No Plan of Action

Posted on by 
In England and Scotland and Wales
Kier Starmer has gone off the rails
A buffoon-like clown
He’s set to step down
As from the Brits eyes, fall their scales

But will his replacement gain traction
Or will Burnham be a distraction
From solving their woes
As Lord only knows
They’ve many, and no plan of action

It has been an eventful weekend for me so let me start by telling you that Marvel was Best of Breed in back-to-back shows last Thursday.  We are very proud and happy.

Second, Friday was a more difficult day for me as I wound up having emergency surgery, although everything is fine.  But I am still in recovery mode.  Sometimes, aging is harder than other times.

With that in mind, we can talk about the three things that matter, I believe, the change of PM in the UK, the on-again-off-again peace talks in Iran and the fact that the yen is now weaker than the level that got the MOF to intervene back in April.

Starting with the UK, PM Starmer has promised to step down now that his most likely successor, Andy Burnham, the former mayor of Manchester, is in Parliament and will now become PM sometime in the next several months depending on the actual timing of certain technicalities.  He is described as left-wing, even by the press, which tells you that he must be quite far to the left.  But the UK has serious problems with respect to their economy, slowing growth and high inflation, and the social structure due to massive immigration, both legal and illegal.  As well, the report that just dropped about the Pakistani grooming gangs that were systematically raping young English girls is so damning, it is hard to believe, yet it was all covered up.  The government doesn’t have to go to the national polls until 2029, so Burnham will have time to try to implement policies, but the nation has many troubles ahead.

As to UK markets, both the pound and FTSE 100 have been underperformers relative to their peer European counterparts over the past month or so as this process has heated up, but in truth, not by very much.  Much of the pound’s weakness can be attributed to dollar strength (see chart below), where the dollar has broken through key technical resistance in the DXY, while the FTSE is just drifting given the lack of positive news.  Certainly, this story didn’t help either one, as both are unchanged on the day.

Source: tradingeconomics.com

In Switzerland, talks are ongoing
As Trump and the Mullahs try showing
That they are the ones
Who have the most guns
But progress seems like it is growing

It cannot be a great surprise that there is a lot of bluster from both sides of this negotiation between the US and Iran as President Trump tries to end the conflict in Iran.  After all, both sides are famous for their bluster!  And you can read whatever you like from whatever source you want to get your spin, but I’m not smart enough to understand the intricacies of international diplomacy.  However, what I do understand is market price movement, and here we are this morning, with oil prices falling further, down -2.5%, and back to levels last seen in early March, right at the beginning of this conflict.

source tradingeconomics.com

Thus far, every story about tank bottoms being reached and an insufficient amount of oil for the pipeline infrastructure to be effective has proven not to be true.  There is still a large group of analysts who are calling for end of days, but the market signals just don’t agree.  I suspect that the only ones who really want to see oil prices remain high are the oil companies who sell the stuff, but for the rest of the world, lower is clearly better.  Obviously, anything can still happen, but by all appearances, it seems that more and more traffic is flowing through the Strait and we are going to see lower prices going forward.

In the end, from my vantage point thousands of miles away from the action, it appears that Iran was greatly weakened by this conflict on a military basis, but more importantly, every one of its Gulf neighbors realized that they needed alternative routes to get their oil to market, and we are going to see a lot more pipeline infrastructure built to do just that, so as time goes by, this choke point is going to lose its effectiveness.  And that is probably a bigger weakness for Iran, as that was something they held over the world, but now it seems it is not as impressive a strength as it had been made out to be in the past.

It’s no waterfall
But the yen keeps dripping down
Whence the BOJ?

Finally, the yen (-0.3%) is having a tough time right now as it has traded back to its lowest level vs. the dollar since 1986!  That’s right folks, it has been forty years since USDJPY traded above 162.00, and we are pushing that level right now as you can see in the chart below.

The last two times the yen reached these levels, back in April and in July 2024, the BOJ intervened in the markets aggressively.  But so far, crickets.  I think the issue for them is the dollar continues to be quite strong, especially as traders are now pricing in rate hikes by the Fed, and so intervening is going to be a waste of money.  And it’s true, if the dollar is rallying across the board, there is very little Ueda-san can do.  As I have repeatedly said, the only way for the yen to break this slide is for serious fiscal and monetary policy changes, and frankly, that doesn’t look like it is in the cards right now.  While I know there are many who think the dollar is heading to its graveyard, it apparently still has a bit of life left in it.

Which takes us to the overnight activity.  Equity markets have been mixed as all this new information gets digested.  In Asia, Tokyo (+1.6%) and China (+2.4%) both had strong sessions although HK (-0.7%) couldn’t keep up.  Elsewhere in the region, there was slightly more green than red led by Taiwan (+2.75%) while the Philippines (-1.65%) was the biggest laggard.  Uncertainty continues to reign although as the Iran situation slowly resolves, I expect to see things brighten here as Asia was the region hurt most by the entire conflict.

In Europe it is also a mixed picture with the UK (+0.3%) now rallying on the news that Starmer is leaving and Spain (+0.4%) has managed a gain as well while both Germany (-0.3%) and France (-0.7%) are lagging this morning, although there is no news of note in either place.  US futures are basically unchanged at this hour (7:15).

In the bond market, Treasury yields (+3bps) have edged higher this morning, I guess on this new belief in higher Fed funds, although I would have thought the bond market would appreciate a hawkish Fed fighting inflation.  European sovereign yields, though, are lower across the board down about -2bps everywhere.  Bonds remain less interesting now that they are back in their ranges and not breaking out as so many though was occurring back in May as per the below chart.

Source: tradingeconomics.com

With oil prices lower, it should be no surprise that gold (+1.35%) and silver (+2.4%) are both higher this morning.  Many have made the case that with the dollar strengthening, the precious metals complex will remain under pressure, and it is a valid case, but for some reason, I have a feeling it will not be as dramatic as they believe.

Finally, the dollar is firmer across the board this morning, albeit not by very much.  Wednesday and Thursday of last week were the big moving days in the wake of the FOMC meeting and the new hawkish read.  Since then, not much has happened, just a slow drift higher across the board.  FWIW, I don’t think that Chairman Warsh is going to be that hawkish, but I look forward to the structural changes that he makes.  However, for now, that is the market assessment.

On the data front, there is nothing today and really nothing of import until Thursday so I will go through it tomorrow.

That’s how things are shaping up, with the dollar gaining, oil sliding and stocks uncertain what to do next.  I am a fan of uncertainty as it will reduce systemic risk, and that is something we really need to see.

Good luck

Adf

My House

Posted on by 
Said Kevin, the Fed’s now MY house
And views that we choose to espouse
Will no longer guide
So, when we decide
To move, we expect some to grouse

As well, we are set to review
Our policies all the way through
So, comms will be changed
And data arranged
In truth, it is quite the to-do

This is an evening note as I will be unavailable to write tomorrow morning as we head off to show GCH Nubia’s Take Your Breath Away, aka Marvel to a show.  That is his handler and the judge who awarded him Best of Breed that day.

But not surprisingly, the only thing that really mattered today was the FOMC meeting.  I have to say, having watched the entire press conference I am really impressed with Chairman Warsh.  I love the fact that he shortened the statement and that they are ending forward guidance.  And it was quite interesting that half the reporters’ questions were trying to get guidance about what the Fed may do in the future, despite him repeating that there was no more forward guidance.  My take is Fed reporters are going to have to learn about how markets work and more importantly, market practitioners are going to make up their own minds rather than rely on the Fed to bail them out.  This is all really positive!

