Trump’s decision to spare Mexico from tariffs “underscores the uncertainty facing the Fed”, TD Securities wrote over the weekend, in a note calling for a “risk-positive” start to the new week.
“We continue to believe [the Fed] can stay on hold for now conditional on what materializes with tariffs”, TD continued, adding that they “doubled down on Friday” on a short 10Y Treasury position.
The idea that the Fed will stay on hold for as long as possible to see how the tariff fights (plural) play out is debatable, to say the least. TD goes on to say that â€œthe focus will now shift back to the G20 and China”, and that’s an important point when it comes to the Fed. Jerome Powell is surely aware of the possibility that a Fed cut at the June meeting could embolden Trump ahead of the G20, possibly compelling the US president to adopt a harder line with Xi than he otherwise might.
To cut or not to cut
Whatever the case, this is set to be yet another week when market participants will try to sort out “who” is right, stocks (which are coming off their best week since November) or bonds (where yields are sitting near their lowest since September 2017).
A string of recent data disappointments suggests bonds are, as usual, correct. ISM manufacturing just hit the lowest of the Trump presidency and last week also brought the worst ADP print in more than nine years and, of course, a lackluster May NFP report.
As Deutsche Bank wrote on Friday, “comparing now to the previous episodes [where rate cuts were priced], the S&P is much closer to the record high, suggesting that either equities are discounting the downside risks more than in the past, or the current pricing of Fed cuts are too aggressive.”
When it comes to assessing the state of the US economy, traders will have plenty of data to parse this week. Hot on the heels of May payrolls, we’ll get PPI, CPI, industrial production, retail sales and University of Michigan consumer sentiment. Mercifully, it’s blackout week ahead of the Fed meeting, which means nobody will be forced to parse any Fedspeak.
The dollar has, in the past, demonstrated a propensity to weaken as a Fed easing cycle begins to get priced in. “Our historical analysis points to USD underperformance after the market begins to price in aggressive rate cutting, with the largest dollar underperformance happening against AE currencies (about 2% after one year) and less so vs. EM FX (about 1.3% after one year, both on a real trade-weighted basis)”, Barclays wrote Sunday.
This time around, though, the bank doesn’t necessarily see things playing out in accordance with history. “We expect the Fed cuts to be precautionary in nature and incoming data to remain consistent with an ongoing expansion, with growth risks largely external”, the bank says, adding that “escalating trade tensions and their consequent negative effect on global trade and growth is likely to weigh on market sentiment and limit USD underperformance, particularly vs. EM, even as the Fed cuts rates.”
That’s been the story of 2019. The Fed has leaned dovish, markets have priced in cuts, and yet the dollar remains resilient as the FOMC’s global counterparts have either cut rates (e.g., RBNZ, RBA, RBI) or else introduced dovish forward guidance and pledged more accommodation (e.g., ECB and BoJ). At the same time, the US economy still looks like the cleanest dirty shirt.
Big week for Chinese data
This is a huge week for data in China. April’s activity data showed the Chinese economy had already started decelerating again prior to the latest trade escalations from Trump. This week, market participants will get a read on how things held up amid the worsening tensions.
In addition to trade data, the FAI/IP/retail sales trio is on deck, as is credit growth. “We expect export growth to extend the contraction to -4% in May, while imports slow to -3%”, Barclays says, adding that IP growth will likely “stay subdued at around 5.5%” while FAI growth should “hold up at 6.1% [and] retail sales could recover to 8% in May from the weak print of 7.2% in April.”
As far as the credit data goes, TSF and new yuan loans will be scrutinized more than usual in light of recent efforts to ensure ample liquidity following the Baoshang debacle.
Over the weekend, Goldman said the yuan may well breach the psychologically important 7-handle within three months. On Thursday, Barclays slashed their outlook for the Chinese economy.
The ChiNext became the first major mainland benchmark to fall into a bear market last week, a mere 69 trading days after surging into bull market territory.
Mexican standoff ends
The peso rebounded sharply in early FX trading following Trump’s decision to “suspend” tariffs on Mexico. The president spent the weekend defending his “deal” amid allegations it’s nothing more than a rehashing of previous commitments. MXN has had a fraught relationship with Trump (as have Mexicans):
“Importantly, some things not mentioned in [the] press release were agreed upon”, Trump tweeted Sunday, in an apparent reference to a Bloomberg story that cited three Mexican officials as saying there was no discussion of a farm deal during last week’s negotiations.
Goldman’s Alberto Ramos warns the deal with Trump has potentially serious fiscal ramifications for Mexico at a delicate time. “Overall, following the US-Mexico agreement and in light of the commitments undertaken by the Mexican authorities, we expect additional pressures on an increasingly tight budget”, he wrote, in a note out just before noon on Sunday. “Furthermore, lingering uncertainty with regards to the terms under which Mexican exporters can access the US market is likely to impact domestic investment decisions and FDI inflows and through them intensify the headwinds to an economy that has been underperforming since 4Q2018”, Ramos went on to say, before warning that “the impact on investment and growth will likely magnify the fiscal pressures, particularly in 2020 [and] sub-par growth and an eventual deterioration of the fiscal baseline could be a trigger for additional rating downgrades.”
In other words, this is yet another example of Trump piling pressure on already fragile EM economies. This time, it’s one of America’s neighbors.
Meanwhile, oil is of course in a bear market, as concerns about the prospect of a global recession and concurrent demand destruction outweigh virtually all other considerations including supply jitters (i.e., Iran and Venezuela).
Javier Blas had a great piece out on Sunday which you should read.
It looks like CBT is on deck this week – that’ll be a joke, as usual, but it’s made more interesting by the looming Istanbul re-run vote and the ongoing S-400 soap opera. Oh, and Russia may cut after Nabiullina opened the door on Thursday.