Much Hotter

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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

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Young Turks? Or Warhorses?

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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

Adf

A Warshach Test

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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

Adf

Theses All Wrecked

Posted on by 
There once was a fire that ceased
Which many hoped would lead to peace
But recent attacks
On ships did climax
In poking the milit’ry beast

The market’s response was direct
With oil bears’ theses all wrecked
The dollar, it rose
While risk takers chose
Their stocks and bonds, now, to reject

While we had all become accustomed to the gradual decline in the price of oil as it appeared there was a solid chance that an agreement would be reached between Iran and the US, that all came a cropper yesterday after Iran attacked 3 different ships exiting the Strait and the US responded with attacks on more than 80 targets, including (according to the WSJ) “air-defense systems, command and control networks, antiship missile sites and more than 60 Iranian small boats near the waterway.”  This was a significant uptick in the nature of the response from previous skirmishes and according to President Trump, the ceasefire is over.

“To me, I think it’s over, I don’t want to deal with them anymore,” Trump told reporters at a NATO summit in Ankara on Wednesday. “They’re liars, they’re cheats, they’re sick people.” 

Given the sudden change in the status in the Gulf, we cannot be surprised by the market response.  WTI (+6.0%) rocketed higher as you can see in the chart below.

Source: tradingeconomics.com

And while that is clearly a significant move, and has changed attitudes in the market, I think it is worth stepping back slightly and looking at the price action over the past month, just to remind ourselves that though things may be changing, we have still seen a dramatic decline in price.

Source: tradingeconomics.com

Here’s the thing, right now there is no way to know if we are going back to the situation in early March, where there was substantial fighting, or at least bombing and missile attacks, each day, or if this, too, is going to pass like the previous minor skirmishes.  Certainly, President Trump appears tired of the current situation, but it is not clear what type of further response is in the offing.

In the meantime, given the new military action and the limited prognosis for a quick return to the previous status of ships moving through the Strait, it can be no surprise that investors decided to dump a lot of risk.  So, let’s take a look at how things behaved overnight.

You will not be surprised that equity markets are broadly lower this morning.  Yesterday’s US session was soft on concerns over the tech sector and that was before the resumption of hostilities in Iran.  So, Tokyo (-2.1%), China (-0.8%), Korea (-5.4%) and India (-2.2%) all fell sharply amongst major markets in Asia with most of the smaller exchanges under pressure as well.  The outliers here were HK (+3.0%) and Taiwan (+0.6%) as both saw continued demand for semiconductor and tech shares.  It feels to me that these two markets will have difficulty maintaining this positivity under the current circumstances.

In Europe, it is a bloodbath with all major bourses lower led by Germany (-2.4%) and Spain (-2.7%) while France (-2.2% and the UK (-1.6%) are not far behind.  The NATO meeting ongoing in Ankara is not helping anybody’s views as President Trump continues to add pressure to NATO to pay their own way.  Ultimately, the NATO transition continues, and it is anybody’s guess as to how involved the US will be going forward.  As to US futures, at this hour (6:35) all the major markets are lower by -1.0% or more.

In the bond market, yesterday saw Treasury yields rise 6bps during the session as yields tracked the oil move pretty closely.

Source: tradingeconomics.com

This morning, Treasury yields are higher by 2bps more but that is nothing compared to the European sovereign markets, which as you can see from the below Bloomberg.com screenshot are substantially higher this morning.

All those visions of inflation finally starting to decline were abruptly altered after the renewed activities in the Gulf.  Adding to the pressure on bonds is the concern over the increased spending promises from governments around the world which has seen traders increase short positions in the bond market to near record levels.

We cannot be surprised that gold (-1.2%), silver (-2.2%) and copper (-2.2%) are lower in response to the renewed fighting and rise in oil prices as that relationship has been very consistent.  We also cannot be surprised that the dollar is a bit firmer this morning, although not universally so.  For instance, JPY (-0.2%) is now pushing back to its recent lows (dollar highs) although the pace of movement remains quite modest.  As well ZAR (-0.6%) is also under pressure amid the decline in gold prices and rising oil prices (they are an importer of oil).  On the flip side, though, NOK (+0.4%) is benefitting from oil’s rally as is CAD (+0.25%) while KRW (+0.6%) seems to be benefitting from money flowing home after the recent equity rout there (covering margin calls?).  NZD (+0.4%) strengthened on the back of the RBNZ raising their base rate by 25bps as they continue to have some concern over inflation, but that only takes it back to 2.50%, hardly tight money.  As to the other main currencies, they have not really done that much, although lean slightly lower this morning.

On the data front, we see the EIA oil inventory data with draws still expected, as well as a 10-year Treasury auction, where it will be quite interesting to see if investors are keen on the extra yield now available.  And we get the FOMC Minutes, which despite the Iran situation, will still be keenly watched and read as the analyst community tries to get a better understanding of the way the Fed will be behaving going forward.  What is the new reaction function?  

Looking at the Fed funds futures market, pricing for that first rate hike has moved to September from the previous October timeframe, and a second hike is back in the cards as well.

However, nothing has changed my view about the way things will evolve.  Certainly, the increased hostilities are a negative for markets, but I suspect that this will be a short-lived episode and things will calm down again sooner rather than later.  With that in mind, I have not changed my view about no rate hikes this year with a potential cut.  However, if this fighting does increase and the oil price creeps higher over the next weeks and months, I will be rethinking this stance.

