3 charts, 3 stories

The chart:  German harmonized inflation

                               source: inflation.eu

The story:  The flash estimate of German HICP surprised to the downside yesterday, dipping into negative territory once again.   The risks to today's Eurozone figure therefore look comfortably skewed to the downside of the consensus expectation of flat y/y.  Now, a lot of this reading still captures the base effects of oil; it's easy to forget that Brent (in dollar terms, at least) is down 50% from its levels of a year ago.  Come the beginning of next year, the bulk of that base effect will drop out and German/European inflation will gradually trend higher (excepting a further 50% collapse in oil, of course.)

That having been said, it does look increasingly likely that Draghi will have another go at the tide of disinflation, ordering it to recede.  Perhaps we'll need to wait for December's forecast round or even early next year, but more easing (be it a further depo rate cut or more QE) looks to be in the pipeline at sometime, even if its difficult to have any confidence whatsoever that it will work.

In any event, the euribor market is willing to buy into the story, even if Eurozone equities are not.  (Though it may be the case that the latter has been suborned by too much length and more stories of automotive malfeasance.)  Yesterday saw a roaring trade in upside euribor option strategies; even though ERM6 has just a 17 tick range over the last six months, a large number of call flies went through yesterday requiring a further 17 tick move to hit max payout (and a 7 tick move to hit the at expiry breakeven.)  OK, at 2 ticks these structures aren't going to break the bank, but Macro Man does find it interesting to see the sudden uptick in volume in a market that he's kind of had on auto-ignore for some time now.

The chart:  USD/CNH

The story:  Remember that time 6-7 weeks ago when USD/CNH was going straight to the moon and taking USD/CNY with it, etc.?   Well, a funny thing happened on the way to the meltdown....it didn't happen, at least not yet.   While Macro Man has had a more constructive (or at least, less destructive) view on the RMB in its various guises than most commentators, he doesn't think the resilience of the CNH represents any sort of vindication other than a very short term one.

Much of the price action on the way down in USD/CNH over recent weeks has been characteristic of official selling; as a general rule of thumb, it's not very surprising that something goes down when a seller with a $3.5 trillion war chest lets a few go.  Then again, recent scuttlebutt is that the last few days' weakness is due to month-end flows rather than PBOC selling.  That, of course, serves as a timely reminder that China manages to generate a hell of a lot of foreign exchange revenues through international trade; this is a prime example of how it can offset capital account outflows. 

All this having been said, now that the CNH and CNY have come together (CNH is actually trading slightly stronger than CNY for the first time in a while), things could get interesting.  There has been a school of thought that the Chinese authorities wanted to harmonize the market pricing of on- and off-shore RMB before unleashing the full fury of the market mechanism (what with its 2% daily trading band.)  Well, now they've done it, so if the RMB were going to become more of a float than a peg, it could and should happen soon.   Stay tuned.

The chart:  The S&P 500 in 2003-2004

The story:  Observe how in the run-up to the first rate hike of the previous cycle (marked by the black arrow for you under-30's), the SPX whipped around in a range for 6 months after the Fed first hinted that something was rumbling.  Granted, that range was a lot tighter than the one we've been mapping out over the past few weeks...but then again, it wasn't as tight as the one the SPX had traced out for the six months prior to the August swoon.

In any event, equities actually rallied towards their highs in the run-up to the first rate hike...only to sell off to fresh lows immediately afterwards.   At the time, there was plenty of commentary that the Fed would only be able to manage a few hikes before having to pause and possibly reverse.  In any event, once it became apparent that the US economy was not, in fact, going to collapse, Spooz recovered...before going on a rip-snorting rally into year end.

Now obviously, the analogue is not perfect.   There is no housing bubble to spur (unsustainable) consumption growth, and today's credit cycle is much more mature, as holders of Glencore and other commodity-based paper can ruefully attest.  Nonetheless, from a market psychology point of view, the precedent of the last cycle may prove to be a useful one.  After all, history may not repeat, but it often rhymes. As such, from current levels Macro Man finds prognostications of an imminent meltdown  or melt-up equally unconvincing.   Once the rate hike happens (if it does) and a month or two pass without the data rolling over....it will be a lot easier to argue a bull case for reasons other than short-term mean reversion.