Monthly Archives: October 2023

Much Maligned

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Though pundits worldwide have opined
The world’s in a terrible bind
Investors don’t seem
Concerned ‘bout that theme
With naysayers still much maligned

But trees cannot grow to the sky
And rallies, at some point, must die
If Jay and his kin
Do not soon begin
To cut rates, bulls will start to cry

I guess the hint at peace negotiations in the Israeli-Palestinian conflict was enough to get the bulls back in front of the move.  Or perhaps it was the comments from Philly Fed president Patrick Harker, who seems to be one of the most dovish on the FOMC these days.  After explaining, “Small firms are really struggling with access to capital,” and “some of the bankers I’ve talked to are concerned that their business plans just aren’t going to be able to make it at the higher rates” he gave us the money line (my emphasis), “This is why we should hold rates steady, we should not at this point be thinking about any increases, because if that’s true – and it is true – then we should let that ride out.”  So here is the first clear signal for an FOMC member that they are done.  Now, Harker is a voter, so that matters, but it seems pretty clear that nobody is expecting a rate hike in early November.  Arguably, the big question is what will happen in December and that is still very far away.

However, that signal implying the Fed is well and truly done was sufficient to boost risk assets, well at least to boost equity markets with US markets all higher by 1% or so while European bourses had smaller gains, on the order of 0.3%.  Bond markets, meanwhile, remain under pressure as the hint of peace talks removed some of the need for a haven, and our Treasury Secretary explained that “we can certainly afford two wars.”  If you were wondering what the fiscal situation was, she seems to have things under control.  However, beware that paying for two wars by issuing yet more debt seems like it may have a significant negative impact on bond prices.  With this attitude in Washington, perhaps we should be looking for 6% in the 10-year Treasury yield soon.

And that’s really the crux of the issue, it seems that the stock market and the bond market are pricing very different outcomes.  Stocks continue to trade well as we enter earnings season and investors remain sanguine about any potential economic downturn.  There is a great deal of belief that if the economy does reverse course from its recent apparent strength, the Fed will step right back into the market, cut rates and end QT, if not restart QE.  Meanwhile, the bond market continues to look at the still too hot inflation data and combines that with the prospect of still more debt issuance as Secretary Yellen funds two wars and more social programs and is quite concerned.  Perhaps it is my age and experience, but alas, I fear the bond market is correct.  The prospects for better investment performance in the near-term seem limited to me.

For now, given the lack of significant new news or data, as well as the anticipation of Chairman Powell’s comments come Thursday, markets in Europe and US futures are biding their time.  Remember, too, that we see US Retail Sales as well as Canadian CPI this morning at 8:30, so either of those could well be a new catalyst.  But until then, a look at markets shows that equities are mixed in Europe with the FTSE 100 slightly higher while continental bourses are slightly softer while US futures are a touch softer at this hour (6:30), down about -0.3%, as they consolidate after yesterday’s rally.

Bond markets, however, continue to fade as the benefits accorded to stocks (potential end to Israeli war and hoped for better earnings) are anathema to bond investors.  Treasury yields are higher by 5bps this morning, leading the way higher while European sovereigns are all higher by between 3bps and 6bps with the Bund-BTP spread widening back above 200bps.  Last night saw JGB yields edge higher to 0.77%, as the new Mr. Yen, Kanda-san, once again explained that intervention was possible as was the idea of raising interest rates.  (Yes, I know that the MOF doesn’t control interest rates, but apparently, he doesn’t.)

Turning to commodities, oil continues to consolidate its recent gains, essentially unchanged today, but still above $85/bbl with a major concern that any escalation in fighting in Israel may spread to OPEC producers.  That certainly cannot be ruled out, and remember, the US has already wasted utilized its SPR so there is no additional supply likely to emerge in that situation.  As to the metals markets, gold (+0.2%) continues to consolidate after last week’s impressive rally while both copper and aluminum are softer this morning on economic concerns.  Here too, there seems to be a disconnect between investors and traders in stocks and commodities with the former remaining quite bullish overall while the latter are anything but.

Finally, the dollar is also biding its time this morning although it is beginning to creep higher.  Two particular movers are the pound (-0.5%) which has responded to slightly softer payrolls and wages data opening some room for the BOE to back off a bit from its tightening schedule, and NZD (-0.7%), where CPI was quite a bit softer than forecast.  Meanwhile, USDJPY seems frozen just below 150 as the threats of intervention are currently sufficient to offset the ongoing carry opportunities.  In this case, I continue to see room for the dollar to rise as intervention is only ever a temporary solution and I cannot see a reason why the Fed would object to a strong dollar given its inflation fighting impact.  

In the EMG space, the dollar is broadly higher with the renminbi back above 7.32 and pushing toward the lows (dollar highs) seen last month.  But KRW, THB, TWD and SGD are all softer as well.  Meanwhile in LATAM, we are seeing the same general price action in BRL and MXN both having weakened more than 9% through August and September and both now edging a bit higher lately.  However, there is no indication that the broader dollar strengthening trend has ended.

As mentioned above, this morning we see Retail Sales (exp 0.3%, 0.2% ex autos) and Canadian CPI (exp 4.0%, core 3.3%).  We also hear from Williams, Bowman, Barkin and Kashkari throughout the day as virtually every FOMC member wants to get on the tape before the quiet period begins on Friday.  In the end, consolidation seems the likely activity for now barring something new in Israel or a blowout number this morning.  Net, I still like the dollar overall.

