Monthly Archives: February 2024

Widow Maker

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The widow maker
Looks like it is about to
Make some more widows

For those unacquainted with the term as it relates to the financial markets, the widow maker trade has been going short JGB’s and buying JPY under the assumption that at some point, the BOJ would normalize monetary policy.  Lately, this trade has been reinvigorated in a major way on the back of the belief that Ueda-san is going to raise the base rate from its current level of -0.10%.  Granted, 10-year JGB yields have risen about 35bps since last summer, which given their starting level of 0.35%, is quite a bit.  Simultaneously, the yen weakened dramatically, falling more than 8% over the same timeframe.  An unstated, but critical, underlying part of the idea was that the Japanese economy was chugging along nicely and would continue to do so.  This would pressure wages higher and force the BOJ to join the rest of the world in raising interest rates.

But a funny thing happened to those plans last night when the Japanese government released its latest GDP data showing that Q4 GDP fell -0.1% Q/Q, far below the expected +0.3% gain.  This, when combined with Q3’s revised decline of -0.8% Q/Q (also worse than before) is the very definition of a recession.  Hence, the problem for all those traders who are short JGB’s and long the yen.  If Japan is in recession, it seems highly unlikely that Ueda-san is going to be tightening monetary policy in the near-term.  Rather, I would expect more fiscal and monetary stimulus which ought to result in lower yields and a still weaker yen.  And this is why the trade is nicknamed the widow maker.  It has fooled traders for some 30 years so far, and many have lost fortunes on its back.

One other quirk of this outcome is that Japan, heretofore the world’s third largest economy, has now slipped into fourth place behind Germany.  Part of this outcome is due to the fact that the weak yen has altered the calculations such that a given yen amount is worth many fewer dollars.  Relatively speaking, the euro has not fallen nearly as much, hence the switch in the rankings.  Should the yen regain even a quarter of its losses over the past two years, the two economies are likely to switch back to their old places.

In Europe and in the UK
The story is growth’s gone away
Recession is nigh
And if you ask why
It’s policy blunders at play

It was not just the Japanese who have fallen into a technical recession, the UK has also managed the trick as Q4 GDP data released this morning showed Q/Q growth of -0.3%, which when following Q3’s -0.1% leaves us with two consecutive quarters of negative GDP growth, the same definition of a recession.  In fairness, the Eurozone managed to skirt recession, but is there for all intents and purposes.  Yesterday, they released their data which showed that Q4 GDP growth was a resounding 0.0% following Q3’s -0.1%, so not a recession, by definition, but certainly a lousy performance.

I highlight these outcomes to contrast them with the data from the US, which has shown massive GDP prints over Q3 and Q4 of 1.2% and 0.8% respectively.  Now, we have discussed that a key part of this growth is the extraordinary amount of deficit spending that is currently ongoing in the US, far more than anywhere in Europe.  But from a monetary policy perspective, it is much easier for the Fed to maintain its current policy stance than it is for either the BOE or the ECB.  It is for this reason that I believe we will see continued changes in market pricing for monetary policy easing going forward.  I expect that Fed funds futures will continue to reduce the number of cuts as well as push out the timing of the first cut while in both the Eurozone and the UK, we start to see pricing that indicates a cut before the US.

As this process plays out, the impact on financial markets will be significant.  Regarding the FX market, this will underpin further strength in the dollar overall.  Although it is certainly possible, if not likely, that the BOJ intervenes to prevent, or at least slow down, further weakness in the yen, there will be no such action by the other two banks.  Regarding bond markets, much will depend on the timing of the first cuts and the status of inflation.  If the pain of economic weakness rises enough to offset the pain of inflation, and cuts come before inflation is under control, look for much steeper yield curves and higher back-end yields.  However, if inflation really does decline as currently wished for projected by all these central banks, then look for those curves to bull steepen, with the front end of the curve rallying and the back remaining fairly static.  After all, 4% or less for 10-year yields does not seem in appropriate in a 2%-3% inflation world.

Summing it all up, there are many potential paths forward, and as has been the case since 2022, inflation remains the number one driver of everything.

Ok, let’s tour markets quickly.  The dip was bought in the US yesterday with decent rebounds in all the major indices.  That was followed by further solid gains in Japan (Nikkei +1.2%) and continuing to make new highs for the run, with most of Asia following suit.  In Europe, equities are doing pretty well, with gains on the order of +0.75% except in the UK which is flat on the day after the weaker GDP data.  As to US futures, at this hour (7:30) they are very slightly firmer, 0.2% across the board.

Bond markets are continuing to rebound from Tuesday’s dramatic declines with yields slipping back further this morning.  Treasury yields are lower by 4bps, and now approaching 4.20% from the high side with many traders expecting that level to be technical support.  European sovereigns are all seeing yields decline either 2bps or 3bps this morning and overnight we saw JGB yields slip 2bps.  Of more note were the moves in Australia (-13bps) and New Zealand (-14bps) after Australian employment data came in a bit soft (Unemployment Rate up to 4.1%) so thoughts of RBA tightening have faded a bit.

Oil prices are continuing yesterday’s slide, -0.7%, after inventory data printed much higher than expected on the back of record US oil production.  Meanwhile, metals prices are mixed with gold edging higher on the softer rates story but copper and aluminum giving opposite signals as the former is higher and the latter lower by about 0.6% each.

Finally, the dollar is a touch softer this morning as US yields drift lower.  Thus far, it has not returned below key perceived levels with USDJPY still above 150 and the DXY still above 104, but I suspect that if risk appetite continues to reassert itself, the dollar may slide further.  The greenback’s movement have been extremely closely tied to 10-year yields of late.

On the data front, we see a bunch of things this morning led by Retail Sales (exp -0.1%, +0.2% ex-autos), Initial Claims (220K), Continuing Claims (1880K), Empire State Manufacturing (-15.0), and Philly Fed (-8.0) all at 8:30.  Later on we see IP (0.3%) and Capacity Utilization (78.8%).  In addition, we hear from Governor Waller at 1:15 this afternoon, so it will be very interesting to get his take on how the recent data is going to impact the FOMC.  There have been no substantive changes in the futures pricing for Fed funds with still less than a 50% probability of a cut in May.

Risk markets were clearly shaken by the CPI data on Tuesday.  More hot data today will further impact those assets negatively in my view.  In fact, this will continue as long as the market is going to trade on interest rate expectations.  At some point, if economic activity manages to continue strongly, it is likely to turn into a positive catalyst for risk assets, but we are not there yet.

Good luck
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Stanching Their Bleeding

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For all of those pundits that claimed
inflation had died and been maimed
The data did show
What now we all know
Inflation is still quite inflamed

The upshot is all those who said
That real rates would soon force the Fed
To quickly cut rates
Are in dire straits
And stanching their bleeding instead

Wow!  Not much else you can say after yesterday’s market activities following the hotter than expected CPI data released in the morning.  As I wrote on Monday, a 0.1% difference in a monthly print is not really substantive in the broad scheme of things, but when the narrative is so strong and so many are convinced that the Fed is itching to cut rates because they don’t want to overtighten as inflation continues to fall, that 0.1% in the wrong direction means a lot.  Hence, yesterday’s price action (which I did presage in the last line of my note yesterday morning before the release.)

Of course, you are all aware that stocks got crushed, with the major indices falling -1.35% to -1.80% while the Russell 2000 small cap index fell -4.0%!  But it wasn’t just stocks, bonds joined the fun with the 10-year yield soaring 15bps to 4.30%, its highest yield since early December.  Gold got crushed, falling $30/oz and back below $2000/oz for the first time in two months, while the dollar exploded higher, rising about 1% against most currencies and almost 1.8% against the yen.

