“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