The New Bling

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Though pundits on all sides maintained

A debt default soon was ordained

Instead, what we got

Was spending a lot

Of cash sans debt issues restrained

 

So, fear has now faded away

While risk preference is on display

AI is the thing

That is the new bling

And everyone wants it today!

 

This poet is in no position to discuss the particular merits, or lack thereof, regarding the debt ceiling deal that was reached over the weekend.  The only thing that ultimately matters is that a deal was reached and that despite a great deal of huffing and puffing yet to come, will almost certainly be passed and signed into law this week thus preventing any chance of a debt default by the US Treasury.  As such, another “crisis” has been averted and the market can go back to focusing on its favorite topic, the Fed.  Or is AI the market’s new favorite topic?

 

Having been around long enough to well remember the dot com bubble of 2000-2001, the AI discussion certainly seems to have a lot of parallels to that time.  Essentially, look for company after company to announce they are utilizing AI to improve their productivity and enhance the features of their products as they try to share the current positive attitude investors have on the subject.  And this is not to dispute that AI has the potential to be very beneficial over time as its strengths and weaknesses are better understood, it is just a comment that in the early stages of a new mania, association with the ‘thing’ is just as important as how that ‘thing’ is used.  I have a sense that like in the gold rush in 1849 in California, the ones making money will not be the miners (all those companies claiming AI is part of their process), but rather the sellers of the picks and shovels and supplies (NVDA and other semiconductor manufacturers) who are building the pieces needed to create AI.  But that doesn’t mean that equity markets won’t rally a bunch from here, regardless of valuations.  Be wary.

 

However, let’s head back to the macro discussion, an area more in tune with poetry.  Starting with the debt ceiling deal, as with all compromises, neither side is happy as both feel they gave away too much.  But the important thing is that, as always, the time pressure was sufficient to force movement on both sides and whatever the final shape of the bill, it will be passed.  This is especially true because you can be sure that now that a compromise has been reached, any failure to complete the process will be squarely blamed on the House Republicans by the entire global media complex regardless of the particulars.

 

With that out of the way, a quick look back to Friday’s PCE data shows that despite a growing sentiment that inflation is heading back down to, and below, 2% shortly, the Core PCE reading was a tick higher than forecast at 0.4% M/M and 4.7% Y/Y.  Meanwhile, the rest of the data Friday showed relative economic strength.  Durable Goods rose sharply, +1.0%, while Personal Income and Spending remained robust.  Not only that, but the Advance Goods Trade Balance widened to a -$96.8B deficit, indicating a lot of imports coming in, and Michigan Sentiment rose to 59.2, still largely awful, but above forecasts.

 

But all this data was in conflict with other data, notably Gross Domestic Income (GDI).  As per the below from Investopedia, GDI measures the amount of earnings while GDP measures the amount of production:

  • GDI = Wages + Profits + Interest Income + Rental Income + Taxes – Production/Import Subsidies + Statistical Adjustments
  • GDP = Consumption + Investment + Government Purchases + Exports – Imports

 

The fudge factor is Statistical Adjustments, but GDP has been the benchmark as the data tends to be more recent.  In theory, they should be equal, but that is just not the case, largely because of the timing of data releases.  Here’s the thing, the GDI data released last week, alongside the GDP data, showed that in Q1, GDI fell -2.3% while Q4 2022 GDI was revised lower to -3.3%.  That is two consecutive quarters of negative GDI, a situation that, when it has occurred in the past, has always happened during a recession.  So, once again we are seeing conflicting data with some numbers indicating ongoing economic strength while others are indicating the opposite.

 

What’s a risk manager to do?  The beauty of hedging is that when done properly, it helps mitigate large movement in whatever is being hedged, whether that is profitability, cash flow or expenses.  However, if pressed, it remains very difficult to believe that we can have the Fed raise interest rates as quickly and as far as they have already done without having some negative economic consequences coming down the line.  Remember, monetary policy works with ‘long and variable lags’ which has historically varied between 6 and 29 months from the onset of policy changes.  We are only 14 months into this process (first rate hike in March 2022), and while the housing market has clearly felt an impact, it is not clear that the rest of the economy has seen that much yet.

 

Looking ahead, there is still a huge wall of debt refinancing to come with rates much higher than before thus, at the very least, significant cost pressures on companies bottom lines.  And there will be those companies that cannot find financing at a level allowing continued operations.  In fact, bankruptcies have already been running at a record rate with more than 230 so far this year (counting companies with >$50 million in liabilities).  There is no reason to believe that trend will slow down as the Fed continues to raise rates.

 

Speaking of the Fed, the market is now pricing a 60% probability of a 25bp rate hike in June, up from just 30% one week ago, 13% two weeks ago and 0% immediately following the last meeting.  In addition, the market is removing its pricing of rate cuts as well, with now just 2 rate cuts priced in one year from now.  That number had been upwards of 150bps of cuts last month.  The point is that the market is finally taking the Fed at their word that rates will remain higher for longer, and that another hike or two are well within the realm of possibility.

 

It remains difficult for me to see how risk assets can continue to outperform with ongoing monetary policy tightening as well as slowing growth elsewhere in the world, notably Germany, which is already in recession, and China, where growth continues to lag forecasts and models as the property market, which had been a primary mover for decades, continues to flounder.

 

As to markets today, risk is mixed with modest gains in Asia overnight, a mixed bag in Europe this morning and US futures pointing to continued NASDAQ gains while the rest of the market stagnates.  Bond markets have seen yields decline sharply as fears over that debt default disappear with Treasury yields falling 8.3bps and similar size yield declines throughout Europe.  In the commodity space, oil (-2.0%) is falling on concerns slowing economic growth will continue to undermine demand while both gold (+0.8%) and copper (+4.5%) are rallying, the former on a bit of dollar weakness while the latter has been getting a huge amount of press regarding the structural shortages that will be exacerbated by the attempts to electrify everything.

 

Finally, the dollar is mixed, largely stronger vs. most of the EMG basket, albeit not hugely so, while the G10 has been outperforming this morning with GBP (+0.6%) the leader after BRC shop prices hit a new all-time high of 9.0% encouraging belief the BOE will need to tighten further.

 

This is a big week for data as we get the payroll report on Friday but plenty before then.

 

Today

Case Shiller Home Prices

-1.60%

 

Consumer Confidence

99.0

 

Dallas Fed Manufacturing

-18.0

Wednesday

Chicago PMI

47.2

 

JOLTS Job Openings

9439K

 

Fed’s Beige Book

 

Thursday

ADP Employment

165K

 

Initial Claims

235K

 

Continuing Claims

1803K

 

Nonfarm Productivity

-2.6%

 

Unit Labor Costs

6.3%

 

ISM Manufacturing

47.0

 

ISM Prices Paid

52.5

Friday

Nonfarm Payrolls

193K

 

Private Payrolls

173K

 

Manufacturing Payrolls

5K

 

Unemployment Rate

3.5%

 

Average Hourly Earnings

0.3% (4.4% Y/Y)

 

Average Weekly Hours

34.4

 

Participation Rate

62.6%

Source: Bloomberg

 

Clearly, all eyes will be on NFP on Friday, but there is much to be gleaned between now and then.  On the Fed speaker front, we hear from 5 more speakers ahead of the beginning of the quiet period starting Friday.  I maintain that the NFP data is the key for the Fed.  As long as it remains strong, Powell has cover to raise rates as much as he likes.  But once it cracks, look out below.  For now, nothing has changed my dollar view of continued strength until such time as policies change. 

