It looks to me like the week ahead has the potential to bring more bullet dodging in terms of risk assets trying to navigate around a variety of data points with the potential to reinforce the U.S.-centric growth narrative that’s underpinned the greenback and emboldened the Fed. A stronger dollar has been associated with all manner of ex-U.S. turmoil this year, so any further signs of U.S. economic exceptionalism could reinforce dollar strength and thereby weigh on sentiment.
There’s a raft of U.S. econ on deck, including CPI which comes on the heels of Friday’s hotter-than-expected average hourly earnings print. I suppose the worst possible scenario is that it too comes in above estimates, heightening market concerns about a hawkish Fed and translating into real wage growth that’s even more negative than it was last month. Consensus is 0.2% MoM on core and generally speaking, it looks like Wall Street thinks the YoY print will edge back down to 2.3% (see here for details on the July report).
This will be set against a backdrop of rising trade tensions and the prospect that the Trump administration could move ahead with tariffs on an additional $200 billion in Chinese goods. On Friday, the President said duties on another $267 billion in items are “ready to go“. It will be impossible to avoid consumer items in the prospective next rounds of tariffs on China, which means any uptick in inflation ahead of the imposition of those duties will only add to inflation jitters in the U.S.
Trump likely feels like he needs to prove something after news that China’s surplus with the U.S. hit a record in August.
“Core inflation has gradually picked up this year, and above-trend growth and diminishing spare capacity should support inflation”, Barclays wrote over the weekend.
Also on the docket: PPI, retail sales, U. of Mich. sentiment, and consumer credit.
Spec positioning in the dollar came off for the second week in a row through Tuesday, as the net long was trimmed by $2.6 billion. Still, folks are overtly bullish.
As far as Treasurys, specs added to the 10Y short, taking it back near a record through Tuesday and ahead of Friday’s payrolls data which of course catalyzed a selloff in bond land.
Notably, Deutsche Bank thinks looks might be deceiving there and thus the extreme positioning shouldn’t necessarily be viewed as a contrarian indicator.
“There is a growing sense that positioning is not as stretched as the data would suggest and rather than outright duration, we think the data reflect basis positions held by leveraged funds and dealers”, the bank’s Steven Zeng writes, in a note dated Friday, before adding the following color and visuals:
The strongest evidence comes from our beta analysis of CTA returns. After controlling for curve changes, the partial beta of CTA returns to duration changes does not capture a large outright short bias. In fact, the beta has rose into positive territory since August, which suggests that CTA funds are either modestly long or at least neutral on duration. This diverges from the positioning data for leveraged funds which show near-record short positions. Our analytics show that the net basis for the front WN contracts has steadily cheapened since late spring, which is consistent with the timing of divergence in the CTA beta and positions data series. The same basis cheapening is also observed for FV and TY contracts.
Dealers have been running a large basis position as well. End of August data show that dealers were net long roughly $130bn 10yr equivalents of coupon Treasuries hedged by short positions of roughly $119bn 10yr equivalent of Treasury futures. This basis position is about twice as big compared to the start of this year. The position likely reflects the increase in inventory dealers had to take on due to increases in auction sizes this year.
So that’s some context for the purported “big short” that folks like Jeff Gundlach think is ripe for a squeeze. Speaking of things that Jeff thinks shouldn’t be ignored, do note that the curve snapped flatter on Friday following the jobs data, meaning anyone who thinks inversion isn’t necessarily a bad sign is likely to have their hypothesis tested sometime in the not-so-distant future.
(5s30s on Friday / Bloomberg)
Also this week, we’ll get the ECB and new staff projections. The GC is of course tapering APP to €15 billion/month from September, with a complete cessation of purchases at year-end, reinvestment plans notwithstanding. Draghi’s addition of state-and-date-dependent forward guidance on rates in June put a dovish spin on things and focused the market’s attention on the meaning of the word “summer”.
While nobody is expecting much from the ECB this week, the Italy “issue” looms large and Draghi will likely be pressed to answer some questions about that, especially in light of reports that the new populist government is considering an appeal to the central bank for a BTP-centric QE extension in order to keep market participants from punishing the country’s leaders for any fiscal profligacy that shows up in the budget due later this month. Here’s Goldman’s take:
In terms of specific questions, we expect Mr. Draghi to be asked about developments in Italy. We expect Mr. Draghi to deliver his usual comments around the importance of fiscal discipline without naming specific countries. We expect Mr. Draghi to avoid making any direct market commentary related to Italy or Italian policy proposals. With regards to ECB treatment of Italian debt, we expect Mr. Draghi to be non-specific and refer to the general rules already in place.
That last bit is a reference to the prospect of a ratings downgrade and how it could become self-fulfilling.
When you think about what lies ahead for Europe as the ECB pulls back, don’t forget that in addition to Italy, there’s some concern about spillover from Turkey to the financials and the threat of car tariffs continues to hang over European equities more generally. The Stoxx 600 banks index hit a 22-month low on Friday after Deutsche Bank got more bad news.
