Out in the Cold

Posted on by 
So, suddenly, silver and gold
Are both getting bought and not sold
But oil’s still rising
So, what are folks prizing?
Perhaps risk’s now out in the cold

At least, here at home that’s the case
As AI stocks sell off apace
And what of the buck?
It’s basically stuck
While bonds are just standing in place

Arguably, the biggest change in market relations in the past two sessions is that the metals markets have rallied alongside the price of oil.  Since basically the beginning of this conflict, this has been one of the conundrums in markets.  Gold, which has a long history as a safe haven, started selling off (granted from a parabolic move) shortly before the US attacked Iran.  In fact, many ascribed the sell off to the naming of Kevin Warsh as Fed Chair given the view he was the most hawkish of the potential candidates.  But once the fighting started, gold continued to decline, falling some 27% from its initial burst higher at the beginning to its recent low, below $4000/oz.

Source: tradingeconomics.com

Of course, the oil story is quite different as there were far more twists and turns in the price action as the military activity ebbed and flowed and as comments about ceasefires and peace talks were made and denied on a regular basis.  

Source: tradingeconomics.com

But certainly, the impression from the recent price action was that when oil rallied, gold sold off and vice versa.  The ostensible rationale was that higher oil prices would drive inflation higher and interest rates would follow thus reducing the attractiveness of holding gold.  And perhaps that was true, at least to some extent.  However, that was never a satisfying explanation to me.  And, throughout the conflict I have maintained that the medium and long-term views for the metals was quite positive.

However, something seemed to have happened yesterday, and I see no indication of exactly what that was, but we saw oil, gold and silver all rally nicely on the day.  The oil story is clear as the latest issue is the Houthis now blocking Saudi ships from traversing the Bab-al-Mandeb at the southern tip of the Red Sea and reducing flows.  But the metals story remains a mystery.  Granted, this has only been ongoing for a bit more than twenty-four hours, but the magnitude of the metals moves (Au +3.0%, Ag +5.7%) in the past two sessions is pretty substantial for markets that had been doing very little but sliding for months.

Source: tradingeconomics.com

I don’t believe this has been short covering, as in reality, both markets had lost speculative interest given the lack of volatility over the past months, and so short sellers were not involved.  There were far too many other, juicier targets for them.  As to the dollar, which has long had a negative correlation to the precious metals, as it has traded in a 1% range for the past month, as per the below chart, it is hard to ascribe much causality there.

Source: tradingeconomics.com

However, I sense that we are beginning to see some changes to the relationships that have held for the past several months, so we need to be alert for other seeming anomalies.

Turning to the other markets, and continuing with FX, while generically today, it is doing very little as per the below screenshot,

Source: tradingeconomics.com

It is worth discussing the yen, which yesterday traded below (dollar above) the 163 level for the first time since 1986.  Not surprisingly, we heard from FinMin Katayama as follows: “The situation involving the US and Iran has taken a sudden turn for the worse — a deterioration that the world did not foresee — creating a very difficult environment. Our policy remains completely unchanged: We will take appropriate and bold action at any time, should the need arise.”  However, as I have maintained, given the incredibly slow pace of the decline of the currency and given that speed of decline and the volatility in markets has always been an important part of the MOF’s decision matrix regarding intervention, it seems we are not near that step.  One need only compare the JPY to KRW, a currency with low historic volatility, to see that the yen has not been very active.  In fact, the biggest movements have been caused by the MOF in their intervention and comments.

Source: tradingeconomics.com

There has been an increase in market discussion regarding whether the BOJ is going to hike rates again at the end of this month, which is not the market forecast, nor would it be considered the norm given they hiked rates last month.  Most analysts expect the pace of rate hikes to be every six months as they gradually tighten policy.  Of course, they could change that, but again, the yen’s weakness has many fundamental drivers with rates being only one of the issues.  Personally, I don’t see a hike next week, but I guess anything is possible.

Which leaves us with bonds where yields around the world are creeping higher on a regular basis, Treasuries +1bp, European sovereigns +3bps today, and equities.  Yesterday was a solid day in the stock market in the US with tech stocks leading the way higher.  And while Europe is following suit this morning (UK +1.2%, France +0.8%, Spain +1.0%, Germany +0.3%), last night’s Asian markets were less buoyant.  Tokyo (-0.2%), China (-0.5%) and HK (-1.0%) led the charge lower although there were some bright spots, notably Singapore (+1.2%), Taiwan (+1.3%) and Korea (+0.7%).  I guess overall it was a mixed session.  As to US futures this morning, as I type at 8:05 they are pointing lower led by NASDAQ futures (-1.5%).  

Net, some of the relationships with which we had become familiar seem to be breaking up a bit.  I think no matter how you slice the equity market, it is trading at rich levels, so a correction of some sort seems realistic.  I presume that if the tech earnings next week disappoint, we will see a pretty big downdraft.  As to oil, while there is still plenty around, the war drums are beating louder and that is not helping things.  But bonds and the dollar are sitting this move out, at least for now.

There is no data released today and the Fed is in its quiet period, so we remain beholden to headlines from Iran, the White House and other earnings outcomes.  I have a sense of uneasiness about the day, but nothing to put my finger on.

Good luck

Adf

Decidedly Iffy

Posted on by 
Though war in Iran keeps on going
The impact is not really showing
Risk assets seem fine
And oil’s benign
So, bubbles still need some more blowing

As I often say, markets are perverse and recent price action is a perfect example of this reality. As the US struck Iranian targets for the 10th consecutive day, and risk appetite during yesterday’s US session clearly waned such that all three major indices closed slightly in the red after solid openings, it was easy to expect a continuation of a risk-off attitude this morning.  But as you can see from the tradingeconomics.com screenshot below at 6:45 this morning, only Australia last night did not get the memo.

So, for now, it appears that everything is just fine.  The big banks all reported blow-out earnings last week and next week we are looking forward to the big tech names’ earnings reports.  Now, recent price action has shown that companies that miss their estimates are punished severely, so there is ample opportunity for more fireworks this week.  But so far, a look at the chart of the NASDAQ below shows the line in the sand that must hold in many market technicians’ eyes to keep the party going, and it continues to hold.

Source: tradingeconomics.com

It’s funny, yesterday afternoon I was considering buying some QQQ puts as my concern was that we were about to break down and a 5%-8% correction would be quite reasonable.  My read on the sentiment was turning decidedly negative, although I didn’t pull the trigger, deciding to wait for the actual break before acting.  And last night I wrote the following limericks, expressing my sense of things.

The mood is decidedly iffy
With stock market bulls getting miffy
And now we’ve heard calls
For much further falls
With bears’ attitudes, oh so sniffy

So, two things have risk-takers tense
The first is the increasing sense
That war in Iran
Has no master plan
And may cause, more problems, immense

The second is whether AI
Has peaked, or has further to fly
If we’ve seen the top
The ensuing drop
Will bring a Wall Street hue and cry

In fact, I think it is instructive to help understand just how quickly sentiment can change without any obvious catalyst.  For the life of me, reading through the headlines this morning, there is nothing I have seen that would cause me to believe things are so much better today than at the close yesterday.  But perhaps this is a case of less market activity allowing a bit more volatility in markets.  After all, it is summer and there are many market participants on vacation on any given day.  According to Grok, in the past 5 trading sessions, average volume for NASDAQ shares was about 7.6 billion, but as large as that is, it is well below the YTD average of around 9.0 billion.  In reduced volume markets (no matter how large they are) there can be large, unexplained moves based on individual flows.  I’m grasping at straws here!

Regardless, this is where we stand this morning.  There are headlines dueling between further military action and further efforts at peace talks, with markets clearly preferring the latter rather than the former.  Oil prices (+0.9%) remain within their recent range although are creeping higher this morning.  Is this a prelude to a move back to $100/bbl?  

Source: tradingeconomics.com

The problem with that story is that there continues to be a massive supply of crude oil around.  And Ukraine’s success in attacking Russian refineries has actually brought more crude to market as the Russians can no longer refine their own in the same volumes thus are shipping it to anyone who will buy it. 