 

Good luck

Adf

 

 

			

	
	



			
				


	

		

			On the Spot
		


				

			Posted on  by 		

			


		

		
This morning, it’s Core PCE


That markets are waiting to see


If it keeps on falling


More folks will be calling


For rate cuts ere end ‘Twenty-three




But what if the data is hot


That could put the Fed on the spot


Instead of a pause


That reading may cause


At least one more hike than was thought




As we head into the Memorial Day weekend, the market is awaiting some more key data points for the Fed’s calculus on inflation.  Today brings a plethora of things as follows (median expectations from Bloomberg):


    

  • Personal Income (exp 0.4%)
    • 

  • Personal Spending (0.5%)
    • 

  • Core PCE Deflator (0.3%, 4.6% Y/Y)
    • 

  • Durable Goods (-1.0%)
    • 

  • -ex Transport (-0.1%)
    • 

  • Michigan Sentiment (58.0)
    • 





Given the Fed’s preference for the Core PCE as their key inflation indicator, this data point is always a critical feature of the monthly slate.  However, since the FOMC Minutes were released on Wednesday, the market has already adjusted its views on the Fed’s future path.  Since the release, the market has removed another full 25bp cut from the medium-term outlook, with pricing for January 2024 rising from 4.50% to 4.735%.  It appears that the market is truly beginning to believe the Fed that it is going to remain higher for longer.




So, let’s look at the consequences of that policy stance and the market’s grudging acceptance.  Over the course of the past 3 weeks, 10-year Treasury yields have risen from 3.38% to 3.78% after giving up 3bps this morning. Meanwhile, 2-year Treasury yields have risen from 3.89% to 4.49%, increasing the curve inversion again, and highlighting the market view that a recession remains in the not-too-distant future.




Generally speaking, the combination of higher interest rates and recessionary indicators tends to undermine the equity market, but that picture is more nuanced these days as the incredibly narrow breadth of the price leaders has been able to overcome a more general malaise.  For instance, yesterday’s S&P 500 gain of 0.88% was largely the result of just three key tech names, NVDA, MSFT and AVGO, with the rest of the group mostly thrashing around.  This continues the trend of a handful of companies driving the value of the “broad” market indices, a situation that cannot go on forever, but for now, it seems fine.  Of course, the NASDAQ is even doing better since all those high performers are NASDAQ names.




However, one needs to ask, if the Fed continues to tighten policy further, and the market is now pricing a one-third probability that they hike another 25bps next month, and the result is a further slowdown in the economy, can these companies continue to perform?  Maybe they can, but history is not on their side.




Other markets, too, have been impacted by the slow realization that the Fed means what they have been saying all along, higher for longer.  While oil prices (+0.5%) are edging higher today, they have been significant underperformers along with base metals as concerns over future economic growth weigh on the sector.  Both copper and oil have been falling for the last several months as the largest importer of both, China, seems to find itself with its own economic malaise.  This is merely another input into the recession story.




Weakening growth in China and higher interest rates in the West to fight still too-high inflation do not bode well for economic activity for now.  Add to these factors the potential outcome from the debt ceiling negotiations, reduced Federal spending in the US, and you have a trifecta of reasons for a negative equity and risk market outlook.




Speaking of the debt ceiling, this morning’s headlines indicate that the two sides are getting closer, but that spending cuts are part of the process.  Naturally, this is controversial on the left side of the aisle, but the fact that not all the spending cuts included in the bill already passed by the House are going to be seen is controversial on the right side of the aisle.  If anything, this sounds like an excellent outcome, where neither side is happy, but both agree something must be done.  It is certainly no surprise to me that they are getting closer to agreement as this all has been part of the Congressional Kabuki that we regularly see on critical issues.  Remember, though, avoiding a debt default is not a huge positive sign, it is merely the absence of a negative one.




Where does this leave us?  Overall, the data remains mixed at best, with manufacturing indicators weakening, service indicators holding up, inflation remaining stickily high and the Fed continuing to pound its one main tool, the hammer of interest rate hikes on the economy.  Perhaps the most interesting data situation is that of Initial Claims, which yesterday printed at a much lower than expected 229K.  The fairly steady increases in layoffs that had been seen since the beginning of the year seem to be abating now.  In fact, the 4-week moving average of claims data has fallen back sharply to 231.8K, an indicator that the trend higher may be ending.  If this is the case, and the NFP data going forward remains robust, the Fed will have every reason to continue to tighten policy further, much further than is currently priced into the market.  As I have written in the past, I continue to believe that NFP is the most important data point.  As long as Unemployment remains low and jobs are created, the Fed will have all the cover it needs to maintain tight monetary policy.  Just be prepared for some other things to break, à la SVB and First Republic.




Finally, a word about the dollar, which while modestly softer today remains in a clear uptrend off the lows seen early in the month.  As long as the Fed maintains its current policy stance, one which is still being priced into the market, the dollar has further to rally.  Although other central banks have been tightening policy as well, notably the ECB and BOE, the Fed remains the leader of the pack.  Until the Fed finally halts, those two will lag and the dollar should remain strong.  It is only when the Fed finally reverses course, which may not be until the middle of next year on current pace, when we should see any substantial dollar weakness.  I would not hold my breath.




In the end, it all comes back to inflation.  Until the central banks believe that they have defeated inflation’s threats, barring a calamitous economic collapse, I would look for bond yields around the world to continue to drift higher, for equity markets to struggle, although further gains cannot be ruled out, and for the dollar to maintain its overall strength.




Good luck and good weekend


Adf



			

	
	



			
				


	

		

			Much Pain
		


				

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There once was a nation quite strong





Whose policies worked for so long





But war in Ukraine





Inflicted much pain





And now it seems they were all wrong





Relying on, energy, cheap





They rose to the top of the heap





But when prices rose





They’d naught to propose





‘Bout how to, advantages, keep





It turns out that Germany has fallen into a recession after all.  The German Statistics office revised down their Q4 2022 GDP reading from stagnation at 0.0%, to a -0.5% reading after adjusting for a substantial decline in government spending.  Meanwhile, Q1 GDP growth fell -0.3%, so Germany is solidly in a recession, at least based on the traditional definition of two consecutive quarters of negative GDP growth.  It certainly is remarkable that an economy that predicated itself on levering cheap, imported energy into the manufacture of steel, chemicals and machinery would encounter any problems simply because it became totally reliant on raw materials from a communist regime…NOT!  But in fairness, the Germans have hamstrung themselves by spending hundreds of billions of euros in their Energiewende program to reduce greenhouse gas emissions.  Unfortunately, this included shuttering their entire nuclear power fleet, which had produced upwards of 25% of their electricity with zero emissions and replacing it with heavily subsidized solar and wind power generation.  (By the way, whoever thought that solar power was a good idea in Northern Europe?  Arizona I get, Germany not so much.)





Granted, prior to Vladimir Putin invading Ukraine, things were going along swimmingly.  China was soaking up so much of what Germany was producing, and of course the rest of Europe were huge customers as well.  But it turns out risk management is a real thing, and not just when it comes to your foreign exchange or interest rate risks.  If we learned nothing else from the Covid pandemic it is that surety of supply of critical products or inputs is worth a lot, perhaps just as much as the price of that supply.  





Once Russia invaded, though, the world changed dramatically, and a critical flaw in the German economy was exposed.  Prior to the invasion, because of Energiewende, German electricity prices were the highest in Europe and approaching the highest in the world.  And that included cheap Russian gas as a source.  Now those prices are higher still and major manufacturers are picking up stakes and moving their facilities to places where they can get reliable, and relatively inexpensive, energy.  BASF moving key production to both China and Saudi Arabia is merely indicative of the problems Germany will have going forward.  It strikes me that Germany has a long road to hoe in order to get their economy back working as effectively as it had in the past.  This does not bode well for the euro (-0.2%) which is continuing its slow grind lower this morning, as the dollar continues to buck the majority analyst view of USD weakness.





