Risk Off’s Set To Soar

Though April saw rallies galore
In equities, bonds and much more
The first days of May
Seem set to convey
A tale that risk-off’s set to soar

Last week finished on a down note for risk appetite, as we saw equities decline sharply on Friday, at least in those markets that were open, as well as the first cracks in the rebound in currencies vs. the dollar. This morning, those trends are starting to reassert themselves and we look to be heading toward a full-blown risk-off session.

A quick recap reminds us that Thursday, which was month end, saw a modest decline in equities which was easily attributed to portfolio rebalancing. After all, the April rally was impressive in any context, let alone the current situation where huge swathes of the global economy have been shuttered for more than a month. Friday, while a holiday in many markets around the world, saw far more significant equity market declines in countries that were open, with US markets falling between 2.5% and 3.2%. The weekend saw loads of stories highlighting the adage, ‘Sell in May and go away’, as an appropriate strategy this year. This was compounded by the far more bearish take by Warren Buffett regarding the US economy, where he explained that Berkshire Hathaway had exited its positions in airline stocks and instead had grown its cash pile to $138 billion. These are not the signs of confidence that investors crave, and so this morning, European equity markets are all much lower, led by the CAC (-4.0%) and DAX (-3.5%). While both China and Japan were closed for holidays, the Hang Seng had a terrible performance, falling 4.2%, and we saw sharp declines throughout the rest of Emerging Asia. Meanwhile, US futures markets are all lower by about 1% as I type.

I guess the question at hand remains the sustainability of last month’s price action. Right now, there are two key subjects where the underlying narrative is up for grabs; risk appetite and inflation. For the former, there is a large contingent who believe that the worst is over with respect to Covid-19, and its spread is abating. This means that over the course of the next few weeks and months, economies are going to reopen and that the situation will return to normal. There is much talk of a V-shaped recovery on the strength of the extraordinary efforts of central banks and governments around the world. The flip side of this argument is that despite the tentative steps toward reopening economies worldwide, the pace of recovery will be significantly slower than the pace of the decline. Concerns about how much of the economy has been irrevocably destroyed, with small businesses worldwide closing, and unemployment everywhere rising sharply, are rife. While we are still in the first half of Q1 earnings season, the data to date have not been pretty, and remember, the virus only became a significant issue in March, generally. This implies that the bearish view may have more legs, and it is the side I believe fits the fact pattern more accurately.

The inflation narrative is just as fierce, with the hard money advocates all decrying the central bank activity as opening the door to currency collapses and hyperinflation right around the corner. Meanwhile, the other side of the argument looks to the history of the past twenty years, where Japan has been printing yen and effectively monetizing its debt, while still unable to achieve any sort of inflation at all. In this case, I think the deflationistas make the best case for the near term, as the combination of unprecedented demand destruction as well as extraordinary growth in debt both point to slower growth and price declines in the short and medium term. However, that is not to ignore the fact that central banks have gone far outside the boundaries of what had traditionally been viewed as their bailiwick, and especially if we do see a debt jubilee of some type, where government debt owned by a nation’s own central bank is forgiven, then the opportunity for a significant inflationary outcome remains on the table. Just not right away.

Adding it up for today points to a reduced risk appetite as evidenced by those equity markets that are open. Bond markets have not played along as one might have expected, with Treasury yields lower by only 1bp, and Bund yields, along with the rest of Europe’s, actually higher this morning. That price action seems to be a response to concerns over the outcome of the German Constitutional Court’s ruling due tomorrow, regarding the legality of QE, the PEPP and, perhaps more critically, the necessity of the ECB to follow the Capital Key when purchasing bonds.

In the FX markets, the dollar has resumed its role as king of the world, rallying against every currency except the yen, which has essentially stayed flat. In the G10 space, NOK is the leading decliner, down 1.2% as oil prices are back on the schneid with WTI down 6.3% this morning. But we are seeing the pound (-0.8%) and Swedish krone (-0.7%) under significant pressure as well. GBP traders are looking ahead to Thursday’s BOE meeting where expectations are rising for another bout of policy ease, which fits in with the broad risk-off framework. The krone, meanwhile, is suffering as the Riksbank finds itself in a difficult spot regarding its QE program. It seems that despite its claims that it would be purchasing not only government bonds, but corporates as well, that is illegal based on the bank’s guiding legislation, and so there is some monetary policy confusion now undermining the currency.

