More Concern

Most data of late have been weak
Thus central banks are set to tweak
Their policy rates
As they have mandates
Designed to keep growth at a peak

Now later this morning we’ll learn
If payrolls are starting to turn
Last month’s poor display
And weakness today
Would certainly cause more concern

It’s payroll day in the US and markets have been extremely quiet overnight. In fact, given yesterday’s July 4th holiday here in the US, they have been quiet for two days. However, don’t let the lack of market activity distract you from the fact that there are still a lot of things ongoing in the global economy.

For example, a key question on analysts’ minds has been whether or not a recession is in the offing. Data continues to generally disappoint, with this morning’s sharply lower German Factory Orders (-2.2%) and UK Labor Productivity (-0.5%) as the latest in a long line of crummy results. And given last month’s disappointment on the US payroll front (recall the outcome was 75K vs. the 185K expected) today’s numbers are being closely watched. Here are the current median expectations based on economist surveys:

Nonfarm Payrolls 160K
Private Payrolls 153K
Manufacturing Payrolls 0K
Unemployment Rate 3.6%
Average Hourly Earnings 0.3% (3.2% Y/Y)
Average Weekly Hours 34.4

A couple of things to note are the fact that the NFP number, even if it comes in at the median expectation, still represents a declining rate of job growth compared to what the US experienced in 2018. This is likely based on two factors; first that this historically long expansion is starting to slow down, and second, that there are less available workers to fill jobs as population growth remains restrained. The other thing to remember is that the Unemployment Report has always been a lagging indicator, looking backwards at how things were, rather than giving direction about the future. The point is that worsening of this data implies that things are already slowing. As I wrote Wednesday, don’t be surprised if when the inevitable recession finally gets determined, that it started in June 2019. I failed to mention the ADP report on Wednesday as a data release, but it, too, disappointed, printing at 102K, some 40K below expectations.

With that as our cheerful backdrop, let’s consider what to expect ahead of the release:

Weaker than expected results – If the NFP number prints at 90K or less, look for equity markets to rejoice as they perceive the Fed will become even more aggressive in their attempts to head off a recession, and the idea of a 50bp rate cut at the end of the month takes hold. Bond markets, too, will soar on the same expectations, while the dollar is likely to give up its overnight gains (granted they were only about 0.2%) as a more aggressive Fed will be seen as a signal to sell the buck. The key conundrum in this scenario remains equities, which continue to rally into weaker economic conditions. At some point, if the economy continues to weaken, the negative impact on earnings is going to outweigh the kneejerk reaction of buying when the Fed cuts, but as John Maynard Keynes reminded us all, ‘markets can stay irrational far longer than you can stay solvent.’

Results on or near expectations – If we see a print in the 120K-180K range, I would expect traders to be mildly disappointed as the call for a more aggressive Fed policy would diminish. Thus equities might suffer slightly, especially given they are sitting at record highs, while bonds are likely to see yields head back toward 2.0%. The dollar, meanwhile, is likely to maintain its overnight gains, and could well see a modest uptick as the idea of more aggressive Fed easing starts to ebb, at least for now.

Stronger than expected results – Any print above 180K will almost certainly, perversely, see a stock market selloff. It is abundantly clear that equity buyers are simply counting on Fed largesse to keep the party going. The market has nothing to do with the fundamentals of the economy or individual company situations. With this in mind, strong data means that the Fed will have no call to cut rates. The result is that the futures market will likely reprice the odds of a rate cut in July lower, perhaps to a 50% probability, while equity traders will take the news as a profit-taking opportunity given the lack of reason for a follow through higher in stocks. Bonds will get tossed overboard as well, as concerns about slowing growth will quickly abate, and a sharp move higher in 10-year yields is entirely realistic. As a point of information, the last time the payroll report was released on July 5th, in 2013, 10-year yields rallied 25bps on a surprising payroll outcome. And remember, technical indicators show that the bond market is massively overbought, so there is ample opportunity for a sharp move. And finally, because of the holiday yesterday, trading desks will have skeleton staffs, further reducing liquidity. Oh yeah, and the dollar will probably see significant gains as well.

The point is that there are two possible outcomes that could see some real fireworks (pun intended) today, so stay on your toes. While one number is just that, a single data point, given the recent trend in place, today’s data seem to have a lot of importance. If pressed, my sense is that the trend of weaker data that has been evident worldwide is going to manifest itself with something like a 50K print, and an uptick in the Unemployment Rate to 3.7% or 3.8%.

We will know shortly.

Good luck and good weekend
Adf

Laden With Fears

When lending, a term of ten years
At one time was laden with fears
But not anymore
As bond prices soar
And bond bulls regale us with cheers

Another day, another record low for German bund yields, this time -0.396%, and there is no indication that this trend is going to stop anytime soon. While this morning’s PMI Composite data was released as expected (Germany 52.6, France 52.7, Eurozone 52.2), it continues at levels that show subdued growth. And given the ongoing weakness in the manufacturing sector, the major fear of both economists and investors is that we are heading into a global recession. Alas, I fear they are right about that, and when the dust settles, and the NBER looks back to determine when the recession began, don’t be surprised if June 2019 is the start date. At any rate, it’s not just bund yields that are falling, it is a universal reaction. Treasuries are now firmly below 2.00% (last at 1.95%), but also UK Gilts (0.69%), French OATs (-0.06%) and JGB’s (-0.15%). Even Italy, where the ongoing fight over their budget situation is getting nastier, has seen its yields fall 13bps today down to 1.71%. In other words, bond markets continue to forecast slowing growth and low inflation for some time to come. And of course, that implies further policy ease by the world’s central bankers.

Speaking of which:

In what was a mini bombshell
Said Mester, it’s too soon to tell
If rates should be lowered
Since, as I look forward
My models say things are just swell

Yesterday, Cleveland Fed president Loretta Mester, perhaps the most hawkish member of the Fed, commented that, “I believe it is too soon to make that determination, and I prefer to gather more information before considering a change in our monetary-policy stance.” In addition, she questioned whether lowering rates would even help address the current situation of too-low inflation. Needless to say, the equity markets did not appreciate her comments, and sold off when they hit the tape. But it was a minor reaction, and, in the end, the prevailing wisdom remains that the Fed is going to cut rates at the end of this month, and at least two more times this year. In truth, we will learn a great deal on Friday, when the payroll report is released, because another miss like last month, where the NFP number was just 75K, is likely to bring calls for an immediate cut, and also likely to see a knee-jerk reaction higher in stocks on the premise that lower rates are always good.

The IMF leader Lagarde
(Whom Greeks would like feathered and tarred)
Come later this year
The euro will steer
As ECB prez (and blowhard)

The other big news this morning concerns the changing of the guard at the ECB and the other EU institutions that have scheduled leadership changes. In a bit of a surprise, IMF Managing Director, Christine Lagarde, is to become the new ECB president, following Mario Draghi. Lagarde is a lawyer, not a central banker, and has no technocratic or central banking experience at all. Granted, she is head of a major supranational organization, and was French FinMin at the beginning of the decade. But all that reinforces is that she is a political hack animal, not that she is qualified to run the second most important policymaking institution in the world. Remember, the IMF, though impressive sounding, makes no policies, it simply hectors others to do what the IMF feels is correct. If you recall, when Chairman Powell was nominated, his lack of economics PhD was seen as a big issue. For some reason, that is not the case with Lagarde. I cannot tell if it’s because Powell has proven to be fine in the role, or if it would be seen as politically incorrect to complain about something like that since she ticks several other boxes deemed important. At any rate, now that politicians are running the two largest central banks (or at least will be as of November 1), perhaps we can dispel the fiction that central banks are independent of politics!

Away from the bond market, which we have seen rally, the market impact of this news has arguably been mixed. Equity markets in Asia were generally weak (Nikkei -0.5%, Shanghai -1.0%), but in Europe, investors are feeling fine, buying equities (DAX +0.6%, FTSE + 0.8%) alongside bonds. Arguably, the European view is that Madame Lagarde is going to follow in the footsteps of Signor Draghi and continue to ease policy aggressively going forward. And despite Mester’s comments, US equity futures are pointing higher as well, with both the DJIA and S&P looking at +0.3% gains right now.

