Tag Archives: #recession

Far From a Floor

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As energy prices decline

Inflation, at least the headline,

Continues to shrink

As central banks think

Their actions have been quite benign

 

The problem is that at its core

Inflation is far from a floor

So, Christine and Jay

Ain’t ready to say

They’re done and won’t hike anymore

 

European inflation readings continue to fall alongside the ongoing decline in energy prices.  Headline numbers in France, Italy and Germany, as well as Spain and most of the Eurozone, have fallen sharply in the past month and seem likely to continue to do so.  Core inflation readings, however, for those countries that measure such things, and for the Eurozone as a whole, are demonstrating the same stickiness that we have seen here in the US.  Ultimately, the problem is that an inflationary mindset has begun to take hold in many people’s view.  While there is a great deal of complaining about rising prices, people continue to pay them, and the hangover of fiscal stimulus that was seen everywhere and continues to be pumped into economies around the world has allowed companies to raise prices while maintaining sales. 

 

There continues to be a strong disagreement within the analyst community regarding the future of inflation as there are many who have watched the trajectory of energy price declines and anticipate a return to 0%-2% inflation by the end of the year.  At the same time, there is another camp, in which the Fxpoet falls, that expects inflation to remain sticky in the 4% range for the foreseeable future.  Arguably, until such time as the massive amount of liquidity that was injected into the economy in response to Covid (and the GFC) is removed, I fear prices will err on the side of rising faster than we had become used to for so long.

 

Taking this one step further, the central bank playbook on inflation, as written by Paul Volcker in the 1980’s, was to tighten monetary policy enough to cause a severe recession and break demand.  We all know that Chairman Powell has read that book and is following it as best he can these days.  And, he has most of his team on board with that view.  Just this morning, Cleveland Fed President, and known hawk, Loretta Mester explained to the FT, “I don’t really see a compelling reason to pause – meaning wait until you get more evidence to decide what to do.  I would see more of a compelling case for bringing rates up…and then holding for a while until you get less uncertain about where the economy is going.”  These are not the words of someone who is concerned that rising interest rates are going to derail the US economy.  It is sentiment like this that has the Fed funds futures market pricing in a 64% probability of a rate hike in two weeks’ time.  It is also sentiment like this that is supporting the dollar, which has traded to its highest level in more than two months and is crushing the large, vocal contingent of dollar short positions around.

 

But, heading back to the recession argument, the data that we continue to receive shows no clear signs in either direction, rather it shows lots of conflict.  Yesterday I mentioned the decline in GDI, a seeming harbinger of weaker growth.  Meanwhile, yesterday’s data releases perfectly encapsulated the issue, with Consumer Confidence printing at a higher than expected 102.3, while the Dallas Fed Manufacturing Index fell to a wretched -29.1, far worse than expected and a level only reached during recessions in the past.  And there’s more to this story as last night China’s PMI data was all released at worse than expected levels (Manufacturing 48.8, Non-manufacturing 54.5, Composite 52.9) with all 3 readings slowing compared to April and an indication that the Chinese reopening story seems well and truly dead. 

 

This poses a sticky problem for President Xi as the clearly slowing Chinese economy seems likely to require further stimulus, whether fiscal, monetary, or both, with the ‘smart money ‘betting on monetary easing.  However, the renminbi (-0.4%) fell again last night and has been sliding pretty steadily since January.  Now, firmly above 7.10, it is fast approaching levels that the PBOC has previously indicated are inappropriate.  The question is, what will they do?  Easing monetary policy opens the door to rising prices, a potentially severe problem in China, while standing pat will likely result in further economic decline, not exactly what Xi is seeking.  My money is on easier policy and if necessary, price controls, something at which the Chinese government excels.

 

One cannot be surprised that with news like this, risk is taking a breather today, despite the ongoing euphoria over NVDA and AI.  Yesterday’s mixed performance in the US led to substantial weakness overnight in Asia, with all main indices falling by at least -1.0%.  Meanwhile, Europe this morning is also largely in the red, albeit only to the tune of -0.5%, and at this hour (8:00) US futures are pointing lower by -0.3% across the board. 

 

At the same time, the combination of falling inflation rates in Europe and the fact that a debt ceiling deal appears to be coming together has yields continuing to slide with Treasuries (-4.4bps) actually underperforming European sovereign yields which are all lower by between 7bps and 8bps.  The other thing to note here is that the yield curve inversion in the US, currently back to -78bps, is showing no signs of righting itself soon.  It has been nearly one year since the curve inverted, and recession alarms have been ringing everywhere, although one has not yet been sighted.  I expect continued volatility in this market as the debt ceiling bill will allow for a significant uptick in issuance right away and the question is, who will buy all this debt? 