The most noteworthy thing was the creation of five task forces to address issues with the way the Fed currently does things on the following subjects:

  1. Communications
  2. Balance Sheet
  3. Data Sources
  4. Productivity and Jobs
  5. Inflation Framework

So, it strikes me that Chairman Warsh is going to look to reprogram the Fed, something that has been sorely in need.  Do not be surprised when much of the commentary is negative on these subjects because those are the folks who benefitted from the old way of doing things.  They now need to change their models and their narratives and they are unhappy.  Another benefit.

The upshot of the meeting was that rates were left on hold and the dot plot, where Warsh did not supply a dot, showed that half the committee thought rates appropriate, and half thought they would be higher by the end of the year.

Of course, this largely jibes with the Fed funds futures market as you can see in the latest table from the CME.

Of course, looking at this table, something seems amiss for September, perhaps there was a large position put in place that drove the market.  At any rate stock markets were unhappy with the major indices slipping -1.0% or more after the FOMC although bonds did very little and commodities continue to show oil slipping while gold and silver rise.  As to the dollar, it rallied pretty much across the board.

It is way too early to anticipate exactly how things are going to play out, but I am encouraged.  I strongly believe a little price volatility is a small price to pay to reduce systemic risk by reducing leverage in the system, and that is very likely to be the outcome if Mr Warsh has his way.  My forecast is the “ample reserves” balance sheet program is going to change before he is done.  If that is the case, I think they will have a real opportunity to get inflation under control.  As well, I believe that prospect will undermine much of the ‘death of the dollar’ narrative.  It truly will be significant.  We shall see.

Good luck

Adf

Future With Dread

Posted on by 
The story today is the Fed
And whether, when looking ahead
Inflation they see
Stays well above three
Or if it just might fall instead

Meanwhile, every comment I’ve read
Discussing the ‘deal’ have all said
Too much was conceded
The US retreated
And look to the future with dread

Starting with the MOU with Iran, and having read the text of the agreement, at least the one published by Bloomberg, Iran has sworn to never have a nuclear weapon and then will effectively be readmitted to polite society, with sanctions and restrictions eventually removed.  The several comments I have read on the deal highlight numerous potential loopholes and semantics regarding tolls and fees and are uniformly unhappy with the deal.  But I’ve also read that many on Iran’s side are unhappy with the deal.  Arguably, the best sign the deal is going to last is just that, neither side got everything they wanted, but both got some of the things they wanted.  Time will tell how this all plays out, but certainly the oil market remains positive that the direction of travel is toward a normalization of flows through the Strait of Hormuz.

However, while the political pundits are going to continue to focus on that issue, markets have turned their focus to the FOMC meeting and how things play out under new Chairman Kevin Warsh.  The previous Fed whisperer, Nick Timiraos at the WSJ, continues to push Governor Powell’s message as there is not yet a new Fed whisperer.  My take is Timiraos will not be the one simply because his loyalties will not lie with Warsh. 

The thing in which we can be most confident is there will be no rate change at today’s meeting although the market continues to price a rate hike in December as per the below CME table.

All the drama will come with the release of the SEP (Summary of Economic Projections) which is the quarterly document the Fed publishes showing the range of economic forecasts by the individual FOMC members regarding GDP, Unemployment and interest rates.  This document also includes the dot plot.  It is important to note that the SEP only started to be released in 2007, so this is not a long-standing tradition, but part of Ben Bernanke’s changes to the institution.

And this is a key feature of what makes Kevin Warsh different.  He has indicated that the Fed talks too much (I agree) and believes that some ambiguity in what is going on is a desired outcome.  This is a controversial stance as Wall Street has minted money on the back of forward guidance, recognizing the Fed has their back whenever they blow up because they built up huge leverage and were wrong.  

While I completely understand the idea that political discussions need to be in the open, I am far more suspect with respect to monetary policy discussions.  Prior to forward guidance, market participants were far more cautious in their positioning as the probability of getting the direction of a trade wrong was far greater.  But once the Fed says, ‘rates are going to stay low for a very long time’, traders can lever up positions massively relying on the fact that their funding costs are going to remain in check.  And it is the massive leverage where the risks to the market lie, not the level of rates per se.

So, the question today is how Chairman Warsh will handle his desire to reduce communications compared to the previous actions of publishing the data and numerous FOMC members speeches.  One thought is he may refuse to put his own forecasts into the document, a sign of what he wants going forward but I am confident he has other ways to move forward.

The other issue is the question of the tone of the statement, which had ostensibly been leaning dovish but seems now likely to be neutral.  My sense is whatever he does, it will be incremental, at least at the beginning, but I anticipate that he is going to make substantial changes to the way the FOMC operates during his tenure as that is why he was put in the role. 

So, with that as our backdrop, let’s see how markets have absorbed the text of the deal as we all await the FOMC this afternoon.  Yesterday’s mixed US performance, with only the DJIA managing a gain while tech stocks dragged down both the NASDAQ and the S&P, was followed by more positivity than not in Asia with gains in Japan (+0.7%), China (+1.0%), Korea (+1.6%) and India (+0.5%) while HK (-0.75%) slipped a bit.  It is always a bit of a surprise when HK and China move in opposite directions, and it seems today’s split arose from different interpretations from a policy conference regarding future PBOC activities as well as potential future government support for a clearly weakening consumer economy.  Other regional exchanges had a mix of gainers and laggards as well, as the overall session was directionless.

In Europe, the picture is also mixed although the movement has been more muted than those in Asia.  Both Germany and the UK are flat to slightly lower this morning with the former under pressure after BMW offered a terrible profit forecast while the latter, despite lower-than-expected inflation readings, is lagging on growth concerns.  However, France (+0.2%) and Spain (+0.5%) have both managed to rally a bit on some slightly positive earnings news.  As to US futures, at this hour (7:15), they are modestly higher across the board.

Bond yields are generally little changed this morning with only UK gilts (-5bps) and JGBs (-4bps) showing any movement at all.  Gilts responded positively to the inflation data while JGBs seemed to take solace in the trade data showing Japan was back to a deficit.  

In the commodity markets, oil (+0.7%) is having a very quiet session after several sharp declines in a row while metals markets are largely unchanged this morning.  It appears even traders here are awaiting the FOMC outcome.  One thing I have seen is a recent report from the World Gold Council showing 45% of central banks surveyed plan to buy the barbarous relic in the next 12 months.

And finally, the dollar is slightly stronger this morning, but like most other markets, not showing much movement at all.  The below chart of the DXY for the past month shows just how lackluster price action has been with a total range of just 1.5%.  The red line is the midpoint of that range showing there is just not a lot of pressure in either direction right now.

Source: tradingeconomics.com

Meanwhile, USDJPY has basically spent the past two weeks hovering just above 160.00 with nary a peep from the MOF or BOJ.  Again, the situation there is the policy changes necessary to strengthen the yen are likely to have very negative economic consequences initially, and that is not something any government is likely to do.

On the data front, ahead of the Fed we see Retail Sales (exp +0.5%, +0.5% ex-autos) and then the EIA oil inventories with more draws expected.  And that’s really all there is.  I anticipate a very quiet session ahead of the Fed and then all will depend on how the market interprets Warsh’s signals.

