Morgan Stanley Finds A "Stunning Divergence" In The Economic Data

Since we first highlighted the data, there has been a great deal of attention paid to the post-election divergence between the so-called soft (sentiment) data in the US, and the hard (quantifiable) data.

Morgan Stanley"s chief equity and rates strategists note "the divergence is stunning."

Upside surprises appear to be completely driven by the soft data while hard data are simply coming in about as expected. This was underscored by the fact the Fed made little revision to its economic forecasts at the March FOMC meeting. Essentially, the hard data are unfolding in line with the Fed"s 2017 outlook.

There is a Record Gap Between the Strength of "Hard" and "Soft" US Macro Data

Simply put, the hard data on the economy is still looking far too soft.

Morgan Stanley offers an additional compelling take on capturing this hard versus soft divergence.

Compare the New York Federal Reserve Bank’s current 1Q GDP tracking vs ours - FRBNY is currently tracking 1Q GDP at 3.0% versus us around 1%. The difference is larger than usual and is being driven by the fact that the New York Fed incorporates soft data into its tracking (attempting to tie it econometrically to GDP, a very hard thing to do especially in real-time). Our method translates the incoming hard data into its GDP equivalent. Note that the Atlanta Fed’s GDPNow tracking also focuses on hard data and is currently tracking 1% for 1Q GDP (Exhibit 2).

Will the hard and soft data reconcile, and in what direction? Optically, a 2Q GDP bounce back would perhaps be taken by markets as the hard data correcting to the soft data—in other words, risk appetite may find renewed inspiration as positive hard data unfolds. But from an economist’s point of view, smoothing through the volatility simply looks like the outlook for around 2% growth remains intact. Moreover, we do expect that the breadth of the 2Q rebound in hard data will be fairly limited, with a swing in consumption as the main driver of the expected 2Q upside, followed by a slightly better net trade and inventory profile. As a consequence, we would not necessarily expect "hard data" surprise indices to start racing higher if the factors behind the 2Q growth rebound remain narrowly confined to a few sectors as we expect.

Additionally, as we noted previously, the problem - for the hope enthusiasts - is the last 5 times that the gap between perceived economic reality and actual economic reality was near this high, the S&P 500 had a troblesome few weeks/months after:

• JUL 2007 -12%


• JUN 2009 -9%


• APR 2010 -17%


• MAR 2011 -19%


• NOV 2014 -6%

Still, this time will probably be different.

Deutsche: The Fed Gave Trump Just Enough Rope To Hang Himself With

There has been no shortage of sellside reactions to last week"s Fed rate hike, which have run the gamut from congratulatory as per BofA and Credit Suisse, to the outright critical, as we showed last week in a note from Goldman Sachs, RBC and SocGen, all of whom accused the Fed of either misleading the market, or soon being being forced to double down on its hawkish message as a result of the dramatic easing in financial conditions as a result of a rate hike.

A somewhat compromise take was provided by JPM"s quant Marko Kolanovic last week who shared the following reaction to the Fed hike:

Fed Put and Buying the Dip: Early this month, the Fed surprised the market by telegraphing a March hike. At the time, investors started speculating whether this was a sudden hawkish turn, or even a politically motivated decision. We think it might have been the move of a prudent monetary Dove. Hiking in March, gives the Fed the option to skip June should there be market turmoil (e.g. related to French elections). Indeed, the market-implied probability of a June hike dropped yesterday from 60% to 50%. After the dovish hike yesterday, extreme short positioning in bonds, and the selloff in rate sensitive assets (such as precious metals and REITs) snapped back. The short squeeze in these assets could have some momentum in the next several days. The dovish Fed outcome implies that the ‘Fed Put’ is likely still alive and well...

Which brings us to the latest, and most whimsical take yet, that of Deutsche Bank credit derivatives expert, Aleksandar Kocic, who usually tends to have some of the more unconvential views on monetary, or any other, policy. He did not disappoint on Monday, when in Deutsche Bank"s latest weekly note, he writes that there are basically two different possible endings to the current economic situation, or as he puts it, "the future is bimodal" with "volatility to be found between politics vs. policy."

Here is a summary of his reaction to the Fed"s third rate hike in a decade

The subtext of the last week"s Fed "package" is a compromise motivated by a desire to extend the comfort zone and to hedge their position against possible fiscal irresponsibility, while, at the same time, not stand  in the way to any possible fiscal stimulus (or its absence) by hiking too aggressively.... Depending on the interplay between degree of political resolve and the Fed actions we could see two distinct paths of resolution of the existing tensions in the mid- or long-run.