A quick analysis of the CPI data shows that the shelter component was the big surprise on the high side, although airfares also were higher than expected.  As well, wages remain much stickier than the Fed would like to see as they continue to support price increases in the services component of the data.  Forgetting the headline for a moment, a look at Median CPI, as calculated by the Cleveland Fed, shows that last month’s rise was 0.5% and the Y/Y number is +4.85%.  That feels to me like a much better estimate of what is happening than the newest darling of the bullish set, Truflation, which claims that inflation is “really” rising at only 1.39% as of yesterday.  One final thing, hopefully, all of those who claimed that the ‘real’ trend of inflation was sub 2% because the 3-month average had fallen there (please look at Monday’s note, What If?) will finally shut up for a while.

The new Mr. Yen
Said “we are closely watching”
So you don’t have to
Do not cross this line!

As mentioned above, the yen was the worst performer yesterday after the data which, not surprisingly, triggered a response from the Japanese government.  Now that USDJPY is back above 150.00, there are many who believe the MOF/BOJ will be intervening soon.  There is a terrific website called Harkster.com which aggregates all sorts of commentary and research from around the web as well as adding their own commentary.  I highly recommend it as a source for information.  At any rate, they have a very nice description of the historical actions that lead to intervention by the Japanese which I show here:

1.     Language such as “monitoring developments in currency markets”.
2.     “Sudden/abrupt/rapid” movements in currency markets are “undesirable”. In addition, markets are “not reflecting fundamentals”.
3.     “Excessive” is introduced next to describe the price movements alongside “clearly” in addition to referring to FX moves as “speculative”.
4.     Readying for action is normally reflected with the phrase “we are ready to take decisive action” which would suggest some action is imminent.
5.     Price checking is the step prior to actual intervention whereby the BoJ will call round selected Japanese banks and ask for a level of USDJPY. Even though they do not deal the act of them asking normally makes the banks, who have been contacted, sell USDJPY in anticipation of intervention and they will also spread the news around the market to encourage more selling.
6.     Same as 5 but this time the BoJ actually do sell USDJPY. This may happen in waves.
7.     Finally, coordinated intervention with other major central banks involved. This would generally happen early NY hours to include the US. This obviously has the most effect on the markets.

Arguably, we are somewhere between numbers 1 and 2 right now, but they can escalate this process quickly.  However, in the end, what matters for currencies over time are relative fiscal and monetary policy settings.  History has shown that to strengthen a currency, a country must run a tight monetary and loose fiscal policy.  To weaken a currency, the opposite is true.  Given the US 7% budget deficits and highest interest rates in the G10 + QT, it is pretty clear that the dollar should be strong.  Now, if the BOJ were to raise rates aggressively, it would have a chance to alter the trajectory of the yen, but while Ueda-san has implied that they may raise rates back to zero after the spring wage negotiations, assuming they agree large increases, unless there is a strong belief that they are going to continue to raise rates to attack inflation in Japan (which isn’t really a big problem) then absent the Fed starting to ease, there is no good reason to think the yen will strengthen very much at all.  Now, if the Fed does start cutting aggressively, that is a different story, but based on yesterday’s CPI, that feels like it is a long way in the future.

And those are the most noteworthy things to absorb.  Now, a look at the rest of the overnight session shows that Japanese stocks were softer, but the rest of Asia (absent China which is still on holiday) was mixed, with gains and losses around.  Europe, this morning, though is firmer, up about 0.5% except the UK, which is higher by 0.9% after CPI there fell more than expected, encouraging talk that the BOE will be cutting sooner.  Now remember, yesterday the UK lagged after their employment data was stronger than expected, especially wage data, so it is not clear which one to believe.  As to US futures, they are firmer at this hour (8:00), up about 0.5%.

After yesterday’s massive yield rallies, it is no surprise to see them slipping a bit today, with Treasury yields lower by 1bp and most European sovereign yields down by 3bps (UK Gilts are -6bps on that inflation data).  Overnight, the Asian session saw government bonds there slide with yields higher across the board although JGB yields were the laggard, rising just 3bps.

In the commodity markets, oil (flat today) is the only market that didn’t sell off yesterday and it has maintained those gains.  This is despite a much bigger inventory build than anticipated as it seems continued concerns over a wider Middle East war are extant, as is a new worry, as Ukraine has been able to bring the attack to Russia more effectively, sinking another Russian ship in the Black Sea last night.  Recall, they have been attacking Russian oil infrastructure and if they are successful in that effort, it will definitely give oil prices a boost.  But the rest of the commodity markets got crushed yesterday with gold, copper and aluminum all falling sharply.  This morning, though, those three markets are little changed, simply licking their wounds and not extending any losses.

Finally, the dollar is also little changed this morning, but that is after a massive rally across the board yesterday against both G10 and EMG currencies.  Against most major counterparts, it has traded back to levels last seen in mid-November, although the pound has been holding up better than most, with smaller net moves.  It is ironic that the dollar strengthens on a high inflation print as fundamentally, high inflation is supposed to weaken a currency.  Of course, this move has nothing to do with inflation per se, and everything to do with interest rate expectations.

On that subject, it is worth noting that the latest Fed funds futures rate cut probabilities are now; March 8.5%; May 37.9%; and there are now just 4 cuts priced into the year, down from 7 about a month ago.

There is no hard economic data released although the EIA oil inventories do come out later this morning.  We also hear from two Fed speakers, Goolsbee and Barr, and I imagine we could get a little ‘we told you so’ in their comments today.

If recent history is any guide, I suspect that equity markets will rebound a bit further early, but potentially drift lower as the day wears on.  The bulls were clearly shaken as their narrative took a big hit.  But this was just one data point of many.  I don’t believe the end is nigh, but in the longer term, it is not hard to believe that the Fed will remain the tightest policymaker of all the central banks and that will help the dollar while hurting risk assets.

Good luck
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Finally Dead

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It’s been, now, two weeks since the Fed
Said rate cuts were not straight ahead
Their confidence lacked
Support to abstract
Inflation was finally dead
 
Which brings us now to CPI
Where analysts identify
Used cars and soft gas
As just ‘nuff to pass
The test and wave ‘flation bye-bye

 

Finally, the CPI report will be released this morning so we will be able to collectively exhale!  The current consensus forecasts are for a 0.2% M/M rise in the headline, leading to a 2.9% Y/Y outcome and a 0.3% M/M rise in the ex-food & energy reading leading to a 3.7% Y/Y increase.  Those annual numbers would be down from 3.4% and 3.9% respectively.

A key part of the thesis for the ongoing decline is that Used Car prices will continue to fall as well as gasoline prices, which fell about 30 cents/gallon on the NYMEX exchange.  However, rent increases remain stubbornly high and any declines in foodstuffs seem to have ended.  There was a ‘brilliant’ article by a UC Berkeley economist, Ulrike Malmendier, that determined most people’s view of inflation was skewed by the prices of things they bought most frequently, rather than the ‘proper’ economists’ view of the totality of prices.  Who would have thunk it?  Honestly, it is hard to believe that some of these people have degrees at all.

At any rate, the market is highly fixated on the number and there is no doubt that many are looking for a soft outcome and, perhaps, sufficient proof for the Fed to gain enough confidence to cut rates in March.  As it stands, right now the Fed funds futures market is pricing a 15.5% probability of a March cut and a 57.5% probability of a May cut.  But the pining for this cut is palpable.  I will reiterate my view that based on the current trajectory of economic data, there is no reason for the Fed to cut at all absent a major downturn.  Clearly, given the government’s ongoing fiscal largesse, economic activity continues to move along.  While price rises have been slowing over time, I would contend there is no risk of a major deflationary event.  