Gold prices, too, are anticipating lower interest rates as after a short-term dip last Friday, with the shiny metal trading as low as $1384, it has rebounded sharply and after touching $1440, the highest print in six years, it is currently around $1420. I have to admit that the combination of fundamentals (lower global interest rates) and market technicals (a breakout above $1400 after three previous failed attempts) it does appear as though gold is heading much higher. Don’t be surprised to see it trade as high as $1700 before this rally is through.

Finally, the dollar continues to be the least interesting of markets with a mixed performance today, and an overall unchanged outcome. The pound continues to suffer as the Brexit situation meanders along and the uncertainty engendered hits economic activity. In fact, this morning’s PMI data was awful (50.2) and IHS/Markit is now calling for negative GDP growth in Q2 for the UK. Aussie data, however, was modestly better than expected helping both AUD and NZD higher, despite soft PMI data from China. EMG currencies are all over the map, with both gainers and losers, but the defining characteristic is that none of the movement has been more than 0.3%, confirming just how quiet things are.

As to the data story, this morning brings Initial Claims (exp 223K), the Trade Balance (-$54.0B), ISM Non-Manufacturing (55.9) and Factory Orders (-0.5%). While the ISM data may have importance, given the holiday tomorrow and the fact that payrolls are due Friday morning, it is hard to get too excited about significant FX movement today. However, that will not preclude the equity markets from continuing their rally on the basis of more central bank largesse.

Good luck
Adf

 

Retreated

Rate cuts “may be warranted soon”
Said James yesterday afternoon
The bond market soared
Though stocks ‘cross the board
Retreated the third day of June

Will someone please explain to me how the Fed expects to be preemptive on economic movements by looking in the rearview mirror? Given that data is almost always backwards looking, (only the ISM surveys really try to look ahead) it seems it would be a far better process to simply explain the reaction function will follow the economy. It is abundantly clear that they have completely lost the ability to lead the economy. So now, following a spate of softer data leading to comments from St Louis Fed President James Bullard about cutting rates soon, Treasury yields have plumbed new depths for the move, touching as low as 2.07% on Monday, and although they have rebounded slightly this morning, there is no indication this movement is going to stop. Weaker ISM data, slower housing growth and ongoing trade uncertainty have certainly stacked the deck against the Fed standing pat. Chairman Powell speaks this morning and markets will be anxiously awaiting his wisdom on the subject. (Spoiler alert, his only choice will be to sound dovish as any hawkish tone will immediately reflect in an equity sell-off.)

Similarly, we continue to see German bund yields pressing to new lows, -0.21% this morning, and the pressure on the ECB to respond is growing stronger. Just this weekend there was a story in Bloomberg describing Eurozone inflation as starting to trend higher. Alas, this morning’s data printed weaker than expected with headline CPI at 1.2% and core at 0.8%. While the euro has barely reacted, interest rate markets are starting to price in even more easing by the ECB and analyst’s comments are moving towards the need for Signor Draghi to do something to show that the ECB is in control. The problem for Draghi is he only has a few more months in the seat and all eyes are looking toward his potential replacement. While there is no strong consensus pick, the view is developing that whoever takes the role will be more hawkish than Draghi, by default. At least initially. However, if Eurozone growth continues to falter and inflation remains around 1.0%, instead of nearer its target of “close to but below 2.0%”, that hawkishness is likely to fade. And one last thing, Eurozone inflation expectations, as measured by five year forward five-year swaps have fallen to near record lows of 1.28%. In other words, nobody thinks inflation is making a comeback soon.

Adding to the interest rate gloom was Australia, last night, cutting its base rate to 1.25%, as widely expected. RBA Governor Lowe made it clear that given the slowing picture in China and the overall slowdown in global growth, the door is open for further rate cuts there. Markets are pricing in at least two more by the end of the year.

How about Switzerland? The nation with the world’s lowest interest rates, the cash rate is -0.75%, is being forecast to cut them further. Given the haven status of the Swiss franc and its recent appreciation vs. the euro, analysts are now looking for another rate cut there. So is the futures market, with a 50% probability of a 25bp cut priced in for March 2020., and SNB President Thomas Jordan has done nothing to dissuade these ideas. If anything, I would expect a cut before the end of the year.