In the EMG space, IDR (-1.45%) and RUB (-1.3%) have been the weakest performers, with the ruble suffering from both weaker oil prices as well as the recent increase in the pace of infections in Russia. While things there are already under pressure, they could well get worse before they get better. Meanwhile, Indonesia saw a reversal of half of last week’s currency gains as PMI data (27.5) highlighted just how weak the near-term looks for the island nation. While the bulk of the rest of the space has suffered on the back of the overall risk-off sentiment, there has been a later reversal in ZAR, where the rand is now higher by 0.75% after its PMI data surprised one and all by printing at 46.1, well above expectations and a very modest decline compared to March, albeit still in contractionary territory.

On the docket this week, we see a great deal of information culminating in the payroll report on Friday, and that is certain to be frightful.

Today Factory Orders -9.4%
Tuesday Trade Balance -$44.2B
  ISM Non-Manufacturing 37.8
Wednesday ADP Employment -20.5M
Thursday Initial Claims -3.0M
  Continuing Claims -19.6M
  Nonfarm Productivity -5.5%
  Unit Labor Costs 3.8%
  Consumer Credit $15.0B
Friday Nonfarm Payrolls -21.3M
  Private Payrolls -21.7M
  Manufacturing Payrolls -2.25M
  Unemployment Rate 16.0%
  Average Hourly Earnings 0.3% (3.3% Y/Y)
  Average Weekly Hours 33.5
  Participation Rate 61.6%

Source: Bloomberg

The range of expectations for the payroll number highlight the ongoing confusion, with estimates between -840K and -30.0M. Regardless, the number will be a record, of that there is no doubt.

In addition to all this data, we hear from the RBA and the BOE on Thursday, with further ease on the cards, and we get to hear from five different Fed speakers. In these unprecedented times, as policymakers struggle to keep up with the economic destruction, we will soon become inured to shocking data. But that will not make it any better, and I fear that shock or not, risk appetites will continue to diminish as the month, and year, progresses. This means that the dollar is likely to retain its bid for a while yet.

Good luck and stay safe
Adf

A Good Place

Said Clarida, “We’re in a good place”
With regard to the policy space
Later Bullard explained
That inflation’s restrained
And a rise above two he’d embrace

“At this point I think it would be a welcome development, even if it pushed inflation above target for a time. I think that would be welcome, so bring it on.” So said St Louis Fed President James Bullard, the uber-dove on the FOMC, yesterday when discussing the current policy mix and how it might impact their inflation goals. Earlier, Vice-chairman Richard Clarida explained that while things currently seem pretty good, the risks remain to the downside and that the Fed would respond appropriately to any unexpected weakness in economic data. Not wanting to be left out, BOE member Silvana Tenreyo, also explained that she could easily be persuaded to vote to cut rates in the UK in the event that the economic data started to slow at all.

My point is that even though the central banking community has not seemed to be quite as aggressive with regard to policy ease lately, the reality is that they are collectively ready to respond instantly to any sign that the current global economic malaise could worsen. And of course, the ECB is still expanding its balance sheet by €20 billion per month while the Fed is growing its own by more than $60 billion per month. Any thought that the central bank community was backing away from interventionist policy needs to be discarded. While they continue to call, en masse, for fiscal stimulus, they are not about to step back and reduce their influence on markets and the economy. You can bet that the next set of rate moves will be lower, pretty much everywhere around the world. The only question is which bank will move first.

This matters because FX is a relative game, where currency movement is often based on the comparison between two nations’ monetary regimes and outlooks, with everyone looking at the same data, and central bank groupthink widespread, every response to a change in the economic outlook will be the same; first cut rates, then buy bonds, and finally promise to never raise rates again! And this is why I continue to forecast the dollar to decline as 2020 progresses, despite its robust early performance, the Fed has more room to cut rates than any other central bank, and that will ultimately undermine the dollar’s relative value.

