With Q1 in the books as the best quarter for US equities in a decade, the first week of Q2 is expected to provide clues as to whether bonds are “right” about the trajectory of the global economy.
First, we should note that tensions inside the Beltway will be running high this week following Donald Trump’s threat to close the southern border and the administration’s decision to cut off aid to El Salvador, Guatemala and Honduras or, as Fox News calls them, “three Mexican countries.”
And to think, that’s where millions of Americans get their “news”. The network would later apologize.
Lawmakers aren’t going to be amused with this decision, nor will they be in any mood to stomach some kind of dramatic action on the border considering Trump just vetoed a bipartisan resolution which sought to nullify his “national emergency” declaration.
The irony, of course, is that the administration’s policies – initially implemented to combat an imaginary “emergency” – look to have created something that is rapidly becoming a real emergency. You can read more on that here.
Bond market ‘gone mad’ meets data deluge
The ferocious DM bond rally has driven benchmark yields into the floor (and below in the case of Germany and Japan) seemingly “confirming” a pessimistic take on the outlook for growth. Concurrently, the global stock of negative-yielding debt has jumped back over $10 trillion, after falling below $6 trillion in October.
The paradox here is that while this will naturally push investors into riskier assets, one could quite easily argue that the spike highlighted in purple above is attributable to a less “favorable” mix of dovish monetary policy and growth concerns than in the past. That is, the pivot from policymakers is driving the rally in DM government bonds and thereby re-igniting the global hunt for yield, but that pivot has a panicky character to it, which would seem to suggest that now is not the time to be piling into risk assets, especially if you believe central banks are at the limits of what they can do when it comes to reflating the global economy.
In any case, the collapse in US 10-year yields (helped along by positioning squeezes) has been nothing short of remarkable. At the same time, US stocks have of course surged along with other risk assets. High yield spreads, for instance, have tightened markedly off the December wides.
Bond bulls (as well as those pricing in Fed cuts by year-end) will get a gut check this week in the form of a raft of data stateside, including payrolls.
February was obviously a disaster on the headline, which printed just 20k, missing even the lowest estimate (85k) by a country mile, not to mention coming in so laughably short of consensus (180k) that the word “miss” was wholly inadequate to capture the disappointment.
On the bright side, we’re still riding a record streak of monthly gains, now at 101. All good things must come to an end, but it probably won’t be this month.
“We expect payrolls to move up 175k in March, returning to a pace in line with their underlying trend”, Barclays wrote Sunday, adding that “trend employment growth should be sufficient to push down the unemployment rate by another 0.1pp, to 3.7%.”
“We expect nonfarm payroll employment growth of 190k in March after a notable slowdown in job growth to 20k in the prior month”, BofAML said Friday, weighing in and noting that “the strong reading from our private payroll tracker suggests that last month’s slowdown in job gains may prove temporary and poses upside risk to our official forecast.”
Remember, Larry Kudlow knows that last month was a “glitch.”
You’re also reminded that wage growth came in hot last month, and given the fact that the Fed is leaning on subdued inflation as an excuse to remain dovish (and also considering how keen Powell has been to talk around the connection between inflation and wage growth), AHE will be watched closely as well.
We’ll also get retail sales, ISM, durable goods, construction spending, consumer credit and, of course, some Fed speakers.
All of the data will be set against a backdrop of the 3M-10Y inversion and expectations for Fed easing. When it comes to the odds of a Fed cut, reams have been written lately on whether the market is “right” (see here, for example). If you ask BofAML, “market participants are pricing in something similar to a 1995 experience.” Here’s a trip down memory lane:
To boost inflation (1995): In December 1994, there were signs of a weakening economy (but not necessarily recession) and soft inflation despite what was believed to be a tight labor market. The Fed decided to cut rates by 25bp, citing more “favorable” inflation than expected and a “moderation in inflation expectations.” The Fed also noted that subdued inflation was a function of “monetary tightening initiated in early 1994.” This suggests that the Fed believed they had overshot.
Whatever the case, the overarching point is that this week’s data will be seen as an opportunity for rates traders and the bond market in general to assess things in the context of key data following a wild couple of weeks.
It will also set the tone for Q2 at a time when key investor groups are still underexposed to equities despite the mammoth rally.