My point is that despite the recent turn in US markets regarding interest rates, where virtually every analyst has come around to the idea that the next move in rates will be lower, and clearly there are Fed members in that camp, none of this happens in isolation. As the above discussion highlights, more dovish policy is quickly becoming the baseline forecast for virtually every country that matters.

So, what does that do for the dollar? Yesterday’s price action showed the dollar’s worst performance since mid-March, when Chairman Powell surprised the market with an uber-dovish policy statement and press conference. Bullard’s comments were enough to turn views toward a rate cut happening much sooner than previously anticipated. And so, if the Fed has truly turned around their thought process, then it will be no surprise for the dollar to have a weak period. Of course, this will only last until we hear Draghi talk about the room for further easing and the need to maintain price stability near the ECB’s target. Once it is clear that the ECB is also going to ease further, the dollar will likely find a bottom. Remember, the ECB meets tomorrow and Thursday, with Draghi’s press conference at 8:30 Thursday morning. Given the recent data, and the overall trade situation, it is not impossible that the ECB turns far more dovish this week. However, my sense is they will focus on the terms of the new TLTRO’s and not on restarting QE. So, the dollar probably has a few weeks of underperformance ahead of it, but it is only a matter of time before the ECB (and correspondingly the BOJ, BOE and BOC) jump on the dovish bandwagon.

As an aside, I keep reading that the only way for the Fed to create a dovish surprise later this month is to cut immediately (the market is pricing in a 25bp cut at the July meeting) but I disagree. All they have to do is cut by more than 25bps when they cut. There is no rule that says 25bps is the proper amount to move rates. If the consensus view is turning to a sharper slowdown, it would be better to get ahead of the problem than to be seen as offering policy prescriptions that are ‘too little, too late.’ It appears to me that President Trump will get his way regarding the Fed, with easier money to come sooner rather than later. Alas, I fear that the stock market may not respond in the manner desired. At this point, cutting rates speaks to panic at the Fed that things are much worse than they have been describing. If that is the perception, equity markets have only one way to go…down.

On the data front, yesterday saw the weakest ISM print since October 2016, which is completely in line with what we are seeing around the world, slowing manufacturing growth. This morning, the only hard data is Factory Orders (exp -0.9%) but both Powell and NY Fed President Williams speak. The default expectation for them both is turning more dovish, and if they live up to that billing, the dollar is likely to continue its recent decline. But, if somehow they sound hawkish, look for the dollar to reverse higher quickly. Remember, FX is still a relative game and its recent weakness is predicated on a more dovish Fed. Changing that changes the market’s perception.

Good luck
Adf

 

Will Powell React?

The Treasury curve is implying
That growth as we knew it is dying
Will Powell react?
Or just be attacked
For stasis while claiming he’s trying?

Scanning markets this morning shows everything is a mess. Scanning headlines this morning shows that fear clearly outpolls greed as the driving force behind trading activity. The question at hand is, ‘Have things gone too far or is this just the beginning?’

Treasury and Bund yields are the best place to start when discussing the relative merits of fear and greed, and this morning, fear is in command. Yields on 10-year Treasuries have fallen to 2.23% and 10-year Bunds are down to -0.17%, both probing levels not seen in nearly two years. The proximate causes are numerous. First there is the continued concern over the trade war between the US and China with no sign that talks are ongoing and the market now focusing on a mooted meeting between President’s Trump and Xi at the G20 in June. While there is no chance the two of them will agree a deal, as we saw in December, it is entirely possible they can get the talks restarted, something that would help mitigate the current market stress.

However, this is not only about trade. Economic data around the world continues to drift broadly lower with the latest surprise being this morning’s German Unemployment rate rising to 5.0% as 60,000 more Germans than expected found themselves out of work. We have also been ‘treated’ to the news that layoffs by US companies (Ford and GE among others) are starting to increase. The auto sector looks like it is getting hit particularly hard as inventories build on dealer lots despite what appears to be robust consumer confidence. This dichotomy is also evident in the US housing market where despite strong employment, rising wages and declining mortgage rates, home prices are stagnant to falling, depending on the sector, and home sales have been declining for the past fourteen months in a row.

The point is that the economic fundamentals are no longer the reliable support for markets they had been in the recent past. Remember, the US is looking at its longest economic expansion in history, but its vigor is clearly waning.

