You could scarcely ask for a more dramatic setup headed into the new week.
Last week (which was also month-end), brought no shortage of excitement. There was domestic political drama, as Robert Mueller’s first public statement on the Russia probe left some Democrats more convinced than ever that the special counsel intended for Congress (not William Barr) to make the final call on obstruction. And, of course, Donald Trump’s “greatest” trade escalations shook markets to the core, leaving traders and analysts to ponder the possibility that by the end of October, the US will be taxing all imports from both China and Mexico at 25%. Ultimately, it was worst week of the year for US stocks, just as May was the worst month of 2019.
As if things needed to get any more harrowing after Trump’s unexpected decision to slap tariffs on Mexico (against the advice of Bob Lighthizer, Steve Mnuchin and even Jared Kushner), China on Saturday announced an investigation into FedEx and on Sunday released a white paper that found Beijing imploring US citizens to come around to the reality that the trade war is not “making America great again.” Throw in the scrapping of GSP status for India, and you’ve got yourself a proper trade war.
With all of that as the backdrop, traders will have to navigate a veritable minefield of data in the week ahead. First up is ISM and as Credit Suisse reminds you, that’s a big deal when it comes to the Fed. To wit, from a note out Friday:
Each 1990s easing cycle was preceded by an external shock that damaged business sentiment and triggered a slump in the tradeable goods sector. The ISM manufacturing index fell below 50 and global industrial production growth turned negative before these cuts. We’ve shown in our prior work that the ISM index is the economic indicator most associated with Fed policy changes since 1994. The Fed has tended to ease policy when ISM manufacturing was below 50. The exceptions were during the energy slump in December 2015-2016 (which prompted a pause in a hiking cycle) and in December 2006 (when ISM reached 49.5).
There’s also factory orders, plenty of Fed speakers (including Powell) and, on Friday, May payrolls. Note that the Fed’s framework review conference (in Chicago) is this week.
Generally speaking, folks expect the US data to hold up ok. “We expect US data to be positive, with ISM PMI likely to improve and another solid month of employment growth to bring the three-month average change in nonfarm payrolls to 197K, with unemployment inching lower and average hourly earnings rising in April”, Barclays wrote Sunday.
Goldman isn’t as upbeat on ISM. “Generally speaking, the early-month manufacturing surveys outperformed (particularly Empire and Philly) and may not have fully reflected the impact of the trade war escalation”, the bank said over the weekend, on the way to predicting a 1pt drop (so, to 51.8) in May. On payrolls, Goldman is at 195k. “Our forecast reflects low overall jobless claims and a possible boost from Census hiring, and we note that the payroll month largely preceded the trade war escalation and stock market sell-off”, the bank says.
The April report, you’re reminded, was a blowout. Here’s where things stand (the purple line shows the consensus estimate for the April report and, thereby, how big of a beat it was):
With yields in free fall and stocks not inclined to be particularly receptive to any further rally in bonds, any big disappointment on the data front this week is likely to be met with extreme consternation. Although hedging dynamics are probably exacerbating the bond rally, it’s clear that growth jitters are proliferating. Suffice to say bonds are overbought.
Oil is in a tailspin thanks to the same growth concerns that catalyzed the global bond rally. On a simple read, crude still has some “catching down” to do (if you will).
Oil’s slide comes even as supply concerns tied to Iran and Venezuela remain squarely in play. That makes the selloff all the more notable, as it seemingly underscores the extent to which the market is starting to fear that the trade war will deep-six the global economy, leading to outright demand destruction.
“While tight fundamentals supported oil prices through mid-May, escalating trade wars and weaker activity indicators have finally caught up with oil market sentiment”, Goldman wrote Sunday, adding the following:
The magnitude and velocity of the move lower were further exacerbated by growing concerns over strong US production growth and rising inventories as well as technicals. The oil sell-off has been swift but is consistent with the heightened price volatility on display since late April driven by high and rising supply and demand uncertainties. We see four catalysts to the move lower, from the increase in trade tensions and disappointing macro readings to the ongoing increase in US oil production and inventories. The technical set-up of the market had a role as well with prices gapping lower through their moving averages and levels of high put open interests, recurring patterns over the past several years.
The dollar has remained resilient despite the rally in US rates. That’s explainable by the relative strength of the US economy, the fact that Fed policy still looks hawkish by comparison to other central banks and the fact that the dollar benefits from the trade conflict (it’s not a “pure” haven like JPY or CHF, but trade frictions have consistently worked to the benefit of the dollar over the past year, a hilarious irony considering America’s adversarial trade stance was supposed to be a weak dollar policy by proxy and also considering how crazy it drives Trump that the dollar continues to hold up, effectively diluting the effect of the tariffs).
