Inflation’s Not Bubbled

Ahead of the Fed’s tête-à-tête
The CPI reading we’ll get
Though Jay remains troubled
Inflation’s not bubbled
The rest of us know that’s bullshet

Yes, it is Fed day with the FOMC set to announce their policy stance at 2:00 this afternoon and Chairman Jay scheduled to meet the press at 2:30. At this point, he and his colleagues have done an excellent job of leading market expectations toward no change, with the futures market pricing in a 0.0% probability of a cut. Interestingly, there is the tiniest (just 5.8%) probability of a rate hike, although that is even less likely in my view. While there will be a great deal of interest in the dot plot, certainly there has not been enough data to change Powell’s oft-stated view that the economy and monetary policy are both in “a good place.”

What should be of greater concern to all of us, as individuals and consumers, is that there has been an increase in discussions about the Fed changing their inflation targeting regime to achieving an average inflation rate of 2.0% over time, meaning that for all the time inflation remains below target (the past 10 years), they will allow it to run above target to offset that outcome. Now, we all know that the Fed’s constant complaints about too-low inflation ring hollow in our ears every time we go to the supermarket, or even the mall (assuming anyone else still goes there) as prices for pretty much everything other than flat screen tv’s has consistently risen for years. But given the way the Fed measures such things; they continue to register concern over the lack of inflation. And remember, too, that the Fed uses PCE, Personal Consumption Expenditures, in their models, which reflects not what we pay, but the rate of change of prices at which merchants sell goods. It is a subtle difference, but the construct of PCE, with a much lower emphasis on housing, and inclusion of the costs that the government pays for things like healthcare (obviously at a lower rate than the rest of us) insures that PCE will always track lower over time. In fact, it is an open question as to whether the Fed can even achieve a higher inflation rate, however it is measured, as long as they maintain their financial repression.

All of that is a prelude to today’s CPI release, where the market is anticipating a reading of 2.0% for the headline and 2.3% for the core. Arguably, this should be an important data point for the folks in the Mariner Eccles building today, but I forecast that they will only see weakness here as noteworthy, arguing for even more stimulus. However, whatever today’s print, it will simply be background noise in the end. It would take some remarkable news to change today’s outlook.

But inflation is important elsewhere in the world as well. For example, this morning Sweden’s CPI rose to 1.8%, a tick higher than expected and basically confirmed to the market that the Riksbank, who seem desperate to exit their negative rate policy, are likely to do so at their February meeting. (Expectations for movement next week remain quite muted.) Nonetheless, the Swedish krona has been a major beneficiary in the market, rallying 0.65% vs. the dollar (0.5% vs. the euro), and is today’s top performer.

Another place we are seeing prices rise more rapidly is in Asia, specifically in both China and India. In the former, CPI rose to 4.5% in November, higher than the expected 4.3% and the highest level since January 2012. This is a reflection of the skyrocketing price of pork there as African swine fever continues to decimate the hog population. (It is this problem that is likely to help lead to a phase one trade deal as President Xi knows he needs to be able to feed his people, and US pork is available and cheap!) In India, the October data jumped to 4.62% (what precision!) and November is forecast to rise to 5.3%. Here, too, food prices are taking a toll on the price index, and we need to be prepared for the November release due tomorrow. When the October print hit the tape, the rupee gapped lower (dollar higher) by nearly 1%, and although it has been slowly clawing back those losses, another surprise on the high side could easily see a repeat.

In contrast to those countries, the Eurozone remains an NPZ (no price zone), a place where price rises simply do not occur. Now, I grant that I have not been there in some time, so cannot determine if the European measurements are reflective of most people’s experience, but certainly on a measured basis, inflation remains extremely low, hovering around 1.0% per annum throughout most of the continent. Remember, tomorrow, Christine Lagarde leads her first ECB meeting and while she has spoken about how fiscal policy needs to pick up the pace and how the ECB needs to be more focused on issues like climate change, we have yet to hear her views on what she actually was hired to do, manage monetary policy. While there is no doubt that she is an exceptional politician, it remains to be seen what kind of central banking chops she possesses. Based solely on her commentary over the years, she appears firmly in the dovish camp, but given Signor Draghi’s parting gift of a rate cut and renewed QE, it seems most likely that she will simply stay the course and exhort governments to spend more money. One thing to keep in mind is that markets have a way of testing new central bank heads early in their terms with some kind of stress. That initial response is everything in determining if said central banker will be seen as strong or weak. We can only hope that Madame Lagarde measures up in that event.

