Cause For Concern

Once more to Great Britain we turn
And so we ask, ‘what did we learn?’
May’s Deal lacks appeal
But No-Deal they feel
Is still quite a cause for concern

Where’s Howie Mandel when you need him to say, “Deal…or No Deal?”

In yet another loss for beleaguered British PM May, the House of Commons yesterday approved a bill ruling out a no-deal Brexit for the UK. Of course, the day before they defeated the only Brexit deal on the table. Like a spoiled child, they cannot figure out what they want, but they know they want something. The next step is to request an extension of the deadline, which is now just 15 days away. However, even on that subject there is no clarity. The length of that extension has been open to debate with many different answers. For the pro-Brexit crowd, those willing to see a no-deal outcome, they want as short a delay as possible. Anything beyond six months is likely to allow a second referendum, with the current polls showing that Bremain would be the winner. Naturally, those who want to remain are seeking the longest extension possible.

But it is important to remember that the other 27 members of the EU need to approve the extension unanimously, which when it comes to EU activities is certainly the exception, not the rule. For example, what if Hungary, which is currently at odds with the EU over other issues, decides to vote against an extension simply to tweak the rest of the bloc’s collective nose? My point is that an extension, while pretty likely, is hardly guaranteed. And we have already heard from a number of different EU members on the importance of a rationale for an extension. Ultimately, now that Parliament has taken control of the process from PM May, they have to decide what they want to do, not merely what they want to avoid. And thus far, that information has been lacking.

Turning to the market reaction, the pound rallied sharply yesterday, a full 2.0%, as traders and investors gained confidence that the UK would not be crashing out of the EU without a deal. Of course, given the current lack of alternatives, that remains a fraught situation. This morning, it has ceded about 0.65% of those gains between profit-taking and a dawning realization that just because they voted not to leave without a deal, that hasn’t actually solved the problem. In the end, there is much more to this process and this story, with the potential for both a bigger rally, if somehow the UK comes up with a viable solution, or a much bigger decline, if the delay doesn’t help solve the problem.

The other noteworthy news has been the postponement of a meeting between President’s Xi and Trump to sign any trade deal. While there had been recent indications that progress was being made, apparently it has not been enough progress to schedule a meeting. In the end, as I have written repeatedly, it is difficult for China to agree to not steal IP and force technology transfers when they have maintained, all along, that they don’t do that to begin with. In addition, yesterday President Trump indicated he was in “no hurry” to sign a deal, so this cloud is likely to hang over the global economy for a while yet.

As evidence of that cloud, Chinese data last night pointed to further slowing in the economy there as IP fell to a 5.3% growth rate, the slowest since 2002! While Retail Sales remained unchanged at 8.2%, auto sales continue to decline, falling -2.8% in the January-February period from year ago levels. (The Chinese statistics agency combines Jan and Feb every year to try to smooth the impact of the Chinese New Year, which typically floats in that period.) Interestingly, the combination of these two stories, trade disappointment and weak data, has led to the renminbi slipping 0.5% this morning, a pretty big move for the currency.

Away from those two stories, we continue to see signs of slowing growth around the developed world with rising Swedish Unemployment (6.6% vs. 6.3% previously) and a continued lack of inflationary pressure from both Germany (1.5%) and France (1.3%). This has helped reverse the euro’s recent modest strength with the single currency lower by 0.25% this morning.

In fact, the dollar is having a strong day virtually everywhere, with Aussie and Kiwi both falling more than 0.5% after the weak Chinese data raised concerns over their key export market. Meanwhile, even the yen is lower by 0.45%, as the economic story there continues to point to slowing growth and the possibility of yet more monetary policy ease. The problem for Kuroda-san is there are precious few things left to do. After all, he already has negative interest rates and owns 43% of the JGB market, as well as 10% of the equity market, all while maintaining a cap on the yield of the 10-year JGB. Barring explicit monetization of the debt, meaning relieving the Japanese government of the obligation to repay the debt on their balance sheet, the list is short. However, if they do go to explicit monetization, you can be sure the yen will fall sharply.

Equity markets, however, remain oblivious of all the potential problems that exist and continue to focus on a single thing, easy money. Slowing growth and weaker profitability are meaningless in the new world. The only thing that matters is free cash. My observation on this phenomenon is that it has diminishing returns. And despite ongoing efforts to prop up the economy by central banks everywhere, equity markets, while well off the lows seen in December, have not been able to take the next step higher. To my untrained eye, it appears that the top has been put in, and that lower is the most likely direction over time. But perhaps not today, where equities continue to hang in there and US futures are pointing slightly higher.

