The reason the stock market fell-a
Is Goldi (locks) turned to Cinderella
At Midnight things changed
as tariffs arranged
By Trump, forced stock owners to sell-a
Please forgive my poetic license, but it is, after all, just a poem!
Category Archives: Uncategorized
Waiting to See
At midnight the US imposed
The tariffs that Trump had disclosed
We’re waiting to see
How President Xi
Responds, or if China’s now hosed
It’s all about the tariffs this morning as the US increased the tariff rate on $200 billion of Chinese imports to 25% as of midnight last night. China has promised to retaliate but has not yet announced what they will do. One of the problems they have is they don’t import that much stuff from the US, so they cannot match it exactly. There was an unintentionally humorous article in Bloomberg this morning that tried to outline the ‘powerful’ tools China has to respond; namely selling US Treasuries, allowing the CNY to weaken further, or stop buying US soybeans. The humor stemmed from the fact that they basically destroyed their own arguments on the first two, leaving just the soybean restriction as potentially viable and even that is problematic.
Consider the Treasury sales first. As the Chinese own ~$1.1 trillion, if they sold a significant chunk, they would almost certainly drive US yields higher as Treasury prices fell. But two problems with this are; they would undermine the value of whatever bonds they retained and more problematically, what else would they do with the dollars? After all, the Treasury market is pretty much the only one that is large enough to handle that type of volume on a low risk basis. I guess they could convert the dollars to euros and buy Italian BTP’s (there are a lot of those outstanding) but their risk profile would get significantly worse. And of course, selling all those dollars would certainly weaken the dollar, which would not help the Chinese economy one bit.
On the flip side, allowing the renminbi to weaken sharply presents an entirely different problem, the fact that the Chinese are terrified that they would lose control of the capital flow situation if it weakened too far. Remember in 2015, when the Chinese created a mini-devaluation of just 1.5%, it triggered a massive outflow as USDCNY approached 7.00. The Chinese people have no interest in holding their assets in a sharply depreciating currency, and so were quick to sell as much as they could. The resultant capital flows cost China $1 trillion in FX reserves to prevent further weakness in the currency. Given we are only 2% below that level in the dollar right now, it seems to me the Chinese will either need to accept massive outflows and a destabilizing weakening in the renminbi, or more likely, look for another response.
The final thought was to further restrict soybean imports from the US. While the Chinese can certainly stop that trade instantly, the problems here are twofold. First, they need to find replacement supplies, as they need the soybeans regardless of where they are sourced, and second, given the Swine virus that has decimated the pig herds in China, they need to find more sources of protein for their people, not fewer. So, no pork and less soybeans is not a winning combination for Xi. The point is, while US consumers will likely feel the pressure from increased tariff rates via higher prices, the Chinese don’t have many easy responses.
And let’s talk about US prices for a moment. Shouldn’t the Fed be ecstatic to see something driving prices higher? After all, they have been castigating themselves for ‘too low’ inflation for the past seven years. They should be cheering on the President at this stage! But seriously, yesterday’s PPI data was released softer than expected (2.2%, 2.4% core) and as much as both Fed speakers and analysts try to convince us that recently declining measured inflation is transitory, the market continues to price rate cuts into the futures curve. This morning brings the CPI data (exp 2.1%, 2.1% core) but based on data we have seen consistently from around the world, aside from the oil price rally, there is scant evidence that inflation is rising. The only true exceptions are Norway, where the oil driven economy is benefitting greatly from higher oil prices, and the disasters of Argentina and Turkey, both of which have tipped into classic demand-pull inflation, where too much money is chasing too few goods.
Turning to market performance, last night saw the Shanghai Composite rally 3.1% after the imposition of tariffs, which is an odd response until you understand that the government aggressively bought stocks to prevent a further decline. The rest of Asia was mixed with the Nikkei lower by a bit and the KOSPI higher by a bit. European shares are modestly higher this morning, on average about 0.5%, in what appears to be a ‘bad news is good’ scenario. After all, French IP fell more than expected (-0.9%) and Italian IP fell more than expected (-1.4%). Yes, German Trade data was solid, but there is still scant evidence that the Eurozone is pulling out of its recent malaise so weaker data encourages traders to believe further policy ease is coming.
In the FX market, there has been relatively little movement in any currency. The euro continues to trade either side of 1.12, the pound either side of 1.30 and the yen either side of 110.00. It is very difficult to get excited about the FX market given there is every indication that the big central banks are well ensconced in their current policy mix with no changes on the horizon. That means that both the Fed and the ECB are on hold (although we will be finding out about those TLTRO’s soon) while both the BOJ and PBOC continue to ease policy. In the end, it turns out the increased tariffs were not that much of a shock to the system, although if the US imposes tariffs on the rest of Chinese imports, I expect that would be a different story.
This morning we hear from Brainerd, Bostic and Williams, although at this point, patience in policy remains the story. The inflation data mentioned above is the only data we get (although Canadian employment data is released for those of you with exposures there), and while US equity futures are tilted slightly lower at this time, it feels like the market is going to remain in the doldrums through the weekend. That is, of course, unless there is a shocking outturn from the CPI data. Or a trade deal, but that seems pretty remote right now.
