Monthly Archives: June 2024

Trussed

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The markets are worried that France
If given a half-decent chance
Will vote for Le Pen
And so, seems the ten-
Year OAT is now looked at askance
 
But ECB “sources” have said
There’s no TPI straight ahead
The French, rather, must
Show they won’t be “Trussed”
Else traders will leave them for dead

 

On an otherwise quiet summer morning, the ripples from the European Parliament election continue to grow. Not only did French President Macron dissolve parliament there and call new elections, but it appears the German government is far closer to falling as well.  However, right now, France is the story of note.

Elections in France are a two-stage affair where multiple candidates run for specific seats and then the two largest vote-getters in each district have a runoff a week later, if nobody won an outright majority.  Additionally, as is common throughout Europe, it is not a two-party affair like in the US, but there are several political parties vying for seats.  What makes this election so different from previous votes is the fact that the parties on the right are leading in all the polls.  Historically, throughout Europe, the right wing was anathema given that so many believed anything right of center would lead to the second coming of the Nazi Party.  This is the main reason that Europe has been consistently left of the US politically since the end of WWII.

However, what we have seen over the course of the past decade, and what has accelerated rapidly in the post-Covid era, is that many citizens of most Western countries are feeling dissatisfied with the politics of the left.  Immigration, which is obviously a huge issue in the US, is no less a problem in Europe.  The other key policy discrepancy is in the politics of global warming climate change global boiling, as it has become clearer each day that the policies that have been enacted, and those promised, have done nothing but raise the price of energy and the cost of living for all Europeans with no corresponding benefit to the climate.

The upshot is that many citizens throughout the continent are ready for a change, and this is beginning to frighten financial markets.  This can be seen in the chart below from tradingeconomics.com that shows German 10-yr yields in blue on the right-hand axis and French 10-yr yields in green on the left-hand axis.  While the spread has been creeping higher for the past six months, it has widened dramatically in the past week and is now at its widest (80 basis points) since the Eurozone crisis in 2013.

Source: tradingeconomics.com

It is not clear to me why financial markets are so concerned with excess spending by the right, as compared to excess spending by the left, but that seems to be the pattern.  (Recall the UK’s issue in October 2022 when Liz Truss, the newly minted PM, proposed a great deal of unfunded spending and the UK Gilt market sold off so sharply it put a number of insurance companies at risk and forced the BOE to buy gilts despite their efforts to shrink the balance sheet.)

At any rate, back in 2022, the ECB created a new program, the Transmission Protection Instrument (TPI) to help them prevent Italian BTPs from collapsing during the pandemic, thus maintaining what they believed to be an appropriate spread between bunds and BTPs.  While that spread peaked at 250bps, it is now a much more sedate 155bps, and despite Giorgia Meloni being a right-wing PM, the markets seem comfortable.  

However, with the ructions in France, there are many questions as to whether the ECB will dust off the TPI again to prevent a greater dislocation of French OATs vs. bunds.  Remember, too, that Madame Lagarde may have a personal vested interest in France, given her nationality, but as of yet, there has been no willingness to discuss using this tool.  However, if OATs continue to widen vs. Bunds, you can be certain this discussion will heat up even more.  We have already seen French stocks fall sharply, with French bank stocks down more than 10% in the past week.  It is movement like this that typically draws a response from central banks.  And of course, the euro is not immune to this situation as evidenced by its nearly 2% decline since the beginning of the month.  We will need to watch this closely until the elections at the end of the month and the second round on July 7th.

Beyond that, however, markets remain relatively dull.  Friday’s weaker than expected Michigan Sentiment data combined with the higher than expected inflation expectations was not very well received by risk assets (other than Nvidia and Apple) although by the end of the day, US major indices closed near flat.  Japanese shares fell sharply (Nikkei -1.8%) while the rest of Asia closed with much smaller declines, albeit they were declines.  In Europe, this morning, the picture is mixed with the big three markets, UK, Germany and France, all little changed on the day (a change for France of late) although there is more movement elsewhere but no consistency with both gainers and losers of up to 0.5%.  And following its recent pattern NASDAQ futures are edging higher this morning while DJIA futures are falling although neither has moved very much.  Arguably, the question is how long can the Magnificent 7 6 3 1 continue to rally in the face of increasing headwinds?

In the bond markets, yields are creeping higher with Treasuries (+2bps) bouncing off recent lows while European sovereigns all have shown similar yield gains except French OATs (+7bps) as the stress there continues to grow.  However, Asian bonds did little overnight with JGBs slipping one more basis point and now back to 0.92%, nearly 15bps lower than its peak at the end of May.  Things in Japan just take a verrryyy long time to play out.

In the commodity markets, oil (+0.25%) has managed to eke higher this morning, but the metals markets remain under pressure (Au -0.5%, Ag -1.0%, Cu -1.6%) as confidence in the economy ebbs alongside significant position reductions as metals had been one of the market themes for the first half of the year.  While I still like the long-term story, it seems clear there is no love for the space right now.

Finally, the dollar is mixed this morning with modest gains and losses overall across both G10 and EMG blocs.  The biggest winner is ZAR (+0.7%) which continues to retrace post-election losses as the new coalition government is gaining adherents in the investor community.  Alas, MXN (-0.2%) continues to feel pressure as concerns grow that president-elect Sheinbaum is going to be far more left leaning than markets expected.  In the majors, there is not much of distinction today with both gainers and laggards, although more laggards than gainers.  It should be no surprise that JPY (-0.25%) is pushing back to 158 given the yield moves overnight.

On the data front, there is some important stuff to be released this week, as well as a plethora of Fedspeak.

TodayEmpire State Manufacturing-9.0
TuesdayRetail Sales0.2%
 -ex Autos0.2%
 IP0.3%
 Capacity Utilization78.6%
ThursdayInitial Claims235K
 Continuing Claims1810K
 Philly Fed4.5
 Housing Starts1.38M
 Building Permits1.45M
FridayFlash PMI Manufacturing51.0
 Flash PMI Services53.3
 Existing Home Sales4.09M
 Leading Indicators-0.4%

Source: tradingeconomics.com

In addition to the data, we hear from seven Fed speakers with Richmond’s Thomas Barkin regaling us twice.  I would contend the narrative is searching for a direction other than BUY NVIDIA, as we continue to see a mixed picture.  While the NFP was strong, it appears data since then has softened.  If this remains the case, then the talk of a Fed cut sooner rather than later is going to really start to come back.  While July is only priced for a 10% chance of a cut, the market has September in its sights with a nearly two-thirds probability currently priced.  If the data weakens, that is viable.  In that scenario, I would expect the dollar to suffer and everything else to rally.  But we need to see a lot more soft data to reach that point.

Good luck

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Ain’t

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Ueda explained
Buying bonds is still our bag
But buying yen ain’t

 

The last of the major central banks met last night as the BOJ held their policy meeting.  As expected, they left the policy rate unchanged between 0.00% and 0.10%.  However, based on the April meeting comments, as well as a “leak” in the Nikkei news, the market was also anticipating guidance on the BOJ’s efforts to begin reducing its balance sheet.  Remember, they still buy a lot of JGBs every month, so as part of the overall normalization process, expectations were high they would indicate how much they would be reducing that quantity.

Oops!  Here is their statement on their continuing QQE program [emphasis added]:

Regarding purchases of Japanese government bonds (JGBs), CP, and corporate bonds for the intermeeting period, the Bank will conduct the purchases in accordance with the decisions made at the March 2024 MPM. The Bank decided, by an 8-1 majority vote, that it would reduce its purchase amount of JGBs thereafter to ensure that long-term interest rates would be formed more freely in financial markets. It will collect views from market participants and, at the next MPM, will decide on a detailed plan for the reduction of its purchase amount during the next one to two years or so. 

In other words, they have delayed the onset of their version of QT by another month and based on the nature of their process, where they pre-announce the bond buying schedule on a quarterly basis, it is entirely possible that the delay could be a bit longer.  You will not be surprised to know the yen fell sharply on the news, as per the below chart.

Source: tradingeconomics.com

In fact, it traded to its weakest (dollar’s highest) level since just prior to the intervention events in April.  However, as you can also see, that move was reversed during the press conference as it became clear to Ueda-san that his delay did not result in a desired outcome.  The issue was the belief that the BOJ cannot make decisions on interest rates and QT simultaneously (although for the life of me, I cannot figure out why that was the belief), and so Ueda addressed it directly, “We will present a concrete plan for long-term JGB buying operations in July. Of course, it’s possible for us to raise the short-term interest rate and adjust the degree of monetary easing at the same time depending on the information available then on the economy and prices.”