The poster child
A similarly crucial deluge of data across the pond will presumably help market participants get a handle on just how bad the economic outlook is in the euro-area.
On deck are CPI, unemployment, retail sales and, crucially, German factory orders.
Obviously, Europe is the poster child for the global slowdown narrative and within the bloc, Germany is the linchpin. You’ll recall that a lackluster German manufacturing PMI print helped accelerate the DM bond rally on March 22.
“Weakness in new export orders will likely drive German factory orders down and, similarly, German IP will likely marginally decline, in line with the weakening outlook of business surveys”, Barclays wrote Sunday.
Markets will also get a look at the March ECB minutes, which will be parsed closer than usual in light of the dramatic downgrades to the outlook and the announcement of a new round of TLTROs. Last week, Draghi reiterated that the risks are skewed to the downside and officials have also cautioned that markets are not priced for a no-deal Brexit. Here’s Barclays:
The minutes of the March ECB meeting will likely attract greater market attention than usual, but are unlikely to provide much direction to the EUR, in our view. In particular, markets will be looking for insights to justify the aggressive downward revisions to the growth and inflation outlooks. After President Draghi’s comments last week on bank profitability, we now believe the ECB may choose to adjust its forward guidance by September/October 2019, and is willing to decouple the refi rate from the depo rate by specifying that only the refi will stay at the current level (zero) for an extended period. We expect the central bank to increase the depo rate to -10bp from -40bp, in H2 20. Given the current macro backdrop, however, this remains too far out for markets to price.
Trade-sensitive German equities are coming off their best quarter since 2015, but it’s the decline in bund yields (to below zero) that’s grabbing headlines.
You’re reminded that in addition to worries about the future of European financials in a “lower forever” rates regime, there are also concerns about European autos and trade-sensitive sectors in light of the fact that despite ongoing upbeat chatter about progress on trade between the US and China, there’s still palpable tension between Washington and Brussels.
Meanwhile, the European elections loom large and Brexit is, well, Brexit is so convoluted that attempting to make sense of things at this point is not only impossible, but also largely pointless. Theresa May suffered a third defeat on Friday. Apparently, the choices are now to leave the EU without a deal, hold elections or angle for a “softer” deal. Or something. Who knows – the only thing we do know is that it clouds the outlook even further.
This will be an interesting week for Turkey following key local elections. Last week was obviously a rollercoaster, as Erdogan’s efforts to prevent the lira from sliding a week prior to voting manifested itself in a comical spike in overnight rates, a stark reminder to investors that when it comes to whether NATO’s favorite autocrat will put political expediency above all other considerations if he thinks the situation calls for it, the answer is a resounding “yes.”
The worry, of course, is that the draconian measures will undermine sentiment and thereby imperil foreign investment. But again, that’s something Erdogan was willing to risk. Turkish stocks posted their worst week since August (when the lira meltdown was in full effect) and the outcome of the elections will generally determine where things go from here for the currency.
“The elections are meant to mark the end of a nearly five-year long election cycle and not only will they be the first since the shift toward a presidential regime, but the polls might be interpreted by some as a quasi-referendum about the performance of the ruling party”, Barclays notes, adding that “an unexpected outcome that gives the opposition control of Istanbul may stoke renewed uncertainty about possible earlier national elections and weigh on the TRY [while] a ‘status quo’ outcome may be taken positively by markets.”
The never-ending story
On trade, poor Liu He will be back in Washington this week, presumably to discuss the same issues he spent last week discussing with Mnuchin and Lighthizer in Beijing, where talks were “constructive.”
Here’s Steve to Mnuchin-‘splain:
.@USTradeRep and I concluded constructive trade talks in Beijing. I look forward to welcoming China’s Vice Premier Liu He to continue these important discussions in Washington next week. #USEmbassyChina pic.twitter.com/ikfcDZ10IL
— Steven Mnuchin (@stevenmnuchin1) March 29, 2019
This is the same old story over, and over, and over again. Ostensibly, there’s been progress on forced tech transfer and IP theft, but who really knows and the US is still keen to keep some tariffs in place once a deal is struck in order to retain “leverage”.
At the risk of downplaying the importance of Donald Trump’s “biggest deal in human history”, this is starting to venture into Brexit territory in terms of market participants giving up on the idea that there will ever be any “real” clarity regardless of the outcome.