Tempting the Fates

Around the world most central banks
Have, monthly, been forced to give thanks
That tempting the fates
With negative rates
Has not destroyed euros or francs

And later today we will hear
From Draghi, the man who made clear
“Whatever it takes”
Would fix the mistakes
Investors had grown, most, to fear

With Brexit on the back burner for the day, as the UK awaits the EU’s decision on how long of a delay to grant, the market has turned its attention to the world’s central banks. Generally speaking, monetary ease remains the primary focus, although there are a few banks that are bucking the trend.

Starting with the largest for today, and world’s second most important central bank, the ECB meets today in what is Mario Draghi’s final policy meeting at the helm. Given their actions last month, where they cut the deposit rate a further 10bps to -0.50% and restarted QE to the tune of €20 billion per month, there is no expectation for any change at all. In fact, the only thing to expect is more exhortations from Draghi for increasing fiscal policy stimulus by Germany and other Northern European nations that are not overly indebted. But it will not change anything at this stage, and he has already tied Madame Lagarde’s hands going forward with their most recent guidance, so this will be the farewell tour as everybody regales him for saving the euro back in 2012.

But there have been a number of other moves, the most notable being the Swedish Riksbank, which left rates unchanged, but basically promised to raise them by 25bps in December to return them to 0.00%. Apparently they are tired of negative rates and don’t want them to become habit forming. While I admire that concept, the problem they have is growth there is slowing and inflation is falling well below their target of 2.0%. The most recent reading was 1.5%, but the average going back post the financial crisis is just 1.1%. SEK gained slightly after their comments, rallying 0.15% this morning, but the trend in the krone remains lower and I think they will need to raise a lot more than 25bps to change that.

Meanwhile, other central bank activity saw Norway leave rates unchanged at 1.50% as core inflation there remains above their 2.0% target. NOK’s response was essentially nil. Indonesia cut rates by 25bps, as widely expected, its fourth consecutive rate cut, and although the rupiah is ever so slightly softer this morning, -0.2%, its performance this year has been pretty solid, having gained 2.3% YTD. Finally, the Turkish central bank cut rates by a surprising 250bps this morning, much more than the 100bps expected. If you recall, President Erdogan has been adamant that higher interest rates beget higher inflation, and even fired the previous central bank head to replace him with someone more malleable. Interestingly, a look at Turkish inflation shows that it has been falling despite (because of?) recent rate cuts. And today, despite that huge cut, the initial currency impact was pretty modest, with the lira falling 0.5% immediately, but already recouping some of those losses. And in the broader picture, the lira’s recent trend has clearly been higher and remains so after the cut.

On the data front we saw PMI data from the Eurozone and it simply reinforced the idea that the Eurozone is heading into a recession. Germany’s numbers were worse than expected (Manufacturing 41.9, Composite 48.6) which was enough to drag the Eurozone data down as well (Manufacturing 45.7, Composite 50.2). It seems clear that when Germany reports their Q3 GDP next month it will be negative and Germany will ‘officially’ be in a recession. It is data of this nature that makes it so hard to turn bullish on the single currency. Given their economic travails, the Teutonic austerity mindset, which was enshrined in law, and the fact that the ECB is essentially out of bullets, it is very difficult to have a positive view of the euro in the medium term. This morning, ahead of the ECB policy statement, the euro is little changed, and I see no reason for it to move afterwards either.

So, there was lots of central bank activity, but not so much FX movement in response. My sense is that FX traders are now going to fully turn their attention to the FOMC meeting next week, as even though a rate cut seems assured, the real question is will the Fed call a halt to the mid-cycle adjustment, or will they leave the door open to further rate cuts. The risk with the former is that the equity market sells off sharply, thus tightening financial conditions, sowing fear in Washington and forcing a reversal. However, the risk with the latter is that the Fed loses further credibility, something they have already squandered, by being proven reactive to the markets, and less concerned with the economy writ large.

