TEXAS FOLD’EM

TEXAS FOLD’EM

In a poker hand you tend to have a few aggressive players which would like to dictate the flow of the game, nevertheless there is only one winner. In some respects, in the last month or so, I feel we are going through a final round of a poker game and the question that we are all awaiting is who is going to fold first.

We came in a short week post Easter celebration with multiple tweets from President Trump criticizing Jerome Powell, the Fed Chair, of how late he is to cut rates and kind of creating a narrative that if there is any economic drag is due to higher restrictive rates. There were also comments that a group of White House advisers are trying to find plausible ways to see if the Fed Chair can be removed before the end of his tenor. As you would expect, the US stock and bond market did not like this sort of uncertainty starting the week with a 2.5-3% daily move lower. It did not take long for President Trump to de-escalate the situation as apparently some close advisors recommended a more benign approach to the Fed Chair, still criticizing him but stating that he has no intention to fire him. The US markets got a breather, and Treasuries were the first to rally, trading around 10bps tighter by mid-week, currently at 4.3%.

Global stocks continued their upward trend with S&P futures retracing around 10% from the recent lows, currently at 5500. A de-escalation rhetoric was more obvious by mid-week as both China and US indicated that they are ready to suspend some of their tariffs facing both countries. Moreover, there has been signs that a trade deal between India and US is imminent as the US seeks to finalize a draft agreement on E-commerce, crops and data storage. According to Bloomberg, there are a lot of trade counterparties which are discussing different deal manifestos with South Korea ready to move to a final agreement as soon as next week. Appetite for risk is returning as the conciliatory tone across many different parties is providing a base for the market, at least for now. In terms of weekly moves US stocks traded between 2.5-5.5% higher on the week with technology stocks out performing. In Europe, we saw a similar picture with equity indices trading 2.5-4.5% higher on the week (see table below). On the rates side, 10yr US Treasury is trading 11.5bps tighter and the 10yr German bunds are trading around 1bp tighter on the week. Peripheral spreads are tighter on the week with good interest in Italian and Greek government bonds across the curve.

On the data side, Eurozone PMI numbers came in at 50.1 from 50.9 in March, in a print showing a falling business sentiment. Manufacturing output numbers came better than expected, contrasting services which revealed a bleaker outlook. On the Q1 earnings side, we are seeing a mixed picture across both sides of the pond, with limited reference to forward guidance by most companies. The reality is that there is still a high degree of uncertainty on the macro side, despite the recent move higher in the equity markets, hence I believe the Q2 earning numbers will reveal the true state of the real economy.

Looking ahead…

Fed Governor Christopher Waller stated that he would support rate cuts if trade policies caused a rise in unemployment. In addition, Cleveland Fed President Beth Hammack mentioned that the central bank could move on rates as early as June if it has clearer evidence of where the economy is heading. Next Friday, we wait for the US Non-Farm Payroll numbers which will give an initial picture of how resilient the labor market is and if there has been any major effect due to the recent change in trade policy. So far soft data has shown a cautious stand in the US economy hence the market is looking for validation through hard data. As it stands today, the market is predicting a US terminal rate of 3.5% by year end, which remains to be seen if this is the case. What I am worried about is a potential US stagflation economic regime, which will make the FED’s job quite hard and push the market into more uncertainty. And with this closing remark, I question myself. Who is going to fold first in this tit for tat trade war? The US administration which has a defined time frame or China which has an unlimited time perspective?

Written by: Michael Konstantinou, Senior Portfolio Manager