Good luck

Adf

Leverage Doomsday

Posted on by 
Though oil continues to be
The lens through which most of us see
The current events
In dollars and cents
There’s more going on causing glee

For instance, as stock markets rise
It cannot be such a surprise
The narrative writers
Are pulling all-nighters
Adjusting their views to seem wise

But naysayers need to say nay
And here’s what they’re pushing today
The Bank of Japan
And their current plan
Will lead to a leverage doomsday

We might as well start off with oil this morning since it is still the top story in markets, and still the major catalyst.  It is lower again this morning, down a further -2.8%, and despite many questions as to whether the deal will hold, both sides appear to be moving toward a signing on Friday.  The below chart from tradingeconomics.com shows WTI prices for the last year.  As you can see, the current price is the lowest since March 10th, which was a reaction low after the spike high on March 9th when it touched its highs for the entire situation.

I eyeballed a line at about $65.00/bbl as an estimate of what prices were like prior to the Iran conflict.  Based on that, the current front month futures price remains about 20% above the pre-war price, certainly high, but it doesn’t seem crippling.  I believe it is very clear that the analysts who were calling for $150/bbl or $200/bbl are now working hard to determine what they got wrong.  Doomberg wrote an interesting piece this morning (it is paywalled, but their stuff is fantastic) describing two likely reasons for the fact that oil prices never rose that high.  First, the original estimates of how much oil was stuck behind the Strait were overstated as all the players there found ways to export some, whether through tankers going dark or via rail or truck or pipeline.  But the more interesting observation was that China was able to reduce its imports by between 3mm and 4mm bpd and things were just fine.  China has altered their energy mix such that oil, while still important, can be substituted out as necessary.  That is a very interesting outcome with respect to one of China’s greatest perceived weaknesses, its lack of natural energy capacity.  If they don’t need as much oil to run their economy (which by the way based on overnight data is struggling) then they have less geopolitical weakness.  

Enough on oil, but while I’m here, it is not surprising that as oil slides, metals prices rise so gold (+0.9%) and silver (+0.8%) are continuing to benefit as is copper (+0.1%) although the latter not so much today.

Turning to the other story that has tongues wagging, the BOJ raised their base rate to 1.00% last night as had been universally expected by markets.  Now, the interesting thing here is that there is a group of analysts who believe that this will lead to net position liquidation by leveraged fund managers (i.e. hedge funds) as their funding costs will have risen.  I disagree, and so far, markets are on my side.  This is evident by the fact that equity markets continue to perform well, and USDJPY has shown no inkling of reversing its multi-year trend of rising.  Below is a table of the base interest rates of the G20 nations.  While Switzerland does have a lower rate, and Singapore is the same, if you are thinking about borrowing in a currency to lever up positions, Japan, given the yen’s depth and liquidity, remains the currency of choice by a long shot.

Source: tradingeconomics.com

Ask yourself if your borrowing costs rose 0.25% but you were still earning a net 13.5% return on your BRL deposits, would you flee the trade?  And if you have been buying equities, you are even less likely to get out.  Japan’s problem is not specifically that their base rate is low, it is that they currently are fighting a terrible demographic position of a shrinking population and they have a massive debt/GDP ratio.  They cannot afford to raise rates enough to have a meaningful impact on the yen without bankrupting the country and decimating the yen.  It is not clear to me how they get out of their current situation, but despite concerns elsewhere in the world about the yen’s weakness being a competitive advantage, I think it has further to go.  Basically, there needs to be another Plaza Accord type agreement to change things, and that doesn’t seem likely right now.  After all, in Evian, it doesn’t sound like things are going smoothly.

So, how have markets behaved overnight?  Well, risk is still in vogue.  Following yesterday’s strong US performance, where the DJIA made another all-time high, there were far more gainers (Korea, India, Taiwan, Malaysia, New Zealand, Indonesia) than laggards (HK -1.4%, China -0.2%) while Tokyo was little changed.  As I mentioned above, the Chinese data was pretty lousy as per the below table:

So, the housing market continues to suffer, and the domestic economy along with it, although the export economy continues to grow.

In Europe, the decline in oil prices is clearly helping as all major indices are higher between 0.4% and 0.75%.  As to US futures, at this hour (7:20), they are pointing slightly higher, about 0.15% across the board.

In the bond market, yields continue to decline with Treasuries (-3bps) back below 4.5% which had been seen as a real problem just a few weeks ago.  European sovereigns are also lower by between -3bps and -4bps, duly following both Treasury yields and oil prices.  The outlier here is JGB yields (+6bps) which responded to the rate hike by rising, perhaps an indication that investors don’t believe the BOJ is doing enough.  However, my wager would be the BOJ is done.

Finally, the dollar is a touch softer, as one would expect given the movements in other markets, but there is very little excitement in the FX markets.  Using the DXY (-0.05%) as proxy, you can see things are little changed.  The biggest movers are BRL (+0.4%) and KRW (+0.4%) both of which are seeing capital inflows supporting the currency.  But otherwise, +/-0.2% defines the session in both G10 and EMG currencies.  Note that despite the BOJ rate hike, USDJPY sits at 160.32 showing no sign of heading lower, even in an environment where the dollar is modestly softer.

On the data front, this morning brings Housing Starts (exp 1.43M) and Building Permits (1.42M) and that’s really it.  With the FOMC tomorrow, and Iran ostensibly solved, Mr Warsh and his press conference will get a great deal of focus.  Until then, I don’t see any reason for recent trends to change absent a complete collapse of the Iran deal, which seems unlikely at this point.

Good luck

Adf

Many Malign

Posted on by 
Said Trump, come next Friday I’ll sign
A deal, and though many malign
The war with Iran
It’s all gone to plan
As they’ve lost their arms and their spine

Thus, oil has fallen in price
While gold and stocks rose in a trice
With bears in retreat
For Trump’s next great feat
Some midterm success would be nice

This is a look at the major energy futures markets according to tradingeconomics.com at 5:15 this morning

Sharp declines on the session in the wake of the announcement, confirmed by the Iranians, that a deal had been struck and that the Strait of Hormuz would be reopening by Friday after the mines are cleared.  And while there has been much discussion over the past week, as you can see in the far-right column, energy prices are still largely higher year-to-date with only NatGas the exception.

To my mind, the question becomes, just how quickly prices continue to decline, and can gasoline prices, the one that matters most to the US consumer, slide back to the $2.00/gallon level that we saw prior to the war?

As you can see from that chart below, it still has a long way to fall, but if the Strait remains open, I suspect it will round trip by the end of the summer, just in time for people to start considering their voting habits.

Source: tradingeconomics.com

Remember this, as well, how much have you heard about Venezuela lately?  Back in January, less than six months ago, the US captured and remanded Nicholas Maduro into custody and the world was up in arms.  I would wager that most people don’t even remember it happened!  Memories are very short for global events like this (consider the fact that the Russia – Ukraine war continues and it never even makes the proverbial papers anymore).  For President Trump, the outcome of this situation will be a massively degraded Iranian military with pretty much the rest of the GCC aligned against everything they stood for, an economy that continues to demonstrate remarkable resilience, high stock prices and the likelihood that inflation, as oil prices slide, will be heading back closer to the theoretical 2% target.