 

Oil prices (-2.8%) continue to point to slowing economic activity and that is confirmed by weakness in the base metals as well.  While the Fed sees no signs of a recession, it seems pretty clear that some markets disagree.  Do not be surprised to see another production cut by OPEC+ as the summer progresses.

 

Finally, the dollar is king again, rising against virtually all its G10 and EMG counterparts, with the G10, sans JPY, all falling between -0.4% and -0.6%.  This is a broadscale risk-off move and one which is likely to continue as long as we see the combination of tough talk from the Fed and slowing economic data.

 

Speaking of economic data, today brings Chicago PMI (exp 47.2), JOLTS Job Openings (9.4M) and the Fed’s Beige Book this afternoon.  It is pretty clear that manufacturing activity remains in the doldrums here but pay close attention to the JOLTS data as the Fed is watching it closely for clues as to labor market tightness.  A weak number there is likely to have a bigger market impact than anything else today.

 

Net, I see no reason to dispute the dollar’s strength at the current time.  Talk to me when the Fed changes its tune, and we can see a dollar reversal.  Until then, higher for longer is both the interest rate and USD mantra.

 

Good luck

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Possibly Burst

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It turns out inflation’s not dead

At least in the UK, instead

With prices there surging

The market is purging

All thoughts rate cuts might be ahead

However, elsewhere, there’s concern

That soon there will be a downturn

Thus, stocks have reversed

And possibly burst

The bubble for which most folks yearn

Interestingly, inflation discussions are really beginning to diverge around the world.  What had been a global phenomenon, with prices rising everywhere on the back of pandemic lockdown induced shortages combined with massive fiscal stimulus pumping up demand, is starting to shake out a bit more idiosyncratically.  While in the US we have seen a clear reduction in the trend of prices over the past year, albeit still far above the Fed’s comfort level, elsewhere, this is not necessarily the case.  Today’s example is the UK, where CPI printed at 8.7%, far above the median forecast of 8.2%, although mercifully lower than last month’s 10.1%.  However, core CPI, which excludes energy, food, alcohol and tobacco in the UK, rose to 6.8%, a new high level for this bout of inflation and the highest in the UK since 1992.

One cannot be surprised that the market responded with Gilt yields jumping more than 6bps while the rest of global bond markets have seen yields decline in the face of a broad risk-off sentiment.  More impressively, the OIS market has immediately priced in more than 30bps of additional rate hikes before the end of the year this morning.  While UK stocks are lower, so are equity markets everywhere around the world and perhaps most surprisingly, the pound has only fallen -0.2%.  I suspect that is due to the tension of higher interest rates supporting the currency while worries over the future of policy and the economy are undermining it.  That said, year-to-date, the pound is still the best performing G10 currency vs. the dollar, with gains on the order of 2.5%.  If pressed, I would expect that the pound is likely to range trade going forward as the market continues to reprice Fed expectations higher (removing those forecast rate cuts) while the UK side remains stagnant for now.

Turning our attention to the economy writ large, there is a growing sense that the widely expected recession is coming soon to a screen near you.  Data continues to show weakening trends with, for instance, today’s German IFO Expectations falling to 88.6, far below forecasts, on the back of weakening manufacturing trends in Germany.  As well, yesterday’s US data had its lowlights with the flash manufacturing PMI falling to 48.5, while the Richmond Fed Manufacturing Index fell to -15, both well below expectations.  Layer on the background debt ceiling concerns, where the most recent word is that talks have stalled right now, and there is plenty of reason to turn pessimistic on things.  Arguably, these were keys to yesterday’s equity market declines in the US and we have continued to see red on the screens in every market in Asia and Europe. 

One of the biggest market concerns is China, where talk of slowing growth is continuing as this month’s production and investment data, released last week, was generally softer than expected with property continuing to drag things down, but fixed assets in general softening further.  There continue to be expectations that the PBOC is going to be easing monetary policy further and the renminbi’s recent slide shows no signs of stopping.  This view is also evident in commodity markets, specifically metals markets where copper (-1.5% today, -4.1% in the past week) and aluminum (-0.6%, -3.7%) are under increased pressure as concerns over slowing Chinese growth are impacting demand for these key industrial metals.  

There is, however, one place where this is not so evident, oil prices (+1.5%) as the market continues to respond to prospective production cuts by OPEC+ in the coming months.   The thing about oil is that its demand elasticity is nearly vertical.  Certainly, at the margins there can be more or less demand based on the economic conditions extant, but there is a baseline of demand that is simply not going to disappear.  It is important to remember that despite all the efforts at reduction in the use of fossil fuels, global oil demand hit a record last year.  It is also key to remember that for the past decade, investment in the production of new oil and gas reserves has been severely lacking.  The implication is that while oil prices have fallen well below the highs seen in the immediate wake of the Russian invasion of Ukraine, nothing has changed the long-term supply demand equation which greatly favors demand over supply, i.e. oil prices are likely to rise consistently, if not steadily, over the coming decades.