For today’s session, we have the only real data of the week, Durable Goods (exp -0.7%, -0.2% ex Transport), and Initial Claims (215K) at 8:30, then New Home Sales (702K) at 10:00. We also see the US PMI data (Manufacturing 50.9, Services 51.0) although the market generally doesn’t pay much attention to this. Instead it focuses on the ISM data which won’t be released until next week.

Without any Fed speakers on the docket, once again the FX market is likely to take its cues from equities, which are broadly higher this morning after a number of better than expected earnings announcements. In this risk-on environment, I think the dollar has room to edge lower, but unless we start to see the US data really deteriorate, I have a feeling the Fed is going to try to end the rate cuts and the dollar will benefit going forward. Just not today.

Good luck
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Demand, More, to Whet

In Asia three central banks met
And all three explained that the threat
Of trade tensions rising
Required revising
Their pathway, demand, more, to whet

The RBNZ cut rates 50bps last night, surprising markets and analysts, all of whom were expecting a 25bp rate cut. The rationale was weakening global growth and increased uncertainty over the escalation of the trade fight between the US and China were sufficient cause to attempt to get ahead of the problem. They seem to be following NY Fed President Williams’ dictum that when rates are low, cutting rates aggressively is the best central bank policy. It should be no surprise that the NZD fell sharply on the news, and this morning it is lower by 1.4% and back to levels not seen since the beginning of 2016.

The Bank of Thailand cut rates 25bps last night, surprising markets and analysts, none of whom were expecting any rate cut at all. The rationale was … (see bold type above). The initial FX move was for a 0.9% decline in THB, although it has since recouped two-thirds of those losses and currently sits just 0.3% lower than yesterday’s close. THB has been the best performing currency in Asia this year as the Thai economy has done a remarkable job of skating past many of the trade related problems affecting other nations there. However, the central bank indicated it would respond as necessary going forward, implying more rate cuts could come if deemed appropriate.

The RBI cut rates 35bps last night, surprising markets and analysts, most of whom were expecting a 25bp rate cut. The rationale was… (see bold type above). The accompanying policy statement was clearly dovish and indicted that future rate cuts are on the table if the economic path does not improve. However, this morning INR is actually stronger by 0.3% as there was a whiff of ‘buy the rumor, sell the news’ attached to this move. The rupee had already weakened 3% this week, so clearly market anticipation, if not analysts’ views, was for an even more dovish outcome.

These are not the last interest rate moves we are going to see, and we are going to see them from a widening group of central banks. You can be sure, given last night’s activity, that the Philippine central bank is going to be cutting rates when they meet this evening and now the question is, will they cut only the 25bps analysts are currently expecting, or will they take their cues from last night’s activity and cut 50bps to get ahead of the curve? Last night the peso fell 0.4% and is down 2.5% in the past week. It feels to me like the market is pricing in a bigger cut than 25bps. We shall see.

This central bank activity seems contra to the fact that equity markets are stabilizing quickly from Monday’s sell-off. The idea that because the PBOC didn’t allow another sharp move lower last night in the renminbi is an indication that there is no prospect for further weakness in the currency is ridiculous. (After all, CNY did fall 0.4% overnight). The global rate cutting cycle is starting to pick up steam, and as more central banks respond, it will force the others to do the same. The market has now priced in a 100% probability of a 25bp Fed cut at the September meeting. Comments from Fed members Daly and Bullard were explicit that the increased trade tensions have thrown a spanner into their models and that some preemption may be warranted.

A quick survey of government bond yields shows that Treasuries are down 4bps to 1.66%, new lows for the move; Bunds are down 5.5bps to -0.59% and a new historic low; while JGB’s are down 3bps to -0.21%, below the BOJ’s target of -0.2% / +0.2% for the first time since they instituted their yield curve control process. Bond investors and stock investors seem to have very different views of the world right now, but there are more markets aligning with bonds than stocks.

For instance, gold prices are up another 1% overnight, to $1500/oz, their highest in six years and show no sign of slowing down. Oil prices are down just 0.2% overnight, but more than 8% in the past week, as demand indicators decline more than offsetting production declines.

