Another week, another litmus test for the economic divergence (read: American exceptionalism) narrative.
The marquee data point this week will be September payrolls. Here’s the lay of the land:
Barclays is at 200K on the headline, BofAML at 220K, Credit Suisse at 190K, Goldman at 175K, and Peter Navarro at 14 million…
The headline number will be useful to the extent it either reinforces the “hitting on all cylinders” characterization of the economy or suggests things are starting to cool down a little bit, but for market watchers, all eyes will be on the AHE print.
The August jobs report was accompanied by (much) hotter-than-expected wage growth, with hourly earnings rising at their fastest pace since 2009.
That’s worrisome to the extent a series of above-consensus AHE readings risks a repeat of what happened in February, when January’s bond selloff collided with a hot wage growth print to catalyze a sharp risk-off move in equities as the market pondered the read-through of nascent inflation pressure for a newly data dependent Fed.
In some ways, the setup this time around is similar. Bonds have sold off of late and inflation pressures look to be building, although the latest read on CPI helped allay some fears.
Specs added to their bearish bets in 10Y futs through Tuesday, ahead of the Fed meeting. This is a new record:
As far as the dollar is concerned, positioning was basically flat in the week through Tuesday – i.e. the net long was unchanged and is still stretched:
“We expect the USD to remain elevated against the G10 and strengthen against EM in the coming months”, Barclays wrote Sunday, adding that “last week’s muted reaction to the third 2018 Fed hike, while due partly to market pricing, also reflects that the USD is wedged between overvaluation on one hand and carry and US economic outperformance on the other.”
Elsewhere, Italy will obviously be in focus after Friday’s bloodbath across Italian equities and demonstrable BTP weakness. The 2.4% deficit target means Salvini and Di Maio have triumphed over Finance Minister Giovanni Tria who has likely lost all credibility with the market. 10Y yields are near YTD highs.
“Italy’s government will submit its worse-than-expected 2.4% deficit target to the EU for approval as early as this week (before 15 October), raising risks of a showdown between Rome and Brussels, as the impending halt of ECB bond-buying threatens to lift the lid on peripheral yields next year”, Barclays notes, stating the obvious, before suggesting that ECB tightening might not be a boon to the euro in light of slowing growth and Italy jitters.
Traders will continue to watch for signs of stabilization in EM. A series of rate hikes from Turkey, Russia, Indonesia and Argentina suggest policymakers are acutely aware of the risks, but it’s by no means clear they’ll be able to stay out ahead of the storm with a December Fed hike baked in.
Turkey inflation is on deck and that could be bad, but as Barclays notes, there’s been some progress on the Brunson issue.
August was a particularly poor month for EM, with crises in Turkey and Argentina souring EM sentiment in general. Now, general EM sentiment may be due for some (short-term) relief, given the IMF’s decision to expand the size of the relief package to Argentina, which will preclude the country from needing to tap debt markets in 2019, although the ARS remains volatile amid thin trading as the new FX trading-band regime is implemented. For Turkey, the US government’s comments that detained American pastor Brunson could be released sparked market optimism. Any positive news ahead of the court hearing in Turkey on 12 October could lead tensions between the US and Turkey to ease further and the TRY to continue to recover from its lows.
Here’s how things have shaped up in EM FX since last month:
Notably, we’ll get the RBI this week. The meeting comes against a backdrop of rupee weakness and recent turmoil in Indian equities.
“We expect RBI to keep policy rates on hold, though signaling clear upside risks to its inflation forecasts”, Goldman says. That assessment is based on the following three factors:
- incomplete transmission of past rate hikes,
- recent weakness in some of the high frequency indicators of economic activity, and importantly,
- the need to avoid giving conflicting signals about the central bank’s objectives, which could undermine its credibility
For their part, Barclays expects a hike. BofAML doesn’t rule it out, but notes that “RBI rate hikes typically hurt INR, as FPI investments in equity, at US$500bn, are 8x of FPI of debt.”
It’s worth highlighting the following chart, which is the ratio of EMFX vol. to G7 FX vol. plotted with the dollar. Basically, this just shows how key it is for the greenback to take a breather when it comes to stabilizing EM:
Oil should be amusing following reports over the weekend that Trump hopped on a call with King Salman to try and talk things out after the U.N. OPEC broadside. The OPEC+ meeting in Algiers earlier this month certainly seemed to suggest the President has reached the point of diminishing returns with the verbal attacks on the cartel. At this point, he may just be offending them.
Finally, you can expect no shortage of domestic political turmoil in the U.S. amid the one-week FBI investigation into the multiple claims of sexual misconduct that are holding up Brett Kavanaugh’s nomination. Although it seems likely the FBI probe won’t end up derailing determined Republicans, it’s at least possible the “now hiring” sign will be up for a little longer at the Supreme Court depending on how things go.