Monthly Archives: November 2023

Gradually Growing

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Two giants have recently passed

Who both, did a century last

Charles Munger went first

Whose wit was well-versed

Then Kissinger, quite the contrast



Meanwhile, recent data is showing

Economies worldwide are slowing

But pundits still think

The world will not sink

Instead t’will keep gradually growing

If there is any truth to the concept that things happen in threes, keep your eyes peeled for another well-known individual to pass away soon.  In the past week, both Charlie Munger, Warren Buffet’s partner at Berkshire Hathaway, and the one with the sharp wit, passed at 99 and, last night, Henry Kissinger passed away after 100 years on this earth.  Both were highly accomplished and extraordinary individuals, and the world is a lesser place for their passing.  May they rest in peace.

But back to the market saga, or perhaps it is the economic saga, that we have been both watching and through which we are living.  The soft-landing narrative remains strong as we continue to see economic activity data slide slowly lower, although it is certainly not collapsing.  In fact, that is the whole point, the idea that the central banks have been able to engineer a sufficient slowdown in growth such that inflation pressures recede but economic activity remains strong enough so unemployment doesn’t rise too far.  While historically this has been a very rare occurrence, perhaps they will achieve it this time.

If we are to look at the recent data, certainly the forward looking data, it certainly seems like growth is slowing.  We can ignore yesterday’s upward revision in Q3 GDP as that is already behind us, although it is impressive in its own right.  But for things that are more current, or the surveys that look ahead like PMI, the news is not quite so robust.  For instance, yesterday saw weakness in Spanish Retail Sales, Swedish Business Confidence and Eurozone Industrial Sentiment.  Overnight, we saw weaker Korean IP and Retail Sales, weak Japanese Retail Sales, a further decline in Australian Building Permits and Chinese PMI data continuing to slide with Manufacturing slipping to 49.4 and Non-Manufacturing falling to 50.2, both the lowest levels in a year.  The point is, looking all around the world, the trend is pretty clearly for slowing economic activity.

The flip side of this story is the one that the central banks are really watching, the inflation situation, and there the central banks are starting to feel better.  Eurozone CPI was released this morning with headline falling to 2.4% and core to 3.6%.  Given the declines in CPI we have seen this month around the world (remember energy prices fell sharply), this should be no surprise.  And of course, later this morning we will see the Fed’s favorite, Core PCE (exp 0.2% M/M, 3.5% Y/Y).  While this reading remains well above their target, the trend has clearly been beneficial of late.

This idea has been largely reinforced by central bank speakers this week, notably with Chris Waller’s comments on Tuesday that in a few months, if inflation continues this trend, it could be time to cut rates, but also mostly from the other speakers, with even uber-hawk Mester, yesterday, saying the Fed is in a good place to wait and watch.  Talk of additional hikes if inflation resurfaces is scarce now and the market is really looking for Chairman Powell to reiterate that message when he speaks tomorrow morning at 11:00.  But the market will not wait for confirmation, they are already onboard with the message as it suits the narrative of BUY STONKS!  So, we have seen Fed funds futures rally further with the market now looking for 125bps of cuts by the end of 2024 with a 50/50 chance of the first coming in March.  Wow!

So, how should we think about this situation?  To me, there are two issues with which to contend.  First, my take is much of the CPI decline is due to energy and the one really sticky piece of inflation, at least in the US, the price of housing, is not showing any signs of declining.  I think the Case Shiller Home Price index remains the best measure and it is continuing to go higher.  While existing home sales have been crashing, it is because of a lack of supply, not a lack of demand.  So, prices remain firm, and that is going to feed into inflation data for a while.   My point is, while recent readings have shown CPI falling, we remain well above target, and I expect that we are going to stay above target, although not anywhere near where things were last summer.

The second thing is that as evidenced by the litany of weaker data we are seeing around the world, economic activity is pretty clearly slowing everywhere.  In this situation, waiting for the Fed to cut first may be a mistake as other central banks may find themselves with more dire economic circumstances before the US gets there.  And, if that is the case, all the bearishness that is building around the dollar because of the renewed belief the Fed is going to cut rates soon could well be misplaced.  Remember, the FX markets are relative, so if the ECB cuts before the Fed, that seems unlikely to help the euro.  The same is true with the BOE or BOC or any other central bank.  My point is, while the dollar has retraced some of its recent gains on the belief the Fed is ready to cut, even if the Fed does cut, they will not do so in isolation.

Remember, too, the wise words from Hemingway’s The Sun Also Rises.  “How did you go bankrupt?  Two ways, gradually and then suddenly”.  It is very possible, if not likely, that we are currently in the gradually phase of economic slowdown, with the suddenly phase yet to come.  Just beware.

Ok, in the meantime, a quick look at markets shows that after another lackluster session in the US, Asian markets were able to rally a bit with the Hang Seng and mainland indices shaking off the weak PMI data while European bourses are clearly benefitting from the soft CPI data this morning out of Frankfurt.  At this hour (7:45) US futures are also a bit firmer, about 0.4% or so.

In the bond market, yields are rebounding a bit with Treasury yields up 4bps and European sovereigns a little less dynamic, higher between 1bp and 3bps.  However, we have come a long way this month, with 10yr Treasury yields down 64bps, their largest monthly decline since 2008.  My take is we will need to see confirmation from Powell tomorrow for there to be another leg lower in yields, but if he pushes back, look for a few fireworks there.

Oil prices are continuing their rebound as OPEC+ is meeting, up another 1% this morning and 4% on the week.  The whispers are another production cut is coming, and we also have seen the inventory builds slow down.  Meanwhile, gold is slightly softer this morning, but remains well above $2000/oz with many looking for a test of that all-time high at $2080.  As to the base metals, they are under a bit of pressure, which given the economic data, makes some sense.

Finally, the dollar is firmer this morning, recouping about 0.4% of its recent losses with strength largely across the board.  Ultimately, relative interest rates remain the key driver in this space and for now, while dollar yields have declined, they have not done so in isolation.  As such, until they start to fall more sharply than rates elsewhere, I think the dollar will be treading water in a range.

On the data front, aside from PCE we also see Personal Income (exp 0.2%), Personal Spending (0.2%), Initial Claims (220K), Continuing Claims (1872K) and Chicago PMI (45.4).  We hear from John Williams this morning as well, so it will be interesting to see if he backs up the recent shift of the Fed is done and things are going well.

My take is Williams will, indeed, hew that new line and we will see a bit more positivity in equities and bonds while the dollar fluctuates and perhaps gives up some of this mornings gains.  But really, all eyes are on Powell tomorrow.

Good luck

Adf

Now Estranged

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“Something appears to be giving”
Said Waller, the true cost of living
So, bonds rallied hard
The dollar was scarred
But stocks were quite unreactive-ing

The narrative clearly has changed
With hawks on the Fed now estranged
Is everything better?
As world’s largest debtor
We need low rates to be arranged

Fed Governor Chris Waller, one of the erstwhile hawks on the FOMC was covered in white feathers yesterday as he explained his latest perception that the Fed was on a path to achieving their 2% inflation goal as Q3’s expansive GDP was clearly an outlier and the data he cited showed economic growth slowing toward trend just below 2%.  The other Fed speakers on the day did not back him up specifically, and in fact, Governor Bowman explained her base case was the Fed needed to hike still further to be certain inflation was under control.  However, the market only had eyes for Waller and has heard the following message from the Fed, ‘we have finished hiking, and the next move will be a cut.’  Although this had been a building narrative, until yesterday there had been consistent pushback from virtually every Fed speaker with the higher for longer mantra.  However, the current belief set is that higher for longer has just been buried and that lower rates are in our future.  Let the celebrations begin because the Fed has achieved the much discussed, though rarely achieved, soft-landing.