And of course, economic data continues to demonstrate the ongoing economic malaise globally. Early this morning, June German IP fell 1.5%, much worse than expected and from a downwardly revised May number, indicating even further weakness. It is becoming abundantly clear that the Eurozone is heading into a recession and that the ECB is going to be forced into aggressive action next month. Not only do I expect a 20bp rate cut, down to -0.60%, but I expect that QE is going to be restarted right away and expanded to include a larger portion of corporate bonds. And don’t rule out equities!

So, for now we are seeing simultaneous risk-on (equity rally) and risk-off (bond, gold, yen rallies) on our screens. The equity investor belief in the benefits of lower interest rates is quite strong, although I believe we are reaching a point where lower rates are not the solution to the problem. The problem is economic uncertainty due to changes in international trade relations, it is not a lack of access to capital. But lowering rates is all the central banks can do.

Overall, the dollar is stronger this morning as only a handful of currencies, notably the yen as a haven and INR as described above, have managed to gain ground. I expect that this will continue to be the pattern unless the Fed does something truly surprising like a 50bp cut in September or even more unlikely, a surprise inter-meeting cut. They have done that before, but it doesn’t seem to be in Chairman Powell’s wheelhouse.

The only data today is Consumer Credit this afternoon (exp $16.0B) and we hear from Chicago Fed President Charles Evans, a known dove later today. But equity futures are pointing higher and for now, the idea that Monday’s sharp decline was an opportunity rather than a harbinger of the future remains front and center. However, despite the equity market, I have a feeling the dollar is likely to maintain its overnight gains and perhaps extend them as well.

Good luck
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Still Writing Obits

The Germans, the Chinese and Brits
Have seen manufacturing hits
But in the US
There’s been more success
Though bears are still writing obits

It is fair to say that the global economic growth rate continues to slow. We have seen weaker data as the norm, whether in manufacturing, housing or agriculture; we have seen a never-ending stream of central bankers expressing concern over this slowing growth and promising to respond appropriately; and we continue to see equity markets trade to new highs. Something seems amiss.

Yesterday was a perfect example of this phenomenon with an ISM print of 51.7, its fourth consecutive decline and the weakest reading since October 2016. In fairness, it was better than consensus estimates of 51.0, and the US was the only major economy to show continued expansion in the sector, but the trend is foreboding. The new orders component was exceptionally weak, and highlights those concerns going forward. And yet, equity prices traded to new highs yesterday afternoon, before ceding some ground into the close.

There has been a pretty complete disconnect between the fundamentals of stock valuation (at least the theories we learned in finance class about discounted future cash flows) and the actual price of stocks. And this is a global phenomenon, not merely a US outlier.

Of course, the missing link in this puzzle is central bank activities. Markets have become entirely dependent on central bank largesse to justify their valuations. Central bankers, after a decade of ZIRP and NIRP led to a huge increase in the financialization of the global economy, are now beholden to markets when they make decisions. This was made plain in January, when the Fed pivoted after equity markets plummeted following their last rate increase. They literally could not stand the pressure for even two weeks before reversing course.

So, the question becomes, will equity markets now dictate every central bank action going forward? While rhetorical, it is not hard to believe that the answer is yes. Despite all the current conversation regarding an uncomfortably low inflation rate as the driver for policy ease, it is abundantly clear that the only data point on which every central bank focuses, is their domestic stock market. I fear this is a situation that will result in extremely negative outcomes at some point in the future. However, there is no way to determine, ex ante, when those negative outcomes will manifest themselves. That is why bulls are happy, they buy every dip and have been rewarded, and why bears are miserable, because despite their certainty they are correct, thus far the central banks have been able to delay the pain.

In the end, though, the story on global growth remains one of a slowdown throughout the world. For all their largesse to date, central banks have not yet been able to reverse that trend.

