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The Ant and the Grasshopper: A Window into Macro Part II

Summary:
Regardless of the dollar's role and function in the world economy and the halls of finance, in the near and intermediate terms, investors and businesses are more concerned with foreign exchange prices.  The greenback has fallen out of favor. Its main supports, like wide interest rate differentials, favorable growth differentials, and political certainty if not stability, have weakened. The pace accelerated from mid-June through the end of July.  It seems to have entered a consolidative or corrective phase, perhaps aided by the stabilization of yields as participants make room for the quarterly refunding, and a surge in coupon issuance through October.   The upcoming US data features July CPI, retail sales, and industrial production figures.  Taken as a whole, the data are likely

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The Ant and the Grasshopper:  A Window into Macro  Part II
Regardless of the dollar's role and function in the world economy and the halls of finance, in the near and intermediate terms, investors and businesses are more concerned with foreign exchange prices.  The greenback has fallen out of favor. Its main supports, like wide interest rate differentials, favorable growth differentials, and political certainty if not stability, have weakened. The pace accelerated from mid-June through the end of July.  It seems to have entered a consolidative or corrective phase, perhaps aided by the stabilization of yields as participants make room for the quarterly refunding, and a surge in coupon issuance through October.  

The upcoming US data features July CPI, retail sales, and industrial production figures.  Taken as a whole, the data are likely to show that the US economic activity moderated from the pace seen in June. The July job figures showed a disturbingly low number of returning workers in manufacturing.  The 26k increase paled in comparison to the median forecast for 255k and June's 357k increase.  Losses were reported in the production of computers and electronic goods, fabricated metals, and machinery.  The auto sector, which has been a bit of an economic catalyst in Canada, and to a lesser extent, Mexico, as well as the US, saw another 39k workers return.   

Retail sales are forecast to rise by around 1.8% after the sizzling 7.5% month-over-month gain in June.  The core measures, which exclude autos, gasoline, and building materials, may slow to a still-strong 0.9% from 5.6%, according to the median forecast in the Bloomberg survey.  Similarly, the growth in industrial output is also likely to slow.  The median forecast calls for a 3% rise after a 5.4% gain in June.  The pace of recovery in the manufacturing sector may have moderated to  2.9% from 7.2%.  Given the manufacturing employment disappointment, the risk would seem to lie to the downside.  Year-over-year measures of headline and core CPI may ease.

The Ant and the Grasshopper:  A Window into Macro  Part II
The surge in German June factory and the jump in industrial output shows the momentum at the start of the Q3.  The four largest countries reported June industrial production that was above expectations, and not by just a narrow margin.  The median forecast was for France and Italy's output to expand by 8.4% and 5%, and instead, production increased by 12.7% and 8.2%, respectively.  Spain's 14% increase easily bettered the median projection of a 10% increase.  The sharp rise in German capital equipment orders and EMU orders, more broadly, will likely provide another data point for the narrative that sees a stronger recovery in Europe.  There may be an upside surprise to the industrial output for EMU countries that will be reported in the week ahead.  The aggregate gain is forecast to have risen by 10.0% by the median projection in the Bloomberg survey. It rose by12.4% in May. The chart here is monthly changes in the US (yellow) and EMU (white) industrial output.

Europe's trade surplus is also likely to have continued to recover.  The eurozone's trade surplus averaged 18.7 bln euros a month in 2019, and as the world economy came to a screeching stop, the trade surplus fell to 1.5 bln euros in April.  It grew to 8 bln euros in May and is poised to rise further in June. The aggregate figure will be reported, but Spain's estimate is not released until August 20, and that ought to be the lede.  For at least three decades, Spain has run a trade surplus on a monthly basis exactly two times before May. In May, the disruptions in trade and uneven contagions and recoveries and contagions resulted in a very small (~124.5 mln euros) trade surplus.  

China reports yuan loans, aggregate financing, industrial production, fixed-asset investment, and surveyed unemployment.  The takeaway is that the world's second-largest economy is continuing to recover, but the pace has moderated.   The PBOC is one of the few major central banks that has not engaged an asset purchase program, and it is moving to slow the rapid expansion of loans.  Aggregate financing, which includes the formal banking system and the shadow banking sector, average CNY1.65 trillion a month in 2019, and more than doubled in Q1 to CNY3.7 trillion.  In Q2 is slowed to CNY3.2 trillion and is likely to fall further in Q3, beginning with the July report.

Around the end of next week, senior US and Chinese officials will have a conference call to review Phase 1 of the trade deal, which seems a bit pretentious given that there is unlikely to be a Phase 2.  It seems clear to everyone who looks at the data that China is so far behind its quantitative targets that it is nearly impossible for it to fulfill its obligations.  China's July trade figures, released before the weekend, showed imports from the US had fallen by 3.5% year-to-date. The question is what to do about it.  Up until now, the mantra has been the trade agreement is on track (don't believe your lying eyes).  There is bound to be some headline risk around the review. 

Ironically, President Trump's confrontation with China was one of the few bipartisan developments over the last couple of years.  Even if there were some tactical differences, Democrat leaders often applauded Trump's strong stance.  The Democrats' criticism of the US policy toward China is that it is not sufficiently effective because the traditional allies have been cast aside or alienated.  

The transformation and deterioration of the US-Sino relationship began when American leaders concluded that Xi's era, for as long as it lasts,  is a break from the Hu Jintao era (2002-2012) of "peaceful rise" or "peaceful development."  Xi goes against Deng Xiaoping's instruction to "keep a low profile and never take the lead."  He wants to flex China's muscles, sparred with India, clamped down on Hong Kong, and continues to harass Taiwan.  At the same time, the US also has experienced its political center shifting in a more economic nationalist direction.  The Democrat Party Platform on which Biden is running offers some variations on the common theme.

Some fraction of China's "underperformance" is a function of a shift in prices. Crude oil prices are still off more than a quarter this year.  The price of soy is off around 10%.  Rather than focus on quantities, the US may have made a tactical error by focusing on dollar value.  From a broader view, the push for a specific outcome is an abandonment of the traditional US approach of focusing on processes.  It no longer sounds or acts like that confident country at the start of the 20th century that defended China's territorial integrity against Europe and Japan's attempts to carve up China into "concessions."   

The concession the US negotiated with China is only one of several fronts where national interests are clashing.  Mobile apps have become part of the contested terrain.  As we noted previously, India may have been the most aggressive is banning some Chinese apps.  The US will ban TikTok and WeChat. Microsoft, who seems to the untrained eye to have a monopoly or oligopolistic control (operating systems), may be taking these monopoly rents to buy all or part of TikTok, a Chinese-based app platform of short video clips (less than a minute).   

As hard as it may have been to secure in the first place, getting out of the Phase 1 trade agreement maybe even tricker.  The proverbial can could be kicked down the road and double up next year's efforts.  The targets can be extended another year.  New tariffs could be imposed to theoretically provide greater inducement to comply. Yet, at the coming review, it may serve both sides' interests to say something that is innocuous and bland, like both sides remain committed to the agreement.  


Disclaimer

Marc Chandler
He has been covering the global capital markets in one fashion or another for more than 30 years, working at economic consulting firms and global investment banks. After 14 years as the global head of currency strategy for Brown Brothers Harriman, Chandler joined Bannockburn Global Forex, as a managing partner and chief markets strategist as of October 1, 2018.

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