There once was a time central banks
Were saviors, and we would give thanks
For all of their aid
When, problems, they slayed
And bankers, they all would close ranks

But last week the ECB raised
Tonight, Ueda-san will be praised
For hiking rates too
So, what will Warsh do?
On Wednesday when his trail is blazed?


Meanwhile, we are in the midst of the monthly central bank onslaught as last week, Madame Lagarde and the ECB raised their base rate by 25 basis points, blaming the ongoing rise in oil prices for leading to inflation.  Of course, 96 hours later, with the announcement by both sides of a deal to end the Iran conflict, this is likely to be seen as an error, the full Trichet as it were.

Tonight, the BOJ meets and all signs are that they, too, are going to be hiking rates by 25bps tonight, to 1.00%, which you will have heard is the highest in more than 30 years.  It’s funny, the official inflation data from Japan is showing a reading of 1.4%, below their target, and now that the prospect of oil prices falling more sharply has increased, it feels like they may be on the cusp of an error here as well.  Consider that of all the governments around, the Japanese with a debt/GDP ratio of about 250% is the nation least able to absorb higher interest rates.  

Which takes us to Wednesday’s FOMC meeting, the first under Chairman Warsh.  There is a long Nick Timiraos article this morning in the WSJ ostensibly explaining that Warsh would like to see less Fed communication, including killing the dot plot, and have the cacophony of Fed speakers shut up.  First, Timiraos has real skin in this game because while he was Powell’s go to, I doubt he will be Warsh’s, thus Timiraos’s status is about to be hit hard.  In fact, the article read as though Powell was writing it to make it seem as though Warsh’s ideas are all wrong.

Personally, I am in favor of less communication by the Fed as policy uncertainty will result in significantly reduced positioning in the speculative community and that is a net benefit for the rest of the market.  Plus, if there is a hiccup, there is less reason for a bailout.  We shall see.  It seems highly unlikely that they move on Wednesday, but we should at least get an inkling of how things may evolve going forward.

So, let’s turn to the markets.  It is no surprise that risk is on everywhere this morning after the Trump announcement so briefly, here is a screenshot from 6:40 this morning showing equity futures markets higher across the board.

Source: tradingeconomics.com

While these are just the major markets, the reality is that markets are higher everywhere except Oslo, as the decline in oil prices hits the Norwegian stock market.  But otherwise, it is universal.

Bond yields are lower across the board as well, with Treasuries (-4bps) leading the way and all of Europe seeing sovereign yields decline by between -4bps and -6bps as the inflation story follows oil lower.  JGBs, too, slipped -4bps overnight and are down -17bps in the past week!

But oil remains the story because its movement is what is driving the narrative.  And, interestingly, there is still strong support from one side of the argument that we are close to hitting tank bottoms and prices are going to shoot higher.  We have heard from both Chevron and Exxon that it is a dangerous situation and even the reopening of the Strait may not happen in time to stop it.  But consider if you are Exxon or Chevron, high oil prices are what you need as you sell your inventory rich and drilling is much more profitable.  And one thing they have is a lot of inventory in their refinery systems.  It hardly seems likely they would be out touting the deal as great and talking prices down.  We have heard throughout the conflict that in a few weeks, prices would spike higher as shortages developed, but that has never happened.  I go back to my view that ignoring market prices in favor of the narrative is a mistake.  At this point, with WTI at $80/bbl, I will argue we will see $50 long before we ever see $100 again.

As to metals markets, based on recent price action, it should be no surprise that gold (+2.75%), silver (+4.3%) and copper. (+0.7%) are all rallying on the lower inflation => lower interest rates => increased commodity demand.

Finally, the dollar is under pressure generally as the DXY (-0.25%) is a pretty good proxy for most things.  In truth, we are seeing some larger movements (INR +0.7%, SEK +0.8%, ZAR +0.6%, CHF +0.6%) all responding to the lower oil price, and in the case of the rand, the higher gold price.  However, there are two outliers here.  NOK (0.0%) is, not surprisingly, unable to show any traction, as like the Norwegian stock market, declining oil prices are a drag here, and JPY (+0.1% and still above 160.00).  The latter must really be concerning to Ueda-san as in a broad dollar decline, if the yen can’t gain traction, that is a real problem.

On the data front, there is a bunch of stuff, but other than Retail Sales on Wednesday, all of it is second tier.

TodayEmpire State Manufacturing14.0
 IP0.3%
 Capacity Utilization76.2%
TuesdayRBA rate decision4.35% (unchanged)
 Housing Starts1.44M
 Building Permits1.41M
WednesdayRetail Sales0.5%
 -ex autos0.5%
 FOMC rate decision3.75% (unchanged)
ThursdayInitial Claims232K
 Continuing Claims1790K
 Philly Fed10.0
 Leading Indicators0.1%

Source: tradingeconomics.com

In addition to all that, the G7 meets this week, starting this evening in Evian, France with French President Macron leading the group.  

As always there is a great deal of naysaying out there as the joint announcement of a deal between the US and Iran has upset the applecart for many narrative writers, and they are committed to their positions.  Personally, I am very happy to see the deal, although it was early as I had anticipated a July 4th outcome, but in this case, a much better result.  I guess it will take some time before it is clear if things are truly operating more normally again, but market pricing is demonstrating a willingness to believe.

With this in mind, the dollar should remain under some pressure for now, as prospects for a Fed rate hike are going to fade, although they haven’t yet according to the futures market, but if anything, that will simply mean that the US will suck in more global capital as the US economy continues to outperform elsewhere.  Ultimately, that will benefit the greenback.

Good luck

Adf

Change Their World View

Posted on by 
The markets are trading like peace
Has come, hence the stock price increase
While crude prices fall
And risk, overall
Is favored like summer in Greece

But can we trust this time it’s true?
Or will, once again, this fall through?
I guess time will tell
If this will compel
The doomers to change their world view

It is certainly a hopeful morning today as risk rallies around the world while oil prices tumble.  At $84.72/bbl, down -3.4% on the session, oil is trading at its lowest level since April 17.  

Source: tradingeconomics.com

While President Trump had once again threatened to destroy Iran’s oil infrastructure, shortly thereafter he reversed that call with news that Iran was back at the table with both sides closing in on a peace deal.  Frankly, despite the absolute certitude that so many pundits seem to have, the reality is nobody really knows if this time is the charm or not.  In fact, I would argue that the Iranians themselves, as well as President Trump, are not certain, as though I’m confident both sides would like to stop this, there are many political calculations that go into the process, and the punditry is simply not party to those conversations.  We shall see.

Of course, markets trade the rumor, not the news, or at least they initiate positioning on the rumor, so with that story making the rounds, it is also no surprise that equity markets have shaken off their early week blues and rallied strongly pretty much everywhere around the world.  The below chart of futures markets shows just how widespread the gains are with only Russia’s MOEX under pressure (is that really even a market still?) and although Toronto, Mexico and Brazil have not yet opened, all rallied yesterday alongside the US.

