Monthly Archives: January 2025

Deceit

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Though many will claim it’s deceit
The Chinese declared they did meet
The target that Xi
Expected to see
Though skeptics remain on the Street
 
In fact, it appears there’s a trend
That data surprises all tend
To flatter regimes
And their stated dreams
As policy faults they defend

 

Last night, the Chinese released their monthly data barrage with final 2024 numbers as part of the mix. Despite numerous indications that Chinese growth is slowing, somehow, they managed to show a 5.4% annualized GDP growth rate for Q4 and a 5.0% GDP growth rate for all of 2024, right on President Xi’s target.  

Now, the government did add some stimulus in Q4 as they recognized things are not going well, and I continue to read articles that President Xi is starting to feel increased pressure from CCP insiders as to his stewardship of the nation and the economy.  Statistics like electricity usage and travel don’t really jive with the data, although it is certainly possible that ahead of the mooted tariffs that President Trump has threatened to impose starting next week, many companies preordered extra inventory to beat the rush, and that goosed growth.  

But there are a couple of things that continue to drag on the Chinese economy, with the primary issue the continuing implosion of the property market there.  For instance, while house price declines have been slightly slower, (only -5.3% last month) it has basically been three years since there was any gain at all as shown in the chart below.

Source: tradingeconomics.com

As well, one of the key concerns about China has been Foreign Direct Investment, which has not merely slowed down but has actually been reversing (companies leaving China) over the past two years as per the next chart.

Source: tradingeconomics.com

Meanwhile, a WSJ headline, China’s Population Fell Again Despite a Surprise Rise in Births, highlights yet another issue President Xi faces, the ongoing aging and shrinking of his nation.  Remember, GDP is basically the product of the number of people working * how much they each produce.  If that first number is shrinking, and the working age population in China is doing just that, it is awfully difficult to generate GDP growth.  Finally, I couldn’t help but notice in yesterday’s confirmation hearings for Treasury secretary, where Scott Bessent offered his view that China is actually in a recession, with massive deflation and are struggling to export their way out of the problems, rather than address their internal imbalances.  This is a theme that has been discussed widely in the past, and ostensibly, China has admitted they want to be more consumption focused in their economy, but it doesn’t appear that is the direction they are heading.

I raise these points in the context of the Chinese renminbi and how we might expect it to behave going forward.  The question of tariffs remains open at this stage, although I daresay we will learn more next week.  If they are imposed, there is a strong belief that the renminbi will weaken to offset the terms.  As it is, the currency remains within pips of its weakest level in 18 years and the trend, both short-term and for the past decade, has been for it to weaken further. 

Source tradingeconomics.com

Xi remains caught between the need for the currency to weaken to maintain competitiveness in the face of threatened tariffs from the US, and his desire to demonstrate that the renminbi is a stable store of value that other nations can trust to hold and use outside the global dollar network.  In the end, I expect the immediate competitiveness needs are going to overwhelm the long-term aspirations, especially if it is true that Xi is feeling internal pressure because of an underperforming economy.  Nothing has changed my view that we approach 8.00 by the end of the year.

Ok, and that’s really the big news overnight.  As an aside, it was interesting to watch Mr Bessent dismantle the attempts by the Democrat senators for a ‘gotcha’ moment.  As I wrote yesterday, it wasn’t really a fair fight given his intelligence, experience and understanding of markets and the economy compared to the Senators.

Let’s start in the equity world where US markets opened higher but ultimately slid all day long to close on their lows.  An uninspiring performance to say the least.  That performance weighed on much of Asia with the Nikkei (-0.3%) sliding alongside Australia, Korea and India.  On the plus side, modest gains were shown in China (Hang Seng and CSI 300 both +0.3%) and some positive numbers were seen in Taiwan, Malaysia and Singapore.  But overall, the movements were not substantial in either direction.  In Europe, though, markets are starting to anticipate more aggressive ECB rate cuts as data continues to show weakness in economic activity.  Weak UK Retail Sales data has the FTSE 100 (+1.3%) leading the way higher as hopes for a BOE cut grow.  Meanwhile, the CAC (+1.0%) and DAX (+1.0%) are both rallying on the thesis that Chinese growth is going to attract imports from both nations.  Meanwhile, US futures are higher by 0.4% at this hour (7:40).

In the bond market, all the inflation fears seem to have abated.  Either that or we continue to see a massive short squeeze and position unwinding.  But the result is yields are lower across the board with Treasury yields down 3bps further, and below 4.60% while European sovereign yields have fallen between -3bps and -5bps as investors take heart that the ECB and BOE are going to be cutting rates soon.  Perhaps the market is showing faith that Mr Bessent will be able to address the US fiscal financing crisis.  After all, he did explain in no uncertain terms that the US would not default on its debt.  But my sense is the market narrative about rising inflation and higher yields had really pushed too far, and this is simply the natural bounce back.  While this week’s inflation data was not as hot as feared, nothing has changed my view that inflation remains a problem going forward.

In the commodity markets, oil is unchanged on the day, having given back some of its substantial gains over the past two sessions, although it remains right near $79/bbl this morning.  Apparently, there are rumors Trump will end Russian oil sanctions as part of the Ukraine negotiations, but that doesn’t sound like something he would offer up initially, at least to me.  Meanwhile, NatGas (-4.0%) though slipping this morning, remains above $4/MMBtu as the US prepares for a major arctic cold snap next week.  In the metals markets, my understanding is there has been a lot of position adjustment and arbitrage between NY and London as we approach futures contract maturities, and that has been a key driver of the recent rally in metals (H/T Alyosha at Market Vibes, a very worthwhile trading Substack), but may be coming to an end in the next several sessions.  However, here, too, nothing has changed my longer-term view of higher prices over time.

Finally, the dollar is a tad stronger this morning, rallying vs. the pound (-0.4%), Aussie (-0.4%), NOK (-0.5%) and NZD (-0.5%) as all those ECB and BOE rate cut stories weigh on those currencies.  Interestingly, JPY (-0.3%) is also weaker this morning despite an article overnight signaling the BOJ will be raising rates next Friday.  On the flip side, looking at the EMG bloc, I see very modest gains by many of the key players (MXN +0.15%, ZAR +0.1%), although those moves feel far more like position adjustments than fundamentally driven changes in view.

On the data front, this morning brings Housing Starts (exp 1.32M) and Building Permits (1.46M) and then IP (0.3%) and Capacity Utilization (77.0%) later on.  There are no Fed speakers on the docket, and tomorrow is the beginning of the quiet period.  The last thing we heard from Cleveland Fed president Hammack was that inflation remains a concern and they have not yet finished the job.

For the day, I don’t think the data will have much impact.  Rather, as we are now in earnings season, I suspect that stocks will take their cues there and FX will remain in the background for now.

Good luck and good weekend

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Shortsighted

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The CPI data delighted
Investors, who in a shortsighted
Response bought the bond
Of which they’re now fond
And did so in, time, expedited
 
But does this response make much sense?
Or is it just way too intense?
I’d offer the latter
Although that may shatter
The narrative’s current pretense

 

Leading up to yesterday’s CPI data, it appeared to me that despite a better (lower) than expected set of PPI readings on Tuesday, the market was still wary about inflation and concerned that if the recent trend of stubbornly sticky CPI prints continued, the Fed would soon change their tune about further rate cuts.  Heading into the release, the median expectations were for a 0.3% rise in the headline rate and a 0.2% rise in the core rate for the month of December which translated into Y/Y numbers of 2.9%% and 3.3% respectively. At least those were the widely reported expectations based on surveys.  

However, in this day and age, the precision of those outcomes seems to be lacking, and many analysts look at the underlying indices prepared by the BLS and calculate the numbers out several more decimal places.  This is one way in which analysts can claim to be looking under the hood, and it can, at times, demonstrate that a headline number, which is rounded to the first decimal place, may misrepresent the magnitude of any change.  I would submit that is what we saw yesterday, where the headline rate rose to the expected 2.9% despite a 0.4% monthly print, but the core rate was only 3.24% higher, which rounded down to 3.2% on the report. Voila!  Suddenly we had confirmation that inflation was falling, and the Fed was right back on track to cut rates again.