Good luck

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Not Quite Yet Dead

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Inflation is not quite yet dead
And that has some thinking the Fed
May now have concern
That there’ll be no turn
And possibly more hikes instead

Last week, though, more Fedspeak, we heard
And three speakers’ comments sent word
That higher long rates
Have altered the fates
Now they think hikes could be deferred

Before I touch on the markets, I must acknowledge the heinous acts that occurred last weekend in Israel.  It is abundantly clear that this will not be ending soon, and it seems likely that it may ultimately have an impact on financial markets.  However, this commentary revolves around how global markets move, what new catalysts are driving things and how we might consider all the information when trying to determine the best way to hedge outstanding FX exposures.

So, before we talk about the overnight session, let’s quickly recap my week away.  Inflation, in both the guise of PPI and CPI, was a bit hotter than expected which has put a crimp in the Paul Krugman ‘inflation battle is won’ narrative.  I am constantly amazed at the disingenuity of analysts explaining that if you ignore food, energy, rent, used cars and any other thing that rose, then inflation is back at the Fed’s target.  It is not clear to me if they don’t eat, use energy, or pay for living expenses, but that is simply ridiculous.  The consumer confidence data makes clear that folks are extremely unhappy with the current economic situation and too high inflation remains the primary cause.  Regardless of the data points, people are feeling it when they buy gas and groceries, or if they go out for dinner, let alone buying other stuff.  

I have maintained this is not going to end soon and that 3.5% – 4.0% is going to be the new normal inflation rate.  While Daly, Logan and Jefferson all explained that the steepening of the yield curve with long end rates rising more rapidly than short end rates was helping the Fed’s cause, not one of them indicated they were even thinking about thinking about cutting rates.  In fact, my money is on at least one more hike, probably in December at this point, and I cannot rule out further hikes in 2024.  And folks, higher rates are going to wind up breaking more things.  Do not believe the soft-landing narrative, things are going to get worse, almost certainly.  Arguably, that sums up last week.

Turning to the overnight session, there was limited new news in the way of data or commentary.  Market participants continue to focus on central banks and any potential adjustments in their policies, economic data and clues as to whether the long-anticipated recession is finally coming, and the trajectory of inflation and whether the price of oil is going to have a longer-term impact on that trajectory.

Regarding the first of these issues, in addition to the above-mentioned Fedspeak, the market is anxiously awaiting Chairman Powell’s comments to be made Thursday afternoon just before the Fed’s quiet period begins.  While we will hear from ten other Fed speakers over sixteen different venues (!), the reality is that Powell’s words are the most important.  However, given the seeming unanimity in the new message about the long end of the curve helping the Fed, I suspect that Powell will touch on that subject as well.  To my mind, this is not an indication they are unhappy with the bond market selloff, rather that they are quite comfortable and will not do anything to stop it.  That could well give the bond market vigilantes a signal to sell even more aggressively so be prepared.

Last night we did hear from Kanda-san of the MOF who explained that rate hikes are one option when excessive forex moves are seen.  Now, that seems a bit of a surprise in that the BOJ is ostensibly the one controlling interest rates, but this shows that the concept of central bank independence is quite tenuous in Japan, and probably in most places.  You may recall a few weeks ago when USDJPY touched 150 and immediately reversed and fell 2% in mysterious fashion as no intervention was confirmed.  Do not be surprised if we see similar price action at various levels higher in the dollar, although helpfully, there was a comment that the fundamentals (meaning interest rate differentials) were responsible for much of the movement in FX.  Nothing has changed my view that USDJPY has higher to go.

On the economic data front, obviously last week’s inflation data had an impact with Treasury yields shaking off their safe-haven bid due to the Israeli-Palastinian conflict and rising again this morning.  While they are not yet back at the highest levels seen two weeks ago, I expect we will get back there and move higher still going forward.  This week’s Retail Sales data (exp 0.3%, 0.2% ex autos) is the big print and recall, it has been running hotter than expected for a while now.  Understand that Retail Sales counts the dollars spent, not the items bought, so rising inflation will drive this number higher even if things aren’t improving.  But for now, there is scant evidence that the economy is slowing rapidly, at least based on the headline data we have been seeing for the past months.

Finally, the inflation story is part and parcel of all the discussions.  Oil’s rise on the back of the Israeli-Palestinian conflict has been pronounced and this morning it remains some 7% higher than before things started there.  There is a growing concern that if the conflict widens, OPEC could consider an embargo of some sort, just like in 1973 in the wake of the Yom Kippur War, which would likely drive oil prices much higher, at least to $150/bbl.  Obviously, that would have a dramatic impact on financial markets as well as on our everyday lives.  It would also have a dramatic impact on inflationary readings.  But the other concern is that despite some of the more Pollyanna-ish narratives about the Fed has already achieved its goals, the reality appears to be that core inflation is simply not falling any further and ultimately, this is going to weigh on equity multiples and earnings as well as further on bond prices.  I would contend that inflation remains the primary issue for the foreseeable future.

With all this in mind, a quick look at the overnight session shows that after a mixed session in the US on Friday, Asian equity markets were all lower by at least -1.0%.  European bourses, however, have managed to eke out very modest gains, on the order of 0.2% and US futures are currently (7:30) higher by about 0.25%.

Meanwhile, Treasury yields are higher by 9bps this morning and we are seeing yields on European sovereigns all higher by between 4bps and 5bps.  Clearly inflation concerns are rampant, as are concerns over continuing increases in supply as every major nation runs a growing budget deficit.  Of course, the exception to this rule is Japan, where yields are unchanged on the day and currently sitting at 0.75%, their high point for the past decade, although still well below the current YCC cap of 1.00%.

