No Panacea

Fiscal stimulus
Is no panacea, but
Welcome nonetheless

At least by markets
And politicians as well
If it buys them votes!

Perhaps the MMTer’s are right, fiscal rectitude is passé and governments that are not borrowing and spending massive amounts of money are needlessly harming their own countries. After all, what other lesson can we take from the fact that Japan, the nation with the largest debt/GDP ratio (currently 236%) has just announced they are going to borrow an additional ¥26 trillion ($239 billion) to spend in support of the economy, and the market response was a stock market rally and a miniscule rise in JGB yields of just 1bp. Meanwhile, the yen is essentially unchanged.

Granted, despite the fact that this equates to nearly 5% of the current GDP, given JGB interest rates are essentially 0.0% (actually slightly negative) it won’t cost very much on an ongoing basis. However, at some point the question needs to be answered as to how they will ever repay all that debt. It seems the most likely outcome will be some type of explicit debt monetization, where the BOJ simply tears up maturing bonds and leaves the cash in the economy, thus reducing the debt and maintaining monetary stimulus. However, macroeconomic theory explains following that path will result in significant inflation. And of course, that’s the crux of the MMT philosophy, print money aggressively until inflation picks up.

The thing is, every time this process has been followed in the past, it basically destroyed the guilty country. Consider Weimar Germany, Zimbabwe and even Venezuela today as three of the most famous examples. And while inflation in Japan is virtually non-existent right now, that does not mean it cannot rise quite rapidly in the future. The point is that, currently, the yen is seen as a safe haven currency due to its strong current account surplus and the fact that its net debt position is not terribly large. But the further down this path Japan travels, the more likely those features are to change and that will be a distinct negative for the currency. Of course, this process will take years to play out, and perhaps something else will come along to change the trajectory of these long term processes, but the idea that the yen will remain a haven forever needs to be constantly re-evaluated. Just not today!

In the meantime, markets remain in a buoyant mood as additional comments from the Chinese that both sides remain in “close contact”, implying a deal is near, has the bulls ascendant. So Tuesday’s fears are long forgotten and equity markets are rallying while government bond yields edge higher. As to the dollar, it is generally on its back foot this morning as well, keeping with the theme that risk is ‘on’.

Looking at specific stories, there are several of note today. Overnight, Australia released weaker than expected GDP figures which has reignited the conversation about the RBA cutting rates in Q1 and helped to weaken Aussie by 0.3% despite the USD’s overall weakness. Elsewhere in the G10, British pound traders continue to close out short positions as the polls, with just one week left before the election, continue to point to a Tory victory and with it, finality on the Brexit issue. My view continues to be that the market is buying pounds in anticipation of this outcome, and that once the election results are final, there will be a correction. It is still hard for me to see the pound much above 1.34. However, there are a number of analysts who are calling for 1.45 in the event of a strong Tory majority, so be aware of the differing viewpoints.

On the Continent, German Factory Order data disappointed, yet again, falling 0.4% rather than rising by a similar amount as expected. This takes the Y/Y decline to 5.5% and hardly bodes well for a rebound in Germany. However, the euro has edged higher this morning, up 0.15% and hovering just below 1.11, as we have seen a number of stories rehashing the comments of numerous ECB members regarding the idea that negative interest rates have reached their inflection point where further cuts would do more harm than good. With the ECB meeting next Thursday, expectations for further rate cuts have basically evaporated for the next year, despite the official guidance that more is coming. In other words, the market no longer believes the ECB can will ease policy further, and the euro is likely edging higher as that idea makes its way through the market. Nonetheless, I see no reason for the euro to trade much higher at all, especially as the US economy continues to outperform the Eurozone.

In the emerging markets, the RBI surprised the entire market and left interest rates on hold, rather than cutting by 25bps as universally expected. The rupee rallied 0.35% on the news as the accompanying comments implied that the recent rise in inflation was of more concern to the bank than the fact that GDP growth was slowing more rapidly than previously expected. In a similar vein, PHP is stronger by 0.5% this morning after CPI printed a bit higher than expected (1.3%) and the market assumed there is now less reason for the central bank to continue its rate cutting cycle thus maintaining a more attractive carry destination. On the other side of the ledger, ZAR is under pressure this morning, falling 0.5% after data releases showed the current account deficit growing more rapidly than expected while Electricity production (a proxy for IP) fell sharply. It seems that in some countries, fiscal rectitude still matters!

