What to Worry about Today: Understanding data

Outlook:

Mr. Draghi was his usual capable and suave self, satisfying the reporters in the press conference room and getting the usual high marks for dancing in the minefield. Nobody seems to notice that what he is saying is inconsistent, if no*t impossible. First, the ECB will stop buying bonds by year-end, as promised in June. And the base rate will be held at zero for another year.

Drahgi said “When we stop [buying bonds], this doesn’t mean our monetary policy stops being” supportive, according to the WSJ. Well, cheap or free money is supportive, to be sure, but withdrawal of a key buyer from the market usually means a rise in yields as the issuers have to pay more to attract substitute buyers. Draghi is creating confusion between the money market and the bond market, which are not seamlessly connected in even the well-oiled US market. 

Besides, Draghi says the improvement in wages and job markets generally will overcome any slowdown from trade war and EM worries, which are raising volatilities. Really? Do those new jobs and falling unemployment not depend to some extent on exports? If China is ever going to slow down, as so long predicted, surely exports will suffer, and behind that, manufacturing.

We would say downplaying risks might be the diplomatic thing to do, but behind the scenes, corporate chieftains and economists are quaking in their boots. We have no news on US-EU trade talks but a bad outcome cannot support the Draghi outlook and cannot be euro-positive. We don’t blame Draghi for taking this stance and he may be right that even a failure of trade talks would not be major influence, but we can’t avoid that the US-China trade war, assuming it happens, is really bad for the eurozone economy.

And we really should assume the trade war will happen. Bloomberg reports Trump tweeted “US officials ‘are under no pressure to make a deal,’ a move seen as undercutting Treasury Secretary Steven Mnuchin who issued the invitation to Beijing. Chinese state media warned the nation shouldn’t expect a quick resolution as Trump has not changed his thinking.” 

The UK is an entirely different animal. The seeming resilience of the UK economy in the face of deep uncertainty over Brexit can probably be based on two factors: the stubbornness of the Brits and the vastly devalued pound. We tend to forget that devaluation, especially a large and long-lasting one like sterling’s—over two years and counting—is stimulative. Therefore, the latest BoE forecast for growth should have come as no surprise—Q3 up 0.5%, revised from 0.4%. As previously reported, wage gains are pretty good, too. Bloomberg has a stunning little chart showing the investor-expected rate hikes over the coming years. You’d never imagine there was an elephant in this room named Brexit. As BoE Gov Carney has warned, a no-deal Brexit will necessitate more hikes.

Compared to Europe’s complex and tricky situation and the US financial markets boiling over, the UK actually looks pretty good. And bring in the famous British stubbornness. After all the talk about big financial institutions moving to the Continent—and some actually doing it—the City is running pretty much as usual, as far as we can tell. London is the financial center of the world (whatever New York may try to claim) and it’s going to find a way around even a no-deal Brexit. 

We get a ton of data today, including retail sales, manufacturing output, and the University of Michigan's consumer confidence and inflation expectation survey.  The dollar is at some risk of retail sales falling more than expected, possibly on auto sales. As for industrial production, it’s probably too early to see any tariffs effects (steel and aluminum). And finally, the important component of the University of Michigan indices is the long-term inflation expectation. Last time it was 2.6%, and perhaps falling in sync with actual inflation as reported yesterday. See the “What to worry about” section above. Yes, inflation is rising and at a brisk pace, but from so low a starting point and still so low in the context of the last two decades that it’s not, in fact, something to worry about.  That means, among other things, the Fed can keep raising rates indefinitely, something that should be dollar-supportive.

The big question going into the weekend is whether the dollar rout has legs and some currencies can break out to the upside, including the pound and euro. Chart reading does not support that view and the current move could be a flash in the pan. But this correction smells a little different. See the dollar index chart in the Chart Package. That’s a sell signal, and it may be meaningful that it comes right after a Fed Gov all but said conditions permit the Fed to keep hiking indefinitely. That this did not provide dollar support must mean something, perhaps that rate hikes are not the end-all and be-all in currency determination, nor rate differentials. Their influence waxes and wanes and we are on the wane now.  

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