The future belongs to AI





At least that’s what bulls glorify





So, last night we learned





Nvidia earned





A ton helping futures to fly





Obviously, this is not an equity piece and so I rarely cover specific names, but the buzz on Nvidia’s earnings is having a significant impact on markets overall.  The most instructive thing is to look at the performance of the NASDAQ vs. that of the Dow, at least in the pre-market futures trading.  At this hour (7:30), NASDAQ futures are higher by 2.0% while Dow futures are lower by -0.4%.  This dichotomy continues to grow on a daily basis, with the tech megacaps generating virtually all of the equity market performance seen this year, hence the relative outperformance of the NASDAQ vs. both the S&P 500 and the Dow.  The narrowing breadth of the market’s performance, with 7 names accounting for more than the entire S&P 500 gains this year means the other 493 names are actually lower.  From a more macro point of view, historically, price action of this nature has preceded significant bear markets every time it has occurred.  It is very easy to look at the totality of information including still high US inflation, softening growth metrics and a stock market that is reliant on just 7 names for its performance, and conclude a reckoning is coming.  Oh yeah, did I mention that the Fed remains committed to keeping its policy at current, relatively tight levels?  It is no wonder that the recession that is forecast to come soon is so widely forecast.





Quickly, the FOMC Minutes yesterday indicated that while there was a lot of discussion as to whether or not rates needed to go higher, there was zero discussion that rates would need to decline anytime soon.  The commentary we have heard since the last meeting has certainly had a less conclusive tone regarding further hikes, with several members indicating they thought a pause for observation was worthwhile.  But unless the economy craters, and Unemployment spikes much higher, there is no reason  to believe the Fed is going to change course.  And that, my friends, will continue to support the greenback for quite a while.





As to the overnight session, after a weak US equity performance yesterday, Asia was mixed and most European bourses are edging lower on the order of -0.2%.  It is certainly no surprise that the DAX is falling, and we have also seen lackluster data from France weighing on the CAC.  The problem for Europe is they don’t have any megacap tech stocks to support the indices.





Bond yields continue to mostly edge higher with gains on the order of 1bp this morning although there was a standout here, Gilt yields have risen by 9bps, still feeling the hangover from yesterday’s inflation data.





Meanwhile, in commodities, recession is the watchword as oil prices (-1.2%) are giving back some of their recent gains, although copper has seen a trading bounce.  





And finally, in the FX markets, the dollar continues to perform well, rising against all its G10 and most EMG counterparts.  Remarkably, the debt ceiling concerns seem to be the driver as the dollar is still considered the safest of havens despite the issues here.  There have been no outstanding stories to note other than the risk-off nature of things.





On the data front, we see Initial (exp 245K) and Continuing (1800K) Claims as well as the second look at Q! GDP (1.1%).  Also, Chicago Fed  National Activity (-0.2) is released, which has been pointing to slowing economic growth for a while now.   Two Fed speakers, Barkin and Collins are on the slate today, but I feel that mixed message continues unabated and won’t be changed here.





Ultimately, until the Fed backs off, the dollar is going to continue to perform well, keep that in mind.





Good luck





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			Possibly Burst
		


				

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It turns out inflation’s not dead





At least in the UK, instead





With prices there surging





The market is purging





All thoughts rate cuts might be ahead




















However, elsewhere, there’s concern





That soon there will be a downturn





Thus, stocks have reversed





And possibly burst





The bubble for which most folks yearn





Interestingly, inflation discussions are really beginning to diverge around the world.  What had been a global phenomenon, with prices rising everywhere on the back of pandemic lockdown induced shortages combined with massive fiscal stimulus pumping up demand, is starting to shake out a bit more idiosyncratically.  While in the US we have seen a clear reduction in the trend of prices over the past year, albeit still far above the Fed’s comfort level, elsewhere, this is not necessarily the case.  Today’s example is the UK, where CPI printed at 8.7%, far above the median forecast of 8.2%, although mercifully lower than last month’s 10.1%.  However, core CPI, which excludes energy, food, alcohol and tobacco in the UK, rose to 6.8%, a new high level for this bout of inflation and the highest in the UK since 1992.





One cannot be surprised that the market responded with Gilt yields jumping more than 6bps while the rest of global bond markets have seen yields decline in the face of a broad risk-off sentiment.  More impressively, the OIS market has immediately priced in more than 30bps of additional rate hikes before the end of the year this morning.  While UK stocks are lower, so are equity markets everywhere around the world and perhaps most surprisingly, the pound has only fallen -0.2%.  I suspect that is due to the tension of higher interest rates supporting the currency while worries over the future of policy and the economy are undermining it.  That said, year-to-date, the pound is still the best performing G10 currency vs. the dollar, with gains on the order of 2.5%.  If pressed, I would expect that the pound is likely to range trade going forward as the market continues to reprice Fed expectations higher (removing those forecast rate cuts) while the UK side remains stagnant for now.





Turning our attention to the economy writ large, there is a growing sense that the widely expected recession is coming soon to a screen near you.  Data continues to show weakening trends with, for instance, today’s German IFO Expectations falling to 88.6, far below forecasts, on the back of weakening manufacturing trends in Germany.  As well, yesterday’s US data had its lowlights with the flash manufacturing PMI falling to 48.5, while the Richmond Fed Manufacturing Index fell to -15, both well below expectations.  Layer on the background debt ceiling concerns, where the most recent word is that talks have stalled right now, and there is plenty of reason to turn pessimistic on things.  Arguably, these were keys to yesterday’s equity market declines in the US and we have continued to see red on the screens in every market in Asia and Europe. 





One of the biggest market concerns is China, where talk of slowing growth is continuing as this month’s production and investment data, released last week, was generally softer than expected with property continuing to drag things down, but fixed assets in general softening further.  There continue to be expectations that the PBOC is going to be easing monetary policy further and the renminbi’s recent slide shows no signs of stopping.  This view is also evident in commodity markets, specifically metals markets where copper (-1.5% today, -4.1% in the past week) and aluminum (-0.6%, -3.7%) are under increased pressure as concerns over slowing Chinese growth are impacting demand for these key industrial metals.  





There is, however, one place where this is not so evident, oil prices (+1.5%) as the market continues to respond to prospective production cuts by OPEC+ in the coming months.   The thing about oil is that its demand elasticity is nearly vertical.  Certainly, at the margins there can be more or less demand based on the economic conditions extant, but there is a baseline of demand that is simply not going to disappear.  It is important to remember that despite all the efforts at reduction in the use of fossil fuels, global oil demand hit a record last year.  It is also key to remember that for the past decade, investment in the production of new oil and gas reserves has been severely lacking.  The implication is that while oil prices have fallen well below the highs seen in the immediate wake of the Russian invasion of Ukraine, nothing has changed the long-term supply demand equation which greatly favors demand over supply, i.e. oil prices are likely to rise consistently, if not steadily, over the coming decades.





Summing it all up, today appears to have investors and traders thinking the worst, not the best of things going forward.





A quick look at overnight markets shows that equity market declines have largely been greater than -1.0% with the biggest markets, DAX, CAC, FTSE 100, pushing -2.0%.  There has been no place to hide here, and from a technical perspective, yesterday’s price action looks like an outside bearish reversal, which simply means that the closing level has market technicians selling for right now.  We have seen a significant equity rally in the face of a lot of negative news, so perhaps that run is now over.





Global bond yields are consolidating recent gains, with small declines today not nearly enough to offset what had been 30bp-40bp increases in the past two weeks.  In this market, clearly the debt ceiling talks are the primary story with macroeconomics a distant second for now.  There is just one week before the X-date, at least the latest one, and I suspect that we will hear of an agreement early next week helping to reduce at least some of the pressure on risk attitudes.





Lastly, the dollar is largely stronger this morning with an outlier in NZD (-1.85%) which fell sharply after the RBNZ essentially promised that last night’s 25bp rate hike, to 5.50%, is the last one coming, a big change from market expectations of a 50% probability of a 50bp hike last night.  Essentially, they explained that property market pressures and slowing consumer activity convinced them rates are appropriate to fight inflation.  Kiwi dragged Aussie (-0.5%) lower as well, but the rest of the bloc has seen far less damage with the yen (+0.15%) actually managing a small gain.  But make no mistake, over the past week and month, the dollar has regained its footing, at least against the G10.





