Week ending: consensus on slower growth, trade uncertainty
During the week that’s just ending, we had three central bank meetings: the Reserve Bank of Australia (RBA), the Bank of Canada (BoC), and the European Central Bank (ECB). It’s worth taking a look at what they had to say:
RBA: “The outlook for the global economy remains reasonable, although downside risks have increased. The trade tensions remain a source of uncertainty.”
BoC: “…the slowdown in the global economy has been more pronounced and widespread than the Bank had forecast in its January Monetary Policy Report (MPR). While the sources of moderation appear to be multiple, trade tensions and uncertainty are weighing heavily on confidence and economic activity.
ECB: “…the weakening in economic data points to a sizeable moderation in the pace of the economic expansion that will extend into the current year. The persistence of uncertainties related to geopolitical factors, the threat of protectionism and vulnerabilities in emerging markets appears to be leaving marks on economic sentiment.”
There seems to be a consensus that global growth is slowing and that trade tensions are one of the main reasons.
Trade policy is certainly the main concern in the US too, far outweighing the usual concerns for the FX market, fiscal and monetary policy.
And if we look in the real world, it’s absolutely true that export growth is declining among the major exporting countries. The trade tensions aren’t just having an impact on sentiment, they’re having an impact on trade, too. Or maybe it’s just due to a slowdown in global economies – as the BoC said, “It is difficult to disentangle these confidence effects from other adverse factors.”
The World Trade Organization’s World Trade Outlook Indicator is now flashing red:
Which currencies are likely to be hurt by this slowdown in trade? I think the euro is the most vulnerable in the G10. That’s because the Eurozone economy is basically the German economy -- Germany alone accounts for 29% of total Eurozone output – and trade is unusually important to the German economy.
Most people think of China as the world’s biggest exporter, but note that Germany’s trade surplus was as big or bigger than China’s until 2014, and now again is almost the same size. You can see too that the Eurozone’s trade surplus is really Germany’s trade surplus. In the past the Eurozone as a whole has even had a trade deficit while Germany alone had a surplus.
It gets even more dramatic when you look at it relative to the size of the economy. The German current account surplus is nearly 8% of GDP, whereas China’s is now less than 1%.
Given that the German economy during 2017-2018 depended on foreign demand for much of its growth – and seeing how that net export demand has turned into one of the major factors dragging down German growth – I would imagine that we are likely to see further weakness in the German and therefore the Eurozone economy. That may delay ECB policy normalization even more and cause the euro to weaken further.
The coming week: Brexit vote, Mueller watch
Once again, politics will be in the limelight. The UK Parliament will vote again on PM May’s Brexit deal sometime on Tuesday. If it passes, then great! Buy sterling. If not…Leader of the House of Commons Andrea Leadsom Thursday said that she would make a statement at that point setting out the timetable to give Parliament votes on whether to leave the EU without a deal on 29 March or to delay Brexit. The problem is, I’m not sure any of those three alternatives can get a majority. I guess the default is to crash out without a deal unless they choose otherwise. Whichever way it goes, this event will be the focus of attention, I’m sure. Remember too that the EU has a habit of pulling a rabbit out of the hat at last minute negotiations. Read the papers and news websites to keep up to date with any last-minute concessions or deals.
Also, I’m still patiently waiting for the report from Special Counsel Robert Mueller. The talk on Twitter is that the report will be released soon (maybe even today, Friday the 8th) and that it will be “not good for anyone named Trump,” i.e. that Donald’s three oldest children will be indicted too, along with son-in-law Jared Kushner. Then again, a lot of stuff goes by on Twitter that I wouldn’t put money on, plus a lot of cute videos of adorable animals.
Economic indicators/events: US CPI, BoJ meeting, UK short-term indicators, China data
There are a large number of significant US economic indicators coming out during the week. The highlight will be the US consumer price index (CPI) on Tuesday. The CPI isn’t the inflation gauge that the Fed actually targets –that’s the personal consumption expenditure (PCE) deflator, or more accurately, the core PCE deflator – but the market pays attention to the CPI almost as if it were. In any event, this month’s CPI is forecast to be extremely boring – both the headline and the core figure are forecast to stay at the same yoy rate of change. With no signs of any acceleration in inflation, there’s no need to tighten pre-emptively – USD-negative (slightly).
