Mere Nonchalance

On Friday we learned the US
Grew faster, but not to excess
The market response
Was mere nonchalance
In stocks, but the buck did depress

This morning in Europe, however,
The outcome did not seem as clever
Growth there keeps on slowing
Thus Mario’s going
To need a new funding endeavor

If you needed a better understanding of why the dollar, despite having declined ever so modestly this morning, remains the strongest currency around, the contrasting data outcomes from Friday in the US and this morning in the Eurozone are a perfect depiction. Friday saw US GDP in Q1 rise 3.2% SAAR, significantly higher than expected, as both trade and inventory builds more than offset softer consumption. Whatever you make of the underlying pieces of the number, it remains a shining beacon relative to the rest of the G10. Proof positive of that difference was this morning’s Eurozone sentiment data, where Business Confidence fell to 0.42, its weakest showing in nearly three years while Economic Sentiment fell to 104, its sixteenth consecutive decline and weakest since September 2016.

It is extremely difficult to look at the Eurozone data and conclude that the ECB is not going to open the taps again soon. In fact, while the official line remains that no decisions have been made regarding the terms of the new TLTRO’s that are to be offered starting in June, it is increasingly clear that those terms are going to be very close to the original terms, where banks got paid to borrow money from the ECB and on-lend it to clients. The latest comment came from Finnish central bank chief Ollie Rehn where he admitted that hopes for a rebound in H2 of this year are fading fast.

With that as the backdrop, this week is setting up for the chance for some fireworks as we receive a great deal of new information on both the economic and policy fronts. In fact, let’s take a look at all the information upcoming this week right now:

Today Personal Income 0.4%
  Personal Spending 0.7%
  PCE 0.2% (1.6% Y/Y)
  Core PCE 0.1% (1.7% Y/Y)
Tuesday Employment Cost Index 0.7%
  Case-Shiller Home Prices 3.2%
  Chicago PMI 59.0
Wednesday ADP Employment 181K
  ISM Manufacturing 55.0
  ISM Prices Paid 55.4
  Construction Spending 0.2%
  FOMC Rate Decision 2.5% (unchanged)
Thursday BOE Rate Decision 0.75% (unchanged)
  Initial Claims 215K
  Unit Labor Costs 1.4%
  Nonfarm Productivity 1.2%
  Factory Orders 1.5%
Friday Nonfarm Payrolls 181K
  Private Payrolls 173K
  Manufacturing Payrolls 10K
  Unemployment Rate 3.8%
  Participation Rate 62.9%
  Average Hourly Earnings 0.3% (3.4% Y/Y)
  Average Weekly Hours 34.5
  ISM Non-Manufacturing 57.0

So, by Friday we will have heard from both the Fed and the BOE, gotten new readings on manufacturing and prices, and updated the employment situation. In addition, on Friday, we have four Fed speakers (Evans, Clarida, Williams and Bullard) as the quiet period will have ended.

Looking at this morning’s data, the PCE numbers continue to print below the Fed’s 2.0% target and despite recently rising oil prices, there is no evidence that is going to change. With the employment situation continuing its robust performance, the Fed is entirely focused on this data. As I wrote on Friday, it has become increasingly clear that the Fed’s reaction function has evolved into ‘don’t even consider raising rates until inflation is evident in the data for a number of months.’ There will be no more pre-emptive rate hikes by Jay Powell. Inflation will need to be ripping higher before they consider it. And in fact, as things progress, it is entirely possible that the Fed does cut rates despite ongoing solid GDP growth, if they feel inflation is turning lower in a more protracted manner. As of Friday, the futures market had forecast a 41% probability of a Fed rate cut by the end of 2019. In truth, I am coming around to the belief that we could see more than one cut before the year ends, especially if we see any notable slowing in the US economy. (At this point, the Fed’s only opportunity to surprise the market dovishly is if they do cut rates on Wednesday, (although in the wake of the GDP data, that seems a little aggressive.)

