A week after publishing our note explaining why we were still bearish on the U.S. dollar, both the markets and economy have once again ornamented the scarecrow that is a cornered Federal Reserve, with a couple more blazing motifs which should eventually seal the coffin of any impulsive Fed tightening.
This not only strengthens the weaker dollar premise we have been advocating for 2 months since April, but also leads the plot towards the real story, free from all that distracting ephemeral white noise that markets have become synonymous with. The real story of divergent economic cycles; something we foresee as a critical driver of forward volatility in the currency markets.
Markets are slowing coming to the realization that monetary policy always lags the underlying economic reality. Once traders are struck with this epiphany, recent moves begin to make more sense; we can also confidently discount the restless banter financial media squawk with wanton abandon. Our advice? Stop chasing your own tail, and be wary of the market's tendency to flick its own kill switch.
America & Canada Officially Slip Into Contraction
We were right and wrong on this front; right about weakness in the American economy, wrong about acceleration in the Canadian economy. Truth be told, we are still much more bullish on the Maple Leaf than the Eagle. For the purposes of today's note, we will skip that and jump straight into the details.
Last Friday, the U.S. economy officially contracted by 0.7% QoQ after 1Q15 GDP was revised 0.9% lower from the sluggish preliminary growth rate of 0.2% reported 3 weeks ago. The -0.7% growth over 4Q14 has been blamed by both the market and Fed officials on the weather. Readers know that we believe the weakness extends much deeper than a harsh winter and seasonal forces.
The magnitude of the downward revision (-0.9%) tells a tale on its own. A -0.7% growth rate is the last thing the Fed wants to encounter on its path of monetary tightening. While no one knows for sure what the final 1Q15 growth rate will settle at, we along with most other analysts believe a contraction is inevitable at this stage. It is a question of how much, not if the U.S. economy contracted from January to March.
Economists were forecasting a -0.8% growth rate on Friday's revisionary print; the -0.7% figure beat in that expect, albeit by the smallest possible amount. That has nevertheless placed America in contraction while Europe as a whole seems to be expanding once again, echoing our point of divergent economic cycles.
The strong dollar picture needs a much less picturesque frame. Word is now out that second quarter GDP growth might too be contractionary. If that unlikelihood materializes, we will be talking about a full-fledged recession. It will take more than another deluge of the proverbial Obamacare fiscal punch bowl then. Our fingers are crossed!
Across the northern boarder, the Canadian economy surprised negatively after it too contracted by 0.2% in the first quarter. Consensus forecast was for a 0.2% expansion, up from the preliminary rate of 0.1%; a -0.4% downward revision in essence.
Apart from its disappointing GDP figures, Canada's CPI data also missed expectations, contradicting the BoC's comments that it expected prices to rebound in the second quarter. We have also observed Canadian macro economic data printing on the soft side in recent weeks, despite oil prices having bottomed in February. Canada's economy is inextricably linked to the U.S.'s, so we might be seeing the larger of the two tugging the other.
We feel that it is still too early to gauge the true strength of Canada's economy in absolute terms. Regardless, between the two mildly stained shirts, it is rather obvious which is the cleaner of them.
All in all, a pretty rude awakening that all is not entirely well in the developed economies as one would have expected given the platitudes of optimism uttered officials who realize that they may be trapped between a rock and a hard place. We are keeping a close watch on the situation going forward for more color.
Grexit Risk Never Higher
Greece is now back in recession while a €1.5bn IMF payment looms just 2 days away.
Greece, now led ever deeper astray by a stubbornly defiant Government, is undeniably the champions when it comes to perpetually kicking the can down the road. We have painstakingly documented the lost decade that Greece has willingly signed itself into by refusing to leave the single currency bloc (read this, this, this and this), and have since given up on trying to predict the future of the country so deep in denial it fails to realize the circles it has been running in.
The 'default' countdown is now under 2 days away and it is becoming increasingly apparent that both the Greek government and the troika have had enough.
The 5 June deadline to repay its €1.5bn IMF loan remains so close yet to distant as we suspect yet more renegotiations to sidestep an outright default - something that none of the Eurocrats will take sitting down.
