Some Fed Policy Analysis

June 12th, 2017 8:06 am

Excellent piece via Chris Low at FTN Financial:

AM Economic Comments

by Chief Economist Chris Low

Monday, June 12, 2017

Stocks are lower in Asia and Europe overnight and NASDAQ futures are down enough this morning to suggests Friday’s tech selloff will continue today. US 10-yr note yields were higher overnight but have fallen back to 2.209%, likely in part thanks to the weakness in equities.

The front page Fed-vs-the-financial markets article in today’s WSJ dives into what ought to be the most controversial reason the Fed is raising rates this year: They have decided stocks are overvalued and they can’t stand when long-term interest rates fall when they raise short rates. The paper notes the Goldman Sachs Financial Conditions Index, which has fallen considerably since December, suggesting markets have eased more than the Fed has tightened. The GSFCI is just exactly the sort of thing the Fed loves to watch while tightening because it allows FOMC participants to ignore the economic damage they are doing to real world economic activity.

There is so much wrong with the contention that financial conditions are easier than they were before the last two rate hikes it is hard to know where to begin, but let’s start with the fact that the Fed appears entirely in agreement with the WSJ. As far as predicting what the Fed will do, the drop in the GSFCI significantly raises the odds of more aggressive behavior. After all, NY Fed President Bill Dudley cited the GSFCI two weeks ago, right before the Fed’s communications blackout, saying there is no reason to think the Fed has tightened too much if financial conditions are easing. Dudley is the Fed’s go-to financial-markets guy.

Next, Mohamed El-Erian and others have been popping up on TV lately citing financial stability as the reason the Fed is tightening. Last week, El-Erian said long-term rates are falling because too much income is going to rich people, and rich people are too prone to invest rather than spend. It rings true because 1. We all know about the income gap and 2. It is fun to think rich people are stupid. Be careful, though. El-Erian’s logic smacks of the same reality-defying thinking as the global savings glut baloney Greenspan popularized in the late Nineties and Bernanke clung to in 2006 as excuses for ignoring a flattening yield curve. People who extended maturity back then knew exactly what they were doing and they likely know what they are doing now, too.

In the meantime, even as the Fed thinks financial conditions have eased despite three rate hikes, business loan growth has slowed significantly. Commercial and industrial loans, which are made at floating rates above fed funds, are lower than they were in October. Mortgage activity has slowed and home equity lending is declining. Delinquencies are rising and lending standards are tightening in response. When the Fed raises interest rates they tend to kill floating rate borrowing first, which makes sense since they raise short-term rates. Money moves into the long end because investors are confident the Fed will check any inflationary tendencies in the economy and because long-yields are the place to be when the Fed (inevitably) tightens too much.

The GSFCI falls when the Fed tightens because it fails to recognize a flat yield curve as a sign of tight financial conditions. In the index, the drop in long yields offsets the rise in short rates. The GSFCI was very low in 2007, for instance, a year in which millions of borrowers were driven into default. And the Fed, watching things like the GSFCI instead of real-life activity in the financial sector – you know, like lending and borrowing activity – failed to recognize how tight financial conditions were in 2006-07. In fact, they did not just fail to recognize it at the time, FOMC participants failed to admit excessive tightening even three years later, in the aftermath of the worst credit crunch since the Great Depression.

The Fed will raise rates on Wednesday, and again in September and/or December, despite a sharp slowdown in credit activity because FOMC participants have a weak spot for indicators like the GSFCI and because they are all-too eager to believe in global savings gluts and the stupidity of rich investors as an alternative to the possibility the fed funds target they arbitrarily chose when they started tightening is too high.

Today, the May Treasury budget. This week, PPI, CPI and May retail sales.

Chris Low

Comments on Possible Fed Appointees

June 3rd, 2017 9:51 am

Via Stephen Stanley at Amherst Pierpont Securities:

GOP Collapse in Reddest of States

May 11th, 2017 8:23 am

This story is via the left wing website DailyKos (dailykos.com). I do not agree with the site’s politics  but if you want a deep dive into elections it is worth a visit.

 

Via the DailyKos:

Daily Kos Elections Morning Digest

Leading Off

Special Elections: On Tuesday night, voters in two counties on the eastern outskirts of Oklahoma City cast ballots in a special election to fill a vacancy for Oklahoma’s 28th State House District, a seat Republicans should have held without so much as an eyeblink: Donald Trump carried it by a monster 73-23 margin in November, even better than Mitt Romney’s 69-31 win four years earlier.

