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Economics: This Week and Last Week. February 21, 2017

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An excerpt from today’s Sevens Report. Subscribe now to get the full report in your inbox before 7am each morning.

Both economic growth and inflation accelerated according to last week’s data, and while the former continues to help support stocks despite a darkening outlook from Washington, the latter also is increasing the likelihood of a more hawkish-than-expected Fed in 2017, and a resumption of the uptrend in interest rates. For now, though, the benefit of the former is outweighing the risk of the latter.

If, however, we do not see any dip in the data between now and early May, I do expect the Fed to hike rates at that May meeting, which would be a marginal hawkish surprise. To boot, if we get a strong Jobs report (out Friday, March 3), then a March rate hike two weeks later isn’t out of the question. Point being, upward pressure is building on interest rates again.

Last Week

Both economic growth and inflation accelerated according to last week’s data.

Looking at last week’s data, it was almost universally strong. Retail Sales, which was the key number last week, handily beat expectations as the headline rose 0.4% vs. (E) 0.1% while the more important “Control” retail sales (which is the best measure of discretionary consumer spending) rose 0.4% vs. (E) 0.3%. Additionally, there were positive revisions to the December data, and clearly the US consumer continues to spend (which is more directly positive for the credit card companies).

Additionally, the first look at February manufacturing data was very strong. Empire Manufacturing beat estimates, rising to 18.7 vs. (E) 7.5, a 2-1/2 year high. However, it was outdone by Philly Fed, which surged to 43.3 vs. (E) 19.3, the highest reading since 1983! Both regional manufacturing surveys are volatile, but clearly they show an uptick in activity, which everyone now expects to be reflected in the national flash PMI.

Even housing data was decent as Housing Starts beat estimates on the headline, while the more important single family starts (the better gauge of the residential real estate market) rose 1.9%. Single family permits, a leading indicator for single family starts, did dip by 2.7%, but even so the important takeaway from this data is that so far, higher interest rates don’t appear to be negatively impacting the residential housing market, and a stable housing market is a key, but underappreciated, ingredient to economic acceleration.

Finally, looking at the Fed, Yellen’s commentary was marginally hawkish, as she was upbeat on the economy, basically saying the nation had achieved full employment and was closing on 2% inflation, and reiterated that a rate hike should be considered at upcoming meetings. None of her comments were new, but the reiteration of them reminds us that the Fed is in a hiking cycle, and the risk is for more hikes… not less.

This Week

The big number this week is the February global flash manufacturing PMI, out Tuesday. With last week’s strong Empire and Philly Surveys, expectations will be pretty elevated for the flash manufacturing PMI, so there is some risk of mild disappointment. On the flip side, if this number is very strong (like Empire and Philly) you will likely see a hawkish reaction out of the markets (dollar/bond yields up) and the expectation for a rate hike before June increases. That, by itself, shouldn’t cause a pullback in stocks, but upward pressure will build on interest rates.

Outside of the flash manufacturing PMIs, the FOMC minutes from the January meeting will be released Wednesday, and investors will parse the comments for any clues as to the likelihood of a March increase. Yet given the amount of political/fiscal uncertainty, and considering the FOMC meeting was before the strong January jobs report and recent acceleration in data, I’d be surprised if the minutes are very hawkish (although given they are dated, I don’t think that not-dovish minutes reduces the chances of a May or even March hike).

Bottom line, the focus will be on the flash manufacturing PMIs, and a good number this week will be supportive for stocks.

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How Big a Risk is a Trade or Military Dispute? February 16, 2017

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An excerpt from the Sevens Report. Sign up for a two-week free trial of the full report at www.7sReport.com.

Earlier this week I began profiling non-political risks to explore when making decisions for your clients and talking with prospects. Here’s number three:

Non-Political Risk #3: Surprise Trade or Military Dispute

Surprisingly, and potentially dangerously, the market has fully embraced Trump’s pro-growth “big three” of tax cuts, infrastructure spending, and deregulation while totally ignoring the hostile trade (and to a lesser degree) military rhetoric—and that selective focus has helped fuel this rally in stocks.

How big a risk is a trade conflict with China?

