On Friday the yield curve inverted
With policymakers alerted
That risks have increased
And growth may have ceased
Both prospects have them disconcerted
While the weekend machinations over Brexit have certainly been intense, the big story this morning is the mild inversion of the US yield curve that occurred on Friday. For the first time since 2007, 10-year yields fell below 3-month yields, a signal that the market is anticipating rate cuts by the Fed in order to shore up weakening growth. In fact, according to the futures market, there is now a ~60% probability of a Fed rate CUT by the end of the year, with a 20% probability of two rate cuts! Following this train of thought, US equity markets had their worst performance in months on Friday, and overnight, Asian markets sold off sharply. However, early this morning, German Ifo data printed at a better than expected 99.6 level, which has helped stop the European equity decline in its tracks. Nonetheless, there is a decided undercurrent of concern over the future of the global economy, and risk positions are being pared back around the world.
This is being seen most clearly in government bond markets where, for example, both Australian and New Zealand 10-year yields have traded to historic low levels, with both now well below 2.0%. Japanese 10-year yields have fallen to -0.09%, pushing toward the bottom end of the BOJ’s yield curve control levels, and German bunds have also retreated to negative territory, currently trading at a yield of -0.01%. I have to admit that while my forecasts for 2019 included lower yields based on a weakening growth outlook, I did not expect these levels to materialize in Q1, but rather only by the end of the year. This price activity is an indication of two things; first that longstanding positions are being unwound as investors reassess the global growth situation; and second, that markets can move awfully fast.
Other indicators have also shown a decided move toward risk aversion with gold rallying nearly 3% in the past two weeks, while the dollar, despite declining interest rates, has rebounded sharply from its post-FOMC lows. As I have consistently maintained, while the Fed surprised one and all by turning so dovish last week, there is little possibility that the Fed will be dovish while other central banks continue their efforts at policy normalization. Certainly, while the odd smaller country may still be considering tighter monetary policy (Norway, Hungary or the Czech Republic), no major central bank can possibly consider tightening policy amid slowing global growth and a complete lack of inflationary pressure. And as I constantly maintain, FX is a relative game, where policy on both sides must be considered. In the current environment, the US not only has the highest rates, thus the most attractive investment landscape, but also retains its haven status in times of trouble. Dollar bears have a long road to hoe before seeing substantial weakness in the buck.
The PM is under the gun
While MP’s, her deal, still do shun
It’s Parliament’s turn
To try to discern
What people in England want done
Meanwhile, back in Merry Olde England, the Brexit situation has absolutely no more clarity than it did last week, in fact it may have less. While politicians on all sides of the argument claim they do not want a hard Brexit, there has been precious little movement in the direction of a solution. And remember, the law still states that the UK will leave the EU this Friday. Yes, the EU has offered a two-week extension, but that is not yet the law in the UK and must be approved in a bill. But in the end, is two weeks sufficient to change minds when two plus years has not been able to do so?
There are stories that a deal is being worked out where Parliament supports the deal and PM May resigns, although she has no obvious successor at this point. And while there is talk of either a second referendum or canceling Article 50, the first would require a significant delay, one that would go well past the EU elections due in late May, and that is a problem, while the second would require a complete backtracking of what the current government has been promising for the past two plus years, not the type of thing that endears politicians to their constituents. As it stands now, it appears that this week Parliament will debate a series of open bills that will try to build some support for a path forward, but even this idea is fraught as party whips may well seek to prevent MP’s from voting their conscience and try to maintain a party line. In other words, it is still a gigantic mess. The one thing that continues to be a very real risk, whether it is this Friday or April 12, is the reality of a hard Brexit. In my estimation, all markets are underpricing that probability, and there is a very real risk that the pound could fall much lower. Hedgers, while option prices are somewhat rich, I would contend they offer a great deal of value at this time. Please consider them.
So, looking at the FX market this morning, we see the dollar little changed overall, but some of the key currencies weaker, notably the euro (-0.2% and the pound (-0.3%). Earlier in the session, but were weaker still, but the release of the German Ifo data helped them as well as European equities.
As to data this week, there is a decent amount coming, as well as a lot of Fedspeak.
|Case-Shiller Home Prices||4.0%|
|Q4 GDP||1.8% (last est 2.6%)|
|PCE||0.0% (1.4% Y/Y)|
|Core PCE||0.2% (1.9% Y/Y)|
|New Home Sales||620K|
On top of all this, we hear from ten different Fed speakers, several of them speaking more than once. This started last night when Chicago Fed President Charles Evans was speaking at an event in HK and said that policy is in a good place and the Fed is watching the data carefully. In other words, if further weakness shows up, they will definitely consider easing, while if the current malaise is short-lived, and growth rebounds, look for talk of another rate hike. At this time, it is abundantly clear that the market is turning quite pessimistic, pricing in rate cuts. But it does appear the Fed is not predisposed in either direction for now.
In the end, the global growth story remains the biggest question out there, and as that develops, so will go the dollar, and all markets with it.