Must read weekend piece by the great macro team at Nordea.
Evidence of the risk of a global earnings recession is gathering, but the risk appetite still chugs along decently, maybe in anticipation of a debt ceiling liquidity bailout. Powell’s QT comments will be the key next week.
Earnings recession coming up?
We have warned about a combination of weaker momentum in global trade and GDP growth coupled with higher cost pressures (accelerating wages and higher credit spreads) for a while. We continue to expect more of the same in coming quarters and the early trade data from South Korea this month again underpinned our viewpoint. The preliminary South Korean trade data revealed an apparent collapse in South Korean exports in January (-12% year on year) – this is one of the oldest canaries in the coalmine when it comes to global EPS growth, as South Korean exports are an early indicator of trend changes in global demand.
The trade data hence add to an already growing list of indicators pointing at an elevated risk of an earnings recession in 2019.
Chart 1: One of the oldest canaries in the coal mine, South Korea, now indicates an elevated risk of EPS recession
On top of the combo of slowing trade and rising cost pressures, we also continue to find increased evidence of slowing growth in the broader money supply in the global economy. Tighter liquidity conditions in the US, the Euro area and in Japan show a slowdown in M1 growth – a sign that borrowing demand is slowing. If money makes the world go around, as we think is the case, then the slowing M1 growth is a concern for the global growth outlook (and the outlook for risky assets). There are admittedly early signs in our models that Chinese M1 growth could re-emerge as a lagged consequence of the continued liquidity injections into the Chinese economy (also a driver behind the improving sentiment). The Chinese M1 comeback may still be six to nine months away, though.
We think the current rebound is likely a temporary “bull trap” (Nordea View: High bull trap risk)
Chart 2: “Money growth” is slowing an issue if money makes the world go around.
The debt ceiling liquidity bailout
Markets may have rallied on the anticipated upcoming “liquidity bailout” stemming from the debt ceiling deadline 1 March. Over the next four to five weeks, the US treasury is legally bound to bring down the cash balance at the Fed, as they cannot hold an “above normal” liquidity buffer ahead of the expiration of the debt ceiling suspension. The commercial banking system will be on the receiving end of this USD liquidity, which should be temporarily positive for risk appetite.
By how much and for how long this liquidity bailout will be in place is ultimately up to Steven Mnuchin and his team in the US treasury (FX weekly: The Mnuchin Bailout?), but at least four to six weeks of further liquidity easing are likely on the cards (the cash balance will not increase again unless politicians lift the debt ceiling), especially given the deadlocked political situation in the US with the ongoing partial government shutdown.
Chart 3: A debt ceiling liquidity bail-out is coming up
As the amount of USD liquidity is likely to increase over the coming four to six weeks, the chance of a weaker USD also increases. In our models the USD could weaken as much as 3-4 % broadly if Steven Mnuchin and the US Treasury re-adds +300 USDbn worth of liquidity over the next months.
Chart 4: More electronic USD liquidity, weaker price of the existing USD
No signs of stabilisation in Euro-area momentum …
The Euro-area manufacturing momentum continues to lose pace and both French and German Manufacturing PMIs now read below 50, but the slowdown is not isolated to the manufacturing sector as the service sector PMI trend is comparable. In our forward-looking models it is still hard to see signs of stabilisation around the corner.
Even though the ECB clearly acknowledged the increased downside risks and even addressed “recession risks” verbally, Mario Draghi keeps relatively upbeat assumptions intact. Just to mention some of them: i) trade tensions will abate, ii) Chinese authorities will re-ignite the momentum in the Chinese economy, iii) German and French weakness is down to more or less temporary factors (new emission measurement procedures in the German car industry and the Mouvement des gilets jaunes in France).
Even though it is mostly old news for markets that ECB assumptions (on growth) are too upbeat, it seems like the ECB stubbornly rejects to acknowledge that fully. However, Draghi took one step to pave the way for a dovish move, as the phrase that monetary policy “continues to provide the necessary degree of monetary accommodation for the sustained convergence of inflation to our aim” was removed from Draghi’s comments. But strengthened forward guidance on the key rates is already at least partly priced in unless the ECB promises to keep rates steady almost until mid-2020 (ECB Watch: Reality bites).
The already dovish pricing of ECB compared to the ECB’s forward guidance limits the scope for EUR (and EUR rates) negative surprises from the ECB (remember the very subdued Euro-area surprise index).
Chart 5: Slower, slower, slowest … Still no signs of stabilisation in Euro-area PMIs
In the fixed income space, the downtrend in the 10yr EUR swap rates space seems intact. With the big bulk of support to be expected in the 0.64-0.66% range, a break below would constitute a big game-changer for EUR rates.
Looking at core EUR rates, the current Bund yield is trading in line with no rate action whatsoever from the ECB over the next 12 months. We judge that a real risk of a cut (or more QE) needs to be priced in to take the Bund yield back to the sub-zero range, but range-bound core rates should probably be expected until something happens to EUR core inflation (a story mostly for H2).
Chart 6: Bunds are almost “priced” as if the ECB has entered easing territory
In the meanwhile Norges Bank will hike again in March …
Norges Bank keeps a firm rhetoric that it will hike interest rates again in March, even despite the wobblier global environment. That is the take-away from Norges Bank’s meeting this week, as domestic Norwegian developments had either been in line with or slightly better than anticipated by Norges Bank since the meeting in December. However, the market is already pricing a 80-85% probability of a rate hike in Norway in March, which is why the market repercussions of a hike will likely be limited for both the NOK and NOK rates heading into that meeting. The uncertainty globally still speaks in favour of a soft wrapping of such a hike in March.