In the end, the only beneficiary of this was the Japanese stock market, which managed a modest rally of 0.25%.  Certainly, this did not help either Ueda’s or the BOJ’s credibility that they are prepared to normalize policy, and it also left the entirety of currency policy in the lap of the MOF.  The problem for Ueda-san is that until the Fed decides it is time to start cutting interest rates, a prospect which seems further and further distant, the yen is very likely to remain under pressure.  I am beginning to suspect that despite Ueda’s stated goal of normalizing monetary policy, the reality is that, just like every other central banker today, his bias is toward dovishness, and he cannot let go.  I fear the risk is that the yen could weaken further from here rather than it will strengthen dramatically, at least until there are real policy changes.  FYI, JGB yields closed 3bps lower after the drama.

Away from that, the overnight session informed us that Chinese economic activity appears to be slowing, at least based on their loan growth, or lack thereof.  Loans fell, as did the pace of M2 Money Supply and Vehicle Sales.  While none of these are typically seen as major data releases, when combined, it seems to point to slowing domestic activity.  The upshot is a growing belief that the PBOC will ease policy further thus supporting Chinese equities (+0.45%) and maintaining pressure on the renminbi which continues to trade at the limit of its 2% band vs. the daily CFETS fixing.

As to Europe, it is becoming clearer by the day that investors around the world have begun to grow concerned over what the future of Europe is going to look like.  Despite the ECB having cut their interest rates last week, the results of the European Parliament elections continue to be the hot topic and we are seeing European equity markets slide across the board, with France (-2.5% today, -5.8% this week) leading the way lower as President Macron’s Renaissance Party looks set to be decimated in the snap elections at the end of the month.  But the entire continent is under pressure with Italy (-2.8% today, -5.7% this week) showing similar losses and the other major nations coming in only slightly better (Germany -2.75% this week, Spain -3.9% this week).  You will not be surprised to know that the euro (-0.4%) is also under pressure this morning, extending its losses to -1.0% this week with thoughts it can now test the lows seen last October.

There is a great irony that the G7 is meeting this week as so many of the leaders there, Italy’s Giorgia Meloni and Japan’s Kishida-san excepted, looks highly likely to be out of office within a year.  Macron, Olaf Sholz, Justin Trudeau, President Biden and Rishi Sunak are all far behind in the polls.  One theory is that the blowback from the draconian policies put in place during the pandemic restricting freedom of movement and speech within these nations, as well as the ongoing immigration crisis, which is just as acute in Europe and the UK as it is in the US, has turned the tide on the belief that globalization is the best way forward.  

Earlier this year I forecast that there would be very severe repercussions during the multitude of elections that have already taken place and are yet to come.  Certainly, nothing has occurred that has changed that opinion, and in fact, I have a feeling the changes are going to be larger than I thought.  

The reason this matters is made clear by today’s market price action.  If the world is turning away from globalization, with a corresponding reduction in trade, equity markets which have been a huge beneficiary of this process (or at least large companies have directly) are very likely to come under further pressure.  As well, fiscal policies are going to put more pressure on central banks as the natural response of politicians is to spend more money when times are tough, and we could see some major realignments in market behaviors.   This will lead to ongoing inflationary pressures, thus weaker bond prices and higher yields, weaker equity prices, much strong commodity prices and the dollar, ironically, likely to do well as it retains its haven status.  Certainly, the euro is going to be under pressure, but very likely so will many other currencies.  This is a medium to long-term concept, certainly not something that is going to play out day-to-day right now, but I remain firmly in the camp that many changes are coming.

As to the rest of the markets overnight, yields are falling everywhere (Treasuries -5bps, Gilts -9bps, Bunds -12bps, OATs -6bps, Italian BTPs -1bp) as investors are seeking havens and for now, bonds seem better than stocks.  You will also notice that the spread between Bunds and other European sovereigns is widening as there is clear discernment about individual nation risk.  This is not a sign that everything is well.

Maintaining the risk-off thesis, gold (+1.25%) and silver (+1.00%) are rallying despite a much stronger dollar this morning and we are also seeing some strength in oil (+0.2%).

As to the dollar, it is stronger vs. almost every one of its counterparts this morning, most by 0.3% or more with CE4 currencies really under pressure (PLN -1.0%, HUF -0.8%).  However, there are two currencies that are bucking this trend, CHF (+0.25%) which is showing its haven characteristics and ZAR (+0.5%) where the market is responding to the news that the ANC has put together a coalition and that President Ramaphosa is going to remain in office.

Yesterday’s PPI data showed softness similar to the CPI on Wednesday but more surprisingly, the Initial Claims number jumped to 242K, its highest print since August 12, 2023, and a big surprise to one and all.  The combination of data certainly added to yesterday’s feel that growth and inflation were ebbing.  This morning, we get the Michigan Sentiment (exp 72.0) and then a couple of Fed speakers (Goolsbee and Cook) later on during the day.

I should note that equity futures are all in the red this morning, with the Dow continuing to lag the other markets, probably not a great signal of future strength.  Arguably, part of today’s price movement is some profit taking given US equity markets have rallied this week and month.  But do not discount the bigger issues discussed above as I believe they will be with us for quite a while to come and put increasing pressure on risk assets with support for havens.  As such, I think you have to like the dollar given both the geopolitical issues and the positive carry.

Good luck and good weekend

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Indigestion

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The answer to yesterday’s question
Is CPI’s seem some regression
Both stocks and bonds soared
The dollar was floored
But Powell now has indigestion
 
To no one’s surprise he left rates
Unchanged, while the dot plot translates
To higher for longer
Though pressure’s grown stronger
To cut to achieve his mandates

 

Unequivocally, the CPI data was cooler than market forecasts.  Month over month prices were unchanged at the headline level and grew only 0.16% on a core basis, with the year-on-year numbers each coming in one tick below expectations.  It took absolutely no time for markets to run with this data as the following charts from tradingeconomics.com for the NASDAQ 100, 10-year Treasury yields and EURUSD demonstrate.  See if you can determine when the CPI data was released.

Now, as I explained, and has become abundantly clear to anyone watching, the equity market is in a world of its own.  While yields backed up and the dollar rebounded (euro fell) after the somewhat more hawkish than expected FOMC statement, dot plot and Powell press conference, the NASDAQ ignored everything and kept on rallying.  While that is remarkably impressive, I remain of the opinion that trees still don’t grow to the sky, although apparently, they can get really tall!

At any rate, a quick look under the hood at the CPI shows that core goods prices continue to fall, which was largely why today’s data looked so good, but primary rents and OER continue to climb at about 0.4% monthly despite many assurances by many pundits, analysts and economists that rental inflation was sure to begin declining soon.  It has been rising at this pace or faster for more than two years, and while the actual pace has backed off from the rate a year ago, if you annualize 0.4% you come up with just under 5.0% inflation.  It remains hard to believe that shelter costs can rise at that pace and the general price level is going to get back to 2.0%.  Yesterday’s data was good, but we are not out of the woods yet.

Turning to the FOMC, the statement was virtually unchanged from the May statement, which makes sense since the mix of data that we have seen in the interim shows some hot and some cold numbers and no clear line of sight to the end game.  As such, it is not surprising that Chairman Powell tried to veer hawkish at the press conference in what appears to have been an attempt to offset the (over)reaction to the CPI data.  In fact, a look at the dot plot shows that, as I suggested, the median expectation for rate moves in 2024 is down to a single cut, although they are more confident that inflation will continue to fall next year with the median expectation for an additional 4 cuts.  However, as I also suggested, the longer-term outlook continues to rise with the median there now up to 2.80% from 2.60% in March, and 2.5% or below for the 3 years prior to that.

Interestingly, in their Summary of Economic Projections they expect PCE inflation to be 2.6% this year, up from 2.4% in March, with core PCE to be at 2.8% this year, up from 2.6% in March.  They did, however, maintain their views of GDP growth (2.1%) and Unemployment (4.0%).  At least, unlike Madame Lagarde who cut rates despite raising inflation forecasts, the Fed’s inaction made far more sense.

But pressure is building on Powell and the Fed to cut rates.  Today, several senators wrote (and released) a letter to Powell exhorting him to cut rates because everybody else is doing it.  They claim that his intransigence is hurting the economy, although the whole point of higher for longer is that there is scant evidence that the economy, as a whole, is in trouble despite rates where they are, although certainly some sectors are feeling a pinch.  As an aside, given the extreme degree of financial and economic ignorance that is routinely demonstrated by virtually every member of the House and Senate, this letter is simply political grandstanding.  But pressure is pressure, and Powell will certainly feel it, although I don’t think he is too concerned by this group overall.

