Natural gas futures broke out above resistance on Friday and extended gains today, trading up to a 10 week high before meeting resistance at the 100 day moving average.
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Last Week
The calendar was busy, but the only numbers of any real importance last week were the flash global manufacturing PMIs. There were gives and takes, as always, but the bottom line was that they met current market expectations (and as such aren’t rocking the global macro boat).
Growth remained strong in the U.S. While it was a “technical miss” vs. expectations (57.9 vs. (E) 58.1), the September flash PMI was the second-highest ever. So on an absolute basis, it’s still strong.
In Europe, official EMU PMI stayed above 50 (so technically in expansion territory). But, the German number was a big miss (50.3 vs. (E) 51.2), and that number was definitely the biggest disappointment last week.
But, if Germany was the disappointment, then China was the positive surprise. Despite loud “whispers” that PMI would drop below 50, it actually rose slightly. It confirmed what we know about China: Growth isn’t particularly strong, but it’s not about to implode either.
The takeaway from last week was: The U.S. is still strong, China is “OK” and Europe remains in the economic ICU.
This Week
It’s a busy week of data with a large number of reports. While we get insight into virtually every corner of the domestic and global economy this week, the most important numbers to watch will be from Europe.
In order of importance: EMU flash HICP (their CPI) (Tuesday), U.S. jobs report (Friday), ECB decision and press conference (Thursday), global official PMIs (Tuesday night/Wednesday morning), global composite PMIs (Thursday night/Friday morning).
The EMU HICP is the most important number of the week because it’ll offer us the latest insight into whether we are seeing a continued slight moderation of deflation fears in the EU. Because a “triple-dip” recession in the EU remains the #1 global macro risk to watch, it’s obvious why this inflation reading is so important.
The jobs report here in the U.S. is always important, although honestly it’s not quite as monumental as it has been in the past. Unless it’s another “dud” like August, or a very hot number (say north of 300K) it’s not going to shift expectations for the Fed. But, it will be important to see a bounce-back and a revision higher to August’s disappointing 142K. Also keep in mind it’s “jobs week,” so we get ADP Wednesday and claims Thursday.
The ECB meeting Wednesday won’t bring any new policies or interest rate cuts, but the market will be looking for more reassurance from Draghi & Co. about both their willingness to do QE if needed (and it almost certainly will be), and their reaction to the soft TLTRO demand. (If he can make a credible case why he thinks the December offering will be good, that will help market sentiment and be EU-stock-positive, bond-negative.)
The official PMIs are released Tuesday night/Wednesday night, and China’s official government manufacturing PMI will be the most important number to watch. It’s holding on above 50 and if it can confirm the surprise uptick we saw in the Markit flash PMI last week, it’ll help alleviate some nerves about the pace of China’s economic growth. The European and U.S. numbers will obviously be closely watched, but they shouldn’t differ too far from the “flash” readings we got last week. (If there’s a surprise negative revision to the European data, it may weigh on markets a bit, but there are too many other catalysts this week for it to do any major damage.)
Finally, we get the composite global PMIs (so, manufacturing and service sector) Thursday and Friday, and again the market will be looking for confirmation of current expectations: Chinese economy losing some momentum but still seeing incremental growth, Europe “hanging on,” and the U.S. recovery progressing. As long as the numbers generally confirm those expectations, don’t expect too much of a market reaction.
But, proving my point it’s a busy week, we also get several other numbers: Personal Income and Outlays will be watched this morning to see if there is a drop in the “core PCE price index” (the Fed’s preferred inflation gauge). Remember, CPI two weeks ago surprisingly dropped. If core PCE confirms this, it may give the Fed some room to stay “dovish” a bit longer than the market may expect. So, there is risk from a Fed expectation standpoint into the number. We also get more housing data, via Pending Home Sales Tuesday, auto sales Wednesday, and non-manufacturing PMIs Friday.
Japan also has a slew of data out overnight tonight, but the biggest number this week will be the Tankan survey, released tomorrow night. Worries about a slowing Japanese economy and eventual incremental stimulus have pushed the yen to multi-year lows and the DXJ to near-all-time highs. So, the data need to confirm that we are indeed seeing a slowdown; otherwise we could see a violent (albeit temporary) snapback move in both the yen and DXJ.
Bottom line is this week is busy, but really the key is Europe. If investors can come away from this week more confident about Europe and the ECB, it’ll become a welcomed tailwind on risk assets (and likely a headwind on Treasuries).
Need to Know on China
China has been in the news the last two days, specifically a WSJ article speculating that the head of the PBOC will be replaced in October. This was the main headline cited for both Wednesday’s move higher, and yesterday’s breakdown.
Before getting into the market reaction, though, basically what the article said was Chinese leadership was considering replacing the current head of the PBOC, Mr. Zhou Xiaochuan.
Zhou is seen as a reformist—meaning he is intent on imposing structural reforms on the Chinese economy (which are needed and longer-term positive). But, those changes, as we’ve seen, also dampen economic growth.
So, his potential removal was seen by the market as a sign that Chinese authorities may be focusing more on stimulating short-term economic growth, and U.S. stocks rose on the news Wednesday.
But, Chinese stocks didn’t—they ignored the news (implying U.S. markets overreacted) and this was part of what turned futures negative Thursday morning (the unwind of the Wednesday rally).
