Taking stock of inventories

Another day, another new low in the euro.  Given the potential monetary fireworks that are driving the decline in EUR/USD (ECB QE!  Rate hike in the US!), the move has seemed strangely quiet.  The price action doesn't really seem consistent with large positions being put on...perhaps punters are reticent ahead of Friday's payroll figure.   Well, either that or they're just selling gold and buying bitcoin.  (That's a jest, of course...the daily volume in Bitcoin is equivalent to one modestly-sized FX ticket from a professional punter.)

Regardless, EUR/USD has broken down, and a fair amount of the volume that has gone through is probably from CTAs.   After largely stopping out of shorts (and perhaps flipping to long) over the summer, key thresholds have been breached to trigger model sell signals.

Yesterday also saw Janet Yellen re-iterate that if the economy performs well enough, the Fed will probably lift-off in December.   That's a bit like saying that if West Ham performs well enough, they might qualify for European competition next year; the proof, as the saying goes, will be in the pudding.

Yellen also made some remarks wherein she refused to rubbish the notion of negative interest rates, suggesting that it could spur bank lending.   One wonders if she has ever met Elizabeth Warren.  The lowlight of the testimony came when some congressman claimed that God wanted the Fed to wait until spring before raising rates.  It's hard to know if he was serious; either way, the comment was a total joke.

Anyhow, with fixed income continuing to roll over the 2nd vs 10th eurodollar calendar spread mentioned here a few weeks ago keeps on trucking.  It's now up 16 ticks since Macro Man first highlighted it, breaking its downtrend from the summer in the process.  Somewhere between 120 and 125 is where it's probably time to start letting a few go.

Yesterday also saw an excellent service PMI release which crushed expectations.  Did you know that this is the second largest gap between the services and manufacturing PMIs since the former survey began in 1997?  Macro Man performed a cursory analysis of the gap and could find no obvious signal for either future growth or market direction, so at this juncture it's just a statistical curiosity.  The composite ISM, meanwhile, remains in territory consistent with solid economic growth.

Obviously high frequency growth can deviate quite a bit from levels suggested by a blunt instrument such as the composite ISM, not least because of factors such as trade and inventories.  Speaking of which, US trade data was also released yesterday; the balance was largely in line, with both exports and imports declining modestly y/y.   While this might seem disappointing, the US actually doesn't look too bad in comparison with many other nations.

As for inventories, it's well known that the inventory to sales ratio has increased steadily over the past few years to levels last seen in the aftermath of the crisis.   It's hard to pin it just on things like oil; I/S ratios have increased across all three sectors tracked by the Census Bureau.

Macro Man is a big believer in the inventory cycle, so this is obviously cause for concern.  Yet the extent of the rise has been so big, dwarfing rises observed in several prior recessions, that it leads Macro Man to wonder if there is something else going on.   I/S ratios put in a secular decline for nearly two decades before the crisis, reflecting the improved information provided by the Internet and enterprise software, etc.  Perhaps firms found that inventories on the lows were just too lean?   It's hard to say, especially given the abrupt collapse in demand engendered by the crisis.   If any readers have a plausible explanation beyond "it's all a Ponzi scheme, innit", Macro Man would be glad to hear it.

As a sense check, he broke out one of his favourite indicators that he hadn't looked at in a few years, the production/inventory scatter.   This indicator generally does a nice job of capturing the economic cycle and providing insight into where we are; an expansion resides in the top-right corner, and the cycle typically progresses counter-clockwise.  Although the US is currently in expansion territory (Q3 is in red), it was flirting with a slowdown earlier this year.

Ultimately, the inventory cycle is likely to determine whether the Fed's decision on potential lift-off will be the right one.   Like so many other things in ZIRP-world, however, the fate of the cycle is not so clear cut.   Perhaps Rep. Sherman could ask God if he has a clue?