Source: tradingeconomics.com

Now, I cannot look at the above chart of core CPI and take away that the rate of inflation is clearly heading back to 2% as the Fed claims to be the case.  But don’t just take my word for it.  On matters inflation I always refer to Mike Ashton (@inflation_guy) who has a better grasp on this stuff than anyone I know or read.  As he points out in his note yesterday, 3.5% is the new 2.0% and that did not change after yesterday’s data.

However, markets and investors did not see it that way and the response was impressive.  Treasury yields tumbled 13bps and took all European sovereign yields down by a similar amount, equity markets exploded higher with the NASDAQ soaring 2.5% and generally, the investment world is now in nirvana.  Growth remains robust but that pesky inflation is no longer a problem, thus the Fed can continue cutting rates to support equity prices even further.  At least that’s what the current narrative is.  

Remember all that concern over Treasury yields?  Just kidding!  Inflation is dying and Trump’s tariffs are not really a problem and… fill in your favorite rationale for remaining bullish on risk assets.  I guess this is where my skepticism comes to bear.  I do not believe yesterday’s data reset the clock on anything, at least not in the medium and long term.

Before I move on to the overnight, there is one other thesis which I read about regarding the recent (prior to yesterday) global bond market sell-off which has some elements of truth, although the timing is unclear to me.  It seems that if you look at the timing of the recent slide in bond markets, it occurred almost immediately after the fires in LA started and were realized to be out of control.  This thesis is that insurers, who initially were believed to be on the hook for $20 billion (although that has recently been raised to >$100 billion) recognized they would need cash and started selling their most liquid assets, namely Treasuries and US equities.  In fact, this thesis was focused on Japanese insurers, the three largest of which have significant exposure to California property, and how they were also selling JGB’s aggressively.  Now, the price action before yesterday was certainly consistent with that thesis, but correlation and causality are not the same thing.  If this is an important underlying driver, I would expect that there is more pressure to come on bond markets as almost certainly, most insurance companies don’t respond that quickly to claims that have not yet even been filed.

Ok, let’s see how the rest of the world responded to the end of inflation as we know it yesterday’s CPI data. Japanese equities (+0.3%) showed only a modest gain, perhaps those Japanese insurers were still out selling, or perhaps the fact that the yen (+0.3%) is continuing to grind higher has held back the Nikkei.  Hong Kong (+1.25%) stocks had a good day as did almost every other Asian market with the US inflation / Fed rate cuts story seemingly the driver.  The one market that did not participate was China (+0.1%) which managed only an anemic rally.  In Europe, the picture is mixed as the CAC (+2.0%) is roaring while the DAX (+0.2%) and IBEX (-0.4%) are both lagging as is the FTSE 100 (+0.65%).  The French are embracing the Fed story and assuming luxury goods will be back in demand although the rest of the continent is having trouble shaking off the weak overall economic data.  In the UK, GDP was released this morning at 1.0% Y/Y after just a 0.1% gain in November, slower than expected and adding pressure to the Starmer government who seems at a loss as to how to address the slowing economy.  As to US futures, at this hour (7:30) they are pointing slightly higher, about 0.2%.

In the bond market, after yesterday’s impressive rally, it is no surprise that there is consolidation across the board with Treasury yields higher by 2bps and similar gains seen across the continent.  Overnight, Asian government bond markets reacted to the Treasury rally with large gains (yield declines) across the board.  Even JGB yields fell 4bps.  The one market that didn’t move was China, where yields remain at 1.65% just above their recent historic lows.

In the commodity markets, oil (-1.0%) is backing off yesterday’s rally which saw WTI trade above $80/bbl for the first time since July as despite ongoing inventory builds in the US, and ostensibly peace in the Middle East, the market remains focused on the latest sanctions on Russia’s shadow tanker fleet and the likely inability of Russia (and Iran) to export as much as 2.5 million barrels/day going forward.  NatGas (+0.75%) remains as volatile as ever and given the polar vortex that seems set to settle over the US for the next two weeks, I expect will remain well bid.  On the metals side of things, yesterday’s rally across the board is being followed with modest gains this morning (Au +0.3%) as the barbarous relic now sits slightly above $2700/oz.

Finally, the dollar doesn’t seem to be following the correct trajectory lately as although there was a spike lower after the CPI print yesterday, it was recouped within a few hours, and we have held at that level ever since.  In fact, this morning we are seeing broader strength as the euro (-0.2%), pound (-0.4%) and AUD (-0.5%) are all leaking and we are seeing weakness in EMG (MXN -0.6%, ZAR -0.6%) as well.  My take is that the bond market, which had gotten quite short on a leveraged basis, washed out a bunch of positions yesterday and we are likely to see yields creep higher on the bigger picture supply issues going forward.  For now, this is going to continue to underpin the dollar.

On the data front, this morning opens with Retail Sales (exp 0.6%, 0.4% -ex autos) and Initial (210K) and Continuing (1870K) Claims.  We also see Philly Fed (-5.0) to round out the data.  There are no Fed speakers today, although in what cannot be a surprise, the three who spoke yesterday jumped all over the CPI print and reaffirmed their view that 2% was not only in sight, but imminent!  As well, today we hear from Scott Bessent, Trump’s pick to head the Treasury so that will be quite interesting.  In released remarks ahead of the hearings, he focused on the importance of the dollar remaining the world’s reserve currency, although did not explicitly say he would like to see it weaken as well.  The one thing I know is that he is so much smarter than every member of the Senate Finance committee, that it will be amusing to watch them try to take him down.

And that’s really it for now.  If Retail Sales are very strong, look for equities to see that as another boost in sentiment, but a weak number will just rev up the Fed cutting story.  Right now, the narrative is all is well, and risk assets are going higher.  I hope they are right; I fear they are not.

Good luck

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Will It Matter?

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Will Japan hike rates?
How much will it matter if
They do?  Or they don’t?

 

Market activity and discussion has been somewhat lacking this week as the real fireworks appear to be in Washington DC where President-elect Trump’s cabinet nominees are going through their hearings at the Senate.  Certainly, between that and the ongoing fires in LA, the news cycle is not very focused on financial markets in the US.  This, then, gives us a chance to gaze Eastward to the Land of the Rising Sun and discuss what is happening there.

You may recall yesterday I mentioned a speech by BOJ Deputy Governor Himino where he explained that given the inflation situation as well as the indication that wages would continue to rise at a more robust clip in Japan, a rate hike may be appropriate.  Well, last night, Governor Ueda basically told us the same thing.  Alas, it seems that the BOJ takes a full day to translate speeches into English because there are no quotes from Ueda, but we now have the entire Himino speech from the day before.

Regardless, the essence of the story is that the BOJ is carefully watching the data and awaiting the Trump inauguration to see if there are any surprise tariff outcomes against Japan (something that has not been discussed) while they await their own meeting at the end of next week.  Market pricing now has a 72% probability of a 25bp rate hike next week, up from about 60% yesterday, and last night the yen did rally, climbing 0.7%.  However, a quick look at the chart below might indicate that the market is not overly concerned about a major yen revaluation.

Source: tradingeconomics.com

In fact, since the last BOJ meeting in December, when they sounded a bit more dovish than anticipated, the yen has done very little overall, treading water between 156.50 and 158.50.  While a BOJ rate hike would likely support the yen somewhat, there is another dynamic playing out that would likely have the opposite effect.  At the beginning of the year I prognosticated that the Fed may well hike rates by the end of 2025 as inflation seems unlikely to cooperate with their prayers belief that 2.0% was baked in the cake.  At the time, that was not a widely held view.  However, in a remarkably short period of time, market participants are starting to discuss the idea that may, in fact, be the case.  Even the WSJ today had a piece on the subject from James Mackintosh, one of their economics writers laying out the case.  The point here is that if tighter monetary policy by the Fed is in the cards, I suspect the yen will have a great deal of difficulty climbing much further.  Let’s keep an eye on the 156.00 level for clues that things are changing.

In England, inflation is rising
Less quickly than some theorizing
Meanwhile in the States
Jay and his teammates
Are hoping for data downsizing

Turning now to the inflation story, European releases were generally right on forecast except for the UK, where the headline rate fell to 2.5% while the core fell to 3.2%, 1 tick and 2 ticks lower than expected respectively.  Certainly, that is good news for the beleaguered people in the UK and it has now increased the odds that the BOE cuts rates at their next meeting on February 6th.  However, we cannot forget that the BOE’s inflation target, like that of the Fed, is 2.0%, and there is still limited belief that they will achieve that level even in 2025. But the markets did respond to the data with the FTSE 100 (+0.75%) leading the European bourses higher while 10-year Gilt yields (-8bps) have seen their largest decline in several weeks and are also leading European sovereign yields lower.  Interestingly, the pound has been left out of this movement as it is essentially unchanged on the day.  Perhaps there is a message there.

Which brings us to the US CPI data this morning.  after yesterday’s PPI data printed softer than expected at both the headline and core levels, excitement is building for a soft print and the resumption of the Fed cutting cycle.  However, it is important to remember that despite the concept that these prices should move together, the reality is they really don’t.  Looking at the monthly core movements below, while the sign is generally the same, the relationship is far weaker than one might imagine.

Source: tradingeconomics.com

In fact, since January 2000, the correlation between the two headline series is 0.04%, or arguably no relationship at all.  I would not count on a soft CPI print this morning based on yesterday’s PPI.  Rather, I am far more concerned that the ISM Services Prices Paid index last week was so hot at 64.1, a better indicator that inflation remains sticky.  But I guess we will all learn in an hour or two how it plays out.

Ahead of that, let’s look at the rest of the overnight session.  Yesterday’s mixed US equity performance (the NASDAQ lagged) was followed by mixed price action overnight with the Nikkei (-0.1%) edging lower on the modestly stronger yen and talk of a rate hike, while the Hang Seng (+0.3%) managed a gain on the back of Chinese central bank activity as the PBOC added more than $130 billion in liquidity ahead of the Lunar New Year holiday upcoming.  However, mainland shares (CSI 300 -0.6%) did not share the Hong Kong view.  Elsewhere in the region Taiwan (-1.25%) was the laggard while Indonesia (+1.8%) jumped on a surprise rate cut by the central bank there.

In Europe, though, all is green as gains of 0.4% (CAC) to 0.8% (DAX) have been driven by ECB comments that rate cuts are coming as concerns grow over the weakness of the economies there.  Germany released its GDP data and in 2024, Germany’s GDP shrank by -0.2%, the second consecutive annual decline and the truth is, given the combination of their insane energy policy and the fact that China is eating their proverbial lunch with respect to manufacturing, especially in the auto sector, it is hard to look ahead and see any positivity at all.  Meanwhile, US futures are higher by 0.5% or so at this hour (7:00) clearly with traders looking for a soft CPI print.

In the bond market, Treasury yields are lower by 3bps this morning but remain just below 4.80% and the 5.0% watch parties are still hot tickets.  European yields have also softened away from Gilts, with the entire continent lower by between -2bps and -4bps.  Right now, with dreams of a soft CPI, bond bulls are active.  We shall see how that plays out.

In the commodity space, oil (+0.3%) is modestly firmer after a reactionary sell-off yesterday.  The IEA modestly raised its demand forecast and supplies in the US, according to the API, were a bit tighter yesterday, so that seems to be the support.  NatGas is little changed right now while metals markets (Au +0.4%, Ag +0.5%, Cu +0.4%) are edging higher although mostly remain in a trading range lately.  Activity here has been lackluster with no new story to drive either direction.

Finally, the dollar is a touch softer overall, but away from USDJPY, most movement is of the 0.1% variety. Right now, the FX markets are not garnering much interest overall.

On the data front, expectations for CPI are as follows: Headline (0.3%, 2.9% Y/Y) and Core (0.2%, 3.3% Y/Y).  As well, we see Empire State Manufacturing (3.0) and then the Beige Book at 2:00pm.  We also have three Fed speakers, Williams, Kashkari and Barkin, but are they really going to alter the cautionary message?  I doubt it and the market continues to price a single 25bp cut for all of 2025.  The real fireworks will only come if/when price hikes start to get priced in as discussed above.

It is hard to get excited for market activity today as all eyes remain on the confirmation hearings and LA.  As such, I suspect there will be very little to see today.

Good luck

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In the “Know”

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According to those in the “know”
It’s certain that tariffs will grow
But now some are saying
The timing is straying
From instant to something more slow

 

In what has been a generally quiet evening in the markets, the story that President-elect Trump is considering imposing all those tariffs on a gradual basis, rather than instantaneously when he is inaugurated, was taken as a bullish sign by investors.  This seems to have been the driving force behind yesterday afternoon’s modest rebound in equity markets as the current market narrative is tariffs = bad, no tariffs = good.  From what I can determine, these are anonymous comments not directly attributed to Trump or his incoming economics team and, in fact, Trump denied that possibility.

But the market impact was real as not only did equity markets rebound a bit, but the dollar, which had soared yesterday, has given back some of those gains and is modestly lower this morning.  If we learned nothing else from President Trump’s first term, it should be clear that there is frequently a great deal of bombast emanating from the White House and responding to each and every comment is a recipe for exhaustion and disaster. While this cannot be ruled out, if one were to ascribe a Trumpian gospel it would be that tariffs are beautiful so slow-rolling them doesn’t really accord with that view.  I guess we will all find out more next week.

Now, turning to data releases
This week its inflation showpieces
Today’s PPI
Is tipped to be high
While Wednesday the core rate increases

Away from that story, though, there has been little else of note overnight.  As such, let’s focus on the PPI data this morning and CPI tomorrow as they ought to help inform our views on the Fed’s actions going forward. Expectations are for headline to rise to 3.4% Y/Y while core jumps to 3.8% Y/Y.  It is difficult to look at a chart of these readings and not conclude that the bottom is in and the trend is higher.

Source: tradingeconomics.com

This is not to say that we are going to see price rises like we did back in 2022 as the waves of Covid spending washed through the economy, but the Fed’s mantra that inflation is going to head back to 2.0% over time is not obvious either.  In fact, if I were a betting man, I would estimate that we are likely to continue to see inflation run between 3.5% and 4.5% for the foreseeable future.  There is just nothing around to prevent that in the short run.  Now, if we do see significant productivity enhancements, those numbers will decline, but my take is the best opportunity for that, more effective and widespread use of AI, is still several years away.

Remember, too, that the government writ large, whether headed by R’s or D’s is all-in on inflation as it is the only opportunity they have to reduce the real value of the outstanding government debt.  Perhaps the Trump administration will take a different tack, but it is not clear they will be able to do so.  The only time inflation is a concern is when it becomes a political liability.  For the two decades leading up to Covid, it was not a daily concern of the population and central banks around the world were terrified of deflation!  In fact, there are so many comments by folks like Yellen, Bernanke and other Fed governors and presidents decrying the fact that their key regret was not getting inflation high enough, it is difficult to count them.  But as evidenced by the chart below of CPI, we no longer live in that world.

Source: tradingeconomics.com

Summing up, the current situation is that inflation has likely bottomed, the government continues to run massive fiscal deficits and given the $36 trillion in debt outstanding, the government needs to reduce the interest rate they pay on their debt.  If pressed, I would expect that we will see synthetic yield curve control (YCC) enabled by regulatory changes requiring banks and insurance companies to own a greater percentage of Treasury notes and bonds in their portfolios to ensure there is sufficient demand for issuance.  That can have the effect of turning long-term real yields negative, exactly the outcome the government wants. Remember, from 1944-1951, the Fed enacted YCC directly and it worked wonders in reducing the debt/GDP ratio.  They know this tool and will not be afraid to use it.

