Monthly Archives: August 2023

Further Downhill

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The data from China is still
Desultory and likely will
Result in support
In order, quite short,
Lest Xi’s plans go further downhill

Perhaps, though, he’ll find a reprieve
If Jay and his brethren perceive
Employment is slowing
And risks are now growing
Recession they’re soon to achieve

Poor President Xi.  Well, not really, but you have to admit his plans for widespread prosperity in China have certainly not lived up to the hype lately.  Last night, PMI data was released, and like the Flash PMI data we saw last week in Europe and the US, it remains quite weak.  Specifically, Manufacturing PMI printed at 49.7, slightly better than expectations but still below the key 50.0 level.  Non-manufacturing PMI printed at 51.0, continuing its slide toward recession and indicative that there is no strong growth impulse coming from any portion of the economy there.

Remember, manufacturing remains a much larger piece of the Chinese economy (28%) than that of the US economy (11%), so weakness there is really problematic for the overall economic situation.  And while the PBOC continues to try to prevent excessive weakness in the renminbi, Chinese exporters clearly need the support of a weaker currency to thrive.  Finally, given the slowing economic situation in Europe, which is now China’s largest export market, demand for their products is simply weak.  

To date, the Chinese government has not really provided substantial support to the economy, certainly there has been no fiscal ‘bazooka,’ and monetary efforts have been at the margin.  In the current environment, it remains hard to make a case for China’s natural rebound until the rest of the global economy rebounds.  And woe betide Xi if (when) the US goes into recession.  Things there will only get worse.  The FX market is uninterested in the PBOC’s views of where USDCNY should trade, maintaining a 1.5% dollar premium vs. the daily fixing rate.  At some point, the PBOC is going to have to relent and USDCNY will go higher, in my view to 7.50 or beyond.

Speaking of recession, while the Atlanta Fed’s GDPNow forecast for Q3 is at 5.90% (a remarkably high number in my view), yesterday we saw Q2 GDP revised lower to 2.1%, with the Personal Consumption component falling to 1.7%.  At the same time, Gross Domestic Income (GDI) in Q2 was released at +0.5%, substantially lower than GDP.  (GDI and GDP are supposed to measure the same thing from different sides of the equation.  GDP represents expenditures while GDI represents income.  Eventually, they must be equal, by definition, but the estimates until all the data is finally received can vary.  In fact, looking at GDI, it was negative in Q4 and Q1 and is just barely growing now.  This is another reason many are looking for a US recession soon.) 

In this vein, Richmond Fed president but non-voter, Raphael Bostic, in a speech overnight in South Africa said, “I feel policy is appropriately restrictive.  We should be cautious and patient and let restrictive policy continue to influence the economy, lest we risk tightening too much and inflicting unnecessary economic pain.  However, that does not mean I am for easing policy any time soon.”  So, this is not exactly the same message we heard from Chairman Powell last week, but the caveat of not cutting is certainly in line.  I suspect, especially if we start to see weaker labor market data, that more FOMC members are going to feel comfortable that rates have gone high enough.  At least that will be the case as long as inflation remains quiescent.  However, if it starts to pick up again, that will be a different story.

Ok, let’s look at the overnight session.  It should be no surprise, given the Chinese data, that equity markets there were underwater, with losses on the order of -0.6% in Hong Kong and on the mainland.  However, the Nikkei (+0.9%) was the star performer across all markets on the strength of strong Retail Sales data.  As to Europe, the DAX (+0.5%) is managing some gains, but the rest of the space is little changed on the day.  It seems the CPI data that has been released from Europe, showing higher prices in Germany, France and Italy despite weakening growth has raised concerns about another ECB rate hike.  As to US futures, at this hour (7:30) they are little changed to slightly higher.

Bond yields are falling today, especially in Europe where they are lower by about 5bp-6bp across the board.  It seems that there is more concern over the growth story, or lack thereof, than the inflation story right now.  In the Treasury market, yields are lower by 2bps as well, although remain well above the 4.0% level.  This has been a response to yet another weak headline labor number with yesterday’s ADP Employment figure reported at 177K.  It seems that the huge revision higher to the previous month, a 47K increase, was ignored.  However, this is setting the stage for tomorrow’s NFP, that’s for sure.

Oil prices (+0.8%) continue to rebound after another huge inventory draw last week and despite concerns over an impending recession.  Gold (+0.1%) has been performing extremely well given the dollar’s rebound, but the base metals remain recession focused, or at least focused on Chinese weakness, and are under pressure again today.

Finally, the dollar is firmer this morning, with only the yen (+0.2%) gaining in the G10 bloc as even NOK (-0.65%) is falling despite oil’s rally.  In fact, this move looks an awful lot like a risk-off move, especially when considering the rally in Treasuries, except the equity market didn’t get the memo.  In the emerging markets, the situation is similar, with many more laggards than gainers and much larger movement to the downside.  ZAR (-0.75%) is the worst performer followed by HUF (-07%) and CZK (-0.6%) although the entire EEMEA bloc is down sharply.  However, these currencies are simply showing their high beta attachment to the euro, which is lower by -0.5% this morning.  Again, given the data from Europe, this can be no surprise.

On the US data front, this morning brings the weekly Initial (exp 235K) and Continuing (1706K) Claims data as well as Personal Income (0.3%), Personal Spending (0.7%), the all-important Core PCE (0.2% M/M, 4.2% Y/Y) and finally Chicago PMI (44.2).  Yesterday’s data was soft and if that continues into today’s session, I suspect the ‘bad news is good’ theme will play out.  That should entail a further decline in yields and the dollar while equities continue higher.  However, any strength is likely to see the opposite.  Remember, too, tomorrow is the NFP report, so given the holiday weekend upcoming, it seems likely that positioning is already quite low and trading desks are thinly staffed.  In other words, liquidity could be reduced and moves more exaggerated accordingly.  However, until we see that recession and drop in inflation, my default view remains the dollar is better off than not.

Good luck

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Singing the Blues

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For Jay and his friends at the Fed
What they’ve overwhelmingly said
Is weakened employment
Will give them enjoyment
While helping inflation get dead

So, yesterday’s JOLTS data news
Which fell more than ‘conomists’ views
Was warmly received,
Though bears were aggrieved,
By bulls who’d been singing the blues

In fairness, Chairman Powell never actually said he would revel in a weaker employment picture, but he did discuss it regularly as a critical part of the Fed’s effort to drive inflation back to their 2% target.  And, in this case, more importantly, he had specifically mentioned the JOLTS data as a key indicator as an indication of the still very tight labor market.  With this in mind, it should be no surprise that when yesterday’s number came in much lower than expected, at ~8.8 million, down from a revised 9.2 million (the original print last month had been ~9.6 million), risk assets embraced the news as evidence that the Fed is, in fact, done raising rates.  Now, tomorrow and Friday’s data releases are still critical with both PCE and NFP on the calendar, so there is still plenty of opportunity for changes in opinions.  However, there is no question that the risk bulls have made up their minds and decided the Fed is done.

There is, however, a seeming inconsistency in this bullish thesis.  If the US economy is set to weaken, or perhaps is already weakening, with the jobs data starting to roll over, exactly what is there to be bullish about?  After all, China is clearly in the dumps, as is most of Europe.  While short-term interest rates are certainly likely to fall amid a recession, so too are earnings.  And if earnings are falling, explain to me again why one needs to be bullish on stocks.  I assume that the goldilocks scenario of the soft landing is the current driving force in markets, but that still remains a very low probability in my mind.  

History has shown that since they started compiling this particular labor market indicator in December 2000, peak-to-trough decline, has occurred leading directly to a recession.  This was true in 2001-02 (39% decline), 2008-09 (49% decline), 2020 (23% decline) as can be seen in the chart below, and now we are at the next sharp decline.  Thus far, the decline from the peak in March 2022 has been 27%, so there is ample room for it to fall further.  I merely suggest that if that is the case, things are probably not that great in the US economy, and therefore, are likely to have a negative impact on risk assets.  Keep that in mind as you consider potential future outcomes.

Source data: Bloomberg

The other data yesterday, Case Shiller House Prices and Consumer Confidence did little to enhance a bullish view.  Confidence fell sharply, by nearly 11 points and is not showing any trend higher.  Meanwhile, house prices fell less than expected, only about -1.2%, which has implications for the inflation picture.  After all, housing remains more than one-third of the CPI calculation, and if the widely assumed decline in house prices has ended, that doesn’t bode well for the idea inflation is going to fall further.  

Remember, Chairman Powell was quite clear that one data point would not be enough to change the Fed’s views, and while he is no doubt relieved that some of the job market pressure seems to be receding, he was also quite clear in his belief that rates needed to remain at least at current levels for quite some time to ensure success in their goal to reduce inflation.  The futures markets have reduced the probability of a September rate hike to 13% this morning, from nearly 25% before the data.  There is about a 50% chance of a hike at the November meeting.  It seems premature to determine that inflation is dead, and the Fed is getting set to cut soon, at least to my eyes.  Beware the hype.

As to the overnight session, after a strong US equity day, which saw the NASDAQ rally nearly 2% and the Dow nearly 1%, Asia had trouble following through. At least China had trouble, with virtually no movement there.  Australia rallied nicely, 1.2%, but otherwise, not much action in APAC.  In Europe this morning, there are far more losers than gainers, but the losses are on the order of -0.2%, so not substantial, but certainly not bullish.  The data out of Europe today showed inflation in Germany remains higher than desired, and confidence across the continent, whether consumer, economic or industrial, is sliding.  Not exactly bullish news.  As to US futures, they are ever so slightly softer this morning, down about -0.1% across the board.

In the bond market, it should be no surprise that bonds rallied and yields fell yesterday after the JOLTS data, with the 10yr yield falling 8bps.  However, this morning, it has bounced 3bps and European sovereign yields are higher by between 6bps and 7bps on the back of that higher than expected German inflation data.  The market is still pricing about a 50% probability of an ECB hike in September, but whether it happens in September or October, it is seen as the last one coming.

In the commodity space, oil (+0.5%) continues to hold its own, perhaps seeing support after OPEC member Gabon saw a coup yesterday, potentially reducing supply.  At the same time, we have seen several large drawdowns in inventories as well, so there seem to be some fundamentals at play.  Now, a recession is likely to dampen demand, but right now, the technicals seem to be winning out.  As to the metals markets, gold had a big rally yesterday on the back of declining real interest rates and is retaining those gains this morning.  The base metals are mixed this morning, but essentially unchanged over the past two sessions as the questions about growth vs. supply continue to be probed.

Finally, the dollar is modestly stronger this morning, but that is after a sharp decline yesterday.  With yields falling in the US it was no surprise to see the dollar under pressure.  With yields backing up, so is the dollar.  USDJPY is back above 146 again, having fallen below yesterday, but today’s movements are far more muted than yesterday’s.  As to the EMG bloc, the picture today is mixed with some gainers and some laggards, but aside from TRY and RUB, which are hyper volatile and illiquid, the gains and losses have been smaller.  One exception is ZAR (-0.5%), which fell after news the government ran a record budget deficit in July was released.

ADP Employment (exp 195K) headlines the data today, although we also see a revision of Q2 GDP (2.4%, unchanged) and the Advanced Goods Trade Balance (-$90.0B).  There are no Fed speakers on the calendar, so that ADP data will likely be the key for the day.  A weak print there will reinvigorate the Fed has finished debate, while a stronger than expected print may well see much of yesterday’s movement reversed.  With that in mind, remember that the past two months have seen very strong ADP numbers that were not matched by the NFP data, so this is likely to be taken with a little dash of salt.

We are clearly in a data dependent market right now as all eyes focus on this week’s news.  I need to see consistently weak data to alter my view that the Fed is going to step off the brakes, and it just has not yet appeared.  Until then, I still like the dollar.  

***Flash, ADP just released at 177K, with revision higher to last month’s number.  Initial move in equity futures is +0.2%, but there is a long time between now and the close.

Good luck

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No Certitude

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The efforts from Xi haven’t yet
For locals, their appetites whet
So, more were announced
And equities bounced
But still there is just too much debt

Meanwhile, elsewhere things are subdued
As traders have no certitude
‘Bout data this week
And if it will wreak
More havoc on everyone’s mood

As the week progresses, we will get a raft of data culminating in Friday’s payroll report.  But for now, the market is looking elsewhere for its catalysts and China continues to provide fodder for the trading community.  Last night, the news hit that Chinese banks were going to be reducing their mortgage rates for mortgages on first homes by up to 60 basis points in order to help support domestic consumption.  At the same time, they are also likely to reduce deposit rates by between 5bps and 20bps as they try to maintain their lending margins, but net, it appears the move should free up some cash for the Chinese consumer.

This should certainly be a positive for the nation’s economy and the equity market in China responded accordingly, with the CSI 300 rallying 1.0% while the Hang Seng jumped nearly 2.0%.  However, Xi’s actions continue to be small beer, tweaking policies at the margin, while he apparently remains adamantly opposed to any broad fiscal stimulus.  Now, in the long-term, this is probably a pretty sensible move for China as they already have a massive amount of debt outstanding, especially in the property market, and if national debt were piled on top, it could lead to much worse long-term outcomes.  However, in the short run, a 50bp cut in mortgage rates is unlikely to change consumption patterns by very much, and more domestic consumption is what they need.  This is especially true given the ongoing economic weakness in Europe, which has become their largest trading partner.

While Xi continues to fiddle with minor policy adjustments, the PBOC is desperately trying to prevent more severe weakness in the renminbi.  Last night, for instance, they fixed USDCNY at 7.1851, far below the market’s calculated expectations and 1.65% lower than the market is actually trading.  Remember, the onshore rules are that spot can only trade within a +/- 2.0% band compared to that CFETS fix, and it has been pushing that boundary for a while now as can be seen in the chart below (source Bloomberg):

The spread between the blue and orange lines continues to increase, but more importantly, the trends are moving in opposite directions.  Given how close the spread already is to the 2% limit, it appears that there is the potential for some fireworks in the future.  At this point, I cannot see how the PBOC will not ultimately allow a weaker CNY.  This is especially true if (when?) the Fed raises the Fed funds rate again.  Nothing has changed my view of 7.50 and beyond.

