Week Ahead: Number One Rule of the Game is Stay in the Game

<br /> Week Ahead: Number One Rule of the Game is Stay in the Game – Marc to Market<br />


The week ahead is short on economic data
and long on anticipation. 
 It could make for some choppy price
action.  The dollar’s uptrend of the first part of the month yielded to
corrective forces last week, though the greenback finished the week on a firm note.  Even among
dollar bulls, the near-term outlook for the dollar is not clear.  However,
many, including ourselves, remain bullish over the medium-term.  
President Trump
is expected to provide details of his tax plan when he addresses both houses of
Congress at the end of the month.  
Remember, many economists has argued that
the border adjustment would “automatically” send the dollar sharply
  Also, lowering corporate tax schedules may get the
headlines, but it is the effective tax rate that is key.  Will loopholes
by closed?  Will it be revenue neutral, as scored by nonpartisans such as
the Congressional Budget Office (CBO)?  Will debt servicing remain tax
We are persuaded that the reason that capital
expenditures are not more robust is not that interest rates are too high or
that businesses do not have access to capital. 
 Therefore, even if tax reform boosted after-tax
profits, it would not necessarily boost investment or growth or employment. It
would more likely boost returns to shareholders by funding share buyback programs and dividend payouts.  
The US
President bemoans the poor economy he inherited. 
 The New York Fed’s GDP tracker see Q1 growth a little
more than 3%, while the Atlanta Fed’s model is a little below 2.5%.  The
point is that after a little disappointment in Q4 16, when the US economy
appears to have grown at what the Fed regards as the sustainable pace (~1.8%),
the economy appears to have re-accelerated.  Practically every economic
report last week, including consumer prices, retail sales, and industrial
production, and the Empire and Philly February surveys, were above
The Fed’s
leadership–Yellen, Fischer, and Dudley–sounded increasingly confident about
the trajectory of the economy and prices. 
  While a March hike may seem soon,
but May is looking particularly interesting.  As we have argued, the Fed
is a bit hamstrung by its own
transparency measures.  It has regularly scheduled quarterly press
conferences, which are used to explain policy and policy views (economic
projections).  In effect, this halves the number of “live”
meetings to four. As the pace of normalization is poised to accelerate, it is
clearly in the Fed’s interest to re-animate, as it were, the other half.  
To do so
requires the Fed to raise raises at a non-quarterly meeting, and May is next to such opportunity. 
 Others are drawing the same conclusion from the Fed’s
comments, especially Yellen’s testimony.  Last week, the implied yield on the March Fed funds futures contract ticked
up one basis point to 0.69% yield.  The implied yield on the May contract rose 3.5 bp to 0.785%.
 The June contract’s implied yield rose three basis points to 0.85%.
Some caution
that the market has a Fed hike and tax reform discounted.
positioning, they argue, is already extremely long dollars.  While some
tax reform may indeed be anticipated, and Yellen acknowledged that the
anticipation of fiscal stimulus might be helping elevate equity prices,
remember the argument is that due to the economic identities and purchasing
power parity that the dollar will rise to offset the border tax (20%-25%).
 Clearly, with the dollar down against all the major currencies so far
this year, it is hard to say tax reform is fully
reflected in current prices.
It is true that
one hike in H1 17 has been largely discounted.
  A second has also been priced into the strip, but the market is
pricing in about a one in four chance of a third hike.  This has room to adjust.  And the
speculative market does not appear to be extremely long dollars.  The
latest CFTC Commitment of Traders report that covers through February 14, show
the net short euros to be near seven-month lows, and the speculative
participants are short US dollars against the Canadian, Australian and New
Zealand dollars.  In fact, the speculators in the futures have not had
such a large net long Canadian dollar position in five months.  The net
long speculative position in Australian dollars is the largest in more than two
months.  Since the end of last year, speculators have cut the net short
yen positions by a third. 
minutes release is the highlight for the US this week.
  After the Yellen’s recent testimony
and comments from various other officials, it the minutes is unlikely to add much to the already
available information set.  It may be interesting to see how the Fed’s
balance sheet was discussed and the
preliminary thinking about fiscal policy initiatives.  
Yellen batted
away concerns that Dodd-Frank was inhibiting lending and bank profitability.
 She pointed to the dramatic increase
in commercial and industry loans and the health of US banks both in absolute
terms and about other countries that did
not impose it (like European banks).   Dodd-Frank may eventually be treated like the Affordable Care Act.
 Rather than dismantling it and replacing it, much of which requires 60
votes in the Senate vs. the 54 held by Republicans), relaxing the discretionary
enforcement, some repealing, some modifying or replacing, but when all is said
and done, much will also likely remain.  
politics remains very much in the fore.
  However, it is a work in progress, and it is too early to expect an end
game.  Even the finance ministers meeting to start the week is unlikely to
resolve matters with Greece.  Greece does not need funds until July.
 One of the rules of brinkmanship is that has
to go to the brink.   
The key issue now is whether the IMF capitulates, contribute funds and
agrees that Greece needs to achieve a  3.5% primary budget surplus next
year, or whether Germany (and the Netherlands) accept that Greece is a European
problem that Europe can and should address without the IMF’s money (but perhaps
with its expertise).
 A Reuters report at the end of last week
suggested the former, while other reports pointed to some softening of the
German stance on the necessity of the IMF.  
Just as many