Products, though, are a different story as the lack of refining capacity (US refiners are running at about 98% capacity) has led to record high crack spreads.  (The crack spread is the value of the products created from crude; gasoline, jet fuel and diesel largely, compared to the price of a barrel of crude.  The higher that spread the more profitable the business is for refiners, and the more we pay at the pump). Referring back to the chart above, the blue line is gasoline futures in NY, which as you can see are much closer to their early war highs despite the more dramatic decline in oil (green line).

In fact, this chart may be the best metaphor for the current sentiment in the US with the population suffering from rising gasoline prices while the government touts the decline in crude prices.

Net, I am having trouble finding a single coherent narrative that is widely believed.  So, let’s look at how other markets behaved overnight, having already seen equities and oil.  Bond yields rose yesterday with Treasury yields higher by 5bps and a further tick up this morning.  Similar price action was seen in Europe although more of these markets are +2bps this morning, rather than the +1bp in Treasuries.  And JGB yields rose 3bps overnight.  

Speaking of Japan, you may recall the story from about two weeks ago where Japanese FinMin Katayama expressed the idea that Japanese pension funds should consider investing more domestically, bringing home some of their massive $3+ trillion in assets.  The market got quite excited about that and as you can see in the below chart, the yen immediately rallied.  

Source: tradingeconomics.com

Well, that was sooooo two weeks ago!  This morning, the yen is just 5 pips, as I write, from breeching the peak seen before the last intervention scare.  As you can see in the chart, the move is extremely gradual, but in this case, the tortoise is being played by the yen.  I saw more discussion on this pension story this morning but while I think it is highly probable to play out over time, I think the timeline is better measured in years, not weeks, or even months.  As such, the gradual depreciation of the yen seems likely to continue.  Elsewhere, it remains very hard to get excited about the dollar vs. any currency right now.  Sure, NOK (+0.6%) is rallying on the oil rally, and perhaps the real surprise today is ZAR (+0.5%) which despite higher oil has seen higher gold prices help sustain it.  But if we look at the dollar writ large, the ‘breakout’ from its year-long range seen back in mid-June has been a damp squib as per the below chart of the DXY.

Source: tradingeconomics.com

Perhaps the big surprise this morning is the metals (Au +1.2%, Ag +4.2%, Cu +3.1%) are all higher despite the rise in oil prices and yields.  While I remain long term constructive on the metals sector, it is very difficult to understand what is driving today’s price action at this point.

And that’s really it today.  There are no frontline data points to be released so I expect that oil sentiment will continue to lead markets although there will certainly be excitement about equities if they can maintain the rally today.  As to the dollar, nobody seems to care.

Good luck

Adf

Iran’s Bases, to Stress

Posted on by 
For nine days and nights the US
Has sought, Iran’s bases, to stress
So, ships through the Strait
Will now have to wait
Until Trump has made more progress

The upshot is prices for crude
Have risen a fifth and are skewed
Right now, to go higher
As three key suppliers
All find their production subdued

Oil (-0.7%) started the overnight session more than 2% higher after nine consecutive days of US military strikes on Iranian ports and missile sites amid more threatening rhetoric on both sides.  It certainly seemed like things were rapidly deteriorating.  Iran struck targets in Jordan as well as Kuwait, Qatar and Bahrain as the conflict escalates.  As such, we cannot be surprised that there has been a steady rise in the price of oil during this period.  Since the increase in fighting, WTI prices have risen about 20%. However, a quick look at the chart below shows that things reversed overnight.  

Source: tradingeconomics.com

The proximate cause for this reversal was commentary from Secretary Rubio that Iran has signaled an interest in resuming negotiations.  Additionally, there is another story about other Gulf intermediaries, although unnamed, who are trying to bring proposals toward the same end.  Now, the one thing I know is that both sides in this conflict (and any conflict really) put out reams of propaganda, especially about the conflict.  With that in mind, we have no way of knowing whether negotiations are going to restart or not.  However, it appears market participants are willing to believe that is the case.  

What does this mean for markets?  If we have learned nothing else throughout this conflict, it is that many old relationships are no longer operating the way they had in the past.  Consider gold for a moment.  Prior to this conflict it was considered the ultimate safe haven, the thing you wanted to own if things got really bad and there was an escalating war.  And yet, here we are with gold having fallen some 25% since the US first bombed Iran as you can see below.

Source: tradingeconomics.com

Now, two things about this are that first, that followed a remarkable rally for the previous twelve months, so a correction wasn’t crazy and second, it seems that one of the key drivers in the price decline was selling of gold by sovereigns that needed the money including Russia and Turkey.  After all, that is why those reserves exist, for a rainy day, and it was certainly raining hard.  Nonetheless, that narrative theme, owning gold in case of war, has not played out at all as expected.  

Or we can look at the equity markets, especially tech stocks.  It is hard to look at the chart of the NASDAQ below and conclude that the Iran conflict was anything but beneficial for them.  This, too, runs counter to the general narrative prior to the war that risk assets would suffer during a war.

Source: tradingeconomics.com

Now, if we widen our lens a bit to include other nations’ equity markets, Korea in this case, the story is not so sanguine.  As you can see from the below chart of the KOSPI, it has fallen 29% since it peaked about one month ago.

Source: Bloomberg.com

But is that war related?  Or is that the air coming out of what appears to have been a massive bubble in semiconductor stocks.  Recall, about 40% of the value of the KOSPI is made up of just two companies, SK Hynix and Samsung, and both have mooned because they build semiconductors that are in huge demand due to the AI race around the world.  

Now, one of the few truisms in markets is that every shortage is followed by a glut as the high prices from the shortage lead to massive overinvestment in whatever is lacking.  So, consider this comment from someone I believe is quite reliable.

There will be a comeuppance in tech sector shares, I believe, although I would not dare to guess when.  Semiconductors are historically a cyclical industry, and I don’t think anything has changed about that, except perhaps the amplitude of this cycle.  But there will be a downwave and likely one that wipes out many of the gains seen.

And how has the escalation/de-escalation played out elsewhere?  Well, Chinese shares rallied (+1.5%, HK +2.3%) although that was because the Chinese plunge protection team was in the market buying shares, and they told us so.  Tokyo was closed for Marine Day and otherwise, Friday’s weak US performance was followed by general declines, although far less than Korea’s -4.5%.  As to Europe, there is very little ongoing this morning with virtually no data, no commentary and limited market movement.  Arguably, the only story of note was the official resignation of Kier Starmer as PM and the installation of Andy Burnham, although that has resulted in the FTSE 100 selling off -0.5%, the laggard in Europe.  And given his history, including a lack of experience and stated preferences for far-left policies, I think there could be more to come there.  As to US futures, at this hour (7:30) they are slightly higher across the board, +0.3% or so.

Treasury yields have edged higher by 2bps, and European sovereign yields are higher by 1bp across the board with only UK gilts (+3bps) doing worse.  But it remains difficult to look at 10-year yields and get overly excited about anything.  I grant that there has been some choppiness, but in the big scheme of things, a 20bp range on a 4.5% handle over the course of the past month is not all that shocking, especially given the backdrop of a war and extremely volatile oil prices.

Source: tradingeconomics.com

With oil retreating, the three major metals, gold (+0.4%), silver (+2.4%) and copper (+1.2%) are all firmer this morning.  That relationship has been quite consistent, I will admit.

Finally, the dollar remains uninteresting overall with the DXY little changed although there have been two stories of note.  First, KRW (+0.6%) has rallied more than 5% over the past several weeks as the BOK works to change its status from a restricted currency to one that is freely convertible.  They have just announced plans for that to become the reality starting in January 2027 and I expect that it will help the won going forward.

Source: tradingeconomics.com

While the downside of convertibility is a potential increase in volatility, one need only look at the chart above to see it was already reasonably volatile.  But the positive is that KRW can become a viable asset for international utilization, opening up investment to a much wider community and that is inherently strengthening.