But, away from the ongoing recalibrations in the Chinese financial systems, there is precious little else on which to focus.  Generally, markets seem to have absorbed the idea that the Fed may continue to tighten further and remain resolutely bullish on risk.  It seems that the no-landing scenario is the current market fave.  And so, last night aside from the Chinese share gains, we saw green everywhere else as well, just not nearly as excited with rises on the order of 0.2% to 0.5%.  In Europe, it is also a positive morning with most gains relatively modest, of the 0.3% variety, with only the FTSE 100 (+1.45%) showing more substantial gains as the UK catches up with yesterday’s rally after their bank holiday.  Alas, US futures are actually leaning slightly negative this morning, but only just, as traders await the first pieces of data this week.  I would contend that the JOLTS data (exp 9.5M) is the most important as a key jobs indicator frequently mentioned by Powell, but we also see Case Shiller Home Prices (-1.60%) and Consumer Confidence (116.0).  Things pick up a bit tomorrow with ADP and then GDP on Thursday ahead of NFP on Friday.

In the bond market, lackluster describes things quite well with Treasury yields higher by 1 basis point and even lesser moves across the European sovereign space.  JGB’s, meanwhile are starting to drive a bit lower, but continue to hang around near 0.6%.  Traders and investors are awaiting this week’s data now that they have absorbed the Fed commentary.  If we see a surprisingly strong NFP print, do not be surprised to see yields back up toward their recent highs of 4.35% as many will assume at least one more hike is coming soon.  Correspondingly, a soft print will likely see a test of 4.00%, at least initially.

Oil prices continue to hold their own, perhaps getting a boost from the China story as any stimulus there is welcome and seen as a fillip for demand.  Metals prices, which had been a touch firmer earlier in the session, have given up those modest gains and at this hour (8:00), are basically flat on the day.

Finally, the dollar is mixed to slightly stronger this morning, but overall movement has been muted, like all the other markets.  While NOK (+0.15%) is managing some gains on oil’s strength, the rest of the G10 bloc is a touch softer, although other than JPY (-0.3%), which has managed to trade above 147 this morning, the movement is tiny.  In the EMG bloc, there is a more mixed view, but none of the movement is very large in either direction, with the biggest gainers and losers at +/- 0.3% on the day, effectively nothing in this space. Here, too, all eyes are on the data this week.

The only Fed speaker today is Michael Barr, and he is talking about banking services, with no policy discussions expected. Adding it all up leads to a conclusion of a pretty quiet session overall unless today’s data is dramatically surprising.  Remember, though, quiet sessions are good days to hedge.

Good luck

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Still Avante-Garde

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As always, when Chairman Jay speaks
Each hawk and each dove caref’lly seeks
The words that best suit
Their story, and mute
All others with varied techniques

Every hawk in the market heard these words, right at the beginning of Powell’s speech Friday morning and rejoiced [emphasis added], “we are prepared to raise rates further if appropriate, and intend to hold policy at a restrictive level until we are confident that inflation is moving sustainably down toward our objective.”

However, the doves didn’t need to wait long to find their counterpoint, with Powell giving them fodder in the very next paragraph, [emphasis added], “given how far we have come, at upcoming meetings we are in a position to proceed carefully as we assess the incoming data and the evolving outlook and risks.”

So, which is it?  Here is the link to the speech, so you can make up your own mind if you so choose but be prepared, if you listen to the punditry, you will hear both sides and likely no clear decision.  With that in mind, my take is that there is still far more hawkishness than dovishness around the table at the Eccles building.  Much of the speech focused on the fact that while things were certainly better than the peak inflation period last year, there is still a long way to go before they feel confident they have achieved their goal.  And one other thing, Powell made it clear that the goal remains 2%.  All this talk of raising the target seems like it will get no hearing at all for the time being.

A quick look at equity markets on Friday shows that the initial impression of the speech was the hawkish view as stocks fell pretty sharply right away.  However, after falling about 0.7% in the first hour, buyers returned, and the major indices all closed nicely higher on the day.  Of course, the irony of that outcome is higher equity prices beget easier financial conditions which implies even more tightening by the Fed.  But whatever.

Then later, said Madame Lagarde
This job that we have is so hard
The future’s unclear
And though we’re sincere
We’re clueless, though still avant-garde

Much later Friday, Madame Lagarde explained her updated framework for how the ECB is going to be handling things in the future.  The very best thing she said was that they would act with humility as they proceed.  And while it would be great if that were to be the case, my 40 years of experience tells me it is unlikely to work out that way.

The essence of her speech was to identify that the world has changed and that old economic relationships may no longer be viable.  As I have written many times about all the central banks, each of them has a series of econometric models by which they steer their course.  The problem is those models have over time been proven to be completely worthless.  And more disturbingly, anytime someone with a different viewpoint has a chance to be nominated to enter the club, they are shot down immediately.  There is virtually zero willingness to truly think outside of the box of their making.  While Lagarde preaches that they will be humble going forward, it seems highly unlikely they will consider anything that is not completely orthodox, even as a thought experiment.  And to my mind, that is the exact opposite of humility.

At any rate, Lagarde’s speech was very late in the market day and did not seem to have much impact at all.  Thus concludes the recap from Friday’s activity.  Now let’s turn to this morning.

In China, old President Xi
Keeps trying to force, by decree
A rally in stocks
By banning sales blocks
And halving the transaction fee

While it is getting tiresome to have to write about China yet again, it remains the other major story in the markets.  Last night, the government unveiled yet another set of measures to try to support the stock market there with only marginally more success than seen last week.  (As an aside, does it seem strange to anyone else that a communist country with state control over most aspects of life is keen to support the bastion of capitalism that is a stock market?).  

The latest effort included three steps; a 50% cut in the transaction tax, down to 0.05%; a limit on new listings (to prevent more supply); and a ban on sales by controlling shareholders if those companies have not paid dividends in the past three years or are trading below their IPO price.  These were announced before the market opened and the initial response was a 5.5% jump compared to Friday’s closing levels in the CSI 300.  Alas, it was a very short-lived gain with half that evaporating in the first 10 minutes of trading and the end result a gain of only about 1% on the day.  Certainly, better than a decline, but clearly not what President Xi had in mind.

Ultimately, the problems in China go far beyond the level of stamp duty on stock trades.  There are fundamental problems in the economy’s structure as well as the demographic and debt overhangs that exist there.  Despite the much ballyhooed efforts by Xi to adjust the Chinese economy away from its mercantilist economic model, that is still the predominant process there.  It is with this in mind that I continue to look for a much weaker renminbi going forward, and an eventual move to 7.50 and beyond.  

As to the rest of the equity markets, currently everything is in the green, with Japan having a great day (+1.7%) and all of Europe higher by between 0.50% and 1.00%.  US futures, too, are firmer this morning, although only just at this hour (7:20), about 0.2% across the board.  As there is a ton of data to come this week, I suspect that traders will be waiting for more information before making their next big bets.

In the bond market, things are quite benign with no major government market having seen a yield change of even 1 basis point this morning.  There are some gainers and some losers, but for all intents and purposes, bonds are unchanged on the day.  The one thing to note, though, is that the US Treasury curve inversion is growing again, back to -86bps, after having traded to as low as -65bps less than two weeks ago.  I feel like this movement simply adds to the confusion over the imminence of a recession, although I definitely believe one is coming by early next year.  Of course, we will learn far more about the economy this week given the data to be released.