Today’s data is just Initial Claims (exp 225K) and New Home Sales (620K), neither of which is likely to have a significant impact. With no Fed speakers, the market is going to be focused on the UK, with their next vote to extend the Brexit deadline, but away from that, has no obvious catalysts. Given the dollar’s decline yesterday, and the rebound thus far today, my money is on a modest continuation of the rebound, at least for the rest of the day.

Good luck
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All We’ve Endured

“Legal changes” have now been “secured”
Which, following all we’ve endured
Encouraged the buying
Of pounds, clarifying
The thought that soft Brexit’s assured

In the ongoing game of chicken, otherwise known as the Brexit negotiations, it seems the EU was the one who flinched. Last night, British PM Theresa May returned from a Strasbourg meeting with European Commission President Jean-Claude Juncker after obtaining potentially substantial modifications to the Irish backstop portion of the negotiated deal. If you recall, this has been the sticking point because the twin objectives of first; preventing a hard border between Ireland and Northern Ireland; and second, insuring that if the UK is outside the EU customs union, appropriate tariffs can be collected, and goods inspected were leading to opposite solutions. The Irish backstop was designed to help alleviate British concerns they would be stuck in the customs union forever. However, as it had previously been written, that did not seem to be the case. Now comes some new language, touted as legally binding, that ostensibly insures that the UK can opt out of the customs union if desired. While I am no lawyer, and thus not qualified to give a legal opinion, my reading of the plain language leaves the impression that nothing much has changed.

This morning, the UK Attorney General, Geoffrey Cox, is going over the package and will be giving his far more qualified opinion to Parliament shortly. (**FLASH – GEOFFREY COX SAYS THE LEGAL RISK OF THE NEW IRISH BACKTOP IS UNCHANGED**) The vote on the deal is still scheduled for 7:00pm this evening (3:00pm EDT) although there are some MP’s who would like a one-day delay in order to be able to read and understand it themselves. In the interim, the market has had quite a wild ride. From yesterday morning, when the pound was trading below 1.30, we have seen a more than 2.0% rally which in the past two hours has completely unwound! Thus, 1.2975 => 1.3250 => 1.3015 has been the movement in the past twenty-four hours. It seems the initial euphoria is being replaced by a more skeptical view that these changes will be enough to turn the Brexit tide in Parliament. At this point, it’s a mug’s game to try to forecast the outcome of this vote. The last I saw was that the deal would lose by 50 votes or so, a much better performance than last time, but still a loss. My gut tells me that a hard Brexit is still a possible outcome, and that there is no certainty whatsoever that Parliament will be able to prevent that.

But away from the pound, the only other currency that has shown any real movement has been the Philippine peso, which has declined a sharp 1.65% overnight. This occurred after the new President of the central bank there explained that the peso had strengthened as much as it could and that given low inflation readings, further rate cuts were on the table. At least this market movement makes sense!

Ongoing stories include the US-China trade talks, where there has been no additional progress, at least none publicized. The Chinese remain concerned that any meeting between the Presidents be just a signing ceremony rather than finalizing negotiations as they are worried that President Trump might reject a deal at the final moments with President Xi thus losing face in the process. I am confident we will hear more on this subject in the next days, and the latest signs point to a positive outcome, but here, too, nothing is certain.

The other ongoing story of note is the rapid change of tack by the world’s central banks. At this point in time, there is only one central bank that is remotely hawkish, the Norgesbank in Norway, where inflation has been running above target, and more importantly, has seen a rising trajectory. However, beyond that, the rest of the world is firmly in the dovish camp. In fact, at this point, the question seems to be just how much more dovish they will become as it grows increasingly clear that global growth is slowing rapidly. While there is the odd positive surprise on the data front, the weight of evidence is pointing to further slowing. The problem the ECB and BOJ have is that they have very little ammunition left to fight slowing growth. While the Fed could certainly cut rates if necessary, that would be quite an abrupt turn of events, given it has been barely three months since they last raised them, and would damage their credibility further. And the PBOC definitely has some room, but they continue to fight their battle against overleverage, and so are stuck between the Scylla of slowing growth and the Charibdis of excess debt. In the end, look for Scylla to win this battle.