The real question is if the Fed turns more dovish, will that be a dollar negative. One thing for certain is that it won’t be an equity negative, and it is unlikely to have a negative impact on Treasuries either, but by rights, the dollar should probably suffer. After all, a more dovish Fed will offset the dovishness emanating from other nations.

The problem with this thesis is that it remains extremely expensive for speculators to short the dollar given the still significantly higher short-term rates in the US vs. anywhere else in the G10. And so, we are going to need to see real flows exiting the US to push the dollar lower. Either that, or a change in the narrative that the Fed, rather than being on hold, is getting set to take rates back toward zero. For now, neither of those seem very likely, and so significant dollar weakness seems off the table for the moment. As such, while it was no surprise that the dollar fell a bit on Friday as profit taking was evident after a strong run higher, the trend remains in the dollar’s favor, so hedgers need to take that into account. And for all you hedgers, given the significant reduction in volatility that we have witnessed during the past several months, options are an increasingly attractive alternative for hedging. Food for thought.

Good luck
Adf

Impugned

The continent east of the ‘pond’
Makes many things of which we’re fond
But data of late
Impugned their growth rate
Just when will Herr Draghi respond?

There is an ongoing dichotomy in the economic landscape that I continue to have difficulty understanding. Pretty much every day we see data that describes slowing economic activity from multiple places around the world. Sales are slowing, manufacturing is ebbing, or housing markets are backing away from their multiyear explosion higher. And all this is occurring while in the background, international trade agreements, that have underpinned the growth in global trade for the past forty years, are also under increasing pressure. And yet, equity markets around the world seemingly ignore every piece of bad news and, when there is a glimmer of hope, investors grab hold and markets rally sharply.

Arguably the best explanation is that the dramatic change in central bank policies have evolved from emergency measures to the baseline for activity. Following that line of thought and adding the recent central bank response to increased ‘volatility’ (read declines) as seen in December, it has become apparent that economic fundamentals no longer matter very much at all. While the central bankers all pay lip service to being data dependent, the only data that seems to matter is the latest stock market close. For someone who has spent a career trying to identify macroeconomic risks and determine the best way to manage them, I’m concerned that fewer and fewer investors view that as important. I fear that when the next downturn comes, and I remain highly confident there will be another economic downturn too large to ignore, we will be wistful for the good old days of 2008-09, when recession was ‘mild’.

Please excuse my little rant, but it continues to be increasingly difficult to justify market movements when looking at economic data. For example, last night we learned that PMI data throughout the Eurozone was confirmed to be abysmal in February (Germany 47.6, Italy 47.7, Spain 49.9, Eurozone overall 49.2) and has led to a reduced forecast for Eurozone GDP growth in Q1 of just 0.1%. Naturally, every equity market in Europe is higher on the news. Even the euro has edged higher, climbing 0.15% (albeit after falling 0.4% in yesterday’s session). Adding to the malaise, Eurozone core inflation unexpectedly fell to 1.0%, a long way from the ECB’s target of just below 2.0% and showing no signs of increasing any time soon.

With the March ECB meeting on the docket for next week, the discussion has focused on how Signor Draghi will justify his ongoing efforts to normalize monetary policy amid weakening growth. His problem is that he has downplayed economic weakness as temporary, but it has lingered far longer than anticipated. It is widely expected that the new economic forecasts will point to further slowing, and this will just make his task that much more difficult. Ultimately, the market is not pricing in any interest rate hikes until June 2020, and there is a rising expectation that TLTRO’s are going to be rolled over with an announcement possible as soon as April’s meeting. Draghi’s term as ECB president ends in October, and it is pretty clear that he will have never raised interest rates during his eight years at the helm. The question is, will his successor get a chance in the next eight years? Once again, I have looked at this information, compared it to the ongoing Fed discussion, and come out on the side of the euro having further to decline. We will need to see much stronger growth and inflation from Europe to change that view.

