Monthly Archives: June 2023

Worries Now Past

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With debt default worries now past

And jobs data set for broadcast

Risk preference has grown

As folks want to own

The highest of flyers, and fast

 

 

Meanwhile, the idea that the Fed

Will raise rates this month is now dead

Inflation is sliding

And pundits are chiding

Those who think price gains are widespread

 

In what can only be surprising to those who traffic in fear porn, the Senate passed the debt ceiling bill, and it heads to President Biden’s desk today for his signature and enactment.  This outcome was always going to be the case, especially once the House passed its debt ceiling increase bill.  All the histrionics about the president’s unwillingness to negotiate were simply part of the theater that goes with the current form of politics.  However, there were enough people who bought into the drama and created hedges so that this outcome has had a market impact.  You may recall that there were fears of a US debt default and if that were to occur, equity markets would sell off sharply.  And that is likely very true, if the US were to default on its debt, that is what would happen.  However, as I wrote from the beginning, that was a highly unlikely outcome.  Nonetheless, yesterday did see a rally in equity markets in the US with the rest of the world following suit overnight.  Risk is back baby!

 

Meanwhile, we got further confirmation that the Fed is going to pause skip a rate hike this meeting and the Fed funds futures market has now fallen to a 25% probability of any movement.  One of the interesting things about this ongoing repricing is that the data is not showing any signs of a slowdown that would help reduce inflationary pressures.  For instance, yesterday’s ADP Employment data was a much stronger than expected 278K, beating forecasts by more than 100K, while Initial Claims data continue to slide from their recent peak in March.  In other words, as we await today’s NFP data, the latest data points show continued strength in the US labor market.  Helping that story was the employment sub index of the ISM report, which while the headline remains weak at 46.9, saw the employment index rise to 51.4.  In other words, companies, at least manufacturing companies, are still looking for employees.

 

So, what is on the cards for today?  Here are the latest median forecasts according to Bloomberg:

 

Nonfarm Payrolls

195K

Private Payrolls

165K

Manufacturing Payrolls

5K

Unemployment Rate

3.5%

Average Hourly Earnings

0.3% (4.4% Y/Y)

Average Weekly Hours

34.4

Participation Rate

62.6%

 

Certainly, none of this data is vaguely representative of a recession, at least in the traditional definition, where growth turns negative, and Unemployment rises sharply.  While Powell and company may skip a hike this meeting, looking at this data, as well as at the fact that the inflation data, whether CPI or PCE, continues to run well above their target, even if that target is an average, certainly does not indicate the Fed is done hiking.  And remember, while we had all gotten quite used to the idea that interest rates at 0% or 1% were the norm, that is not the long-term reality.  Going back to 1970 (all the data I have), the average Fed funds rate has been 4.92%, essentially where we are today, with a peak of 20.0% in March 1980 and of course a floor of 0.0%, which was the level until the recent hiking cycle for the bulk of the previous 13 years. 

 

My point is that anticipation of the Fed stopping because Fed funds are so much higher than they were for the last decade is a serious mistake.  Rates can go much higher, and at this point, as long as the Unemployment rate remains at or near its current level, all the evidence of this Fed points to higher rates in the future.  In fact, it has been this thesis that drives my dollar expectations for continued strength because I believe the US economy is far better placed to handle higher rates than are most others, and these high rates will continue to support the greenback.  Once again, this is why I continue to believe the NFP data is far more important than CPI, as NFP will be the trigger for a policy change, not CPI (or PCE).

 

As we await the data, the market is clearly in a good mood.  As mentioned above, equity markets worldwide have rallied nicely with every virtually every major market higher by 1% or more (the Hang Seng jumped 4% last night on rumors of further Chinese government support for its still faltering economy.)  Naturally, US futures are also pointing higher this morning as well, with all three major indices up at least 0.5%.

 

Meanwhile, bond yields have edged higher this morning with Treasury yields up less than 1bp while European sovereigns are seeing yields creep up 2bp-3bps.  This has all the feel of a risk-on move with investors moving from fixed income to equity investments at the margin.  After all, no US default combined with a Fed pause skip is as good as it gets!

 

In a reversal of recent moves, commodity prices are feeling quite frisky this morning with oil (+1.5%) and copper (+1.5%) both benefitting from the same story that helped the Hang Seng, further Chinese stimulus on the way.  Meanwhile, gold (+0.1%) is holding onto yesterday’s sharp gains as the dollar is under pressure this morning.

 

Speaking of the dollar, despite my medium-term view of pending strength, it is definitely on its back foot this morning. The bulk of the G10 is firmer, with the highest beta currencies leading the way (SEK +0.85%, AUD +0.75%, NOK +0.6%) as commodity strength feeds through the market.  In addition, there is a growing belief that the RBA may have one more hike in them if data continues to show strength.  In the emerging markets, the story has largely been the same with almost the entire bloc firmer vs. the dollar led by KRW (+1.25%) and ZAR (+1.0%).  The rand story is clearly a commodity one, while the won story is in sync with the Chinese stimulus idea given how dependent South Korea is on Chinese growth.  I should note the renminbi has also rallied about 0.5% this morning on that very same story.

 

And that’s really it.  At this point, all we can do is wait for the labor market data to be released.  Until then, don’t look for any movement of note.  If we see another strong NFP print, something like last month’s 253K, I expect that the dollar should benefit and reverse some of its overnight losses, although equities may very well remain supported on the soft landing scenario that continues to reappear.  FWIW, this poet sees continued NFP strength for now, but we shall see shortly.