Turning to commodities, with oil quiet this morning focus is turning to the metals markets where gold (-0.8%) is retracing some of last week’s 5.0% rally as the combination of rising inflation and fear seems to have underpinned the barbarous relic.  As to base metals, they are mixed this morning with copper a touch higher and aluminum a touch lower, a perfect metaphor for the confusion on the economic situation.

Finally, the dollar is clearly not dead yet.  While this morning it is consolidating last week’s gains and has edged lower about 0.15%, last week saw gains in excess of 1% vs. most major counterparts.  The dollar, despite all the problems in the US, continues to be the haven of choice for most investors.

On the data front, aside from Retail Sales and the remarkable amount of Fedspeak, we see the following:

TodayEmpire Manufacturing-7
TuesdayRetail Sales0.3%
 -ex autos0.2%
 IP0.0%
 Capacity Utilization79.6%
WednesdayHousing Starts1.38M
 Building Permits1.455M
ThursdayInitial Claims213K
 Continuing Claims1707K
 Philly Fed11.1
 Existing Home Sales3.89M

Source: TradingEconomics.com

For my money, barring something surprising from the Middle East, like an OPEC move, I expect that the market will be entirely focused on Powell’s speech Thursday at noon.  We are also at the beginning of earnings season, so we could get some surprises there.  However, the big picture remains sticky inflation, massive new supply of Treasuries and higher yields along with a higher dollar overall.

Good luck

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Worse Than Just Sloth

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With payrolls on everyone’s mind
The overnight range was confined
The bulls live in fear
That job growth’s still clear
While bears worry payrolls declined

But, looking beyond NFP
There’s something the bulls fail to see
Liquidity’s growth
Is worse than just sloth
It’s shrinking to quite a degree

Before I start this morning, please know I will be on vacation next week so there will be no poetry again until the 16th.

Now, to start this morning, all eyes are on the payroll report where the market is definitely in the ‘bad is good’ frame of mind.  Median analyst expectations are as follows:

Nonfarm Payrolls170K
Private Payrolls160K
Manufacturing Payrolls5K
Unemployment Rate3.7%
Average Hourly Earnings0.3% (4.3% Y/Y)
Average Weekly Hours34.4
Participation Rate62.9%

Source: tradingeconomics.com

We know that Wednesday’s ADP number was quite weak, and we know that Tuesday’s JOLTS number was quite strong.  Yesterday’s Initial Claims data was also a harbinger of strength with the weekly number falling to 207K.  If we look at the ISM employment sub-indices, both showed relative strength with the Manufacturing number rising above 50 for the first time in 5 months while the Services employment index remains at a healthy 53.4 level.  Much of what I have read over the past several weeks has focused on the idea that companies are still reluctant to lose employees as they remember how difficult it was to hire post the Covid fiasco.   I have a funny feeling we are going to see a better than expected number this morning, as between the JOLTS and Claims data it feels like we’re due for a pop.  However, I believe we need to see a print above 200K to have a meaningful impact on the markets.

To be clear, if I am correct, I would look for bond yields to retest their recent highs, equities to fall and the dollar to rebound from its recent consolidation/correction.

But let’s discuss the dollar for a moment and a data point that gets short shrift these days, the Trade Balance.  A brief history lesson shows that once upon a time, the Trade Balance was the most important monthly release for the FX market.  This was during the Reagan years when US policy was highly focused on the trade deficit with Japan and concerns over whether Japan was going to replace the US as the preeminent global economy.  (We know how that worked out!). But the point is trade data used to matter.  One of the things that gets little attention these days but is directly impacted by the trade data is the amount of global USD liquidity that exists. Despite all the hyperventilation over the concept of dedollarization, the reality is that the dollar has never been a more integral part of the global financial system than now.  The reason for this is the fact that there is somewhere north of $275 trillion of USD debt outstanding around the world, according to the IMF, and the US portion is only on the order of $95 trillion.  This means the rest of the world needs to service $180 trillion of debt, paying USD interest.   

How, you may ask, does everybody get those dollars to pay the interest on that debt?  Well, one of the keys had been the US running a massive trade deficit, buying stuff and sending dollars all over the world.  Those dollars were used to service the debt.  But lately, the US trade deficit has been declining pretty steadily, with yesterday’s better than expected reading of -$58.3 billion a continuation of the last two years’ trend from the worst print of -$105B in March 2022.   The thing is, if the US trade deficit is shrinking, we are not sending as many dollars out into the world for everyone else to use.  There has also been a great deal of discussion lately about how M2 money supply has been shrinking at an unprecedentedly fast rate, yet another sign that liquidity is drying up.  One consequence of these two factors, shrinking M2 and a shrinking trade deficit, is that foreigners need to bid more aggressively for the dollars they need to service and repay their USD notional debt.  This has been a key driver in the dollar’s recent strength and there is no sign this is going to change in the near future.

But shrinking liquidity also weighs on other things, notably risk assets.  Again, think about the post GFC era when QE’s 1 through infinity were ongoing and all the calls for inflation to ramp up never materialized.  Well, as I wrote during that time and is becoming clearer today, there was plenty of inflation, it was just concentrated in asset prices like stocks, bonds and real estate, as opposed to everyday items like groceries, clothing and dining out.  At this point, we realize that the Covid fiscal stimulus around the world is what unleashed the recent bout of inflation, and that central banks are working feverishly to halt this trend.  Combine the Fed leading the way, having raised rates the furthest of the major central banks, and the fact that there are less dollars around due to shrinking money supply and trade deficits, and you come up with a good understanding of why the dollar remains well bid.  Regardless of the short-term impact of numbers like today’s NFP, the underlying structural effects continue to point to dollar strength.

