It seems that on Friday, we learned
The prospect for rate cuts upturned
The ISM sunk
And Michigan stunk
So, doves got the data they yearned
 
And so, things are priced for perfection
Though history cautions reflection
Is what we all need
As not fear, but greed
Is likely to cause the correction

 

Markets are funny things with a history of reacting to catalysts that were completely unexpected while ignoring the ‘big’ things all the time.  Friday was a perfect example as the release of some second-tier data, ISM and Michigan Sentiment, drove a major change in the narrative and market prices in every asset class.  Prior to the Friday data releases, which saw ISM Manufacturing fall to 47.8, far below last month and forecasts, as well as the Michigan Sentiment index fall to 76.9, also well below last month’s number and forecasts, there had been a steady stream of strong data and hawkish Fed rhetoric.  

By now, you are all familiar with the Fed’s general lack of confidence that inflation is going to return to their 2.0% target soon as that sentiment has been expressed by, literally, all 17 FOMC members in the past three weeks.  The result of the hawkish talk and the solid data was a repricing in the Fed funds futures market of just how many rate cuts were coming in 2024, as well as their timing.  As well, we saw Treasury yields back up nearly 50bps during the month of February as the concept of higher for longer was finally getting internalized by market participants.  

But observing the market’s behavior, it was never clear that investors and traders really believed that tale of higher for longer.  Undoubtedly, there has been a camp, FX poets included, who have been singing that tune all year long.  But a much larger camp has been convinced that inflation was clearly on its way to 2% or lower and the Fed would want to cut sooner rather than later.  The rationales for these cuts had very little to do with the economy and focused instead on one of two things; the election this year and their effort to prevent President Trump from being elected support the current administration, or the fact that the extraordinary amount of funding that the Federal government needs to pay for its increasing deficits requires lower interest rates to prevent a fiscal disaster.

Then along comes Friday’s data and much of the Fed’s hard-won respect regarding higher for longer got tossed right out the window.  Treasury yields fell sharply, down 8bps, while the futures curves upped the ante for a May rate cut and made June that much more certain.  Not surprisingly, equity markets got quite the boost, although they have mostly been ignoring the rates story anyway. But perhaps the most interesting thing was what happened in the gold market, where the price of the barbarous relic jumped nearly 2% on the idea that rates were set to decline in the face of still high inflation.

It is important to remember that these two data points were, as I said at the top, secondary.  The fact that both pointed to economic weakness after a long string of strong data points was interesting, but was it really a signal that the trend has changed?  Personally, I am skeptical that is the case.  However, for a market that was looking for a reason to push back on the growing narrative of fewer rate cuts, they were a welcome sight.

In the broad scheme of things, though, this week is likely to be far more important in helping us all understand the nature of the current economy as well as the ongoing Fed reaction function thereto.  After all, not only do we hear from Chairman Powell as he testifies to the Senate and House on Wednesday and Thursday respectively, but Friday brings the payroll report.  Too, on Wednesday the Bank of Canada and on Thursday the ECB meet to lay out their latest views.  Remember, too, that the Chinese National People’s Congress is being held this week, and while leaks are rare, they will ultimately be announcing their growth targets for the year, so another crucial piece of information.  Net, I do not believe that last Friday’s data will have changed the minds of any FOMC members, and continue to believe that even a June cut is a low probability absent a significant overall economic decline, including lower inflation data.  But then, that’s what makes all this so exciting  .

As we await all the activity to come, let’s recap the overnight session.  In Asia, only the Nikkei (+0.5%) managed to generate any excitement as it made yet another new all-time high and breached the 40,000 level for the first time.  Chinese shares were dull as was most of the rest of the region.  In Europe, the picture is mixed although the only mover of note is the FTSE 100 (-0.6%) which seems to be declining on the prospects of a lackluster budget announcement by the government this week.  Otherwise, bourses here are within +/- 0.2% of Friday’s closing levels.  And at this hour (8:00), US futures are edging slightly lower.

In the bond market, Treasury yields are backing up from Friday’s decline, rising 3bps this morning, but in Europe, sovereigns are mostly seeing some demand with yields slipping 2bps-4bps across the board.  The one exception is, again, the UK, where Gilt yields are unchanged on the day.  Overnight, JGB yields were unchanged, while we saw lower yields across the rest of Asia which seemed to simply be following the Treasury market.

In the commodity space, Friday also saw oil prices rise 2%, and this morning they are essentially unchanged, consolidating those gains.  OPEC+ announced that they would continue their lower production levels which clearly has had a bigger impact than rumors that a ceasefire would soon be taking place in Gaza.  Gold is also little changed this morning, holding its gains while copper is edging higher, and aluminum is slipping.  There are many analysts who discuss the coming super cycle for commodities, but thus far, there is little consistency in the price action there.

Finally, the dollar is mixed this morning.  In the G10 we are seeing weakness from SEK (-0.65%), NOK (-0.35%) and JPY (-0.3%) although some strength from the euro (+0.1%) and pound (+0.2%).  Similarly, EMG currencies are seeing gainers (ZAR +0.4%) and laggards (CLP -0.8%) and everything in between.  If the new narrative of easier Fed policy turns into reality, then I would look for the dollar to suffer.  However, I don’t yet accept that as the case.

As mentioned above, there is much on the data front this week as follows:

Tuesday	ISM Services	53.0
Wednesday	ADP Employment	150K
	Bank of Canada Rate Decision	5.0% (unchanged)
	JOLTS Job Openings	8.9M
	Fed’s Beige Book
Thursday	ECB Rate Decision	4.0% (unchanged)
	Initial Claims	215K
	Continuing Claims	1885K
	Trade Balance	-$63.4B
	Nonfarm Productivity	3.1%
	Unit Labor Costs	0.6%
	Consumer Credit	$10B
Friday	Nonfarm Payrolls	200K
	Private Payrolls	158K
	Manufacturing Payrolls	10K
	Unemployment Rate	3.7%
	Average Hourly Earnings	0.3% (4.4% Y/Y)
	Average Weekly Hours	34.3
	Participation Rate	62.6%

Source: tradingeconomics.com

In addition, as well as Chairman Powell’s testimonies in Congress, there are another four Fed speakers, although with Powell headlining, I don’t think folks will pay too close attention to them.  Last week, the Fedspeak onslaught was very consistent about that lack of confidence that inflation would reach target soon, and there is clearly no hurry to cut rates, although virtually all speakers expect rate cuts to be the case.  Perhaps the data this week will change some minds, but remember, the big number doesn’t come out until after Powell speaks, and after Friday, the Fed enters its quiet period ahead of the next FOMC meeting.  

Right now, I have to believe last Friday’s data was the exception, not the rule, but we will learn more as the week progresses.  In the end, I think the dollar remains tied to the yield story, so as long as growth remains stronger here than elsewhere, and doesn’t show signs of falling sharply, the dollar should maintain its broad level of strength.

Good luck

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