The other story is INR (0.0%) which while little changed this morning, saw another bout of central bank intervention on Friday as you can see on the chart below (the long green spike downward on the second candle from the right).

Source: tradingeconomics.com

Alas, the 1.4% gain was very short-lived and merely wasted some more of the RBI’s reserves.  The rupee is likely to remain under pressure until the Iran conflict ends as higher oil prices are a severe impediment to the Indian economy.  I cannot help but think that we are going to test 100.00 at some point before the end of 2026, although I also imagine we will see some more substantial changes from India going forward to help mitigate the impact.  But other currencies are doing little overall.

On the data front, it is an extremely quiet week with the ECB meeting (no change expected) arguably the highlight on Thursday.

TodayLeading Indicators-0.1%
ThursdayECB Rate Decision2.25% (unchanged)
 Chicago Fed Index0.14
 Initial Claims212K
 Continuing Claims1809K
FridayNew Home Sales610K
 Flash PMI Manufacturing54.5
 Flash PMI Services51.5

Source: tradingeconomics.com

As we are in the quiet period, there will be no Fedspeak until, at least, the FOMC meeting next week.  So, the war remains the story to watch, and who knows how that will go this week.

Good luck

Adf

Risk-Taking Cracks

Posted on by 
The president told us elections
Were filled with some lethal infections
He’s unclassified
More docs to help guide
The courts to start making corrections

Meanwhile in Iran more attacks
Has led to some risk-taking cracks
Thus, oil is higher
While semis look dire
Have we seen the market climax?

A few words on the president’s speech last night as it was widely touted.  In it, he explained he declassified a trove of documents offering proof that there have been many election irregularities over the past six years, naming China as a major player in the process.  These documents are available online for all to see and ostensibly refute (I have not read them, nor am I likely to do so) that our elections have been secure in the US.  In fact, the same government analysts that have declared there to have been no issues are the ones who these documents purport to show were interfering.  My only observation, especially on this topic, is that no matter the proof available, minds have long been made up, and this will not change opinions, at least until arrests are made and trials are held.

Which takes us to more relevant market issues.  Arguably, the poster child for semiconductor stocks is the Korean KOSPI (-6.4%), where just two companies, both major players, Samsung and SK Hynix, represent some 40% of the index value.  As you can see from the below chart, it has been tough sledding for the past month, with that market closing lower by nearly 28% from its highs on June 22nd.

Source: barchart.com

And while that may be extreme, if we look across major markets in Asia, there was some rough times last night almost everywhere.  Tokyo (-4.0%), HK (-1.8%), China (-3.6%) and Taiwan (-6.5%) all had serious dislocations downward.  And, of course, the thread running through them all is the tech exposure.  There has been much discussion of a rotation out of tech and AI stocks into other areas, with financials and energy amongst the beneficiaries, and certainly, last night’s price action supports that thesis.  Interestingly, India (+1.25%) completely bucked that trend, but then, India is perceived to be a major loser from the AI story, so if that is unwinding, I guess it’s no surprise that India benefits.  Elsewhere in the region, things were far less volatile.

As to Europe, despite a glaring dearth of technology companies, equity markets there are also under pressure this morning (DAX -0.9%, CAC -0.9%, IBEX -0.5%, FTSE 100 -0.1%) although that is more likely to be a response to the fact that oil prices have picked back up as the US resumes more aggressive military activities against Iran.  As to US futures, at this hour (6:45), they are all lower led by the NASDAQ (-1.8%) although both the SPX and DJIA are down by -0.7%.

Which takes us to oil.  The black, sticky stuff is higher by 2.0% this morning, although, as you can see from the chart below, it is still hovering right around $80/bbl, the level I described as its new home earlier in the week.  

Source: tradingeconomics.com

The key question here remains just how much of an interruption in economic activity has been caused by the Iran conflict.  Not dissimilar to the election question at the top, it seems the two sides of this argument are dug in and will countenance no discussion that they are misreading the situation.  There are still analysts who discuss tank bottoms and the idea that now that so many reserve inventories have been released, we are quickly approaching a situation where their much mooted $200/bbl is right around the corner.  And yet, despite the tick higher overnight, the market continues to price a relative lack of concern over future supplies.  As always, I go with prices as the best arbiter, but that’s just me.  The massive production increases from the US and Canada, as well as Brazil and Guyana, increases from Venezuela and the workarounds by the Gulf nations to get their oil to market continue to demonstrate that supply is available.  

One wild card that is very difficult to completely understand is China, where things are always opaque, and where their imports have fallen sharply, thus reducing demand.  Was that demand “destroyed” in the sense that it will never return?  Seems unlikely.  Rather, my best guess, and it is just a guess, is that China tapped into their own SPR and has been using that, rather than importing.  Whatever the situation, there appears to be no shortage of oil available.  

One other thing weighing on the price has been Ukraine’s success in attacking Russian refining capacity.  If the Russians cannot refine their oil, they need to sell it as crude rather than products, and that is adding to the inventories available for sale.  It is also part of the explanation as to why products prices and the crack spread remain so high, more oil, less refining.

Looking at precious metals, gold (+0.4%) closed below $4000/oz yesterday for the first time since last November as per the below chart.

Source: tradingeconomics.com

Silver (-0.4%) also remains under pressure and this morning copper (-1.9%) is suffering alongside the precious space.  But perhaps a few words on what gold really represents are in order.

As J.P. Morgan said in 1912, before the Federal Reserve was created, “Gold is money, everything else is credit.” Certainly, the second part of the statement is correct as your bank deposits rely on your bank standing behind them, making you a creditor of your bank.  Federal Reserve Notes are paper obligations of the US government, so again, represent purchasing power, but as we have learned, a decreasing amount of it every day.  Meanwhile, gold has a 5000-year history of being accepted as a thing of inherent value.  Now, the widely accepted definition of money these days is it must have three characteristics; it serves as a medium of exchange, a store of value and a unit of account.  Gold historically has served as the first two, although rarely as a unit of account.  Rather, gold holdings were always converted into whatever the unit of account was at the time.

Which takes us to the present, why does gold continue to represent a part of the financial markets, and over the past several years, an increasingly important part.  I would contend this is all of a piece with the broader changes in the global community, notably the end of the Pax Americana, where the US no longer chooses to (or can) guarantee the peace of the post WWII and Cold War worlds.  Instead, we have seen a constant increase in debt by every nation as governments around the world seek to placate their own citizens and are unable to pay for all the goodies they offer, thus borrow the difference.  

However, the freezing of Russian reserve assets by the West in the wake of the invasion of Ukraine has altered many views about what is safe and represents value, and what is paper and doesn’t represent value and central bankers, charged with maintaining a nation’s wealth, have gone back to gold as the one thing they know will retain value given it is nobody’s liability.  The chart below shows activity in May, which is similar to what has been happening virtually every month, that central banks are relatively price insensitive, buying the stuff as a strategic asset.  And the sellers, were selling because they needed the money!

One last chart to make the point about gold and purchasing power.  The below chart from the FRED database demonstrates just how much purchasing power the dollar has lost since the Fed came into existence; i.e. just how much inflation has destroyed the real value of the dollar.  For reference, that opening level is 1021 compared to today’s 29.9, a 97.1% devaluation in 113 years of the Fed.  It can be argued that the Fed has failed catastrophically in their effort to maintain the value of the dollar.

Ok, quickly elsewhere bond yields have edged lower, with Treasuries (-3bps) leading the way and European sovereigns either unchanged or having slipped by -1bp.  JGBs overnight also slid -2bps, but overall, while there is a lot of discussion about yields, they are not moving very far.

Finally, the dollar is a bit firmer this morning with the pound (-0.3%), Aussie (-0.4%) and euro (-0.1%) all slipping although NOK (+0.2%) is benefitting from oil’s move.  In the EMG bloc, though, there is more trouble with KRW (-0.5%), ZAR (-0.6%) and MXN (-0.3%) representative of more anxiety there.  Ultimately, I still have a hard time getting too bearish the dollar in the current world.