Good luck and good weekend
Adf
Growing Concern
The trade talks have taken a turn
Amidst markets growing concern
The story today
Is China won’t play
By rules which trade partners all yearn
The trade talks narrative is shifting, and markets are not taking kindly to the change. Prior assumptions had been that the talks were progressing well and that this week’s meetings in Washington were going to produce the final agreement. However, this morning the tone has changed dramatically. President Trump tweeted that the Chinese “broke the deal”, implying that items previously agreed by the two sides are no longer acceptable to China. To my reading, the key issue is the Chinese refusal to codify into law the changes being agreed regarding IP and forced technology transfer. It appears that the Chinese believe this too onerous and difficult to accomplish and instead will be giving guidance to local governments. (Perhaps somebody can explain to me how it is too onerous for a dictatorship to change its own laws.) Essentially, they want the US to trust that they will perform as expected. Simultaneously, it appears the Chinese have interpreted President Trump’s hectoring of the Fed to cut rates as an admission that the US economy is not strong, and that Trump needs to cut the deal. This has encouraged the Chinese to play hardball as they believe they have the upper hand now.
The upshot is that the odds of a successful conclusion of the talks have fallen sharply. At this point, my read is they are no more than 50:50, which is far lower than the virtual certainty the market had been pricing as recently as last Friday, and quite frankly far lower than the market is currently pricing. In fact, it is easy to make the case that at least half of the equity rebound since Christmas is due to the growing belief a trade deal would be agreed, so if that is no longer the case, a further repricing (read decline) is in the cards. As such, it should be no surprise that equities in Asia continue to retreat (Nikkei -0.95%, Shanghai -1.5%, Hang Seng 2.4%) and we are seeing weakness throughout Europe as well (DAX -0.9%, CAC -1.3%, FTSE -0.4%) given concerns that a failure in these talks will have a much wider impact spread across the investment community. Not surprisingly, US futures are pointing lower with both Dow and S&P futures -0.75% as I type.
Continuing with the risk-off theme, Treasury yields continue to decline, falling two basis points even after a very weak 10-year auction yesterday, while German bund yields have fallen another bp to -0.06%, their lowest level in two months. The flight to safety is beginning to gain some momentum here.
Finally, looking at the dollar, it should be no surprise it is having another good day. While it is little changed vs. the euro, it continues to trade near the lower end of its recent trading range. However, the pound has fallen a further 0.2% hindered not only by the modest dollar strength but by the realization that there will be no grand deal between the Tories and Labour regarding Brexit. Adding to the risk-off mood is the yen’s further appreciation, another 0.2%, taking it below 110 for the first time in three months.
In the EMG bloc, one cannot be surprised that CNY is weaker, pushing back toward 6.85 and touching its weakest level since January. On top of that, the offshore CNH is even weaker as speculation grows that a collapse in the trade talks will result in the Chinese allowing the renminbi to fall much more sharply. But it’s not just China under pressure here; we are seeing weakness in every area. For example, the Mexican peso has fallen 0.5%, Indian Rupee 0.3% and Korean won 0.85%. In other words, the carry trade is under pressure as the first investors search for a safe place to hide. Unless the talks get back on track, I expect that we will see further weakness in the EMG bloc especially.
On the data front, overnight we saw Chinese financing data which demonstrated that despite the PBOC’s efforts to add liquidity to the market, financing is not growing as rapidly as they would like. For example, New Yuan Loans increased a much less than expected CNY 1trillion (exp CNY 1.2 trillion), while Outstanding Loan Growth ebbed as well. The point is that like every other central bank, the PBOC is finding that their ability to control the economy is slipping.
This morning brings Initial Claims (exp 220K) along with the Trade Balance (-$50.2B) and PPI (2.3%, core 2.5%) all at 8:30. Also at that time, we hear from Chairman Powell, followed by speeches from Atlanta’s Rafael Bostic and Chicago’s Charles Evans later in the day. The thing is, it beggars belief that any of them are going to change their tune regarding the Fed’s patience as they watch the economy develop. At this point, the key question is, if the trade talks completely fall apart and new tariffs are imposed by both sides leading to a severe decline in the equity market, will the Fed start to contemplate cutting rates? At this point I am sure they would vehemently deny that is their thought process. But if recent history is any guide, the financialization of the US economy has forced the Fed to respond to any significant movement in the S&P. So I would answer, yes they will! But that is a story for another day. Unless there is positive news from the trade front today, look for the overnight trends to continue; weaker equities, stronger Treasuries and a stronger dollar.
Good luck
Adf
Uncertainty Reigns
Concerns over trade still remain,
For bullish investors, a bane
They want to believe
That Trump will achieve
His goals, so investments can gain
But right now uncertainty reigns
Resulting in stock market pains
When risk is reduced
Then bonds get a boost
While euros and pounds feel the strains
The one thing we know for sure is that the trade situation continues to be a major topic on investor minds, whether those investors are of the equity or fixed income persuasion. Despite the ostensible good news that Chinese vice-premier Liu He would still be coming to Washington later this week to continue the trade talks with Mnuchin and Lighthizer, it seems the market has become a bit less convinced that a deal is coming soon. As I have written several times over the past few weeks, it seems clear the market had fully priced in a successful completion of the trade talks and an (eventual) end to tariffs. But the President’s tweets on Sunday has caused a serious reconsideration of that pricing. Arguably, the 2% decline we have seen in US equity indices over the past two sessions is not nearly enough to offset the full risk, but it is a start. Ironically, I think the constant reiteration by financial heavyweights like Christine Lagarde and Mario Draghi, of how important it is to avoid a trade war, has set up a situation where in the event no deal is reached, the market reaction will be worse than if they had never piped up in the first place.
