The Fed has regaled us this week
With speakers who all tried to tweak
Their message on rates
And foster debates
On havoc their actions might wreak
Some told us their hiking was done
That, as to inflation, they’d won
But others explained
They’d not yet obtained
Relief from this price rising run
Now into this breech steps the Chair
Who later this morning will share
His views where they stand
And how he has planned
To reach rate nirvana sans prayer
As we enter the final month of 2023, the bulls are in the ascendancy. The 60/40 portfolio, which had been declared obsolete last year and certainly behaved that way most of this year, just had its best month since 1985. US equity markets rallied between 8%-10% and 10-year Treasury yields fell 40bps through the month. In other words, the price of virtually everything went higher. This includes gold (+3.0%), silver (+10.5%) and copper (+5.0%) with only oil (-7.5%) and the dollar (DXY -2.5%) as the losers in November.
To what do we owe this remarkable performance across asset classes? Or perhaps the question should be to whom do we owe this outcome? My vote is for goldilocks! Her story of everything winding up ‘just right’ remains the dominant market narrative. This has been encouraged by a plethora of Fed, and other central bank, speakers harping on the fact that inflation readings continue to decline nicely, and although nobody is ready, yet, to begin cutting interest rates, there seems to be an implicit wink, wink, nod, nod that the market is sensing rate cuts are coming soon. And maybe they are, but that is certainly not my base case.
However, my base case is not relevant here, the market viewpoint is the driver. Interestingly, yesterday we heard from NY Fed President Williams and while he has been encouraged over the recent path of inflation readings, when asked about the market’s pricing of rate cuts early next year he explained, “he wasn’t losing any sleep over the issue.” In other words, he is unconcerned with the market chatter and is focused on the data and his perception of the economy’s performance. In fact, I believe that to be the case for all the FOMC members, despite the prevailing narrative that the Fed will never surprise the market if they can avoid doing so.
This brings us to this morning’s speech by Chairman Powell. His is the last communication by a Fed member ahead of the FOMC meeting on the 13th. At this point, it remains unknown if he will hew toward the idea that things look good and they have reached an appropriately tight level of monetary policy and financial conditions, or if he will try to continue with the higher for longer concept, highlighting that while progress has been made, the dangers of easing prematurely are grave and must be avoided at all costs. The fact that Governor Waller, earlier this week, expressed that it might be appropriate for rates to decline in 3-4 months’ time has the equity and bond bulls pawing the ground and ready to charge again. However, I would contend that Williams’s comments yesterday, indicating little concern over market pricing and greater concern that they finish the job to be just as important. Powell clearly listens to both these gentlemen closely. In the end, the one thing that Powell has explained time and again is that he will not make the Arthur Burns mistake of easing before inflation was well and truly dead. It is this consistency in his communications that leads me to believe that the bulls are a bit ahead of themselves for today.
Remember, too, we will see the NFP report next Friday, and the November CPI report the day before the FOMC announcement, as well as a bunch of other data to help fill in some blanks. In fact, yesterday’s PCE data, both headline and core, were right on expectations as was virtually everything else except Continuing Claims, which at 1927K, was the highest since early 2022, and another sign that the labor market is loosening up. Countering that, though was a dramatically higher than expected Chicago PMI print of 55.8, pointing to strong growth. Again, the data continues to lack a unifying direction at this stage. And so, regardless of Powell’s comments today, the FOMC will still have much to digest before they decide.
As to how this will impact markets, my take is the following: goldilocks is still the predominant narrative which means that weaker economic data will be seen as bullish news for both stocks and bonds because it will cement the view that the Fed is not only finished but that cuts are coming soon. Correspondingly, strong data will be much harder to swallow as it will renew concerns that the Fed is not done hiking yet. But until Powell speaks this morning at 11:00, we are in the dark.
Reviewing the overnight activity shows that equity markets in Asia were mostly lower with the Hang Seng (-1.25%) continuing to feel the pressure of the weak Chinese property market. The story is that China Evergrande has until Monday to avoid liquidation with further potential ramifications for other property developers. Alas, President Xi has not been able to find a Chinese solution for taking on too much debt and blowing a bubble that does not include popping that bubble. As to Europe, after a strong November in equity markets there as well, this morning is seeing gains across the board on the order of +0.7% while US futures are currently (8:00) ever so slightly softer, -0.2%.
In the bond market, after a rip-roaring month around the world as the prevailing narrative grew that the peak in inflation, and therefore, yields has been seen, this morning is starting off quietly. The yield on the 10yr Treasury is higher by just 1bp and in Europe, we are actually seeing modest yield declines, 1bp-2bps, as investors respond to still weak PMI data across the continent. While the uber-hawks on the ECB are unwilling to discuss rate cuts, given the slowing growth in the Eurozone and the fact that inflation readings there are declining much more rapidly than in the US, the market is quite confident that rate cuts are coming soon.
Oil prices are slightly softer this morning, -0.5%, which takes them right back to where they started the week. However, they have fallen for the previous 5 weeks. The OPEC+ meeting was something of a dud, with what appears to be a further production cut, but there was certainly no unanimity of action there. Gold prices are unchanged on the day, maintaining most of their recent gains and copper prices (+0.6%) are actually edging higher again. To the extent that copper is an accurate harbinger of future economic activity, it certainly seems that prospects are improving and a recession will be avoided.
Finally, the dollar, which has seen universal hatred based on the decline in 10yr Treasury yields as well as the narrative that the Fed is going to be cutting rates early next year, continues to hold its own. In fact, it is slightly firmer in the past week overall, although we have seen a mix of movements depending on the currency. Among the weakest has been the euro, which while it peaked above 1.10 earlier this week for a brief time, is now back below 1.09 as traders start to understand that whatever the Fed may do with interest rates, the ECB is going to be cutting sooner than the Fed. At the same time, we have seen some strength in the commodity bloc over the past week, with AUD, NZD, CAD, NOK and ZAR all showing solid performances on the back of the recent commodity strength.
And lastly, we cannot ignore the yen, the currency that everyone was certain was set for a major rally as the diverging paths of the Fed (imminent cuts) and the BOJ (ending QE and tighter money) would finally change the trend. Oops! While the yen is a bit stronger this week, about 0.8%, that barely covers the negative carry of the position and with 10yr JGB yields back in the 60bps range, there is really no evidence that Japan is actually preparing to tighten policy. While I personally think they do need to start doing so as inflation has remained above their 2% target for more than a year, things work differently in Tokyo than elsewhere. For hedgers, I have to believe that JPY puts are the best protection around, relatively inexpensive and allowing for any significant rallies in the yen without locking in bad rates.
Leading up to Powell’s speech this morning, we see ISM Manufacturing (exp 47.6) although after yesterday’s blowout Chicago PMI number, don’t be surprised to see a bit higher. Canadian Employment data was just released, largely in line with expectations as the Unemployment Rate ticked up to 5.8% as forecast. Again, we continue to see a mixed picture with regard to the future of the economy. I think that is why we put so much stock into central bank speakers, but also why things remain so confused. After all, they don’t have any better models or insight than the rest of us and are just winging it anyway!
Big picture is, if Powell is hawkish and pushing back on the narrative, I expect the dollar to edge back higher. However, if he does not push back, look for another serious equity and bond rally and for the dollar to sink.
Good luck and good weekend
Adf
fxpoetry 