The only other story is the UK election, certainly critical, but given it takes place tomorrow, we will look to discuss outcomes then. One interesting thing was that a Yougov poll released last evening showed PM Boris and the Tories would win 339 seats, still a comfortable majority, but a smaller one than the same poll from two weeks earlier. The pound fell sharply on the news, having traded as high as 1.3215 late yesterday afternoon it was actually just above 1.3100 when I left the office. This morning, it is right in the middle at 1.3150, which is apparently where it was at 5:00 last evening as the stated movement today is virtually nil. Barring a major faux pas by either candidate at this late stage, I think we will see choppiness in the pound until the results are released, early Friday morning. While a vic(Tory) by Boris will likely see a knee-jerk response higher in the pound, I remain of the view that any rally will be modest, perhaps 1%-2% at most, and should be seen as an opportunity to add hedges for receivables hedgers.

And that’s really it for today. I would look for modest movement overall, and don’t anticipate the FOMC meeting to generate much excitement.

Good luck
Adf

 

Both Sides Connive

The trade war continues to drive
Discussion as both sides connive
To show they are right
And it’s their birthright
The other, access to deprive

Once again, discussion about the trade situation seems to be the dominant theme in market activity. Not only did we get comments from Chinese President Xi (“We didn’t initiate this trade war and this isn’t something we want. When necessary, we will fight back, but we have been working actively to try not to have a trade war,”) but we also got a raft of weak PMI data from around the world where, to an analyst, the blame was attributed to… the impact of the trade war.

For instance, Australia started off the data slump with Composite PMI falling to 49.5, below that magic 50.0 boom-bust level and endangering the ‘Lucky Country’s’ 27 year streak of growth with no recession. This outcome increased the talk that the RBA would soon be forced to cut rates again, or perhaps even consider QE, a road down which they have not yet traveled. Aussie, however, is little changed on the day although it has been trending steadily lower for the entire month of November.

Next we saw PMI data from the Eurozone and the UK, all of which was pretty awful. On the EZ side, the interesting thing was that the manufacturing readings were all slightly higher than expected (Germany 43.8, France 51.6, EZ 46.6) but the services data were all much worse driving the composite figures lower (Germany 49.2, France 52.7, and EZ 50.3). The point is that one of the key fears expressed lately has been that the global manufacturing slump would eventually bleed into the rest of the economy. This data is some powerful evidence that is exactly what is occurring. The euro, however, is little changed on the day having rallied on earlier confirmation that Germany did not enter a technical recession, but falling back after the PMI release.

In the UK, however, things were even worse, with all three PMI data points printing much lower than expected and all three with a 48 handle. These are the weakest readings since the immediate aftermath of the Brexit vote in June 2016, and speak to the increased uncertainty that led to the recently called election. In this case, the pound did suffer, falling 0.3% and earning the crown for worst performer of the day. There are just less than three weeks left before the election and thus far, it still appears that Boris is well placed to win. But stranger things have happened with regard to elections lately. Next week we will get to see the Tory manifesto, which you can be sure will be very different than Labour’s version. Once again, I look at that document and wonder why any politician would believe that promising higher taxes, on what appeared to be everyone, is seen as a winning position. I’m confident that Boris will not be proposing a tax program of that nature, although I’m sure there will be plenty of spending promises. However, all of these political machinations are only likely to have modest impacts on the value of the pound at this point. We will need to see the outcome of the election for the next move to be defined. I still believe that a Tory majority in Parliament will see the pound rally a few cents more, but that trading above 1.35 will be very difficult in the near term.