At any rate, the increased tensions have certainly reduced risk appetites across the board. Not only have equity markets suffered (Nikkei -1.5%, Shanghai -1.1% after yesterday’s US declines) but Treasury yields continue to fall. This morning 10-year Treasury yields have fallen to 2.43%, their lowest since late March and essentially flat to the 3-month T-Bill. Expect to hear more discussion about an inverted yield curve and the omens of a recession in the near future.
Away from the trade situation, it seems most other market stories are treading water. For example, the Brexit situation has been back page news for the past two weeks. PM May continues to negotiate with opposition leader Jeremy Corbyn, but there is no consistency to the reports of progress. Labour wants to join the customs union which is something the pro-Brexiteers are fiercely against. Depending on the source of the article you read, a deal is either imminent or increasingly unlikely, which tells me that nobody really knows anything. The pound, which had seen some strength last week, especially on Friday when rumors of a deal were rife, has fallen a further 0.45% this morning and is back near the 1.30 level. It seems increasingly likely to me there will be no solution before the EU elections, and that there will be no solution before the October 31 deadline. Parliament remains riven and leadership there has been completely absent. I expect this to be exhibit A in the long tradition of muddling through by European nations.
Elsewhere in the FX markets, the RBNZ did cut rates last night by 25bps, unlike their Australian brethren who stayed on hold. Kiwi is softer by 0.25% this morning on the back of the news and has helped drag the Aussie with it. Of course, part of the malaise in these currencies is the ongoing uncertainty over the trade talks, as well as the suspect Chinese data.
Speaking of that data, last night China released much worse than expected trade results with exports falling 2.7% and imports rising just 4.0% resulting in a trade surplus of ‘just’ $13.8B, well below expectations. It seems that the tariffs are starting to have a real impact now that inventories need to be replenished. Aside from the impact on the Shanghai exchange noted above, the renminbi also drifted modestly lower, -0.1%, and continues to push toward levels last seen in January. One thing of which I am confident is that if the trade talks fall apart completely, CNY will weaken sharply and test the 7.00 level in short order. Part of the recent stability in the currency has been due to a general malaise in the FX market as evidenced by the extremely low volatility across the board. But part of it, no doubt, is the result of the PBOC managing the currency and absorbing any significant selling in order to demonstrate they are not manipulating the currency lower to enhance their trade. But that will surely end if the talks end unsuccessfully.
Away from those stories it is much more about a modest risk-off scenario today with both JPY and CHF stronger by 0.2%, while EMG currencies are suffering (MXN -0.4%, TRY -0.5%). However, the overall market tone is, not unlike the Fed, one of patience for the next catalyst to arrive. Given the dearth of important data until Friday’s CPI, that should be no real surprise.
In fact, this morning there are no data releases in the US although we do hear from Fed Governor Lael Brainerd at 8:30. Yesterday’s comments from Governor Clarida were generally unenlightening, toeing the line that waiting was the best idea for now and that there were no preconceived notions as to the next rate move. As such, I expect Brainerd to be on the same page, and the FX market to continue to tread water at least until Friday’s CPI.
Good luck
Adf
Cold Sweats
The President’s tactic of threats
On trade talks gave some the cold sweats
So equities fell
But then by the bell
Those sellers had many regrets
Stock prices rebounded with verve
But bonds, if you look at the curve
Continue to price
A fools’ paradise
And cuts by the Federal Reserve
One of the most interesting dichotomies that we see these days is the completely different views of the global economy by stock markets and bond markets. Stock prices continue to see every glass as at least three-quarters full, willing to look past any potential bad news and rally. Yesterday saw a rout in the Far East after the President’s tweets regarding the raising of tariff rates by the end of this week. Europe continued the trend, closing down sharply as concerns grew that a change in tactics by the US could result in a renewed focus on the European auto sector and, not surprisingly, US equity markets opened sharply lower. But within a few hours, buyers emerged as the story morphed from ‘the US-China trade talks were about to collapse’ to ‘this is just a negotiating tactic by President Trump and everything is still on track for a successful (and fully priced) completion of these negotiations.’ And overnight, equity markets in Asia steadied with generally modest gains, although not nearly enough to offset Monday’s price action. Overall, equity markets remain quite optimistic.
At the same time, Treasury yields have fallen further and are back below 2.50% in the 10-year for the first time in a month. The implication is that bond investors and traders are now far less sanguine over the outcome of these talks. Certainly, if the trade talks do collapse, markets would be severely impacted with equity prices likely to see sharp declines and risk assets, in general under pressure. Treasuries (and Bunds) however, would very likely see a significant uptick in demand and it would not be hard to envision another period of a yield curve inversion. My point is it almost appears as if equity investors and bond investors are reading different stories about current events. I guess the reality is that bond investors are inherently more risk averse, so any hint of trouble forces a response. And of course, equity investors are the ones who continue to highly value ‘zombie’ companies, those firms whose profits cannot cover interest payments and who stay in business by the grace of Federal Reserve largesse.
