Can 'Soft' Become 'Hard'? - RBC Explains The Market's "Longer-Term Battle"

The last few days have seen the yawning chasm between 'soft' survey and confidence data (soaring) and 'hard' real macroeconomic data (tumbling) widen still further.

And while The Fed jawbones rate-hike expectations into the market and stocks follow PMIs blindly, RBC's Charlie McElligott explains that the market is now in a longer-term battle between "economic (data) escape velocity" against the prospects for "financial tightening ahead of growth."  It will continue coming-back to "soft data converting to hard," and for now, it’s very difficult to fade the PMIs despite the fiscal policy implementation delays and challenges ahead.

"Best-case scenarios” abound overnight for “reflation” trades, broad risky-assets and fixed-income shorts, between:


1) Fed speakers messaging “statements of intent” on March hikes

2) a “Presidential” speech from the POTUS low on bluster (and details), big on ‘vision’ and spending and

3) +++ global PMI (“animal spirits” ascendancy continues) and inflation data. 


USD up (almost entirely against Yen, Euro and Sterling weakness), stocks up, crude and industrial metals up, gold and global sovereign bonds HAMMERED (US front-end hammered with 100k contracts liquidated in over 2 days), as the reapplication of the macro narrative trades begins anew with the “reflation” script reinvigorated, despite this being vast-majority driven by the Fed rather than ‘Trumpflation.’


For this event to have been obviously “grossed-down” into and to instead see a ‘gap move’ higher on the first-of-the-month only creates more fuel for the fire (higher in USD, stocks & commods / tighter credit, lower in UST / ED$ and gold).  View here is that although some may be ‘forced in’ to chase the market (i.e. BAML raising their SPX target to the “standard” 2450 overnight from 2300), I’m still hearing plenty of buyside skepticism.   It’s now a bet on ‘economic escape velocity’—i.e. being able to outgrow the reaccelerating ‘financial tightening’ (US 5Y real yields seeing a 2SD move over the past 3 sessions).

McElligott offer some quick observations:

There has been a clear reassessment / shift from the buy-side with regards to the Fed’s hiking trajectory, fresh off the back of major “statements of intent” from the Fed’s Williams and Dudley late yesterday.  As a matter-of-fact, Dudley actually noted the upticks in ‘soft data,’ specifically household and business confidence, which in a sense DOES incorporate fiscal stimulus expectations.  Fed Funds Futures now pricing-in ~ 71% of a “March GO” as it is almost impossible to imagine a more perfect backdrop for a hike (from data, asset levels and mkt perception perspective).  Note: don’t use WIRP bc Bloomberg calculates implied probabilities off of the mid-point of the target band even-though FF’s hasn’t been fixed there for all of February…thus it’s overstated at current ‘82%.’




I gotta own it--The POTUS speech ‘worked’ for the very reason I initially thought it wouldn’t—that is, he went “Trump the campaigner”, a.k.a. low on details but big on vision. 


This allows the market to “choose your own adventure” and perpetuate whichever narrative they’d have already built into their forecasts.  Thus no reversals in the ‘now.’ 

Four other major Trump takeaways:

  1. This was Trump at his “most Presidential,” measured and on-script.  Market continues to reward this behavior.
  2. There were conciliatory overtures, with Trump touching on civil rights, African American history and recent hate crimes.  This ‘softer’ POTUS is perceived as “more manageable” for markets from tail-risk perspective.
  3. Trump talked BIG on spending—which risk-assets love from the “reflation” perspective of course.
  4. Post-speech data showed that 78% of Americans who were polled came away feeling “hopeful”—i.e. “animal spirits” continue to run (as evidenced by U.S. “soft data” as noted below).