While this morning brings PPI (exp 0.1%/2.5% headline and 0.3%/2.4% Core) as well as the weekly Initial (225K) and Continuing (1800K) Claims data, it is hard to believe that either of those data points are going to have any substantive impact given everything we learned yesterday.  So, let’s look elsewhere to see what is happening.

One of the interesting stories right now is the ongoing situation in France with the snap elections called by President Macron.  Apparently, the quick timing has resulted in significant confusion on both the left and right of the spectrum as to who will be allying with whom, and what they stand for.  While this is amusing in its own right (see this Twitter thread), the ramifications are greater for the impact on the French OAT market and the euro.

Briefly, the issue is that France has been slowly sliding from the figurative north of Europe to the South, meaning that it used to be considered a country with almost Germanic fiscal sensibilities and now it is much more akin to the PIGS than Germany.  The WSJ had an interesting article this morning describing the situation.  Ultimately, the market response has been for French yields to rise compared to German yields, adding pressure to the country as it needs to continue to finance its 5%+ budget deficit.  Now add to that the absolute trainwreck that is the current government leadership (as evidenced by that Twitter thread) and investors have decided that there are better places to invest with less credit risk.  After all, S&P Global downgraded French debt last month due to their profligate spending and I assure you, whatever the election outcome, there will be more spending not less.  

If we view this through a FX lens, the combination of clear dysfunction in Europe, lower interest rates in Europe and a Fed still committed to seeing the whites of 2%’s eyes before cutting rates here, it is very easy to anticipate the euro will be biased downwards over time.  While I know there are many who continue to write the dollar’s obituary, the fact remains that it is still standing with no competitors of note.  In fact, part of the raison d’etre of the euro was to be able to replace the dollar as a reserve currency.  It seems that hasn’t worked out all that well.

Ok, let’s see how global markets responded to the US data yesterday.  Perhaps the most interesting thing was that even in the US, the DJIA fell slightly, despite the conviction that rates are heading lower.  In Asia, the picture was mixed with Japan (-0.4%) and China (-0.5%) sliding while Hong Kong (+1.0%) rallied on the tech rally.  Many consider the Hang Seng to be China’s NASDAQ with respect to the weight of tech companies in the index.  As to European bourses, they are all in the red this morning by more than -1.0% with France (-1.4%) leading the way lower.  Of course, based on the above discussion, that can be no surprise.  Lastly, in the US, futures at this hour (6:45) are mixed with NASDAQ higher by 0.6% while DJIA futures are -0.4%.  Apparently, the prospect of lower rates doesn’t help more mature companies.

In the bond market, after yesterday’s wild ride (see above chart), Treasury yields have edged lower by -1bp, but in Europe, yields are continuing higher from their closing levels, catching up to the Treasury yield rebound in the wake of the FOMC meeting.  Not surprisingly, French OATs are leading the way with yields higher by 4bps while Germany has seen only a 2bp rise.

This morning, commodities are uniformly under pressure with oil (-0.8%) sliding after a solid weekly performance while metals markets are also slipping (Au -0.1%, Ag -0.8%, Cu -0.6%) as traders try to come to grips with the next interest rate moves and adjust their positions.  An interesting story this morning is that a shipment of copper from Russia to China for 2000 tons apparently never arrived in China.  This is simply the latest quirk in the metals markets where confirmation of what is being traded is limited.  You may recall the story last year about nickel inventories at the LME actually being bags of painted rocks.  In this space, the broad trend remains that there is excess demand for metals, especially copper, silver and aluminum, as all three are critical to electrification of systems and grids, but it is going to be a bumpy ride higher!

Finally, the dollar, which was decimated in the immediate wake of the CPI data yesterday, managed to claw back some of those losses in the afternoon thanks to the more hawkish Fed and this morning, that slow rebound continues with the greenback higher vs. almost all its counterparts in both the G10 and EMG blocs.  However, nothing really stands out as having moved significantly, with a general trend of about 0.2% or so across the board.

And that is really all we have today.  The first post-FOMC speaker is NY Fed president Williams at noon, although I suspect his message will be identical to Powell’s yesterday.  As to the rest of things, the BOJ meets tonight and while there is no expectation of a policy change, Ueda-san’s comments will be carefully parsed for any clues to when a change may be coming.  

Since nothing seems to matter to the NASDAQ and everyone wants to own it, I suspect that the dollar will maintain its gradual strength until further notice.

Good luck

Adf

Thoroughly Schooled

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Has CPI actually cooled?
Or did April have us all fooled?
Both Tiff and Lagarde
Have played their first card
Has Jay now been thoroughly schooled?
 
First, if CPI comes in hot
The Chairman will certainly not
Decide to cut rates
And leave the debates
Til things show the damage he’s wrought
 
But if the inflation report
Is nothing at all of that sort
Then many have said
This summer, the Fed
‘Round rate cuts will gather support

 

A quick look at yesterday’s 10-year Treasury auction shows it was far better than the 3-year on Monday with a strong bid/cover ratio of 2.67, its highest since February 2022, and a result where the auction cleared 2bps lower than the pricing ahead of the announcement, a sort of negative tail.  Indirect bidders represented nearly 75% of the bids, so there was real demand for this paper.  Certainly, Janet and Jay are feeling better, and yields fell 6bps on the day.  

As I explained yesterday, the auctions are just one tiny signal in a large body of information, and just like almost everything else, it seems there is no consistency there either.  However, one auction does not a trend make.  One last thing, the strength of the auction ahead of today’s CPI report and FOMC meeting seems somewhat odd given the potential risks attached to both those events.  Generally, investors would prefer to reduce exposure ahead of a big event, not increase it.  This has awakened some conspiracy theorists as to who actually bought the paper.  There is no evidence that there was any behind the scenes Fed activity, but many are trying to figure out the incentive to aggressively bid for bonds ahead of key data.  We need to stay vigilant.  

Ok, on to the CPI this morning.  The current consensus forecasts are for the headline (0.1% M/M and 3.4% Y/Y) and the core (0.3% M/m and 3.5% Y/Y).  During the month of May, wholesale gasoline prices fell nearly 6% which is clearly weighing on the headline monthly outcome.  Of course, that is not a seasonally adjusted number, that is the raw result.  Last month, despite gasoline prices rising a similar amount, in the CPI data, the seasonally adjusted number showed a decline, and that is what is in the report.  That is just one of the many unusual features of the way CPI is calculated, and why it must be carefully considered.  

However, beyond gasoline prices, the indications of rising prices continue to come from things like the ISM Prices paid index for both Manufacturing and Services, as well as the robust wage growth from the NFP report last week.  And certainly, I am hard-pressed to have seen prices do anything but rise in the past month and year based on my personal consumption basket.  But I do not have an econometric model that I use to estimate these things like my good friend the @inflation_guy, who you all should be following on X(Twitter) or at his inflationguy blog.  However, based on the other pricing data we have seen, I expect that the risks to the consensus are on the high side, not the low side.  We shall find out at 8:30.

In this case, I think it is clear that a hot number will result in a sharp decline in bond prices (jump in yields), a rise in the dollar and, at least initially, a decline in equity markets.  Of course, the latter clearly have a life of their own.  A lower-than-expected print should see the opposite, with stocks ripping higher.

And lastly, we turn to this afternoon’s FOMC meeting.  At this point, the only thing that anyone is discussing is the dot plot.  Below is the March edition where the median indicated 3 rate cuts in 2024, but it was very close, a 10-9 outcome with 9 members seeing 2 cuts or less.

Source: federalreserve.gov

As I recall, I was far more interested in the idea that the Longer run rate, which is often defined as R* or the neutral rate, started to creep higher than its recent estimates of 2.5%.  Since the March meeting, there has been an uptick in discussion as to what the longer run rate should be, with every estimate rising some amount.  

As to the immediate situation, given there is a vanishingly small chance they adjust rates today, there are only four meetings left in 2024 so it would seem likely that the maximum number of cuts the updated version of the dot plot will indicate is two.  Personally, I think it will come in at one unless this morning’s CPI is much lower than expectations, although given the ECB managed to cut rates while raising their inflation forecasts, anything is possible in the convoluted world of central banking.  Funnily, the strength of yesterday’s 10-year auction may give them enough confidence that their current policy is not a problem resulting in an estimate of fewer cuts rather than more.

