Monthly Archives: June 2023

The Battle’s Been Won

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‘Bout Jay and the FOMC
The market has come to agree
The battle’s been won
And hiking is done
So, buy stocks with verve and with glee

In Europe, though, Madame Lagarde
Is finding that things are still hard
Inflation’s not tamed
And she will be blamed
If prices, she cannot retard

Meanwhile on the world’s other side
Where growth has begun to backslide
The PBOC
More cash will set free
As Xi tries to hold back the tide

When looking at the market activity yesterday, it is easy to conclude that the market believes the Fed has instituted their last hike.  This was evident in the equity market’s performance where all three major indices rallied more than 1% and it was evident in the FX market where the dollar was pummeled, falling by 1% or more against 7 of its G10 counterparts as well as about half the EMG bloc.  In addition, Treasury yields fell sharply as the idea that the Fed is going to continue hiking, as implied by Chairman Powell in his comments on Wednesday, seems to have faded from memory. 

 

But that’s not all!  While key markets are beginning to discount any further Fed activity, the ECB not only raised their rate structure by 25bps as expected, but Madame Lagarde essentially promised another hike in July and this morning the ECB’s hawks are circling and hinting that a September rate hike is quite possible as well. 

 

Now, we already know that the Fed’s dot plot is calling for 2 more rate hikes this year, but the Fed funds futures market is not in accord with that view.  Rather, it is pricing a 70% probability of a July hike as the final move.  But, will they hike again?  Clearly, between now and the end of July we will all have seen a great deal more data, including both an NFP and CPI report, and that will have a major impact on the Fed.  But after yesterday’s US data dump, which showed Retail Sales holding up far better than expected while both the Import and Export Price Indices showed price declines, there has been a significant increase in the chatter of the Fed pulling off a soft landing after all.  And, if the landing is soft, do they need to hike more?

 

Although the manufacturing side of the economy remains lackluster, Services have been killing it.  There is one other reason to believe the Fed will remain on hold as well, and that is the employment situation.  While we have seen a much hotter than forecast NFP print basically each month for the past year, we are starting to see Initial Claims data tick higher.  Yesterday’s 262K was both higher than expected and the highest print since October 2021 when claims were tumbling during the post-pandemic recovery.  More ominously, the 4-week and 13-week moving averages (analyzed to seek a trend and remove the weekly choppiness) are both clearly trending higher.  If that number continues to rise, the Fed’s confidence in the economic recovery continuing is likely to be impaired.  In fact, I think this is the feature that is most likely to cause the Fed to stop hiking.

 

If we pivot to Asia for a moment, we see a completely different set of concerns in both China and Japan.  Starting with China, after cutting their lending rates earlier this week, the PBOC is still struggling to figure out how to support what is a clearly softening economy.  Although there has been much lip service paid to the fact that China will no longer prop up the property market and investment and is instead seeking to generate more domestic consumption, the fact that the youth unemployment rate is at a record 20.8% and that the only playbook the Chinese really understand is infrastructure spending and leveraged property speculation, they are falling back into that trap.  Rumors abound that the government is going to put forth a CNY1 trillion (~$140B) spending package and that the PBOC is going to ease restrictions on property lending, removing the ban on second home purchases in small cities.  Remember, property speculation was a critical part of China’s rapid growth as people there have little confidence in a social safety net and were using those second homes as an investment to secure their nest egg.  Alas, with China’s population shrinking, that may no longer be an interesting investment for the middle class.  So, while China’s problems are different, they are no less severe than those in the West.

 

Uncertainty is
“Extremely high” over both
Wages and prices

So, Ueda-san
Will keep liquidity flows
Like flooding rivers

As to Japan, I’m old enough to remember when there was a growing belief that once Kuroda-san stepped down as BOJ head, his replacement would have free rein to tighten policy. Boy, were we ever wrong about that.  After last night, while there was no policy adjustment as expected, Ueda-san’s comments can only be construed as strongly dovish and the market got the message.  JGB yields slid a few basis points and are back below 0.40% while the yen is the only currency that is underperforming the dollar.  Meanwhile, the Nikkei (+0.65%) continues its recent strong performance as the second best major index after only the NASDAQ.

The one thing that we know is that things do not seem to be evolving as per much of the consensus from earlier this year.  While there is still a long way to go before this cycle ends, and I still expect a more significant economic slowdown globally, the possibility that Chairman Powell pulls off a soft landing cannot be dismissed.  And as I saw on Twitter yesterday, if he does so, he will be hailed as the greatest Fed chair ever, even more so than Paul Volcker.  Alas, I fear things will not work out that way.  Remember that monetary policy works with long and variable lags, and I would contend that the economy is likely just beginning to feel the true impacts of tighter policy.  Now, this may only happen in the manufacturing sector, where the cost of capital is such a critical input, but history has shown if that sector stumbles, it drags the economy down with it.  Remember that so much of the service economy exists to service manufacturing, so the two are quite intertwined.

Remember, too, there are potential exogenous shocks, both positive and negative, that can have a big impact.  What if the Ukraine war ended?  What if China invaded Taiwan?  What if there was an escalation of fighting in the Middle East with a dramatic reduction in oil production?  All I am pointing out is that myopically focusing on just the economic data is not sufficient for a risk manager.  Sh*t happens and it can matter a lot.

Ok, as to today, we already know that risk is on.  The data coming out this morning is Michigan Sentiment (exp 60.0) and of the three Fed speakers, two have already commented with Governor Waller not talking economics or policy, but rather bank regulation and Bullard was more theoretical than policy focused, so really there has been nothing new there either.  In a little while, Richmond’s Barkin will discuss inflation, so that could be interesting.  But for right now, the market has made up its mind.  Everything is right as rain so add risk.  That means the dollar is likely to remain under pressure with a test of its lows (EUR 1.11, DXY 102) coming soon to a screen near you.

Heading into a bank holiday weekend, I expect positions to be lightened but the recent dollar weakening trend to remain intact.

Good luck and good weekend

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Firmly On Hold

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For now the Fed’s firmly on hold
While Powell made statements quite bold
It’s time to assess
How great is the mess
Created by stories we’ve told

This morning then, Christine is live
With certainty that twenty-five
Is how much she’ll hike
As she tries to spike
Inflation while growth she’ll still drive

To virtually nobody’s surprise, the Fed left policy rates on hold yesterday after what has been characterized by many as a hawkish pause.  This seems a fair assessment given the effort by Chairman Powell to stress that inflation remains too high and has not been falling as rapidly as they would like to see.  For instance, comments like the following during the press conference were quite clear:

 

“If you look at core PCE inflation over the last six months, you’re not seeing a lot of progress. It’s running at a level over 4.5%, far above our target and not really moving down. We want to see it moving down decisively, that’s all.”

“We’re two-and-a-quarter years into this, and forecasters, including Fed forecasters, have consistently thought inflation was about to turn down and typically forecasted that it would, and been wrong.”

