Tag Archives: #RBA

Still Writing Obits

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The Germans, the Chinese and Brits
Have seen manufacturing hits
But in the US
There’s been more success
Though bears are still writing obits

It is fair to say that the global economic growth rate continues to slow. We have seen weaker data as the norm, whether in manufacturing, housing or agriculture; we have seen a never-ending stream of central bankers expressing concern over this slowing growth and promising to respond appropriately; and we continue to see equity markets trade to new highs. Something seems amiss.

Yesterday was a perfect example of this phenomenon with an ISM print of 51.7, its fourth consecutive decline and the weakest reading since October 2016. In fairness, it was better than consensus estimates of 51.0, and the US was the only major economy to show continued expansion in the sector, but the trend is foreboding. The new orders component was exceptionally weak, and highlights those concerns going forward. And yet, equity prices traded to new highs yesterday afternoon, before ceding some ground into the close.

There has been a pretty complete disconnect between the fundamentals of stock valuation (at least the theories we learned in finance class about discounted future cash flows) and the actual price of stocks. And this is a global phenomenon, not merely a US outlier.

Of course, the missing link in this puzzle is central bank activities. Markets have become entirely dependent on central bank largesse to justify their valuations. Central bankers, after a decade of ZIRP and NIRP led to a huge increase in the financialization of the global economy, are now beholden to markets when they make decisions. This was made plain in January, when the Fed pivoted after equity markets plummeted following their last rate increase. They literally could not stand the pressure for even two weeks before reversing course.

So, the question becomes, will equity markets now dictate every central bank action going forward? While rhetorical, it is not hard to believe that the answer is yes. Despite all the current conversation regarding an uncomfortably low inflation rate as the driver for policy ease, it is abundantly clear that the only data point on which every central bank focuses, is their domestic stock market. I fear this is a situation that will result in extremely negative outcomes at some point in the future. However, there is no way to determine, ex ante, when those negative outcomes will manifest themselves. That is why bulls are happy, they buy every dip and have been rewarded, and why bears are miserable, because despite their certainty they are correct, thus far the central banks have been able to delay the pain.

In the end, though, the story on global growth remains one of a slowdown throughout the world. For all their largesse to date, central banks have not yet been able to reverse that trend.

With that out of the way, let’s see what those central bank activities have wrought in the FX markets. The first thing to note was that the dollar actually had an impressive day yesterday, rallying 0.7% vs. the euro and 0.5% vs. the pound after the ISM data. Given the better than expected print, market participants decided that the Fed may not be as aggressive cutting rates after all, and so the key recent driver of dollar weakness was reevaluated. Of course, one day’s reaction does not a trend make, and this morning, the dollar is backing off yesterday’s rally slightly.

Last night the RBA cut rates another 25bps, to a record low of 1.00%, and left the door open for further rate cuts in the future. Aussie, however, is higher by 0.4% this morning on a classic, sell the rumor, buy the news reaction. In the end, Australia remains entirely dependent on growth in China and as that economy slows, which is clearly happening, it will weigh on the Australian economy. While Australia managed to avoid ZIRP in the wake of the financial crisis, this time around I think it is inevitable, and we will see AUD resume its multiyear weakening trend.

Weighing on the pound further this morning were two data points, the Construction PMI at 43.1, its weakest in more than ten years, as well as the ongoing malaise in housing prices in the UK. Brexit continues to garner headlines locally, although it has not been front page news elsewhere in the world because of all the other concerns like trade, OPEC, North Korea, and in the US, the beginnings of the presidential campaigns.

But there is a very interesting change ongoing in the Brexit discussion. Throughout the process, the EU has appeared to have the upper hand in the negotiations, forcing their views on outgoing PM May. But with all signs pointing to a new PM, Boris Johnson, who has made clear he will leave with or without a deal, suddenly Ireland is finding itself under extreme pressure. A recent report by the central bank there indicated that a hard Brexit could result in a 4.0% decline in Irish GDP! That is HUGE. At the same time, the EU will require Ireland to uphold the border controls that are involved in the new separate relationship. This means they will need to perform any inspections necessary as well as arrange to collect tariffs to be charged. And the UK has made it clear that they will not contribute a penny to that process. Suddenly, Ireland is in a bad situation. In fact, it is entirely realistic that the EU needs to step in to delay the impact and cave to an interim deal that has nothing to do with PM May’s deal. At least that is the case if they want to maintain the integrity of their borders, something which has been given short shrift until now. My point is that there is still plenty of Brexit mischief ahead, and the pound is going to continue to react to all of it. In the end, I continue to believe that a hard Brexit will result in a weaker pound, but I am not so sure it will be as weak as I had previously believed. Maybe 1.20-1.25 is the right price.

