Powell and Draghi, Xi and Trump

The investment climate will be determined by three events next week. The testimony of ECB President Draghi before the European Parliament will begin this week. Fed President Powell speaks to the New York Economic Club mid-week. Presidents Trump and Xi are scheduled to meet at the G20 meeting to close the week in hopes of revisiting the escalating trade dispute. Also at the G20 summit, the NAFTA 2.0 should be signed and steel and aluminum tariffs on Canada and Mexico could be changed (turned into quotas?) Shortly.

Draghi speaks a few weeks before the next meeting of the ECB. Market participants may be sensitive to two topics. First, the state of the economy of the euro area. The German contracted unexpectedly in the third quarter and the fast PMI indices suggest that weakness persisted in the fourth quarter. Forward-looking order data continue to signal a weakness that exceeds the auto sector,

The ECB has always conditioned the end of its asset purchases on incoming data, but it has been widely accepted that conditionality was for decorum purposes and that in fact, the impediment to an extension of the purchases of Net assets to next year was high. Draghi focused his optimism on the job market. This has not changed. At the same time, Draghi acknowledges that the economy still needs an extraordinary monetary policy and he can tell the European Parliament that the policy will remain simple once the asset purchases are completed. Refi's operations are fully allocated to a fixed (zero) rate, there are liberal guarantee rules, the deposit rate remains below 40bp.

The ECB also insists on its forecasts. The ECB's pre-commitment not to raise rates until next summer has been an important stabilizing factor. However, the market reaction function is even faster. Since the beginning of the month, the implied odds that the ECB will not raise rates as long as Draghi does not withdraw in October have now doubled to more than 50%. The implied yield on the Euribor futures contract in December 2019 has decreased by approximately 15 basis points in the past two weeks before the October meeting of the ECB.

In addition to comments on the economy and monetary policy, investors will pay attention to what Draghi, the former governor of the Italian central bank, said about his country. It is unlikely that Draghi opposes the EC recommendation to initiate excessive deficit procedures against Italy after refusing to substantially amend its budget proposals. He warned that Italy "was dozing in instability". However, the EU is moving slowly and many observers believe that investors will want investors to put pressure on Italy. The poor receipt of recent bond sales would seem to confirm this.

However, contrary to expectations, Italian bonds rose sharply last week. The 10-year yield rose from a peak above 3.70% on Nov. 20 to 3.35% ahead of the weekend before settling at nearly 3.41%, the lower the fence in two weeks. Consider the move in the short term. The two-year yield peaked near 151bp on November 20th and fell to nearly 82bp before ending the week with just over 95bp. Italy is back on the market next week with a series of issues, ranging from six-month bonds and one-year, five-year bonds on inflation and five-year bonds. and ten years.

We also believe that investors will become more sensitive to tensions in the Italian coalition government. The League and the Five Star Movement are not natural allies and have a marriage of convenience. Salvini, the junior coalition's partner, outperforms Di Diño, who has less experience, and his support has increased in the polls. Tensions are inevitable and it is too early to think about the next government. However, if League support continues to increase, Salvini may be tempted to pause after the elections to the European Parliament next May.

II

The market has never accepted the FOMC's indications that three rate hikes would probably be appropriate in 2019, but recently, he has similarly retreated his prices in more than a rise. According to the GCE model, there is a bit more than a 30% chance that the Fed will have completed its action or that its tightening cycle will fall short of a rise. There is a 36% chance that the federal funds target will reach 2.50% -2.75% by the end of next year, up from the current target of 2.00% -2, 25%. Between these two scenarios, there is a chance in two. The GCE model shows a 23% chance of achieving a fund objective of between 2.75% and 3.0% and less than 9% on a higher target.

The implied yield on the federal funds futures contract in December 2019 fell by almost 25bps since November 8 to reach 2.70%, the lowest level in two months. Similarly, the Eurodollar futures contract of December 2019 rose after its third execution attempt at 96.70. The implied yield has dropped about 27bp since the trough of November 8th.

Some observers attribute the fall of the US stock market to President Powell's comment in early October that there was still some way to go to reach a neutral framework. However, given the relative performance of the different sectors, a more convincing scenario would link the fall in equities to other factors, such as lower oil prices, higher telecommunications and communication by MSCI / S & P. , maximum benefit concerns, regulatory changes, and trade tensions.

During previous business cycles, the actual rate of federal funds, once adjusted for the overall CPI, has often had to move into negative territory to facilitate recovery. Today, nine years after the start of the recovery and expansion, the goal of federal funds is less than the CPI of 2.5%. How can monetary policy be viewed as restrictive when the policy rate is negative in real terms, unemployment is close to its lowest level in half a century and the economy has grown at an average annualized rate? more than 3.8% in the last two quarters?

