Payrolls takes center stage this week in the U.S. and markets continue to expect the incoming data to support the Fed’s upbeat take on the domestic economy despite lingering concerns about spillover from the turmoil in emerging markets and uncertainty around trade.
Last week, Goldman suggested traders might be underestimating the significance of Jerome Powell’s reference to a study by Christopher Erceg, James Hebden, Michael Kiley, David Lopez-Salido, and Robert Tetlow, in his Jackson Hole speech. Specifically, the bank notes that Powell’s nod to the research likely tips an inclination to assign at least as much weight to the labor market (which is arguably overheating) as the inflation data when thinking about the course of monetary policy. That’s hawkish at the margin as opposed to the market’s dovish interpretation of the speech.
The July jobs report was a mixed bag, missing on the headline but tipping wage growth that’s still firming.
BofAML is looking for 205k on the headline print and and an uptick to 2.8% YoY on average hourly earnings. Barclays is at 200k and 2.8%. The trade balance is on deck this week too, as is ISM. There are also a number of Fed speakers scheduled.
As ever, the data and the messaging will be parsed for anything that reinforces the crowded long USD trade. The greenback’s relentless ascent since April has weighed heavily on EM and ex-U.S. risk sentiment more generally as chatter about a dollar liquidity crunch continues to permeate the narrative. Just when it looked like something was on the verge of snapping in mid-August, Trump renewed his criticism of the Fed. His comments, along with the perception that Powell was dovish at Jackson Hole and, importantly, the PBoC’s move to reinstate the counter-cyclical adjustment factor in the yuan fix, together conspired to slam the brakes on the greenback rally. That, in turn, gave emerging markets a fleeting bit of respite which helped green light U.S. stocks to summit new peaks.
(Bloomberg)
The net long in the dollar was trimmed a bit in the week through Tuesday, but still sits at $24.7 billion overall.
(Goldman)
Again, as long as the data continues to come in strong in the U.S., the dollar is likely to remain supported. Trade jitters have also been bullish for the dollar this year for several reasons, not the least of which is the prospect that eventually, Trump’s tariffs will end up feeding through to consumer prices, making the Fed more wary of an inflation overshoot and thus more inclined to hawkishness. Reports suggest the Trump administration is prepared to move ahead with duties on an additional $200 billion in Chinese goods as early as this week. That’s likely to be dollar positive.
As far as the yuan is concerned, Barclays notes that “a week after the PBoC announced that it had reinstated the counter-cyclical adjustment factor, the central bank has indeed been using the CCAF to drive USDCNY lower.”
(Barclays)
We’ll get FX reserves date for August this week and it will be parsed relentlessly for signs of intervention. As Barclays goes on to write (referencing the chart in the right pane above) “reserves data have surprisingly shown that the PBoC did not sell FX to defend the currency (it likely bought small amounts of FX in June and July).” Remember, the July data showed a surprise build in China’s war chest.
(Bloomberg)
Of course China may simply be holding fire in terms of selling dollars until they see if they can arrest the slide in the yuan using the bevy of other tools at their disposal. The reinstatement of the CCAF was the fourth such tool deployed in August alone. Beijing also reinstated forwards rules (August 3), chided onshore banks for selling RMB (August 7) and moved to squeeze offshore liquidity (August 16).
(Bloomberg, w/ annotations)
“We believe the use of the countercyclical factor by the PBoC means the central bank desires to not using a heavy handed approach in containing RMB depreciation, i.e. aggressively drawing down its FX reserves via spot market operations only”, BofAML wrote, in a note dated August 29, adding that their base case “is for China’s FX reserves to be stable even if the RMB comes under speculative depreciation pressure.”
Notably, the yuan is now more volatile than the euro for the first time in history. “It also exceeded 1M GBP/USD and USD/JPY vol in August,” BofAML goes on to write, in the same note cited above, adding that while it wouldn’t be the first time the yuan has been more volatile than sterling and the yen, it’s “still is a rare occurrence.”
(BofAML)
All of that will be key for emerging markets, which are coming off a rough August. EM FX fell for a fifth consecutive month as mid-month dollar weakness was not sufficient to offset renewed pressure on the Turkish lira and the collapse of the Argentine peso when it comes to sentiment. Pressure showed up in the rand (volatility soared to its highest since 2016), the rupiah (weakest against the dollar since 1998), and the rupee (record lows), among others. This is the longest streak of monthly declines for MSCI’s gauge since 2015.
