Markets are Data-Driven, but which Data?

Like a Newtonian law of motion, market
participants will continue to rely on a particular trading style or system
until it stops working. 
that volatility stays low is a cash register for many, and there appears to be
what Soros called “reflexivity” here, like a self-fulfilling
prophecy.  Why is volatility low?  Because it is being sold in
various ways besides directly selling options.  Buying equity pullbacks
and selling euro bounces, for example, also seem to be expressions of short
There is little on next week’s calendar
that threatens to pull the plug on this cash register. 
 In other circumstances, the
eurozone’s preliminary February PMI could have potential.  It is to be
reported at the end of the week ahead.  The composite had not fallen since
last September when it reached 50.1.  In January, it was at 51.3, little
above where it finished 2018 (51.1).  However, one of the most important
reasons market participants pay attention to sentiment data, of which this
purchasing manager survey is an example, is that it ought to shed light on real
sector developments.
Yet the market was shocked by the magnitude of the decline in
the December industrial figures.
The December manufacturing PMI for EMU eased to 46.3 from 46.6, having bottomed
in September at 45.7.  The 2.1% decline reported last week was tipped by
the national figures, but the aggregate decline was the largest since February
2016 (-2.2%), which itself was the biggest drop since early 2009.  While
the flash PMI may pose headline risk, it is most unlikely to turn the market.
The ECB’s course also appears set.  Lagarde has not “cleaned
house” as Georgieva has at the IMF, and continues on the path set out by
Draghi.   However, her presence has already been evident in the lack
of sniping and media leaks. This represents an improvement in
communication.  There have been reports in the media claiming a backlash
against negative interest rates. Yet, Lagarde has given a spirited defense.
Last week so did Germany’s Executive Board member, Schnabel, who may be the
first in her position to defend it (and vigorously).  The ECB’s chief
economist Lane also endorsed its efficacy.
China’s economic data for January and
February was always going to be distorted by the Lunar New Year holiday.
  This year, because of the new
coronavirus  (Covid-19), the data is, particularly, of little value. 
In addition to monitoring the progress of the virus in China, where the cases
and mortality are the highest, the setting of the Loan Prime Rate will be an important
Recall the one-year Loan Prime Rate has become the new
benchmark, and it is set by a survey of the leading banks. 
 In this sense, it is a more
market-driven metric than previously administered attempts.  It is set on
the 20th of every month and currently stands at 4.15%.  The median
forecast in the Bloomberg survey looks for a 10 bp cut.  If it is wrong,
it is likely because rates have fallen faster.  The PBOC granted banks
this week funds that can be re-lent to businesses struggling to cope with the
effects of the Covid-19 for 100 bp below the one-year Loan Prime Rate.
The signal from Beijing is to go for growth. Yet, the inclusion of CAT scan diagnosis
(rather than the nucleic acid test) saw a jump in confirmed cases, and nearly
doubling of fatalities. This raises new questions and prompts an extension of
closures and disruptions.  While
the initial reaction is this was a one-off adjustment, it is not immediately
clear.  There are problems outside of China too, with some observers, for
example, seeing that Indonesia’s claim of having no cases, is a bit
unlikely.  Also, there is concern in some quarters that the incubation
period may be longer than initially estimated.
The political consequences are already materializing.  The death of Li Wenliang, a young
doctor who was among the first to detect the virus and was harassed by local
officials for doing so, and ended up being infected himself, is an unexpected
catalyst for change.  It seems clear that public health requires clear and
forthright communication, and yet in China (like several other places), this
does not exist.  In fact, the lack of open and honest communication costs
lives.  It is in this way that this experience is similar to the Soviet
Union’s Chernobyl tragedy in 1986.  A campaign pushing for open
communication has begun on social media.
Another political fallout is the replacement of the Communist
Party heads in Hubei and Wuhan. 
the replacement of the Director of Hong Kong and Macau Affairs suggests that Xi
may be using Covid-19 as cover to pursue a broader agenda.  It may not be
so dissimilar from using the anti-corruption campaign to also punish rivals and
secure greater power.   A common understanding is that there is a
social contract between the Chinese people and the Communist Party.  The
latter delivers the goods, literally: rising living standards, and the people
defer to the Party.  However, the lack of trust that was simmering below
the surface is becoming manifest.  This is another window of opportunity
for a change, a concession to people, a civil liberty,  but the greater
probability is the opposite.  Push hard for a quick resumption of economic
activity and repress dissent.
At the start of the week, investors will
learn just how bad last year ended for Japan with the first official look at Q4
19 GDP. 
 The tax
hike and typhoons are expected to have led to a 1% quarter-over-quarter
contraction and risk is on the downside.  The reason the market will not
act much is that the data is historical, and there are no new policy
implications.  More important is how the economy is doing in Q1. There are
concerns about the disruption of trade due to Covid-19  and the
sluggishness of consumption after the sales tax increase. This may translate
into an economic contraction here in the first quarter. 
Japan’s January trade figures will be released.  The
interest lies not in the balance itself but the components. 
