Well needless to say, this has the potential to be an interesting week, so you better buckle up.
The situation in Washington is of course touch-and-go, and even if the shutdown proves fleeting, the devil will be in the details of the deal. To be sure, no one is going to come out of this a “winner” per se, least of all Trump.
Objectively speaking (and we don’t often speak objectively about Trump) this was a poor political gamble for the President. Americans have come to expect ineptitude from lawmakers and approval ratings reflect how low the bar truly is. From a reputational perspective, Congress really doesn’t have much to lose here.
Trump, on the other hand, just had to “celebrate” the first anniversary of his inauguration with a government shutdown that is at least in part attributable to an ill-fated bipartisan meeting on immigration that will forever be remembered as the day someone said “shithole”. The optics are laughably bad for Trump and realizing that, he probably should have done anything in his power to avoid this scenario because as he himself put it back in 2013, “the interesting thing [about shutdowns] is when they talk about it [later], they’re gonna be talking about who was the President at that time not who the head of the House was [or who] the head of the Senate was.” We actually don’t agree with that assessment entirely, but due to how contentious Trump’s presidency has been, it’s almost certainly going to be true with this shutdown and it definitely doesn’t help that it started one year to the day from the inauguration.
That said, it’s unlikely this will derail markets in the short-term. For much more on markets and shutdowns and what the outlook is for the debt limit, see here.
For now, it’s unclear whether Trump will attend the World Economic Forum in Davos as planned. We have to admit that we were looking forward to that spectacle, so it would be a damn shame if the shutdown ends up meaning he can’t go. We all know how “well” his international trips tend to play out and when you combine his penchant for making a complete fool of himself with the fact that in Davos, he would be attending a gathering of the same “globalists” that he spent the entire campaign maligning on behalf of “Sloppy Steve”, you’ve got a recipe for all types of Austin Powers-ish shenanigans. So fingers crossed, because we’d hate to be deprived of more of these moments…
Traders will be focusing on the dollar this week. While the greenback did manage to close near session highs on Friday, the BBDXY was down for a sixth week and DXY for a fifth:
That’s in no small part due to the ongoing drama inside the Beltway and it’s especially notable because rising Treasury yields have provided no relief. Speaking of bonds, everyone will be laser-focused on the ongoing selloff for signs that Bill Gross (and others) were correct to suggest that a bear market has arrived. Here’s an annotated chart that shows you the push-pull between notable events this month on the way to 10s at 2.65 and climbing:
You’ll note that the BoJ and the ECB are mentioned there and they’ll both take center stage this week.
While policymakers in Japan have variously contended that the market overreacted to the trimming of 10-25Y JGB purchases, speculation is running rampant that Kuroda and co. are pondering how to subtly begin tweaking the messaging on the way to eventually following in the footsteps of the ECB and the Fed in starting down the long road towards normalization. USDJPY reflects that speculation:
As do 10Y JGB yields:
This presents a daunting communications challenge for Kuroda. The market has become so accustomed to the BoJ being a non-event that the slightest change to the messaging will likely be magnified. Here’s Goldman recapping exactly what happened on January 9:
At 10:10 AM on January 9, the BOJ announced the amount of JGB purchases in its regular operations, revealing reductions of ¥10 bn each for 10-to-25-year JGBs (from ¥200 bn to ¥190 bn) and over-25-year JGBs (from ¥90 bn to ¥80 bn). With the introduction of yield curve control in September 2016, the BOJ has shifted its policy target to interest rates, from quantity, in terms of the JGB holdings. Although the BOJ has maintained that it continues to purchase around ¥80 tn of JGBs annually, Governor Kuroda has repeatedly explained that it is possible that the BOJ could deviate from its ¥80 tn guideline since its mandate is to maintain short- and long-term interest rates at -0.1% and around 0%, respectively, and the amount of JGB purchases is determined endogenously. In fact, BOJ purchases have declined tangibly since around autumn 2016 (see Exhibit 2).
In this sense, we were not surprised by the reduction in JGB operations on January 9, as we think it is in keeping with the BOJ’s moves to date. The bond market had a broadly similar reaction. The forex market, however, reacted very differently. The USD/JPY rate moved downward rapidly in the wake of the announcement (at 10:10 AM) of reduced buying operations, with the yen appreciating sharply.
So again, Kuroda needs to get the messaging right, or risk exacerbating this situation. “We expect Governor Kuroda to strike a relatively dovish tone to prevent further yen strength,” BofAML wrote over the weekend.
As a reminder, there is little chance that they are actually going to risk a change to policy anytime soon as inflation is still nowhere near target. This is all a forward guidance game and what we’ve seemingly learned following January 9 is that the stakes are perhaps higher than Kuroda would ideally like for them to be.
Fortunately for all of those riding the Japanese equity rally, the correlation between USDJPY and the Topix has eased, so you may have a bit of a cushion before it reasserts itself (which it invariably will over time):
Speaking of communications challenges surrounding a rapidly appreciating currency on the heels of what the market perceived as a hawkish signpost, we’ll get the ECB this week. The January meeting comes amid a euro rally that really – really – needs to be jawboned, although there’s probably a NEER argument that we haven’t overshot too far just yet.
As a reminder, the euro was coming off its best year against the dollar since 2003 and starting with the news that China is considering “slowing or halting” its purchases of U.S. Treasurys, the single currency got another shot in the arm, only to be supercharged further by the market’s hawkish interpretation of the December minutes:
The “problem” here is that as the econ continues to come in strong in Europe, markets are increasingly latching onto the idea that ECB will call an end to APP in September as opposed to tapering a bit further and extending it through the end of the year. While it’s accepted that there will be no hike prior to the end of QE, pulling forward the cessation of APP necessarily pulls forward expectations for a hike and so, the euro rally has legs. Here’s BofAML on Draghi’s communications challenge:
During the last two weeks markets have reacted to every single comment from ECB speakers. Far from the “peace and quiet” the ECB probably thought it had bought itself last October, this clearly suggests the press conference next week will not be an easy one for Draghi. In our view this reflects what we have highlighted before: changing one part of the forward guidance opens the door to the market questioning every single bit of it. Still, we would expect Draghi to emphasize that any changes to forward guidance will only be gradual and that the sequencing (rate hikes only after net QE purchases are over) is something that won’t be altered. Those expecting rate hikes at the end of this year may end up being disappointed.
For their part, Barclays says Draghi will “deliver a balanced message which does not dismiss discussions around forward guidance changes in the coming months but still reinforces the broadly very accommodative outlook and curbs unwanted EUR strength [and] in that respect, we expect some profit taking of long EURUSD positioning ahead of the meeting.”
Don’t forget that Draghi almost always threads the communication needle. This motherfucker has it down to a science. So whatever you think he would like to see happen is probably what will end up happening. Keep that in mind before you go out and do something stupid like bet on him to screw it up.
Playing out against that backdrop is the political drama in Germany where it now appears Angela Merkel is set to stave off a political disaster after the Social Democrats voted to enter formal coalition talks.
For added context on all of the above, here’s positioning in the euro and the yen, annotated by Goldman:
On the data front, watch out the advance read on Q4 GDP in the U.S. (consensus is 3.0% qoq saar) and core PCE.
So yeah, “just” all of that.
Good luck out there and remember, if you need assistance, you can always use a lifeline and call a “stable genius”…
Full calendar via BofAML