It's going to be a week of being bombarded with data and earnings from all angles. This week will see the first reading of US Q4 GDP as well as the first FOMC statement, Payrolls and ISM print of the year. In Europe we will get a handful of confidence indicators in the earlier part of the week but the main highlight will be the Spanish and Italian manufacturing PMIs on Friday. The coming week could see further sizeable moves in FX, mainly because investors – and policymakers – have become a lot more focused on currency markets. Finally, a few potentially interesting policy speeches are scheduled in the upcoming week. In Japan, Prime Minister Abe will likely talk in parliament about his economic policy, which could contain more comments on the BoJ and the Yen. In Germany, Buba President Weidmann will talk at the car manufacturers association and the recent sharp move in EUR/JPY may well be a subject given the competition between German and Japanese brands. Interestingly, Mr. Weidmann already mentioned the BoJ in a recent speech about global pressures on central bank independence.
While the overnight session has been relatively quiet, the overarching theme has been a simple one: currency warfare, as more of the world wakes up to what the BOJ is doing and doesn't like it. The latest entrants in global warfare: Taiwan, whose central bank overnight said it would step in the FX market if needed, then Thailand, whose currency was weakened on market adjustment according to Prasarn, and of course South Korea, where the BOK said that global currency war spreads protectionism. Last but not least was China which brought out the big guns after the PBOC deputy governor Yi Gang "warned on currency wars." To wit: "Quantitative easing for developed economies is generating some uncertainties in financial markets in terms of capital flows,” Yi, who is also head of China’s foreign-exchange regulator, told reporters. “Competitive devaluation is one aspect of it. If everyone is doing super QE, which currency will depreciate?” “A currency war, a series of tit-for-tat competitive devaluations, would trigger trade protection measures that would damage global trade and therefore growth globally,” said Louis Kuijs, chief China economist at Royal Bank of Scotland Plc in Hong Kong, who previously worked for the World Bank. “That would not be good for any country with a stake in the global economy.” Which brings us to the fundamental question - if everyone eases, has anyone eased? And is there such a thing as a free lunch when central banks simply finance global deficits while eating their soaring stock market cake too? The answer, of course, is no, but we will cross that bridge soon enough.
This objective report concisely summarizes important macro events over the past week. It is not geared to push an agenda. Impartiality is necessary to avoid costly psychological traps, which all investors are prone to, such as confirmation, conservatism, and endowment biases.
With the market basking in glow of good earnings results yesterday, mostly out of IBM, and to a lesser extent GOOG, which missed on the top line but beat on EPS squeezing some recent inbound shorts, S&P500 futures have yet to post a solid move to the upside. Perhaps a big reason for this is the recent recoupling of risk based on not one but two carry signals: the first is the well-known EURUSD pair, while the second is the recent entrant, the USDJPY, and it is the latter that continues to see a cover of the massive short interest accumulated over the recent 1000 pip move higher on what upon ongoing reflection has been a disappointing announcement out of the BOJ. Needless to say, the Nikkei whose recent surge higher was all due to currency weakness has tumbled overnight despite corporate fundamentals, if not economic data, which continues to post substantially subpar prints.
The market has been rallying over the last few weeks as the bulls have definitely taken charge in the New Year. Most of the recent analysis has pointed to signs of an improving economy and stronger employment as the driving force behind the advance. My view has clearly been that it has been the impact of the Fed's liquidity injections pushing asset prices higher. There is one caveat here. Last winter was the warmest winter on record in 65 years which skewed much of the seasonal data by allowing work to continue when normally workers would have been shut in due to inclement weather. We are seeing the exact same anomalies occur this year as the winter is currently the warmest in the last 55 years combined, and when combined with lower energy prices, is giving a temporary boost to incomes. As we witnessed in 2012 - when the seasonal adjustments come back into alignment in the spring the drop off in reported economic activity will be fairly severe.
Yesterday, UBS' Maury Harris released a naive note titled "UofM confidence bounce after tax deal?" which we did not understand: would the bounce be on the ongoing depression, the uncertainty over the debt ceiling, the fate of the sequester and coming spending cuts, the manipulated market which just saw a $610 million reserve injection via repo to be followed by another $1.5 liquidity injection via POMO, or the fact that everyone is now paying more taxes in 2013? Turns out the confusion was irrelevant as the preliminary January UMichigan consumer confidence number just printed at 71.3, far below the December final 72.9, and the biggest miss to expectations in seven years. It was also the lowest print since November 2011. And of course, the reaction of the central bankers' soapbox formerly known as the "market" is.... up.
China’s monthly data dump was the main macro update overnight, which however with ongoing mockery of the Chinese data "goalseeking" and distribution methodologies, most recently by the likes of Goldman, UBS and ANZ, had purely political window dressing purposes for the new Chinese politburo. Sure enough, that all the data came precisely Goldilocks +1 was enough to put a smile on everyone's face. To wit - Q4 GDP growth came in just higher than consensus (+7.9%yoy v +7.8%). On a full year basis the economy grew by 7.8%, also a tad above expectations. Then we got industrial production, also just higher than expected (+10.3% v +10.2%) and retail sales - just higher as well (+15.2% v +15.1%). Much more important than meaningless, jiggered numbers, was the announcement from the PBOC that in light of the entire world going "open-ended" on easing, China - which now can't afford to lower rates for fears of rampant inflation together with importing everyone else's hot money - announced it will start short-term liquidity operations as additional tool for controlling liquidity, engaging in a reverse repo on a daily basis, which will have a maturity of less than 7 days. This way the central bank will be able to reacted almost instantly to any inflationary spikes across the economy, as it too has no choice but to ease although not by the conventional inflation targeting methods now used by everyone else.