So what happened? Republican Zack Taylor, the owner of an oil and gas company, eked out just a 50-48 victory over attorney Steve Barnes, his Democratic opponent, a difference of only 56 votes. That is, simply put, a stunning collapse: Trump won by 50, yet Taylor squeaked through by just 2—a 48-point fall. By contrast, former Republican state Rep. Tom Newell, whose resignation created this vacancy, easily won re-election last year 67-33.

We’ve almost never seen anything this dramatic, but the outcome fits into a pattern we’ve witnessed ever since Trump’s win last year. Nationwide, there have now been a dozen races pitting a Republican versus a Democrat in legislative and congressional special elections, and in nine of them, Democratic candidates have performed better than the 2016 presidential results.

As we’ve noted repeatedly, this is a remarkable development. For years, Democratic turnout has struggled mightily when there’s no presidential race on the ballot. Indeed, one thorough study examining elections that took place in 2013 found that Democrats tended on average to perform 12 points worse than Barack Obama had just the previous year. Now the exact opposite is happening.

Of course, every race has unique elements, and in Oklahoma in particular, a savage and unresolved budget crisis presided over by the GOP has soured many voters on Republicans. And not every election has moved toward Democrats (Republicans simultaneously held on to the mayor’s office in Omaha, Nebraska Tuesday night) or augured for future gains (Democrats picked up two dark red legislative seats in Oklahoma special elections last cycle but didn’t do well in the fall).

But the one common thread to all of these elections in every state is, of course, Trump. His outrages continue to fire up Democrats everywhere, and his latest—his efforts to repeal health care and his sacking of FBI Director James Comey—will only take things to new heights.

We’ll continue to monitor these races to see whether this pattern holds, and we have several upcoming contests to watch, including special elections for Congress in three states, as well as another legislative special election in Oklahoma in July, near Tulsa. But Tuesday’s election in the Sooner State suggests there’s no sign this surge will abate any time soon.

Firing Comey and Trump Agenda

May 10th, 2017 11:08 am

This is an interesting collage of analyst opinions on the firing of FBI Director Comey and the impact that action will have on the Trump legislative agenda.

I think the Watergate comparisons are hyperventilating hyperbole. Watergate had been a dominating  from March of 1973 and the so called Saturday Night Massacre was in October. There was a Select Committee chaired by Senator Sam Ervin which produced the John Dean ” cancer on Presidency” narrative and there was Alexander Butterfield and his bomb shell disclosure of Nixon’s taping system. There was significant evidence that Tricky Dick was a crook.

In my opinion we have nothing remotely analogous to that body of evidence this time.

 

Here is the Bloomberg article:

Comey’s Firing May Suck Oxygen From Trump’s Agenda: Street Wrap
2017-05-10 13:46:39.346 GMT

By Felice Maranz and Brian Chappatta
(Bloomberg) — Donald Trump’s abrupt firing of FBI Director
James Comey is raising questions about whether the president’s
pro-growth, tax-cutting agenda will stall as the focus shifts to
why Comey was dismissed amid probes into possible Russian ties
to Trump’s campaign.
* Stocks were little changed in early trading, with the S&P 500
down less than 0.1 percent at 9:45 a.m. in New York

COMPASS POINT (Isaac Boltansky, in email to Bloomberg)
* Comey’s firing is unlikely to sink Trump’s agenda, but surely
slows it, as dismissal now becomes the focus on Capitol Hill
* Congressional Republicans still want tax reform, and they’ll
work toward that goal — but decision distracts from legislating
and further muddies the agenda; Republicans “have to be
befuddled” that White House refocused attention on this issue
right after they’d finally secured “some modicum of momentum” in
wake of AHCA passing
* In note to clients, Compass Point writes timing is
“inconceivably curious,” political ripples will further
complicate Trump’s Congressional agenda

COWEN (Chris Krueger)
* “EVERYTHING just got more challenging on Capitol Hill”;
situation is “almost unimaginably fluid,” with more questions
than answers
* Sees Comey dismissal as likely to consume most of the oxygen
in Washington for foreseeable future, with any momentum from
House health care passage having gone up in smoke
* Sees “bigly problem” for White House and all Republicans; hard
to see any political and policy upside; watching key House and
Senate Republicans on appointment of special prosecutor or
bipartisan committee to investigate; sees Oct. 1 as likely hard
catalyst, with Democrats possibly demanding special prosecutor
or triggering govt shutdown

HEIGHT SECURITIES (Peter Cohn)
* Comey’s firing will likely end up being “a political story for
the ages and cocktail party outrage fodder,” but Trump will
probably stay in the Oval Office, legislative agenda will be
unaffected
* Notes Sen. Lindsey Graham, usually a thorn in Trump’s side,
was quick to praise the president (good sign for avoiding party
revolt); sees “little more than crocodile tears” for Comey on
both sides of the aisle, while Trump probably moved too quickly
to let issue impact 2018 midterms or his own reelection
prospects in 2020
* House is unlikely to initiate impeachment; notes effort to
craft ACA repeal/replace that can get 50 Senate votes plus
Pence’s continues, as does work on FY2018 budget resolution, tax
reform