The upshot is that risk seeking behavior remains the dominant theme in markets. As long as central banks continue to add liquidity to the mix (which despite the Fed having stopped, the BOJ and ECB continue to add as does the PBOC), that money needs to find a home somewhere. And stock markets have been the primary destination for the past ten years.
The interesting thing about the willingness to seek risk is that the dollar continues to outperform most other currencies. For the longest time, during periods of strong global growth, the dollar would soften as investment flowed to other nations and drove economic activity. However, the current situation shows a willingness to take risk and yet a simultaneous desire to hold dollars. For instance, a look at the Dollar Index (DXY) which is a broad measure against a number of currencies, shows that the dollar remains near its highest level in two years and the trend remains higher. All I’m saying is that there seems to be a disconnect between the three key global markets with both FX and bonds seeing a much darker future than equity markets.
Looking at the overnight activity, the RBA left rates on hold, which was mildly surprising as at least half the analyst community was looking for a rate cut. In the end, AUD rallied 0.4% and is, by far, the best performer of the day. As it happens, the RBNZ meets tonight and is widely expected to cut rates by 25bps thus the kiwi is lower by 0.25%. The euro and pound are essentially unchanged as there has been precious little in the way of new information either data wise or regarding the ongoing Brexit fiasco. And the rest of the G10 seems to be under very modest pressure with CAD and CHF both softer by about 0.15%.
In the emerging market space, CNY continues to fall, down a further 0.15% this morning and we continue to see pressure on LATAM currencies (MXN -0.2%). TRY is also under pressure (-1.0%) as the investors exit both stock and bond markets there in the wake of the decision to rerun the Istanbul mayoral election and the further erosion of democracy in Turkey. In APAC, MYR is little changed in the wake of the widely anticipated 25bp rate cut by the central bank there, although it has been falling steadily for the past two weeks in anticipation. But otherwise, in truth, it has been quiet.
Data today brings just the JOLTs Jobs Report (exp 7.24M) and we hear from Randal Quarles, the Fed governor overseeing regulations. Yesterday’s Fed talk was largely in line with the view that the recent dip in inflation is ‘transitory’ and that they continue to watch the data for information to help them make their next move. Overall, it is shaping up as a pretty dull session, and unless we hear something else on the trade front, I expect limited movement in most markets.
Good luck
Adf
10%’s Not Enough
Said Trump, 10%’s not enough
It’s time that we really get tough
So starting next week
A quarter we’ll seek
Believe me, this ain’t just a bluff
If there was any question as to whether or not markets had fully priced in a successful conclusion of the US-China trade talks, last night’s price action should have answered it in full. President Trump is clearly feeling his oats, as his approval rating rises alongside the stock market and the economy, and so he changed the landscape once again. With Chinese Vice-premier Liu He, the chief negotiator in the trade talks, scheduled to arrive in the US later this week to continue, and in the market’s view conclude, those discussions, the President, last night, threatened to increase tariffs on $200 billion of goods to 25% from the current 10%, and to impose 25% tariffs on another $325 billion of goods, which is essentially everything else the US imports from China. In a heartbeat, views changed from rainbows and unicorns to Armageddon. Equity markets around the world plunged, commodity prices tumbled and the dollar and yen both rallied. Interestingly, Treasury prices have not moved much yet, although with the UK and Japan on holiday, overseas Treasury markets are extremely thin, so it could be there just hasn’t been any trading. Of course, it also could be that Treasury prices had already incorporated a less rosy future than equity markets, and so have less need to adjust.
One of the most common themes espoused lately has been the remarkable decline in asset price volatility this year, with measures in equities, bonds and currencies all pushing to cyclical lows. While there is a contingent of analysts (present company included) who believes that this is the calm before the storm, it is also true that market activity has been unidirectional since January, with that direction higher.
With respect to volatility, nothing has yet changed regarding the view that volatility increases when prices fall in both equity and bond markets although the relationship between volatility and the dollar is far less structured. In fact, there has been a significant increase in the amount of short volatility bets being made in the market, similar to the situation we saw at the beginning of 2018. Of course, I’m sure we all remember the disintegration of the XIV ETF (really it was an ETN), when a spike in volatility reduced its value by more than 85% in two days. Well, currently, records show that there is an even larger short volatility position now than there was last February when things went pear-shaped. The point is it is worthwhile to be careful in the current environment.
As to the dollar, historically volatility has increased in both rising and declining dollar environments depending on the circumstances. Given the dollar’s overall strength lately has been accompanies by a decline in volatility, it seems a fair bet to assume that if the dollar were to reverse lower, it would do so in a volatile manner rather than as a steady adjustment. Remember, too, currencies tend to overshoot when large moves occur. However, at this point, I would expect that fear in other markets will continue to support the dollar, and hence keep volatility at bay.
A recap of price movement overnight shows that the Shanghai Composite fell 5.5% and the Hang Seng fell 2.9% (the Nikkei was closed). Europe is currently trading with both the DAX and CAC falling 2.0% (FTSE is also closed) and US futures are pointing to nearly 2.0% losses on the open as well.