But that is not the case today, or this week really, where the dollar has been extremely robust even with the tensions in Iran quickly dissipating. I think one of the reasons this has been the case is that the US data keeps beating expectations. As we head into the payroll report later this morning, recall that; the Trade Deficit shrunk, ISM Non-Manufacturing beat expectations, Factory Orders beat expectations, ADP Employment beat expectations and Initial Claims fell more than expected. The point is that no other nation has seen a run of data that has been so positive recently, and there has been an uptick in investment inflows to the US, notably in the stock market, which once again traded to record highs yesterday. While this continues to be the case, the dollar will likely remain well bid. However, ultimately, I expect the ongoing QE process to undermine the greenback.

Speaking of the payroll report, here are the latest median expectations according to Bloomberg:

Nonfarm Payrolls 160K
Private Payrolls 153K
Manufacturing Payrolls 5K
Unemployment Rate 3.5%
Average Hourly Earnings 0.3% (3.1% Y/Y)
Average Weekly Hours 34.4
Canadian Change in Employment 25.0K
Canadian Hourly Wage Rate 4.2%
Canadian Unemployment Rate 5.8%
Canadian Participation Rate 65.6%

With the better than expected ADP report, market participants are leaning toward a higher number than the economists, especially given the overall robustness of the recent data releases. At this point, I would estimate that any number above 180K is likely to see some immediate USD strength, although I would not be surprised to see that ebb as the session progresses amid profit-taking by traders who have been long all week. Ironically, I think that a weak number (<130K) is likely to be a big boost for stocks as expectations of Fed ease rise, although the dollar is unlikely to move much on the outcome.

On the Canadian front, they have been in the midst of a terrible run regarding employment, with last month’s decline of 71.2K the largest in more than a decade. While inflation up north has been slightly above target, if we continue to see weaker economic data there, the BOC is going to be forced to cut rates sooner than currently priced (one cut by end of the year) as there is no way they will be able to resist the pressure to address slowing growth, especially given the global insouciance regarding inflation. While that could see the Loonie suffer initially, I still think the long term trend is for the USD to soften.

As to the rest of the world, the overnight session was not very scintillating. The dollar had a mixed performance overall, rising slightly against most of its G10 brethren, but faring less well against a number of EMG currencies, notably the higher yielders. For example, IDR was the big winner overnight, rising 0.6% to its strongest point since April 2018, after the central bank explained that it would not be intervening to prevent further strength and investors flocked to the Indonesian bond market with its juicy 5+% yield. Similarly, INR was also a winner, rising 0.4% as investors chased yield there as well. You can tell that fears over an escalation of the US-Iran conflict have virtually disappeared as these are two currencies that are likely to significantly underperform in the event things got hot there.

On the downside, Hungary’s forint was today’s weakest performer, falling 0.5% after PM Victor Orban explained that Hungary joining the euro would be “catastrophic”. While I agree with the PM, I think the market response is based on the idea that if the Hungarians were leaning in that direction, the currency would likely rally before joining.

On the G10 front, both French and Italian IP were released within spitting distance of their expectations and once again, the contrast between consistently strong US data and lackluster data elsewhere has weighed on the single currency, albeit not much as it has only declined 0.1%. And overall, the reality is that the G10 space has seen very little movement, with the entire block within 0.3% of yesterday’s closes. At this point, the payroll data will determine the next move, but barring a huge surprise in either direction, it doesn’t feel like much is in store.

Payables hedgers, I continue to believe this is a great opportunity as the dollar’s strength is unlikely to last.

Good luck and good weekend
Adf

Hawks Must Beware

The BOE finally sees
That Brexit may not be a breeze
So hawks must beware
As rates they may pare
For doves, though, this act’s sure to please

Two stories from the UK are driving the narrative forward this morning, at least the narrative about the dollar continuing to strengthen. The first, and most impactful, were comments from BOE member, Michael Saunders, who prior to this morning’s speech was seen as one of the more hawkish members of the MPC. However, he explained that regardless of the Brexit outcome, the continuing slowdown in the UK, may require the BOE to cut rates soon. The UK economy has been under considerable pressure for some time and the data shows no signs of reversing. The market has been pricing in a rate cut for a while, although BOE rhetoric, especially from Governor Carney, worked hard to keep the idea of the next move being a rate hike. But no more. If Saunders is in the cutting camp, you can bet that we will see action at the November meeting, even if there is another Brexit postponement.

