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CHART OF THE DAY: Investor Consensus = Bearish On Bonds & U.S. Dollar... WHY?

Editor's Note: Below is a brief excerpt and chart from today's Early Look written by Hedgeye Senior Macro analyst Darius Dale. Click here to learn more.

 

"... One such incongruence that needs to work its way through markets is the relatively bearish position on both Treasuries (across the curve) and the U.S. Dollar Index in the futures and options markets.

 

Specifically, the +11.2k net long position on the latter represents a -1.7 z-score on a 1Y basis, while the -148.9k net short position in 2Y notes and -93.5k net short position in 10Y bonds represent z-scores of -1.4 and -1.6, respectively. How can investor consensus be that bearish on bonds amid a hawkish Fed, but not commensurately bullish on the dollar?"

 

CHART OF THE DAY: Investor Consensus = Bearish On Bonds & U.S. Dollar... WHY? - Chart of the Day 6 1


Something’s Gotta Give

“One of these things is not like the others.”

-Big Bird

 

One such incongruence that needs to work its way through markets is the relatively bearish position on both Treasuries (across the curve) and the U.S. Dollar Index in the futures and options markets.

 

Specifically, the +11.2k net long position on the latter represents a -1.7 z-score on a 1Y basis, while the -148.9k net short position in 2Y notes and -93.5k net short position in 10Y bonds represent z-scores of -1.4 and -1.6, respectively. How can investor consensus be that bearish on bonds amid a hawkish Fed, but not commensurately bullish on the dollar?

 

Something’s Gotta Give - Hawk or dove cartoon 05.31.2016

 

Back to the Global Macro Grind

 

We’re not so sure how to answer that question, but with the nascent trend of higher-lows in the U.S. dollar (up +2.7% MoM on the DXY and +2.9% on a broad trade-weighted basis) remaining a general headwind to reflation assets broadly, we thought this would be a good opportunity to highlight two policy catalysts emanating from the Far East that may serve to catalyze incremental upside in the underowned USD from here:

 

Japanese Officials Are Increasingly Worried:

 

  • The latest batch of high-frequency economic data in Japan continued to leave investors and policymakers alike wanting for more in terms of seeing material benefits from Abenomics. Specifically, various metrics of consumer spending growth remained in contraction despite accelerating sequentially (retail sales were down -0.8% YoY in APR, while overall household spending fell -0.4% YoY). Industrial production decelerated sharply to -3.5% YoY amid a deepening of deflation (headline CPI slowed to -0.3% YoY from -0.1% prior) and a -20bps deceleration in core CPI to +0.9% YoY. This follows last week’s sequential deceleration in Japan’s flash manufacturing PMI to 47.6 in MAY – the lowest reading on record – as well as export growth that plunged -10.1% YoY in APR.
  • In response to this general deterioration in reported growth and inflation, Prime Minister Shinzo Abe has ratcheted up pledges of fiscal support, which is in line with his recent pleas to other G7 officials. Specifically, in a press conference today, Abe announced his plan to delay next April’s scheduled +200bps consumption tax increase by 2.5 years to October 2019. This decision is accompanied by his decision to forgo snap elections in the lower house (which itself subsequently rejected a no confidence motion drawn up by opposition leaders). In addition to the aforementioned measures, Abe is allegedly mulling the introduction of Japan’s second supplementary budget this year, which would likely fall in the ¥5-10T ($45-90B) range and be introduced after next month’s upper house elections.
  • The decision to shift to a more fiscally-oriented policy support strategy in Japan comes amid more toned-down rhetoric out of BoJ Governor Haruhiko Kuroda – at least in terms of frequency (he’s only made material public statements twice over the past week). That said, however, he was keen to reiterate his consistent message of the BoJ’s commitment to its +2% inflation target and the board’s willingness to do ‘whatever it takes’ to accomplish that goal. As outlined in our recent work, we continue to think the BoJ is setting up to expand monetary policy over the next 1-2 months and that has been generally reflected in Japanese financial markets over the past month with the Nikkei 225 Index up +1.7%, the JPY down -2.8% vs. the USD, 1Y OIS Spreads -2bps narrower, 10Y Yields -4bps lower and 5Y5Y Breakeven Rates +3bps higher. All told, Japan looks to have unofficially exited the unofficial global FX détente – an outcome that is right in line with our expectations over the past 4-6 weeks.