However…it is still a bit premature, to my mind, to celebrate accordingly.  In fact, just yesterday the Case Shiller Home Price Index showed an annual rise of 3.9%, which although 0.1% less than forecast, also shows that the widely claimed decline in house prices due to higher yields, has not materialized.  And consider, if yields are set to go lower, the idea that house prices are going to fall and feed into lower inflation seems absurd unlikely.

But logic has never been an important part of any market narrative, and this time is no different.  The fact that declining bond yields (Treasuries fell 6bps yesterday and a further 5bps in the aftermarket) and the fact that the dollar, as measured by the DX, fell 0.5% led by USDJPY falling nearly 1.5% to its lowest level since September, has eased financial conditions thus supporting economic activity and inflation, is of no importance to the narrative.  Once again, we have heard from some big-name traders, Bill Ackman in this case, claiming that the Fed is now going to cut well before the market is pricing, predicting the first cut in March 2024. The market response to this has been for Fed funds futures to price a 40% chance of a March cut and a 75% chance of one at the May meeting.

And maybe all this is correct.  However, as I wrote yesterday, I believe that we are going to see a significant additional amount of federal government largesse to help prop up the economy, and that is not going to push inflationary pressures lower, the opposite in fact.  As is always the case, nothing matters until it matters, and right now, the only thing that matters is that the narrative is all-in on rate cuts coming soon to a screen near you.  While we could easily see further short-term weakness in equity markets as portfolios rebalance after a huge equity rally this month, it certainly seems like a push higher in risk assets is on the cards into Christmas.

As we consider the price action from yesterday and overnight, the thing that really stands out is that the US equity markets did so little on this very clear change in tone from a key Fed speaker.  Had you told me this was going to be Waller’s attitude prior to the session, I would have expected US equity markets to rally by 1+% each, with the NASDAQ really embracing the idea of lower rates.  But while the three major indices all closed in the green, it was only at the margin, +0.1% – +0.3% with a very late day rally.  Yes, futures are pointing higher this morning, up about 0.3% across the board, but again, this is somewhat unimpressive.  Perhaps the market has already priced in this idea, hence the 10% rally in November.

There is another wrinkle in this narrative as well, and that is that APAC shares are underperforming in both China and Japan.  Regarding the former, the Hang Seng (-2.0%) fell again as continuing concerns over Chinese corporate growth and profitability weigh on the index with Meituan reporting poor results.  On the mainland, despite hopes that the government was going to do more to support the property market, thus far it has been all talk, and no action and investors are getting tired of waiting.  Europe, however, is having a better go of it this morning, excluding the UK, where continental indices are all nicely higher, at least 0.5% with some as much as 0.9%.  

Not surprisingly, European debt markets are rallying as European sovereigns are following the US lead, ignoring the pleas from ECB speakers that higher for longer remains the path forward.  As such, we are seeing further declines on the order of 4bps – 6bps across the continent, matching US yield declines for the past two days.  Yields in Asia, though, are quite interesting with some very different narratives playing out there.  Starting with Japan, which saw yields fall 9bps last night, back to their lowest level since September, we heard from BOJ member Seiji Adachi that it was premature to consider exiting ultra-loose monetary policy amid global economic uncertainties and the end of the aggressive rate hikes in the US.  That seems counter to what had been the building narrative regarding Ueda-san’s next move.  Australia saw yields decline 14bps but in New Zealand, the decline was much more muted, just 2bps, after the RBNZ left rates on hold, as expected, but was far more hawkish in their statement than expected and hinted at potential further rate hikes.  

Turning to the commodity markets, oil continues to rebound, rallying another 1.8% this morning and recouping all its recent losses as confusion still reigns over the OPEC+ meeting tomorrow, or perhaps to be delayed again.  As well, it seems that a massive early winter storm closed ports in the Baltic and so oil shipments have been interrupted there for the time being.  Gold, though, has been the big story in commodity markets as it exploded higher yesterday after the Waller comments, jumping $30/0z (1.5%) to levels last seen in May and once again approaching its all-time highs of $2085/oz.  The market technicians are getting quite excited as they see a break there as having potential for a much larger run higher.  A case can be made that this is not a vote of confidence in the Fed’s anticipated future handling of inflation, but for now, we can simply attribute it to lower interest rates around the world.

Finally, the dollar has taken a straight-right to the chin and is reeling against virtually all its counterparts, both G10 and EMG. While we have seen a bit of a rebound this morning, since Monday’s close, EUR (+0.3%), GBP (+0.5%) and JPY (0.65%) have all rallied nicely, and that is after giving up some of those gains overnight.  We saw similar movement in the EMG bloc with CNY (+0.3%), PLN (+0.3%) and BRL (+0.8%) all responding positively to the Waller comments.  As I have been saying recently, if the Fed is truly done, then the dollar is likely to suffer, at least until such time as the other central banks fall in line.

On the data front, in addition to the Case Shiller Home Prices yesterday, we saw Richmond Fed Manufacturing which disappointed at -5.0 (exp 1.0), yet another sign that growth is waning.  It is data like this that has Waller in the mindset that slowing growth will lead to lower inflation.  Of course, rising home prices would certainly be a crimp in that theory.  Today we see the second look at Q3 GDP (exp 5.0%) with Real Consumer Spending expected at +4.0%.  We also get the Fed’s Beige Bok at 2:00pm and Cleveland Fed president Mester speaks at that time.  It will be interesting to hear if Mester, a very clear hawk, confirms the Waller thoughts or tries to push back alongside Governor Bowman.

For now, while the dollar has bounced slightly this morning, as long as the narrative remains the Fed is done and that cuts are coming soon, you have to believe the dollar is going to fall further from here.  If pressed, I would suggest USDJPY has the furthest to decline, but the fact that we have already had pushback from the BOJ implies that they are not that unhappy it remains weak.  After all, it supports their corporate sector and helps keep inflation higher, which remains one of their goals.

Good luck

Adf

Talk the Talk

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It seems that investors are waiting
For Powell, and so they’re debating
Will he be a hawk
And still talk the talk
Or will he be accommodating?

The punditry seems unpersuaded
Another rate hike could be slated
So, most views expressed
Say; time to invest!
And bearish ideas must be faded

It is almost as if we are still on holiday given the lack of price movement across most markets so far this week.  In fact, other than the Chinese markets (Hang Seng -1.0%), which are continuing to suffer from the ongoing implosion of their property bubble, market activity yesterday in the US, overnight through the rest of Asia and in Europe this morning has been quite muted.  Perhaps the tone has been very mildly bearish, with declines on the order of -0.25% or so, but that comes in the wake of gains as much as 10% or more through the month of November.  As such, it should be no surprise to see a bit of portfolio rebalancing.  Certainly, there is a lot more discussion about the soft/no-landing scenario and we are beginning to see S&P 500 prognostications for the end of 2024 being above 5000.  

The premise seems to be that inflation has been defeated, and that while the Fed may wait a few more months before cutting rates, by this time next year they will be celebrated for having achieved the elusive soft-landing.  The implication is that once they are more comfortable that inflation is dead, they will start to cut rates because…?  And that is where I get lost.  If the economy continues to grow with rates at 5%, exactly why should the Fed consider cutting them?  The only reason I can see is that the pressure from the administration grows too intense as the cost of refinancing the currently outstanding and growing debt continues to rise dramatically.  The problem with this outcome, however, is that if the Fed is seen to be cutting rates under pressure from the administration to reduce financing costs, it is likely to signal to the market that fiscal policy is in complete control (yesterday’s discussion on fiscal dominance is apropos here).  Historically, when that happens, inflation is not merely, not dead, it is ready to roar.

The implications of this policy direction are unlikely to be welcome in government, in boardrooms or in households, as rising inflation and a declining currency are a toxic mix for economic success.  Let’s think this through before cheering it on.

As we progress toward the 2024 presidential election, it is abundantly clear that the federal government is going to seek to spend as much money as possible.  Not only that but I am confident they learned the lessons from the GFC and Covid that QE simply pumps up asset prices while helicopter money is far more effective in getting cash into the hands of the voters.  Given the recent surveys that show 80% of the country believes they are worse off than prior to President Biden’s election, the recipe to address this is quite clear; give more money directly to the people.  And so, you can be sure that there will be numerous fiscal giveaways as 2024 unfolds.

