Posts tagged monetary policy
Nothing has changed

As I emerge relaxed, and slightly sunburnt, from a week on Ibiza’s still-balmy  beaches, I am met with news that the world is going to hell, in a hurry. The dreadful September PMIs, and the soggy ISM headlines in the U.S., seem to have been the key catalyst for a reversal in sentiment. These data appear to have crystalised two bearish stories for markets. First, the trade wars are now a serious issue for the global and U.S. economy, and Mr. Trump either won’t, or doesn’t have the ability, to de-escalate the stand-off. At the very least, the assumption that the White House will be forced to blink into the next year’s election is now under threat. It is now just as likely that the U.S. president will double down on the conflict as a strategy to seek re-election. Secondly, the otherwise resilient consumer and services sectors are now infected by the slowdown in manufacturing and trade. Taken together these points translate rather obviously into a rising threat of a global slowdown, or even a recession.  I can’t refute the fact that these two claims are looking increasingly, and worryingly, accurate. For starters, the data clearly are deteriorating, with the most recent alarm bells coming from the hitherto solid U.S. economy. 

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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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