Inflation remains
Elusive in the distance
A crow at midnight

Japan released their latest inflation data overnight and it showed that, despite the 2% rise in the GST, to 10%, the general price level did virtually nothing. The headline number was unchanged at 0.2% while the core number did manage to tick up to…0.7%. Wow. If one were to evaluate the BOJ’s performance on an objective basis, something like how they have done achieving their inflation target, it strikes me that Kuroda-san would be deemed a colossal failure. This is not to imply that the job is easy, but he has been in the chair for more than six years at this point, and despite an extraordinary amount of monetary stimulus (growing the balance sheet from 32.3% of GDP to 104.2% of GDP) core CPI has risen only from -0.7% to +0.7%. Granted, that is not actual deflation, but there is certainly no reason to believe that the 2.0% target is ever going to be attainable. To his credit, I guess, he has been able to drive the yen lower by some 16% since he started (95.00 to 108.50) which has clearly helped Japanese corporate profitability but arguably not much else. I know I’m a bit of a heretic here, but perhaps the Japanese might consider another measure of what they want to achieve. Again I ask; do policy makers around the world really believe that their populations are keen to pay more for anything? I fear that a slavish pursuit of some macroeconomic model’s mooted outcome has resulted in creating more problems than it has fixed. Just sayin’.

A quick peek at the EMG bloc shows that no currency has moved even 0.2% today, which implies that there is nothing, at all, to discuss here. On the data front, yesterday’s Initial Claims data was higher than expected at 227K with a revision higher to the previous week’s print. This is a data point that is going to get increasing scrutiny going forward, because if it starts to trend higher, it could well signal the US economy is starting to suffer more than currently believed (or at least expressed) by the Fed and its members. And that means more rate cuts and the potential for a lower dollar. This morning’s only data point is Michigan Sentiment (exp 95.7) and mercifully we don’t hear from any more Fed speakers.

It is difficult to broadly characterize this morning’s market activity, with the dollar mixed, bond yields slightly lower but equity markets slightly higher. My take is that after a week of modest overall movements, and with the Thanksgiving holiday approaching next week, there is little reason to believe we will see any currency move more than a few ticks in either direction before we head home for the weekend.

Good luck and good weekend
Adf

 

Removal of Tariffs

According to some in Beijing
Removal of tariffs’ the thing
That ought to diminish
And fin’lly help finish
The problems the trade war did bring

Another day, another story about progress in the trade talks. Given the complete lack of movement actually seen, a cynic might conclude that both sides have realized just talking about progress is probably as effective as making progress, maybe more so. After all, making progress requires both sides to make actual decisions. Talking about progress just hints that those decisions are being made. And let’s face it; the one thing at which politicians have proven especially inept is making decisions. At any rate, the news early this morning was that part of the elusive phase one deal would be simultaneous rollbacks of the current tariff schedules. If true, that is a great leap forward from simply delaying the imposition of new tariffs. But the key is, if true. At this point, it has become difficult to recognize the difference between actual progress and trial balloons. The one thing going for this story is it was put out by the Chinese, not President Trump. Of course, that could simply be a negotiating tactic trying to force Trump’s hand.

It should be no surprise that the market reacted quite positively to the story, with equity markets in Asia turning around from early losses to close higher on the day. While the Nikkei just clawed back to +0.1%, the Hang Seng finished higher by 0.6% and Australia’s ASX 200 gained 1.0% on the day. Europe has followed the trend with the DAX leading the way, +0.75%, and the rest of the Continent showing gains of between 0.2% (CAC) and 0.6% (IBEX). And of course, US futures turned higher on the news, now showing gains of approximately 0.5% across all three.

So risk is in vogue once again. Treasuries and Bunds have both sold off sharply, with yields in the 10-year space higher by roughly 6bps in both markets. And the dollar, as would be expected, is under further pressure this morning.

A trade truce cannot come soon enough for Germany, which once again released worse than expected data. This morning’s miss was IP, which fell 0.6% in September, and is down 4.3% Y/Y. So while yesterday’s Factory Orders seemed positive, they also seem like the outlier, not the trend. However, given the dollar’s overall performance this morning, it should be no surprise that the euro has edged higher, rising 0.1% as I type. But a step back for some perspective shows that the euro has actually done essentially nothing for the past month, trading within a range barely exceeding 1.0%. It will take more than just the occasional positive or negative economic print to change this story.