Ok, let’s take a look at what little action there was overnight.  After yesterday’s late rebound resulted in a mixed close with the NASDAQ still lower but the other two indices closing in the green, Asian equity markets also had a mixed picture.  The Nikkei (-1.8%) was the laggard, seemingly following last week’s US market movement after reopening from a holiday weekend.  However, Chinese shares (Hang Seng +1.8%, CSI 300 +2.6%) rallied sharply on the latest news that more Chinese stimulus was coming soon.  This time the Ministry of Commerce claimed they would be looking to boost consumption this year, but neglected to mention how they will do so.  Regardless, investors liked the story and when added to the gradual tariff story, it was all green.

European bourses are also in fine fettle this morning with gains across the board (CAC +1.2%, DAX +0.8%, IBEX +0.6%) and even the FTSE 100 (+0.1%) has managed to rally a bit.  This price movement, and that of the rest of Asia where gains were seen, seems all to be a piece with the slower tariff story discussed above.  As to US futures markets, at this hour (6:40), they are pointing modestly higher, 0.45%.

In the bond market, the only place where yields have moved significantly today is in Japan, where JGB yields have jumped 5bps and are now at their highest point since February 2011.  This followed comments from Deputy Governor Himino that the board was likely to debate a rate hike at their meeting next week and market pricing has a 60% probability priced in for the move.  There is much talk of wage increases in Japan, and Himino-san also raised questions about what the Trump administration will do and how it will impact yields.  Interestingly, despite the more hawkish rhetoric, the yen (-0.25%) actually declined today, not necessarily what you would expect.  As to the rest of the bond market, everything is within 1bp of Monday’s closing levels.

In the commodity markets, oil (-0.3%), which has been rocking lately on the increased Russia sanctions, is consolidating this morning although remains higher by nearly 6% this week and 12% in the past month. (As an aside, I don’t understand the Biden theory that sanctions driving up prices is going to be a detriment to Putin as he will make up for the loss of volume with higher prices, but then, I’m not a politician.). Meanwhile, NatGas (-3.2%) has backed off its recent highs as storage concerns ebb, although the ongoing cold weather appears to have the opportunity to push prices higher again.  As well, the latest dunkelflaute throughout Europe is driving demand for LNG.  In the metals markets, yesterday’s declines have been arrested, and we are basically unchanged this morning.

Finally, the dollar is mixed this morning, edging higher against some G10 counterparts (GBP -0.3%, JPY -0.4%) but sliding against others (NZD +0.6%).  Versus the EMG bloc, again the picture is mixed today with gainers (ZAR +0.4%, KRW +0.3%) and laggards (CZK -0.2%) although overall, I would argue the dollar is a touch softer on the back of the gradual tariff story.

On the data front, this morning’s PPI data (exp 0.3% M/M, 3.4% Y/Y) headline and (0.3% M/M, 3.8% Y/Y) core is the extent of what is to come.  Interestingly, the NFIB Index jumped to 105.1, the highest print since October 2018, as small businesses are clearly excited about the prospects of a Trump administration and the promised regulatory cuts.

Right now, both the dollar and Treasury yields are pushing to levels that have caused market problems in the past.  If these trends continue, be prepared for some more significant price action.  That could manifest as a sharp decline in equity markets, or some surprising Fed activity as they try to address any potential market structural problems that may arise.  But there is nothing due to stop the trends right now.

Good luck

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Quite Clearly Concerned

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The data on Friday exceeded
All forecasts, and has now impeded
The idea the Fed
When looking ahead
Believes further rate cuts are needed
 
Meanwhile from the Chinese we learned
Their exports are still widely yearned
But imports are falling
As growth there is stalling
And Xi is quite clearly concerned

 

Under the rubric, even a blind squirrel finds an acorn occasionally, my prognostications on Friday morning turned out to be correct as the NFP number was much stronger than expected, the Unemployment Rate fell, and signs of labor market strength were everywhere.  One of the most interesting is the number of quits rose to 13.8%, its highest level in several years and an indication that there is growing confidence amongst the labor force that jobs are available if needed.  As well, as you all are certainly aware, the market responded by selling equities and bonds while reducing the probability of Fed rate cuts this year.  In fact, this morning, the market is pricing in just 24 basis points of cuts for all of 2025, in other words, one cut only.  

Meanwhile, the bond market continues to sell off with yields rising another 2bps this morning.  the chart below shows the dichotomy between Fed funds and 10-year Treasury yields.  Historically, when the Fed was cutting or raising rates, the bond market followed.  But not this time.

Source: tradingeconomics.com

There have been many explanations put forth by analysts as to why this is the case, but to me, the most compelling is that investors disagree with the Fed’s analysis of the economy and, more specifically, with their pollyannaish tone that inflation is going to magically return to 2% because their models say so.  In fact, when looking back over the past 50-years of data, this is the only time that I can see when this dichotomy even existed.

Source: tradingeconomics.com

If I had to guess, there is going to be a lot more volatility coming as previous market signals, and more importantly, Fed market tools, no longer seem to be working as desired.  Nothing has changed my view that 10-year yields head to 5.5%, and if I am correct, look for equity markets to suffer, perhaps quite a bit.

The other story of note overnight was the Chinese trade surplus, which expanded to $104.8 billion in December which took the 2024 surplus to $1.08 trillion.  Now, much of this seems to be preordering of Chinese goods ahead of Trump’s inauguration and the promised tariffs.  But China’s surplus with other Asian economies also grew dramatically last year.  Remember, President Xi is desperate to achieve 5% growth (even on their accounting) and since the Chinese public remains unenthusiastic about spending any money given the $10 trillion hole in their collective savings accounts due to the property market collapse, Xi is reliant on exporting as much as possible.  While this is not making him any friends anywhere else in the world, it is an existential issue for him, so he doesn’t really care.  It will be very interesting to see just how the Trump-Xi relationship moves forward and what concessions are made on either side.

In the end, while the renminbi is basically unchanged this morning, it remains pegged against its 2% limit vs. the CFETS fixing onshore and is 2.35% weaker in the offshore market.  That pressure is going to continue until either the Chinese step up, apply significant stimulus to the domestic economy and start to rebalance the trade process or the PBOC lets the currency go.  Remember, too, Xi is in a tough position because he continuously explained that the renminbi is a good store of value and has been asking his trading partners to use it rather than the dollar.  But if he lets it slide, that will destroy that entire narrative, a real loss of face at the very least, and potentially a much bigger economic problem.  Interesting times.

And so, let us turn to the overnight market activity and see how things are shaping up for today and the rest of the week.  Friday’s sharp decline in US equity indices was followed by similar price action throughout Asia (Nikkei -1.05%, Hang Seng -1.0%, CSI 300 -0.3%, Australia -1.25%) as the narrative is struggling to come up with a positive spin absent further US rate cuts.  European bourses have also come under pressure (DAX -0.7%, CAC -0.8%, IBEX -0.7%, FTSE 100 -0.4%) despite the fact that ECB talking heads continue to explain that more rate cuts are coming, they just won’t be coming quite as quickly as previously expected.  At this point, the market is pricing in 84bps of cuts by the ECB this year.  And yes, US futures are also in the red at this hour (7:00), falling between -0.5% (DJIA) and -1.1% (NASDAQ).

It seems that the narrative writers are struggling to put together a bullish story right now as inflation refuses to fall while growth, at least in Europe, continues to abate.  At least, a bullish story for equities and bonds.  The dollar, on the other hand, has gained many adherents.

Turning to bonds, yields continue to climb across the board with European sovereign yields rising between 2bps (Germany) and 8bps (Greece) and everything in between.  It seems nobody wants to hold bonds right now.  The same was true overnight in Asia where the best performer was the JGB, which was unchanged, but other regional bond markets all saw yields rise between 3bps (Korea) and 9bps (Australia).  Even Chinese yields edged higher by 1bp!