On the data front this morning, we see Initial Claims (exp 215K), Trade Balance (-$48.5B), Factory Orders (0.3%) and Durable Goods (0.6%, 0.6% ex transport). Yesterday we saw weaker than expected US data (ADP Employment rose just 67K and ISM Non-Manufacturing fell to 53.9) which has to be somewhat disconcerting for Chairman Powell and friends. If today’s slate of data is weak, and tomorrow’s NFP report underwhelms, I think that can be a situation where the dollar comes under more concerted pressure as expectations of further Fed rate cuts will build. But for now, I am still in the camp that the Fed is on hold, the data will be mixed and the dollar will hold its own, although is unlikely to rally much from here for the time being.

Good luck
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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
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Decidedly Slowed

In China they’ve reached a crossroad
As growth has decidedly slowed
The knock-on effects
Are not too complex
Watch markets, emerging, erode

Once again, the overnight data has disappointed with signs of further slowing in the global economy rampant. The headline was in China, where their big three data points; Fixed Asset Investment (5.2%), Industrial Production (4.7%) and Retail Sales (7.2%) all missed expectations badly. In fact, all of these are at or near historic low levels. But it was not just the Chinese who exposed economic malaise. Japanese GDP printed at just 0.2% in Q3, well below the expected 0.9% outcome. And how about Unemployment in Australia, which ticked higher to 5.3%, adding to concern over the economy Down Under and driving an increase in bets that the RBA will cut rates again next month. In fact, throughout Asia, all the data was worse than expected and that has had a negative impact on equity markets as well as most commodity markets.

Of course, adding to the economic concern are the ongoing protests in Hong Kong, which seemed to take a giant step forward (backward?) with more injuries, more disruption and the resulting closure of schools and work districts. Rumors of a curfew, or even intervention by China’s armed forces are just adding to the worries. It should be no surprise that we have seen a risk off attitude in these markets as equity prices fell (Nikkei -0.75%, Hang Seng -0.95%) while bonds rallied (Treasuries -5bps, JGB’s -3bps, Australian Treasuries -10bps), and currencies performed as expected with AUD -0.75% and JPY +0.3%. Classic risk-off.

Turning to Europe, Germany managed to avoid a technical recession, surprising one and all by releasing Q3 GDP at +0.1% although they did revise Q2 lower to -0.2%. While that is arguably good news, 0.4% annual growth in Germany is not nearly enough to support the Eurozone economy overall. And the bigger concern is that the ongoing manufacturing slump, which shows, at best, slight signs of stabilizing, but no signs of rebounding, will start to ooze into the rest of the data picture, weakening domestic activity throughout Germany and by extension throughout the entire continent.

The UK did nothing to help the situation with Retail Sales falling 0.3%, well below the expected 0.2% rise. It seems that the ongoing Brexit saga and upcoming election continue to weigh on the UK economy at this point. While none of this has helped the pound much, it is lower by 0.1% as I type, it has not had much impact overall. At this point, the election outcome remains the dominant story there. Along those lines, Nigel Farage has disappointed Boris by saying his Brexit party candidates will stand in all constituencies that are currently held by Labour. The problem for Boris is that this could well split the Tory vote and allow Labour to retain those seats even if a majority of voters are looking for Brexit to be completed. We are still four weeks away from the election, and the polls still give Boris a solid lead, 40% to 29% over Labour, but a great deal can happen between now and then. In other words, while I still expect a Tory victory and Parliament to pass the renegotiated Brexit deal, it is not a slam dunk.

Finally, it would not be appropriate to ignore Chairman Powell, who yesterday testified to a joint committee of Congress about the economy and the current Fed stance. It cannot be a surprise that he repeated the recent Fed mantra of; the economy is in a good place, monetary policy is appropriate, and if things change the Fed will do everything in its power to support the ongoing expansion. He paid lip service to the worries over the trade talks and Brexit and global unrest, but basically, he spent a lot of time patting himself on the back. At this point, the market has completely removed any expectations for a rate cut in December, and, in fact, based on the Fed funds futures market, there isn’t even a 50% probability of a cut priced in before next June.

