To say the week ahead features a full docket would be to grossly understate the case.
Whatever narrative you subscribe to when it comes to making sense of things will be tested over the next five days.
BUILD THAT … slat fence?
All eyes will be on the Trump administration to see how conciliatory (or, perhaps more aptly, not conciliatory) the White House is inclined to be in negotiations with Democrats following Friday’s humiliating Rose Garden relent. Trump spent the weekend expounding on the relative merits and timeless perfection of “walls”, a sign that he hasn’t yet thrown in the towel on his vanity project.
On Sunday, Mick Mulvaney refused to rule out another shutdown.
That doesn’t bode particularly well. It looks as though analysts are inclined to project only a modest hit to Q1 GDP from the shutdown, and Goldman was out Saturday evening predicting that we’ll make up for it in Q2. Of course if Trump shutters the government again in three weeks, all bets are off.
Moment of truce
One persistent worry is that a renewal of DC gridlock late next month will end up colliding with a “no deal” outcome from the US-China trade negotiations. Nobody believes it’s possible for Washington and Beijing to resolve the myriad structural issues at the heart of the dispute by March. “We’re miles and miles from getting a resolution. Trade is very complicated”, Wilbur Ross said Thursday, adding that “there are lots and lots of issues [and] people shouldn’t think that the events of next week are going to be the solution to all of the issues between the United States and China.”
The “events” Wilbur was referring to are trade negotiations with Chinese Vice Premier Liu He, who will be in Washington on Wednesday and Thursday for talks with Representative Lighthizer and Steve Mnuchin. Conflicting reports over the past two weeks with regard to exactly what’s been offered have left markets in the lurch, with traders (perhaps mistakenly) inclined to key on upbeat headlines (e.g., China’s purported offer to cut the imbalance with the US to zero over six years, Treasury’s rumored “recommendation” to ease off on tariffs until March as a sign of good faith).
Meanwhile, optimists hope the latest activity data out of China marks a trough and while there were signs of “stabilization“, the jury is still out on whether Beijing’s various easing efforts will ultimately trickle down and manifest themselves in favorable real economic outcomes.
“A deal at this stage seems unlikely, in our view, given the limited progress on the key structural issues of forced technology transfer, IP protection, and SOE subsidies”, Barclays wrote over the weekend, noting that “even if a ceasefire extension beyond the March deadline is agreed (as markets increasingly expect, given the low levels of USDCNH skew and almost 2% CNY trade-weighted appreciation since late-November), the US is unlikely to immediately remove existing tariffs and Chinese exports are likely to decline further through Q1”. The bank’s economists are still looking for a 20% y/y fall.
‘Stop with the 50 B’s’
We’ll also get the Fed this week and you can be absolutely sure they’re cognizant of the possibility that another government shutdown could end up conspiring with an unfavorable outcome from the trade negotiations to spell trouble in March.
Friday’s WSJ trial balloon suggests it’s just a matter of time before Powell tips a tweak to the pace of balance sheet rundown in an effort to placate markets that, as he well knows, will never be satisfied – it’s never “dovish enough”, so to speak.
Needless to say, Powell and co. have gone out of their way to emphasize data dependence of late and the “patient”, “ear-to-the-street” messaging is in no small part responsible for the voracious rally in risk assets.
“Recent speeches by Fed officials have emphasized that the Committee can be patient for now and that decisions about further changes in the policy stance are data dependent”, Goldman writes, in their Fed preview, adding that they “expect both themes to be incorporated into the statement by noting that the Committee will ‘patiently continue to monitor incoming data.'” Here’s the bank’s mock January statement:
Goldman doesn’t expect any formal changes to the balance sheet plan, but notes that going forward, the market will be focused on the following two “potential changes”:
First, the FOMC could revise the June 2017 addendum to the Policy Normalization Principles and Plans, which currently says that “a material deterioration in the economic outlook” leading to “a sizable reduction” in the funds rate would be required to resume reinvestment before runoff has run its course. To us, even a scenario of limited rate cuts alongside continued balance sheet reduction—using the two tools simultaneously but at cross purposes—seems unlikely, and the FOMC might eventually lower the bar for ending runoff in the event of a slowdown in the economy.
Second, the FOMC could eventually taper its run-off by gradually reducing the monthly roll-off caps as the level of reserves approaches its longer-run level.
