Journalists vs central bankers: Who's got it right?

Outlook:

The FT headlines that currencies and bond yields are retreating from an exaggerated response to central bankers' talk of normalization. Well, no. The retreat, if that is not an over-statement, is the normal next step three days after a Shock, amplified by month-end, quarter-end and a major American holiday next Tuesday. The probability of prices returning to the status be-fore the central bank speeches is close to zero. We may not know the exact trajectory, but we know a Major Event when we see one.

The FT sub-head says "Investors jump Draghi's finely tuned starting gun" and "Markets should not assume that monetary tightening is inevitable." The article starts out "Few things cause more unneces-sary gyrations in financial markets than the over-interpreted words of central bankers."

Who, exactly, can say when a gyration is "unnecessary"? And who is the judge of what is a correct in-terpretation and "over-interpretation?" The Draghi remark that withdrawing stimulus to keep conditions neutral is "unexceptional." Wrong again. It was exceptional. After the last two policy meetings, Draghi made a special point of denying that tapering had been discussed. After a slew of good data, the finan-cial world was on tiptoes waiting to hear that tapering was becoming a realistic expectation.

Markets does not have "difficulty understanding the use of the conditional and the hypothetical." No. We live with it all the time. It is our paid job to weigh conditionals and hypotheticals to come up with real-money trading decisions. Journalists do not make real-money trading decisions. Traders have the special ability to hold two opposing ideas in their heads at the same time and not go barking mad. We'd like to see the ordinary scribbler do that.

The FT is sarcastic—"investors may have learnt a lesson in reading to the end of a sentence in a speech before leaping to react." The FT says Draghi was only posing a hypothetical, "not signalling that the moment for change is near." But this is to misinterpret Draghi's skill. Draghi knew exactly what he was doing and he knew exactly what the response would be. Maybe he regrets a misinterpretation of his words as downplaying inflation, but otherwise, he had to know that talk of normalization would set off a firestorm. Any acknowledgement of tapering was always going to set off a storm. The occasion of the ECB Forum was as good a venue as any and absolutely better than the press conference following a policy meeting.

The FT preaches to the central banks that they need to be more careful with their words to avoid a taper tantrum as we had in the US in 2013. In other words, the FT thinks these guys are stupid. And a final parting shot is to call markets "febrile." We had to go look up the meaning of the word. It means "feverish" and usually without an underlying cause. "Communicating to febrile financial markets is always likely to create some unwarranted volatility. Central bankers should continue to patiently ex-plain their strategy rather than giving a running commentary on where rates are likely to go in the very near future. They should make clear they set monetary policy to react to data as they come in rather than looking for excuses to reach a predestined goal." That's a good one—journalists telling central bankers how to communicate with markets, when central banks pay a fortune to wordsmiths and spend an inordinate amount of time on "communications strategies" in order to be transparent.

The article is offensive to traders and central bankers alike.

We have two economic myths to debunk today. The first is the one embraced by the Bank of England, that rising investment, construction and exports will more than offset falling consumer spending and thus provide a driver for the UK economy. But that is not happening. After UK Q1 GDP came out at a lousy 0.2% this morning, Pantheon Macroeconomics wrote "The national accounts demonstrate that net trade and investment are not compensating for the slowdown in growth in households' spending, and therefore are a setback for the hawks on the MPC who seek an immediate increase in Bank Rate. The revised expenditure breakdown of GDP shows that net trade subtracted 0.8 percentage points from quarter-on-quarter GDP growth in Q1. Although this drag was smaller than the -1.4pp estimated for the second estimate of GDP, the data continue to show that sterling's depreciation has been the less suc-cessful in Britain's post-war history."

We are not crazy about the use of language—what does "the less successful" mean? Should it not be "least successful" or maybe "less successful than XXX"? But never mind. The point is that Carney was talking through his hat when he suggested the economy is going to be just fine as Brexit goes forward. The loss of consumer confidence and consumer spending is central and not something that can be offset by activity elsewhere, especially since that activity is not actually materializing.