Right now, we are back to being hostage to events on the other side of the world.  All we can do is watch and respond.  

Good luck

Adf

Subterfuge

Posted on by 
The narrative right now is run
By hawks who think Warsh is the one
To raise short-term rates
Right out of the gates
And so, they’re long bucks by the ton

Thus, futures positions are huge
With no effort at subterfuge
But if they are wrong
About being long
The hawks will have all been the stooge

In an otherwise quiet session, this morning I am going to borrow from Ole Sloth Hansen, the futures maven at Saxo Bank.  He publishes a Substack that is well worth reading if you are actively involved in the markets as he breaks down futures positions and offers context.  This morning I am going to juxtapose those positions with my views, which are diametrically opposed to the way the market is currently positioned.

Starting with the FX market, he has created a wonderful chart showing that the net non-commercial long USD position against eight major currencies has reached 10-year highs.  Interestingly, the DXY is not anywhere near those highs, although it appears that is the growing expectation of many traders.

Arguably, this is based on the idea that Chairman Warsh is Paul Volcker redux and will be quite hawkish going forward.  Now, I cannot tell if this is the narrative because, absent forward guidance, narrative writers must now think on their own and are incapable of doing so, or if they truly believe that despite all the talk that rising oil prices were going to feed through to inflation readings, declining oil prices won’t have the same impact on the way down.

But it is not just the FX trading community that is on board with this story, so too is the short-term interest rate trading community.  While LIBOR has been forced out of existence, SOFR (Secured Overnight Funding Rate) is the new benchmark in interest rate markets and, naturally, there is an active futures market there as well.  As you can see from the below chart, also from Mr Hansen, the current positioning is strongly expecting higher short-term interest rates.

This is completely in accord with the Fed funds futures market where the market continues to price a 25% probability of a hike at the end of July and a virtual certainty of a hike by October.  By my calculations, as per the chart from cmegroup.com below, the market is pricing about 30bps of rate hikes by the December meeting.

Or course, by now you know that my view is the Fed will not be hiking rates at all, and as measured inflation slides back (just look around the world and at oil prices) the narrative will belatedly shift to the need willingness to reduce rates on Warsh’s part and all these market positions will adjust.  

My longer-term positive view of the dollar is based on the ongoing investment inflows into the US, for real investment, not merely equity market participation, and nothing has happened to change that view.  In fact, the announcement yesterday by Toyota that they will be expanding their San Antonio truck and SUV plant with a $3.6 billion investment is just the latest in a series of these announcements.  But that is not the carry trade driving things.  In fact, ironically, we could easily see US rates slide a bit as the dollar rallies on natural investment demand rather than financial demand.  As well, if I am correct, the Fed funds futures market is going to head back to pricing no rate hikes, perhaps as soon as next week after the CPI data is released.

I think the lesson is that the narrative writers need to bone up on their understanding of macroeconomics and international finance as the central bank policy driver may not be the future.  Certainly, if Mr Warsh has anything to say about it, and he does, that will likely be the case.

Which takes us to the overnight session. The most excitement overnight was for Belgium as they completely outplayed the USMNT in a 4-1 victory in Seattle.  But otherwise, the story that Iran fired two missiles at ships heading through Hormuz helped support oil prices, but as I type, they are higher by just 0.7% (~50¢/bbl) so not really very much.  The interesting discussion in the oil market this morning is the fact that Iranian oil, which is no longer sanctioned, cannot seem to find any buyers with some 58 million barrels in floating storage and no takers.  Meanwhile, despite ongoing buying by central banks around the world, gold (-0.5%) continues to struggle, although appears to be putting in a base and silver (-1.4%) is suffering as well.  

In the bond market, yields are creeping higher with both Treasuries and European sovereigns all higher by 2bps this morning with a similar move by JGBs overnight.  My take is this is less of an inflation concern than a supply concern.  Certainly, there is no indication that the US, Europe or Japan are about to slow down their fiscal stimulus, with Europe now further ramping up its defense spending as the US pressures NATO further.  To me, this is where the rubber will meet the road as if Warsh really does seek to reduce the Fed’s balance sheet, it is not clear where buyers are going to be found to replace them.  I suspect we will see more regulatory freedom for banks and insurance companies to hold Treasuries without capital penalties, but that is a big hole to fill.  

In the equity markets, yesterday’s US rally was followed by a reversal in Asia with Korea (-4.9%) leading the way lower on the back of weakness in SK Hynix stock despite stellar earnings.  But that dragged down the entire region (Japan -2.1%, China -1.0%, HK -0.5%, Taiwan -2.3%) and various declines everywhere else except Singapore (+1.4%) although I can find no specific catalyst for that outlier move.  In Europe, things are more mixed with Germany (-0.7%) under pressure although there is modest strength in the UK (+0.3%), France (+0.2%) and Spain (+0.1%).  All the talk here is about defense spending, although one would have thought that would help Germany the most.  As to US futures, at this hour (7:55), NASDAQ futures are following Asia lower, -1.3%, but the other indices are little changed.

Finally, the dollar is generally a bit stronger this morning, at least against its G10 counterparts, although JPY (+0.1%) is holding up.  But the dollar’s gains are minimal, about 0.1% to 0.2%, so it is difficult to get too excited.  In the EMG bloc KRW (+1.0%) is the clear leader after the country expanded trading hours in the currency markets, and there has been modest strength in BRL (+0.4%) and INR (+0.4%) although neither has seen any major policy changes.