In the emerging market bloc, the picture is more mixed with both winners and losers overnight with HUF (+0.8%) the leader, bouncing after the central bank cut its Deposit rate by 1 full percentage point yesterday, as expected and the forint fell sharply.  Meanwhile, MXN (+0.6%) is also showing signs of life after having fallen every day in the past week as the market now assumes Banxico has finished its rate hikes.  On the downside, MYR (-0.45%) and KRW (-0.4%) are both feeling the pressure of the weaker Chinese growth story given its importance to their own economies.





On the data front, the FOMC Minutes are released this afternoon and have a chance to be quite interesting given what appears to be the beginning of a split of opinions regarding the appropriate next steps.  As well, we hear from Governor Waller around lunch time, and ahead of the Minutes.  Waller certainly leans toward the hawkish end of the spectrum, so keep that in mind.





Adding it all up and the combination of declining risk appetite and a growing belief that the Fed is not going to pivot anytime soon implies that the dollar should maintain its footing for now.





Good luck





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			Widened the Spread
		


				

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Twixt ceilings for debt and the Fed





The market has widened the spread





Of rates here at home





Despite what Jerome





Last weekend ostensibly said





  




















Thus, dollars remain to the fore





As traders want so many more





The megacaps rise





But in a surprise





There’s less and less talk of the war





The debt ceiling negotiations remain at the top of the market’s list of concerns as the ostensible X-date of June 1stapproaches.  Certainly, the positive aspect is that both sides are talking as opposed to merely grandstanding, but as is always the case in a political standoff with a non-political impact, it is clear no deal will be reached until the Nth hour.  The other thing to remember is that the June 1st date is not a hard deadline, it is the current estimate by Secretary Yellen and subject to change.  In the end, nothing has changed my view that a deal will be reached as both sides desperately want one, but also, no deal will be reached until both sides can explain to their supporters that they did everything possible to achieve their agendas.





However, this process is clearly having an impact on the markets, especially in the interest rate space as we have seen 10-year Treasury yields, which are higher today by 3.3bps, rise 36 basis points in the past two weeks.  In addition, the yield curve inversion, which at one point had fallen to as low as -41bps, is back to a -64bp difference.  Not only that, but the 4-week T-bill, the nearest expiry past the X-date, is now yielding 5.47%, far above Fed funds and the highest spot on the yield curve.  That is clearly a direct response to fears over a possible default.  My sense is this process will go on right through Memorial Day and US interest rates may well have further to rise between now and then.





But this begs the question, are US rates dragging up rates around the world?  I would argue the answer is yes.  Looking at European sovereigns, which have all seen yields rise by around 3bps-4bps today (Gilts are actually +8bps), they have all risen in concert with Treasury yields.  During the same time frame that Treasuries rose 36bps, Bunds are +28bps, OATS +25bps and Gilts +43bps.  Yet during that period, the dollar has gained more than 1% vs. both the euro and the pound (and all the other G10 currencies as well). 





Perhaps what we are seeing is a new safe haven asset being born, the US megacap tech stock.  The likes of Apple, Microsoft and Alphabet have seen steady strength, helping to drive the NASDAQ 100 Index up nearly 5% during this same two-week period.  In fact, a quick look at YTD performance in US equity markets shows that the Dow Jones Industrials are +0.4% YTD while the NASDAQ is up 21.5%.  In the past, there was a concept during bouts of USD strength that investors were buying dollars to buy Treasuries.  I think right now investors are buying dollars to buy Apple!  In fairness, one can see the premise as regardless of the debt ceiling outcome or timing, the belief that Apple (or Microsoft or Alphabet) shares will react to that news rather than their own positive stories generates no concerns.





Of course, those names are the exceptions to the rule as the bulk of the rest of the market has been under pressure recently on the back of all the catastrophic predictions if the debt ceiling isn’t raised and the US defaults on its debt.  This can be seen in the fact that the other major indices have seen almost no movement, just sideways trading, during the recent period in question.





Turning to the Fed, it appears that we are reaching an inflection point in the tightening process, or at least in the rate hiking cycle.  While prior to the last FOMC meeting, virtually every speaker was on the same message, we are starting to see some differences.  Most importantly, Powell, last weekend, hinted that there was some concern that the continued rate hikes were starting to impact financial stability (seriously, after 4 major bank failures it is now a concern?). But the implication is that while inflation remains job number one, there are other issues on the agenda.  That seems to be the dovishness that was attributed to Powell over the weekend.





Meanwhile, yesterday we heard from two regional Fed presidents.  James Bullard from St Louis, who said that he saw at least two more rate hikes (50bps total) as necessary to be certain they have slain the inflation dragon.  As per Bloomberg news, “I think we’re going to have to grind higher with the policy rate in order to put enough downward pressure on inflation and to return inflation to target in a timely manner,” Bullard said at an event in Florida on Monday.  “I’m thinking two more moves this year — exactly where those would be this year I don’t know — but I’ve often advocated sooner rather than later.”





However, we also heard from Minneapolis President Neel Kashkari with a different message, “I think right now it’s a close call, either way, versus raising another time in June or skipping.  What’s important to me is not signaling that we’re done.”  I guess the Eccles Building will be rocking in June when they next meet.





As it stands currently, at least according to the Fed funds futures market, the market is pricing in a 23% probability of a 25bp rate hike on June 14th.  Remember, though, between now and then we see a lot of critical data including this week’s Core PCE release, next week’s NFP data and finally the May CPI data, scheduled to be released the day before the FOMC announcement.  In the meantime, all eyes seem to be on the debt ceiling negotiations, and reasonably so, given the fallout could begin before the big data comes. 





Looking at today, the big movers overnight were the bond markets with equity markets mildly in the red in both Asia and Europe.  US futures are also edging lower, but barely -0.1% at this hour (7:45).  As to commodities, oil (+0.5%) is edging higher on word that the Saudis are going to push for another production cut, while gold (-0.5%) is sliding on the back of the strong dollar and the base metals are falling again, clearly anticipating a recession.





As to the dollar, it remains king of the hill, continuing to rally vs. virtually all its G10 counterparts with only the yen (+0.1%) managing to hold its own.  In the emerging market space, the story is similar with HUF (-1.0%) the laggard on expectations of a rate cut today and the bulk of the bloc lower.  The one outlier seems to be KRW (+0.4%) which saw substantial equity inflows as the driver.  I would be remiss if I didn’t mention that CNY has rallied substantially in my absence and is now well above 7.0500 as there is a growing belief the PBOC will continue to ease policy to support the Chinese economy.





On the data front today, we see preliminary PMI data (exp 50.0 Mfg, 52.5 Services) and New Home Sales (665K).  The European flash PMI data was slightly soft, but pretty close to expectations.  Meanwhile, only Dallas Fed President Lorie Logan is on the docket today, but don’t be surprised to hear from others on CNBC or BBG as they basically cannot shut up.





In the wake of the Silicon Valley Bank failure, I was convinced the Fed was going to be finished and accordingly, changed my views on the dollar.  I had been bullish until a clear pivot was seen and I thought that was the case.  However, it increasingly appears that no pivot is coming and that higher for longer is the future.  In that case, I have to revert to my original stance and look for continued dollar strength until we get that signal.