FTN (Jim Vogel)
* Sacking FBI Director Comey took the U.S. by surprise; optics
might be worse for overseas investors, with buying in UST
immediately after London open to erase Tuesday’s sell-off
* Equity futures aren’t “shaken or stirred” by the news,
however, leaving large domestic accounts to sort through the
fallout; both stocks and credit spreads are susceptible to
profit-taking
* Based on available information, firing Comey shouldn’t have
long-run implications for bond prices, as key economic questions
revolve around who puts their stamp on legislation – White
House, moderate Congressional Republicans, or Freedom Caucus
members; those dynamics were in place before FBI changes

BMO (Ian Lyngen, in phone interview)
* “It’s unclear whether this matters more than the last several
iterations of the Trump dysfunction, but it’s clear that this
adds another level of complexity beyond simply the Washington
gridlock”
* “I know the market is nervous about it, but I haven’t heard
anyone say that this is a material change in the way people are
thinking about the administration”
* “For the Fed, I don’t think this would take out a June hike,
unless there’s something really dramatic or unseen”
* In earlier note, BMO said the Treasury market benefited from
the political uncertainty triggered by Comey’s abrupt firing;
BMO cognizant that technical indicators are simply a reflection
of the risk-off move inspired by dismissal, but argues selloff
had extended to extremes that left it susceptible to headline-
driven reversal

RHINO TRADING PARTNERS (Michael Block)
* Puzzled by timing, though thinks will end up “going away”
* Sees Comey’s ouster as yet another distraction from progress
on public policy that could support economic growth
* “Every moment of every day that we have to hear about Trump
hiring lawyers to attack anyone who questions him on Russia,
Democrats screaming that this is a constitutional crisis, and
GOP flaks saying, ‘What about Hillary’s emails?’ is yet another
roadblock to getting tax reform and stimulus done”

TD SECURITIES (Gennadiy Goldberg, in email to Bloomberg)
* “We’ll have to see more of the fallout from the Comey firing
to gauge whether the broader legislative timeline has been
affected”
* Also worth keeping in mind about half of the FOMC hasn’t
penciled in any substantial fiscal stimulus into projections, so
tax reform and infrastructure spending are not necessarily
prerequisites for Fed to hike rates another 2 times this year

Related earlier stories:
* Equity Group’s Sam Zell on Bloomberg TV asks, ‘What Took Trump
So Long’ to Fire Comey? See video
** “Mr. Comey voluntarily or otherwise got himself involved in a
whole bunch of stuff. So he was a wounded animal to begin with
so the only question I’d ask is what took Trump so long?”
* Markets Should Forget Comey and Focus on Fundamentals: Macro
Man
* Comey Ouster Threatens to Backfire on Troubled Trump White
House
* Is This Trump’s Saturday Night Massacre? Don’t Count On It.
This president isn’t Nixon and Washington isn’t lined up against
him: Politico

Resistance Broken

April 13th, 2017 5:46 am

This is an excerpt from a piece written by Steve Feiss of Government Perspectives. The excerpt summarized dealer views on the break of resistance on the 10 year note at 2.28/2.30 and what that signals for the near term course of interest rates. If you have Twitter you can follow Steve Feiss  @stevefeiss.

Via Steve Feiss at Government Perspectives:

Ø  CitiFX Weekly RoundUp: Sacre Bleur. To parity and beyond? … and on US RATES (“flip a coin”), “The 2.30% area we have been highlighting on US 10s is now coming under pressure. Our medium to long term bias of higher US yields remains unchanged; however, the question is whether the base is in from which we will move higher or whether a broader decline (position flush out) will first be seen before higher levels later in the year. Unfortunately, for the time being, the answer to that question remains elusive and we would like to see further developments to take a view one way or the other. A weekly close below 2.30% on US 10s would be the first sign that lower levels are likely in the short-term. Further confirmation comes if yields across the curve also take out key supports (e.g., below 1.80% on US 5s and below 2.90% on US 30s). It is worth waiting for such a development to materialize, though, before expecting the next move in US yields to be lower.”

Ø  CSFB: from SHORT to stopped OUT and buyer of dips (both 10s AND 30s). Chart of day – 10y yields, “have broken key resistance at 2.31/29%, which sets a yield top. We look for a move to the 38.2% retracement of the 2016 yield rise at 2.18/14% next, potentially 2.01/1.98%.” And on 30s, “have broken key resistance at 2.90%, which establishes a yield top to target 2.78/77%.”