With that structural backdrop in mind, a look at today’s price activity shows modest net activity ahead of the data.  Asian equity markets that were open had a mixed session with the Nikkei sliding while the Hang Seng managed some solid gains (+1.6%) and mainland Chinese markets remained closed, set to reopen on Monday.  European bourses, though, are having an ok day, with gains on the order of 0.5% or so after better than expected Factory Orders data from Germany.  As to US futures, they are currently (7:30) higher by 0.1% and trading in a tight range.

Bond yields are backing up again with Treasuries and most of Europe higher by 3bps or so.  One move that has been growing lately is the Bund-BTP spread, which is now 202bps, right at the level where the ECB has historically started to get a bit nervous.  If this spread continues to widen look for more ECB talk about, first, how the market is wrong, and then second, how the TPI, their program to buy BTPs and sell Bunds, is likely to be appropriate.  At 250bps, their hair will be on fire, but that still feels pretty far off.

Oil prices, which are unchanged today, appear to be consolidating after a hellacious week where they fell >$10/bbl.  The thing is demand data continues to point to growth and supply data continues to point to limits.  The recent price action has all the earmarks of Russian disinformation a trading response to the massive run higher through the summer where a lot of trend followers got into the market too late.  Longer term, the direction here remains higher in my view.  As to the metals markets, they also are consolidating after a rough period with gold unchanged though silver, copper and aluminum are all higher between 0.3% and 0.9% this morning.  Again, we have seen a pretty sharp decline here, so this feels like a trading reaction, not a fundamental thing.

Finally, the dollar is a bit firmer this morning as we await the data.  USDJPY continues to hold the 149 level and it looks to be merely a matter of time before we test 150 again.  According to the flow data from the BOJ, there was no indication that they intervened earlier this week which implies there was some rate checking.  However, it is very clear they remain quite concerned over the movement.  One currency that has really seen some movement lately is MXN, which after a long period of strength on the back of a very stout monetary policy by Banxico, has given back 10% in the past 5 weeks.  Interestingly, the US is running a growing trade deficit with Mexico, which should help alleviate some pressure on the peso, but right now, the difference in tone between the Fed’s higher for longer and Banxico’s we are done is the driver.

Aside from payrolls this morning we see consumer Credit (exp $11.7B) and hear from Governor Waller at noon.  Yesterday’s Fed speak was much of a muchness with no changes in tone overall.  At this point, all we can do is wait.

Good luck, good weekend and until Monday October 16th

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Two-Faced

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On Tuesday the market was JOLTed
And buyers of assets revolted
But then ADP
Said, no, look at me
And bulls, toward risk assets, all bolted

Now those numbers offer a foretaste
Of how market prices are two-faced
But really the key
Is Sep’s NFP
Ahead of which, traders will stay chaste

Remember all the carnage on Tuesday?  Never mind!  In truth, it is remarkable that the market response to the Tuesday JOLTS data was so strong, given the number has historically not been a key market driver. At the same time, yesterday’s weaker than expected ADP Employment data, just 89K new jobs, had the exact opposite impact on the market.  So, bonds rallied, and yields declined sharply, with 10-yr Treasury yields lower by 14bps from the highs seen yesterday pre-data, while stocks rallied nicely, led by the NASDAQ’s 1.4% gains although the other two indices lagged that badly.

My first thought was to determine what type of relationship both numbers have with the NFP data which is set for release tomorrow morning.  I ran some simple regressions for the past year and as it happens, the R2 between NFP and ADP is 0.5 while between NFP and JOLTS it is 0.65.  I do find it interesting that the JOLTS data, which has a bigger lag built in, has the stronger relationship, but I also remember that ADP changed its model and formulation and since they have done that, the fit to NFP is far less impressive.

It is anyone’s guess as to what tomorrow’s data is actually going to be like, but it is clearly instructive that the market was so keen to react to both of these data points so dramatically ahead of the release.  Ostensibly, the market has come around to my view that NFP is the data point on which the Fed is relying to continue their higher for longer mantra.  As such, a weak number (something like 100K or lower) seems very likely to soften the tone of Fedspeak and result in an immediate rip-roaring rally in the stock market.  Correspondingly, a strong number (200K or higher) seems more likely to bring out the hawkishness that remains widely evident on the FOMC.  The consensus view appears to be 160K, but then consensus for ADP was 150K and that missed badly.

The point is, for now, the market is hyper focused on the NFP number, and I suspect that between now and then, we are unlikely to see too much movement.  As an aside, one of the best indicators of the employment situation is Initial Claims, which is more frequent and thus timelier, and that number, which is expected at 210K this morning, has clearly been trending lower, a sign of a strong jobs market.  I believe we will need to see a lot of convincing evidence for the Fed to alter their current stance, but tomorrow’s NFP will certainly be important.

Away from that, right now other fundamentals just don’t seem to matter very much.  The dysfunction in Washington is a big issue in Washington, but not in financial markets, at least not yet.  I guess if we wind up in a situation where there is a government shutdown it may wind up mattering, but we know there is six weeks before that will come up again.  Next week is the Treasury refunding auction with $102 billion of notes and bonds coming to market.  I believe a key part of the bond market’s recent downward trend is the concern over the massive supply that is coming to market.  Next week’s realization, plus the fact that there is no end in sight should continue to weigh on bond prices and support yields.  And as long as US yields are forced higher, so too will be European sovereign, and truthfully, global yields.