The flip side of this argument is that the Federal government cannot afford to continue with interest rates this high.  Much has been made of the fact that interest payments on the Federal debt are now in excess of $1 trillion per annum, more than either defense spending or Medicare, and trending inexorably higher.  While they remain <5% of GDP, the fact that the government is running a budget deficit of >7% of GDP and slated to do so for the foreseeable future, there will come a time when this process will be unsustainable.  However, as Japan has proven over the past twenty years, things previously thought impossible are not necessarily so if the population tolerates them.  Right now, the major financial problem for the government is not the deficit, but inflation.  So that is where the attention is focused.  Eventually, something will have to give, but it is not clear that will occur within the next several political cycles, and ultimately, that’s the only time things like this will be addressed.  So, look for more of the same for now.

Turning back to markets, ahead of the CPI report, most markets around the world have remained quiet, with one notable exception, Japanese equities which have continued their impressive rally.  After a mixed and lackluster session yesterday in the US, the Nikkei rose nearly 3.0% overnight as the ongoing yen weakness and a growing suspicion that the BOJ is not going to act anytime soon continues to support things there. Chinese markets remain closed all week for the New Year holiday but the rest of the APAC markets had solid sessions.  European bourses, however, are under some pressure this morning with all of them lower by between -0.3% and -0.6%.  The data from the UK showed that the employment situation was better than expected, with lower Unemployment and firmer wage growth.  This will not encourage the BOE to consider cutting rates anytime soon.  As to US futures, at this hour (7:45) they are somewhat lower with the NASDAQ (-0.75%) leading the way down.

Meanwhile, in the bond market, yields have edged lower everywhere except the UK (+2bps and see employment data for explanation) as Treasuries (-2bps) show the way and most of Europe has followed directly in its footsteps with similar yield declines.  Interestingly, JGB yields were unchanged overnight despite the equity rally and yen weakness.

Oil prices (+0.75%) are bouncing this morning as any hopes of a ceasefire in the Middle East have faded for now but we are also seeing broad-based strength across the metals markets with gold (+0.4%), copper (+0.75%) and aluminum (+0.3%) all finding support this morning.  Perhaps this is on the back of dollar weakness in anticipation of a cool CPI print.

Speaking of the dollar, it is broadly softer, albeit not dramatically so.  GBP (+0.4%) is the leading G10 currency although CHF (-0.4%) has fallen on the back of a much lower than expected CPI reading there, just 1.3% Y/Y, with market participants now looking for rate cuts sooner rather than later.  In the EMG bloc, things are mixed although there are more gainers than laggards with ZAR (+0.5%) the leader of the pack on those strong metals prices.

Looking at this week’s data beyond today shows the following:

ThursdayInitial Claims220K
 Continuing Claims1880K
 Retail Sales-0.1%
 -ex autos0.2%
 Empire State Manufacturing-15
 Philly Fed-8
 IP0.3%
 Capacity Utilization78.8%
 Business Inventories0.4%
FridayPPI0.1% (0.6% Y/Y)
 Ex Food & energy0.1% (1.6% Y/Y)
 Housing Starts1.46M
 Building Permits1.509M
 Michigan Sentiment80.0

Source: tradingeconomics.com

As well, today we already saw the NFIB Small Business Optimism Index show a little less optimism printing at 89.9, down 2 points from last month.  Of course, things would not be complete without a bit more Fedspeak, with 6 more on the calendar including Governor Waller, perhaps the 3rd most important voice there.

Overall, while I don’t think the rate of inflation has much further to fall, and in fact, I expect it to rise again as the spring and summer progress, today’s number feels like it could be soft.  Here’s the thing, the market is anticipating that soft number so it is not clear to me how much further they can drive risk assets higher on this news.  They need something new.  However, if it is hot, look for a sharp down day in risk assets and higher yields and a higher dollar.

Good luck

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What If?

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What if inflation’s not dead
And set to go higher instead?
Can Fed funds still fall?
Well, that’s a tough call
If not, look for trouble ahead

 

As we await Tuesday’s latest CPI data, I thought it might be a good time to review how things currently stand on a macro basis.  As I am just an FX guy, I am not nearly smart enough to see through the headlines and determine what is wrong with the narrative story of Goldilocks.  However, I can look at the actual numbers and perhaps we can draw some conclusions from that data.

Let’s start with CPI, as that is the next shoe to drop.  Looking at the last twelve months of monthly data, we see the following results on both an original and adjusted basis:

 CPI m/mannualizedCPI m/m (adj)annualized
Dec-230.33.60.22.4
Nov-230.23.00.22.4
Oct-230.12.40.12.0
Sep-230.43.00.42.7
Aug-230.53.60.53.36
Jul-230.23.40.23.2
Jun-230.2 0.2 
May-230.1 0.1 
Apr-230.4 0.4 
Mar-230.1 0.1 
Feb-230.4 0.4 
Jan-230.5 0.5 
Data tradingeconomics.com, calculations @fx_poet

Since the January 2024 data hasn’t been released, there would ordinarily be no revision yet.  However, as I wrote last week, the BLS does an annual revision which lowered the December 2023 result by a tick.  

As you can see that one tick had a big impact on the annualization trend for the past 6 months, and especially the past 3 months (highlighted), reducing it substantially.  Now, given the imperfections of the measuring process, 0.1% is probably not significant in the broad scheme of things.  But oh boy, for the narrative, it is everything.  Prior to that revision, it was pretty easy for those who believe inflation has bottomed to highlight that turn higher in the annualization rate.  This was especially true given how much the ‘inflation is dead’ crowd was relying on just that point.  But now that turn looks like a dead-cat bounce and is not nearly so impressive.  Tuesday’s outcome will be quite interesting as anything that is soft will almost certainly encourage the doves to be calling for a March cut more aggressively, and just as certainly, we will see risk assets rally sharply as the dollar declines.  A hot print, though, 0.3 or more, will have the opposite impact.

What if the ‘conomy’s state
Was built by the deficit’s weight?
And actual growth
Ain’t fast, but more sloth
Will Janet, more spending create?

 

When looking at GDP data and Federal government expenditures, it becomes pretty easy to determine why GDP continues to percolate along so well.  Given that GDP = Consumption + Investment + Government + Net eXports (Y = C + I + G + NX), a quick look at the G component shows just how much support the government has been adding to the economy despite what has been recorded as strong growth.  Or perhaps, more accurately, this is why growth has been so strong.  The below chart shows the trend of government expenditures relative to total GDP growth.  I removed the Covid years because they are extremely volatile and confusing. However, looking at the trend since the GFC in 2008/2009, there has been a step change higher in the amount of government activity measured in the economy. 

Source: data FRED St Louis Fed, calculations @fx_poet

Given the current budget deficit is running > 7% of GDP and is projected to remain at least this high going forward, it is quite clear that there is a lot of nonorganic effort to raise the GDP measures.  Look at the sharp upward turn at the right side of the chart.  It appears that the administration will do everything they can to continue to show that the economy is strong.  

Of course, this is where the rubber meets the road.  If the administration continues to pump more government spending into the economy, can inflation really decline any further?  Remember, government spending is almost entirely consumption based, with limited investment at this time.  Even the CHIPS Act only created incentives for private companies to invest, it is not government investment per se.  The point is, pumping up consumption demand without adding productive capacity is very likely to drive prices higher.  And if anything, given this administration’s war on energy markets, they are discouraging investment in critical infrastructure.  It is hard to see how this plays out for a Goldilocks outcome.  Far more likely, in my view, is that they continue to pump as hard as possible, and prices start moving higher again.  Timing is everything in life, and perhaps they can work it out so price hikes are delayed until after the election, but I am skeptical given the vast incompetence this administration has shown in virtually every sphere in which it operates.