Summing it all up, today appears to have investors and traders thinking the worst, not the best of things going forward.

A quick look at overnight markets shows that equity market declines have largely been greater than -1.0% with the biggest markets, DAX, CAC, FTSE 100, pushing -2.0%.  There has been no place to hide here, and from a technical perspective, yesterday’s price action looks like an outside bearish reversal, which simply means that the closing level has market technicians selling for right now.  We have seen a significant equity rally in the face of a lot of negative news, so perhaps that run is now over.

Global bond yields are consolidating recent gains, with small declines today not nearly enough to offset what had been 30bp-40bp increases in the past two weeks.  In this market, clearly the debt ceiling talks are the primary story with macroeconomics a distant second for now.  There is just one week before the X-date, at least the latest one, and I suspect that we will hear of an agreement early next week helping to reduce at least some of the pressure on risk attitudes.

Lastly, the dollar is largely stronger this morning with an outlier in NZD (-1.85%) which fell sharply after the RBNZ essentially promised that last night’s 25bp rate hike, to 5.50%, is the last one coming, a big change from market expectations of a 50% probability of a 50bp hike last night.  Essentially, they explained that property market pressures and slowing consumer activity convinced them rates are appropriate to fight inflation.  Kiwi dragged Aussie (-0.5%) lower as well, but the rest of the bloc has seen far less damage with the yen (+0.15%) actually managing a small gain.  But make no mistake, over the past week and month, the dollar has regained its footing, at least against the G10.

In the emerging market bloc, the picture is more mixed with both winners and losers overnight with HUF (+0.8%) the leader, bouncing after the central bank cut its Deposit rate by 1 full percentage point yesterday, as expected and the forint fell sharply.  Meanwhile, MXN (+0.6%) is also showing signs of life after having fallen every day in the past week as the market now assumes Banxico has finished its rate hikes.  On the downside, MYR (-0.45%) and KRW (-0.4%) are both feeling the pressure of the weaker Chinese growth story given its importance to their own economies.

On the data front, the FOMC Minutes are released this afternoon and have a chance to be quite interesting given what appears to be the beginning of a split of opinions regarding the appropriate next steps.  As well, we hear from Governor Waller around lunch time, and ahead of the Minutes.  Waller certainly leans toward the hawkish end of the spectrum, so keep that in mind.

Adding it all up and the combination of declining risk appetite and a growing belief that the Fed is not going to pivot anytime soon implies that the dollar should maintain its footing for now.

Good luck

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Desperate Straits

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In Europe, the growth impulse faded
As governments there were persuaded
To lock people down
In city and town
While new strains of Covid invaded

Contrast that with here in the States
Where GDP growth resonates
Tis no real surprise
That stocks made new highs
And bond bulls are in desperate straits

There is no better depiction of the comparative situation in the US and Europe than the GDP data released yesterday and today.  In the US, Q1 saw GDP rise 6.4% annualized (about 1.6% Q/Q) after a gain of 4.3% in Q4 2020.  This morning, the Eurozone reported that GDP shrank -0.6% in Q1 after declining -0.7% in Q4 2020.  In other words, while the US put together a string of substantial economic growth over the past 3 quarters (Q3 was the remarkable 33.4% on this measure), Europe slipped into a double dip recession, with two consecutive quarters of negative growth following a single quarter of rebound.  If you consider how markets behaved in Q1, it begins to make a great deal more sense that the dollar rallied sharply along with Treasury yields, as the economic picture in the US was clearly much brighter than that in Europe.

But that is all backward-looking stuff.  Our concerns are what lies ahead.  In the US, there is no indication that things are slowing down yet, especially with the prospects of more fiscal stimulus on the way to help goose things along.  As well, Chairman Powell has been adamant that the Fed will not be reducing monetary accommodation until the economy actually achieves the Fed’s target of maximum employment.  Essentially, this has been defined as the reemployment of the 10 million people whose jobs were eliminated during the depths of the Covid induced government lockdowns.  (Its stable price target, defined as 2.0% average inflation over time, has been kicked to the curb for the time being, and is unimportant in FOMC discussions…for now.)

At the same time, the fiscal stimulus taps in Europe are only beginning to drip open.  While it may be a bit foggy as it was almost a full year ago, in July 2020 the EU agreed to jointly finance fiscal stimulus for its neediest members by borrowing on a collective level rather than at the individual country level.  This was a huge step forward from a policy perspective even if the actual amount agreed, €750 billion, was really not that much relative to the size of the economy.  Remember, the US has already passed 3 separate bills with price tags of $2.2 trillion, $900 billion and just recently, $1.9 trillion.  But even then, despite its relatively small size, those funds are just now starting to be deployed, more than 9 months after the original approval.  This is the very definition of a day late and a dollar euro short.