On the oil front, the OPEC+ meeting came and went without incident as the production cuts that the Saudis initiated back in June are to remain in place through December, at least, with the group set to revisit the issue later in the year.  While oil (-2.0%) has been slumping badly during the past week, falling $10/bbl in that short time frame, I would contend the trend remains higher.  Remember, oil is a highly volatile commodity, both in reality and from a market price perspective.  We have heard nothing to alter my long-term conclusion that oil demand is going to continue to grow and oil supply remains constricted.  In truth, if I were a hedger, I would be looking to take advantage of the current price action, especially since the market is in backwardation (future prices are lower than current spot prices) so hedging is quite cost effective.  It’s kind of like earning the points in FX.

At the same time, metals prices remain under pressure with gold suffering from the combination of still high US yields and a strong dollar, while industrial metals like copper and aluminum are both pointing to weaker economic activity.  I continue to believe this is a short-term fluctuation in a broader long-term move higher in commodities in general, but again, if I were a hedger, current prices would be interesting.

A look at equity markets overnight showed that the Nikkei (+1.8%) approved of the US price action and that dragged much of the rest of Asia along for the ride although, recall, mainland China remains closed for their Golden Week holidays.  In Europe, today has been far less impressive with very modest gains across the continent averaging about 0.2% while US futures are little changed at this hour (7:30).  As I said before, I anticipate a slow day ahead of tomorrow’s NFP report.

Turning to the dollar, it, too, is little changed this morning after a bit of a sell-off yesterday.  For instance, the euro, which has rebounded from its recent lows, is still just barely above 1.05 and higher by just 0.1% this morning.  And those gains are similar across all the major currencies.  Now, if we look at the EMG bloc, despite the dollar’s pullback against some G10 counterparts, we see MXN (-1.0%) and ZAR (-1.25%) leading the way lower as both of those nations have large commodity sectors and the decline in prices there is more than sufficient to offset any benefit of a little bit of dollar weakness broadly.  Here, too, I see no reason to change my view on the dollar following yields higher, and the fact that yields have backed off for a day does not change the underlying reality.

In addition to the Initial Claims data, we see the Trade data (exp -$62.3B) and we hear from three more Fed speakers, Mester, Daly and Barr.  ADP did not change the world.  We will need to see more data demonstrating that growth, at least as defined by the Fed, is slowing before they are going to change their tune.  Today is shaping up as quite dull, but tomorrow, at least immediately after the 8:30 data print, could be interesting.  Remember, too, that Monday is Columbus Day, so markets will have less liquidity and be susceptible to larger movements.

Good luck

Adf

Towel Throwing

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Did they sell?  Or not?
The new Mr Yen, Kanda
Explained, “No comment”

As is clear from the chart below (source tradingeconomics.com), there was a bit of movement in the USDJPY market yesterday morning.  The price action certainly had the feel of intervention, with a nearly 2% decline that occurred in seconds, but there has been neither confirmation nor denial of any BOJ trading activity.  Kanda-san, who is vice minister of international affairs which is the MOF role that deals with the currency, is the current Mr Yen.  His comments were certainly cryptic and as such, not very informative.  “We will continue with the existing stance on our response to excessive currency moves,” said Kanda. “While we are basically like a Gulliver in the market, we’re also coming and going as a market player, so usually we won’t say whether or not we’ve intervened each time,” Kanda said.  

The story that makes the most sense is that the BOJ reached out to the major Japanese banks in NY and London and checked rates.  The fact that the move happened minutes after the spot rate finally breeched the 150 level certainly was suspicious and indicated that contrary to yesterday’s comments by Watanabe-san, a former Mr Yen, the level really does matter, not just the speed of the move.  Others have tried to explain that breeching 150 triggered selling levels, but if there were exotic option barriers at 150, and I’m sure there were, the more typical move would be an acceleration higher as stop-loss orders by dealers were triggered.  The spike down, at least in my experience, is a sign of exogenous activity, not market internals.

Looking ahead, are we likely to see more of this type of activity?  You can never rule out currency support from any nation whose currency is weakening sharply, but there are G7 and G20 constructs that are supposed to limit these, and are designed to focus on volatility of movement, not levels.  This appeared contrary to those concepts, so we have much yet to learn.  At the end of the month, the BOJ will publish any intervention activity as part of their transparency initiative, but that might as well be next year for all the information it will provide.  Be wary of further movements like this, but the fundamentals continue to point to a higher USDJPY, especially given the accelerating rise in US Treasury yields.

The bond market rout keeps on going
As we see more folks towel throwing
The question at hand
Is can Powell stand
The pressure that’s certainly growing

Thus far, there’s no sign that the Fed
Is worried when looking ahead
More speakers were heard
To follow the word
That higher for longer’s not dead

Of course, away from the FX market, where the dollar has continued to show remarkable strength overall, the big story is the Treasury market.  After yesterday’s sharp move, the 10-year yield is higher by 23bps so far in October and it is only the morning of the third session of the month!  The yield curve inversion is down to -32bps and 30-year Treasury yields are pressing 5% now, a level not seen since summer 2007.  This sharp move has been the true driver of almost all markets and as long as it continues, there is going to be more pain for risk assets.  There has been no change in the fundamentals and yesterday’s move was ascribed to a much higher than expected JOLTS Job Openings number, which printed at 9.61M, far above the forecast 8.8M and a huge jump from last month’s outcome.  This seemed to encourage the Fed speakers to maintain their higher for longer attitude with a number still looking for one more rate hike this year.  Once again, I will point to Friday’s NFP number and its importance as a key driver of Fed policy.  If that number remains strong, and Unemployment remains low, the Fed can maintain this policy stance with limited fallout politically.