With that out of the way, let’s see what those central bank activities have wrought in the FX markets. The first thing to note was that the dollar actually had an impressive day yesterday, rallying 0.7% vs. the euro and 0.5% vs. the pound after the ISM data. Given the better than expected print, market participants decided that the Fed may not be as aggressive cutting rates after all, and so the key recent driver of dollar weakness was reevaluated. Of course, one day’s reaction does not a trend make, and this morning, the dollar is backing off yesterday’s rally slightly.

Last night the RBA cut rates another 25bps, to a record low of 1.00%, and left the door open for further rate cuts in the future. Aussie, however, is higher by 0.4% this morning on a classic, sell the rumor, buy the news reaction. In the end, Australia remains entirely dependent on growth in China and as that economy slows, which is clearly happening, it will weigh on the Australian economy. While Australia managed to avoid ZIRP in the wake of the financial crisis, this time around I think it is inevitable, and we will see AUD resume its multiyear weakening trend.

Weighing on the pound further this morning were two data points, the Construction PMI at 43.1, its weakest in more than ten years, as well as the ongoing malaise in housing prices in the UK. Brexit continues to garner headlines locally, although it has not been front page news elsewhere in the world because of all the other concerns like trade, OPEC, North Korea, and in the US, the beginnings of the presidential campaigns.

But there is a very interesting change ongoing in the Brexit discussion. Throughout the process, the EU has appeared to have the upper hand in the negotiations, forcing their views on outgoing PM May. But with all signs pointing to a new PM, Boris Johnson, who has made clear he will leave with or without a deal, suddenly Ireland is finding itself under extreme pressure. A recent report by the central bank there indicated that a hard Brexit could result in a 4.0% decline in Irish GDP! That is HUGE. At the same time, the EU will require Ireland to uphold the border controls that are involved in the new separate relationship. This means they will need to perform any inspections necessary as well as arrange to collect tariffs to be charged. And the UK has made it clear that they will not contribute a penny to that process. Suddenly, Ireland is in a bad situation. In fact, it is entirely realistic that the EU needs to step in to delay the impact and cave to an interim deal that has nothing to do with PM May’s deal. At least that is the case if they want to maintain the integrity of their borders, something which has been given short shrift until now. My point is that there is still plenty of Brexit mischief ahead, and the pound is going to continue to react to all of it. In the end, I continue to believe that a hard Brexit will result in a weaker pound, but I am not so sure it will be as weak as I had previously believed. Maybe 1.20-1.25 is the right price.

In the US today there is no data to be released although we do hear from NY Fed president Williams and Cleveland Fed President Mester this morning. If the Fed is serious about staying on hold at the end of this month, rather than cutting the 25bps that the market has already priced, they better start to speak more aggressively about that fact. Otherwise, they are going to find themselves in a situation where a disappointed equity market sells off sharply, and the pressure ratchets even higher on them to respond. Food for thought as we hear from different Fed speakers during the month.

Good luck
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Not So Fast

While everyone thought it was nifty
The Fed was about to cut fifty
Said Jay, not so fast
We’ll not be harassed
A quarter’s enough of a gift-y

Once again, Chairman Powell had a significant impact on the markets when he explained that the Fed is fiercely independent, will not be bullied by the White House, and will only cut rates if they deem it necessary because of slowing growth or, more importantly, financial instability. Specifically, he said the Fed is concerned about and carefully watching for signs of “a loss of confidence or financial market reaction.” In this context, “financial market reaction” is a euphemism for falling stock prices. If ever there was a question about the existence of the Fed put, it was laid to rest yesterday. Cutting to the chase, Powell said that the Fed’s primary concern, at least right now, is the stock market. If it falls too far, too fast, we will cut rates as quickly as we can. Later in his speech, he gave a shout out to the fact that low inflation seems not to be a temporary phenomenon, but that was simply thinly veiled cover for the first part, a financial market reaction.

