Left foot in, right foot out, is a settlement preferable to shaking it all about?
During a holiday-shortened week, US stocks have continued to grind higher with volatility continuing to fall, as Treasury yields move broadly sideways.
US Federal Reserve minutes endorsed the notion that interest rate policy remains on hold for several months, notwithstanding a relatively upbeat view with respect to the domestic economy.
Meanwhile, it seems increasingly likely that the FOMC will plan to end quantitative tightening (QT) some time later this year, even if this means the balance sheet remains close to USD3.5 trillion – substantially in excess of what may previously have been targeted, as is consistent with a neutral monetary policy stance.
These suggestions have seen LIBOR cash rates fall and the FRA-OIS spread decline, as QT has been responsible for a relative tightening in cash money markets and this may now reverse.
In this context, we have continued to see a steady easing in financial conditions indices since the start of the year and these series indicating that 50% of the net tightening of conditions across the entirety of 2018 has been reversed in the first six weeks of this calendar year.
Reflecting on this only reinforces the upbeat view we have with respect to growth and this underlines our belief that, ultimately, US rates are likely to rise again later this year.
From washing machines to coking coal
Trade policy continues to make headlines, with comments this week pointing towards an extension of the deadline with China, as Washington and Beijing work towards an agreement just as Section 232 findings takes Trump a step closer to announcing tariffs on imported autos, in a move directly confrontational with the EU, and Germany in particular.
Ultimately, we expect a negotiated settlement as we have seen in other trade discussions, though eventually we see these steps as continuing to benefit US growth versus its trading partners, as the US continues to claim victories in the trade war it has been waging over the past 18 months.
Meanwhile, this week reportedly saw China ban imports of coking coke from Australia (which constitutes 5% of the country’s exports) following a number of visa bans and restrictions on Chinese investment into Australia.
With the WTO looking increasingly marginalised, it seems that the geopolitics of trade policy are set to remain volatile and it promises to be a very challenging environment for a newcomer to trade deals, such as the UK, to try and go it alone.
Split factor in UK politics
Brexit discussions in the past week have centred on a renewed push by Theresa May to get support for her deal by the end of the month, as she tries to get supplemental wording from EU partners with respect to the backstop without opening renegotiations on the deal, which she has already agreed.
Fresh urgency came from a new political split in the UK, with eight Labour and three Tory MPs breaking away to form an independent centrist movement. Further defections seem likely, and with this new group already receiving as much as 15% of support in the opinion polls, it could possibly emerge as a new force in UK politics for years to come.
However, for now, such ambitions are premature and since this group represents many of the hard ‘Remain’ supporting members within both major established parties, it seems unlikely it will change the Brexit landscape much in the short term.
Arguably, were the number of MPs in the break-away to swell above 30, then this could become more interesting, but for now it remains to be seen whether this movement – which we have been aware of for a number of months – can coalesce into a new party with a coherent agenda.
Spanish Vox gains momentum
Elsewhere, we have been paying some attention to political developments in Spain. A new party on the far right of Spanish politics, Vox, has climbed in polls recently and will probably find itself in government with the People’s Party and Ciudadanos should the right win at the elections announced for 28 April.
The populist stance of Vox has already caused these two other parties on the right to turn more nationalistic in recent months, taking a tougher line on Catalonia, in particular.
In this context we have some concern that should Vox make Gibraltar discussions a pre-condition of supporting an Article 50 extension, then Gibraltar and Brexit could become Spanish election issues.
Otherwise, domestic fundamentals in Spain remain constructive as the economy outperforms its regional peers. As long as the rise of Vox doesn’t surpass 20% support (which seems very unlikely for now), then the policies of both the centre left and the centre right in Spanish politics should help to continue this progress, and help Spanish ratings migrate higher over time.
Accommodative conditions for risk assets
European PMI data this week contained some (modest) cheer, with overall readings in Germany and France bouncing from January – even if German manufacturing remains a weak spot.
More broadly we believe we are seeing a bottoming of Chinese data, and in the next few months, markets should be supported by slowly improving data, declining growth slowdown fears and a benign policy backdrop.
Meanwhile, having been concerned about the direction of European policy when visiting Brussels last week, we have since heard from a number of ECB speakers and are comforted that it seems that an LTRO announcement is now back on the agenda for March.
This should be supportive for EU banks and assets in the periphery, and with policy in China continuing to ease and fiscal policy in a number of countries turning more accommodative, these feel like conditions that should benefit risk assets in general.
Having said this, we believe that caution remains warranted with respect to corporate credit. Corporate spreads have rallied since the start of the year, but issuance has been light.
March is a seasonally heavy month for issuance and against anecdotal evidence of clients reducing exposure to investment grade credit, we feel that these technicals represent a strong headwind against a further rally in spreads on a generic basis.
Next week’s votes in Westminster will be an obvious focus for the market. However, at this time, we continue to think that it is likely that these won’t amount to much and that the Brexit countdown will run into March, with the temperature starting to rise as the clock ticks down.
The ECB will be moving into its blackout period ahead of the 7 March meeting and elsewhere the data calendar is relatively light – save for the US, where we continue to catch up after the hiatus following the government shutdown. Otherwise, following the trade headlines and seeking to determine the winners and the losers will remain the order of the day. On European autos, this is a factor that sees us looking for the euro to drop below USD1.10.
Meanwhile, turning to China, the observation that a trade deal with the US will mean that it buys more US-produced goods, and therefore fewer goods produced elsewhere, seems a likely outcome.
Perhaps more US Diet Coke and less Aussie coking coke is this week’s takeaway…but all of this seems to be a bit of a dance with movements forwards and backwards in the tactics of negotiations. Everyone is dancing the trade ‘hokey cokey’ – or so it seems.