Good luck





Adf

			

	
	



			
				


	

		

			Bombarded
		


				

			Posted on  by 		

			


		

		

There once was a poet who wrote
‘Bout foreign exchange in a note
Right now he’s at home
Though, yet, he may roam
For now, though, enjoy, please, each quote

Meanwhile, for the week that has passed
The debt drama has some aghast
So, markets are guarded
While we are bombarded
With stories this drama can’t last

Since I last wrote, the dollar is broadly stronger, stocks have managed to continue to rally, and bond yields have risen to the top end of their recent trading range with the 10-year at 3.65%.  But really, it seems that despite a weak Retail Sales print last week, and some other mixed data, all eyes are really turning to Washington and the ongoing debt ceiling negotiations between President Biden and House Speaker McCarthy.  At this point, while the House has passed a bill that includes a significant, $1.5 trillion, debt ceiling increase, although combined with spending cuts over the next decade that amount to ~$4.5 trillion, the President has proffered nothing other than a resounding No.  Ultimately, this is a political calculation as to the President’s belief he can blame any negative outcome on McCarthy and the Republicans, although that remains to be seen.

At the same time, we continue to receive apocalyptic warnings from Treasury Secretary Yellen, as well as various other officials, politicians, and bank CEOs.  And there is no doubt that an actual US default would be extraordinarily bad for pretty much everyone.  However, as Winston Churchill has been credited with saying (though remains true whoever said it), Americans can always be counted on to do the right thing…once every other choice has been exhausted.  We have seen these political dramas before, and I have no doubt we will see them again in the future but in the end, nothing has changed my view that a deal will be struck and there will be no apocalypse, at least not this time.

So, what does that mean when that deal is struck?  Well, ironically, one of the drivers of recent equity market strength has been the running down of the Treasury General Account (TGA) at the Fed.  That is the Treasury’s ‘checking’ account from which they pay all the US’s bills.  As can be seen from the below chart, post the GFC, the average balance has been in the $200 billion range, although there have obviously been several enormous peaks during the Covid situation.  For context, prior to the GFC, the TGA balance averaged just $5.8 billion.  Perhaps there is no better description of what QE has done than this, as well no better signal of today’s inflation and its causes than this fact.











Data Source, FRED database

The problem is that number has been shrinking, maintaining liquidity in the market that might otherwise not be available.  In fact, one of the key concerns in the market right now is that when the debt ceiling is finally raised, the Treasury, which through its extraordinary measures has been running down balances as well as delaying payments into government pension accounts and the like, will need to issue a significant amount of new debt, perhaps up to $1 trillion pretty quickly, which will suck a lot of liquidity out of the equity market as investors look at the return on T-bills and conclude safety at a 5% yield is very attractive.  Clearly, tax receipts are another part of the puzzle, but recent receipts have been coming in lower than forecast adding more pressure to the Treasury.  

The point is that one needs to be careful in expecting that the resolution of this issue will automatically have a bullish impact on risk assets.  In fact, it could be just the opposite, so beware.

As to this morning’s markets, mixed is an apt description.  While Friday’s US equity market performance was dull, with very modest declines, Asia saw gains overnight and Europe opened in the green.  Alas, European bourses have since turned lower although US futures are currently unchanged (7:30).  Given the potential impact on financial markets in the event the US does default, it seems likely that risk assets will struggle to gain much until there is a conclusion of this drama.

Bond yields, meanwhile, are continuing their drift higher from last week, although Treasury yields are unchanged at this hour.  In Europe, though, sovereign yields are edging up between 1bp and 2bps.  There is one place, though, where yields remain in check, Japan, where the 10yr yield, at 0.378%, remains far below the YCC cap and is exerting no pressure on Governor Ueda.

Oil prices (+0.3%) are a touch higher this morning having bounced off their lows from the beginning of the month but remain far below the post OPEC+ production cut highs from April.  As I have been writing, the commodity market seems to be the only one that is really pricing in a recession, with metals prices also continuing under pressure, including gold despite its haven characteristics.

Finally, the dollar is showing both gains and losses today in both the G10 and EMG blocs.  CHF (+0.4%) is the leading G10 gainer on what appear to be technical trading patterns more than new information.  On the flip side, the commodity bloc (AUD, NOK, CAD) is under very modest pressure this morning, but really not much to say here.  In the EMG bloc, ZAR (+0.65%) and KRW (+0.6%) are the top of the heap, ostensibly on the back of a dovish reading of some comments by Chairman Powell over the weekend.  However, there are a number of laggards, notably MXN (-0.5%) despite those same remarks.  Arguably, if they were truly that dovish, we would see the dollar softer across the board, something that has not been the case for a while.

Until the debt ceiling drama is over, I anticipate a relatively limited amount of market movement.  And when it is finally concluded, it will depend on the actual agreement, I think, to really get a sense of any medium- or long-term impacts.  Until then, trade the range.

Good luck
Adf


			

	
	



			
				


	

		

			Ready to Pop
		


				

			Posted on  by 		

			


		

		
Investors are having some trouble

Determining if the stock bubble

Is ready to pop

Or if Jay will prop

It up, ere it all turns to rubble


So, volatile markets are here

Most likely the rest of this year

Then, add to this fact

A Russian attack

On Ukraine.  I’d forecast more fear


One has to be impressed with yesterday’s equity markets in the US, where the morning appeared to be Armageddon, while the afternoon evolved into euphoria.  Did anything actually change with respect to information during the day?  I would argue, no, there was nothing new of note.  The proximate cause of the stock market’s decline appeared to be fear over escalating tensions in the Ukraine.  Certainly, that has not changed.  Russia continues to mass troops on its border and is proceeding with live fire drills off the coast of Ireland.  The Pentagon issued an order for troops to be ready for rapid deployment, which Russia claimed was fanning the flames of this issue.  While the key protagonists continue to talk, as of yet, there has been no indication that a negotiated solution is imminent.  With that in mind, though, today’s market reactions indicate somewhat less concern over a kinetic war.  European equity markets are all nicely higher (DAX +0.6%, CAC +0.8%, FTSE 100 +0.75%) and NatGas in Europe (-2.4%) has retraced a bit of yesterday’s surge.  Granted, these reversals are only a fraction of yesterday’s movement, but at least markets are calmer this morning.


However, one day of calm is not nearly enough to claim that the worst is behind us.  And, of course, none of this even considers the FOMC meeting which begins this morning and from which we will learn the Fed’s latest views tomorrow afternoon.  The punditry is virtually unanimous in their view that the first Fed funds hike will come in March and there will be one each quarter thereafter.  In fact, if there are any outliers, they expect a faster pace of rate hikes with five or more this year as the Fed makes a more concerted effort to temper rising prices.


Now, we have not heard from a Fed speaker since January 13th, nearly two weeks ago, although at that time there was a growing consensus that tighter policy needed to come sooner and via both rate hikes and balance sheet reduction.  But let’s take a look at the data we have seen since then.  Retail Sales were awful, -1.9%; IP -0.1% and Capacity Utilization (76.5%) both disappointed as did the Michigan Sentiment indicator at 68.8, its lowest print since 2011.  While the housing market continues to perform well, Claims data was much higher than anticipated and the Chicago Fed Activity Index fell sharply to -0.15, where any negative reading is seen as a harbinger of future economic weakness.  Finally, the Atlanta Fed’s GDPNow indicator has fallen to 5.14%, down from nearly 10% in December.  The point is, the data story is not one of unadulterated growth, but rather of an economy that is struggling somewhat.  It is this issue that informs my decision that the Fed is likely to sound far more dovish than market expectations tomorrow,  The policy error that has been discussed by the punditry is the Fed tightening policy into an economic slowdown and exacerbating the situation.  I think they are keenly aware of this and will move far more slowly to tackle inflation, especially given their underlying view that inflation is going to return to its previous trend on its own once supply chains are rebuilt.