Part of the reason investors have somewhat ignored the rhetoric is because they assumed that once Trump got into power, the realities of global trade would soften his tone. To a point, that has happened. Last week, Trump embraced the “One China” policy of governance over Taiwan. And, this past weekend visit with Japanese PM Abe came and went with no explicit mention of currency manipulation or unfair trade. But, while those are positives it’d be foolish to think there isn’t a real risk of a trade dispute/war with China.

Originally, the fear was that Trump would instruct the Treasury Department to label China a “currency manipulator” in its semi-annual currency report, due out in late March/early April. That would likely ignite some sort of a trade war as it would place automatic tariffs on Chinese goods. Obviously, that wouldn’t be good for stocks.

Trump appears to have backed away from such a direct confrontation, but as a WSJ article detailed, the administration is looking for a less “in your face” way to punish China for its trade practices (you can read the article if you’re really interested) but basically the strategy is to label currency manipulation an “unfair subsidy,” not just by the Chinese, but by every country. If that’s done, then individual US companies can lobby the Commerce Department to impose du-ties on competitive goods from countries they believe use currency manipulation. It’s basically a less-direct way to put duties/tariffs on Chinese goods.

Here’s the problem: Other countries can retaliate and do the same thing to the US, and cite the Fed’s ultra-low rates as manipulating the US dollar lower.

This will obviously be a fluid situation, but with Peter Navarro as the head of the National Trade Council (remember he wrote the book, Death by China) it’s un-likely that we won’t at least have a trade scare this year with China.

Looking militarily, the only real area of concern right now (well, there are multiple areas of concern, but the most pressing one) is the growing conflict between the US and China regarding their bases in the South China Sea. Trump advisor Bannon is particularly focused on this issue, and military officials have flat-out said that China won’t be allowed to operate a functioning naval or air base on these manufactured islands. Again, this is a low-probability event, but it remains a possibility.

Probability of a disruptive trade war? <30%. While the possibility is there, I’d expect marginal moves to try and correct trade imbalances with China, not all out tariffs or import duties (although I’m sure they will be publicly threatened, which will be negative for sentiment).

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Economic Growth Slows: February 14, 2017

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An excerpt from today’s Sevens Report.

Non-Political Risk #1: Economic Growth Slows.

Stronger economic data remains an unsung hero of this post-election rally, and while Trump gets the headlines, it’s really the economic data that’s enabling this rally as better economic growth is allowing the market to continue to give Trump and the Republicans the benefit of the doubt.

I can go through the litany of reports, but whether it’s PMIs, the Jobs Report, or Business Investment, the data has been accelerating since mid to late 2016, and that’s created the proverbial “rising tide” that’s helped under-write both policy optimism and the rally in stocks.

But, while hope may be growing that there will be less drama from the administration (the reason for Monday’s rally), at the same time there’s growing evidence that actual policy reality will not meet market expectations.

So, in the near term, it’s going to be up to economic data to continue to provide a reason for markets to give Washington the benefit of the doubt, otherwise the sober reality of a market that now trades well over 18X current-year earnings will begin to cause problems.

Bottom line, if economic growth slows in the near term, that will cause a pullback in stocks. So, in today’s Sevens Report for subscribers, I go into detail on: 1) How likely is an economic slow down? 2) What are the leading indicators to watch? and, 3) How do we position if it happens?

First, how likely is an economic slow down? > 50%.

A probability that high may surprise people, but I have several reasons for it: First, we’ve seen an acceleration in economic activity, but we still haven’t really achieved the “breakout” pace of consistent 3% GDP growth that tends to feed on itself and further stimulate the economy. For all the excitement, we’re still in a 2%ish GDP regime (GDP Now from the Atlanta Fed has Q1 GDP at 2.7% in Q1). Point being, things down have to slow very much before the economy is right back in neutral.

Second, the consumer has powered this economic acceleration, but the consumer is tired. Credit creation is slowing, and retail sales reports have been lackluster of late. To boot, the job market remains basically at full employment and while wages are rising, they aren’t rising fast enough to power incremental acceleration consumer spending. Unless we see proof consumers are accessing the equity in their homes, I don’t see what will cause consumer spending to grind higher.