Source: tradingeconomics.com

Of course, there is another equity story and that is SpaceX, which IPO’d last night at a price of $135/share, and which, like so many things these days, has a seen a huge disparity between the pros and the cons.  Many analyses have been performed showing that the company is not “worth” anywhere near the $1.8 trillion market cap at which it is starting.  But those same folks have consistently explained that Tesla is not worth the $1.5 trillion, and yet there Tesla sits.  There was a huge amount of interest with more than $75 billion of retail orders to buy the IPO.  My observation is that Elon Musk is somebody who gets things done, and usually better than anyone else.  But markets are, as I always say, perverse, so this will be an interesting ride.

Other than the end of the war and the SpaceX IPO, the two stories that made a brief appearance were yesterday’s PPI data, which depending on the analyst were either hot or cold, and the fact that Madame Lagarde and the ECB raised their base rate by 25bps yesterday, right as energy prices started falling dramatically.  This is not the first time the ECB has made a mistake of this nature, one need only look back to the beginning of the GFC when then-president Jean Claude Trichet controversially raised interest rates in July 2008 and reversed course 3 months later after Lehman Brothers failed.

And that’s what the setting is as we head into the last trading session of the week.  So, let’s see how other markets are behaving.

It should be no surprise that bond yields are falling.  While Treasury yields are unchanged this morning, they fell about -7bps across the board yesterday.  But the Iran news was after the European close so sovereign yields are lower by between -4bps and -7bps this morning.  I presume some investors are happy that the ECB is fighting inflation, but I think most are responding to the idea that the end of the war means lower oil prices and therefore a significant reduction in inflation pressures.  Last night in Asia, we also saw yields fall sharply across the board with JGBs down -6bps and every other market (Australia, Singapore, Korea) slide by a similar or even greater amount.

In the metals markets, while gold (-0.1%) is little changed this morning, it did manage to rally more than $100/oz yesterday, or more than 2%.  Silver (-0.5%) is also slipping a bit today but that is after a 6% rally yesterday.  My take is these are short term profit taking trades.

Finally, the dollar is, overall, little changed this morning.  it was very modestly weaker during yesterday’s session with the DXY slipping back below 100 (currently 99.75), but USDJPY remains above 160, still in a danger zone although there has been precious little discussion on the topic for the past several sessions.  You will not be surprised that NOK (-0.5%) is under pressure as it is probably the currency that tracks most closely to oil prices.  But other than that, not much to say in this market either.

On the data front, this morning brings only Michigan Sentiment (exp 46.0), which continues to hug the lows of the series as a contradiction to the highs in equity markets.  But now, with CPI/PPI out of the way, all eyes will turn to next week’s FOMC meeting.  If we look at the Fed funds futures curve, it is still forecasting a rate hike by the end of this year.

Source: cmegroup.com

But I have to wonder, if the fighting stops and a deal is reached such that the Strait is reopened and the blockade is lifted, the one certainty is that oil prices will fall much lower, probably below the levels seen prior to the war began.  Given all the talk about secondary effects of high oil prices, I would expect that talk to disappear.  History has shown that every shortage of a commodity is followed by a glut.  Will economists be explaining why persistently low energy prices in the future are going to undermine inflationary expectations?

Markets are still beholden to the headlines so if this deal falls apart, you need to expect all these moves to reverse course with oil higher alongside yields and the dollar while stocks and precious metals fall.  But if this is the end of the Iranian engagement, I suspect that risk is going to be in vogue for quite a while, investment will be flowing into the US and the dollar will hold its own, even as yields decline.  (Going back to my flows as a key driver, not just interest rates.)

Good luck and good weekend

Adf

Frankly, Outré

Posted on by 
The rate of inflation expanded
Though core came out more evenhanded
The war in Iran
Ain’t going to plan
But oil’s not over demanded

However, the story today
Is SpaceX shares soon on their way
To stock market listing
Though some are insisting
Its value is, frankly, outré

It’s a funny thing lately, there has been quite a bit of market activity, but the narrative storylines are changing so quickly that they don’t seem to have a real impact.  So, every day there is some new thesis as to why prices are behaving in whatever manner they are.  It is almost as if the market is trying on different stories to see which one fits best.

As I am wont to do, I always like to step back and take a longer-term view on things as regardless of the daily wiggles, my experience is that those very big picture issues are what drive markets over time.  So, let’s review what I see as the key long-term drivers;

  • FX – ultimately, the combination of monetary and fiscal policies is critical in this space with a good rule of thumb being tight monetary and loose fiscal policy strengthen a currency while the opposite settings tend to weaken them.  When both policies are on the same setting, it is far less clear, although I would err on the side of monetary policy being the driver.  Key to this is that monetary policy tends to drive short-term flows.
  • Equities – earnings are still the ultimate issue here as, remember, shares represent ownership in a company (although the recent gamification of markets has certainly obscured that view).  Too, equities tend to be forward-looking, anticipating how future earnings are going to evolve.  The biggest change in this space has been the steady growth of passive investing, though, which represents more than 50% of the market now.  Passive investing simply means that as money flows into funds, like 401K’s, the funds buy stocks with the S&P 500 the most popular destination regardless of earnings and prospects.  So, flows are the other critical issue, just like in FX.
  • Bonds – despite much recent angst, Treasuries remain a haven asset and benefit from that status.  However, especially as you move out the maturity ladder, inflation expectations are the primary driver in an unencumbered market.  While much hay has been made regarding the extraordinary size of the US outstanding debt, now approaching $40 trillion, I do not believe we have reached a point where anyone believes they will not get their money back, albeit money that has been devalued by inflation.
  • Commodities – this is the space where supply and demand remain paramount, and really, it’s current supply and demand.  As such, the fact that oil is back below $90/bbl this morning tells us that a combination of increased non-OPEC supply plus some measure of demand destruction has found a new equilibrium level.  This remains far below the levels anticipated by many after the closure of the Strait of Hormuz, and there are still many analysts calling for a sharp move higher when all the mitigating factors that have prevented a much bigger move run out. This morning, Javier Blas at Bloomberg had an excellent piece describing his view of why oil prices aren’t higher despite the war.

Every narrative is an attempt to either describe or hide the longer-term issue, with much more hiding than describing in my experience.  But I stand by these concepts.

Which takes us to today’s narratives.  CPI yesterday was largely as expected, actually the core number at 0.2% M/M came in a bit light, but that stopped mattering about 2 minutes after the release.  Inflation has become a favorite subject about which to bitch, but very few do anything about it.  (if you want to do something, go to www.usdicoin.com and you can buy some USDi which is a fully backed inflation tracking cryptocurrency).  

There was a short resumption of military activity in the Gulf after a US helicopter was shot down by Iran and the US retaliated.  Frankly, I didn’t even read the details as they just don’t matter to the big picture.  It is unclear whether negotiations are ongoing, but the stalemate continues.

And finally, the truly big story, the SpaceX IPO this evening.  It is the one thing that has the most tongues wagging in the markets and if you read X, it appears there are many more analysts who believe the price is absurdly high than that it represents value.  I have no opinion on the deal but anecdotally, I did speak with someone last evening who just put money into a Fidelity VC fund that has stakes in all the big names (SpaceX, Anthropic, OpenAI) and a 10-year lockup and is very excited.  

So that’s where I see things this morning.  Yesterday’s US equity declines were followed by more weakness (China, HK, India, Australia, New Zealand) than strength (Korea, Singapore) in Asia.  Tokyo was essentially unchanged.  However, in Europe this morning things are much brighter with solid gains across the board.  US futures, too, are higher this morning by about 0.7% across the board as I type at 7:15.