Speaking of EM, we’ll get inflation data out of Turkey this week and that should be all kinds of amusing for obvious reasons. “We see inflation accelerating to 18.1% y/y (consensus: 17.7%, previous: 15.9%), with any upside surprise prompting renewed TRY weakness, a further sell-off in front-end rates and likely spillover to other vulnerable EMs”, Barclays wrote on Sunday.
Turkey has cobbled together what counts as a “policy response” in recent weeks, but it’s unlikely to do the trick.
“Rebuilding credibility will require a combination of monetary and fiscal tightening and even that may be insufficient without external assistance”, Goldman wrote Friday. “The former is challenging due to the fact that the real economy and financial sector are under pressure (from the financial conditions and confidence shock), while there remains significant political resistance to the latter”, the bank continued, stating the obvious.
Elsewhere in EM, the real is under immense pressure amid ongoing election jitters in Brazil. Lula is out, which I guess is some semblance of positive, but the fundamentals are bad too. Here’s a bit of color from Goldman’s Alberto Ramos:
The public debt dynamics remain a source of concern. The stock of gross general government debt reached 77.0% of GDP in July, up from 74.0% in December 2017 and 70.0% of GDP in December 2016.
Given the slow progress on fiscal consolidation and the implied path of sizeable primary fiscal deficits for a number of years, we do not expect to see primary surpluses before 2022, at best. Hence, we expect the public debt picture to continue to deteriorate and for the gross level to exceed a disquieting 80% of GDP before stabilizing. This leaves the fiscal picture, and the economy at large, vulnerable to adverse domestic and external shocks.
Markets will also be waiting to hear what exactly Argentina plans to do next to shore up confidence. On Sunday, reports suggest Macri will shutter as many as a dozen ministries in an effort at fiscal retrenchment. Meanwhile, the IMF is insisting the country not use money from the fund to intervene in the peso.
In a testament to how unsure folks still are about EM, flows in the week through August 29 were basically flat, despite what should have been a favorable backdrop with a weaker dollar, an ostensibly dovish Powell speech and a PBoC that clearly wants to arrest the yuan’s slide.
(Barclays, EPFR)
In Europe, markets are concerned about Italy and the prospect of a budget battle with Brussels. The timing is bad. The ECB will taper monthly asset purchases to €15 billion/month from September and seemingly realizing how precarious things might get, the Italian government is reportedly seeking a BTP-centric QE extension, even as the populists thumb their noses at E.U. budget guidelines.
The BTP-bund spread is sitting at levels on par (there’s a bond pun in there somewhere) with May, when the market imploded.
(Bloomberg)
On Sunday, in an interview with la Repubblica, Italian Finance Minister Giovanni Tria said the end of ECB QE would be a “blow” to many countries. The difference, he said, is that Italy is “less strong.”
Right. And it’s also “more populist.”
Speaking of populist agendas, Brexit negotiations were thrust back into the spotlight late last week and they’ll be on the agenda this week too. “Parliament returns from summer recess on Tuesday and resumes Brexit withdrawal bill discussions”, Barclays writes, reviewing the outlook for sterling. They continue:
Following the recent focus on “no deal” scenarios, EU Chief Negotiator Barnier’s comment last week that the EU was prepared to offer the UK an “unprecedented partnership” has opened some near-term optimism and EURGBP downside, in our view. While we do not view this as a new development, given it is in line with our central case of an orderly but hard Brexit, we do feel a lot of negativity was discounted in GBP asset prices.
Last but not least, this week’s Bank of Canada meeting will be set against the backdrop of ongoing negotiations with the U.S. on trade. Talks stalled on Friday after leaked comments found Donald Trump telling Bloomberg that anytime Canada tries to drive a hard bargain he simply “puts up a picture of an Impala.”
Nothing further.
Full calendar from BofAML
Jeff Snider begs to differ re. overheating. I have to agree, and so do Eurodollar futures.
Yeah, well, Jeff Snider has never seen an upbeat economic variable that he doesn’t want to argue with. That’s great and all. And it’s entertaining to read. But I can’t add a 3,000-word footnote every time I use the words “overheating” and “labor” and “market” in the same sentence.
To be fair Giovanni Tria also said that Italy will respect the 3% budget limit. I have the feeling that both Salvini and Di Maio are less stubborn with their implementation of electoral programme after seeing how things developed in the Italian bond (and stock) market. The whole yield curve, from 6 months bills to 2-10 years bonds, jumped 60bp in the primary market. They are realizing that this is not only a matter of a secondary market selloff that can be deemed as exagerated. Demand remains strong during auctions, with a ratio 2:1 between demand and offer, but the market clears with yields at 3.20% instead of 2.70-80%.