Running the US economy ‘hot’ could boost real wages and labour’s share of income, Absolute Strategy Research argues on April 30. This could squeeze smaller firms, which are already complaining about rising labour costs. These firms might slow hiring and capex as their margins and cashflow come under pressure. In the medium term, wage inflation has the potential to increase credit risks at smaller firms and reinforce consolidation. With corporate leverage being highest among smaller companies, credit risk could continue to rise, even if a ‘Goldilocks-type’ environment
As ever, Russell Napier of the Solid Ground, succinctly points out the risks in global markets to his readers in his latest fortnightly newsletter. In this edition he turns his attention to Europe, China and the broader EM markets. On Italy, Napier argues that while still in a poor state of health, it may not be faring as badly as other economies in Europe. He cites the deleveraging efforts, particularly in the private sector that is offsetting the marginal misses by the government on fiscal policy, but growth will continue to be sluggish as it battles with an uncompetitive exchange rate. While the country deleverages, the same can’t be said for France, where the non-financial debt-to-GDP ration now stands near an all time high of 314% of GDP (Italy’s at 253% of GDP and falling). He wonders why the market has placed such a big emphasis on Italy when a country like France, also struggles with sluggish growth but where leverage is heading in the opposite direction. Turning to emerging markets, Napier observes the latest trade volume data from the CPM World Trade Monitor, which shows that trade volumes year-on-year are showing the largest contraction since 2009. This is particularly problematic for EM economies, which after significant currency depreciation in 2018 one may have expected some uplift. It’s been a dead cat bounce. Turning to China specifically, Napier says that markets seemed to have swallowed the narrative that policy makers have/are successfully reflating the economy, yet effectively quantitative tightening is taking place. The PBoC’s balance sheet declined 6.4% in Q1 19, and while there maybe other tools in the toolbox, Napier reckons that a managed exchange rate makes it problematic to further ease liquidity and boost growth by other means. The full note is available for free, all you need to do is register on the ERIC Platform to gain access.
Can the Eurozone face its economic demons? It can only but try, writes Vincent Deluard from INTL FC Stone, who has a gift for catchy headlines and a fresh way of looking at old problems. He first highlights the underperformance of the European equity market over the past decade, highlighting the bias towards low-multiple stocks, a lack of technology champions and the near decimation of the banking sector. But the underperformance is more than just the sum of these 3 factors, he says. Poor growth dynamics are at its core and Germany’s export-led policy has in the end proved to be folly, says Deluard, when one looks at export/GDP ratios for the real truth. Can Europe mend the error of its ways? Deluard suggests that it can, and this year’s European elections may be a catalyst for increased urgency in addressing the economic malaise.
Writing this note ahead of yesterday’s PMI’s PRC Macro’s William Hess argued that the next run of PMIs and macro data starting should provide a clearer view of the underlying state of final demand and real sector activity. Hess correctly pointed out that PMI data out would help confirm the extent to which the March data was distorted by pre-VAT cut manoeuvering. Their survey of high frequency data indicated that the next prints should fall back but not collapse. And then soon enough, the data for May will be subject to new distortions courtesy of PM Li and the State Council, after they extended the May 1 holiday for a couple of extra days to boost domestic consumption. PRC Macro continue to expect the next couple of months of data to average out to a shallower recovery than was evident in March, and this is something that equity markets appear to be pricing in. Longer-term, they think Beijing is resigned to decreasing marginal returns in terms of growth and increasing marginal returns in terms of financial risk from aggressive stimulus. With fiscal burdens rising rapidly, however, this does not preclude efforts to contain further increases to fiscal borrowing costs broadly defined, something that will become easier to do if and when the Fed actually starts cutting, they say. This points to a favourable entry point to get long China duration.
Neil Azous of Rareview Macro sticks with the opposite FX trade to SG – in this note published Monday, ahead of yesterday’s EZ GDP data – arguing the record short positioning has some justification, and the key question to his mind is what will be the impetus – for those positioned with a head start – to press their bets or what brings in new entrants to expand the breadth of this position. He lines up a series of factors that could drive the Euro lower this week. These include the US dollar smile theory, technicals, seasonality, and Turkish lira. On the dollar smile, Azous cites Nordea’s smile curve here. All the action is on the left, and it’s not moving down. On the technicals, Azous cites the break of the multi-year descending triangle on the weeklies, on seasonality, May is the weakest month. and the EUR/USD on average over the last nine years has fallen 2.74% in this month, and finally, Turkey could represent the killer punch. Azous thinks that if USD/TRY reaches an acceleration point that takes the currency cross above 6.00, the risks of contagion into European equities rise. That is, European financials lead corporate credit spreads to widen from very tight levels, and the euro weakens in response.