In the commodity space, oil (+2.0%) is en fuego, as the impact of further sanctions on the Russian tanker fleet is being felt worldwide.  It seems the Biden administration has added another 150 Russian tankers to the sanctions list along with insurance companies, and so China and India, who have been the main recipients of Russian oil, are seeking supplies elsewhere.  As long as this continues, it appears oil has further to run.  Meanwhile NatGas (+3.8%) has blasted through $4.00/MMBtu and is now at its highest level since December 2022.  Despite all those global warming fears, the recent arctic blast has increased demand dramatically!

As to the metals markets, the story is different with gold (-0.5%) sliding alongside silver (-2.1%) and copper also trickling lower (-0.15%).  Part of this is clearly the dollar’s strength, which is impressive again today, and part is likely concern over how things are going to play out going forward between the US and China as well as the overall global economy.  Certainly, a case can be made that growth is going to be much slower going forward.

Finally, the dollar is king again, rallying sharply against the euro (-0.5%) and pound (-0.8%) with smaller gains against the rest of the G10 (JPY excepted as it rallied 0.2% on haven flows).  But we are also seeing gains against virtually all EMG currencies (CLP -0.6%, PLN -0.7%, ZAR -0.4%, INR -0.6%) as concerns grow that these other nations will not be able to ably fund their dollar debt as the dollar continues to rise.  FYI, the DXY (+0.35% to 110.07) is at its highest level since October 2022 and looking for all the world like it is going to take out the highs of that autumn at 113.20.

On the data front, this week brings CPI and PPI as well as Retail Sales.  In addition, I was mistaken, and the Fed is not in their quiet period so we will hear a lot more from them this week as well.

TuesdayNFIB Small Biz Optimism100.8
 PPI0.3% (3.4% Y/Y)
 Ex food & energy0.3% (3.7% Y/Y)
WednesdayCPI0.3% (2.8% Y/Y)
 Ex food & energy0.2% (3.3% Y/Y)
 Empire State Manufacturing4.5
 Fed’s Beige Book 
ThursdayInitial Claims214K
 Continuing Claims1870K
 Retail Sales0.5%
 Ex autos0.4%
 Philly Fed-4.0
FridayHousing Starts1.32M
 Building Permits1.46M
 IP0.3%
 Capacity Utilization76.9%

Source: tradingeconomics.com

As well, we hear from five Fed speakers over six venues.  Now, the message from the Fed has been pretty unified lately, that caution and patience are appropriate regarding any further rate cuts but that to a (wo)man they all believe that inflation is heading back down to 2.0%.  I’m not sure why that is the case because if you look at the data, it certainly has the feeling that it has bottomed, and inflation rates are turning higher as you can see from the below chart of core CPI.

Source: tradingeconomics.com

And this is before taking into account that energy prices have been soaring lately!  I realize I’m not smart enough to be an FOMC member, but they certainly seem to be willfully blind on this issue.

At any rate, certainly all things still point to a higher dollar going forward, and I imagine we are going to test some big levels soon enough (parity in the euro, 1.20 in the pound) but I am beginning to get uncomfortable as so many analysts have come around to my view.  Historically, if everybody thinks something is going to happen, typically the opposite occurs.  Remember, markets are perverse!

Good luck

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A Future Quite Noeth

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All eyes will be on NFP
As pundits are hoping to see
A modest result
That can catapult
The market to its apogee
 
If strong, the concern is that growth
Will strengthen and Jay will be loath
To cut rates once more
Which bulls will deplore
Implying a future quite noeth
 
If weak, then the problem for stocks
Is earnings will suffer a pox
So even if rates
Are cut in the States
The NASDAQ may still hit the rocks

 

It’s payroll day and especially after yesterday’s day of respect for the late President Carter closed equity markets in the US, investors are anxious to get back to business.  Here are the latest consensus estimates for the key figures to be released

Nonfarm Payrolls160K
Private Payrolls135K
Manufacturing Payrolls5K
Unemployment Rate4.2%
Average Hourly Earnings0.3% (4.0% Y/Y)
Average Weekly Hours34.3
Participation Rate62.8%
Michigan Sentiment73.8

Source: tradingeconomics.com

As well, there will be annual revisions to the household report today, which is the portion of the process that calculates the Unemployment Rate.  Next month we will see the annual revisions to the NFP, where estimates are already circulating that the number of jobs created in 2024 will be revised down by more than 1 million, nearly one-half of the claimed number (~2.2 million) created.

But ultimately, the reason this data point gets so much press is that it is half of the Fed’s mandate and so is closely watched by the FOMC as they consider any policy stance.  Yesterday, St Louis Fed president Musalem became the seventh or eighth Fed speaker since the last meeting to explain that more caution was warranted as the Fed tries to reduce what they still believe is a modest tightening bias.  “… [rate reductions] have to be gradual – and more gradual than I thought in September,” according to Musalem.  So, caution remains the watchword for every member of the FOMC and accordingly, the market is pricing just a 5% probability of a rate cut later this month.

The thing that has really changed over the past several months is the market’s reaction function to the data.  Part of this is based on the fact that it appears the Fed’s reaction function has changed a bit, and part of this is because the economic situation remains so confusing.

Regarding the Fed, given the fact that the data since they started cutting rates in September has been quite robust and given the fact they no longer have a political/partisan motive to cut rates, it strikes me it will be far harder for Powell and friends to justify further rate cuts from here.  After all, if GDP is growing at 3.0% and inflation is running at 3.3%, absent all other information, that data would truthfully argue for rate hikes.  However, there remains a large camp of analysts that continue to expect a significant slowdown in economic activity, with a number of well-respected voices claiming that we are already in a recession and have been in one since sometime in 2024.  

My view is that this confusion remains best explained by the concept of the K-shaped recovery where a smaller portion of the population, notably those with assets and investments in the markets, have been huge beneficiaries of Fed policies as they not only have seen their portfolios climb in value, but their cash is earning a nice return.  Meanwhile, a much larger percentage of the population, although a group that receives far less press from the financial reporters, continues to struggle given still rising prices and less overall opportunity for advancement.  This is the genesis of the labor strife we have seen, but there are many who remain left behind.  The problem for the Fed is they don’t really see this second cohort as their constituents, at least based on their policy actions.

As to today’s release, if we look at the recent Initial Claims data, it is consistent with a stronger number rather than a weaker one.  However, from a market perspective, I believe that a strong NFP number, something like 200K, will see a risk sell-off as the market continues to remove pricing for any rate cuts in 2025.  This will hurt stocks and likely bonds, although it will help the dollar and, surprisingly, commodities, as the market is likely to see increased demand forthcoming.

Elsewhere, aside from the wildfires in LA, which are a terrible tragedy, the other story in markets today revolves around the ongoing, slow motion disintegration of any remaining credibility in the UK government and its ability to address the many problems there.  Gilt yields continue to rise sharply, although I continue to hear many rationales as to why this is NOT like the October 2022 Gilt crisis.  Alas, while certainly the speed of this decline in Gilts is not quite as dramatic as we saw back then, the duration of the problem is far greater, and we have moved further now than then.  As you can see from the below chart, Gilt yields have risen 110bps since the middle of September, outpacing even Treasury yields and 10yr Gilts now yield 15bps more than Treasuries.  

Source: tradingeconomics.com

In fact, UK 10-year yields are the highest in the G10, although in fairness, they are not yet approaching levels like Mexico (10.6%), Brazil (14.75%) or Turkey (26.4%).  Perhaps Chancellor Reeves has those targets in mind.

OK, let’s see how markets behaved in the lead-up to the data this morning.  There was no joy in Mudville Asia last night as the Nikkei (-1.05%) slid amid new stories that the odds of a BOJ rate hike in two weeks are rising, while Chinese shares (Hang Seng -0.9%, CSI 300 -1.2%) were also under pressure amid news that the PBOC would stop buying bonds (ending QE) and additionally might be selling some to reduce liquidity in Hong Kong as they attempt to slow the decline of the renminbi.  The rest of the region was similarly under pressure across the board. 

