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Monday, April 17, 2017

There is also strong appetite to BUY the Euro and European assets if favourite Emmanuel Macron or the centreright’s François Fillon.

The dollar appears to be sliding downhill in a continuation of last week’s action but many markets are closed, including Australia/New Zealand, most of Europe, and London. The US delivered unhappy CPI and retail sales data on Friday but it remains to be seen whether these factors linger. The Asian session saw the US 10-year yield fall to 2.20%.

The bigger stories are geopolitical, including Erdogan winning vast new dictatorial powers in Turkey and the latest N. Korean missile blowing up right after being launched. VP Pence warned M. Korea not to annoy Trump. The safe haven play remains in force—dollar/yen fell to a low of 108.10 overnight and gold is flirting with $1300 for the first time since last November.

Bloomberg reports crude oil slipped back on the Friday news that the US added 11 new rigs in the latest week, “capping the longest stretch of gains since 2011, according to Baker Hughes Inc. data. The latest CFTC data did show hedge funds boosting their bets on higher West Texas Intermediate crude prices for a second week, however, as expectations build for an extension of OPEC's production cut agreement.”

In the US, retail sales disappointed by falling 0.2% (for the second month of decline) when a gain of 0.1% was forecast. Retail stores are closing. You have to wonder if the data-gatherers are missing something, although the drop this time was due mostly to autos and gasoline and it should be hard to mess up that data. Everyone wonders how sales can be falling when consumer confidence is so high—the best since 2000.

Also in the US, CPI fell 0.3% m/m and up at 2.4% y/y when 2.6% was expected. Core CPI is also down 0.1% vs. a gain of 0.2% predicted, and at 2% y/y. The WSJ reports “It was the first monthly decline for core prices since January 2010 and the steepest drop for overall prices since January 2015.” The Atlanta Fed GDP Now forecast for Q1 is a lousy 0.5% (from 0.6% on April 7). We get another forecast on Tuesday, April 18. See the chart.

China is not a currency manipulator, according to the Treasury’s biennial report to Congress on Friday. Trump had already said so last week but seemingly changed the reason. The first time it was because he had been educated by Pres Xi and TreasSec Mnuchin. The second time, in a tweet over the weekend, is because China is helping us with N. Korea. A lot of people are not happy about bartering economic policy for political gain.

 China reported Q1 growth at 6.9% after 6.7-6.8% in the previous few quarters. Such steady growth smells fishy. The NYT reports “Official data shows that China’s economy has grown 6.7 percent to 7.2 percent for the last 11 quarters, a stunningly long period of stability by international standards. By comparison, figures for growth in the United States can move by one or two full percentage points from quarter to quarter.” And March industrial production is up 7.6% after 6.3% in Jan and Feb. Fixed asset investment is up 8.8% in Q1 after 8.9% in Jan + Feb.


The euro bottomed Sunday evening around 1.0601 but surged to 1.0652 late in the Asian session. Since Europe is mostly closed, the action since then is sideways and we await the New York traders. We have a lot of commentary in print and TV about how scary a LePen win would be in next Sunday’s election first round, and so it’s a little surprising the euro is not suffering.

The U.S 10-year yield index closed at 2.232% on Thursday, from 2.294% the day before. The market was closed on Friday. So far today we have 2.208%, from 2.6% in March. The Bund yield stabilized at 0.191% from 0.174% yesterday morning 0.245% last Friday morning. The market is still closed in Germany.

MARKET Outlook: 

The US trade deficit has persisted through cycles of strong dollar and weak dollar alike. The US is the world largest exporter in terms of volume and notional dollar value, but still it runs a deficit. The last time the US ran a surplus was 1975—a year after the dollar was floated. We have dozens of factors influencing the trade deficit, but we can surmise that too-low currencies is among them. Other countries can’t afford US products. This time the Treasury report was sharply critical of China, which “has a long track record of engaging in persistent, large-scale, one-way foreign-exchange intervention.” While China has allowed appreciation in recent years, past interventions “imposed significant and long-lasting hardship on American workers and companies.”

The Treasury report has always been a diplomatic tool rather than an honest economics judgment. The Treasury pretends to be severe: “Treasury will be scrutinizing China’s trade and currency practices very closely, especially in light of the extremely sizable bilateral trade surplus that China has with the United States.” But this is not credible, nor is the statement ““Treasury is committed to aggressively and vigilantly monitoring and combating unfair currency practices.”