Now, forecasts for Q2 and beyond in Europe are much better as the third wave lockdowns are slated to end in early to mid-May thus freeing up more economic activity.  But the US remains miles ahead on these measures, with even NYC declaring it will be 100% open as of July 1st.  Again, on a purely economic basis, it remains difficult to look at the ongoing evolution of the Eurozone and US economies and decide that Europe is the place to be.  But we also know that the monetary story is critical to financial markets, so cannot ignore that.  On that score, the US continues to pump more money into the system than the ECB, offering more support for the economy, but potentially undermining the dollar.  Arguably, that has been one of the key drivers of the weak dollar narrative; at some point, the supply of dollars will overwhelm, and the value of those dollars will decrease.  This will be evident in rising inflation as well as in a weakening exchange rate versus its peers.

The thing is, this story has been being told for many years and has yet to be proven true, at least in any significant form.  In the current environment, unless the Fed actually does ease policy further, via expanded QE or explicit YCC, the rationale for significant dollar weakness remains sparse.  Treasury yields continue to define the market’s moves, thus, that is where we must keep our attention focused.

Turning that attention to market activity overnight, whether it is because it is a Friday and traders wanted to square up before going home, or because of the weak data, risk is definitely on the back foot today.  Equity markets in Asia were all red led by the Hang Seng (-2.0%) but with both the Nikkei and Shanghai falling 0.8% on the session.  Certainly, Chinese PMI data were weaker than expected (Mfg 51.1, Services 54.9) both representing declines from last month and raising questions about the strength of the recovery there.  At the same time, Japanese CPI remains far below target (Tokyo CPI -0.6%) indicating that whatever policies they continue to implement are having no effect on their goals.

European bourses are mixed after the weaker Eurozone data, with the DAX (+0.2%) the star, while the CAC (-0.2%) and FTSE 100 (0.0%) show little positive impetus.  Looking at smaller country indices shows lots of red as well.  Finally, US futures are slipping at this hour, down between -0.4% and -0.7% despite some strong earnings reports after the close.

Perhaps the US markets are taking their cue from the Treasury market, where yields continue to edge higher (+1.2bps) with the idea that we have seen the top in rates fading quickly.  European sovereign bonds, however, have seen demand this morning with yields slipping a bit as follows: Bunds (-1.8bps), OATs (-1.2bps) and Gilts (-1.3bps). Perhaps the weak economic data is playing out as expected here.

Commodities are under pressure this morning led by WTI (-1.9%) but seeing weakness in the Agricultural space (Wheat -0.7%, Soy -0.9%) as well.  The one thing that continues to see no end in demand, though, is the base metals with Cu (+0.3%), Al (+0.9%) and Sn (2.2%) continuing their recent rallies.  Stuff is in demand!

In the FX markets, the day is shaping up to be a classic risk-off session, with the dollar firmer against all G10 counterparts except the yen (+0.1%) with SEK (-0.55%) and NOK (-0.5%) the leading decliners.  We can attribute Nokkie’s decline to oil prices while Stockie seems to be demonstrating its relatively high beta to the euro (-0.3%). EMG currencies have far more losers than gainers led by ZAR (-0.7%), TRY (-0.65%) and RUB (-0.6%).  The ruble is readily explained by oil’s decline while TRY is a bit more interesting as the latest central bank governor just promised to keep monetary policy tight in order to combat inflation. Apparently, the market doesn’t believe him, or assumes that if he tries, he will simply be replaced by President Erdogan again.  The rand’s weakness appears to be technical in nature as there is a belief that May is a particularly bad month to own rand, it having declined in 8 of the past 10 years during the month of May, and this is especially true given the rand has had a particularly strong performance in April.

On the data front, today brings a bunch more information including Personal Income (exp 20.2%), Personal Spending (+4.1%), Core PCE Deflator (1.8%), Chicago PMI (65.3) and Michigan Sentiment (87.5).  Given the Fed’s focus on PCE as their inflation measure, it will be important as a marker, but there is no reason to expect any reaction regardless of the number.  That said, every inflation reading we have seen in the past month has been higher than forecast so I would not be surprised to see that here as well.

In the end, though, it is still the Treasury market that continues to drive all others.  If yields resume their rise, look for a stronger dollar and pressure on equities and commodities.  If they were to head back down, so would the dollar while equities would find support.