 

Chinese Officials Are Not (But You Should Be):

 

  • Arguably the most important development out of China in recent weeks is the PBoC reaffirming its commitment to exchange rate reform – specifically to boosting two-way flexibility and the market’s impact on setting the exchange rate. This affirmation was in response to speculative reports put forth by the Western media that Beijing has since deviated from this policy path in favor of reduced FX volatility via tighter capital controls. To the extent such reports are indeed false in the sense that Beijing remains committed to market-oriented exchange rate reform, it would be wise for investors to brace for another round of China-centric headline risk – particularly if the Fed is keen to make another policy error next month by tightening into a trending slowdown across both the domestic and global economies.
  • Specifically, if the capital outflows which perpetuated broad-based economic and financial stability concerns in China were indeed a catalyst for G20 policymakers to institute the so-called “Shanghai Accord” and a sharply-dovish pivot out of the Fed, Janet Yellen will be pleased to note that said capital outflows have likely reversed following what had been accelerated foreign currency debt repayment by mainland enterprises. Specifically, China’s FX reserves are showing a nascent trend of positive growth, up +$10.3B and +$7.1B in MAR and APR, respectively. The aforementioned growth figures compare to declines of -$87B, -$108B, -$100B and -$29B in NOV, DEC, JAN and FEB, respectively. Capital account stability in China may have sown the seeds of its own future instability via an incrementally hawkish Fed.
  • All that being said, it is unlikely that the next bout of China concerns will be as concerning as the previous iteration which acted as a bearish overhang for risk assets for much of 2H15 and into the early part of this year. Specifically, the propensity for the PBoC to revalue the CNY lower in a seemingly hurried manner has been dramatically reduced, thanks to a dramatic narrowing of critical spreads; the spread between the onshore spot rate and the PBoC’s reference rate is now +13bps (vs. -1.5% in early AUG and -0.7% in early FEB) while the spread between the onshore and offshore yuan has narrowed to -11bps (vs. -1.8% in early SEP and -2.1% in early JAN).
  • It’s interesting to note that FX-related financial stability risk has largely subsided in China despite the PBoC revaluing its reference rate to the lowest level in over five years. As previously alluded to, a critical component of this reduced risk is the fact that peak/near-peak foreign currency debt repayment is likely a thing of the past for the time being. We arrive at this conclusion based on the sharp deceleration in total social financing growth to 751B CNY in APR vs. 2.3T CNY in MAY and the fact that 42% of prospectuses for corporate bond issues contain language that earmarks funds to pay outstanding debts in the YTD (up from 8% in 2014).
  • The key takeaway here is that if Beijing is less concerned about financial stability risk, it will be less inclined to support growth with monetary and fiscal policy. This move to tighter policy is already underway, as highlighted in our 5/20 note titled “A LOT Happened Across Asia, LatAm and EEMEA This Past Week…”; the reasons why Chinese policymakers are getting hawkish, at the margins, are detailed in our 5/2 note titled, “Post Stabilization, Are You Now Too Sanguine On China?”. In short, less policy support is not good in the context of the preponderance of key high-frequency growth indicators negatively inflecting from what had been a trend of stabilization in the month of APR and continuing here in MAY with the advent of this morning’s PMI figures.

 

All told, the aforementioned developments are but two of the external catalysts that we think are likely to perpetuate upside in the U.S. dollar from here on both a narrow and broad trade-weighted basis; a likely exit from the aforementioned global FX détente out of the ECB is another.

 

Assuming long-term correlations hold – a critical assumption given the lasting strength in the energy market – we expect incremental dollar strength to weigh upon reflation assets broadly (it’s already happening across emerging markets with the EEM ETF down -5.6% since peaking on 4/20).

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 1.74-1.91% (bearish)

SPX 2042-2109 (bearish)
Nikkei 161 (bearish)

DAX 90 (bearish)

VIX 12.74-16.99 (bullish)
EUR/USD 1.10-1.12 (bearish)
YEN 109.10-111.63 (bullish)
Oil (WTI) 46.60-50.05 (bullish)

Gold 1 (bullish)

 

Keep your head on a swivel,

 

DD

 

Darius Dale

Director

 

Something’s Gotta Give - Chart of the Day 6 1


The Macro Show with Darius Dale Replay | June 1, 2016

CLICK HERE to access the associated slides.

 


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JT TAYLOR: Capital Brief (formerly Morning Bullets)

JT TAYLOR:  Capital Brief (formerly Morning Bullets) - JT   Potomac banner 2

 

LIBERTARIAN LIMELIGHT:. The Libertarian party has recently drawn more attention this election due to voters seeking alternatives to likely presidential nominees Hillary Clinton and Donald Trump. Now with former NM Governor Gary Johnson locking up the Libertarian party’s presidential nomination along with former MA Governor Bill Weld  as his running mate, expect the Libertarian duo to pull votes from presumptive Republican nominee Donald Trump. Looks like a third party run may come back to bite Trump – and that doesn’t even include the potential entry of an Independent party candidate being recruited by conservatives - David French (yes, who?) is considering jumping into the fray.

 

NOT  ALL THAT GLITTERS IS GOLD: Bernie Sanders continues to hold massive rallies in CA ahead of next Tuesday’s primary. If Sanders can pull off the win next week, it should be a huge momentum boost, but where does it carry him given that primary season will be over that day (with the exception of DC on June 13)?  A win for Sanders could only weaken Clinton, especially after she grabbed CA Governor Jerry Brown’s endorsement yesterday. The outcome is sure to be close, but when June 8th rolls around and Clinton is well over the delegate count, either the flame will be snuffed out of the Sanders campaign or his scorched earth tactics will continue all the way to the Democratic convention in late July.