There are two things to note about these comments. First, the Fed, and really every major central bank, continues to believe they are in complete control of both their respective economies and the financial markets therein. And while it is absolutely true this has been the case since the GFC ended, at least with respect to the financial markets, it is also absolutely true that the law of diminishing returns is at work, meaning it takes much more effort and stimulus to get the same result as achieved ten years ago. At some point, probably in the not too distant future, markets are going to begin to decline and regardless of what those central banks say or do, will not be deterred from actually clearing. It will not be pretty. And second, the ongoing myth of central banks being proactive, rather than reactive, is so ingrained in the central bank zeitgeist that there is no possibility they will recognize the fact that all of their actions are, as the axiom has it, a day late and a dollar short.

But for now, they are still in command. Yesterday’s price action was informed by the fact that despite the weakest Consumer Confidence data in two years and weaker than expected New Home Sales, Powell did not affirm a 50bp cut was on its way in July. Since the market has been counting on that outcome, the result was a mild risk off session. Equity prices suffered in the US and continued to do so around the world last night and Treasuries settled below 2.00%. However, gold prices, which have been rocking lately, gave up early gains when Powell nixed the idea of a 50bp cut. And the dollar? Well, it remains mixed at best. It did rally slightly yesterday but continues to be broadly lower than before the FOMC meeting last week.

We also heard from two other Fed speakers yesterday, Bullard and Barkin, with mixed results. Bullard, the lone dissenter from the meeting made clear that he thought a 25bp reduction was all that was needed, a clear reference to Minneapolis Fed President Kashkari’s essay published on Friday calling for a 50bp cut. However, Thomas Barkin, from the Richmond Fed, sounded far less certain that the time was right for a rate cut. He sounds like he is one of the dots looking for no change this year.

And the thing is, that’s really all the market cares about right now, is what the Fed and its brethren central banks are planning. Data is a sidelight, used to embellish an idea if it suits, and ignored if it doesn’t. The trade story, of course, still matters, and given the increasingly hardened rhetoric from both sides, it appears the market is far less certain of a positive outcome. That portends the opportunity for a significant move on Monday after the Trump-Xi meeting. And based on the way things have played out for the past two years, my money is on a resumption of the dialog and some soothing words, as that will help underpin stocks in both NY and Shanghai, something both leaders clearly want. But until then, I expect a general lack of direction as investors make their bets on the outcome.

One little mentioned thing on the data front is that we have seen every regional Fed manufacturing survey thus far released show significantly more weakness than expected. Philly, Empire State, Chicago, Richmond and Dallas have all fallen sharply. That does not bode well for economic growth in either Q2 or Q3, which, in a twisted way, will play right into the President’s hands as the Fed will be forced to cut rates as a response. Strange times indeed.

This morning, two data points are released; Durable Goods (exp -0.1%, +0.1% ex transports) and the Goods Trade Balance (-$71.8B). Look for weakness in these numbers to help perk of the equity market as anticipation will grow that more rate cutting is in the offing. And look for the dollar to suffer for the same reason.

Good luck
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The Doves Are Ascendant

A recap of central bank actions
Shows sameness across all the factions
The doves are ascendant
And markets dependent
On easing for all their transactions

Yesterday’s markets behaved as one would expect given the week’s central bank activities, where policy ease is the name of the game. Stock markets rose sharply around the world, bond yields fell with the dollar following yields lower. Commodity prices also had a good day, although gold’s rally, as a haven asset, is more disconcerting than copper’s rally on the idea that easier policy will help avert a recession. And while, yes, Norway did raise rates 25bps…to 1.25%, they are simply the exception that proves the rule. Elsewhere, to recap, the three major central banks all met, and each explained that further policy ease, despite current historically easy policy, is not merely possible but likely going forward.

If there were questions as to why this is the case, recent data releases serve as an excellent answer. Starting in the US yesterday, Philly Fed, the second big manufacturing survey, missed sharply on the downside, printing at 0.3, down from last month’s 16.6 reading and well below expectations of 11.0. Combined with Monday’s Empire Manufacturing index, this is certainly a negative harbinger of economic activity in the US.