For now, barring live fire in Ukraine, it seems the market is quite likely to remain rangebound until we hear from Mr Powell tomorrow afternoon.  As such, it is reasonable to expect a bit less market volatility than we saw yesterday.  But, do not discount the fact that markets remain highly leveraged in all spaces and that the reduction of high leverage has been a key driver of every market correction in history.  Add that to the fact that a Fed that is tightening policy may push rates to a point where levered accounts are forced to respond, and you have the makings of increased market volatility going forward.  While greed remains a powerful emotion, nothing trumps fear as a driver of market activity.  Yesterday was just an inkling of how things may play out.  Keep that in mind as we go forward.


Touring the markets this morning, while Europe is bouncing from yesterday’s movement as mentioned above, Asia saw no respite with sharp declines across the board (Nikkei -1.7%, Hang Seng -1.7%, Shanghai -2.6%).  US futures, too, are under pressure at this hour with NASDAQ (-1.7%) leading the way, but the other main indices much lower as well.


Looking at bond markets, European sovereigns are all softer with yields backing up as risk is re-embraced (Bunds +2.1bps, OATs +1.4bps, Gilts +4.4bps) as are Treasury markets (+0.7bps), despite the weakness in equity futures.  Bond investors are having a hard time determining if they should respond to ongoing high inflation prints or risk reduction metrics.  In the end, I continue to believe the latter will be the driving force and yields will not rise very high despite rising inflation.  The Fed, and most central banks, are willing to live with rising prices if it means they can stabilize bond yields at relatively low levels.


In the commodity markets, oil (+0.1%), after falling sharply from its recent highs yesterday has rebounded slightly.  NatGas (-1.4%) in the US is also dipping although remains right around $4/mmBTU in the US and $30/mmBTU in Europe.  Gold (-0.25%) and Copper (-0.3%) continue to consolidate as prospects for weaker growth hamper gains of the latter while uncertainty over inflation continue to bedevil the former.


As to the dollar, it is stronger for a second day in a row today, with substantial gains against both G10 (NOK -0.7%, CHF -0.7%, SEK -0.6%) and EMG (PLN -0.75%, RON -0.5%, MXN -0.45%) currencies.  Clearly, the Ukraine situation remains a problem for those countries in proximity to the geography, while Mexico responds to slightly disappointing GDP growth data just released.  But in the end, the dollar remains the haven of choice during this crisis and is likely to remain well bid for now.  However, if, as I suspect, the Fed comes across as less hawkish tomorrow, look for the greenback to give up some of its recent gains.


This morning brings only second tier data; Case Shiller Home Prices (exp 18.0%) and Consumer Confidence (111.1).  So, odds are that the FX market will continue to take its cues from equities, and if the sell-off resumes in stocks, I would expect the dollar to remain firm.  For payables hedgers, consider taking advantage of this strong dollar as I foresee weakness in its future as the year progresses.


Good luck and stay safe

Adf

			

	
	



			
				


	

		

			Becoming a Bane
		


				

			Posted on  by 		

			


		

		
Twixt Europe and Russia, Ukraine

Is feeling incredible strain

As diplomats leave

The markets perceive

That risk is becoming a bane


The fear is that war is in view

At which time the best thing to do

Is buy francs and yen

And Treasuries, then

Be ready for stocks to eschew


While it is true that the Fed meeting on Wednesday is of significant importance to market participants, there is another, much greater concern that has risen to the top of the list today, the growing sound of war drums in the Ukraine.  Both sides seem to be increasing both their activities and their rhetoric, and financial markets are really starting to take notice.  The immediate losers have been on the Russian side as the MOEX (Russian stock market index) is down 6.1% so far this morning and 15% YTD.  In addition, RUB (-1.5%) is the worst performing EMG currency today and this year, having fallen -5.0% so far.  The implication is that international investors are fleeing given the threats of retaliation by the EU and NATO in the event Russia actually does invade.


The latest headline from the EU is, FURTHER MILITARY AGGRESSION TO COME AT SEVERE COST.  You can see why owning Russian assets seems quite risky here as on a military basis, there is probably very little the EU or NATO can do in response to an invasion.  But they can certainly impose much more severe economic sanctions and even boot Russia from the SWIFT system, removing the nation’s access to dollars for any transactions.  Of course, given the fact that Germany is so reliant on Russia for its natural gas supply, which by the way has seen prices explode higher this morning in Europe by 12.3%, it does seem unlikely that the most severe sanctions will be imposed.


Will this devolve into war?  There is no way to know at this time.  My take is neither side wants a hot war as those are extremely expensive and difficult to prosecute, but President Putin has an agenda with respect to the West’s attitude toward the Ukraine and what constitutes the Russian sphere of influence.  Arguably, one of the big concerns is that leadership in the West lacks both real world experience and any mandate to “protect” the Ukraine.  However, they also don’t want to look either foolish or weak to their own constituents.  I fear that pride and hubris on both sides could result in a much worse outcome than needs to occur.  For a long time, I read the Ukraine tensions as a negotiating tactic by Putin to achieve a greater buffer zone around Russia.  Alas, the situation seems to have deteriorated pretty severely and pretty quickly.  At this time, one must be prepared for a more dramatic and negative outcome, one which is likely to see traditional havens like yen, Swiss francs, the dollar, and Treasuries rise dramatically.


Apparently, President Xi

Does not like the FOMC

As Jay keeps implying

That rates will be flying

And Xi can’t force growth by decree


While Covid has been an extraordinary burden on the world in so many different ways, as with all things, there has been a modicum of good as a result as well.  For instance, the WEF has been downgraded to a bunch of Zoom calls with no elite hobnobbing and very little press overall.  However, that elite cadre persist in their efforts to rule the world by decree and I thought it worth highlighting something that didn’t get much press last week when it occurred but offers an indication of China’s current economic thinking.  President Xi’s speech included the following, (emphasis added) “Second, we need to resolve various risks and promote steady recovery of the world economy. The world economy is emerging from the depths, yet it still faces many constraints. The global industrial and supply chains have been disrupted. Commodity prices continue to rise. Energy supply remains tight. These risks compound one another and heighten the uncertainty about economic recovery. The global low inflation environment has notably changed, and the risks of inflation driven by multiple factors are surfacing. If major economies slam on the brakes or take a U-turn in their monetary policies, there would be serious negative spillovers. They would present challenges to global economic and financial stability and developing countries would bear the brunt of it.”


Boiled down, this comes to Xi Jinping basically asking (telling?) Jay Powell to avoid raising rates as that would be a problem for China, as well as other EMG economies.  Now, I don’t believe that Chairman Powell is overly concerned about China, but I do believe that while the tightening of policy is very likely to start, it will be short-lived as the economic situation proves to be less robust than currently thought.  However, I thought it instructive as backdrop for recent actions by the PBOC and as a harbinger of the future, where interest rates there are likely to continue declining.  However, nothing has changed my view that the renminbi (+0.2%) is going to continue to strengthen this year.


Ok, so a tour of markets makes for some pretty sad reading this morning.  While the Nikkei (+0.25%) managed to eke out a gain, the Hang Seng (-1.25%) could not despite ostensible positive news regarding Chinese property developers being able to sell some properties.  Europe, though, is bleeding badly on the Russia/Ukraine story (DAX -1.8%, CAC -1.7%, FTSE 100 -1.2%) with the UK clearly the least impacted for now.  Meanwhile, US futures, which had spent the bulk of the evening in the green, are now lower by -0.25% across the board.


Treasuries are playing their haven role like Olivier, rallying further with yields declining another 2.5bps, taking them 15bps from recent highs.  Bunds (-2.4bps), OATs (-1.9bps) and Gilts (-3.3bps) are all seeing strong demand as well as investors flee to the relative safety of fixed income.


Turning to commodities, oil (-0.2%) is in consolidation mode, although the uptrend remains strong.  NatGas in the US (-1.0%) is clearly dislocated from that in Europe but feels very much like it is developing a base around $4/mmBTU.  Gold (+0.4%) is proving more of a haven these days despite the dollar’s strength, although industrial metals (Cu -1.8%, Al -0.85%) are under pressure today.