 

PLAN PREVIEW: Keep an eye out for a bill from Financial Services Chairman Jeb Hensarling (TX) reforming Dodd-Frank. The legislation could preview how Trump handles Wall Street, Dodd-Frank and his plans to change future financial regulations. The bill is likely to exempt banks with high capital levels from Dodd-Frank regulations.

 

TRUMP TRAILING - BADLY: Trump did not actively solicit donations during the primary election, but has softened his position after finding himself well behind on that front. The problem comes down to shortfalls in fundraising and boots on the ground - without one, you can’t have the other. Republicans have only a fraction of the money they had 2008 and 2012, and less of an infrastructure than their counterparts.  While he’s certainly learning on the fly, he’ll soon appreciate the fact that you can’t win a general election the same way you won the primary.

 

TRUMP AT WAR WITH PRESS: The battle between Trump and the media thickens - this time over money he raised for veterans and why distributing the funds took so long as Trump held the fundraiser back in January to much fanfare. Although the motive behind the story remains uncertain, it reminds us that we are indeed in an election year and every detail will come into question. Trump can no longer rattle off outlandish ideas and not be questioned as a result - these types of challenges will become the norm and the media should and will hold his feet to the fire. Trump will fight, complain and whine - but it’s time he meets his maker - the media.

 

BA, LMT, RTN, HII, GD WILL BENEFIT FROM CONGRESS' DEFENSE SPENDING BOOST IN FY17: Check out our Senior Defense Policy Advisor LtGen. Emo Gardner’s insight on the Senate’s FY17 Pentagon spending bill - “BA, LMT, RTN, HII, GD Will Benefit from Congress’ Defense Spending Boost

 

OPEC MEETING PREVIEW: NO POLICY CHANGE NOW BUT POTENTIAL SIGNALS ABOUT THE FUTURE: In case you missed it, our Senior Energy Policy Analyst Joe McMonigle, who is in Vienna this week for the Energy Summit, shared insight on a potential policy changes at OPEC - “OPEC Meeting Preview: No Policy Change Now but Potential Signals

 

We will be hosting a conference call today at 1:00 PM ET with Joe McMonigle from Vienna and former US Energy Secretary Spencer Abraham from Washington.   Please email us for details.


Cartoon of the Day: Janet's Mess

Cartoon of the Day: Janet's Mess - Hawk or dove cartoon 05.31.2016

 

"On Friday at Harvard, Janet Yellen said that, based on her estimate of where the US economy is at, the Federal Reserve will “probably” raise rates in June or July," Hedgeye CEO Keith McCullough wrote in today's Early Look. "Ok. What if she raises and her estimates are wrong (again)?"


3 Charts: Why We're Still Bearish On U.S. Growth

Takeaway: Our reading of the bond market, consumer confidence, and S&P 500 earnings confirms our U.S. #GrowthSlowing call.

3 Charts: Why We're Still Bearish On U.S. Growth - GDP cartoon 04.26.2016

 

Nothing about today's economic data changes our thinking that U.S. economic growth continues its descent off the cycle peak.

 

Quite the contrary. We’re sticking with our sub-1% GDP forecast for Q2 and the worst profits of #TheCycle in Q2 and Q3. 

 

All is not well in the U.S. economy, particularly in manufacturing. Today's Chicago PMI clocked in a recessionary 49.3 vs. 50.4 last month. Meanwhile, the Dallas Fed Manufacturing Survey fell -13.1%, contracting alongside the four other regional Fed manufacturing surveys.

 

Not good.

 

In the bond market...

 

The yield spread (10-year minus 2-year Treasury) is not budging. It's still at YTD lows of 94 basis points wide. That's a crystal clear U.S. #GrowthSlowing indicator.

 

3 Charts: Why We're Still Bearish On U.S. Growth - 10yr treasury 5 31 today

 

Today's U.S. Consumer Confidence reading did little to inspire, well, confidence. 

 

It slowed (again) in May to 92.6 vs. 94.7 last month. #TheCycle peak was in 1H 2015. Notice what happens to consumer confidence, in the chart below, once it rolls off the cycle peak.

 

3 Charts: Why We're Still Bearish On U.S. Growth - consumer confidence 5 31

 

S&P 500 Earnings are downright terrible.

 

A grand total of 491/498 S&P 500 companies have reported. The results thus far aren't pretty:

  • Aggregate sales and earnings growth have come in at -2.3% and -8.5% respectively;
  • 6/10 sectors have reported negative earnings and sales growth;
  • Energy sales and earnings growth are down -30.1% and -109.1% respectively;
  • Rounding out the bottom of the barrell: Materials sales and earnings growth are down -8.8% and -16% respectively; Financials are down -1.7% and -14.2% respectively;

 

3 Charts: Why We're Still Bearish On U.S. Growth - earnings 5 31


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