…but it is what it is

Not For The Faint-Hearted: Full Week Ahead Preview

By Heisenberg

There’s no shortage of event risk in the week ahead. This is not going to be for the faint of heart.

Chief among concerns is of course Trump’s trade war, pre-announced last Thursday, much to the surprise and chagrin of damn near everyone, including investors.

The decision on steel and aluminum tariffs rattled markets and although some Trump surrogates have suggested it shouldn’t come as a surprise given Wilbur Ross’s recommendation and, perhaps more to the point, candidate Trump’s promise to try and restore lost “greatness” by propping up dying industries, everyone was assuming that rationality (or some semblance thereof) would ultimately prevail.

Long story short, everyone was wrong.

While some analysts are still holding out hope that the rhetoric will turn more conciliatory going forward, Peter Navarro didn’t exactly inspire much confidence on Sunday. Make sure and stay tuned to Trump’s Twitter feed or maybe Fox & Friends for the latest updates on this because if we learned anything on Thursday, it’s that unless you’ve got a direct line to Wilbur Ross (which I guess would mean having two Campbell’s Soup cans joined together with a string), the first people to know what the next step is are Fox anchors and Donald Trump (in that order).

Bottom line:

The dollar managed to eke out a gain last week and it will obviously be in focus again as it’s being pulled between the twin deficit boondoggle and the administration’s weak dollar by proxy policy on one hand, and higher rates/a more hawkish Fed on the other.

“Respite from the USD downtrend has come alongside expectations of faster near-term Fed rate hikes,” Barclays wrote over the weekend, before noting that “on the flipside, a late-cycle fiscal stimulus is likely to increase the twin deficits and bring higher rates along with a weaker dollar.”

On the tariffs, Deutsche Bank was out late last week calling it “a ‘soft dollar’ policy by proxy.”

“The USD’s tendency to weaken broadly on news of new tariff measures implicitly reflects a view that a preference for increased trade protection goes hand in hand with a preference for a weaker USD,” BNP said last week, weighing in, before noting that “this may reflect the logic that improving the US trade balance materially, which seems to be a key metric for the administration, will be impossible with the current elevated levels of the USD exchange rate [but] it may also be a function of the history of US trade policy dating back to the auto disputes with Japan in the 1980s and early 1990s, when US efforts to protect the auto industry were associated with a perceived preference for a weaker USD.”

So there’s that.

We’ll also get the February jobs report. Obviously, this has the potential to create problems in the event the average hourly earnings print beats like it did with January payrolls. The last AHE number (which betrayed the briskest pace of annual wage growth since 2009) made a bad situation worse last month, by accelerating the bond rout and ultimately setting the stage for “Volpocalypse” on February 5.

You’re reminded that all of this is connected. Stocks have become a slave to real rates, real rates are a function of expected inflation as any uptick in the latter causes the market to try and price in more Fed hikes, and the tariffs have the potential to stoke more inflation. Hence the VIX is now the most simultaneously sensitive to real yields and inflation expectations it’s been in a long, long time:

Here’s a quick payrolls preview from Goldman:

We estimate nonfarm payrolls rose 210k in February, compared to a consensus forecast of +205k. Our forecast reflects warmer weather and unseasonably light snow in the month of February. Following a fourth 4.1% reading in a row, we estimate the unemployment rate edged lower to 4.0% in February as the underlying job growth trend likely remained strong; labor market perceptions improved, and initial claims continued to decline. For average hourly earnings, we estimate a +0.3% month-over-month gain (with risks tilted to the downside) and +2.8% from a year ago, reflecting favorable calendar effects.

Barclays is at 200K (0.1% m/m and 2.7% y/y on average hourly earnings). Notably, BofAML is well below consensus on the headline payrolls number. “We look for nonfarm payrolls to increase by 160k in February, a modest deceleration from the 200k increase in January,” the bank writes on Sunday, adding that “some sectors such as trade, transportation and warehousing and retail trade will experience some negative payback after a strong performance in January.”