However, the real interest will be Powell’s press conference.  Based on everything we heard from Powell and all his acolytes prior to the quiet period, there certainly seemed to be no rush to cut rates as they still lacked confidence that inflation was going to head back to target.  And, of course, the biggest piece of data we have seen in the interim, last Friday’s NFP number, was much hotter than expected as was the wage data, so it doesn’t seem that he would change that tune.  Thus, much relies on this morning’s CPI and how that may change any opinions on the committee.  While I believe that his underlying desire is to cut rates, there does not yet seem to be an opening to do so.  In the end, my take is that the risk to the market is he is more hawkish than dovish with the corresponding risk-off results.  That’s what makes markets.

Ok, I’ve rambled on a lot already so suffice to say that the overnight price action was generally pretty benign as everyone around the world has been awaiting today’s CPI and FOMC.  Yesterday’s mixed US session was followed by a mixed Asian session with some gainers and some laggards although European bourses are feeling chipper this morning, with all higher by about 0.5%.  As to US futures, they are ever so slightly firmer at this hour (7:00), just 0.1%.

Bond yields around the world have followed Treasuries lower, with the US 10-yr falling one more basis point while all of Europe is down 2bps, except for Italy (-5bps) where the spread to bunds is narrowing on hopes of broader interest rate declines.  Even JGB yields (-4bps) softened last night.  As I have repeatedly explained, as goes the Treasury market, so goes the rest of the global bond market.

Oil prices (+1.1%) are climbing again after inventory data yesterday showed larger draws than expected while metals prices are little changed this morning after another weak session yesterday.

Finally, the dollar is on its back foot, down about -0.15% vs. most of its G10 counterparts save the yen (-0.2%) which continues to drift back toward that 160 level which catalyzed the BOJ’s intervention.  I think the dollar’s movement is the easiest to forecast ahead of the CPI and FOMC as hot CPI will see the dollar rally, as will a hawkish Fed, with the opposite also true in the event that things are cool and/or dovish.

And that’s really all today.  So, buckle up for the 8:30 data and then after that flurry, you can relax until 2:00pm.

Good luck

Adf

Concern ‘Bout the Fate

Posted on by

While waiting for Jay and the Fed
And CPI data on Wed
This week’s 3-year note
Was less than the GOAT
Though risk assets still moved ahead
 
But talk from some sources of late
Exhibit concern ‘bout the fate
Of how the US
Will deal with excess
Supply of bonds as they inflate

 

Since we observe market activities daily, though we remain subject to surprising outcomes (see Friday’s NFP results), there are more consistent features that offer a hint of how the mechanics of financial markets are working, and whether those mechanics are running smoothly or a bit creakier.

Arguably, the thing getting the most press is Nvidia’s stock price, as its continued rapid rise has resulted in the company now representing ~6.5% of the market capitalization of the S&P 500.  Along with Apple and Microsoft, all currently having market caps > $3 trillion, we are looking at three companies representing nearly 20% of the S&P 500.  This is unprecedented and many (including this poet) believe that it is unsustainable in the long run, and probably the medium run.

But another key market, arguably the most important when discussing the financial markets and the Fed, is the US Treasury market.  Countless hours are devoted to dissecting each tick and how movements in the yields of various maturity bonds may impact the economy and overall market sentiment.  With this in mind, when new securities are auctioned, it is always worth a look.  So, yesterday, the Treasury issued $53 billion of 3-year notes at a yield of 4.659%.  The underlying characteristics of this auction were not particularly encouraging for a Treasury that will be issuing 10-year and 30-year bonds as the week progresses, as well as another $trillion this year.  

The numbers that are most closely watched are the tail (the difference between the market estimate of the final yield prior to the auction and the actual results) which was at 1.1bps, a full basis point above the average tail of the past 6 months, an indication that demand was lacking.  As well, the bid to cover ratio (how many $ of bids were received vs. the $53 billion offered) fell to 2.43X, well below the average over the past 6-months of auctions.  Dealers were saddled with nearly 20% of the paper and overall, domestic demand was not very robust.

This gets highlighted because these little data points are often harbingers of bigger problems to come.  After all, if there is a dearth of demand for US Treasury paper, even short-dated paper like 3-year notes, that bodes quite ill for the US government, as well as for global financial markets.  Remember, US Treasury paper is the baseline for virtually all debt issuance around the world.  If it fails here, it will be GFC 2.0 or worse.

Why, you may ask, is this becoming an issue?  Well, one answer would be that the US’s current financial profligacy is starting to be discussed in quite negative terms at key institutions around the world.  For instance, the IMF’s managing director, Kristalina Georgieva, has expressed concern recently that the US is essentially hogging all the borrowing capacity around the world.  As well, Banque de France governor, Francois Villeroy de Galhau, explained, “U.S. fiscal policy is the elephant in the room: it is not in the hands of the Fed, and could significantly affect the level of long-term interest rates.  A large U.S. fiscal deficit tightens financial conditions and fuels inflation.”  

The point is that while Secretary Yellen, and Chair Powell, will not even discuss the potential ramifications of excess US government borrowing, it is being noticed in the halls of power elsewhere in the world, as well as on trading floors and in investment meetings at major asset managers.  This is not to say that anything dramatic is going to happen anytime soon, but death by a thousand cuts is still death.  Remember this, whatever the Fed’s mandate may say about price stability and maximum employment, I assure you, their number one priority, by miles and miles, is a smoothly working Treasury bond market.  A 1 basis point tail may not seem to be much, but like the little boy in Holland with his finger in the dike, it may foretell bigger problems to come.

The reason I can focus on minutiae like the details of a Treasury auction is that there is so little else ongoing from a macro perspective right now.  With US CPI to be released tomorrow and the FOMC meeting, statement and subsequent Powell press conference coming later tomorrow afternoon, most market participants are effectively holding their collective breath waiting for new information.

So, let’s review the overnight activity, which was not that exciting.  After modest gains in the US yesterday, Asia couldn’t seem to follow except for Japan (+0.25%) with most of the rest of the region selling off, notably the Hang Seng (-1.0%) and Australia (-1.3%).  European bourses, too, are under pressure across the board this morning with Spain (-1.4%) leading the way, but all the other large markets lower by at least -0.7%.  There is a rumor that French President Macron may resign if the RN wins the election at the end of the month and the first polling shows that Marine Le Pen’s group will win a plurality of votes, but not necessarily a working majority.  This will obviously be a major focus of markets going forward as regardless of who is in charge, it would be reasonable to expect many of the key issues that have driven this political shift (immigration, inflation, Ukraine) to become policies going forward.  As to US futures, at this hour (6:45) they are lower by about -0.25%.

In the bond market, the big news is really in Europe where the spread between German bunds and French OATs has widened by a further 8bps as concerns over the future government of France creep into investors’ minds.  Historically, Madame Le Pen has been quite anti-Europe so there seem to be some worries that if the RN wins an outright majority, there will be significant ructions in the European Union with France seeking more independence.  In the end, uncertainty breeds investor concern so I would not be surprised to see this spread widen further leading up to the election.  As to the Treasury market, yields have backed off 4bps this morning in what appears to be position inspired trading rather than being caused by new information.

Commodities, which had a very nice rebound yesterday with both energy and metals markets performing well, are back under pressure this morning with oil (-0.3%) and gold (-0.1%) the least impacted but the rest of the metals complex feeling the heat again.  However, NatGas continues its strong rally, up another 5% this morning and looking for all the world like it is going to continue rising until it tests the November 2023 highs of $3.80/MMBtu which is still $.75 higher.

Finally, the dollar continues to gain at the margins with the euro (-0.2%) slipping further on the French political news, although the pound is bucking the trend with a very modest rise.  The other currency that is having a good day is MXN (+0.8%) which continues its slow rebound from its post-election collapse last week.  Otherwise, EEMEA currencies are all under pressure as is the CNY (-0.1%).  Now, 0.1% may not seem like a lot, but the PBOC has been walking the value of the renminbi lower (dollar higher) ever so slightly every day for the past three months and the fix last night was at its highest level since January.  It appears clear that the pressure for a devaluation is strong in China and that the PBOC is working very hard to maintain a sense of stability.  My sense is this gradual weakness will continue for quite a while, at least until the Fed makes a change.