Ø  GS (on 10s, and BEs): “U.S. 10-year yields have broken 2.308-2.29% support. The area has been in focus for some time now, as the place to watch for signs of a base. Having now broken clear through it, chances are even greater that the market really has put in 5-waves at the March high. This allows room for a protracted corrective period, one which could last another 2-3 months, into June/July. In terms of next support, there’s a minor gap up from Nov. ’16 that comes in at 2.166-2.15%. The next level thereafter is 2.135% (38.2% retrace of the initial advance from July). View: Initially see support at 2.166-2.15%. Thereafter 2.135%. Likely messy/overlapping for another 2-3 months.”

Impending Debt Crisis

April 12th, 2017 6:48 pm

Via UK Telegraph and Ambrose Evans Pritchard:

Dealing With Debt

April 12th, 2017 12:28 pm

Carmen Reinhart spoke yesterday at Harvard (where she teaches) and one of my contacts summarized her comments:

·         The debt overhang in Europe will act as a constraint on ECB policy and she expects no action by the ECB this year (although they will need to announce something about the current Asset Purchase Program which is set only through December).

·         Target 2 (T2) balances, which represent claims on the financial systems within the EZ (banks in Greece lost deposits to banks in Germany, so the Central Banks must square up these flows) are an representation of FX rates within the EUR. In other words, if there were floating exchange rates within the EUR the large capital outflow from Greece, Spain and Italy, among others, would have forced devaluations of their currencies and the capital flight into Germany a revaluation of its (non-existent) currency. The large magnitude of these T2 balances represents the imbalances built up within the EZ, with no FX outlet.

·         Given the lack of flexibility within the EZ, she expects there eventually will be more restructuring of debt, with Greece (shorter term) and Italy (longer term) the ones to watch.

·         Regulatory policy implementation after the financial crisis was (partly) designed to encourage broader holding of government debt, a policy that helped finance the huge surge in fiscal deficits.

·         Japan still is a very difficult fiscal situation as the (aging) voters will not vote to cut entitlements or raise taxes to fund them. As a result, she expects low/negative yields will persist for a long time as a way to “tax” savers through negative yields to help fund the debt and effectively reduce the debt burden, a theme that is key to her views across the developed world rate markets for many years to come.

·         Growth is a very good way to deal with excessive debt, and she does expect some reduction of regulatory burdens as a way to increase potential/trend growth rates which are too low to finance debt loads. But that improvement, while welcome, is unlikely to be sufficient over the long term.

·         At Jackson Hole last year BOJ Gov. Kuroda opined on why the world continues to gravitate to the JPY and JGBs in times of global stress given Japan’s massive debt burden and lack of inflation and nominal growth.  To be sure, Kuroda was “talking his book” as he would prefer a weaker JPY, but there is a logic to Japan being one of the worst fundamentals situations in the G7.

·         On the US, she fears the combination of stimulative FP and tighter MP would drive the USD higher…and the Trump Administration would be extremely displeased. Given that she views there is little appetite for a Plaza Accord type arrangement on FX rates, she expects the Fed to tread carefully in hiking rates – 3 hikes this year, at most, in her view.

·         When asked about her views on next Fed Chair, she noted the lack of respect for academics in the current Administration (still no Chair of the Council of Economic Advisors). As a result, she expects a “business type” as next Fed Chair. Her original strong expectation was Kevin Warsh, but she worries he might be viewed as too academic, although he is not. Other names now include, in her view, Gary Cohn, Bill Dudley (known quantity and, after all, he WAS a GS guy) or Jamie Dimon. Economics PhDs need not apply, apparently.

·         Finally, she does NOT believe the impact of the financial crisis is behind us (and the world). Smart regulatory reform and tax policy adjustments could increase potential/actual growth, but the debt overhang in the developed world will be an issue for years to come. There are ways to deal with debt overhangs, which include strong growth (unlikely, esp in EZ and Japan), spending cutbacks, esp on entitlements (good luck), higher inflation (trying, but no progress…so far) and continued financial repression (negative real interest rates), with the latter likely to be a persistent development, particularly in the EZ and Japan.