The problem is that these giveaways do not create organic growth in the economy, rather they are the antithesis of organic growth.  As such, tax revenues will continue to lag, and the deficit will continue to grow ever larger.  Already, the cost of funding the outstanding ~$34 trillion in debt has reached $1 trillion, more than the government spends on defense, the largest non-entitlement program.  As well, the average tenor of US Treasury debt continues to decline with almost half needing to be refinanced by the end of 2025.  If interest rates remain at 5.5% and the Treasury continues to skew toward T-bills rather than coupons, that $1 trillion bill is going to grow to $2 trillion pretty quickly.  That will require even more debt issuance to repay, and the cycle will grow ever larger and faster.

It doesn’t take much imagination to see where this could be headed and there is a history of how it has worked in the past, notably with Weimar Germany in 1921-1923 and more recently, in Zimbabwe in 2008-2009 and again in 2019, and, of course, Argentina today.  The classic response to this problem is to institute yield curve control so that those debt payments are contained.  Of course, that means that government debt will pay negative real yields, and the Fed will wind up owning most of it*.  The natural consequence here will be that the dollar will likely decline sharply, at least against ‘real’ stuff like commodities, and a little less-so against quasi-real stuff** like equities.  Versus other currencies it is much harder to tell because if the US is in this situation, other countries are likely to be in difficult straits as well, so the FX value of the dollar may not collapse.  Of course, other countries may not have the same debt dynamics as the US, and those currencies will likely hold up better than the rest.

My fear is this is the new direction of travel.  It is not a given by any stretch, but it is going to seem quite attractive to politicians of every stripe, regardless of their political affiliation or ostensible principals because, remember, to an elected politician, the most important policy is one that gets them re-elected and they will vote for anything that they believe will help them in that cause, principals be damned. 

Will this have any impact today?  Very unlikely.  But it is important to remember this possible path as we await to hear more Fed speakers, but notably Chairman Powell on Thursday morning.  Any hint that the pressure to cut is working (and I am sure there is plenty of pressure for that from Treasury and the executive branch) and we will see a massive rally in equities, bonds and commodities as the dollar declines.  At least at first.  In fact, it is for this reason that I believe that we are going to hear much more hawkish rhetoric from all the Fed speakers this week, and that Powell will be particularly so.  They understand the potential ramifications of capitulation and are not yet ready to allow it.

As to today’s markets, bond yields are within 1bp of yesterday’s closes but leaning lower right now, US equity futures are basically unchanged as are gold and the entire metals complex although oil is edging higher on the news that Saudi Arabia is pushing for another 1mm bbl/day production cut at Thursday’s OPEC+ meeting.

On the data front, yesterday’s New Home Sales data was quite weak, with both prices and volumes falling.  This morning we see Case Shiller Home Prices (exp 4.0%) and Consumer Confidence (101.0) and we hear from four Fed speakers, Goolsbee, Waller, Bowman and Barr.  Look for that hawkish tilt.  It is also supomatsu, the day when spot FX settles on month end, so I expect FX volumes to pick up a bit, but historically, this is more of a swap exercise than a directional one, and so looking for directional movement based on this would be a mistake in my view.  

If I am correct and hawkishness is the Fed mantra today, I expect the dollar will be able to edge a bit higher along with yields, but until Powell speaks, I suspect we will remain fairly muted overall.

Good luck

Adf

*There is another possibility with regards to ownership of treasury debt to prevent the Fed from owning all of it, new rules can be instituted that require banks, insurance companies and even your 401K or IRA accounts to maintain a certain percentage of assets in treasury bonds.  So, in the latter case, which has already been discussed in Washington, you could see 20% or 30% of your retirement next egg forced into negative real yielding assets for a long time.  I assure you that will not help your retirement situation!  

** I use the term quasi-real stuff as equities represent shares in a real business, so there is underlying value to that business and its assets, although not quite the same as owning the actual hard assets they represent.

Clearly the Rage

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While AI is clearly the rage
Where Mag 7 try to engage
Consider the fact
That during this act
They’re fighting each other backstage

Just a little aside regarding the situation in equity markets, which in the US really means the Magnificent 7 these days.  One of the key features of their cumulative success was that these companies had no significant overlap regarding their business models.  Online shopping, iphones, EV’s, search, GPUs, streaming services and a social network clearly intersected to some extent, but the main focus of all these companies was spread out in different directions.  Yes, Amazon prime competes with Netflix, as does Apple TV, and yes, Amazon Web Services, Microsoft Azure and Google Cloud are all in the same business, but there is a huge amount in that particular segment that is still unfulfilled, so competition but not cutthroat.

But AI is a different kettle of fish.  All of them are actively investing in their own AI programs and working to integrate them into their current services and products.  And we are already seeing announcements of new GPU’s to directly compete with Nvidia and bring that supply chain in-house for the other users.  The point is, there is going to be a lot more investment, if not overinvestment, in this space with, arguably, quite a while before whatever AI does starts to really help the bottom line.  In other words, do not be surprised to see margins start to decline in these companies which is unlikely to help drive their share prices higher.  As well, with investment focused on this new area, we need to expect to see a reduction in share repurchases, removing one of the key bids to the market.

All I’m saying is that even in a soft or no landing scenario, it strikes me that the Magnificent 7 may be running out of room to continue their amazing run of share price gains.  And if they start to stumble, just the very nature of the equity indices, where their capital weightings are so large combined, > 30%, I suspect the indices themselves may find themselves under a lot of pressure, regardless of whether the Fed cuts rates or not.  And if the Fed cuts rates because the economy is slipping into recession, or has already gotten there, that cannot be good for margins either.  While timing is everything in life, this is something that needs to be on everyone’s radar, because it will change the risk narrative, and that matters for all markets.  Just sayin’.

While last week was mercif’ly free
Of Fedspeak, the FOMC
This week will explain
Again and again
Why higher for longer’s the key

As the market returns to full strength, at least from a staffing perspective, post the Thanksgiving holiday, things are opening fairly quietly.  A quick recap of the data since I last wrote shows that the mix of good and bad continues to leave prospects uncertain going forward.  This has allowed both the soft/no landing camp and the recession camp to point to specific things and claim they are on the right track.  So, Durable goods were pretty lousy in October and Michigan Sentiment also fell sharply, but Initial Claims fell as well, indicating that the labor market remains robust overall.  In other words, uncertainty continues to reign.  

One of the interesting things is that different markets appear to be pricing very different outcomes.  For instance, commodity markets, or at least energy markets, are clearly in the recession camp as oil prices remain under pressure, falling another 1.5% this morning as the market awaits the outcome of Thursday’s delayed OPEC+ meeting.  Talk is that there could be another 1 million bbl/day production cut to help support prices, but nothing is yet certain.  At the same time, both copper and aluminum remain under pressure, sliding a bit further last week and this morning while gold (+0.5%) is back firmly above $2000/oz, hardly a sign of a positive future.

However, as dour as the commodity markets feel, equity markets remain quite resilient overall.  Although this morning, we are seeing modest declines around the world, with European bourses lower by -0.2% or -0.3%, and US futures are currently (8:00) down by -0.15%, the month of November has been a big winner almost everywhere.  Gains, ranging from 5% – 11% are the order of the month as equity investors have gone all-in on the idea of a soft landing and that the major central banks are going to be slowly reducing interest rates to ensure economic growth continues.

In truth, bond markets are of a similar mind as equities with 10-year yields lower by between 25bps and 40bps during November throughout the G10 (Japan excepted but even there lower by 10bps).  Clearly, all this can be traced back to the QRA released back on November 1st when Treasury Secretary Yellen let it be known that there would not be as much coupon issuance as had been anticipated, and that more of the Federal government’s borrowing would take place in the T-Bill market.  That was the starting gun for the bond market rally and the ensuing stock market rally. 

So, which of these two views is correct?  That, of course, is the $64 trillion question, and one with no clear answer yet.  As I have written numerous times, and as we saw last week, the data continues to be mixed, with both positive and negative signs.  While the Fed, and virtually every other G10 central bank continues to harp on the idea that they will not be cutting rates anytime soon, markets are pricing in rate cuts starting in early Q2 of 2024.

Ultimately, there will be a winner of this battle, but the game is still afoot.  FWIW, while I have long been concerned that the imbalances in the economy were going to lead to a more significant correction in equity prices, there is another side to the story that is worth exploring, and that is the concept of fiscal dominance.  

According to the St Louis Fed, a good definition of fiscal dominance is: “…the possibility that accumulating government debt and deficits can produce increases in inflation that dominate central bank intentions to keep inflation low.”  The corollary here is that the Fed is losing its power over one of its key mandates, stable prices, because the Federal government’s fiscal impulse is so great as to overwhelm the Fed’s actions.  

With 2024 a presidential election year, and with the TGA currently at $725 billion plus negotiations for more spending on Ukraine, Israel and the southern border, there will be no shortage of additional Federal moneys flowing into the economy.  Add to this the fact that the surge in T-Bill issuance will move savings from a “dead zone” in the standing RRP facility, which is still at $935 billion, to more active money, able to be used in the real economy, and it is easy to see how economic activity is going to be supported throughout 2024.  Whatever your views on the appropriateness of these policies, the reality on the ground is that the current administration will do everything in its power to be re-elected and that includes spending as much money as possible.  Remember, too, that there is no operable debt ceiling, so they can issue as much debt as they want to fund whatever they can get legislated.  

If the Fed has lost control of the narrative, and it does appear to be slipping through their fingers, then we will need to start to focus elsewhere to find market drivers. Of course, if the Fed is losing its grip, do not think for a moment they will go meekly into the sunset.  Instead, I could see several more rate hikes as they continue to try to fight for price stability amid an economy flush with cash.  In other words, this story is nowhere near finished.

At this point, let’s take a look at this week’s data, which will bring updated GDP and PCE readings amongst other things.

TodayNew Home Sales723K
 Dallas Fed Manufacturing-17
TuesdayCase Shiller Home Prices4.0%
 Consumer Confidence101.0
WednesdayQ3 GDP5.0%
 Goods Trade Balance-$85.7B
ThursdayInitial Claims220K
 Continuing Claims1872K
 Personal Income0.2%
 Personal Spending0.2%
 Core PCE0.2% (3.5% Y/Y)
 Chicago PMI45.4
FridayISM Manufacturing47.6

Source: Tradingeconomics.com

Despite Friday being the first of December, payrolls are not released until next week due to the holiday last week.  Plus, in addition to the data above, we hear from seven different Fed speakers over ten venues including Chairman Powell Friday morning.  That will be the last Fed speaker until the next FOMC meeting, so it will be keenly watched.  However, I would wager a great deal it will continue to harp on progress made but higher for longer to prevent any resurgence in inflation.

As to the dollar, right now, it is softening as market participants focus on the idea of Fed cuts and simultaneously reduce large, long USD positions.  For now, I feel like lower is the way forward, but if we start to see increased hawkishness again because there is no landing, merely continued growth, look for the dollar to return to its winning ways.

Good luck

Adf

Somewhat Sedate

Posted on by 
Nvidia’s earnings were great
The Minutes were somewhat sedate
At OpenAI
They got back their guy
And traders, for closing, can’t wait

In Europe, they’re still quite concerned
Inflation’s not been overturned
But positive news
Twixt Arabs and jews
A truce for four days has been earned

As we head into the holiday weekend, the truth is the macroeconomic story is quite dull.  Not only has there been a dearth of Fedspeak (which is a good thing I think) but the data has been second-tier, at best, and sparse overall.  The fact that Existing Home Sales fell further given the current mortgage market situation cannot be surprising.  After all, folks are quite reluctant to give up the 3% mortgage on their current house to buy a new house and pay 7.5%.  As to the Minutes of the last FOMC meeting on November 1st, they were deemed hawkish by some, although they are so out of date, it is not clear why any attention is paid to them.  

Arguably, of much more interest to most every market participant were the earnings results from Nvidia, which beat lofty expectations as the AI phenomenon continues to grow.  In that same vein, the OpenAI saga, where Sam Altman, one of the founders, was ostensibly fired, set to go to work at Microsoft and bring his entire team with him, but now is back at OpenAI has been garnering the lion’s share of market bandwidth.  But I ask, does that really have a macro impact?  I would argue not at all.  

In fact, I would say that the market is quite ready for the Thanksgiving holiday, as most participants are far more concerned about the travel conditions than the market conditions.  Yes, the ECB keeps trying to threaten that they are not done hiking interest rates, although given growth there is fading fast, this feels much more like brave talk than a precursor to action.  And thankfully, it appears there is going to be a four-day cease fire agreement in Gaza with a release of some of the hostages, so that is clearly a good thing.  

But really, it is very difficult to get too excited about too much at all today.  There is some data due this morning, with Initial (exp 225K) and Continuing (1875K) Claims, Durable Goods (-3.1%, +0.1% ex Transports) and Michigan Sentiment (60.5).  But none of it seems very enticing as a rationale to change any opinions or positions.

Reviewing markets, after yesterday’s very modest pullback in the US equity markets, Asia saw mixed price action with Tokyo a bit firmer while China was under pressure.  In Europe this morning, other than the UK (-0.2%) there are modest gains despite a lack of new data.  The UK story seems a reaction to a much weaker than expected CBI Industrial Trends report, indicating much slower growth ahead.  As to US futures, they are a bit firmer at this hour (8:00), arguably benefitting from those Nvidia earnings.

In the bond market, Treasury yields continue to drift lower, down 3bps this morning and currently at 4.36%, just above that first key support level.  European sovereigns are also rallying with yields down by between 3bps and 5bps across the board.  The outlier here was Japan overnight, where yields rebounded 3bps after what had been a very quick decline given all the discussion about how the BOJ was set to tighten policy.  For now, there is a great deal of enthusiasm over the soft-landing scenario which I believe is a key driver of the bond market rally.  However, the future here will be highly dependent on the Fed’s actions going forward, and I, for one, continue to believe in the higher for longer story.  Unless growth really drops quickly, or unemployment skyrockets, I don’t see a rate cut anytime soon.

In the commodity markets, oil (-2.0%) seems to be falling on the back of the de-escalation in the Middle East, as well as word that Russia is exporting diesel fuel again.  Gold prices captured the $2000/oz level yesterday and are still hanging on, although copper and aluminum are both under pressure this morning, down about -0.5% each.  Broadly, I would say that the commodity sector has been the one area most actively considering a recession is coming with the overnight price action merely a reflection of this.

Finally, the dollar is a touch firmer this morning, halting its recent declines with both USDJPY and USDCNY higher by about 0.2% this morning.  Given the lack of news, this seems much more like a trading event, with traders closing positions ahead of the long holiday weekend.  I maintain my view that if the Fed is actually done and beginning to lean toward easier monetary policy, the dollar will decline a bit further.  But that is a big if in my mind.  It is very difficult to get excited about the prospects of most other currencies given the inherent weakness in economies around the world.  However, a change in Fed policy will definitely have an impact on the buck.

And that’s really all for today.  There will be no poetry until Monday as I, too, will be taking a break from the action.

Good luck and have a wonderful holiday

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Vaporized

Posted on by 
The powers-that-be are concerned
That Argentine voters have spurned
Advice they’ve provided
And rather decided
It’s time some new lessons were learned

And so, we cannot be surprised
The media pundits advised
Milei should step back
And take a new tack
Lest talking points get vaporized

It has been quite a slow session overnight.  There has been precious little new in the way of data or commentary of note with respect to the current economic story.  At the same time, the Thanksgiving holiday has trading desks thinly staffed and the Fed is noteworthy in its absence from the tape.  As such, the news cycle has been filled with the OpenAI saga, something far outside the scope of this poet, the ongoing political infighting that is a constant thrum in the background, and one very interesting thing, the mainstream response to the election of Javier Milei as president of Argentina.

Given the dearth of other news, and the fact that I believe this has the opportunity to be quite impactful going forward, I thought I would take a little time and discuss this further.

According to Wikipedia, which in this case I have no reason to disbelieve, Milei, while new to politics, is a serious economist.  He has earned two masters degrees in the subject, taught at university and is a widely published author on the subject.  The point is, he has very clear ideas on how economies work from a theoretical perspective and having grown up in Argentina during one of its earlier hyperinflations, from a practical aspect as well.

What makes all this so fascinating is the deluge of articles that have been published in the WSJ, Bloomberg, CNN, the New York Times, et al. which are quite keen to highlight that his views are highly unorthodox and will fail dramatically, dragging the nation into an even deeper hole.  In fact, I cannot find a single mainstream media source that believes his ideas will succeed.  However, 56% of the voters in Argentina, who are actually living through the economic disaster of the mainstream views, thought differently.

Perhaps the clearest signal of this disagreement is that the Merval, Argentina’s main equity index, rose 7.1% yesterday on the news of his election.  One need not be a conspiracy theorist to understand that if Milei is successful in righting the Argentine ship by throwing out the current orthodoxies, it will call into question everything that finance ministries throughout the G10 have been claiming and doing.  As I wrote yesterday, I believe this election has the potential to signal a beginning of a significant change in the make-up of governments around the world.  Do not be surprised when there is significant support for 3rd party candidates in the US; when AfD wins an outright majority in a state election or two in Germany; and if Mexico throws the ruling PRI out of office.  As Neil Howe and William Strauss wrote in their tour de force, The Fourth Turning, this is the time when major upheavals occur.  Be prepared for more volatility in financial markets as these changes make their way into the system.  In other words, stay hedged!

Ok, back to the markets as they currently sit.  Yesterday’s strong US equity performance found limited follow-through around the world.  Asian indices were mostly slightly lower and European indices are mixed with the DAX (+0.2%) edging higher while the CAC (-0.25%) and FTSE 100 (-0.5%) are both under pressure.  As to US futures this morning, at this hour (7:30), they are ever so slightly softer, -0.1%.

In the bond market, Treasury yields edged lower yesterday amid a relatively quiet session and are a further 1bp softer this morning.  European sovereign yields are also a touch softer, somewhere between -2bps and -4bps, generally speaking, while JGB yields fell a further 5pbps overnight and are now down to 0.69%.  This is certainly a far cry from the idea of tighter Japanese policy, although the yen continues to strengthen.  Two noteworthy aspects in the Treasury market are that the 20yr auction yesterday went off without a hitch as the tail was actually negative (the highest yield was lower than the when-issued price) and dealers only took down 9.5% of the auction.  This is a far cry from the terrible 30-year auction we saw last week.  But the other thing that is not getting much press is the fact that the yield curve continues to reinvert with the 2yr-10yr spread back to -48bps this morning.  Recall, this had fallen as low as -15bps and looked like it was about to normalize just a few weeks ago.  Arguably, investors are telling us that the prognosis for future growth is declining although they are still uncertain as to when the Fed will begin cutting rates.

Oil prices, which have rallied for the past several sessions, are a touch softer this morning as the market has become confused to the key drivers.  Does OPEC+ and its production matter more than economic activity?  Are supplies tight or loose?  I expect that we are going to continue to see uncertainty and volatile price action until something clearer shows up.  As to the metals markets, gold and silver have both rallied this morning with gold creeping back toward that $2000/oz level, although not yet breaking through.  But base metals are mixed with very minor movement.  While equity investors remain convinced the soft landing is a given, the commodity space is far less certain.

Finally, the dollar remains under pressure as sliding Treasury yields weigh on the greenback.  Once again JPY (+055%) is the leading gainer in the G10 and remarkably, CNY (+0.35%) is leading the way in the EMG space.  What is quite interesting here is that the spot USDCNY rate in the market has fallen below the fixing rate for the first time since June.  You may recall that the spot rate had been hovering at the 2% band limit for quite a while.  This is another indication that the near-term outlook for the dollar remains lower.

On the data front, we get the Chicago Fed National Activity Index (exp 0.02) and Existing Home Sales (3.9M) this morning and then the FOMC Minutes at 2:00 this afternoon.  You may recall that the Statement in the beginning of the month was seen as hawkish, but the press conference was seen as dovish and they talked about how financial conditions had tightened and helped the Fed along.  But now, those conditions have eased again.  Also, we have heard from so many Fed speakers in the interim, it is hard to believe that whatever they said three weeks ago is newsworthy.

So, with more eyes on the clock ,as folks want to get away for the holiday and are worried about travel conditions, than market conditions, I suspect today, and tomorrow and Friday, will be very quiet indeed.

Good luck

Adf

Could Cause Contraction

Posted on by 
A story that’s gained lots of traction
Is Jay will soon jump into action
By cutting the rates
They charge for short dates
Cause high real rates could cause contraction

In fact, this idea ‘s gone mainstream
And it’s now a favorite theme
But history shows
The ‘conomy grows
Despite real rates high with esteem

After a spate of slightly softer than expected data in the US, it is very clear the consensus in markets is that not only is the Fed finished raising rates, but that cuts are coming soon.  At this point, based on pricing on the CME for Fed funds futures, the Fed is going to cut rates by 100 basis points next year.  While I’m certainly no PhD economist (thank goodness!), this strikes me as a mistake.  Consider the following:

  1. If the economy really does go into recession in Q1 or Q2 of next year, where GDP turns negative and the Unemployment Rate rises close to 5.0%, it strikes me that the Fed is going to cut a lot more than 100bps.  In fact, the one thing we know is that Fed funds tend to decline much more rapidly than they rise as the Fed is usually responding late to some crisis.  So, a simple model can be created that shows 100bps of rate cuts is made up of a 20% probability of no movement at all; a 60% probability of 50bps of cuts next year as they try to tweak policy at the margin, and a 20% probability of 350bps of cuts as they respond to a recession and get aggressive.  Now, you can adjust those probabilities in any number of ways, but that seems reasonable to me.  However, that is not the market narrative.  Rather, the narrative is that the Fed is going to start to cut rates because policy is already overtight (real rates are positive) and they will want to get ahead of the curve.
  2. However, exactly why will the Fed need to cut, absent a full-blown recession?  Going back to 1982, these are the highest and lowest levels for real 10Yr yields, real Fed funds (defined as Fed funds – CPI) and Y/Y GDP each quarter:
 Real 10YrReal Fed fundsGDP Y/Y
Max7.60%8.30%9.60%
Min-0.35%-7.90%-2.20%

            Data: FRED database, calculations Fxpoet

So, we have seen real yields, both short- and long-term much higher and much lower than the current situation.  But the funny thing is, the relationship between GDP growth and real interest rates, whether 10Yr or overnight, is basically zero.  In fact, I ran the numbers and came up with an R2 of just 0.03 which tells me that there is no relationship of which to speak.  My point is just because real rates have risen to a positive level in the past year does not mean that the Fed has ‘overtightened’.  It just means that they have tightened policy trying to address what they still see as too high inflation.  It also does not indicate that because real yields have risen over the past quarters, that the economy is about to crash.  That’s not to say we are going to necessarily avoid recession, but the point is it will take much more than modestly higher real interest rates to push us over the edge.  At least that’s my view.

But for now, most markets are getting quite excited about the idea that peak interest rates are behind us and that the upcoming lower interest rates are going to support risk assets, especially equities, aggressively.  I feel a lot can go wrong with that model, but then I’m just an FX guy.

The Argentine people have spoken
As they want to fix what’s been broken
So, starting today
The new prez, Milei
Must change more than merely a token

A brief comment on this electoral outcome.  While Argentina’s economy is quite small on the global scale, I believe this is a harbinger of far more electoral shake-ups in 2024 and 2025.  We need only go back to 2015 when the Austrian presidential election was initially called for the complete outlier candidate, a non-politician as well as a right-wing firebrand, before being overturned by the courts there.  That story preceded the Brexit vote and then, of course, the election of Donald J Trump as US President in 2016.  People were very clearly tired of the political elite explaining why the masses needed to suffer while the elite got along just fine.  

The ensuing resistance by the entrenched politicians was fierce and so we saw Trump lose his reelection bid amidst great turmoil and then the election and collapse of Liz Truss in the UK.  But it appears that things have gotten worse in the broad populace’s collective mind, with inflation remaining stubbornly high, and perceptions of opportunity shrinking.  Combining those features with a growing distrust of media and government pronouncements after the Covid situation, where vaccines did not prove as efficacious as promised and, in fact, seemed to result in at least as many harms as benefits, and people are ready for a new look.

So, be prepared for some more non-traditional electoral winners next year.  Presidential elections are due in Taiwan, Mexico and the US with major regional elections throughout Germany, Canada, South Korea, India and the UK as well as the European Parliament.  Many people are quite pissed off at the incumbents around the world so look for more fragmentation and new faces.

This implies that much of how we consider the macroeconomic picture could well change.  And that means market volatility seems likely to increase further.  Just something to keep in mind, and an even more important reason to maintain hedges for major exposures, whether FX or interest rates.

Ok, it was easy to spend time on these issues as there is really nothing else going on.  Overnight, the only news was that the PBOC left their Loan Prime rates unchanged, as expected, so not really newsworthy.  Else, the biggest news over the weekend was arguably the Argentine elections.

It should not be surprising that market movement has been quite muted with the biggest equity move in Hong Kong (+1.85%) which is just a retracement of its recent woes.  Otherwise, Japanese markets fell somewhat (-0.6%) and the rest of APAC was very muted.  In Europe, there is a mix of gains and losses with nothing more than +/- 0.25%, so no real news and US futures are essentially unchanged at this hour (7:00).

Bond yields are, overall, a touch firmer this morning with Treasury and most European sovereign yields up 3bps.  But that is after another decline on Friday, and the 10yr remains quite close to its new home of 4.50%.  The ‘inflation is dead’ theme had a lot of proponents last week, but as we head into this, holiday shortened, week with limited new economic data, I suspect that things are going to be quiet without any new trends taking hold.  The market technicians explain that 4.33% and then 4.00% are the key yield supports.  So far, the first has held and I expect we will need to see much softer data to break it.

Oil prices are rebounding further this morning, up 1.5%, as there is talk that OPEC+ may be set to cut production even further with the price now below the level when they first initiated cuts in the summer.  There seems to be a disconnect between the official supply and demand data and the price, where the data would indicate prices should be higher.  One possible explanation has been that more Iranian oil has been reaching the market than officially allowed and so weighing on prices.  Alas, that is a very hard story to prove.  As to the metals markets, precious metals are softer this morning, but still retain the bulk of their recent gains while copper (+0.4%) is higher after Chinese demand indicators started to show strength.  

Finally, the dollar is starting to edge lower this morning as NY walks in the door after a very quiet overnight session.  USDJPY is the leader here, falling -0.8%, and we are seeing a large decline in USDCNY (-0.55%) as well.  Recently, there has been a distinct uptick in the number of pundits who are calling for a sharp decline in USDJPY.  Much is predicated on reading between the lines on Ueda-san’s pronouncements and expecting that QQE is finally going to end there.  Ironically, 10yr JGB yields are down to 0.74%, well below the highs seen at the beginning of the month and do not appear to be headed higher, at least for now.  To the extent that the Japanese MOF actually does want a stronger yen, something about which I am not at all certain, one must beware the idea that they could come in and intervene now, when they are jumping on the bandwagon rather than trying to stop a rush against them.  It would certainly be a lot more effective and would likely change a lot of opinions.  The one thing I have learned in my time in the markets is that when USDJPY starts to move lower, it can do so very quickly and for quite a long way.  

Away from those two currencies, both Aussie and Kiwi are firmer by about 0.6%, benefitting from strength in the renminbi as well as most commodity prices.  Not surprisingly, NOK (+0.5%) is rallying although it is a bit more surprising that CAD is essentially unchanged on the day.  Also remarkable is that CNY is the biggest mover in the EMG space, with most other currencies just barely changed on the day.

During this holiday week, there is very little data to be released with Existing Home Sales (exp 3.9M) tomorrow along with the FOMC Minutes and then Durable Goods (-3.2%, +0.1% ex transport) on Wednesday along with the Claims data.  Happily, it appears that the FOMC has taken this week off and will not be adding to their recent commentary.

Overall, the short-term trend appears to favor softness in interest rates leading to modest strength in risk assets and weakness in the dollar.  I am not yet convinced that is the long-term view, but for this week, I think that’s a fair bet.

Good luck

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More Fun Than Blondes

Posted on by 
In just the past week we have seen
That traders have changed their routine
They’re confident bonds
Have more fun than blondes
‘Cause rate cuts are what they now glean

Despite this, most central bank threads
Explain rate cuts ain’t in their heads
They all still maintain
Inflation’s not slain
And so now, they’re at loggerheads

There is only one story that continues to drive market activity lately, and that is bond yields.  They have become the best barometer of market sentiment we’ve seen in quite a while and the reaction function is quite clear; lower yields mean a soft landing, is coming and with it, central bank rate cuts to prevent a hard one.  While the US continues to lead the way, we are seeing yields decline around the world.  In essence, the bond markets worldwide have declared victory on behalf of the central banks.  In fact, as I look at my screen this morning, of the major economies in the world, only two, Mexico and South Africa, have seen 10yr yields climb today and that has been by 1.5bps and 0.5bps respectively.  In other words, virtually unchanged, while the rest of the world has seen declines of between 3bps and 7bps with even JGB yields lower by 5bps.

There are more and more adherents to the soft landing story as recent inflation readings have been declining steadily while economic activity is not slipping nearly as quickly.  Of course, this view is not universal as there remains a camp that points to underlying pieces of the economic puzzle like slowing bank lending growth or sliding manufacturing and are still looking for a more dramatic downturn in economic activity.  But generally, between the cheerleaders in finance ministries around the world and CNBC talking heads, all is right with the world.

Of course, if you are a central banker right now, all this positivity is working at cross purposes to your view that inflation is not actually dead and there is still further to go.  This is why we continue to hear that although progress has been made, it’s too early to take the victory lap.  We heard it from Cleveland Fed President Loretta Mester yesterday and from Austrian Central Bank chief and ECB Council Member Robert Holzmann this morning.  And we have been hearing it consistently for the past week, policy is somewhat restrictive, but we need to stay here until we are sure inflation is heading back to target.

Now, I am old enough to remember when the idea of tighter financial conditions doing the Fed’s job for them was a thing.  But in the month that has passed since that was first mooted, financial conditions are actually looser now than then.  The point is that the feedback loop between the data and the market response is now so dramatic, and occurring so rapidly, that the central bank reaction function is falling further behind the curve.  I have neither heard nor read a single thing in the past several days that implies there is a possibility the central banks are not done.  

But whether more rate hikes will do anything for inflation is no longer the issue, my sense is central banks want to make sure they are seen as in control.  I know things have been great lately with equities and bonds on fire and everybody’s 401Ks growing, but Jay doesn’t really care about your portfolio, and absent a complete collapse in economic activity in the next month, I would not be surprised by a December rate hike.  There is clearly no certainty on this, and the Fed funds futures market is currently pricing in just a 0.3% chance of it occurring.  I also know the Fed does not like to surprise markets, but I think the Fed fears the appearance of losing control more than anything else.  

However, until such time as they sound increasingly forceful, or the data starts to show inflation is not collapsing, it is hard to fight this move.  We have come a very long way in a very short period of time with respect to 10-year Treasury yields, a 60 basis point decline in slightly less than a month.  Be careful in assuming this will continue in a straight line.  As well, the fact that the yield curve’s inversion remains at -40bps is quite interesting.  Given the market is pricing 100bps of rate cuts by the end of 2024, I would have expected the front end of the curve to have fallen further in yield.

But that is where things stand as we get ready for another weekend and then, next week’s Thanksgiving holiday.  So, a quick tour of the overnight session shows that Chinese equities remain under pressure, especially in Hong Kong (-2.1%) as whatever they are doing over there is not solving their problems.  However, Japan is benefitting with modest gains and Europe is higher this morning across the board, about +0.8%.  As well, after a mixed day yesterday, US futures are pointing slightly higher, +0.2% or so at this hour (8:30).

We know the bond story so a look at commodities shows oil bouncing a bit, +1.3%, although it has been a horrific week and month for the black sticky stuff, down -15% in the past month.  Gold and silver, however, are huge beneficiaries of the decline in yields as they continue to rally and base metals are holding their own as well on the softer yield story.

Finally, it should be no surprise that the dollar remains under pressure, down 0.2% broadly (the DXY).  In the G10, JPY (+0.85%) is the leader followed by AUD (+0.5%) but all of them are firmer.  While there is a little more divergence in the EMG bloc, the broad trend remains for a softer dollar and as long as US yields remain under pressure, the dollar is likely to do so as well.  The one place I would watch carefully is the yen, as there is a growing belief it is set to rebound sharply.  On the plus side is the fact that US yields are falling, and the rate narrative is changing rapidly.  But remember, Japanese yields are also declining, and their recent GDP data was terrible, -2.1% in Q3, so the idea that the BOJ is going to tighten policy soon seems shaky at best.  There are many technical support levels on the way down, but do not be surprised of a test of 142.00 in the coming weeks if the current zeitgeist continues.

On the data front, Housing Starts (1.372M) and Building Permits (1.487M) were both released this morning pretty much on target and put paid to the idea that the housing market is collapsing. For the rest of the day, we have 5 more Fed speakers, but I doubt we hear anything new.  One other thing to remember is that Sunday, Argentina goes to the polls and the chances for the upstart candidate, Javier Milei, seem pretty good as the people there are fed up with the current government.  That could have some repercussions both financially and politically around the world, especially the latter, as it would be another step away from the current ruling class.  The point is, I do not believe that everything is better, and while right now things look good, there is more volatility in store.  Be careful and stay hedged, it is your best protection.

Good luck and good weekend

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Inflation is Dead

Posted on by 
For anyone who’s ever doubted
Inflation is falling and touted
The price of their food
Or Natgas and crude
The market has recently shouted

Inflation is dead, can’t you see?
The CPI’s back down to three
Soon Jay and the Fed
Will clearly have said
It’s time to cut rates, we agree

Another day, another soft inflation reading, two of them, actually.  First, the UK reported that CPI there fell to 4.6% in October, its lowest point in two years and a bit below expectations.  While that was quite a sharp decline from the September print of 6.7%, things there are still a bit problematic as the core rate remains much higher, at 5.7%, and is not declining at anywhere near the same rate as the headline.  What this tells us is that the energy component is a big driver as the price of oil is down about 10% in the past month.

Then, US PPI printed with the M/M number at -0.5%, much softer than expected which took the Y/Y down to 1.3%.  Core PPI is a bit higher, 2.4% Y/Y, but obviously, at a level that is not seen as a major problem.  Meanwhile, Retail Sales was released at a slightly less negative than expected -0.1% and last month’s print was revised up to 0.9%, the indication being that economic activity is not collapsing yet.  For the optimists, this has all the earmarks of a soft landing, declining inflation, modest growth, and still relatively strong employment.  As well for the optimists, they are all in on the idea that not only has the Fed, and every other central bank, finished their rate hiking cycle, but that rate cuts are coming soon!

In fact, that is the clear narrative this morning, rate hikes are dead, long live rate cuts.  There are numerous takes on this particular subject, but the general view is that now that inflation is finally heading back toward target, the central bank community will need to cut rates to prevent destruction in economic activity.  Europe is already teetering on the edge, if not currently in recession, and though GDP in Q3 here in the US printed at a robust 4.7%, Q4 appears to be slowing down somewhat with the latest GDPNow estimate at 2.2%.  However, given that growth in the US remains far better than many anticipated considering the speed and magnitude of the Fed’s rate hikes, my question is, why would the Fed cut?  At this point, there is limited evidence in the data that the economy is going to fall into recession, and based on their models, strong growth is likely to be inflationary, so maintaining the current levels should be fine.

At any rate, that is the crux of the bull/bear argument these days, and for now, the bulls are leading the dialog.  Equity markets continue to buy into that narrative as evidenced not just by Tuesday’s powerful rally, but the fact that yesterday saw a continuation of those gains, albeit at a much more muted pace.  Now, Asian markets didn’t really participate last night, with Japanese shares modestly lower but Chinese shares, especially the Hang Seng (-1.4%) suffering more broadly.  The data from China continues to show that the property market is crumbling, with home prices reported declining further last month despite Xi’s government pumping more money into the sector.  That is a bubble that is going to haunt President Xi for a very long time.  As to European bourses, they are mixed this morning with some (Germany and Spain) modestly firmer while others (UK and France) are modestly softer.  It is hard to get a read from this, especially given there has been no data released this morning.  Finally, US futures are ever so slightly softer at this hour (7:10), maybe on the order of -0.2%.  However, this seems a lot like a consolidation rather than a major retracement.

The bond market story, though, is probably more inciteful with regard to the overall narrative.  Given the softer inflation data, and the fact that futures and swaps markets are now pricing in the first interest rate cuts by May and 100bps of cuts over 2024, interest rates are still the key focus.  You will remember that in the wake of the CPI number, 10yr yields crashed 20bps.  Yesterday they did rebound a bit, rising 10bps at one point in the day before closing higher by about 7bp at 4.54%.  this morning, though, they are slipping back again, lower by 5bps as that 4.50% level remains the market’s trading pivot.  We are seeing similar yield declines throughout Europe as well, with investors there embracing the slowing inflation story.  In fact, UK yields are down 8bps this morning continuing the positive inflation story there.

Interestingly, the oil market is not embracing the goldilocks narrative as oil prices are softer again this morning, -0.75%, and have no real life in them.  Yesterday we did see EIA data describe a much larger than expected inventory build, and the US continues to pump out record amounts of oil, 13mm bbl/day, so in the short run, there is clearly ample supply.  Do not be surprised to see other OPEC members discuss voluntary production cuts in the near future.  On the other hand, gold and silver continue to rally, taking their cue from lower interest rates and the weaker dollar while this morning, the base metals are little changed.  One thing to remember is that if we truly are in a new, declining interest rate regime, look for the dollar to fall, and all the metals to rally.

Speaking of the dollar, it is very slightly firmer overall this morning, but remains well below levels seen prior to the CPI print on Tuesday.  In the G10, AUD (-0.4%) and NZD (-0.8%) are the laggards with the rest of the bloc seeing much smaller price action.  But, to demonstrate that things seem to be heading back to pre-CPI levels, USDJPY is back firmly above 151, although has not yet threatened the apparent line in the sand at 152.  In the EMG bloc, the story is far more mixed with KRW (+0.7%) seemingly benefitting from the warmer tone between Presidents Biden and Xi at yesterday’s APEC meeting, while ZAR (-0.7%) is suffering on the back of signs the economy there is slowing more rapidly based on construction activity reports.  The big picture remains that the dollar should continue to follow US yields broadly.  This means that if the Fed really is done and that cuts are coming, the dollar is going to fall further.  This is especially true if they start cutting before inflation is truly under control.  This is the key risk which we will need to watch going forward.

