While equity bulls all still dream
The Fed has a rate cutting scheme
All ready to go
That going’s been slow
And clearly is losing some steam
 
Kashkari’s the latest to say
That higher for longer will stay
The policy choice
Of every Fed voice
Thus, bonds had a terrible day

 

Arguably, the most impactful news from yesterday’s session was the fact that the Treasury auctions of 2-year and 5-year Notes was so poorly received.  The tails on both auctions were more than 1 basis point, which for short-dated paper is highly unusual.  As well, the bid-to-cover ratio for the 5-year was just 2.3, well below the longer-term average of 2.45 resulting in dealers taking down more of the auction than either expected or wanted.  The overall bond market response was to see 10-year yields rise 7bps, although the 2-year yields only edged higher by about 2bps, thus steepening the yield curve a bit.

Of course, the question at hand is, what happened?  Not surprisingly, there are as many answers to this question as people asked, but a few of the logical responses ranged from the short-term concept that recent data has shown more robust growth than anticipated thus reducing the chance of any rate cuts soon to the long-term view that the Treasury is issuing so much debt they have overwhelmed the market and buyers are reluctant to step in at current levels given the ongoing deficit spending and lack of prospects for that to end regardless of the election results in November.

Of course, there may have been a more direct answer after Minneapolis Fed president Kashkari, added some quite hawkish commentary from an event in London.  Comments like, “I don’t think anybody has totally taken rate increases off the table.  I think the odds of us raising rates are quite low, but I don’t want to take anything off the table,” got tongues wagging, as well as, “Wage growth is still quite robust relative to ultimately what we think would be consistent with the 2% inflation target,” and “I want to get all the data I can get before the next FOMC meeting before I reach any conclusions, but I can tell you this, it certainly won’t be more than two cuts.”  This certainly didn’t warm the cockles of bond bulls’ hearts.  Stock bulls either, as other than Nvidia, equity markets gave up early gains after the comments.

Whatever the specific driver(s), the end result was that bonds sold off, and both stocks and metals markets gave up early gains.  In fact, the only beneficiaries on the day were the dollar, on the back of those higher interest rates and less prospects for future cuts, and oil, which continues to benefit from re-escalating tensions in Gaza and expectations that OPEC+ will continue producing at its current reduced rates.  

However, in truth, market activity remains lackluster overall.  The funny thing is that despite most risk asset markets still hovering near all-time highs, the mood has become far dourer than you might expect.  My take on reading headlines as well as my X(nee Twitter) feed is that there is much less bullishness around than just a week or two ago.  Certainly, the FOMC Minutes released last week didn’t help sentiment, but in fairness, the Fed commentary has been consistent since the last meeting, higher for longer has been the default option for every speaker.  So, let us look elsewhere for the catalysts.

Overnight, the Australian inflation rate rose to 3.6% unexpectedly with the result that traders have increased the odds of a rate hike Down Under although the Aussie dollar did not benefit at all, actually falling -0.25%. The bulls’ basic problem is that inflation throughout the Western economies is simply not cooperating with respect to heading back to central bank targets, and the prospect of rate cuts is slipping away.  In fact, in Japan, a BOJ member, Seiji Adachi, even indicated that the BOJ may be forced to act if the yen continues to weaken, even though he is not confident that the inflation rate is going to be sustainably at 2.0% anytime soon.  The point is, central banks, which had been almost universally expected to cut rates aggressively this year based on the idea that inflation was receding, are beginning to abandon those views and have continued to put rate hikes back in play, at least verbally.  While markets have not really started pricing hikes in yet, the number of rate cuts expected has fallen dramatically.  Keep in mind that if the future has higher rates in store, it seems likely that many risk assets will struggle.

Ok, let’s review last night’s price action to flesh out this bearishness.  In Asia, Japanese (Nikkei -0.8%) and Hong Kong (-1.8%) stocks were under pressure alongside Australian (-1.3%), Korean (-1.7%), Indian (-0.9%) and Taiwanese (-0.9%) shares.  In fact, the only market that managed to hold its own was China’s CSI 300 (+0.1%) after the IMF upgraded their GDP forecast to 5.0% for 2024. Not surprisingly given the overall tone, European bourses are all lower as well, ranging from -0.25% in the UK to -1.0% in Paris.  The most relevant data seems to be German inflation with the States reporting slightly higher than last month although the national number isn’t released for a little while yet.  Meanwhile, at this hour (7:30) US futures are in the red by about -0.6% across the board.

In the bond market, yesterday’s rally in yields is continuing with Treasuries higher by another 2bps and European sovereign yields all higher by between 4bps and 7bps.  Even JGB yields rose 5bps overnight to new highs but the biggest move was seen in Australia at +14bps after that inflation data.  While the future remains uncertain, I still don’t see any evidence that inflation is ebbing further and so there is no reason for bond yields to decline sharply.

In the commodity markets this morning, as mentioned above, oil (+0.1%) continues to edge higher while metals (Au -0.7%, Ag -0.35%, Cu -1.3%) are under pressure with higher interest rates all around the world.  But in fairness, these metals are all still solidly within their recent upward trends, so this seems like consolidation rather than a change in theme.

Finally, the dollar continues to benefit from the higher yield story in the US with gains this morning tacking onto yesterday’s moves.  While none of the moves have been very large, the movement has been universal, with only the yen, which is unchanged on the day, holding its own.  Aside from the interest rate story we also have South African elections today where the ANC, which has led the government since the end of Apartheid, appears set to lose its majority as Unemployment and Inflation rage there and the rand (-0.3%, today, -1.7% in the past week) is suffering accordingly.  Otherwise, there are precious few new stories to note here.

On the data front, the most noteworthy release is the Fed Beige Book this afternoon and we also hear from two more Fed speakers, Williams and Bostic, although it would be shocking if they didn’t repeat the higher for longer mantra.

Summing it all up, the recent Fed speakers seem to be leaning even more hawkish than the Minutes seemed to be, US yields continue to shake off every effort to sell them as the data has held in well enough to prevent any major fears of a sharp decline in the economy and quite frankly it is very difficult to look at the current situation and conclude that the US economy is in any trouble or that the dollar is going to suffer.  Can equities fell some pain?  Certainly, that is possible, but it is hard to see investors fleeing to bonds in that situation.

Good luck

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