FX

April 11th, 2017 6:21 am

Via Marc Chandler at Brown Brothers Harriman:

Dollar Pushed Lower in Subdued Activity

  • Geopolitical concerns continued to be elevated
  • Oil is threatening to snap a five-day rally
  • There is little concession built for today’s $20 bln auction of US 10-year notes
  • South Africa and Mexico report February manufacturing and industrial production

The dollar is mostly softer against the majors.  The Scandies are outperforming, while the dollar bloc is underperforming.  EM currencies are mixed.  ZAR and RUB are outperforming, while MXN and KRW are underperforming.  MSCI Asia Pacific was down 0.1%, with the Nikkei falling 0.3%.  MSCI EM is down 0.1%, with China markets rising 0.3%.  Euro Stoxx 600 is flat near midday, while S&P futures are pointing to a lower open.  The 10-year UST yield is down 2 bp at 2.34%.  Commodity prices are mixed, with oil down 0.3%, copper up 0.2%, and gold up 0.2%.

The US dollar has a slight downside bias today through the European morning.  The market does not seem particularly focused on high frequency data, though sterling traded higher after an unchanged year-over-year CPI reading of 2.3% while the euro traded higher after a stronger Germany ZEW survey.    

Geopolitical concerns continued to be elevated.  The South Korean won’s slide has been extended for the sixth consecutive session and ten of the past 11 sessions.  Its 0.3% decline today brings this week’s loss to 1.0% after a 1.4% loss last week.  Korea’s Kospi’s nearly 0.5% loss today is also its sixth consecutive loss and also was among the larger losers in today’s session that saw the MSCI Asia Pacific Index slip 0.1%.

European shares are also trading with a slight downside bias.  Information technology and financials are leading the way lower, while consumer discretionary and real estate are doing better.  With tightening seen in the French polls ahead of the election in a couple of weeks, pressure is staying on France, where bonds are under pressure and the 10-year premium over Germany continues to trend back to the high seen in February.  

Since the end of March, the French premium on 10-year yields has risen a little more than 10 bp to 75 bp.  The late February high was 79 bp.  The 2-year premium investors are demanding to hold French paper is making new multi-year highs today near 56 bp.  It has more than doubled since late March.  The February high was 45 bp.  It has been nearly five years since the 2-year premium was this large.  Earlier today, the German 10-year yield slipped briefly below 20 bp for the first time since late February.  It is trading a little above there near midday in Europe.

The German ZEW investor survey rose more than expected.  The assessment of the current situation rose to 80.1 from 77.3.  This is a new six-year high.  The expectations component rose to 19.5 from 12.8.  This is the highest since August 2015.  With the DAX up four consecutive months through March and a euro that makes German businesses extremely competitive and low yields, it is hardly surprising that investor confidence is buoyant in Germany.  That said, sentiment is running ahead of real sector data.  

As we noted yesterday after seeing the large states report national figures, the risk on the eurozone aggregate industrial output was on the downside, despite relatively upbeat PMI data.  Industrial output in February fell 0.3%.  The Bloomberg consensus was for a 0.1% gain.  Adding insult to injury, and underscoring the gap between real sector data and the surveys, the January gain was slashed to 0.3% from 0.9%.  

BRC like-for-like UK retail sales in March fell 1.0%.  This matches the largest decline in since April 2015.  The 0.8% decline in non-food sales was the worst in nearly six years.  Part of the reason for weaker sales may be higher inflation.  Separately, the UK reported March CPI unchanged at 2.3% year-over-year while rising 0.4% on the month.  Many look for UK inflation to push toward 3.0% before peaking later this year, as last year’s oil rally and sterling’s slide drop out of year-over-year calculations.  The UK’s core rate slipped to 1.8% from 2.0%, but also probably has not peaked.  Producer prices were a little firmer than expected.  Input prices (17.9% year-over-year) continues to outstrip output prices (3.6% year-over-year), which is often seen as pressure on profits.  Tomorrow the UK reports the latest employment figures.

Oil is threatening to snap a five-day rally.  The May light sweet crude oil futures contract rallied more than a dollar a day over the past three sessions and four of the past five.  Disruptions in Libya and reports that Russia is considering extending its cuts helped fuel the last gains.  We note that the May contract is running into a technical area that may give the bulls a pause.  The 61.8% correction of this year’s decline is found near $53.50, which also corresponds to trend line resistance off of the early January and late February highs.  The upper Bollinger Band is just above $53.20.  

Oil prices have done little to lend support to the US Treasuries.  The 10-year yield currently near 2.33% is six bp below yesterday’s high.  Yellen’s comments yesterday failed to inspire the bears despite saying nothing to deter the expectations of a June hike.  She did acknowledge that the Fed has a different posture now.  Previously, the Fed was concerned about ensuring the economy was recovering from the financial crisis.  Now it is engaged in trying to extend the expansion.  

There is little concession built for today’s $20 bln auction of 10-year notes.  This maturity is the fourth most popular among foreign investors and central banks, behind the 10- and 30-year TIPS and the 7-year note.  Foreign official demand is often picked up in the indirect bids.  In the last dozen auctions, the indirect bids took almost 2/3 of the 10-year sale.  