And his detailed take:f

Last week, the Fed delivered what appears as a dovish hike, in all likelihood to be followed with two hikes more in 2017 and three in 2018. Such a choice of the Fed action was a compromise driven by the developments in the labor market and the key events in Europe, on one side, combined with the risk associated with the approval of the fiscal stimulus, on the other. The subtext of this compromise can be interpreted as being motivated by the Fed’s desire to extend the comfort zone and to hedge their position against possible fiscal irresponsibility, while, at the same time, not stand in the way to any possible fiscal stimulus by hiking too aggressively.

Despite all the efforts not to create more uncertainty, this is likely to create at least mild ambiguity regarding the long-run. A Fed which is not in a standby position waiting for the fiscal package to arrive and kick in is going to be supportive for USD and higher real rates. The March FOMC “package” (in terms of rate hike, dots, rhetoric and Q&E) implies effectively a real rate rise and is most likely bearish for breakevens, which could diminish the effect of the border tax on the trade deficit and, as such, reduce the impact on growth potential. In addition, having higher real rates increases the costs of borrowing and possibly creates political resistance against deficit expansions and structural steepening of the curve. On top of that, given what we saw in the last weeks, this suggests that the political process around the budget plan and the Legislative package already expected by the market is going to be anything but smooth, which is adding further doubts about its success and timing.

Depending on the interplay of politics and policy -- degree of political resolve and the Fed actions -- we could see two distinct paths of resolution of the existing tensions in the mid- or long-run. On one hand, it appears that the Fed is removing uncertainty around the terminal rate, while on the other, politics is creating a binary outcomes which could have a dramatically different effect on long rates. In that context, we are facing a future with bifurcating back end of the curve. Either political bottlenecks clear and the stimulus gets approved and goes full force leading to higher growth potential with subsequent rise in price levels and structural steepening of the curve, or political tensions effectively sabotage either its arrival or content (or both), and the curve initially bear flattens or even twists with rate shorts capitulation accelerating the rally of the back end.

The above, simply summarized: the Fed has given Trump just enough rope to hang himself with; and since all that matters now is how effective the President will be in passing his political agenda - which is not looking good- should Trump fails, the one of two possible outcomes that is most likely is the one where the "curve bear flattens or inverts", prompting the next, long overdue, recession. 

China Responds To Fed Jawboning March "Live" - Weakens Yuan, Spikes Money Market Rates

After a week of jawboning markets into believing that the March FOMC meeting is now "live", it appears China has decided to send a little message.

After weakening the fix by the most since Jan 9th, Chinese money market rates are soaring (1 week CNH HIBOR up 303bps) despite notable liquidity injections...

Of course an unexpected rate hike in March is an implicit tightening of the world"s financial conditions and thus liquidity withdrawal... reversing recent improvements in global dollar liquidity.

As Mark St.Cyr asks (and answers), is China about to begin pre-emptively devaluing the yuan?

Remember when any member of the Federal Reserve, regardless of the action be it a speech, interview, what they had for breakfast et cetera, was met with panting breaths by the financial media? You know, like it was back in the old days, say around 90 days ago more or less. My how time both flies and changes.

Today? Like it or not (and I presume they disdain it) the President as opposed to a Fed. president, has reclaimed all the oxygen, print, airwaves, bandwidth, and more from not only the general news, but the business/financial news as well. I have a feeling that’s not sitting well within the confines of the Eccles Building. Remember: Elites don’t like sharing stages, especially with those they deem as “outsiders.”

So what does the above have anything to do with March and the Yuan you may be asking? It’s this:

You or I may be enjoying a respite from the media where the Fed. (or central bankers in general) aren’t dominating every topic of business/financial discussion. Yet, the one audience I’ll contend that’s still hanging on every syllable for meaning and intent is China. And China is the, and I mean just that – the – only audience that matters. The reasoning is simple:

China, overnight, can bring the entire global markets crashing to its knees via one wrong move, exponentially faster than any Fed. misstep, intentional, or otherwise. Period.

In other words, the Fed. more often than not will signal first (yet they can surprise) and the move would cause turmoil, but the move (and resulting chaos) itself would be more reaction to surprise than substance, where knee-jerk-selling is met with horns-over-hooves buying from Bulls just itching to buy the next dip. (i.e., 1/4% unannounced or unanticipated hike or something else in kind.)

China on the other hand could intentionally devalue the Yuan in whole number, even double-digit percentages, unannounced overnight, and the chaos could quickly transform into unstoppable monetary bedlam. And there’s recent precedent for clues. e.g., August of 2015.

