Making it all add up
Analysing and trading the markets, particularly from a fundamental perspective involves a lot of number crunching. Data is released almost nonstop in the modern market place and new reports and metrics are being introduced on a regular basis.
Established items need to be compared to estimates and historical trends, whilst the new methodologies need to be assessed and weighed against their peers, before being included in models and calculations. But as Mark Twain put it in his autobiography, as he discussed the use of figures to support an argument or view
"There are three kinds of lies: lies, damned lies and statistics."
Whilst that may be a somewhat uncharitable viewpoint, it highlights the fact that we often do need to look beyond the headline figures in data releases to discover just what's going on behind those numbers.
A case in point
An excellent case in point would be the sharp jump in Machinery Orders seen in Japan during January. That data that was released this week. The headlines and the headline numbers show a 15% jump, month on month for January. Given that Japan's economy is still largely reliant on manufacturing that should surely be seen as a positive, which of course it is. However we would not be wise to view that figure in isolation and we therefore need to look behind the headline data.
The sharp rise in machinery orders emanates from one sector, the steel industry, which had been shopping for boilers and motors earlier in the year. In fact we if look at Machinery Order data from manufacturers (which includes the steel sector orders) we find they have jumped 42% in January. However if we exclude those items (steel sector orders) or view them as one offs, which they most likely are. Then we find that the overall trend in Machinery Orders is actually flat at best. Furthermore the sharp jump in orders from manufacturers are largely offset by a sharp drop in orders from abroad, which fell 29.4% during the first month of the year.
Chart plots Japan Machinery Orders vs Japan Industrial Production
As we can see from the chart above Industrial Production in Japan (the dotted line), which we can consider to be a broader measure of activity in Japan's manufacturing economy, is actually trending lower and has been since the start of 2014. On that basis the Machinery Orders data would not have been a compelling reason to trade Dollar Yen, of and on its own, over anything other than the shortest of time frames. If you were even awake at midnight on a Sunday evening London time that is.
Against that background the Bank of Japan meet on Tuesday to decide on the level of Interest Rates and Quantitative Easing in the country. In recent comments BOJ Governor Kuroda has suggested that the Japanese Central Bank will sit pat and take no further action. While it assess the impact of negative interest rates on the economy and the banking sector in particular. Whether the ECB decision, on Thursday last week, to move rates further into negative territory and boost QE, will have an influence on the BOJ, remains to be seen.
If the BOJ do surprise the markets and cut rates further I think it likely that the Yen could initially strengthen, just as we saw with the Euro when the ECB moved. At the risk of sounding like a broken record in both cases it seems clear to me that Monetary Policy is reaching the end of what it can usefully achieve on its own and that politicians in Japan and Europe now need to grasp the nettle and make the difficult choices and structural changes necessary to re boot their economies.
Fork in the road
On Wednesday evening we will here from the US Federal Reserve as it meets to make its own decision on interest rates. Of course US interest rates have taken a different fork in the road heading uphill whilst those of many other economies remain in the lowlands or have descended "below sea level ".
The Fed must decide if the US economy, in its current state, warrants a further interest rate rise. I.E. is demand / inflation sufficiently strong to require the cost of money to rise? Historically inflation has been defined as "too much money chasing too few goods" and raising interest rates is seen as a method of slowing down the availability of money.
Whilst that definition might be too simplistic for a global economy that remains under the influence of unconventional monetary policy (QE) the Fed must try to look ahead or get ahead of the curve as they say and anticipate where levels of demand (inflation) are likely to be in the future. If they chose not to act now, as well as if they do.
Chart plots the markets expectations of Future rates of US inflation (source Fred data)
Inflation expectations are picking up in the US. As we can see from the chart above a clear rally is visible from the end of February. However these projections are for rates of inflation that will apply five years into the future and I note that these future expectations remain below the Feds own current 2% inflation target.
As I write Fed Funds Futures, which are used to calculate the probabilities of rate rise in a given month, show a zero percentage chance of a Fed move on Wednesday evening. Despite the steady improvement in the flow of positive economic data coming out of the USA since mid-February. As can be seen by the rising blue line, highlighted in the pink box in the chart below.
Chart plots the level of economic surprises in selected economies vs analyst's consensus forecasts
So let's listen to what the Fed say and do on Wednesday evening (not forgetting that US clocks have moved to day light saving time) and prior to that, what the Bank of Japan announce early on Tuesday morning. Whatever the individual outcomes are, as we move through 2016 Monetary Policy Divergence will take on an increasing importance and the proper interpretation of economic data that supports the policies that have brought it into being, should become more prominent in our decision making and trading processes as well.
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