investors began feeling more comfortable with French politics, reflected in the
10-year spread narrowing from 77 bp on February 6 to 66 bp on February 16, a
new twist to the drama unfolding. 
 There was an initiative to run a
united left ticket, the Socialists, to be led by its left-wing candidate Hamon,
the former Socialist, Melenchon’s faction and, the Greens, under Jadot’s
leadership.  Such a coalition is seen taking votes away from Macron, who
had moved into second as Fillion is snarled
in a scandal.  A left candidate running against Le Pen would give the
National Front its best chance of winning the second round.  The prospects
spooked investors, and the premium
widened again.  The 10-year spread rose back to 73 bp before the weekend.
 The two-year premium rose to 32 bp, the highest since the mid-2013.
 It stood at 11 bp at the end of 2016.  
The simmering
political drama in Italy may also be taking a turn. 
 Former Prime Minister Renzi stepped down as the head of the center-left PD, which sets up a formal leadership context, probably in April or May.  It would seem to reduce the chances of an early election.  Parliament’s term ends in February 2018.   There is still risk that the left-wing of the PD splits off to form their own party, although polls suggest it would not do well in an election.  Estimates suggest, such a schism could see a score of Deputies and a dozen Senators leave.  It could weaken the current PD
government and work to the benefit of the 5-Star Movement, which is having its
difficulties in governing the city of Rome where it had won a local election last spring.    
In contrast to
the political drama, the economic
impulses have told a story of steady growth and prices (excluding energy). 
 Markit will report the preliminary February PMIs.
 The composite is expected to ease slightly to 54.3 (from 54.4).  To
put it in perspective, consider that the three-month average is 54.2 and the
six-month average is 53.6.  The 12-month average is 53.3.  It is the
picture of slow and steady improvement.  The January reading of 54.4 was
the highest since the time series began in early 2014.  Similarly,
quarterly GDP has averaged roughly 0.4% a quarter for the past four, eight, and
12 quarters.  
Japan reports
its January trade balance. 
For over two decades, Japan’s January
balance always deteriorates from December.  The median guesstimate in the
Bloomberg survey for a deficit of JPY626 bln after a JPY648 bln deficit in
January 2015, and a December 2015 surplus of JPY641 bln. Despite the powerful
seasonal factors, the underlying signal, that trade is improving, that imports
and exports are improving, is likely to be
sustained.  Imports, which have been contracting on a year-over-year basis
since the start of 2015 have begun recovering and may have moved into positive
ground in January.  Exports had been negative since Q4 2015 but turned positive in December 2016, and likely remained around 5% in January.
Canada reports
retail sales and consumer prices in the days ahead. 
Weak auto sales are expected to have flattened the headline
to zero after a 0.2% increase in November.  However, excluding auto,
Canadian retail sales may have risen 0.6% after an
unchanged report in November.  Recall that Canada had also had
strong jobs growth in December, and this may warn of upside risks.
 Consumer prices likely rose in January.  The median expectation is
for a 0.4% increase, which due to the base effect would lift the year-over-year
rate to 1.6% from 1.5%.  
With rising
terms of trade, the long-term decline in business investment in Australia
should be winding down.  
With a few exceptions, capex
has been contracting since the second half of 2012. The 20-quarter average
(five years) fell into negative territory in Q2 16.  The decline in the
eight-quarter average (two years) has accelerated to stand at minus 4.3%.  It has been negative since
Q1 15. The median forecast is for a 0.5% decline in Q4 16 after a 4% decline in
Q3 16.  A weaker report could fan speculation of a rate cut in Q2 and
reinforce the cap for the Australian dollar near $0.7700. 
We note
that Moody’s upgraded its outlook for Russian credit to stable.  
 The Ba1 rating is one step below
investment grade, but if Russia continues its fiscal consolidation, oil prices
stay firm, and the economy continues to emerge from an almost two-year
recession, investment grade status may be possible later this year.
 Russia’s 5-year CDS finished last week near 1.82%, which is just below
Italy’s CDS (1.87%).  The ruble has
appreciated 4.8% this year, tying it with the Taiwan dollar for fourth place
among emerging market currencies. 
Last year, the
ruble’s gain of 20.1% put it in second place behind the Brazilian real, which
rose nearly 21%.  
easing cycle is expected to take another step.  The Selic is expected to
be cut by another 75 bp to bring it to 12.25%.  It peaked at 14.25%, and this would be the fourth move in the cycle.
 Inflation has fallen much faster.  It has been halved.  Since shortly after the US election last
November, the dollar has fallen nearly 13.5% against the Brazilian real.
 On February 16 a potential reversal pattern was recorded.  Initial
resistance is seen in the BRL3.10-BRL3.15

China unexpectedly announced that it would not purchase coal from North Korea this year.  This was understood as a sign of Beijing’s increasing frustration with the regime after the latest test of an intermediate range missile and the assassination of Kim Jong Nam, the half-brother of Kim Jong Un.  Coal exports to China are thought to be North Korea’s largest export.  China’s move will intensify the economic pressure on North Korea.  North Korea’s missile tests have justified the establishment of a missile defense system in South Korea that also can, of course, be directed at others in the region, including China.  China’s move may also be seen implementing the UN agreement, and is consistent with a political and economic solution.  Some may see it as an overture to the new US Administration, and underscores another potential area where cooperation between the US and China can be helpful.  


Week Ahead: Number One Rule of the Game is Stay in the Game
Week Ahead:  Number One Rule of the Game is Stay in the Game

Reviewed by Marc Chandler

February 19, 2017

Rating: 5

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