Turning to the data story, yesterday’s Retail Sales report printed at +0.2%, after a downward revision of the December print to -1.6%. While there was significant disbelief in the December data point when it was first released, it looks like it was real. The most immediate impact was to the Atlanta Fed’s GDP Now tracker, which fell sharply and is now estimating a 0.5% GDP growth rate for Q1. As to today, CPI is due shortly, with the market expecting 1.6% headline and 2.2% core readings. The Fed remains concerned that they have been unable to generate sufficient inflation. Personally, I think we have too much inflation, but that’s just one man’s opinion.

The upshot of all this is that nothing has changed in the big picture with regard to the dollar. While risk has been embraced in the past two sessions, the dollar story remains one of relative monetary policy stances, and in that camp, the Fed reigns supreme, and by extension, the dollar!

Good luck
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Disruption and Mayhem

Tomorrow when Parliament votes,
According to some anecdotes,
Another rejection
Will force introspection
As well as a search for scapegoats

For traders the story that’s clear
Is Brexit may soon engineer
Disruption and mayhem
And soon a new PM
Who’s not named May just might appear!

As we begin a new week, all eyes remain focused on the same key stories that have been driving markets for the past several months; the Fed, Brexit and the US-China trade talks. Ancillary issues like weakening Eurozone and Japanese growth continue to be reported but are just not as compelling as the first three.

Starting with Brexit this morning, after a weekend of failed negotiations, PM May looks on course to lose the second vote on her negotiated deal. Interestingly, the EU has been unwilling to make any concessions of note which implies they strongly believe one of two things: either the lack of a deal will force a delay and second referendum which will result in Remain winning, or they will be effectively unscathed by Brexit. I have to believe they are counting on the first outcome, as it is a purely political calculation, and in the spirit of European referenda since the EU’s creation, each time a vote went against the EU’s interest (Maastricht, Treaty of Lisbon, etc.) the government of the rejecting country ignored the result and forced another vote to get the ‘right’ result. However, in this case, it appears the EU is playing a very risky game. None of the other referenda had the same type of economic consequences as Brexit, and a miscalculation will be very tough to overcome.

While several weeks ago, it appeared that PM May had been building some support, the latest estimates are for a repeat of the 230-vote loss from late January. The question is what happens after that. And to that, there is no clear answer. The probability of a hard Brexit continues to rise, although many still anticipate a last-minute deal. But the pound has declined for nine consecutive sessions by a total of 3.0% (-0.2% overnight) and unless some good news shows up, has the opportunity to fall much further. The next several weeks will certainly be interesting, but for hedgers, quite difficult.

As to the Fed, last night Chairman Powell was interviewed on 60 Minutes along with former Fed Chairs Bernanke and Yellen. Powell explained that the economy was strong with a favorable outlook and that rates were at an appropriate level for the current situation. When questioned on the impact of President Trump’s complaints, he maintained that the Fed remained apolitical and independent in their judgements. And when asked about the stock market, he essentially admitted that they have expanded their mandate to include financial markets. Given the broad financialization of the economy, I guess this makes sense. At any rate, there is no way a Fed chair will ever describe the economy poorly or forecast lower growth as it would cause a panic in markets.

Finally, turning to the trade talks, the weekend news indicated that there has been agreement over the currency question with the Chinese accepting an effective floor to the renminbi. Although the Chinese denied that there was a one-way deal, they repeated their mantra of maintaining a stable currency. As yet, no signing ceremony has been scheduled, so the deal is not done. However, Chinese equity markets rebounded sharply overnight (after Friday’s debacle) as expectations grow that a deal will be ready soon. It continues to strike me that altering the Chinese economic model is likely to take longer than a few months of negotiations and anything that comes out of these talks will be superficial at best. However, any deal will certainly be the catalyst for a sharp equity rally, of that you can be sure. One other thing to note about China is that we continue to see softening data there. Over the weekend, Loan growth was reported at a much lower than expected CNY 703B ($79.4B), not the type of data that portends a rebound. And early this morning, Vehicle Sales were reported falling 13.8%! Again, more evidence of a slowing economy there.