At the same time, Bloomberg’s Mark Cranfield has a good little take out on Sunday evening (well, Monday where he is, I suppose). “Treasury yields are already anticipating a growth slowdown, which the central bank won’t be able to ignore, and that is a major USD negative”, he wrote, before noting that with USD/JPY and USD/CHF “leading the way” we just need to see the euro “get on board for investors to be fully convinced USD’s bullish days are over.” Cranfield continues, writing that when you look at “the long list of negatives against the [euro], it’s impressive that EUR/USD isn’t already trading on a 1.10 handle [and] with positioning skewed bearish, a move above 1.12 could trigger a nasty short squeeze higher for the cross.”
“We expect markets to trade defensively, with the JPY likely benefiting the most and EM FX underperforming the USD, even as the Fed cuts rates”, Barclays wrote Sunday, on the way to delivering the following somewhat handy summary:
Hopes that the muted start to the year would be offset by receding risks have quickly reversed with the breakdown in US-China trade talks and the US announcement of possible tariffs on Mexico last week. Moreover, any hopes of a US-China trade deal are being pushed out, as investors acknowledge prolonged uncertainty during this stand-off and risks of further escalation. Weak global growth prospects augur for continued support to the broad USD index strength, particularly vs. EM FX. Indeed, the USD index is back to year-to-date highs, with the GBP and CNY leading the losses, while reserve currencies such as the JPY have gained. A closer look at recent FX performance shows that only phases of synchronized growth momentum, where the RoW is catching up, have been consistent with broad USD depreciation.
Adding to the impetus for dollar strength (even in the face of Fed cut bets and deteriorating US data, assuming more cracks start to show), is the dovish pivot by the FOMC’s global counterparts. That will continue this week.
The RBA will almost surely cut on Tuesday after months of speculation. Last week, as bonds rallied across the globe, 10-year yields down under fell below the RBA cash rate (top pane).
It’s now a race to the bottom when it comes to RBA watchers. Last week, the vaunted Bill Evans said a trio of cuts are in the cards and JPMorgan took it a step further, predicting 100bp of easing by mid-2020. “A number of developments in recent months suggest the RBA is unlikely to achieve desired macro-economic outcomes with only 50bp of easing”, the bank wrote.
“A 25bp cut is unlikely to fuel optimism on growth yet, especially with the June RBA OIS pricing in 100% chance of a cut”, Barclays said Sunday. “Since the May meeting, the unemployment rate unexpectedly rose to 5.2%, 1Q2019 wages surprised to the downside and – most importantly – Governor Lowe strongly guided to near-term rate cuts”, Goldman remarked.
There’s no ambiguity here. Everyone is on the same page now when it comes to the RBA. This has been coalescing for months.
On Thursday, we’ll get the ECB, and the focus there will obviously be on the new round of TLTROs. Lurking in the background is the increasingly fraught situation in Italy, where Matteo Salvini is about one errant Di Maio comment away from pulling the plug on everything and declaring himself king. (That’s a joke, but like all good jokes, there’s a lot of truth in it.) Brussels and Rome are now headed for another budget battle and the situation is fluid.
Don’t sleep on this ECB meeting, it could be critical. Despite some green shoots having emerged of late, and although the EU elections did not produce the kind of populist wave some feared, the German economy is still teetering, as is the grand coalition – Nahles resigned on Sunday and Merkel has soured on AKK, which leaves both SPD and CDU in flux. Bund yields pushed to record lows last week (bottom pane in the visual above). German industrial production data is due Friday.
The threat of auto tariffs from Trump continues to cast a pall over the outlook for Europe and the Mexico escalation will only add to reservations in Brussels about the relative wisdom of negotiating with the US.
“We do expect communication [from the ECB] on several fronts”, Goldman writes. Here’s more:
We expect the Governing Council to acknowledge downside risks to the growth outlook as well as risks posed by weaker inflation expectations. We also expect the Governing council to announce key details of an easing package as an insurance against these downside risks, with generous TLTRO-III pricing and a further three-month extension of the date-based guidance to March 2020, although more forceful action is possible. Given the continued weakness in actual and expected inflation, we now think that lift-off will be delayed and move our forecast for the first hike by six months to end-2020.
That last bit is key. ECB forward guidance is now undergoing perpetual “enhancement”, where that means the first hike is getting pushed further and further out. For their part, Barclays expects “a decisively dovish message [from] Draghi in the press conference, in the form of concrete measures (more generous terms on TLTRO III) and verbal interventions (keeping rate cuts/tiering prospects alive).”
And then there’s the RBI, which will probably cut.
Needless to say, China will be in focus as well, as traders watch to see how aggressive the PBoC will be when it comes to keeping liquidity ample following the Baoshang debacle and ahead of upcoming MLF maturity.
All eyes will be fixated on Trump’s Twitter feed for clues as to what the crazy badgers that live in his brain are whispering at him to do next. On Sunday afternoon, the president appeared to suggest that Mexico is wasting its time trying to negotiate with him. “Mexico is sending a big delegation to talk about the Border”, he said. “We want action, not talk.”