An Aura of Fear

An aura of fear’s been created
By actions both past and debated
Investors are scared
As they’re unprepared
Since models they’ve built are outdated

There is certainly more red than green on the screens this morning as the weekend brought us further complications across the board. The headline issue of note is the increased anxiety in Hong Kong as the ongoing protests spread to the airport forcing the cancelation of all flights there today, clearly a problem for a nation(?) that is dependent on international business and travel. President Xi is attempting to address this crisis with economic weapons rather than real ones, with the first shot fired by a state-owned company, China Huarong International Holdings Ltd, which instructed its employees to boycott Cathay Pacific Airways, the Hong Kong based airline. Given Hong Kong’s status as an open trading economy, it will have a great deal of difficulty handling boycotts from its major market.

Adding to the Chinese anxiety was word from the White House that September’s mooted trade talks may not happen at all as President Trump appears convinced that the Chinese need a deal more than the US does. As most of the escalation occurred late in the Asia day, the impact on markets there was more muted than might be expected. While it’s true the Hang Seng fell, -0.4%, Chinese stocks rallied as did Korea and India. At the same time, currency activity was less benign with the dollar continuing its strengthening pattern against most EMG currencies in APAC. For example, both INR and KRW are weaker by 0.55% this morning and the renminbi continues its measured decline, falling a further 0.1% with the dollar now trading above 7.10.

However, Europe has felt the brunt of the negative impact with early 1% rallies in equity markets there completely wiped out and both the DAX and CAC down by 0.4% as I type. Currency markets in Europe have also been less impacted with the euro edging just slightly lower, -0.1%, and the pound actually rallying 0.5% after Friday’s sharp sell-off.

But arguably, the real action has been in the bond market where Treasuries have rallied nearly a full point with the yield down 5bps to 1.68%. German bund yields are also lower, falling back to their record low of -0.59%. And adding to the risk-off feel has been the yen’s 0.5% rally, despite the fact that Japan was closed for Mountain Day, a national holiday. Finally, it wouldn’t be complete if we didn’t see pressure on US equity futures which are pointing to a 0.5% decline on the opening right now.

All told, I think it is fair to say that in the waning days of summer, risk is seen as a growing concern for investors. With that in mind, we do see some important data this week as follows:

Tuesday NFIB Small Biz 104.9
  CPI 0.3% (2.1% Y/Y)
  -ex food & energy 0.2% (1.7%Y/Y)
Thursday Initial Claims 214K
  Retail Sales 0.3%
  -ex autos 0.4%
  Empire State Mfg 2.75
  Philly Fed 10.0
  IP 0.1%
  Capacity Utilization 77.8%
  Business Inventories 0.1%
Friday Housing Starts 1.257M
  Building Permits 1.27M
  Michigan Sentiment 97.3

So, as you can see, Thursday is the big day, with a significant amount of data to be released. The ongoing conundrum of weakening manufacturing and still robust sales will, hopefully, be better explained afterwards, but my fear is as the global economy continues to suffer under the twin pressures of trade issues and declining inflation, that the path forward is lower, not higher.

In addition to this data, we see some important data from elsewhere in the world, notably Chinese IP (exp 5.8%) and Retail Sales (exp 8.6%) with both data points to be released Tuesday night and notably lower than last month’s results. It is abundantly clear that China is suffering a pretty major economic slowdown. The other noteworthy data point will be German Q2 GDP growth on Wednesday, currently forecast to be -0.1%, a serious issue for the continent and ample reason for the ECB to be more aggressive in their September meeting.

Wrapping it all up, there seems little reason for optimism in the near term as the key global issues, namely trade and growth, continue to falter. Central banks are also very obviously stretched to the limits of their abilities to smooth the process which means that unless there is a major change in governmental views on increased fiscal stimulation, slower growth is on the horizon. With it will come reduced risk and corresponding strength in haven assets like the yen, gold, Treasuries, Bunds and the dollar. While today offers no new information, these trends remain intact and show no signs of abating any time soon.

Good luck
Adf

Totally Thwarted

The data that China reported
Showed growth there somewhat less supported
Meanwhile in Hong Kong
The protesting throng
Has bullish views totally thwarted

Once again, risk is under pressure this morning as the litany of potential economic and financial problems continues to grow rather than recede. The latest concerns began last night when China reported slowing Investment (5.6%, below 6.1% expected) and IP (5.0%, weakest since 2002) data (although Retail Sales held up) which led to further concerns over the growth trajectory in the Middle Kingdom. PBOC Governor Yi Gang assures us that China has significant firepower left to address further weakness, but traders are a little less comforted. Adding to concerns are the ongoing protests in Hong Kong over potential new legislation which would allow extradition, to mainland China, of people accused of fomenting trouble in Hong Kong. That is a far cry from the separation that has been key in allowing Hong Kong’s financial markets and economy to flourish despite its close ties to Beijing.

