While many are looking ahead
To Europe, Japan and the Fed
Today’s PMI’s
Were quite a surprise
As weakness was truly widespread

Meanwhile, from Beijing, what we heard
Was policies they now preferred
Included support
For housing to thwart
The story that weakness occurred

While most market participants are anxiously awaiting this week’s central bank meetings for the next steps in monetary policy by the big 3 (Fed, ECB & BOJ), we did see a bit of surprising news from two sources this morning which has led to some market reactions.  The first thing to note was that the Chinese remain very disappointed that they cannot will their economy to grow faster in isolation and so have announced yet another round of policies intended to foster economic growth.  

The key plank of this policy is to further relax property investment rules, the so-called three red lines from several years ago, in order to encourage people to start buying houses again.  The property slump in China was first recognized when China Evergrande, one of the largest property development companies in the country, started down its road to bankruptcy nearly 2 years ago.  Since then, it has been a slow-motion train wreck with many more firms needing to halt debt payments, restructure debt and even go out of business.  Naturally, this didn’t sit well with the Chinese government, especially since property was a key part of the social safety net.  (Chinese families bought property as a nest egg investment since price appreciation had been so strong for so long.  Price declines have scared new investment away at the same time that many families need to cash in on their investment, adding further downward pressure to the housing market.)

The other main plank of this policy change was a renewed effort to deal with local government debt.  Historically, local governments would issue debt to fund economic investment and would repay that debt by selling property to investors and home buyers.  But with the property market in such a slump, these local governments no longer have the cash flow available to stay current on the debt, let alone repay it.  As such, the Chinese government is going to step into the market and restructure the debt in some manner with simple restructuring on the table as well as debt-swaps, where I assume debt holders will wind up with equity ownership of some extremely illiquid assets.  Neither of these things points to economic strength in China so I would continue to look for further measures as well as more direct fiscal support as we go forward.  As well, although CNY is little changed today, do not be surprised to see it continue its weakening trend.

The other major news this morning came from the Flash PMI data across Europe, which was, in a word, putrid.  While the initial data overnight from Australia and Japan was a bit soft, the continent redefined weakness.  Manufacturing remains mired in a serious recession in Europe as evidenced by Germany’s 38.8 reading, far below expectations and the second lowest print in the series, exceeded only by the Covid lows in April 2020.  But the weakness was widespread with France (44.5) underperforming expectations and the Eurozone as a whole (42.7) even worse.  Services data, while better than Manufacturing is also softening, and the Composite readings show are sub 50 across the board.  UK data was also soft, just not quite as awful, but the general takeaway is growth is slowing in the Eurozone and the UK.

Later this morning we see the US numbers (exp 46.2 Mfg, 54.0 Sevices) as well as the Chicago Fed National Activity Index (exp -0.13), which will help flesh out the story of US economic activity as well.  But the big picture remains that economic activity around the world is suffering, of that we can be sure.

And yet, despite this weakening growth story, expectations for rate hikes by both the Fed and ECB remain a virtual lock although the BOJ seems likely to remain on hold for a while yet.  We will delve into the central banking story tomorrow though.  For today, markets continue to respond to the PMI data as well as the China story.

And how have they reacted you may ask?  Well, starting in Asia, Chinese shares did not seem to like the announcements coming from Beijing as both the Hang Seng (-2.1%) and CSI (-0.45%) suffered although the Nikkei (+1.25%) embraced the idea that the BOJ was going to continue to print as much money as possible.  It should be no surprise that European bourses are in the red after that data with a particular note for Spain (-0.8%) which is also dealing with an election outcome that seems destined to result in another hung parliament.  But don’t worry, US futures continue to point to modest gains at this hour (8:00) although that remains highly earnings dependent I believe.

In the bond market, yields are lower across the board with Treasuries (-3.3bps) that laggard as virtually all the European sovereigns have seen yields slide by 6bps or so.  Apparently, the European investment community is not willing to believe the ECB will continue to raise interest rates into a very obvious recession on the continent.  We shall see if they do so.  As to JGB’s, they saw yields rise 2.4bps, but are still not too close to the YCC cap.  I expect that we will see a little more volatility in the JGB market ahead of Friday’s BOJ announcement as speculators try to get ahead of any potential policy change.

In the commodity space, oil (+0.75%) continues its recent winning ways and is up more than 11% in the past month.  Given the economic news, this has to be a supply driven story.  I have written many times about the structural deficit in oil that we are likely to face given the ESG movement’s systematic underinvestment in oil production.  The problem is that even with a recession, oil demand continues to grow and even the IEA, a complete convert to ESG and net-zero ideas, admits that oil demand will grow to a new record this year in excess of 102 million bbl/day globally.  Rising demand and static or falling supply will drive prices higher, that much is clear.  The base metals are under a bit of pressure, though, this morning, responding as would be expected to the weaker economic story and gold (+0.3%) continues to find support, arguably today on the basis of lower yields around the world.

Finally, the dollar is mixed, although I would argue leaning slightly stronger today.  The worst performer is CZK (-0.8%) which is suffering from weakness in its largest export market, Germany, as well as continuing to respond to central bank comments from late last week about policy ease.  On the flip side, ZAR (+0.7%) as there is a growing influx of investment into rand bonds given the huge yield advantage.  In the G10, JPY (+0.45%) is today’s leader, although if the BOJ stands pat, I have to believe that further weakness is in the future.  Meanwhile, EUR (-0.3%) is the laggard on the back of that terrible PMI data.

There is a lot of data out there this week in addition to the 3 big central bank meetings.

Today	Chicago Fed National Activity	-0.13
Tuesday	Case Shiller Home Prices	-2.40%
	Consumer Confidence	112.0
	Richmond Fed	-10
Wednesday	New Home Sales	725K
	FOMC Decision	5.50% (current 5.25%)
Thursday	ECB Decision	3.75% (current 3.50%)
	Initial Claims	235K
	Continuing Claims	1750K
	GDP Q2 (2nd look)	1.8%
	Durable Goods	1.0%
	-ex Transport	0.1%
Friday	BOJ Decision	-0.1% (current -0.1%)
	Personal Income	0.5%
	Personal Spending	0.4%
	Core PCE Deflator	0.2% (4.2% Y/Y)
	Michigan Sentiment	72.6
Source: Bloomberg

Obviously, there is plenty of information to be gleaned this week, although there are no scheduled Fed speakers after the meeting and press conference on Wednesday.  I guess they are all going on vacation!  

My read on the current situation is that economic activity continues to slow, although perhaps not yet to a recessionary level.  As well, I fear that inflationary pressures will remain stickier than we would like and that for now, the Fed is not feeling any pressure to end their current higher for longer policy.  In fact, it will be next week’s NFP data that is the first really critical release, as a weak number there will start to give weight to the idea that the terminal rate has been reached.  However, if we see strength in job growth, pencil in at least one more hike past Wednesday.  As to the dollar, I am confident that if the US is ending their tightening cycle, the other major central banks will be ending theirs soon as well.  I see no dollar collapse, nor even significant weakness for quite a while yet.

Good luck
Adf