Then there are the political ructions ongoing. Brexit is a well-worn story, yet one that has no end in sight. The pound remains under pressure (-0.1%, -3.0% in May) and UK stocks are falling sharply (-1.3%, -3.3% in May). As the Tory leadership contest takes shape, Boris Johnson remains the frontrunner, but Parliament will not easily cede any power to allow a no-deal Brexit if that is what Johnson wants. And to add to the mess, Scotland is aiming to hold a second independence referendum as they are very keen to remain within the EU. (Just think, the opportunity for another border issue could be coming our way soon!)

Then there is the aftermath of the EU elections where all the parties that currently are in power in EU nations did poorly, yet the current national leadership is tasked with finding new EU-wide leaders, including an ECB President as well as European Commission and European Council presidents. So, there is a great deal of horse-trading ongoing, with competence for the role seen as a distant fifth requirement compared to nationality, regional location (north vs. south), home country size (large vs. small) and gender. Meanwhile, Italy has been put on notice that its current financial plans for fiscal stimulus are outside the Eurozone stability framework but are not taking the news sitting down. It actually makes no sense that an economy crawling out of recession like Italy should be asked to tighten fiscal policy by raising taxes and cutting spending, rather than encouraged to reinvigorate growth. But hey, the Teutonic view of the world is austerity is always and everywhere the best policy! One cannot be surprised that Italian stocks are falling (-1.3%, -8.0% this month).

At any rate, the euro also remains under pressure, falling yesterday by 0.3%, a further 0.1% this morning and a little more than 1% this month. One point made by many is that whoever follows Signor Draghi in the ECB President’s chair is likely to be more hawkish, by default, than Draghi himself. With that in mind, later this year, when a new ECB leader is named, if not yet installed, the euro has the chance to rally. This is especially so if the Fed has begun to cut rates by then, something the futures market already has in its price.

Other mayhem can be seen in South Africa, where the rand has broken below its six-month trading range, having fallen nearly 3% this week as President Ramaphosa has yet to name a new cabinet, sowing concern in the market as to whether he will be able to pull the country out of its deep economic malaise (GDP -2.0% in Q1). And a last piece of news comes from Venezuela, where the central bank surprised one and all by publishing economic statistics showing that GDP shrank 19.2% in the first nine months of 2018 while inflation ran at 130,060% last year. That is not a misprint, that is the very definition of hyperinflation.

Turning to today’s session, there is no US data of note nor are any Fed members scheduled to speak. Given the overnight price action, with risk clearly being cast aside, it certainly appears that markets will open that way. Equity futures are pointing to losses of 0.6% in the US, and right now it appears things are going to remain in risk-off mode. Barring a surprise positive story (or Presidential tweet), it feels like investors are going to continue to pare back risk positions for now. As such, the dollar is likely to maintain its current bid, although I don’t see much cause for it to extend its gains at this time.

Finally, to answer the question I posed at the beginning, there is room for equity markets to continue to fall while haven bonds rally so things have not yet gone too far.

Good luck
Adf

 

“Talks” Become “War”

At what point do “talks” become “war”?
And how long can traders ignore
The signs that a truce
Are, at best, abstruse?
It seems bulls don’t care any more

So, markets continue to shine
But something’s a bit out of line
If problems have past
Then why the forecast
By bonds of a further decline

I can’t help being struck this morning by the simultaneous rebound in equity markets alongside the strong rally in bond markets. They seem to be telling us conflicting stories or are perhaps simply focusing on different things.

After Monday’s equity market rout set nerves on edge, and not just among the investor set, but also in the White House, it was no surprise to hear a bit more conciliatory language from the President regarding the prospects of completing the trade negotiations successfully. That seemed to be enough to cool the bears’ collective ardor and brought bargain hunters dip buyers back into the market. (Are there any bargains left at these valuations?) This sequence of events led to a solid equity performance in Asia despite the fact that Chinese data released last night was, in a word, awful. Retail Sales there fell to 7.2%, the lowest in 16 years and well below forecasts of 8.6% growth. IP fell to 5.4%, significantly below the 6.5% forecast, let alone last month’s 8.5% outturn. And Fixed Asset Investment fell to 6.1%, another solid miss, with the result being that April’s economic performance in the Middle Kingdom was generally lousy. We have already seen a number of reductions in GDP forecasts for Q2 with new expectations centering on 6.2%.