And speaking of Brexit postponements, Boris won a court victory in Northern Ireland where a lawsuit had been filed claiming a no-deal Brexit was a breach of the Good Friday accords that brought peace to the country. However, the court ruled it was no such thing, rather it was simply a political act. The upshot is this was seen as a further potential step toward a no-deal outcome, adding to the pound’s woes. In the meantime, Johnson’s government is still at odds with Parliament, and is in the midst of another round of talks with the EU to try to get a deal. It seems the odds of that deal are shrinking, although I continue to believe that the EU will blink. The next five weeks will be extremely interesting.

At any rate, once Saunders’ comments hit the tape, the pound quickly fell 0.5%, although it has since regained a bit of that ground. However, it is now trading below 1.23, its weakest level in two weeks, and as more and more investors and traders reintegrate a hard Brexit into their views, you can look for this decline to continue.

Of course, the other big story is the ongoing impeachment exercise in Congress which has caused further uncertainty in markets. As always, it is extremely difficult to trade a political event, especially one without a specific date attached like a vote. As such, it is difficult to even offer an opinion here. Broadly, in the event President Trump was actually removed from office, I expect the initial move would be risk-off but based on the only other impeachment exercise in recent memory, that of President Clinton in 1998, it took an awful long time to get through the process.

Turning to the data, growth in the Eurozone continues to go missing as evidenced by this morning’s confidence data. Economic Confidence fell to its lowest level in four years while the Business Climate and Industrial Confidence both fell more sharply than expected as well. We continue to see a lack of inflationary impulse in France (CPI 1.1%) and weakness remains the predominant theme. While the euro traded lower earlier in the session, it is actually 0.1% higher as I type. However, remember that the single currency has fallen more than 4.4% since the end of June and nearly 2.0% in the past two weeks alone. With the weekend upon us, it is no surprise that short term positions are being pared.

Overall, the dollar is having a mixed session. The yen and pound are vying for worst G10 performers, but the movement remains fairly muted. It seems the yen is benefitting from today’s risk-on feeling, which was just boosted by news that a cease-fire in Yemen is now backed by the Saudis. It is no surprise that oil is lower on the news, with WTI down 1.1%, and equity market have also embraced the news, extending early gains. On the other side of the coin, the mild risk-on flavor has helped the rest of the bunch.

In the EMG space it is also a mixed picture with ZAR suffering the most, -0.35%, as concerns grow over the government’s plans to increase growth. Meanwhile, overnight we saw strength in both PHP and INR (0.45% each) after the Philippine central bank cut rates and followed with a reserve ratio cut to help support the economy. Meanwhile, in India, as the central bank removes restrictions on foreign bond investment, the rupee has benefitted.

But overall, movement has not been large anywhere. US equity futures are pointing higher as we await this morning’s rash of data including: Personal Income (exp 0.4%); Personal Spending (0.3%); Core PCE (1.8%); Durable Goods (-1.0%, 0.2% ex transport); and Michigan Sentiment (92.1). We also hear from two more Fed speakers, Quarles and Harker. Speaking of Fed speakers (sorry), yesterday vice-Chairman Richard Clarida gave a strong indication that the Fed may change their inflation analysis to an average rate over time. This means that they will be comfortable allowing inflation to run hot for a time to offset any period of lower than targeted inflation. Given that inflation has been lower than targeted essentially since they set the target in 2012, if this becomes official policy, you can expect prices to continue to gain more steadily, and you can rule out higher rates anytime soon. In fact, this is quite dovish overall, and something that would work to change my view on the dollar. Essentially, given the history, it means rates may not go up for years! And that is not currently priced into any market, especially not the FX market.

The mixed picture this morning offers no clues for the rest of the day, but my sense is that the dollar is likely to come under further pressure overall, especially if risk is embraced more fully.

Good luck and good weekend
Adf

A New Plan

While all eyes are turned toward Japan
Most central banks made a new plan
If there’s no trade truce
They’ll quickly reduce
Their base rates, stock markets, to fan

As the week comes to a close, the G20 Summit, and more importantly, tomorrow’s meeting between President’s Trump and Xi are the primary focus of investors and traders everywhere. While there is still great uncertainty associated with the meeting, at this point I would characterize the broad sentiment as an expectation that the two leaders will agree to resurrect the talks that were abruptly ended last month, with neither side imposing additional tariffs at this time. And quite frankly, that does seem like a pretty reasonable expectation. However, that is not nearly the same thing as assuming that a deal will be forthcoming soon. The negotiations remain fraught based on the simple fact that both nations view the world in very different ways, and what is SOP in one is seen as outside the bounds in the other. But in the meantime, I expect that markets will take the news that the situation did not deteriorate as a massive bullish signal, if only because the market has taken virtually everything that does not guaranty an apocalypse as a massive bullish signal.

