Submitted by Michael Every, Rabobank's Head of Financial Markets Research Asia-Pacific
Silver plates and s’il vous plâit
If one ever wanted a perfect example of just what a mess we are in globally, look at the market reaction to Friday’s payrolls data. Even with the caveats offered in the last Daily (that the data are an often-revised, backwards-looking, lagging, and artificial “birth-death model” statistical rounding error) what we saw was a very healthy report.
Jobs rose 224K vs. 160K expected, even though the unemployment rate rose a tick to 3.7% and wage pressures again remained absent. In short, despite genuine fears of recession ahead, these often-revised, backwards-looking, lagging, and artificial “birth-death model” statistical rounding error say that all is well and hence the economy--on the surface--is just fine. That should have been a gift to the Fed presented on a silver plate – but it wasn’t.
Why? Because post-release, US Treasury yields naturally went up again, with 10s back to around the 2% level… and yet US equities went down, while USD also went up. So it would seem the crucial stock market and its presumed rational pricing basis of a projected flow of future corporate earnings would rather have juicy rate cuts than a healthy US economy. Which, as I said, speaks volumes about where we are now globally. And it also risks presenting the Fed’s head on a silver plate.
Just what is the Fed supposed to do now? On the measures they look at the outlook is good and trade wars aren’t escalating (yet); interest rates are still very low by historical standards; those all-important equity markets remain close to record highs. So is Fed Chair Powell, who testifies this week, going to make clear that while he is ready to step in if needed, right now he isn’t?
If so, can we expect an apple in his mouth? Equity markets want those rate cuts. The yield curve is still saying rates are too high where they are. Inflation expectations and the growth outlook are plunging globally. The offshore USD debt market needs lower borrowing costs and a rapid injection of USD liquidity to help alleviate a looming USD squeeze that trade war will massively exacerbate.
Moreover, US President Trump wants rate cuts now. After all, the volume of his criticism is rising as he tweeted:
“Strong jobs report, low inflation, and other countries around the world doing anything possible to take advantage of the United States, knowing that our Federal Reserve doesn’t have a clue! They raised rates too soon, too often, & tightened, while others did just the opposite...As well as we are doing from the day after the great Election, when the Market shot right up, it could have been even better - massive additional wealth would have been created, & used very well. Our most difficult problem is not our competitors, it is the Federal Reserve!”
What a pity for Trump that he can’t just put tariffs on the Fed or build a wall around it: but that isn’t an option for him.
Of course, Trump isn’t the only leader with that kind of view. Consider what just happened in Turkey. As Piotr Matys comments, by abruptly dismissing Governor Cetinkaya on Saturday--without providing any official reason--President Erdogan reminded everyone who is in charge of monetary policy. The decision is set to undermine credibility of the central bank, which may start unwinding the emergency rate hike announced in September much faster than previously anticipated starting with a large cut on July 25. While Erdogan correctly interpreted the outcome of mayoral elections in Istanbul--won by the opposition--as a major warning signal from the voters, instead of implementing structural reforms it seems that he intends to ‘fix’ economic woes of persistently high inflation by forcing the CBRT to cut interest rates aggressively. To recall, the Turkish President is a strong advocate of an unorthodox notion that inflation will fall in line with lower interest rates. Given that his controversial decision caused a sharp fall in the value of the Turkish lira in the early hours of trading on Monday, the CBRT will make a major policy mistake if it cuts rates by a few hundred bps on July 25.
Meanwhile, don’t think Europe isn’t in on this game-plan too. Does anyone really think that Lagarde at the ECB, instead of a Germanic hard-money figure, is anything other than foaming the runway? That’s the market chatter anyway – and Europe will be able to sanctimoniously pretend it is maintaining total central-bank independence by placing a total dove prepared to restart QE and “do whatever it takes” in the driving seat. As is the case with the RBA and regulators like APRA too.
However, consider this. TRY slumped following Erdogan’s actions. EUR is back to around 1.1220, and news from German factory orders and a large German bank does not suggest much buoyancy alongside new ECB management. AUD is holding around 0.70, but there remains a distinctly Wyle-E-Coyote-running-off-a-cliff feel to it. By contrast, USD remains firm despite Trump’s Fed onslaught, and that was even before the payrolls data.
Perhaps part of the reason for that is clear when we see the other headlines today:
Hong Kong protests are not stopping, merely shifting location and form. Make what you want of that, but it isn’t risk on;
World media are running a report that alleges Huawei has deep ties to the Chinese military. Make what you want of that, but it isn’t risk on either; and
Iran is now processing uranium to a 5% level, which is a clear breach of the 2015 JCPOA,…to which Germany, France, and the UK have all responded with a plea to stop but no action. By contrast, the US is almost certain to escalate either via sanctions or (far less likely) the military. Either option says hold USD regardless.