In the meantime, Friday’s payroll data was a lot less positive than had been expected. The headline NFP number of just 20K (exp 180K) was a massive disappointment, and though previous months were revised higher, it was just by 12K. However, the Unemployment Rate fell to 3.8% and Average Hourly Earnings rose 3.4% Y/Y, the strongest since 2007. Housing data was also positive, so the news, overall, was mixed. Friday saw markets turn mildly negative on the US, with both equities and the dollar under pressure.

Add it all up and you have a picture of slowing global growth with the idea that monetary policy is going to tighten quickly fading from view. The critical concern is that central bankers have run out of tools to help positively impact their economies when things slow down. And that is a much larger long-term worry than a modest slowing of growth right now.

Looking at the data this week, two key data points will be released, Retail Sales and CPI. Here is the full list:

Today Retail Sales -0.1%
  -ex autos 0.2%
  Business Inventories 0.6%
Tuesday NFIB Small Biz Optimism 102.0
  CPI 0.2% (1.6% Y/Y)
  -ex food & energy 0.2% (2.2% Y/Y)
Wednesday Durable Goods -0.7%
  -ex transport 0.2%
  PPI 0.2% (1.9% Y/Y)
  -ex food & energy 0.2% (2.6% Y/Y)
  Construction Spending 0.4%
Thursday Initial Claims 225K
  New Home Sales 620K
Friday Empire Manufacturing 10.0
  IP 0.4%
  Capacity Utilization 78.5%
  Michigan Sentiment 95.5
  JOLT’s Jobs Report 7.22M

So, lots of stuff, plus another Powell speech this evening, but I think Retail Sales will be the big one. Recall, last month, Retail Sales fell 1.2% and nobody believed it. But I have to say the forecast is hardly looking for a major rebound. In the end, though, the US economy continues to be the top performing one around, and while the Fed may no longer be tightening, we are seeing easing pressures elsewhere (RBA, ECB). Today’s price action has shown little overall movement in the dollar, but the future still portends more strength.

Good luck
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Mario’s Turn

It’s Mario’s turn to explain
Why rates should start rising again
His problem, of course
Is he can’t endorse
A rise if it leads to more pain

Markets have been quiet overnight as traders and investors await the ECB’s policy statement, and then perhaps more importantly, Signor Draghi’s press conference to be held at 8:30 this morning. The word filtering out from the ECB is that the TLTRO discussion has moved beyond the stage of IF they need to be rolled over to the stage of HOW exactly they should construct the process. Yesterday’s OECD downgrade of Eurozone growth is likely the last straw for the more hawkish ECB members, notably Germany, Austria and the Netherlands. This is especially so given the OECD slashed their forecasts for German growth by 0.8%! As it happens, Eurozone GDP data was released this morning, and it did nothing to help the monetary hawks’ cause with Q4’s estimate revised lower to 1.1% Y/Y. While the FX market has shown little overall movement ahead of the ECB meeting, European government bonds have been rallying with Italy, the country likely to take up the largest share of the new TLTRO’s, seeing the biggest gains (yield declines) of all.

Once again, the juxtaposition of the strength of the US economy and the ongoing weakness in the Eurozone continues to argue for further gradual strength in the dollar. That US strength was reaffirmed yesterday by the much higher than expected trade deficit (lots more imports due to strong demand) as well as the ADP Employment report, which not only saw its monthly number meet expectations, but showed a massive revision to the previous month, up to 300K from the initial 213K reported. So, for all the dollar bears out there, please explain the drivers for a weaker dollar. While the Fed has definitely turned far less hawkish, so has every other central bank. FX continues to be a two-sided game with relative changes the key drivers. A more dovish ECB, and that is almost certainly what we are going to see this morning, is more than sufficient to undermine any long-term strength in the euro.

Beyond the ECB meeting, however, the storylines remain largely the same, and there has been little movement in any of the major ones. For example, the Brexit deadline is drawing ever closer without any indication that a solution is at hand. Word from the EU is that they are reluctant to compromise because they don’t believe it will be sufficient to get a deal over the line. As to PM May, she is becoming more explicit with her internal threats that if the euroskeptics don’t support her deal, they will be much less pleased with the ultimate outcome as she presupposes another referendum that will vote to Remain. The pound continues to struggle in the wake of this uncertainty, falling another 0.25% overnight which simply indicates that despite all the talk of the horror of a no-deal Brexit, there is a growing probability it may just turn out that way.