On the data front, yesterday’s ISM Services data was right on the button at 54.0.  This morning we see the Trade Balance (exp -$78.5B) and that’s it.  The hawkish Fed story continues to be the most popular, and until we see some data that can undermine that story, I expect it will remain in place.  Tomorrow’s FOMC Minutes should be interesting as there was obviously a lot of back and forth at the meeting, but since we have already heard further from Mr Warsh, and it is way too early to hear back from the task forces, I suspect we are in for more quiet markets for now.

Good luck

Adf

Discussing Their Plight

Posted on by 
Now, all eyes will turn to the chat
When Warsh and his minions, they sat
Round oak polished bright
Discussing their plight
‘Bout prices and jobs and all that

But since they met three weeks ago
Chair Warsh very clearly did show
His view that inflation
Was short in duration
And rate hikes were not apropos

It is getting increasingly difficult to maintain a hawkish Fed view as both the data and the Chairman are working against you.  While we all enjoy the World Cup this week, arguably the biggest market related news will be Wednesday’s release of the Minutes from the last FOMC meeting.  You may recall that in the wake of that meeting, interest rate hawks were in the ascendancy with an October hike fully priced and odds for a second, December, hike priced as well as you can see in the below CME table from June 24th.

Now, in the wake of that meeting and the press conference, the combination of the dot plot showing half the committee expecting a hike this year and the lack of forward guidance along with the succinct statement explaining the Fed would achieve their 2.0% inflation mandate had many analysts expecting a serious tightening cycle upcoming.

But a funny thing happened on the way to the next FOMC meeting, still three weeks hence, the price of oil, and energy in general, accelerated its decline.  Given how much effort was made to explain that the core inflation readings were heading higher because of the impact that energy has on everything, hence the need to hike rates, this has been an inconvenient outcome for the hawks.  Add to that Chairman Warsh’s comments at Sintra, Portugal last week, regarding the easing of inflationary pressures as energy prices decline (oil -0.9% this morning) and futures traders have been adjusting their views pretty steadily as per this morning’s CME table.

While a hike is still assumed by year end, the second one has fallen by the wayside.  Personally, as we continue to see inflation pressures subside alongside energy prices, I expect that not only will we not see a hike this year at all, but a cut by December is viable.

Adding to the downward bias on Fed funds futures was Thursday’s payroll report, where the headline number was softer than expected, although the Unemployment Rate did slip another tick to 4.2%.  I think a key problem with using the Unemployment report as such a critical signal is the fact that since President Trump’s inauguration and the actual closing of the Southern border, as well as the deportation (by both the government and on a self-basis) of somewhere between 2.5 million and 3.0 million according to Grok, the old econometric models of what type of job growth was necessary to maintain solid economic growth are no longer terribly useful. If we throw in the dramatic changes to the economy on the back of the increase in AI as a tool and infrastructure investment, it becomes increasingly difficult to utilize the old models.  Too, one of the main themes from several months ago was that AI was going to replace hundreds of thousands of jobs and unemployment would skyrocket, while now, those ideas are being rethought with many analysts now expecting AI will support more jobs.  Perhaps, the best thing that can come of this change is that markets will no longer radically adjust based on an outdated statistic.

There is still a long way to go before the next FOMC meeting and I doubt that the many task forces will have come to any conclusions yet, but if energy prices continue to decline, and I couldn’t help but notice this WSJ article discussing the sudden glut of oil driving prices lower, and I am growing increasingly confident in my views.

Which takes us to the currency that most needs to see a more dovish FOMC, the yen (-0.6%).  You may remember last week when the yen, after making yet another new low for the move, suddenly reversed course ahead of the July 4thholiday.  While there was no actual intervention, the discussion was that the MOF would no longer discuss their intentions ahead of any intervention and with a holiday weekend seeing reduced liquidity, many anticipated some action.  Well, as you can see from the chart below, that idea has essentially been erased with the yen softening again and pushing back to those lows seen last week.

Source: tradingeconomics.com

Bloomberg ran an article this morning about a former Vice Minister from the MOF explaining his view that the yen was undervalued by 20% or so.  If we look at the yen on a PPP basis, the IMF claims the value should be about 93-95 instead of the current 162+.  The Economist’s Big Mac Index calls for 78.00, and by all accounts, visiting Japan is relatively inexpensive for most foreigners.  In fact, I read that Japan was increasing the visa fees to try to discourage the massive amount of tourism as people around the world see it as a cheap destination.

Ultimately, the problem with the yen, in my view, remains that real interest rates remain deeply negative and the government’s spending plans continue to indicate massive deficits as far as the eye can see.  While reduced energy prices are a boon, the yen was falling sharply long before the Iran conflict began.  Policy changes of substance are required, and they are still uncomfortable for domestic politics.  While the pace of the yen’s decline may slow, I still see it weakening going forward.

So, let’s briefly look at markets overnight before closing.  Regarding the dollar, it is broadly stronger this morning with only BRL (+0.3%) finding any support despite their ignominious defeat to the Norwegians.  But modest slippage across the G10 is the rule, -0.1% to -0.2%, while similar movement has been observed in the rest of the EMG space.  For now, the yen remains the only interesting currency.

