Bond markets continue to flash a warning

Week ending Friday November 17th 2017

A busy week in data but no major signals. Markets were volatile. The USD fell partly due to potential tax reform negatively affecting the deficit and partly due to EUR strength. The grinding flat of the US yield curve continued as the 10yr less 2yr spread dropped towards 60bps from 75bps. Short rates continue to climb higher, but are not budging longer rates.

Monetary offset coming soon to the US?

US politics was mostly center stage as tax cuts made more progress through Congress but with little clarity on related expenditure cuts. Financial engineering to allow deficit-increasing measures will most likely be offset by the Fed. At least that is what the market is saying: short rates up, long rates flat.

We don’t like to see flat yield curves at low levels of rates as it clearly implies slower and slower nominal growth and a possible flirting with recession.

EuroZone growth patterns

Belatedly, more detailed figures were released for RGDP growth for the Eurozone and the major countries’ NGDP growth data. The releases showed a continuing RGDP and NGDP surge in Germany. On the one hand regional (i.e. Individual EuroZone country) charts should be irrelevant to monetary policy, only the whole matters. But in the EuroZone, regional disparity can and does drive monetary policy politics.

Germany is almost growing above its long-term NGDP trend and the former CEE satellite countries are growing more rapidly. It has been the case before that German sentiment drives the EuroZone policy – Trichet followed it closely with disastrous results.

Sure we do see some better RGDP and NGDP growth this year in France, Italy and Spain but these three large countries are all still far below trend growth levels. We expect German rhetoric to ramp up and trump Draghi’s so far very successful caution on tightening. The release of the stronger than expected growth rates this week immediately jacked up the EUR and depressed equities in expectation of tighter policy to come.

The economy

The surveys this week from the NFIB, the Empire State Manufacturing Index and the Philly Fed were all weaker than expected. Data was better, especially Industrial and Manufacturing Production with levels now reaching those of 2014 again. Joy! While some point to overall activity manufacturing being only 20% of the economy no aggregate can move the dial on NGDP on its own. In contrast, retail sales disappointed and CPI inflation remained low.

Next week

Will be quiet in terms of data and should be quiet on other fronts in the lead up to Thanksgiving on the 24th. Best wishes to all from us!

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