Mr. Market Waits for the Other Shoe to Drop

Hot air balloon

  • Market participants are cautious as they wait for another shoe to drop
  • The US reports March CPI, and the Fed releases its minutes from the March FOMC meeting
  • The FOMC minutes are drawing more attention than usual
  • As the forum continues in China, the new PBOC Governor wasted no time following President Xi’s speech yesterday to flesh out more details of the reforms
  • Fallout from the US sanctions on Russia continues
  • Turkey February current account deficit was -$4.15 bln; National Bank of Poland is expected to keep rates steady at 1.5%

The dollar is narrowly mixed against the majors as markets await fresh drivers. Nokkie and yen are outperforming, while Aussie and Swissie are underperforming. EM currencies are mostly weaker. THB and PHP are outperforming, while RUB and TRY continue to see significant weakness. MSCI Asia Pacific was flat, with the Nikkei falling 0.5%. MSCI EM is flat on the day, with the Shanghai Composite rising 0.6%. Euro Stoxx 600 is down 0.2% near midday, while S&P futures are pointing to a lower open. The 10-year US yield is down 1 bp at 2.79%. Commodity prices are mixed, with WTI oil up 0.5%, copper down 0.2%, and gold up 0.5%.

Between Syria, trade tensions, and the US special investigator into Russia’s attempt to influence the US election, market participants are cautious as they wait for another shoe to drop. The US equity market recovery yesterday has short coattails as markets in Asia and Europe struggle. Bond yields are mostly softer, and the US 10-year note yield is dipping back below 2.80%.

The US dollar is mixed, with small gains against the dollar bloc and small losses against the euro, yen, and sterling. The sense is that whichever shoes drop, the headline risk is dollar negative. The euro closed above CHF1.18 yesterday for the first time since January 15 and is at its best level since the SNB gave up its franc-cap. Elsewhere the Russian ruble continues to fall (~-2%), but Russian bond yields are little changed. According to central bank figures, foreign investors owned a record 34% of Russian bonds. The sanctions announced before the weekend spurred the sales of the bonds and currency.

The US reports March CPI, and the Fed releases its minutes from the March FOMC meeting. The risk is on the upside of the market expectation for a flat CPI, which due to base effects, would rise by 2.4% from a year ago, up from 2.2%. The core rate is expected to have increased by 0.2%, and this would lift the y/y rate above 2.0% for the first time in a year as some factors that the Fed has suggested were transitory are proving so.

The FOMC minutes are drawing more attention than usual. The March meeting was Powell’s first and a rate hike was delivered. However, ideas that the minutes will reveal much insight into what officials were thinking about the rising trade tensions or the thrust of fiscal policy, which the CBO estimated this week would produce a $1 trln deficit in 2020 (two years earlier than previously expected) may be disappointed.

The minutes of central bank meetings should not be confused with an objective record of the meetings. They are purposefully crafted as part of the official communication to help shape investor expectations. This is to say that they are a policy tool. Increased protectionism poses a downside risk to the economy. Not much more can be said at this juncture. The same thing is true of the fiscal position. It poses risks, and it is too early to judge the economic consequences in full, but it will likely bring the Fed closer to its mandates of full employment and price stability (at it defines it).

As the forum continues in China, the new PBOC Governor wasted no time following President Xi’s speech yesterday to flesh out more details of the reforms. These include quadrupling the Shanghai-Hong Kong stock connect as of May 1. Limits on foreign insurers and ownership of securities firms will be reduced. Yi Gang pushed against “big bang” ideas, noting that it is not China’s way, which is cautious and gradual.

Even if Xi offered old wine in new skin yesterday, the specifics today reinforce our sense that China is pursuing a three-prong strategy in dealing with the US trade stance. First, it flexes some of its considerable economic heft. Second, it challenges the unilateral US actions at the WTO, perhaps in concert with others. Third, it will enact several economic and financial reforms that are in China’s own immediate interest.

The yuan both onshore and offshore was little changed. Chinese shares edged higher (0.5%). The MSCI Asia Pacific Index was fractionally lower, as is the MSCI Emerging Markets Index. China reported softer than expected inflation. March PPI rose 3.1% y/y, down from 3.7% in February. Consumer price inflation slowed to 2.1% from 2.9%. This is the fifth month; producer price inflation has slowed. The slowing of consumer price inflation seems to be largely unwinding the Lunar New Year-related jump. The quarterly average has edged higher for the third consecutive quarter, but the pace in Q1 was exaggerated.

There have been a few economic reports, even if there is little impact in the markets. Japan reported stronger than expected core machine orders (2.1% vs. expectations -2.5%) and followed the 8.2% rise in January. Officials will find encouragement in the data, which suggest the underlying economic dynamics are still intact. The capital spending cycle is supported by exports and the semiconductor fabrication facilities being built abroad (e.g., China).

France’s Industry Sentiment Indicator edged lower, consistent with other survey data. In March it stood at its lowest level since January 2017. Italy reported a slightly better than expected February retail sales, which rose 0.4% after a 0.5% decline in January.

The EU announced that it would add to its major data reports a new measure that excludes the UK from aggregates. This is in preparation for the UK leaving the EU at the end of next March. UK data today mostly disappointed, but the February trade deficit fell. The overall trade balance fell to GBP965 mln. It has been rarely smaller than this since 2000, and it is usually a transitory spike.

Like other countries in Europe, the UK’s industrial output figures disappointed in February. UK output rose 0.1%. The market was looking for something closer to 0.4%. It follows a 1.3% rise in January. However, this overstates the strength. Manufacturing output itself fell 0.2% in February following a revised flat report in January (initially 0.1%). Separately, construction spending fell 1.6% after January’s 3.1% slide. Economists had expected an increase.

Fallout from the US sanctions on Russia continues. RUB has lost another 2% today after losing over 4% on each day to start the week. USD/RUB trading at a high near 64. This is the highest since November 2016 and on track to test that month’s high near 66.87. Just to illustrate how far the ruble rallied after the worst of the Ukraine-related sanctions, the 67 area represents the 38% retracement objective of the big 2016-2018 move. The high in January 2016 was near 85.96, and so we see scope for significant ruble weakness ahead.

Turkey February current account deficit was -$4.15 bln vs. -$4.25 bln is expected. The 12-month total rose to -$53.35 bln, the largest since April 2014. The external accounts are worsening significantly even as EM comes under greater pressure. USD/TRY made another all-time high today near 4.1560 and we expect this trend to continue. Poor fundamentals are likely to keep Turkish assets in the underperforming camp. Furthermore, we don’t see much on the horizon to turn this around, with the exception of a massive rate hike (which Erdogan won’t allow).

National Bank of Poland is expected to keep rates steady at 1.5%. Inflation was 1.3% y/y in March, below the 1.5-3.5% target range. This supports the central bank’s intent to keep rates steady in 2018, but we are not convinced it can stand pat in 2019 as well. February trade and current account data will be reported Friday.