DXY eased Friday night:
AUD was still very weak:
The shorts are getting longer but there’s more room yet:
Commods enjoyed relief:
But not miners:
Nor EM:
Junk is screaming again:
The crazy bear steepening eased off:
Stocks fell:
BofA poses the trillion-dollar question:
The decoupling continues, but can it last?
This week, global data confirmed our view that the main economic blocks are gradually decoupling, both in terms of growth and inflation dynamics, as their cycles normalize post pandemic. The US economy remains strong, while China continues disappointing at the margin and global investors are becoming increasingly concerned. Going forward, we wonder whether this decoupling can continue or eventually will the negative impact of a China slowdown on global growth will contaminate sentiment to the point of triggering a correction in risk assets that could impact the US outlook.
The US is too good to be true
Starting with the US, recent data show that consumption remains very resilient, with retail sales, housing starts and industrial production all pointing in the same direction. Moreover, FOMC minutes indicate that another hike might be needed given the observed dynamics of service inflation and the labor market combined. In this context, the market will seek for further guidance at Jackson Hole.
Despite the smooth delivery of the recent data, the bear steepening of the US curve driven by a selloff in the long end is somewhat concerning. The stronger-than-expected economy validates somewhat higher rates, but the price action observed in the last month does not seem consistent with that. Instead, a combination of higher rates in Japan and renewed concerns on fiscal dynamics is most likely behind the observed repricing of the long end of the curve.
The Fitch downgrade, though downplayed by the market when it happened, acted as a coordination device to move the market to the bad equilibrium. Justified or not, the market is starting to trade as if the US had a serious fiscal problem, and usually this price action feeds back into the real economy, validating the market concerns. The question here is how much of the recent repricing will weigh on economic activity via tighter financial conditions, not only for the US but also globally.
China vs Japan: Is the world upside down?
On the other side of the spectrum, July data in China continues to show signs of weakness in consumption and investment, with house prices dropping further in line with sluggish property sales. Weak data induced the PBoC (People’s Bank of China) to surprise the market by lowering the MLF (Medium term Lending Facility) rate by 15bp and the 7-day OMO (Open Market Operation) rate by 10bp. The decision to ease monetary policy is the path of least resistance as the economy continues to struggle with negative inflation prints. A sizable fiscal package doesn’t seem to be in the authorities’ cards until more evidence of deceleration is revealed by the data, in our view. It remains to be seen how comfortable the PBoC is in validating a much weaker currency.
It is also an open question whether piecemeal policy intervention will be enough to stabilize business and consumer confidence. The domestic dynamics, coupled with more structural geopolitical concerns, are weighing on global investor’s confidence as well. To make the contrast even stronger, 2Q data in Japan surprised strongly to the upside, driven by remarkable export growth. Consumption remains somewhat weak but nominal income is recovering at a fast pace. The most important question is whether the current inflation shift proves sustained and induces the BoJ (Bank of Japan) to continue tightening monetary policy, since this quasi-regime change will have first order implications for global yields.
My base case is a recoupling of all economies as China and Europe lead the globe into recession. EM economies slide into export shocks. And the US is readily dragged in by a rising DXY, falling foreign earnings dragging down stocks and tumbling bank credit.
There is nothing in this to reverse the downards course of the AUD.