Recap 3-10-14: Fed, NZ, China, EM, SPX History Lesson



  • GS notes that a move to ‘qualitative guidance’ as suggested by Dudley last week will make the FOMC forecasts even more important for the markets. There were also some articles today about the Fed’s shifting focus to wage growth. That’s not really a surprise rates market participants, but I do want to reiterate my point on 2/14 that wage growth is likely to be subdued for quite a bit longer than the most recent prints suggest. The disconnect over the past several years between real wage growth and the employment gap suggests a fair bit of pent up ‘slack’ that are likely to keep real wage growth contained, similar to the late 80’s period.

  • NZ rates market is pricing in ~97% odds of hike Thursday and ~100bps of hikes by October. The New Zealand Dollar REER is at the strongest level since 1984, but the data remains strong. RBNZ has been complacent about the currency strength, and along with the strong data and improvement in the Terms of Trade means that the trend could continue for now… but note the next point:
  • The China trade figure miss was substantial. Without a good explanation, most research desks seem to believe that this was a one off, but the markets are less complacent. Copper prices (orange) have dropped sharply recently. It has been a leading indicator for Chinese equities (white) and the EEM in general, so the fact that it is again close to breaching support is notable.

    CNH deprecation looks pretty reasonable now, and hopes of a quick reversal are probably fading. The chart below shows CNH / CNY fix in white and copper prices in orange and inverted. As it demonstrates, spot copper prices have been a pretty decent leading indicator for the past 6 months and if anything suggest a continuation of the weakening trend.

    Another factor is that the CNY REER (as calculated by JPMorgan) is at the strongest level ever. The pattern of PBoC intervention at these levels (last June, this Jan) suggest that the PBoC may not be comfortable with much more FX appreciation:

    Now of course this could all be a headfake of some kind, but the fact that this weakness in Chinese data has been corroborated by other indicators (PMI, real money supply growth) suggests that at least some of these patterns are real. But note that this recent trend in Chinese data is broadly speaking what China needs. The appropriate shrinking of capital intensive sectors and the expansion of household consumption is SUPPOSED to result in a declining trade balance along with weaker industrial production. A successful rebalancing of the Chinese economy should coincide with a broad continuation of recent data trends for an extended period.

  • In addition to China downside risks, GS published a good note on how EM equities have tended to underperform nominally (and probably exhibited negative real returns) during tightening cycles:

    In addition, mutual fund inflows into EM equities actually only turned negative recently:

  • Also, here is a interesting history lesson (showing the previous relationship between the Fed Balance sheet and S&P) from Market Anthropology, although I very much disagree with the conclusion later in the article: (I actually think the late 50’s is a better comp)
    In an effort to keep interest rates low during and directly following WWII and avoid another chapter of the near-view Great Depression, the Fed purchased all available short-term US Treasuries and virtually all long-term US Treasuries from the market starting in April of 1942. When all was said and done, the US had a debt to GDP ratio that was almost 20% larger than where it currently resides today.
    In Milton Friedman and Anna Schwartz’s seminal "Monetary History of the United States", the market climate in the 40’s is described as being so sensitive and suspect of the Fed and Treasury’s very visible hand, that the entire equity market rally (150+%) from the April 1942 low through the cyclical high in 1946 was deemed "artificial" and likely to end very badly. The fresh scars of the Great Depression provided abundant fear for market participants of a possible revival of kindred economic instabilities, despite the countervailing strength of the equity markets that even continued to rally more than 20% through the recession in 1945.

  • Finally, the NY Fed notes that FX triangular arbitrage was essentially eliminated by 2006. The removal of simple arbs such as that is another reason why historical hedge fund returns pre-2006 should be noted with an asterisk.


  • Japan
  1. Eco Watchers Outlook Survey dropped sharply to 40 vs 50.5 exp and 49 prev
  2. Current Account declined to -1589B vs -1411B exp and -639B prev
  3. GDP in Japan was revised down to +0.7% versus the preliminary estimates of +1%. The majority of demand components were revised down from first preliminary estimates, with notable revisions for capex (contribution of +0.4%, versus +0.7% previously) and consumer spending (+1.0%, vs. +1.2%).


  1. Trade Balance posts $37bn miss in the trade balance with an 18.1% drop in exports. The balance swung to a deficit of $22.99bn versus a surplus of $14.50bn expected. Exports -18.1% vs +7.5% expected. Imports +10.1% vs +7.6% expected. The averaged Jan-Feb exports declined 1.6 % y/y. Exports to the developed market and most Asian countries outperformed, but those to Hong Kong tumbled. Import growth held up at 10.1%y/y in February vs 10.0% in January. Seasonality was an issue but the size of the miss is substantial.
  2. M2 stable at 13.3% vs 13.2% exp and prev
  3. CPI declined to 2.0% YoY vs 2.1% exp and 2.5% prev
  4. PPI declined to -2.0% YoY in Feb vs -1.9% exp and -1.6% prev

Canada Housing Starts improved to 192.1K vs 190k exp and 180.2k prev

“The Kremlin’s strategy emerged haphazardly….an emotional Mr. Putin acted out of what the officials described as a deep sense of betrayal and grievance, especially toward the United States and Europe…..the decision to invade Crimea was made not by the national security council but in secret among a smaller and shrinking circle of Mr. Putin’s closest and most trusted aides.” NYT

Crimea has a referendum scheduled for Sun 3/16 (on whether to join the Russian Federation) although no one (other than Moscow) thinks this vote is legitimate. The risk would be if Russia takes an affirmative outcome (i.e. the referendum comes out in favor of being annexed into Russia) as a pretext for a more explicit takeover of Crimea.

ECB’s Noyer: “When the euro tends to strengthen, it creates additional downward pressure on the economy and inflation, which in both cases isn’t warranted. So we’re not happy at the moment.”

GS: Spain reforms insolvency law to favour early corporate debt restructuring. On Friday, the Spanish government approved a Royal Decree Law to support early debt restructurings and debt refinancings of viable companies. The reform promotes the use of deferral of payments and debt for equity swaps. The process for individual and collective agreements has been streamlined (requiring lower levels of approval among creditors and, in the case of debt for equity conversions, also among equity-holders). Fresh capital injections will have super senior status. Given required balance sheet adjustments associated with Spain’s high level of corporate debt (130% of annual GDP) and its low inflation, this marks an important reform.

Upcoming Data:

  • Mon: NAB Business Confidence
  • Tue: BoJ, UK IP
  • Wed: NZ House Sales, Turkey Current Acct, RBNZ, Japan Machine Orders, Rics House Price Balance, Australia Employment
  • Thu: ChinaData, US Retail Sales, Jobless Claims, BoJ Minutes
  • Fri: US Core PPI, U Michigan Confidence