Rolling with the punches

Summary

• Macro update — Can you hear the beat of the fiscal drum?

• US update — Rolling with the punches.

• Week ahead — Welcome to the party Christine Lagarde. 

Macro data this week dealt a body blow to the narrative that growth had bottomed, with several key data points around the globe coming in well below expectations.The biggest disappointment came out of Germany, where industrial production numbers dropped like a sack of hammers. Production fell to the lowest since the Great Financial Crisis and complimented the weaker factory orders that wear release earlier in the week. The latest data helps offset some of the positive rhetoric surrounding the particulars of the manufacturing and service sector Purchase Managers Survey's, which suggested that growth may have been bottoming. With the Euro bloc still mired by a manufacturing recession, many continue to hope that officials in Berlin will open their checkbooks. Remember that Germany narrowly avoided entering a recession last quarter, growing by a whimpering 0.1 percent. Despite interest rates remaining below zero, German officials will likely stick to their fiscal guns and continue to run a budget surplus. Germany's stubbornness runs in complete juxtaposition to Japan, where the beat of the fiscal drum was ringing loud and clear this week. 26 Trillion Yen (US$ 121 billion) is the answer to the question all of you were asking, that is: how much money will Shinzo Abe pump into the Japanese economy? The rather large stimulus package came as a result of a poorly timed consumption tax that went into effect in late summer. The tax threatens to tip the economy into a recession, given the precarious global backdrop. Of course, a recession isn't hard to fathom. Japan has struggled to grow for over a decade despite the best effort from the Bank of Japan (BoJ). Although the BoJ will insist that they can do more if needed, it's foolish to suggest that there is ample room to maneuver, especially when your central bank has a majority share of the government bond market. 

Continuing on the theme of fiscal stimulus, Hong Kong (HK) posted some comically horrific data with retail sales plunging 26 percent year over year. With no end in sight for the protests, the city has proposed a third round of stimulus with the hopes that the package will help stabilize the economy. Interestingly, fiscal spending has become the tool of choice for governments grappling with social unrest (Chile rolled out a US$ 5.5 billion package to help pacify protests). Social unrest has become ubiquitous around the globe and has done a number against global growth. The two mechanisms through which social unrest impacts growth comes from domestic factors (people aren’t working if they are protesting) and external influences (investors pulling their money out of the country) — the latter results in a weaker currency and higher inflation. As a result, central banks must raise interest rates, or restrict the amount of money investors can pull out of the country. These policies aim to curb currency depreciation (and inflation) but also create issues domestically given the dangerous combination of falling growth and rising interest rates. The capital controls approach sends a signal to investors that when things get ugly, they may not be able to get their money out, which may impact the country's borrowing costs in the future. The social unrest stems from a variety of issues that I won't get into in this post, but many analysts view that the worst may be over in Latin America. That's at least somewhat of a relief. 

Meanwhile, in Canada, the Bank of Canada (BoC) left rates unchanged as widely expected. The BoC remains one of the few central banks to stay on hold throughout 2019, although the recent commentary suggests that the BoC may be acknowledging more downside risks. The latest job report turned a few heads, posting one of the more significant job losses in a decade and contrasts with much of the optimism originating out of Ottawa. With that in mind, the Canadian labor force data is a random number generator (given how volatile the reports are), and we would need to see a more sustained trend to put any weight on these labor numbers. Staying on the topic of the BoC, the Governor of the Bank of Canada, Stephen Poloz, announced that he would step down in June 2020 after a term of 7-years. The most likely person to take over his position appears to be Carolyn Wilkins, the second in command at the BoC currently. A Financial Post article outlines some possible candidates for the job for those interested. Meanwhile, the board of directors announced that recruitment for the position has begun and is expected to be completed by spring 2020. A new governor will be in place by June 3, 2020. 

The US continues to roll with the punches from the global economy, printing a Texas-sized beat on non-farm payrolls. Any worries that might have been culminating throughout the week following a miss in ISM manufacturing and ADP employment numbers were wiped clear following Friday's blow out jobs report. Between the reasonable GDP print and the latest job numbers, investors appear to be generally content with the state of the US economy. The fact that wage inflation has remained muted despite a 50-year record low unemployment rate quells any fears of inflation (as if there were many in the first place) and sets global assets up for another potential goldilocks period. The chart below shows how the relationship between wage inflation and unemployment has become less significant since the financial crisis. 

It was a relatively volatile week for equities as markets tried to digest the news flow surrounding trade. The worry remains that as US stocks push to record highs and economic data continues to come in above expectations, the President may view the "good news" as an excuse to push some of Beijing's buttons on trade. That will be the risk going forward.

There is plenty of event risk coming up next week, with the Fed, ECB, UK election, and the trade deadline looming.The FOMC meeting on Wednesday is expected to be the main event this week, where the committee will release updated forecasts along with the infamous dot plot (a chart that shows each committee member's outlook for interest rates). The Fed funds futures market continues to price in one more rate cut out to 2020, but, for the most part, market participants expect this meeting to reinforce the message pushed at the last FOMC. That is, steady rates until we see a material change in the outlook. On the data front, the US will report inflation data along with retail sales -- both of which will be an essential update on the shape of the US economy. The ECB will meet on Thursday, and it will be the first meeting under Christine Lagarde. Although no change in policy is expected and the underlying economy hasn't changed much, market participants will still be watching to see if there are any changes to forward guidance. The recent decent among governing council members have impacted market pricing, with markets no longer pricing in rate cuts into the next year. Meanwhile, in the UK, general elections will be held on Thursday. Polls will close at 5 PM EST, and markets have priced in a positive outcome, which should result in Johnson getting his Brexit deal passed by the January 31 deadline next year. Analysts covering the UK will have an even busier week with the UK reporting GDP, trade numbers, and construction output. The recent data has been coming in soft as uncertainty surrounding Brexit has weighed on the consumer and businesses. Indeed, markets still show some probability of easing from the Bank of England next year, but, of course, that will depend on how Brexit unfolds. Trade news will be the primary driver in markets, especially considering the speculation that President Trump's trade policy becomes more volatile when the stock market reaches new highs. Given that there is little risk of a hawkish Fed (because of muted inflation), the President may very well choose to push the envelope with Beijing. The consensus remains that a phase on a deal will be signed if not this year, then early next year. The December 15 planned escalation will likely be pushed off. 

Tiago Figueiredo