What if employment’s a mess
And actually in some distress?
Is JOLTS data real?
And what is the deal
With households, it’s hard to assess

 

The last big macro area is, of course, the employment situation.  We all know that the NFP report was much stronger than expected for January, rising 353K, but also seeing upward revisions of the previous months for the first time in quite a while.  In fact, one of the bearish stories had been that the revisions mattered more than the headline data, and if revisions were for the worse, that was indicative of a slowing economy.  

Remember, too, that the US employment situation is measured in two ways, via the establishment survey which is a survey of companies’ (both large and small) actual hiring activity and leads to the NFP number, and the household survey, which is a telephone survey of ~60,000 households and asks the question if someone is employed and if not, whether they are looking for work.  The Unemployment Rate is calculated from the household survey, so both are clearly critical in assessing the situation on the ground.  

The funny thing is that the numbers come across pretty differently when you dig down.  While in the long-term, both data series have shown a strong correlation (96% since January 2000), the Household survey is far more volatile and in the past year has been telling a somewhat different story than the establishment survey.  Look at this chart below mapping each since the beginning of 2023:

Source: data FRED St Louis Fed, calculations @fx_poet

Doing the math shows that the establishment survey claims that 3.409 million jobs were created while the Household survey comes in at just over half that amount, 1.852 million jobs.  Now, in a nation of 330 million people, especially given the expansion of the gig economy and the dramatic changes in employment overall, maybe that is not such a big deal.  As well, simply looking at the two lines shows that the Household survey is far more volatile than the Establishment survey.  Does this mean we should ignore the household survey, given it seems to have more noise and less signal?  The problem with this is the household survey drives the Unemployment Rate, and nobody is willing to ignore that.  And these differences beg the question, is the employment situation as rosy as it seems?  With the Unemployment rate remaining so low for so long, it certainly appears that there is ample demand for workers.  Of course, that also implies that the cost of labor seems unlikely to decline very much and could well increase further and faster.  If that is the case, the impact will be seen in the inflation data as well.

Trying to sum things up here, looking at the three critical macro variables, inflation, growth and employment, there is a strong case to be made that the combination of ongoing government support and continued demand for labor into an aging workforce can lead to solid nominal GDP growth with inflation remaining far stickier than many currently anticipate.  If that is the situation, all the hopes and dreams of the interest rate doves may be delayed, if not destroyed, as it will be increasingly difficult for the Fed to ease policy into an inflationary environment.  Arguably, this is why they are seeking greater confidence that inflation is really dead.  

Now, maybe Goldilocks is real, and inflation will continue to decline on its own because…well just because.  But I find it hard to look at the data and conclude that lower inflation is our future, at least for any length of time.

Ok, this has gotten much longer than I intended but fortunately, absolutely nothing of note happened overnight in markets.  Literally.  There has been de minimis movement in stocks, bonds, commodities and currencies, and there is a distinct lack of data to be released today.  Tomorrow’s CPI is THE number of the week, so perhaps that will get the juices flowing again and drive some movement.  Until then, a quiet day is usually a good one on which to establish hedges.

Good luck

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So Puissant

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Ueda explained
When NIRP disappears, ZIRP is
His view of the world

“Even if we end minus rates, the accommodative financial conditions will likely continue.”  This was the key comment from Kazuo Ueda’s testimony in parliament last night, which followed a similar comment from BOJ Deputy Governor Shinichi Uchida on Thursday.  It should be no surprise that this is the case as the recent data from Tokyo, notably the inflation data, has been softening quickly and reducing the need for tighter policy.  After all, for two decades the BOJ has been trying to overcome a generational view that deflation is a given and instill an inflationary mindset in the populace there.  If inflation readings are falling, they will definitely not be in a hurry to raise interest rates.

It appears, from these comments, that while the BOJ may lift the key deposit rate from its current -0.10% level, it would be a mistake to look for very much movement.  My money is on either 0.00% or +0.10% as the peak.  It should also be no surprise that the yen has suffered further on these comments with USDJPY having traded as high as 149.55 overnight, although it has since slipped back to unchanged at 149.40.  There remains a great deal of belief that the BOJ is highly focused on 150.00 as a line in the sand to prevent further weakness.  Personally, I think their line in the sand is higher, at least at 152.00 and perhaps even higher than that.  They are very consciously making dovish comments while listening to every Fed speaker reiterate higher for longer and no rate cuts in the US anytime soon.  They know the yen will fall further and are already prepared for that outcome; I assure you.

The talk of the market today
Is whether revisions display
That CPI’s recent
Decline is so puissant
Or if tis a ‘flation doomsday

It should not be that surprising that in a market bereft of serious data, traders and analysts are turning over every stone to find something on which to hang their hat.  Today’s story is the annual CPI revisions that are due from the Bureau of Labor Statistics at 8:30 this morning.  The reason this is getting so much play is that last year, the revision was dramatic, adjusting the annualized rate up to 4.3% from its pre-revision level of 3.1%, and casting doubt on just how much progress the Fed had actually made in their inflation battle.  But last year was a dramatic outlier with respect to revisions as historically, the average adjustment is something like 3 basis points, so the different between 3.10% and 3.13%.  In other words, nothing.

However, the concerns come from the fact that ever since Covid changed so much in the economy, measuring the data has become far more complex leading to potentially larger revisions.  I have no way of knowing what will happen here, and I suspect there is an equal chance of the revisions showing CPI has actually been lower than reported, but the point is, this obscure data adjustment has become the topic du jour on an otherwise quiet day.

What we can do is game out how markets may respond to a surprisingly large adjustment in either direction.  If, like last year, the revisions show inflation is running hotter than previously reported, I would look for bonds to sell off further, especially the 2-year, as it would push the probability of a rate cut further into the future.  This would likely weigh on stocks and support the dollar overall.  Oil has been in its own world, rallying on the increased middle east tensions, but metals would suffer, I think.  And if the revision is substantially lower, just turn around all those movements.  Any large revision will be a binary event.

But really, those were the major discussion points overnight.  Turning to the markets, after another set of records in the US (although the S&P 500 couldn’t quite make 5000), Japanese equities rallied further on the interest rate story from above, setting new 34-year highs and approaching the 1989 bubble peak.  Chinese shares are closed for a while now, but the Hang Seng, in a half-day session, managed to slide another -0.8%.  However, the rest of Asia was in the green.  In Europe, there is very little net movement this morning as we continue to hear from ECB speakers that rates will not be cut soon, although it is not clear anybody believes them given the overall economic weakness.  Lastly in the US, futures are a touch higher at this hour (7:45), but only about 0.2%.

In the bond market, yields continue to edge higher with Treasuries up 2bps, and most European sovereigns higher by just 1bp.  Interestingly, despite the Ueda comments overnight, JGB yields have crept 2bps higher along with everything else.  It is hard to know if bond investors are more concerned with sticky inflation or massive issuance, but something has them uncomfortable this morning.

Oil, which has rallied all week is unchanged this morning as the market digests the fact that there will be no cease-fire between Israel and Hamas, and the Houthis continue to fire missiles into the Red Sea.  As to the latter, given that ship traffic has fallen to near zero, that seems like a waste of ammunition, but so be it.  Metals markets, meanwhile, are a touch softer this morning with copper the underperformer (-0.5%) although precious metals have edged lower as well.

Finally, the dollar continues to perform well overall, as we have already discussed the yen, but are also seeing it edge higher against most of its counterparts in the G10.  The exception is NZD (+0.6%) which seems to believe that the RBNZ, after having paused in their rate hiking cycle, may raise rates yet again.  On the EMG side, the most noteworthy mover is ZAR (-0.35%) suffering from metals weakness although we are seeing a bit of strength from the LATAM bloc with both MXN and BRL edging higher this morning.

