The Trade Week Ahead - The US The Destiny of Everything
US economics is driving everything and will drive everything into FY19 and FY20. Fed hike speeds, the President’s fiscal stimulus programs and the possibility of a push pull scenario between monetary and fiscal policy are all going to play out on a global scale in the next two years.
The push-pull between US monetary policy and fiscal policy is a rather interesting scenario. Does it create a scenario where monetary policy is likely to counter fiscal policy? The US economy is firing and the stimulus from the tax changes and the proposed “infrastructure building” on the fiscal side will be countered by tighter monetary policy on the other side to slow down overheating risks.
Or do we get a scenario where the White House rages against this, (a key risk) and the President does something unthinkable and intervenes at the Fed? FY19 and FY20 has all this and more to consider.
The immediate concern for trade is the movements in the US bond market off the back of the economic strength and risk of harder and faster rate rises.
This week, sees the Fed’s core metric on inflation the Personal Consumption Expenditures (PCE) being release and on a year on year basis is likely to remain above the Fed’s 2% year-on-year target band at 2.3%
Below are the year-end estimates of the Fed – as you can see PCE is likely to exceed its estimate on Thursday by quite some way.
Now remember that from the Fed’s point of view things are really positive US forward-looking indicators are in some cases at 45 year highs.
For example: The measure of consumer confidence is at the highest level in 15 years; it’s actually at the third highest read ever been surpassed by a reading in the late 1960s and in 1998 which was the top of the Tech bubble. SME Optimism (the NFIB) is at its highest level in its 45-year history of the survey (barring an outlier reading in September 1983).
Non-farm payroll growth is healthy despite seven rate rises and an end to the ‘Bernanke Put’ (QE program) over the past three years. Unemployment is at its lowest level since the late 1960’s, at 3.8% which is ‘full employment’ in most economists’ books interestingly the consensus for the unemployment rate come June 2019 is 3.3%, that would be the lowest level since 1953.
Why this is so important from a global perspective is that, if the Fed does see inflation accelerating faster and harder than is comfortable not only will the FOMC raise rates 4 times in 2018 and 3 in 2019, in all likelihood it could make it 4 rises next year rather than waiting for 2020 to do one more movement.
The EUR and AUD have been showing stress off the back of US hike expectations. The AUD in particular is facing a scenario where the US 10-year could be 2% higher than its Australian counterpart – a long-term negative for the local currency for sure.
This ‘high-speed’ tightening has a double-edged issue on equities and bond markets too. First, it will slow US and global growth – if we take the faster tightening scenario as ‘fact’ US interest rates would be 3.5% to 3.75% come December 2019 that will hit overall borrowing and will make variable rates rather expensive – the US wealth story will slow everything.
The other (bigger risk) side is what’s happening in bond market spreads. As stated earlier US geo-politics is creating risk, whether it be US-China trade wars, changes to fiscal policy or global geo-politics such as Italian elections, Germany political stability and Brexit all this is driving funds to the US ten-year treasury the most risk-adverse financial instrument on the planet.
The ten-year yield has managed to stay below 3% over the past 6 weeks despite the Fed’s explicit actions and forecasts on rate raises as geo-political risk is driving monies to the ten-year and fast – EURUSD is tell us that too.
Now the US two-year is steeping by the day, as it should be considering the short-term outlook from the Fed around rates and the market has finally woken up to this fact seeing the 2-year adding 121 basis points over the past year too 2.55%.
Why the concern? is the spread between the 2-yr and 10-yr is 35bps –very close to inverting. Over the 152-year history of the US market each time the 2/10 spread has inverted – it has led to a bear market. This is why I see the US as the driver of all things market in FY19 and 20.