Japan’s inflation
Continues to edge lower
Is that really bad?

Then, last night we saw Japanese CPI data print at 0.7%, falling 0.2% from the previous month and a strong indication that the BOJ remains far behind in their efforts to change the deflationary mindset in Japan. It is also a strong indication that the BOJ is going to add to its current aggressive policy ease, with talk of both a rate cut and an increase in QE. The one thing that is clear is that verbal guidance by Kuroda-san has had effectively zero impact on the nation’s views of inflation. While the yen has softened by 0.2% this morning compared to yesterday’s close, it remains in a clear uptrend which began in April, or if you step back, a longer-term uptrend which began four years ago. Despite the fact that markets are anticipating further policy ease from Tokyo, the yen’s strength is predicated on two factors; first the fact that the US has significantly more room to ease policy than Japan and so the dollar is likely to have a weak period; and second, the fact that overall evaluations of market risk (just not the equity markets) shows a great deal of concern amongst investors and the yen’s haven status remains attractive.

Closing out our analysis of economic malaise, this morning’s Flash PMI data from Europe showed that while things seem marginally better than last month, they are still rotten. Once again, Germany’s Manufacturing PMI printed well below 50 at 45.4 with the Eurozone version printing at 47.8. These are not data points that inspire confidence in central bankers and are amongst the key reasons that we continue to hear from virtually every ECB speaker that there is plenty of room for the ECB to ease policy further. And while that is a suspect sentiment, there is no doubt that they will try. But once again, the issue is that given the current status of policy, the Fed has the most room to ease policy and that relative position is what will maintain pressure on the buck.

Away from the central bank story, there is no doubt that market participants have ascribed a high degree of probability to the Trump-Xi meeting being a success at defusing the ongoing trade tensions. Certainly, it seems likely that it will help restart the talks, a very good thing, but that is not the same thing as making concessions or coming to agreement. It remains a telling factor that the Chinese are unwilling to codify the agreement in their legal system, but rather want to rely on administrative rules and guidance. That strikes as a very different expectation, compared to the rest of the developed world, regarding what international negotiations are designed to achieve. When combined with the fact that the Chinese claim there is no IP theft or forced technology transfer, which are two of the key issues on the table for the US, I still have a hard time seeing a successful outcome. But I am no trade expert, so my views are just my own.

And finally, Brexit has not really been in the news that much lately, at least not on this side of the pond, but the Tory leadership contest is down to the final two candidates, Boris Johnson and Jeremy Hunt, the Foreign Secretary. The process now heads to the roughly 160,000 active members of the Conservative Party, with Johnson favored to prevail. His stance on Brexit is he would prefer a deal, but he will not allow a delay past the current October 31, 2019 deadline, deal or no deal. It is this dynamic which has undermined the pound lately and driven its lagging performance for the past several months. However, this will take more time to play out and so I expect that the pound will remain in limbo for a while yet.

On the data front, we see only Existing Home Sales (exp 5.25M) this morning, but with the FOMC meeting now past and the quiet period over, we hear from two Fed speakers, Governor Brainerd (a dove) and Cleveland Fed President Mester (a hawk). At this point, all indications are that the Fed is leaning far more dovish than before, so it will be telling to hear Ms Mester. If she comes across as dovish, I would expect that we will see both stocks and bonds rally further with the dollar sinking again. Thus, a tumultuous week is ending with the opportunity for a bit more action. The dollar remains under pressure and I expect that to be the case for the foreseeable future.

Good luck
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Clearly On Hold

Though policy’s clearly on hold
Most central banks feel they’ve controlled
The story on growth
And yet they’re still loath
To change their inflation threshold

Amidst generally dull market activity (at least in the FX market), traders and investors continue to look for the next key catalysts to drive markets. In US equity markets, we are now entering earnings season which should keep things going for a while. The early releases have shown declining earnings on a sequential basis, but thus far the results have bested estimates so continue to be seen as bullish. (As an aside, could someone please explain to me the bullish case on stocks trading at a 20+ multiple with economic growth in the US at 2% and globally at 3.5% alongside extremely limited policy leeway for further monetary ease? But I digress.) Overnight saw Chinese stocks rock, with Shanghai soaring 2.4% and the Hang Seng 1.1%. European stocks are a bit firmer as well (DAX +0.6%, FTSE +0.4%) and US futures are pointing higher.