The Citi Economic Surprise Index rose steadily through Q4 of 2016 as economic data consistently beat expectations. Going forward, this index is now an important leading indicator for the market, as any material move back down towards zero will create a headwind on stocks.

Third, business investment has accelerated lately and that is good, but the uncertainty over the tax code changes (and trade in general) has the potential to be-come a headwind on business investment. Here’s my point: The tax changes being discussed in Congress could eliminate interest deductibility and change a host of other tax issues. If I’m a business and I’m thinking of getting a big loan to finance expansion, I’m likely going to wait until there’s more clarity on these and trade issues be-fore taking on too much risk.

Finally, leading indicator of growth for the global economy, China, is actively trying to slow its economy. China’s credit-fueled expansion back in February 2016 marked an inflection point in the global economy and things have been better since. But with a year of stimulus be-hind it, currency issues, and once again overheating property and asset markets, Chinese authorities are trying to cool their economy. The effects aren’t immediate or direct on the US economy, but the fact is that a slow-ing Chinese economy will become a headwind on the US at some point (how much of a headwind depends on how well the cooling is managed).

“Leading Indicators” and, “How do we position if it happens?” sections are restricted to subscribers.

Take advantage of the limited time special offer—if you subscribe to the Sevens Report today, and after the first two weeks you are not completely satisfied, we will refund your first quarterly payment, in full, no questions asked.

Copyright 2017, Kinsale Trading LLC. All Rights Reserved. www.sevensreport.com

Dollary Futures: “Trump-Off Trade” Leads Dollar to Test Key Support

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The dollar index fell into a key support level yesterday as the market remained in “Trump-Off” mode. If support just above 100 is violated, dollar index futures could quickly fall back to the uptrend line pictured above, near 98.00

Donald Trump and British PM Teresa May were the two major influences on the currency markets yesterday, as Trump’s comments to the WSJ over the weekend about the dollar being too strong, combined with May’s Brexit address being slightly less hardline than feared, caused a big drop in the greenback. Meanwhile, the pound surged nearly 3% (it’s best day since ’08). The Dollar Index closed down 0.75%.

Starting with the biggest mover on the day, the pound hit fresh multi-decade lows over the weekend on fears of PM May taking a hard line in her Brexit address (the pound briefly broke through 1.20 late Sunday). But in her comments yesterday, May said that while she will seek a clean break from the EU, any final deal will be put to a vote before Parliament.

It was the last point that ignited the pound rally, because while the news of the vote isn’t exactly positive (it will still be a “hard Brexit”) it does introduce some sort of moderating force and influence into the negotiations. And, since it was unexpected, it caused one massive short-covering rally.

Going forward, do we think today’s news marks the low in the pound?

No, not unless US economy rolls over. That’s because Brexit will be a consistent headwind on the pound for quarters and years (May said she will begin a two-year negotiation with the EU in late March). Unless you are a nimble traders, we certainly would not want to be long the pound, as we don’t think this is the start of any material rally (again, absent any rollover in the US data).

Turning to the US, Trump’s comments about the dollar being too strong over the weekend and “killing” US manufacturing hit the currency. As a result of those comments, all other major currencies were universally stronger vs. the buck. The euro and yen rose 0.80% each while the Aussie rose 1% and the loonie rose 0.60%.  Nothing particularly positive occurred with those currencies, they were simply reacting to dollar weakness.

Going forward, at this point I don’t see Trump’s comments as necessarily dollar negative, and for one simple reason. If he accomplishes his goals of tax cuts, infrastructure spending and deregulation, the Fed will hike interest rates much more aggressively than is currency expected, as inflation will accelerate—and that will be demonstrably dollar positive despite what Trump says.

Near term, clearly the momentum is downward, and the dollar is testing support at 100.24. A close below that level likely opens up a run at, and through, par, with truly firm support resting in the high 90s.

Turning to Treasuries, they also traded Trump Off yesterday, in part due to the uncertainty of Trump’s comments (generally though, he didn’t say anything Treasury positive), and the 30 year rose 0.60% while the 10 year rose 0.35%. The 10 year hit a fractional two-month intraday high while yields on both bonds hovered near two-month lows.