But the market reaction was not as might have been expected as the Shanghai composite rose a solid 1.9%. It seems that China is moving into the ‘bad news is good’ scenario, where weak data drives expectations of further monetary stimulus thus supporting stock prices. The other interesting story has been the change in tone in the official Chinese media for domestic Chinese consumption, where they have become more stridently nationalist and are actively discussing a trade “war”, rather than trade “talks”. It seems the Chinese are girding for a more prolonged fight on the trade front and are marshaling all the resources they can. Of course, at the end of the day, they remain vulnerable to significant pain if the second set of tariffs proposed by the US is enacted.

One consequence of this process has been a weakening Chinese yuan, which has fallen 2.7% since its close on Friday May 3rd, and is now at its weakest point since mid-December. At 6.9150 it is also less than 2% from the 7.00 level that has been repeatedly touted by analysts as a no-go zone for the PBOC. This is due to concerns that the Chinese people would be far more active in their efforts to protect their capital by moving it offshore. This is also the reason there are such tight capital flow restrictions in China. It doesn’t help the trade talks that the yuan has been falling as that has been a favorite talking point of President Trump, China’s manipulation of their currency.

This process has also renewed pundit talk of the Chinese selling all their Treasury holdings, some $1.1 trillion, as retaliation to US tariffs. The last idea makes no sense whatsoever, as I have mentioned in the past, if only because the question of what they will do with $1.1 trillion in cash has yet to be answered. They will still need to own something and replacing Treasuries with other USD assets doesn’t achieve anything. Selling dollars to buy other currencies will simply weaken the dollar, which is the opposite of the idea they are trying to manipulate their currency to their advantage, so also makes no sense. And finally, given the huge bid for Treasuries, with yields on the 10-year below 2.40%, it seems there is plenty of demand elsewhere.

Speaking of the Treasury bid, it seems bond investors are looking ahead for weaker overall growth, hence the declining yields. But how does that square with equity investors bidding stocks back up on expectations that a trade solution will help boost the economy. This is a conundrum that will only be resolved when there is more clarity on the trade outcome.

(Here’s a conspiracy theory for you: what if President Trump is purposely sabotaging the talks for now, seeking a sharp enough equity market decline to force the Fed to ease policy further. At that point, he can turn around and agree a deal which would result in a monster rally, something for which we can be sure he would take credit. I’m not saying it’s true, just not out of the question!)

At any rate, nothing in the past several sessions has changed the view that the trade situation is going to continue to be one of the key drivers for market activity across all markets for the foreseeable future.

After that prolonged diatribe, let’s look at the other overnight data and developments. German GDP rose 0.4%, as expected, in Q1. This was a significant uptick from the second half of last year but appears to be the beneficiary of some one-off issues, with slower growth still forecast for the rest of the year. Given expectations were built in, the fact that the euro has softened a bit further, down 0.1% and back below 1.12, ought not be too surprising. Meanwhile, the pound is little changed on the day, but has drifted down to 1.2900 quietly over the past two sessions. Despite solid employment data yesterday, it seems that traders remain unconvinced that a viable solution will be found for Brexit. This morning the word is that PM May is going to bring her thrice-defeated Brexit deal to Parliament yet again in June. One can only imagine how well that will go.

Elsewhere in the G10 we have the what looks like a risk-off session. The dollar is modestly stronger against pretty much all of that bloc except for the yen (+0.2%) and the Swiss franc (+0.1%), the classic haven assets. So, bonds (Bund yields are -0.10%, their lowest since 2016) and currencies are shunning risk, while equity traders continue to lap it up. As I said, there is a conundrum.

This morning we finally get some US data led by Retail Sales (exp 0.2%, 0.7% ex autos) as well as Empire Manufacturing (8.5), IP (0.0%) and Capacity Utilization (78.7%) all at 8:30. Business Inventories (0.0%) are released at 10:00 and we also hear from two more Fed speakers, Governor Quarles and Richmond Fed President Barkin. However, it seems unlikely that, given the consistency of message we have heard from every Fed speaker since their last meeting, with Williams and George yesterday reinforcing the idea that there is no urgency for the Fed to change policy in the near term and politics is irrelevant to the decision process, that we will hear anything new from these two.