Looking at the US-China trade talks, there has been no word since Sunday night’s WSJ story that said the two sides were moving closer to a deal. The trade data released yesterday morning was certainly significant but is really a reflection of the current global macroeconomic situation, namely that the US economy continues to be the strongest in the world and continues to absorb a significant amount of imports. At the same time, weakness elsewhere has manifested itself in reduced demand for US exports. In addition, there was probably some impact from US importers stuffing the channel ahead of worries over increased tariffs. With that concern now dismissed after the US officially stated there would be no further tariff increases for now, channel stuffing is likely to end, or at least slow significantly. Given the lack of information regarding the status of the trade talks, there is no way to evaluate their progress. The political imperatives on both sides remain strong, but there are some very difficult issues that have yet to be addressed adequately. In the meantime, the reniminbi has been biding its time having stabilized over the past two weeks after a 3.0% rally during the previous three months. That stability was evident overnight as it is essentially unchanged on the day.

Beyond those stories there is precious little to discuss today. There is a bit of US data with Initial Claims (exp 225K) along with Nonfarm Productivity (+1.6%) and Unit Labor Costs (+1.6%) all released this morning. In addition, we hear from Fed governor Brainerd (a known dove) early this afternoon. But those things don’t seem likely to be FX drivers today. Rather, it is all about Signor Draghi and his comments. The one other thing to note is that risk appetite in markets, in general, has been ebbing of late. US Equities have fallen in six of the past eight sessions and futures are pointing lower again. The same has largely been true throughout Europe, where markets are lower this morning by roughly 0.4%. fear is a growing factor in markets overall, and as we all know by now, both the dollar and the yen are the main FX beneficiaries in that scenario. It feels like the dollar has room to edge higher today, unless Draghi is quite hawkish. And that is a low probability outcome!

Good luck
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A Little Less Clear

In China, the outcome this year
For growth is a little less clear
The target has changed
To feature a range
That’s lower, but still not austere

The Chinese have reduced their target rate of GDP growth to a range of 6.0%-6.5% from last year’s “about 6.5%” goal. It is, of course, unsurprising that the Chinese met last year’s goal, on paper, as despite significant evidence from individual economic data points, given the lack of independence of the Chinese statistics agency and the political imperative for President Xi to be seen as a great economic leader, 6.6% was determined to be the appropriate representation in 2018. However, given the fact that the growth trajectory in China has been slowing steadily for the past decade, and adding the fact that global growth continues to slow, it seems that even the mighty Chinese bureaucracy can no longer be certain of a particular outcome, hence the range. There is a large group that remains skeptical of the veracity of Chinese data (myself included), and the ongoing gradual reduction in forecasts that we have seen during the past several years simply reinforces the idea that previous data was too rosy.

At the same time, further fiscal stimulus was announced with a cut in VAT and more infrastructure spending, so for now, China remains focused on fiscal support rather than adding more monetary ease and potentially reflating the credit bubble they have spent the last two years trying to deflate. Much of this forecast, naturally, depends on a successful conclusion to the trade talks with the US, and while Sunday night there was a report indicating the deal is almost done, it is not done yet. If, in fact, the mooted deal falls through, look for analyst revisions lower and even government guidance toward the lower end of this range.

As to the renminbi, China has pledged to maintain a stable currency, although they have not indicated exactly what the benchmark for stability will be. This remains a key focus for President Trump and is ostensibly part of the nascent trade agreement. While I believe that economic pressures would naturally tend toward a weaker renminbi over time, as I had forecast at the beginning of the year, the one thing I know is that if the Chinese choose to strengthen the currency in the short run, regardless of the macroeconomic factors that may exist, they will be able to do so. Wall Street analysts are slowly adjusting their forecasts toward a stronger CNY this year, and if a trade agreement is reached, that seems exactly correct. Of course, if the talks founder, all bets are off.