Much like the dollar, we don’t see the recent Trump Off rally in bonds as longer-term violation of the new downtrend. Again, that’s based on the simple fact that if growth accelerates, so will inflation, and the Fed will have to hike rates faster than is expected—and that will power bond yields higher.

Near term, clearly we are seeing consolidation. If today’s CPI is light, and the Philly Fed is light later this week, and if Yellen is dovish in her comments, then we could see the 10-year yield test 2.30%. Longer term, unless we see a big reversal in economic growth, this counter-trend rally in bonds remains an opportunity to get more defensive via shorter duration bonds, inflation-linked bonds (VTIP) or inverse bond ETFs.

 

 

Chart of the Day: Trump Trips the Dollar

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The dollar index traded down to a one-month low yesterday as the markets grew cautious after Trump failed to divulge details of his administrations’ plans after inauguration, most notably corporate tax reform.

 

Chart of the Day: Key Dollar Support Ahead of the Fed

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The bull market in the dollar index remains very much alive, but if the Fed surprises dovishly today, it is possible that technical and psychological support at 100 is violated which would lead to a pull back into the upper-90s.

 

Bonds and Currencies Report (BOE Surprise?)

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It was a generally quiet day in the currency and bond markets as the various cross currents (election, M&A, economic data, etc.) all largely cancelled each other out.  The Dollar Index closed little changed after spending most of the day modestly stronger.

The euro was modestly weak for most of trading Monday (down 0.30% at the low) thanks to a slightly soft October core HICP (their CPI). Year over year, core HICP rose just 0.7% vs. (E) 0.8%, and with inflation still sluggish the idea that the ECB will materially reduce its QE program remains an outlier. The risk to markets is that they underwhelm with their extension (i.e. taper and extend, as opposed to extending the current 80 billion monthly purchases).

It is just one indicator, and growth has appeared better in October, so it wasn’t a materially dovish influence and the euro rallied yesterday afternoon to finish with mild losses. Going forward, The Sevens Report continues to expect the euro to chop largely sideways near 1.10 vs. the dollar until we have more color on the ECB’s plans for its QE program.

Looking elsewhere in the currency markets it was quiet. The yen, Aussie and loonie were all little changed (the loonie held up well despite the plunge in oil, down just 0.20%).

It was equally quiet in bonds as Treasuries rallied small (the 10-year yield rose 1 basis point while the 30-year Treasury rose 0.33%). Part of that was buying following the soft EMU HICP (remember, deflation in Europe sends money into higher-yielding US Treasuries) and some of that rally was just general election angst given the October email surprise.

Going forward, the FOMC, BOE and jobs report are the next significant catalysts for the bond market, so I’d expect generally quiet trade into those events starting Wednesday.

Bottom line, if those events are hawkish and the 10-year yield moves up through 1.90% and towards 2% (remember the 10-year yield rose 11 basis points last week, so it could theoretically get close to 2%) that will be a headwind on stocks.

The Bank of England meeting is the most important Central Bank meeting this week.

Much of the media focus is on the Fed meeting this week, but actually the central bank meeting with the greatest potential market impact is the Bank of England meeting on Thursday.

The reason is well known. US Treasury yields continue to follow global yields (remember, Bund and GILT yields rose more than Treasury yields last week), and if BOE Governor Carney disappoints markets on Thursday we’ll see GILT yields move higher, and that will drag Treasury yields higher and become a headwind on stocks.

The risk into Thursday’s meeting is that Carney backs away from his promise for more stimulus this year because of the near-20%, post-Brexit collapse in the British pound, which is causing an uptick in inflation pressures across Britain.

Now, to be clear, he’s not expected to dial back his support for more stimulus, but it is possible, and that’s a risk to stocks as markets have priced in another move by the BOE (in December).

So, while the media likely won’t cover it nearly as much as a likely anti-climatic Fed or jobs report, this BOE announcement actually has the biggest potential to surprise markets this week. Stay tuned.

Chart of the Day: Dollar Touches 7-Month High

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The dollar index broke out to levels not seen since early March yesterday as investors continue to price in a December rate hike.

Chart of the Day: Pound Tests Brexit Lows

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The pound fell to a 3-month low yesterday thanks to news that British PM May set a March deadline for formally beginning the Brexit Process.