On the data front this morning brings Housing Starts (exp 1.31M) and Building Permits (1.40M) as well as IP (0.2%) and Capacity utilization (76.2%).  Finally, at 10:00 we see Michigan Sentiment (51.0).  There are no Fed speakers scheduled, and they are entering their quiet period, so we won’t hear from them until the meeting on the 29th.  (Perhaps we won’t hear from them anymore after that too!). 

Summing up, Iran and oil are still key drivers, equity market rotation is happening, although given how far it has moved, we may be near the end of that process, and yields have no direction.  Regarding yields, we may have reached the point where the issue is not inflation concerns, per se, but rather the sheer volume of debt that is going to be issued going forward, and the fact that private investors want more yield to be persuaded to buy it.  As to the dollar?  Like I said, I just don’t see the bear case over any longer-term horizon.

Good luck and good weekend

Adf

Many Critiques

Posted on by 
This evening the president speaks
And pundits have many critiques
Meanwhile in Iran
There’s no clear game plan
As havoc, the president wreaks

But right now, seems traders don’t care
‘Bout Persia or any warfare
Instead, soft inflation
Has changed the narration
So, pundits, high rates now foreswear

Some days, it’s simply more difficult to find stories that bring coherence to the narrative.  But let me try.  Yesterday’s PPI data was also much cooler than forecast, although still clearly quite high on a year over year basis, but it certainly added to Tuesday’s CPI result and has changed a lot of views regarding the Fed’s future actions.  For instance, if we look at my favorite CME table for current probabilities of future rate moves, we see that there is now just a 10% probability of a hike in two weeks’ time, and just one hike priced in for the next 18 months.

Remember, Monday, there was a 40% probability of a hike priced for the July meeting and two+ hikes priced through 2027.  (As I recall, I was an advocate of fading that price action.)  I expect that this will alter the narrative as calls for an immediate rate hike to burnish Warsh’s, and the Fed’s, credibility are likely to fade away.  In the meantime, he didn’t say anything new at the Senate testimony and the rest of the Fed talking heads continue to reiterate that they would be comfortable raising rates if inflation pressures rise.  Remarkably, they didn’t seem to notice the recent numbers.

Turning to the Strait of Hormuz, the US blockade of Iranian vessels is back in force and there have been a significant number of new US attacks on Iranian military sites.  As well, the IRGC has fired drones/missiles at several tankers trying to exit the Strait on the Omani side.  I read this morning that the president is considering whether to escalate things by attacking Kharg or Qeshm Islands, two key Iranian strongholds, and my guess is if that were to be the case, the oil market would likely take a turn higher.  But right now, WTI is effectively unchanged on the day, and has been since Monday’s rise.  I guess $80/bbl +/- is the new home.

Source: tradingeconomics.com

As to the President’s speech tonight, the word is it is going to involve election related issues, seemingly regarding the integrity of elections, the SAVE Act and the results of the 2020 elections.  Recall, Tulsi Gabbard, before she resigned to care for her husband, declassified a great deal of information and some portion apparently was election related.  Alas, this will simply further stoke partisan feelings as there is very little evidence that showing proof of something political has the ability to change the opposing viewpoints of partisans.

So, away from oil, we are now into earnings season, and the big banks all had monster quarters while there is growing angst over the AI sector and whether the main players will be able to make the money that was assumed for so long.  So, while yesterday saw US indices trade higher, the overnight session has been far less positive.

Starting in Asia, Tokyo (-2.8%), China (-1.9%) and Korea (-6.4%) all felt the pain of semiconductor weakness although HK (+1.3%) bucked the trend with most of the rest of the region showing far less movement in either direction.  There was precious little data to drive things, so this clearly seemed to be tech sector woes.  In Europe, broad, but modest, weakness is today’s theme with both France and Germany lower by -0.65% with Spain (-0.5%) also under pressure and the UK (-0.3%) the best of the bunch after GDP data was mildly better than the last reading at 1.3% Y/Y in May.  While the Trade Balance improved a bit, IP was weak and although it has been spun as a positive report, it hardly quickens the pulse.  Meanwhile, at 7:20 this morning, NASDAQ futures are lower by -1.1% although the other two major indices are little changed.  Tech is definitely under pressure here.

In the bond market, this morning we are seeing yields higher by basically 2bps across the board in Treasuries and European sovereigns.  Much is being made of the French OAT 30-year yield this morning as it trades to its highest level since the GFC as per the below from barchart.com.

While this headline of the highest rate in X years is splashy, what we have been seeing consistently, across all nations, is that debt issuance continues to rise and central banks have not been absorbing nearly as much as they had in the more recent past.  This means that the private sector needs to buy bonds, and they are demanding higher yields.  Someone made the point (and I cannot remember where I first read it, but it is valid) that bond yields appear to be less about inflation concerns, per se, and more about the ability for markets to absorb the ever-increasing amount of debt being issued by governments…and companies.  Just look at how much debt is being issued by the hyperscalers to fund their AI buildout.  Regardless of what happens to the front end of the curve and central bank rate activities, it does feel like the back end of the curve is where the signal is going to be found going forward.

Precious metals continue to bat about, rallying and then giving those gains back, but net remain under pressure as gold (-0.75%) and silver (-1.9%) are both softer this morning although copper (+0.7%) continues to find support.  It is difficult to look at the gold chart and be optimistic about a reversal of fortune in the near-term.  

Source: tradingeconomics.com

However, as per the discussion above regarding the increasing issuance of government debt around the world, at some point, the larger fiat vs. physical stores of value question is going to reassert itself and gold will be one of the main beneficiaries of that story.  Alas, it has a history of doing nothing from a price perspective for years on end.

Finally, the dollar, which suffered yesterday, with the DXY slipping -0.5%, is not very interesting this morning.  the pound, interestingly, has slipped -0.3% despite what many are trying to spin as a positive GDP report.  The other noteworthy mover is KRW (+0.4%) on the back of the BOK raising interest rates by 25bps to 2.75% last night.  While this was widely expected, the rhetoric about faster growth driving the need for higher rates has been a boon to the won.  (And remember, this was despite the KOSPI getting crushed last night on weakness in the two big semiconductor firms.)

On the data front, this morning brings the weekly Initial (exp 217K) and Continuing (1820K) Claims as well as Retail Sales (0.2%, -0.1% ex autos) and the Philly Fed (13.0).  With the recent surprises in CPI and PPI, I’m sure there will be a lot of focus on this morning’s Retail Sales data.  Certainly, a weak number will feed into the new, growing narrative, that the economy is slowing and rate hikes are slipping from view.  But yesterday’s Empire Mfg number was quite strong. There are still many inconsistencies in the data, which if nothing else, allows every analyst to point to something and claim they are right.

Ultimately, to me the great concern is an escalation of US activity in Iran, especially bringing troops into play.  In that case, I think things would change a lot, and we could well see another jump in oil prices.  But absent that, right now there is a lot of noise, but not much signal.  I don’t think the big picture has changed, i.e. investment into the US remains strong and that is going to support both the economy and the dollar.  But there will be many twists and turns.

Good luck

Adf

Some Heartburn

Posted on by 
Chairman Warsh, to the House, testified
And explained that his tolerance died
For higher inflation
Throughout this great nation
And ‘bout this, he will not backslide

But prior to his starlike turn
Investors and markets did learn
That CPI fell,
Though not a death knell,
And caused, for rate hawks, some heartburn

It is better to remain silent and be thought a fool than to speak and remove all doubt. – Abraham Lincoln

The attributed saying above, while not certain that it was uttered by President Lincoln, still makes its point eloquently, as well as somewhat humorously.  And I strongly believe that every member of the FOMC should take it to heart before they speak.  In fact, they should be thanking Chairman Warsh for his efforts to shut them up, because then they won’t sound quite so foolish.

For instance, just Monday, Governor Waller, in a speech in New York, finished with the following line, “But I don’t take the inflationary signals I have discussed today lightly. If we get another hot reading on core inflation this week, then the FOMC will need to consider tightening monetary policy in the near term.”  Oops!