Month after month of tense negotiations have gone nowhere and yielded exactly nothing and it now looks like PM Alexis Tsipras and Finance Minister Yanis Varoufakis may be willing to miss the IMF payment.
After all, Syriza was elected into power because voters believed that they were voting for change. Promises to end years of painful austerity, challenge the creditors' demands of draconian reforms and ultimately outwitting the troika in the game of bargaining.
The implications of a missed payment are still not entirely clear as of now but it seems Athens is keen to predict the worst as it tries to squeeze concessions from creditors. Their strategy has not paid dividends 2 days from the much dreaded deadline.
The IMF itself, along with several key European figureheads have in the last few days voiced their skepticism that a deal would be brokered despite rumors to the contrary from the Greek side.
The markets have however been much more sanguine. The Euro has rallied more than 3 big figures to highs above 1.12 despite renewed conflagrations between a practically insolvent debtor and patient creditors.
European equities and government bonds haven't been as ebullient though. A mixture of positive economic data from the Eurozone and an increasingly confident ECB has bolstered the Euro higher while subtracting from the impetus to scale up on QE.
"A day after Prime Minister Alexis Tsipras said Greek society can’t absorb any more austerity measures, Finance Minister Yanis Varoufakis said his government has met the euro area and IMF three-quarters of the way, and that it’s up to creditors to cover the remainder.
“Greece has made enormous strides reaching a deal, it is now up to the institutions to do their bit,” Varoufakis said Sunday on BBC’s Andrew Marr Show. “It is not in their interests as our creditors that the cow that produces the milk should be beaten into submission to the extent that the milk will not be enough for them to get their money back”...
German Finance Minister Wolfgang Schaeuble, meanwhile, signaled there isn’t much wiggle room after Tsipras’s government committed to policy changes in return for aid in a euro-area accord on Feb. 20.
“That is the condition for completing the current program,” Schaeuble said in a Deutschlandfunk radio interview aired Sunday. “The problems are rooted in Greece. And now Greece does have to fulfill its commitments.”
Some members of Tsipras’s Syriza party advocate defaulting on loans rather than backing down from the anti-austerity policies that swept it to power in January even if that leads the country out of the euro.
Greece doesn’t have the money, and won’t pay what it owes the IMF in June, Interior Minister Nikos Voutsis said in a Mega TV interview on Sunday. Spiegel Online on April 1 cited Voutsis as saying Greece should delay an April 9 payment to the fund, which was made.
“We’ve done remarkably well for an economy that doesn’t have access to the money markets to meet our obligations,” Varoufakis said. “At some point we will not be able to do it.”
“Once you are in a monetary union, getting out of it is catastrophic,” Varoufakis said. “It would be a disaster for everyone involved. It would be a disaster primarily for the Greek social economy but it would also be the beginning of the end of the common currency project in Europe, whatever some analysts might be saying.”"
Path Of Least Resistance
Other then the circus surrounding the IMF payment due Friday, Greece slipped back into recession in the first quarter after its GDP contracted 0.2% from 4Q14.
This means that the brief 3 quarters of expansion it saw starting 2014 was mere statistical noise and that the chasm between the rest of the EU19 and Greece continues to widen at an alarm rate, with the only logical resolution being a Grexit.
Both broad and core prices (CPI and PPI) continue to slump in Greece, contrasting with a generally improving improving inflation situation in the rest of the Eurozone. In fact, Tuesday's data showed that inflation in the currency union warmed to 0.3% YoY from 0.2% in April - yet another sign that Greece is being left far in the wake of a ship that has long set sail.
All these indicates to us that the risk of a Grexit (Greek Exit) has never been greater, although it might not seem so on the surface. The impetus to leave the Euro and write off just about all of its external liabilities looks to be the path of least resistance to us.
The toil of staying in the Eurozone, being in a constant and never ending tug of war, and having to cede to the demands of its creditors whom will ultimately have their way just adds fodder to the chimeric spirit of a once independent and free Greece.
This is why we say the upside risks of a Grexit is undervalued and which probabilities are overly discounted.
We will discuss this in greater length as the situation develops. But for now, traders should know that Greece has never been in a more vulnerable state with ever fewer cards to play with.