“What we’d like to see is credible evidence that inflation is topping out and then getting it to come down.”

 

These were just some of the comments but give a flavor for what the mindset appears to be in the Eccles Building.  Looking at the dot plot, the median expectation is for two more rate hikes in 2023 and there were zero expectations of a rate cut.  The point is that higher for longer, which is what they have been preaching for upwards of a year, remains the mantra and given how robust the employment situation remains, they do not seem likely to change that view in the near term.  A quick look at the Fed funds futures market shows a market probability of 71% for a rate hike in July where things peak, and then pricing for a cut in January.  However, as I have maintained, I see inflation remaining quite sticky and the probability of a rate cut as far lower than that.

 

The market response was perfectly sensible in the bond market, where yields continue to climb, and the yield curve inversion increased to -91bps.  2-Year yields are now back to 4.73% as traders and investors price in a much higher probability that even if rates don’t rise much further, they are unlikely to fall back.  In fact, 10-Year yields around the world have all risen further as the global tightening cycle seems set to continue.  Recall, we saw Canada, Australia and now the Fed come out hawkishly and this morning the ECB is set to follow suit with a 25bp rate hike.  At this stage, there are no G10 central banks that believe they have solved the inflation problem…and they are right.

 

A quick look at European sovereign yields ahead of the ECB announcement shows they have risen between 5bps and 10bps this morning as there is clearly an expectation that after the extremely hawkish commentary from Powell yesterday, Madame Lagarde will be forced to follow suit.  In truth, that seems a reasonable expectation and when looking at the OIS market in Europe, expectations appear to be for another one or two hikes after today’s move.  Given that inflation remains sticky there too, that doesn’t seem far-fetched.

 

On last thing regarding central bank hikes is the Bank of England next week, where a 25bp hike is fully priced, but more impressively, an additional 4 hikes are priced in by the end of the year.  Inflation in the UK has clearly been even more problematic than in the Eurozone or the US, while the Old Lady has been lagging lately so this does make sense as well.

 

There are, though several places where tighter policy is not on the cards, namely China and Japan.  Starting with Japan first, YCC remains the current policy framework and there is no indication they are going to change things anytime soon.  10-year yields there remain well below the YCC cap and there is much more discussion regarding the potential for a snap election in Japan than about monetary policy.  The yen (-0.8%) is weakening further today as the more hawkish Fed combined with the continued dovishness of the BOJ weigh on the currency.  We’ve seen this movie before when the dollar ran up above 150 in October, and while that is still a long way from today’s price, the trend since March has been very clear.  Absent a major policy change from either the Fed or the BOJ, look for a weaker yen over time.

 

As to China, they did cut their Medium-Term Lending Facility rate by 10bps last night as widely expected although the currency did not really move as it was fully priced already.  However, the Chinese government is clearly flailing about for ways to support the economy without increasing the leverage that already exists.  The problem is that the PBOC toolkit, as well as the CCP toolkit, relies on centralized direction not market activity, and it appears that the limits of those policies are starting to be reached.  There is little reason to believe the renminbi is going to rebound in the short-term as a weaker currency is the only outlet valve they have.  Given measured inflation in China has been so low, I expect we can see a continued grind lower (dollar higher) in the second half of the year.  Think 7.50 by Christmas.

 

With all that news, US equity markets had a mixed picture yesterday with the NASDAQ continuing its run higher with a small (0.4%) gain, but the rest of the market under more pressure.  Chinese equities responded quite positively to the rate cut there with substantial gains, but the Nikkei was simply flat on the day.  And now, European bourses are in the red by about -0.7% with US futures also pointing lower.

 

Oil prices (+0.75%) are edging higher but that is after a reversal yesterday brought them back below $70/bbl.  There remains a great deal of controversy over just how badly demand is going to be hit given the lackluster Chinese economy and the huge split on views regarding the US and Europe with a recession call still quite popular although there are those who are now calling for a successful soft landing by the Fed.  Precious metals are a little less precious this morning as are base metals which are indicative of dollar strength I believe.  However, net, I would say the commodity space is more in the recession camp than not.

 

Finally, the dollar is stronger vs virtually all its EMG counterparts with HUF (-1.25%) the laggard as market participants take profits in anticipation of a rate cut from Hungary vs. the Fed’s tough talk.  But the bulk of the bloc is weaker across all three regions.  In the G10, while the yen is worst off, we are seeing weakness almost everywhere except NOK (+0.3%) which is clearly benefitting from oil’s modest rally.  Given the Fed’s unambiguous hawkishness, I suspect the dollar will remain better bid than not for a while yet.

 

On the data front, there is a lot coming today as follows:  Retail Sales (exp -0.2%, +0.1% ex autos); Initial Claims (245K); Continuing Claims (1768K); Empire Manufacturing (-15.1); Philly Fed (-14.0); IP (0.1%); and Capacity Utilization (79.7%).  At this point, the Retail Sales data is likely the most important as the discussion regarding a recession will hinge on whether or not economic activity is still improving.  Remember, though, this data is nominal, not inflation adjusted.  On a real basis, Retail Sales have been falling for 6 months straight, not a good sign.  As to the Fed speaking slate, nobody is on the calendar today, but we will hear from three (Bullard, Waller and Barkin) tomorrow, with all likely to be focused on reiterating the hawkish message.

 

A hawkish Fed bodes well for the dollar going forward, so unless (until?) something in the US economy breaks, my money is on higher rates and a stronger dollar.

 

Good luck

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Which One Means More?

Posted on by 
The question is, which one means more?
The headline inflation? Or core?
The former declined
But please bear in mind 
The latter rose more than before

Which brings us today to the Fed
Where skipping a rate hike is said
To be what they’ll try
Then come late July
Will hike ere more water they tread

By now you are all aware that CPI’s release yesterday was a bit of a mixed bag with the headline number falling slightly more than expected to 4.0% while the core (ex food & energy) fell slightly less than expected to 5.3%.  As always, my go-to source on inflation is @inflation_guy, who in yesterdays’ post clearly laid out that there is very limited evidence that core inflation is going to decline sharply from these levels anytime soon.  In a nutshell, the key issue is that the housing portion of the index remains robust and that represents slightly more than one-third of the entire reading. 

 

Ask yourself the following question; why would a landlord reduce his asking rents if his costs are rising (taxes and maintenance) and his potential customers are all seeing wages rise healthily, at least as per measured by the BLS and the Fed?  Of course, the answer is that landlord is unlikely to reduce rents, but rather raise them, and that is not going to feed into lower inflation.  One other thing to note is the price of energy, which was the key driver of the decline in headline CPI, has the earmarks of a bottom here.  Not only have we seen production cuts from OPEC+, but it appears the Biden administration is beginning the process of finally refilling the SPR which means they have likely mapped the bottom of oil prices which have rebounded more than 5% from the lows seen Monday after the news broke.