Other important US indicators out include retail sales (Monday); durable goods (Wednesday); and Empire State survey, industrial production, JOLTS report and the U of M consumer sentiment survey (Friday).
Among these, probably retail sales is the most important one. The disastrous December figure sent economists scurrying to downgrade their GDP forecasts. We’ll have to see whether the weakness continued in the new year.
As you can see, last month’s decline was of the magnitude rarely seen outside of recessions. After that calamitous decline, the meagre 0.1% mom rebound that the market expects is pitiful, in my humble opinion. It shows weak consumer demand and low confidence no matter if the U of M survey does show an increase, as expected. USD negative.
The Bank of Japan (BoJ) Policy Board also meets on Friday. Usually I write about central bank meetings first, as they’re the most important events for the FX market, but the BoJ has been on hold for ages and is likely to continue to be on hold for ages, and even if they do change, would it have any effect? They’ve been trying to create inflation for 20 years with no luck yet. The market has more or less thrown in the towel here – inflation is now forecast to be around 0.25% or less for the next five or 10 years!!
Perhaps because of that, the JPY market seems to be less active than usual on BoJ days, perhaps because investors hold off trading in case something is announced but then find no reason to get involved afterwards.
It is possible though that we see some change in policy in the next few months. Officials have been dropping hints, especially about what they would do in case the yen started appreciating. The Nikkei recently published an article entitled “Additional easing speculation, likely to surface in April.” “Speculation about additional easing by the BoJ might surface as soon as April in financial markets,” it said. “The BoJ is worried about weaker economic activity and prices than anticipated and might be forced to act depending on economic data and the price outlook.” Note the recent slew of weaker-than-expected economic indicators, which have sent the Japan economic indicator surprise index fall sharply over the last three weeks (in line with the US, by the way).
Further easing is in theory still possible in Japan. BoJ Gov. Kuroda said so recently when he testified to the Diet and repeated his statements in a newspaper interview. He mentioned for example that it was still possible to cut the negative short-term policy rate further into negative territory. Nonetheless, there was nothing new here – he’s been saying basically the same thing since he introduced the Yield Curve Control (YCC) policy in September 2016.
It’s hard to say what would get the BoJ to move again. Its goal used to be hitting its inflation target. Any downward revisions to its price outlook in the quarterly Outlook Report were therefore likely to be accompanied by or followed by further easing. However, that link is now gone as the BoJ is emphasizing the much fuzzier concept of “momentum toward the 2% price stability target” in decisions about policy. What this momentum consists of isn’t clear, but as the graph above of inflation expectations shows, whatever it is, it’s not working yet. Meanwhile, they’re well aware that pushing short rates deeper into negative territory would hurt bank profitability, a negative spillover effect from a policy that might not even be effective. I think the hurdle for further BoJ easing is quite high as a result. I don’t expect any change out of this meeting. Accordingly, I expect JPY to be little changed.
Elsewhere, Tuesday is not only Brexit vote day but also UK short-term indicator day, with the monthly GDP figures, the trade data, and industrial production coming out. It’s quite likely that the Brexit vote will obliterate any temporary impact that these indicators have on the FX market, but in any case, note that while the mom change in GDP is expected to recover a bit after December’s fall, the 3m/3m average is expected to be still headed downward – not a good sign. GBP-negative.
Finally, the monthly China trio of industrial production, retail sales and fixed asset investment (FIA) will be released on Thursday. Since it’s the February data, they release it in terms of year-to-date year-on-year, to eliminate the effect of the Lunar New Year. They’re expected to show a steady decline in activity, which should come as no surprise given the below-50 manufacturing PMIs. Nonetheless, it could cause a risk-off response that would be negative for AUD and positive for JPY.
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