But there is still room for the NOK to strengthen without it being an issue for Norges Bank. The NOK is still 1.5-2% weaker than anticipated in December.
Chart 7: A weak NOK amongst the reasons why Norges Bank can continue to sound upbeat compared to market expectations
In Sweden, unemployment rose more than expected in December due to a bigger increase in labour supply than anticipated. However, other indicators (such as the orders-to-inventories ratio in the Swedish PMI) suggest that demand for labour will soon fall in Sweden. The Riksbank expects a rise towards 6.5% unemployment in 2020, which now seems “within reach” sooner given this week’s jump to 6.4% (Sweden: Employment dipped in December). Also, the weak Swedish retail sales report emphasize that there are downside risks to Swedish growth, which makes the case for Swedish rate hikes and a stronger SEK weak currently.
What is most important next week?
Most eyes will be on the FOMC meeting concluding Wednesday night and many will in particular be looking for clarity from Jerome Powell, who has been uncharacteristically capricious in recent weeks. First it seemed like he back-tracked a little from the otherwise almost robotic neglection of the balance sheet as a policy tool at the December press conference, but then shortly after Powell said that the balance sheet would be “substantially smaller” when the Fed had normalised policy. Flip-flopping at its best. We would be surprised if Powell sounds ready to discuss the pace of the balance sheet run-off as a policy tool already, especially given that the calmer markets have provided him with some leeway (Fed Watch: Explaining patience)
Should the Fed opt to pause the balance sheet rundown at some point during H1 2019, we would consider such an event a positive game-changer for risky assets and consequently a negative game-changer for the USD.
Chart 8: QT comments from Powell will be key for markets next week
Also, the market will likely be even more sensitive towards the US ISM index than usual (Friday), given the 5-index point drop in December. Even though regional surveys hint of a more benign January report, we see mainly downside risks, as in particular the swiftly slowing import component of the Chinese PMI hints at a weaker ISM index. Also, even with the recent rebound of equities, financial conditions still suggest more medium-term downside in the ISM Manufacturing index. Hence, we see downside risks to the early consensus of an unchanged reading of 54.1 in the ISM Manufacturing index.
Chart 9: Even despite the recent comeback for equities, financial conditions still point to more ISM pain
The monthly US job report has “government shutdown” written all over it on Friday, as data on everything from the size of the labour force to wages could be distorted by the shutdown. Furloughed public workers will though not count as unemployed in the NFP, but the indirect effects on private contractors (working for the public sector) may be substantial. However, we still keep an eye on the unemployment rate, as some of our more bearish indicators have started to hint at an upcoming trough in the unemployment rate relatively soon. Our main view that the labour market tightness will drive wage growth even higher (than expected) remains intact.
Chart 10: Some of the most bearish indicators hint that US unemployment has already troughed
Outside the US, Draghi’s hearing in Brussels on Monday could prove interesting. It is noteworthy that his hawkish “vigorous inflation” remarks were made at a similar hearing in the autumn. We have noted a tendency for Draghi to sound a little more upbeat on the inflation target when speaking in front of the policy-makers in Brussels (ultimately his employers). Next week’s EUR core inflation figure will not provide Draghi with any renewed optimism, though, as we expect core inflation to have moved sideways at 1% for another month (Friday).
On Tuesday, the House of Commons is expected to vote on Theresa May’s Brexit plan B, including amendments put forward by others. We still struggle to see any breakthrough in the Brexit process being just ahead and consider the current GBP/Brexit optimism too excessive (short-term).
In Scandinavia, we watch the Swedish PMI on Friday with extra interest, as it is one of the indicators that could also hint at whether Euro-area momentum will find its footing three to five months down the road as well. So far Sweden hints at more downside in the Euro area.
Key research pieces over the past week:
FX weekly: The Mnuchin Bailout (20 January)
EM View: China touchdown (24 January)
ECB Watch: Reality bites (24 January)
Fed Watch: Explaining patience (25 January)
Table 1: Main releases to watch
The week starts off slowly with few key figures in the calendar. During the day, Draghi speaks at a European Parliament hearing.
All eyes on the UK, as the parliament votes on Theresa May’s plan B. In continental Europe, the Hungarian central bank will also draw some attention as they hold a central bank meeting.
Wednesday is filled with important events and figures. The main focus will be on the Fed’s meeting and the start of a two-day meeting between US and Chinese officials. Markets will also pay close attention to the US Q4 GDP numbers and the German inflation figures. During the day we also get the ADP employment change from the US, French GDP figures, Norwegian retail sales and in Sweden, the economic tendency survey is released.
The meeting between US and Chinese officials continues on Thursday. Markets will also pay close attention to Europe as the Q4 GDP figures for the Euro area, Spain and Italy are announced. We also get Spanish and French inflation figures, official manufacturing PMI from China and core PCE figures from the US. In Australia, the RBA holds a central bank meeting and in Japan the BOJ publishes its summary of opinions. During the day, the ECB’s Coeure (neutral/hawk, voter) and Mersch (neutral/hawk, voter) will speak.
The week rounds off with a busy day in the calendar. The focus will be on the Euro area’s inflation figures, the US job report, the US ISM manufacturing figure and China’s Caixin Manufacturing PMI. Friday is a hectic PMI day, as manufacturing PMI figures from Sweden, Norway, the UK, Italy, Spain, Germany (final) and France (final) are released. We also get the Norwegian unemployment rate before the weekend kicks off.
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