May 21 weekly – Economy Clouded Even Before Political Risks

Last week I quoted Ben Hunt of Epsilon Theory: “…how is it possible that our capital markets are not similarly gripped by volatility and stress? What is responsible for breaking the transmission mechanism from political risk to market risk?”  It was a timely question.

Political uncertainties have now spilled over into markets, and the possibility of further volatility and stress has increased.  This week potential Comey news will overshadow all else (with CNN reporting this weekend that Comey now believes Trump was trying to influence him).

On Wednesday, the FOMC minutes from May will be released, which will perhaps contain information about Balance Sheet Adjustment plans.  There are Fed speakers in the early part of the week, including Lael Brainard on Monday evening.  Brainard doesn’t appear as frequently as some Fed officials, and had previously been a consistently eloquent voice for the dovish argument.  However, in early March she was more upbeat, though still repeating that removal of accommodation should be gradual.  She also said she favored a subordination strategy, “…that would prioritize the federal funds rate as the sole active tool away from the effective lower bound, effectively subordinating the balance sheet.”

Now I am just going to cite a couple of news stories and tie them into markets.  This isn’t meant to be a comprehensive view of the news, however, the markets supposedly ARE comprehensive, incorporating all information, and I’ll follow up with a couple of market notes.

First, from Reuters: “U.S. states collected less personal income tax revenue in April than they did a year earlier, a Reuters analysis shows, and analysts said they believed high earners were shifting income to next year, hoping for tax cuts from the federal government.  State personal income tax (PIT) revenue dropped an average of 6.6 percent in April from the same month last year in the 27 states for which Reuters has data.”

A drop of 6.6% is large, even if the conclusion of an income shift into next year is correct.

Second, a Bloomberg article highlights declining real estate deals.  “In New York City, first-quarter property sales plummeted 58 percent, to $4.3 billion, compared with a year earlier, according to data from brokerage Cushman & Wakefield Inc. It marked the lowest quarterly sales volume in six years. Nationwide, the picture wasn’t much better. Sales dropped 18 percent, research firm Real Capital Analytics Inc. found.”

A drop of 18% across the country.  Hard to ignore.  When deals decline, prices follow.  A ZeroHedge article attributes a part of this fall to Chinese capital controls which were instituted at the beginning of this year.  I don’t know how to weigh this factor, but what I do know is that even without Trump’s issues, the goal of reaching 3% growth in the US appears to be a tall order, given some of the deterioration we’re seeing, if only on an anecdotal basis.  If stocks slump, it will be impossible.

The political environment now looms much larger.  The response of the Fed will also be key.  Many markets obviously had huge moves after the November election, and have either stalled or else completely reversed those moves.  The dollar index closed the week at the low of the calendar year.  It has reversed the election rally, which topped at the very start of the year, and is now around the average level of 2015 and 2016.  The Euro closed at its high, just above 112, having shaken off populism risks.  The Daily Shot notes that the 3m 25 delta risk reversal in EURUSD now slightly favors calls!

The US curve has flattened to new lows, with 2/10 ending the week at just 97 bps.  This is down nearly 40 bps from the high posted in December following the euphoria post-election.  I have previously mentioned the round-trip of inflation measures such as the ten year treasury to tip spread, now around the year’s low of 180, having been holding above 2% for the first couple of months of the year.  The 5y5y inflation forward swap tells the same story.

I include below a chart of China’s 5/10 gov’t bond spread, which has inverted.  I suppose that the interesting thing to note here was that the aftermath of the US taper tantrum in 2013 led to a high in China’s rates as well as the US, but at that time China’s curve did not invert.  Now, with Chinese rates at a much lower level, the China curve IS inverting as financial conditions have tightened.  This fits the ZH Commercial RE story.  Fed officials have warned about frothy valuations in US CRE.  Perhaps THAT asset ‘bubble’ bursts as a result of China’s financial policies.

It’s a bit hard to see on this chart, but 5’s and 10’s are essentially the same yield, 3.65 and 3.63.  In 2013 China’s 10 hit 4.75.  The difference between the two yields is in the lower panel. 

The Trump/Comey situation is going to drag along, and drag down the odds of instituting important parts of the economic agenda.  I think new rules on student loan debts are also going to be a negative for the economy at the margin.  (One company being chosen for collections, with increased fees).

The Fed leans towards removal of accommodation, and odds for a June hike closed at around 75%.  We’re not all that far from the end of Yellen’s Chairmanship, and the Fed may not be as generous in terms of cushioning asset declines as in times past.  The underlying treasury bid is underpinned by both political and economic risk.

Posted on May 22, 2017 at 5:21 am by alexmanzara · Permalink
In: Eurodollar Options

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