Meanwhile, one week before PM May is set to have another Parliamentary vote on her Brexit deal, she continues to try to get a modification to the terms of the Irish backstop. Uncertainty remains high as to the actual outcome, but it appears to me that either the deal, as written and newly interpreted, will squeak through, resulting in a short delay in order that all sides can pass the appropriate legislation, or the deal will fail and Parliament will vote to ask for a 6-9 month delay with the intent of having a new referendum. While there is still a chance that the UK leaves without a deal at the end of the month, it does seem to be a very small chance. With that in mind, a look at the pound, which has fallen ~1.5% in the past week (-0.15% overnight), and it appears that we are witnessing another ‘buy the rumor, sell the news’ outcome. As hopes grew that there would be no hard Brexit, the pound steadily rallied for a number of weeks. I have maintained that even a positive outcome has only limited further potential upside given the UK economy remains mired in a slowdown and their largest trading partner, the EU, is slowing even more rapidly. Don’t be surprised to see the pound jump initially on a positive vote next week, but it will be short-lived, mark my words.

Pivoting to the euro, this morning’s Services PMI data was mildly better than the flash projections of two weeks ago. The current market interpretation is that the slowdown in the Eurozone has stabilized. And while that may be true for the moment, it is in no way clear the future portends a resumption in growth. Meanwhile, the euro has continued its recent drift lower, with a very modest decline this morning, just 5bps, but approaching a 1% decline in the past week. The ongoing discussion about the ECB is focused on exactly what tools they have available in the event that the slowdown proves more long-lasting than currently hoped expected. I continue to believe that TLTRO’s will be rolled over with an announcement by June, but after that, the cupboard is bare. Pushing rates to an even more negative level will be counterproductive as the negative impact on banks will almost certainly curtail their lending activity. And restarting QE just months after they ended it would be seen as an indication the ECB has no idea what is going on in the Eurozone economy. Therefore, though Signor Draghi will be reluctant to discuss much about this on Thursday at his press conference, pressure on the ECB will increase when they lower their growth and inflation forecasts further. Look for the euro to continue to drift slowly lower and talk of TLTRO’s to increase.

Last night the RBA left rates on hold, which was universally expected, but the market continues to expect an eventual reduction in the overnight interest rate Down Under. The housing market bubble has been rapidly deflating, and while employment has so far held up, remember employment is a lagging indicator. With that in mind, it is not surprising that AUD has fallen -0.25% overnight, and I think the underlying trend will still point lower. This is especially true if the US-China trade talks falter given China’s status as Australia’s largest trading counterparty. Slowing growth in China means slowing growth in Australia, count on it.

As can be seen from these discussions, the dollar is modestly higher overall this morning, although movement in any given currency has been fairly small. While President Trump continues to decry the dollar’s strength, the US remains the only large economy that is not slowing sharply. And as I have written consistently, with the Fed’s clear stance that further tightening is off the table, you can be sure that no other central bank will be looking to tighten policy anytime ahead of the Fed. The president will not get satisfaction on this front anytime soon.

Turning to this morning’s data, we see ISM Non-Manufacturing (exp 57.3) and New Home Sales (600K). We also hear from Fed uber-dove Neel Kashkari, but now that the Fed has turned dovish overall, it is not clear that he can say much that will alter impressions in the market. While throughout February, the dollar was on its back foot, taking a step back shows that it has been range trading since last October. Given the recent data situation, as well as the sentiment shifts we have seen, it does appear that the dollar can grind back toward the top of that trading range (think of the euro at 1.1200), but we are still lacking a catalyst for a substantial change.

Good luck
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Lost Traction

The tea leaves that everyone’s reading
‘bout trade talks claim risk is receding
Since Donald and Xi
Are desperate anxious to see
A deal that shows both sides succeeding

The equity market reaction
Has been one of great satisfaction
But bonds and the buck
Have had much less luck
As growth on both sides has lost traction

This morning is all about trade. Headlines blaring everywhere indicate that the US and China are close to ironing out their differences and that Chinese President Xi, after a trip through parts of Europe later this month, will visit the US at the end of March to sign a deal. It should be no surprise that global equity markets have jumped on the news. The Nikkei rose 1.0%, Shanghai was up 1.1% while the Hang Seng in Hong Kong rallied 0.5%. We have seen strength in Europe as well, (FTSE +0.5%, CAC +0.5%) although the German DAX is little changed on the day. And finally, US futures are pointing to a continuation of the rally here with both S&P and Dow futures currently trading higher by 0.25%.