And perhaps there is a story brewing that will do just that. Several weeks ago there was a Bloomberg article about inflation in the Eurozone, specifically in Spain, that highlighted the dichotomy between the low rate of measured inflation, which in Spain is running at 1.0%, and the fact that the cost of home ownership and rent is rising at a double digit pace. It turns out that the European CPI measurements have rent as just 6.5% of the index and don’t even include the costs of home ownership. In contrast, those represent more than 30% of the US CPI measurement! And housing costs throughout Europe are rising at a much faster rate, something on the order of 3.0%+ over the past five years. In other words, a CPI basket constructed to include what Europeans actually spend their money on, rather than on some theoretical construct, would almost certainly have resulted in higher CPI readings and potentially would have prevented the poisonous negative interest rate conundrum.

With this in mind, and considering Madame Lagarde’s review of ECB policy, there is a chance, albeit a small one, that the ECB will consider changing the metric, and with a change in the metric, the need for further QE and NIRP will diminish greatly. That would be hugely euro positive! This is something to watch for going forward.

The other big news that just hit the tape was from the Bank of England, where while rates were left unchanged, two members of the MPC voted to cut rates by 25bps in a complete surprise. Apparently, there is growing concern inside the Old Lady that the recent weakening data portends further problems regardless of the election outcome. Of course, regarding the election, the fact that both the Tories and Labour are promising huge new spending plans, the need for low rates is clear. After all, it is much easier to borrow if interest rates are 0.5% than 5.0%! The pound, which had been trading modestly higher before the news quickly fell 0.4% and is now back toward the lower end of its recent trading range. Sometimes I think central banks do things simply to prove that they matter to the markets, but in this case, given the ongoing economic malaise in the UK, it does seem likely that a rate cut is in the offing.

As to the rest of the market, some of the biggest gainers this morning are directly related to the US-China trade story, with the offshore renminbi trading higher by 0.6% and back to its strongest level in three months’ time. In addition we have seen NOK rally 0.85%, which seems to be on the back of stronger oil and the fact that easing trade tensions are likely to further support the price of crude. Combining this with the fact that the krone has been mysteriously weak given its fundamentals, relatively strong economic growth and positive interest rates, it looks like a lot of short positions are getting squeezed out.

Finally, I would be remiss if I didn’t mention the Brazilian real, which yesterday tumbled 2.0% after a widely anticipated auction of off-shore oil drilling rights turned into a flop, raising just $17 billion, far less than the $26 billion expected. In fact, two of the three parcels had no bids, and no oil majors were involved. While they will certainly put them up for auction again, the market’s disappointment was clear. It should also be no surprise that the real is rebounding a bit on the open, currently higher by 0.5%.

On the data front this morning the only thing of note is Initial Claims (exp 215K) and there are two more Fed speakers on the agenda, Kaplan and Bostic. However, the plethora of speakers we have heard this week have all remained on message, things are good and policy is appropriate, but if needed we will do more.

And that’s really it. I expect we will continue to hear more about the trade talks and perhaps get a bit more clarity on the proposed tariff rollbacks. But it will take a lot to turn the risk story around, and as such, I expect the dollar will continue to be under pressure as the session progresses.

Good luck
Adf

 

A Currency Pact

The market is focused on trade
And hoping that progress is made
There’s news China’s backed
A currency pact
If tariff boosts can be delayed

Activity overnight was considerably more volatile than usual as conflicting stories regarding the US-China trade talks hit the tape. Risk was quickly jettisoned after a story from the South China Morning Post indicated that the talks, starting this morning in Washington, would be cut short. Shortly thereafter, the White House denied that report encouraging traders to buy back their stocks and sell bonds. Then Fox Business reiterated the original report less than a half hour later and the sell-off happened all over again. Finally, two positive reports helped equity markets recoup all of their overnight losses and took the shine off bonds. The first of those was that the currency pact that had been agreed between the US and China back in May (when chances of a big deal seemed realistic) was being dusted off and likely would be part of a mini-deal with the US agreeing to delay the imposition of new tariffs next Tuesday. And finally, President Trump has allowed US firms to sell non-critical technology to Huawei again, which was seen as additional thawing of the trade situation.

Of course, all this means is that we are back where we started, the trade talks are due to begin this morning and the Chinese delegation is scheduled to leave tomorrow evening. Arguably, the story that both sides are willing to agree on a currency pact as part of this round, and the indications that there are low level things that can be agreed, bode well for the rest of the week. But make no mistake, the major issues; IP theft, forced technology transfer and state subsidies are nowhere near being solved, and quite frankly, given they are integral to China’s economic model, seem unlikely ever to be solved. But for equity bulls, at least, hope springs eternal.

