Markets Search for Direction After Major Tail Risks Ease

  • We are reluctant to pull our strong dollar call yet
  • Despite the weak November retail sales data, the US economy is still doing better than anticipated in Q4
  • Trade tensions between China and Germany are heating up; eurozone and UK reported weak December PMI readings
  • Strong Chinese data provided an extra boost of confidence for global markets

The dollar is broadly lower against the majors as the new week begins.  The Scandies are outperforming, while Swissie and yen are underperforming.  EM currencies are mixed.  ZAR and RUB are outperforming, while TRY and CNY are underperforming.  MSCI Asia Pacific was down 0.1% on the day, with the Nikkei falling 0.3%.  MSCI EM is flat so far today, with the Shanghai Composite rising 0.6%.  Euro Stoxx 600 is up 1.1% near midday, while US futures are pointing to a higher open.  10-year UST yields are up 2 bp at 1.84%, while the 3-month to 10-year spread has risen 1 bp to +27 bp.  Commodity prices are mostly higher, with Brent oil up 0.2%, copper up 1.0%, and gold up 0.1%.

With the two biggest tail risks seemingly addressed last week, markets are now searching for direction.  As we’ve noted before, there is still much uncertainty for markets to assess and that will take time.  Global equity markets are marginally higher today, whilst the dollar remains under modest pressure.  Both the euro and sterling have yet to recover the highs from last week near $1.12 and $1.3515, respectively.  On the other hand, risk-on sentiment has seen USD/JPY move back above 109.  MSCI EM and MSCI EM FX are both basically flat today and trading below last week’s highs.  The price action since last week’s major events has been confusing, to put it mildly.   More choppy trading is likely before we get a clearer picture of the dollar’s next move.

We are reluctant to pull our strong dollar call yet.  Fundamentally, the US is doing better than the rest of the world.  And yet the reduced odds of hard Brexit and the Phase One trade deal remove tail risk for the entire world economy, not just for the signatories.  Many central banks are sounding more upbeat (ECB, RBA, RBNZ), feeding into the notion that the global easing cycle has reached an end.  Perhaps that is true, but that still leaves the US with an advantage in yield and relative growth rates.  We note that December PMI readings across the globe have so far come in weaker than expected (see below).



The first December readings for the US manufacturing sector kick off this week.  Flash Markit PMI readings will come out today, with manufacturing expected to remain steady at 52.6 and services to rise a few ticks to 52.0.  Regional Fed manufacturing surveys for December start to trickle out, with Empire reading to be reported today (4.0 expected).  October TIC and JOLTS job openings will also be reported today.  The FOMC media embargo has ended and so Kashkari speaks.

Despite the weak November retail sales data, the US economy is still doing better than anticipated in Q4.  The Atlanta Fed’s GDPNow model currently estimates Q4 GDP growth at 2.0% SAAR, steady from the previous reading.  Elsewhere, the NY Fed’s Nowcast model now has Q4 growth at 0.69% SAAR, up from 0.58% previously.  It also raised its estimate for Q1 growth to 0.82% SAAR from 0.66% previously.  The Atlanta Fed is likely overstating growth a bit and the NY Fed understating it, and we suspect the truth is somewhere in between.  Either way, we are far from recession and the Fed is right to pause for now to assess the landscape.  Because we are upbeat on the US outlook, we do not see further easing in 2020.



Broad positive sentiment took the EU’s EuroStoxx 600 index (+1.0%) to a record high.  Unlike it’s US counterpart S&P 500, the euro area index hasn’t made a new high since mid-2015. The EuroStoxx 600 is up 23% year to date, compared to a 26% gain for the S&P 500 and a 20% for the Nikkei 225. Italy (+28%) has been the outperformer so far this year, while Spain (+13%) has lagged behind.

Yet trade tensions between China and Germany are heating up. China threatened to retaliate against Germany’s decision to block Huawei as participant in its 5G wireless network equipment. CDU lawmakers are looking to table a bill imposing a broad ban on “untrustworthy” 5G vendors. In response, China’s ambassador said that the “government will not stand idly by.”  China is Germany’s third largest export destination, and the mainland slowdown has already hurt the economy.  Further trade tensions with China would make things even worse, to state the obvious.  Stay tuned.

Eurozone flash December PMI readings were reported.  The composite PMI was steady at 50.6 vs. 50.7 expected, as manufacturing fell a point to 45.9 and services rose half a point to 52.4.  Looking at the country breakdown, German composite was steady at 49.4 as manufacturing fell to 43.4 and services rose to 52.0.  France showed a similar pattern, with its composite falling a tick to 52.0 as manufacturing fell to 50.3 and services rose to 52.4.  Overall, the data support Madame Lagarde’s assertion that the eurozone outlook has perhaps gotten “less bad.”  Still, we are far from a strong recovery.

Ahead of the BOE meeting Thursday, UK reported preliminary PMI readings for December.  Manufacturing plunged a point and a half to 47.4 vs. 49.2 expected while services fell to 49.0 vs. 49.5 expected, dragging the composite down to 48.5 vs. 49.5 expected.  This is the low for this cycle.  While the UK election gives some clarity on Brexit, negotiations over the future trading arrangement with the EU will likely take years to sort out.  As such, some uncertainty will still hang over UK businesses in 2020 and so the PMI readings are likely to remain subdued.



Australia reported preliminary December PMI readings.  The composite PMI fell to 49.4 from 49.7 in November, as manufacturing dropped half a point to 49.4 and services fell a couple of ticks to 49.5.  The composite PMI is the lowest since August and nearly matches the cycle low of 49.1 from February.  At its last meeting, the RBA gave a fairly upbeat outlook for the economy but stands ready to ease again if needed.  Next policy meeting is February 4 and WIRP suggests nearly 45% odds of a cut then.

Strong Chinese data provided an extra boost of confidence for global markets, adding to optimism from the agreed upon trade deal. Industrial production came in at 6.2% y/y in November, well above expectations and the previous month’s figure, while retail sales accelerated to 8.0% y/y. We still don’t have a lot of detail on the deal, but we don’t think it matters much. Some tariff reduction in exchange for agricultural purchases and IP protection is close enough to what markets were looking for. Eventually, markets will start to worry about implementation as well as the next phase, but for now it’s all about the signing effect. If this view needs any reinforcement, note that the PBOC’s CFETS fixed the yuan back below the psychologically important level of RMB 7.00.