 

As expected, the equity market took this news as a huge positive and continued its recent rally as it is almost certain that the Fed will be holding rates unchanged when they announce their policy update this afternoon.  The Fed funds futures market has reduced its pricing for a rate hike to just 9% this morning although the implied probability of a hike in July has risen to 71% now.  As an aside, the futures market is still pricing in the first rate cut by December or January 2024, although I suspect we will need to see a more significant decline in economic activity with much higher Unemployment for that to come to fruition.

 

This afternoon’s FOMC statement, and more importantly Chairman Powell’s press conference are the next critical features for the market.  There is much talk of this being a ‘hawkish pause’ where they will not change rates but really play up the still hot core inflation data to make sure that everyone knows they are not going soft on inflation.  As I have repeatedly explained, I continue to look at NFP as the most critical data point these days because as long as that number keeps printing solidly and beating expectations, the Fed will not be overly concerned a recession is coming and will feel comfortable tightening further if inflation starts to tick higher again.  And so, at this time, all we can do is wait for the outcome at 2pm.

 

Ahead of that, here’s what’s been happening:  risk has largely been in favor as yesterday’s US equity rally was followed by strength in Japan (+1.5%) and Australia (+0.3%) although many other APAC markets, notably China and South Korea, fell.  The China situation is quite interesting as there is news that the Chinese government has convened several meetings with business leaders to get ideas as to how to improve the economy there.  Not surprisingly, according to a Bloomberg story, the discussions focused on more market-oriented actions and less state planning as well as better coordinated fiscal and monetary policy stimulus.  My guess is that President Xi is not keen to let the market do the work as he will not control that, so it will be interesting to see how things there progress.  Meanwhile, European bourses are all much stronger this morning, even the FTSE 100 (+0.6%) despite a modestly weaker than expected set of GDP and IP data being released.  And of course, US futures continue to edge higher, at least NASDAQ futures do, although it would be quite surprising to see any large movement ahead of the FOMC this afternoon.

 

Of much greater interest to me is that bond yields rose so sharply yesterday with 10yr Treasuries rising 7 bps yesterday and another 1.5bps this morning, despite (because of?) the CPI data being soft.  The curve inversion remained essentially unchanged at -85bps, so I guess the story I saw that might have been the driver was when Treasury secretary Yellen was asked in Congressional testimony about the Fed and Treasury being prepared if China were to liquidate their entire portfolio of Treasuries, which is ~$875 billion.  That seems highly unlikely to me, but I guess anything is possible.  European sovereign yields are also rising after gains yesterday, which seems at odds with the equity markets that clearly believe in lower inflation.  Things are quite confusing these days.  As well, there will be much attention paid to China tonight to see if the PBOC follows through with a 10bp rate cut in the 1yr lending facility, or perhaps, if they are concerned about economic weakness, opts for more.

 

As mentioned, oil prices continue to rebound, pushing back to $70/bbl while gold got crushed yesterday seemingly in response to the rise in Treasury yields.  This morning the barbarous relic is ever so slightly firmer but in a bigger picture view, remains relatively unchanged over the past month.  Copper has continued its recent countertrend rally, but I expect that we will need to see real signs of an economic rebound for the red metal to get back to levels seen earlier this year above $4.00/pound.

 

Finally, the dollar remains under modest pressure overall, sliding about 0.25% against most of its G10 counterparts and a bit further against several EMG currencies.  Notably, ZAR (+1.0%) is the best performer today, after a solid Retail Sales print this morning.  As well, we see PLN (+0.7%) rising on rising zloty yields after the government increased the budget deficit on increased spending.  On the downside, KRW (-0.55%) is the laggard, falling after several days of a sharp rally has led to profit-taking.

 

Ahead of the Fed, we see PPI this morning (exp 1.5%, 2.9% ex food & energy) although that seems anti-climactic after yesterday’s CPI.  Add to that the Fed is coming and I cannot believe it will have any impact at all.

 

So, it is all about the Fed and how they sound since it seems pretty clear that they will not be adjusting rates today.  Look carefully at the dot plot as well, for clues to their forward-looking beliefs.  As to the dollar’s response, nothing has changed my big picture view that higher rates here will continue to support the greenback.

 

Good luck

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Desperate Straits

Posted on by 
Ahead of today’s CPI
Jobs data from England showed why
Inflation remains
The greatest of pains
That central banks can’t wave good-bye

Despite all their hiking of rates
In seeking to reach their mandates
The job market’s growing 
Which seems to be showing 
Their models are in desperate straits

Today’s key feature is the monthly CPI report from the US where expectations are for a 4.1% headline reading and 5.2% core reading, with both still far higher than the Fed’s 2.0% target.  While the headline number is certainly good news, the Fed’s problem is that the core reading continues to bump along pretty steadily above 5.0% and is not showing any indication of a sharp move lower.  While an exceptionally weak headline reading will almost certainly result in a further rally in risk assets on the premise that the Fed’s pause skip is now baked in, the greater question is how long can the Fed tolerate such a high core CPI reading before resuming their rate hikes?  As we head into the data, the Fed funds futures market is currently pricing just under a 25% chance of a hike tomorrow but nearly an 87% chance of at least one hike by July.  However, that is the peak with a cut then assumed by December.

 

Of course, the thing that is not getting any attention at this point is what happens if the reading is hot?  I have literally not read a single analysis that anticipates a higher outcome showing inflation has become even more intractable than it had seemed for the past several months.  My take is a higher-than-expected reading, especially in the core print, could see the market substantially increase their pricing for a rate hike tomorrow as well as another one or two before the year is over, and that may not be a positive for risk assets.

 

And that’s where the UK’s employment data comes into the discussion, as it is showing the same characteristics as the US employment data, surprising strength.  Briefly, instead of a rising Unemployment Rate, it fell to 3.8% with wages rising by 6.5% Y/Y, well above last month’s and well above forecasts.  There was a reduction in the number of jobless claims and a significant growth in employment of 250K on a quarterly basis, also far above forecasts.  In other words, despite a lot of doom and gloom regarding the UK economy and the irreparable damage that Brexit has done to the nation, it seems that there is continued economic activity at a decent pace and businesses are still hiring and paying up to do so.  I have to say that sounds suspiciously like the commentary regarding the US economy, where despite an ongoing belief that Unemployment is set to rise, each monthly data point has been surprising on the high side, often by a significant amount.  As I have written before, perhaps it is time for the central banking community to review the efficacy of their models as they no longer seem to represent any sense of reality.

