to come.  Beware.

How are markets responding to the latest news?  Pretty much as you might expect with risk assets under pressure and bond markets rallying.  For instance, after Friday’s mixed picture in the US, Chinese equity markets were under pressure, although the rest of Asia was pretty benign.  European bourses, though, are all in the red led by the CAC (-1.25%).  As to US futures, at this hour (7:30) they are all slightly softer as the market awaits earnings, this week’s Retail Sales data and, of course, next week’s FOMC.

Bond markets, though, are unambiguous in their views with yields falling sharply across the board.  Treasury yields are down 5bps, as are virtually all European sovereigns and UK gilts.  The decline in US CPI last week is clearly spilling over, as is the weaker Chinese growth data.  While central banks have insisted that they are not done fighting inflation by raising interest rates, markets are pretty clearly expressing the view that yes another hike may be coming soon, but that by early next year, they will be cutting rates quickly.  

As to the commodity markets, oil, which had really rallied nicely over the past week or so, has fallen again this morning, down -1.20%, and we are seeing weakness in the base metals as well with both copper and aluminum lower by about -2.0%.  Only gold is managing to maintain a little bid as the dollar remains under some pressure this morning.

Finally, the dollar is mixed this morning, with about half its counterparts in both the G10 and EMG blocs higher and the other half lower.  Given the Chinese data, it is no surprise CNY and several other Asian currencies are weaker this morning.  Perhaps a little more surprising is that the ZAR is stronger despite softer metals prices.  But given that there has been a broad-based theme of dollar weakness in the wake of the CPI data last week, my sense is traders are simply adjusting positions ahead of the Fed next week.  This idea is bolstered by the fact that the yen remains one of the best performing currencies of late as the yen continues to be the favored funding currency for short positions given its still negative interest rate structure, but as the long dollar idea fades, traders are forced to cover those short yen positions.  I suspect that there is further to go in this trade.

On the data front, Retail Sales is the highlight of the week, although there is a decent amount of stuff, as follows:

Today	Empire Manufacturing	-3.5
Tuesday	Retail Sales	0.5%
	-ex autos	0.4%
	IP	0.0%
	Capacity Utilization	79.5%
Wednesday	Housing Starts	1475K
	Building Permits	1490K
Thursday	Initial Claims	241K
	Continuing Claims	1730K
	Phily Fed	-10.0
	Existing Home Sales	4.21M
Source: Bloomberg

With no Fed speakers, I expect that the market will be focused on the Retail Sales data from an economic perspective, but we are also entering the earning period, so it is likely that is going to have a bigger impact on all markets without any Fed narrative.  Barring extreme results in either data or earnings, I suspect a quiet week as all eyes focus not only on the 25bp hike coming next week from Powell and company, but more importantly, the tone of the statement and the press conference.  

Good luck
Adf