And that’s really it today.  Not only is there no additional data, but no Fed speakers are scheduled either.  Next week will see a number of holidays around the world as Carnival begins alongside the Chinese New Year.  Really, Tuesday’s CPI is the next key data point for us all.  Until then, I expect that traders will want to close the S&P over 5000 but do not see an explosive move higher coming.  As to the dollar, there is no reason for it to cede its recent gains.

Good luck and good weekend
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Turns to Sh*t

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The FOMC’s out in force
Explaining the still likely course
Of rates is to stay
Where they are today
Unless there’s some hidden dark horse
 
Investors, though, don’t give a whit
As Spooz seem quite likely to hit
Five thousand quite soon
Then onto the moon
Take care lest this view turns to sh*t

 

The WSJ led with an interesting article today with the below graphic as the teaser.  This is called a hair chart, for obvious reasons, with those light blue lines describing Fed funds futures curves and comparing them to the subsequent actual Fed funds rate over time.  The article’s point, which is important to understand, is that the futures market tends not to get things right very often.  In other words, just because the market is pricing in 5 or 6 rate cuts today does not mean that is what will occur over time.  In fact, looking at the chart, it almost seems that 5 or 6 cuts is the least likely outcome.  One need only look at the past several years to see that while they were pricing cuts, the Fed was still hiking.

Of course, this fits with my thesis that the Fed funds futures market is actually reflecting a bimodal outcome of either zero cuts or 10.  But regardless of my view, the equity market is all-in on the idea that the Fed is going to be cutting rates soon as evidenced by the fact that the S&P 500 is now trading just a hair below 5000 after yesterday’s 0.8% gain.  

In the meantime, yesterday we heard from four more Fed speakers and to a wo(man) they all said effectively the same thing; progress has been made on the inflation front but they still don’t have confidence that 2% inflation on a sustainable basis has been achieved.  In fact, several mentioned that the recent hot GDP and NFP data indicated more caution is warranted.  By the way, if we look at the Atlanta Fed’s GDPNow forecast, it currently sits at 3.4%, hardly a level of concern, while their Wage Growth Tracker remains at 5.0%.  Again, that is not data that indicates inflation is collapsing.  It remains very difficult for me to expect inflation to fall given the recent totality of the data.  In other words, nothing has changed my view that inflation will remain stickier than currently priced and very likely start to creep higher again, and that will ultimately have a negative impact on risk assets.  But not today!

The other news overnight was that Chinese CPI rose less than expected in January, just 0.3%, which took the annual change to -0.8%.  As China heads into their two-week Lunar New Year holiday, welcoming the Year of the Dragon, the question for investors around the world is, will Xi do anything to halt the decline?  Thus far, his efforts have been weak and insufficient as evidenced by the equity markets in Hong Kong and on the mainland both having fallen sharply over the past year with little net movement this year despite several efforts at support and stimulus.  Now, Xi has nearly two weeks to come up with a new plan to get things going when markets return on February 20th, but for the past several years he has been unwilling to fire a big fiscal bazooka.  Will it be different this time?  Remember, they still have a catastrophic mess in the property market there which will impinge on anything they do.  I expect there will be some more half-hearted measures, but nothing sufficient to turn things around.  Ultimately, while they don’t want to see the renminbi fall sharply, I suspect it may have a bit more weakness in it before things are done, especially if the Fed really does stay higher for longer.

Ok, let’s look at markets elsewhere overnight.  The Nikkei (+2.0%) rallied sharply after comments by a BOJ member indicating that even when rates get back above zero, they will not move very much higher, and it will take time.  This saw the yen weaken further while stocks benefitted.  Meanwhile, the only loser in Asia overnight was India, where investors were disappointed that the RBI left rates on hold rather than cutting them (see a pattern here?).  Otherwise, everything followed the US rally yesterday.  The same is broadly true in Europe with decent gains, about 0.5%, almost everywhere except the UK, which is flat on the day after comments by a BOE official that cuts may not come as soon as hoped.  As to the US, at this hour (7:30) futures are basically unchanged.

In the bond market, after a generally quiet session yesterday, yields are starting to creep higher again with Treasuries +2bps and European sovereign yields rising a similar amount across the board.  Once again, the global bond markets revolve around Treasury yields with the only exception being JGB’s which saw the yield decline 1bp after those BOJ comments.

In the commodity markets, oil (+0.9%) is higher once again with Brent trading back above $80/bbl, as Secretary of State Blinken returned to the US with no real improvement in the Israeli-Hamas war and no prospects for a cease-fire.  Meanwhile, the US was able to kill the Iranian commander who allegedly led the attack on a US base that killed three soldiers, certainly not the type of thing to cool down tensions in the region.  Between the rise in cost of shipping oil from the Mideast to the rest of the world because of the Red Sea situation, and the lack of hope for an end to the fighting, it seems oil may have some legs here.  As to the metals markets, there is a split with both gold and copper under some pressure but aluminum seeing a bid this morning.  Quite frankly, I understand the former two rather than the gains in aluminum, but in the end, none of these metals has moved very much over the past months and remain trendless for now.

Finally, the dollar is starting to assert itself this morning as though the yen (-0.75%) is leading the way lower, pretty much every G10 and EMG currency is weaker vs. the greenback at this time.  Again, I would contend this is all about the ongoing Fed message of caution and confidence regarding inflation’s disposition, and the prospects of higher for longer.  FWIW, the current probability of a March cut is 18.5%.  barring a collapse in the CPI data next week, I expect that to head toward zero over time.

As to the data situation, we only see the weekly Initial (exp 220K) and Continuing (1878K) Claims data first thing and then it is Fedspeak for the rest of the day.  I expect that traders are going to push the S&P 500 over 5000 early this morning, if for no other reason than to say it was done, but what happens after is far less certain.  Earnings data has been generally ok, but some pretty bad misses have had quite negative impacts on individual names.  As to the dollar, the more I hear Fed speakers urge caution in the idea for rate cuts soon, the better its prospects.

Good luck

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Singing the Blues

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Here’s what’s underlying most views
Inflation is yesterday’s news
But what if it’s not
And starts to turn hot?
Those bulls will be singing the blues
 
So, care must be taken, I think
As in the bulls’ armor, a chink
Is wages keep rising
While homes are surprising
Be careful, the Kool-Aid, you drink

 

Market activity has generally been benign as investors and traders await the next big news.  Arguably, that is next Tuesday’s US CPI data given the dearth of new information otherwise due to be released this week.  The one thing we have in spades this week is central bank speakers, with three from the Fed yesterday and four more today, including the first comments I have seen from the newest Governor, Adriana Kugler.  As well we have been regaled by ECB, BOE and BOC speakers and they will continue all week as well.

Thus far, the message has been pretty consistent with the general theme that inflation has fallen nicely and is expected to continue to do so.  However, in a great sign of some humility, they are unwilling to accept that because price levels have fallen for the past 3 months that their job is done.  Obviously, the recent NFP and ISM data have shown no indication that the economy is even teetering on the brink of a slowdown, let alone desperate for rate cuts for support.  And for this, I applaud them.

But in this case, the central bank community seems to be in a small minority of economic observers who are not all-in on the idea that rate cuts are necessary right now.  Because, damn, virtually every other analyst seems to be on that train.  