In the commodity markets, despite oil’s continuing slide, this morning the metals (Au -0.4%, Ag -0.6%, Cu -0.1%) are also under pressure, but that accords with the dollar’s strength.  As long as the dollar remains bid, it appears the metals markets will have difficulty gaining traction.  But if I am correct regarding the Fed and the market turning toward a more dovish view, I would look for the metals to head higher again.

In the bond market, Treasury yields (-3bps) are slipping as the market reopens after the holiday weekend, arguably following through on the softer payroll data.  European sovereign yields are little changed to lower by -1bp amid a quiet market while JGB yields (+4bps) are the notable outlier, arguably as concerns rise over the weakening yen.

Finally, equity markets remain beholden to the semiconductor and AI trade and with the US having been closed on Friday, there was less information for the rest of the world.  But this morning, NASDAQ futures (+0.9%) look like they are set to resume their march higher, dragging the S&P with them.  But this follows a mixed to lower session in Asia (Tokyo 0.0%, China 0.0%, HK +1.1%, Korea -0.5%, India +0.7%, Taiwan -0.5%) as leadership was lacking.  Not surprisingly, European bourses are also mixed this morning (Spain -0.7%, UK -0.2%), Germany and France both +0.1%) as the question of note is how much defense investment is going to be forthcoming from NATO and European nations and how much of that will be spent in Europe.  Perhaps excitement in the US will help global risk appetite as the day wears on.

On the data front, it is a quiet week for numbers with just the below on the docket:

TodayISM Services54.0
TuesdayTrade Balance-$78.0B
WednesdayFOMC Minutes 
ThursdayInitial Claims220K
 Continuing Claims1810K
 Existing Home Sales4.20M

Source: tradingeconomics.com

As well, we hear from three Fed speakers, Waller, Williams and Logan. Now it will be interesting to see if any of them start to discuss the lower energy prices and how that is likely to moderate their inflation concerns.  If we do hear something like that, I expect the Fed funds table above will reflect that quickly.  We shall see.

It is summer, and there is not much new to discuss.  With the US playing Belgium tonight, all eyes will be there, and my take is we are not looking forward to a terribly exciting session today.

Good luck

Adf

Really Vexed

Posted on by 
Said Warsh, when I think of what’s next
For prices, I’m not really vexed
The narrative’s starting,
A new view, imparting
That lower, is what it expects

While futures have yet to adjust
The more this idea gets discussed
The more it’s presumed
The hike story’s doomed
While negative vibes turn to dust

Fed Chair Warsh was in Sintra, Portugal yesterday on a panel with Madame Lagarde, BOE Governor Bailey and BOC Governor Macklem answering questions about monetary policy, forward guidance, and the future of economies as they are impacted by AI.  Now, despite Mr Warsh’s adamant explanation at the last FOMC presser that forward guidance was dead, that didn’t stop the interviewer from asking about the Fed’s likely future moves repeatedly.  This is getting tiresome.  

Nonetheless, here is the comment I believe was most important. “Expectations of future inflation [over the last four weeks] have come down. Inflation risks have come down,” and anyone expecting the Fed would tolerate inflation running above its 2% goal “would be disappointed,” he added.

So, the first thing I did was look at the CME’s probability matrix based on its Fed funds futures contract, and there is no evidence to support Warsh’s comments there.  As you can see from the below table, it looks virtually identical to what we have seen over the past week, a hike in October and a 40% chance of a second one in December.

Now, I will cut him some slack because, while I agree with him and expect that we will see lower inflation readings this month, simply on the back of the decline in energy prices, the rate hike narrative has been building for a while and has many adherents.  My take is that the above table will not change very much until we have seen the two key data points this month, today’s NFP and CPI which is due to be released on Bastille Day.

While I’m on the subject, here is the current view of today’s median expectations according to tradingeconomics.com

Nonfarm Payrolls110K
Private Payrolls110K
Manufacturing Payrolls3K
Unemployment Rate4.3%
Average Hourly Earnings0.3% (3.5% Y/Y)
Average Weekly Hours34.3
Participation Rate61.7%
Initial Claims220K
Continuing Claims1810K
Factory Orders-1.8%
-ex Transport0.4%

Yesterday saw a slightly softer than expected ADP employment number, 98K vs. the 113K expected and 122K last month, but as you can see from the chart below, comparing ADP to NFP, while the trend remains similar in both, there are an awful lot of wiggles in any given month.

Source: tradingeconomics.com

As things currently stand, the market’s strong Keynesian belief is if NFP is strong, that will be inflationary although it is quite clear that Chairman Warsh does not adhere strictly to that viewpoint (another reason I like him) as he anticipates significant productivity enhancements going forward on the back of AI adoption.  But my point is, if we see a strong print this morning, I would look for the market to price more aggressively for a rate hike.  I guess we’ll find out shortly.

In the meantime, let’s see what happened overnight.  Starting with commodity markets, oil (-1.5%) continues to slide regardless of the group of doomporners who insist that we are about to run out of oil, or that Iran now controls the Strait of Hormuz and will kill the global economy.  In fact, from a technical perspective, we have filled the gap that opened back on March 2nd, the first day markets were open after the conflict began.

Source: tradingeconomics.com

My question for all those who remain certain that we have merely delayed oilmageddon is, how low will prices need to fall before they are willing to admit they misread the reality of the global oil market?  And, with oil sliding, precious metals (Au +0.8%, Ag +1.1%) are finding support.  It seems to me there is a lot of wood left to chop in the PM market, but I maintain my longer-term bullish outlook.

