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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Much Darker Moods

Five decades of trade under GATT
Resulted in policies that
Increased global trade
While tariffs did fade
And taught us the term, technocrat

Then followed the WTO
And new rules that they did bestow
The Chinese then joined
(And some say purloined)
Much IP which helped them to grow

But in the past year attitudes
Have shifted to much darker moods
So trade growth is slowing
As nations are showing
A willingness to stir up feuds

It seemed that half the stories in the press today were regarding trade issues around the world, notably the ongoing US-China trade talks, but also the struggle for the EU and China to put together a communique after a locally hyped trade summit between the two. Shockingly the EU is also unhappy with Chinese IP theft and their subsidies for state-owned companies that compete with European companies. Who would have thunk it? But in their ongoing efforts to maintain the overall world trade order, they found some things on which they could agree in order to prevent the meeting from becoming a complete fiasco.

In addition, today we hear from the IMF with their latest global economic updates that are widely touted to have an even more pessimistic view than the last one which, if you recall, produced substantial downgrades in economic growth forecasts. IMF Managing Director Christine LaGarde has been quite vocal lately about how all the trade spats are slowing global growth and she continues to exhort everyone to simply get back to the old ways. Alas, the trade toothpaste is out of the tube and there is no putting it back. It will likely be several more years before new deals are inked and the new trading framework fleshed out. In the meantime, expect to see periodic, if not frequent, discussions on the benefits of free trade and the good old days.

The question remains, however, if the good old days was really ‘free’ trade. Arguably, the fact that there are now so many ongoing trade issues globally is indicative of the fact that, perhaps, freedom was in the eye of the beholder. And those voters who saw their jobs disappear due to the ‘benefits’ of free trade, have clearly become a lot more vocal. Like virtually everything else in life, the case can be made that trade sentiment is cyclical, and there is a strong argument that we have seen peak trade for this cycle. The reason this matters for the FX market is that restrictions on trade will result in changing fortunes for economies and changing flows in currencies. It is still far too early to ascertain the direct impact on many currencies, although given the increasing probability that this will reduce risk appetite, it would be fair to assume the yen and dollar will be beneficiaries over time.

The Brexit saga, meanwhile, continues to rush toward the new deadline this Friday without any resolution in sight. Not surprisingly, trade plays a big role in this process, as the ability to negotiate new trade deals for the UK was a key selling point in the vote to leave. While PM May’s minions continue to have discussions with Labour to find some kind of compromise, they have thus far come up short. At the same time May is heading to Brussels to meet with Frau Merkel and Monsieur Macron in an effort to find some support for her request for another extension to June 30. At the same time, the Euroskeptics in her Tory party back home are trying to figure out how to oust her from Number 10 Downing Street, although, like the Brexit process, they have been unable to arrive at a coherent solution. With all this drama ongoing, and the emergency EU summit scheduled for tomorrow, the pound continues to hover around the 1.30 level. The one notable thing about the pound has been the reduction in market liquidity as fewer and fewer traders are willing to run positions with the potential for a bombshell announcement at any time. And seriously, who can blame them? The situation remains the same here where clarity in either direction will result in a sharp movement, but until then, flat is the best way to be!

Overall the dollar is under modest pressure this morning (EUR +0.15%, JPY +0.15%, CAD +0.2%), and in truth was in similar shape yesterday. The thing is, the magnitude of the movement has been so limited, I am reluctant to give it any credence with regard to a trend. In fact, since the dollar’s rally peaked last summer, we have been essentially trendless. I expect that this will remain the case until one of the big stories we have been following; trade, Brexit or central banking, has a more distinctive outcome than the ongoing uncertainty we have seen lately. Well, I guess that’s not completely correct, the central bank story has been one of universal dovishness, but the result is that no currency benefits at the expense of any other.

Turning to the data this week, prices are the focus with CPI tomorrow, and we also see the FOMC Minutes and hear from the ECB. And boy, do we have a lot of Fed speakers this week!

Today NFIB Small Biz Optimism 101.8 (released)
  JOLTs Job Report 7.55M
Wednesday CPI 0.3% (1.8% Y/Y)
  -ex food & energy 0.2% (2.1% Y/Y)
  FOMC Minutes  
Thursday ECB Rate Decision -0.4% (unchanged)
  Initial Claims 211K
  PPI 0.3% (1.9% Y/Y)
  -ex food & energy 0.2% (2.4% Y/Y)
Friday Michigan Sentiment 98.0

We have nine Fed speeches including Chairman Powell three separate times although there is absolutely no indication that any views are changing within the Mariner Eccles Building. However, with the increasing drumbeat of pressure from the White House for the Fed to ease policy further and restart QE, it will be very interesting to see how Powell responds. While early indications were that he seemed impervious to that pressure, these days, that doesn’t seem to be the case.

Ultimately, there is no reason to believe that the FX market, or frankly any market, is going to see much movement today given the lack of new catalysts. As I wrote above, we need a resolution to shake things up, and right now, those are in short supply.

