Heisenberg Report

If You Thought That Was Crazy: Full Week Ahead Preview

If you thought last week was crazy, this week has the potential to be just as manic.

Last week began with the government partially shut down in the U.S., a state of affairs that stemmed at least in part from the President undercutting the bipartisan immigration push by calling the whole of Africa a giant “shithole”. Washington decided to kick the can on the shutdown to next month and with that domestic “distraction” out of the way, Trump was free to get back to more ambitious projects, like rolling back seven decades of progress on global trade by inexplicably starting a residential washing machine war with the South Koreans. Having thus set the stage, Trump took the band on world tour to Davos where, upon getting off the plane, Steve Mnuchin had an opportunity to allay fears that the tariffs Trump slapped on laundry and sun gathering equipment 36 hours prior were the start of a trade war.

Given that Mnuchin is rational and not prone to just parroting Trump’s agenda at the worst possible time and under the worst possible circumstances (i.e. at a globalist gathering that definitely isn’t about isolationism), Mnuchin took the high road and declined to comment ……………. I’m just kidding. He said a weaker dollar is good for U.S. trade.

 

That triggered a mini-panic in FX markets as the dollar careened lower. The next day, an irritated and noticeably flummoxed Mario Draghi chided “someone else” at the ECB presser and roughly 5 hours later, CNBC decided maybe it was time to do some damage control, so they released a clip from an interview with Trump that found the President talking about the relative merits of a stronger dollar. “The gun was not loaded!

The whole thing culminated on Friday with Kuroda and the BoJ effectively switching roles from earlier in the week. On Tuesday, the bank tweaked the language around their inflation outlook only to have Kuroda walk it back in the post-meeting presser, and on Friday, Kuroda sounded an upbeat tone on inflation at a panel discussion in Davos only to have the BoJ issue a “clarification” hours later to arrest a rapid move lower in USDJPY.

Just to underscore the confusion…

The whole thing was laughably ridiculous and if last week proved anything it’s that tossing Donald Trump’s trade “strategy” into the middle of the BoJ and the ECB’s tedious efforts to lean slightly hawkish amid a rally in the yen and euro is like hitting a flaming wok with a dash of gasoline.

Now, it’s bond traders’ turn to step into the firing line. The calendar is a veritable minefield, with PCE, ECI, a Fed meeting, the Treasury refunding announcement (that’s huge), and jobs on Friday. I mean, I’m not even sure why that setup was even allowed to happen. There are so many things that could go awry there that it would be difficult to catalogue them all, but the bottom line is that everyone is going to be parsing the data for signs of inflation amid a rally in breakevens, the Fed statement will be parsed for signs of hawkishness, and then this, via Deutsche Bank on the refunding announcement:

Treasury will likely begin increasing auction sizes at the February refunding next week. It will be the first time Treasury makes adjustments to its current set of coupon auction lineup in two years, and the first auction size increase since 2009. Despite being telegraphed in advance and a general consensus forming around the announcement, there is some uncertainty regarding timing and pace which could bring about potential surprises.

This comes against a backdrop that’s seen the likes of Ray Dalio and Bill Gross shouting about a bond bear market and we’re also in an environment where there are real questions about foreign demand and the extent to which investors will be willing to step in and absorb increased supply now that the Fed is stepping back (balance sheet rundown) and Treasury’s borrowing needs are rising (thanks deficit-funded tax cut!).

Here’s Goldman on the Fed statement:

At Janet Yellen’s final FOMC meeting next week, we expect the FOMC to issue a generally upbeat post-meeting statement that includes an upgrade to the balance of risks and a slightly hawkish rewording of the inflation assessment. Taken together, we believe the tone of the statement will be consistent with a hike at the March meeting, barring a sharp weakening in economic conditions.

November headline and core PCE inflation rates were a few tenths above their respective summer lows (yoy). And based on the Q4 GDP report and on CPI and PPI source data, core PCE inflation has ended the year a quarter-point higher than its August bottom (we estimate +1.54% in December compared to +1.30% in August). Sequential inflation readings have similarly firmed. While core inflation remains below target and the recent firming has been gradual in nature, we think many Committee members will view the rebound as additional evidence that last year’s shortfall largely reflected temporary, idiosyncratic factors. Similarly, market-based inflation expectations have moved higher since the December meeting, and the 5Y/5Y measure monitored by the Fed reached 2.25% on Friday (see Exhibit 3).

Of course you don’t want too much of a “good” thing on the inflation front because then they lose control. Here’s Deutsche’s Kocic:

Fed has an enormous control of the markets, and as long as this is the case, the markets are unlikely to get excited. Bear steepening of the curve would be the first sign of loosening of that control. In that context, volatility and risk premia are hostages of the long rates. A rise in inflation can seriously challenge this control. This is the path where central banks are negatively convex and have no adequate response and control.

For what it’s worth, BofAML sees the Fed leaning hawkish in the statement as well.

As for the whether the hapless dollar is set to get any less, well, any less hapless, Barclays has this to offer in their week ahead:

The US federal government shutdown reminded markets of US political risks and comments by Treasury Secretary Mnuchin were interpreted as signalling a potential shift in US foreign exchange policy, only to be rebutted later by Commerce Secretary Ross and President Trump. This added to the negative sentiment stemming from the renewed push for US trade enforcement and weighed on the greenback. At the same time, weaker-than-expected US economic data have also been a drag, with our Data Surprise Index topping out in early December and declining into negative territory recently (Figure 1). We think the USD remains sensitive to headline political comments, but the extent to which US economic data meet the heightened growth expectations from tax cuts will likely be the main driver of the USD’s path, in our view.

Meanwhile, across the pond, we’ll get inflation and GDP and given everything said above about the euro, these prints are potential land mines too, to the extent outsized beats coupled with any misses in the U.S. econ could catalyze still more EURUSD upside. Here’s BofAML:

This week brings important GDP and CPI releases in Europe. Our economists remain positive on Euro area GDP, currently tracking at 0.7% q/q for 4Q. They believe the year will start strong and see upside risk to their 2018 forecast of 2%. While the ECB has been positive in their growth and inflation outlook, our economists remain skeptical on inflation. They expect HICP to print at 1.3% y/y and core inflation to jump from 0.94% y/y to 1.09% due to an improvement in services. However they still see weakness in core inflation from procyclical components. Also look for CPI releases in Germany, France and Spain this week.

Then again, if any of that misses and the data in the U.S. surprises to the upside, then I guess it’s conceivable that the dollar might catch a break, especially in light of extreme one-sided positioning (left pane):

(Goldman)

There’s more, but those are the high points.

Oh, and we’ll get Trump’s State of the Union address. That should be all kinds of hilarious because after all, Trump “has the best words”…

Full calendar from BofAML

 

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