There is a very good analyst group that calls themselves Doomberg, which mostly write about energy policy and its impacts on everything else, but in this morning’s article, I want to highlight a more general comment they made which I think is really important:

“How can you tell the difference between an analyst and an advocate? It is all in the handling of data that runs counter to assertion. To an analyst, being wrong is disappointing, but it is primarily an opportunity to learn—an expected element in a feedback loop of continuous improvement. When knowledge is your only objective, there is no such thing as a bad fact, only one which you do not yet understand. Not so for the advocate. The advocate has tied their hopes (and often their livelihoods) to a specific outcome and feels compelled, whether consciously or not, to rationalize away or attack inconvenient realities. It is advocacy when every perturbation in the weather is tagged as evidence of climate change, each squiggle of unfavorable price action is declared market manipulation, and no act or utterance from a favored politician is disqualifying.”

First, I cannot recommend their writings highly enough as they are consistently thoughtful, well-researched and important.  But second, I think this point is exactly in tune with the Goldilocks welcoming committee as they will ignore every piece of data that runs counter to their narrative and double down by saying the Fed is overtightening because inflation is collapsing, and deflation is going to be the economic problem soon.

While I am often quite critical of the Fed and their comments, and still think they speak far too much, right now, I am very happy to see them maintain a reluctance to cut rates just because the market is pricing in those cuts.  Certainly, to my eye, looking at the totality of the data (as Chairman Powell likes to say) there is little indication that prices are collapsing.  In fact, the super-core data, which was all the rage last year, has turned higher.  I understand why Wall Street analysts are better described as Wall Street advocates, but for the independent analysts out there, and over the past several years those numbers have exploded higher, it is remarkable to me that more of them are not suspect on the idea that rates need to be cut and cut soon.  In fact, at this point, one month into the year, I continue to like my 2024 forecasts of perhaps one cut in the first half of the year, but a reversal as inflation reignites.

Yes, the futures market is now only pricing five cuts into 2024, but nothing has changed my view that the pricing is bimodal, either 0 or 10 cuts will be the outcome, with the former if the economy continues along its recent pace and the latter if the recession finally arrives.  Given that interest rates, led by Treasury yields, are the clear driver of global market movements, and given that inflation is going to play a critical role in their movement going forward, I have altered my view as to the most important piece of data.  Whereas I used to believe it was NFP, it is now entirely CPI/PCE.  As I wrote yesterday, if next week’s print is at 0.4% M/M, watch out for a significant repricing.

But now, let’s turn to today.  President Xi continues to have problems with his stock market and is seemingly getting a bit more desperate aggressive in his efforts to prevent a complete implosion.  Last night, the head of the CSRC (China’s SEC analog) was replaced as blame needs to be placed on others for Xi’s policy errors.  It ought not be surprising that Chinese shares, after a weak start, rebounded on the news and closed higher by about 1%.  However, the Hang Seng could not manage any gains and the Nikkei edged lower as well.  All in all, it was not a great session overnight.  In Europe this morning, the markets are lower by between -0.25% and -0.5% as once again we saw weak German data (IP -1.6%) continuing to point to a recession on the continent.  Finally, US futures are basically flat at this hour (7:30).

In the bond market, yields, which all slid a bit yesterday on what seemed to be a profit-taking move after that massive runup following the NFP and ISM data, are a bit higher this morning, with Treasury yields up by 3bps and most of Europe seeing similar movements, between 2bps and 4bps.  As I wrote above, this story remains all about inflation’s future, and as data comes in to add to the conversation, I suspect that will be the key mover going forward.

Oil prices (+1.0%) are continuing their modest recent rebound with WTI touching $74/bbl this morning and Brent above $79/bbl.  Comments by the Biden administration that they would continue to attack Iranian proxy groups seems to have traders worried about an escalation.  But a more concerning story is that Ukraine has been targeting Russian refineries in an effort to degrade Putin’s cash flow.  They have already hit several and reduced capacity by 4%-5%.  If that continues successfully, then oil prices are going to go much higher.  This doesn’t seem to be in the bigger narrative right now, so beware.  As to the metals markets, they are all slightly softer this morning, but movement has been tiny.

Finally, the dollar is under a modest amount of pressure this morning, which given the rising yields and softer commodities, seems out of character.  Granted, the movements are small, with most currencies just 0.1% – 0.2% firmer vs. the dollar.  And this could also be profit-taking given the dollar’s recent rally.  After all, the euro remains below 1.08 and USDJPY above 148.00 so this is hardly a collapse.

Turning to the data today, the Trade Balance (exp -$62.2B) is this morning’s release and then after oil inventories, at 3:00 we get Consumer Credit ($16.0B).  As mentioned above, we have many more Fed speakers as well, and I sense that will be of far more interest to market participants.  I don’t anticipate anybody straying from the current theme of inflation has been falling nicely but they are not yet convinced.  If someone strays, that could move markets, but again, I see little to drive things today, or this week.

Good luck

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Ain’t Hunky-Dory

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For President Xi it appears
The stock market’s shed enough tears
So, he’s set to meet
The finance elite
And likely to box all their ears

As such, I expect we shall see
The Hang Seng will start on a spree
With New Year’s approaching
A little more coaching
By Xi, for a rally, is key

The big news overnight was that Chinese equity markets rebounded sharply (Hang Seng +4.0%, CSI 300 +3.5% CSI 1000 +7.0%) after the news that President Xi Jinping would be meeting with market regulators to find out what is going on there.  Banning short sales has not yet been effective nor has increased purchases by specific state funds.  According to Morgan Stanley, foreign investors sold $2.4 billion in Chinese equities in January, arguably a key driver of the market’s recent weakness there.  But the fact that Xi is getting involved directly has traders believing that more support from the government is on its way, hence today’s big rally.

While that is all fine and well for equity investors, the far more important question for the rest of us is will this stock market support help the Chinese economy as well?  Or will that continue to meander along at a weak growth pace?  Of course, it is far too early to know the answer to this question but given that the preponderance of Chinese individual wealth is tied up in real estate, not equities, I expect that this will have far less impact on the economy there than is hoped by both Xi and the traders.  After all, one of the key reasons so many in the US care about the stock market is that so much of our 401K investments are in equities, a rally shows up in our accounts daily.  But in China, that same situation does not hold.  Will a rally in stocks, if it even comes, be enough to sway the average person’s thinking there that things are getting better?  I have my doubts.

A turn to the interest rate story
Shows things there just ain’t hunky-dory
Yields just won’t stop rising
And that’s neutralizing
The thought rate cuts are mandatory

Friday morning, 10-year Treasury yields traded as low as 3.82% prior to the release of the NFP report.  This morning, they are trading at 4.16%, 34 basis points higher and the largest two-day yield rally since the covid volatility in March 2020.  Prior to that, it was 1981 when yields moved that far that fast.  Adding to Friday’s NFP story, yesterday’s ISM Services report was not only stronger than expected at 53.4, but the Prices index jumped to 64.0, its highest in a year and hardly a comforting thought for Chairman Powell and his fight against inflation.

At this point, the Fed funds futures market has lowered the March rate cut probability to 16.5%, and some of the punditry, although not yet any Fed speakers, have raised the question if another hike might be in order if things continue on their recent trajectory.  I assure you that the equity market has not priced in the possibility of a rate hike anywhere in the next 2 years at least.  Let’s just say that next week’s CPI report is going to be quite closely watched by everyone as if what I have seen as recent stickiness continues to exert itself, and with the economy seeming to be ticking over quite nicely, then the narrative could well change.  It is not impossible for the Fedspeak to turn even more hawkish if we were to see CPI rise 0.4%, a rate that is far too high for Fed comfort.  And that, my friends, would likely not be well-received by the equity market or risk assets overall.  While I have no special insight into how this data is going to evolve, I think the reaction function is clear.