In the US today there is no data to be released although we do hear from NY Fed president Williams and Cleveland Fed President Mester this morning. If the Fed is serious about staying on hold at the end of this month, rather than cutting the 25bps that the market has already priced, they better start to speak more aggressively about that fact. Otherwise, they are going to find themselves in a situation where a disappointed equity market sells off sharply, and the pressure ratchets even higher on them to respond. Food for thought as we hear from different Fed speakers during the month.

Good luck
Adf

 

Cold Sweats

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The President’s tactic of threats
On trade talks gave some the cold sweats
So equities fell
But then by the bell
Those sellers had many regrets

Stock prices rebounded with verve
But bonds, if you look at the curve
Continue to price
A fools’ paradise
And cuts by the Federal Reserve

One of the most interesting dichotomies that we see these days is the completely different views of the global economy by stock markets and bond markets. Stock prices continue to see every glass as at least three-quarters full, willing to look past any potential bad news and rally. Yesterday saw a rout in the Far East after the President’s tweets regarding the raising of tariff rates by the end of this week. Europe continued the trend, closing down sharply as concerns grew that a change in tactics by the US could result in a renewed focus on the European auto sector and, not surprisingly, US equity markets opened sharply lower. But within a few hours, buyers emerged as the story morphed from ‘the US-China trade talks were about to collapse’ to ‘this is just a negotiating tactic by President Trump and everything is still on track for a successful (and fully priced) completion of these negotiations.’ And overnight, equity markets in Asia steadied with generally modest gains, although not nearly enough to offset Monday’s price action. Overall, equity markets remain quite optimistic.

At the same time, Treasury yields have fallen further and are back below 2.50% in the 10-year for the first time in a month. The implication is that bond investors and traders are now far less sanguine over the outcome of these talks. Certainly, if the trade talks do collapse, markets would be severely impacted with equity prices likely to see sharp declines and risk assets, in general under pressure. Treasuries (and Bunds) however, would very likely see a significant uptick in demand and it would not be hard to envision another period of a yield curve inversion. My point is it almost appears as if equity investors and bond investors are reading different stories about current events. I guess the reality is that bond investors are inherently more risk averse, so any hint of trouble forces a response. And of course, equity investors are the ones who continue to highly value ‘zombie’ companies, those firms whose profits cannot cover interest payments and who stay in business by the grace of Federal Reserve largesse.

The upshot is that risk seeking behavior remains the dominant theme in markets. As long as central banks continue to add liquidity to the mix (which despite the Fed having stopped, the BOJ and ECB continue to add as does the PBOC), that money needs to find a home somewhere. And stock markets have been the primary destination for the past ten years.

The interesting thing about the willingness to seek risk is that the dollar continues to outperform most other currencies. For the longest time, during periods of strong global growth, the dollar would soften as investment flowed to other nations and drove economic activity. However, the current situation shows a willingness to take risk and yet a simultaneous desire to hold dollars. For instance, a look at the Dollar Index (DXY) which is a broad measure against a number of currencies, shows that the dollar remains near its highest level in two years and the trend remains higher. All I’m saying is that there seems to be a disconnect between the three key global markets with both FX and bonds seeing a much darker future than equity markets.

Looking at the overnight activity, the RBA left rates on hold, which was mildly surprising as at least half the analyst community was looking for a rate cut. In the end, AUD rallied 0.4% and is, by far, the best performer of the day. As it happens, the RBNZ meets tonight and is widely expected to cut rates by 25bps thus the kiwi is lower by 0.25%. The euro and pound are essentially unchanged as there has been precious little in the way of new information either data wise or regarding the ongoing Brexit fiasco. And the rest of the G10 seems to be under very modest pressure with CAD and CHF both softer by about 0.15%.

In the emerging market space, CNY continues to fall, down a further 0.15% this morning and we continue to see pressure on LATAM currencies (MXN -0.2%). TRY is also under pressure (-1.0%) as the investors exit both stock and bond markets there in the wake of the decision to rerun the Istanbul mayoral election and the further erosion of democracy in Turkey. In APAC, MYR is little changed in the wake of the widely anticipated 25bp rate cut by the central bank there, although it has been falling steadily for the past two weeks in anticipation. But otherwise, in truth, it has been quiet.

Data today brings just the JOLTs Jobs Report (exp 7.24M) and we hear from Randal Quarles, the Fed governor overseeing regulations. Yesterday’s Fed talk was largely in line with the view that the recent dip in inflation is ‘transitory’ and that they continue to watch the data for information to help them make their next move. Overall, it is shaping up as a pretty dull session, and unless we hear something else on the trade front, I expect limited movement in most markets.

Good luck
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