 

Good luck and good weekend

Adf

 

This Time They’ll Skip

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Twas clearly much more than a quip

When several Fed speakers did flip

The narrative’s tune

‘Bout rate hikes in June

Implying that this time they’ll skip

 

However, don’t think that they’re done

As they know that in the long run

Inflation’s not dead

And Jay Powell’s said

They’ll not stop til this battle’s won

 

We learned some important new things yesterday regarding the economy and the Fed’s current reaction function, namely that the Labor market continues to be pretty hot and, more importantly, that despite that fact, the Fed is almost certainly going to forego a rate hike this month.  Regarding the Labor market, yesterday’s JOLTs Job Openings data printed back above 10 million openings after a dip below that level in the previous two months indicated that there was less labor demand.  This is crucial because the Fed clearly watches this number closely as part of their employment situation dashboard, and more openings implies more wage pressure higher, the key thing Powell and friends are trying to ameliorate.  After the release, stocks, which had opened lower already, fell a further 0.5% as expectations for a 25bp rate hike in two weeks rose further.

 

But never fear, when it comes to supporting financial markets, the Fed is always there to help and yesterday was no different than normal.  While, as noted yesterday, non-voter and uber-hawk Loretta Mester was clear she saw no reason to pause, we subsequently heard from two other Fed speakers, Philadelphia’s Patrick Harker and Governor (and vice-chairman select) Phillip Jefferson, that now would be a good time to pause skip a meeting and look around at how the already 500 basis points of rates hikes are impacting the economy. 

 

“I am in the camp increasingly coming into this meeting thinking that we really should skip, not pause, but skip an increase.  A pause would mean the Fed is going to hold its policy interest rate steady for a while.  It is too soon to make that call,” explained Harker at the OMFIF* Economic and Monetary Policy Institute. [emphasis added]

 

Meanwhile, Philip Jefferson explained, “a decision to hold our policy rate constant at a coming meeting should not be interpreted to mean that we have reached the peak rate for this cycle.  Indeed, skipping a rate hike at a coming meeting would allow the Committee to see more data before making decisions about the extent of additional policy firming.” [emphasis added]

 

Rounding out the guidance was an article from the Fed Whisperer, the WSJ’s Nick Timiraos, highlighting these two speeches and clearing any doubt that a rate hike on June 14th is a dead issue.  So, summing things up, the Fed is going to hold fire in two weeks but fully well expects to tighten policy further starting in July unless something really significant occurs.  It should be no surprise that the Fed funds futures market has adjusted its pricing to a 30% probability of a hike in June (down from ~65% yesterday morning) and an additional 45% probability of one by July.  I am confident, that barring a remarkably strong NFP number on Friday, that we will see that June probability shrink even further, likely to around 20%.

 

How will this impact markets?  Well, yesterday saw the first equity weakness in a while, although US markets only fell about -0.6% on the day.  However, we are already seeing a rebound as Asian markets were broadly higher, albeit not dramatically so, and we are seeing real strength in Europe this morning with the DAX higher by more than 1.1% and leading the way.  The interesting thing about Europe is that early this morning we saw the PMI Manufacturing data releases and it was not a pretty picture.  Germany (43.2) was the laggard, but the Eurozone as a whole (44.8) was hardly something to write home about.  In fact, these PMI readings have been sub-50 since last July, a pretty strong indication of a recession.  Adding to the dysfunction was German April Retail Sales, falling -8.6% Y/Y, back to Covid levels, and before that, last seen in 1980!  Arguably, this ongoing weakness in economic data is going to stay Madame Lagarde’s hand when it comes to the ECB’s policy tightening.  The combination of lower headline CPI data and clearly weaker economic activity will make any more rate hikes, especially in the face of a Fed that is not hiking this month, much more difficult.

 

As to bond yields, this morning they have stabilized after their recent sharp declines.  Right now, we are looking at slightly higher yields, on the order of 1bp to 2bps, which seems to be merely a trading reaction to the previous week’s decline of 18bps.  With the House having passed the debt ceiling bill last night (it now moves to the Senate), that market drama seems to have ended so I expect we will get back to talking about the economy and the Fed again, as well as, of course, inflation.

 

Oil prices (-0.4%) are continuing their downward slide as regardless of any supply questions, this market sees demand as cratering as we head into a recession.  It is, of course, this price action, that has the deflationistas back crowing again about the inevitable collapse of CPI and how the Fed will need to reverse course quickly.  I am not in that camp, but only time will tell.  Meanwhile, gold (+0.25%) and copper (+2.3%) are telling a different story, especially copper.  It is hard to make sense of a rising copper price, the metal most closely associated with economic activity, and a simultaneous decline in oil.  But hey, nobody ever said markets made sense.  This will resolve itself at some point, but clearly not today.

 

Finally, the dollar is a non-event today, with about half the G10 and EMG blocs rising and the other half sliding, none more than about 0.3%.  Movement like this is hard to define as anything more than position adjustments and trading activity with no real catalysts seen.

 

On the data front, we get a bunch of releases today as follows:

 

  • ADP Employment 170K
  • Nonfarm Productivity -2.4%   
  • Unit Labor Costs 0%    
  • Initial Claims 235K   
  • Continuing Claims 1800K
  • ISM Manufacturing 0
  • ISM Prices Paid 3

 

The ADP number is a day late due to the Memorial Day holiday on Monday, but I cannot help but look at the productivity and ULC data and consider how negative that is for the economy writ large.  As well, we hear again from Patrick Harker, the last scheduled speaker before the FOMC meeting on the 14th.  Of course, we heard his views yesterday so I doubt there will be anything new.

 

A skip is not a pause, and I believe that the Fed will not be deterred from their mission at this stage.  This means that the market will continue to price in tighter Fed policy and the dollar is likely to benefit accordingly.

 

Good luck

Adf

 

 

 

*OMFIF is the Official Monetary and Financial Institutions Forum, a think tank devoted to banking and central banking.  I, too, have never heard of this before.