The FX impact in the end has been for a much softer dollar pretty much across the board. The idea is that if risk is to be embraced again, the higher yields available in Emerging Markets, as well as developed markets on a swapped basis, are the place to be. While the biggest mover overnight has been SEK, that is actually due to a surprising CPI report, with the annual pace of price increases rising to 1.5%, above the 1.3% expectation and a boon for the Riksbank who has been trying to normalize monetary policy by raising rates back to, and above, zero again. This report has given the market reason to believe that at their next meeting, in two weeks, while they won’t hike, they will continue to give guidance that a hike is coming before the end of the year. As such, SEK has rallied a solid 1.4%, although arguably, the trend is still for a weaker krone.

But the rest of the G10 has performed as well, with AUD, NZD and NOK all higher by 0.6% and the euro, despite disappointing data from both Germany and France, higher by 0.5%. Even the pound is higher this morning, up 0.35%, as the market awaits word on the outcome of a lunch meeting between Boris and Irish PM Leo Varadkar as they try to find a compromise. It seems to make the most sense that Varadkar is representing the EU given Ireland will be the nation most negatively impacted by a hard Brexit. My sense is we should start to hear about the outcome of this lunch around the time that US CPI is released, although I would read a delay as quite positive. The longer it takes; it seems the more likely that they are making headway on a compromise which would be very bullish for the pound. But until we actually see the news, the broad dollar trend is all we have.

In the EMG bloc we have also seen broad based strength paced this morning by HUF’s 0.7% rally. While much of this move is simply on the back of the euro’s rise, Hungary did have a quite successful auction of 5yr-15yr bonds which encouraged additional forint buying. Otherwise, the rest of the CE4 have moved directly in line with the euro and gains throughout Asia were only on the order of 0.2%. Of course, those markets closed before all the trade news had been released, so assuming nothing changes on that front (a difficult assumption) APAC currencies are likely to perform well tonight.

Turning to today’s session, we see our most important data of the week with CPI (exp 1.8%, 2.4% ex food & energy) as well as the usual Initial Claims data (220K). Regarding the former, Tuesday’s PPI report was surprisingly soft, with the headline number printing at -0.3% on the month and dragging the annual number down to just 1.4%. While there have been no forecast shifts amongst economists, there is still some lingering concern (hope?) amongst market participants that we could see a soft number here as well. The issue is a soft number would seem to open the door for the Fed to be far more aggressive in their rate cutting. Remember, Chairman Powell has repeated several times lately that the committee is watching the data closely and will do what they need to do in order to maintain the expansion while achieving their twin goals of stable prices and maximum employment. Obviously, with the Unemployment Rate at 3.5%, there is not much concern there. But falling inflation will ring alarm bells.

One last thing, though, regarding employment. The Initial Claims data is often a very good leading indicator of the overall employment situation, starting to rise well before the nonfarm numbers start to decline. Since the financial crisis, Initial Claims have tumbled from a peak of 665K in March 2009 to the low 200’s that we have seen for the past year. But recently, it appears that the number is beginning to creep higher again, with the 210k-215k readings that we had been seeing regularly now edging toward 220K and beyond. And while I know that seems extremely subtle, I merely caution that Initial Claims is a measure of job cuts, so if they are actually growing, that bodes ill for the economy’s future performance.

As to today, unless and until we hear more from the Trade talks or Boris, don’t look for much movement. But certainly the bias is to add risk for the day meaning the dollar should remain under pressure.

Good luck
Adf

 

Powell’s Fixation

The latest release on inflation
Revealed, despite Powell’s fixation,
That prices have yet
To pose a real threat
So, look for more accommodation

Much to the Fed’s chagrin, yesterday’s inflation data was disappointing, with CPI rising just 1.8% in May, below both expectations and their target. Of course, they don’t target CPI, but PCE instead, however, history has shown that PCE typically runs about 0.3%-0.4% below CPI. Regardless of the statistic they view, what is abundantly clear is that price pressures, at least as measured by the both the Labor and Commerce departments, remain well below the level the Fed believes is consistent with a healthy economy. And it is this outcome which continues to animate the investment community.