Good luck, good weekend and stay safe
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Still Aren’t Buying

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The market continues to fear
The virus, as it’s become clear
Whatever they try
Recession is nigh
And coming worldwide late this year

But Jay and his friends keep on trying
To help us all so they’re supplying
A hundred beep cut
Which might aid somewhat
Investors, though, still aren’t buying

It is getting hard to keep up with all the policy actions being undertaken by the world’s central banks and governments as every nation tries to address the Covid-19 outbreak. By now, I am sure you are all aware that the Fed, in an unprecedented Sunday night move, cut the Fed funds rate by 100bps, back to the zero bound. But here is what else they did:

• They committed to QE4, which involves purchasing $500 billion in Treasury coupon bonds as well as $200 billion in mortgage-backed securities.
• They cut the interest rate at the discount window to 0.25% and will allow borrowings there for up to 90 days (it had been an overnight facility prior to this).
• And perhaps the most interesting thing, they cut bank reserve requirements to 0.0%, essentially allowing infinite leverage for banks to encourage them to lend.
• Finally, they reinstituted USD swap lines with other major central banks around the world to help everyone else get access to USD liquidity.

The Bank of Japan, meanwhile, pulled their monthly meeting forward to last night so they could act in concert with the rest of the world. With interest rates already negative, they did not touch those, but doubled their target for ETF and corporate bond purchases to ¥12 trillion and they introduced a new zero-rate lending program to help businesses hit by the pandemic. Kuroda-san also made clear there was more they can do if necessary.

The PBOC in a somewhat lukewarm response offered 100 billion yuan of liquidity via the medium-term lending facility at an unchanged rate of 3.15%. Given they are one of the few central banks with room to cut rates, that was somewhat of a surprise. It was also surprising given just how incredibly awful the economic data releases were last night:

Retail Sales -20.5%
Industrial Production -13.5%
Fixed Asset Investment -24.5%
Unemployment Rate 6.2%

The RBNZ cut its base rate by 0.75%, taking it down to 0.25%, and promised to maintain that rate for at least 12 months. They also indicated they would be starting QE if they needed to do anything else. (And to think, New Zealand historically had been considered a ‘high-yielder’!)

The Bank of Korea cut its base rate by 0.50%, taking it to 0.75% in an unscheduled emergency meeting. Analysts are looking for another 50bps at their regular meeting on April 9.

The RBA offered further liquidity injections via repurchase agreements (repos) extending their tenor and indicated it “stands ready” to purchase government bonds (i.e. start QE) with further announcements due Wednesday.

In addition, we saw the Philippines, Hong Kong, Turkey and Sri Lanka act last night. This is clearly a global effort, but one that has not yet gained traction amid the investment community.

Speaking of the investment community, equity markets worldwide are getting crushed, with Asia falling sharply and Europe in even worse shape, as all markets are down at least 6%. Meanwhile, US equity futures are limit down at -5.0% after Friday’s remarkable late day short-covering rally. Again, the only constant here is that volatility is extremely elevated!

Treasury yields have fallen sharply again, down 20bps as I type, but were lower earlier. Interestingly, other than Treasuries, Bunds and Gilts, the rest of the government bond markets have lost their appeal to investors. Instead, we are seeing them sold off alongside equity markets with French yields higher by 4bps, Italian yields +16bps and Greek yields +26bps. In fact, pretty much every other country is seeing yields rise today. I think part of this is the fact that as equity markets decline and margin calls come in, investors must sell the only thing that has any liquidity, and that is government bonds. This behavior could go on for a while.

And lastly, turning to the dollar, it is a mixed picture this morning. The haven currencies, JPY (+1.6%) and CHF (+0.7%) are doing what they are supposed to. The euro, too, has rallied a bit, up 0.5% in what arguably is a response to the dramatically lower US interest rate picture. But NZD and NOK are both lower by 1.5%, the former on the back of its surprise central bank actions while the krone is suffering because oil has collapsed 5.6% this morning amid the ongoing oil war. CAD and AUD, the other G10 commodity currencies are also under pressure, down 0.8% and 0.5% respectively.

Turning to the EMG space, the bright spot is Central Europe, which has seen gains in PLN, RON and BGN. But otherwise, these currencies are under pressure again, some more extreme than others. RUB is the leading decliner, -2.9%, along with oil’s decline, and MXN is also getting hammered, -2.6%. ZAR (-2.4%) and CZK (-1.8%) are the next in line, but basically all APAC currencies have suffered by at least 0.5%, and one can only imagine what will happen to LATAM when it opens. It is not likely to be pretty.

We do see some data this week, but it is not clear how important it will be. Arguably, these will be the last data points prior to the onset of the epidemic.