The interesting thing about the fact that the Fed is clearly on hold for the time being is the coincident fact that the equity markets in the US continue to trade at or near record highs. Given the fact that earnings data has been flattish at best, there seems to be a disconnect between pricing in equity markets and in interest rate markets. While I am not forecasting an equity correction imminently, at some point those two markets need to resolve their differences. Beware.

Yesterday’s CPI data was interesting as core was softer than expected at 2.3% on the back of reduced rent rises, while headline responded to higher oil prices last month and was higher than expected at 1.8%. As to this morning, PPI (exp 0.3%, 0.2% core) and Initial Claims (215K) is all we get, neither of which should move the needle. Meanwhile, Chairman Powell testifies to the House Budget Committee and seven more Fed speakers will be at a microphone as well. But given all we have heard, it beggar’s belief any of them will change from the current tune of everything is good and policy is in the right place.

As to the dollar, it is marginally higher overall this morning, and has been trading that way for the past several sessions but shows no signs of breaking out. Instead, I expect that we will continue to push toward the top end of its recent trading range, and stall lacking impetus for the next leg in its movement. For that, we will need either a breakthrough or breakdown in the trade situation, or a sudden change in the data story. As long as things continue to show decent US economic activity, the dollar seems likely to continue its slow grind higher.

Good luck
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Flummoxed

Kuroda flummoxed
As inflation fails to rise
How low can rates go?

You know things are tough in Japan, at least for the BOJ, when a sales tax hike, that in the last go-round increased inflation by nearly two percentage points, had exactly zero impact on the latest CPI readings. Last night’s Tokyo CPI data was released at 0.4%, unchanged from the September data and well below the 0.7% expected. And that’s an annual number folks, not the monthly kind. It seems that the government’s efforts to help young families by reducing tuition for pre-school and kindergarten to zero was enough to offset the impact of the rise in the Goods and Services Tax, essentially the Japanese VAT. However, the upshot is that CPI inflation, at least in Tokyo which is seen as a harbinger for the nation as a whole, remains nonexistent. Now for the average Japanese family, one would think that is a good thing. After all, who wants the prices of the stuff they need to buy rising all the time. But for the BOJ, who doggedly continues to believe that unless inflation rises to 2.0% the economy will implode, it is merely the latest sign that central banks are out of ammunition.

The yen’s response to this ongoing futility was to rise ever so marginally, not quite 0.1%, but that has not changed its more recent trend. In the past two months, the yen has weakened a solid 4.4%. But the picture changes if you step a bit further back for more perspective. Over the past six months, since late April, the yen has actually strengthened nearly 3.0%. So, which is it; is the yen getting stronger or weaker? In fact, I would argue that it is doing neither, but rather the yen is in a major long-term consolidation pattern (a triangle formation for the technicians out there) and that barring a major exogenous shock like a GFC2, the yen is likely to continue trading in an even narrower range going forward, perhaps for as long as the next year. The thing is, these triangle patterns tend to resolve themselves with a very significant break-out move when they end. At this stage, there is no way to discern which direction that will follow, and , as I said, it is probably a year away, but it is quite realistic to expect that the doldrums we have experienced in the yen for the past many years is likely to end. Perhaps the US presidential election will be the catalyst to cause a change, at least the timing will be right.

For hedgers, the best advice I can offer is to extend the tenor of your hedges as much as you can. This is especially true for receivables hedgers, where the carry is in your favor. But the reality is that even a payables hedger needs to consider the benefits of hedging in an extremely low volatility environment as opposed to waiting until a breakout, which may result in the yen jumping higher by as much as 5%-10%, completely outweighing the current cost of carry.

Three Latin American nations
Have populist administrations
Brazil, on the right
Of late’s shining bright
But fear’s grown ‘round Argie’s relations

For the past two weeks, the story in Brazil has been one of unadulterated joy, at least for investors. The real has rallied more than 5.0% in that time as President Jair Bolsonaro, the right-wing firebrand, has been able to push pension reform through congress there. That has been warmly received by markets as it implies that Brazil’s long-term finances are likely to remain under control. The pension system had been massively underfunded and was far too generous relative to the government’s ability to pay. Correcting these problems is seen as crucial to allowing Brazil to move forward with other investments to help the nation’s economy and productivity. Again, a glance at the charts shows that USDBRL has formed a triple top formation and is already accelerating lower. Quite frankly, it would not surprise to see BRL strengthen to 3.70 before this movement is over.