In the commodity space, oil is marginally softer this morning, back just below $80/bbl, although there seems to be an increasing effort by OPEC+ to continue to restrict supply as they fear a recession coming.  Metals prices are generally little changed this morning, again, with market behaviors driven by the uncertainty over the week’s upcoming news.

Finally, the dollar is also mixed this morning, with a nice mix of gainers and losers across both the G10 and EMG blocs.  I feel the bias will be for a stronger dollar given my take on Powell’s comments as being hawkish, but as I explained, there was plenty of fodder for both arguments.

Turning to the data, there is a lot this week as follows:

TodayDallas Fed Manufacturing-19.0
TuesdayCase Shiller Home Prices-1.65%
 JOLTS Job Openings9450K
 Consumer Confidence116.2
WednesdayADP Employment 198K
 Advance Goods Trade Balance-$90.0B
 GDP Q22.40%
ThursdayInitial Claims235K
 Continuing Claims1705K
 Personal Income0.30%
 Personal Spending0.70%
 Core PCE Deflator0.2% (4.2% Y/Y)
 Chicago PMI44.1
FridayNonfarm Payrolls168K
 Private Payrolls150K
 Manufacturing Payrolls3K
 Unemployment Rate3.50%
 Average Hourly Earnings0.3% (4.3% Y/Y)
 Average Weekly Hours34.3
 Participation Rate62.60%
 Construction Spending0.50%
 ISM Manufacturing47.0
 ISM Prices Paid44.0

Source: Bloomberg

So, as can be seen there is a ton of stuff to digest this week.  On top of that, we do hear from a few Fed speakers, but I think that given we just got Powell’s views, the data will be far more important than anything from a few regional bank presidents.  While obviously, Core PCE is critical, as it is their key inflation metric, I continue to look at the payroll data as the key for Powell to believe that he has not broken anything yet.  Once that data starts to fade, we can look for a change in tone from the Fed.  But until then, higher for longer remains the key, and the dollar should continue to benefit.

Good luck

Adf

A Gaggle of Bankers

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At altitude 8000 feet
A gaggle of bankers will meet
All eyes are on Jay
And what he might say
Regarding the Fed’s balance sheet

Now, pundits galore have opined
But something we need bear in mind
Is policy tweaks
Are still several weeks
Away, and will like be refined

Well, at 10:00 this morning, Chairman Powell will speak to the world regarding his latest views on “Structural Shifts in the Global Economy.”  At least that is the theme of the entire event where there will be numerous speeches by central bankers including Madame Lagarde later today, as well as papers presented by economists.  The reason this event is so widely discussed is in the past, Fed Chairs have used the forum to signal a shift in policy.  

Is that likely today?  This poet’s view is no, it is unlikely.  The message from the July meeting was that the Fed was still concerned about inflation running too hot and that the higher for longer mantra still applied.  Since then, the data has, arguably, been somewhat better than expected, although certainly not universally so.  At the same time, 10-yr yields are some 40bps higher and the S&P 500 is lower by about 4% since the last FOMC meeting, market moves that indicate investors are listening.  I do not believe Chairman Powell is keen to rock the boat.  As well, I don’t believe he feels the need to imply any major changes are necessary and I have a feeling that he is actually going to speak about the global economy, and not the US one specifically.

Summing up, I have a feeling this is going to be a complete non-event, with no useful information forthcoming, at least from Powell.  As it happens, Madame Lagarde speaks at 3:00 this afternoon NY time, and there is considerably more uncertainty as to the ECB’s path forward given the fact that the economic data in the Eurozone continues to be weak (today, German GDP in Q2 was confirmed as 0.0% Q/Q, -0.2% Y/Y, with Private Consumption also at 0.0% and the Ifo sentiment fell to 85.7, several points below expectations) while inflation remains far above their target.  While the ECB hawks are still claiming it is far too early to consider a pause in rate hikes, the ECB doves have been clear they are ready to stop.  Remember, too, Lagarde is a dove at heart.  It would not be difficult to believe that Lagarde discusses the slowing growth in China and the assumed knock-on effects for Europe as a rationale for expecting inflation to continue to fall without further ECB actions.

But as always, this is merely speculation ahead of the speeches, which is why we all listen.  Away from this meeting, though, investors are demonstrating some concerns about the overall situation, at least as evidenced by recent market activity.

Yesterday, in what was clearly something of a surprise to most pundits, equities sold off sharply in the US, led by the NASDAQ which was down -1.9%.  The surprise comes from the fact that the Nvidia earnings the night before were so strong and the stock rallied sharply on the news.  And this weakness was spread across all the major US indices.  Adding to the confusion was the fact that the US data yesterday generally pointed to more economic growth, with lower Claims data, and a strong Durable Goods -ex transport print with survey data looking up as well.  I guess this is a ‘good news is bad’ situation as continued economic strength informs the idea the Fed is not going to change their stance on higher for longer.

That weakness fed into Asia, where markets were lower across the board led by the Nikkei (-2.05%).  But in Asia, the interesting thing was that China announced, during the session, additional support for the property market by altering some mortgage and tax rules to encourage more home buying as Beijing tries to grapple with the increasing speed of the property implosion.  Alas for President Xi, the positive impact in the stock market lasted…10 minutes only!  After that, selling resumed and all the major indices in Asia finished lower on the day.  Now, European bourses have reversed that trend and are higher by roughly 0.6% across the board, perhaps anticipating a Lagarde ease, while US futures at this hour (7:30) are edging higher by 0.2% or so.

In the bond market, yields, which had fallen sharply earlier in the week, bottomed on Wednesday and are now higher in the US and throughout Europe.  While the move largely occurred in the US yesterday, with a 5bp bounce, and this morning we are little changed, Europe is seeing yields climb by 5bp-6bp across the board today.  The one place where yields remain dull is Japan, which has seen the 10yr JGB hover either side of 0.65% for the past week or two.

In the commodity space, oil (+1.5%) is rebounding again, arguably on the better than expected US data.  This is consistent with firmer prices in base metals, which are rising despite the rise in yields.  Ultimately, what this tells me is that there remains a great deal of uncertainty as to the near future regarding the economy.  The battle over whether a recession is coming soon or never coming continues apace.  The thing about commodities is that the supply piece of the puzzle continues to be undermined (pun intended) by ESG focused investors and governmental actions, and so the ultimate direction remains higher in my mind. 

Finally, the dollar is mixed to slightly stronger this morning, with most of the G10 a touch weaker vs. the greenback except for NOK (+0.4%) which is clearly benefitting from oil’s rally.  In the EMG sector, ZAR (+0.9%) is the outlier on the high side as allegedly traders are betting on increased investment flows to the country in the wake of the expansion of the BRICS nations.  (As an aside, can somebody please tell me why adding Argentina, a nation with a history of hyperinflation and serial debt defaulter, would inspire confidence in a BRICS currency?). But other than the rand, movement in this space has also been limited, arguably with everyone waiting for Powell.

On the data front, just ahead of Powell’s speech, we get the Michigan Sentiment Survey (exp 71.2), but that will clearly be overshadowed by Powell.  While I anticipate very little activity in the market ahead of 10:00, I also anticipate very little after the speech as I don’t believe he is going to change any perceptions at this point.  There is still a lot of data before the next meeting, another NFP, CPI and PCE reading, so it is too early to look for a change.  