 

The other noteworthy news overnight was that the PBOC reduced their 7-day Reverse Repo rate by 10bps to 1.90% in a surprising move.  Tomorrow night the PBOC has their monthly meeting and expectations are for a 10bp reduction in their medium-term lending facilities as the Chinese government struggles with a much slower than expected rebound from their latest Covid reopening.  In fairness, it is not just the Chinese government that is surprised as one of the main themes we have seen for the past several months was the expectation that China’s rebound would result in a significant increase in demand for commodities and that has just not occurred.  However, the fact remains that China is easing policy, both fiscal and monetary, while the G7 remains in a tightening phase.  The natural outcome here is that the renminbi has continued to slide.  While the onshore market closed little changed, with CNY -0.1%, the initial reaction upon the announcement of the rate cut was a little more substantial.  Net, though, the renminbi has been weakening steadily all year long and given recent very low inflation data, it is abundantly clear that the PBOC is not concerned at current levels.  I expect that USDCNY and USDCNH have much further to climb as the summer progresses, especially if CPI continues to run hot here in the US.

 

And those are really the key stories as we await that CPI print shortly.  Asian equity markets followed the US higher last night with the Nikkei continuing its sharp rally, rising 1.8%, and the rest of the markets trailing along behind. Europe, though, is having a less formidable session with minimal movement as the major indices are +/-0.1% from yesterday’s closing levels.  As to US futures, only NASDAQ futures are showing any movement, gaining 0.3% at this hour (7:30).

 

Bond markets are similarly dull, save the Gilt market which has seen 10yr yields rise 5.7bps, as both Treasuries and the rest of the European sovereign market are within 1bp of yesterday’s prices.  The Fed continues to be active in the Treasury market, taking down a significant portion of the issuance yesterday, albeit not directly as they bought off-the-run bonds instead of the issuances.  However, today’s data could easily have a significant impact as traders try to reassess the Fed’s response to a data surprise.

 

Oil prices have stopped falling and have bounce 1.8% from yesterday’s lowest levels of just below $67/bbl, although the trend continues to be lower.  As I have repeatedly written, this is the one market that is all-in on the recession call. Gold (+0.4%) has been pretty uninteresting lately as it stopped falling but has basically flat-lined for the past month just below $2000/oz.  Meanwhile, copper has rallied 2% this morning but is still well below highs seen earlier this year.  However, I think a large part of these movements are the fact that the dollar is generally softer this morning.

 

Versus its G10 counterparts, the dollar is softer across the board with GBP (+0.5%) the leading gainer but decent strength everywhere.  Versus the EMG bloc, there is a bit more variety with KRW (+1.3%) by far the leading gainer on a combination of reported corporate repatriation of overseas cash flows as well as hopes that China’s rate cut will support further growth in Korean exports.  However, after that, the bloc is basically split between gainers and laggards with the biggest moves just 0.3% either way, not enough to get excited about.

 

And that’s really it for today.  It is all about CPI this morning and depending on the data, we have the opportunity to get a better sense of how the Fed might behave tomorrow.

 

Good luck

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Views Will Be Tested

Posted on by 
When looking ahead to this week
With data and central bank speak
Some views will be tested
And some have suggested
The market is reaching its peak

But there is a growing belief
The future (that’s AI in brief)
Is shiny and bright
And stocks will take flight
Beware though, it could lead to grief

First a correction to Friday’s note regarding the blip lower in oil prices.  It was not inventory data but a story on a relatively obscure website, Middle East Eye, (h/t @inflation_guy) that discussed a seeming breakthrough in US-Iran talks that would allow Iran to export up to 1 million bbl/day in exchange for an agreement to slow their Uranium processing.  However, the story was vehemently denied by both the Iranians and the US and has been consistently denied since then by both sides repeatedly.  Now, I am of two minds on this story as denials of this extremity tend to point to some reality underlying the situation, but politically it would seem very difficult for the Biden administration to be seen to be negotiating with Iran heading into an election.  Regardless of the driver though, oil (-2.2%) is falling sharply again today with WTI below $69/bbl now.  This continues to point to the dichotomy of commodity markets sensing significant global slowing in growth while the equity markets see the world growing gangbusters.  Both sides cannot be correct, so at least one set of markets will need to adjust going forward.

 

Meanwhile, after an extremely lackluster week regarding new information, this week is exactly the opposite with critical data points like CPI as well as three major central bank meetings, Fed, ECB and BOJ.

 

Tuesday

NFIB Small Biz Optimism

88.4

 

CPI

0.2% (4.1% Y/Y)

 

-ex food & energy

0.4% (5.2% Y/Y)

Wednesday

PPI

-0.1% (1.5% Y/Y)

 

-ex food & energy

0.2% (2.9% Y/Y)

 

FOMC Rate Decision

5.25% (unchanged)

Thursday

ECB Rate Decision

3.50% (0.25% increase)

 

Initial Claims

250K

 

Continuing Claims

1787K

 

Retail Sales

-0.1%

 

-ex autos

0.1%

 

Empire Manufacturing

-15.1

 

Philly Fed

-13.0

 

IP

0.1%

 

Capacity Utilization

79.7%

 

Business Inventories

0.2%

Friday

BOJ Rate Decision

-0.1% (unchanged)

 

Michigan Sentiment

60.1

Source: Bloomberg

 

So, clearly, we have a lot to absorb this week although today is lacking in new news.  A quick look at the PPI data shows why there is a growing cadre of people who are in the ‘inflation is over’ camp, as the Y/Y data is collapsing back to levels with which we are more familiar over the past decades.  However, I would highlight that core CPI remains well above the Fed target with only a very slow decline ongoing.  I remain in the sticky inflation camp on the basis of both personal experience and the fact that a critical part of the statistic, housing, is not actually showing any real declines.  Here is a link to an excellent article that helps explain the fact that rents are not declining very much at all, in reality, and if housing costs continue to climb, so will CPI.

 

I think the real question is what will happen if the CPI number is hot, say 5.5% core and showing no indication that the much hoped for slowing is ongoing?  How will the Fed respond the following day?  Remember, the market is largely priced for a pause skip with a 27% probability of a rate hike currently in the futures market, although an 80% chance of one by next month.  However, we all thought Australia was done and they hiked last week.  We all thought Canada was done and they hiked last week.  Will the Fed be willing to ‘surprise’ the market if the data points to continuing inflation pressures? 

 

This is especially timely as this morning there was a story in Bloomberg explaining that the idea that wage pressures are driving inflation is losing credence with a far less certain outlook on that prospect.  Essentially, a Fed paper was published explaining that while wages and inflation are correlated, the direction of causality, if there is one, is not clear.  That seems like a way for the Fed to be able to pivot their views to a different underlying cause and given housing’s huge importance to the total CPI number, ongoing rises in rentals would certainly be a concern.  One thing we do know is that if the CPI data come out soft, the equity market will rocket higher, at least initially, as the working assumption will be that the Fed is done.  Like I said, lots to anticipate this week.

 

As to today, the bulls remain in control as Friday’s very modest US rally saw Asia follow higher and Europe currently showing gains on the order of 0.5% – 0.6%.  US futures are following suit, with NASDAQ futures up 0.5% at this hour (7:45) and leading the way.