The US economic calendar is light, featuring the JOLTS report on job openings.  Minneapolis Fed President Kashkari, the lone dissent to the last month’s decision to hike rates, speaks late in the session.

South Africa reports February manufacturing production, which is expected to rise 0.2% y/y vs. 0.8% in January.  It then reports February retail sales Wednesday, which are expected to contract -1.6% y/y vs. -2.3% in January.  The economy remains weak, but the high inflation and a softening rand are preventing rate cuts.  Next SARB policy meeting is May 25.  While steady rates seem likely, much will depend on the external environment.

Mexico reports February IP, which is expected at -1.5% y/y % y/y vs. -0.1% in January.  Banco de Mexico will release its minutes Wednesday.  At that meeting, it hiked rates 25 bp, down from 50 bp at its last several meetings.  For now, we think the bank would like to pause its tightening cycle and keep rates steady at 6.5% at the next policy meeting May 18.  However, we think it may hike 25 bp at the June 22 meeting if the Fed hikes June 14.       

FX

April 10th, 2017 6:55 am

Via Marc Chandler at Brown Brothers:

Drivers for the Week Ahead

  • Even though the Federal Reserve does not meet, Yellen’s speech on Monday (with live and Twitter-sourced questions) will be closely monitored
  • Economic data for the US and Europe may not be important drivers
  • The UK reports on inflation and employment in the holiday-shortened week
  • EM FX weakness is carrying over to this week, due in large part to rising political risks

The dollar is mostly firmer against the majors as the holiday-shortened week starts.  Markets remain nervous after US missile strikes on Syria, amidst reports that a US aircraft carrier has been diverted to waters near North Korea.  Sterling and Nokkie are outperforming, while the euro and Aussie are underperforming.  EM currencies are mostly weaker.  IDR and PHP are outperforming, while ZAR and KRW are underperforming.  MSCI Asia Pacific was flat, with the Nikkei rising 0.7%.  MSCI EM is down 0.5%, with China markets falling 0.3%.  Euro Stoxx 600 is down 0.2% near midday, while S&P futures are pointing to a lower open.  The 10-year UST yield is down 1 bp at 2.37%.  Commodity prices are mixed, with up 0.8%, copper down nearly 1%, and gold down 0.1%.  

There were no celebrations; no horn or trumpets, nary a sound, but an important shift took place last week.  The shift was signaled by two events.  The first was the US strike on Syria, and the second was investors’ willingness to look past Q1 economic data.  

The US missile strike on Syria was significant even if it fails to change the dynamics on the ground.  It undermines the Trump Administration’s ability to “reset” the US relationship with Russia.  What the new Administration recognized last week is that the tension in the US-Russian relationship was not a function of personalities or leadership styles but a genuine and fundamental difference of national interests. Russia supports the Assad regime as it supported his father’s.  It is the key way Russia can project its power and influence into the Middle East.  

The G7 finance ministers meetings understandably are important for investors.  The meeting of foreign ministers hardly draws much notice.  However, their meeting on April 10-11 will attract interest.  Many have labeled the Trump Administration as isolationist due to its criticism of the WTO, the UN, and other multilateral arrangements.  However, we have argued this misunderstands the thrust of the Trump Administration.  It is unilateralist, not isolationist.  

An isolationist may argue that there is not a direct national interest at stake, and killing people (including children) with missiles from the sky to punish a government who killed people (including children) with gas does not make sense.  A multilateralist would have allowed UN investigation and international law to run its course.  The US, arguably, has a vested interested in the international rule of law.  What the Kremlin has called a significant blow to US-Russian relations may allow a new convergence of US and Europe perceptions of the threat Russia poses, but whether diplomats can work it out is a different matter.  

Nevertheless, the Russian ruble will likely yield to the changing circumstances.  It has been the strongest currency in the world since the US election, gaining 11.4%.  It had made new highs for the year last week prior to the US missile strike (as the US dollar fell to almost RUB55.80).  It would not be surprising to see the ruble unwind a good part of these gains, giving the dollar scope to rise toward RUB60-RUB62.  The dollar-ruble exchange rate and oil prices typically are inversely correlated.  On a rolling 60-day basis, the correlation of the percent change in the exchange rate and the Brent prices is -0.34, which is among the least over the past year.  

Meanwhile, the EU and Greece appears to be nearing an agreement that will free up another payment tranche that will allow Greece to make a large debt payment to its official creditors that comes due in a few months.  Greece’s 10-year bond yield fell 19 bp to 6.86% last week.  The yield peaked two months ago near 8.10%.  It began the year near 7.10%.  However, one key piece of the puzzle is missing:  the IMF.  