The upshot is that stocks in Hong Kong (-0.65%) and Beijing (-1.0%) fell again, while interest rates in Hong Kong pushed even higher. This has resulted in a liquidity shortage in Hong Kong which is supporting the HKD (+0.2% this week and finally pushing away from the HKMA’s floor). The renminbi, meanwhile, has gone the other way, softening slightly since the protests began. Other signs of pressure were evident by the weakness in AUD and NZD, both of which rely heavily on the Chinese market as their primary export destinations.

Risk is also evident in the energy markets where there has been an escalation in the rhetoric between the US and Iran after the tanker attacks yesterday. This morning the US is claiming it has video proof that Iran was behind the attacks, although it has not been widely accepted as such. Oil prices, which rose sharply yesterday, have maintained those gains, although on the other side of the oil equation is the slowing economy sapping demand. In fact, the IEA is out with a report this morning that next year, production increases in the US, Canada and Brazil will significantly outweigh anemic increases in demand, further pressuring OPEC and likely oil prices overall. However, for the moment, the market concerns are focused on the increased tension in the Gulf with the possibility of a conflict there seeming to rise daily. Remember, risk assets tend to suffer greatly in situations like this.

Aside from the weaker Aussie (-0.25%) and Kiwi (-0.55%), we have also seen strength in the yen (+0.2%), a huge rally in Treasuries (10-year yield down 4.5bps), gold pushing higher (+1% and back to its highest level in three years) and the dollar, overall performing well. The latter is evidenced by the decline in the euro (-0.2%), the pound (-0.3%) and basically the rest of the G10 with similar declines.

This is the market backdrop as we await the last major piece of data before the FOMC meeting next week, this morning’s Retail Sales numbers. Current expectations are for a 0.6% increase, with the ex-autos number printing at 0.3%. But recall, last month economists were forecasting a significant gain and instead the headline number was negative. A similar result this morning would certainly add more pressure on Chairman Powell and friends next week. And that is really the big underlying story across all markets, just how soon are we likely to see the Fed or the ECB or the BOJ turn clearly dovish and ease policy.

It has become abundantly clear that inflation is the only data point that the big central banks are focusing on these days. And given their fixation on achieving a, far too precise, level of 2.0%, they are all failing by their own metrics. Wednesday’s US CPI data was softer than expected leading to reduced expectations for the PCE data coming at the end of the month. In the Eurozone, 5y/5y inflation swaps, one of the ECB’s key metrics for inflation sentiment, has fallen below 1.20% and is now at its lowest level since the contract began in 2003. And in Japan, CPI remains pegged just below 1.0%, nowhere near the target level. It is this set of circumstances, more than any questions on growth or employment, that will continue to drive monetary policy. With this in mind, one can only conclude that money is going to get easier going forward. I still don’t think the Fed moves next week, but I could easily see a 50bp cut in July. Regardless, markets are going to continue to pressure all central banks until policy rates are lowered, mark my words.

Regarding the impact of these actions on the dollar, it becomes a question of timing more than anything else. As I have consistently maintained, if the Fed starts to ease aggressively, you can be sure that the ECB and BOJ, as well as a host of other central banks, will be doing so as well. And in an environment of global weakness, I expect the dollar will remain the favored place to maintain assets.

As for today, a weak Retail Sales print is likely to see an initial sell-off in the dollar but look for it to reverse as traders focus on the impacts likely to be felt elsewhere.

Good luck and good weekend
Adf

 

Both Driver and Bane

Though Brexit and China remain
For markets, both driver and bane
The rest of the globe
Is worth a quick probe
Since some things are clearly germane

The markets are beginning to demonstrate Brexit fatigue as each day’s anxieties are no longer reflected in price movements. Broadly, a hard Brexit is still going to be bad and result in a significant decline in the pound, and a signed deal should see the pound rally somewhat, but the political machinations are just getting annoying at this point. Yesterday’s news was the House of Commons voted to seek a delay, although there has been no definition of how long that delay should be. It seems PM May is going to bring her deal to the floor one more time to see if she can get it passed this time:

Although her rep’s suffered much harm
The PM has rung the alarm
It’s time to get real
And vote for her deal
Perhaps the third time is the charm

The threat to the Brexiteers is a long delay opens the way for a reversal of the process, so this deal is better than that outcome. Of course, as I have written before, a delay requires unanimity from the rest of the EU and given the uncertainty of what can be gained by a delay at this time, it still appears there is a real risk of a hard Brexit, despite Parliament’s vote yesterday.