The rise in Treasury yields is being copied elsewhere around the world with yields following the US higher.  While today is seeing a bit of consolidation, with European sovereign and Treasury yields currently softer by 1bp-2bps, this is a trading effect, not a change of heart.  Interestingly, even JGB yields are getting dragged along higher as they closed last night at 0.80%, their highest level since 2012, the beginning of Abenomics.  But in the end, this is all about US yields with the rest of the world continuing to follow their lead.  I heard some analysts claiming this was a blow-off top in yields and we have seen the end.  Alas, I don’t believe that as history shows the yield curve will move back to a normal stance and with the Fed firmly in the higher for longer camp, 10-year yields have further to rise.  Yes, something is likely to break at some point, but so far, the few hiccups have been contained.

Not surprisingly, risk assets had a tough time in yesterday’s session with US indices all falling sharply, by -1.3% or more.  Yesterday’s European bourses were also under significant pressure and the Asian markets open overnight got hit hard as well with the Nikkei (-2.3%) and Hang Seng (-0.8%) the biggest movers.  However, this morning, Europe has a touch of green on the screen, with small gains on the order of 0.3% and US futures are also edging higher, +0.15% at this hour (7:45).  I wouldn’t read too much into this modest bounce and fear that there is further, and potentially much further, to go.  One of the remarkable things about the equity market is that earnings estimates for 2024 are for a rise of 12% on 2023 earnings.  Given the ongoing rise in energy costs and the increasing probability of a recession, those seem quite optimistic.  As they are revised lower, that, too, will weigh on equities, and by extension all risk assets.

Lastly, in the energy space, oil (-1.7%) is under further pressure this morning, although the fundamentals wouldn’t indicate that is the right move.  Not only did we see a further draw in inventories in the US, notably at the key Cushing, OK storage depot, but we heard from Russia that they are going to continue to restrict production by 300K bbl/day through the end of the year.  Meanwhile, the law in the US is set that the government cannot sell oil from the SPR when the inventory level falls below 330 million barrels.  Currently, it sits at 327 million, so that supply has ended.  Nothing has changed my view that oil has much higher to go, albeit not in a straight line.

Metals prices remain generally under pressure although gold (+0.2%) seems to be bouncing with other risk assets this morning on a technical trading basis.  However, both copper and aluminum are still sliding, typically a harbinger of weaker economic activity to come.

As to the dollar broadly, it, too, is a touch softer this morning, pulling back from highs seen yesterday in sync with all the markets.  But the same fundamentals driving the bond and stock markets are in play here, higher yields leading to more demand and a higher dollar.  Yes, this will end at some point, but we need to see a change in policy for that to happen.  The next real chance we have for something like that is on Friday with the payroll report.  A weak report, which seems unlikely at this time given the other employment indicators, would almost certainly change the market’s tone.  However, until then, look for positioning to continue to favor a stronger dollar, and for more and more dollar short sellers to get stopped out.

On the data front, this morning brings ADP Employment (exp 153K) as well as Factory Orders (-2.1%) and ISM Services (54.5).  the PMI Services data from Europe indicated that the worst may be over, but that there is, as yet, no real rebound.  We hear from a few more Fed speakers, but thus far they remain consistent, higher for longer is appropriate.

Today could see more consolidation of the recent moves across the board, but I do not believe that we have come to the end.  Calling a top or bottom is always impossible but remembering that the trend is your friend is likely to keep your activities in good shape.

Good luck

Adf

Much More Afraid

Posted on by 
Watanabe-san,
A previous Mr Yen,
“No intervention”

As USD/JPY approaches the psychological level of 150.00, there is a growing belief in the market that the BOJ is soon going to intervene.  Recall, last week we heard about the urgency with which the MOF is watching the exchange rate.  Historically, the next step would be for the BOJ to ‘check rates’.  This is when they call around to the big Tokyo bank FX trading desks and ask for levels.  The implication is they are ready to sell dollars and defend the yen.

However, unlike the previous decline in the yen almost exactly a year ago, the recent movement has been somewhat more gradual as can be seen in the chart below (source tradingeconomics.com)

This was highlighted last night by Hiroshi Watanabe, the deputy FinMin in charge of currency policy from 2004 through 2007.  He explained that after seeing the dollar remain in a 145-150 range for much of the past year, “I don’t think authorities are worried about the outlook as much as they were last year.  There’s no sense of imminence because the dollar/yen level hasn’t changed much from a year ago, and it doesn’t seem like the yen will start to plunge even if it breaches the 150 mark.”

As is often the case when it comes to concerns about a currency’s value, the pace of its decline is far more important than the actual level.  Most countries, or at least most finance ministries, feel they can handle slow and steady.  It is the abrupt collapses that scare them.  This move has been quite steady, and as long as both the Fed and BOJ maintain their current monetary policies, a continuation seems likely.  Hedgers, keep that in mind.

Now, turning to yesterday’s trade
A message was clearly conveyed
As interest rates rise
Risk appetite dies
And people are much more afraid

The most pressing story in markets continues to be the US Treasury market where sellers outnumber buyers on a daily basis.  Yields on the 10-year rose 10bps yesterday, touching 4.70% and are continuing higher by another 2bps so far this morning.  The bear steepener continues to be the story with the 2yr-10yr spread falling to -40bps and looking for all the world like it is going to go positive before the end of the year, if not the end of the month.  And it makes sense.  There is still substantial demand for short-term paper yielding more than 5% (yesterday’s 3mo T-Bill auction cleared at 5.35%).  Meanwhile, we are seeing money flee those assets with long duration over fears that inflation has not yet been quelled and that the structural issues (ongoing massive supply meeting limited demand) has investors pulling back quickly.  Not only are Treasury bonds being sold aggressively driving yields higher, but yesterday saw utility stocks, often seen as a duration proxy given the high amount of debt on their balance sheets, fall nearly 5%.  