And another one: Yellen and other economists have an abiding faith in the Phillips Curve—the trade-off between employment and inflation. The Phillips Curve has been refuted hundreds of times over the past forty years and yet its seeming inherent logic persists. What are the conditions under which full employment fails to result in wage increases that drive inflation? There must be some set of conditions under which this is true. You don't have to buy into the pictures of downtrodden labor under the thumb of cruel capitalist masters to observe that full employment does NOT always result in wage increases. And even when you do get wage increases, you don't always get inflation.

Consider Japan. We always go to great pains to point out that the Japanese economy and Japanese soci-ety are very different from Western economies and societies. For one thing, the Japanese are genuinely civilized and have really good manners. We can guess what they think of the boorish Trump.

But Japan has a situation where the jobs-to-applicants ratio is at a 43-year high in May on an extreme labor shortage. There are 149 jobs for every 100 job seekers. The economy is running at near full ca-pacity and "jobs for life" may be returning. You'd think jobs for life would encourage spending. But Japan is not getting wage inflation and it's not getting overall inflation, either. Headline CPI is up only 0.4% y/y and the core version ex-food ticked up from 0.3% to 0.4%, reported today. Excluding food and energy, the core CPI is unchanged at zero. And household spending contracted 0.1% y/y for the 15th month of contractions.

If they are not spending, they must be savings, right? The latest information we could get is April, when the savings rate rose to 8.2% from 3.8% in March. Tradingeconomics.com reports "Personal Sav-ings in Japan averaged 11.80 percent from 1970 until 2017, reaching an all time high of 49.70 percent in December of 2015 and a record low of -9.90 percent in May of 2012."

We know that the ageing population has something to do with spending, but this chart indicates savings are hysteria-driven, not demographics-driven. The savings rates in other counties are far more stable. The US averages around 5%. The eurozone, around 9.3% (of which France gets a whopping 15.6%). Bottom line, the absence of household spending in Japan and thus the absence of inflation remains a mystery that the Phillips Curve cannot resolve.

China Tidbit: Bloomberg has a story about the yield on a corporate bond in a far-away province rising from 7% to over 9% and triggering suspension of trading on doubts about the guarantee of another cor-porate. Cross-corporate guarantees are common in China to secure funding and perhaps not worth the paper they are written on. A domino effect could spread. "The amount of debt guarantees at privately held firms in the nation is equivalent to 11 percent of their equity, according to Citic Securities Co. Guarantors don't mark the pledges on their balance sheets and often disclose them only on an annual basis. Such shadow debts pose rising risks after the government's campaign against leverage pushed up borrowing costs."

To end the week (and month and quarter), see the monthly chart. The euro may be about to correct downward to about 1.1243 or so, more or less, but not past the recent lowest low or even the lowest low this week (1.1170). Something big has happened and a retracement now is only normal.

 

Currency	Spot	Current Position	Signal Date	Signal Strength	Signal Rate	Gain/Loss
USD/JPY	111.96	LONG USD	06/21/17	WEAK	111.09	0.78%
GBP/USD	1.2987	LONG GBP	06/28/17	WEAK	1.2701	2.25%
EUR/USD	1.1407	LONG EURO	06/28/17	WEAK	1.1218	1.68%
EUR/JPY	127.70	LONG EURO	06/27/17	WEAK	125.73	1.57%
EUR/GBP	0.8783	LONG EURO	04/25/17	STRONG	0.8490	3.45%
USD/CHF	0.9586	SHORT USD	06/28/17	WEAK	0.9675	0.92%
USD/CAD	1.2990	SHORT USD	05/17/17	STRONG	1.3621	4.63%
NZD/USD	0.7329	LONG NZD	05/30/17	STRONG	0.7062	3.78%
AUD/USD	0.7686	LONG AUD	06/08/17	STRONG	0.7548	1.83%
AUD/JPY	86.05	LONG AUD	06/16/17	WEAK	84.65	1.65%
USD/MXN	18.0461	SHORT USD	05/17/17	WEAK	18.7098	3.55%