In Europe, the picture is more nuanced with the DAX (+0.4%) and CAC +0.3%) showing some modest gains after slightly better than expected French IP data.  However, the FTSE 100 (-0.4%) and other continental bourses (IBEX -0.9%) are not quite as positive, with the FTSE clearly feeling pressure from the overall negative sentiment on the UK, while mixed data elsewhere is undermining any investor sentiment.  US futures at this hour (7:15) are pointing lower by about -0.25% across the board.  Fears of a strong number?

In the bond market, Treasury yields continue to climb, as they are holding onto yesterday’s rise of 5bps and this morning we are seeing European sovereign yields all creep higher by 1bp to 2bps.  JGB yields also rose 2bps overnight as part of that BOJ rate hike story.  In fact, the only market that didn’t see yields rise is China, where they remain within 2bps of their recent all-time lows

In the commodity markets, oil (+3.2%) is skyrocketing as continued cold weather increases heating demand while the reduction in inventories in Cushing, Oklahoma (the main point for NYMEX contract settlements) has raised concern over available supply of crude.  Meanwhile, metals prices continue to climb steadily with gold (+0.3%) continuing its run alongside silver (+0.8%) and copper (+0.45%).  The demand for “stuff” remains strong as nations around the world slowly lose confidence in government bonds as an effective store of value.

Finally, the dollar is, net, little changed this morning with some gains and some losses although few large moves.  On the dollar’s plus side we see KRW (-0.5%), ZAR (-0.55%) and BRL (-0.35%) while the yen and renminbi have both seen modest gains (+0.1%) on the back of the liquidity reduction stories in both nations.  However, we must keep in mind the dollar, as measured by the DXY, remains above 109 and continues to strongly trend higher.  My take is the highs seen in autumn 2022 are the next target, so look for the euro to sink below parity and the pound well below 1.20, probably 1.15, before too long.

There are no Fed speakers on the schedule today, although I imagine we will hear from somebody after the data since they cannot seem to shut up.  However, after today, they head into their quiet period ahead of the next FOMC meeting, so until then we will need to rely on Nick Timiraos from the WSJ to understand what Powell is thinking.

While nothing is that clear, and we could easily see a weak NFP report, my take is we are far more likely to see a strong one with stocks and bonds selling off and the dollar rising further.

Good luck and good weekend

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Quite a Fuss

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Inflation is still somewhat higher
Though currently nor quite on fire
Thus, further reductions
In rates may cause ructions
In markets, which we don’t desire

 

“With regard to the outlook for inflation, participants expected that inflation would continue to move toward 2 percent, although they noted that recent higher-than-expected readings on inflation, and the effects of potential changes in trade and immigration policy, suggested that the process could take longer than previously anticipated. Several observed that the disinflationary process may have stalled temporarily or noted the risk that it could. A couple of participants judged that positive sentiment in financial markets and momentum in economic activity could continue to put upward pressure on inflation.” [emphasis added]

I think this paragraph from the FOMC Minutes was the most descriptive of the evolving thought process from the committee.  Since then, we have heard every Fed speaker discuss the need for caution going forward with regard to further rate reductions although to a (wo)man, they all remain convinced that they will achieve their 2% target while still cutting rates further, just more slowly.  While today is a quasi-holiday, with the Federal government closed along with the stock exchanges, although banks and the Fed are open and making payments, I anticipate activity will be somewhat reduced.  This is especially so given tomorrow brings the NFP data which will be closely monitored given the recent strength seen in other economic indicators.  If that number is strong, I anticipate the market will reduce pricing for future rate cuts towards zero from this morning’s 40bps total for 2025.  This, my friends, will serve to underpin the dollar going forward.

In England, there is quite a fuss
As traders begin to discuss
Can Starmer and Reeves
Address what aggrieves
The nation, or are they now Truss?

The situation in the UK seems to be going from bad to worse.  Even ignoring the horrifying stories regarding the cover-up of immigrant grooming gangs and their actions with young girls, the economic and policy story is a disaster.  While the exact genesis of their fiscal issues may not be certain, the UK’s energy policy, where they have doubled down on achieving Net Zero carbon emissions and continue to remove dispatchable power from their grid, is a great place to start looking.  UK electricity prices are the highest in Europe, even higher than Germany’s, and that is destroying any ability for industry to exist, let alone thrive.  The result has been slowing growth, reduced tax receipts and a growing government budget deficit.

Some of you may remember the Gilt crisis of September/October 2022, when then PM Liz Truss proposed a mini-budget focused on growth but with unfunded aspects.  Confidence in Gilts collapsed and pension funds, who had been seeking sufficient returns during ZIRP to match their liabilities and had levered up their gilt holdings suddenly were facing massive margin calls and insolvency.  The upshot is that the BOE stepped in, bought loads of Gilts to support the price and PM Truss was booted out of office.

While the underlying issues here are somewhat different, the market response has been quite consistent with both Gilts (+5bps this morning, +34bps in past week) and the pound (-0.6% this morning, -2.0% in past week) under significant pressure again this morning.  Unlike the US, with the global reserve currency, the UK doesn’t have the ability to print as much money or borrow as much money as they would like to achieve their political goals.  In fact, the UK is far more akin to an emerging market than a G7 nation at this stage, running a massive fiscal deficit with rising inflation and a sinking currency amid slowing economic growth.  There are no good answers for the BOE to address these problems simultaneously.  Rather, they will need to address one thing (either inflation and the currency by raising rates, or economic activity by cutting them) while allowing the other problem to become worse.  

It is very difficult to view this situation as anything other than a major problem for the UK.  While it occurred before even my time in the markets, back in the 1970’s, the UK was forced to go to the IMF to borrow money to get them through a crisis.  There are some pundits saying they may need to do this again.  For some perspective, the chart below shows GBPUSD over the long-term.

Source: tradingeconomics.com

The history is the pound was fixed at $2.80 at Bretton Woods and then saw several devaluations until 1971 when Nixon closed the gold window, and Bretton Woods fell apart.  The spike lower in the 1970’s was the result of the UK policies driving them to the IMF.  The all-time lows in the pound were reached in 1985, when the dollar topped out against its G10 brethren, and that resulted in the Plaza Accord.  But since then, and in truth since the beginning, the long-term trend has been for the pound to depreciate vs. the dollar.  

It continues to be difficult for me to see a strong bull case for the pound as long as the current government seems intent on destroying the economy.  FX option markets have seen implied volatility spike sharply, with short dates rising from 8% to 13% in the past week while bids for GBP puts have also exploded higher.  Meanwhile, the gilt market cannot find a bid.  Something substantive needs to change and don’t be surprised if it is political, with Starmer or Reeves, the Chancellor of the Exchequer, finding themselves out of office and a new direction in policy.  However, until then, look for both these markets to continue lower.

I apologize for the history lesson, but I thought it best to help understand today’s price action in all things UK.  And that’s really it for discussion.  Yesterday’s mixed US session was followed by weakness in Asia (Nikkei -0.95%, Hang Seng -0.2%, CSI 300 -0.25%) with the rest of the region also lower.  However, this morning in Europe other than the DAX, which is basically unchanged, modest gains are the order of the day.  Surprisingly, the FTSE 100 (+0.55%) is leading the way higher, but given the large majority of companies in this index benefit from a weaker pound, perhaps it is not so surprising after all.

In the bond market, Treasury yields are 3bps lower this morning, although still near recent highs above 4.65%, while European sovereigns continue to rise as the global interest rate structure climbs amid growing concerns nobody is going to adequately address the ongoing inflation.  Even Chinese yields rose 2bps despite CPI data showing deflation at the factory gate continues and consumer demand remains moribund.

