Said Jay, “The economy’s strong”
But rate cuts before weren’t wrong
We’re in a good place
To further debase
Your dollars and will before long
As we slow the pace
Of policy ease all year long

 

Chairman Powell regaled the market for the last time before the Fed’s quiet period begins tomorrow evening and here are the three comments that seem to explain his current views. 

• “We wanted to send a strong signal that we were going to support the labor market if it continued to weaken.”
• “The economy is strong, and it’s stronger than we thought it was going to be in September.”
• “The good news is that we can afford to be a little more cautious as we try to find a rate-setting that neither spurs nor slows growth.”

My read is he was trying to make an excuse for the 50bp cut that started the process in September as there is still no justification for that move.  However, he essentially reiterated his last remarks of the Fed not being in a hurry to cut rates further.  As it happens, SF Fed president Mary Daly also explained, “We do not need to be urgent. There’s no sense of urgency, but we do need to continue to carefully calibrate our policy and make sure it’s in line with the economy we have today the one we expect to have going forward.” 

Now, a funny thing happened to me yesterday as I read those comments, and my expectation was that the Fed funds futures market might reduce the probability of a December rate cut.  After all, we just heard from the Chairman that things are good and they can be cautious about further cuts, while another member expressly said there was no urgency to cut.  But in fact, the 74% probability this morning is unchanged from yesterday’s level and the punditry remains very convinced that they are going to cut next week despite their caution.  It seems that my understanding of caution and Powell’s are somewhat different.  However, his understanding is the one that matters, so it appears absent a major upside surprise in both NFP tomorrow and CPI next week, a cut is coming on the 18^th.

The French president, M. Macron
May soon find himself overthrown
His PM is out
And there is great doubt
‘Bout any new views he has shown

The other topic of note this morning is the collapse of Monsieur Macron’s minority government in France.  This was the widely expected outcome that markets had priced in, so there has been little in the way of impact there.  However, the bigger picture impact is about the structure of the Eurozone (and EU) and its rules.  After all, if the second largest economy in the group is not merely floundering economically, but essentially leaderless, the concept of a coherent set of plans to oversee the Eurozone seems a bit of a stretch.

Macron’s term is not up until 2027, and he has consistently maintained he will not step down early, but there are increasing calls for him to do just that.  Members of parliament on both the left and right, although not Marine Le Pen, the RN’s leader, have been vocal on the subject and a recent poll by Cluster17 for Le Point magazine showed that 54% of the French public wanted him to step down as well.  Now, you know as well as I that absent a criminal conviction, the odds of an elected official stepping down anywhere in the world approach zero and I expect nothing less from Macron.  At the same time, French law prevents another parliamentary election for 12 months after the last, which means July.  At that time, one will almost certainly be called, and it will be interesting to see how that plays out.  

However, in the meantime, it seems likely that France will be floundering with no ability to address fiscal issues, be they spending or deficit focused.  This cannot be a positive for the single currency, especially if France slips into recession.  Again, despite all the concerns over the dollar and the untenable fiscal deficits, things in Europe appear far worse.  Parity in the euro and below seems a far better bet over the next 6 months than the opposite.  While the euro (+0.2%) has bounced slightly this morning, a look at the chart below indicates, at least to me, that the trend is distinctly lower.

Source: tradingeconomics.com

And with that, let’s look at the overnight session in markets.  Continuing in the FX world, that modest euro gain is descriptive of the market as a whole, with the dollar slightly softer this morning, although few currencies showing any notable strength.  I suspect much of this is based on the idea that the Fed will cut rates soon despite the “strong economy”.  In truth, in the G10, no currency has moved more than 0.2% and even in the EMG space, only ZAR (+0.4%) and HUF (+0.5%) have climbed more.  Those moves, which don’t appear to have any fundamental drivers, seem more likely to be expressions of the fact those markets are more volatile than the G10.

In the equity markets, yesterday’s US rally, to new all-time highs across the board, saw a mixed review in Asia with the Nikkei (+0.3%) edging higher but both Hong Kong (-0.9%) and Shanghai (-0.25%) slipping a bit.  The rest of Asia was also mixed with Korea (-0.9%) still suffering from the bizarre happenings there yesterday but other markets performing well (India +1.0%, Singapore +0.6%).  In Europe, only the UK (-0.1%) is under water this morning although the CAC (+0.2%) is the continental laggard.  Spain’s IBEX (+1.2%) is the leader on the back of stronger IP, and although Eurozone Retail Sales were much weaker than expected, it has not seemed to impact investor views.  As to US futures, they are little changed at this hour (7:30).

In the bond market, Treasury yields have backed up 3bps and I am beginning to sense that there is a negative correlation to the probability of a Fed rate cut and the 10-year yield.  As that probability rises, bonds sell off further, but that is merely an anecdotal observation, I have not done the math.  In Europe, yields are mixed, but within 1bp of yesterday’s closing levels with even French yields slipping 1bp. It will be very interesting to see how the European Commission handles the fact that the French budget deficit is so far above the targeted 3% level and now without a government, there is no way to address the situation.  The original idea when the euro was formed was that governments would be fined if they broke the policy caps on debt and deficits.  Of course, no fine has ever been imposed and I don’t suppose one will be now.  (However, if Marine Le Pen’s RN wins the election next summer, you can be sure they will seek to impose fines on her government!)

Finally, in the commodity markets, it is very quiet this morning.  Oil (+0.3%) is edging higher after a big rise and fall yesterday.  The rise was the result of a steep draw in US inventories, but the decline seemed to be a response to OPEC+ confirming they will be increasing production at some point in 2025.  Meanwhile, metals markets are basically unchanged this morning.

One other thing I have not discussed but is obviously getting a lot of press this morning, is Bitcoin which traded through $100K yesterday after President-elect Trump named Paul Atkins to be his new SEC Chair.  Atkins has a very pro crypto bias, and I expect we will see far more impetus in the crypto space going forward, not just in Bitcoin.

On the data front, yesterday’s ISM data was a bit softer than forecast while the Beige Book explained that economic activity rose slightly in the past month along with employment and prices, but all movements were quite modest.  This morning, we see Initial (exp 215K) and Continuing (1910K) Claims as well as the Trade Balance (-$75.0B) and later we hear from Richmond Fed president Barkin.  

Looking at the overall situation, investors continue to ignore any potential problems and run to risk assets, as evidenced by the rally in Bitcoin and new highs in stock prices.  Unless we see some really surprising data, either crazy strong implying the Fed is going to stop easing, or crazy weak implying we are in a recession, I see no reason for this process to end heading into the new year and President Trump’s inauguration.  Again, in that scenario, I think you have to like the dollar higher.

Good luck

Adf