And that’s what we have today.  The NFIB Small Business Optimism Index was just released at 90.5, a bit firmer than forecast, but that is not a market-moving data point.  And there are no other data points to await today, nor any Fedspeak so the FX markets will take its cues from bonds and stocks.  Given that CPI and the Fed are both tomorrow, I anticipate another very quiet session overall in the US as investors (and algorithms) will want new news to drive their next trades.  Broadly, I think we are in a ‘good data is bad’ for risk assets as the mindset is it will delay any Fed rate cuts even further.  Of course, if Treasury auctions continue to see shrinking demand (today there is a 10-year auction for $39 billion) that will certainly have an impact on the bond market, the Fed’s response, and by extension risk assets and the dollar.  So, arguably, that auction is the biggest news of the day this afternoon.

Good luck

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Crushed

Posted on by

On Friday, the NFP showed
That job growth has not really slowed
And wages were hot
So, pundits all thought
That ‘flation just might well explode
 
But under the NFP’s hood
Some things didn’t look quite so good
The joblessness rate
Itself did inflate
Though household jobs fell, understood?
 
Meanwhile across Europe the vote
For Parliament seems to denote
Incumbents were crushed
And governments flushed
While media seeks a scapegoat

 

Remember the narrative that had everyone feeling so good?  Inflation was drifting lower, albeit not in a straight line, but central bankers around the world were quite confident that their collective 2.0% targets were coming into view, and pretty soon at that.  This would lead to lower bond yields, continued strong performance in risk assets and slowing, but still solid economic activity.  In other words, many were invested in the Goldilocks thesis of a soft landing.  

Now, the data that we had seen last week seemed to indicate that was a viable process as the ADP Employment number was a touch soft, the JOLTS Job Openings number was definitely soft and although the ISM Services data was a lot stronger than anticipated, the ISM Manufacturing number was soft as well.  In addition, if we go back to the previous week, the Chicago PMI print was abysmal at 35.4.

This was all a prelude to Friday’s NFP data which confirmed confused everything.  While the headline number was much stronger than expected at 272K, the Unemployment Rate rose to 4.0% for the first time in more than two years, and Average Hourly Earnings rose 0.4% with an annual increase of 4.1%.  But even more confusing was the fact that looking at the Household survey, the survey that is used to calculate the Unemployment Rate, showed the number of jobs FELL by 408K while 250K people exited the workforce.  Now, if things were truly running smoothly, as the NFP number indicated, we would expect to see that household number of jobs rise, not fall.  Something is amiss.

Having read far too much about this over the weekend, it appears that the BLS data and its models are not a very accurate representation of the current reality, at least for the monthly data.  The BLS also produces a quarterly survey called the Quarterly Census of Employment and Wages (QCEW) which is a census of 11 odd million businesses in the US, rather than a survey of some 600k businesses for the NFP.  If one looks at the growing discrepancy between the number of jobs shown in that data vs. the NFP data, the NFP data has been rising far faster with the gap widening severely.   This can be seen in the below graph from the mishtalk.com website (from Mike Shedlock, an excellent economist/analyst).

The upshot is that while that headline NFP number has looked very good, there appears to be something else happening in the underlying data.  Early next year, the BLS will revise its NFP data, and you cannot be surprised if they reduce the readings significantly.  But revisions don’t have the same cachet as headlines, and so this is our current world. 

The market response was as you would expect; bonds got crushed with the entire yield curve jumping 15bps, the dollar rallied sharply, up nearly 1% on the DXY with several currencies falling farther than that (e.g., MXN -2.85%, NOK -1.5%, BRL -1.6%), and equity markets falling although not nearly as much as you might expect, only about -0.15% on average across the big indices.  But the notable moves were in commodities with gold (-2.2%), silver (-3.9%) and copper (-3.0%) just in the wake of the NFP data, with larger declines overall on the day.  Energy was the only space that held in on the day, but of course, it has been under pressure for several weeks.

What’s next?  Well, this week brings a great deal of new information including CPI, PPI, the FOMC Meeting and the BOJ meeting.  My take is many traders are licking their wounds right now, so given today’s calendar is quite benign, I imagine things will be a bit choppy as positions get adjusted, but direction will be hard to discern.  Except…

The European Parliament elections were held starting last Thursday but running through Sunday, with all 27 nations in the EU voting for their parliamentary representatives.  The story is, as you will clearly have heard by now, that the left wing, center-left and centrist parties got decimated while everyone on the right side of the aisle massively outperformed.  The Belgian PM resigned and there will be elections there.  French President Macron dissolved parliament for a snap election as his party won just 15% of the vote while Marine Le Pen, the conservative candidate leading the National Rally, won more than 31% of the votes.  As well, German Chancellor Olaf Sholz has been decimated as have the Green parties across the continent.  Times, they are a-changin’.  It is no surprise that the euro continues to falter after Friday’s declines as the European part of the equation just added to the woes from the US implication of higher interest rates.

What will these elections mean for markets?  The clearest message that I see is that the climate agenda is likely to be altered such that demand for oil and gas may well increase.  Do not be surprised to see more European nations abandon the Net Zero concept, at least reaching it by 2050.  Ironically, while the first move was seen as a negative for the euro, this may well be a harbinger of future euro strength if the Eurozone economies waste less money on impossible dreams and spend more on actual economic activity that generates benefits and income for its citizens without government subsidies.  But that will take a bit more time.

Perhaps the most important thing is that this election may well be a harbinger of the US election in November as the European people have clearly rejected the current themes and are looking for a change.  Far left Green policies that have been promulgated by the Biden administration have found no favor in Europe and certainly the current polling indicates it is equally unpopular in the US.

OK, a quick tour of the overnight session shows that Japanese equity markets performed well after GDP data there last night showed a less negative outcome in Q1 than originally reported, while most of the rest of Asia was closed for various holidays.  European bourses, however, are under pressure across the board led by France (-2.2%) although most of the rest of the continent has seen declines on the order of -1.0%.  As to the US futures markets, at this hour (6:15), they are lower by -0.3%.

Bond yields continue to climb with Treasuries up another 2bps and European sovereigns rising between 2bps (Germany) and 8bps (France and Italy) as the combination of higher US yields and some concerns over the future direction in Europe have come to the fore.  Overnight, JGB yields also jumped 7bps and are back above 1.00%, with the Japanese data and US data the drivers.  The BOJ meets Friday this week, so there is much speculation as to the outcome, although a rate hike is not forecast.

In the commodity markets, after Friday’s rout in the metals space, the big ones are all firmer this morning, although this looks like a trading bounce rather than a change of views.  Oil markets are little changed this morning, trading at the lower end of their recent ranges but NatGas, something I haven’t discussed in a while, is rallying again.  It is higher by 3% this morning and 26% in the past month, rising to $3.00/MMBtu, its highest price since November and double the lows seen in March.  Consider that if there is continued pushback against the Green agenda, as evidenced by the European elections, demand for NatGas is likely to grow quite strongly.

Finally, the dollar is continuing to gain strength this morning, with the euro down -0.6% following Friday’s declines and the EEMEA currencies all falling more than that.  Given the holidays in Asia, there was limited trading in the onshore markets there, and other than MXN, which is unchanged this morning, the rest of LATAM hasn’t opened yet.  However, remember that the peso has fallen 10% in the past week, so there is likely going to be some more movement in that space going forward.  Markets typically don’t dislocate by 10% and then just stop.

As if last week didn’t bring enough surprises between the NFP and election results in India, Mexico and Europe, this week we have a lot more to look for, although today is a blank slate.

TuesdayNFIB Small Biz Optimism89.8
WednesdayCPI0.1% (3.4% Y/Y)
 -ex food & energy0.3% (3.5% Y/Y)
 FOMC Rate Decision5.5% (unchanged)
ThursdayInitial Claims224K
 Continuing Claims1800K
 PPI0.1% (2.5% Y/Y)
 -ex food & energy0.3% (2.5% Y/Y)
FridayBOJ Rate Decision0.10% (unchanged)
 Michigan Sentiment72.0
Source: tradingeconomics.com

As this is a quarterly meeting of the FOMC, we will get new projections and a new dot plot, and of course, Chairman Powell will be speaking afterwards.  As of now, the market is pricing about a 50:50 chance of the first cut coming in September and a total of one and one-half cuts for the rest of the year.  It remains very difficult to discern what is really happening in the economy with all the conflicting data.  However, whatever the growth stories, nothing has indicated that inflation is going to decline very far.  I maintain the Fed is going to be higher for longer for even longer.  It continues to be difficult to see the benefits of many other currencies, although I would not be surprised to see MXN regain much of its lost ground as I doubt Banxico will be easing policy anytime soon, and president-elect Sheinbaum is not going to change things there that much and doesn’t take office until October.

