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Fundamental Analysis 16.02.2018 - Market Outlook

Market Recap

The spectre of stagflation is haunting the markets. US industrial production was revised down for December 2017 and actually fell in January 2018, contrary to expectations, as did capacity untilization. Meanwhile, following Wednesday 14th February's higher-than-expected Consumer Price Index (CPI) data, Thursday 15th February's Payment protection insurance (PPI) also beat expectations, while the prices paid indices for the two Federal indices out yesterday – Empire State and Philadelphia Federal Reserve Bank – both went up. So we have output stagnating or even falling, while inflation accelerates.

This mix can be deadly for the markets – back in the early 1980s, the-then Federal Reserve Chair Paul Volcker raised the Federal Reserve funds rate up to 20% inan effort to defeat inflation. However, the US stock market seems to have taken it in stride yesterday, closing up 1.2%, while Treasury yields were largely unchanged (2yrs up 2 bps, 10 years down 1 bp).

It may be that the market feels the Federal Reserve won’t be so aggressive this time around – that given the trade-off between inflation and growth, they will lean towards supporting growth and therefore won’t hike rates as much as they would normally during a period of high inflation. Or it could be that the market is focusing more on the deterioration in the “twin deficits” as the government budget deficit expands without end while the non-oil trade deficit hits a record.

USD/JPY continued to fall (i.e., JPY continued to strengthen). That’s what suggests that interest rates are not behind this latest move, because USD/JPY is the pair where interest rate differentials are likely to be expressed most clearly. JPY rates are pegged, meaning that the USD/JPY interest rate differential will expand or contract one-for-one as US Treasury yields move. Japan is the only such market; all other markets are subject to some influence from the Treasury market.

That key difference is likely to continue for some time, given today’s news that Bank of Japan (BoJ) Govenor Haruhiko Kuroda was reappointed. He’s the architect of Japan’s quantitative easing program and so is likely to keep Japanese yields constrained and  continue to expand the BoJ’s balance sheet. In fact he specifically said that the BoJ will continue with its current easing policy and that it’s too early to start talking about an exit policy. His reappointment was well telegraphed in advance though so may not have impacted the market much today.

One other key point to note about recent USD/JPY action is that the pair declined even though the Tokyo stock market gained. As you can see from the graph below, over time the two do tend to move in tandem – USD/JPY tends to move up as the stock market moves up, or perhaps we should say that the stock market tends to move up as USD/JPY moves up.

However, if we just look at the day-to-day changes, they don’t always move together. Over the last five years, they’ve moved in different directions about 40% of the time, and slightly more often (43%) over the last one year. So it’s by no means too strong for USD/JPY to fall when the Tokyo stock market is increasing. Nonetheless, in today’s world this probably signals that the USD/JPY move isn’t just a “risk on” move, but rather a reaction to something deeper, such as the structural problems in the US.

Today’s market

The day starts with Britain’s retail sales. This figure comes in two sorts, with and without auto fuel, but the fact is that they both move pretty much in line together. In any event, the market pays a bit more attention to the “with” figure, even though that can be distorted by a change in the price of gasoline.

On a month-on-month basis, the figure is expected to bounce back but only slightly from the deep decline in December 2017. This is slightly worrisome, as the December 2017 fall did not follow any unusually big leap in November 2017, either. It looks as if the pace of growth in retail sales is starting to take a hit from the fall in real wages. It’s going to be hard to do better than this in future months as uncertainty about Brexit rises. This could be GBP-negative.

Canadian manufacturing sales are expected to be up only slightly from the previous month. Still, considering that the previous month saw growth in sales, This could be CAD-positive.

US import prices may be watched more closely than usual today because of the focus on inflation. The mom rate of growth is forecast to accelerate, although that would leave the yoy rate unchanged. Import prices excluding petroleum are rising much more slowly, but that doesn’t seem to be as much of a focus for the market.

US housing starts are expected to be up somewhat, while building permits are forecast to be unchanged. For some reason the market focuses more on starts than on permits, even though permits are the more forward-looking indicator. The figure could therefore be modestly USD-positive.

Finally, the University of Michigan consumer sentiment index is expected to decline slightly from the relatively high level that it’s been at for the last several months. It is gradually declining, but given that it’s still well above average – the 10-year average is 79.2, the 20-year average is 86.5 and the 30-year average is 87.3, vs the expected outturn of 95.4 – a modest decline of this level should not affect the markets much. This might be USD-neutral.

The Fundamental Analysis is provided by Marshall Gittler an external service provider of an independent analytical company. Any views and opinions expressed are explicitly those of the writer. Any information contained in the article, is believed to be reliable, and has not been verified by STO and is not guaranteed to be accurate. References to specific products, are for illustrative purposes only and are not a form of solicitation, recommendation or investment advice. Past performance is not a guarantee of future performance.


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