At the same time, it has become abundantly clear that the major central banks have prepared for the worst and are all standing by to ease policy further in the event the talks fall apart. Of course, the major central banks have all been pretty clear lately that they are becoming increasingly comfortable with the idea that interest rates can remain much lower than historical levels without stoking inflation. In fact, there are still several central bankers, notably Kuroda-san and Signor Draghi, who feel they are fighting deflation. In fairness, the latest data, released just last night, highlights that runaway inflation is hardly a cause for concern as Japan clocked in at 1.1%, with core at 0.9% and the Eurozone reported inflation at a rip roaring 1.2%, with core at 1.1%. It has been data of this nature that stokes the imagination for further policy ease, despite the fact that both these central banks are already working with negative interest rates.

Now, it must be remembered that there are 18 other national leaders attending the meeting, and many of them have their own concerns over their current relationship with the US. For example, the president has threatened 25% tariffs on imported autos, a move which would have a significantly negative impact on both Germany (and by extension the EU) and Japan. For now, those tariffs are on hold, but it is also clear that because of the intensity of the US-China trade situation, talks about that issue with both the EU and Japan have been relegated to lower level officials. The concern there is that the original six-month delay could simply run out without a serious effort to address the issue. If that were to be the case, the negative consequences on both economies would be significant, however, it is far too soon to make any judgements on the outcome there.

And quite frankly, that is pretty much the entire story for the day. Equity markets remain mixed, with Asia in the red, although the losses were relatively modest at between 0.25% and 0.50%. Europe, meanwhile, has taken a more positive view of the outcome, with markets there rising between 0.2% and 0.5%, which has left US futures pointing to modest, 0.2%, gains at the opening. Bond prices are actually slightly lower this morning (yields higher) but remain within scant basis points of the lows seen recently. For example, Bunds are trading at -0.319%, just 1.5bps from its recent historic low while Treasuries this morning are trading at 2.017%, just 4bps from its recent multi-year lows. Perhaps the most remarkable news from the sovereign bond market was yesterday’s issuance by Austria of 100-year bonds with a coupon of just 1.20%! To my mind, that does not seem like a reasonable return for the period involved, but then, that may be very backwards thinking.

Consider that the acceptance of two policy changes that have been mooted lately, although are still quite controversial, would result in the Austrian issue as being seen as a virtual high-yield bond. Those are the abolition of cash and the acceptance of MMT as the new monetary policy framework. I can assure you that if when cash is abolished, interest rates will turn permanently negative, thus making a yield of 1.20% seem quite attractive, despite the century tenor. As to MMT, it could play out in one of two ways, either government bonds issued as perpetual 0.0% coupons, or the end of issuing debt completely, since the central banks would merely need to print the currency and pay it as directed. In this case too, 1.20% would seem awfully good.

Finally, let’s look at the FX markets this morning, where the dollar is modestly softer against most of its counterparts. But when I say modestly, I am not kidding. Against G10 currencies, the largest movement overnight was NZD’s 0.14% appreciation, with everything else + or – 0.1% or less. In other words, the FX markets are looking at the Trump-Xi meeting and waiting for the outcome before taking a view. Positions remain longer, rather than shorter, USD, but as I have written recently, that view is beginning to change on the back of the idea that the Fed has much further to ease than other central banks. While I agree that is a short-term prospect, I see the losses as limited to the 3%-5% range overall before stability is found.

Turning to the data picture, yesterday saw GDP print as expected at 3.1%. This morning we get Personal Income (exp 0.3%), Personal Spending (0.4%), Core PCE (1.6%). Chicago PMI (53.1) and Michigan Sentiment (98.0). However, barring an outlandish miss in anything, it seems unlikely there will be too much movement ahead of tomorrow’s Trump-Xi meeting. Look for a quiet one.