Ok, let’s look at the overnight session beyond Chinese stocks.  In what cannot be that surprising after US equities struggled and given its recent negative correlation to Chinese stocks, the Nikkei fell -0.5% while the rest of Asia was mixed with some gainers (India, Taiwan) and some laggards (Korea, Australia).  However, the story in Europe is a little brighter with gains most everywhere except Germany, which is flat on the day after mixed data, with a blowout Factory Orders result of +8.9%, but the Construction PMI falling to 36.3.  Contradictory data leading to no movement.  As to US futures, at this hour (7:45) they are essentially unchanged on the day.

In the bond market, it seems traders are sitting on the sidelines after the bloodbath described above as 10-year Treasury yields are unchanged on the day and in Europe, the sovereign bonds are higher by a mere 1bp-2bps across the board.  We saw a similar lack of movement in Asia as well, despite the fact that the RBA, at their meeting last night, sounded somewhat hawkish although left policy rates on hold as universally expected.  As the treasury market is clearly leading the way globally, we will need to get some new information here, I think, before we see any substantive movement again.  Since the next big piece of data is CPI in one week’s time, it could be a quiet week for bonds.

In the commodity market, oil (+0.6%) is bouncing slightly this morning although it remains far lower than levels seen last week.  Gold (+0.1%) is also edging higher along with the industrial metals although there has been no strong catalyst here today given the lack of substantive rate movement.  Perhaps there is some optimism from the Chinese stimulus story, but that feels quite premature.

Finally, the dollar is a touch softer this morning, although only just.  While the euro has been unable to bounce, we have seen some modest gains in the pound (+0.25%) and Aussie dollar (+0.25%) as well as the renminbi (+0.3%).  In addition, the LATAM bloc is very modestly firmer this morning but generally, most of the movement is of that 0.25% magnitude or less.  This feels very much like a trading response to a powerful rally over the past two days.

There is no hard data to be released today but we do hear from three more Fed speakers, Kashkari, Collins and Mester, all this afternoon.  Yesterday, Chicago Fed president Goolsbee strayed from the Powell message, indicating he still believed a cut in March was possible, but he is not a voter this year and nobody really paid any attention.  After yesterday’s data, it would be hard to believe that any of these three would sound dovish, but you never know.

Overall, when looking at the dollar, as long as the inflation story has reawakened and is driving yields in the US, it is hard to see coming weakness.  This is especially true given the economic weakness we continue to see elsewhere in the world.  Today feels like a reaction, not a trend in the making, and I expect that the dollar has better days ahead for as long as inflation is once again the driving force.

Good luck
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Not Quite Mawkish

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On Friday, in quite the surprise
Our payrolls did massively rise
At least that’s what printed
But where those jobs minted?
Or will, next month’s data revise?
 
Perhaps Chairman Jay had a sense
And that’s why his press confer-ence
Was ever so hawkish
Although not quite mawkish
So, traders, more buys, did commence

 

I would contend that nobody was anticipating the NFP data on Friday which printed so much higher than forecasts it was remarkable.  A headline number of 353K with a revision up for December of 116K is huge and certainly puts paid to any thoughts of the economy slowing.  As well, Average Hourly Earnings rose a more than expected 0.6%, certainly good for workers, but another nail in the coffin of a quick rate cut by the Fed.  Of course, none of that seems to matter anymore to equity investors as despite every indication that given the recent data, the Fed will remain higher for longer, stocks rocked higher.  Bonds did not fare quite as well, though, as 10-year yields rocketed 15bps higher by the close.

Another interesting anomaly was in the Fed funds futures market where in the immediate wake of the FOMC meeting, the probability of a March rate cut (which you may recall Powell specifically took off the table) fell to 20% from a coin toss earlier.  But Friday, that closed back at 38%! (PS, this morning it is down to 15.5%, so remains quite volatile.)  Rounding out the asset classes, the dollar followed yields, with the euro falling nearly 1% and other currencies close behind.  As to oil, that slid about $1, but it has been softening all week, so there are obviously other issues there.  What gives?

The first thing to recall is that January data tends to be pretty sloppy.  My good friend, Mike Ashton (aka @inflation_guy) made the point eloquently as follows:

This is not to say that the adjustments WILL be huge, just that over time, that has been the case.  Recall that almost every reading last year was revised lower in subsequent reports.  All I’m saying is that as terrific as that number was, add at least a pinch of salt, I think.

The other thing that doesn’t seem to square is that so many other employment indicators are trending in the opposite direction.  After all, ADP was only 107K, and the employment reading in the ISM fell last month along with the employment readings in many of the regional Fed surveys.  As well, continuing claims have been trending higher for the past several months, generally not a good sign for employment.  Again, all I am trying to highlight is that this number may not be quite as robust as it seems on the surface.  At the same time, for the Fed, if they need an excuse to leave policy at current levels, the combination of strong job growth and rising wages is plenty of ammunition.

Sunday night, Chairman Powell was interviewed on 60 Minutes but really didn’t tell us anything new.  Essentially, I would say he repeated his Wednesday press conference with one exception, he did, when asked, indicate that the current fiscal profligacy would be a problem in the long run.  To date, he has been reluctant to even discuss the issue, so perhaps that is a signal of something, but of what I have no idea.

Moving on from Friday, finally, the weekend saw the Biden administration’s retaliation for the deaths in Jordan of 3 US soldiers, however, that is not a market impactful event.  Coming into the new week, the Services PMI data has been released everywhere and we are awaiting ISM Services this morning in NY.  In aggregate, the data showed that some nations are doing better than others.  In the positive camp, India (61.8 final) was by far the nation with the highest reading, but Japan, China, Spain, Italy and the UK all showed growth above 50.  On the other side of the ledger, Australia, Germany, France and the Eurozone overall remain well below 50, although seem to have found a bottom for now.  As to the US, the current forecast is for a 52.0 print, up from December’s number of 50.6.

Is this really telling us that much?  Remember, the question that is asked in these surveys is, how do things compare this month to last month?  Remember, too, that recent data has shown weakness across the surveys with strength in the hard data.  Friday’s NFP is the perfect encapsulation of that idea.  Perhaps the one thing we can consider is that if today’s ISM is quite strong, it will be enough to completely remove March from the rate cut schedule.  Of course, my question is, if today’s data is strong, why exactly will the Fed feel the need to cut rates at all?  I simply do not understand this baseline assumption that interest rates are “too high”.  In fact, based on the evidence provided by GDP and NFP data, they seem to be just fine.  And, hey, isn’t it better for all of us to earn 5% in our Money Market Fund accounts than 0.0% like we did for years?  In fact, based on the common view that there are several trillion dollars of “excess” savings in the economy, it seems the holders of those savings must be quite happy with rates where they are.

Ok, let’s tour overnight market behavior quickly before we finish up.  In the equity space, Japanese stocks continue to rise with the Nikkei up another 0.5% while Chinese stocks continue to struggle.  While the CSI 300 managed a 0.6% gain, the small-cap CSI 1000 fell 8% as small cap stocks around the world remain unloved.  However, the Chinese government is definitely concerned as rumors of another rescue package are all over the tape.  As to Europe, modest gains are the order of the day, with most markets higher by about 0.25%.  meanwhile, US futures, they are ever so slightly softer at this hour (7:15), down about -0.1%.

Turning to the bond market, apparently everybody is turning away from the bond market!  Yields are higher across the board with Treasuries leading the way, up a further 7bps, but all European sovereign yields higher by between 3bps and 5bps as well.  The story in Asia was even more impressive with JGB’s (+5bps) and Australia (+12bps) all catching up to the Treasury story.  Ultimately, the issue I see is that while growth in the US remains strong, pretty much all of Europe is in recession.  This seems likely to lead to the ECB cutting rates before the Fed as they will have a reason to do so, while as I ask above, what is the Fed’s rationale for a cut?