And this is one of the issues because many believe that the FOMC gets the data earlier than the release date and so have inside information.  Thus, when Waller talks about the risk of a hot print, many think he knows something.  And this is yet another reason that ending forward guidance and reducing the commentary of the FOMC will be valuable.  

By now, I am sure you are aware that yesterday’s CPI reading was the largest downside miss since Covid in 2020, with the headline number falling -0.4% on the month and the annual slipping back to 3.8% while the core number was flat with the annual falling to 2.6%.  Now, as the Inflation Guy explains, this was the product of numerous subcomponents declining, not just the price of oil/gasoline and this is not the venue to discuss them (read the link).  

But it certainly helped Chairman Warsh in the timing of his testimony as nobody there could ‘blame’ him for still rising prices, at least for now.  As expected, several House members tried to get interest rate information from him, but he remains firm that the Fed’s mission is to drive inflation lower and this will be done through both interest rate and balance sheet policy changes, not through forward guidance.

It is not surprising that the market responded dramatically with the following chart from Polymarket (taken from Kobeissi on X) showing an impressive change of heart.

While I use the Fed funds futures chart from the CME as my guidepost, there is something to be said for the wisdom of crowds here.  Remember, this is a binary call, not a gradient one.  But even the futures markets adjusted significantly, and rightly so, with the probability of a July hike there falling to 16% from 40% when I wrote yesterday morning.  As well, while there is still more than one rate hike priced for 2026, the calculated change has declined to 33bps from 43bps yesterday morning.

Source: cmegroup.com

Skepticism remains rife regarding Chairman Warsh and his attempt to change the way things are done at the Fed, but personally, I am quite optimistic that he is attacking the real problems.  Remember, the Fed is a 114-year-old institution with an extremely long memory and a staff that, like most of government, believes they know what is best for others.  I strongly subscribe to the monetarist view that printing more money leads to more inflation, but making a change that dramatic all at once is just not possible.  Let us be thankful that Chairman Warsh appears to have a better understanding and is working to change things.  And remember, he has only been in the Chair for two months, give him some time.

As I start to recap markets, it is quite interesting that the price of oil seems to have decoupled from the war in Iran.  I say this because as I type at 7:15, a bit more than an hour after CentCom explained they had instituted another wave of military attacks on Iran, WTI is largely indifferent to the news.  While it has edged higher by 0.7%, a look at the chart below of the past 24-hours shows essentially no response.

Source: tradingeconomics.com

So, let’s turn to equities, which rallied on the CPI data in the US yesterday and saw follow through in Asia with Tokyo (+1.5%), HK (+1.4%) and Korea (+6.25%) all having strong sessions as did almost every market in the region.  However, there was an exception, China (-0.2%) which while not disastrous, substantially lagged other markets.  Arguably, the proximate cause of that disappointment was the disappointing data released last night as per the below:

Source: tradingeconomics.com

Certainly, GDP at 4.3%, below even Xi’s reduced target must be concerning and Fixed Asset Investment (housing) continues to crumble.  It is very difficult to look at this data, as well as their monetary data which, for instance, shows loan growth not merely trending lower, but doing so at an accelerating rate as per the below chart and conclude things are going will there for the economy or the equity markets.

Source: tradingeconomics.com

Europe, though, continues to lag with all the major bourses lower as the DAX (-0.8%) leads the way followed by Spain (-0.6%) and then France and the UK both slipping -0.2%. (I guess World Cup results are not indicative of their equity markets!). As to US futures, at this hour (7:25) they are all up very slightly.

Bond yields fell yesterday, notably the 2yr slipping -6bps, while the 10yr only fell -3bps.  This morning, though, yields are edging back higher with Treasury yields up 2bps and European sovereign yields higher by between 3bps and 4bps.  While equity markets remain sanguine about Iran, it seems bond markets are having a tougher time.  JGB yields (-2bps) are bucking the trend as there are still those who are looking for Japanese pension funds to start bringing more money home.

While the metals markets rallied yesterday, this morning they are under pressure again with gold (-0.6%) and silver (-1.2%) giving back yesterday’s gains while copper (-0.3%) is consolidating after jumping a dime yesterday.

Finally, the dollar is sidelined this morning with no notably large movements in either the G10 or EMG blocs.  A brief word on the yen, which has certainly been the subject of much digital ink spillage lately, as it seems all those thoughts of the pension fund support for the yen are not part of the FX conversation.  We remain less than 50 pips from the peak seen back on June 30 and I see very little reason for the broader trajectory to change.  The BOJ is not going to waste its reserves in this process, and given the gradual movement, I don’t think they are that upset.  As long as PM Takaichi is planning to spend more money, whether on infrastructure or investment, given they are borrowing all of it, a strong yen seems highly improbable.

On the data front, this morning brings PPI (exp 6.2% headline, 5.2% core) and the Empire State Manufacturing Index (8.8) at 8:30.  Then, at 9:45 the BOC will most likely leave their base rate on hold at 2.25% and at 10:00, Chairman Warsh will testify to the Senate Banking Committee.  We also get the Fed’s Beige Book this afternoon, EIA oil inventories and three more Fed speakers, although with Warsh speaking, will anybody care?  Especially since they continue to make fools of themselves with their own forward guidance.

The most remarkable thing to me is how insouciant market participants have become despite increased hostilities in the Gulf.  But both oil and equity traders have seemingly decided that other things matter more.  With that in mind, it is hard to get excited about too much these days.  Unless we see markets breaking their recent ranges, in either direction, I suspect that the weight of summer, and reduced liquidity is going to prevent anything substantial from happening anytime soon.

Good luck

Adf

The Score

Posted on by 
Hormuz is blockaded once more
The latest response in the war
So, crude prices rose
While both sides expose
Their relative views of the score

Now after a month of some peace
Seems tensions are set to increase
So, what about stocks?
The sales are in blocks
While buyers, few bids will release

After a brief respite for markets, where oil had seemed to be drifting out of the headlines, the events of the past weekend plus the US reimposition of the blockade of the Strait of Hormuz has changed the narrative dramatically, and rightly so.  The benign attitude of an eventual conclusion to this situation has been tossed aside and the oil bulls and war hawks are both back in the ascendancy.  Yesterday ultimately saw oil prices rise 9.4% and this morning they are a further 3.2% higher, and perhaps more importantly, back above the psychological level of $80/bbl.

Source: tradingeconomics.com

There doesn’t seem to be any short-term solution to this situation.  There are clearly enough hard-liners still with power in Iran to prevent any move toward a negotiated solution.  As long as this maintains, the outlook for oil will tilt higher.  However, as I have written before, and is very clear now, the effort to reroute oil shipments from the Gulf nations away from the Strait is intensifying and will continue to do so.  As well, alternative sources of supply including additional US production, Brazil, Argentina, Guyana, Venezuela and Canada are satisfying demand.  While uncertainty remains high, especially in the short run, by the end of next year, my take is less than 8% – 10% of the world’s oil will need to transit the Strait.  However, in the meantime, given that everybody who was long oil as the war initially ramped up has sold out, there are few sellers left to cap the price.  I imagine a move toward $90/bbl is quite possible in the next weeks.

As well as the story on crude
Two other themes will be pursued
First CPI’s print
Will offer a hint
Then Warsh will discuss why he’s screwed

If we turn our attention away from the oil market now, the two main events today are the CPI release at 8:30 this morning followed by Chairman Warsh testifying to the House Financial Services committee in his semi-annual trip to Congress.  Starting with CPI, expectations are for a decline from last month as headline (exp -0.1% M/M, 3.8% Y/Y) and core (0.2% M/M, 2.8% Y/Y) are due.  From what I can tell, there are a number of analysts who are calling for a relatively hotter number, although I’m not sure on what basis they believe that.  Certainly, oil prices, and energy prices across the board, declined significantly in June and that will be reflected in the reading.  Looking at the home price data, that doesn’t appear to have risen dramatically, and other commodity prices have also slipped.  I don’t’ rule out any outcome, but on the surface, expectations seem reasonable.  