Turning to Mexico, it too has performed extremely well over the past two months, rallying more than 5% during that time. It is interesting that the markets have been extremely patient with AMLO as, since his initial action to cancel the Mexico City Airport construction, which was seen in an extremely negative light, his policies have been far less disruptive than most investors feared. Clearly, Mexico has been a beneficiary of the ongoing US-China trade war as companies seek low cost manufacturing sites near the US and given the (still pending) USMCA trade agreement, there is more confidence that companies will be able to set up shop there with fewer repercussions.

However, as with the yen, I might argue that what we have seen over the past five years is an increasingly narrowing consolidation in the peso’s exchange rate, albeit with a tad more volatility attached. And the thing about this pattern is its culmination is likely to occur much sooner than that in the yen. A quick look at MXN’s PPP shows that the peso remains significantly undervalued vs. the dollar, and in truth vs. most currencies. All this points to the idea that barring any surprisingly anti-business actions from AMLO, the peso may be setting up for a much larger rally, especially with the carry benefits that continue to exist.

Argentina, on the other hand, with newly elected left-wing President Fernandez, has its work cut out for itself. If you recall, the preliminary vote back in August, saw the peso decline more than 35%, and while it was choppy for a bit, the price action of late has been for steady depreciation. It is too early to know what Fernandez will do, but given the dire straits in the Argentine economy, with inflation running north of 50% while growth is shrinking rapidly and the debt situation is untenable, it seems the path of least resistance is for ARS to continue to weaken.

A quick look at the majors sees the dollar generally firmer this morning as there is a mild risk-off sentiment in markets. However, the news moments ago that the Labour party agreed to an early election has helped bolster the pound specifically, and risk in general. I expect that the pound will now be reacting to the polls as it becomes clearer if Boris can win with a majority, or if he will go down to defeat and perhaps an even more beneficial outcome for the pound will arise, the withdrawal of Article 50. My money remains on a Johnson victory and a Brexit with the recently negotiated deal.

This morning we get two minor pieces of data, Case Shiller Home Prices (exp 2.10%) and Consumer Confidence (128.0). Yesterday we did see a weak Dallas Fed manufacturing index print, but equity markets made new highs. I can see little reason, beyond the ongoing Brexit story, for traders to alter their positions ahead of tomorrow’s FOMC meeting, and so anticipate another quiet day in the market.

Good luck
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The Question at Hand

There is an old banker named Jay
Who’ll cut Fed Funds later today
The question at hand
Is, are more cuts planned?
Or is this the last one he’ll weigh?

Well, no one can describe the current market situation as dull, that’s for sure! The front burner is full of stories but let’s start with the biggest, the FOMC announcement and Chairman Powell’s press conference this afternoon. As of now, futures markets are fully pricing in a 25bp cut this afternoon, with a small probability (~18%) of a 50bp cut. They are also pricing in a 50% chance of a cut at the October meeting, so despite the hawkish rhetoric and relatively strong data we have seen lately, the doves are keeping the faith. In fact, it would be shocking if they don’t cut by 25bps, although I also expect the two regional Fed presidents (George and Rosengren) who dissented last time to do so again. What has become clear is that there is no overriding view on the committee. The dot plot can be interesting as well, as given there are only two meetings left this year, it will give a much better view of policy preferences. My guess is it will be split pretty evenly between one more cut and no more cuts.

Then it’s all on Chairman Jay to explain the policy thinking of the FOMC in such a way that the market accepts the outcome as reasonable, which translates into no large moves in equity or bond markets during or after the press conference. While, when he was appointed I had great hopes for his plain spoken comments, I am far less confident he will deliver the goods on this issue. Of course, I have no idea which way he will lean, so cannot even guess how the market will react.