Good luck

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The Fed’s Tug-of-War

Posted on by

Each month there’s a Payrolls report
That pundits and traders exhort
To rise or to fall
Subject to their call
And whether they’re long or they’re short
 
But this month, there seems to be more
At stake, for the Fed’s tug-of-war
If joblessness rises
Each pundit advises
That rate cuts, this summer, we’ll score

 

Here we are on the first Friday of the month and, as almost always, markets remain quiet ahead of the release of the monthly Payroll report.  For good order’s sake, here are the current median expectations:

Nonfarm Payrolls185K
Private Payrolls170K
Manufacturing Payrolls5K
Unemployment Rate3.9%
Average Hourly Earnings0.3% (3.9% Y/Y)
Average Weekly Hours34.3
Participation Rate62.7%
Source: tradingeconomics.com

Recall, on Wednesday, the ADP Employment number was a bit softer at 152K while the ISM Employment sub-indices showed conflicting data between Manufacturing (much stronger at 51.1) and Services (weaker at 47.1).  Ironically, the headline ISM data was the other way around, with Manufacturing weaker and Services stronger than expected.  One other data point of note was the JOLTS Job Openings which shrunk about 300K to 8.059M, still high relative to the number of unemployed people, but with the ratio falling to 1.24 jobs/unemployed person.  That ratio is down from nearly 2:1 shortly after the pandemic, but up from about 1:1 pre-pandemic.

As with so much of the other data that we have seen over the past months, there is no clear direction here. Economy bulls can make the case that job growth remains solid and that there is no indication that a recession is on the way.  While the no-landing thesis has lost adherents, there are still many soft-landing adherents to be found.  At the same time, the economic bears have plenty of data to claim that a recession is around the corner, if we are not already in one.  I saw an analysis by Mike Shedlock (@MishGEA), a well-respected economist, that claims the NFP data has overstated job growth by 3.4 million jobs as per the following Tweet:

Since the beginning of 2023, looking at BLS data, the initial NFP report has been revised down in twelve of the fourteen months where there has been a third revision, by a total of 496K.  I created a chart to show the consistency of those revisions to help you get a better idea of the issue.

Source: data BLS, graph @fx_poet

Something that has always been true with respect to economic data, and NFP is no different than any other piece of information, is that the revisions tell an important story.  When initial data gets revised lower on a consistent basis, it has been indicative of a slowing economy.  Remember that when the NBER declares a recession, it is always a backward-looking effort, it is never in real-time.  But revisions are a key part of that process.  As well, given the fudge factors built into the BLS model, notably the birth/death factor for new businesses, history has shown that particular piece of the puzzle is always a lagging indicator as during a recession, more companies fail than are created, and that needs to be addressed via the revisions.

In the end, the issue is no matter the actual data point this morning, it will almost certainly be revised substantially before the end of the summer and could well tell a very different tale.  But today’s task is to understand what tale it is going to tell right now.

To that end, the narrative, the best that I can tell, is that we are seeing a gradual reduction in economic activity, but nothing dramatic.  Recession is still a remote concern, perhaps for 2025 or 2026, but the slowdown in activity will open the door for the Fed to start to ease policy going forward.  While the futures market is virtually certain that there will be no Fed action next week, the probability of a July cut has risen to 22.5% from less than 16% a week ago.  Several big banks are calling for a July cut, including JPM and Goldman Sachs, and there is a group of analysts who maintain that the underlying data that has been released indicates we are already in recession, and that rate cuts are coming very soon.

Here’s the thing, this focus on the Fed cutting rates remains, IMHO, a bad indicator of future risk asset strength.  Rather, as I showed earlier this week, when the Fed is cutting rates, it is usually because the economy is already in a recession and earnings are declining rapidly.  So, while the first cut may be sweet, the second should be a serious warning of what is coming down the pike.  I have already made my bed regarding my view that the top is in, but a softish number this morning, especially if the Unemployment Rate were to rise to 4.0% or 4.1%, would certainly increase the July cut probabilities, and almost certainly be followed by an equity market rally.  However, I would call that the last leg of the move.  As to my opinion of what today’s number will be, my sense, looking through my lens of further economic weakness (although still sticky inflation) is that it will be on the soft side, but not dramatically so.  Maybe 130K-150K.

Ok, ahead of the data, a quick tour of the markets shows that stocks in Asia were mixed with Japan edging lower, China and Hong Kong seeing declines of about -0.5%, but South Korea (+1.2%) and India (+2.1%) having strong sessions.  The same cannot be said for Europe, where every major index is lower by between -0.5% (Spain) and -1.0% (France) as German IP (-0.1%) continues to lag and the French Trade Balance (-€7.6B) fell into a deeper deficit than forecast.  Not surprisingly, US futures are essentially unchanged ahead of the NFP.

In the bond market, yields are edging up from their recent lows with Treasuries up 1bp and European sovereign yields higher by between 3bps and 5bps despite yesterday’s rate cut from the ECB.  Or perhaps because of it as remarkably, the ECB raised its own inflation forecasts and then cut rates.  The political imperative to cut interest rates is clearly growing quite strongly.

In the commodity markets, while oil (+0.7%) continues to rebound from its recent lows as OPEC+ worked to clarify their statements about future production, the big move today is in metals where gold (-1.8%) is selling off sharply after the news that the PBOC did not buy any additional metal during the month of May.  As they have been one of the key supporters of the barbarous relic, their absence really was a surprise.  Most pundits believe they are simply taking a break for now given the sharp rise in the price of the metal, but that they will return.  However, the other metals have all sold off alongside gold, with silver (-3.0%) and copper (-2.25%) giving back a good portion of their gains from the past two sessions.

Finally, the dollar is basically unchanged ahead of the NFP data with none of the G10 currencies moving more than 0.1%.  In the EMG bloc, though, ZAR (+0.9%) is the outlier, as despite the weakness in the gold price, the political situation seems to be getting better with a coalition government looking to be formed shortly.

In addition to the payroll data, we see Consumer Credit (exp $11B) this afternoon, and confusingly, despite the Fed being in its quiet period, Governor Lisa Cook is on the calendar to speak at noon today.  I would guess this will not be a discussion on monetary policy, but you never know.

At this point, it’s all about the data.  A hot number should see yields rise, stocks fall and the dollar bounce.  A cool number the opposite as more and more people anticipate that first rate cut.  Buckle up!

Good luck and good weekend

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In Vogue

Posted on by

The cutting of rates is in vogue
And Madame Lagarde won’t go rogue
She’ll cut twenty-five
And keep hopes alive
That with Chair Jay, she did collogue
 
The stock market clearly believes
That soon they’ll be getting reprieves
In higher for longer
So, markets are stronger
As everyone, rate cuts, conceives

 

First it was Switzerland in March with a surprise 25bp rate cut.  Then Sweden cut 25bps in early May, although that was more widely touted ahead of the move.  Yesterday, the Bank of Canada joined the fray with a 25bp cut with Governor Tiff Macklem explaining that they are “not close to the limits” of the difference between US and Canadian interest rates and that with both inflation and growth receding, “markets have a very good idea of what’s on our minds” with respect to the value of CAD.  I think the last comment was an indication that they are comfortable if CAD were to weaken further, although after a very short-term dip of about -0.5% yesterday in the wake of the announcement, it is right back to where it was before and unchanged this morning.

With this as background, we turn now to the ECB which has virtually promised us a 25bp rate cut this morning and will almost certainly deliver it.  While many will remember that just last week, Eurozone CPI was released at a higher than expected 2.6% with core CPI also rising, up to 2.8%, at least those numbers have the same big figure as the ECB’s target.  But, as per the CPI chart below from tradingeconomics.com, it is not hard to make the case that the decline in inflation has bottomed above their target.

That could be awkward for their future actions but is also very likely why virtually every ECB speaker has been adamant that a July cut is not a given and they will continue to be data dependent.  Many analysts believe that there will be a total of three cuts this year, June, September and December, as the ECB will roll out their latest forecasts at those meetings, but beyond June, it is a bit less certain.  Market pricing shows that there are about 60bps total priced in at this stage, including today’s cut, as per the chart below.

Source: Reuters.com

Perhaps the most important question is, why do we care?  Well, certainly in the FX markets, given the importance of interest rate differentials, the relative speed of policy rate changes by the ECB and the FOMC can have an impact on the EURUSD exchange rate.  However, absent a surprise, something most central bankers try strenuously to avoid, the movement has already occurred ahead of the announcement.  Arguably, the more important part of this whole charade is the signal it gives for official views of future economic activity.  