Turning to the bond market, yields rose again yesterday in the US (10-year +6bps) and have edged higher again this morning by 1bp.  My sense is this is based on the idea that Warsh’s final comment from above about tolerating above-target inflation has the hawks all bulled up.  Perhaps, Sintra helped the hawkish case elsewhere as well as European sovereign yields are all higher this morning by between 4bps and 5bps and JGB yields overnight jumped 8bps.

But there is a kink in the narrative now as despite this perceived hawkishness in the bond market, the FX market clearly heard a different tune.  This is clearest in USDJPY, my favorite recent discussion, as you can see in the chart below.  The yen jumped 0.7% ostensibly on the idea that Warsh’s comments about reduced inflation expectations implied a less hawkish Fed, despite the bond market reading the comment about unwillingness to tolerate inflation as a more hawkish Fed.

Source: tradingeconomics.com

But it’s not just the yen.  The dollar is lower vs. virtually all its counterparts in both G10 and EMG spaces.  So, the question you need to ask yourself is, who do you believe?  Bond traders or FX traders?  Historically, observers call bond investors/traders the ‘smart’ money, but they have made plenty of mistakes in the past.  And the thing about FX traders is they seem to be far nimbler.  Of course, you know I am an FX guy, and as it happens, I think this is the market that has it right.

Finally, equity markets had a mixed performance in Asia (Japan -2.5%, China -3.0%, Korea -7.9%) as tech stocks have been feeling some pain, but we did see gains in HK (+0.8%), India (+0.8%) and Singapore (+1.1%) as a counterbalance.  That Korean number was impressive, but mostly what we are seeing there is serious volatility as the KOSPI is even more concentrated than the NASDAQ with just two companies, Samsung and SK Hynix, representing about 40% of the index.  If they have a bad day, the index does as well.

In Europe, though, things are brighter this morning with gains across the board (Germany +0.9%, Spain +0.9%, France +0.8%, UK +0.5%) although there is no obvious catalyst for the move.  There was no data of note (Eurozone Unemployment fell to 6.2% but that seems unlikely to be the driver) so perhaps the very fact there are no tech companies in Europe and tech is what is currently under pressure makes Europe seem a bargain.  As to US futures, ahead of all the data this morning, they are little changed.

And that’s really it for today.  As tomorrow is a holiday, there will be no poetry, so I wish you all a wonderful holiday weekend.  3 Cheers for the USMNT after their Round of 32 victory last night (alas it was on way too late for me to watch, but we will all be cheering on Monday night.

Good luck and good weekend

Adf

40-Year Nadir

Posted on by 
Each day, one more pip
As the yen slides to the next
40-year nadir

The current blame is
The Fed’s recent hawkishness
What if that’s all wrong?

I feel like I must apologize by focusing on the yen again this morning, but quite frankly, there is not that much else to discuss.  And in fairness, it is not as though the yen’s move overnight, edging lower by a further -0.1%, is all that much to write about.  However, the yen has been getting a great deal of press as there is a cadre of analysts who are ‘certain’ that the MOF/BOJ is going to step in and intervene again soon, although I have seen more discussion of how 170 is in the cards as well.

Now, as it is the beginning of the second half of the year, I thought I might look at what I wrote at the beginning of the year regarding the yen to see how it’s going.  And while it is far too early to discern if I was prescient, things are looking pretty good right now.  Below, I have copied my yen discussion from back in January.  You decide if I’m on track.

A turn to the East where the Sun Also Rises
Will teach us that, really, there are no surprises
To date you’ve heard much ‘bout the rise in yen rates
With pundits opining the Carry Trades’ fates
This year, so they say, look for much stronger yen
As local investors buy yen bonds again
Thus, all the hedge funds who’ve been funding their trades
By borrowing yen, and they’ve done so in spades,
Will need to buy back all that Japanese Money
The outcome, for yen shorts, will not be so sunny
But what if this idea of yen heading home
Is wrong?  This implies quite a different syndrome

At this point there’s no sign the government there
Is ready, more spending and debt, to forswear
Instead, what seems likely is more of the same
More government spending in all but its name
So, debt will continue to rise without end
And up to One-Eighty the buck will ascend

So, with that in mind, let’s see what we learned overnight.  First, Japanese Tankan data was released and the economy, or at least the corporate sector, seems in fine fettle.  The below chart of the Large Manufacturer’s Index shows the strongest reading since 2017.

Source: tradingeconomics.com

Clearly, the corporate set is not unhappy with the yen’s movement.  Now, there was yet another Bloomberg articlediscussing comments from the current Mr Yen, Atsushi Mimura, and reflecting on the fact that the MOF is in regular contact with Secretary Bessent and the Treasury department and there is no obvious concern on then US’s part with the current level of the yen.  

However, the consensus view is that the yen’s recent decline has been driven by the change in attitude regarding the FOMC.  The idea is that while the market was anticipating Fed rate cuts back in January, the comments by Chairman Warsh (more of which we will hear later this morning from Sintra, Portugal) have turned things around dramatically and we are now pricing a one-third chance of a hike at the end of July, a certain hike in October and another 40% probability of a second hike in December as per the below CME table.

So, if we take this sentiment shift into account, we can look at the last month of trading in USDJPY, which basically encompasses two weeks before the FOMC meeting and two weeks since.