Observers add to the difficulty for investors to separate signal noise by treating all Fed speakers equally. None of the regional presidents, with the exception of the president of the New York Fed, vote each year. Some simply express aberrant views that do not represent the majority of the Fed. Kashkari and Bostic opposed almost all the increases in the cycle. Therefore, when they say that the Fed should pause, investors can expect it. Fed officials who will be constantly on the lookout are Powell, chairman, Clarida, vice chairman of the board of the Federal Reserve, and Williams, president of the New York Fed and vice president of the FOMC.

All three are talking next week. They will not depart from the message they delivered. The monetary cycle is not over and further incremental increases will be provided. The risk assessment of the Fed is balanced. In recent speeches, some of the potential headwinds have been specified. These include slowing global growth, the cumulative effect of past increases, and the decline in fiscal stimulus. Some observers suggest that the sale of the shares may give the Fed the cover to pause, but this is to misrepresent its intentions. The Fed is not looking for cover or excuse for not raising rates. He wants to raise rates because he has fulfilled his mandate. For all intents and purposes, full employment is at your fingertips and the goal of inflation has been achieved.

Some observers suggest that the dramatic drop in oil prices will keep inflation under control, which is why the Fed does not need to raise rates. This is an error. The Fed targets underlying inflation, which excludes food and energy. Indeed, the Fed has found that over time, headline inflation converges towards the core rather than the other way around. Another way of saying that it is the basic rate is the signal while the total inflation is noisy. Remember that in July 2008, the ECB had raised interest rates because of the inflationary implications of rising oil prices, a political blunder with epic proportions, it seems, while the economy of the euro zone had already begun to contract before the collapse of Lehman. months later.

Modern central bankers consider financial conditions when defining monetary policy. The performance of the shares is part of the financial conditions. However, this does not mean that each technical correction (10% decrease) or the bear market (20% decrease) requires a political response. Many Fed officials have realized that the stock market is rich compared to historical valuation measures. The narrowness of the advance seemed to conceal the weakness below, for example the number of companies trading below 100 or 200-day moving averages. Some decline in a period of time likely to elicit a reaction from the Fed, but this level is probably much lower than what we have seen so far.

III

The highly anticipated G20 meeting will take place from November 30th to December 1st. The Trump-Xi meeting is at the center of the debate, as this meeting has long been seen as the last chance to ease trade tensions. Vice President Pence's speech to APEC and Lighthizer's report last week poisoned the well, saying that even in the run-up to APEC, China continued to steal intellectual property.

Trump and Xi can agree on a discussion framework. Recent administrations have put in place a framework for trade and economic discussions, which Trump avoided. However, in and of themselves, they count little for investors. The most pressing question is whether Trump threatens to freeze a 10% tariff on the remaining $ 265 billion worth of goods for which he has not yet imposed a new tax, and if Trump is considering raising the tariff of 10% 25% on 200 billion dollars of Chinese products.

One of the arguments against intervention on the foreign exchange market is that it would undermine the effort to persuade China that exchange rates are better set in the market. Similarly, the United States pushing into waters unknown to national security to justify its protectionism undermines arguments that China is somehow unique in playing rules to its advantage. And to be sure, it's not just Trump. Take the Obama tariffs on tires and Bush's on steel.

It seems quite clear that the United States regards China as more than a commercial problem. Senior US officials have insisted in their recent speeches in favor of China. The projection of Chinese power is a threat to the United States and its vision is contrary to American values. This is radically different from the way the United States perceives their economic competitors as Canada, Mexico, the United Kingdom, Germany and Japan. Bill Kristol, a neoconservator and editor-in-chief of The weekly standard, meditated in social media about whether regime change should be the US goal in China.

At the G20 meeting, the United States, Canada, and Mexico should sign what Canada and Mexico call the new NAFTA agreement, which US officials have suggested will serve as model for future agreements. This agreement contains a clause that basically states that in exchange for privileged access to US markets, countries must agree not to enter into free trade agreements with non-market economies. (which is a euphemism for China). The United States is laying the groundwork for a new world order.

US rhetoric and actions reinforce China's willingness to reduce its trade ties with the United States. Some Americans have suggested that a trade agreement could be based on products such as soybean and LNG or rare earths. Although there is logic, China does not consider the United States as a reliable trading partner. China could be better served by finding alternative sources of inputs and markets for its products.

Many, including Trump, argue that the fact that China has a large trade surplus with the United States means that China will be more affected by trade tensions. This minimizes potential disruptions for US consumers. The disparity of wealth in America means that many households depend on cheap consumer goods. America seems ill-prepared for an import substitution strategy. Despite corporate tax cuts, investments in the United States have been lower than the Trump administration had anticipated. Retaliation fees also discourage the expansion of onshore capacity.

Disclosure: I / we have / we have no position in the actions mentioned, and do not plan to initiate position in the next 72 hours.

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