After hearing Fed President Eric Rosengren yesterday afternoon again giving his support for allowing the balance sheet to “start the roll off now” as “we’re basically at our employment mandate and we’re basically at our inflation mandate. So ideally we don’t have to manipulate the yield curve” as he joins a growing line of Fed members that are supportive of reducing the size of their balance sheet, I realized one word has been missing from all of their comments on this important issue. We’ve heard ‘shrinking/trimming the balance sheet’, allowing it to ‘roll off’, and ‘gradually removing accommodation’. We haven’t heard that this is another form of ‘tightening.’ I’m thus going to call it what it is, Quantitative Tightening, QT. No more shrinkage comments from me which I know you thought of that Seinfeld episode when you did.
While the fed funds futures market has reduced the odds of a June hike to about 50%, nothing tells me that the Fed wants to back off from moving again in June. I mean if they’re talking persistently about QT and that won’t start after more rate hikes, then we’ll get more rate hikes. Voting member Robert Kaplan today says because he expects a GDP pickup in Q2, he still sees two more hikes. But data dependency hasn’t gone away as he also said they can slow that down if the economy softens, and vice versa. Thus, 2 more hikes this year is his “baseline” scenario. By the way, Kaplan referred to QT as ‘balance sheet unwind.’
The French CAC index is leading the rally in Europe (outside of the UK on the pound strength) after a poll today saw Emmanuel Macron’s lead rise by 1 pt to 25% vs Le Pen at 22% and with Fillon and Melenchon both at 19%. The euro is also benefiting with it trading at $1.075. The German-French 10 yr yield spread is narrower by 2 bps at 73 bps but still remains much wider than it was just 3 weeks ago at 60 bps. It’s interesting times with this group of candidates where we have a communist, a xenophobe, a Reagan like figure and a socialist that acts like a centrist.
German PPI in March was flat m/o/m vs the estimate of up .2% but the y/o/y gain of 3.1% held steady at the quickest pace since December 2011. The m/o/m change in energy is beginning to soften but remains higher by 4.5% y/o/y which also will soon start to flatten out. Price pressures though were evident in two other categories including basic goods (up 3.9% y/o/y) and non durable goods prices (up 2.7% y/o/y). Capital and durable goods prices, as seen in the US, were up modestly, around 1%. It’s amazing how fast markets have gone off the Trump ‘reflation’ trade. I must make the point again that the commodity bear market for industrial material prices ended in mid January 2016, 10 months before the presidential election. The 5 yr 5 yr euro inflation swap sits at 1.60%, 20 bps from the peak in January but still well off the low last year of 1.25%.
While the US had a mild winter, so did Europe and that, in addition to cheap financing, sent construction in the eurozone to a 6.9% m/o/m and 7.1% y/o/y jump, the most since early 2012. Looking y/o/y, German construction spiked 11.6%, France by 9.3% and Spain by 5.4%. Italian activity remained anemic though with a rise of 1.6% and it fell in the UK as real estate in London cools.
We got more confirmation that global trade has stabilized after seeing the Japanese trade data. Exports rose 12% y/o/y, double the estimate which is the fastest pace of gain since January 2015. On a merchandise volume basis, exports were higher by 6.6% y/o/y with particular strength in exports to China. Exports to the US rose 4.5% but were flat y/o/y to the EU. Overall merchandise volume exports is at the highest since March 2012. Imports jumped by 15.8% y/o/y vs the estimate of up 10%. This improving data point joins a slew of other Asian trade numbers over the past few months that reflects a recovery after a few challenging years of soft global trade. With the yen still sitting near the highest level in 5 months, the Nikkei was flat overnight and is down 3.6% ytd, the worst major market performance.
After being positive for a few years on Japanese stocks since Abe won his 2nd term, I really struggle with an opinion on them now. I like the growing ROE for corporate Japan, the improved earnings and the better acknowledgement of shareholder returns but the BoJ is in the midst of a slow creep of nationalizing the stock market with its continued ETF purchases. Also, this market is one giant bet on the direction of the yen.
For more of my views on various currencies see the ideas page (members only)