The investment climate rests on three legs: the divergence that is characterized by the de-synchronized business cycle, the decline in commodity prices and a slowing of China. Data that underscores these factors appear to have stopped having much significance for investors.
At the same time, small changes to perceptions, like the downtick in the University of Michigan survey's inflation expectations, can have seemingly out-sized market impact. Before the weekend, it reported that the five-year inflation expectation slipped through the 2.7%-3.0% range that has confined expectations over the past year or two. It now stands at 2.6%, the same the as the one-year expectation, which eased from 2.9%. It was sufficient to push US 10-year Treasury yields back to the lower end of their recent range (~2.30%), and sparked a pullback of the dollar.
The flash euro area PMI and ZEW survey, on the other hand, are most unlikely to change perceptions of the near stagnant economies. It will not alter ideas that policy makers have to do more to get back to a meaningful growth path. Some observers are emphasizing the possibility that the ECB announces some measures to increase the participation of the second TLTRO next month. And despite our claim that there is no agreed upon definition of quantitative easing, many say the ECB is slowly moving toward it. By that they mean the purchase of sovereign bonds.
The technical, legal and political obstacles remain formidable. There are several other classes of assets that the ECB can buy, including supra-nationals, corporates and non-covered bank bonds that are less cumbersome. Moreover, it is possible that the low point of inflation is at hand, and the second TLTRO will be considerably more successful than the first. Together they could be worth about 250 bln euros. Some of the second TLTRO may be used to pay back part of the LTRO funds outstanding, especially among Italian banks.
Despite some journalists and pundits, arguing that ECB and BOJ actions are shots in a currency war, it seems like hyperbole to us. Leaving aside confusing a metaphor with the real thing, there is no sign that other high-income countries see this as a currency war. In fact, the US (and IMF) are pressing European officials to do more. US Treasury Secretary Lew was clear: "Resolute action by national authorities, and other European bodies are needed to reduce the risk that the region could fall into a deeper slump."
The weekend G20 meeting was an ideal forum for countries to push back against the "currency warfare", but this did not appear to be a salient issue, formally or informally. Russia was center stage, and Putin was so criticized that he left the forum early. Despite Putin's denials, there seems to be little doubt that Russia has tanks, artillery and combat troops in east Ukraine. Russia also sent a large navy armada toward Australia (where the G20 meeting was held) and announced the resumption of long-range air patrols as far as the Gulf of Mexico and the East Pacific Ocean. Its submarines have also been chased from Swedish waters.
Monday will be the first meeting of European foreign ministers under the new High Representative for Italy, Federica Mogherini. Recall her candidacy was resisted by some Baltic and central European countries because she was too soft on Russia. She has made it clear that actions next week will, at most, be limited to broadening existing sanctions. They will likely focus on the Ukraine separatists and Russians that facilitated the November 2 elections in east Ukraine. The decision to expand economic sanctions outside finance, defense and energy sectors requires decisions by the heads of state, which effectively pushes more severe action into next month.
There was no backlash against the more aggressive turn of Japan's monetary policy. It seems like a strange currency war if no one recognizes it as such. If Japanese export volumes are not rising, it is hard to make a compelling case that the depreciation of the yen is hurting its trading partners. Japanese companies seem to rely on the translation of its foreign earnings to lift profits, not increasing market share. The US auto market is a case in point. US producers market share has risen in recent months even as the dollar has risen.
Barring a significant Q3 GDP surprise from Japan on November 17, Prime Minister Abe is likely to do two things. First, he will likely postpone, but not scrap, the retail sales tax increase from 8% to 10% that was to be implemented next October. The prospect of postponing the sales tax help lift Japanese equities, and through this channel, weighed on the yen. Second, Abe will likely seek a new mandate, which means dissolving the lower chamber of the Diet and calling for elections, likely for December 14.