But there’s another issue at the Fed, one that is being described as technical in nature and not policy driven. Yesterday saw a surge in the price of overnight money in the repo market which forced the Fed to execute $53 billion of repurchase agreements to inject cash into the system. It turns out that the combination of corporate tax payments in September (removing excess funds from the banking system and sending them to the Treasury) and the significant net new Treasury issuance last week that settles this week, also in excess of $50 billion, removed all the excess cash reserves from the banking system. As banks sought to continue to manage their ordinary business and transactions, they were forced to pay up significantly (the repo rate touched 10% at one point) for those funds. This forced the Fed to execute those repos, although it did not go off smoothly as their first attempt resulted in a broken system. However, they fixed things and injected the funds, and then promised to inject up to another $75 billion this morning through a second repo transaction.

It seems that the Fed’s attempt at normalizing their balance sheet (you remember the run-off) resulted in a significant drawdown in bank excess reserves, which are estimated to have fallen from $2.8 trillion at their peak, to ‘just’ $1.0 trillion now. There are a number of economists who are now expecting the Fed to begin growing the balance sheet again, as a way to prevent something like this happening again in the future. Of course, the question is, will this be considered a restarting of QE, regardless of how the Fed tries to spin the decision? Certainly I expect the market doves and equity bulls to try to spin it that way!

Ultimately, I think this just shows that the Fed and, truly, all central banks are losing control of a process they once felt they owned. As I have written before, at some point the market is going to start ignoring their actions, or even moving against them. Last week the market showed that the ECB has run out of ammunition. Can the same be said about Powell and friends?

Moving on to other key stories, oil prices tumbled ~6% yesterday as Saudi Arabia announced that 41% of their production was back on line and they expected full recovery by the end of the month. While oil is still higher than before the attacks, I anticipate it will drift lower as traders there turn their collective focus back toward shrinking growth and the potential for a global recession. Chinese data continues to look awful, Eurozone data remains ‘meh’ and last night Tokyo informed us that their trade statistics continued to deteriorate as well, with exports falling 8.2%, extending a nearly year-long trend of shrinking exports. The point is, if the global economy continues to slow, demand for oil will slow as well, reducing price pressures quite handily. In a direct response to the declining oil price we have seen NOK fall 0.5% this morning, although other traditional petrocurrencies (MXN, RUB) have shown much less movement.

On the Brexit story, Boris met with European Commission President, Jean-Claude Juncker on Monday, and while he spun the meeting as positive, Juncker was a little less optimistic. His quote was the risk of a no-deal Brexit was now “palpable” while the EU’s chief Brexit negotiator, Michel Barnier, said, “nobody should underestimate the damage of a no-deal Brexit.” It should be no surprise the pound fell after these comments, but that is a very different tone to yesterday’s NY session. Yesterday, we saw the pound rally more than a penny after word got out that the UK Supreme Court justices were ostensibly very skeptical toward the government’s argument and sympathetic to the plaintiffs. The market perception seems to be that a ruling against the government will essentially take a no-deal Brexit off the table, hence the rally, but that is certainly not this morning’s tale. In the end, the pound remains binary, with a deal of any sort resulting in a sharp rally, and a hard Brexit on Halloween, causing just the opposite. The UK hearings continue through tomorrow, and there is no official timeline as to when an opinion will be released. I expect the market will continue to follow these tidbits until the announcement is made. (And for what it’s worth, my sense is the Supremes will rule against the government as based on their biographies, they all voted remain!)

Finally, a look at the overnight data shows that UK inflation fell to its lowest level, 1.7%, since December 2016. With the BOE on tap for tomorrow, it beggars belief they will do anything, especially with Brexit uncertainty so high. At the same time, Eurozone inflation was confirmed at 1.0% (0.9% core), another blow to Signor Draghi’s attempts to boost that pesky number. As such, the euro, too, is under some pressure this morning, falling 0.25% after yesterday’s broad dollar sell-off. In fact, vs. the G10, the dollar is higher across the board, although vs. its EMG counterparts it is a much more mixed picture.

