Does Macro Matter?

Indexing and passive investment have little to learn from macro.  At the start of April, the Bloomberg Barclay bond index included mainland Chinese bonds for the first time.  A macro strategist could have explained how China’s 10-year yield had been falling since reaching above 4% in May-June 2018 was near 3.40% in late-March, and why it might not go down much further.  The government was committed to supporting the economy. New stimulus was being delivered, and more were in the pipeline. The yuan had appreciated by nearly 2.5% in Q1.  It was the third strongest currency behind the Russian rouble (~6.2%) and Thai Baht (~2.6%).  The dollar had approached a level (~CNY6.70) where Chinese officials had seemed to draw a line (signals are indirect and can change). 

Not only were yields low but the currency was strong.  It was not an attractive time to be adding mainland bonds to the portfolio.  Still, the index is the index.  If one second guesses the index that makes it a different kind of fund.  Actively managed funds cost more than passive funds, though fixed income managers are more likely to beat their benchmark than equity managers. 

In a more immediate sense, macro does not seem to matter either.  The US reported growth accelerated Q1 to above three percent, blowing away expectations, and the dollar? Meh.  The US reported a jobs beat a week later, and a drop in the unemployment rate, and again, meh.  The eurozone reported better stronger than expected growth, with Italy emerging from the H2 18 recession.  It followed it up with a larger than expected rise in CPI.  The euro did not get any traction was near the lows for the week prior to the US jobs report.   

But let’s not jettison macro too quickly.  Equity analysts often talk about the market as a discounting mechanism.  To say that same thing slightly differently, markets anticipate.  There was net demand for dollars ahead of the GDP report.  There was demand for dollars before the employment report.  It is as if the “smart money” bought the dollar (effect) before the cause (strong economic data).  It is as if some of those who bought ahead of the news were happy to sell to those who thought the headlines justified a stronger dollar.   

We suspect that divergence that has been the primary fuel of the dollar’s rally has run its course for now.  US growth is not quite as strong as it may look and the eurozone is not as weak. The risk is on the upside for the European service and composite PMI. Even in Germany, where the manufacturing sector is still contracting, the flash service PMI was a five-month high. The UK is likely to report that growth accelerated to 0.5% in Q1 from 0.2% in Q4 18, which would lift the year-over-year rate to 1.8% from 1.4%.  

Japan is the laggard.  It will not report Q1 GDP until the middle of the month, but it looks like it contracted.  Household spending in March is expected to have slowed on a year-over-year basis for the second month. Here is part of the problem:  Cash earnings are a falling year-over-year and March is likely to be the third consecutive decline.  Since deflation has been arrested

The Reserve Banks of Australia and New Zealand meet.  The RBNZ is more likely to cut rates that the RBA.  The market has a little more than half the cut discounted.  The New Zealand dollar has fallen a little more than 5% since late March.   It came within a few hundredths of a penny from the flash crash low (~$0.6575) on January 3.  Along with other currencies, it staged an upside reversal ahead of the weekend.   It was mostly a question of the broader US dollar pullback, but the market may be looking past the first cut.  If it is one and done, there would be scope for the Kiwi to trade higher.  The market appears to have discounted a little more than a 1 in 3 chance of second rate cut this year.  In this context, what the RBNZ says may be more important than what it does. 

Some will argue that the case for an RBA rate cut is just as compelling, but the market thinks otherwise.   The derivatives suggest around a 37% chance of a cut has been priced.  However, speculators in the futures market have net short Australian dollar futures position (~54k vs. ~11.5k).  Yet the Aussie had fallen about 3.1% since April 17 when it tested a two-month high a little above $0.7200.  It made a marginal new low since the flash crash in the knee-jerk reaction to the jobs data (~$0.6985) before recovering to almost $0.7025 and closing again on above $0.7000, the previous floor. 

As China returns from an extended May Day holiday, there will be several economic reports, including international reserves (might increase a little) and trade (slower growth in exports and a smaller contraction in imports may result in a wider surplus).  Consumer price pressures probably edged a little higher to 2.5%, matching its highest level since the first quarter last year.  The deflationary scare in producer prices has subsided.  It might rise it 0.6%, which would be the strongest this year.  The takeaway is that what appeared to have been a slowing of the Chinese economy has been arrested.