While yesterday’s stronger eurozone 1Q GDP may have been a surprise to many, it was not for SG, who in a note to clients late last week wrote that they expected 0.5% for the quarter, so they weren’t far off the actual of 0.4%. SG fear clients are still bearish on the euro growth outlook and are not positioned appropriately for the the upturn. That’s because the focus has been on the survey data, the PMIs as a case in point, which have continued to paint a bleak picture. Meanwhile, the hard data has proven strong. And looking ahead, SG’s fundamental analysis suggests that growth will remain firm this year. In terms of positioning, FX appears most sensitive, say SG. Anything that triggers a shift in growth expectations will clearly have a significant impact on the currency. With inflation failing to rise much vs the central bank target, economists believe that any positive data will only support the ECB baseline scenario and thus reduce the need for dovish measures. Hence, bond markets are not likely to sharply reprice ECB monetary policy. But a sustainable rebound in growth could cause the recent rally to fade, help peripherals and raise inflation expectations, also leading to some steepening of the short end of the yield curve. In contrast, credit and equity markets seem to be better positioned. SG’s equity strategists recommend being selective when playing the eurozone recovery by being long on small caps, Europeans autos and some selected stock baskets.
Today, a kind of hush seems to have fallen over bond markets around the world as investors are falling in love with bonds again. Yields have remained remarkably subdued despite mounting government deficits in the US, Europe, Japan, China, and almost everywhere else. That’s because there’s a kind of hush all over the world about inflation, argues Ed Yardeni from Yardeni Research. It’s hard to worry about a problem that has remained a no-show for so many years, he adds. The bond markets continue to confirm that subdued inflation is having a much greater bullish impact on bond prices than is the bearish impact of rising government debt. Of course, says Yardeni, subdued inflation is also keeping the monetary policies of the major central banks on the easing side. Yardeni then goes onto look at the TIPs market, concluding that it is an imperfect measure of “the” real interest rate. Here he offers a few more thoughts on the “meaning” of the yield spread between the 10-year and TIPS bonds. Yardeni says that since 2003, the 10-year inflation spread has been relatively stable, averaging out the volatility in the actual CPI inflation rate, which is mostly attributable to the price of oil. This suggests that the spread is in fact a good measure of expected inflation over the next 10 years. Secondly, the spread between the actual CPI inflation rate and the 10-year expected inflation rate is highly correlated with the price of oil. All of the above suggests, concludes Yardeni, that inflationary expectations tend to be fairly steady in the short term because they only partially discount the inflationary consequences of short-term swings in the price of oil. When forming their inflationary expectations, investors have learned that big increases (decreases) in the price of oil are always followed by big decreases (increases).
Recognition of the rebound in crude oil prices was the main driver of higher headline inflation in March, with a notable boost to food prices outside Europe, say Economic Perspectives, who produce comprehensive heat maps on global inflation each month. While other traded goods prices, such as clothing and leisure goods, remain subdued in the wake of China’s supply chain convulsion, housing inflation is gaining ground in the Eurozone. In relation to oil prices, EP say the fall in crude oil prices through late-2018 has begun to wash out of the inflation rates with half of their sample seeing rises in energy inflation on an annual basis. Brent has since recovered to US$74/barrel, but expect annual comparisons to remain muted over the summer, Ep says in this report.
A generational shift is set to be the key to reawakening dormant inflation, INTL FC Stone argues in April. US baby boomers who own the bulk of the national wealth have imposed deflationary policy, the piece argues, but they will be displaced by the millennials who have a completely different set of interests. A debt-ridden generation with few assets has already understood that it can only benefit from an “inflationary debt jubilee” – and this is reflected in their political preferences. Costly renewable energy and a labour market that is tighter than the Fed thinks will help to stoke inflationary pressures.
Oil’s bark is worse than its bite when it come to prospects for inflation and global growth, Cornerstone says in a April 24 report. It can take years for higher oil prices to crimp global economic activity, the piece argues. Today, the increase in oil is not enough to offset the lagged impact of China’s massive stimulus, and the concurrent easing of global financial conditions. Even the unlikely, worst case scenario of oil going to $100 and staying there would have only a small impact on 2021 global growth, Cornerstone says. As for inflation, Cornerstone’s regression analysis calculates that the expected run-up in oil will probably lift Global CPI year-on-year by only 0.30 percentage points in the 4Q of 2019, to 2.0% year-on-year. A jump to $100 dollar oil by year-end (a 46% increase year-on-year, would add 0.90 percentage points to the base-case CPI estimate.