In the bond market, yields have edged back down with Treasuries (-3bps) leading the way and European sovereigns right there with them.  Whatever longer term concerns about inflation exist are not showing up aggressively at this point.

In the commodity markets, oil (-1.1%) continues to underperform all the calls for catastrophe and another anecdote, I saw diesel below $5.00/gallon yesterday for the first time in several months.  Products are available.  As to the metals, they are uniformly hated although this morning both gold (+0.4%) and silver (+0.6%) have edged a touch higher.  However, the trend here in gold (and silver) is clearly back down for now. 

Source: tradingeconomics.com

Nothing has changed my longer-term concerns over fiat debasement, but for now, gold is not the play.

Finally, the dollar is somnolent this morning, with the euro, pound and yen all basically unchanged but sticking near recent dollar highs.  No matter how I slice it, I cannot come up with a significant dollar down story despite many having that view.  The US economy, by most measures, continues to drive global growth and I suspect that will remain the case for a while yet.

On the data front, this morning brings the weekly Initial (exp 219K) and Continuing (1780K) Claims data as well as PPI (0.7% M/M, 6.4% Y/Y) and core (0.5% M/M, 5.4% Y/Y).  We also hear from the ECB shortly, with a near universal belief that they will be hiking 25bps in order to drill for more oil push back against the recent energy induced price rises.  The beginnings of a major error in my view.

And that’s really it.  It has been getting more difficult to find interesting things to discuss, that’s for sure, and as we head deeper into the summer, the doldrums have a history of keeping things dull.

Good luck

Adf

Stoke Some More Fear

Posted on by 
The word of the day is inflation
As data from many a nation
Appears, still, to show
It has room to grow
With fears this is no aberration

But are things as bad as we hear
From media outlets who cheer
More pain, as they make
Their case Trump will break
The nation, and stoke some more fear

It’s CPI day here in the US and similarly, we got readings from various nations around the world overnight.  To level set, expectations for this morning’s numbers are:

  • Headline – 0.5% M/M, 4.2% Y/Y
  • Core – 0.3% M/M, 2.9% Y/Y

On an annual basis, as you can see in the below chart from tradingeconomics.com, 4.2%, while much higher than some recent data and much higher than we would like, was seen as recently as April 2023 during the “transitory” phase from the Covid years.

And don’t get me wrong, I am as sensitive to inflation as all of you as I go to the supermarket or Costco and see prices and fill up my car’s gas tank as well.  In fact, speaking of gasoline, there is no question it is much higher than it was prior to the beginning of the Iran conflict.  Looking at the chart I drew from FRED data below shows that, nominally, it is back at levels from the immediate aftermath of Russia’s invasion of Ukraine in 2022.  But look at the other line on the chart, that is the price of a gallon of unleaded adjusted for CPI starting back in 1990.  It is remarkable that the latest reading, while still obviously higher than a few months ago, is just $1.635/gallon in real terms.

Somebody else pointed out that gasoline is one of the few things that seems rarely to be described in real terms, arguably because it hasn’t really risen all that much over time and those who describe things in real terms are frequently trying to make the point that inflation is far too high.  Arguably, though, this is further proof of famed economist Julian Simon’s thesis that commodity prices all head lower over time as the ability to produce them in abundance, and their relative abundance in the earth, drive those prices lower.

As to elsewhere in the world, last night China reported that CPI (blue bars) remained at 1.2% but PPI, which may be a better indication of price activity there, rose to 3.9%.  This implies that Chinese corporate profits are under increasing pressure.  It also represents a sea change in China as can be seen in the below chart where PPI (grey bars) was negative for the 3 years prior to April.  

Source: tradingeconomics.com

As with all inflation analysis, the real question is who absorbs the price pressures.  In the US, the recent experience from Covid, when the government helicoptered $5 trillion into the economy so people had money to spend, businesses raised prices and continue to believe they can do so.  Apparently in China, that is not the case.  To finish the discussion, below is a chart of 17 of the G20 nations and their most recent headline CPI readings (I left out Argentina, Turkey and Russia as I couldn’t fit them all on the screenshot).  Interestingly, only 11 of these 17 nations have seen CPI rise in the past month.  I wonder, is inflation the global phenomenon that some make it out to be.

Country Last. Previous Date

Ok enough on that.  Let’s move on to market activity.  For the past several days, the oil story did not seem quite as important as despite a few random missiles being fired, it appeared that the Iran conflict was quieting down.  This allowed the focus to turn to important things like AI and the SpaceX IPO coming tomorrow after the close.  For example, when I sat down this morning around 5:00, oil was around $87.50/bbl and had slipped slightly lower compared to yesterday’s close.  However, in the interim, President Trump tweeted out the following:

But despite these comments, while oil has jumped as per the below chart, it is just barely at $90/bbl, hardly a sign the market believes something dramatic is on its way.

Source: tradingeconomics.com

In the meantime, there continue to be multiple articles that we are heading to the cliff for oil inventories and prices will skyrocket soon.  You know my opinion on those as I take the market’s side things are not as dire as some believe.

But if things heat up in Iran and the Gulf, I expect that we will see a downdraft in equities and bonds while the dollar moves higher.  And that is what we are currently seeing.  Below is a screenshot of equity futures markets as of 7:45 this morning.

source: tradingeconomics.com

Not a lot of happy faces there.  As well, overnight saw weakness throughout most of Asia after yesterday’s modest US declines.

In the bond market, Treasury yields are backing up 3bps and European sovereign yields are also higher this morning, between 3bps and 5bps across the entire continent.  So despite my statements above that inflation may not be as big a deal as some explain, bond investors are at least a bit uncomfortable this morning.

As to the metals markets, that break below the 200-day moving average in gold is seeing real follow through as old long positions and new short momentum plays pile on with the barbarous relic (-2.5%) tumbling as well as silver (-1.9%) and copper (-1.2%).  The key here is that whatever the short-term price action is, I think the one unalloyed truth is that fiat currencies will continue to get printed like there is no tomorrow and precious metals will regain their form.  But it could take a while.  In that vein, there was a Bloomberg article this morning explaining that more government bonds have been sold at this point in the year, ~$504 billion, than the first half of 2020 with Covid.  If my short-term inflation thesis is wrong, this is the reason why.

Finally, the dollar has edged higher this morning but is generally little changed.  The noteworthy thing is that USDJPY is at 160.50, above the supposed line-in-the-sand for the MOF, but as you can see from the below chart, the movement has been extremely gradual, with very little volatility.  Remember, one of the things the MOF focuses on is that volatility, so if the dollar continues to creep higher, they are likely to hold off for a while before feeling the need to intervene.

Source: tradingeconomics.com

But otherwise, most currency movement has been modest overnight.

Aside from CPI, and the oil inventory data, we do hear from the Bank of Canada, which is likely to leave policy rates on hold.

It feels like the market is getting increasingly concerned over an uptick in activities in the Gulf, which will have a negative impact on financial assets but support the dollar.  We shall see.

Good luck

Adf

The Narrative Shatter(ed)

Posted on by 
For months data just did not matter
Twas oil that drove all the chatter
But Friday that changed
As NFP ranged
So high that the narrative shatter(ed)

Now suddenly, eyes have all turned
To data, with many concerned
Their previous views
Will naught but confuse
All efforts, more cash, to be earned

Since the Iran conflict began on the 1st of March, pretty much the only key variable in financial markets has been the price of oil.  As you can see in the chart below, the price gapped higher that Monday morning and has been the major topic of conversation ever since.