Today Empire Manufacturing 4.9
Tuesday Retail Sales 0.2%
  -ex autos 0.1%
  IP 0.4%
  Capacity Utilization 77.1%
  JOLT’s Job Openings 6.401M
Wednesday Housing Starts 1502K
  Building Permits 1500K
Thursday Initial Claims 219K
  Philly Fed 10.0
  Leading Indicators 0.1%
Friday Existing Home Sales 5.50M

Source: Bloomberg

At this point, the Fed has canceled their meeting this week, having acted yesterday, which means that we will be able to hear from Fed speakers as they try to massage their message. But the essence of the problem is this is not a financially driven crisis, it is a global health crisis, and all the central banks can do is adjust monetary policy. Fiscal policy adjustments as well as government actions directed at ameliorating the impacts of Covid-19 are much harder, especially in large democratic nations, and so I fear that it will be a number of weeks before things even begin to return to a semblance of normal. Only then will we learn how effective all this monetary policy action will be. In the meantime, I see further declines in equity markets and continued volatility. In fact, the only positive catalyst I could see coming up is the announcement of successful testing of a vaccine for Covid-19, and its immediate production. Alas, nobody knows when that will come.

In the meantime, while bid-ask spreads will be wider, and based on what we have seen in the CDS markets, credit spreads are wider as well, the FX market is still operating, and hedgers should be able to get most everything they need done.

Good luck
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QE We’ll Bestow

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The data continue to show
That growth is unhealthily slow
The pressure’s on Jay
To cut rates and say
No sweat, more QE we’ll bestow

The market narrative right now is about slowing growth everywhere around the world. Tuesday’s ISM data really spooked equity markets and then that was followed with yesterday’s weaker than expected ADP employment data (135K + a revision of -38K to last month) and pretty awful auto sales in the US which added to the equity gloom. This morning, Eurozone PMI data was putrid, with Germany’s Services and Composite data (51.4 and 48.5 respectively) both missing forecasts by a point, while French data was almost as bad and the Eurozone Composite reading falling to stagnation at 50.1. In other words, the data continues to point to a European recession on the immediate horizon.

The interesting thing about this is that the euro is holding up remarkably well. For example, yesterday in the NY session it actually rallied 0.45% as the market began to evaluate the situation and price in more FOMC rate cutting. Certainly it was not a response to positive news! And this morning, despite gloomy data as well as negative comments from ECB Vice-President Luis de Guindos (“level of economic activity in the euro area remains disappointingly low”), the euro has maintained yesterday’s gains and is unchanged on the session. At this point, the only thing supporting the euro is the threat (hope?) that the Fed will cut rates more aggressively going forward than had recently been priced into the market. Speaking of those probabilities, this morning there is a 75% probability of a Fed cut at the end of this month. That is up from 60% on Tuesday and just 40% on Monday, hence the euro’s modest strength.

Looking elsewhere, the pound has also been holding its own after yesterday’s 0.5% rally in the NY session. While I think the bulk of this movement must be attributed to the rate story, the ongoing Brexit situation seems to be coming to a head. In fact, I am surprised the pound is not higher this morning given the EU’s reasonably positive response to Boris’s proposal. Not only did the EU not dismiss the proposal out of hand, but they see it as a viable starting point for further negotiations. One need only look at the EU growth story to recognize that a hard Brexit will cause a significant downward shock to the EU economy and realize that Michel Barnier and Jean-Claude Juncker have painted themselves into a corner. Nothing has changed my view that the EU will blink, that a fudged deal will be announced and that the pound will rebound sharply, up towards 1.35.

Beyond those stories, the penumbra of economic gloom has cast its shadow on everything else as well. Government bond yields continue to decline with Treasury, Bund and JGB yields all having fallen 3bps overnight. In the equity markets, the Nikkei followed the US lead last night and closed lower by 2.0%. But in Europe, after two weak sessions, markets have taken a breather and are actually higher at the margin. It seems that this is a trade story as follows: the WTO ruled in the US favor regarding a long-standing suit that the EU gave $7.5 billion in illegal subsidies to Airbus and that the US could impose that amount of tariffs on EU goods. But the White House, quite surprisingly, opted to impose less than that so a number of European companies that were expected to be hit (luxury goods and spirits exporters) find themselves in a slightly better position this morning. However, with the ISM Non-Manufacturing data on tap this morning, there has to be concern that the overall global growth story could be even weaker than currently expected.

A quick survey of the rest of the FX market shows the only outlier movement coming from the South African rand, which is higher this morning by 0.9%. The story seems to be that after three consecutive weeks of declines, with the rand falling more than 6% in that run, there is a seed of hope that the government may actually implement some positive economic policies to help shore up growth in the economy. That was all that was needed to get short positions to cover, and here we are. But away from that story, nothing else moved more than 0.3%. One thing that has been consistent lately has been weakness in the Swiss franc as the market continues to price in yet more policy ease after their inflation data was so dismal. I think this story may have further legs and it would not surprise me to see the franc continue to decline vs. both the dollar and the euro for a while yet.

On the data front, this morning we see Initial Claims (exp 215K) and then the ISM Non-Manufacturing data (55.0) followed by Factory Orders (-0.2%) at 10:00. The ISM data will get all the press, and rightly so. Given how weak the European and UK data was, all eyes will be straining to see if the US continues to hold up, or if it, too, is starting to roll over.