Commodity prices are modestly firmer this morning with oil (+0.2%) stabilizing after a sharp decline yesterday on supply concerns after a large build of product inventories in the US.  Metals prices continue to be supported (Au +0.4%, Ag +0.8%, Cu +1.2%) despite the dollar’s ongoing strength as it appears investors want to hold real stuff rather than financial assets these days.

Finally, the dollar continues to climb with most currencies sliding on the order of -0.2% aside from the pound mentioned above and the yen (+0.3%) which seems to be acting as a haven this morning.  Nonetheless, this remains a dollar focused process for now.

There is no economic data to be released today although I must note that Consumer Credit was released yesterday afternoon and fell -$7.5B, a much worse outcome than expected.  As you can see from the below chart, declining consumer credit, while not completely unheard of, is a pretty rare occurrence.  You can clearly see the Covid period and the best I can determine is the December 2015 decline is a data adjustment, not an actual decline.  The point to note, though, is that despite lots of ostensibly strong economic data, this is a warning.

Source: tradingeconomics.com

I keep looking for something to turn the tables on the dollar, but for now, it is hard to make the case that the greenback is going to suffer in any broad-based manner.  Tomorrow, though, with NFP should be quite interesting.

Good luckAdf

Falling Further

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Like a stone toward earth
The yen keeps falling further
Beware Kato-san

 

While we have not discussed the yen much lately, its recent weakness, in concert with the dollar’s broad strength, has begun to cause some discomfort in Japan.  Last night, Japanese FinMin Katsunobu Kato explained, “We will take appropriate action if there are excessive movements in the currency market.”  He went on that he is “deeply concerned” by the recent weakness, especially moves driven by those evil pesky speculators.

The problem, of course, is that all those expectations that the BOJ would be tightening policy to fight domestic inflation while the Fed would continue to ease policy since they “beat” inflation, with the result being the yen would regain its footing, have proven to be false hope.  Instead, as you can see from the below chart, since the Fed first cut rates back in September, the yen has tumbled nearly 13% and very much looks like it is going to test the previous four-decade highs seen last summer.

Source: tradingeconomics.com

Last year, the MOF/BOJ spent about $100 billion in their efforts to stem the yen’s weakness.  They still have ample FX reserves to continue with that process, but ultimately, history has shown that maintaining a cap on a currency that is weakening for fundamental reasons is nigh on impossible.  If a weak yen is truly seen as existential in Tokyo, then Ueda-san needs to be far more aggressive in tightening monetary policy.  This is especially so given the Fed continues to back away from earlier expectations that it would be aggressively loosening policy.  Now, while JGB yields have moved higher over the past several sessions, trading now at 1.18%, which is their highest level since April 2011, that is not going to be enough to stem this tide.  From what I read, inflation is an issue, but not the same as it was in the US in 2022, so Ueda-san is not getting the same pressure to address it as Powell did back then.  My read is the BOJ remains on hold this month and hikes rates in March while the yen continues its decline.  Look for another bout of intervention when we test the 162 level, but that will not stop the rot.  Nothing has changed my view of 170 or higher in USDJPY by year end.

Though Treasury yields have been rising
Most credit spreads have been downsizing
So, corporate supply
Is ever so high
An outcome that’s somewhat surprising

In the bond market, government bond yields continue to rise around the world (China excepted) as investors increase their demands in order to hold the never-ending supply of new bonds.  Ironically, despite this ongoing rout in government bonds across the board, corporate debt issuance looks as though it will set new records this month.  One thing to remember here is that corporates have a lot of debt coming due over the next two years as all that issuance during the ZIRP period needs to be rolled over.  But the other thing to recognize is that corporate credit spreads, the amount of yield investors require to own risky corporate bonds vis-à-vis “safe” government bonds, has fallen to its lowest levels in years, and as can be seen in the chart below, the extra yield available for high-yield investors is shrinking faster than for investment grades.

Potentially, one reason for this is the dramatic increase in the amount of Private Credit, the latest investment fad where weaker credits go directly to funds designed to lend money rather than to their banks, and investors ostensibly remove one of the middlemen from the process.  As such, there is less of this debt around than there otherwise might be, hence increasing demand and reducing that credit spread.  But the other reason is that there continues to be a significant amount of investable assets looking for a home, and with global yields near the highest they have been in a decade or more, and with the equity market dividend yield down to just 1.27% or so, a record low, there are lots of investors who are comfortable with clipping 5% or 5.5% coupons on BBB corporate bonds.

The question I would ask is, if government bond yields continue to climb, and I see no reason for that to stop given the trend in inflation and necessary issuance, at what point are investors going to get scared?  We are likely still a long way from that point, but beware if the new Treasury Secretary, Scott Bessent, follows through with his hinted views of reducing T-bill issuance and increasing coupon issuance, yields could go much higher absent the Fed implementing QE.  That would cause some serious market ructions!

Ok, let’s see how things look around markets this morning after yesterday’s sell-off in the US equity markets.  It seems Japanese stocks were caught between the weaker yen (generally a stock positive) and the tech sell-off (generally a stock negative) with the Nikkei closing lower by -0.25% on the session.  Meanwhile, the Hang Seng (-0.9%) suffered a bit more on the tech move, although Mainland shares (-0.2%) were not as badly affected.  An interesting story here is that the chief economist at state-owned SDIC Securities made comments at an international forum run by the Peterson Institute that really pissed off President Xi.  Gao Shanwen said the quiet part out loud when he claimed that actual GDP growth in China for the past several years has likely been much closer to 2% than the 5% published.  That story has been widespread in the West, although has never been given official credence.  And for Xi, 2% growth is not going to get it done, what with the property bubble still imploding and consumption declining despite promises of more stimulus.  Stay tuned to this story to see if we start to see more Western analysts reduce their expectations.  Elsewhere in Asia, the picture was mixed with gainers (Korea, Australia, Singapore) and laggards (Taiwan, Malaysia, Philippines).

In Europe, red is today’s color, led by the CAC (-1.0%) although we are seeing losses across the board. Eurozone data showed declining Consumer Confidence, Economic Sentiment and Industrial Sentiment all while inflation expectations remain stubbornly high.  That stagflationary hint is typically not an equity market benefit so these declines should be expected.  The story on the continent is not a positive one and I maintain that the ECB is going to have to cut rates more aggressively than their inflation mandate would suggest.  That might support equities a bit, but it will be hell on the euro!  Finally, US futures are a touch softer (-0.2%) at this hour (7:05) although they were higher most of the overnight session before this.

As mentioned above, bond yields are higher with Gilts (+9bps) leading the way as not only is the economy suffering from some very poor policy decisions by the Starmer government, but it seems that the ongoing political crisis regarding grooming gangs has investors shying away.  But yields continue to rise across the board with continental yields up between 3bps and 6bps, Treasury yields higher by another 1bp this morning after a 10bp rise in the previous two sessions, and JGB yields, as mentioned, higher by 5bps.  This trend is very clear!

In the commodity markets, oil (+0.5%) keeps on keeping on, as API data showed a greater than 4mm barrel draw on inventories, far more than expected and indicating a reduced supply around.  Cold temperatures are keeping NatGas (+5.0%) firm as well.  In the metals markets, both precious and base are under a touch of pressure this morning, down less than -0.2%, largely in response to the dollar’s rebound.

Speaking of the dollar, it is higher against all its counterparts this morning with the pound (-1.2%) the G10 laggard although weakness on the order of 0.5% is pretty common this morning.  In the EMG bloc, ZAR (-1.5%) is the worst performer, after weaker than expected PMI data called into question the economic path forward.  But here, too, we are seeing weakness like MXN (-0.9%), CLP (-0.8%), PLN (-0.8%) and KRW (-0.5%).  I would be remiss to ignore CNY (-0.25%), which is trading below (dollar above) 7.3600 in the offshore market, and is now 2.4% weaker than last night’s fixing rate.  This is also the weakest the renminbi has been since it touched this level back in September and then November 2007 prior to that.  Those Chinese problems are coming home to roost for President Xi.