So with the above for context the question that should be first and foremost in everyone’s mind is this:

If China believes there’s a rate hike in March, regardless of what the rest of the world (and academia) might think. Will it force  China into delivering a monetary strike first, and deal with its aftermath later, rather, than simply waiting around to then deal with any potential monetary aftermath or chaos unleashed by the Fed. later?

I believe not only will they move first – the move borders on inevitable.

I base this on no other reasoning than watching the Fed. continuing to throw ever-the-more fuel onto this “monetary powder keg” that brings that response on quicker, rather than later. For the more they pile on, the more this “monetary powder keg” moves from in-need-of-a-match, into self-igniting.

I am of the opinion China’s ever-growing capital flight problems, and more can not withstand another rate hike, let alone one so close after December. And the tell-tale signs for this to be more plausible than not have been occurring in plain sight with far more telling frequency (and I’ll imply: intent) than previously. And the ones who seem to not be reading the “tea leaves” is none other than the Fed. itself.

Here’s some of my reasoning from the article, “Feb’s FOMC Meeting: A Powder keg In Search Of A Match” To wit:

“If China feels that it is in a no-win situation (and it’s easily conceivable using the Fed’s latest words, speeches, shift in policy signaling and a whole lot more) They might decide after coming back from their New Year holiday and – act first – question later.”

Guess what the politburo did when they returned? Hint: Everything and anything but (and it’s a very big but) the one thing they always did in unison – defend the Yuan.

Everything in China went ballistic. Bonds, stocks, commodities, all up. The Yuan? Tumbled to one-month lows.

I’ll contend this is an overt signaling action which screams warning signs everywhere. For why did China, this time, throw so much money everywhere else except for the one place it basically threw the “kitchen sink” at only a month or so prior? (e.g., The Yuan as to strengthen it away from the much dreaded psychological USD/CNH 7.00 cross.)

Was this a test to see what reaction (both market and political) would take place doing something other than something solely Yuan centric? Or, was this a move of desperation as to subside further capital flight? After all: This is precisely the exact opposite of what one should/would do if the plan was to strengthen, rather than weaken one’s currency, correct?

Again: Why would you throw enormous sums of money into actions which not only have a negative effect, but a canceling effect on what you just threw (again) enormous sums of money only a month prior? Does the old joke “Drilling holes in the bottom of the boat to let the water coming in out.” come to mind here? Which is why I’m siding on the side of desperation – first, as opposed to  a test. And here’s why, as stated by economist, and China watcher Andy Xie (one of the few economists I admire) to wit:

“China’s domestic woes and international challenges are largely due to its inefficient system. The government is obsessed with concentrating economic resources in its own hands, and asset markets are like casinos, sucking people in and making them lose money. The government uses its vast resources inefficiently. Hence, China’s currency has a tendency to depreciate.”

Using the above for a prism it’s easy to see how the politburo can do two things at the same time which seem diametrically opposed to what was professed (or signaled) only weeks prior. Why? Because when elites panic – they’ll throw money everywhere and anywhere first, because that’s all they know. And I believe this demonstrates China is beginning to panic.

The real question (and problem) now is: How far, and how fast, from the “beginning” to “end game” they decide to proceed going forward from here? I believe all we have to do is look to our own Fed. for clues, for they appear utterly clueless to what is taking place right before their own eyes.

So what kind of signaling (hence exacerbating China nervousness) is forthcoming from the Fed you ask? Fair question, to wit:

From Reuters™ “Dollar Index Rises As Yellen Signals More Rate Hikes”

“Waiting too long to remove accommodation would be unwise,” Yellen said in prepared remarks before the U.S. Senate Banking Committee, the first of her two-day testimony before Congress.

That was just a few days ago from Fed. chair Janet Yellen’s televised two-day testimony before Congress.

But what went along with the above was what went nearly unreported (as I implied when stating “the old days”) when none other than the Fed’s Dennis Lockhart (another Fed. president retiring at the end of the month) stated in an interview with Bloomberg™ “March meeting is live.”

That’s a lot of confirmation that March is to be considered live, is it not?

As I’ve iterated before, I believe the rest of the world (or “markets”) are still of the idea that the Fed. is once again “crying wolf” as they did all throughout 2016. For China? I think they’re back to an August 2015 frenzy caught between what to do next, never-mind, what not to do. And it’s getting more complicated for them by the day.