 

Treasury yields are little changed this morning with the yield up just 1bp although European sovereign yields are all lower, especially Italy (-5.6bps) after the news that former Italian PM, Silvio Berlusconi, passed away overnight.  As he was still quite active in Italian politics and a key force in the Forza Italia party, the story is that his passing will have removed some anxiety from markets and allow the Bund – BTP spread to narrow further still.  Perhaps of more interest is the increasing inversion in the 2yr-10yr portion of the curve, now back to -86bps, and a direct result of the massive amount of Treasury issuance that has been happening since the debt ceiling was removed.  In fact, today there are auctions for 3m, 6m and 1y bills and 3y and 10y notes to the tune of $278 billion, a huge amount of supply.  Do not be surprised if the curve inversion continues further.

 

Finally, looking at the dollar, it is generally, though not universally softer.  Given oil’s decline, it is no surprise that NOK (-0.35%) is the G10 laggard, but there is also a bit of weakness in the CHF (-0.25%) on the back of a slight decline in Sight Deposits there.  Meanwhile, the rest of the bloc is modestly firmer with no outsized gainers.  In the EMG bloc, ZAR (+1.1%) continues its recent strength, having rallied 7% this month on continued belief that the electricity situation in the country is getting better.  But away from that, and the fact that TRY (-0.7%) continues to slide, the rest of the bloc appears to be awaiting the upcoming onslaught of news this week.

 

I have a sense that by the end of this week, we may have new marching orders from the markets.  I would not be surprised to see a hot CPI print get the Fed to hike instead of skipping and if we see something like that, I would look for the dollar to test its recent resistance levels and potentially break through.  Correspondingly, if CPI is soft, I imagine the market will assume the Fed is done, and we will see equities rally with the dollar falling, at least for the first leg of the move.  We shall see starting tomorrow.

 

Good luck

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No Ceiling

Posted on by 
The narrative’s taken a turn
As traders, for lower rates, yearn
Initial Claims jumped
And that, in turn, pumped
The idea that rate hikes, Jay’d spurn

To add to the positive feeling
Inflation in China is reeling
Now bulls are all in
And to bears’ chagrin
It seems that for stocks there’s no ceiling

Well, it seems that Initial Claims can have an impact after all!  Yesterday the data series printed at 261K, the highest level since October 2021 and significantly higher than all the economists’ forecasts.  The market impact was clear as it appears there is an evolution from the narrative preceding the data release to a newer version.  For clarity’s sake, I would argue the prevailing narrative went something like this:

  • Prices were falling sharply, and inflation would soon be back at or near the Fed’s 2% target.
  • Unemployment remains low because of a significant mismatch between job openings and potential employees so consumption would remain robust
  • This economic strength will overcome further Fed tightening…so
  • Buy stocks!

 

Arguably the newer narrative is something like this:

  • Initial Claims data shows that the employment situation may be deteriorating
  • Not only will the Fed skip hiking at next week’s meeting, but at any meeting going forward
  • Rising Unemployment will force the Fed to finally pivot and cut rates…so
  • Buy stocks!

 

Granted these may be somewhat simplistic descriptions, but I would argue that they are representative of the current zeitgeist.  If nothing else, I would argue that the algorithms that implement so much trading these days are written in this manner. 

 

At any rate, the impact was far more significant than would ordinarily be expected from an Initial Claims release.  Rate hike expectations by the Fed have begun to fade, not only for next week, but for the July meeting as well.  Treasury yields fell 8bps yesterday, although they have rebounded slightly this morning by 3bps along with European government bonds.  And, of course, equity markets all rallied further yesterday with the S&P 500 ticking up to a level 20% above the October lows so now “officially” in a bull market.  In fact, that equity rally continued through into Asia as all markets there were higher led by the Nikkei (+2.0%).  Life is good!

 

Is this sustainable?  I guess so, the market for risk assets has been willing to look through every potential problem and continue to rally.  Are there flaws in the argument?  I would argue there are, but as John Maynard Keynes explained to us all, the market can remain irrational far longer than you can remain solvent.

 

One other noteworthy data point was released overnight, Chinese CPI and PPI, both of which remain quite low.  CPI rose only 0.2% in the past year while PPI fell -4.6%.  These results have market participants looking for the Chinese to ease monetary policy still further to support the economy, continuing to widen the policy differential between China and the G10 nations which, at least for now, remain in tightening mode.  As such, it should not be that surprising that the renminbi (-0.3%) fell further last night.  Given the distinct lack of inflationary pressures currently evident in China, I suspect the PBOC will be quite comfortable watching CNY weaken further still, with another 3%-5% quite realistic as the year progresses.  After all, China remains a mercantilist economy highly reliant on exports and a weaker yuan will only help their cause.

 

Now, keep in mind that everything is not positive.  We continue to see weak economic activity throughout the Eurozone with this morning’s Italian IP data (-1.9% M/M, -7.2% Y/Y) showing there are still many problems on the continent.  It is no wonder that Italian PM Meloni is so unhappy with the ECB as the Italian economy continues to stumble while the ECB continues to tighten policy.  But it certainly appears that Madame Lagarde is unconcerned about Italy at least for the time being.  However, while the ECB will almost certainly raise rates next week, if the Fed truly has finished their rate hike cycle, the ECB will not be far behind.

 

So, as we head into the weekend, the equity markets that are actually trading at this hour (7:30) are in the red with all of Europe down on the order of -0.2% to -0.4% and US futures also slightly softer.  Meanwhile, oil prices (+0.25%) are edging higher this morning, although that was after a sharp afternoon decline yesterday on inventory data.  Meanwhile, gold, which rallied sharply yesterday amid a weak dollar session, is consolidating its gains and the base metals are mixed.

 

Finally, the dollar is mixed this morning with about a 50/50 split in the G10 led by NOK (+1.1%) after CPI printed at a higher than expected 6.7% in May and the market is now pricing in further policy tightening by the Norgesbank.  This seems to fly in the face of the inflation is collapsing narrative which should make next week’s US CPI data on Tuesday that much more interesting.  After that, the rest of the commodity bloc of currencies is slightly firmer vs. the greenback while the European currencies as well as the yen are all under a bit of pressure.  However, on the week, the dollar has definitely backed off its recent strength.

 

In the EMG bloc, the pattern is similar with KRW (+1.0%) the leading gainer on the view that more Chinese policy support will help the Korean economy substantially, while we continue to see ZAR (+0.5%) rally on the commodity price gains.  On the downside, TRY (-1.25%) continues to lag despite (because of?) the appointment of a new central bank chief, Hafize Gaye Erkan, within the new government.  Perhaps her background as co-CEO of First Republic Bank did not inspire confidence given its recent demise.  But regardless, TRY has fallen more than 10% this week alone and shows no signs of stopping the slide anytime soon.

 

And that, my friends, is all there is heading into the weekend.  There is neither data nor Fedspeak to look for so the FX market will almost certainly be taking its cues from the US equity markets for the day.  As such, if equity markets decline, I would look for the dollar to gain a bit and vice versa, but until we get at least through next Tuesday’s CPI, and more likely the FOMC on Wednesday, I see more range trading overall.