Meanwhile, the dollar is broadly higher. It has rallied 0.5% vs. the pound, offsetting a large part of Friday’s GBP rally that was based on the rumor PM May and Labour leader Corbyn were soon going to announce agreement on a Brexit deal. While nothing has come of it yet, that does explain the pound’s sharp Friday movement. AUD and NZD are both lower by 0.5% as the market looks to this evening’s RBA meeting with a 50% probability of a rate cut priced and the belief that the RBNZ will need to match that tomorrow if it occurs. Aussie is back below 0.70, and my sense is it has further to fall, especially if the trade situation deteriorates. Elsewhere in the G10, the euro is little changed after slightly better than expected PMI data seems to have been enough to offset trade concerns. And finally, the yen, as would be expected of a haven asset, is higher by 0.25%.
Versus emerging market currencies, the dollar has had an even stronger performance. It should be no surprise that CNY has fallen sharply (-0.75%) especially since the PBOC cut the RRR for small and medium sized banks by another 1.0% in an effort to stabilize markets. Elsewhere in Asia both INR and KRW fell 0.65% with other currencies having a slightly less negative result. EEMEA has seen ZAR fall 1.0% and TRY -1.20% although the latter has more to do with the possibility that the recent election in Istanbul, where President Erdogan’s party lost, would be overturned and a new one held thus undermining the concept of democracy in Turkey even further. Finally, LATAM markets are waking up under modest pressure, but have not yet fallen sharply.
Turning to this week’s data, there is not much overall, but we do see CPI data Friday.
| Tuesday | JOLTs Job Openings | 7.24M |
| Thursday | Initial Claims | 220K |
| Trade Balance | -$50.2B | |
| PPI | 0.2% (2.3% Y/Y) | |
| -ex food & energy | 0.2% (2.5% Y/Y) | |
| Friday | CPI | 0.4% (2.1% Y/Y) |
| -ex food & energy | 0.2% (2.1% Y/Y) |
We also will hear a lot of Fed speaking, with eleven speeches from eight different FOMC members including Chairman Powell on Thursday. This week’s talks could well be market moving as last week’s press conference was not as smooth as it might have been. Look for lots of nuance as to what the Fed is looking at and why they think it is appropriate to be patient. As of now, it doesn’t seem that there is any leaning toward an “insurance” rate cut in the near term, but, especially if Friday’s CPI data is softer than expected, that theme could well change. As such, for now, I don’t see a good policy reason for the dollar to retreat, and if the trade situation deteriorates, it should help the buck, but given the mercurial dynamics of the President’s negotiating tactics, I wouldn’t rule out a complete reversal of things before long.
Good luck
Adf
The Chaff from the Wheat
As markets await the report
On Payrolls they’re having to sort
The chaff from the wheat
From Threadneedle Street
As Carney, does rate hikes exhort
The gloom that had been permeating the analyst community (although certainly not the equity markets) earlier this year, seems to be lifting slightly. Recent data has shown a stabilization, at the very least, if not the beginnings of outright growth, from key regions around the world. The latest news was this morning’s surprising Eurozone inflation numbers, where CPI rose a more than expected 1.7% in April, while the core rate rose 1.2%, matching the highest level it has seen in the past two years. If this is truly a trend, then perhaps that long delayed normalization of monetary policy in the Eurozone may finally start to occur. Personally, I’m not holding my breath. Interestingly, the FX market has responded by selling the euro with the single currency down 0.2% this morning and 1.0% since Wednesday’s close. I guess that market doesn’t see the case for higher Eurozone rates yet.
In the meantime, the market continues to consider BOE Governor Carney’s comments in the wake of yesterday’s meeting, where he tried to convince one and all that the tendency for UK rates will be higher once Brexit is finalized (and assuming a smooth transition). And perhaps, if there truly is a global recovery trend and policy normalization becomes a reality elsewhere, that will be the case. But here, too, the market does not seem to believe him as evidenced by the pound’s ongoing weakness (-0.3% and back below 1.30) and the fact that interest rate futures continue to price in virtually no chance of rate hikes in the UK before 2021.
While we are discussing the pound, there is one other thing that continues to confuse me, the very fact that it is still trading either side of 1.30. If you believe the narrative, the UK cannot leave the EU without a deal, so there is no chance of a hard Brexit. After all, isn’t that what Parliament voted for? In addition, according to the OECD, the pound at 1.30 is undervalued by 12% or so. Combining these two themes, no chance of a hard Brexit and a massively undervalued pound, with the fact that the Fed has seemingly turned dovish would lead one to believe that the pound should be trading closer to 1.40 than 1.30. And yet, here we are. My take is that the market is not yet convinced that a hard Brexit is off the table or else the pound would be much higher. And frankly, in this case, I agree. It is still not clear to me that a hard Brexit is off the table which means that any true resolution to the situation should result in a sharp rally in the pound.
Pivoting to the rest of the FX market, the dollar is stronger pretty much across the board this morning, and this is after a solid performance yesterday. US data yesterday showed a significant jump in Nonfarm Productivity (+3.6%) along with a decline in Unit Labor Costs (-0.9%), thus implying that corporate activity was quite robust and the growth picture in the US enhanced. We also continue to see US earnings data that is generally beating (quite low) expectations and helping to underpin the equity market’s recent gains. Granted the past two days have seen modest declines, but overall, stocks remain much higher on the year. In the end, it continues to appear that despite all the angst over trade, and current US policies regarding energy, climate and everything else, the US remains a very attractive place to invest and dollars continue to be in demand.