Ahead of the FOMC at 2:00 we see Housing Starts (exp 1250K) and Building Permits (1300K), but they will not excite with the Fed on tap. Equity markets are modestly higher in Europe though US futures are pointing slightly lower. Overall, barring something from the UK ahead of the Fed, I expect limited activity and then…

Good luck
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Clearly On Hold

Though policy’s clearly on hold
Most central banks feel they’ve controlled
The story on growth
And yet they’re still loath
To change their inflation threshold

Amidst generally dull market activity (at least in the FX market), traders and investors continue to look for the next key catalysts to drive markets. In US equity markets, we are now entering earnings season which should keep things going for a while. The early releases have shown declining earnings on a sequential basis, but thus far the results have bested estimates so continue to be seen as bullish. (As an aside, could someone please explain to me the bullish case on stocks trading at a 20+ multiple with economic growth in the US at 2% and globally at 3.5% alongside extremely limited policy leeway for further monetary ease? But I digress.) Overnight saw Chinese stocks rock, with Shanghai soaring 2.4% and the Hang Seng 1.1%. European stocks are a bit firmer as well (DAX +0.6%, FTSE +0.4%) and US futures are pointing higher.

Turning to the central banks, we continue to hear the following broad themes: policy is in a good place right now, but the opportunity for further ease exists. Depending on the central bank this is taking different forms. For example, the Minutes of the RBA meeting indicated a growing willingness to cut the base rate further, and market expectations are building for two more cuts this year, down to 1.00%. Meanwhile, the Fed has no ability to cut rates yet (they just stopped raising them in December) but continues to talk about how they achieve their inflation target. Yesterday, Boston Fed president Rosengren posited that a stronger commitment to the symmetry around their 2.0% target could be useful. Personally, I don’t believe that, but I’m just a gadfly, not a PhD economist. At any rate, the idea is that allowing the economy to run hot without tightening is tantamount to easing policy further. In the end, it has become apparent the Fed’s (and every central bank’s) problem is that their economic models no longer are a good representation of the inner workings of the economy. As such, they are essentially flying blind. Previous relationships between growth, inflation and employment have clearly changed. I make no claim that I know what the new relationships are like, just that 10 years of monetary policy experiments with subpar results is enough to demonstrate the central banks are lost.

This is true not just in the US and Europe, but in Japan, where they have been working on QE for nearly thirty years now.

More ETF’s bought
Will be followed by more and
More ETF’s bought

It’s vital for the Bank of Japan to continue persistently with powerful monetary easing,” Governor Haruhiko Kuroda said. As can be seen from Kuroda-san’s comments last night in the Diet, the BOJ is a one-trick pony. While it is currently illegal for the Fed to purchase equities, that is not the case in Japan, and they have been buying them with gusto. The thing is, the Japanese economy continues to stumble along with minimal growth and near zero inflation. As the sole mandate for the BOJ is to achieve their 2.0% inflation target, it is fair to say that they have been failing for decades. And yet, they too, have not considered a new model.

In the end, it seems the lesson to be learned is that the myth of omnipotence that the central banks would have us all believe is starting to crack. Once upon a time central banks monitored activity in the real economy and tried to adjust policy accordingly. Financial markets followed their lead and responded to those actions. But as the world has become more financially oriented during the past thirty years, it seems we now have the opposite situation. Now, financial markets trade on anticipation of central bank activity, and if central banks start to tighten policy, financial markets tend to throw tantrums. However, there is no tough love at central banks. Rather they are indulgent parents who cave quite quickly to the whims of declining markets. Regardless of their alleged targets for inflation or employment, the only number that really matters is the S&P 500, and that is generally true for every central bank.

Turning to this morning’s data story, the German ZEW survey was released at a better than expected 3.1. In fact, not only was this better than forecast, but it was the first positive reading in more than a year. It seems that the ongoing concerns over German growth may be easing slightly at this point. Certainly, if we see a better outcome in the Manufacturing PMI data at the end of April, you can look for policymakers to signal an all clear on growth, although they seem unlikely to actually tighten policy. Later this morning we see IP (exp 0.2%) and Capacity Utilization (79.1%) and then tonight, arguably more importantly, we see the first look at Chinese Q1 GDP (exp 6.3%).

If you consider the broad narrative, it posits that renewed Chinese monetary stimulus will prevent a significant slowdown there, thus helping economies like Germany to rebound. At the same time, the mooted successful conclusion of the US-China trade talks will lead to progress on US-EU and US-Japanese talks, and then everything will be right with the world as the previous world order is reincarnated. FWIW I am skeptical of this outcome, but clearly equity market bulls are all-in.