 

Good luck and good weekend

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Canada’s Burning

Posted on by 
In Europe, the data today
Showed growth’s in a negative way
Recession is here
Though not too severe
While pundits are filled with dismay

Meanwhile in the States there’s a haze
Of smoke for the last several days
That Canada’s burning
Is somewhat concerning
As forests there still are ablaze

Arguably, the story that is getting the most press is the ongoing wildfires in Canada which has led to significant smoke issues throughout the Midwest and East Coast of the US.  In fact, at one point yesterday, the FAA closed LaGuardia Airport in New York because the smoke was so thick.  The latest that I have seen indicates these fires are likely to continue to burn for a number of days yet as they are nowhere near under control in Canada.  I guess we will need to get used to an orange sun rather than a yellow one for the time being.  While there is no evidence yet of any true behavioral changes, be alert for government edicts to prevent people from traveling or going outside and a short-term reduction in economic activity, at least in June while this is ongoing.  I fear that the willingness of government officials to declare states of emergency and take on dictatorial powers has grown since Covid, so it will be interesting to see how this plays out.  A headline across the tape just now (7:00) shows that LaGuardia is shut down for inbound flights again due to reduced visibility.  In the end, be careful as inhaling too much smoke will not be good for you.

 

But after that, which is truly wagging every tongue in NY, the other story of note is that the Eurozone has fallen into a technical recession, with the final revision of Q1 GDP falling to -0.1%, and Q4’s numbers being revised lower as well, to -0.1%, after much weaker than previously assumed data from both Germany and Ireland was incorporated into the statistics.  You may recall the argument in the beginning of 2022 when the US suffered through two consecutive quarters of negative real GDP growth, but there was a great effort to claim that was not a recession.  And officially it was not as in the US a recession is not official until the NBER declares it so in hindsight.  But Europe does not have an NBER and there is no argument at this point that the Eurozone went through quite a weak patch recently. 

 

Arguably, though, of more importance is whether this weakness will continue or whether we have just witnessed the much-anticipated recession.  This matters a great deal because next week, the ECB meets and is widely expected to raise its interest rate scheme by a further 25bps with the market pricing in an additional hike there by summer.  If the Eurozone is in recession, especially if it starts to deepen a bit more aggressively than the recent -0.1% quarterly data, will the ECB have the resolve to continue to fight inflation and keep raising rates?  Granted, their mandate is purely inflation focused, unlike the Fed’s dual mandate of inflation and employment, so they would be well within their rights to do so.  But…continuing to raise interest rates into a clear recession is a very difficult decision as it can easily be seen as a policy error.  At this point, my take is they will indeed hike next week, but I am far more skeptical about future hikes especially as the Fed is pausing skipping this meeting and may well be done.  The idea that the ECB will continue to tighten policy aggressively while the Fed is not seems pretty far-fetched based on its history.

 

Speaking of rate hikes, Canada is in the news there as well after the BOC surprised the market and unpaused (?) by hiking 25bps yesterday.  Essentially, they have concluded that economic activity is too strong to allow inflation to return to their 2% goal, the same reasoning we heard from the RBA last week when they surprised markets and raised their base rate.  While the FX market response was not quite as aggressive as in Australia (CAD rose 0.5% on the news and has basically tread water since then), the move has certainly forced rethinking the assumption that the Fed is actually going to skip this meeting.  Arguably, much will depend on next Tuesday’s CPI data with current estimates there for 4.2% headline and 5.2% core.  Any number that prints hot will get tongues wagging about the Fed continuing to raise rates with corresponding market impacts.  For now though, we can merely guess.

 

And that is the background for today’s session.  Yesterday saw a bit of a pullback in risk assets in the US with most of Asia following lower, although Chinese stocks held up.  Eurozone bourses are all marginally higher this morning, as it seems the growth data was less concerning and hopes that the ECB would be forced to stop hikes sooner have been a driving force.  As to US futures, they are all essentially unchanged this morning as everybody continues to wait for the Fed next week.

 

Bond markets, though, were a bit shaken by the BOC move with yields climbing in the US yesterday and a further 1bp rise this morning back to 3.80%.  In addition, 2yr yields are back up to 4.55%, and with the Treasury now having no debt ceiling at all, I expect we will see significant issuance driving yields higher still.  In Europe, the picture is more mixed with yields either side of unchanged as there is confusion on how to play this market.  And one final thing is in Japan, where JGB yields have edged higher by 2bps overnight and are now at 0.434%, slowing approaching the YCC cap.  That is a potential issue for the not-too-distant future so we will keep on top of it.

 

Oil prices continue their slow rebound, up 0.9% this morning and actually up 4.3% in the past week.  Perhaps the Saudi production cuts are finally being priced, or perhaps the idea that Canada has indicated stronger growth is seen as a harbinger of a better economic situation and less demand destruction.  As to metals prices, gold, which fell sharply yesterday, is rebounding slightly and the base metals are mixed.  As long as we get conflicting economic signals (weakness in Europe, strength in North America) I think these metals will have a difficult time choosing a direction.

 

Finally, the dollar is generally softer this morning, which given the higher yields in the US is a bit surprising.  But NOK (+0.7%) leads the way on oil strength, and we continue to see strength throughout the commodity bloc.  Even the euro has rallied this morning, although that feels far more like position adjustments than fundamentally driven movement.  As to the EMG bloc, ZAR (+0.7%) is once again at the head of the list, entirely on commodity movement but most of EMEA is stronger while Asian currencies were generally under a bit of pressure overnight.  At this point, I continue to believe most markets are awaiting the FOMC meeting as the next potential catalyst and so expect limited directional trading until then.

 

On the data front, Initial (exp 235K) and Continuing (1802K) Claims are on tap this morning, neither of which seem likely to move the needle.  Yesterday’s Trade data was modestly better than expected while Consumer Credit grew a bit more than expected.  In the end, though, it is still all about the Fed.  As such, I expect more back and forth but no secular movement until we hear from the FOMC.

 

Good luck

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Somewhat Decreased

Posted on by 
The OECD has released
Its forecasts for West and for East
Alas what they’ve said
Is looking ahead
The growth story’s somewhat decreased

It’s another extremely dull day in markets as the passing of the debt ceiling crisis has left traders and investors looking for anything new at all to help catalyze trading ideas.  Granted, all market participants are anxiously awaiting next Wednesday’s FOMC meeting, but there is a lot of time between now and then to fill.  As there was a dearth of new data of importance overnight, the talk of the market is the OECD’s release of their June 2023 Report on global GDP growth as per the below:

In truth, it does not make for great reading as the estimates point to continued subdued growth, well below the pre-pandemic average of 3.4% globally.  As well, they highlight that this slower growth trajectory will be matched with higher inflation (exp 6.6% in 2023 and 4.3% in 2024), a truly unenviable situation.  Of course, just like every forecast, these must be taken with a grain of salt as the one thing we know about forecasting is…it’s really hard, especially about the future.  It is not clear that anybody altered their views on anything after the release of the report, but it has been the talk of the town.