Regarding this morning’s data, not only do we see the payroll report, but also the ISM Non-manufacturing number comes at 10:00.
| Nonfarm Payrolls | 185K |
| Private Payrolls | 180K |
| Manufacturing Payrolls | 10K |
| Unemployment Rate | 3.8% |
| Participation Rate | 62.9% |
| Average Hourly Earnings | 0.3% (3.3% Y/Y) |
| Average Weekly Hours | 34.5 |
| ISM Non-Manufacturing | 57.0 |
One cannot help but be impressed with the labor market in the US, where for the last 102 months, the average NFP number has been 200K. It certainly doesn’t appear that this trend is going to change today. In fact, after Wednesday’s blowout ADP number, the whisper is for something north of 200K. However, Wednesday’s ISM Manufacturing number was disappointingly weak, so there will be a great deal of scrutiny on today’s non-manufacturing view.
Adding to the mix, starting at 10:15 we will hear from a total of five Fed speakers (Evans, Clarida, Williams, Bowman, Bullard) before we go to bed. While Bullard’s speech is after the markets close, the other four will get to recount their personal views on the economy and future policy path with markets still open. However, given that we just heard from Chairman Powell at his press conference, and that the vote to leave rates was unanimous, it seems unlikely we will learn too much new information from these talks.
Summing up, heading into the payroll report the dollar is firm and shows no signs of retreating. My take is a good number will support the buck, while a weak one will get people thinking about that insurance rate cut again, and likely undermine its recent strength. My money is on a better number today, something like 230K, and a continuation of the last two days of dollar strength.
Good luck and good weekend
Adf
Rather Wrong
While Powell said growth may be strong
He still thinks it seems rather wrong
That prices won’t rise
So it’s no surprise
That rates will go lower ‘ere long
After the FOMC left policy largely unchanged yesterday (they did tweak the IOER down by 5bps) and the statement was parsed, it appeared that the Fed’s clear dovish bias continues to drive the overall tone of policy. Growth is solid but inflation remains confusingly soft and it appeared that the Fed was moving closer to the ‘insurance’ rate cut markets have been looking hoping for to prevent weakness from showing up. Stocks rallied and so did bonds with the yield on the 10yr falling to 2.45% just before the press conference while stock markets were higher by 0.5% or so. But then…
According to Powell the story
Is price declines are transitory
So patience remains
The thought in Fed brains
With traders stuck in purgatory
Powell indicated that the majority view at the Fed was that the reason we have seen such weak price data lately is because of transitory issues. These include reduced investment management fees in the wake of the sharp equity market declines in Q4 of last year and the change in the way the Fed gathered price data at retail stores where they now collect significantly greater amounts of data digitally, rather than having ‘shoppers’ go to stores and look at price tags. The upshot is that while he was hardly hawkish in any sense of the word, trying to maintain as neutral a stance as possible, he was far more hawkish than the market had anticipated. Not surprisingly, markets reversed their earlier moves with 10yr yields shooting higher by 6bps, closing higher than the previous day’s close, while equity markets ceded all their early gains and wound up falling about 0.7% on average between the three major indices.
What about the dollar? Well, it followed the same type of trajectory as other assets, softening on the dovish ideas throughout the session before rallying a sharp 0.55% in the wake of Powell’s press conference opening statement. Since then, it has largely maintained the rebound, although this morning it is softer by about 0.1% across the board.
Looking ahead, markets are going to continue to focus on the interplay between the data releases and the central bank comments. Nothing has changed with regard to the overarching dovish bias evident in almost all central banks, but in order for them to act, rather than merely talk, the data will have to be clearly deteriorating. And lately, the best description of the data releases has been mixed. For example, yesterday saw a huge ADP Employment number, 275K, boding well for tomorrow’s NFP report. However, ISM Manufacturing fell sharply to 52.8, well below last month’s 55.3 reading as well as far below the 55.0 market expectation. So, which one is more important? That’s the thing. As long as we see strength in some areas of the economy along with weakness in others, the Fed is almost certainly going to sit on the sidelines. That is, of course, unless the inflation data starts to move more aggressively in either direction. I think it is far better than even money that Fed funds are 2.25%-2.50% on December 31.
But what about other places? Well, the ECB seems stuck between a rock and a hard place as Q1 data has been disappointing overall and they are running out of tools to fight a slowdown. Given the current rate structure, the question being debated in the halls in Frankfurt is just how low can rates go before having a net detrimental impact on the economy. If we see any further weakness from the Eurozone, we are going to find out. That brings us to this morning’s PMI data, where Bloomberg tried hard to put a positive spin on what remains lousy data. Germany (44.4), Italy (49.1) and France (50.0) remain desultory at best. The Eurozone print (47.2) is hardly the stuff of dreams, although in fairness, it was better than analysts had been expecting. So perhaps we are seeing the beginnings of a stabilization in the decline, rather than a continuing acceleration of such. But that hardly gives a rationale for tighter policy. The ECB remains stuck on hold on the rate front and is certainly going to see significant uptake of their new TLTRO’s when they come out. It remains difficult to see a reason for the euro to rebound given the underlying economic weakness in the Eurozone, especially with the ECB committed to negative rates for at least another year.