The week ahead will deliver important data from the US and China. In the US, the focus will be on retail sales and housing starts, as well as on the Philadelphia Fed and U. Michigan Consumer Sentiment surveys. Turning to China, the consensus forecast for China Q4 GDP is 7.8%yoy, while secondary data will come from the country's IP and FAI data updates.
We are back to that phase in market euphoria where no news is good news, good news is better, and bad news is best. While there was little news over the weekend, and overnight, what news there was uniformly negative: northern China drowning in smog, the Apple fad bubble bursting, European Industrial production printing below expectations (-0.3%, exp.-0.2%, down from revised -1.0%), and ever louder rumors that the debt ceiling debate may metastasize into an actual government shutdown for at least a few days, which means the first technical default in US history. Yet nothing seems able to faze the risk on mood, still driven by a relentless surge in the EURUSD which touched on 1.34 overnight before retracing, and the EURCHF, which too has soared by over a 100 pips in recent trading action, which according to some is a result of Swatch buying the Harry Winston watch and jewelry brand for $1 billion, and an aggressively selling of CHF into USD by the company. Eventwise, today will be a quiet day in the US, although the action will pick up tomorrow as more companies report earnings as well as the all important retail sales report will put to rest all debate over just how good or bad this holiday shopping season (pre and post seasonal adjustments) truly was.
The biggest highlight of the day is the launch of Q4 earnings season with Alcoa after the close. The question is by how much will the ES/SPY correlation have dragged individual stock prices higher from far lower cash flow implied valuations - we will get a glimpse this week, as well as get a sense of how Q1 is shaping up, this week but mostly next week as earnings reports start coming in earnest. There was the usual non-event newsflow out of Europe, which has no impact on risk levels, now driven solely by every twitch of Mario Draghi's face, and best summarized by this from SocGen: "In the wake of September's 3 point VAT increase in Spain, which saw a significant bringing forward of consumption to beat the tax hike, euro area activity in Q4 has been genuinely awful."
The main events of this week, monetary policy meetings at the BoE and the ECB on Thursday, are not expected to bring any meaningful changes. In both cases, banks are expected to keep rates on hold and to hold off on further unconventional policy measures. While significant economic slack still exists in the Euro area, and although the inflation picture has remained relatively benign, targeted non-standard policy measures are more likely than an interest rate cut. As financial conditions are already quite easy in the core countries, where the monetary transmission mechanism remains effective, the ECB’s first objective is to reverse the segmentation of the Euro area’s financial markets to ensure the pass-through of lower rates to the countries with the most need for further stimulus.
The Cliff is dead; long live the Cliff. Yesterday’s impressive market rally was a great way to kick off the New Year, but (as ConvergEx's Nicholas Colas notes) we do have 251 trading days to go before we can lock in those gains and dance a celebratory jig. The market’s psychological pendulum swings between extremes of “Macro” and “micro” focus, and we shouldn’t take it for granted that the stock market’s positive take on the Fiscal Cliff negotiations portend a better economy, a stronger financial picture for the U.S., or any of the actual nuts-and-bolts which hold together the framework of corporate earnings and cash flows. Colas' prime concern is that the increase in Social Security tax withholding by 2 percentage points – back to its pre-2011 12.4% - will take a chunk out of the spending power for tens of millions of households. In the abstract, the amounts involved are not huge – perhaps 50 basis points of GDP. But everything counts when GDP growth remains stubbornly subpar.
The first two economic indicators of 2013 are in and are a beat and a miss. The beat was in the December ISM Manufacturing printed at 50.7, higher than the 50.5 expected, and up from November's 49.5. This is happening even as 7 of the 18 manufacturing industries in December report growth while 9 reported contraction: go figure. Looking at the component data, New Orders remained flat at 50.3. The index was driven higher by Backlog of Orders +7.5, Exports +4.5, Supplier Deliveries +4.4, Employment +4.3, and Prices + 3.0. The declines were in Inventories and Production, down -2.0 and -1.1 respectively. The miss was in November Construction Spending, which printed at -0.3%, down from a downward revised October 0.7% (from 1.4%), and well below expectations of a 0.6% print: this was the biggest miss in 10 months, and the first negative print in 10 months, which however will likely be blamed on Sandy.
Time is running out. The cliff negotiations have devolved into two unpalatable options: (1) extend just the middle income tax cuts and extended unemployment benefits and allow about two-thirds of the cliff to happen, or (2) go over the cliff in the entirety. In BofAML's view, given the short time frame and legislative hurdles, the latter appears much more likely. Stock market vigilantes have replaced bond vigilantes as the potential good, bad, and ugly scenarios are devoured flashing red headline by flashing red headline. They, like us, believe that going over the cliff is not a benign “slope” as some suggest. Rather, it accelerates the already-building damage to the economy and markets. The latest evidence is the plunge in consumer confidence. Indeed, this could mark the beginning of the rotation in the uncertainty shock from businesses to consumers. Going over the cliff has many secondary, largely ignored, negative impacts, including tax changes that could damage the housing recovery, as well as negatively impact education and alternative energy, among many others.
Talks on the fiscal cliff have resumed, but as of this writing there is not yet an agreement. The current negotiations focus on the income threshold under which tax cuts should be extended, among other topics. As we have noted, the sides seem as far apart as ever, and as Goldman notes, while it is still possible that an agreement will be reached by year end, a retroactive deal in January looks more likely. The eventual resolution still looks likely to be a scaled down agreement that addresses only the policy changes scheduled for year-end and omits other issues, such as an increase in the debt limit or longer-term fiscal reforms. The greatest area of uncertainty is whether the spending cuts scheduled under the sequester will be addressed. The fiscal policy timeline below shows how we are rapidly approaching the more ominous debt ceiling debate and Goldman's Q&A asks and answers provides context for where we are from both an economic and ratings agency impact basis.