The higher interest rate story has weighed heavily on commodity prices with oil sliding -0.8% this morning, although it has been falling for a week.  But we see metals prices under pressure as well with gold (-0.6%), copper (-0.4%) and aluminum (-0.6%) all sliding this morning amid the move in yields.

Not surprisingly, the dollar has been a major beneficiary of the higher yield story, following Friday’s sharp rally with a continuation across the board.  The euro is back to 1.0750, a level not seen since mid-November, while USDJPY is back above 148.50 and USDCNY above 7.21.  In fact, the only currency bucking the trend today is KRW (+0.4%) which managed to rally despite any obvious macro catalysts.  Equities fell there alongside Chinese stocks, so it was not investment inflow.  Sometimes, currencies just move, that much we know.

Turning to the data this week, there is much less on the docket than we saw last week with, arguably, today’s Services ISM the most important number.

TodayISM Services52.0
WednesdayTrade Balance-$62.2B
 Consumer Credit$15.0B
ThursdayInitial Claims220K
 Continuing Claims1902K

Source: tradingeconomics.com

However, we do hear from 10 different Fed speakers this week starting with Atlant’s Raphael Bostic and then inundated rhoguhout the week.  But I ask you, will they really stray far from Powell’s message?  Especially after the blowout NFP number?  Higher for longer still lives, and if we continue to get strong data, May will soon start losing its appeal for a rate cut.  This will not help the bond market, that’s for sure, but it will help the dollar.

Good luck

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Beware

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It wasn’t all that long ago
When Powell commanded the show
At least so it seemed
But maybe we dreamed
Those attributes we did bestow
 
But now traders seem not to care
That Wednesday, Chair Jay said beware
No rate cuts next meeting
Instead, they are treating
That warning’s though it wasn’t there
 
The upshot is bonds are on fire
And stocks turned around and went higher
Today’s NFP
Will help us to see
If Jay is still leading the choir

 

Well, it seems that Chair Powell’s hawkish message resonated with investors for about 12 hours, at which point they decided to forget all he said and side with Treasury Secretary Yellen and her spending plans.  Or maybe the trading community just doesn’t believe he can pull it off, keep policy rates at 5.5% while the government needs to borrow so much money.

There are other possible explanations as well.  The NYCB meltdown yesterday may have opened some eyes regarding the commercial real estate (CRE) problems that certainly exist everywhere in the world, but notably here in the US.  If reclassifying just two loans was enough for a $100 billion bank to cut their dividend completely and increase loan loss reserves nine-fold, what about all the other CRE loans that are also under pressure on other bank balance sheets?  Perhaps the bond market is sniffing out the next banking crisis in front of our eyes.  For the conspiracy theorists, the Fed did remove the following line from their statement yesterday, “The U.S. banking system is sound and resilient.”  Perhaps that was a hint that it is not sound and resilient.

Regardless of the driver, yesterday saw a ripping rally in the bond market with the 10-year yield touching 3.82% before bouncing, nearly as low as it reached following Powell’s ultra-dovish performance in December.  That certainly doesn’t square easily with the hawkish statement and comments on Wednesday.

I have no good explanation for the movements, and I would argue neither does anyone else.  As has been the case for the past year, at least, economic data is simply a Rorschach test for your underlying views and biases.  Once again, the financial markets appear to be fighting the Fed tooth and nail.  Perhaps one clue was the fact that gold prices rallied yesterday, as did bitcoin.  Now, it is possible that is simply because lower yields enhance the willingness to hold those assets, or perhaps it is because the market smells a banking crisis coming and wants to hide.

Fortunately, we get new and important information this morning with the release of the NFP data at 8:30.  Here are the current median forecasts:

Nonfarm Payrolls180K
Private Payrolls155K
Manufacturing Payrolls5K
Unemployment Rate3.8%
Average Hourly Earnings0.3% (4.1% Y/Y)
Average Weekly Hours34.3
Participation Rate62.4%
Factory Orders0.2%
Michigan Sentiment78.9

Source: tradingeconomics.com

As well, the BLS will be releasing their annual revisions to their data, so everything will be a mess.  However, traders, and trading algorithms, only ever look at the headlines.  The fact that 11 of the past 12 NFP numbers have been revised lower over time seems not to be a major concern to investors, although it is certainly not a positive signal for the economy writ large.

In the end, we are all beholden to this data point and the market’s reaction function.  Based on what we have seen since the FOMC meeting I would suggest that a weak number will be seen as risk-on because it will encourage more rate cut talk and bring March back into view.  (FYI, the current probability of a March cut according to the futures market is 34.5%.  Sub 100K and I would look for that to go back to 50% at least.)  At the same time, a strong print, > 200K, and I expect a risk-on response as it will encourage the earnings growth story and reduce the probability of a recession.  In fact, after the strong earnings reports from Meta and Apple last night, the only way I think we see a risk-off outcome today is if NFP is sharply negative, enough so it forces people to put recession back on their bingo cards.  We shall see.

In the meantime, a quick look at the overnight session shows that Asian equity markets are back on the buy Japan / sell China train with the CSI 300 falling to its lowest level since 2019 as investors remain unimpressed by Xi’s efforts to fix things in China.  But away from China, the rest of the markets in Asia all had good session, up between 0.5% and 1.5%.  In Europe, green is the theme as well with every market higher on average by 0.7% or so.  Not surprisingly given the earnings reports, US futures are green as well, with the NASDAQ +1.0% at this hour (7:10).

Bond markets are all over the map this morning.  Treasury yields are unchanged from the closing level yesterday, although they bounced 5bps from that intraday low print mentioned above.  As to European sovereigns, yields have edged higher by 1bp-2bps on the continent although UK Gilts are higher by 6bps which is a bit strange given the BOE yesterday seemed far more dovish than many expected.  While leaving rates on hold, they explained they expected inflation to temporarily get back to their 2% target in Q2 before bouncing a bit, and the vote included one vote to cut rates, 6 to maintain and 2 to raise, a more dovish tilt.  And yet here we are, with Gilts selling off.  If you were interested, JGB yields have fallen as well, down 2bps and falling away from any ideas of policy changes in Tokyo.

Oil is little changed this morning after getting crushed yesterday on unconfirmed rumors of a cease-fire in the Israel-Gaza conflict.  It seems the betting is that if there is a cease-fire, the Houthis will stop attacking ships in the Red Sea and things will improve everywhere.  However, as of yet, no cease-fire has been reached.  As to the metals markets, gold is little changed after a more than 1% rally yesterday, while both copper and aluminum are softer this morning, although the movements have been small and may be meaningless.

Finally, the dollar is a bit softer this morning with AUD (+0.5%) the leading G10 gainer on the back of the ASX 200 reaching a new all-time high closing level overnight.  But the movement here is broad and shallow, most currencies are a bit stronger vs. the dollar, but that 0.5% move is the largest by far.  My take is that as long as US yields remain under pressure, the dollar will be on its back foot as well.  Hence, a strong NFP this morning could see yields bounce and the dollar along with it.

And that is all we have today.  It has been quite a week between the QRA, the FOMC and Powell presser and now today’s NFP.  While there was a great deal of uncertainty as the week began, at this point, it seems clear that the market has decided that rates are coming lower regardless of what Powell has to say.  We have yet to hear from any other Fed speakers, although I imagine we will be getting a full dose next week.  And Sunday night, on 60 Minutes, Powell will be interviewed so that will be closely watched for any clues.  Until then…

Good luck and good weekend

Adf