With the US having narrowly averted another government shutdown (no thanks to Donald Trump, who clearly did not want to sign the spending bill), market participants are free to obsess over every headline emanating from yet another round of trade talks.
Let him eat big, beautiful cake
At this point, a benign outcome seems to be largely priced in, although some analysts have suggested that a “real deal” could propel US equities to new record highs. That’s probably some semblance of true, but a “real deal” (where that means a resolution to key sticking points around the structural issues that continue to elude attempts at consensus building) likely isn’t in the cards for Q1. Rather, expectations are that the March deadline will be pushed out so that Trump has an opportunity to meet with Xi (perhaps over an even bigger, even more “beautiful” piece of chocolate cake).
“We believe China can address US concerns about merchandise trade and bilateral deficits by committing to purchase more American goods, which would allow the countries to reach a short-term deal”, Barclays said over the weekend, before cautioning that “US demands on intellectual property and tech transfers remain unsolved, and an agreement is not likely in the short term.”
In the meantime, there’s likely to be some manner of interim agreement attached to the deadline extension. Between ostensible “progress” on trade and a deal that keeps the US government open, investors are in a forgiving mood even as global growth continues to weaken and corporate earnings growth decelerates. Last week was the fourth week of 2%+ gains for the S&P since the December lows.
Whether or not the YTD rally is sustainable likely hinges at least in part on volatility remaining suppressed enough for long enough to draw in the systematic crowd and coax reluctant fundamental/discretionary investors off the sidelines.
“He hates these cars! Stay away from the cars!”
Meanwhile, Sunday was the deadline for the Commerce Department to deliver a Section 232 report on the relative merits of auto tariffs. Trump has been itching to move ahead with duties on foreign cars for months and it seems likely he’ll get the excuse he needs from Wilbur Ross.
The White House will have 90 days to make a decision, and Trump will doubtlessly use the report to pressure Europe and Japan into making concessions during that window. Whether or not he’ll actually go through with tariffs is anyone’s guess, but in the interim, the wrangling could introduce additional uncertainty.
The risks for Trump of moving ahead with the auto tariffs are myriad. Over the weekend, Angela Merkel essentially called the idea absurd and as BofAML reminds you, consumers would feel it.
“The Trump administration has been avoiding putting tariffs on consumer products since the tariff on washing machines caused a 17% jump in price”, the bank notes, adding that “The Alliance of Automobile Manufactures estimated that consumers may see an average price increase of $5,800 from a 25% import tariff, including both imports and their domestic competitors.” All told, consumers would take a ~$34 billion hit. Here’s a handy timeline on Trump’s auto tariff threats:
Also on deck this week are the January Fed minutes, which will be parsed closely for obvious reasons. Multiple banks have thrown in the towel on their Fed calls following the committee’s dovish pivot and the market will be looking for any further clarity on how balance sheet policy will evolve.
Last week, we got another WSJ end-of-QT trial balloon and Brainard suggested she’d be in favor of ceasing runoff by the end of the year. “Any hint of consensus around this view in the FOMC minutes could mildly support risk sentiment this week”, Barclays writes on Sunday, before noting that “indications to terminate normalization earlier than expected could bring mild weakness to term premium, the dollar, and support risk, confirming another dovish step from the Fed.”
It seems unlikely that we’ll get any real “details” about what an end to runoff might look like and/or about the committee’s vision for the balance sheet, but expectations generally revolve around the idea that the Fed will try to shorten the average duration now in order to make way for another Operation Twist later.
Below are some quick bullet points on the curve from Nomura’s Charlie McElligott. The second point touches on the balance sheet:
The steepening is stalling—so the next catalyst for a potential “impulse” steepening is likely to come in one of three ways from here:
- First scenario would be a meaningful deterioration in US data, which would then see the market “pull forward” the Fed CUT priced-into 2020 implieds—in turn, the front-end rally would accelerate even further (entire curve would ‘bull-steepen’)
- Second scenario would be what George Goncalves has been discussing and I have been advocating, which is the very reasonable / rationale case for the Fed to address the COMPOSITION of its balance-sheet in coming meetings, with a move to what looks something like a “Reverse Operation Twist” where reinvestments would be allocated towards the front-end in order to shorten the weighted average maturity of the portfolio (while still seeing MBS run-off to zero); this implicit “steepener” would then help avoid the bad optics of curve inversions; the steepening would throw a bone to the banking industry; would provide potential wiggle room w.r.t. IOER ‘buffer’ concerns; and ultimately, a steeper curve would then allow the Fed to engage in an EASING via resumption of the original “Operation Twist” down the road to FLATTEN CURVE and ease financial conditions in the case of the next crisis, but one that is “sterilized” without “creating money”
- The third scenario is likely the lowest-delta but perhaps the highest risk / reward: That would be a mix of 1) PBoC / China easing- / stimulus- / liquidity- pumping which, in conjunction with the above-discussed 2) potential pivot in the Fed’s inflation framework (in order to allow for an inflation overshoot) which could then create a powerful global reflationary impulse—in this scenario, theoretical inflation would then see the long-end sell-off on potential bear-steepening fashion
There are also a bevy of Fed speakers on deck this week, including Mester (Tuesday), Bostic (Thursday), Williams, Clarida, Bullard, Harker, and Quarles (Friday).