This activity is having the knock-on effects that one would expect as well.  Yields around the world continue to get dragged higher by Treasuries, the dollar continues to benefit, and commodity prices are suffering.  In fact, yesterday saw a sharp decline in the price of oil and it has now retraced more than 6% from the peak last week.  I had written about the simultaneous rise in yields, the dollar and oil as being a HUGE problem for global markets.  Well, it seems that oil is starting to feel the pain of higher yields and a stronger dollar.  As well, tomorrow OPEC meets in Vienna and there is some talk that the Saudis may increase their production, unwinding those unilateral cuts made back in June and continued since then.   

But make no mistake, ongoing rises in Treasury yields will continue to underpin the dollar and that will be enough of a problem for economies elsewhere even if oil prices slide some more.  And right now, there is no indication things are going to change.  Yesterday we heard from two Fed speakers, Governor Bowman and Cleveland Fed President Mester with both maintaining the hawkish views.  In fact, Bowman expressed the need for several more rate hikes in order to get inflation under control and both were clear that higher for longer was crucial.  As long as that remains the Fed attitude, until we see a substantial change in the data stream, yields are going to continue to rise.

Now, this week brings the all-important NFP report on Friday, which has been a key driver of Fed policy.  With inflation readings continuing far above the Fed’s target, as long as NFP remains positive and the Unemployment Rate remains either side of 4%, the Fed will have no reason to reconsider the current policy mix.  In their minds, they have not yet broken anything, at least not so badly that it couldn’t be fixed.  I’m sure they are straining their arms as they pat themselves on the back for the effectiveness of the Bank Term Funding Program (BTFP) which was created after the bank failures in March.  In fairness, it seems to be working for now.  However, I will warn that cans can only be kicked down the road for so long, and I fear the end of that road is nearing.

As to the rest of the session today, risk is decidedly on the back foot.  Those equity markets in Asia that were open all fell pretty sharply with the Nikkei (-1.6%) and Hang Seng (-2.7%) leading the way lower.  The story is similar in Europe with the major indices all lower by about -0.75% or so as they respond to the ongoing increase in interest rates around the world.  Finally, US futures are lower by -0.45% at this hour (7:30) with concerns growing that yields will not stop rising.

Looking at European sovereign bonds, yields there are rising alongside Treasury yields with most of them higher by 3bps-4bps and Italy higher by 9bps.  That Bund-BTP spread, currently at 193bps, is something we need to watch as 200bps is likely to be the first place the ECB really shows concern and if it heads higher than that, expect more direct actions.  As to JGB yields, they remain static at 0.76%.

We already discussed oil prices and we are seeing serious weakness across the entire metals complex lately, although today’s declines are relatively muted, on the order of -0.2%, as the moves have already been pretty large.  The lesson from the recent price activity is that yields continue to drive the market.

Finally, the dollar remains king with the euro below 1.05, USDJPY just below 150 and the pound making a run at 1.20.  Last night, the RBA met and left rates on hold, as widely expected, but the tone of new governor Michele Bullock’s first meeting was seen as somewhat dovish leading to a nearly 1% decline in the Aussie.  At the same time, the EMG bloc of currencies is also coming under pressure with declines today on the order of -0.5% across all three regions.  There is a term, the dollar wrecking ball, which is quite apt.  As it continues to rise it puts intense pressure on countries around the world as they scramble to get dollars to service the trillions upon trillions of dollars of debt outstanding.  Nothing has changed my view that this has further to run.

On the data front today, the only release is JOLTS Job Openings (exp 8.8M) a number that remains significantly larger than the number of unemployed.  We also hear from Atlanta Fed president Bostic this morning so it will be interesting if he is willing to push back against the ongoing hawkishness.

I see no catalysts to change the current trend in the dollar, so for all you receivables hedgers out there, keep that in mind.

Good luck

Adf

Waters, Uncharted

Posted on by 
Last quarter, chair Jay set the stage
For yields to go on a rampage
Now, Q4 has started
And, waters, uncharted
Seem dead ahead in this new age

Both oil and dollars are rising
And bond yields worldwide keep surprising
By rising as well
With efforts to quell
Those hikes what CB’s are devising

As we begin the fourth quarter it appears the trends that had been quite clear for most of Q3, rising oil prices, rising bond yields and a stronger dollar, all remain intact. Historically, when this condition has prevailed, it has been a negative, and frequently a very large negative, for risk assets.  This begs the question, is something going to change or is it different this time?  Now, we all know that it is ‘never’ different this time, the cycles of financial markets have repeated constantly throughout history with pretty clear causes and effects.  In the current circumstance, the combination of these three indicators rising simultaneously is going to reduce the ability of non-USD economies to access necessary commodities as their prices are rising even more in local terms than in dollar terms, and the rise in interest rates is forcing them to pay more interest on their outstanding debt.  And every developing country has lots of outstanding debt, so this is a universal issue.

If we work under the assumption that this time is NOT different, then the question is, what is going to change and when might that occur?  This goes back to the idea that the Fed will raise rates until something breaks.  As of now, while a few things have broken (UK insurance companies, some regional US banks, Credit Suisse) it appears the economy continues to perform at a higher level than virtually everybody had anticipated it could.  As of yet, the most highly anticipated recession in history has still not occurred.  In fact, the soft-landing narrative, where the Fed manages to reduce inflation without pushing the economy into recession, has become the consensus view (alas this poet disagrees with that view and fears a much deeper recession is coming our way.)

