That was the week that was – Sunday February 14, 2016


Luckily we only write the weekly after all the “noise” has died down. And what a lot of noise. It turned out that the big event of the week was the Janet Yellen testimony before Congress, but she was merely as dour as expected.

The evidence for her being “in line” was that US equity markets and shorter term bond yields fell as she testified before almost recovering back to where they closed the previous week.

The S&P500 was down less than 1% and NASDAQ was flat. The damage to these indexes had occurred the previous week. The actual bad news from the unexpectedly weak services, or “Non-Manufacturing”, ISM had been followed by decent news on wages that was then taken as bad news because the Fed would take encouragement to tighten.

The yield curve continued to flatten. The shorter rates were volatile but the 12m and 2 year yields recovered to their starting positions.

Longer rates continued to gently decline – indicating weaker and weaker nominal growth expectations. US 10 year bonds yields fell by another 10bps to yield just 1.73%, and 30 year bonds now yield just 2.6%. Both are still far above comparative yields in the Euro Area and Japan. More curve flattening seems inevitable, with all the action at the long end as markets prevent the FOMC actively tightening. Almost needless to say, except to the economically-blind gang at the FOMC, 5-Year Breakeven inflation rates crashed through 1% on monday.


Helping US equities has been the somewhat mysterious weakness of the US Dollar. It had fallen heavily around the ISM data two weeks ago and the very strong bounce in the oil price, and then stayed weak. The Dollar should be rising relative to its major rivals who all have easier monetary policies. “Weakness” is a relative term, however, as the DXY trade-weighted Dollar index is still far from the lows of 2015. I expect that the weakness was caused by short-covering and that the strengthening will resume shortly.


A recession in the US would of course be bad for the US Dollar, but also lead to more volatility as we saw in 2008-09, caused by the relative strength and weakness of the US economy versus its major trading peers becoming very volatile.

The Chinese authorities appear to have concluded that there has been enough weakness in their currency versus the US Dollar. The managed, or dirty, float policy they follow means that their currency has also weakened against most other trading partners. The pain trade has been for the Yen and the Euro.

The Yen strengthened by 3% in a week and led to a mini-crash in Japanese stocks, which fell by over 10% last week, a serious drop. It is likely to reverse somewhat on Monday thanks to the Friday rally in the US after Japan closed.

The Euro was up 4% and has also had a mini-stock market crash of around 10% over two weeks. Sterling has also been strong and the UK stock market, consequently, weak too.

All three stock markets, Japan, Euro Area and the UK are down 20% from mid-2015 highs, the S&P500 is only down 10% by contrast. The US sneezes and the rest of the world catches a cold? This is strange given the relative stance of monetary policy in the US vs the Rest of the World (ex-US Dollar bloc, China).

Topic of the week: Relative Euro Area market weakness

The Janet Yellen testimony has been well covered elsewhere. The stranger weakness is that of the European markets and particularly the bank sector, both equities and credit. The US bank sector has also been exceptionally weak. The bank sector makes up a bigger part of the UK index.

The US banks equity index is 20% off its mid-2015 highs, like the major global stock markets. However, the European banks index is down 40% from those highs. Credit spreads have also blown out too. Partly it is because all the biggest banks in Europe are universal banks, like Citi, and heavily weighted to investment banking which gets hit hard by market turmoil.

More retail-oriented banks are down less, as in the US. Except for Italy, where most banks are retail-oriented but in something of a crisis.

Bank contagion, like sovereign contagion is a very bad thing. And markets clearly fear it. Ironically, the cause of the current bank pain is partly related to the global efforts to make banks safer by not only making them hold much more equity, but also much more junior debt too. The huge issuance of junior debt over the last couple of years is now trading at very low levels, and in Italy half is reportedly held by retail investors – never a good thing.

All that said, there should be no repeat of the bank liquidity crises at European banks thanks to the ECB backstops all being properly in place, unlike in 2011. However, it doesn’t help that the Netherlands Finance Minister and chair of the informal group of European finance ministers, Dijsselbloem, is a rather typical blunt Dutchman who, in trying to restore confidence in the sector, also encouraged fear by emphasising there would be no taxpayer bail outs again. There will be taxpayer bailouts if the taxpayers’ representatives like Dijsselbloem do nothing to encourage the ECB to change its targets.

