Recap 2015-04-22: My Take

Commentary:

The weak US data in 1Q has been unusually surprising. The Bloomberg measure of surprises, for example, is at the most negative level since the Lehman recession:

The drivers seem to be a result of both the data as well as the resilience of analyst estimates. Clearly, the US economy is feeling the front loaded effects of the move in oil and the dollar. However, analyst estimates has remained broadly sanguine, with many expecting a bounce back in 2Q. The chart below illustrates how despite the sharp drop off in 1Q growth estimates (white line) 2Q estimates has actually ticked up. (orange)

The wide spread consensus expectation of a strong rebound means that the data needs to hit expectations. And given where we are in 2Q, that needs to start happening soon.

Asset prices have already moved in response to the weak 1Q data. As economic surprises (orange) fell in late Dec and accelerated in Feb and March, treasury yields (white) fell, and equities (yellow) and the dollar (green) consolidated.

In other words, data over the next few weeks are likely to be quite important. If the recent string of data disappointments continue, analysts as well as the Fed are likely to need to reassess their growth projections. In particular, they are likely to need to reassess the impact of the dollar. The US economy is actually relatively closed, but its exposure to global trade has been increasing over the years, just like those of other DM countries. Dudley on Monday said that

While I am relatively optimistic about the growth outlook for 2015, I also must acknowledge that there are some significant downside risks. In particular, the roughly 15 percent appreciation of the exchange value of the dollar since mid-2014 is making U.S. exports more expensive and imports more competitive. My staff’s analysis concludes that an appreciation of this magnitude would, all else equal, reduce growth of real GDP by about 0.6 percentage point over this year. Some of the recent softness in indicators of manufacturing activity is likely a reflection of this development.

Given that US growth has been averaging 2.3%, the 0.6% figure is quite substantive. In addition, an upward revision of the ‘beta’ of the dollar on US growth is important because expectations for further dollar strength are widespread. Such a revision would thus have a compounded effect on expectations for US growth & monetary policy.

Furthermore, note that there is probably a reasonable basis for such a revision. All macro models use historical data as a basis for estimates. GMO recently published a white paper noting that domestic sales of EAFE (non-US developed market) country corporations have continued to fall since the recession, also that trend may have stabilized as of 2012:

In other words, it is quite possible that the continued globalization of corporate profits (which leads investment & hiring intentions) has not yet been fully incorporated into analyst models.

Having said that, however, most of the charts support analyst optimism. The S&P is in the middle of a textbook bullish wedge that looks likely to be resolved soon. The last such occurrence was a year ago:

US 30y yields’ downward momentum appears to be flagging, with yields unable to re-break support at 2.5%. Like the S&P chart, we are likely to get some sort of formation break soon, either up or down. There are some similarities to 2012 here also.

The Dollar is consolidating above long term support / resistance.

Finally, Gold appears to be consolidating before a push lower. If yields and the dollar move higher, such a move would not be surprising.

In fact, short gold may be one of the better proxies to express a short interest rate view. Since the curve is in contango, carry is positive. (rather than negative in most expressions) In addition, an end to global central bank easing is in sight. Finally, the sharp drop in commodity prices globally the past few quarters means the marginal cost of production has likely fallen dramatically.

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