Good luck and good weekend

Adf

No Mean Feat

Posted on by 
Nvidia managed to beat
The whispers, which was no mean feat
But PMI data
Revealed that the beta
For growth going forward’s dead meat

The upshot is pundits believe
The market will get a reprieve
Tomorrow, Chair Jay
Could possibly say
That higher for longer’s naïve

Markets have been choppy, if nothing else, for the past 24 hours as we have seen substantial moves in Treasury (and other sovereign) yields, a major rally in gold, and the dollar fall sharply and then regain almost all of its losses.  Oh yeah, equity markets continue to rally as the Nvidia story was even better than hoped by the biggest bulls out there.  Briefly, the chipmaker exceeded earnings forecasts by a large margin and guided Q3 numbers even higher as the CEO explained that things were just getting started in the AI boom.  While he is certainly correct that there will be a lot of investment in the space going forward, it remains an open question as to whether AI will actually change the course of human history.  After all, cold fusion was recently “shown” to work amidst a great deal of hype, and that hasn’t worked out quite like the bulls expected.  

More importantly, there is a long time between now and when AI is going to result in all these great leaps forward, and we need to address the here and now.  And that is where things look a little less wonderful than they did before the week began. 

Typically, the PMI data doesn’t get as much play in the US as it does in Europe and Asia since the US has their own survey, ISM, which is reported at the beginning of each month.  But after a series of weak numbers from Europe yesterday, the US PMI data was much weaker than expected with all three indicators, Manufacturing (47.0), Services (51.0) and Composite (50.4) coming in at least a point lower than estimates and indicating that while perhaps not in a recession, the US growth picture is quite subdued.  

Again, the survey data has been pointing, for some time, to economic weakness that has not yet appeared in many of the hard numbers like NFP or Retail Sales, but the market, at least the bond market, is quickly becoming of the opinion that recession is around the corner.  One need only look at 10yr yields to see the trend.  Yesterday saw 10-yr Treasury yields slide 13bps after touching a new cycle high on Tuesday.  This morning they are largely unchanged, but the day is still young.  But the picture in Europe and the UK is much more substantial, with yields, which had been rising alongside Treasuries have fallen far more sharply.  Since Tuesday’s close, German bund yields are down 19bps, Italian BTP yields have fallen 23bps and UK gilt yields are lower by 13 bps.  The market continues to reduce the terminal rate for the ECB, now below 3.80% and for the BOE, now 5.80%, as economic weakness is clearly the key concern.

Tomorrow, we will hear from Chairman Powell, but also from Madame Lagarde and then Saturday, BOE deputy governor Broadbent will make a speech.  In other words, at this point, markets are quite keen to hear if there is any change in the G3 central bank mindset.  Based on the large retracement in yields, markets are clearly expecting a dovish outcome.  While that is certainly possible, I think there is ample room for the Chairman to maintain the current view of higher for longer absent weakness in real data.

Speaking of real data, yesterday’s NFP revisions were a bit less than the whispers, with 306K jobs removed from the record.  I expect that data was also part of the bond market rally as changes there mean more than the PMI data, at least they have so far.  In the end, the dichotomy between the bond market which is beginning to believe the recession story, and the stock market, which sees no landing at all, is widening.  Commodity markets have been leaning recession, and the dollar has been strong, which would arguably be more in tune with growth than weakness.  In other words, there is no consistency here so we will need to continue to focus on the information as it comes out.

As mentioned, stocks are on fire this morning after the Nvidia earnings with yesterday’s anticipatory US rally matched by Asian gains, especially in HK which jumped >2%, and Europe is all green, but not nearly as aggressively with gains on the order of 0.3% across the board.  As to US futures, on the back of Nvidia, NASDAQ futures are higher by 1.3%, which is dragging the SPX up as well, however the Dow is little changed this morning.  It seems the Dow’s members lack that high tech sense about them.

Turning to commodities, oil (+0.3%) is bouncing off its recent lows although remains under pressure overall on the economic weakness story.  Gold (+0.2%) which exploded higher yesterday by more than 1%, remains in demand, perhaps on the back of the BRICS meeting and some discussion there, while base metals are softer, also on the recession theme.

As to the dollar, it is stronger across the board vs. its G10 counterparts on the day, but if you look at the move over the past two sessions, it is a more mixed picture.  Yesterday morning’s USD strength was reversed in the wake of the PMI and NFP revision data and the dollar fell sharply on the day against virtually all its G10 and EMG counterparts.  This morning, it is back on the way up, against both groupings, leaving an overall mixed picture.

Perhaps this would be a good time to touch on the BRICS meeting.  For those who believe in the end of the dollar, this had to be quite a disappointment given there was virtually no discussion of a new currency.  However, they did invite 5 countries to join, Saudi Arabia, Argentina, Iran, Egypt and Ethiopia, so expansion is real. (I wonder if they are going to change the name!). However, if you are Brazil, India, South Africa, Argentina or Egypt, all democracies with elected leadership, it seems a question that needs to be asked is do they really want to get into bed with a murderous thug like Putin, who coincidentally, had a key rival murdered yesterday.  That is not a very good look.  At any rate, anything that is going on in the BRICS group remains a distant question, at least from a current risk management perspective.  

Meanwhile, the dollar’s fluctuations are going to remain beholden to the perception of the US economy and the Fed.  Yesterday’s weakness was a clear response to declining yields on the weak data.  In the same vein, look for any strong data to help boost the dollar back up.

Speaking of data, today brings a good amount with Initial (exp 240K) and Continuing (1705K) Claims, Chicago Fed National Activity Index (-0.22) and Durable Goods (-4.0%, 0.2% ex transport).  Yesterday’s other data was New Home Sales, which was slightly higher than expected, but after a downward revision to the previous month, so no real net change.

Right now, stocks are the driver, tech stocks in particular, but watch the bond market.  If today’s data hints at weakness, I suspect that yields will fall further as will the dollar.  Of course, that means stocks will probably rally on the lower yield story.  

Good luck

Adf

Lacking In Gains

Posted on by 
The PMI data remains
A place clearly lacking in gains
At least cross the pond
And Asia beyond
But will the US feel those pains?

The hard data hasn’t supported
That weakness, but is it distorted?
The latest we hear
Is NFP’s near
Revisions that show growth’s been thwarted

As market participants look ahead to Friday’s Powell speech at Jackson Hole, and seemingly more importantly to Nvidia’s earnings report and forecasts this afternoon, we must look at a few things that are going on in the economy.  The most noteworthy situation is that there remains, at least in the US, a wide gap between the survey data and the actual data.  We continue to see weak readings from the regional Fed manufacturing surveys, as well as PMI and ISM data, yet the key numbers, like NFP and Retail Sales continue to perform at a better than expected rate consistently.  While we await this morning’s Flash PMI data (exp Mfg 49.0, Services 52.2, Composite 51.5), which are essentially unchanged from last month’s readings and perhaps the best in the G10, there is a story this morning that the NFP data is going to be revised down by 650K jobs at the preliminary revisions today.  That is a huge adjustment and one that would certainly call into question the ongoing strength in the labor market.