Other than that discussion, there is very little of real note happening today. Chinese Caixin PMI data was slightly better than expected at 49.9, which has been today’s argument for adding risk, but recall just yesterday how weak the official statistic was. As with everything from China, it is difficult to understand the underlying story as the data often has inconsistencies. But this has been enough to create a risk-on atmosphere with Treasuries falling (10-year yields +2bps) and JPY falling (-0.4%) while commodities and equities rally. Gold, naturally, is the exception to this rule as it has softened this morning.

Regarding trade, today’s news stories discuss documents being prepared for an eventual Trump-Xi summit later this month. If there really is a deal, that will be a global positive as it would not only clear up US-Chinese confusion, but it would bode well for all the other trade discussions that are about to begin (US-Japan, US-Europe). Hopefully, President Trump won’t feel the need to walk away from this deal.

Looking back at yesterday’s session, we saw Q4 GDP actually grew 2.6%, a bit stronger than expected, which arguably helped underpin the dollar’s performance. We also learned that the House Finance Committee is equally unconcerned over what the Fed is doing, as Chairman Powell’s testimony was a complete sleeper. So, with no oversight, the Fed will simply motor along. At this point, it would be remarkable if the Fed raised rates again in 2019, and unless Core PCE goes on an extended run higher, perhaps even in 2020. I have a feeling that we are going to see this flat yield curve for a long time.

This morning brings a bunch more data with both December and January numbers due. Looking at the January data, the only forecast I find is Personal Income (exp 0.3%) but Personal Spending, and PCE are both due as well. At 10:00 we see ISM Manufacturing (55.5) which is now biased higher after yesterday’s Chicago PMI printed at a robust 64.7, its strongest print in 18 months. With risk being embraced today, I think we are far more likely to see the dollar edge lower than not by the end of the day.

Good luck and good weekend
Adf

 

Growth Had Decreased

While Draghi and his ECB
Evaluate their policy
The data released
Showed growth had decreased
A fact they’re unhappy to see

With limited new information on the two key stories, Brexit and the trade war, the market has turned its attention to this morning’s Flash PMI data for Europe, which it turns out was not very good. French, German and Eurozone numbers (the only ones released) all printed much lower than expected with German Manufacturing dipping to 49.9, a concerning signal about future growth there. The euro responded as would be expected, falling 0.3% and helping to drag down many other currencies vs. the dollar.

This is the backdrop to today’s ECB meeting, further signs of slowing Eurozone growth, which cannot be helping the internal debate about slowly normalizing policy. The policy statement will be released at 7:45 this morning and is expected to show no changes in rates or the balance sheet. Remember, the most recent guidance has been that rates would remain on hold “at least through the end of summer” and that maturing securities would be reinvested. But today’s data has to weigh on that process. As I have argued in the past, there is, I believe, a vanishingly small probability that the ECB raises rates at all. And that is their big problem. If the current slowdown turns into a recession, exactly what else can the ECB do to support the economy there? Nothing! I’m sure they will restart QE, and it is a given that they will roll over the TLTRO’s this year, but will it be enough to change the trajectory? Mario will be pretty happy to turn over the reins to someone else this October as the next ECB President is likely to have a very unhappy time, with lots of problems and lots of blame and not many tools available to address things. This remains the key reason I like the euro to decline as 2019 progresses.

Away from that, though, the Brexit story is waiting for Parliamentary votes next week regarding the elimination of the no-deal choice, which has been seen as a distinct GBP positive. While it is a touch softer this morning, -0.2%, the pound is getting the benefit of every doubt right now. As I wrote yesterday, maintain a fully hedged positions as the risk of a sharp decline has not yet disappeared by any stretch.

There has been no discussion on trade, no US data and no Fed speakers, so traders and investors are running out of cues on which to deal, at least for now. Overall, the dollar is firmer this morning, but that is really just offsetting yesterday’s weakness. In fact, it is very difficult to look at the current situation and anticipate any substantive price action in the near term. While the ECB could surprise by easing policy, that seems highly unlikely for now. However, if we get an even gloomier outlook from Draghi at the 8:30 press conference, I could see the euro declining further. But absent that, it is shaping up to be quite a dull session.

Good luck
Adf