If you were following along last week, you know that more than a few commentators believe rates and the dollar have simply priced in too much pessimism around the U.S. economy and the fiscal outlook.
No, the incoming data hasn’t exactly been what one might call “gangbusters” and the prospects for tax reform and fiscal stimulus seem to dim every time Trump opens his Twitter app or decides to deviate from the teleprompter, but with yields near YTD lows, the dollar struggling to get any kind of traction, and positioning stretched, one could make a contrarian case based simply on the proposition that it would be difficult for the outlook to deteriorate much further from here.
(Deutsche Bank, CFTC)
As a reminder, part of the reason why folks are so concerned has to do with the daunting tasks ahead for a Congress that has proven utterly incapable of getting anything done.
“Members of Congress return from summer recess Tuesday with the eyes of bond traders squarely upon them,” Bloomberg wrote on Friday, before reminding anyone who might not follow markets closely that the angst is readily apparent in the T-Bill curve:
Of course everyone you care to ask will tell you there’s no chance the debt ceiling won’t be raised and as Goldman and others have variously suggested, it’s likely that Hurricane Harvey will help matters along.
“GOP leaders are likely to pair the first installment of Harvey aid with legislation to raise the debt ceiling, easing its passage and then take up a stopgap government-spending measure later in the month,” WSJ notes.
“In a letter to House Speaker Paul Ryan requesting [nearly $8 billion] in storm aid, Budget Director Mick Mulvaney on Friday stopped short of explicitly asking for the aid to be tied to raising the debt ceiling,” Bloomberg goes on to write, in a separate piece out Saturday before adding that “the letter [does] make clear that the emergency spending will accelerate the timetable for raising the limit and conveys the idea that failure to pay obligations could imperil essential government services.”
So basically, one of two things will happen here: either the hurricane relief and the debt ceiling get rolled up into one, or else Congress will wait until the absolute last minute in yet another game of brinksmanship that will push the U.S. to the edge of default.
As noted here on Thursday, House Freedom Caucus Chairman Mark Meadows has come out against using disaster relief as a trojan horse, saying “the Harvey relief would pass on its own, and to use that as a vehicle to get people to vote for a debt ceiling is not appropriate.”
Turns out, Republicans in Texas seem a little more inclined to go along with an effort to bundle the two (imagine that). Take Blake Farenthold, whose Texas district was affected by the hurricane, for instance. Here’s what he had to say on Friday:
It may have to be attached to a debt-ceiling bill, because the amount of devastation here probably will push us much closer to the debt ceiling/ I’m not going to like it, but I think they can probably throw a debt ceiling in with it and I’d vote for it.
There you go. And here’s the latest from Goldman:
It is not yet clear if the first installment of hurricane funding will include a debt limit increase or continuing resolution (CR) to keep the federal government open past September 30.
However, even if the upcoming bill omits both issues, we believe that the need to address hurricane relief has substantially reduced the odds of late-September fiscal showdown, for two reasons. First, there is likely to be less public sympathy for a shutdown than there would have been prior to the hurricane, given the important government role in relief efforts.
Second, the initial funding request is likely to be the first of several hurricane-related legislative items considered over coming weeks.
Anyway, getting back to where we started here, the fact that we’re even talking about this in the first place is indicative of government ineptitude and serves to underscore why Americans have become so disillusioned with lawmakers.
In short: this is why “drain the swamp” resonated with voters. Unfortunately, those voters didn’t realize what Trump meant when he said “drain the swamp” was “lambast fellow Republicans on Twitter and build a Cabinet full of Wall Streeters, billionaires and family members.” But that’s another story.
So against this fractious backdrop, does it make any sense whatsoever to suppose that the dollar and yields can rise or that there’s any hope left at all when it comes to the reflationary euphoria that, in the wake of the election, made “long USD” and “short USTs” the most crowded trades on the planet?
Maybe. Consider this, for instance, from Deutsche Bank on why it might make sense to fade the consensus in Treasurys:
During the August rally we have maintained our bearish yield forecasts (T10 at 2.75% for end-2017) in spite of soft inflation data, debt ceiling risk, increasing geopolitical risk, and summer seasonality. Against these headwinds, growth has remained solid, financial conditions have remained easy, central banks appear inclined to reduce their pace of asset purchases, the regulatory environment looks likely to ease, the dollar has weakened, and commodity prices have been buoyant. In recent weeks we have illustrated that 10y yields are consistent with a “one and done” Fed trajectory and an unchanged term premium. Absent a malign turn in the data or an acute geopolitical event, we find risk/reward increasingly favorable for bearish positioning.
Of course ruling out “a malign turn in the data or an acute geopolitical event,” doesn’t seem like an entirely safe bet, but you get what they’re trying to say.
Meanwhile, Bloomberg’s Cameron Crise has his own take on things and what you’ll read below is in many respects a follow up to a post he penned on Thursday. Long story short: folks may be exaggerating the extent of the economic malaise and in doing so, they may be making erroneous assumptions about the Fed.
Via Bloomberg
There are some people who think that you should never trade immediately after the U.S. employment figures, and Friday provided a perfect example of why. There is almost always noise in high-frequency data releases, and it often takes awhile to tease out the signal embedded in the figures. More broadly the US economy looks to be in fine fettle, and even inflation may be on the verge of making a modest comeback. Anyone taking a view on the Fed would do well to remember these factors.
- One the face of it, Friday’s U.S. payroll numbers were uniformly awful, with disappointing prints on the headline job gains, unemployment rate, and average earnings. Unsurprisingly, quick- twitch traders scrambled to buy bonds and sell dollars. However, on closer inspection there are a number of mitigating circumstances. Despite the fact that many U.S. children went back to school in August, there was no sign of teachers returning to payrolls. There’s a payback in the pipeline for September’s data. While the earnings number was poor, that’s largely a function of a calendar quirk that means mid-month paychecks are not captured in the data. Again, that will reverse in September
- Meanwhile, the ISM manufacturing survey printed its highest level in more than six years and GDP nowcasts project growth of more than 3% for the second consecutive quarter. In the old days, that level of growth would be called “brisk”
- While it’s still too early to completely assess the impact of Harvey on the economy, there is one thing we can say for sure: there are a LOT of cars that will need to be replaced. Given auto sales have been an albatross around the neck of the economy this year, that provides further cause for optimism
- There’s even reason to expect inflation to tick higher. Obviously gasoline prices have risen because of the closure of refining capacity, but that will hopefully be a temporary phenomenon. More intriguingly, there is a chance that ethylene supply could be curtailed for some time, possibly driving up global plastic prices.
- Beyond these storm-related factors, however, moves in broad commodity markets are consistent with an uptick in inflation: a model projects the headline PCE deflator to move to 1.9% from the current 1.4%
- Immediately after the payroll release, markets were pricing just 14 bps of Fed tightening over the next year. Given the solid growth backdrop and chances of an inflation rebound, that’s just not enough