 Exports were off 6.3% year-over-year
in December, which of course, was before the public knew about China’s new
virus.  Recall that in December, Japan’s exports of semiconductor
fabrication equipment to China jumped by 60%. This is important too because
semiconductor chips (design and manufacturing) are seen to be a bottleneck for
Japan reports CPI and the preliminary
February PMI.
  The composite PMI was at 50.1
in January.  Any decline would fan recession (two quarters of contraction)
fears.  While much has been done in the name of the core inflation
(excluding fresh food), it tends not to elicit much of a market reaction. 
The headline may ease from 0.8% to 0.6%, while the core rate is likely steady
at 0.7%. 
The UK reports employment CPI, retail
sales, and the flash PMI.
  A couple of weeks
ago, the market was particularly sensitive to speculation that Bank of England
Governor Carney would cut rates at his last meeting.  Not only wasn’t it
delivered but now the data might not be so important either.  The two
dissenters at the BOE have been unable to convince any colleagues to join them,
and the new governor is unlikely to start his tenure with a rate cut.  The
market is fully pricing in a 25 bp rate cut around the middle of Q3. 
Meanwhile, the fiscal rules were already relaxed before Chancellor Javid
unexpectedly resigned as a consequence of the cabinet and staff shuffle. 
The market anticipates an expansionary budget when it is presented in less than
a month.  
Last week, the
Reserve Bank of New Zealand flagged that its easing cycle was over, and the
markets believed it. 
 The currency rallied, and yields rose. 
The Reserve Bank of Australia and the Bank of Canada are in somewhat different
positions.  The Bank of Canada withstood three Fed cuts last year and
stuck to its neutrality.  It has since softened its tone, and the January
employment data was sufficient to refute any sense of urgency.  The
January CPI report, due in the middle of next week, is expected to reinforce
this message.   After finishing last year at 2.2% (November and
December), it is forecast to rise to 2.4%, which would match last May’s pace,
which itself was the strongest since the 2.8% rate in August 2018.  The
core measures are expected to remain broadly steady 2.0%-2.2%.  
The Reserve Bank
of Australia’s cautious optimism rests on the labor market, which naturally
draws attention to the January employment report. 
 The market
is expecting the RBA will cut the cash rate by 25 bp in June or July. 
Australia created an average of almost 22k net new jobs a month last year after
nearly 21k a month in 2018.  The median forecast in the Bloomberg survey
calls for a 10k increase last month.  Full-time positions grew by an
average of 12.7k month in 2019 and 13.5k in 2018.  This may overstate the
recent trend.  Full-time jobs fell in Q4 19 for the first time since Q1
18.  If the Australian dollar sells off on a strong report, it would be
revealing about psychology and positioning.  It has depreciated by 4.4% so
far this year to multiyear lows.  According to the OECD’s measure of
Purchasing Power Parity, the Aussie is less than 1% undervalued (~$0.6720).
The key to
the dollar’s outlook and to Fed policy does not hinge on the high-frequency
data that will be reported in the week ahead.
  The market continues to
discount one rate cut fully and is roughly half-way toward factoring a second
cut.  The logic is the same as last year.  The PCE deflator measure
of inflation, which the Fed targets, is at 1.6%.  The target is 2%. 
Officials continue to see mostly international risks and continued weakness in
the industrial sector (contraction four of the past five months), indicating
that some risks are, in fact, materializing.  The economy, they assure us,
is in a good place, but that does not preclude taking further insurance out,
possibly in Q2, extending the business cycle further and pushing the envelope
of full employment.
Last week’s
retail sales and industrial production reports for January told investors and
policymakers that the new year has begun pretty much the way 2019 ended. 
consumer continues to shop but at a more subdued pace.  It should not be
surprising as investors also learned last week that real weekly pay is flat
year-over-year even though average hourly pay has increased (higher hourly is
offset by working a few hours).  Revolving debt (credit cards) has
increased to pick up some of the slack.
production cuts at Boeing are being felt.
  Aerospace and parts output
fell 9.4% in January, and without it, manufacturing output may have gained 0.3%
instead of contracting by 0.1%.  On the other hand, auto production picked
up, and without it, manufacturing output would have fallen by 0.3%. 
Manufacturing accounts for around three-quarters of industrial output (which includes
mining/drilling and utilities).  The output of utilities also fell in
January due to unseasonably warm weather that helped other sectors.  More
troubling is the continued decline in capacity utilization.  At 76.8%, it
is the lowest in nearly 2.5 years.  The low usage rates are associated
with weaker profitability and deter new capital expenditure. 
The Empire
State and Philadelphia manufacturing surveys may draw attention because,
outside of weekly jobless claims, they will offer the first insight into economic
activity in February.  
The Fed’s term repo will also attract
interest.  Despite the last three repos being oversubscribed, the Fed
announced it would reduce the amount it would make available, and taper further
next month.  The Fed is implicitly assuming that it is the cheapness of
the funds it makes available that attracts the strong demand and not a shortage
of reserves.  

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