And finally, the dollar is showing its traditional haven characteristics as well, rallying against all its G10 counterparts and most EMG currencies.  SEK (-0.8%) and NOK (-0.75%) are leading the way lower, arguably because of the proximity of those nations to the Ukraine and the escalation of military and naval activity in the Baltic and North Seas with both Russian and NATO ships and submarines seen.  AUD (-0.7%) is obviously feeling the impact of weakening commodity prices as well as the general dollar strength.  The rest of the bloc is all weaker, just not quite to this extent.


Aside from the RUB (now -2.0%), PLN (-0.9%), ZAR (-0.9%) and CZK (-0.85%) are the worst performers this morning in the EMG bloc.  The zloty story is interesting given central bank comments that “Polish rates should rise more than the market expects”, which would ordinarily be seen as currency bullish, however, given Poland’s proximity to the Ukraine, one cannot be surprised to see investors selling the currency.  The same is true of CZK, although frankly, other than a pure risk-off play, I can see no news from South Africa.


This is a big data week with far more than the Fed on tap.






Today
PMI Manufacturing
56.7





PMI Services
54.8




Tuesday
Case Shiller Home Prices
18.2%





Consumer Confidence
111.8




Wednesday
New Home Sales
765K





FOMC Decision
0.00% – 0.25%




Thursday
Initial Claims
260K





Continuing Claims
1650K





Durable Goods
-0.5%





-ex Transport
0.3%





Q4 GDP
5.3%





Q4 Personal Consumption
2.9%




Friday
Employment Cost Index
1.2%





Personal Income
0.5%





Personal Spending
-0.6%





PCE Deflator
0.4% (5.8% Y/Y)





Core PCE Deflator
0.5% (4.8% Y/Y)





Michigan Sentiment
68.8






Source: Bloomberg


So, while of course the FOMC meeting is the primary piece of data, both the Claims and PCE data is going to be carefully scrutinized as well for indicators of the current economic situation and the Fed’s likely reaction function.  As of now, no Fed speakers are scheduled after the meeting for the rest of the week, although I imagine we will hear from several by the end of the week.


As to the dollar, right now, its haven status is all that matters.   Look for it to continue to perform will unless there is a real de-escalation of the Ukraine situation.


Good luck and stay safe

Adf

			

	
	



			
				


	

		

			Selling Aggression
		


				

			Posted on  by 		

			


		

		
There once was a time when the dip
Was what people bought ere the rip
As equity prices
Would brush off all crises
And FAANGs showed incredible zip
 
But this year there is a new theme
That’s more like a nightmare than dream
The end of each session
Sees selling aggression
As bearishness moves to mainstream
 
There has been an evolution in the market narrative recently that is growing in strength.  After a very long period where BTFD (buy the f***ing dip) was the mantra of algorithms and day traders alike, backed up with don’t fight the Fed, it seems that market price action has turned around to sell every rally you see.  While there is not yet an acronym in place (and I’m sure there will be one soon, perhaps AS for Abandon Ship), what has become abundantly clear is that the sentiment that inflated the broad asset bubble in which we have been living is starting to change.
 
Arguably, the Fed is the cause of this change, which is to be expected as it was their monetary policies that inflated the everything bubble in the first place.  Consider that since the GFC, the Fed has increased the size of its balance sheet by $8 trillion, and the US economy has expanded by another $7.3 trillion (already a problem that the balance sheet grew faster than the economy), while the S&P500 has grown by $28.2 trillion, nearly twice as fast again.  It is certainly difficult to continue to justify the valuation premiums attributed to the equity market if there are any concerns about future growth rates.  And there are plenty of concerns about future growth rates, especially if the Fed is true to its word and actually tightens monetary policy.    
 
The upshot is that investors have been paying an increasing premium for the same dollar of earnings during the past 14 years and we appear to be reaching the breaking point.  The key thing to remember about markets is that their behavior in a rally and in a decline tend to be very different.  Rallies are made of steady, albeit sometimes sharp, moves higher with much buying at the end of each session to insure that asset allocators have their proper proportions in various sectors.  Declines are characterized by mayhem, where sellers often seek to sell anything that is liquid and as quickly as possible.  So, in the vernacular, stocks ride the escalator up and fall down the elevator shaft.  And quite frankly, having witnessed some of the biggest market declines in history (Oct 1987 anyone?) price action recently has started to take on those negative characteristics.  
 
Just think, too, this is happening before the Fed has actually even begun to tighten.  In fact, this week, their balance sheet rose to a new record high!  How will things perform when they actually raise rates, let alone start to allow the balance sheet to shrink.  For those of you who disagree with my thesis that any Fed tightening will be small and short-lived, this market reaction function is exactly how I have arrived at my conclusions.
 
Earlier this week I explained that I believe we are at peak Fed hawkishness, where market expectations have moved to the first (of four) rate(s) hike in March (some calling for 50bps) while balance sheet reduction (QT) will start this summer and proceed to the tune of $40-$60 billion per month thereafter.  Arguably, QT will be much more damaging to the equity markets than a 50-basis point rise in Fed funds, but neither will help.  Many analysts believe that next week’s FOMC meeting will result in a clear timetable for the Fed’s future actions, but I disagree.  Between the recent equity decline and the softening data, the Fed will not want to lock itself into a tightening schedule.  As I wrote earlier, look for Wednesday’s meeting to appear dovish compared to current expectations.  However, that is unlikely to help change risk attitudes that much.
 
Risk is off and has further to go.  Yesterday’s US price action was abysmal as equity markets were higher all day until the last hour and then turned around and fell between 1.5%-2.0% to close with sharp losses.  Asia generally followed that line of reasoning with both the Nikkei (-0.9%) and Shanghai (-0.9%) falling although the Hang Seng was unchanged on the day.  In fact, the Hang Seng was the only bright spot around.  Europe is much softer (DAX -1.6%, CAC -1.4%, FTSE 100 -0.9%) with the only data being weaker than expected Retail Sales in the UK (-3.7%, exp -0.6%).  It can be no surprise that US futures are also under pressure, with the NASDAQ (-0.7%) leading the way at this hour, but all in the red.
 
Remember when the bond bears were certain that the 10-year was getting set to trade through 2.0%?  Yeah, me too. Except, that is not what is going on as this morning, the 10-year Treasury has seen yields decline by another 1.6bps, taking it more than 10bps from its recent high yield.  European bonds are rallying as well with Bunds (-3.0bps), OATs (-2.2bps) and Gilts (-2.4bps) all behaving as havens this morning, and even the PIGS’ bonds performing well.  It is abundantly clear that heading into the weekend, the marginal investor does not want to own risky assets.
 
Today’s risk-off theme is alive and well in commodities too with oil (-1.9%) leading the way lower but weakness in precious metals (Au -0.3%, Ag -0.4%) and industrials (Cu -1.8%, Al -0.8%).  The only outlier is NatGas (+2.8%) which based on the 13-degree temperature at my house this morning seems driven by the weather and not risk.
 
Finally, looking at the dollar this morning it is difficult to discern a strong theme.  In the G10, gainers and losers are split 5:5 with the commodity currencies (AUD -0.4%, NZD -0.4%) leading the way lower while the financials (CHF (+0.4%, SEK +0.35%) are rising.  Given commodity price weakness, this should not be that surprising.  As to the financial side, with Treasury yields declining, those suddenly seem more attractive.
 
However, that same thesis does not appear to be valid for the EMG bloc where the leading gainers (ZAR +0.5%, CLP +0.4%, MXN +0.3%) are all commodity focused while the laggards, aside from TRY which has its own meshugas (look it up), are all commodity importers (TWD -0.25%, THB -0.25%, HUF -0.2%).  In other words, it is difficult to tell a coherent story about the FX markets right now although the one thing that is very clear is that volatility across virtually all currencies has been moving higher.  Old correlations seem to be breaking down, which is leading to the increased volatility we are observing.
 