Dollars and sense
All of that is playing out against a vociferous dollar debate. The greenback has risen in nine of the 12 sessions since the Fed meeting. On the surface, that would appear counterintuitive, until you consider that the Fed’s dovish pivot seems to have started a chain reaction (e.g., RBA shifting neutral, more TLTRO chatter from the ECB, RBI cut, etc.). A dovish lean from other central banks means the policy divergence doesn’t narrow as much on the Fed’s 180. And even if rates differentials move against the greenback, as long as the US economy continues to outperform, the dollar will find support even as the Fed capitulates.
Additionally, the dollar can benefit from haven flows if things get particularly acute and intuitively, an overtly dovish Fed would tend to coincide with acute macro environments. Consider, for instance, the following excerpt from a Goldman note out Wednesday:
So just how unusual is it that the recent rally in US real rates has not led to Dollar depreciation? As a simple exercise, in Exhibit 2 we show Dollar behavior for different quintiles of 3-month changes in 10-year TIPS yields [from] 2004-present. The results reveal a crude version of the familiar “Dollar smile”— the Dollar tends to depreciate in benign environments, and appreciate in more extreme cases in both directions.
This is relevant in the current environment because when growth concerns are especially acute, the Dollar tends to rally on a safe-haven bid (this is offset somewhat in EMs that also benefit from a cheaper cost of capital). Over the last 15 years, rate rallies of a similar magnitude as the current one have seen the Dollar appreciate about 60% of the time. In the “sweet spot” of more benign lower real rates, the Dollar tends to fall about two-thirds of the time (and with an almost 80% hit rate against EM). In other words, given the extent of global growth concerns at the moment, the recent Dollar rally is not at all unusual. But if things stabilize as we expect, that would make for a much friendlier “Dollar down” environment.
That’s actually a highly useful (if extremely simple) exercise and it makes all manner of sense.
We’ll get RBA minutes this week, along with Lowe’s semi-annual testimony. This will get a lot of attention in light of his recent shift to neutral which helped confirm the notion that global central banks are increasingly coming to terms with the idea that the coordinated tightening/normalization effort is no longer tenable (somebody forgot to tell the Riksbank, though). Labor market data is on deck for Australia as well.
Remember, Australia’s fate is to a certain extent bound up with the success or failure of China’s efforts to avert a hard landing. In that regard, January data on both Chinese credit growth and trade is helpful, although it came with the usual caveats about seasonality.
We mentioned the Riksbank above. After last week’s decision to drop the FX intervention mandate and stick with the rate path, this week’s inflation data and meeting minutes could be interesting. Ingves has a speech scheduled as well.
There’s a ton of data on deck in Japan, including CPI, PMI, core machine orders, trade balance, all industry activity index and machine tool orders, but at this point, it’s by no means clear that anything matters. The recent dovish turn by the BoJ’s global counterparts likely means any effort to normalize policy has been pushed out even further. Throw in the usual bit about the yen being the beneficiary of safe haven flows tied to any acute bouts of risk-off sentiment, and you’re left with the same inevitable conclusion: there is no end to accommodation in Japan. Here’s Barclays with a rather fatalistic summary of those points:
With regards the BoJ policy, we have delayed our expectations for removal of negative interest rate policy to Q2 20 from Q3 19, due to the dovish shifts in other major central banks and uncertain global growth backdrop. While the window of opportunity for BoJ normalization could reopen in Q2 20 after VAT effects run their course (hence, our new forecast), the uncertainty on global fundamental backdrop is cloudier further down the road, suggesting a risk of prolonged period of NIRP. While the delay of BoJ normalization itself reduces JPY appreciation pressures, the drivers of that change (ie, weaker global growth and lower global rates) indicate a greater risk of JPY appreciation from a safe-haven perspective.
Finally, don’t forget that the US is experiencing a “national emergency”. If you want the specifics, you’ll have to ask the White House, but the gist of it is that America is being “invaded” from the south by drug-dealing “aliens”, “vicious, duct-tape-wielding coyotes” and “gang monsters”.
In light of Trump’s Friday declaration, the administration is about to be inundated with legal challenges. When taken in conjunction with Adam Schiff’s increasingly aggressive Russia probe, you can expect the president to be in a particularly combative mood this week.
Calendar via BofAML