In the end, it feels like yesterday’s equity rebound was more dead-cat than a start of something new. Risks still abound and slowing economic growth remains the number one issue. As long as US data continues to outperform, the case for dollar weakness remains missing. For now, the path of least resistance is for a mildly firmer buck.

Good luck
Adf

A Year So Dreary

(With apologies to Edgar Allen Poe)

‘Eighteen was a year so dreary, traders studied hara-kiri
As they pondered every theory, algorithm and z-score.
Interest rates were slowly rising, growth no longer synchronizing,
Brexit’s failures mesmerizing, plus we got a real trade war
Italy, meanwhile explained that budget limits were a bore
Europe looked aghast and swore.

Thus instead of markets booming, (which most pundits were assuming)
What we got was all consuming angst too great to just ignore
Equities reduced to rubble, high-yield bonds saw their spreads double
As the Fed inspired bubble sprung a leak through the back door
Balance sheet adjustment proved to be more harsh than heretofore
Stock investors cussed and swore.

But the New Year’s now commencing, with the markets’, trouble, sensing
Thus predictions I’m dispensing might not be what you wished for
Life’s not likely to get better, ‘specially for the leveraged debtor
Who ought write an open letter to Chair Powell and implore
Him to stop his raising rates so assets grow just like before
Would that he would raise no more.

Pundits far and wide all wonder if Chair Powell’s made a blunder
Or if he will knuckle under to entreaties from offshore
Sadly for mainstream investors, lest our growth decays and festers
Powell will ignore protestors though they’ll raise a great uproar
Thus far he has made it clear that neutral’s what he’s shooting for
Jay, I fear, sees two hikes more.

At the same time Signor Draghi, who’s EU is weak and groggy
Using words in no way foggy, told us QE’s dead, he swore!
Plus he strongly recommended that when summer, this year, ended
Raising rates would be just splendid for those nations at the core
Even though the PIGS keep struggling, this he’s willing to ignore
Higher rates might be in store.

Lately, though, are growing rumors, that six billion world consumers
Are no longer in good humors, thus are buying less, not more
This result should be concerning for those bankers who are yearning
Rates to tighten, overturning years when rates were on the floor
Could it be what we will see is QE4 as an encore?
Maybe low rates are called for.

What about the budget shortfall, in the States that’s sure to snowball
If our growth rate has a pratfall like it’s done ten times before?
While this would be problematic, growth elsewhere would crash to static
Thus it would be quite pragmatic to assume the buck will soar
Don’t believe those euro bulls that think rate hikes there are in store
Christmas next we’re One-Oh-Four.

Now to Britain where the story of its Brexit’s been so gory
Leaving Labour and the Tories in an all out civic war
Though the deal that’s on the table, has its flaws, it would help cable
But when PM May’s unable to find votes here’s what’s in store
Look for cable to go tumbling well below its lows of yore
Next December, One-One-Four.

Time to focus on the East, where China’s growth just might have ceased
Or slowed quite sharply at the least, from damage due to Trump’s trade war
Xi, however’s not fainthearted, and more ease he has imparted
Trying to get growth restarted, which is really quite a chore
But with leverage so extended, how much more can they pay for?
Not as much as days of yore.

With growth there now clearly slowing, public cash is freely flowing,
Banks are told, be easygoing, toward the Chinese firms onshore
But the outcome’s not conclusive, and the only thing conducive
To success for Xi is use of weakness in the yuan offshore
I expect a steady drift much lower to Seven point Four
Only this and nothing more.

Now it’s time for analyzing, ten-year yields, so tantalizing
With inflation hawks advising that those yields will jump once more
But inflation doves are banking that commodities keep tanking
Helping bonds and Bunds when ranking outcomes, if you’re keeping score
Here the doves have better guidance and the price of bonds will soar
At what yields will they sell for?

Slowing growth and growing fear will help them both throughout the year
And so it’s not too cavalier to look for lower yields in store
Treasuries will keep on rising, and for now what I’m surmising
Is a yield of Two point Five is likely come Aught Twenty’s door
Bunds will see their yields retreat to Zero, that’s right, to the floor
Lower ten-year yields, look for.