Source: tradingeconomics.com

And, if you do the math, it seems that the yen weakened 0.72% (from 159.45 => 160.60) in the first two weeks of June and 1.32% (160.60 => 162.72) since the FOMC meeting.  I completely agree that modest change in trajectory is the result of this newfound belief in Fed hawkishness.  Of course, you all know that I don’t believe that is what the Fed is going to do, and in fact, my 180 call at the beginning of the year had nothing to do with the Fed raising rates, it was all about deterioration of Japan’s fiscal account.  However, as we learned this morning from Europe, where inflation fell to 2.8% headline, 2.4% core, both much lower than last month and forecasts (good thing the ECB hiked into the energy price shock, right?) we can look forward to at least a few months of softening inflation in the US as well based simply on the ongoing decline in oil prices (-1.0% this morning) and continuing to trend lower as per the below chart.

Source: tradingeconomics.com

Softer US inflation numbers are going to undermine the call for rate hikes, and I expect to see those hikes priced out of the markets by the end of July.  That alone should help prevent the yen from collapsing in the short-term, although their long-term problems remain extant.

But one thing to keep in mind is that we are coming up to a holiday weekend in the US with market liquidity impaired.  It would not be surprising to see the MOF step in to markets Friday when liquidity is thin and they will get more bang for their buck.  But the yen is a basket case regardless of US rates.  Like I said, short-term, maybe a dip in USDJPY back toward 155 on the back of intervention, but longer-term, unless they change their fiscal policies, lower the yen will go.

Otherwise, there is not much new to discuss.  Equity markets finished the quarter with their best result in forever, with the NASDAQ rising ~30%.  Seems like it will be hard to repeat that again, and this morning, futures are slightly in the red, about -0.3% or so.  As to the rest of the world (do we really care?) last night saw Tokyo (+0.6%) rally along with India (+0.6%) and Taiwan (+1.9%) but the rest of the region slumped led by Korea (-2.0%) which had been the leader, with China (-0.4%) and HK (-0.6%) also falling and the rest of the regional bourses seeing more red than green.  In Europe, there is more negativity than not with only the DAX (+0.2%) edging higher after their PMI release (50.3) was slightly better than expected, although still weak.  However, the rest of Europe is softer this morning (Spain -0.7%, France -0.65%, UK -0.4%) amid unimpressive PMI results.

In the bond market, yesterday saw US yields pop nearly 10bps in what appeared to be a major futures led move.   Certainly, yesterday’s data releases didn’t indicate dramatic strength in the economy, just that things are still fine.  But things being what they are as the Treasury market drives global bond yields, we did see yields climb everywhere yesterday and have followed on in Europe this morning with sovereign yields higher by between 3bps and 5bps across the board.  JGB yields (+3bps) rose overnight as well, although Treasury yields are little changed this morning.  I feel like this move will be reversed by month end, if not sooner.

In the metals markets, oil’s decline has seen support for both gold (+0.4%) and silver (+0.6%) although copper (-1.6%) is struggling this morning.  Nonetheless, I continue to like the long-term outlook for metals.

Finally, the rest of the dollar story is one of strength for the greenback with the euro (-0.25%) slipping back below 1.1400 and every G10 currency under pressure.  Meanwhile, in the EMG bloc, KRW (-0.7%) is today’s dog, as it approaches its GFC levels as the equity market selling weighed on the currency.  Otherwise, broad dollar strength, but nothing dramatic.

On the data front, ISM Manufacturing (exp 54.0) is coming later this morning as are the EIA oil inventory data. And, of course, Mr Warsh’s speech at 9:00am.  It will be quite interesting to hear what he has to say, as I think it will be the most critical thing for the session, and frankly, I have no idea where he may go.

So, as we head into a holiday weekend, less positioning is better, and choppiness is to be expected.

Good luck

Adf

Just Keeping Up

Posted on by 
The yen slid further
Is it accelerating?
Or just keeping up?

There has been a lot of press this morning regarding the yen (-0.25%) which as you can see has weakened a bit, but hardly an extraordinary move.  Thus, the press is all about the level at which it now trades, 162.30ish which is a new high for the move, although it has yet to break above its 1986 levels.  The nature of the articles has been a question as to when the BOJ is going to be back intervening again which then morphs into a discussion as to whether intervention is effective.  (While I don’t know if they will be back in, I imagine that will be the case at some point, we know it is not effective.)  At any rate, I have created the following chart on tradingeconomics.com so that you can (hopefully) see why they have not yet intervened.

One of the key features of the MOF seven step program to intervention is the pace of the yen’s movement.  A rapid decline is far less tolerable than a gradual movement.  As well, there is the question of whether the yen is declining across the board, or it if is declining specifically, or at least more rapidly, vs. the dollar.  It is no surprise to me that the MOF remains on the sidelines as the dollar is rallying everywhere right now, so yen weakness is really more about dollar strength.  If you look at the chart above, I tried to show the slope of the movement in USDJPY vs. DXY back in the beginning of 2024 which was the previous time the yen started to show serious weakness and the BOJ intervened.  To my eye, the slope of the two lines in 2024 are far different than the slope of the current movement.  In fact, the table below shows that the yen’s weakness over the past week and month is hardly an outlier.  In fact, it has basically held up better than its major counterparts.

My point is much is being made about the yen’s breech of the 162 level, but the movement has been quite gradual, hardly the rapid and volatile movement that has driven intervention decisions in the past.  Frankly, there is little reason to believe that with the dollar strong across the board, the BOJ can do anything other than waste money in an intervention effort.