Good luck and good weekend
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

 

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

 

Here To Stay

Fed speakers are starting to say
That lower rates are here to stay
It’s not about trade
Instead they’re dismayed
Inflation just won’t go their way

Since the FOMC meeting two weeks ago, we have heard a steady stream of Fed speakers with one main theme, current interest rate policy is appropriate for the economy right now. While the market continues to price in another rate cut for later this year, and economists and analysts are starting to lean in that direction as well, the Fed remains resolute in their conviction that they don’t need to do anything. When asked about the trade situation, they mouth platitudes about how free trade helps everyone. When asked about political pressures, they insist they are immune to any such thing. These responses cannot be any surprise and are what every FOMC member would have said any time during the past century. However, there is one theme that is starting to coalesce that is different; the idea that interest rates are going to be permanently lower in the future than they have been in the past.

NY Fed President John Williams has highlighted the fact that recent research indicates r* (the theoretical neutral rate of interest) for the five main economies (US, UK, Japan, Eurozone and Canada) has fallen to just 0.5% from something more like 2.5% prior to the financial crisis. The implication is that there is no reason for interest rates to rise much further, if at all, from current levels as that would result in tightening monetary policy with a corresponding slowing of economic activity. If this is correct, it bodes ill for central banks abilities to help moderate future economic downturns. After all, if rates are near zero when an economy slows down, interest rate cuts are unlikely to have a material impact on the situation. Of course, this is what led to unconventional policies like QE and forward guidance, and we can only assume that every central bank is trying to think up new unconventional policies as those lose their efficacy. Do not be surprised if legislation appears that allows the Fed to purchase any assets it deems appropriate (stocks, real estate, etc.) in its efforts to address the next downturn. This is also why MMT has gained favor in so many places (although not the Fed) as it removes virtually all restrictions on spending and fiscal policy and reduces the role of monetary policy.

One other thing that seems incongruous is the precision with which the Fed believes is should be able to manage inflation. Inflation is a broad reading of price pressures over millions of items ranging from houses to pencils. Its measurement remains controversial and imperfect, at best. Pricing decisions continue to be made by the sellers of products, not by government fiat, and so the idea that the Fed can use a blunt tool like the general level of interest rates, to fine-tune price changes is, on the face of it, absurd. Is there really a difference between 1.6% and 2.0% inflation? I understand the implications regarding compounding, and of course the biggest issue is that cost of living adjustments in programs like Social Security and Medicare have enormous fiscal consequences and are entirely dependent on these measurements. But really, precision is a mistake in this case. It would be far more sensible, and achievable, for the Fed to target an inflation range like 1.5%-2.5% and be happy to focus on that rather than aiming for a target and miss it consistently in the seven years since it was defined.

Now back to markets. While Asian equity markets continued the US sell-off, it seems that the course has been run for now elsewhere. European shares are higher by between 0.5% and 1.0% this morning, while US futures are pointing to a 0.75% or so rebound at the open. At this point, all the tariff news seems to be in the market, and there continues to be a strong belief that a deal will get done, most likely in June when President’s Xi and Trump meet on the sidelines of the G20 meetings in Japan. The dollar continues to hold its own, although it has not been able to make any general headway higher lately.

In the currency market, this morning shows that risk is being tentatively reacquired as the yen falls (-0.35%) while EMG currencies edge higher (MXN +0.25%, INR +0.3%). The G10 beyond the yen is little changed, although most of those currencies suffered during yesterday’s equity rout. One thing that appears to be ongoing lately is that central banks have been slowly reducing the dollar portion of their holdings, taking advantage of the dollar’s recent strength to diversify their portfolios. That would certainly be a valid explanation for the dollar’s inability to make any substantive gains lately.

On the data front, overnight saw a disappointing German ZEW Index reading of -2.1 (exp +5.0), which implies that the hoped for rebound in Germany may still be a bit further away than the ECB is counting on. At the same time, UK labor markets continue to show robust strength with another 99K jobs created and average earnings continuing to grow at a solid 3.3% pace. However, neither of these data points had any impact on the FX market. In the US, the NFIB Business Index rose to 103.5, slightly better than forecast and demonstrating a resiliency in the small business psyche in this country. However, we don’t see any further data here today, and so if pressed, I would expect the FX market to be uninspiring. If equity markets manage to maintain their rebound, then I would expect a modicum of dollar weakness as investors rush back into the EMG bloc, but I think it far more likely that there is little movement overall.

Good luck
Adf