It is not yet clear if it will impact the Unemployment Rate but if this story is accurate, it will almost certainly impact some of the thinking at the Eccles Building.  Consider that, after revisions, the seven NFP numbers have totaled 1807K so far this year, with the last two months showing 185K and 187K respectively.  If that 650K number is correct, and it comes from the past two months, then they will be revised into negative territory, a very different indication than anyone has considered to date.  However, even if it is more evenly spread across the year, it still represents more than one-third of the alleged jobs created.  This feels important to me.  While I have no way of determining if this story is accurate, it is important to understand it is making its way through the markets.  If this is the case, I would expect that the market’s view on the economy, as well as the Fed’s is likely to change somewhat.  

Arguably, the market response would be to alter pricing for interest rates going forward with more rate cuts priced in and priced in sooner than the middle of next year.  At the same time, though, former St Louis Fed President Bullard was interviewed by the WSJ yesterday and was crowing about how the market got the recession call wrong and the economy is doing much better than expected.  These diametrically opposed views are the norm in the markets these days, with no clear consensus that things are going to improve or worsen.  Again, it is this situation that informs why hedges for natural exposures are so important.

Turning to the other PMI’s released this morning, the story in Europe remains one of desultory growth or outright shrinkage.  The German manufacturing sector PMI printed at 39.1, better than last month’s 38.8, but still deep in recessionary territory.  While the French and Eurozone numbers were a bit better, they were both well in recession territory.  In fact, given the weakness of this data, and the fact that the ‘hard’ data in Europe has also been soft, the new narrative is the ECB is finished.  What had been a 50:50 probability for a hike in September has fallen to a one-third chance and if we continue to see weaker data, I expect that will fall further.  As to the UK, it also saw weak PMI data, with both Services and Manufacturing below the key 50 level, and the market has pulled back to just two 25bp rate hikes over the next 6 months despite the fact that inflation in the UK remains the highest in the developed world at 6.9% core, while the base rate sits at 5.25%.

It is not hard to look at this data and understand why the dollar continues to perform well.  Despite all the problems in the US, especially regarding the debt and massive interest payments, as well as the recent credit downgrade by Fitch, the US remains the most attractive opportunity around in the G10.  In fact, this is why that story about the massive downward revision in NFP data is so important.  Without it, the distinction is very clear, buy the USD, but if it is true, opinions are likely to change somewhat.

Turning to the overnight session, while most markets managed to do reasonably well in Asia, the mainland equity markets continue to suffer with the CSI 300 down -1.6%.  In Europe, the picture is mixed with some early gains being ceded and only the UK (+0.7%) managing to stay positive while the continent slips slightly into the red.  US futures, meanwhile, are barely in the green as all eyes await the Nvidia earnings after the close.

In the bond market, it is a one-way street with yields falling across the board and in a meaningful way.  Treasuries are actually the laggard with yields only down by 5bps while European sovereigns have seen yield declines of 9bps and UK gilts of 11bps.  Clearly, the bond market is responding to the weak PMI data and anticipating weakness in the US as well.  One other interesting thing is that the yield curve inversion, which had been unwinding for the past week or two, widened again yesterday and is back above the -75bp level, having traded as low as -65bps just a few days ago.

Recession is the view in the commodity space as well, at least in energy, as oil prices (-1.5%) fall again and are now back below the $80/bbl level.  Stories of more Iranian crude making its way to the market as well as fears over reduced demand are having an impact.  Interestingly, the metals markets are holding up this morning with both base and precious varieties all in the green led by copper (+1.0%).  This is a harder outcome to square with the recession fears.

Finally, the dollar is doing quite well this morning, which given the growing risk-off attitude makes some sense.  Vs. the G10, only the yen (+0.25%) has managed any gains, and they are small.  Meanwhile, the rest of the bloc is weaker across the board led by the pound (-0.9%) and NOK (-0.9%) for obvious reasons.  In the EMG bloc, ZAR (+0.5%) is the lone gainer of note after South African data implied better times ahead.  On the flipside, though, weakness is broad based with APAC, EEMEA and LATAM currencies all under pressure amidst the risk sentiment today.

Yesterday’s Existing Home Sales data was a bit softer than expected and as well as the PMI data due, we also see New Home Sales (exp 703K) and that NFP revision.  Clearly, all eyes will be on that last piece of data given the rumors of a large decrease.  So, we will need to see how that comes.  If it is benign, then I expect risk appetite may return as the bulls look for a big Nvidia story this afternoon.  However, if that huge revision appears, I suspect risk will remain in abeyance for now.

Net, nothing has changed the medium-term view of dollar strength, but the day to day remains open to the news.

Good luck

Adf

Alternate Ways

Posted on by 
In Joburg a gath’ring of nations
Is trying to firm up foundations
For alternate ways
That each of them pays
The other with no complications

Meanwhile, we are starting to hear
A story that we should all fear
The calls have come forth
Inflation that’s north
Of two percent’s where Jay should steer

The BRICS nations are meeting in Johannesburg starting today with, ostensibly, a mission to exit the dollar financial system.  While Russia has already done so involuntarily, the biggest proponent of the move is China, although the other nations are certainly willing to listen.  In addition to this goal, they will hear from many other developing nations as to whether these other nations merit inclusion in the BRICS club.

Ultimately, the problem that this disparate group of nations has is that none of them really trust any of the others.  Certainly, the historical conflict between China and India is well-known and long-lasting.  It was not that long ago that their soldiers were shooting at each other in the Himalayas.  At the same time, both Brazil and South Africa are extremely remote from the other nations and have completely different economic and political systems.  In other words, the common ground of wanting to do something about the US and its dollar, while certainly a goal, is unlikely to be enough for any of them to risk potential negative consequences of a failed concept.  

Much will be made of this meeting in the press, but we have already heard from South Africa’s FinMin, Enoch Godongwana, that it is premature for South Africa to stop using the USD and SWIFT system.  Ultimately, my strong belief is this is much ado about nothing, at least for the foreseeable future.  Perhaps in 25 years, after the 4th Turning is complete, the global currency system will be different, but not anytime soon.

Which brings us to the other story which has me far more concerned about the dollar and the US economy, the substantial increase in calls by mainstream economists to raise the Fed’s inflation target.  Understand that I have never been a fan of the target to begin with, recognizing its arbitrary nature.  However, the world in which we live has been predicated on the idea that the Fed is focused on that target and its policies are designed to maintain a relatively low rate of inflation.  Raising that target, with 3% the new favored call, is just as arbitrary as the initial level, but it changes the dynamic in the economy as well as markets.

It seems these calls are coming from the hyper-Keynesians who lean toward MMT and believe that the risk of any economic growth slowdown should be addressed ahead of all other concerns.  (It could be argued that the current administration is quite concerned that a recession next year, heading into the presidential election, would not favor President Biden’s reelection.). Now, nobody is happy when the economy slows down as it makes life difficult for us all, but one of the reasons the nation is in its current situation, with unsustainable levels of debt outstanding, is because the willingness of any politician to allow markets to actually clear (meaning asset prices fall sufficiently to hurt the 1% club) is essentially nil.  This has been the underlying driver of constant spending programs and ultimately, the cause of the ballooning budget deficits and Federal debt.  

The unspoken piece of this concept is that permanently higher inflation will reduce the real value of the outstanding debt that much more quickly, hence allowing for even more deficit spending going forward.  The fact that higher inflation is an effective tax on the bottom 99% of the income brackets, with the pain increasing more rapidly the further down that scale you look, is of no concern it seems.