What about the UK? Well, the BOE met this morning and left rates on hold by a unanimous vote. They also released new economic forecasts that showed reduced expectations for inflation this year, down to 1.6%, with the out years remaining essentially unchanged. They indicated that the delay in Brexit would have a limited impact as they continue to plan on a smooth transition, and their growth forecasts changed with 2019 rising to 1.5% on the back of the inventory led gains in Q1, although the out years remain unchanged. Here, too, there is no urgency to raise rates, although they keep trying to imply that slightly higher rates would be appropriate. However, the market is having none of it, pricing a 30% chance of a 25bp rate cut before the end of next year. The pound chopped on the news, rallying at first, but falling subsequently and is now sitting at 1.3050, essentially unchanged on the day.
Of course, Brexit continues to influence the pound’s movements and recent hints from both PM May and Labour Leader Corbyn indicate that it is possible they are going to agree a deal that includes permanent membership of a customs union with the EU. Certainly, verification of that will help the pound rally back. But boy, if I voted for Brexit and this is what they delivered, it would be quite upsetting. In essence, it destroys one of the main benefits of Brexit, the ability to manage their own trade function. We shall see how it plays out.
This morning brings more data, starting with Initial Claims (exp 215K), Nonfarm Productivity (2.2%) and Unit Labor Costs (1.5%) at 8:30, then Factory Orders (1.5%) at 10:00. The onslaught of Fed speakers doesn’t start until tomorrow, so that’s really it for the day. Equity futures are rallying this morning as the idea that the markets fell yesterday seems more like a mirage than a market response to new information. In the end, you cannot fight city hall, and though Powell tried to sound tough, I didn’t see anything to change the view that the Fed remains biased toward cutting rates as their next move.
Good luck
Adf
Biding Their Time
While markets in Europe are closed
For May Day, the Fed is disposed
To biding their time
Til prices do climb
Or else til slow growth is exposed
As Fed day dawns in NY, market activity has been muted around the world for two reasons. First, it happens to be May Day, an official holiday in 66 nations around the world, including most of Europe, honoring labor solidarity. While May Day was initially a pagan rite of spring (the origin of the Maypole) it was coopted in the mid 1800’s by the International Labor movement as a day to recognize its demands for better working conditions, including the beginning of the eight-hour workday norm. To this day, it remains a labor holiday, with large marches overnight throughout Korea, Indonesia, Taiwan and other Asian nations as well as in Europe, where the French, specifically, are concerned given the recent history of violent protests by the gilets jaunes.
But of more interest is the other reason market activity has been muted, the FOMC meeting ends this afternoon and the market will hear the latest words of wisdom from Chairman Powell at 2:30pm.
There are currently no expectations that Fed policy is going to change at this meeting, at least not by the Wall Street analyst community. Instead, all eyes are on the tone of the statement as well as Powell’s responses to the Q&A at his press conference.
Ever since the Fed’s pivot to patience in January, financial conditions in the US (and worldwide) have eased considerably. After all, government bond yields have tumbled (Treasuries -25bps, Bunds -25 bps, JGB’s -7bps) while equity markets have soared (S&P +21%, DAX +18%, Nikkei +16%). This combination has reduced corporate bond yields in both the investment and non-investment grade sectors, thus freeing up further cash flow and helping to prime the economy’s collective pump. At the same time, as evidenced by Monday’s data, PCE inflation, the number the Fed uses in their models, has fallen back well below their 2.0% symmetrical target, printing at 1.5% in March. The problem for the Fed is that their go to move of preemptive rate hikes when growth starts to pick up has been increasingly called into question. And not just by President Trump, who laughably suggested a 1.0% rate cut for today, but by economists of all stripes who are still at a loss as to why their cherished econometric models no longer represent economic reality.
‘Patience’ seems to be the Fed’s way of explaining that since they don’t have a clue as to what to expect from the economic data going forward, they have decided to sit on their hands. Arguably, that is a pretty good move, although I’m sure they are not keen to admit they are clueless right now. But in the end, it has become clear that throughout the central bank community, the idea of raising interest rates simply because growth numbers improved, if there is no concurrent rise in inflation has become discredited. As long as inflation remains quiescent, at least on a measured basis, the pressure to maintain or cut rates will be enormous. And while every central banker will explain they are apolitical, there is no question that they respond to political pressure like everyone else in government.
So the real question is at what point will central banks start easing further if inflation continues to stagnate? Ironically, I would argue that central banks have painted themselves into a different corner lately, continuously making the claim that 2.0% inflation, or thereabouts depending on the country, is necessary to insure a healthy economy. But if growth is solid and inflation is falling, are they going to cut rates further, to the extent possible given current levels, in order to revive inflation at the risk of blowing asset bubbles? And that doesn’t even consider the issue for Japan, Sweden, Switzerland and the Eurozone, where interest rates are already negative, and how those central banks will respond if either growth or inflation weakens more aggressively. The point is, despite all its warts, it continues to be clear that the US economy remains the most attractive place to invest capital. And with that, the dollar will continue to be supported.
