Thursday, July 12, 2012
It's one of those times when so many different things are happening with no clear direction that a brain dump is required. So today, TMM are going to think about what is going on and ask some questions that we hope to find the answer to over the coming week. So without delay...
First, it's pretty clear that the past couple of months have seen a material slowdown in the data globally - especially in Europe, but also to a material degree in the US, and now Asia. Why has this come about and to what degree might we expect a reversal? Or has the World already entered a dreaded Global Recession? As many have commented, the degree to which we have followed the 2010/2011 playbook this year is remarkable, but in contrast to those years, this has been the consensus view in the macro community, stemming partially from the X-12 2008/9 seasonal echo effects. Thus, shorts in risk assets & longs in the Dollar have been widely held, so while the PhDs have been caught out (see CESIUSD...), it's not entirely obvious that this expectation was not in the market already.
Of course, we cannot blame seasonals for everything, given the ISM surveys have been adjusted for this effect and it is pretty clear that activity has slowed. But that is only half the picture, as the service PMIs globally are not in such a poor state. It kind of appears to TMM that in line with constant fears of a repeat of 2008 that inventory liquidation has been particularly dramatic over the past several months, and the inventory cycle can have material impact upon growth (TMM would note that historically, mild recessions are usually the product of a sharp inventory cycle as it is pretty difficult to get the US consumer to stop spending - 1981 and 2008 are the exception...). So if the services side isn't quite as bad (at least outside Europe), then it could be argued that things are perhaps not as bad as they seem at first sight. Indeed, even using TMM's back of the envelope year ahead ISM-based forecast model would have consensus economists looking for about 1.5% in the US over the next year. Mathematically it is unrealistic for the World to be in recession if the US is not. But that is not to say the deterioration will not continue...
...So is it a case of "2010/2011 Again", in which case, the recent bottoming of US Economic Surprises will soon be followed by a turn back up in the data, and this has just been another inventory cycle laid upon the Eurobllx? Evidence in favour here would be the high frequency data like Initial Claims & Rasmussen Confidence. If the deterioration continues, then growth-related assets have a long way to fall. Don'tcha just hate those binary scenarios...?
Hmm... So if claims & confidence appear to have turned for the better, does that mean the consumer is back? TMM suppose a lot of this is related to Oil, which took quite a tumble last quarter and has evidently lowered gas prices and thus in tandem with the disinflation of recent months fuelled real income growth. The consistent growth in consumer credit (and not just student loans) perhaps supports this theory and thus consumer is replacing capex as the driver of final demand? This is something that would be pretty significant. Of course, confidence is a fickle thing, and if the labour market truly is deteriorating to the degree that Payrolls suggest, then this tentative consumer recover could quickly fizzle. TMM will take a closer look at Oil and the consumer next week.
The degree to which earnings expectations have been revised lower over the past month is dramatic, with flat growth seen. Now, TMM's model (more in the coming days) has about 5% YoY EPS growth for SPX, but that does not include Libor-fixing related fines which can clearly make a big dent in the numbers. And it also implies that Q3 will see flat YoY growth, which isn't exactly fantastic news... But given TMM are not micro-focused, they will decline to offer an opinion here. The worries around Asian growth have too been cited as quite a big contributor to weakness in many of the international names, but TMM do get the impression that given the poor guidance provided so far and the de-rating undergone, that there is probably an exceptionally low bar for the earnings season now.
Europe? TMM once again find themselves utterly disinterested, as the A-Team appear to have engineered at least some demand for carry with banks bidding negative rates in EUR. As the Squid pointed out yesterday, this is the first time that institutions have been faced with depositing EUR cash at negative rates and the effect of this is uncertain. Maybe it will keep going negative as most stick with the safety of Schatz, or maybe some funds will increase the amount of risk they are going to take. Either way, it is clear that this has pulled short dated periphery rates lower and that has to be a good thing in terms of financial conditions. What it means for the Euro is perhaps less clear. It is notable that peripheral bonds appear to have disconnected from risk assets more broadly the past week or so - what that means is also not clear. Perhaps short covering, perhaps related to the summit, perhaps related to negative rates. TMM do not know. But it does seem as though the Eurostriches may opt for the STFU strategy this summer in the absence of further progress nor the German Constitutional Court Ruling.
Does that mean that the Euro-funded carry trade can progress without obstacle?
TMM suppose that with the can kicked for perhaps a month or two in Europe that this depends entirely on the outlook for QE3. And on this front, the three months of poor payrolls coupled with a sub-50 ISM probably mean that this is forthcoming, despite the argument perpetuated by many that they have not quite been "poor" enough for the Fed to move to ease. TMM accept that this is a valid point, and to that one could also argue that 5y5y breakevens are also not in the region of where the Fed typically acts, and neither have equity prices fallen to such a degree either.
The trouble with this view, in TMM's eyes, is that historically - at least since the early-1990s (and probably before, but TMM couldn't be bothered to check) - there has only been one occasion where ISM moved below 50 when the Fed have not eased. And that occasion was December 2006. TMM would guess that if challenged, Chairman Bernanke and the rest of the committee would probably agree that they *should* have eased then, in hindsight. It is also worth noting that in contrast to last summer, when the Fed merely twisted, that Europe is in deep recession, partially driven by last summer's dramatic tightening of financial conditions. Most observers would probably agree that the Fed under Bernanke tends to out-Dove the market. And it is hard to avoid the conclusion that three months of poor data equals a trend. And TMM also think the committee are unlikely to be influenced by the upcoming election (the 2008 election did not stop them from acting, though TMM accept that that was a time of crisis), given that preventing labour market deterioration is part of their mandate. As a result, TMM reckon the Chairman will use next week's Humphrey-Hawkins Testimony (or whatever it's called these days) to hint that QE3 is coming or at the very least, the conditions for which QE3 will be enacted. August is probably too early, so TMM are thinking September is the likely time. Which means the rest of the summer is potentially set up to be a large "sell the Dollar vs. risk" trade. But that is obviously dependent upon Bernanke's testimony and/or the FOMC statement at the beginning of August.
The alternative scenario is that there is nothing specific from Bernanke and then markets begin to probe where the Bernanke Put is struck and/or the tug between data strength and data weakness that *will* trigger QE3 leads to a choppy several weeks as the QE3 undercurrent runs through markets. We also should probably address the possibility that policy is impotent... TMM are not really ready to go down that road yet, but also not sure which of the above scenarios is most likely.
So... plenty of questions:
1) Are we headed for global recession?
2) Have growth & earnings expectations been lowered enough yet?
3) What is going on with the consumer?
4) When will the inventory cycle turn?
5) Have European rates markets moved onto the complex plane?
6) Is Asian growth about to tank? What about monetary policy? Does it matter?
7) Has Europe done enough to get through the summer?
8) Is QE3 coming and if so, when?
9) Will the Euro-funded carry trade continue or is the Dollar about to get smoked?
10) When will the Debt Ceiling debacle kick off again?
We hope to tackle these questions in the next few posts.