Thus far, Chairman Powell has been adamant that there is no change to the goal on the table.  But I assure you that the longer it takes for inflation to retreat to its former levels, the more we will hear about this idea.  When I combine this concept with my belief that inflation is going to remain sticky in the 3%-4% range going forward for quite a while, it does not paint a promising picture.  The Fed already has credibility issues; moving the goalposts in the middle of their inflation fight would really destroy any remaining credibility they have, and that would be a real problem for monetary policy activities going forward.

But these problems are far too forward looking for today’s markets.  Instead, the future is…Nvidia!  At least, that seems to be the case right now.  As investors await their Q2 earnings release tomorrow afternoon, the working thesis seems to be that they will beat the currently inflated analyst expectations and drive the next leg of the equity bull market higher.  Now, remember, they currently trade at a 228 P/E ratio, which seems pretty high in the scheme of things, regardless of the promise of AI going forward.  (You can tell AI didn’t write this as I call into question its value here).  There has been much talk of a big ‘beat’ in earnings and that has been the catalyst for today’s equity rally.  Well, that and the fact that the Chinese seem to have instructed their ‘plunge protection team’ to get back to buying Chinese stocks as well as the yuan.  Regardless of the rationale, though, risk is definitely in favor today.

Asian equity markets were higher across the board, with the big ones all higher by just under 1%.  European bourses are similarly situated, all higher by about 1% while US futures, at this hour (7:30) are lagging a bit, only up by about 0.5%, although that was after a pretty solid performance yesterday.  Woe betide the equity markets if Nvidia misses its numbers!

At the same time, bond yields are generally lower this morning with 10yr Treasuries down 2bps from yesterday’s new closing high near 4.35%.  European sovereign bonds have also seen demand with yields sliding between 4bps (Germany) and 7bps (Italy) as a combination of mildly positive UK Public Sector Finance news and a very large Eurozone Current Account surplus seem to have bond investors quite excited.  Asia, however, did not share this excitement with JGB yields rising 2bps and getting to their highest level (0.663%) since the change of policy last month.  

On the commodity front, oil (-0.2%) has edged back below $80/bbl, representing a sharp decline yesterday afternoon after signs of increased supply started to show up in the market.  The metals markets, however, are in much better shape this morning with gold (+0.4%) back above $1900/oz and the base metals both firmer as well.  It seems that mildly lower yields and a weaker dollar are having quite a positive effect.

Speaking of the dollar, it is under broader pressure this morning vs. most of its G10 and EMG counterparts.  In the G10, NZD, AUD and SEK have all gained about 0.5% with NOK +0.4% as commodity prices find some support, and the China renewal story helps the overall global growth story this morning.    While the euro is little changed on the day, the rest of the bloc has edged higher as well.  Meanwhile, in the EMG bloc, ZAR (+1.1%) is the biggest gainer on the day, perhaps getting a little boost from positive BRICS vibes, but more likely from positive commodity vibes.  As to the rest of the bloc, APAC currencies have benefitted from the China story and THB (+0.65%) has benefitted from the resolution of the political crisis with a new PM finally being named.

On the data front, we see Existing Home Sales (exp 4.15M) and Richmond Fed Manufacturing (-10) and we hear from several Fed speakers.  However, with Powell on the calendar for Friday morning, I don’t think a great deal of attention will be paid to any other Fed speaker until he’s done.  There is a strong belief he is going to lay out the policy framework going forward, but I have a suspicion that he is happy with the current ‘guidance’ of higher for longer and may not say much at all.

Right now, risk is to the fore, and as such, the dollar is likely to remain under pressure until that changes.  It may be this way all week, or if Nvidia misses its numbers, don’t be surprised to see the dollar reverse course higher after that.

Good luck

Adf

Simply a Bummer

Posted on by 
As tiresome as it may be
To talk about China and Xi
The doldrums of summer
Are simply a bummer
With nothing else worthy to see

However, come Friday we’ll turn
To Jackson Hole where we should learn
If Jay and the Fed,
When looking ahead,
Decide rate hikes soon can adjourn

The biggest news overnight was that the PBOC cut interest rates again, but this time somewhat less than expected.  You may recall that last week, they cut the 1-yr Lending Facility rate by 15bps in a surprising move.  In fact, this is what started the entire chain of events last week that resulted in China dominating the macroeconomic news.  Well, last night they cut the 1yr Loan Prime rate by a less than expected 10bps with the market looking for a 15bp cut.  And they left the 5yr Loan Prime rate, the rate at which most mortgages in China are priced, unchanged at 4.20% rather than implementing the 15bp cut that the market had anticipated.  The result is that so far, Chinese support for their economy remains tepid at best.

At the same time, there continues to be a grave concern in Beijing regarding the exchange rate as, once again, the daily fixing was far below the market rate, and once again, the renminbi fell anyway.  It has become abundantly clear that the PBOC is quite concerned over a ‘too weak’ renminbi, hence the maintenance of the 5yr interest rate.  As well, it was widely reported that Chinese state-owned banks were actively selling USDCNY in the market to prevent further weakness in their currency.  

Perhaps this is a good time to briefly discuss the concept of the end of the dollar again, a topic that continues to make headlines.  One of the key pillars of this thesis is that the PBOC has reduced the number of dollars on its balance sheet substantially over the past several years which is seen as an indication that they are preparing to support some new reserve asset.  However, as last night’s price action indicated, it is quite possible, if not likely, that the only change has been one of location, rather than amount.  As the PBOC reduced the dollars on its balance sheet, the big state-owned banks all increased the amount on their balance sheets.  So now, the PBOC can direct those banks to intervene on their behalf whenever they want to do something.  At the same time, the PBOC has the appearance of decoupling, something they are clearly trying to demonstrate.  

This week is the big BRICS meeting where the stories are that they are going to unveil a new BRICS currency, allegedly to be gold-backed, as these nations try to undermine US power as well as offer an alternative to non-aligned nations.  The thing to remember about this group of widely disparate nations is that it has never been a cohesive bloc, it was simply an acronym created by a Goldman Sachs analyst in 2001 to describe a group of fast-growing emerging markets.  However, other than China and Russia, which have become closer since Russia’s invasion of Ukraine, they really have very little in common.  They are geographically widely diverse, have very different governing structures as well as very different financial and monetary policies.  In other words, there is nothing to suggest they can act as a cohesive group for any major decision.  While I am certain there will be some announcement of some sort at the end of the conference, an alternative to the dollar will not be coming anytime soon.

As to Jackson Hole, since Powell’s speech isn’t until Friday morning, we have plenty of time to touch on that topic later in the week.  In the meantime, risk is arguably in modest demand this morning.  While Chinese shares suffered significantly overnight on the disappointing rate news, European bourses are all nicely higher, generally between 0.75% and 1.00%.  Too, US futures are firmer this morning by about 0.5% after a late day rally Friday brought the major indices back near unchanged on the day from earlier lows in the session.

At the same time, bond yields continue to rally with 10-year Treasury yields back at 4.30%, up 4bps this morning, while European sovereign yields are all higher by between 4bps and 5bps.  It seems the bond market is not completely on board with the soft-landing narrative even though an increasing number of analysts are coming around to that view.  I think what we have learned thus far is that the US economy is not nearly as interest rate sensitive as it used to be.  The post-Covid period of QE and ZIRP saw a massive refinancing of debt, both mortgage and corporate, into longer-dated, low fixed rates.  With yields higher, there is much less need for refinancing, at least not yet, and so many of the problems that have been widely expected just have not happened yet.  At some point, when debt needs to be refinanced, if rates are still at current levels, it is likely to prove problematic for the companies and the economy writ large.  But that could still be some time from now.  In the meantime, I continue believe the yield curve inversion, which is now down to -67bps, could disappear completely by 10yr yields continuing to rise.  That is clearly not the consensus view.