Of course, with oil prices rising, talk of more rate hikes is all the rage and according to the Fed funds futures market, as per the below CME table, you can see that expectations have risen to a 40% probability of a hike this month and a two-thirds probability of two hikes before the end of the year.  My personal view, FWIW, remains that there will be no hikes this year, although with the resumption of hostilities in the Gulf, I think a cut is off the table as well.  Remember, too, that if oil prices remain elevated that will negatively impact economic activity, so hiking rates into that scenario doesn’t seem to make much sense.  But then, I’m not on the FOMC.

Now, I have long maintained that FOMC members should shut up, but it seems Mr Warsh will have a hard time getting them to do so.  I’m not sure if they think they are helping, or they are just enamored with their own voices.  But yesterday, Governor Waller spoke and explained that if the CPI data was hot, a rate hike would be an appropriate response.  And remember, we hear from another 7 or 8 of these folks just this week, four today!  

While I expect that Warsh’s testimony will be dry, and that most of the questioning will be either long-winded preening by some idiot member, or an attempt at a gotcha question, I am confident that Chairman Warsh will continue to avoid discussing his views of where policy should go and reiterate forcefully that the Fed’s goal is to reduce inflation, full stop.  I am also confident that he will not be dragged into any discussions of other issues like global warming or DEI and simply repeat that ending inflation is the only job he has.  We shall all find out shortly.

On to the markets.  It should be no surprise that equity markets were under pressure yesterday in the US with the jump in oil prices.  This added to the chorus of those who believe the AI bubble is popping as the NASDAQ led the way lower, falling -1.5%.  But a funny thing happened in Asia.  Despite the jump in oil prices and declines in US equity markets, Tokyo (+0.75%), HK (+0.5%) and China (+2.15%) all rallied nicely last night.  In fact, so did Korea (+0.7%) and Malaysia (+1.3%) although we did see declines in India (-0.7%) and Taiwan (-1.4%) with the rest of the region moving far less.  This is a surprising outcome to me, especially as Asia is the region most negatively impacted by rising oil prices.

Europe though is trading true to form with declines across the board ranging from Spain (-1.1%) to the UK (-0.4%) and everywhere in between.  There has been precious little data overnight to drive things, and this appears to be entirely oil related.  Of course, Europe’s suicidal energy policy, notably the UK’s ban on drilling for oil in the North Sea, remains one of the key reasons that the area will continue to struggle.  As to US futures, this morning DJIA futures are lower (-0.8%) but the other two major markets are little changed at this hour (7:25).

In the bond market, 10-year Treasury yields jumped 6bps yesterday although are little changed this morning.  However, as you can see from the chart below, they are pushing back up toward the highs seen in late May.

Source: tradingeconomics.com

There is a lot of talk about how Warsh should hike rates aggressively this month to gain bond market credibility in his fight against inflation, but I sense that is a lot of people talking their books.  I continue to believe that there will be no Fed action ahead of task force reports.  As to other nations, yields are generally firmer in Europe today, ranging between +1bp (Germany) and +3bps (Italy) with the UK worst of all (+4bps) as 10-year Gilts now yield more than 5.0% again, also pushing back to late-May highs.  The one exception is Japan (JGBs -5bps) where the latest ploy by Katayama-san is to propose JGBs be allowed to be invested in tax-free accounts for individuals in Japan.  Given the long history of zero rates there, a tax-free return of 2.7% with no currency risk could well be quite attractive, I think.

In the metals markets, it is no surprise that both gold and silver fell yesterday with the jump in oil prices, but despite oil’s continued rally this morning, both gold (+0.7%) and silver (+0.7%) are finding support, with gold seeming to hold the $4000/oz level for now.  Copper (+1.6%) is also holding up well, but its relation to the precious sector seems to be waning.  Perhaps the precious metals story is less about oil and more about the dollar.

Turning to the dollar, yesterday it put in a strong performance with the DXY rallying about 0.3% from Friday’s closing levels as you can see in the chart below.

Source: tradingeconomics.com

However, as you can also see in the chart, this morning the greenback is under pressure despite the rise in oil prices and yesterday’s increase in yields.  The biggest outlier is NZD (+0.9%) as the RBNZ continues to make hawkish statements about the need for further rate hikes.  And of course, NOK (+0.7%) is benefitting from the oil price rise.  But the rest of the G10 are all firmer, and so is most of the EMG bloc with only INR (-0.5%) standing out as underperforming.  That story appears to be based on higher oil prices and concerns, or thoughts at least, that the RBI will not be aggressively hiking rates to protect the rupee.  Otherwise, most currencies have moved higher vs. the dollar on the order of +0.15% to +0.25%.

And that’s really it today with CPI the only data release other than the already released NFIB Small Business Optimism index (97.4, exp 95.8), but that predates the change in the Gulf.  Chairman Warsh has his work cut out for him to get his colleagues to shut up.  I wonder if he can fine them if they speak.

We are in a narrative transition right now, but longer term, I remain bullish the US and the dollar.  

Good luck

Adf

Much Hotter

Posted on by 
This weekend both wars got much hotter
Iran attacked ships on the water
Ukraine sent its drones
Across three time zones
And struck inside Vlad’s magna mater

Thus, oil has risen a bit
While gold and stocks both trade like sh*t
And soon, CPI
Will prove or deny
That views at the Fed are now split

By now, of course, you know that there has been more military activity in the Strait of Hormuz with the IRGC attacking commercial ships and the US retaliating with significant strikes of military sites along the Strait.  From what I can see, there are factions within the IRGC that do not want to end the conflict and whatever government exists within Iran has no control over them.  As such, it is no surprise that the price of oil (+3.5%) has risen, but even in this scenario, it is well off its overnight highs.

Source: tradingeconomics.com

At this point, I believe the trading community will need far greater proof that there is a shortage of oil before responding with significantly higher prices.  Of course, one way that could come about is if Ukraine continues its success with attacks on Russian oil infrastructure as there has been an uptick in that activity with several refineries having been hit in the past several days and Russia imposing an export ban on diesel.  Net, things in the oil space remain precarious, but for all the analysts who continue to promulgate the idea that the end is nigh, markets continue to disagree.  As always, I vote with markets here.

And, not surprisingly, other markets have responded in a similar fashion to their recent trends with higher oil prices leading to pressure on both stocks and bonds, as well as precious metals while the dollar finds some support.  The thing is, my take is the strength of these correlations has been waning somewhat.  Frankly, and remarkably, it appears as though an increase in military activity in the Strait of Hormuz has become somewhat normalized to traders and they are looking for other, fresher signals as to their next move.

What might those other signals be?  Well, much was made of SK Hynix’s IPO in the US on Friday, which many pundits are now calling the top as the stock fell sharply in Korea overnight, down -15.4% dragging the KOSPI down -9.0% and tech stocks, in general much lower.  Of course, the KOSPI had risen dramatically over the past year, as you can see below, and is still higher by more than 100%  in the past year despite the recent decline of more than 25% since its peak on June 22.

Source: finance.yahoo.com

The problem with calling the top in stocks is that the earnings data, which starts in earnest this week, has been pretty good so far.  If companies continue to earn real profits, investors will continue to purchase stocks.

So, where else can we turn for new information?  Tomorrow brings the latest CPI report (exp 3.8% headline, 2.9% core), and you know that will be heavily scrutinized as the punditry tries to determine the FOMC’s reaction function and if it has changed with the new Chairman.  At this point, I do believe the Fed’s reaction function has changed, and more importantly, I don’t think anybody knows what it will be like, the Fed included.  The previous Fed whisperer, Nick Timiraos at the WSJ put out an article overnight discussing the idea that Chairman Warsh needs to decide whether to undo the most recent rate cuts.  However, there is no evidence that Warsh speaks to Timiraos and based on everything Warsh has said, he is not likely to tip his hand.  Chairman Warsh does testify to Congress this week, but I expect he will deflect all questions about the future path of monetary policy, and let’s face it, with the likes of Maxine Waters on the House committee, they won’t understand anything he says anyway.