 

Aside from that, I must follow up on a comment from yesterday’s note regarding the interest rate adjustments made in China, as it seems there is even more nuance involved.  The big 4 Chinese banks have reduced their onshore deposit rates for USD by about 30bps to try to discourage dollar hoarding and incremental additions to the carry trade.  With US rates now above 5%, the carry opportunity to hold dollars relative to renminbi has been quite significant and has been a key driver of the renminbi’s weakness this year.  In fact, from the renminbi’s high point this year in mid-January, it has weakened nearly 6.6%, which is quite far for a currency that traditionally runs with about a 4% annualized volatility.

 

One other thing to consider here is that the fact that Chinese banks had to lower their USD deposit rates in order to discourage the owning of dollars seems at odds with the idea that the Chinese are getting out of their dollar holdings.  Rather, it might be a signal that the Chinese people, regardless of what their government may want, seem pretty comfortable holding the greenback. 

 

And, my goodness, there is virtually nothing else marketwise to discuss from the overnight session.  Equity markets have been generally quiet overall, with modest gains or losses following yesterday’s very modest US rally.  Major European bourses are +/- 0.1% on the day although we did see the Nikkei fall -1.8% overnight, arguably on the back of the latest Policy proposal by PM Kishida which calls for more spending and debt.

 

Bond markets are also quite subdued with yields edging slightly higher in most places, but just on the order of 1bp-2bps, hardly a worry.  The one noteworthy thing here is now that the debt ceiling has been suspended, the Treasury issued just under $400 billion in T-bills yesterday and is likely to continue on that pace for the rest of the month as they refill the TGA.  The market impact is that the curve’s inversion is increasing with 2yr-10yr now back to -83bps and seemingly heading far lower again.  A test of -100bps seems entirely likely here.  Meanwhile, the 3m-10yr spread is -163bps, which is far below the levels seen even in the 1970’s and 1980’s during Volcker’s time in office.  Given the amount of issuance likely still forthcoming, I suspect this can fall further still.  It is not clear to me that this is a positive for the market.

 

Turning to commodities, oil (+1.1%) is rebounding slightly as it retraces yesterday’s losses while metals markets are a bit more positive today with copper (+0.5%) and aluminum (+0.75%) both rebounding although gold is little changed on the day.  I sense that part of this is related to the dollar softening a bit, as the growth story just does not seem that positive.

 

Speaking of the dollar, other than vs. the Turkish lira, which has collapsed nearly 7% this morning after President Erdogan’s new government took office, it is generally a bit softer on the day.  With oil’s rebound, NOK (+0.8%) is leading the G10 higher followed by SEK (+0.6%) and AUD (+0.4%) on broader commodity strength, but the whole bloc is firmer.  In the EMG bloc, ZAR (+1.0%) is the leader, also on better commodity pricing as well as an increasingly positive outlook on the power situation there, followed by the rest of the bloc (save TRY) edging up between 0.1% and 0.3%.  There really aren’t any other good stories there.

 

And that’s all she wrote.  This morning we see the Trade Balance (exp -$75.8B) and this afternoon, Consumer Credit ($22.0B), but these days, neither of those is likely to matter to the trading community.  I expect another dull day, and potentially a whole week of dull until the CPI data next Tuesday and then the FOMC meeting on Wednesday.  At this stage, the medium-term trend is for modest dollar strength, but on a given day, there doesn’t seem to be much directional impetus in either direction.

 

Good luck

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Quite a Surprise

Posted on by

Down Under, in quite a surprise

The RBA did analyze

Inflation of late

And then couldn’t wait

To raise rates to multi-year highs

 

Explaining inflation’s been hot

The Governor and his team thought

If we don’t act now

We may well endow

The idea, our goal, we forgot

 

You know it is a dull day when the biggest news in the market is that the RBA surprised markets and raised their base rates by 25bps last night, taking the level to 4.10% and implying in their accompanying statement that more hikes were still on the table.  The money line from Governor Lowe was as follows, “The board remains alert to the risk that expectations of ongoing high inflation contribute to larger increases in both prices and wages, especially given the limited spare capacity in the economy and the still very low rate or unemployment.”   That does not sound like a central bank that has finished their hiking efforts and the market is now pricing a 50% probability of another rate hike by August.   It should be no surprise that the Aussie dollar (+0.6%) is the leading performer in the FX markets today, especially given that the dollar remains well bid overall.

 

In China, the PBOC

Has lately begun to agree

That growth’s in a slump

So, it’s time to pump

It up with a rate cut or three

 

The other interesting news overnight was that the PBOC has asked Chinese commercial banks, notably the big five banks, to cut deposit rates to their clients by 5bps in order to help encourage more spending, and correspondingly more growth.  Clearly, all is not well in the Middle Kingdom with respect to the economic situation although it is very interesting that the PBOC is not adjusting rates themselves.  Now, the big five state-owned banks are a critical part of Chinese monetary policy transmission, so a PBOC rate cut would feed through those institutions anyway, but I believe this is more theater in an effort to separate the government’s actions from direct support for the economy.  In the end, it’s all the same, as the Chinese rebound is very clearly under pressure.  One of the key drags remains the property sector and it is just not clear how the Chinese are going to solve that problem.  As of yet, like every government, they have simply kicked the can down the road a bit.  As to the renminbi, it continues to trade on the soft side, with the dollar above 7.10, although it is certainly not collapsing. 

 

However, after these two stories, there has been a dearth of news to drive things with just some desultory Factory Orders data from Germany (-0.4% M/M, -9.9% Y/Y) helping to remind everyone that the German economy, and by extension the Eurozone, has many issues yet to overcome after the loss of their cheap Russian energy.  So, let’s take a quick tour of markets and call it a day.

 

Yesterday’s big announcement from Apple regarding their new headset was less than scintillating to the trading community and we saw US equity indices slip a bit.  Overnight, while the Nikkei (+0.9%) managed a rally, the rest of the space generally fell and Europe, this morning is all in the red as well, albeit only on the order of -0.2%.  In fact, that -0.2% describes the US futures markets at this hour (7:30) too.

 

Bond yields have edged a bit lower on this modest risk off session with Treasuries (-1.1bps) consolidating their recent losses (yield gains) while European sovereigns have seen more demand with yields there lower by about -4bps across the board.  We haven’t touched on JGBs lately because there has been absolutely nothing happening in that market with the 10yr trading at 0.42%, still well below the YCC cap, and showing no pressure higher of note.

 

The one place where we have seen real movement this morning is commodity prices with oil (-2.2%) giving up almost all its post Saudi production cut gains.  The commodity market continues to be the leading proponent of a recession as can be seen in the base metals as well with both copper and aluminum under pressure today.  Meanwhile, gold (+0.1%) continues to hold its own despite pretty consistent dollar strength, definitely an unusual outcome and perhaps a commentary on general risk attitudes being heightened.

