With Jerome Powell’s congressional testimony out of the way and Robert Mueller’s appearance on Capitol Hill delayed until July 24, markets are ostensibly free to focus on the “fundamentals” again.
It’s a big week on the data front stateside, with retail sales, industrial production, Empire manufacturing, U of Michigan sentiment, Philly Fed manufacturing, housing starts, import prices and business inventories all due.
You’re reminded that Trump is now the proud owner of the largest MoM drop in the Empire manufacturing gauge in history. The index plunged 26.4 points last month, underscoring the notion that the global factory slump might be on the verge of making landfall at home.
The key going forward will be how the market responds to data surprises. The fact that equities made new highs last week despite rising US yields and the hottest MoM CPI print since January 2018 opens the door to good news being greeted warmly by risk assets again. With the Fed now committed to cutting rates irrespective of how the data evolves, there would appear to be no reason why stocks can’t rise in the event the numbers come in good. Of course, if the numbers come in bad, that’s just another argument for more easing, which, at least in the post-crisis environment, is risk-asset-positive, as more easing means abundant liquidity and a continuation of the global hunt for yield.
That said, the risk is that a continuation of the nascent bond selloff that gathered steam late last week following the hot CPI print in the US and an ugly 30-year auction, accelerates, pushing yields up too far, too fast.
With a record amount of duration parked on various balance sheets (not all of it very liquid), interest rate risk is simply massive and the prospect of liquidity vacuums (especially during the summer lull) potentially opens to door to a bond tantrum or, technically speaking, a VaR shock.
With the theatre as crowded as it is in bond land, it’s important that folks avoid screaming “fire”.
“Cross-asset volatility is revisiting its pre-May lows, except in rates, amid confirmation of a dovish Fed and prospects for monetary easing in both DM and EM with near-term relief on US-China trade issues”, Barclays wrote Sunday, adding that “in FX, declining volatility has been accompanied by a normalization of skews in risk-sensitive pairs such as USDJPY and AUDUSD, indicating a renewed preference for carry over volatility [and] this may offer some cheap hedging options for those less complacent and wary of another upset in risk sentiment”.
Markets are likely to be particularly sensitive to any further currency “manipulation” rhetoric emanating from the presidential Twitter feed. There is rampant speculation that the Trump administration may resort to outright, active intervention in order to bring down the dollar and thereby strengthen the president’s hand in the trade war.
Of course, earnings season kicks off this week, which will afford everyone a chance to appraise the health of corporate America now that the fiscal impulse is waning. “On an aggregate basis, consensus forecasts a 2% year/year decline in S&P 500 EPS during the quarter, with earnings expected to fall in six of the 11 sectors, led by Info Tech (-10%) and Materials (-8%)”, Goldman notes. That said, the median company is expected to grow EPS by 4% in the second quarter.
Here’s some additional color from BofA:
Consensus expects a 3% YoY decline in net income, while sales are expected to rise 3%. Non-Financials’ net margins are expected to fall to 10.8% from 11.5% a year ago. Our Corporate Misery Indicator suggests more margin pressure ahead and we expect full-year Non-Financial net margins to fall to 11.2% in ‘19 from 11.7% in ‘18. Materials, which has the most sensitivity to China, is expected to see the largest YoY decline in 2Q earnings and sales. Consensus also forecasts Tech earnings -12% YoY on a 1% decline in sales. Utilities are expected to post the best earnings growth (+7%).
Here’s a chart to ponder whenever you’re tempted to deride the Fed for a decision to proactively cut rates:
Also on deck this week is a raft of crucial data out of China. GDP kicks things off on Monday. Consensus was looking for a 6.2% print (down from 6.4% in Q1) and Beijing delivered just that – 6.2%. Nothing more, nothing less. The retail sales/IP/FAI trio topped estimates easily.
Note that multiple desks still believe the PBoC will be effectively forced to cut the benchmark rate this year. That would be a big deal, as it would entail a shift towards broad-based easing versus the more targeted measures pursued thus far.
“An important part of our policy view is that China will cut benchmark interest rates twice in 2019, by 25bp each in September and December, after the US Fed starts a new rate cut cycle”, BofA wrote Friday, on the way to saying that while the PBoC “may not follow the Fed immediately with a benchmark rate cut in July, the hurdle is low for an imminent OMO cut”.
Weakness in the Q2 GDP print and/or the latest activity data would have helped cement the case in the eyes of those who are already calling for benchmark cuts. The fact that the data beat estimates muddies the waters a bit, but policymakers are still likely to see a strong case for continuous, targeted easing at minimum.
Speaking of EM monetary policy, Barclays notes that “with G3 central bank meetings still 1-2 weeks away, monetary easing by EM central banks will likely attract attention this week with the Bank of Korea, Bank Indonesia, and South Africa all expected to cut their policy rates by 25bp, to 1.50%, 5.75%, and 6.50%, respectively”.