However, beyond the equity markets, there has been much less movement in prices. Treasuries have barely edged higher and the dollar, overall, is little changed. It is pretty common for equity market reactions to be outsized compared to other markets, and this appears to be one of those cases. In fact, I would caution everyone about one of the oldest trading aphorisms there is, “buy the rumor, sell the news.” A dispassionate analysis of the trade situation, one which has evolved over the course of two decades, would indicate that a few months hardly seems enough time to solve some extremely difficult issues. The issue of IP (whether stolen or forced to be shared in order to do business) and state subsidies for state-owned firms remains up in the air and given that both these issues are intrinsic to the Chinese economic model, will be extremely difficult to alter. It is much easier for China to say they will purchase more stuff (the latest offer being $23 billion of LNG) or that they will prevent the currency from weakening, than for them to change the fundamentals of their business model. While positive trade sentiment has clearly been today’s driver, I would recommend caution over the long-term impacts of any deal. Remember, the political imperatives on both sides remain quite clear and strong, with both Presidents needing a deal to quiet criticism. But political expediency has rarely, if ever, been a harbinger of good policy, especially when it comes to economics.

Of course, one of the reasons that a deal is so important to both sides is the slowing economic picture around the world and the belief that a trade deal can reverse that process. Certainly, Friday’s US data was unimpressive with Personal Spending falling -0.5% in December (corroborating the weak Retail Sales data), while after a series of one-off events in December pumped up the Personal Income data, that too declined in January by -0.1%. The ISM numbers were softer than expected (54.2 vs. the 55.5 expected) and Consumer Confidence slumped (Michigan Sentiment falling to 93.7). All in all, not a stellar set of data.

This has set up a week where we hear from three key central banks (RBA tonight, Bank of Canada on Wednesday and ECB on Thursday) with previous thoughts of policy normalization continuing to slip away. Economic data in all three economic spheres has been retreating for the past several months, to the point where it is difficult to blame it all on the US-China trade situation. While there is no doubt that has had a global impact (look at Germany’s poor performance of late), it seems abundantly clear that there are problems beyond that.

History shows that most things have cyclical tendencies. This is especially true of economics, where the boom-bust cycle has been a fact of life since civilization began. However, these days, cycles are no longer politically convenient for those in power, as they tend to lose their jobs (as opposed to their heads a few hundred years ago) when things turn down. This explains the extraordinary effort that even dictators like President Xi put into making sure the economy never has a soft patch. Alas, the ongoing efforts to mitigate that cycle are likely to have much greater negative consequences over time. The law of diminishing returns virtually insures that every extra dollar or euro or yuan spent today to prevent a downturn will have a smaller and smaller impact until at some point, it will have none at all. It is this process which drives my concern that the next recession will be significantly more painful than the last.

So, while a trade deal with China would be a great outcome, especially if it was robust and enforceable, US trade with China is not the only global concern. Remember that as the trade saga plays out.

Aside from the three central bank meetings, we also get a bunch of important data this week, culminating in Friday’s payroll report:

Today Construction Spending 0.1%
Tuesday New Home Sales 590K
  ISM Non-Manufacturing 57.2
Wednesday Trade Balance -$49.3B
  ADP Employment 190K
  Fed’s Beige Book  
Thursday Initial Claims 225K
  Nonfarm Productivity 1.7%
  Unit Labor Costs 1.6%
Friday Nonfarm Payrolls 180K
  Private Payrolls 170K
  Manufacturing Payrolls 10K
  Unemployment Rate 3.9%
  Average Hourly Earnings 0.3% (3.3% Y/Y)

In addition to all this, we hear from four more Fed speakers, including Chairman Powell on Friday. It seems increasingly clear that Q1 growth has ebbed worldwide compared to the end of last year, and at this point, questions are being raised as to how the rest of the year will play out. Reading those tea leaves is always difficult, but equity markets would have you believe, based on their recent performance, that this is a temporary slowdown. So too, would every central banker in the world. While that would be a wonderful outcome, I am not so sanguine. In the end, slowing global growth, which I continue to anticipate, will result in all those central bankers following the Fed’s lead and changing their tune from policy normalization to continued monetary support. And that will continue to leave the dollar, despite President Trump’s latest concerns over its strength, the best place to be.

Good luck
Adf

Impugned

The continent east of the ‘pond’
Makes many things of which we’re fond
But data of late
Impugned their growth rate
Just when will Herr Draghi respond?

