By Michael Every of Rabobank
A pinch and a punch for the first of the month
…and no returns, as we used to say to each other a long time ago in school while pinching and punching arms. Except now it is negative returns. Indeed, the first trading day of August was hardly the breezy, care-free summer session one would have normally expected. US stocks fell (S&P –0.2%); the 10-year US Treasury yield went as low as 1.14% intra-day before closing at 1.18%, taking US real yields to new negative lows; and the entire German yield curve went below zero again, pushing up the global stock of negative yielding debt.
One ostensible trigger was a weakening in the US ISM manufacturing survey from 60.6 to 59.5 rather than rising to 61.0 as expected, and prices paid falling from 92.1 to 85.1 rather than the higher 89.0 foreseen; however, employment was up to 52.9 vs. 49.9 and 51.7 expectations, and new orders were 64.9 vs. 64.2 expected.
Another was fears over Delta, indoor mask mandates, and potential Western lockdowns. On which, the two early vaccine front-runners, Israel and the UK, are not only going for different approaches --tightening and loosening virus controls, respectively-- but are also seeing very different outcomes: Israeli cases are rising and British ones falling. Those who like to make snap judgements from messy, early data to support pre-existing positions on Covid-19 will have lots of fun in that sandbox. And the virus will do what the virus does – which is surely the key point.
Sentiment was also not helped by a Fed speaker (Waller) going off script --or saying the quiet part out loud-- and proclaiming if the next two payrolls reports are good (so this Friday and the one at the start of September) then as far as he was concerned, QE tapering could start as soon as September. Enjoy the rest of the summer though!
Moreover, as we keep hearing ‘Build Back Blah-Blah’, the UK and Israel --and unless fiscal stimulus is passed, the US-- are now ripping off the plaster, fiscally. Furlough and unemployment benefits are being ended, and we will finally start to see just what the scars of the post-Covid labor market and economy looks like. The bond market thinks it has a fair idea already.
In Israel, it is currently high unemployment despite cuts to the pandemic benefits that were supposed to encourage people to get back to work now things are ‘normal’. Again, that pattern may not fit everywhere, but it won’t stop people taking messy, early data and using it to back a pre-existing position. And the post-virus world will be what the post-virus world will be – which is also surely the key point.
It’s almost as if all the “Great Reflation” and “Roaring 20s” memes from a few months ago were “I have never read any history” nonsense, and a deeply deflationary reality still looms underneath – unless we see the supply chain, structural, and fiscal changes that are being promised but not delivered. (And which then create whole new sets of problems.) Whocouldanooed?
If you want to get back in the summer mood and read why ice-cream and reflation and Risk On will soon re-emerge again, look elsewhere: because most of the key news today points in the same direction as yesterday.
China has now shut down all travel to Beijing to try to deal with an outbreak of the Delta variant even the local press is calling the most serious outbreak since Wuhan. Domestic demand was already slowing, and the Politburo already calling the domestic economic recovery “still unstable and uneven” and the external environment “more complex and severe”: so what stimulus comes now and on what scale – and with what implications for commodity inflation?
But don’t think that means *global* stimulus. Even as the market tries to put the ongoing Beijing crackdown behind it, Reuters reports “China quietly sets new 'buy Chinese' targets for state companies” that require up to 100% local content on hundreds of items, erecting fresh barriers for foreign suppliers, violating the Phase One trade deal with the US, and specifically closing off niche export avenues where the US had been a key supplier. Should we expect a sharp reaction from USTR Tai, a trade lawyer by experience, or tell ourselves this will be swept under the carpet at a time when the US wants to export more and is backing its own ‘Buy American’ policies?
Of course, some prices are up. For example, demand-destroying stagflation as a precursor to subsequent deflation is also evident in EU natural gas prices, which have hit a record high because Russia is cutting back on supplies. That may even threaten a failure to fill up key European reserves for winter ahead of time, pushing prices even higher as the snow starts to fall. This slowdown in supply comes right after Moscow and Germany tied the EU into Russian gas for decades via Nord Stream 2. Considering neither Germans nor Russians are renowned for their sense of humor (unfairly in the latter case if you count Soviet jokes) that is quite the punchline being delivered by somebody.
Kiwi house prices were meanwhile up 24.8% y/y this morning – which is supposed to mean something to the RBNZ given its new house-price mandate and as that figure is more than ten times its inflation target. However, let’s see if it actually does anything against this kind of global backdrop. Indeed, it underlines the dilemma that central banks can’t hit all the varied, wonderful targets we want them to. In fact, they can’t even hit just one – inflation: or if they do, it is only at the price of just about everything else going wrong in the background.
I told you this wasn’t the place for ice-cream.