When central banks are cutting interest rates, there is obviously concern that prospects for future economic activity to support the government in power are dimmer than they had been previously, hence the need to act.  As such, the very fact that a rate cutting cycle has begun in so many nations is indicative of the fact that expectations for future economic growth are diminishing.  It remains very difficult for me to understand that concept and expect that equity prices should rally substantially on the news.  But clearly, I am very old-fashioned in my thinking as evidenced by the fact that yet again, the S&P 500 and NASDAQ 100 have made new all-time highs on the strength of Nvidia’s non-stop rally.  While the Dow and NASDAQ Composite are still lagging, as are small cap stocks, euphoria remains the theme. (PS, my dour view from last Friday has been damaged, but I remain quite concerned with long-term prospects.)

However, this is where we are today.  The ECB will soon be the fourth major central bank to cut their policy rate and the pressure on the Fed to begin their cutting cycle will increase further.  Alas for the Fed, they continue to receive mixed signals from the data and rate cuts are not necessarily the proper prescription for what ails the US economy.  Just yesterday we received two contradictory signals with the ADP Employment report showing a weaker than expected 152K jobs created after a downwardly revised April number.  A few hours later, the ISM Services indicator was released at a much stronger than expected 53.8 reading, its highest since last August, and certainly not indicating that growth is ebbing.  As well, the Prices Paid subindex was a still hot 58.1, again not screaming out for a rate cut.

As of now, the market is pricing in virtually a zero probability of any rate move next week, but there has been a pickup in chatter about a cut at the July meeting with the probability of a cut then rising to 18.5% as of this morning, according to the Fed funds futures market.  If the Fed were to cut later this summer, nothing has changed my view that it will result in a significant decline in the dollar, and a significant rally in commodities. And, while the first move in both stocks and bonds might be higher, the specter of rising inflation will ultimately squash those moves.  But that is not today’s story, rather it is a story for the future.

Today, after those record highs in the US, we saw strength throughout most of Asia although Mainland Chinese shares did not participate in the fun.  That said, the gains were modest, between 0.25% and 0.5% overall.  In Europe this morning, the screens are all green with gains ranging from 0.3% in the UK to 0.7% in Germany as investors seem to believe in the goldilocks scenario there.  As to the US, futures at this hour (7:00) are unchanged as investors await tomorrow’s NFP data.

In the bond markets, after further declines yesterday, with 10-year Treasury yields touching their lowest level (4.27%) since the end of March, yields have bounced slightly this morning, higher by 2bps.  We are seeing similar price action throughout Europe, yield rallies of 2bps, except for the UK, which has seen a further 2bp decline despite the only data point, Construction PMI, rising the most in 2 years.  One last thing is that JGB yields, the ones that were supposed to be breaking out and running much higher now that the BOJ is leaving them alone, fell 5bps and are at 0.96%, below the 1.00% dotted line in the sand.

Commodity prices are rising this morning, continuing to rebound from the sharp declines earlier in the week, as oil (+0.6%) and NatGas (+0.4%) show there is still demand for energy regardless of the economic situation.  In the metals space, all the big four precious and industrial metals are higher this morning as it appears more and more like the weakness at the beginning of the week was a trading event, not a fundamental one.

Finally, the dollar is little changed overall this morning with the biggest mover being PLN (-0.3%), an indication that there is nothing ongoing.  While some currencies have managed small gains vs. the dollar and others have lagged, my sense is everyone is awaiting tomorrow’s NFP before deciding the next move, given the certitude of the ECB move later today.

We do, however, get some data this morning as follows: Initial Claims (exp 220K), Continuing Claims (1790K), Trade Balance (-$76.1B), Nonfarm Productivity (0.1%), and Unit Labor Costs (4.9%).  While we already know that the growth in the Trade Balance has been the key driver in the decline in the GDPNow figures (net exports are a subtraction from the calculation), I think the Fed may be more focused on the productivity numbers which are hardly inspiring and when combined with rising Labor Costs imply that inflation will have a tough time declining further.

So, the ECB will act first thing and then Madame Lagarde will very likely tell us that they remain data dependent, so nothing is promised for July or anytime the rest of the year.  As to today’s US data, I don’t believe it will be market moving.  This means that the equity bulls will continue to make their case and will need to be strongly disabused of the notion that the world is a great place right now.  When that time comes, beware, but it doesn’t seem likely today.

Good luck

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Change at the Top

Posted on by

Democracy lives and it dies
By voting for folks who devise
The laws to define
What’s right, or a crime
And this year, there’s much to surmise
 
Some sixty-four nations will vote
And watch as incumbents scapegoat
Political foes
For national woes
And claim they’re the best antidote
 
However, results that we’ve seen
Show that many nations are keen
For change at the top
Or leastwise, to swap
The current regimes’ philistines

 

So, I know I am not a political analyst, but I try to be a keen observer of trends around the world.  After all, to understand the macroeconomic situation globally, one needs to at least be aware of the politics in the major nations.  As such, I am going to attempt to analyze the elections we have seen around the world to date and see if we can use this trend to look ahead and forecast how things may turn out here in the US come November.

As of today, 35 nations have held elections for either Parliament (Congress), president, or both ranging from St. Maarten to India and many in between with respect to populations.  Arguably the most important have been India, Mexico, South Africa, Taiwan, Russia, Indonesia and Iran.  That list is based on both population and geopolitical importance.  

A look at the results shows the following:

  • India – PM Modi lost significant support and will now be ruling in a coalition, rather than his previous majority.  This was a far cry from the anticipated super-majority he sought.
  • Mexico – AMLO’s hand-picked successor, Claudia Sheinbaum won handily and the Morena party won a supermajority in the lower house, but not in the Senate, so there are great expectations for significant changes unchecked by congress there.
  • South Africa – President Ramaphosa and the African National Congress (ANC) the party that has ruled this nation by itself since the end of apartheid in 1994, lost their absolute majority and is casting about for a coalition partner to allow them to remain in power.
  • Taiwan – New President Lai Ching-te, an avowed separatist relative to China won, but the people did not give him the parliamentary majority to enable significant policy changes
  • Russia – was this really an election?
  • Indonesia – New President Prabowo, a former soldier and defense minister is tipped to be far more aggressive in his handling of dissent and criticism, a concern for some, but clearly given the size of his majority (>58%) something the people are ready for.
  • Iran – This is difficult to assess as the parliamentary elections have been overshadowed by the recent accidental death of the president in a helicopter crash, with a presidential election slated for June 28th.

As well, starting tomorrow, there will be voting for the European Parliament by all twenty-seven member nations.  This is a three-day process so we should know the results by next week.

In the meantime, let me offer my take on the results in a broad-brush manner.  People around the world are unhappy with their leadership and are seeking change.  More importantly, current incumbents are really annoyed by the fact that their populations are not happy.  It has been quite a long time since there have been so many efforts by governments to control all dialog and censor anything that offers an opposing view to government rules, laws and commands.

For instance, in India, despite being very popular, Modi must now account for the fact that he has lost majority support.  He has done much good for the nation, but clearly, there is a large segment of the population that does not feel they are benefitting and were looking for change.

In South Africa, it was a little different as the economic situation there is a wreck.  Inflation is rising (5.3% and climbing), Unemployment is rampant (32.9%) and confidence readings are negative while GDP stagnates. Even though the ANC has ruled for 30 years, people want change, especially since there have been numerous allegations of corruption at the top, and the country continuously has blackouts because of failures with energy policy.

In Taiwan, while former president Tsai Ing-wen was widely admired and had high favorability ratings, there is a clear concern over too much saber rattling with the mainland.  Arguably, China spent a lot of money to interfere in that election but was unsuccessful in getting their candidate elected.  However, the population there does not want war, and that seems to be the driving force.

My point is that even popular leaders have found that their popularity is not necessarily translating into power.  It is not hard to understand why this is the case given that inflation has been a global phenomenon, and the list of military conflicts has grown and forced many nations to choose sides rather than simply do what’s seen as best for themselves.

I know I ignored Mexico here, the exception that proves the rule, although perhaps the people felt that AMLO didn’t go far enough and given the huge rise in crime from the cartels there, people were looking for a stronger government to act, hence the supermajority.

