Job Insurance

July 7, 2019 – Weekly Comment

“President Trump was unhappy about the interest rate and he expressed his discontent at every chance.  The bank’s decision to keep rates constant added to the problem with Powell,” a senior gov’t official told Reuters.

That’s a direct quote from a Reuters piece on July 5.  Except for the fact that I changed the names.  It’s not President Trump, but President Erdogan.  And it’s not Powell, it’s Cetinkaya.  The title of the article is ‘Turkey fires central bank chief as policy differences deepen amid economic malaise’.  Murat Cetinkaya was, of course, the CB head, who reminded Erdogan of the bank’s independence and declined the invitation to resign just prior to being sacked.  The same story played out in India last year, as CB head Urjit Patel resigned at the end of 2018 under government pressure.  Easy money and a subservient CB solves everything, right?

It was a year ago that the Turkish Lira collapsed from 4.5 to 7.0 to the dollar, from the beginning of July to the beginning of August.  Cetinkaya hiked a total of 750 bps and has kept the rate at 24% since September. TRY is now 5.6.  Maybe Erdogan has a point. Trump on the other hand…

Like the markets, I have become comfortably numb to random tweets. I have to admit though, that  Trump’s doozy about matching the currency manipulation game of Europe and China left me slack-jawed.  Markets didn’t react at all.  The president is calling for the devaluation of the currency and rate cuts.  This week Powell will provide more information on the rate side of the equation while Mnuchin, ostensibly in charge of USD policy, squirms on the sidelines. 

The jobs report was stronger than expected with NFP of 224k though annual wage gains of 3.1% were a shade softer than expected.  As a result, thoughts of a 50 bp cut in July were dashed.  August Fed Funds settled 9786.5, down 6.5 bps and 25.5 bps above July, which settled 9761.0.  So the market is now priced for one cut at the end of the month FOMC.  The Fed Effective rate has been from 2.37 to 2.40%.  Trading a few bps on either side of 25 makes sense.  The curve flattened as the red euro$ pack fell 12.75 bps, while greens fell 9.875 and blues 8.25.  2/10 treasury spread posted a new recent low of 17.1, falling 1.8 on the day and 8.8 on the week.  It’s the curve, which is signaling a ‘tight’ central bank, that provides cover for a rate cut.

Also on Friday, the Fed released the semi-annual report to Congress, in front of Powell’s testimony on Wednesday and Thursday.  From the way the short end was trading early in the morning, I think some details of the report likely leaked before its official 11:00 am release.  Shall we characterize the upcoming ease as an “insurance cut” or the start of a prolonged campaign?  The document provides some clues.  The shortfall in inflation was once again viewed as transitory.  The report refers to the Dallas Fed’s trimmed mean PCE inflation data.  From that chart, pictured below from the St Louis Fed, one would conclude that there is NO problem at all with the inflation target.   It has moved sideways since 2015 with a small upward bias.   From the text, “The trimmed mean PCE price index, produced by the FRB of Dallas, provides an alternative way to purge inflation of transitory influences, and it is less sensitive than the core index to idiosyncratic price movements such as those noted earlier.” 

The case for easing is even less compelling with respect to labor markets.  The last twelve-month NFP average ending with Friday’s data is 192k.  Over the year ending in June 2018, it was 206k. The previous year was 195k and the year ending in 2016 was 206k.  There’s just not much in the way of variation.  The Atanta Fed’s Wage Tracker has generally firmed since 2010, and has bounced between +2.9 and +3.9% since 2015, and is last at 3.7%.  

Here’s where the semi-annual report implicitly makes the case for insurance cuts: “The [Q2} slowing that occurred in consumer spending appears to have been temporary, but the slowing in business fixed investment appears to be more persistent.”  Further,  “…forward-looking indicators of business spending such as capital spending plans have deteriorated amid downbeat business sentiment and profit expectations from industry analysts, reportedly reflecting trade tensions and concerns about global growth.”  Morgan Stanley’s index of planned capex fell to the lowest level in two years, and S&P cut its forecast for capex growth to 3% in 2019 from 11% in 2018.   

In essence, the Fed is likely to lean towards the idea of a couple of insurance cuts, called for by Trump, but circularly made necessary by his trade policies that have undermined business confidence and spending plans.  China’s insistence that existing tariffs will have to be removed if there is to be a deal (July 4) indicate a long slog ahead on trade.   

This week’s news will be dominated by Chairman Powell’s Congressional testimony on Wednesday and Thursday, but he also speaks at 8:45 on Tuesday morning regarding Stress testing.   FOMC minutes out on Wednesday afternoon.  Inflation data at the end of the week, with CPI Thursday, expected yoy Core 2.0% and PPI Friday with yoy Core 2.1%.      

OTHER MARKET/TRADE THOUGHTS

Mester last week made the case for no ease.  Kaplan is also concerned that easing may accentuate imbalances.  However, Bullard and Kashkari are inclined to ease immediately.  Powell will likely walk the center line and again refer to “an ounce of prevention.”  Nothing in ISM pricing data suggests an upside surprise in CPI or PPI data.  The adjustments made in prices of rate futures after the employment data are therefore probably a short term anchor.  The dollar index surged Friday and is now in the upper half of the year’s range.  A rally to new highs would signal stress for EM, but for now, it’s not much of a concern.  On the other hand. Lagarde as ECB head probably portends a move in EUR to 1.05 to 1.10.   

The treasury auctions 3’s, 10’s and 30’s starting Tuesday.  USU made a new high on Friday and then posted a large outside range.  While 5/30 fell this week along with almost all other curve measures, it still is in an uptrend.  5/30 declined 3 bps Friday to 70.7, and was down 6.5 on the week.  Worth looking to sell rallies in USU against new highs. 

In spite of Friday’s move there are still buyers of the idea that rates will approach zero next year.  On Friday an additional 70k 0EM 9925/9975 c 1×2 bought.  Settled 3.25 vs 9834.0 in EDM21.  This trade has also been sizably accumulated in 0EH, settled 2.0 vs 9835.0.  Open interest in March is 308k and 380k, and in June 146k and 248k. 

6/28/2019 7/5/2019 chg
UST 2Y 173.9 187.1 13.2
UST 5Y 175.5 183.9 8.4
UST 10Y 199.8 204.2 4.4
UST 30Y 252.7 254.6 1.9
GERM 2Y -75.0 -74.9 0.1
GERM 10Y -32.7 -36.3 -3.6
JPN 30Y 35.4 33.4 -2.0
EURO$ Z9/Z0 -35.5 -36.5 -1.0
EURO$ Z0/Z1 6.0 -0.5 -6.5
EUR 113.72 112.26 -1.46
CRUDE (1st cont) 58.47 57.51 -0.96
SPX 2941.76 2990.41 48.65
VIX 15.08 13.28 -1.80

https://www.reuters.com/article/us-turkey-cenbank-governor/turkey-fires-central-bank-chief-as-policy-differences-deepen-amid-economic-malaise-idUSKCN1U1032

Posted on July 7, 2019 at 3:58 pm by alexmanzara · Permalink
In: Eurodollar Options

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