Which begs the question, why is the dollar performing so well?  The pat answer remains that the market is pricing in a suddenly hawkish FOMC with the Fed funds futures market pricing an October rate hike now, with a one-third chance of a second one in December.  See below from the CME.

But I still don’t understand that pricing.  Despite all the ongoing chatter about the imminent shortage of oil/diesel/gasoline/jet fuel that has yet to appear and has now been delayed to H2 of this year, markets continue to price limited further interruption to energy availability.  In addition, one need only look at today’s raft of Eurozone inflation data where France (1.8%), Italy (3.0%) and every German state (between 2.1% and 2.4%) all printed lower than last month, as well as lower than forecast, and recognize that the significant decline in energy prices over the past month is going to push down measured inflation.  Nothing has changed my view that the Fed is on hold for now, and over the next several months the idea of rate cuts will come back into vogue.  At that point, I assume the dollar will give up its recent gains, although I do not foresee a reason for a substantial decline.  After all, investment flows into the US are going to remain robust.

And with that, let’s look at other markets.  As proof positive that nothing is ongoing, oil is unchanged this morning, just above $70/bbl and there has been precious little new news about the situation in the Gulf.  Metals are edging higher (Au +0.4%, Ag +1.3%, Cu +1.3%) but the precious set remain in downtrends although copper is in demand.

You’ve already seen the dollar movement above, at least vs. the bulk of the G10.  But elsewhere, it is not a very interesting picture either.  Perhaps the fact that ZAR (+0.3%) is firmer this morning on the back of both the modest rise in gold and the fact that their fiscal situation looks a bit better (significantly reduced budget deficit in May) is the outlier of note.

Bond markets continue to drift as 10-year Treasury yields slip -1bp and we see similar price action across most of Europe.  The outlier here is Italy (+3bps) which given the better-than-expected inflation data is confusing and I have seen no other cogent explanation.  As well JGB yields (+4bps) overnight reacted to the yen’s weakness as well as to comments by the newest BOJ member, Ayano Sato, who sounded modestly dovish.

Finally, turning to the equity markets, another record setting day in the US was followed by a mixed picture in Asia with both gainers (Tokyo +0.9%, China +1.1%, Korea +1.0%, Taiwan +2.5%) and laggards (HK -0.6%, Australia -0.5%, India -0.3%, Indonesia -3.1%) with the latter a response to a legal verdict of corruption which the market has taken as a major government intrusion into the economy and frightened investors.

Turning to Europe, though, everybody is happy this morning with gains across the board (Germany +1.5%, UK +1.2%, Spain +0.7%, France +0.6%) as those slipping inflation numbers help the overall sentiment.  As to US futures, you will not be surprised that at this hour (7:25) they are marginally higher.  

One must be impressed with the consistency of equity market gains.  It is enough to make you reconsider your prior ideas as to how markets work.  Arguably, the key feature of the recent equity market performance is that earnings data continues to improve.  Now, if you look at the ongoing growth in money supply, both in the US and around the world, it is no surprise that nominal results continue to rise.  It is also not surprising that people are feeling stressed by inflation regardless of the data that is printed as all that money has to find a home somewhere.  And the Cantillon effect tells us that the first folks who get the newly printed money (banks and institutions) are the ones who benefit the most while the rest of us simply watch our cost of living increase.  This is the entire wealth/income inequality story and, arguably, the reason that the idea of socialism is making a comeback.  And socialism does have a perfect record in its economic outcomes; it has failed 100% of the time it has been tried.  But right now, I fear that record is not going to be a problem.  There is much potential trouble ahead.

Today’s data brings Case-Shiller Home Prices (exp 0.9%) as well as Chicago PMI (58.1), JOLTs Job Openings (7.30M) and Consumer Confidence (94.7).  But with Warsh on the tape tomorrow morning and then NFP on Thursday, I don’t see today’s data having much impact.

While the Iran situation is in the background right now, it remains the issue with the biggest potential impact going forward.  A successful conclusion of a deal and resumption of flows of energy through the SOH will put additional downward pressure on energy prices, and by extension general inflation.  In that scenario, central banks will be quick to turn away from rate hikes.  However, if things collapse there, then we will need to be prepared for another major hiccup, that’s for sure.

Good luck

Adf

Peace Was in Sight

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The weekend saw missiles in flight
As both sides continued the fight
But just ere the open
The market put hope in
The idea that peace was in sight

So, here we are first thing today
And focus has moved far away
We’re back to AI
And pie in the sky
As stocks, once again, make more hay

Much has been made of the fact that President Trump is hyper aware of financial markets and seeks to ensure that whatever is happening in the world, it happens on weekends so that by the time markets reopen, the situation appears far less dire, hence less need to sell stocks.  This weekend is a perfect example as Friday after the close, it was announced that the US had responded to the several Iranian attacks on ships in the Strait of Hormuz last week with significant force.  The early punditry on Friday night and Saturday was that when markets reopened, the recent decline in oil prices would reverse as that has been predicated on a more lasting peace.  But then, last night shortly before futures markets opened, there were announcements that the US had finished its response and that the peace talks were back on under the guise of the 60-day ceasefire.  