Source: tradingeconomics.com

There continues to be a large contingent of analysts who, once the Strait of Hormuz was closed, have been calling for a substantial rise in the price of the stuff, but here we are this morning, back below $90/bbl and lower by -2.3% on the day.  Stories about declining reserves, floating reserves, demand destruction and new production are all available on any given day, and all certainly have facts to support them.  But the big picture, at least so far, has been that the market has found a clearing price between the release of strategic reserves and some amount of demand destruction, which has kept prices in check.

The greatest irony to me is that all the discussion regarding the long-term damage high oil prices are going to inflict on the economy seems to ignore the cardinal rule of commodities; the cure for high prices is high prices.  Last week I highlighted comments from an Exxon SVP about the coming crisis.  If that is Exxon’s corporate belief, they will be drilling like there is no tomorrow as their costs are far below current price levels, let alone the mooted rise to $150/bbl.  However, if we look at the one source of data that discusses drilling, the Baker Hughes oil rig count, you can see in the below chart that while it is a few rigs off its recent lows, there is still limited oil industry belief that the price is going to remain this high for any extended length of time.

Source: tradingeconomics.com

I think what last Friday’s very surprising employment report has done is to change some of the thinking of investors, turning their attention from exclusively oil to the rest of the economy and, now that we are 3+ months into this adventure, to how the rest of the economy is behaving.

This brings us to the two key pieces of information that are upcoming in the US, tomorrow’s CPI report and then next Wednesday’s FOMC meeting.  But it also has market participants going back to their more regular processes with discussion of market technicals, earnings, and global policy decisions.  So, let’s look in those areas this morning.

On the policy front, a few things happened overnight.  First, Bank Indonesia raised their base rate 25bps, to 5.50%, in an emergency meeting as the rupiah continues to decline to record lows, although in the wake of the rate hike, it rebounded some 0.8% as per the below chart.  Another data point is the fact that their FX reserves have fallen by >$1 billion in the past month indicating that they are actively intervening to prevent a further decline.  Too, this comes after a 50bp hike just two weeks ago.

Source: tradingeconomics.com

Elsewhere on the central bank front, Nikkei news reported that the BOJ will be raising its base rate by 25bps, to 1.00%, the highest level since 1995, when it meets next Monday night (recall, Nikkei has a perfect track record when calling these moves).  This has been widely expected in the market, and so there was no reaction in the FX market, although with USDJPY hovering just above 160.15 this morning, I imagine there is a bit of nervousness at the Ministry of Finance there.  Interestingly, the word from Nikkei is also that they may end the tapering of the balance sheet next year, which certainly detracts from the hawkishness of the rate move.

Moving on to data, the noteworthy datapoint overnight was the Chinese Trade Balance ($105.4B), which while somewhat larger than expected is right in line with recent activity as per the below chart.  It seems that demand for semiconductors has been significant and while trade with the US continues to remain moderate, the rest of the world is getting inundated with Chinese stuff.

Source: tradingeconomics.com

The one other major topic of conversation is the SpaceX IPO set for Thursday and the fact that OpenAI filed to go public as well.  I expect that those discussions are going to be a large part of the equity market narrative for a while yet, but that is well outside the purview of this note.

So, let’s look at market behavior and then see what is on tap for the week data wise.  Friday’s equity declines in the US were like a bad dream, they felt terrible but now it seems everybody has awakened and the world did not end.  Yesterday saw a steady climb from opening lows all day with the NASDAQ closing higher by +0.9%.  The upshot is that Asian markets broadly followed that movement with Japan (+2.2%), China (+1.9%), Korea (+8.2%!), Taiwan (+2.8%) and Indonesia (+7.6%!) all shaking off fears and rebounding sharply.  While HK (-0.4%) and Australia (-0.2%) both lagged, the other regional markets were broadly positive.  I continue to be amazed at the idea that Asia is in the worst energy shape and yet its equity markets are screaming higher.

In Europe, there is also a positive vibe with Spain (+1.2%), France (+0.9%) and Germany (+0.7%) all having solid sessions.  In fact, only the UK (-0.2%) is lagging this morning and not based on any data, but it seems more like some idiosyncratic stories regarding pharma companies there.  As to US futures, at this hour (7:20), they are firmer by 0.5% or so across the board.

In the bond market, yields, which have been moving higher for the past week, have backed off a bit with Treasury yields down -2bps while European sovereign yields have also slipped, mostly by -1bp or -2bps.  Last night, JGB yields (-4bps) fell after the story about the rate hike.  Perhaps investors believe Ueda-san is going to be more hawkish.  But it seems they missed the story about ending QT.

In the commodity space, with oil lower, as discussed above, it is no surprise that gold (+0.5%), silver (+0.6%) and copper (+1.7%) are all higher.  In the gold market, much has been made of the fact that technically, gold closed below its 200-day moving average Friday and has stayed there so far.  If this continues, it will be seen as a negative medium-term signal.  (my chart is showing the 40-week as I cannot get a long-term chart of the 200-day, but it is essentially the same thing.)

Source: tradingeconomics.com

Finally, in the currency markets, the dollar has backed off its recent highs this morning with the DXY (-0.3%) back below 100 and its decline a pretty good proxy for most of the G10 currency’s movements.  This is in no way a rout, but a correction after a strong move higher over the past month as you can see in the below chart.

Source: tradingeconomics.com

On the data front, we see the following this week.

TodayTrade Balance-$56.1B
 Existing Home Sales4.07M
WednesdayCPI0.5% (4.2.% Y/Y)
 Ex-food & energy0.3% (2.9% Y/Y)
ThursdayInitial Claims219K
 Continuing Claims1780K
 PPI0.7% (6.4% Y/Y)
 Ex-food & energy0.4$ (5.3% Y/Y)
FridayMichigan Sentiment46.0

Source: tradingeconomics.com

So, all eyes will be on CPI tomorrow as Fed speakers are now in their quiet period ahead of next week’s meeting.  Certainly, there is very little I have seen that is going to moderate inflation in the near term, but perhaps, if we do see an end to the Iran conflict, that will remove a key price support, although I imagine it will take time to feed through.  But inflation is highly dependent on how much money is around, and that is what makes the FOMC next week so critical.  Until then, it feels like a limited price action day today as we all await CPI tomorrow.

Good luck

Adf

Changing the Fate

Posted on by 
With things in the Gulf getting hotter
And risk assets heading to slaughter
The question on lips
Can stocks e’er eclipse
Their highs, or ‘stead sink ‘neath the water
 
But really, the question I’d ask
Is Chairman Warsh up to the task
Of changing the fate
Of the Fed funds rate
And if so, what will he unmask?

It is very difficult to focus on the Gulf situation as not only is it fluid, but there is also no direction of travel whatsoever.  So, this morning I want to have a different conversation.  Let me start by explaining this isn’t my idea, per se, although the analysis is solely mine.  Listening to the Macro Voices podcast Sunday morning while walking the dog, (he’s the one on the left)

Michael Every was on and expressed a very interesting thought, one that I had not considered, nor heard anywhere else.  What if the Fed, as Chairman Warsh seeks to adjust how it works, decides that they are going to put their fingers on the scale with respect to the interest rates paid by different industries, not merely by differently rated credits.  The idea is that in conjunction with the Treasury, Warsh and Bessent would decide which industries needed to have the most cost-effective funding for the nation to be able to maintain and develop the industries necessary for national defense reasons.