If we ignore the comments from the White House and simply focus on the economic data, it is pretty easy to see why expectations of a rate cut are growing rapidly. The employment situation seems to have peaked and started to reverse, price pressures remain quiescent and every Q2 GDP forecast is for a pretty significant slowdown relative to Q1’s 3.1% rate. Given what appears to be a weakening trajectory in the US economy (not even considering the possibility of bigger issues driven by a full-blown trade war) and given that the Fed has implicitly assumed the responsibility to manage economic growth, a rate cut might seem pretty tempting at this point. While next week’s meeting seems quite aggressive for this line of thought, July, where the market is pricing in nearly a 100% probability, makes sense barring a sudden upturn in the data.

One of the things that has been weighing on the inflation data has been the sharp decline in oil prices over the past two months. Even with today’s 3.5% rally on the news of two oil tanker attacks in the Persian Gulf, WTI is lower by more than 20% since the third week of April. And the oil data continues to point to softening demand and growing supplies. Slowing global growth is sapping that demand, but producers continue to drill as quickly as possible. So, the central bank logic continues to be; lower interest rates will help sustain economic growth which will push up demand for energy (read oil prices) and help inflation get back to their comfort zone. Alas, that has been shown to be a pretty tenuous path for central banks to achieve their desired results and there is limited reason to believe it will work this time. In the end, it is becoming abundantly clear that we are about to embark on the next round of monetary ease, even in those nations which never tightened from the last round.

The difference this time is that markets do not seem to be embracing that as a panacea for all their troubles. While equity markets are modestly higher this morning, that follows two lackluster sessions with small losses. We continue to hear pundits highlighting a Fed cut as an important driver, but slowing global growth, especially the continued weakness in China, means that earnings estimates continue to slide and with them, expected equity gains. Add to this mix the unraveling of a few stories (Tesla, government pressure on tech companies) and suddenly the future is not so bright. We have also seen continued concern registered via the Treasury market, where 10-year yields have edged lower again today, trading at 2.11% as I type. While this is a few bps higher than the recent lows, it remains more than 50bps below where we started 2019 and the trend remains firmly downward. And rightly so if inflation is going to continue to decline.

The FX market has weighed all this evidence and remains…confused. While the dollar remains stronger overall in 2019, it has given back some of its gains during the past several weeks, at least against most G10 currencies. Today is a perfect example of the mixed view we’ve seen lately with the euro and the pound within 0.05% of yesterday’s closing levels, albeit the euro is higher and the pound lower. We see Aussie down 0.3% but CHF up 0.3%. You get the picture, there is little in the way of a trend. And quite frankly, that is likely to remain the case until we actually see the Fed (or ECB or BOJ or BOE) actually change policy. Broadly, there is little evidence that global growth is going to improve in the short run, and so FX movement is going to be based on the relative rate of weakness we see in economic data and the corresponding interest rate assumptions that will follow.

Looking at this morning’s data, we really only see Initial Claims (exp 216K), which is generally not a market mover. However, given the heightened sensitivity to the employment situation based on last Friday’s weak NFP report, any uptick here (above, say 230K) might have an outsized impact. Arguably, tonight’s Chinese data in Retail Sales and IP is likely to have a much bigger impact. And that’s really the day. Once again it looks like limited activity and correspondingly, limited movement in markets.

Good luck
Adf

 

Markets Are Waiting

For right now most markets are waiting
To see if key risks are abating
Next week it’s the Fed
Then looking ahead
The G20 is captivating

The question is what we will learn
When Powell and friends next adjourn
The bond market’s sure
A cut has allure
To help them avoid a downturn

Markets this morning are pretty uninteresting as trader and investor focus turns to the two key upcoming events, next week’s FOMC meeting and the G20 meeting at the end of the month. At this point, it is fair to say that the market is pricing in renewed monetary ease throughout most of the world. While the Fed is in their quiet period, the last comments we heard were that they would act appropriately in the event economic growth weakened. Futures markets are pricing in a 50% chance of a cut next week, and a virtually 100% chance of a cut in July, with two more after that before the end of the year. While that seems aggressive to many economists, who don’t believe that the US economy is in danger of slowing too rapidly, the futures market’s track record is pretty good, and thus cannot be ignored.