What does this mean for Europe this weekend and the US later in the year?  I have been quite clear in my views that this is a change election year.  The current left leaning coalition in the European parliament is in danger of losing its ability to enact any legislation.  We have seen these changes in the Netherlands and Sweden, and Germany’s AfD party continues to gain adherents alongside the National Front in France and Italy’s European Conservative party.  Germany has three landes (state) elections in September, all in the former East Germany, where AfD is strongest.  While every other party has indicated they will not enter a coalition with AfD, I predict that in at least one of these states, AfD will win outright, and that will really shake things up.  As to the European parliament, the voting bloc on the right may be large enough to prevent almost all new legislation.  

Meanwhile, turning back home, the US election season is heating up and here, too, I would argue the population is very unhappy.  This is evident by the dreadful polling numbers of President Joe Biden, and perhaps even more significantly, by the growth in the number of Trump converts from previously solid democratic voters (watch this 2 minute video and ask yourself if Joe Biden is in trouble or not).  The efforts to utilize the DOJ to prevent Trump from contesting the election is not going over well across the nation, and I believe it will be seen as the biggest own goal in this process.

While I believe that Mr Trump WILL BE PUT IN JAIL because the Democratic party is desperate to do anything to tarnish him, it will not matter.  In fact, it will martyr him even further.  Remember, Nelson Mandela was jailed before being elected president, Vaclav Havel of the Czech Republic was imprisoned before being elected president, Lech Walesa of Poland was imprisoned before being elected president, Lula da Silva of Brazil was imprisoned before being elected president, Mohandas Gandhi was imprisoned for sedition, and yet still became leader of India.  History shows that the people of a nation can see through the political efforts of an incumbent party in their effort to remain in power, and when they demand change, they will get it.

With this in mind, my views on the economic situation remain that inflation continues to be a major impediment for every government worldwide, but if recent data is truly an indication of slowing economic activity, the outcome could well be easier monetary policy, but still weak growth, rising inflation, a falling dollar and rising commodities.  

Politics clearly matters, but it is a longer-term issue.  For now, all the efforts by governments and central banks to apply band-aids for the current ailments seem unlikely to be effective in the timeline required to alter the current broad-based unhappiness amongst the electorate.  Change is coming, and there will be hell to pay on the other side as all these short-term fixes will simply leave the long-term problems in worse shape.

One poet’s views, and I welcome any commentary and pushback.

Thanks

Adf

Fervor and Joy

Posted on by

The talk of the Street is the Fed,
While quiet this week, will soon shed
The higher for longer
Idea, with words stronger
That cuts are directly ahead
 
So, bonds are the new favorite toy
Of every hedge fund girl and boy
Since growth is now slowing
Investors are going
To buy bonds with fervor and joy

 

The amazing thing about markets is just how quickly they can shift their focus and reverse course if they find the right catalyst. Consider that just one week ago, 10-year Treasury yields were trading at 4.63%, having risen nearly 30 basis points in the prior two weeks on the strength of hawkish commentary from FOMC speakers, a much more hawkish than expected FOMC Minutes release, and economic data that indicated economic growth was still solid.

Source: tradingeconomics.com

And yet, in the past seven days, that entire move has been reversed and now the commentary is pointing to weakening economic activity, declining inflation, a looser jobs market and the inevitability of the Fed cutting rates before the election!  So, what happened?

Well, first, a little perspective is in order.  While a 30 basis point move in 10-year yields is a nice sized move, it is hardly unprecedented.  Consider that if we look at a chart of yields over just the past year, rather than the past month as above, the most recent dip does not stand out as particularly impressive.

Source: tradingeconomics.com

But second, the economic data in the US is starting to align more clearly in a negative fashion.  Yesterday I showed the Citi Surprise economic indicator index, which demonstrated that data is failing to keep up with forecasts.  Then yesterday, the JOLTS Job Openings data was released at a much diminished 8.059M, more than 300K jobs less than both anticipated and than last month.  In fact, despite this data point really looking backward (yesterday’s print was for April data), the recent trend, as seen below is very clearly lower.  

Source: tradingeconomics.com

This is an indication that the jobs market is much looser than the Fed had been worried about with regards to inflation, but of course is a problem for their maximum employment mandate.  In any event, the weaker data continues to pile up and the natural response of investors is to start to price in a more traditional weak growth scenario.  This includes declining bond yields on the assumption the Fed is going to ease policy, declining commodity prices on lessening demand, and a declining dollar on the back of those lower interest rates.  And that is exactly what we have seen.  

You will notice I left out the equity response to these events as I would contend it is far less clear.  Initially, I expect that equity investors will be excited by the prospects of rate cuts, and we could see stocks rally, but if growth is really slowing, then that is going to negatively impact earnings which should undermine equity prices.  Historically, when the Fed is cutting rates, it is in response to a slowing economy and equity prices have not fared well in this scenario.  You can see in the chart below, that the Fed tends to cut rates (orange line) during recessions (grey areas), and those declines are coincident with equity market (S&P 500 – blue line) declines.

Source: macrotrends.net

So, has the economy turned down for real now?  I would contend there are more indicators that are widely followed which indicate that is the case.  Several months ago, one really needed to dig into the secondary parts of major releases to conclude things were rolling over.  Today, it seems a bit clearer.  But remember, too, Treasury Secretary Yellen has > $700 billion in the TGA to spend leading up to the election in an effort to prevent that outcome, and you can be certain she will do all in her power to do so.  Will it be enough?  I guess we will find out.  

One last thought, though, is that my take is the current sticky inflation may well remain sticky despite an economic slowdown.  Remember, there is a humongous amount of money around, and the response of every government will be to print even more if things slow, so the idea of stagflation remains very real and cannot be dismissed at this time.

Ok, let’s look at the overnight session to see how things have fared.  After yesterday’s late equity rally resulted in very minor gains in the US, Asia had a mixed session with both Japan (-0.9%) and China (-0.6%) lower, although there were gains throughout the region led by India (+3.6%) rebounding from the initial election news there.  PM Modi will continue ruling, but in a coalition, so with much reduced power.  But Korea, Australia and Taiwan all performed well.  In Europe this morning, equity markets are having a good day with gains on the continent around 0.9% across the board although UK stocks are only higher by a bit (0.3%).  PMI Services data was released, and it was generally a touch better than forecasts (France excepted) but certainly not significant enough to change the view that the ECB is going to cut rates tomorrow.  Meanwhile, US futures are picking up at this hour (8:00), rising 0.3% across the board.

We discussed bonds earlier but not the fact that Treasury yields fell 7bps yesterday after the softer data, dragging European yields down as well.  This morning, Treasuries are another 1bp softer with Europe sliding by between 1bp and 4bps.  Overnight, yields also fell, with JGB’s down 2bps and now right back at 1.00%, while other bonds in Asia saw yields fall more sharply.  It seems pretty clear that the market is starting to price in a global slowdown in the economy.

In the commodity sector, after a week of routs, things have settled this morning with oil (+0.5%) bouncing slightly, although still lower by -7% in the past week.  Gold (+0.25%) too, is a bit firmer, although that was not the metal that fell most sharply.  Both silver and copper are unchanged this morning as the bullish long-term story mongers (present company included) are all licking their wounds, but absent more weak data, there is no incentive to sell things aggressively here right now.  However, if the data keeps softening, so will these prices.

Finally, the dollar, which had fallen earlier in the week, has edged up a touch this morning.  JPY (-0.6%) is giving back some of its recent haven inspired gains, and we have also seen both MXN (+0.9%) and INR (+0.25%) recoup a small amount of their election related losses.  ZAR (-1.0%), however, is still under pressure as the weakened state of the government combined with the weakness in metals prices is clearly a major weight on the rand.  All eyes today will be on CAD (unchanged) as the BOC meets and will be announcing their rate decision at 10:30. There is a 60% probability of a rate cut priced into the market, as recent data softness is getting traders excited that Governor Macklem will ignore his recent comments about needing “months of data” to confirm the situation.  After all, inflation up there is within the BOC’s range, and I suspect a cut is coming.

On the data front, ADP Employment was just released at a slightly softer than forecast 152K (exp 170K) and then we see ISM Services (50.8) at 10:00am.  As of yet, there has been no real response to the ADP data.  At this point, the narrative is swinging quickly to the idea that softer economic activity will lead the Fed to cut sooner than previously expected.  The Fed funds futures market has moved the probability of the September cut up to nearly two-thirds.  For now, that is going to drive things, and as such, I believe the dollar will remain under pressure overall.  Absent a very strong NFP report Friday, perhaps we have seen some near-term tops in yields and the dollar.

Good luck

Adf