The IMF’s role is important because both the German and Dutch parliament say it is a prerequisite for their continued participation.  The IMF has come under criticism from many of its non-European members, including the US, for overruling its own internal policies and overexposing the multilateral lender to Greece.  The US continues to enjoy a sufficiently large quota (votes) at the IMF to be able to veto a commitment of new funds.  

Blocking the IMF from participating in new lending to Greece could come at an awkward time for Germany, given the national election in less than six months.  Also, while there is awareness of the French presidential contest, few have focused on the legislative election in June.  Neither of the leading candidates (Macron and Le Pen) commands a bloc in the current legislature.  The French premium over German is elevated even if stable in recent weeks, but it is likely to persist for much of the second quarter.  

The week ahead is short.  After Wednesday, April 12, full liquidity will not return until April 18, following Easter Monday.  The Bank of Canada is the only major central bank that meets.  There is little doubt that policy is on hold.  Under Governor Poloz, the central bank is very cautious despite a strong rebound in the last two quarters of 2016 (2.8% annualized pace in Q3 and 2.6% in Q4).  The economy expanded by 0.6% in January, which was twice the pace expected.  The labor market has been firm, even if exaggerated, which should help underpin demand going forward.  The central bank expects the output gap to take another year to close (mid-2018).  Bringing it forward could spark investors to anticipate a rate hike sooner.  Uncertainty about US policy (trade and fiscal) may discourage a significant change in rhetoric.  

Even though the Federal Reserve does not meet, Yellen’s speech on Monday (with live and Twitter-sourced questions) will be closely monitored.  Since the FOMC minutes, the focus has shifted toward the Fed’s balance sheet.  There remain three issues of concern.  The first is when the Fed will stop reinvesting maturing issues.  Many had expected this to be a 2018 story, but the minutes and Dudley’s comments suggest Q4 is possible.  

The second issue is how this will be executed.  Will the Fed focus on its MBS portfolio or its Treasury assets?  The initial inclination is to do both.  Should it be done all at once or should it be phased in over time?  The mere fact that it doing it at once is even considered is striking.  That course would be very aggressive given the maturing issues over the next two years (2018-2019 ~$770 bln of the $2.4 trillion Treasuries held by the Fed will mature).  The Fed seeks to do it in a way that is predictable and transparent for investors and not disruptive.  

The third issue is the relationship between the balance sheet and the Fed’s interest rate policy.  It is clear that the Fed will rely on its Fed funds target is its primary tool.  Dudley has suggested that when the balance sheet begins shrinking, the Fed could pause in the interest rate cycle.

The initial scenario that this suggests may be a hike in June and September, providing the opportunity is still there, pausing to slow the reinvestment process before (ideally) resuming the rate hikes in 2018.  An important caveat that investors need to bear in mind is that the configuration of the Federal Reserve Board of Governors will significantly change over the next 12-15 months.  We had been surprised that the Fed’s dots last month did not seem to line up with the rhetoric, but the balance sheet discussion that was aired in the minutes may explain why.  

Economic data for the US and Europe may not be important drivers.  We note that the two most important US data points, March CPI and retail sales, will be reported on Good Friday, which is a holiday for many.  The Fed’s March hike means that US Q1 data is of little consequence.  Policy is forward-looking, as are investors.  A tick down in the pace of CPI and soft headline retail sales which are expected will simply confirm what investors already know.  Price pressures are elevated but not accelerating, and after a shopping spree in Q4 16, American consumers pulled back in Q1 17.  

The Atlanta Fed’s Q1 GDPNow forecast was halved lasted a week.  It now suggests the US economy nearly stagnated in Q1 (0.6% at an annualized pace).  However, the NY Fed’s tracker put growth near 2.8% in Q1.   Even splitting the difference (1.7%) seems unrealistically high.  

In Europe, the aggregate February industrial production will be reported.  In the national reports, German surprised big on the upside, while France and Spain disappointed.  Italy reports an hour before the aggregate figure.  The median Bloomberg forecast is for a 0.1% gain.  The risk is on the downside.  

There are two important points to be made.  First, the survey data in Europe, like in the US, appears to be running ahead of actual performance.  The key question is how these will realign.  How much does growth improve?  We are more confident that below trend Q1 US growth will yield to stronger growth in Q2 than we are that eurozone growth can accelerate much from the current pace.  Sentiment indicators may also soften in the months ahead.  