The latest news is a delay
In Brexit is what’s on the way
But will that resolve
The issues involved
Don’t count on it in any way

As to the pound, yesterday it fell, today it is rallying, but in general, it is still stuck. For the past three plus weeks it has traded between 1.30 and 1.33, albeit visiting both sides several times. Let’s move on.

The China trade story continues in slow motion as hopes of a late March meeting between President’s Xi and Trump have now faded to late April. Of note overnight was a new law passed by the Chinese government that alleges to address IP theft and international investment. While that certainly appears to be in response to US concerns, the lack of an enforcement mechanism remains a significant obstacle to concluding the process. However, it does appear to be a tacit admission that IP theft has been a part of the program in the past, despite vehement protestations on the part of the Chinese. But for now, this issue is headed to the back burner and will only matter to markets again when a deal seems imminent, or the talks collapse.

So what else is happening in the world? Well, global growth remains under pressure with data around the world indicating a slowdown is essentially universal. German production, US housing, Japanese inflation, you name it and the data is weaker than expected, and weaker than targeted. What this means is that pretty much every central bank around the world, at least in the developed world, has stopped thinking about policy normalization and is back on the easy money bus.

While Chairman Powell takes the brunt of the criticism for his quick volte-face last December, we have seen it everywhere. ECB President Draghi will have spent eight years at the helm and only cut rates and added monetary stimulus, all to achieve average growth of a whopping 1.5% or so with inflation remaining well below the target of 2.0% throughout his tenure. And, as he vacates the seat, he will leave his successor with further ease ongoing (TLTRO’s) and no prospect of a rate hike for years to come. But hey, perpetual debt-fueled slow growth and negative interest rates should be great for the stock market! What could possibly go wrong?

Meanwhile, the BOJ finds itself in exactly the same place as the ECB, lackluster growth, virtually no inflation and monetary policy set at extreme ease. Last night, Kuroda-san and his friends left policy unchanged (although two BOJ members voted for further ease) and said that the 2.0% inflation target remained appropriate and they were on track to achieve it…eventually. Alas, unless anti-aging medicines are available soon, I don’t think any of us will ever see that outcome. The yen’s response was to sink slightly further, falling 0.2%, and it is trading near its weakest levels of the year. However, in the big scheme of things, it remains right in the middle of its long-term trading range. My point is that we will need a stronger catalyst than more of the same from Kuroda to change things.

Other noteworthy currency stories are the weakness in HKD, as a glut of cash pouring into the island territory has driven interest rates there down significantly and opened up a carry trade opportunity. The HKMA has already spent close to $1 billion supporting the currency at the floor of its band over the past two weeks and seems likely to spend another $5-$7 billion before markets are balanced again.

Sweden has watched its krone depreciate steadily as slowing growth has caused a change in the Riksbank’s tune. In December, it was assumed they would be raising rates and exiting NIRP given the growth trajectory, which led to some modest currency strength. However, the reality has been the growth has never appeared and now the market has priced out any rate hikes. At the same time, FX traders have all unwound those long krone positions and pushed down the SEK by more than 4% this year. While it has rallied 0.4% overnight, it remains the key underperformer in the G10 this year. in fact, there is talk that the Riksbank may need to intervene directly in FX markets if things get much worse, although given the lack of inflation, it seems to me that is excessive.

So you see, there is a world beyond Brexit! As to today’s session, we see a bit more data from the US including: Empire Manufacturing (exp 10.0); IP (0.4%); Capacity Utilization (7.4%); JOLT’s Job Openings (7.31M); and Michigan Sentiment (95.3). This is a nice array of data which can help give an overall assessment as to whether the economy is continuing to sag, or if there are some possible bright spots. But unless everything is extraordinarily strong, I imagine that it will have limited direct impact and the dollar, which has been broadly under pressure today (after a rally yesterday) will continue to slide a little. Right now, there is no strong directional view as traders await the next central bank pronouncements. With the Fed, that comes next week. Until then, look for range trading.

Good luck and good weekend
Adf