Poppycock. In the 20 years the report has been mandated, no country has ever been named a “currency manipulator.” Market players grind their teeth but Congress goes along with it, not always gracefully, because of backroom deals not related to trade. That’s what happened this time, too, which is not to suggest China egged on N. Korea to stave off Trump tariffs.

Ahead of World Bank/IMF meetings in Washington this week, IMF chief LaGarde warned the US against protectionism. This infuriated Commerce Secy Ross, who told the FT “… we are the least protectionist of the major areas. We are far less protectionist than Europe. We are far less protectionist than Japan. We are far less protectionist than China. We also have trade deficits with all three of those places. So they talk free trade. But in fact what they practice is protectionism. And every time we do anything to defend ourselves, even against the puny obligations that they have, they call that protectionism. It’s rubbish….. Our tolerance for continuing to be the deficit that eats the surpluses of the whole rest of the world — the president is not tolerant of that any more.”

Trump is playing an interesting hand on trade. He has all the aces, including quitting the World Trade Organization if partners refuse to fall in line and currency-adjusted subsidies/tariffs are the next step. These “plans” are probably no such thing and just a bluff, but you never know. Then there’s de- faulting on US debt. We have no doubt Trump has investigated whether he can default on just the amounts that China owns, or Japan. We think Trump is unqualified and uninformed, and probably not all that good a deal-maker, either, but on trade, we wouldn’t bet against him.

Participants in various markets are not paying enough attention to trade and instead worrying about tax reform and where is the infrastructure spending? The postponement of fiscal plans is throwing cold water on the expectation that yields will rise to 3% on rising growth and inflation—the Trump reflation trade. But you can get reflation from trade, too, although it lacks the same “announcement effect” punch.

If higher yields are what we need to support the dollar, Trumpian policies are not the only source of inspiration. There could be a drop in geopolitical worries, although we have to wait for the final French election. More importantly, there’s the Fed. If the Fed is serious about a hike in June, it has to pull another rabbit out of the hat, as it did in March. A Jeffries economist told the WSJ “I’m inclined to think that we’re in a temporary blip.” The WSJ rephrases his comments: “As the Fed’s June policy meeting approaches, officials will likely try to prepare the market for another rate increase, causing yields to rise.”

And Bloomberg has an interesting editorial take, too. “In markets, we've seen a breakdown in reflationary bets. After tons of talk about a new policy regime and higher interest rates this year, the yield on the benchmark U.S. 10-year bond has drifted back to around 2.20 percent, right where it was just three days after the election.”

The back-seating of strategic advisor Bannon is a source of gloom. Bannon is the guy behind the trillion-dollar infrastructure initiative, while rising star Gary Cohn opposes it. This is a classic populism vs. Wall Street battle. “Populism is often an inflationary ideology, and a lot of places around the world that have inflation have more populist leadership. Meanwhile, the Wall Street perspective is inherently anti-inflation, as price increases erode the value of a future stream of payments. I wouldn't go as far as claiming White House internal politics are driving 10-year yields, but the two stories are at least interesting to ponder together.”

After Trump has flip-flopped on so many things in the past week, can we count on the infrastructure initiative returning? Yes. Trump fancies himself a builder. He’s also a bullying arm-twister. And heaven knows, the US is in dire need of infrastructure fixes. Trump may have to back down on the travel ban and other campaign promises, but this one is not going away. We just have to wait for it. Market lack patience and hate to wait. At some point somebody will explain the Trump reflation trade to him and we will get the infrastructure plan. Of course it won’t be a “plan” in any traditional (i.e., coherent) way, but never mind.

Meanwhile, Europe has its own Trumpian problem and it’s a woman. The FT notes euro volatility is the highest since Brexit ahead of the first round of the French election next Sunday. There is a real possibility that in the end the boring Macron will get shoved out of the  way and the two contenders will be the far-right LePen and the far-left Mélenchon. Both want Frexit.

The FT writes “Although portfolio managers and traders are wary of another populist victory, there is also strong appetite to buy the euro and European assets if favourite Emmanuel Macron or the centreright’s François Fillon prevail. A victory for either would drive positive investor sentiment towards the eurozone, sending the euro to $1.15 from current levels of about $1.06 by the end of the year, according to analysts at JPMorgan….. By contrast, victory for Ms Le Pen on May 7 could see the euro tumble to 98 US cents in a matter of weeks, JPMorgan forecast. The European currency has already fallen from slightly more than $1.09 at the end of March, falling almost 3 per cent this month against the yen, one of the most favoured haven assets, while the spread between French and German 10-year yields has widened.”

Be careful about shorting the dollar. You could end up with egg on your face.

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