And really, those are the only things that I think matter for now, so let’s review the overnight activity in markets.  As mentioned above, stocks are generally under pressure, but not universally so.  For instance, in Asia, Tokyo (-1.9%), China (-1.8%) and the aforementioned South Korea all had rough sessions, but HK, Taiwan, India and Australia were all basically flat on the day.  The big surprise is Taiwan as given the semiconductor weakness; I would have thought that market would have been significantly impacted.  But I guess not.  Meanwhile, European investors appear to be completely focused on tomorrow’s France-Spain World Cup semifinal as equity indices there are virtually unchanged this morning.  As to US futures, at this hour (7:30) NASDAQ futures are weaker by -1.2%, but the other markets are little changed.

Bond yields are higher this morning, but not hugely so.  Treasury yields have edged up by 1bp, and European sovereign yields are higher by 2bps across the board with UK Gilts (+4bps) the real laggard there.  Overnight, JGB yields backed up 4bps as well, but that story has more to do with the GPIF than anything else.

Remember Friday?
Japan was bringing home yen
They were just kidding

Think back to Friday.  Japanese FinMin Katayama mentioned that the GPIF and other Japanese pension funds ought to consider investing more money in Japan and less abroad.  That got tongues wagging about a major policy change coming that would serve to support the yen, and the JGB market while undermining Treasuries as the idea was the GPIF would sell their US Treasuries and buy JGBs instead.  Well, it turns out that is not actually the case.  The GPIF reevaluates its policy annually but has expressed no urgency to change things now despite the FinMin’s comments, at least according to Reuters.  The upshot is that JGBs sold off as did the yen (-0.3%) as per the below chart.

Source: tradingeconomics.com

Perhaps more surprisingly, though, the dollar is mixed on the day, not higher across the board as might have been expected given the uptick in oil and military activity.  So, we have seen weakness in GBP (-0.1%), AUD (-0.2%) and INR (-0.5%) while EUR (+0.1%), NZD (+0.2%), NOK (+0.3%) and KRW (+0.4%) have all had decent sessions.  Net, the DXY is essentially unchanged this morning.

Finally, and quickly, both gold (-1.5%) and silver (-2.0%) are under pressure with the higher oil price although copper (+0.6%) continues to find support and remains well above $6.00/lb.

In addition to the CPI data, it is a pretty busy week as follows:

TuesdayNFIB Small Biz Optimism95.6
 CPI-0.1% (3.8% y/Y)
 -ex food & energy0.2% (2.9% Y/Y)
 Warsh Testimony 
WednesdayPPI-0.1% (6.2% Y/Y)
 -ex food & energy0.3% (5.2% Y/Y)
 Empire State Mfg8.9
 Warsh Testimony 
 Fed’s Beige Book 
ThursdayInitial Claims218K
 Continuing Claims1811K
 Retail Sales0.2%
 -ex Autos-0.1%
 Philly Fed13.5
FridayHousing Starts1.30M
 Building Permits1.40M
 IP0.2%
 Capacity Utilization76.2%
 Michigan Sentiment51.5

Source: tradingeconomics.com

We also hear from 9 other Fed speakers (it almost seems like they didn’t get the memo about reducing communication) but with Warsh on the stand both Tuesday and Wednesday, I don’t think the others will matter that much.  Of course, it will be interesting to hear the other speeches if CPI comes in softer than expected as it may put a crimp in the hawks’ views.

In the end, not that much has really changed I would argue.  The war is an exogenous variable, and the market has learned to largely ignore it.  The Fed is still too uncertain in its new construction for many views to have changed, but I think the one thing we can conclude is that the old models of their reaction function are no longer viable.  My take is the beauty of the task forces for Chairman Warsh is they won’t report for at least 3 months, and probably more like 6 months, so until they report, absent a massive spike in measured inflation, the Fed is not going to do anything.  The Fed funds futures market is now pricing a one-third probability of a hike at the end of this month and certainty of one and 50% probability of two by the end of the year.  I would fade those trades.

Good luck

Adf

Young Turks? Or Warhorses?

Posted on by 
Stories about yen
Have multiplied like rabbits
Is it really news?

You know it has been a slow session when the yen’s movement, as seen in the chart below, was enough to draw 4 headline stories in Bloomberg.

Source: tradingeconomics.com

And here is a screenshot of the 4 headlines on Bloomberg.com

While it may look dramatic on the screen, that almost one yen move represents less than 0.6%, and as you can see, about half of it has already retraced.  The underlying premise is that FinMin Katayama, in a regular speech about general things, suggested that the GPIF (Japan’s national pension fund) ought to consider investing more assets in Japan and JGBs rather than internationally.  The idea is that if the GPIF changes its investment mix, so will many other Japanese institutional funds, and they do have a lot of money there, upwards of $2 trillion equivalent.  This is not to say that they are going to invest all their money back home, just that the mix could change somewhat.

Now, if they were to do this, it would certainly have an impact on both the FX and global bond markets, with the yen likely to strengthen along with JGB prices (hence JGB yields declining) and potentially Treasury yields rising as a key buyer of US debt would reduce its appetite.  

But this is just a suggestion, and one that has been made numerous times in the past with no further action.  At the same time, yesterday’s US 30-year Treasury auction was extremely well-received with more than 77% indirect bidders.  That statistic is generally seen as foreign investors and central banks.  With the yield coming at 5.058%, it is not surprising that foreign bidders, especially the Japanese, would have significant interest.  After all, their currency continues under pressure, so if the GPIF holds Treasuries, in yen terms they look better almost every day.

The other spate of stories this morning was about the carry trade, and how Goldman Sachs has just explained to its clients that the carry trade, notably shorting yen to hold dollars, amongst other things, is an excellent risk reward trade right now.  I’m guessing Katayama-san didn’t really want to hear that.

My larger point, though, is that despite the yen (+0.4%) having moved a relatively modest amount, it certainly garnered a lot of attention.  In other words, there’s not much else to discuss.

Since Warsh and his minions last met
The question was who they would vet
To lead the task forces
Young Turks? Or warhorses?
Alas, tis the latter quintet

The other moment of excitement yesterday came from the Fed when they released the names of the leaders of each of Chairman Warsh’s five task forces.  The list is linked here.  It certainly did engender a lot of discussion with different analysts taking different views, and while I have some opinions, mine are no more useful than anybody else’s as they are not going to change things.  My observation, though, is that there is an awful lot of old school thinking represented by the list, which is somewhat disappointing for those of us who were looking for a new direction from the Fed.  As an example, Mervyn King, ex-BOE governor, and active participant in forward guidance, seems unlikely to offer many new views on communications.  But that is what we have.  Hopefully some new thinking will come about.

And that’s all there is regarding news, I think so let’s turn to market activity.  Under the theme, you can’t keep tech stocks down, yesterday’s US equity rally was followed by more strength (Tokyo +1.2%, HK +0.6%, Korea +2.5%, India +1.1% and Australia +0.5%) than weakness (China -2.0%, Taiwan -0.8%) in Asia.  The rest of the smaller regional exchanges were largely higher as well.  Arguably, the fact that whatever is happening in the Strait of Hormuz, oil prices have no strong bid, is part of that investment thesis.  As to Europe, other than Spain (+0.5%), the rest of the continent and the UK are all +/-0.1%.  And US futures at this hour (7:15) are showing softness in the NASDAQ (-0.5%) but otherwise not much movement.

Bond yields, though, are uniformly lower, backing off their recent test of 4.60% in 10-year Treasuries, as now that the auctions have passed, I think a lot of the short positioning into those auctions has been covered.  If oil continues to trade either side of $70/bbl, it is hard to make the case inflation will be running away.  So, Treasuries (-2bps) continue to back off while European sovereign yields have slipped by a similar amount.  The outlier was the JGB market (-13bps) which as you can see in the below chart has really changed vs. its following of Treasury yields, entirely on the GPIF story.

Source: tradingeconomics.com

In the commodity space, oil (+0.3%) continues to erase the gains seen Tuesday after the increase in military activity in the Strait.  Even though that seems to be ongoing, the markets just don’t care.