There is an ongoing dichotomy in the economic landscape that I continue to have difficulty understanding. Pretty much every day we see data that describes slowing economic activity from multiple places around the world. Sales are slowing, manufacturing is ebbing, or housing markets are backing away from their multiyear explosion higher. And all this is occurring while in the background, international trade agreements, that have underpinned the growth in global trade for the past forty years, are also under increasing pressure. And yet, equity markets around the world seemingly ignore every piece of bad news and, when there is a glimmer of hope, investors grab hold and markets rally sharply.

Arguably the best explanation is that the dramatic change in central bank policies have evolved from emergency measures to the baseline for activity. Following that line of thought and adding the recent central bank response to increased ‘volatility’ (read declines) as seen in December, it has become apparent that economic fundamentals no longer matter very much at all. While the central bankers all pay lip service to being data dependent, the only data that seems to matter is the latest stock market close. For someone who has spent a career trying to identify macroeconomic risks and determine the best way to manage them, I’m concerned that fewer and fewer investors view that as important. I fear that when the next downturn comes, and I remain highly confident there will be another economic downturn too large to ignore, we will be wistful for the good old days of 2008-09, when recession was ‘mild’.

Please excuse my little rant, but it continues to be increasingly difficult to justify market movements when looking at economic data. For example, last night we learned that PMI data throughout the Eurozone was confirmed to be abysmal in February (Germany 47.6, Italy 47.7, Spain 49.9, Eurozone overall 49.2) and has led to a reduced forecast for Eurozone GDP growth in Q1 of just 0.1%. Naturally, every equity market in Europe is higher on the news. Even the euro has edged higher, climbing 0.15% (albeit after falling 0.4% in yesterday’s session). Adding to the malaise, Eurozone core inflation unexpectedly fell to 1.0%, a long way from the ECB’s target of just below 2.0% and showing no signs of increasing any time soon.

With the March ECB meeting on the docket for next week, the discussion has focused on how Signor Draghi will justify his ongoing efforts to normalize monetary policy amid weakening growth. His problem is that he has downplayed economic weakness as temporary, but it has lingered far longer than anticipated. It is widely expected that the new economic forecasts will point to further slowing, and this will just make his task that much more difficult. Ultimately, the market is not pricing in any interest rate hikes until June 2020, and there is a rising expectation that TLTRO’s are going to be rolled over with an announcement possible as soon as April’s meeting. Draghi’s term as ECB president ends in October, and it is pretty clear that he will have never raised interest rates during his eight years at the helm. The question is, will his successor get a chance in the next eight years? Once again, I have looked at this information, compared it to the ongoing Fed discussion, and come out on the side of the euro having further to decline. We will need to see much stronger growth and inflation from Europe to change that view.

Other than that discussion, there is very little of real note happening today. Chinese Caixin PMI data was slightly better than expected at 49.9, which has been today’s argument for adding risk, but recall just yesterday how weak the official statistic was. As with everything from China, it is difficult to understand the underlying story as the data often has inconsistencies. But this has been enough to create a risk-on atmosphere with Treasuries falling (10-year yields +2bps) and JPY falling (-0.4%) while commodities and equities rally. Gold, naturally, is the exception to this rule as it has softened this morning.

Regarding trade, today’s news stories discuss documents being prepared for an eventual Trump-Xi summit later this month. If there really is a deal, that will be a global positive as it would not only clear up US-Chinese confusion, but it would bode well for all the other trade discussions that are about to begin (US-Japan, US-Europe). Hopefully, President Trump won’t feel the need to walk away from this deal.

Looking back at yesterday’s session, we saw Q4 GDP actually grew 2.6%, a bit stronger than expected, which arguably helped underpin the dollar’s performance. We also learned that the House Finance Committee is equally unconcerned over what the Fed is doing, as Chairman Powell’s testimony was a complete sleeper. So, with no oversight, the Fed will simply motor along. At this point, it would be remarkable if the Fed raised rates again in 2019, and unless Core PCE goes on an extended run higher, perhaps even in 2020. I have a feeling that we are going to see this flat yield curve for a long time.

This morning brings a bunch more data with both December and January numbers due. Looking at the January data, the only forecast I find is Personal Income (exp 0.3%) but Personal Spending, and PCE are both due as well. At 10:00 we see ISM Manufacturing (55.5) which is now biased higher after yesterday’s Chicago PMI printed at a robust 64.7, its strongest print in 18 months. With risk being embraced today, I think we are far more likely to see the dollar edge lower than not by the end of the day.

Good luck and good weekend
Adf