On the data front, only Leading Indicators (exp +0.8%) are due this morning at 10:00.  Yesterday’s US data was kind of awful with Initial and Continuing Claims both printing far higher than forecast (although attributed to omicron’s impacts) while Existing Home Sales also fell far more than expected which was attributed to a lack of inventory.  However, I would contend that the US growth trajectory is definitely pointing lower as evidenced by the Atlanta Fed’s GDPNow Forecast which is currently at 5.14%, down from 9.7% just one month ago.  
 
As we all await next week’s FOMC meeting, the dollar’s cues are likely to continue to come from the equity markets, and given how poor they currently look, if nothing else, I expect the haven currencies to continue to perform reasonably well.
 
Good luck, good weekend and stay safe
Adf
 
 
 

			

	
	



			
				


	

		

			Every Reason
		


				

			Posted on  by 		

			


		

		
While prices in Europe are leaping

According to Christine’s bookkeeping

She’s got “every reason”

To keep on appeasin’

The ECB doves who are sleeping


So, rather than look to the Fed

She’s focused on China instead

Where they just cut rates

As growth there stagnates

And Covid continues to spread


One has to wonder exactly what Christine Lagarde is looking at when she makes comments like she did this morning.  Specifically, she said the following in a radio interview in France, [emphasis added] “We have every reason to not react as quickly and as abruptly as we could imagine the Fed might, but we have started to respond and we, of course, stand ready to respond with monetary policy if figures, data, facts, require it.”  Remember, the ECB has a single mandate, achieving price stability which they define as 2% inflation over the medium term.  With this in mind, let me recount this morning’s data, which clearly has Madame Lagarde nonplussed: German Dec PPI +5.0% M/M and +24.2% Y/Y, the highest figures ever in the history of German record keeping back to 1949.  Eurozone Dec CPI +0.4% M/M and 5.0% Y/Y, also the highest since the creation of the Eurozone.  I realize I am a simple FX salesman, but to my uneducated eye, those indications of inflation seem somewhat above 2.0%.  Perhaps mathematics in France is different than here in the US, but I would challenge Madame Lagarde to explain a bit more carefully why, despite all evidence to the contrary, she thinks the ECB is acting in accordance with their mandate.  I suspect there are about 83 million people in Germany who may be wondering the same thing.


Certainly, traders do not believe her or her colleagues when they say, as Pablo Hernandez de Cos did “an increase in interest rates is not expected in 2022.”   De Cos is the head of the Spanish central bank and a Governing Council member and clearly not a hawk.  Yet, the OIS market in Europe is pricing in 0.20% of rate hikes by the end of 2022 (the ECB has been moving in 10 basis point increments), so two rate hikes.  I also realize that there appear to be many econometric models around that are forecasting a return to much lower inflation within the next twelve months, certainly those are the models the central banks themselves are using.  It seems that the real question is at what point will the central banks, specifically the Fed and ECB, recognize that their models may not be a very accurate representation of reality?  And I fear the answer is, never!


Perhaps Madame Lagarde was channeling Yi Gang, the PBOC’s Governor, although the situation on the ground in China is clearly different than that in Europe.  For instance, after cutting two important interest rates last Friday, the PBOC cut two different interest rates last night, the 1-year loan prime rate by 0.10% down to 3.70%, and the 5-year rate was cut by 5 basis points to 4.60%.  China continues to struggle with their zero covid policy.  They continue to fall behind the curve there as the omicron variant is so incredibly transmissible.  But what is clear is that China is growing increasingly concerned over the pace of growth in the economy and so the PBOC has begun to act even more aggressively.  While 5 and 10 basis point moves may not seem like a lot, given how infrequently the PBOC has been willing to cut interest rates, they are an important signal to market participants that support is at hand.  This was made clear by the equity markets last night where the Hang Seng, home to so many property companies, exploded higher by 3.4% although Shanghai’s market was quite subdued, actually slipping 0.1%.


In the end, it is clear that global synchronicity is not an appropriate way to think about the current macroeconomic situation.  Given the dramatically different ways that different nations approached the Covid pandemic, it should be no surprise that there are huge differences in rates of growth and inflation around the world.  The hedging implications of this outcome are that it will require more specific analysis of each country in which there is an exposure to determine the best way to mitigate risks there.


With that in mind, let us take a look at markets this morning.  Despite Shanghai’s lackluster performance, the rest of Asia was actually quite solid with the Nikkei (+1.1%) rounding out the top markets.  Europe, on the other hand, has been less positive with the DAX (+0.1%) edging higher while both the CAC (-0.1%) and FTSE 100 (-0.1%) are slipping a bit.  I guess more promises of ongoing policy ease were not enough to overcome the soaring inflation story on the continent.  US futures are all pointing higher at this hour, with NASDAQ (+0.9%) leading the way although that index has fallen by 10% from its highs, so has more room to catch up.


Looking at the bond market, I can’t help but wonder if we have seen peak hawkishness earlier this week, at least for the Fed.  After the long weekend, we saw the 10-year Treasury yield trade up to 1.88%, but since then it has slipped back with today’s price action seeing yields fall an additional 2.7 basis points and placing us 4bps off those highs.  Now, this could simply be a short-term correction, but with the Fed announcement next week, it really does feel like the market has gotten way ahead of itself.  At this point, the only way next week’s FOMC could be seen as hawkish would be if they actually raised rates, something to which I ascribe a zero probability.  One other thing to recall is that recent surveys continue to show a large contingent of fund managers believe that inflation is transitory which implies that they are likely to take advantage of the current rise in yields and prevent things from running away.


On the commodity front, oil (-0.4%) has stopped running higher, although this pause seems much more like a consolidation than a change in views.  NatGas (-1.5%) is also a bit softer today in both the US and Europe as seasonal or higher temperatures continue to reduce marginal demand.  Turning to metals markets, gold (-0.2%) is slightly softer this morning, but overall, despite rising interest rates, has held up quite well lately and remains well above the $1800/oz level.  Interestingly, silver (0.0% today +4.6% this week) seems to be having a much better time of things and technically looks to have broken out higher.  Arguably, this information blends well with the thought that bond yields may have peaked, but we shall see.


As to the dollar, it is mixed this morning with both gainers and losers in both the G10 and EMG spaces.  The funny thing is, other than RUB (-0.6%) which is leading the way lower today on the back of threats of more substantial sanctions in the event Russia does invade the Ukraine, the rest of the story is much harder to pin down.  For instance, from a news perspective Bank Indonesia met last night and left rates on hold, as expected, but indicated that it would begin normalizing monetary policy in March, returning its RRR to its pre-covid levels, but the rupiah only rose 0.2%.  In fact, today’s leading gainer is ZAR (+0.75%), but given the dearth of either data or news, the best bet here seems to be a response to precious metals strength.  One other thing to remember is that despite easing by the PBOC, the renminbi continues to edge higher.  Frankly, I see no reason for it to weaken anytime soon, especially with my view the dollar will be suffering going forward.


On the data front, Initial Claims (exp 225K), Continuing Claims (1563K), Philly Fed (19.0) and Existing Home Sales (6.43M) are on the calendar.  Remember, Empire Manufacturing was a huge bust earlier this week, so watch the Philly Fed number for any indication of weakness and slowing growth here at home.  In fact, it is that scenario that will allow the Fed to remain on the dovish side, although I fear it will not slow down the inflation train.


If there are any inklings that the Fed is not going to be as hawkish as had seemed to be believed just a few days ago, I expect that the dollar will come under further pressure.  In fact, in order to change that view we will need to see a very hawkish outcome from next Wednesday’s FOMC, something I do not anticipate.  Payables hedgers, I fear the dollar may be near its peak, so don’t miss out.


Good luck and stay safe

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