Turning to commodities, they are generally looking good today led by oil (+1.2%) which has rebounded over the past several sessions and is back above $82/bbl.  The metals, too, are looking good with gold up at the margin, although hovering just below $1900/oz, while copper also has a bit of support today, up 0.3%.  For the industrial metals, China remains a key question mark.  If the Chinese economy continues to slow, then demand for these commodities is likely to be disappointing and prices seem likely to come under short-term pressure.  But remember, the long-term story remains one where many of these are essential for the mooted energy transition, and there simply is not enough of the stuff to satisfy the demand.  Longer term, prices still have room to rise.

Finally, the dollar is starting to slide as I type.  An earlier mixed picture has seen buyers of NOK (+0.75%) as oil continues to rebound, but also in essentially all of the G10 with only the yen (-0.3%) lagging.  In fairness, this is classic risk-on price action.  Turning to emerging market currencies, Asian currencies were mostly under pressure last night after the China rate news, but this morning EEMEA currencies are looking much better as they follow the euro (+0.3%) higher.  It appears that fear is taking a day off today.

On the data front, there is not much of real interest this week:

TuesdayExisting Home Sales4.15M
WednesdayFlash Manufacturing PMI49.0
 Flash Services PMI52.0
 New Home Sales704K
ThursdayInitial Claims240K
 Continuing Claims1700K
 Chicago Fed Nat’l Index-0.20
 Durable Goods-4.0%
 -ex transports0.2%
FridayMichigan Sentiment71.2
 Powell Speech 

Source: Bloomberg

Given the number of market participants on summer holiday, I suspect that there will be very little activity this week until we hear from Chairman Powell.  I would look for a little bit of choppiness, but no real directional moves until we know the Fed’s latest views.  And there is a real chance that he doesn’t tell us anything new, which means that we would then be waiting for NFP a week from Friday.  Net, until the Fed’s hawkishness breaks, I still like the dollar best.

Good luck

Adf

Problems Galore

Posted on by 
The story continues to be
The China of President Xi
Has problems galore
With more still in store
So, traders, as such, want to flee

The issue for markets elsewhere
Is knock-on effects aren’t rare
Protecting the yuan
Means it is foregone
Bond sales will send yields on a tear

For yet another day, China is offering the biggest market stories.  In no particular order we have seen the following overnight; China Evergrande filed for Chapter 15 bankruptcy, a process by which foreign entities can access the US bankruptcy court system, regarding $19 billion of their offshore debt; the PBOC set their CFETS fixing more than 1000 pips lower than market expectations, the largest gap since the process began in 2018, in their effort to arrest the yuan’s consistent decline; and Chinese police visited the homes of the protesters who were complaining about Zhongzhi’s missed payments (I wrote about these Monday in Risks Were Inbred).  And this doesn’t include the fact that Country Garden, the largest property developer in China is losing money quite rapidly and may also be on the brink of bankruptcy.  It seems the Chinese property bubble is deflating.

Ultimately, there appear to be two main impacts of the gathering storm in China, market participants are increasingly leery of taking on risk in general, and the PBOC’s efforts to stem the decline of the yuan means they must sell their holdings of Treasuries to generate the dollars to deliver into the FX market thus adding downward pressure to the bond market.  Of course, one of the typical outcomes of a risk-off attitude is that bond markets rally as investors exit equities and run to bonds.  This stands at odds to the recent bond market behavior, although it is quite evident this morning.  In fact, after touching yields above 4.30% in the 10yr Treasury yesterday, this morning we have seen a half-point rally with yields declining about 5bps in the US.  In Europe, the yield declines have been even greater, mostly around -10bps, so this is a real reprieve for bond markets everywhere.

The key question here is whether we have seen the worst, or if other potential selling catalysts will appear.  Consider for a moment the fact that between China and Japan, they represent >26% of foreign owned US Treasury debt, and that both of these nations are dealing with rapidly weakening currencies.  Not only that, but both have demonstrated they are quite willing to intervene in FX markets to arrest those declines, and as mentioned above, that typically requires selling Treasuries.  It’s a self-reinforcing cycle as higher yields beget currency sales which beget Treasury sales to intervene, which results in higher yields starting the cycle all over.  

With this in mind, we need to consider, what can break the cycle?  Well, if the Fed were to turn dovish and indicate they agreed with the futures markets that rate cuts are coming early next year, I suspect the dollar would fall against most currencies, especially these two, and the cycle would break.  Alternatively, China could step up and guarantee the debt of Countrywide and Evergrande thus removing the investor risk and reduce pressure dramatically.  Finally, I suppose the Fed could make a deal with the BOJ and PBOC and directly absorb their bond sales, so they never hit the market while restarting QE.  That, too, would likely end the cycle.  It is possible there are other ways to break the cycle, but I doubt we will see any of these occurring anytime soon and so the cycle will have to wear out naturally.  That will occur when either or both of the currencies decline far enough so the market believes the trade has ended and unwinds their short positions.  In other words, none of this has changed my view that 7.50 is on the cards for USDCNY as the year progresses, very possibly with 10yr yields getting to 4.5% or more.  And don’t be surprised if we see another move to 150.00 in USDJPY.

But, away from the China connection, things are very much in the summer doldrums.  Equity markets have been treading fearfully and continue to do so this morning.  However, while we have seen several days of declines, there has been no panic selling of note.  So, yesterday’s US weakness was followed by selling throughout Asia and this morning in Europe with most markets down about -1.0%.  US futures, too, are softer, down about -0.5% at this hour (8:00).

Oil prices (-0.85%) which stabilized yesterday, are back under a bit of pressure on the overall negative risk sentiment as they continue to trade either side of $80/bbl.  Metals prices, meanwhile, are mixed with precious metals finding a bit of support while base metals suffer today.  The most interesting story here I saw today was that CODELCO, the world’s largest copper miner in Chile, may be going bankrupt as previous projects didn’t pan out.  That strikes me as a very large potential problem, but one for the future.  

Finally, the dollar is mixed this morning.  It had been softer overall in the overnight session, but as risk is getting marked down, the dollar is gaining strength.  The biggest mover has been PHP (+1.1%) which rallied after the central bank indicated they were going to put a floor under the currency and adjust rates accordingly.  After that, the EMG bloc has not done very much, +/- 0.25% type activity.  However, just recently, G10 currencies started to slide with NOK (-0.8%) the laggard as oil slides, but the entire bloc now coming under pressure.  This is all about risk off.  

There is no US data today nor are there any Fed speakers.  As such, the dollar will take its cues from the equity markets, and the bond market to some extent.  Right now, equity weakness is driving the risk attitude and that means the dollar is likely to remain bid into the weekend.  Next week brings the Fed’s Jackson Hole meeting where everybody will be looking for any policy hints by Chairman Powell on Friday morning.  But for now, the dollar is on top of the mountain.

Good luck and good weekend

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