By now, you know the narrative – or at least you should.
Last month’s “growth scare” and concurrent DM bond rally which pushed 10-year yields in the US to their lowest since December 2017 (a move exacerbated by convexity flows following the March Fed) has morphed into this month’s “cyclical reflation” story.
On the home front, benchmark Treasury yields are back up to 2.56% and in Germany, 10-year bund yields are back above zero, helping ease fears that the “jaws” might close via a steep decline in equity prices (a “catching down”, if you will, to what the bond market was purportedly “saying” last month about the outlook).
Needless to say, a string of better-than-expected data out of China has helped allay fears that the global economy is headed for a steep downturn. Over the past three weeks, Beijing has delivered upbeat reads on PMIs, credit growth, exports, retail sales, IP and Q1 GDP. Throw in a solid March jobs report in the US and you’ve got more than enough “evidence” to shift the narrative, even as the gloom and doom continues in Germany. Market participants will focus on Q1 GDP in the US for more clues about the state of the economy.
A trade deal between the US and China is apparently imminent, something that should be good news, although as noted Wednesday, this appears to have been priced in a long – long– time ago. With Trump set to turn his figurative guns on Europe next, trade worries aren’t likely to abate anytime soon.
Boeing will likely be in the spotlight again this week – for the wrong reasons. A New York Times report out over the weekend painted a decidedly disconcerting picture of the company’s factory in North Charleston, S.C. This is on top of ongoing safety concerns tied to the 737 debacle. The shares are desperately trying to recover from their second-worst month since 2009.
Also on the radar this week: An expected announcement from Joe Biden on a 2020 bid. This can’t come fast enough for beleaguered health care stocks. As mentioned a few days back, the space is under enormous pressure as the “Medicare for all” push gains traction and one assumes that Biden would take a softer approach to things. He would enter the race as the front runner. The S&P 500 heath care index erased its YTD gains last week amid a series of horrible sessions.
Cross-asset volatility has collapsed as forward guidance works its magic. At the same time, liquidity has stopped improving, giving rise to familiar fears that a sudden bout of turmoil could do outsized damage. Here’s Barclays:
However, we caution against a risk of a near-term retracement for several reasons. The global risk asset rally has come a long way, as global equities have already recovered their losses in absolute terms and relative to global business sentiment. With the general risk-on mood came the decline in cross-asset volatility to multi-year lows. Average 1m G10 FX implied volatility has been in the lowest 5 percentile (of the period since 2010) for 13 consecutive days (as of 19 April), but vols rarely settle at such low levels for long; G10 FX vols have only traded below the 5 percentile for 19 consecutive days, on average, in the past before rising back.
The bank also cites questions about the durability of the upward inflection in the Chinese data, lackluster earnings in the US and the persistence of holiday illiquidity with a 10-day Golden Week coming up for Japan (more on that here).
Speaking of Japan, the BoJ is on deck. The bank cut bond purchases for the first time in months on Friday, taking some market participants off guard. At the meeting, you can probably expect a cut to the inflation outlook (surprise!). Notably, markets will get a first gander at the bank’s FY2021 inflation forecast. Generally speaking, this story remains the same: Policy unchanged, inflation target drifting further out of reach all the time.
“In our view, the key topic of interest will be the first release of the BOJ’s CPI outlook for FY2021, which we think will initially be set at around +1.6%”, Goldman wrote Thursday, adding that “while we expect the BOJ to forecast a slight acceleration from its FY2020 CPI outlook (as of January), this would indicate that the 2% inflation target will remain out of reach even through FY2021.” As for GDP, Goldman reckons the BOJ will forecast FY2021 real GDP growth “of around +0.8%, a slight slowdown from its FY2020 outlook (as of January), reflecting a deceleration in the US and Chinese economies and a drop-off in public demand, which is expected to increase prior to the Tokyo Summer Olympics in 2020.”
Again, traders are intently focused on the prospect of another “flash event” in the yen given the holiday that’s coming up at the end of the month. Here’s Barclays with a little color on this:
As long as there is resistance at the YTD high (112.1), we expect USDJPY to hold in a narrow range of 111-112. However, the risks may be skewed somewhat toward JPY appreciation, given concerns about a decline in liquidity during upcoming holidays in major markets (eg, Easter, May Day), including the 10-day Golden Week holiday in Japan, and the outlook for this to trigger some early profit-taking and hedging selling in risk assets, which have already rallied sharply. If US 10y yields rise sharply above 2.60%, on the other hand, we caution that USDJPY could come under upward pressure with no clear resistance up to the 113-114s.
If you need a recap of what happened in January, you’re encouraged to go back and read “This Flash Crash Matters – Here’s Why“. In a nod to that episode (and a similar event last year) Barclays goes on to note that “Long TRYJPY positions by Mrs. Watanabe remain near levels seen last summer when TRY tumbled, whose position squeeze, if triggered, pose some risks of pass-through to other cross-JPY pairs.” This is a key point.
Speaking of the lira, Turkey will be in focus this week as well. Erdogan is still angling for some kind of re-run of the Istanbul vote and the market is still looking for clarity from CBT when it comes to what’s going on with net reserves in light of “rumors” (scare quotes are there for a reason) that the central bank is using swaps to inflate the numbers. When you look at the following chart, do note that the figure never rose above $500 million from January to the end of March. So, yeah, the sudden jump to ~$13 billion is odd.
Amusingly, AKP submitted yet another petition to have the Istanbul vote nullified and re-cast over the weekend. The rationale: Thousands of ballots were cast by people the party claims were ineligible to vote thanks to “previous government decrees”. You really can’t make this stuff up. Think of that as a “coming to an American voter booth near you in 2020” type of deal.
Other notables this week include the Bank of Canada and the Riksbank. In EM, we’ll get Bank Indonesia and CBR.
The Riksbank could be fun considering recent inflation trends and the perception that the February meeting was somewhat “hawkish” against a backdrop characterized by a near universal dovish pivot. Inflation has undershot for three months in a row (although core stabilized in March), and while not everyone agrees, it’s hard to see how another hike is possible at this point. This is a particularly vexing scenario for krona bulls – things were already going poorly and now, it looks like bets for further hikes may be misplaced. (More on the Riksbank here and here).
Finally, expect domestic politics in the US to be a hot mess (again). The release of the Mueller report has led to calls for impeachment from the likes of Elizabeth Warren. More back-and-forth between Democrats on the relative merits of trying to oust Trump is likely and if the president’s recent tweets are any indication, his “good” mood has now morphed into a recriminatory fury.