Posts tagged monetary policy
The New Regime

Friday’s initial price action in response to the June U.S. payroll report provides a nice microcosm for investors’ mood and short-term expectations. The data themselves were so-so. The unemployment rate increased slightly, due mainly to a lower labour force participation rate, and wage growth slipped, albeit marginally. Markets, however, homed in on the above-consensus increase in headline payrolls, a 224K jump relative to expectations of a 160K gain, and immediately started selling equities and bonds. Running the risk of skipping several important steps in the argument, I reckon the story is relatively simple. Markets have been angling for a 50bp cut by the Fed in July, a position that was washed out, at least for the time being, by Friday’s above-consensus NFP print. Even if this interpretation is right—and it might not be—it doesn’t change the main thrust of the story, which I have been trying to describe on these pages in recent months. Markets have made their bet on further easing by monetary policymakers, and they’re now expecting central banks to deliver. Friday’s session suggests that the consensus is easily spooked, though as I type, Spoos are virtually flat on the day, and EDZ9 is still pricing-in two-to-three cuts between now and year-end.

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Anticipation is everything

It’s difficult to get past the obvious at the moment. Markets have made their bet on further monetary easing, and they’re now waiting for central banks to deliver. Policymakers have been showering markets with promises to “act if needed,” and assurances from those stuck at the zero bound that the toolbox is far from empty. But they haven’t done anything yet, though this is a position that will be closely examined this week. Mr. Draghi will be at the spotlight first today when he delivers his introductory statement at the ECB forum in Sintra. The nebulous 5y/5y forward inflation gauge has crashed to new lows recently, and it seems to me that the consensus now expects a signal from Mr. Draghi that the ECB will cut its deposit rate, or re-start QE, as soon as September, which incidentally will be Mr. Draghi’s last meeting as ECB president. Meanwhile at the Fed, the only question seems to be whether The FOMC cuts by 25 or 50 basis points in the next few months, setting the stage for an interesting June meeting this week. To the extent that markets have priced-in monetary easing in response to the deteriorating trade negotiations between the U.S. and China, it would make the most sense to assume that the much anticipated Osaka sit-down between Mr. Trump and Xi—at the end of June—to be a catalyst for something in markets.

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Front-running Easy Money

In a nutshell, this is what my models are telling at the moment: the three-month stock-to-bond ratios in the U.S. and Europe have soared, indicating that equities should lose momentum in Q2 at the expense of a further decline in bond yields. That said, the three-month ratios currently are boosted by base effects from the plunge in equities at the end of last year. They’ll roll over almost no matter what happens next. Moreover, the six-month return ratios are still favourable for further outperformance of stocks relative to fixed income. Looking beyond relative returns, my equity valuation models indicate that the upside in U.S. and EM equities is now limited through Q2 and Q3, but they are teasing with the probability of outperformance in Europe. Finally, my fixed income models are emitting grave warnings for the long bond bulls, a message only counterbalanced by the fact that speculators remain net short across both 2y and 10y futures. This mixed message from my home-cooked asset allocation models is complemented by a mixed message from the economy. The majority of global growth indicators still warn of weaker momentum, but markets trade at the margin of these data, and the green shoots have been clear enough recently. Chinese money supply and PMIs showed tentative signs of a pick-up at the end of Q1, a boost reinforced by data last week revealing that total social financing jumped 10.7% y/y in March.

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Finely Poised

Let’s spare a few moments of symphathy for the equity bears. The Q4 rout was supposed to have been an appetizer for a more sustained bear market, and by most accounts, the major narratives are still on their side. Excess liquidity indicators—chiefly real M1—and other leading macro-indicators look dire, and the hard data have predictably rolled over. They gave up the ghost in Europe a long time ago, and are now softening in the U.S. Even better for the bears, earnings growth is now slipping and sliding, a logical consequence of the sharp drop in the rate of growth in almost all main hard macroeconomic indicators and surveys. 

Despite such a perfect set-up from the macro data, the equity market has rallied strongly at the start of the year, and is showing few signs of rolling over mid-way through February. There is still hope for the bears. If you are just looking at the headline data, it is relatively easy to dismiss the rebound at the start of the year as a reflexive rebound from the horror show in the latter part of 2018, a bear market rally to suck in the naive bulls before the next deluge. The idea of a bear market rally is still alive, but equity bears also now have to contend with a revival of their greatest foe to date; the global central bank put. 

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