 

As to the dollar, it should be no surprise that NOK (-0.6%) is the G10 laggard given oil’s declines, but other than that and AUD’s gains, the rest of the G10 is split with modest gains and losses, although the euro (-0.2%) seems to be feeling a little heat from those lousy German numbers.  In the EMG space, though, there is a lot more dollar buying evident with both APAC and EMEA currencies under pressure.   Part of this movement seems to be related to some softer CPI prints encouraging the belief that interest rate rises are less likely, and part of this seems to be a bit of risk-off sentiment.

 

And that’s all there is today.  There is no US data to be released and, of course, the Fed is in their quiet period ahead of next week’s FOMC meeting.  As such, when it comes to the dollar, I expect that its recent underlying strength will remain barring a complete reversal in risk sentiment.

 

Good luck

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The Issuance Tap

Posted on by

The Saudis thought oil was cheap

So, figured that they’d rather keep

More stuff in the ground

And in a profound

Move, cut back production quite steep

 

 

Meanwhile now the debt ceiling’s gone

The Treasury’s set to turn on

The issuance tap

To refill the gap

In finance that started to yawn

 

The biggest story over the weekend was the Saudi’s decision to cut oil production by 1 million barrels per day as they are concerned the pending recession is going to further destroy demand and so are aiming to keep prices supported.  No other OPEC+ members joined with the Saudis as it seems they all want the money.  And who can blame them?  Not surprisingly, oil prices are firmer this morning, up nearly 2%, but remain far below levels seen prior to the last OPEC+ production cut when WTI was pushing $80/bbl.   However, if we look back to pre-covid times, oil was trading a full $10/bbl lower than the current level of ~$73/bbl.  In the interim, we have seen significant structural changes in the oil market, and I continue to expect these changes to force prices higher over time.

 

First, the election of President Joe Biden led to an immediate change in US energy policy with a destruction in production capabilities in the name of global warming.  Second, the Russian invasion of Ukraine and the ensuing sanctions on Russian oil (and NatGas) exports have helped reduce the amount of energy molecules available to be used worldwide.  Add to this the longer-term lack of energy infrastructure investment given the ESG push for the past decade, and the supply side of the equation does not look robust. 

 

On the demand side, however, things are likely to continue to trend higher for the foreseeable future.  Despite trillions of dollars of investment in alternative sources of energy, namely wind and solar, fossil fuels continue to represent more than 80% of total energy usage worldwide.  As well, every advancement in civilization throughout history has been driven by access to cheaper energy, and all those nations that we currently call emerging markets are quite keen to continue to advance their economies to the benefit of their populations.  They are far less concerned about global warming than they are about better living standards.  According to the IEA’s most recent forecasts, 2023 will set yet another record for oil demand regardless of the recession calls and the war in Ukraine.  Ultimately, this supply/demand imbalance is going to resolve toward higher prices still.  Mark my words.

 

As to the other discussion making the rounds in markets this morning, the upcoming deluge of Treasury security issuance, there are many claiming that this may have a significant impact on risk asset pricing, notably equities.  The idea is that as the Treasury refills its TGA (checking account) with up to $500 billion to get it back to its more normal balance, it will draw liquidity from potential equity investors who decide that earning a risk-free 5+% on their money is quite attractive, thus reducing demand for stocks.  However, this is a more nuanced discussion as there are other features in the money markets that will be impacted as well, and that are likely to offset a significant portion of that impact.

 

On the surface, that argument has validity, but digging a bit deeper is worthwhile to get a better understanding here.  The Fed runs a Reverse Repo program (RRP), where they essentially pay a small subset of investors to hold their securities at the Fed funds rate.  This program currently has about $2.2 trillion in it and is widely used by Money Market funds as an investment.  And that money in the RRP program is stuck at the Fed and not available for other investment.  However, T-bills have been yielding higher than Fed funds, and it is expected that those same Money Market funds will be snapping up the newly issued T-bills while running down their RRP balances, thus absorbing a great deal of the new issuance.  If this is the case, it will reduce the amount of available risk-free assets to which the equity investors described above will have access.  In other words, the feared demand drain is likely to be far smaller than the $1 trillion that has been bandied about lately.  Do not count on this as a rationale for equity weakness, although that doesn’t mean there are no problems ahead.

 

And, as we begin another week, those are really the noteworthy stories around.  After Friday’s blowout NFP number of 339K new jobs with a revision higher in the previous months, US equities took off and had a big day.  That has mostly been followed by Asia, which saw strength almost everywhere (mainland China being the most prominent exception) although Europe has had a less robust session today.  Arguably, that is because the Services PMI data in Europe released this morning was softer than expected across the board, and they had already reacted to the US payroll data on Friday as those markets were open during the release.  Meanwhile, US futures are either side of unchanged this morning, clearly not feeling any additional love from the payroll story.

 

Of more interest is the fact that bond yields are higher around the world this morning, with Treasuries (+5.4bps) seeing selling pressure along with all of Europe (Bunds +7.2bps, OATs +7.0bps, Gilts +5.8bps, BTPs +8.1bps) as it seems the flood of issuance due from the US is being felt everywhere.  After all, given the dollar’s recent trend higher, which is very evident today, for non-USD investors, higher yielding Treasury securities are likely to be very attractive. As to domestic investors, selling ahead of significant issuance is a time-honored tradition.

 

Aside from oil, metals markets are under very modest pressure this morning, which has more to do with the rising dollar than anything specific to those markets.

 

And speaking of the dollar, it is on top of the world yet again this morning, rising against all its G10 counterparts and almost all its EMG counterparts.  SEK (-1.1%) is the worst G10 performer, after its PMI data was substantially worse than forecast with the Composite index tumbling to 47.6, a level only ever achieved during Covid, the GFC and the Eurozone banking/bond crisis.  In other words, things don’t look too good there.  But even NOK (-0.55%) is under pressure despite the strong rally in oil.  This is unadulterated USD strength.  Similarly, EMG currencies are all under pressure save ZAR (+0.6%), which seems to have responded positively to news that there would be reduced blackouts going forward. 

 

On the data front, there is not very much this week, so activity is likely to be driven by other markets given the FOMC is in their quiet period.

 

Today

Factory Orders

0.8%

 

-ex Transport

0.2%

 

ISM Services

52.4

Wednesday

Trade Balance

-$75.5B

Thursday

Initial Claims

237K

 

Continuing Claims

1802K

Source: Bloomberg

 

And that’s really all we’ve got for today.  To me, the biggest risk to markets is the fact that US equity performance is entirely reliant on 7 companies, all of which are very good companies, but whose performance has been extraordinarily outsized and does not seem representative of the economy or market as a whole.  At some point, those stocks are likely to come back to earth and that will result in a very large adjustment to views about the Fed, the economy, and the stock market.  But for now, it is hard to fight the trend, and that includes the dollar higher trend.

 

Good luck

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