Turning to the central banks, we continue to hear the following broad themes: policy is in a good place right now, but the opportunity for further ease exists. Depending on the central bank this is taking different forms. For example, the Minutes of the RBA meeting indicated a growing willingness to cut the base rate further, and market expectations are building for two more cuts this year, down to 1.00%. Meanwhile, the Fed has no ability to cut rates yet (they just stopped raising them in December) but continues to talk about how they achieve their inflation target. Yesterday, Boston Fed president Rosengren posited that a stronger commitment to the symmetry around their 2.0% target could be useful. Personally, I don’t believe that, but I’m just a gadfly, not a PhD economist. At any rate, the idea is that allowing the economy to run hot without tightening is tantamount to easing policy further. In the end, it has become apparent the Fed’s (and every central bank’s) problem is that their economic models no longer are a good representation of the inner workings of the economy. As such, they are essentially flying blind. Previous relationships between growth, inflation and employment have clearly changed. I make no claim that I know what the new relationships are like, just that 10 years of monetary policy experiments with subpar results is enough to demonstrate the central banks are lost.

This is true not just in the US and Europe, but in Japan, where they have been working on QE for nearly thirty years now.

More ETF’s bought
Will be followed by more and
More ETF’s bought

It’s vital for the Bank of Japan to continue persistently with powerful monetary easing,” Governor Haruhiko Kuroda said. As can be seen from Kuroda-san’s comments last night in the Diet, the BOJ is a one-trick pony. While it is currently illegal for the Fed to purchase equities, that is not the case in Japan, and they have been buying them with gusto. The thing is, the Japanese economy continues to stumble along with minimal growth and near zero inflation. As the sole mandate for the BOJ is to achieve their 2.0% inflation target, it is fair to say that they have been failing for decades. And yet, they too, have not considered a new model.

In the end, it seems the lesson to be learned is that the myth of omnipotence that the central banks would have us all believe is starting to crack. Once upon a time central banks monitored activity in the real economy and tried to adjust policy accordingly. Financial markets followed their lead and responded to those actions. But as the world has become more financially oriented during the past thirty years, it seems we now have the opposite situation. Now, financial markets trade on anticipation of central bank activity, and if central banks start to tighten policy, financial markets tend to throw tantrums. However, there is no tough love at central banks. Rather they are indulgent parents who cave quite quickly to the whims of declining markets. Regardless of their alleged targets for inflation or employment, the only number that really matters is the S&P 500, and that is generally true for every central bank.

Turning to this morning’s data story, the German ZEW survey was released at a better than expected 3.1. In fact, not only was this better than forecast, but it was the first positive reading in more than a year. It seems that the ongoing concerns over German growth may be easing slightly at this point. Certainly, if we see a better outcome in the Manufacturing PMI data at the end of April, you can look for policymakers to signal an all clear on growth, although they seem unlikely to actually tighten policy. Later this morning we see IP (exp 0.2%) and Capacity Utilization (79.1%) and then tonight, arguably more importantly, we see the first look at Chinese Q1 GDP (exp 6.3%).

If you consider the broad narrative, it posits that renewed Chinese monetary stimulus will prevent a significant slowdown there, thus helping economies like Germany to rebound. At the same time, the mooted successful conclusion of the US-China trade talks will lead to progress on US-EU and US-Japanese talks, and then everything will be right with the world as the previous world order is reincarnated. FWIW I am skeptical of this outcome, but clearly equity market bulls are all-in.