But it’s not just the US where markets are pushing toward further rate cuts, we are seeing the same elsewhere. For example, last week Signor Draghi indicated that the ECB is ready to act if necessary, and if you recall, extended their rate guidance further into the future, assuring no rate changes until the middle of next year. Eurozone futures markets are pricing in a 10bp rate cut, to -0.50%, for next June. This morning we also heard from Banque de France President, and ECB Council member, Francois Villeroy that they have plenty of tools available to address slowing growth if necessary. A key pressure point in Europe is the 5year/5year inflation contract which is now pricing inflation at 1.18%, a record low, and far below the target of, “close to, but below, 2.0%”. In other words, inflation expectations seem to be declining in the Eurozone, something which has the ECB quite nervous.

Of course, adding to the picture was the news Monday night that the PBOC is loosening credit conditions further, targeting infrastructure spending. We also heard last week from PBOC Governor Yi Gang that the PBOC has plenty of tools available to fight slowing economic output. In fact, traveling around the world, it is easy to highlight dovishness at many central banks; Australia, Canada, Chile, India, Indonesia, New Zealand and Switzerland quickly come to mind as countries that have recently cut rates or discussed the possibility of doing so.

Once again, this plays to my constant discussion of the relative nature of the FX market. If every country is dovish, it becomes harder to discern which is the most hawkish dove. In the end, it generally winds up being a case of which nation has the highest interest rates, even if they are falling. As of now, the US continues to hold that position, and thus the dollar is likely to continue to be supported.

While the Fed meeting is obvious as to its importance, the G20 has now become the focal point of the ongoing trade situation with optimists looking for a meeting between Presidents Trump and Xi to help cool off the recent inflammation, but thus far, no word that Xi is ready to meet. There are many domestic political calculations that are part of this process and I have read arguments as to why Xi either will or won’t meet. Quite frankly, it is outside the scope of this note to make that call. However, what I can highlight is that news that a meeting is scheduled will be seen as a significant positive step by markets with an ensuing risk-on reaction, meaning stronger equities and a sell-off in the bond market, the dollar and the yen. Equally, any indication that no meeting will take place is likely to see a strong risk-off reaction with the opposite impacts.

Looking at the overnight data, there have been few releases with the most notable, arguably, Chinese in nature. Vehicle Sales in China fell 16.4%, their 11th consecutive monthly decline, which when combined with slowing monthly loan growth paints a picture of an economy that is clearly feeling some pain. The only other data point was Spanish Inflation, which printed at 0.8%, clearly demonstrating the lack of inflationary impulse in the Eurozone, even in one of the economies that is growing fastest. Neither of these data points indicates a change in the easing bias of central banks.

In the US this morning we see CPI data which is expected to print at 1.9% with the ex food& energy print at 2.1%. Yesterday’s PPI data was on the soft side, so there is some concern that we might see a lower print, especially given how rapidly oil prices have fallen of late. In the end, it is shaping up as another quiet day. Equity markets around the world have been slightly softer, but that is following a weeklong run of gains, and US futures are pointing to 0.3% declines at this point. Treasury yields are off their lowest point but still just 2.12% and well below overnight rates. And the dollar is modestly higher this morning, although I don’t see a currency that has moved more than 0.2%, indicating just how quiet things have been. Look for more of the same until at least next Wednesday’s FOMC announcement.

Good luck
Adf

Waiting to See

At midnight the US imposed
The tariffs that Trump had disclosed
We’re waiting to see
How President Xi
Responds, or if China’s now hosed

It’s all about the tariffs this morning as the US increased the tariff rate on $200 billion of Chinese imports to 25% as of midnight last night. China has promised to retaliate but has not yet announced what they will do. One of the problems they have is they don’t import that much stuff from the US, so they cannot match it exactly. There was an unintentionally humorous article in Bloomberg this morning that tried to outline the ‘powerful’ tools China has to respond; namely selling US Treasuries, allowing the CNY to weaken further, or stop buying US soybeans. The humor stemmed from the fact that they basically destroyed their own arguments on the first two, leaving just the soybean restriction as potentially viable and even that is problematic.