Source: tradingeconomics.com

As to the metals, yesterday’s gains are being moderated with both gold (-0.4%) and silver (-0.7%) slightly softer while copper is unchanged on the day.

Finally, the FX market, away from the yen, remains generally uninteresting.  Three weeks ago, much was made of the DXY’s break higher from a longer-term range as it traded through 100.50, almost reaching 102.00.  but as you can see in the chart below, for now, that excitement seems to be fading with a nice little downtrend developing since June 24th.

Source: tradingeconomics.com

In these dog days of summer, it is hard to get too excited.  Generically, while I remain in the camp that the Fed will not adjust rates this year, and so the market will need to reduce the current 33bps of rate hikes priced into the Fed funds futures curve as you can see below, I also think that ongoing inward investment into the US is going to underpin the dollar over the medium term.

There is no data to be released today, and yesterday’s numbers saw a marginally better Initial Claims number (215K vs 218K expected) and a slightly worse than forecast Existing Home Sales number.  As well, we heard from NY Fed president Williams who said his new main concern is that demand for AI infrastructure is going to drive inflation higher and he is wary of that.  Of course, that is exactly at odds with Chairman Warsh’s view that AI is going to reduce inflationary pressures.  Next week, Chairman Warsh will be testifying to Congress and there are four other Fed speakers, but my take is that over time, we will hear less and less from the rest of the Committee. (Or maybe that is just wishful thinking on my part!)

At any rate, it is shaping up to be a quiet one, so close up early and take a long weekend, you’ve earned it!

Good luck and good weekend

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A Warshach Test

Posted on by 
While narrative writers obsessed
For some this was a Warshach test
The doves and the hawks
Each messaged their flocks
That Warsh, to their views, acquiesced

Meanwhile, in Iran bombs are falling
And President Trump is name calling
However, despite
The restarting fight
Risk assets keep on, higher, crawling

So, the FOMC Minutes were released, and they were hawkish dovish irrelevant.  The best expression of this came from Bloomberg’s Joe Weisenthal when he posted this on X,

Two simultaneous takes on the release that he received.  And I confess, I read those Minutes and didn’t learn anything at all.  It seems that the decision to leave rates on hold was unanimous although several committee members would have voted for a hike as well.

What does this say about the state of things?  I am very hopeful that we are on our way to a Fed that is less intrusive in market activities, both by reducing its balance sheet size, something that Chairman Warsh has expressly indicated as a goal, and by hearing less from committee members.  As @inflation_guy, Mike Ashton explains here, if forward guidance is dead, then why do we need to hear from any FOMC members about anything?  All those speeches were simply each member’s way to get their opinion out there and try to influence markets.  As I have frequently written, we would be much better off if the Fed were opaquer in their decision making as it would reduce risk and leverage and that would enhance financial market stability.  For everyone who wants Warsh to be Volcker redux, remember, back then, there were probably fewer than 10 people on Wall Street, let alone anywhere else, who could name a single member of the FOMC other than Mr Volcker himself.  That is an aspirational goal!

How did the market respond to the Minutes?  They basically ignored them.  Equity markets, which had opened much lower, were already in the process of reclaiming those losses when the Minutes were released and edged higher from there, with no meaningful change in trajectory as you can see in the below chart of the S&P 500.

Source: tradingeconomics.com

How about bonds?  Well, here is the 10-year chart and you tell me if the Minutes had an impact.

Source: tradingeconomics.com

I guess the real question is will the rest of the world’s central banks follow Mr Warsh’s lead and seek to end forward guidance and simply go about their job of managing inflation?  One can always hope.

Which takes us to the other story of note, the apparent end of the ceasefire in Iran and the question of what is now happening in the Strait of Hormuz.  First, let’s be clear, nobody really knows as the fog of war remains thick.  Obviously, yesterday saw a sharp rise in the price of oil as concerns over future transits of the Strait rose dramatically.  However, as of this morning, while WTI (+0.6%) has edged slightly higher from yesterday’s closing levels, as you can see from the chart below, it seems to have found a new short-term home here around $74/bbl.

Source: tradingeconomics.com

Scrolling through X this morning, the $200/bbl analysts were back at it, explaining that this time, with all those inventories having already been used up, we are going to see much higher prices.  But weirdly, yesterday’s EIA data showed an inventory build of 3 million barrels.  I keep seeing charts of the US SPR and how it is at its lowest level since 1982 implying that we are on the cusp of running out like this one from Bob Elliott.  Now, Bob Elliott is a really smart guy, but I feel like the piece of the puzzle that is missing in these analyses is that right now, the US is producing just under 14 million bpd of oil, plus another ~7.5 million bpd of natural gas liquids and 110 billion cubic feet/day of dry natural gas.  In fact, we are a massive exporter of oil and products, so perhaps a better question is, why do we need an SPR anymore?  After all, it was created when we were at the mercy of the Middle East and producing just 8.6 million bpd.  That is no longer the case.

My take is the world can run perfectly well on $75/bbl oil and there is plenty of supply at that level.  In addition, we have seen numerous announcements of how Gulf oil producers are building new methods of transport away from the Strait, and over time, that will no longer be a choke point with any meaning.  War is exciting to market participants for about two weeks, at which point they get bored and move on to the next big thing.  After all, the Ukraine war has been ongoing for 4 years and it doesn’t get a mention in market commentary.  Next week we start to see earnings releases for Q2 and that will be much more interesting for equity, and likely all other, markets.

In the meantime, let’s see what happened overnight.  Based on the mix of information, we cannot be surprised that there were mixed outcomes in equity markets around the world.  Yesterday’s US split (DJIA -1.1%, NASDAQ +0.2%) was followed by gains in Tokyo (+1.4%), China (+2.5%), Korea (+0.6%) and India (+0.3%) while HK (-0.7%), Taiwan (-0.8%) and the Philippines (-0.8%) all slid a bit.  There was no rhyme or reason here.  The only data of note overnight was Chinese inflation data where CPI fell to +1.0%, while PPI rose to +4.1%.  It strikes me that Chinese companies will continue to see pressure on their margins.

In Europe, things are also mixed with Spain (+0.8%), Italy (+0.7%) and France (+0.3%) all higher while the UK (-0.6%) is slipping and Germany is little changed.  As to US futures, they are leaning higher at this hour (7:50).

Bond markets seem to have stopped selling off as yields this morning are little changed (Treasury +1bp, Bunds +1bp, Gilts -3bps, OATs -3bps).  JGBs were unchanged overnight.  The 10-year auction yesterday went pretty well with a bid-to-cover ratio of 2.59, although with yields at 4.58%, it is not that surprising there was real demand.  I will say this, bonds, too, are a market with some smart folks with diametrically opposed views of the future outcome.  Both 3% and 6% are seen as the next major destination depending on the analyst.

Interestingly, metals markets are showing some life this morning with gold (+0.8%), silver (+1.4%) and copper (+2.2%) all bouncing off recent lows.  This is a bit out of character compared to recent price action relative to oil, but maybe we are putting in some bottoms here.

Finally, the dollar is, net, little changed this morning.  In the G10, NZD (+0.65%) is the big mover, which continues on the back of their rate hike from yesterday.  But otherwise, +/-0.1% is the norm here.  In the EMG bloc, KRW (-0.5%) is giving back some of its recent gains but continues to hover near multi-decade lows.  The recent gains have been on the back of a record current account surplus, but it remains an interesting conundrum that despite the massive gains in the Korean stock market, the currency has not attracted more buying interest.  Otherwise, modest EMG gains on the order of +0.1% are today’s story.

On the data front, we see Initial (218K) and Continuing (1820K) Claims as well as Existing Home Sales (4.20M) today.  In addition, there are two Fed speakers as I imagine getting them to shut up will take some time.  However, I wonder, will they really add to the discussion?

Oil continues to be the driving force in markets, but right now, my sense is eyes are turning to upcoming earnings releases.  Of course, we also get CPI next week, which will be a critical number for markets, at least for now.  

Good luck

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