In the end, the dollar has been extremely quiet (volatility measures are back to historic lows) and it is hard to get excited about movement in the near-term. Nothing has yet changed my view that the US will ultimately remain the tightest policy around, and thus continue to draw investment and USD strength. But frankly, recent narrow ranges are likely to remain in place for a little while longer yet.

Good luck
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The Market’s Malaise

Said Trump we might wait sixty days
Before, Chinese tariffs, we raise
Since talks have gone well
There’s no need to sell
Thus ended the market’s malaise

The US-China trade talks continue to dominate the news cycle with the latest news being President Trump’s comments that a sixty-day delay before imposing further tariffs is being considered. While this had been mooted by many analysts, including me, it still was sufficient to help boost the equity market in the US yesterday afternoon. Interestingly, it also seemed to boost the dollar, which rallied throughout yesterday’s session. Clearly, if the Chinese trade situation gets settled, which I continue to believe is quite difficult, it is a net positive for the global economy. But don’t forget that the President is also looking at tariffs on the European auto sector, as well as is maintaining tariffs on imported aluminum and steel, so all is not clear yet. But certainly, the China story has received top billing of late.

The other big story, Brexit, has had less press lately (at least outside the UK) as the ongoing machinations of the British Parliamentary process remain obscure to almost everyone else. The current argument seems to be that a bloc of EU skeptics wants to ensure that the option of a no-deal Brexit remains on the table as a negotiating tactic. You can’t really blame the EU for getting frustrated as the UK has not yet provided a united front as to their demands. But with that said, ultimately it will come down to the Irish backstop and how that can be tweaked to get enough support by the UK. It’s still a game of chicken. Elsewhere in the UK, MPC member Gertjan Vlieghe, one of the more dovish by reputation, commented that a hard Brexit was unlikely to require higher rates as Governor Carney had mentioned previously. That has been my stance all along, and I continue to see the UK leaning toward cutting rates as growth continues to ebb there.

Speaking of ebbing growth, German GDP in Q4 printed at 0.0%, no growth at all. If you recall, Q3 growth there was -0.2%, so they barely avoided a technical recession. While many analysts continue to point to a series of one-off circumstances that drove the poor performance, it remains pretty clear that the underlying growth impulse is under downward pressure. We saw this when the IMF and the European Commission both significantly reduced their forecasts for 2019 GDP growth in Germany, as well as throughout the Eurozone. Today’s data did nothing to change any views on that issue. Regarding the impact on the euro, while it is unchanged today, that is after a 0.5% decline yesterday and a more than 2% decline this month. In the end, the relative situation continues to favor the dollar over the euro in my view.

Japan released GDP data last night as well, with Q4 growth rebounding to a 1.4% annual rate after a sharp decline in Q3. Here, too, Q3 was blamed on idiosyncratic features, but the underlying features of this report show slowing consumption and softening external demand. The yen has been moving in lock-step with the euro, having fallen pretty steadily all month and is down a bit more than 2.0% as well. The difference between the euro and the yen, however is that the yen retains its haven status, and if the deterioration of economic growth continues and we start pushing toward recession, I see the yen outperforming going forward.

Stepping back and looking at the broad picture of the dollar this morning, it is modestly higher, with gains against some EMG currencies (INR, RUB, BRL), but weakness against both Aussie and Kiwi. In the end, the major currencies have done little although it seems the dollar continues to have legs, even in the short term.

On the data front, yesterday’s CPI data came in just a touch firmer than expected, with the core number unchanged at 2.2% rather than the expected 0.1% decline. This morning brings PPI, which nobody is really going to care about given we already got CPI, and Retail Sales, which have been delayed by the shutdown. Expectations there are for a 0.2% rise with a 0.1% rise ex autos. Yesterday we also heard from three Fed speakers, all of whom expressed confidence the economy was solid, and today we hear from one more. As I have recently written, the Fed message has been very consistent lately, growth is solid, inflation pressures remain tame and there is no reason to raise rates further. As long as that remains the case, it will support asset markets, and likely the dollar.

Good luck
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