In the end, the dollar has been extremely quiet (volatility measures are back to historic lows) and it is hard to get excited about movement in the near-term. Nothing has yet changed my view that the US will ultimately remain the tightest policy around, and thus continue to draw investment and USD strength. But frankly, recent narrow ranges are likely to remain in place for a little while longer yet.

Good luck
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A Future Upgrade

The data from China conveyed
A story that can be portrayed
As Q1 was weak
But policy tweaks
Imply there’s a future upgrade

In a relatively dull session for news events, Chinese data was the biggest story. The trade surplus there expanded dramatically, rising to $32.6B, much larger than any expectations, as not only did exports grow more robustly (+14.2%) but imports fell sharply (-7.6%). On the surface this suggests that the global situation may have seen its worst days, as demand for Chinese goods was strong, but the domestic economy there continues to be plagued by weakness. However, a few hours later, Chinese money supply and loan data was released with a slightly different message. Here, M2 grew more than expected at an 8.6% rate, while new loans also expanded sharply (+13.7%) implying that the PBOC’s efforts at stimulating the economy are starting to bear fruit. The loan data also implies that growth going forward, in Q2 and beyond, is likely to rebound further. In fact, the only negative piece of news was that auto sales continue to decline in China, falling 5.2% in March, the ninth consecutive year/year decline in the series. The market response to this was muted in the equity space, with Shanghai virtually unchanged, but the renminbi did benefit, rising 0.2% in the wake of the release.

Away from those data points, the news has been sparse. Interestingly, the dollar has been under pressure across the board since yesterday’s close with the euro now higher by 0.6%, both the pound and yen by 0.3% and Aussie leading the way amid firmer commodity prices, by 0.7%. In fact, despite the Shanghai equity performance, today has all the other earmarks of a risk-on session. Equity markets elsewhere in Asia were firm (Nikkei +0.75%, Hang Seng +0.25%), they are higher in Europe (FTSE and CAC +0.4%, DAX +0.6%) and US futures are pointing higher as well (DJIA +0.7%, S&P +0.5%). At the same time government bond yields are rising with 10-year Treasury yields now higher by 5bps. Much of this movement has occurred early this morning after JP Morgan released better than expected results. So, for today, all seems right with the world!

Away from those data releases, there has been far less of interest. Yesterday we heard from NY Fed President Williams who explained that the rate situation was appropriate for now and that there was no reason for the Fed to act in the near future. While growth seems solid, the continuing lack of measured inflation shows no signs of changing and so rates are likely to remain on hold for an extended period. In a related story, a WSJ survey of economists described this morning shows expectations for the next Fed move to have been pushed back to Q4 2020, with a growing likelihood that it will be a rate cut. In other words, expectations are for an extended period of time with no monetary policy changes. If that is the case, then markets will need to find other catalysts to drive prices. Who knows, maybe equity prices will start to reflect company fundamentals again! Just kidding!

Actually, this situation will drive the market to be even more focused on the economic data as essentially every central bank around the world has indicated the current policy pause is designed to observe the data and then respond accordingly. So, if weakness becomes evident in a country or region, look for the relevant central bank(s) to ease policy quickly. At the same time, if inflation does start to pick up someplace, policy tightening will be discussed, if not implemented right away. And markets will respond to these discussions given the lack of other catalysts.

For now however, Goldilocks has been revived. Rates have almost certainly peaked for this cycle, and policy stability may well lead us to yet further new highs in the equity space. Perhaps the central banks have well and truly killed the business cycle and replaced it with a permanent modest growth trajectory. Personally, I don’t believe that is the case, as evidenced by the diminishing impact of each of their policies, but the evidence over the past several years is working in their favor, I have to admit.

This morning’s only data point is Michigan Consumer Sentiment, which is expected to decline slightly from last month’s 98.4 to 98.0 today. We also hear from Chair Powell again, but that story is old news. With risk being acquired, look for the dollar to continue to falter for the rest of the session, albeit probably not by much more. Things haven’t changed that much!

Good luck and good weekend
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