Think I’m over exaggerating? Fair point, so here’s just a few “other” headlines China returned from holiday to read and think about, let alone, needing a response to:

“…Trump Backs Japan Over Disputed East China Sea Islands”

Or how about this from the WSJ™ implying further retaliation, “U.S. Eyes New Tactic To Press China”

So where are we now? As I stated in my previous article, I believe it’s all about the Fed. minutes, to wit:

During that time I believe China will wait for the minutes to be released, and if it is made apparent that there was indeed further discussion as to bolster the inferences that the Fed. may be actively considering a path as to embark on a march towards higher rates, along with the thinning of its balance sheet, which would inevitably send the $Dollar rocketing skywards?

They’ll act first and ask (or maybe not) questions later. Sending everything that is now taken for granted in the “markets” (e.g., “It’s good to be long!) into total chaos. All before March 15th’s next meeting. Again, which just so happens to be the exact date originating the “Ides of March” warning.”

If the actions by China after returning from their holiday break are any clue? Than the possibility for a “monetary first strike” is all the more plausible, if not probable, than these “markets” are signaling, let alone contemplating.

China has thrown buckets of capital at not only the Yuan, but its credit markets in unison – and capital flight is accelerating still on all fronts. All while the $Dollar strengthens, and Yuan weakens seemingly against the will of both monetary bodies.

So again, with all the above for context, as I said in the title…

If March Is indeed “live?”  Then so too is the mother of all monetary shocks.

We shall see our first clues for the minutes of the latest FOMC meeting are to be released this week. And if they are indeed “hawkish?” I believe it will force China’s hand before the next meeting. Whether anyone is prepared for it, or not.

And if any clues are to be extrapolated by current “market” action? The answer is self-evident: nobody thinks such a thing is possible anymore, let alone – positioned for it, making things more problematic than they already are. If that’s even possible.

*  *  *

Finally we wonder if - just as was the case after the Shanghai Accord had fulfilled its Plunge Protection Team role in Q1 2016 - whether the same is about to occur...

Notice that the Yuan has been strengthening against the USD for the last 2 months (despite all the gnashing or political teeth over its manipulation). A Fed rate hike is the perfect excuse to let that pretense slide again.

Goldman Raises March Rate Hike Odds, Sees "Strong Support For Near-Term Policy Action"

With "Goldman Guys" forming the core support pillar of Donald Trump"s economic and financial advisory team, it is easy to forget that Goldman is also the one bank whose alumni also dominate not only the Fed, but all other central banks, and as such its take on Fed prepared remarks is probably the most notable of all sellside analysts.

With that in mind, moments ago Goldman"s chief economist Jan Hatzius just summarized her prepared remarks as follows: "Fed Chair Yellen said the FOMC would review the stance of policy at its “upcoming meetings”; if data “continue to evolve in line” with its expectations, further tightening would be warranted. We see the remarks as offering relatively strong support for near-term policy action."

He also notes that Yellen "indicated that if employment and inflation are “continuing to evolve in line with [the committee’s] expectations”, “a further adjustment of the federal funds rate would likely be appropriate”. We see these comments as expressing somewhat more support for near-term tightening than we had expected. We therefore have nudged up our subjective probability of a rate increase at the March FOMC meeting to 20% from 15% previously"

He also made the following two key points:

1. In prepared remarks for her first day of Congressional testimony, Fed Chair Yellen indicated that the FOMC would evaluate the economy’s progress at its “upcoming meetings”. She indicated that if employment and inflation are “continuing to evolve in line with [the committee’s] expectations”, “a further adjustment of the federal funds rate would likely be appropriate”. We see these comments as expressing somewhat more support for near-term tightening than we had expected. We therefore have nudged up our subjective probability of a rate increase at the March FOMC meeting to 20% from 15% previously. We left our subjective probabilities for the May and June meetings unchanged at 20% and 45% respectively; today’s adjustment therefore implies cumulative odds of 85% of at least one hike by June (up from 80%). For the committee to move as soon as the March meeting, we would likely need to see better-than-expected data in the coming weeks, starting with a firm CPI report tomorrow.

2. In her comments today, Chair Yellen described the stance of policy as “accommodative”, in contrast to her remarks in January in which she said policy was only “modestly accommodative”. The former phrasing suggests that the committee will have a stronger presumption to lift rates, in our view. Lastly, Yellen declined to put emphasis on the “room to run” message she stressed at times last year, despite the modest increase in the unemployment rate. Instead, her comments focused on cumulative progress in the labor market. She said that the unemployment rate is more than 5pp from its 2010 peak, and noted that the U6 measure of labor market utilization “also continued to improve over the last year”.