Out Of The Frying Pan, Into The Fire: Full Week Ahead Preview

First thing’s first: according to Steve Mnuchin, the trade war has been put “on hold” following constructive talks in Washington last week that culminated in a warm and fuzzy joint statement released over the weekend.

Apparently, China is going to try and pacify Trump although for now, the “deal” is short on specifics and long on the conciliatory rhetoric. Regardless, that’s probably good enough for markets to the extent it’s seen as a meaningful improvement compared to where things stood earlier this month, when Mnuchin returned from Beijing with nothing but a promise that the two sides would keep talking.

I suppose it’s not accurate to call this a “stalemate” anymore, which should (and I emphasize “should” there) be incrementally positive for risk.

But it could be “out of the frying pan and into the fire”, if Trump’s weekend tweets are any indication.

Following a cartoonish two-day tirade, America’s “very stable” President “hereby demanded” that the DoJ open an investigation into itself (and the FBI) to find out whether anyone was spying on him “for political purposes”.

and I hereby declare that you are increasingly paranoid and remind me of Ray Liotta at the end of Goodfellas driving around town doing crazy shit and looking for black helicopters. pic.twitter.com/bSEqNBTvYL

— Heisenberg Report (@heisenbergrpt) May 20, 2018

That was followed pretty much immediately by this:

DOJ ASKED INSPECTOR GENERAL TO EXPAND FISA REVIEW OF FBI: AXIOS
DOJ ASKS REVIEW TO INCL. DETERMINING POLITICAL MOTIVATION:AXIOS

— Heisenberg Report (@heisenbergrpt) May 20, 2018

“If anyone did infiltrate or surveil participants in a presidential campaign for inappropriate purposes, we need to know about it and take appropriate action,” Rosenstein (who is of course himself in Trump’s crosshairs) said in a statement.

So you know, just another in a series of attempts to commandeer the nation’s law enforcement agencies and use them to try and exonerate himself for alleged crimes that are only “alleged” if you forget about all the people that have already pleaded guilty.

Meanwhile, Rudy Giuliani is still saying crazy shit to the press in his ongoing efforts to force Robert Mueller to wind down the special counsel probe.

In addition to that, other risks for markets include the Fed minutes, which traders will parse for clues as to whether the FOMC is truly prepared to tolerate a meaningful inflation overshoot in light of the “symmetric” language from the May statement.

This comes a week after 10Y yields hit their highest levels since 2011 and real yields bumped up against the taper tantrum peak. One thing worth noting there is that when it comes to rates vol., it’s the curve that matters, not necessarily some “magic” level on 10s. The minutes could potentially entail bear steepening depending on how they’re interpreted. Here’s BNP:

The markets are focused on the 10y UST, which finally closed through 3% on 15 May and is at 3.10% at the time of writing. Despite making headlines, there is a noticeable lack of panic.

As the Fed has begun hiking rates, volatility has been driven more by the level of the curve rather than the level of rates. Our economists expect four more rate hikes this cycle and this is reflected in the forward curve. Therefore, we expect the recent 2s10s steepening to be limited and the flattening trend to resume.

Fingers crossed on that latter bit.

“This week’s FOMC minutes should confirm the constructive outlook and the Fed’s intent of allowing for a modest overshoot of inflation above target,” Barclays writes, in their week ahead outlook, adding that the FOMC is “looking for the discussion surrounding the inclusion of the word ‘symmetry’ when referring to the inflation target.”

For their part, BofAML suggests that the minutes could add to the risk of further steepening.

“A risk to the flattening however comes from the FOMC minutes, which could hint at a desire to engineer a sustained inflation overshoot following the reference to the ‘symmetric’ inflation objective in the May statement, and/or flag concerns over a possible Fed-induced curve inversion,” the bank wrote over the weekend.

But listen, nobody wants to hear your damn steepening story, ok?

(BBG)

That, despite recent events:

Across the pond, the focus will be on Italy again following the worst week for Italian bonds since 2015:

Here’s the latest on the situation as of Sunday evening:

DI MAIO PROPOSED AS LABOR MIN, SALVINI INTERIOR MIN: CORRIERE

— Heisenberg Report (@heisenbergrpt) May 20, 2018

CONTE SAID TO BE AGREED FIVE STAR-LEAGUE PREMIER : CORRIERE

— Heisenberg Report (@heisenbergrpt) May 20, 2018

“The Italian political situation and its effect on BTPs and other EA peripheral bond markets will likely be the single most important driver for the EUR this week,” Barclays says, adding that “while our rates strategists do not see the recent BTP weakness as the beginning of a structural widening trend, we think near-term uncertainty will continue to pressure the EUR and increase the risk that the positive tone held by rating agencies on Italy reverse.”

For much more on the Italy situation and the implications for € credit and the ECB, you can check out “Pulling The Punchbowl When The Espresso Is Hot And The Economy Is Cooling“, but for our purposes here, just note that between the political jitters and the psychological overhang from the deceleration in Q1 economic activity, the euro is facing more near-term headwinds even as it sits at a five-month low.

The dollar is of course ascendant, coming off another weekly gain and rising in tandem with U.S. yields – YTD high here:

The spec short continues to come off. The world’s third-most crowded trade (anecdotally) was trimmed by a further $2.4 billion in the week through last Tuesday and as Goldman notes, “USD net shorts have fallen in each of the past four reports, decreasing by a cumulative $17 billion.”

Further dollar strength and a hawkish interpretation of the Fed minutes could potentially pile more pressure on emerging markets. EM FX is coming off its six weekly loss in seven:

EM debt funds are getting hit as well with the pain being especially pronounced in local currency vehicles.

Venezuela had an “election” on Sunday. Obviously that’s a fucking farce.

The State Department has already said America won’t recognize it. Here’s the only chart you need:

And here’s a brief update on the economic situation from BofAML:

Inflation accelerated to 80% in April according to the National Assembly (13,800% yoy and 897% ytd) and to 140% in the last 30 days according to Inflación Verdadera, (the top 5 Latin-American hyperinflation episodes according to Hanke-Krus). An additional 155% minimum wage hike (third in four months) adds pressure to the hyperinflationary process. The government has not implemented deep adjustment policies and instead continues with a radicalization of policies including price control and intervention in private activities. Following several arrests and investigations on “dollar manipulation” and “cash smuggling” general prosecutor Tarek William Saab ordered the detention of 11 top executives of Banesco (biggest private bank, 20% of all deposits) on the same charges including its executive president. PDVSA 20 collateralized bond due April 27 was paid on time, the first on-time payment since sanctions were imposed; next amortization payment not due until October 27. This particular bond payment passed through DTC before going to Euroclear and appears to have been acceptable to Euroclear so that there were no further “compliance checks” on the payment. PDVSA 22N April 28 interest payment was missed. Elecar April 10 principal and interest payments were missed, but the Oct 10 Elecar coupon payment was unblocked and investors can access the payments. All of the rest of the Venezuela, PDVSA and Elecar bonds are in arrears totaling $4.4bn. Ten bonds have missed the second coupon. Another $0.2bn is due in June.

Maybe Tareck El Aissami can invite international investors to another pancake brunch to celebrate Maduro’s victory. Then everybody can stay up all night blowin’ lines shaved straight off a kilo with a Treet razor.

Let’s see, what else? Oh, U.K. inflation on Wednesday (which I guess is interesting in light of the BoE’s dilemma) and more Brexit talks.

Here’s the full calendar from BofAML: