Monthly Archives: December 2023

Sufficiently

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Said Madame Lagarde, I don’t care

‘Bout dovishness seen over there

Though I’m not omniscient

We need rates sufficient-

Ly high til inflation is rare



The Old Lady’s governor, too

Expressed that no cuts were in view

But can both withstand

More slowing than planned

And, with their tough talk, follow through?

A little housekeeping to start this morning.  Today will be the last poetry until January 2nd when I will publish my ‘crystal ball’ viewings in a long-form poem.  For all my readers, thank you for reading and have a wonderful Christmas, Hannukah (I know it’s’ over), Kwanzaa, Festivus or whichever holiday is important as well as let’s hope 2024 is a fantastic new year.

So, let us review yesterday’s activity, and then, more broadly, the state of things as we come to the end of the year.

Arguably, the biggest news yesterday was not that the ECB left rates on hold, which was universally expected, but that Madame Lagarde tried very hard to continue to sound hawkish despite the Fed’s turn on Wednesday.  “Based on its current assessment, the Governing Council considers that the key ECB interest rates are at levels that, maintained for a sufficiently long duration, will make a substantial contribution to this goal. The Governing Council’s future decisions will ensure that its policy rates will be set at sufficiently restrictive levels for as long as necessary.” [emphasis added.]

As well, she explicitly mentioned that there was no discussion of interest rate cuts in the meeting.  The hawks on the committee managed to get a bone thrown their way with the announcement of a phased exit from the PEPP program starting in the second half of next year.  At the same time, their staff projections for GDP growth and inflation were all reduced slightly for 2024 and 2025 with low numbers penciled in for 2026.  She maintained that inflation has been “too high for too long”, clearly true, and has been unwilling to consider anything but their inflation fight.

Alas, this morning’s Flash PMI data releases make ugly reading with French, German and the Eurozone overall reading weaker than last month and weaker than expected.  The Eurozone growth engine has been stalling for quite a while despite falling energy costs.  And now, in the wake of the Fed turning dovish, energy costs are rebounding which will almost certainly negatively impact the continent’s growth trajectory.  Maybe Lagarde can hold out for another month, but I suspect if the data continues to erode in the manner, it has recently, the ECB will recognize that the worst is over and it’s time to alter policy, just like the Fed has done. As well, given the economy in Europe is in far worse shape than here in the US, I expect that they will be cutting more quickly as 2024 progresses.  That will not help the euro, but that is a story for some time next year, not for the remainder of this one.

At almost the same time, the BOE also maintained their policy rate and also indicated that they were not anywhere near ready to cut rates.  In fact, 3 voters wanted a 25bp rate hike, which given inflation in the UK is the highest in the western world, with core still at 5.7%, makes sense.  But, as on the continent, economic activity continues to stumble along, with manufacturing, according to this morning’s Flash PMI reading of 46.4 in recession although Services activity, 52.7 does seem to be rebounding.  However, here, too, I believe the gravitational pull of a dovish Fed is going to quickly weigh on the BOE and we are going to see a pivot in the first half of next year amid weaker growth and slowing inflation.

One final note from yesterday was that Retail Sales were a bit stronger than expected, rising 0.3% and failing to show the slowdown that would be expected to help reduce inflationary pressures.  And just think, that was before the Fed pivot, which has ignited a massive risk-on rally in assets and likely will juice things even more in the short-term.

The result of these policy decisions is that stocks are rallying pretty much everywhere in the world, bonds are rallying pretty much everywhere in the world, commodities prices are rallying, and the dollar is falling.  Not only that, I see nothing that is likely to change those views until somewhere toward the end of Q1 2024 at the earliest.

But let’s step back for a moment and consider the medium-term impacts of all this change.  Remember this, a soft-landing is merely the last stop in the cycle before a hard landing.  The soft-landing narrative is clearly the majority view and driving force in markets as 2023 comes to a close.  But is that a realistic outcome?  

I think a very strong case can be made that we have seen the bulk of the disinflationary forces that are coming as the combination of Covid driven supply chain issues being fixed and higher interest rates / QT has weighed on marginal demand.  It has been a fun story while it lasted and has certainly cheered markets.

But structural issues remain, many of which are outside any central bank’s abilities to address adequately.  Consider what I believe is the biggest structural change, the turn from capital-focused economic policies to labor focused economic policies.  This is inherently inflationary and regardless of what Powell or Lagarde or Ueda or anyone in that chair does, this change is going to continue.  It is a political change, and one that is only getting started.  Politically, we call it populism, and one need only read the papers to recognize this is the new world.

For 40 years, since the Reagan/Thatcher leadership, the world has seen low inflation from a combination of demographics and globalization creating downward pressure on wages and reduced taxation increasing the return on capital.  This led to the financialization of western, especially the US, economies and expanded the wealth/income gaps that are prevalent around the world today.  

But this is changing, and changing far more rapidly than the current governments in power would like to see or believe.  As I wrote earlier, 2016 was a test run for what is looming in 2024.  Consider the populist views of recent election outcomes in Argentina and the Netherlands as well as the rise in the polls of the National Front in France, AfD in Germany, and the strength of both Trump and RFK Jr in the US, with populism as the driving force.  2023 saw more labor unrest in the US than any time in the past 20 years and harkens back to conditions in the 60’s and 70’s.  The big difference between now and then is that union membership has declined so dramatically in the interim.  Do not be surprised to see unions rise again in popularity.

But populism drives more than labor unrest, and ultimately rising wages, it also encourages governments to consider trade barriers and tariffs, both of which drive consumer prices higher.  And populism is very easy for governments to adopt because it sounds so good.  Consider the key tenets; buy domestic goods, limit immigration and tax the rich so they pay their fair share.  We will hear some version of these policies in every country around the world in 2024, and not just western nations, but communist bloc countries as well.  

If this is the future, and I believe it is, then the current risk rally is merely a hiatus before things turn much worse.  In a populist driven society, profit margins are going to decline, and capital will flee to where it feels safest.  That may be whichever nations push back against this trend, although they will be few and far between, and things like real assets, commodities, and real estate.  While I believe this will be the general trend, from an FX perspective, given everything is relative there, strength or weakness will depend on the relative decisions made in each nation.  Arguably, the less populist the decision outcomes, the stronger the currency, but ex ante, there is no way to know how that will turn out.  If I had to bet now, I would suggest that the nation least susceptible to this wave is Japan, a truly homogenous society, and that bodes well for the yen going forward.

In the meantime, as I head off, here are today’s data points with Empire State Manufacturing just released at a much worse than expected -14.5.  We are due to see IP (exp 0.3%), Capacity Utilization (79.1%), and the Flash PMI’s (Mfg 49.3, Services 50.6).  Through the rest of the month, the most important data point will be the PCE data on the 22nd, but arguably, Powell already told us it is not going to be hot, that’s why he turned away from higher for longer.

Today is triple witching in the equity markets, with stock options, future options and futures all expiring, so volume should be high and movement can be surprising.  But the trend right now is positive for risk assets, and I believe that will continue through the holidays and into January.

Good luck, good weekend and have a wonderful holiday

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Miles Off Base

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This poet was miles off base

As Powell, more growth, wants to chase

So, hawks have been shot

With nary a thought

While doves snap all stocks up apace.



It seems clear that Jay and the Fed

Decided inflation is dead

Through Q1 at least

Bulls will have a feast

Though after, take care where you tread

It turns out that not only were my tail risk ideas wrong, I was on the wrong side of the distribution!  Powell has decided that the soft-landing narrative is the best estimator of the future and wants to make sure the Fed is not responsible for a recession.  Concerns over inflation, while weakly voiced, have clearly dissipated within the Eccles Building.  I hope they are right.  I fear they are not.

In fairness, once again, yesterday I heard a very convincing argument that inflation was not only going to decline back to the Fed’s target of 2.0%, but it would have a 1 handle or lower by the middle of 2024 based on the weakening credit impulse that we have seen over the past 18 months.  And maybe it will.  But, while there is no question that money supply has been shrinking slowly of late, which has been a key part of that weakening credit impulse story, as can be seen from the chart below based on FRED data from the St Louis Fed, compared to the pace of M2 growth for decades, there are still an extra $3 trillion or so floating around the economy.  Iit seems to me prices will have a hard time falling with that much extra cash around.

Of course, there is one other place that money may find a home, and that is in financial assets.  So, perhaps the outcome will be a repeat of the post-GFC economy, with lackluster growth, and lots of money chasing financial assets while investors lever up to increase returns.  My guess is that almost every finance official in the world would take that situation in a heartbeat, slow growth, low inflation and rising asset prices.  The problem is that series of events cannot last forever.  As is usually the case with any negative outcome, the worst problems come from the leverage, not the idea.  When things are moving in one’s favor, leverage is fantastic.  But when they reverse, not so much.

A little data is in order here.  According to Statista, current global GDP is ~$103 trillion in current USD, current global stock market capitalization is ~$108 trillion, and the total amount of current global debt is ~$307 trillion according to the WEF.  In a broad view, the current debt/equity ratio is about 3:1 and the current debt/sales ratio is the same.  While this is not a perfect analogy, usually a debt/equity ratio of 3.0 is considered pretty high and a company that runs that level of debt would be considered quite risky.  Now, ask yourself this, if economic activity only generates $108 trillion, how will that >$300 trillion of debt ever be repaid?  The most likely answer is, it never will be repaid, at least not on a real basis.

If you wonder why central bankers favor lower interest rates, this is the primary reason.  However, at some point, there is going to be more discrimination between to whom lenders are willing to lend and who will be left out because they are either too risky, or the interest rate demanded will be too high to tolerate.  When considering these facts, it becomes much easier to understand the central bank desire to get back to the post-GFC world, doesn’t it?  And so, I would contend that Chairman Powell has just forfeited his efforts to be St Jerome, inflation slayer. 

The implication of this policy shift, and I would definitely call this a policy shift, is that the near future seems likely to see higher equity prices, higher commodity prices, higher inflation, first higher, then lower bond prices and a weaker dollar.  The one thing that can prevent the inflation outcome would be a significant uptick in productivity.  While last quarter we did see a terrific number there, +5.2%, the long-term average productivity growth, since 1948 is 2.1%.  Since the GFC, that number has fallen to 1.5%.  We will need to see a lot more productivity growth to keep goldilocks alive.  I hope AI is everything the hype claims!

Today, Madame Christine Lagarde

And friends are all partying hard

Now that Jay’s explained

Inflation’s restrained

And rate cuts are in the vanguard



This means that the ECB can

Lay out a new rate cutting plan

The doves are in flight

Which ought to ignite

A rally from Stuttgart to Cannes

Let’s turn to the ECB and BOE, as they are this morning’s big news, although, are they really big news anymore?  Both these central banks have been wrestling with the same thing as the Fed, inflation running far higher than target, although they have had the additional problem of a much weaker economic growth backdrop.  As long as the Fed was tightening policy, they knew that they could do so as well without having an excessively negative impact on their respective economies.  But given that pretty much all of Europe is already in recession, and the UK is on the verge, their preference would be to cut rates as soon as possible.  

But yesterday changed everything.  Powell’s bet on goldilocks has already been felt across European markets, with rallies in both equity and bond markets in every country.  The door is clearly wide open for Lagarde and Bailey to both be far more dovish than was anticipated before the FOMC meeting.  And you can be sure that both will be so.  While there will be no rate cuts in either London or Frankfurt today, they will be coming soon, likely early next year.  

At this point, the real question is which central bank will be cutting rates faster and further, not if they will be cutting them at all.  My money is on the ECB as there is a much larger contingent of doves there and the fact that Germany and northern European nations are already in recession means that the hawks there will be more inclined to go along for the ride.  Regardless, given the Fed has now reset the central bank tone to; policy ease is ok, look for it to happen everywhere.

Right now, this is all that matters.  Yesterday’s PPI data was soft, just adding fuel to the fire.  Inflation data that was released this morning in Sweden and Spain saw softer numbers and while Retail Sales (exp -0.1%, ex autos -0.1%) are due this morning along with initial Claims (220K), none of this is going to have a market impact unless it helps stoke the fire.  Any contra news will be ignored.

Before closing, there are two things I would note that are outliers here.  First, Japanese equity markets bucked the rally trend, with the Nikkei sliding -0.7% and the TOPIX even more (-1.4%) as they could not overcome the > 2% decline in USDJPY yesterday and the further 1% move overnight.  That very strong yen is clearly going to weigh on Japanese corporate profitability.  The other thing is that there is one country that is not all-in on the end of inflation, Norway.  This morning, in the wake of the Fed’s reversing course, the Norges Bank raisedrates by 25bps in a total surprise to the markets.  This has pushed the krone higher by a further 2.3% this morning and nearly 4% since the FOMC meeting.  

As we head toward the Christmas holidays and the beginning of a new year, it seems like the early going will be quite positive for risk assets and quite negative for the dollar.  Keep that in mind as you consider your hedging activities for 2024.

Good luck

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The Doves Will Be Shot

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Inflation was just a touch hot

And certainly more than Jay sought

So, later today

What will the Fed say?

My sense is the doves will be shot



Instead, as Jay’s made manifest

Inflation is quite a tough test

So, higher for longer

Or language much stronger

Is like what he’ll say when he’s pressed






Let’s think a little outside of the box this morning, at least from the perspective of virtually every pundit and their beliefs about what will happen at the FOMC meeting today.  At this point, most of the punditry seems to believe that Powell cannot be very much more hawkish, especially since the market is expecting comments like inflation is still too high and the Fed will achieve their goal.  So, there is a growing camp that thinks any surprise can only be dovish, since if he doesn’t push back hard enough or talk about loosening financial conditions being a concern, the equity market response will be BUY STONKS!!!





But what if, the thing Powell really wants, or perhaps more accurately needs, is not a soft landing, but a full-blown recession!  Think about it.  As I have written repeatedly, the idea that the Fed will cut rates by 125bps next year because growth is at 1.5% or 2.0% and inflation has slipped to 2.5% seems like quite an overreaction.  But given the current US debt situation ($34 trillion and counting) and the fact that the cost of carrying that debt is rising all the time, what would get the Fed to really cut rates?  And the only thing that can do it is a full-blown, multiple quarters of negative GDP growth, rising Unemployment Rate, recession.  If come February or March, we start seeing negative NFP numbers, and further layoff announcements as well as declining Retail Sales and production data, that would get the Fed to act. 





At least initially, we would likely see inflation slide as well, and with that trend plus definitive weakness in the economy, it would open the door for some real interest rate cuts, 400bps in 100bp increments if necessary. Now, wouldn’t that take a huge amount of pressure off Treasury with respect to their refi costs?  And wouldn’t that encourage accounts all over the world to buy Treasuries so there would be no supply issues?  All I’m saying is that we cannot rule out that Powell’s master plan to cut rates is to drive the economy into a ditch as quickly as possible so he can get to it.  In fact, it would open the door to restart QE as well.





This is not to say that this is what is going to happen, just that it is not impossible, and I would contend is not on anyone’s bingo card.  Now, Powell will never say this out loud, but it doesn’t mean it is not the driving force of his actions.  Powell is incredibly concerned with his legacy, and he has made abundantly clear that he will not allow his legacy to be the second coming of Arthur Burns.  Instead, he has his sights on the second coming of Paul Volcker, the man who killed the 1970s inflation dragon.  St Jerome Powell, inflation slayer, is what he wants as his epitaph.  And causing a recession to kill inflation and then cut rates is a very clever, non-consensus solution.





How will we be able to tell if I’m completely nuts or if there is a hint of truth to this?  It will all depend on just how hard he pushes back on the current narrative.  Yesterday’s CPI results could best be described as ‘sticky’, not rebounding but certainly not declining further.  Shelter costs continue apace at nearly 6% Y/Y and have done so for more than 2 years.  I was amused this morning by a chart on Twitter (I refuse to call it X) that showed CPI less shelter rose at just 1.4% with the implication that the Fed needs to start cutting rates right away.  The problem with that mindset is that shelter is something we all pay, and there is scant evidence that housing markets are collapsing.  In fact, according to the Case Shiller index, they are rising again.  I would contend that there is plenty of evidence to which Powell can point that makes his case for an economy that is still running far too hot to allow inflation to slide back to their target.  And that’s what I expect to hear this afternoon.





Speaking of recession, let us consider the situation in China, where despite the CCP’s annual work conference just concluding with some talk of building a “modern industrial system” the number one goal this year, thus boosting domestic demand, they announced exactly zero stimulus measures to help the process.  Data from China overnight showed that their monthly financing numbers were all quite disappointing compared to expectations and the upshot was a further decline in Chinese and Hong Kong equity markets.  This ongoing economic weakness and the lack of Xi’s ability or willingness to address it continues to speak to my thesis that commodity prices will remain on the back foot.  If you combine the high interest rate structure in the G10 with a weaker Chinese economy, the direction of travel for energy and base metals is likely to be lower.  The one exception here is Uranium, where there is an absolute shortage of available stocks and a renewed commitment around the world to build more nuclear power plants.





At the same time, Europe remains pretty sick as well, with Germany leading the entire continent into recession, and likely dragging the UK with it.  Germany, France, Norway, the UK and others are all sliding into negative growth outcomes.  While Chairman Powell will continue to push back on the idea of rate cuts soon, I expect that tomorrow, when both the ECB and BOE meet, they will open the door to rate cuts early next year.  Inflation in both places has been falling sharply and there is no evidence that Madame Lagarde or Governor Bailey is seeking to be the next Paul Volcker.  Both will blink with the result that both the euro and the pound should feel pressure.





Summing it all up, today I think we get maximum hawkishness from the Fed with Powell pushing back hard on the market pricing.  Initially, at least, I expect we could see yields rise a bit and stocks sell off while the dollar continues its overnight rise.  But I also know that there are far too many people invested in the idea that the Fed must cut soon, and they will be back shortly, buying that dip until they are definitively proven wrong.  





As to the rest of the overnight session, aside from China’s weak performance, South Korea also lagged, but the rest of the APAC region saw modest gains.  Europe, meanwhile, is all green, although it is a very pale green with gains on the order of 0.2%, so no great shakes.  Finally, US futures are firmer by 0.1% at this hour (7:15) after yesterday’s decent gains.





Bond yields are sliding this morning, down 2bps in the US and falling further in Europe with declines of between -3bps and -6bps on the continent as investors and traders there start to price in a more aggressive downward path for interest rates by the ECB.  UK yields are really soft, -9bps, after GDP data this morning was disappointing across the board, especially the manufacturing data.





Oil prices (+0.45%) which got slaughtered yesterday, falling nearly 4%, are stabilizing this morning, as are gold prices, which fell yesterday, but not quite as much as oil.  However, the base metals complex continues to feel the pressure of weak Chinese demand.  I continue to believe that there are structural supply issues, but right now, the macro view of weak economic activity is the main driver, and it is driving prices lower.





Finally, the dollar is firmer this morning as weakness elsewhere in the world leaves fewer choices for where to park funds.  While the movement has not been overly large, it is quite uniform across both G10 and EMG currencies.  The laggards have been NZD (-0.6%) after a softer than expected CPI reading and ZAR (-0.6%) on the back of weakening metals prices.  If I am correct about the path going forward, the dollar should perform well right up until the Fed responds to much weaker economic activity and starts to cut rates aggressively.  At that point, we can see a much sharper decline in the greenback.





Ahead of the FOMC meeting, this morning we get November PPI (exp 1.0%, 2.2% core) which would represent a small decline from last month’s data.  We will also see the EIA oil inventory data, which has shown a recent history of builds helping to drive the oversupply narrative there.





At this point, it is all up to Jay.  I suspect that markets will be quiet until then, and it will all depend on the statement, the dot plot and the presser.





Good luck





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			No Matter What
		


				

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The story that’s got the most press

Is CPI’s sure to regress

So, Jay and the Fed

Without any dread

Can start cutting rates with success



But what if instead of a nought

The data is higher than thought?

Will markets adjust?

Or will folks still trust

That rate cuts come no matter what?






While all eyes truly remain on the FOMC meeting announcement tomorrow afternoon, and of course, the ensuing press conference by Chairman Powell, this morning brings the November CPI report, which could well have an impact on tomorrow’s outcome.  Current median expectations are for a M/M headline release of 0.0% leading to a Y/Y result of 3.1%.  As to the core (ex food & energy) result, M/M is forecast to be 0.3% with the Y/Y result being unchanged at 4.0%.





Lately, the inflation bulls, aka the deflationistas, have been harping on the fact that if you annualize the past 3 months’ worth of data or the past 6 months’ worth of data, the annualized outcome is 2.5% or lower, and so the Fed has basically done their job and returned inflation back to their target.  In the very next breath, they explain that with inflation back at target, they can start to cut rates because otherwise they will choke off the economy.





Even if I grant the first part of this thesis, of which I am suspect, it is the corollary rate cuts that make no sense at all.  Thus far, the bulk of the data that we have been observing has shown that the economy has held up extremely well despite 525 basis points of rate hikes over the course of less than two years.  This was made evident by Friday’s payroll report as well as the Q3 GDP report and much of the hard data that abounds.  Given the economy’s clear resilience to this higher rate structure, I can see no good case for the Fed to cut.





In fact, I think the key for the entire macroeconomic outlook revolves around just how long the US economy can maintain its growth trajectory with interest rates at their current levels.  The one thing of which we can be certain is that the Fed is not going to pre-emptively cut rates because they think a recession might show up, at least not now while inflation remains well above their target.  If the US economy continues to perform, meaning grow at 2%-2.5% over time while the Unemployment Rate stays below 4.5%, I would argue there is no incentive for the Fed to cut, at least not on a macro basis.  (There may be political reasons for them to cut, but that’s a different story.)  Now, if growth continues apace, will that be bullish or bearish for stocks?  For bonds?  For the dollar?  For commodities?  I would say that these are the questions we need to answer and are why the Fed remains such an important part of the discussion.  Do not discount a world where 10-year yields are 5.5%, Fed funds are 5.25% and GDP is 2.0% while inflation runs at 3.0%.  This could well be the near future.  It would also likely be quite a negative for risk assets.





My point is there continues to be a great dichotomy of thought as to how the future will unfold as we all are looking for the next clue to support our thesis.  While I continue to believe that a slowdown is coming, to date, there has been no clear evidence that is the case.  In fact, Friday’s Michigan Sentiment data was substantially better than anticipated while inflation expectations fell alongside the price of gasoline.  In fact, a marginally stronger than anticipated print this morning will simply be more proof that the market’s current anticipation for rate cuts in 2024, which sit between 4 and 5 cuts, will need to be repriced.  If risk assets have rallied on the basis of future Fed rate cuts, that could be a problem.  Just sayin’!





Ok, ahead of the data, this is what we have seen.  Yesterday’s modest US equity rally was followed by generally modest strength in Asia with the best performer being the Hang Seng (+1.1%).  Last night, China’s government made a series of announcements describing all the sectors of the economy that they would be supporting going forward with fiscal policy, although there were no numbers attached to any of it, it was all cheerleading.  Saturday night, Chinese CPI data was released at -0.5% both M/M and Y/Y, while PPI there fell to -3.0%.  The implication is that economic activity is not going very well.  In fact, it might be appropriate to define it as a recession, although I’m sure that won’t be the case.  However, looking for China to be the world’s growth engine may be a bad call for the time being.  As to Europe, it is a mixed picture there, with both modest gainers and modest laggards and no real direction overall.  US futures are higher by 0.2% at this hour (7:30) but are obviously keenly focused on the data release.





Yesterday’s bond market price action, where yields backed up, has been completely reversed this morning with 10-year Treasury yields lower by 5bps and European sovereign yields lower by even more, 6bps-7bps while UK gilts have really rallied, with yields there down by 12bps after the employment data showed wage pressures declining far more than anticipated.





On the commodity front, oil is drifting lower again this morning, down -0.6%, although the metals complex is showing strength with gains in gold (0.4%) and copper (0.3%), which seem to be rising on the back of a weaker dollar and lower US rates.  But a quick aside on oil and the commodities space in general.  I have made the point that the commodity markets are the only ones that are pricing in a recession.  And I would contend that is still the case.  Perhaps, though, I have been looking in the wrong place for that economic weakness.  Consider that China is the largest consumer of raw commodities in the world, by a wide margin.  Consider also that the Chinese economy is having all kinds of difficulty as the dash for growth seems to have reached its apex and is now sliding lower.  As I mentioned above, the idea that China is in a recession may not be absurd, and perhaps the fact that the commodity markets, in general, have been so soft is simply a recognition of that fact.  If this is the case, we need to watch Chinese economic activity closely in order to get a sense of the trend in commodities.  Or perhaps, we need to watch the trend in commodities to better understand the Chinese economy.  When base metals turn higher, look for Chinese stocks to do the same.





Finally, the dollar, as mentioned above, is under pressure this morning, down -0.3% when measured by the DXY.  The biggest mover is JPY (+0.7%) but we are seeing all the G10 bloc as well as the bulk of the EMG bloc rallying against the greenback.  Speaking of Japan, last night there was further commentary pushing back on the idea of any movement by the BOJ next Monday regarding the normalization of monetary policy in the near future.  I maintain that nothing will happen before they see the wage negotiation outcomes in March and, in the meantime, they are praying quite hard for the recent global inflation trend to remain downward as this will allow them to maintain their QE and fund the government.





And that’s really it for the day, as the CPI is the only news to be released.  Unless it is significantly different than the current expectations, I suspect that things will be quiet today, modest continued equity and bond rally as everybody places their bets that the Fed is getting ready to start to cut rates.  I’m not holding my breath.





Good luck





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			The New Allegory
		


				

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On Friday, the data surprised

With job growth more than advertised

So, bonds took a bath

And stocks strode a path

Where growth is what’s now emphasized



But what of the soft landing story?

Will rate cuts now be dilatory?

If Jay just stands pat

Will stocks all go splat?

Or is this the new allegory?






Well, this poet was clearly wrong-footed by Friday’s employment report where not only were non-farm payrolls stronger than anticipated at 199K, but hours worked rose and the Unemployment Rate fell 2 ticks to 3.7%.  While revisions to previous reports were lower, as they have been all year, the report did not point to an imminent slowing of the economy nor a recession in the near-term.  Arguably, the soft-landing crowd made out best, as equity markets, which initially plunged on the report following Treasury prices, rebounded as investors decided that growth is a better outcome than not.  Yields jumped higher, as would be expected, rising 8bps in the US with larger gains throughout Europe before they went home for the weekend.  And finally, the dollar flexed its muscles again, rallying universally with gains against 9 of the G10 currencies, averaging 0.4% (only CAD (+0.1%) managed to hold its own) and against most of the EMG bloc with a notable decline by ZAR (-1.1%), although MXN (+0.6%) bucked the trend.





Does this mean the soft landing is coming?  As we start the last real data intensive week of 2023, it remains the favored narrative, but is by no means assured.  After all, before the end of this week we will have seen the latest CPI reading in the US (exp 3.1% headline, 4.0% core) and we will have heard from the FOMC, ECB and BOE as well as several smaller central banks like the Norgesbank and the SNB.  And let us not forget that the BOJ meets next Monday.  So, there is plenty of new, important information that is coming soon and will almost certainly drive potential narrative changes.





Perhaps an important part of the discussion is to define what we mean by a soft landing, or at least what the ‘market’ means by the concept.  My best understanding is as follows: GDP slides to 1% or so, but never goes negative.  Unemployment may edge higher than 4.0%, but only just, with a cap at the 4.2% or 4.3% area, and inflation, as measured by Core PCE finds a home between 2.0% and 2.5%.  This result, measured inflation falling back close to target while the growth and employment story just wobbled a bit, would be nirvana for Powell and friends.  





How likely is this outcome?  Ultimately, history is not on their side as arguably the only time the Fed ‘engineered’ a soft landing was in 1995, and on an analogous basis they had already started cutting rates by this time in the cycle.  The fact that we are still discussing higher for longer implies that there is much more pain likely to come than the optimists believe.  We have already seen the first signs of trouble as the number of bankruptcies soar and stories about non-investment grade companies needing to refinance their debt at much higher interest rates than the previous round fill the news.  Certainly, Friday’s employment data is encouraging for the economic situation, but the chink in the armor was the wage data which showed more resilience (+0.4%) than expected.  Given the Fed’s focus on wages and their impact on inflation, the fact that wage growth remains well above the levels the Fed deems appropriate to meet their inflation target is not a sign that policy ease is coming soon.





And ultimately, I believe that is the critical feature here.  The economy has held in remarkably well considering the pace and size of the interest rate changes we have already seen.  The big unknown is how much of that interest rate change has really been felt by the economy.  Obviously, the housing market has felt the impact, and to some extent the auto industry, but otherwise, it is not as clear.  Do not be surprised if this period of slow economic activity extends for a much longer time than in the past as the drip of companies that find themselves unable to refinance at affordable rates slowly grows.  By 2025, about $1 trillion of corporate debt that was issued at much lower interest rates will need to be refinanced.  I’m not worried about Apple refinancing their debt, but all the high-yield debt that was snapped up with a 4% or 5% handle during the period of ZIRP will now be at 10% or so and it is an open question if those business models will be functional with financing that expensive.  





So, perhaps, the story will be as follows:  economic activity is going to muddle along at low rates for an extended period, another 2 or 3 quarters, until such time as the debt ‘time-bomb’ explodes with refinancing rates high enough to force many more bankruptcies and start a more aggressive recessionary cycle with layoffs leading to rapidly rising Unemployment rates and economic activity falling more sharply.  In this timeline, we are talking about the recession becoming clear in Q3 of 2024, a time when most of that $1 trillion of corporate debt will be current.    While interest rates will certainly be slashed at some point, this does not bode well for risk assets in the second half of 2024.  For now, though, it certainly seems like the current narrative is going to continue.





There’s no urgency

To change policy quite yet

But…some day we will






A quick story about the BOJ which last night pushed back firmly against the growing narrative that they were about to start normalizing interest rate policy with a rate hike in either December or January.  Instead, several stories were released that described the recent decline in both GDP and inflation as critical and the fact that they still don’t have enough information with respect to wages in Japan, given the big spring wage negotiation has not yet happened, to make a decision.  In other words, the BOJ was successful at convincing markets to behave as the BOJ wants, not as the rest of the world wants.  The upshot was that the yen weakened sharply (-0.9%) while the Nikkei rose 1.5% and JGB yields were unchanged.  The BOJ pivot remains one of the biggest themes in the macro community, mostly because it is seen as the place where the largest profits can be made by traders.  But my experience (4 years working for a Japanese bank) helps inform my view that whatever they do will take MUCH longer to happen than the optimists believe.





Ok, let’s try a quick trip around markets here for today.  Aside from Japan, most of Asia had a good equity session with Hong Kong (-0.8%) the only real laggard.  Remember, a key story there remains the Chinese property sector as many of those firms are listed in HK.  Meanwhile, European bourses are mixed although movements haven’t been very large in either direction.  The worst situation is the UK (FTSE 100 -0.5%), while we are seeing some gains in the CAC and DAX, albeit small gains.  Finally, US futures are pointing a bit lower, -0.2%, at this hour (7:45).





In the bond market, after Friday’s dramatic price action, Treasury yields are continuing to rise, up 5bps this morning, although European sovereign yields are little changed on the day, with the bulk of them slipping about 1bp.  Given most saw quite large moves on Friday, and given the imminent policy decisions by the big 3 central banks, I suspect traders are going to be quiet for now.  





Oil prices (-0.3%) are slipping slightly this morning but are mostly consolidating Friday’s gains.  On the metals front, though, everything is red with gold, silver, copper and aluminum all under pressure.  Again, this is the one market that has been pricing a recession consistently for the past several months while certainly equity markets have a completely different view.





Finally, the dollar is continuing to rebound on the strength of rising Treasury yields.  While the euro is little changed on the day, the yen is driving price action in Asia with weakness also seen in CNY, KRW and TWD.  As well, ZAR (-0.8%) continues to suffer on weaker commodity pricing and both MXN and BRL are under pressure leading the LATAM bloc lower.  At this point, I would say the FX market has more faith in Powell’s higher for longer mantra than some other markets.





As mentioned, there is a lot of data this week:





TodayNY Fed Inflation Expectations3.8%
TuesdayNFIB Small Biz Optimism90.9
 CPI0.0% (3.1% Y/Y)
 -ex food & energy0.3% (4.0% Y/Y)
WednesdayPPI0.1% (1.0% Y/Y)
 -ex food & energy0.2% (2.3% Y/Y)
 FOMC Rate Decision5.5% (unchanged)
ThursdayECB Rate Decision4.5% (unchanged)
 BOE Rate Decision5.25% (unchanged)
 Retail Sales-0.1%
 -ex autos-0.1%
 Initial Claims221K
 Continuing Claims1891K
FridayEmpire State Manufacturing2.0
 IP0.3%
 Capacity Utilization79.2%
 Flash PMI Manufacturing49.1
 Flash PMI Services50.5





Source tradingeconomics.com





Thursday also has the Norges Bank and SNB, both of whom are expected to leave rates on hold.  For today, it strikes me that the discussion will continue as pundits try to anticipate what the FOMC statement will say and how Powell sounds in the press conference.  As such, it is hard to get excited that there is going to be a big move in either direction.  With all that in mind, my overall read on the economy is that while we may muddle along in the US for a while yet, it will be better than many other places in the world, notably the EU, the UK and China, and so the dollar is likely to hold up far better than most expect…at least until Powell changes his tune.





Good luck





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			Jay Powell’s Dream
		


				

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As markets await the release

Of Payrolls, all things are at peace

But once it’s revealed

We need watch the yield

In 10-years lest it should decrease



While Goldilocks is still the meme

And certainly, Jay Powell’s dream

The data’s beginning

To show growth is thinning

More quickly both down and upstream






So, here’s the scoop.  Today is payrolls day and that is the only thing that anybody cares about right now, ahead of the release, and it will be the topic du jour by all the talking heads for the rest of the day.  As of 7:00am, here are the latest consensus forecasts according to tradingeconomics.com:





Nonfarm Payrolls180K
Private Payrolls153K
Manufacturing Payrolls30K
Unemployment Rate3.9%
Average Hourly Earnings0.3% (4.0% Y/Y)
Average Weekly Hours34.3
Participation Rate62.7%





Now, looking at a chart of the past year’s releases, the numbers seem to show a very gradual decline, albeit hardly in a regular manner.










But let’s take a look at some underlying data that may help us understand the bigger picture a bit better.  First off, one of the things that draws a great deal of criticism is the birth/death model that the BLS uses to estimate the number of new companies that start up, hiring people, compared to the number of companies that close with the resulting job losses.  A key reason that every month this year has seen the data revised lower is because that portion of their data continues to be revised lower.  Historically, the birth/death model is at its worst during an inflection point, when the economy is either entering or exiting a recession.  Those downward revisions are a strong clue that things are not going that well.





But there is something else worth noting and that is the BLS breaks the payroll data down on a state-by-state basis as well.  This is not something that gets a lot of press but is nonetheless important.  While this data only goes back to 1976, that is still a fairly robust series.  I highlight this because every time in the past, when all 50 states + Washington DC have seen a decline in the number of employed workers, we have been in a recession already.  And shortly thereafter, the first negative NFP prints started showing up, usually withing 2-3 months.  Well, guess what?  Last month saw every state in the union report a decrease in the number of employed persons.  This is quite a negative signal for the economy, and one that is not getting much press, certainly not from the soft-landing set.  





I’m not saying that we are going to get a negative NFP print this morning, just that it seems one is coming to a screen near you soon.  If history is any guide, then sometime in Q1 seems realistic.  And ask yourself how Chairman Powell and his friends on the FOMC will respond to that type of data.  They had better hope that the recent trend in inflation, which has clearly been on a downward trajectory, continues, because otherwise, the Chairman will have nowhere to hide.  Cut rates to address economic weakness while stoking still firm inflation?  Leave rates on hold to fight inflation and let growth crater further?  Talk about a rock and a hard place.





It seems to me that the evidence continues to pile up on the side of a recession coming early next year.  Absent another wave of MMT or helicopter money or some type of direct fiscal stimulus by the federal government, this business cycle seems destined to end soon.  The bond market has been telling us that since the beginning of last month.  The oil market has been telling us that since the beginning of last month too.  The stock market has still not gotten the message.  It will, trust me, and it won’t be pretty.  However, I don’t think today is the day it will happen.  Just be prepared.





So, how have markets performed leading up to the NFP data?  Well, following yesterday’s rally in US stocks, Asia had a mixed picture.  Japanese equities continue to be pressured by a combination of concern over tighter monetary policy and a strengthening yen.  There was, however, a bump on the road to that tighter policy thesis as Q3 GDP was revised lower to -2.9% Y/Y, with the M/M falling -0.7%.  Will they really tighten policy into a shrinking economy?  Meanwhile, despite the word from the Chinese Politburo that they would be adding more fiscal stimulus in 2024, shares in Hong Kong and on the mainland barely eked out gains of 0.1%.  The rest of APAC, though, had a decent performance, with gains ranging from 0.3%-0.9%.





European bourses are in good shape today, with green across the board, albeit some just barely (DAX +0.1%) and some more robustly (CAC +0.7%).  Finally, US futures are edging lower, -0.2% or so, as I type (7:30am).





In the bond market, yields, which as we know have been trending sharply lower since early November, are rebounding slightly this morning with Treasuries up 3bps and European sovereigns all showing increases of between 5bps and 9bps. That seems a bit odd to me as there has been no data indicating inflation is rising or growth is impressive of late.  In fact, the Eurozone inflation data continues to point to deflation as Germany’s final reading came in at -0.4% in November.  In fact, as much as markets are expecting the Fed to cut rates soon, with a 60% probability now priced in for the March meeting, I suspect that the ECB is going to be cutting before the Fed as Eurozone growth and inflation are falling rapidly.  As to JGB’s, yields there edged higher by 1bp overnight and currently sit at 0.75%, certainly not pressing on the 1.00% cap.  





Turning to the commodity markets, oil (+2.2%) has finally found its footing with WTI back above $70/bbl.  While there continue to be rumors that OPEC+ is going to cut production further, this feels much more like a trading bounce than a structural move.  Interestingly, industrial metals are having a very good day with both copper and aluminum higher by 1% or more although gold is unchanged on the day.  Ordinarily, I might attribute that to a weaker dollar except that the dollar’s not weaker this morning.





Speaking of the dollar, if you remove the yen from the equation, it has, in truth, been reasonably strong.  Perhaps a better description is that other currencies have been weak as things like European economic doldrums weigh on those currencies while declining oil prices weigh on the petro-currencies.  Now, for all the JPY bulls out there, be careful as the weakening GDP growth and the fact that the most recent CPI data, while still above target, started to decline means that there is less pressure on Ueda-san to change policy.  Yes, they have started to discuss the idea of lifting rates out of negative territory, but they have also been quite clear that they need to see wage gains and the wage story really won’t be clear there until the March wage negotiations are completed.  All I’m saying here is that we have come quite a long way in less than a month.  Do not be surprised by a sharp rebound that wipes out a lot of profit and positions.





And that’s really it for the day.  At 10:00 we also see the first cut of the Michigan Sentiment Index (exp 62.0) as well as the concurrent inflation expectations indices (1yr 4.5%, 5yr 3.3%).  But by then, I expect that the excitement will have passed, and the market will be following whatever trend develops from the payrolls.  If pressed, I expect a softer number, something like 100K and a tick higher to 4.0% on Unemployment.  If that is correct, I expect that the market will continue with its ‘bad news is good’ concept and buy stocks in anticipation of Fed rate cuts.  But remember, virtually every time the Fed is cutting rates aggressively because economic activity is declining, risk assets are being sold, not bought.





Good luck and good weekend





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			Buyers’ Chagrin
		


				

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Last month everything was just fine

As stocks traded up on cloud nine

But this week has been, 

To buyers’ chagrin,

Less fun, and perhaps e’en malign



While soft is the landing of choice

And one where the Fed would rejoice

As data keeps slipping

The narrative’s flipping

Said some, in a very low voice






Oops!  ADP Employment fell further last month, down to 103K, well below forecast and moving into a more dangerous territory for the growth story.  Last month’s outcome was revised lower as well and the 3-month moving average is now 99K.  This is certainly not a level that inspires confidence in future economic activity.  Now, we all know that ADP is not the really important number, that is Friday’s NFP, but of late, the story there has also not been that fantastic either.  Last month printed just 150K, and revisions for virtually the entire year have been lower.  All I’m saying is that I get a soft landing requires slowing growth which will impact the employment situation.  But this is a $27 trillion economy, and not something that is steered so easily.  Be prepared for the narrative to start to slip from soft-landing to recession and perhaps onto deep recession.  





One number does not a trend make, but as I discussed yesterday, the weight of evidence is beginning to pile up on the slowing growth story.  The market that really is buying the recession story is the oil market, where prices fell a further 4% yesterday with WTI settling below $70/bbl.  That is not a market that is convinced demand is going to be robust!





I guess the question is, at what point does the data stop confirming the goldilocks wishes and point to a more significant economic decline?  With respect to the employment situation, I suspect we will need to see a series of negative NFP prints as the Unemployment Rate rises.  While the former has not yet been seen, the Unemployment Rate has risen by 0.5% over the past seven months.  While tomorrow’s rate is forecast to be unchanged at 3.9%, there will be much angst in some circles if it goes higher.  As far as other metrics, Retail Sales, which had a very strong run in Q3, slipped last month and is forecast to be -0.1% when released next week.  Currently, the GDPNow forecast from the Atlanta Fed is calling for a 1.3% growth rate in Q4, much weaker than last quarter but not recessionary.





Combining these ideas, plus the other ancillary ones that come from the plethora of data released each month, it is easy to understand the belief in the soft landing.  But remember this, monetary policy famously works with long and variable lags.  That is just as true when the Fed is easing policy as when they are tightening policy.  Currently, there is an ongoing debate over whether the Fed’s 525 basis points of tightening is fully embedded in the economy, or if there is still more pain to come.  But if we are already seeing economic activity slow and the Fed continues to expound its higher for longer mantra, it is easy to make the case that the slowdown will be far deeper than a soft landing.  





One other thing, all this is happening while measured inflation remains well above the Fed’s target which is likely to remain a constraining factor on their behavior going forward.  If pressed, I would say the economy is heading toward a more significant recession, probably starting in Q1 or early Q2 of next year unless we see a remarkable turn of events in the US.  Given the intransigence that the current House of Representatives is demonstrating with respect to funding Ukraine, it appears that fiscal help may be a quarter or two later than hoped.  Be prepared.





Is the BOJ

Ready to change policy?

No breath-holding please!






One other thing of note was an article in Nikkei Japan that discussed recent comments from Governor Ueda as well as Deputy Governor Himino, where the implication seems to be that the committee there is contemplating the idea of raising their base rate to 0.0% or even 0.1% from its current -0.1% level.  Certainly, the market is willing to believe this story as evidenced by the moves last night where 10-year JGB yields jumped 11bps while the Nikkei fell 1.75%.  As to the yen, this morning it is the outlier in the FX market, with a 1.4% rally and is now trading back to its strongest level (weakest dollar) since August.  While the most recent inflation data from Japan has continued to show consumer prices rising above the BOJ’s 2% target, 19 straight months now, wages remain more benign and that is a key metric there.  While I’m sure that the BOJ will alter policy at some point, it still feels like it is a mid 2024 event.





And one other thing to note with respect to USDJPY, tomorrow the December futures options on the CME expire and there is some very substantial open interest at strike prices right here.  Apparently, a single buyer purchased upwards of $2 billion notional of JPY calls with strike prices ranging from 145.50 down to 144.75 back in mid-November, which are now at- and in-the-money.  The thing to look for here is a choppier market as dealers hedge their gamma risk.  And don’t be surprised if we see another leg lower in USDJPY before they expire tomorrow.





Ok, let’s look at how all the other markets have behaved overnight as we await today’s Initial Claims data, but more importantly, tomorrow’s payroll report.  After another soft showing in the US yesterday regarding equity markets, Asia, aside from Japan were broadly weaker, albeit not dramatically so.  In Europe, the screens are all red too, but the losses are quite small, between -0.1% and -0.2%.  Adding to the idea that there is very little ongoing, US futures, at this hour (7:30) are essentially unchanged.





Turning to the bond markets, Treasury yields, which had fallen below 4.10% briefly yesterday, have bounced on the day and are firmer by 5bps.  But European sovereign bonds are little changed on the day with only UK Gilts (+5bps) an outlier here.  Perhaps that move was on the back of the Halifax House Price Index, which rose slightly more than expected, but I suspect it has more to do with position adjustments ahead of tomorrow’s US payroll data.  After all, remember, the US is still the straw that stirs the drink.





After a horrific day yesterday, oil (+0.6%) is trying to stabilize although WTI remains below $70/bbl.  There is now talk in the market that OPEC+ is going to cut production further, although given they just held their monthly confab last week, this seems premature.  Gold (+0.4%) is finding support again after its wild ride earlier in the week, and copper and aluminum are both showing green today.





Finally, the dollar, away from the yen, is mixed with modest weakness vs. most G10 currencies, and a completely uncertain picture in the EMG bloc.  For instance, MXN (-0.5%) is under pressure this morning while ZAR (+0.9%) is putting in quite a performance.  Looking at the entire space, it is hard to characterize a general theme here today.  As such, it strikes me that choppiness ahead of tomorrow’s data is the most likely outcome in the session.





As mentioned before, Initial (exp 222K) and Continuing (1910K) Claims are the only data this morning although we do see Consumer Credit ($9.0B) this afternoon at 3:00pm.  Right now, the dollar is trendless, except perhaps against the yen, although that means that hedging should be quite viable right now.  As to the broader economic trend, tomorrow’s data will really set the tone for the FOMC meeting next week, and for Q1 next year.





Good luck





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			Hawk-Eyed
		


				

			Posted on  by 		

			


		

		

A landing that’s soft will require

A joblessness growth multiplier

Demand needs to slide

Enough so hawk-eyed

Fed members, rate cuts can inspire



The thing is, when looking at data

The trend hasn’t been all that great-a

While prices are falling

Growth seems to be stalling

More quickly than Jay’d advocate-a






As we await the onslaught of data starting this morning with ADP Employment and culminating in Friday’s Payroll and Michigan Sentiment reports, I thought it would be worthwhile to try to take a more holistic look at the recent data releases to see if the goldilocks/soft landing narrative makes sense, or if there is a growing probability of a more imposing slowdown in growth, aka a recession.





The problem is, when looking at the past one month’s worth of data, the trend in either direction is not that clear.  One of the things that has been true for a while is that there continues to be a dichotomy between the survey data and the hard figures.  Survey data has tended toward weakness, with one outlier, the most recent Chicago PMI print at 55.8.  But otherwise, ISM data has been quite soft for manufacturing and so-so for services.  Looking at the regional Fed surveys, it has been generally much worse with more negative outcomes than positive ones.  





At the same time, we all remember last week’s blowout GDP result for Q3 at 5.2% and we continue to see employment growth, albeit at a slowing pace to what was ongoing last year and earlier this year.  Retail Sales finally fell slightly last month, but that is after a string of much stronger than expected prints, arguably why Q3 GDP was so strong.  Perhaps the more worrying points are that the Continuing Claims data has started to grow more rapidly, meaning that people are remaining on unemployment insurance for longer and longer periods and yesterday’s JOLTS data was substantially lower than expectations and lower than the November reading.  Finally, Durable Goods and Factory Orders have been quite weak.





If I try to add it up, it seems to point to a weaker outcome than a soft-landing with the proper question, will the recession be mild or sharp?  Funnily enough I think the data highlights the Biden administration’s ‘messaging’ problem.  Surveys are generally quite negative and now hard data seems to be rolling over.  That is clearly not the story that a president running for re-election is seeking to tell.  





All this begs the question, how will the Fed respond?  And here’s the deal, at least in this poet’s view; the current market pricing of upwards of 125 basis points of rate cuts through 2024 is not the most likely outcome.  Rather, I continue to strongly believe that we will see either very little movement, as higher for longer maintains, or we will see 300-350bps of cuts as a full-blown recession becomes evident.  





To complete the exercise, let’s game out how markets may behave in those two situations.  If the Fed holds to its guns and maintains the current policy stance with Fed funds at 5.50% and QT ongoing, risk assets seem likely to have problems going forward.  It is quite easy to believe that the key driver to last month’s massive equity rally was the pricing of easier monetary policy to support the economy, and by extension profitability and the stock market.  So, if the Fed does not accommodate this view, at some point investors and traders are going to need to reevaluate the pricing of their holdings and we could see a sharp decline in equities.  As well, this would likely result in a further inversion in the yield curve as expectations for a future recession would grow.  On the commodity front, this ought to weigh on both the energy and metals complexes even further than their current pricing.  Recall, I have been highlighting that the commodities markets seem to be the only ones pricing in a recession.  As to the dollar, in this scenario I expect to see it regain its strength as the rest of the world will be sliding into recession regardless of the US outcome, so rate cuts will be on the table for the ECB, BOE, BOC, and PBOC.





Alternatively, the economic situation in the US could well deteriorate far more rapidly than the current goldilocks set believes.  In fact, I believe that is what it will take to get the much larger rate cuts that everybody seems to be pining for.  But ask yourself, do you really want rate cuts because economic activity is collapsing?  That seems a tough time to be snapping up risk assets.  In fact, historically, equity market declines through recessions occur while the central bank is cutting rates.  Be careful what you wish for here.





But, to finish the scenario analysis, much weaker economic data (think negative NFP as a first step along with Unemployment at 4.5%) will almost certainly result in cyclically declining inflation data and a dramatic fall in demand.  So, equity markets would be under pressure everywhere.  meanwhile, the normalization of the yield curve would finally occur with the front end falling far faster than the back.  In the commodity markets, I think precious metals will outperform as real rates tumble and safety is sought.  However, industrial metals would decline and likely so would energy prices, both driving inflation lower.  As to the dollar, this is much trickier.  At this point, I would argue the Eurozone is ahead of the US in the economic down wave and so will also be cutting rates.  The dollar’s performance will be a product of the relative policy response and I suspect will result in a very choppy market.  At least against G10 currencies.  Versus its EMG counterparts, I suspect the dollar will significantly underperform absent a global recession.





But enough daydreaming, let’s take a look at the overnight session.  From an equity perspective, yesterday’s late rally in the US, getting things back close to unchanged, was followed by strength in Asia, notably in Japan (Nikkei +2.0%) but also across the board with India’s Sensex making yet more new all-time highs, and modest strength in Europe despite some weak German Factory Orders data.  Or perhaps because of that as traders grow their belief the ECB is going to start cutting rates soon.  US futures are edging higher at this hour (7:00), but only by 0.2% or so.





In the bond market, after a day where yields fell sharply, this morning we are seeing a slight bounce with Treasury yields backing up by 3bps and European sovereign yields edging higher by between 1bp and 3bps.  The European bond market is clearly of the opinion that the ECB is done hiking with that confirmation coming from the Schnabel comments yesterday morning.  Now, the only question is when they start to cut.  Something else to note is that JGB yields have fallen 3bps this morning and are essentially back at levels seen in early September before the BOJ’s latest comments about the 1% cap being a guideline, not a hard cap.  Perhaps the argument that the BOJ was going to normalize its policy was a bit premature.  





On the commodity front, oil prices continue to slide, down another 0.7% this morning and nearly 8% this week.  While this is great for when we go to fill up the gas tank, it is a harbinger of a weaker economy going forward, which may not be so great overall.  Gold prices have stabilized and are still above $2000/oz and we are also seeing stabilization in the base metals prices right now.





Finally, the dollar, which rallied nicely yesterday, and in fact has been climbing for the past week, is little changed this morning stabilizing with the euro below 1.08 and USDJPY above 147.  There continues to be a narrative that is calling for the dollar’s demise, and in fact, I understand the idea based on the belief that the Fed is turning easy.  But for right now, it is also becoming clear that the rest of the world’s central banks are rolling over on their policy tightening and given the lack of a strong interest rate incentive, plus the fact that a weaker global economy will send investors looking for safe havens, the dollar is likely to maintain its recent strength, if not strengthen further going forward.  In order to see a substantial dollar decline, IMHO, we will need to see the US enter a sharp recession without the rest of the world following in our footsteps.  As I see that to be an unlikely outcome, my guess is we have seen the bottom of the dollar for the foreseeable future.





On the data front, we start today with the ADP Employment (exp 130K) and also see the Trade Balance (-$64.2B), Nonfarm Productivity (4.9%) and Unit Labor Costs (-0.9%).  From North of the Border, at 10:00 we see the Ivey PMI (their ISM data, expected at 54.2) and the BOC interest rate decision where there is no change expected and there is no press conference either.





I really wanted to get bearish on the dollar and felt that way when we heard Fed Governor Waller talk about rate cuts, but lately, the news from everywhere is negative and I just don’t see the dollar suffering in this situation.  Stable, yes; falling no.





Good luck





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			Already Wary
		


				

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In China, the news wasn’t great

As Moody’s no longer could wait

Because of a glut

Of debt, they did cut

The outlook for China’s whole state



Investors were already wary

And as such, since last January,

Afraid of more shocks

Have been selling stocks

In quantities not arbitrary






The biggest news overnight was Moody’s downgrading their outlook for Chinese debt to negative from its previous stable view.  Moody’s currently rates the nation at A1, 4 notches below the best available of Aaa, but still a solid investment grade rating.  However, citing the property downturn in the country and the concomitant fiscal pressures that are building on local governments’ balance sheets, it appears there is a growing concern that national debt will be issued to cover the local failures.  





It must be very difficult to be a local government financial official in China as the competing pressures of ever faster growth and maintaining sound finances have become impossible to attain simultaneously.  The real question is, will President Xi determine that fiscal stability is more important than economic growth?  While that appeared to be his view last year, this year he seems to have changed his focus to growth.  Perhaps the fact that the US economy seems to be maintaining very solid growth while China is stumbling has become too much of a bad look for him to tolerate further.  (And that’s not to say things are fantastic here.) 





At any rate, his efforts to encourage more widespread economic activity while simultaneously deflating the immense property bubble there is starting to run into trouble.  As the pace of growth slows in the country, exacerbated by the demographic decline of the population (it is getting old and the population is shrinking), Xi appears to have thrown fiscal caution to the wind.  Once again, my concern is that if the domestic economy continues to deteriorate, Xi will determine that it is time for some international adventures to shore up his support at home.  I would contend that is not on anyone’s bingo card right now, but it is something to watch.





The market response to the news was to further sell Chinese equities with both onshore and Hong Kong markets suffering, each declining nearly 2%.  This weighed on Japanese markets (Nikkei -1.4%) as well as Taiwan, South Korea, and Australia, with only India ignoring the story.  It makes some sense that the China and India stories are uncorrelated given India is one of the few nations not reliant on China for much with respect to trade.  





Away from that story, however, things have been remarkably quiet on the economic front.  We saw Services PMI data from around the world with China, interestingly, one of the few nations printing above 50 (Caixin Services PMI 51.5), while all the continent remains firmly below the 50 boom-bust line save the UK which printed a much better than expected 50.9 reading.  While the market is waiting for US ISM Services data (exp 52.0) as well as JOLTS Job Openings data (9.3M), there is scant little else to discuss this morning.  Recall, though, as the week progresses, we will be receiving much more important data, notably the payroll report, which may help clarify the state of things now.





But, lacking anything else to discuss, let’s run down markets.  Away from Asia, equity markets are mixed with continental bourses all modestly firmer, on the order of 0.3%, although the FTSE 100 is lower by -0.5% despite the better than expected PMI data.  US futures are also pointing lower this morning, about -0.5% after a desultory day yesterday on Wall Street.





In the bond markets, Treasury yields have edged a bit lower this morning, -3bps, resuming what has been a powerful downtrend in yields.  In Europe, though, yields have really taken a dive, with sovereign bonds there all seeing declines of between 7bps and 9bps.  The weak PMI data has investors now bringing forward EB rate cuts to June.  Adding to this story were comments from the ECB’s Schnabel, historically one of the more hawkish members, describing the possibility of rate cuts next year as appropriate.  This seems quite similar to the Waller comments last week given Schnabel’s presumed importance on the ECB.  Finally, JGB yields are 2bps softer after slightly softer than expected Tokyo CPI data was seen as a harbinger for slowing inflation across Japan.  Once again, the idea that interest rate policy in Japan is due to normalize soon is being challenged by the facts on the ground.





Turning to commodities, oil (-0.3%) is slipping again as the weak PMI data encourages worries of an impending recession and the OPEC+ meeting was not taken seriously by the market as an effective manner to reduce supply.  Inventories have been building lately, so further pressure seems viable.  Meanwhile, metals markets are under further pressure with both copper and aluminum falling by more than -1.0% and gold, which had a remarkable session yesterday with a greater than $100 trading range, edging down a few bucks, but still well above the $2000/oz level.





Finally, the dollar refuses to obey the narrative and die.  Instead, it is higher again this morning vs. almost all its counterparts, both G10 and EMG.  The laggard today is AUD (-0.9%) which fell after the RBA left rates on hold, as expected, but apparently was not seen as hawkish as traders anticipated and the market has removed the pricing for any further rate hikes there.  The only exception to this movement has been the yen, which is now 0.1% firmer although in the wake of the Tokyo CPI data, it fell sharply.  USDJPY remains beholden to the twin narratives of declining US interest rates and normalizing monetary policy in Japan.  Right now, those stories are not working in concert, so until they do so, in either direction, I expect the yen will be choppy but not really make much headway in either direction.





Aside from the ISM and JOLTS data, we only see the API Crude Oil inventory data with a draw of 2.2 million barrels expected.  As there are no Fed speakers, it is shaping up to be a quiet day overall.  With that in mind, look for limited activity until 10:00 when the data is released and then I suspect that we remain in a ‘bad news is good’ regime.  So, weak ISM is likely to encourage risk taking on the belief the Fed will cut more aggressively and vice versa.  The same is true with the JOLTS data.  As to the dollar, I suspect it will follow the rate story, so strong data will help the buck and weak will see a bit of selling.





Good luck





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			Too Clever by Half
		


				

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Said Jay, “it would be premature”

To think we’ve arrived at a cure

For higher inflation

Though there’s a temptation

By some to claim that we are sure



Instead, if we think it’s correct

More rate hikes we will architect

Investors, however,

Think Jay is too clever

By half and this view did reject






As we start a new week that will culminate in the payroll report on Friday, I think it is appropriate to consider how last week finished, notably how Chairman Powell left things leading into the Fed’s quiet period ahead of their next FOMC meeting on the 13th of this month.  To my ears, the two most important comments were as follows: “The strong actions we have taken have moved our policy rate well into restrictive territory, meaning that tight monetary policy is putting downward pressure on economic activity and inflation.”  A little later he explained, “It would be premature to conclude with confidence that we have achieved a sufficiently restrictive stance, or to speculate on when policy might ease. We are prepared to tighten policy further if it becomes appropriate to do so.”  





Now, interpretation is a subjective idea already, but FWIW my interpretation is he clearly understands they have tightened policy quite substantially, perhaps enough to achieve their goal of 2% inflation, but in a nod to this nation’s history, and ostensibly his hero, Paul Volcker, he is not going to get fooled by a temporary respite in inflation.  I believe he has made perfectly clear in the past that the Fed, or at least Chairman Powell, is willing to push the economy into a recession if he believes it is necessary to truly end inflation.





Of course, the biggest problem that he has is that the Fed is losing its ability to manage the situation as the Treasury continues to issue extraordinary amounts of new debt to fund spending.  This fiscal dominance results in a situation where the Fed’s actions have a diminishing impact on the macroeconomic variables they are trying to manage.  In fact, as I consider this situation it is actually a viable explanation for the fact that the market is very clearly ‘fighting the Fed’.  





One of the most common refrains from the post GFC period, when the Fed first introduced QE and kept repeating the exercise, driving asset prices substantially higher, although having very limited impact on goods and services inflation, was that investors, ‘don’t fight the Fed.’  The idea was that if the Fed was going to continue to print money, whatever the macroeconomic story was had limited impact on risk asset prices.  The Fed was the dominant factor and would continue to be so going forward. 





And that proved to be sage advice right up until the end of 2022.  The huge rally was supported by their easy money, and the reversal in 2022 was a result of them tightening policy substantially.  However, since then, and especially since the debt ceiling law was suspended until 2025, the Treasury has been able to issue as much debt as they like, and the government has been spending as quickly as possible.  While the Fed’s policy tightening was dramatic throughout 2022, it has slowed dramatically this year, and now it is being eclipsed, at least in a market response sense, by the flood of money entering the economy.  The result is that despite the Fed’s effort to maintain tight monetary policy, they are being overwhelmed by the Treasury’s profligate ways.  Hence, fighting the Fed is making sense.  It has largely worked in 2023 and while higher for longer may be the Fed’s mantra, it is being trumped by Yellen’s mantra of ‘issue another $1 trillion in T-bills just in case.’  





Setting aside, for a moment, the potential negative implications of the surge of Treasury issuance, its ability to crowd out private funding and therefore slow economic activity, from the market’s perspective, all those Federal dollars are being spent somewhere, and between the subsidies for ‘green’ energy, and the reshoring efforts across numerous manufacturing sectors, that money is circulating in the economy quite rapidly.  Since the government doesn’t really care what interest rate they pay (they will just borrow more to pay that interest), there is no financial brake on this activity.  It needs to be political.  And given there is a presidential election next year, the incentive for the incumbent administration to slow spending is not merely zero, it is negative.  





Ultimately, I believe this means that the Fed’s importance with respect to market movements overall is diminishing, although they will still have some impact.  Rather, I think we need to watch the spending plans more carefully.  One other thing to remember, especially for all the dollar bears out there, is that historically, a nation that runs tight monetary and loose fiscal policy winds up with a stronger currency.  This alone implies that news of the dollar’s demise may be greatly exaggerated.





Ok, while last week was all about Fed speak, this week is much more data focused.  Leading into the data dump, a look at markets shows that despite Friday’s strength in US equity markets, the rest of the world has been a little more suspect of things.  Both Japan and China saw weakness even though a court in HK ruled that China Evergrande had another 2 months to try to work things out before liquidation, although some other markets in Asia, notably India’s Sensex, (+2.0%) performed far better.  In Europe this morning, markets are mixed but I would argue are leaning slightly lower as both the FTSE 100 and CAC lower although the DAX and Spain’s IBEX are a touch firmer.  Finally, US futures at this hour (7:30) are pointing lower by about -0.35% across the board.





In the bond market, Treasury yields have backed up 5bps this morning, but are still at just 4.25%.  European sovereigns are also higher, albeit not quite as aggressively as Treasuries with the movement between 1bp and 3bps.  UK gilts are the outlier, also higher by 5bps.  Looking at Asia, while that 5bp rise was the norm Down Under, JGB yields are unchanged at 0.68%.  All this discussion regarding Japanese yields normalizing certainly seems to be premature at this stage.





In the commodity markets, oil (-0.6%) is slipping again as the response to the OPEC+ meeting has been less than impressive.  While production cuts were mooted, there is no clarity on which members will be cutting and by how much and for how long.  As we have been observing for the past months, the commodity market is the one that is truly pricing in a recession.  Equity markets are clearly on a different page although bond markets, given the magnitude of last month’s move, have certainly taken notice that things are slowing down.  In the metals markets, gold is little changed from Friday’s levels this morning, although Friday saw a sharp 1.5% rally.  As well, I would be remiss if I didn’t mention that in the overnight session, gold exploded to a new all-time high of $2135/oz before retracing those gains.  There is a growing interest in the barbarous relic, especially with the market’s growing belief that the Fed and other central banks are going to be cutting rates soon.  The rest of the metals complex, though, is under pressure this morning, once again pointing to concerns over a recession in the near future.





Finally, the dollar, overall, is slightly higher although there has been a mix in the components.  Notably, the yen strengthened sharply on Friday after the Powell comments but the same cannot be said of either the euro or the pound.  In fact, both of those currencies, as well as the rest of the European bloc, are under pressure as there is a growing certainty that Europe is entering, or perhaps already in, a recession, and the central banks there are going to be cutting rates soon.  As to the EMG currencies, today is a broadly dollar strength day and we are seeing virtually all of them under pressure vs. the greenback.  As I mentioned above, tight monetary and loose fiscal policies are a recipe for a currency’s strength.





Ok, let’s turn to the data story.





TodayFactory Orders-2.8%
TuesdayISM Services52.0
 JOLTS Job Openings9.35M
WednesdayADP Employment128K
 Trade Balance-$64.1B
 Nonfarm Productivity1.9%
 Unit Labor Costs-0.9%
ThursdayInitial Claims2223K
 Continuing Claims1940K
 Consumer Credit$9.0B
FridayNonfarm Payrolls180K
 Private Payrolls155K
 Manufacturing Payrolls25K
 Unemployment Rate3.9%
 Average Hourly Earnings0.3% (4.0% Y/Y)
 Average Weekly Hours34.3
 Participation Rate62.7%
 Michigan Sentiment62.0





Source: Tradingeconomics.com





So, a huge amount of new data with ISM to start the week and NFP to finish.  Perhaps there will be a decisive trend that implies either recession is coming soon or not at all but based on everything we have seen over the last 6 months, at least, I imagine there will be both hot and cold data to absorb.  Fortunately, there are no Fed speakers although keep your eyes peeled for a WSJ article from the current Fed whisperer, Nick Timiraos, if things start to point to even more aggressive rate cuts by the Fed next year (5 cuts are already priced starting in March).  





For today, my take is the market seems likely to take a breather after a remarkable risk rally last month.  Absent any real new news today, look for a quiet one.  But we need to watch the data this week carefully for clues as to whether the goldilocks or recession narrative will dominate.  Funnily enough, in either case, I feel like the dollar is likely to hold its own.





Good luck





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