Here are Goldman’s guesses for minor revisions to the ECB staff projections:
Also worth watching across the pond is the evolution of the political situation in Sweden, which appears headed for a drawn-out period of gridlock following a largely inconclusive election. As a reminder, the krona has had a miserable year. Maybe there’s a silver lining in here somewhere depending on what the political outcome ends up being. As far as the policy backdrop, Goldman notes that “given the Riksbank’s lowered CPI forecast, a hike at the December meeting now looks plausible [and] there are four inflation prints scheduled before then, with the first on September 14.” Barclays has this to offer on the subject:
In Sweden, the first part of the week will likely be volatile as markets digest today’s general election outcome. While the SEK will likely be vulnerable to headline risk, we think much of the political negativity is already in the price and subsequent realization of policy continuity, after short-term political volatility, could lead some SEK shorts to unwind in the coming weeks. Instead, inflation and growth data could prove bigger market movers, in our view, as the debate about the timing of Riksbank rate hikes intensifies.
The BoE meets as well, although that will be a non-event following the August hike. The following out from FT over the weekend is worth noting, though:
The EU is preparing to give its Brexit negotiator new instructions to help close a deal with Britain, in a conciliatory move that will bolster Theresa May as she suffers savage attacks from Brexiters at home. After a weekend in which Boris Johnson, former UK foreign secretary, lambasted Mrs May’s Brexit strategy as wrapping “a suicide vest around the British constitution”, any positive signals from the EU would provide a rare fillip for the British prime minister.
In EM, the focus will be on, well, frankly the focus will be on whether the space can hold it together or whether the train is going to careen further off the tracks.
One concern for the space is that China isn’t seemingly prepared to countenance any further yuan depreciation in the interest of fighting the trade war with Trump. If Beijing decides to resort to “alternative” measures, it’s likely to spook the market. The yuan has drifted back weaker against the dollar over the past two weeks which, given what we’ve seen in EM and heard from Trump on trade over the same period, suggests the PBoC’s reinstatement of the counter-cyclical adjustment factor (the fourth in a series of measures taken in August to arrest the yuan’s slide) might not be enough to take the pressure off entirely. Here’s our annotated chart again:
The yuan is hardly the only currency in the crosshairs. The rand is still under siege after South Africa fell into a recession for the first time since 2009, the rupiah likely needs an out-of-cycle hike from BI to stabilize, the ruble was waylaid last week by errant comments from Dmitry Medvedev whose implicit call for rate cuts hurts Elvira Nabiullina’s credibility at a delicate juncture and the Turkish lira will live or die by CBT’s decision.
CBT pledged to act last week after inflation data showed the picture worsening materially in August. Perhaps most worrisome were producer prices, which soared a truly harrowing 32%, suggesting the true pain from the lira collapse is not yet being passed on to consumers. That state of affairs isn’t sustainable, and it’s just a matter of time before consumer prices accelerate even more than they already have, which will in turn kill demand in a self-feeding economic doom loop. Here’s PPI in Turkey:
CBT has backed themselves into a corner here by pledging to act, just like they did in June. As noted in the linked post above, it’s not so much that they shouldn’t have promised to do something, rather, it’s that because it isn’t feasible to expect Erdogan to allow the kind of decisive hike to the policy rate that would help the central bank get a handle on things, they’re setting themselves up for failure. They implemented a “stealth hike” last month, by driving everyone into the overnight market where rates are 150bps higher than the policy rate, so who knows what they’re going to try this week. Barclays thinks CBT will hike all policy rates by 300bps and “revert all funding provision through its one-week repo rate”. Count me skeptical, although Goldman is on pretty much the same page with Barclays:
We expect that the TCMB will increase the one week repo rate by 350bp to +21.25% and the overnight lending rate to 22.75%. The TCMB has already communicated that it will take some form of action following the August CPI print. We think that the Bank’s reference to price stability suggest that the size of the adjustment may be linked to the increase in inflation expectations, which have risen materially since the last MPC meeting. We also think that the TCMB will return to funding through the one week repo rate following the rate hike and the effective rates will have risen by 200bp as a result.
As alluded to above, we’ll also get CBR (Friday) and that will be watched more closely than it otherwise might have been because now, you’ve got a situation where Nabiullina is saying one thing (it’s time to at least talk about a hike) while Medvedev is saying something different (it’s time to at least talk about a cut).
Here’s a quick bit of useful color from Barclays on EM and FX depreciation pass-through to inflation:
Figure 1 presents the cumulative response of CPI to a 10% NEER depreciation for different EM. Turkey, Indonesia, Mexico and Russia show the highest 1y pass-through, while Asian countries with current account surpluses show the smallest reaction. Currency weakness has been starker in externally vulnerable EM, many of which have higher pass-through, a mix that makes the potential for accelerating inflation more acute. As a result, some central banks have been more assertive: Indonesia and Mexico have been proactive in tightening policy, India and Philippines have reacted as upside risks to inflation build, while Turkey and Argentina delivered large emergency hikes. In contrast, central banks in Russia, Brazil, South Africa and Hungary have not tightened policy, despite the potential high pass-through.
Oh, and watch the FANG stocks. They’re coming off the worst week in six months as regulatory jitters once again take center stage for the market’s darlings.
Full calendar from BofAML