Brexit is about to enter a new phase.  The local elections results were stark.  Of 8400 council seats the Tories loss almost 1335, considerably worse than expected.  Labour cannot capitalize on the Tory self-immolation.  It lost 82 seats.  The Lib-Dems were the big winner, picking up 703 seats, and the Greens, who are also pro-Europe, gained 194 seats.  Independents also did well.  The key to what happens next is the lesson that is taken from these results. Talks between the government and Labour resume next week.   There is a small window of opportunity to strike a deal, which would probably entail a softer exit than the kind envisioned by the likes of Boris Johnson or Nigel Farage.  Talk suggests if a deal can be made, it will be known by the end of next week.

If a deal cannot be worked out shortly, the pressure on May to step down will build.  She led the party into losing its majority in the House of Commons.  The Withdrawal Agreement, her government, negotiated for 18 months did what little else has done–it united parliament delivering historic defeats to her bill, not one, twice, but three times. 

Sterling’s impressive pre-weekend rally was more than a reflection of the dollar’s pullback.  It approached its best level in two years against the euro and is supported by a 15 bp increase in the implied yield of the December short-sterling futures contract.  Speculators in the currency futures have seen a nearly two-thirds increase in gross long positions since late March.  Meanwhile, the premium for three-month sterling puts over calls has shrunk to its smallest level since last June.  

The Federal Reserve cut the interest rate it pays on reserves because not capping the effective average fed funds rate.  It has tried this strategy twice in H2 18 with little success. The immediate impact was inauspicious.  The interest on reserves now stands at 2.35%, while was 2.41% the day after the FOMC meeting.  The secured overnight funding rate that may eventually replace LIBOR finished last week at 2.50%, the top of the fed funds target range.  

Powell said that the soft inflation was transitory.  This might not be as controversial as some made it seem.  April CPI will be reported at the end of next week.  Recall that the year-over-year pace was nearly halved from last June and July’s 2.9% to 1.5% in February.  A 0.4% increase that is the median forecast in the Bloomberg survey would lift the year-over-year back above 2.0% for the first time since last November.  It may not sound like much, but a 0.1% rise in the core rate would be the first increase this year.  

The Mueller Report was only one front on which President Trump is being stymied.   Moore is his fourth candidate to the Federal Reserve that was not defeated by Democrats but by Republicans, a party that continues to support Trump by an overwhelming majority.  The Republicans are also threatening to reject Trump’s $2 trillion infrastructure initiative that is the subject of talks with the Democrats.  North Korea reportedly tested several short-range missiles for the first time in two years. The steel and aluminum tariffs are threatening to sabotage the new North American free-trade agreement.   The March trade balance, due May 9, could impact revisions to Q1 GDP, but they will be a reminder that despite (because?) of the administration’s economic nationalism the trade balance has deteriorated by nearly 20% over the past two years.   The 12-month moving average has been above $51 bln a month for the past five months.  

The quarterly refunding takes place next week.  It is a reminder of the cost of last year’s stimulus.  The Treasury will auction $84 bln of coupons, that same as in Q1.  It will raise almost $29 bln of new cash.  Recall that Treasury is taking extraordinary (but not unprecedented) measures in lieu of the debt ceiling being lifted.  These measures are limited, and it appears crunch time could be by the end of Q3.  

China’s trade negotiating team will be in Washington in the coming days.  There have been some reports that President Xi’s calendar is making space for a meeting with Trump next month, which suggests an agreement is near.  Leaks from China are rare, raising the possibility that it was purposeful. At the same time, there is talk that an announcement of a meeting could take place by the end of the week ahead. Recent accounts indicate that the US has softened its position on intellectual property rights in biologics and in cyber espionage.  A deal is an executive agreement, which means that unlike NAFTA 2.0, it will not require Senate approval.  The same holds for the current talks with Europe and Japan. 


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