So, what might change?  Well, last night the BOJ indicated that they are going to be performing an extra round of JGB buying in Q4 as they are growing increasingly concerned about the rise in JGB yields.  Last night, 10yr JGB’s moved up to 0.76%, after touching 0.775%, the highest level in more than a decade.  So, more QE is a clear possibility.  Now, we all know that the Fed is continuing its QT process, having reduced its balance sheet by a shade under $1 trillion so far and claiming they will continue to allow bonds to roll off without replacing them for quite a while yet.  The ECB is also engaged in this process and the BOE actually increased its target, now planning to sell £100 of gilts in 2024, up from the previous amount of £80 billion.  Will the central banks be able to continue these policies if the economy does tip into recession?  I think not, but they have maintained that the balance sheet issue is separate from their policy framework.

A direct impact of the QT programs is that bond yields are rising because of the absence of demand from what had been price insensitive buyers (aka central banks) which forces the private sector to absorb all the new issuance and they are requiring higher yields to take the paper.  Given the extraordinarily high levels of debt that exist, both on government and private balance sheets, it certainly seems like we might soon reach a breaking point here.  However, until that point is reached forcing a reversal in central bank views regarding their balance sheets, I anticipate yields will continue to rise.

The direct corollary to rising yields, especially rising Treasury yields as they are leading the way, is that the dollar is following along for the ride.  If you are looking for the dollar to reverse course, you are, almost by definition, looking for the Fed to reverse course.  Yet, there is no indication that is the case.  In fact, the only central bank that has demonstrated they are willing to end the tightening cycle is the BOJ, and let’s face it, they haven’t really started a tightening cycle, the market is simply anticipating that one is coming soon.

Oil, meanwhile, remains exogenous to the central bank story and is an OPEC story.  The poohbahs there meet this week in Vienna but there is no expectation of a change in their current production policy.  This means that the supply of oil is unlikely to rise anytime soon while demand, given the more robust than expected economic activity, continues apace.  Nothing has changed this story that a decade of misguided ESG policies has created a structural supply deficit of oil and the price is destined to continue to rise going forward.

Alas, the upshot of this set of conditions as we enter Q4 remains risk assets are likely to remain under pressure until whatever that something is finally breaks and the central banking community, notably the Fed, changes their tune.  Keep your ears peeled for that change in tune.

Now to today’s markets, where equity markets in Asia that were open, notably Japan, were a bit softer while China is on their Golden Week holiday so markets are basically closed all week.  That said, we did see their PMI data released on Friday night and Saturday and it was slightly stronger than expected, and for the first time since March, all the readings were above 50.0, albeit just barely.  Nonetheless, a positive sign.  As to Europe, weakness across the board is the description of the day, with the major bourses lower by between -0.3% and-0.6%.  US futures, which had been barely positive earlier in the evening session, are now slightly softer as well, -0.3% or so at 8:30.

Bond yields are rising again with Treasuries higher by 6bps and back above 4.60% while the bear steepening continues with the 2yr-10yr spread now “just” -47bps.  As well, throughout Europe we are seeing sovereign yields rise about 3bp-4bp across the board as this trend of still high inflation, rising oil prices and ongoing QT is working its ‘magic’.

Speaking of oil, it is back on the rise with WTI up 0.5% and above $91/bbl this morning as we have seen consistent drawdowns in inventory for the past several months as the OPEC supply cuts have really started to bite.  One thing that we need to keep an eye on going forward is NatGas, which as we come into winter and the colder weather, could well see a lot of upward pressure, especially in Europe.  Looking at the metals markets, the combination of rising prices in oil, yields and the dollar is really starting to weigh on this sector with gold down another -0.75% and getting closer to $1800/0z, down more than 5% in the past month.  Copper (-1.6%) and aluminum (-0.3%) are also under pressure today and both are feeling the weight of developing downtrends.

Finally, the dollar, which sold off slightly on Friday into month-end, has reversed course and is stronger across the board this morning with the DXY up 0.35% while some outliers are ZAR (-1.1%) and MXN (-0.7%), both suffering from the strong dollar disease.

On the data front, the PMI data from Europe was still awful, with Germany still sub 40.0 and the Eurozone at 43.4.  As to the rest of the week, we get important things culminating in Fridays NFP report.

TodayISM Manufacturing47.7
 Construction Spending0.5%
TuesdayJOLTS Job Openings8.83M
WednesdayADP Employment160K
 ISM Services53.6
 Factory Orders0.3%
ThursdayInitial Claims210K
 Continuing Claims1678K
 Trade Balance-$64.6B
FridayNonFarm Payrolls163K
 Private Payrolls160K
 Manufacturing Payrolls5K
 Unemployment Rate3.7%
 Average Hourly Earnings0.3% (4.3% Y/Y)
 Average Weekly Hours34.4
 Participation Rate62.9%
 Consumer Credit$12.5B

Source: Tradingeconomics.com

As well as all this, we hear from nine different Fed speakers across eleven events including Chairman Powell this morning at 11:00am.  And that is just what is on the schedule, I expect we will hear some BBG interviews or things like that as well.  

The question remains, is something going to change, either because of the data or the tone of Fed speeches?  There is no indication the Fed is changing their attitude and I expect that will remain the case until the data changes.  I have maintained for more than a year that the NFP report is critical to Powell and friends as it is their CYA document.  As long as the Unemployment rate remains lower than 4.2% or so, and NFP is positive, nothing will deter them on their mission against inflation.  And that means the dollar will remain underpinned.

Good luck

Adf