Now, I know this is anathema to almost all of us having been raised on the idea(l) of free markets and that markets are better at allocating, well everything, but in this case credit, than any cabal of central bankers.  And in a world where markets were truly free and where everyone competed on a level playing field, I am 100% in agreement with that view.  Alas, I’m not sure if you noticed, but that is not the world in which we live.

If Covid taught us nothing else, it was that 40 years of globalization and creating the most efficient processes for manufacturing resulted in significant fragility in those very processes.  It turns out that while economists in the US, Europe, Japan, the World Bank and IMF all explained that this was a great outcome (the US prints paper notes and gets lots of stuff for it), that only works when there is peace on earth.  During this period, China chose to play by a different set of rules, explaining they were just a poor country so didn’t need to play by the G10’s rules, and massively subsidized numerous industries while essentially ignoring all environmental issues.  That tilted the playing field pretty aggressively, and while President Trump has been adamant about that very issue for a decade, he was largely ridiculed, right up until Europe recently figured out that China was eating their lunch too, and now they are looking to impose tariffs on China’s excessive exports.  There is an excellent Substack that comes out Sunday mornings called The Brawl Street Journal,written by an analyst in Germany.  This week’s, linked here, explains that very issue extremely well.

So, I’ve set the table here, and the key to understand is the table is tilted horribly, with China getting the benefit of the doubt for almost everything.

Now, let’s consider what Mr Every’s idea would mean.  Below is a chart showing current 10-year yields for Treasuries and a series of corporate bonds delineated by their credit ratings.

Data: streetstats.finance

Makes sense, less creditworthy names pay more.  That is how things have always been within a market system as the worse the credit rating, the higher the perceived risk of the investor and therefore the higher yield they demand.

But what if that were to change?  What if the Fed and Treasury decided that companies that manufactured products, be they semiconductors, automobiles, tractors, airplanes or flat panel screens, and mining companies that mined in the US (and Canada) and energy extraction companies that drilled in the US (and Canada) needed a lower cost of capital to be more competitive globally as those companies were the ones necessary for the US to maintain its global hegemon status.  But media companies, and retailers, non-bank financial institutions and home health services companies, for example, were not deemed as critical.  Perhaps the new “credit” curve might look like this instead (all hypothetical)

The point is, China has been subsidizing numerous manufacturing industries for decades with the goal of excess production designed to drive other nations’ competitors out of business and gain a strategic advantage in all those industries.  It is why President Trump’s tariffs were a problem for them, and the rest of the world, as the US had been the dumping ground for much excess Chinese production in the past, and now that stuff is going elsewhere.  

The world we once knew is no longer the world in which we live.  Mr Every’s term, economic statecraft, is much more applicable today than any time in the past 40 years, probably longer, since the end of WWII.  Statecraft implies nations will use all the power they have, economic, military and diplomatic, to achieve their desired goals.  For more than 70 years, the US did not play by those rules under the assumption that if they created a level playing field, and even tilted it in favor of weaker allies, peace would reign.  China doesn’t play by those rules, and that is how we have arrived where we are.  

This is all hypothetical, but remember, Chairman Warsh has talked about restructuring the Fed.  All the economists think he is talking about shrinking the balance sheet.  But what if he is talking about completely changing credit markets with Fed support?  I would argue that is not on many bingo cards.

So, briefly, let’s consider how markets would respond to this action by the ‘new’ Fed.  Here are my conclusions, I would love to hear yours.

  • Stocks – broadly lower, although clearly favored sectors would continue to perform well.  But overall leverage would shrink and that has been a huge part of this rally.
  • Bonds – a steeper Treasury yield curve seems certain as subsidies for those favored industries will weigh on the US budget.  Meanwhile, non-favored industries would find themselves with real difficulties in terms of financing.
  • Commodities – offsetting forces here as industrial metals would see increased demand, and getting supply on line takes years if not a decade, but energy may result in a glut sooner as drilling takes much less time to get going.  Precious metals would soar, I believe, on the basis of investors and central banks, seeking an asset with no counterpart.
  • FX – this is the toughest call as different nations will be impacted in very different manners.  Commodity producing nations (e.g., Chile, Norway, US) should see relative strength.  Consuming nations would likely suffer somewhat, although Japan and Korea, for instance, could essentially fall within the US umbrella as their key industries are the US focus.

Again, this is all hypothetical but is probably worth some thought.  In the meantime, a brief tour of markets overnight after Friday’s sharp declines in the US shows nobody is very happy this morning.  The tradingeconomics.com screenshot below shows futures as of 6:10am.

What sticks out to me is Italian equities are bucking the trend, although there has been no data and I cannot find a specific catalyst there.  Also, it is interesting that US futures are broadly higher this morning despite growing concerns that the situation in the Gulf is going to heat up again.  But Asia had a rough session and most of Europe is feeling a little pain as well.

In the bond market, after climbing on Friday, yields continue higher this morning across the board.  The below Bloomberg screenshot explains things well.  Recognize that Canadian and Mexican markets haven’t opened yet and Australian markets were closed last night for the King’s Birthday.  But net, there is growing concern over inflation on a worldwide basis it appears.  

Turning to the commodity markets, oil (+3.8%) is higher again, after falling on Friday as there were missile attacks by Iran on Israel in response for Israel’s ongoing attacks on Hezbollah in Lebanon. This situation remains fraught and frankly nobody has any idea when it will settle down into something a bit less volatile.  If we look at a chart of the past six months of oil price movement, I have drawn a line at $95/bbl, which to my eye offers a pretty good estimate of the average since things began.  There are still many doomsayers who believe $200/bbl oil is coming soon, but that has been their forecast since March.  Something to remember about commodity markets is that they do not forecast the future, they are the prices at which physical stuff clears, so it appears that so far, there is ample inventory available.

Source: tradingeconomics.com

Not surprisingly, given the recent relationship between gold and oil, the barbarous relic is lower this morning by -0.7% while silver, though unchanged on the day, suffered dramatically on Friday, falling $6/oz or about 8%.

Finally, the dollar is little changed this morning, but that is after a sharp rally on Friday in the wake of the much better than expected NFP data (+172K with revisions higher in the previous two months of +93K) which helped push yields higher as a rate hike this year has now been priced by the futures market as per the below CME table.

But more than just the futures market is thinking that way.  The below chart showing the 2-year Treasury vs. Fed Funds shows that not only have 2-year yields moved above Fed funds, but they are accelerating higher.  This is seen as another harbinger of a higher Fed funds rate.

Source: tradingeconomics.com

So, the DXY is back over 100.00, USDJPY breeched 160.00, and is right on that number as I type at 6:50am, and generally, the dollar is pushing the top of its recent ranges.  The one exception here is KRW (+1.6%) where the central bank and Finance Ministry both were actively jawboning the currency higher after it traded to yet another new low (dollar high).

As there is no data of note this morning, I will go through that tomorrow given how long things got today.  The world is changing rapidly and the most important thing, I think, is to recognize that old relationships may no longer be valid.  Nimbleness is critical, whether investing or hedging.

Good luck

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