Bottom line with China is this: 7% GDP growth is the Maginot Line. Fears are rising that the Chinese government will reduce its 2015 GDP growth target from 7.5% to 7.0%, and that may well happen in October. But if growth is forecast sub-7%, that will re-ignite worries about a “Chinese hard landing,” which will be a new macro headwind on stocks. So, despite all the “noise,” the number to watch is 7% — above that and China will not be a major negative on equity prices.
The S&P 500 is now down 2.5% from last week’s fresh all time highs, trading well below support at both the recent 1980 level as well as the 50 day moving average (1976).
It’s Not Just About Europe and the Long Bond
We focus predominantly on the long end of the curve here because that’s where I see the biggest money-making opportunity given the ETFs we have access to. But, watching the entire yield curve is important in gauging the overall trend of bonds.
To that end, I want to point out that the yield on the 2– year Treasury, which is most sensitive to Fed Funds rate expectations, rose 5 basis points to 0.59% (5 basis points is nearly 10% and the yield on the 2-year is at a multi-year high). This is important because while Europe is a major influence on the long bond, there appears to be something else going on here (European buyers wouldn’t buy the 2-year in a “reach for yield”).
As I’ve said, the short end of the curve is much more sensitive to Fed Funds expectations. So, the fact that the 2-year bond has declined/yields risen to multi-year levels is significant. It implies the bond market is preparing for a more “hawkish” Fed – at least compared to what we’re seeing in the equity market. Simply, the 2-year yield wouldn’t be at multi-year highs if the market wasn’t starting to price in the possibility of sooner than expected Fed Funds “lift off” (the date rates start to rise), or a faster than expected rise in rates. That, on the margin, further validates my idea the trend in bonds is now lower, and that’s positive for our various “higher rate” positions.
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That’s not good – the Russell 2000 50 day MA just crossed the 200 to the downside.
Last Week
There were plenty of economic reports last week (and they were in aggregate slightly weaker than expected) but the real focus was on the FOMC. While the Fed’s “hawks” seem to be gaining strength, the takeaway is that the expectations for policy remain unchanged.
Starting with the Fed, you know by now that they kept the “considerable time” phrase in the statement. Generally speaking the statement was considered slightly “dovish” when compared to expectations (which got a touch too “hawkish” going into the meeting).
But, the “dots” were increased, implying Fed officials now expect interest rates to rise faster than they envisioned back in June, and that was taken as “hawkish” by both the bond and currency markets. So, depending on which camp you’re in (equities vs. all other assets), the Fed was both “hawkish” and “dovish.”
Stocks rallied after the meeting because, while the Fed was on balance slightly more “hawkish” in an absolute sense, they certainly aren’t going to pull forward tightening at this point. So, the Fed will remain a tailwind on stocks.
But, from a risk standpoint, I took this Fed meeting to show that it’s just a question of “when” the Fed gets more hawkish. The risk of a “hawkish” surprise in the coming months is rising, while the risk of a “dovish” one has diminished almost to zero. So, incrementally the risk of a “hawkish” surprise is rising, and that makes me less bullish on U.S. stocks generally. The risk of a “hawkish” Fed surprise that rattles markets is rising, while the risk of a “dovish” surprise is virtually nil at this point.
Turing to the actual data, it was a bit soft last week. August industrial production missed and, even stripping out a big negative for a drop in auto production, the number was still underwhelming.
Housing starts also missed estimates, while the first look at September regional manufacturing activity was mixed, with Empire State manufacturing beating while Philly slightly missing. (But both remain strong on an absolute sense.)
The biggest surprise of the week came from CPI, which dropped -0.2% in August, while “core” CPI was flat month-over-month for the first time since January. It was a surprise, and I saw some analysts try and spin it as a “dovish” influence on the Fed. But I don’t think any moderation in inflation would make the FOMC more dovish at this point, as deflation simply isn’t a threat. The FOMC knows they have to start removing liquidity before something bad (like a bubble) starts to form (or pop) depending on your opinion of the Fed.
This Week
The biggest release to watch this week is the global flash manufacturing PMI. The most important number is China’s, which comes tonight. Recent data show the Chinese economy is losing some steam, but we’re still a long way from any renewed fears of a “hard landing.” So, even if this number is a miss, it likely won’t be too much of a negative influence. But, that said, if it drops below the 50 level, that could weigh on markets tomorrow morning (so, more of a short-term thing than a negative macro event).
Europe comes Tuesday morning and markets will want to see some incremental improvement over August (the absolute level will be very low, but at this point it’ll be encouraging if Europe is at least seeing some incremental acceleration of activity). And, here in the U.S., everyone expects the number to be strong. But if it’s very hot, that may push levels of Fed angst a touch higher, so the stocks bulls need a “Goldilocks” to slightly weaker number. Outside of the global PMIs, it’s quiet internationally.
Domestically, we get more housing data (Existing Home Sales today, New Home Sales Wednesday). Again, the market is looking for constant reinforcement that the housing recovery remains in gear and is gaining momentum.
Bottom line is the global flash PMIs are the most important release this week, and as long as they meet general market expectations (slow but positive growth in China and Europe; strong growth in the U.S.), they shouldn’t elicit too much of a response).
Bad is Good in Europe
This morning the ECB released it’s first tranche of TLTRO funding, and it flopped, badly. Takedown by banks of the offer was just 82.6 billion euro, a little over half of the 150 billion that was expected.
But, this low figure is seen as only further increasing the likelihood that the ECB will have to eventually launch a large scale QE program – and European markets are all sharply higher on the news.