In their own preview, Barclays expects tweaks to soften the forward guidance in line with recent communications.
“We think the statement will say that ‘some further increase’ in the target range for the federal funds rate ‘may’ be appropriate to achieve the committee’s goals”, the bank says. On the balance sheet, Barclays notes that Powell “will likely need to address outcomes that would cause the Fed to slow or stop”. On the bank’s view, the presser will find Powell explaining that the committee “would be prepared to alter its balance sheet policies if a major deterioration in the outlook were at hand.”
That might not be enough. The market wants more than, to quote Barclays, a Fed that’s “inclined to slow its runoff [due to] nascent recession risk.” Rather, the market is clearly looking for hints that runoff will be reconsidered well before a recession becomes a “nascent risk”.
“The Fed is almost certain to remove its forward guidance of ‘further gradual increases’ in interest rates, and we expect some new language emphasizing data dependence [where] an explicit reference in the statement to ‘patience’ in the hiking cycle would be a dovish development, in our view”, Credit Suisse muses. They also see Powell as “likely to indicate more flexibility in changing the Fed’s balance sheet policy if economic conditions deteriorate.”
Speaking of economic conditions, this week will feature ISM and, of course, payrolls. You might recall that December’s ISM manufacturing print was a disaster and, when combined with Apple’s “shock” guidance cut (which hit the previous day), was good for a quick swoon on January 3, the day before Powell engineered a rally with comments in Atlanta.
In addition to the December print, the January ISM number will be set against dour data out of Germany and, of course, contraction-territory prints on both the official and Caixin gauges for China (we’ll get an update on the official – i.e., the NBS – gauge this week).
“ISM manufacturing fell sharply in December, with the headline index declining to a 2-year low of 54.1 [and] we expect a further modest decline to 53.5 in January, before a stabilization in the next few months”, Credit Suisse says.
“In terms of data releases, on Friday, we expect the ISM manufacturing index to edge lower to 53.9 in January [and] with little hard data to assess the health of the US economy, the ISM PMI takes a more prominent role, especially after the sharp deterioration in December, which brought market nervousness and concern about US manufacturing”, Barclays adds.
On payrolls, you’re reminded that the December report was a blockbuster of epic proportions. Things should moderate materially this month to ~160k (from 312k).
For what it’s worth, Goldman is looking for 180k on the headline. “We estimate nonfarm payrolls increased 180k in January reflecting very low jobless claims and warmer weather than usual in January”, the bank wrote on Sunday evening, adding that they “expect the unemployment rate to increase one tenth to 4.0%, reflecting the effect from federal workers furloughed by the government shutdown.”
Credit Suisse notes that “unpaid government contractors could lead to some job losses, but this hasn’t had a clear impact on headline payroll numbers in past shutdowns.”
The big boys are on deck with earnings this week. The market will have to digest numbers from Amazon, Facebook and Apple, with the main question for the latter being whether all the bad news is priced in. Any kind of wide-of-the-mark miss from the heavyweights could materially dent sentiment – especially if something goes “wrong” on any of the other fronts mentioned above.
Eurozone GDP is up as well and they’ll be some Brexit drama, as usual. To wit, from Goldman:
On Tuesday, MPs in the House of Commons will vote on a handful of amendments to Brexit legislation. The most high-profile of those amendments, if selected and if passed, would imply that—in a scenario in which no Brexit deal can be agreed by 26 February—the UK government must allow MPs to vote on whether to request an extension of the Article 50 deadline, beyond 29 March.
And from Barclays:
FX markets appear overly optimistic about the ‘Cooper amendment’, to be voted on Tuesday, that would force the Government to ask the EU for an extension of the Article 50 (A50) negotiation period if a deal cannot be agreed by the 29 March deadline for exit. The amendment would raise serious constitutional issues; hence, we think it is unlikely to pass despite an effective endorsement by Labour’s leadership and several Conservatives. With sterling trading at levels we consider consistent with the passage of the Withdrawal Agreement, we believe GBP faces material downside risk in the week ahead.
Finally, expect plenty of fireworks around the Roger Stone indictment. He’s been giving interviews all weekend long and Trump seems pretty keen on suggesting he never even knew him (not really, but the President is resorting to the usual strategy of downplaying the campaign’s connections to someone who now faces charges from the special counsel).