I have to say, though, it almost appears as if Iran is in on the joke.  After all, if not, wouldn’t they try to force Trump’s hand during market hours?  Just asking.  Whatever the case, the situation as we wake up this morning is that oil (+0.8%) has edged back higher near $70/bbl but certainly doesn’t have the feel of breaking out higher.  Meanwhile, equity markets are generally positive and have been overnight while bond yields and the dollar are little changed.  in other words, there’s not much happening this morning.

In reality, it is not that surprising that things are quiet.  It is summer and summer markets are typically somewhat less active.  As well, away from the uncertainties of the Iran conflict, economic activity seems to be ticking along pretty well.  Arguably, the biggest story remains AI and both its potential impact on workers and the economy as well as the questions about its ability to generate sufficient revenue to repay the hundreds of billions of dollars being spent on it.  But those are longer-term stories, not day-to-day.

Which takes us to this morning.  Frankly, I don’t think there is an interesting market related them right now.  Instead, we have much time-biding until the next big thing.

Let’s start with commodities as oil continues its multi-month decline from the early April peak.  it remains very difficult to look at the below daily chart and think, damn, oil is about to run away higher.  At least for me.

Source: tradingeconomics.com

There are still numerous analysts who maintain that the drawdown of reserves is going to come back and haunt the market, driving prices much higher as inventories fall and tank bottoms are reached.  And I am sure they earnestly believe those outcomes are ordained.  But the relative wisdom of market prices disagrees.

Remember back when this all started, there was another point that was made by these same analysts, that fertilizer shortages would be manifest and food prices would rise much higher.  The story was that the closing of the Strait would reduce the ability of Qatar to produce and ship LNG and that was a critical input into the making of Urea.  Let me show you the price chart for Urea.

Source: tradingeconomics.com

While it certainly rose initially, apparently there is sufficient urea around to continue with agriculture as we know it.  Again, much of the initial fear seems to have been misplaced.  I do not know if that is because analysts didn’t really understand the way these markets operated, or because they have models that they have used for years, and those models are no longer fit for purpose.  My observation is that many analysts try to determine the price trends by looking at their understanding of both supply and demand of a given commodity.  But I might argue that the price is what defines both supply and demand, and that at given prices, those two curves adjust to make the system work.  Think of it as price is the independent variable, not supply/demand.

Moving on to the metals markets, they remain under pressure this morning with both gold (-1.3%) and silver (-1.9%) unable to find support, especially the latter.  Copper (-0.3%) is holding up better and I continue to believe that all three will fare well over time, but not right now.

In the equity markets, Friday’s nondescript US markets were followed by more strength (Tokyo +0.15%, HK +1.6%, China +1.2%, Australia +0.7%, Taiwan +1.0%) than weakness (Korea -0.2%, India -0.5%, Indonesia -1.3%) in Asia.  The big news overnight was the South Korean government supporting a massive semiconductor investment by the two big Korean firms, SK Hynix and Samsung, to build four more fabs.  In Europe, though, things are less positive with Germany’s unchanged performance leading the way although the declines elsewhere (UK -0.2%, France -0.3%, Spain -0.4%) are hardly devastating.  We ought not be surprised that US futures are higher this morning as I type (7:25) led by the NASDAQ (+0.9%) as the AI/semiconductor theme continues.

Bond markets continue to do very little with yields essentially unchanged on the day in Europe or the US.  10-year Treasury yields are currently 4.37%, well off the highs seem a month ago near 4.70% when there was much discussion about a breakout higher.  But look at the below longer-term chart of the 10-year Treasury yield and tell me that anything substantive has happened in the past 3+ years.  Since yields rise alongside the 2022 inflation surge, we have seen very little net movement.

Source: tradingeconomics.com

Finally, the dollar is a bit softer this morning but is clearly not the focus today.  I continue to read analyses about Chairman Warsh and what he is going to do and why he will not be able to achieve his goals.  The implication is that either he will need to be ultra hawkish, raise rates quickly and the dollar will soar, or he will wind up with QE 5 or 6 or whatever number we are on, and the dollar will collapse.  My personal view is neither of those scenarios will play out.  As I wrote in the wake of his first meeting, I expect inflation data will ease along with the recent decline in energy prices, and he will be able to do nothing without consequences as he works to change the way things work there.  In the meantime, the dollar will remain supported by real investment flows.

On the data front, even though it is a holiday-shortened week with markets closed Friday for July 4th, we get a lot of data.

TuesdayCase-Shiller Home Prices0.8%
 Chicago PMI60.0
 JOLTS Job Openings7.28M
 Consumer Confidence94.2
WednesdayADP Employment113K
 ISM Manufacturing54.0
 ISM Prices Paid79.0
ThursdayNonfarm Payrolls110K
 Private Payrolls115K
 Manufacturing Payrolls3K
 Unemployment Rate4.3%
 Average Hourly Earnings0.3% (3.5% Y/Y)
 Average Weekly Hours34.3
 Participation Rate61.7%
 Initial Claims220K
 Continuing Claims1825K
 Factory Orders-2.1%
 -ex Transport0.4%

Source: tradingeconomics.com

Obviously, all eyes will be on the payroll data on Thursday.  But Chairman Warsh will be at Europe’s version of Jackson Hole, in Sintra Portugal and speaking at 9am Wednesday morning.  It will certainly be interesting to hear what he has to say there.

It doesn’t seem like there is much about which to get excited today, or tomorrow frankly.  So, Warsh and then NFP will be this week’s story absent another major flareup in the gulf.

Good luck

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