Week ending Friday May 5 2017
US markets were mostly quiet except for a late week further drop in the USD and modest pickup in equities. The driver appears to us to have been more from outside the US than inside, particularly from the Eurozone.
Relief rally will add pressure on ECB to tighten, foolishly
The EUR continued its relief rally post the 1st round of the French Presidential elections. The result seems to have emboldened both important German politicians and various ECB Board Members to talk about the end of QE in Europe and potential rate rises. It seems barely credible when real inflation in the Eurozone, aka the GDP deflator, is solidly below 1% and growth merely average. There has been no recovery in GDP levels.
The confidence is also surging through the Eurozone stock markets, despite the obvious problems that will come from the rising currency and potentially tighter monetary policy. Somehow, rising French bond prices/falling yields are seen as a good thing. To us these divergent asset price moves presage an economic slowdown to come. Short-term rates are still solidly negative, indicating continuing tight monetary policy. French NGDP growth released during the week showed a slowdown to a mere 1.45% YoY while YoY RGDP was a mere 0.85%. If elected this weekend Macron will have a lot of work to do.
US monetary policy tightening, Eurozone more so
While US monetary policy is still tight and is likely to see more rate rises this year, as more or less confirmed in the FOMC statement on Wednesday, policy is not so tight as at the Eurozone – there is also the relatively sane voice of William Dudley worrying about the impact of Fed decisions on financial conditions. Hence, the prospective tightening by the ECB has driven up its currency by nearly 5% relative to the USD. UK politics has also helped the GBP. Overall, the USD has fallen 2% over the last month or so.
Conflicting signals from market
Intriguingly, the USD also fell on Friday on the inline payroll news, while the likelihood of a US rate rise in June rose. This split decision seems to indicate that further rate rises are seen as having a negative impact on the economy. US equities still don’t see it that way, benefiting further from a good 2017Q1 earnings season and from the impact of a weaker USD on future earnings.
Global monetary conditions tightening nonetheless
Both major monetary areas seem to be getting tighter, even if the Eurozone is tightening faster. Unusually, Australia also seems to want to get in on the act. This global monetary tightening could well be what is playing out in commodity prices. We have long predicted that OPEC’s production cutting would fail and this view is now being played out in prices. However, in many other commodities there has been plenty of negative price action: copper, iron, silver. It is suggested that issues in Chinese banking are causing a drying up of liquidity but those ways are mysterious. The fact is that China remains linked to US monetary policy via the semi-fixed exchange rate. Therefore, as US rates rise, China’s monetary policy also tightens.
April hard data begins to appear
Very mixed surveys on business conditions for April will be tested by the retail sales figures for April on Friday. Inflation will be weak as the impact of falling oil prices continues to roll through the data. The Fed should have been warned by the continuing weak earnings growth numbers that the Philips Curve is dead, but they remain as pig-headed as ever, meaning speeches from cloth-eared FOMC members could roil markets yet.