Oil will continue to be in the news this week, and it will continue to impact inflation expectations. With risks of inflation fading, the Fed changed its tone, and Trump may have revealed more than he intended about a potential US-China trade deal.
Rate Outlook Challenged
In the past week, there has been a significant change in USD interest rate expectations. The Fed’s vice chairman, Richard Clarida, hinted that the Fed may stop hiking at the neutral rate. Despite increasing wages and a booming US economy, the Fed may be sensing trouble on the horizon. The trade war and the severe correction in crude oil prices are now flagging disinflationary pressures. Futures are also pricing in a pause in the Fed’s rate hikes in 2019.
In our note to clients on 29 October 2018, we wrote that one of the markers we were looking for to call a top in the US equity markets is the Fed’s pause in interest rate hikes. While the S&P 500 is still up for the year, having closed at 2736 on Friday, the recent volatility may be an early warning sign that end of the bull run is near.
US Core CPI came in at 1.6%, and with the recent spectacular plunge in crude oil, the market’s inflation expectations have also corrected lower.
Emerging Market Reprieve
High oil price and a strong US dollar were mostly hurting emerging market economies. The oil exporting ones did not benefit much from the recent surge on oil prices because they were still suffering the results of previously implemented fiscal and monetary policy tightening.
Many of these emerging markets saw their currencies rise against the US dollar in the last month. For the most part, the rise in floating emerging market currencies was due to their central banks’ interest rate hikes in response to capital outflows.
While emerging markets are dancing to a different tune, the heavyweights have not been fairing so well against the dollar. The market is beginning to realize that Brexit is not only bad for the GBP, but it is also Euro-negative. While we refrain from taking sides in this battle over sovereignty in the EU, we do not see a good outcome for either side. Even if Theresa May survives the Tory rebellion, we view it is highly unlikely that her Brexit deal will pass through Parliament.
The other heavyweights are the Swiss franc, Japanese yen, and Chinese renminbi. The yen and Swiss franc no longer pack the same punch as they used to, with the safe-haven advantage now dominated by the mighty US dollar. Meanwhile, market forces are pressuring the Chinese renminbi lower, despite the PBOC’s line-in-the-sand just below 7.
Therefore, we view any general dollar weakness to be temporary.
Trump Reveals Hand
As many of our clients know, we are avid fans of Daniel Kahneman’s Prospect Theory, which forms the basis of the risk assessment service we offer to all our clients. Kahneman’s book, Thinking, Fast and Slow, inspired many others to write and expand on our mental models for decision-making. One of those books was Super Forecasting: The Art and Science of Prediction by Philip Tetlock and Dan Gardner. In the hallmarks of superforecasting, the authors find that a common trait among the best forecasters is the ability to break a seemingly complex problem into tractable sub-problems.
We have such a problem on our hands: will the US and China agree on a trade deal? Despite the negative news and the advertised hostility at the APEC summit, in which everyone was expecting the US and China to come out with a joint statement on trade. Needless to say, no such statement was issued by the two largest trading nations. There’s nothing particularly unique about this specific time and place; there will always be another summit as a venue to issue a symbolic statement. Next up: G20 summit in Argentina.
JP Morgan came out with a timely note that bears more resemblance to the scientific approach we take on event probabilities. In its note, JP Morgan’s Marko Kolanovic writes about the significance of Trump’s statements that the “China list is pretty complete” and that there are “four or five things left off.” Kolanovic rightly points out that the original list had 142 requests. So if we were to break down this complex question into a simple tally of equally-weighted requests, Trump’s statement implies that 96% of items have been addressed, which makes it highly probable that the US and China will agree on a trade deal.
The Week Ahead
It will be a relatively light week for economic data. US Durable Goods Orders, PMI, and housing data should give us some insight into the longevity of this expansion. Eurozone PMI levels and German GDP will be published on Friday.
The information herein contained, including any terms and conditions presented (the information) has been prepared and distributed by Harbour Wealth Management (HWM) and is directed at Clients (non-retails costumers) who qualified as either professional clients (as defined in DFSA’s rule book, glossary module (“GLO”) or Market Counterparties (cf.GLO) enacted by Dubai Financial Services Authority (‘DFSA’). This document is being furnished to the intended recipient solely for information purposes. Any investments carry its own risks; the investor must be aware of the risks posed by an investment (Cf. GLO) and is fully responsible for the risks incurred. The information is not and cannot be understood as impartial investment research. HWM does not guarantee the accuracy or completeness of the information and the opinions expressed herein are HWM’s opinions at the moment they are conveyed only and are subject to change without prior notice. This document cannot be reproduced, in whole or in part, in any form or by any means without HWM’s specific authorization and any distribution of the information on behalf of HWM is strictly prohibited. Neither this document nor any copy hereof may be sent or taken or transmitted into or distributed, directly, or indirectly, in any jurisdiction other then Dubai International Financial Centre. Any failure to comply with this restriction may constitute a violation of the laws of the jurisdiction where the document is being redistributed. This document does not constitute or form part of, and should not be construed as, any offer for sale or subscription of or solicitation of or invitation to make any offer to purchase or subscribe for any financial products or services and neither this document nor any part of it shall form the basis of or be relied on in connection with or act as an inducement to enter into any contract or commitment whatsoever. HWM does not accept any kind of liability for losses or damages which may arise from the use of this document or its contents nor for the unlawful reproduction and/or redistribution of the same. HWM is dully licensed and Regulated by the DFSA and is 100% owned by AFM INTERNATIONAL, a company with registered address at Level 3, Sky Parks Business Centre, Malta International Airport, Luqa, Malta.