The second point is that for the ECB’s reaction function, the real sector is not the driver of policy.  It is to boost consumer prices toward the ECB’s target of near but less than 2%.  However, there are now numerous case experiments, and it is not clear that expanding the central bank’s balance sheet through the purchase of debt has a very high success rate it boosting the basket of goods and services that make up the CPI.  The rise in inflation that raised the ire of the Bundesbank and a few other European central bankers was a mirage caused primarily by the recovery in energy prices.  Core inflation bottomed in early 2015 at 0.6%.  The ECB’s balance sheet has expanded by more than a trillion euros, and the initial estimate suggests that core inflation stood at 0.7% last month.  

The UK reports on inflation and employment in the holiday-shortened week.  Core inflation in the UK is expected to tick down to 1.9% from 2.0%.  Headline inflation may slow, but if it does, it will likely prove temporary.  The past decline in sterling and the rally in energy prices have not completely worked their way through the system.  Inflation has yet to peak in the UK.  On the other hand, the labor market remains firm, and the ILO measure of unemployment is expected to be steady at 4.7% in February.  

The market often pays more attention to the average weekly earnings than to the unemployment rate. Average weekly earnings are expected to be steady at 2.2%, but they appear to be holding up due to bonus payments.  Excluding bonuses, average weekly earnings growth is expected to slow to 2.1% from 2.3%.  That would be the slowest rise since last July, which itself was the lowest since the end of 2015.  Softening wage growth will likely allow the BOE to look past the near-term overshoot of inflation.  

US 10-year yields (as a proxy for the rate differential) still seem to be the single largest influence on the dollar-yen exchange rate. However, there are a couple of economic reports that are important for investors.  First, Japan reported a larger than expected February current account surplus.  February always improves over January, as Japan’s surplus was JPY2.8 trln vs. JPY2.5 trln expected and JPY65 bln in January.  In February 2016 it was almost JPY2.4 trln, and in February 2015 it was nearly JPY1.5 trln.  Still under-appreciated by many, Japan’s current account surplus is driven more by its investment income balance than its trade balance.  Moreover, in February, the US Treasury makes a coupon payment, and as of the end of January, US data suggests Japanese investors held $1.1 trillion of US Treasuries.  

The strengthening international activity for Japanese companies is boosting capital expenditures and industrial output in Q1.  This will likely be seen in the upcoming machine tool orders and industrial output figures.  Also, Japanese fund managers had been sellers of foreign bonds and stocks in recent weeks but turned buyers at the end of March.  A renewed portfolio outflows can remove one source of the upward pressure on the yen.  On the other hand, the anticipation of a weaker yen may encourage foreign investors to return Japanese equities, which underperformed in Q1 (both the Nikkei and Topix have fallen thus far this year while the other G7 markets have risen).  

Lastly, we note that Australia may receive more attention too.  The Australian dollar was the weakest of the major currencies last week, falling 1.7% to its lowest level since mid-January.  It reports mortgage lending, which probably was flat in February, and credit card usage before the employment report on April 12.  The median expectation in the Bloomberg survey calls for a 20k increase in net new jobs Down Under.  It would be the most in four months.  The unemployment and participation rates are expected to be unchanged at 5.9% and 64.6% respectively.  

Although speculators in the futures market are still net long Australian dollars, the more recent price action warns of a sentiment shift.  The RBA is thought to be one of the few major central banks that could still cut interest rates later this year.

EM FX is carrying over to this week, due in large part to rising political risks.  Risks of further flare ups in Syria could lead to more risk-off trading, with RUB remaining under pressure.  Reports of a US aircraft carrier heading to waters near North Korea have likewise pressured KRW.  Domestic concerns are likely to weigh on TRY and BRL this week.  Next weekend’s referendum in Turkey could cement Erdogan’s rule further, while Brazil’s Congress has forced Temer to water down his reforms.  All in all, we think EM is likely to remain under pressure this week ahead of key US data Friday.      

Treasury Auctions This Week

April 10th, 2017 12:42 am

The Treasury will auction 3s 10s and 30s this week. Here is some interesting commentary from Ian Lyngen at BMO Capital markets on auction dynamic. This is an excerpt from a longer note to clients:

We’ll also see the takedown of the 3s, 10s, 30s trio of Treasury auctions on an accelerated scheduled with the first installment on Monday afternoon. While the shift in timing and holiday closures might intuitively be concerns for auction participation, this week’s $56 bn in gross issuance will be more than offset by $76.8 bn in maturities, leaving a net paydown of $20.8 bn.  For context, this will be the largest paydown on record for this trio and in fact, one needs to go back to May 2008 (prior to the introduction of the 3-year) for find a larger paydown. The influence on the auction process is less obvious from the net negative cash need, but we struggle to view this as anything outside of a bond-bullish underpinning.