Good luck
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Trembling With Fear

The one thing increasingly clear
Is markets are trembling with fear
As stock markets tumble
Most central banks fumble
Their message, then get a Bronx cheer

Being a central banker has become much more difficult recently, especially in the wake of yesterday’s global equity market rout. It seems that policies that they have collectively promulgated, QE and ZIRP/NIRP are now quite long in the tooth, and no longer having the positive impact desired. Let’s recap quickly.

The Great recession in 2008 called for an extraordinary monetary response by central banks around the world, and rightly so. The deepest recession since the Great Depression saw liquidity across many markets completely dry up. Even FX, arguably the most liquid market of them all, had structural problems. So the combination of QE and USD swap lines offered by the Fed to the rest of the world’s central banks was an appropriate response to help untangle the mess. Alas, fiscal policy never chipped in to the recovery and central banks took it upon themselves to do all the lifting, thus relieving governments of the need to make hard decisions. In hindsight, this was a key mistake!

Fast forward ten years to today and the situation, remarkably, is that most of that extraordinary monetary stimulus is still sloshing around the world as other than the Fed and the Bank of Canada (who raised rates yesterday and indicated they would be quickening the pace of doing so in the future), no other major central bank has done anything of note. The ECB, the BOJ and the PBOC are all still adding liquidity to their systems, while the BOE has raised rates just 25bps, net, from the lows established after the crisis. And the same is true of peripheral nations like Switzerland, Sweden and Australia, where interest rates remain at their post crisis nadirs (-0.75%, -0.50% and 1.50% respectively).

The problem for these central banks is that growth is starting to slow on a global basis. Whether it is the increased trade friction between the US and China, concerns over Brexit or simply that the US recovery (which still arguably drives most of the global economy) is now the longest on record and due to end, the situation is increasingly fraught. And that’s the rub. If interest rates are already negative, what can central banks do to stimulate the economy in the event of a recession? The answer, of course, is not much. More QE and even deeper negative interest rates are unlikely to have the same positive impact the first efforts had, in fact they could have the opposite effect by generating greater concern amongst investors and causing a more severe sell-off in markets. But politically, no central bank will be able to sit by and do nothing if a recession does appear. As I said, central banking has become much more difficult lately.

That is all a preamble to discuss what is going on in markets right now. FX is a backburner issue with equities front and center around the world. While European markets have stabilized at this time, one session of stability is not sufficient to declare an end to the rout. In the end, markets remain beholden to broad sentiment, the narrative if you will, and for the past ten years that narrative was that continued low inflation combined with steady growth would allow the central banks to maintain ultra easy monetary policy with no negative side effects. But in the past year, the cracks in that narrative have grown to the point where it is no longer seen as viable. First, inflation has begun to creep higher in certain areas around the world, notably the US and China. At the same time, growth data appears to have peaked last quarter. Tomorrow we will see the first estimate of Q3 GDP growth in the US (exp 3.3%), which is already considerably lower than Q2. In addition, we have seen Chinese growth slow more than expected and German growth fall to 0.0% in Q3. The combination of rising inflation and slower growth has put central banks in a bind forcing them to choose which issue to address first. The problem is by addressing one they are likely to exacerbate the other. So as the Fed fights threats of higher inflation, it impedes growth. Meanwhile, China has opted to support growth, thus feeding faster inflation. In the end, as the next recession looms closer, central banks will find themselves with fewer policy arrows in their quiver.

But this is an FX note, so let’s take a quick look at the market this morning. The dollar is a touch softer, with both the euro and the pound higher by 0.15% while we are seeing similar moves in most emerging market currencies. Activity in the market seems muted relative to the excitement in equities, but my sense is this will not last. Rather, if the equity sell-off continues, the dollar should find itself in a much stronger position. As to the stories that have been driving things in FX, the Italian budget, Brexit, central bank policies, there have been no real changes in the past twenty-four hours. The possible exception is that the interest rate futures market in the US has removed one price hike from the Fed’s expected path as concern grows that a continues slide in the stock market will lead to weaker growth and less need to keep driving rates higher. It seems that the Fed realizes that it began its tightening process far too late (thank you Chair Yellen!) and is now desperately trying to catch up so they can respond to the next downturn. But hey, the ECB is MUCH further behind.

Looking forward to today’s session, we start with the ECB meeting, where they announced no change in policy rates, but we still await Signor Draghi’s press conference at 8:30. It will be interesting if he continues to characterize the Eurozone economy risks as balanced, or if the downside risks are now elevated. If the latter, look for the euro to decline sharply! We also get US data including Durable Goods (exp -1.0%, ex transport +0.5%) and the Goods Trade Balance (-$74.9B). Yesterday’s New Home Sales data was awful, just 553K, well below expectations, and another sign that parts of the economy here are rolling over. I still don’t believe that the data turn has been enough to change the Fed’s mind about a December rate hike, but if numbers start to fall, watch out. Tomorrow’s GDP print will be quite important to the market. But today, I think the ECB dominates the story.

Good luck
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