The biggest risk to Europe and its banks is the fact that the QE is still being so heavily offset by the inflation ceiling target. And the fact that Euro-QE struggles to offset the US monetary tightening. It puts the ECB end up in a bind. The QE is helpful and they can do more, of course. But the target is so depressing to spirits and expectations.

On top of that the German economy is doing OK by its long-term standards. NGDP growth last week was reported at 3.6% for 4Q15, only a touch down on the 3.7% recorded in both 2Q and 3Q 2015. It’s not great, but it is above Germany’s long-term average.

And Germany is 30% of Euro Area GDP and has an influence at the ECB somewhat bigger, thanks to some its more loyal hangers on like Austria, Belgium and the Netherlands.

Sometimes France looks more rational, sometimes not. NGDP growth for 4Q in France was also reported dipping a little, from 2.55% to 2.51% YoY, below their long term 3% average. Perhaps the fact that their banks are being crucified by the equity markets will have an impact, perhaps not. SocGen was particularly weak, just like in 2011. The country is, like the US, in the long run-up to 2017 elections and so remains distracted.

Full Euro Area RGDP figures came during the week and were a bit disappointing, especially due to a bit of unexpected weakness from Italy. Not that this was so unexpected given the bad loan problems at the Italian banks.

The more important individual Euro Area country NGDP numbers come out over an extended period. First out are French and German numbers, discussed above, plus a few others. We get no full Euro Area figures for a month, along with the 2nd estimate of RGDP.

Two smaller countries that have reported have continued the weak trend of smaller countries visible in 3Q15. Netherlands NGDP growth dropped alarmingly, in line with the UK, to just 1.6% YoY. Greece continued to show negative NGDP growth at -2% YoY. Spain is important but has not produced RGDP or NGDP figures yet. Italy has not produced an NGDP figure but its unexpectedly weak RGDP does not bode well for its NDGP result.

Overall, you have to remain cautiously optimistic about the Euro Area given the continued strength of Base Money growth, it’s just that the market indicators look so poor. The battle between QE and the inflation ceiling is a mighty one.


The US Census Bureau produced figures from both wholesale and retail trade last week. Rather touchingly, the wholesale trade figures were for last December, and are somewhat historical now. They showed a rising trend for inventories. This is “good” for growth as it shows more investment and led to a swing in its contribution from negative to positive as an element of RGDP growth. It had no impact on the more stable “final sales” quarterly growth estimate, which had been running higher than RGDP quarterly growth anyway, as it ignores movements in inventory. As usual, it is hard to tell whether inventories have been run up due to anticipated sales or lack of realised sales.

The retail trade figures were for January 2016 of the current quarter. They were “unexpectedly strong” at a massive 0.2% MoM vs an estimated 0.1%. Big deal. Our own forecast was for 3.3% YoY growth, with the release print coming in at 3.4%.

The YoY trend looks harder to decipher. The Atlanta Fed GDPNow model liked the trend and boosted its QoQ RGDP forecast from 2.5% to 2.7% annualized. Our forecast indicates it will grow closer to 4% YoY in February before turning down at a rather fast rate for the remainder of 2016.


Throughout 2015 total retail trade was running at a feeble 2% growth YoY, reflecting zero Base Money growth and the tightening monetary policy. The jump to over 3% YoY growth over the past two months is in the adjusted data set (adjusted for “Seasonal variation and for holiday and trading day differences”). The unadjusted data set had risen but fell back to the dull 2% YoY trend.

Although the market´s attention is focused on the adjusted series, we prefer the non-adjusted data set for YoY change, even if it is a little more volatile. As a data set Market Monetarists like this release as it is not adjusted for price changes. Its big sister, the Personal Consumption Expenditure data is used to create both real and nominal figures. It has not been released for January, but the nominal growth rate shows a declining trend since mid-2014, consistent with the fall in overall nominal aggregate demand growth (NGDP).

Next week is very quiet for US data that can influence the GDPNow estimate. There are the usual up to the minute mid-month surveys of activity like from the Philly Fed. The baleful FOMC will release the minutes of its most recent meeting. No one can expect to learn anything about the economy from the formal deliberations of that bunch. Amongst the usual slate of Fed chatterers new boy on the FOMC Neel Kashkari is talking on Tuesday which could be interesting as he is young and a potential high flyer given his insider track record, even if he isn’t a monetary expert. The two monetary experts haven’t proven great Chairs for the Fed since Greenspan left.


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