Abe needn't call an election until 2016. Although some observers think Abe is taking a gamble, we suspect there is little risk. The LDP may lose a few seats, but the New Komeito party, the junior coalition partner, may pick up a few seats. There is no compelling alternative. The DPJ, the main opposition party, is polling less than 10%. Surveys indicate that some three-quarters of Japanese voters are opposed to increasing the sales tax.
A new mandate would do two things for Abe. First, it would effectively deter a leadership challenge within the LDP next year. Second, it would allow Abe to pursue more controversial policies, like restarting nuclear power plants, and further pursuing new "national security" legislation. It may also breathe fresh life into the elusive third arrow of structural reforms.
Turning to the United States, there is much interest in the FOMC minutes from last month's meeting. The minutes have a high noise to signal ratio, and therefore we encourage investors to look past the knee-jerk market reaction. Recall at the meeting the FOMC upgraded its assessment of the labor market and announced the conclusion of its long-term asset purchase program. It did not call these asset purchases QE (so remind us again why we should consider it QE but not the ECB's effort to increase its balance sheet or why the BOJ can buy a wide range of assets, including corporate bonds, ETFs and REITs and is still regarded as QE?).
We continue to argue that the real policy signal emanates from the Troika of Yellen, Fischer and Dudley. They continue to indicate that a rate hike around the middle of next year is the most likely scenario, barring a significant economic surprise. Over the next six-seven months, the labor market is expected to continue to improve as the recent JOLTS and Labor Market Conditions Index suggest is indeed taking place.
While Fed officials will take the dollar's appreciation into its economic assessment, it does not appear to be a critical factor. In fact, there is some suggestion that the stimulative effect from the drop in energy prices largely offsets the appreciation of the dollar. In addition, the risk of further appreciation of the dollar has not deterred US officials from pressing other countries from pursuing more aggressive pro-growth policies.
Given the FOMC's statement last month, many expect the minutes to have a hawkish bent. Yet, there was a dovish dissent, and it seems that the risk is that the doves' cries will be more prevalent in the minutes. The short-term market could be caught leaning the wrong way, which would add to the short-term gyrations.
Both price gauges (PPI and CPI) will be reported. Generally speaking, the decline in energy prices may soften the headline figures, but core rates will likely prove stickier. The US also reports industrial production figures. The 1.0% rise in September is unlikely to be repeated, and the consensus calls for a modest 0.2% increase. Manufacturing output growth is also expected to moderate to 0.3% from 0.5%. However, the regional Fed surveys for November offer more current assessments of the manufacturing sector. On balance, we expected Q3 GDP to be revised lower, while Q4 GDP appears to be tracking something between 2.5%-3.0%.
There is much discussion of the impact of the mid-term US elections. One of the first legislative consequences is being played out with the lame-duck Congress. Before the weekend, the House of Representative approved the controversial Keystone Pipeline, which would accelerate the flow of Canada's tar sand oil to the US Gulf refineries. The Senate will likely approve the bill as it has before. The critical point is whether it gets 60 votes, which would nullify Obama's threat to veto, as he did previously.
Meanwhile, the euro has slipped to its lowest level against the Swiss franc in two years to come perilously close to the Swiss National Bank's floor (CHF1.20). Partly this may reflect the general bearishness toward the euro. However, note that Swiss money market rates out through nine months are negative, while euro area money market rates, except EONIA is positive.
There is also some speculation that if the "Save the Gold" referendum on November 30 passes, it would force the SNB to sell euros to buy gold. However, as we have noted the real story is considerably more complicated. Even if a majority of voters approve of the measure, which currently the polls suggest not to be the case, a majority cantons (state governments) would also have to approve. Part of the return on SNB reserve assets is paid to the cantons, which helps defray social spending costs. If the referendum passes, taxes may rise to compensate or the basket of benefits may be cut.
Lastly, the deadline for the negotiations with Iran over its nuclear program is approaching (November 24). A successful conclusion does not look particularly likely. The most that can be hoped for is a statement outlining the progress and an extension of the negotiations. A collapse of talks completely could lend support to the oil market, while a successful conclusion would mean more of Iranian oil would enter the market legitimately.