From the Fed we hear from five more FOMC members (Evans, Quarles, Mester, Kaplan and Clarida), adding to the cacophony from earlier this week. We already know Mester is a hawk, so if she starts to hedge her hawkishness, look for bonds to rally further and the dollar to suffer. As to the rest of the crew, Evans spoke earlier this week and explained he had an open mind regarding whether or not another rate cut made sense. He also said that he saw the US avoiding a recession. And ultimately, that’s the big issue. If the US looks like a recession is imminent, you can be sure the Fed will become much more aggressive, but until then, I imagine few FOMC members will want to tip their hand. (Bullard and Kashkari already have.)

Until the data prints, I expect limited activity, but once it is released, look for a normal reaction, strong data = strong dollar and vice versa.

Good luck
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An Own Goal

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So, Parliament’s taken control
Of Brexit, but can they cajole
Frau Merkel and friends
To finally bend
Or have they now scored an own goal

The one truism about the FX markets these days is that nobody has a real clue as to what is going to happen to the pound. Every day there is a different view as to whether or not there is going to be a deal or a hard Brexit, or something else. The latest machinations in the UK have changed the process there somewhat, with Parliament voting to wrest control of the negotiations from PM May’s hands and make decisions directly. The upshot of this is that tomorrow, they will vote on a series of bills that try to outline what the members would like to see in a Brexit outcome. Of course, it strikes me as fanciful that Parliament, in a few days’ time, will be able to come to agreement on something that has been this contentious for more than two years. And while everybody continues to claim there cannot be a hard Brexit, I almost think this new tactic will assure that outcome. The only thing we know for sure is that there is no majority FOR any direction. While there have been clear rejections of the PM’s negotiated deal, nobody has come up with something that the UK wants, and that might be acceptable to the EU. Remember, too, the EU has given just a two-week extension for Parliament to come up with something. In other words, this is all still a huge mess with no clear outcome. The pound, as should be expected, continues to chop back and forth as the flavor of the day indicates either a deal, or a crash. As I type, the pound has rallied slightly, up 0.2%, but it continues to trade within its recent range, and will likely do so until a decision, any decision, is taken.

The other story of note this morning is the news that the French and Chinese have signed some trade deals as Chinese President Xi wraps up his European tour. I admit I am a little confused that France is allowed to ‘negotiate’ directly with a non-EU member on trade deals as I thought that was the whole point of the EU, the same terms for everyone. At any rate, this optimism has bled into the US-China trade discussion which is set to become headline news again with Messrs. Lighthizer and Mnuchin arriving in Beijing today to resume those talks. The last we heard on this subject indicated concerns over whether the Chinese were willing to agree to some key US demands regarding IP protection and the available punishments in the event of a breach of the new rules. But, today, the glass is half full, so markets are rebounding on the idea that a deal is, in fact, near.

Turning back to yesterday’s yield curve story, while 10-year yields in the US have edged higher this morning, they remain below 3-month yields. There have been several articles recently describing why this inversion is not the same as the ones that we have seen in the past. Briefly, past inversions arose because the Fed was raising short-term rates in order to head off rising inflationary pressures that had built up during a recovery. And while in one sense, that is what seems to have happened this time, the missing ingredient has been the actual inflation. The Fed’s rate hikes over the past three years were partly in anticipation of higher inflation based on the declining unemployment rate (the misapplied Phillips Curve). But a key difference this time has been the fact that in the wake of QE, the Fed’s balance sheet is much larger, and by design, longer term rates are much lower than they might otherwise be. If the Fed did not own an extra $2.5 trillion of Treasuries, where would the 10-year yield actually trade? Arguably, far higher than 2.4%. And so, the crux of the argument that this time is different is based on that fact. Without QE, short-term rates would not yet be approaching long-term rates, and so no inversion discussions would be taking place.

The opposing view, however, is that we have continued to see weaker data in the US and throughout the world, which implies that global growth is slowing. So, inverted yield curve or not, a recession may well be coming. It is important to remember that an inverted yield curve does not cause a recession per se, it has simply been a pretty reliable indicator of upcoming recessions based on its history over the past 50 years. And, in truth, the indicator that gets the most press is the 2yr-10yr spread, which as of yet has not inverted, although remains quite close to flat at just 15bps right now.

The reason this discussion matters is it helps drive market views of the Fed’s next steps and therefore the market reactions to those steps. As I have maintained consistently, however, the US is unlikely to head into recession without dragging the rest of the world along for the ride. And correspondingly, if the rest of the world is actually headed toward a recession, the US is certainly going to see slower growth. But as this relates to the dollar’s value, there is no evidence the US is weakening faster than the EU, the UK, China or most of the rest of the world, and so as dovish as the Fed may sound, other central banks will be more dovish still. The dollar should still be the main beneficiary of this situation, especially if it includes a significant equity correction and risk-off scenario.