Recapping the most recent data shows that yesterday’s Chicago PMI was quite disappointing at 52.6, well below expectations and the lowest print in more than two years. A harbinger of the future or an outlier? We will find out more this morning when the national ISM number is released (exp 55.0). The other data point of note in the US yesterday was Case-Shiller Home prices, which rose only 3.0%, reinforcing the idea that the housing market continues to cool. Meanwhile, Canadian GDP for February printed at -0.1%, with forecasts for Q1 now falling down to stagnation north of the border. So even though the housing market in the US is under modest pressure, the broad economy here continues to outperform just about everywhere else in the world.
This morning we also see ADP Employment (exp 180K) and then the Fed speaks. Overall, the dollar has been under modest pressure for the past several sessions, but all told, the movement has barely been a 1% decline. And while choppy, the trend remains in the dollar’s favor at this point. I have yet to see an argument that supports a much weaker dollar, at least on a cyclical basis, and as such, see no reason to change my views of further dollar strength ahead.
Good luck
Adf
Still Feeling Stressed
The overnight data expressed
That China is still feeling stressed
But Europe’s reports
Showed growth of some sorts
Might finally be manifest
The dollar is on its heels this morning after data from Europe showed surprising strength almost across the board. Arguably the most important data point was Eurozone GDP printing at 0.4% in Q1, a tick higher than expected and significantly higher than Q4’s 0.2%. The drivers of this data were Italy, where Q1 GDP rose 0.2%, taking the nation out of recession and beating expectations. At the same time Spain grew at 0.7%, also better than expectations while France maintained its recent pace with a 0.3% print. Interestingly, Germany doesn’t report this data until the middle of May. However, we did see German GfK Consumer Confidence print at 10.4, remaining unchanged on the month rather than falling as expected. Adding to the growth scenario were inflation readings that were generally a tick firmer than expected in Italy, Spain and France. While these numbers remain well below the ECB target of “close to but just below” 2.0%, it has served to ease some concerns about Europe’s future. In the end, the euro has rallied 0.25% while European government bond yields are all higher by 2-5bps. However, European equity markets did not get the memo and remain little changed on the day.
Prior to these releases we learned that China’s PMI data was softer than expected, with the National number printing lower at 50.1, while the Caixin number printed at 50.2. Even though both remain above the 50.0 level indicating future growth, there is an increasing concern that China’s Q1 GDP data was more the result of a distorted comparison to last year’s data due to changed timing of the Lunar New Year. Remember, that holiday has a large impact on the Chinese economy with manufacturing shutdowns amid widescale holiday making, and so the timing of those events each year are not easily stabilized with seasonal adjustments to the data. As such, it is starting to look like Q1’s 6.4% GDP growth may have been somewhat overstated. Of course, China remains opaque in many ways, so we may need to wait until next month’s PMI data to get a better handle on things. One other clue, though, has been the ongoing decline in the price of copper, a key industrial metal and one which China represents approximately 50% of global demand. Arguably, a falling copper price implies less demand from China, which implies slowing growth there. Ultimately, while it is no surprise that the renminbi is little changed on the day, Chinese equities edged higher on the theory that the PBOC is more likely to add stimulus if the economic slowdown persists.
Of course, the other China story is that the trade talks are resuming in Beijing today and market participants will be watching closely for word that things are continuing to move in the right direction. You may recall the President Xi Jinping gave a speech last week where he highlighted the changes he anticipated in Chinese policy, all of which included accession to US demands in the trade talks. At this point, it seems the negotiators need to “simply” hash out the details, which of course is not simple at all. But if the direction from the top is broadly set, a deal seems quite likely. However, as I have pointed out in the past, the market appears to have already priced in the successful conclusion of a deal, and so when (if) one is announced, I would expect equity markets to fall on a ‘sell the news’ response.
Turning to the US, yesterday’s data showed that PCE inflation (1.5%, core 1.6%) continues to lag expectations as well as remain below the Fed’s 2.0% target. With the FOMC meeting starting this morning, although we won’t hear the outcome until tomorrow afternoon, the punditry is trying to determine what they will say. The universal expectation is for no policy changes to be enacted, and little change in the policy statement. However, to me, there has been a further shift in the tone of the most recent Fed speakers. While I believe that Loretta Mester and Esther George remain monetary hawks, I think the rest of the board has morphed into a more dovish contingent, one that will respond quite quickly to falling inflation numbers. With that in mind, yesterday’s readings have to be concerning, and if we see another set of soft inflation data next month, it is entirely possible that the doves carry the day at the June meeting and force an end to the balance sheet roll-off immediately as a signal that they will not let inflation fall further. I think the mistake we are all making is that we keep looking for policy normalization. The new normal is low rates and growing balance sheets and we are already there.
As Powell and friends get together
The question is when, it’s not whether
More policy easing
Will seem less displeasing
So prices can rise like a feather
Looking at this morning’s releases, the Employment Cost Index (exp 0.7%) starts us off with Case-Shiller home prices (3.2%) and then Chicago PMI (59.0) following later in the morning. However, with the Fed meeting ongoing, it seems unlikely that any of these numbers will move the needle. In fact, tomorrow’s ADP number would need to be extraordinary (either high or low) to move things ahead of the FOMC announcement. All this points to continued low volatility in markets as players of all stripes try to figure out what the next big thing will be. My sense is we are going to see central banks continue to lean toward easier policy, as the global focus on inflation, or the lack thereof, will continue to drive policy, as well as asset bubbles.
Good luck
Adf
fxpoetry 