Global sovereign bonds being hit hard on inflation and survey data, along with the fade in the month-end duration-extension bid adding to the optics of the downdraft:

  • Overseas, very strong German State CPI’s / broad HICP—pushing north to 2.2% YoY in short-order.
  • Italian Manu PMI’s printed at 55 vs consensus 53.5 and a prior reading of 53, while the entirety of EZ remained ‘deeply-expansive’ at 55.4.
  • In China, we saw still very upbeat PMI trajectory continue, with Manufacturing beating at 51.6 vs 51.3 (and both output and new orders accelerating), while Services missed slightly but too remained ‘deeply-expansionary’ at 54.2.
  • And in US, we see a ‘cycle high’ for the scale of “soft data” beats in the Bloomberg Economic Surprise Monitor.  ‘Surveys and Business Cycle Indicators’ currently are running at 1.9 z-scores above expectation.

(As an aside, one point regarding ‘flows’--the ‘long risk, short fixed-income’ trade now is now seeing renewed ‘buy-in’ from US blue-chip corporate treasuries, who are clearly anticipating a ‘higher rate’ backdrop in the coming years on growth prospects amidst the tax cut and deregulation anticipation.  As such, we’ve now seen almost $30B of US IG issuance week-to-date, with many deals over 5x’s subscribed.  That said though, tax policy clarity is HUGE here in this space when looking at the potential for the removal of the ‘deduction of net-interest expense’ incentive.  The risk then becomes a stock market whose predominant source (by FACTORS) of demand for the past five years—corporate buybacks funded in the debt markets—is suddenly altered / dis-incentivized, as the offsetting holiday on overseas cash repatriation is likely to drive a preference-shift towards paying down debt instead of buying back stock.)
Back to the “Big Picture” - the reason I’ve been highlighting the ‘grossing-down’ behavior in the market has been to highlight the stuff going on ‘beneath the surface’ of the all-time high stock index levels.  This ‘resumption of reflation’ will drive relief here certainly within the macro complex, but too within equities because they can move back to their narrative of choice - either ‘secular growth’ or ‘cyclical beta’ will work with rates moving higher.  Conversely, ‘long duration’ correlated-trades back under the gun today, as those recently-bid low-vol ‘bond proxies’ / defensives should receive a proper-beating.
As stated in my first paragraph summary above, the market is now in a longer-term battle between “economic (data) escape velocity” against the prospects for “financial tightening ahead of growth.”  It will continue coming-back to “soft data converting to hard,” and for now, it’s very difficult to fade the PMIs despite the fiscal policy implementation delays and challenges ahead. 

What does the equities ‘bear-case’ hinge upon / what are the risks?

  1. The view that the Fed is now “jumping the gun” (policy-error) in allowing things like ‘confidence data’ to dictate their outlook which could create a situation where rates can become an impediment to substantial economic growth upside from and expected-returns, as they suddenly view themselves as behind-the-curve.
  2. Similarly, the original thesis that Mark Orlsey and I put-forth in January, which is the likelihood for substantial uptick in global interest rate volatility into the back-half of 2017.  Not just “Fed behind curve” risk, but also “ECB overshooting on inflation” risk into the German election, as the “Tapering pressures” will only further increase from here in light of today’s inflation data and its trajectory.  Ahem…*WEIDMANN SEES 2017 INFLATION WELL IN EXCESS OF CURRENT FORECAST
  3. Ongoing compression of the equity risk premium means a weakening incentivize to take on higher risk within equities relative to risk-free assets.
  4. Aforementioned risks to the ‘debt-for-buybacks’ source-of-demand for equities with tax-policy changes.
  5. The danger of a reversal in Crude Oil as the core-input into global inflation expectations.  Asymmetrical / consensual ‘long’ positioning that would ‘tip’ (on, say,  China’s slowing credit-creation mechanism) could see a lot of ‘weak-hands’ come out of the trade, which with it would greatly affect the now-and-still ‘virtuous cycle’ of “higher crude = higher inflation expectations / higher equities prices / lower equities volatility / tighter credit spreads.”
  6. Slow-and-steady march higher of sentiment as a contrarian indicator, with Investors Intelligence ‘bulls’ at 63.1, the most since January ’87.

My sense is that almost none of these (ex the ‘crude oil’ risk) are “now” –matters.

Source: RBC's Charlie McElligott