Turning to this morning’s story, Housing Starts (exp 1.213M), Building Permits (1.3M), Case-Shiller House Prices (4.0%) and Consumer Confidence (132.0) are on the docket as well as three Fed speakers (Harker, Evans and Daly) two of whom have already spoken overseas but whose comments have not been widely circulated yet. Overall, the dollar is slightly softer this morning, but that is after several positive sessions, so in the end, we continue to chop in our trading range waiting for the next key driver. At this point, my money is on Brexit, but you never know.

Good luck
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Compromised

Posted on by

The punditry seemed quite surprised
That trade talks have been compromised
If President’s Xi
And Trump can’t agree
To meet, forecasts need be revised

What then, ought the future might hold?
It’s likely that stocks will be sold
And Treasuries bought
As safety is sought
Plus rallies in dollars and gold

Risk appetites have definitely diminished this morning as evidenced by yesterday’s US equity decline alongside a very weak showing in Asia overnight. The proximate cause is the news that President’s Trump and Xi are not likely to meet ahead of the March 1 deadline regarding increased tariffs on Chinese goods. And while trade talks are ongoing, with Mnuchin and Lighthizer heading to Beijing next week, it seems pretty clear that the market was counting on a breakthrough between the presidents in a face-to-face meeting. However, not unlike the intractable Irish border situation in the Brexit discussions, the question of state subsidies and IP theft forced technology transfer are fundamental to the Chinese economy and therefore essentially intractable for Xi. I have consistently maintained that the market was far too sanguine about a positive outcome in the near-term for these talks, and yesterday’s news seems to support that view.

Of course, eventually a deal will be found, it is just not clear to me how long it will take and how much pain both sides can stand. Whether or not Fed Chair Powell believes he capitulated to Trump regarding interest rates, it is clear Trump sees it in that light. Similarly, it appears the president believes he has the upper hand in this negotiation as well and expects Xi to blink. That could make for a much rockier path forward for financial markets desperate to see some stability in global politics.

The trade news was clearly the key catalyst driving equities lower, but we continue to see weakening data as well, which calls into question just how strong global growth is going to be during 2019. The latest data points of concern are Italian IP (-0.8%, exp +0.4%) and the German trade surplus falling to €13.9B from €20.4B in November. Remember, Germany is the most export intensive nation in the EU, reliant on running a significant trade surplus as part of its macroeconomic policy structure. If that starts to shrink, it bodes ill for the future of the German economy, and by extension for the Eurozone as a whole. While it cannot be too surprising that the Italian data continues to weaken, it simply highlights that the recession there is not likely to end soon. In fact, it appears likely that the entire Eurozone will be mired in a recession before long. Despite the ongoing flow of weak data, the euro, this morning, is little changed. After a steady 1.25% decline during the past week, it appears to have found a little stability this morning and is unchanged on the day.

In fact, lack of movement is the defining feature of the currency markets this morning as the pound, yen, Loonie, kiwi, yuan, rupee and Mexican peso are all trading within a few bps of yesterday’s levels. The only currency to have moved at all has been Aussie, which has fallen 0.25% on continued concerns over the growth prospects both at home and in China, as well as the ongoing softness in many commodity prices.

The other noteworthy items from yesterday were comments from St Louis Fed president Bullard that he thought rates ought to remain on hold for the foreseeable future. Granted, he has been one of the two most dovish Fed members (Kashkari being the other) for a long time, but he was clearly gratified that the rest of the committee appears to have come around to his point of view. And finally, the Initial Claims data printed at a higher than expected 234K. While in the broad scheme of things, that is still a low number, it is higher than the recent four-week average, and when looking at a chart of claims, it looks more and more like the bottom for this number is likely behind us.

A great deal has been written recently about the reliability of the change in the Unemployment rate as a signal for a pending recession. History shows that once the Unemployment rate rises 0.4% from its trough, a recession has followed more than 80% of the time. Thus far, that rate has risen 0.3% from its nadir, and if claims data continues to rise, which given recent numbers seems quite possible, the implication is a recession is in our future. The one thing we know about recessions is that the Fed has never been able to forecast their onset. Given the fact that this recovery is quite long in the tooth, at 115 months of age, it cannot be surprising that a recession is on the horizon. My concern is that the horizon is beneath our feet, not in the distance.

There is no US data to be released today although next week brings both inflation and manufacturing data. But for now, all eyes are on the deteriorating view of the trade situation, which is likely to keep pressure on equity markets (futures are currently pointing lower by 0.5%) while helping support the dollar as risk is continuously reduced.

Good luck and good weekend
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