In a world where growth is slowing, earnings data won’t be glowing
Red ink will, for sure, be flowing which investors can’t ignore
P/E ratios will suffer, and most firms will lack a buffer
Which means things will just get tougher for investors than before
What of central banks? Won’t they be able, prices, to restore?
Not this time, not like before.

In the States what I foresee is that the large cap S&P
Can fall to Seventeen Fifty by year end next, if not before
Europe’s like to see the same, the Stoxx 600 getting maimed
Two Fifty is where I proclaim that index will next year explore
Large percentage falls in both are what investors all abhor
But its what I see in store.

Oil’s price of late’s been tumbling, which for drillers has been humbling
OPEC meanwhile keeps on fumbling, each chance to, its strength, restore
But with global growth now slowing, storage tanks are overflowing
Meanwhile tankers, oceangoing, keep on pumping ship to shore
And more drilling in the States means lower prices are in store
Forty bucks I now call for.

One more thing I ought consider, Bitcoin, which had folks on Twitter
Posting many Tweets quite bitter as it tumbled ever more
Does this coin have true potential? Will it become influential?
In debates quite consequential ‘bout where assets you may store?
While the blockchain is important, Hodlers better learn the score
Bitcoin… folks won’t pay much for

So instead come winter next, Bitcoin Hodlers will be vexed
As it suffers from effects of slowing growth they can’t ignore
While it might be worth Two Grand, the end result is that demand
For Bitcoin will not soon expand, instead its like to shrink some more
Don’t be fooled in thinking you’ll soon use it at the grocery store
Bitcoin… folks won’t pay much for

Fin’lly here’s an admonition, if these views do reach fruition
Every single politician will blame someone else for sure
I’m not hoping for this outcome, I just fear the depths we might plumb
Will result in falling income and recession we’ll explore
So if risk you’re managing, more hedging now is what’s called for
Fear and risk are what will soar!

For you folks who’ve reached the end, please know I seek not to offend
But rather try to comprehend the state of markets and some more
If you read my thoughts last year, I tried to make it very clear
That economic trouble’s near, and so that caution is called for
Mostly though I hope the time invested has not made you sore
For you, my readers, I adore!

Have a very happy, healthy and prosperous New Year
Adf

 

Conditions Have Tightened

The Treasury market is frightened
As risk of inflation has heightened
So 10-year yields jumped
The dollar got pumped
And credit conditions have tightened

The dollar rallied yesterday on the back of a sharp rise in US Treasury yields. The 10-year rose 13bps, jumping to its highest level since 2014. The 30-year rose even more, 15bps, and both have seen those yield rallies continue this morning. The catalyst was much stronger than expected US data, both ADP and ISM Non-Manufacturing were quite strong, and further comments by Chairman Powell that indicated the Fed would remain data dependent and while they didn’t expect inflation to rise sharply, effectively they are prepared to act if it does.

Adding to the inflation story was the Amazon news about raising the minimum wage at the company to $15/hour, and don’t forget the trade war with China, where tariffs will clearly add upward pressure on prices. All this makes tomorrow’s payroll report that much more important, as all eyes will be on the Average Hourly Earnings number. We have a fairly recent analogy of this type of market condition, the first two weeks of February this year, when the January AHE number jumped unexpectedly, and within a week, equities had fallen 10% while the dollar rallied sharply as risk was jettisoned with abandon. While I am not forecasting a repeat of those events, it is best to be aware of the possibility.

And quite frankly, that has been THE story of the market. It cannot be that surprising that the dollar has been the big beneficiary, as this has turned into a classic risk-off scenario. EMG currencies are under increasing pressure, and even the G10 is suffering, save the yen, which has rallied slightly vs. the dollar. At this point, there is no obvious reason for this trend to stop until tomorrow’s data release. If AHE data is firm (current expectations are for a 0.3% rise on the month translating into a 2.8% Y/Y rise), look for this bond rout to continue, with the concurrent impact of a stronger dollar and weaker equities. But since that is not until tomorrow, my sense is that today is going to be a session of modest further movement as positions get squared ahead of the big news.

Good luck
Adf