On the data front, today brings the weekly Initial (exp 220K) and Continuing (1847K) Claims data as well as the Philly Fed Manufacturing Index (-9.0).  Later we will see IP (-0.3%) and Capacity Utilization (79.4%) and we hear from four more Fed speakers before the day is through.  So far, the cacophony of Fedspeak has not wavered from the Powell idea that higher for longer is the game plan and that they will not hesitate to raise rates if they feel it is necessary.  Not one of them has cracked and acknowledged that rate cuts may happen next year, so keep an eye for that.

However, absent a Fed slip of the tongue, I suspect that today will be relatively quiet although this bullish equity/bullish bond/bearish dollar move does seem to have legs.  With the big data now behind us, until GDP and PCE at the end of the month, my take is the bulls are going to push as hard as they can.  Be prepared.

Good luck

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Markets No Longer Have Fear

Posted on by 
The CPI data made clear
That markets no longer have fear
But Jay and his team
Will still push the theme
That cuts in Fed funds just ain’t near

As such markets have been persuaded
It’s time for the Fed to be faded
The bulls are on top
And they just won’t stop
Til new record highs have been traded

By now, you are all well aware that yesterday’s CPI data came in a bit softer than the forecasts with the headline printing at 3.2% Y/Y while the core printed at 4.0% Y/Y.  Both of these were 0.1% lower which doesn’t seem to be that big a difference.  But the bulls are stampeding on the idea that if you look at the recent trend, the annualized rate for the past 6 months is lower still (3.0% and 3.1% respectively) and the implication is that inflation is dead and the Fed has achieved the impossible, reducing inflation without causing a recession.  And maybe they have, but boy, that is a lot to take away from a single data point that printed a smidge lower than expectations.

Two weeks ago, in the wake of the last FOMC meeting, I wrote (Bulls’ Fondest Dreams) that the Fed changed their tune and despite all the pushback we have received from Fed speakers in the interim, they definitely saw the end of the hiking path coming into view.  Yesterday’s data seemed to confirm this view, at least in the markets’ eyes.  As such, we saw a massive rally in both stocks and bonds, with 10-year yields falling 20 basis points at one point in the day before closing lower by about 17bps.  They are 2bps higher this morning on the bounce.  Interestingly, European sovereign yields also fell quite sharply despite the lack of local news as the price action once again proved that the 10yr Treasury yield is the only bond price that really matters in the world.

So, to me the question is now, is this view correct?  Has the Fed actually threaded the needle and successfully reduced inflationary pressures without causing a meaningful economic slowdown?  If so, Chairman Powell will rightly be hailed as a brilliant central banker, even if there was some luck involved.  How can we know, and more importantly, when will we be certain this is the case?

I think it is important to try to separate the markets and the economy as the two are really quite different.  The economy is where we all live.  From an individual perspective, I would contend it is a combination of one’s employment situation(and whether there is concern over losing one’s job or finding a new one), the true cost of living, meaning the ability to afford the mortgage/rent as well as put food on the table, and then to see if there is any additional money left to either save or spend on desires rather than necessities.  It seems abundantly clear that from this perspective, there is a large segment of the population that doesn’t feel great about things.  This was made clear in an FT survey that showed just 14% of those surveyed thought things had gotten better economically under the Biden Administration’s policies.

However, if this poet has learned nothing else in his time trading in, and observing, financial markets, it is that policymakers do not care one whit about those issues.  Despite periodic attempts to seem down-to-earth, the reality is they all exist within a policy bubble with no concerns about the rent or their next meal.  In this bubble exist only numbers like yesterday’s CPI or today’s Retail Sales (exp -0.3% headline, 0.0% ex autos).  GDP, to them, is not a measure of people’s confidence or belief in the state of the current world, it is a policy variable that they are trying to manage or manipulate so they can make positive pronouncements.

There is obviously quite a gulf between those two views of the world and the markets are the connection, trying to interpret the reality on the ground through the lens of the data.  Well, the policymakers must be thrilled today because the extraordinary bullishness that is now evident across all risk markets, in their minds, means that their jobs are secure.  When things are going well, reelection/reappointment are the expected outcomes.  However, that FT survey was clearly a warning shot across the bow of their Good Ship Lollipop that everything was going to be great going forward.

So, what’s it going to be?  As I wrote after the FOMC meeting, I believe the market is prepped to rally through the rest of the year.  After yesterday’s data, that seems even clearer.  But do not forget that one of the key rationales for the Fed’s change of heart was that the market was doing the Fed’s work for them, tightening policy by raising rates and watching risk assets drift lower, thus tightening financial conditions.  Let me tell you, financial conditions loosened a lot yesterday, and if this rally continues, you can be certain that Powell and friends will grow more concerned about a rebound in inflation.  The market has completely removed any probability of a December rate hike, or any further rate hikes by the Fed as of yesterday with the first cut now priced for May 2024.  At this stage, it seems probable that the October PCE data will be on the soft side so much will depend on the next NFP and CPI readings, both of which are released before the next FOMC meeting.

And there is one more thing that must be remembered when it comes to the bond market.  The US is still going to issue an enormous amount of debt going forward between refinancing ($8.3 trillion though 2024) the current debt and the new $2 trillion budget deficit that needs to be funded for next year.  Can bonds continue to rally in the face of that much supply?  Maybe they can, but it would seem to require a reengagement of foreign buyers rather than relying entirely on domestic savers.  Either that or the Fed will need to end QT and possibly even restart QE.  In the latter case, inflation would almost certainly become a major issue again.  The point is, while everyone is feeling great this morning, there are still numerous perils to be navigated in order to maintain economic growth with a low inflation regime.  I hope Jay and all the central bankers are up to the task, but a little skepticism seems in order.

Ok, the overnight session can be summed up in one word: BUY!  Equity markets everywhere rallied with strong gains in Asia (Hang Seng +3.9%) and Europe, after rallying yesterday, continuing higher by nearly 1% this morning.  US futures are also all green this morning, generally +0.5% at this hour (7:30).

Bond markets have mostly held onto yesterday’s impressive gains with some trading activity, but movements all within a basis point or two from yesterday’s close.  The exception was Asian government bond markets, where prices rallied sharply, and yields tumbled there as well, following the US lead.

Metals prices are ripping higher again this morning, with gold, silver, and copper all up nicely after strong gains yesterday.  The outlier here is oil, which is a touch lower (-0.4%) this morning after a very lackluster session yesterday.  Now, in fairness, it has been creeping higher for the past several sessions, but compared to other markets, oil is remarkably quiet right now.

Finally, the dollar got smoked yesterday, with the euro rallying 1.5% and similar moves across the other European currencies.  Meanwhile, AUD rallied more than 2% yesterday as the combination of rocketing metals prices and a broadly weaker dollar were just the ticket for the currency.  In the EMG bloc, ZAR (+3.0%) and MXN (+1.5%) were the big winners yesterday although, interestingly, most of the APAC currencies had much more muted runs, on the order of 0.5%-1.0% gains.  This morning, price activity is much more subdued as FX traders are trying to get their bearings again.  It was, however, a 3-sigma day, a rare occurrence.

On the data front, as well as Retail Sales, we also see PPI (exp 2.2% headline, 2.7% ex food & energy) and the Empire Manufacturing Survey (-2.8) along with EIA oil information where inventory builds are forecast.  There is only one Fed speaker, vice chairman of supervision Michael Barr, and I don’t expect he will be able to sway any views today.

For now, the die is cast, and the bulls are in the ascendancy.  We will need to see some very big changes in the data trajectory for the current momentum to stall, and quite frankly, I don’t see what that will be for now.  So, go with the flow here, higher stocks, lower yields and a softer dollar seem to be the trend for now.  There will be some trading back and forth, but you can’t fight City Hall.

Good luck

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