We’ll also get the ECB this week. The January minutes revealed a governing council that’s reluctant to drop the easing bias and the latest econ in Europe hasn’t been as inspiring on some fronts as one might have expected. Additionally, the Trump administration’s penchant for fostering a weaker greenback complicates the ECB’s normalization plans by raising the odds that a hawkish lean could trigger unpalatable euro strength that could ultimately imperil the inflation target (and European stocks). As a reminder, the first step here is a tweak to the forward guidance and then a decision will have to be made about September – do you call an end to APP and thus start the rate hike conversation? Or do you taper a bit further and let purchases run through December, thus effectively ensuring that no rate hike is forthcoming until 2019? Who knows, but for their part, Goldman thinks the tweak to the guidance will come this week:

We think it is more likely than not that the ECB will drop the ‘dovish bias’ on the APP (the explicit statement that the APP can be increased if the outlook worsens or if financial conditions tighten in a way inconsistent with further progress on achieving the inflation aim). We think this dovish option is of little practical value at the current juncture and its removal allows the ECB to show some gradual progress in its communication reflecting the ongoing economic recovery.

And BofAML agrees. To wit:

We think the central bank will wait until June (with a risk of a push to July if market conditions are choppy) before announcing the end of net purchases in December (i.e., maintaining a trickle after September). What will remain in essence is (1) the notion that reinvestment will continue for an extended period; and (2) that rates will not move until well after the end of the net purchases and as a new feature “not before inflation is on a sustained adjustment path towards price stability”. However, the ECB has been communicating on a “gradual” change in language. We think the first step will be taken next week with the removal of the easing bias, i.e., the idea that QE could be reincreased if need be. If markets are choppy after adverse political developments in Germany and Italy over the weekend, this adjustment could be pushed until April, but we think there is little value in postponing the inevitable, since the current forward guidance is not deliverable.

Ok, well on that point about the political environment, the SPD vote went well. Merkel’s fourth term is secured, and thank God because as noted in “The Austin Powers World“, she’s the last bastion of stability left.

As for the Italian election, that’s going to take some time to sort out, but the exit polls revealed this:

Additionally, the BoJ is on deck this week. Don’t sleep on this. On Friday, the market was caught off guard when Kuroda mentioned “exit” during his confirmation hearing and although he really didn’t say anything that is inconsistent with the bank’s outlook (i.e. all he really said was that they’ll consider an exit in 2019 when inflation is expected to return to target), this is an environment where USDJPY is extremely sensitive to any perceived lean in the direction of normalization from the BoJ.

We documented this at length on Friday and needless to say, the situation is complicated further by the yen’s safe haven status. As a reminder, here’s an annotated USDJPY chart that shows you the tariff announcement, the Kuroda comment, and Trump’s absurd Friday morning “trade wars are good” tweet:

“Although impending normalization is not on the BoJ’s agenda, the market will pay attention to Governor Kuroda’s press conference, following his recent comments on the exit strategy, especially given that USDJPY is trading at post-US election lows,” Barclays notes.

Also, don’t forget that JGB futures were roiled on Friday when Kuroda’s comments hit the wires. You’re reminded that over the past two months, the BoJ has been at pains to “explain” any trimming of JGB purchases. A paring of buying in the 10-25Y bucket triggered an outsized FX reaction on January 9 (that was an early domino in the chain of events that ultimately conspired to trigger the February selloff). The bank tried to calm everyone down later in the month by raising purchases of 3-5Y JGBs only to trim long-end purchases last week in an effort to stop the curve the from flattening.

So yeah, that’s a clusterfuck and don’t forget how USDJPY was whipsawed after the last BoJ meeting when a tweak to the inflation language had to be talked back by Kuroda a couple of hours later only to have the market fade him almost immediately. Here’s a snapshot of that episode for nostalgia:

There’s a BoC meeting as well and that should be at least somewhat interesting in the context of the recent data and also in light of what Trump’s increasingly adversarial approach to trade is likely to mean for NAFTA. Here’s Barclays:

Uncertainties around the economy abound: NAFTA negotiations, new protectionist measures from the US, the continued decline in house sales in Toronto, new measures adopted in British Columbia to cool the housing market, and the response of the economy to previous hikes. As such, we expect the BoC to retain its data-dependent mode and risk-management approach. There is no press conference or economic projections at this meeting, and the statement is likely to discuss recent data and market volatility, while keeping the view that the economic outlook warrants higher rates over time, but some monetary accommodation and caution regarding future action are needed.

The RBA is up too, but I don’t think there’s much in the way of headline risk on that.

Let’s see, what else?

Oh, there’s a CBT meeting this week. Pay attention to that if you want a preview of what the Fed is going to eventually look like once Trump starts taking a page out of the Erdogan playbook when it comes to adopting an “unorthodox” theory on interest rates and inflation in the interest of compelling Jerome Powell not to hike.

Full calendar from BofAML