Consider the Treasury sales first. As the Chinese own ~$1.1 trillion, if they sold a significant chunk, they would almost certainly drive US yields higher as Treasury prices fell. But two problems with this are; they would undermine the value of whatever bonds they retained and more problematically, what else would they do with the dollars? After all, the Treasury market is pretty much the only one that is large enough to handle that type of volume on a low risk basis. I guess they could convert the dollars to euros and buy Italian BTP’s (there are a lot of those outstanding) but their risk profile would get significantly worse. And of course, selling all those dollars would certainly weaken the dollar, which would not help the Chinese economy one bit.

On the flip side, allowing the renminbi to weaken sharply presents an entirely different problem, the fact that the Chinese are terrified that they would lose control of the capital flow situation if it weakened too far. Remember in 2015, when the Chinese created a mini-devaluation of just 1.5%, it triggered a massive outflow as USDCNY approached 7.00. The Chinese people have no interest in holding their assets in a sharply depreciating currency, and so were quick to sell as much as they could. The resultant capital flows cost China $1 trillion in FX reserves to prevent further weakness in the currency. Given we are only 2% below that level in the dollar right now, it seems to me the Chinese will either need to accept massive outflows and a destabilizing weakening in the renminbi, or more likely, look for another response.

The final thought was to further restrict soybean imports from the US. While the Chinese can certainly stop that trade instantly, the problems here are twofold. First, they need to find replacement supplies, as they need the soybeans regardless of where they are sourced, and second, given the Swine virus that has decimated the pig herds in China, they need to find more sources of protein for their people, not fewer. So, no pork and less soybeans is not a winning combination for Xi. The point is, while US consumers will likely feel the pressure from increased tariff rates via higher prices, the Chinese don’t have many easy responses.

And let’s talk about US prices for a moment. Shouldn’t the Fed be ecstatic to see something driving prices higher? After all, they have been castigating themselves for ‘too low’ inflation for the past seven years. They should be cheering on the President at this stage! But seriously, yesterday’s PPI data was released softer than expected (2.2%, 2.4% core) and as much as both Fed speakers and analysts try to convince us that recently declining measured inflation is transitory, the market continues to price rate cuts into the futures curve. This morning brings the CPI data (exp 2.1%, 2.1% core) but based on data we have seen consistently from around the world, aside from the oil price rally, there is scant evidence that inflation is rising. The only true exceptions are Norway, where the oil driven economy is benefitting greatly from higher oil prices, and the disasters of Argentina and Turkey, both of which have tipped into classic demand-pull inflation, where too much money is chasing too few goods.

Turning to market performance, last night saw the Shanghai Composite rally 3.1% after the imposition of tariffs, which is an odd response until you understand that the government aggressively bought stocks to prevent a further decline. The rest of Asia was mixed with the Nikkei lower by a bit and the KOSPI higher by a bit. European shares are modestly higher this morning, on average about 0.5%, in what appears to be a ‘bad news is good’ scenario. After all, French IP fell more than expected (-0.9%) and Italian IP fell more than expected (-1.4%). Yes, German Trade data was solid, but there is still scant evidence that the Eurozone is pulling out of its recent malaise so weaker data encourages traders to believe further policy ease is coming.

In the FX market, there has been relatively little movement in any currency. The euro continues to trade either side of 1.12, the pound either side of 1.30 and the yen either side of 110.00. It is very difficult to get excited about the FX market given there is every indication that the big central banks are well ensconced in their current policy mix with no changes on the horizon. That means that both the Fed and the ECB are on hold (although we will be finding out about those TLTRO’s soon) while both the BOJ and PBOC continue to ease policy. In the end, it turns out the increased tariffs were not that much of a shock to the system, although if the US imposes tariffs on the rest of Chinese imports, I expect that would be a different story.

This morning we hear from Brainerd, Bostic and Williams, although at this point, patience in policy remains the story. The inflation data mentioned above is the only data we get (although Canadian employment data is released for those of you with exposures there), and while US equity futures are tilted slightly lower at this time, it feels like the market is going to remain in the doldrums through the weekend. That is, of course, unless there is a shocking outturn from the CPI data. Or a trade deal, but that seems pretty remote right now.

Good luck and good weekend
Adf