On the data front, ADP Employment (exp 140K) leads the day followed by Initial (218K) and Continuing (1870K) Claims.  These are being released this morning because of tomorrow’s quasi holiday regarding the late President Carter, when US markets will be closed.  This afternoon, the FOMC Minutes arrive and will be scrutinized closely to see just how hawkish they have become.  We also hear from Governor Waller this morning with caution being the watchword from virtually every Fed speaker of late.

It is all playing out like I anticipated, with the ISM data showing strength yesterday, not just in the headline number, but also in the Prices Paid number.  The Fed will have no chance to cut rates again, and I look for the dollar to continue to rise.

Good luck

Adf

No Reprieve

Posted on by

The scuttlebutt had it correct
Trudeau hit the button, eject
But he’s yet to leave
And there’s no reprieve
His legacy will be neglect

 

Those reports from yesterday morning were spot on as around 11:00am, PM Trudeau announced that he would, in fact, be stepping down.  There is a somewhat convoluted process involved which sees the Canadian Parliament prorogued until late March, while the ruling Liberal party seeks a new leader.  At that point, Parliament will be called back into session, and it seems likely a vote of no confidence will be held.  Assuming that vote goes against the new leader, an election will be called.  No matter how long the Liberals delay this process, and you can bet they will hang on for as long as possible, by October, an election is required.  As well, currently all things point to the Conservative party led by Pierre Poilievre winning that election and taking power with a significant majority.  Obviously, Poilievre would like the election to happen sooner, rather than later, but it seems hard to believe now, regardless of the new Liberal leader, that the Conservatives will fail to win.

The market impact of this news needs to be separated from the broader drivers, but as I showed yesterday, CAD had been weakening more quickly than the dollar writ large, and now it seems to be moving back into line with the general movement as per the below chart showing the movements between the DXY and USDCAD right on top of each other. 

Source: tradingeconomics.com

My sense is that Canada has now had its day in the sun and will soon retreat to the background of most market consciousness going forward.  After all, despite it being our largest trading counterparty, it has a small population and small economy with limited impact on the global situation.

Certification’s complete
And Trump, in two weeks, takes his seat
Between now and then
Again and again
Prepare for a surfeit of Tweet(s)

In truth, aside from the Canadian story, the bulk of the discussion in both financial and political circles is focused on exactly what President Trump will do when he is inaugurated on the 20th.  The biggest financial discussion revolves around tariffs and exactly how he plans to utilize them going forward.  For the surface thinkers, tariffs are an unadulterated bad policy with significant negative consequences.  As well, the idea that tariffs = higher dollar is axiomatic to these people.  In fact, yesterday’s reversal in the dollar’s recent substantial gains was based entirely on a story that despite some campaign rhetoric of large tariffs imposed on Day 1 of the new Trump administration, in fact things would be far more nuanced.

While I understand the economic case behind tariffs driving the dollar higher (nations hit with tariffs will devalue their currency sufficiently to offset the tariff and allow their exports to remain competitive in the US), I have always been suspect of that theory and logic.  First, we can look at Trump’s first term and see how things played out.  The chart below of USDMXN, a tariff target, shows that, in fact, initially the peso strengthened upon Trump’s inauguration and range traded for the bulk of his term, only weakening substantially during the Covid market dislocations.

Source: tradingeconomics.com

We can look at USDCNY as well and see that over Trump’s first term, there were several large ebbs and flows in the yuan but that, in fact, CNY was stronger vs. the dollar at the end of his term than at the beginning.  Again, this assumption the dollar will appreciate strongly because of tariffs is a talking point, not an empirical reality.

Source: tradingeconomics.com

The other thing to remember about Trump (although it is not clear how you can forget it) is that he is a businessman, not a politician.  He is very transactional and wants to make deals.  I am a strong proponent of the idea that Trump sees tariffs as a negotiating tool and while he is a man of great bluster in his public pronouncements, his ultimate goal remains clearly to achieve his sense of fairness in trade relations.  If his belief is that a nation is maintaining a weak currency to enhance its mercantilist model, Trump will respond aggressively.  Ultimately, I believe a large part of the angst that is evident in governments around the world is that Trump will not behave in a diplomatic manner and will call out all the problems he sees or believes.  And other governments are uncomfortable with their own dirty laundry left to air dry.  While I continue to believe that inflation remains far stickier than the Fed is willing to admit now, nothing has changed my view that the Fed will not cut again and may be forced to raise rates before the year ends.  And that will support the dollar!

Ok, let’s turn to the overnight session.  After a mixed Wall Street performance, where the Mag7 continue to shine, but not so much else, we saw the Nikkei (+2.0%) rally sharply as well, following the NASDAQ.  Chinese shares (CSI 300 +0.7%, Hang Seng -1.2%) were split with the former benefitting from the reduced tariff story while the Hang Seng suffered largely on the back of Tencent Holdings being named a military contractor by the US DOD with its shares tumbling 8% in the US and HK.  Elsewhere in the region, there were both gainers and laggards but nothing of any note in either direction.  In Europe, UK shares (-0.3%) are under pressure as 30yr Gilt yields have risen to their highest level since 1998, an indication that investors are becoming concerned over the UK’s future path.  For context, current levels are 50bps above those which triggered the October 2022 gilt crisis and spelled the end of PM Liz Truss’s time in office.  Meanwhile, continental bourses are modestly higher led by the CAC (+0.6%) which seems to be benefitting from both the lower tariff story as well as hopes that Chinese stimulus will support the luxury goods sector.  As to US futures, at this hour (7:05) they are essentially unchanged.

In the bond market, yields are continuing to edge higher everywhere with Treasuries up 1bp and European sovereign yields higher by between 2bps and 4bps across the board.  Asian government bond markets continue to sell off as well, with yields there climbing in Japan and Australia and even Chinese 10yr yields edging higher by 1bp.  As long as central banks around the world insist that rate cuts are the future (and most of them do) look for bond yields to continue to climb.

In the commodity space, oil (+0.8%) continues to hold its own as trading activity remains modest and hopes are pinned on Chinese stimulus.  NatGas (-3.2%) is backing off its highs as the winter storm has passed (although it is still really cold here!) while the metals markets are performing well.  Gold (+0.5%) continues to trade either side of $2650/oz as speculators await the next major leg.  However, silver (+1.1%) and copper (+0.5%) have both bounced nicely from recent lows as specs look for another breakout higher.

Finally, the dollar is under modest pressure this morning compared to yesterday’s closing levels but is actually slightly firmer than when I wrote yesterday morning.  My point is that while it has been selling off from its peak late last week, there is no collapse coming and all eyes will be turning toward the data later this week to see if the Fed will have room to ease further, or if the NFP report will once again show strength and push any further rate cuts off in time.  The leading gainer in the G10 is NZD (+0.65%) which is benefitting from a combination of higher commodity prices, hopes for more Chinese stim and the tariff reduction story.  But for the rest of the market, 0.2% gains are the norm with only JPY (-0.15%) bucking the trend.

On the data front, this morning brings the Trade Balance (exp -$78.0B) as well as ISM Services (53.3) and JOLTS Job Openings (7.70M).  Yesterday’s PMI data while solid was softer than forecast and Factory Orders, too, were a tick lower than expected at -0.4%.  First thing this morning we will hear from Richmond Fed president Barkin who has been on the more hawkish side lately.  After the weekend chorus that cuts needed to be deliberate, I expect more of the same here.

For now, the broad themes remain unchanged, higher US yields on the back of inflation concerns forcing the Fed to reverse course this year.  But on a day-to-day basis, it would not be surprising to see the dollar continue to give back some of its recent gains given the significant size and speed with which they were attained.  I still like hedgers picking levels and leaving orders to buy dollars a bit cheaper from here.

Good luck

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Active De-Bonding

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Up north is a nation quite vast
Whose money, of late’s been, out, cast
But word that Trudeau
Is soon set to go
Has seen Loonies quickly amassed
 

One of the biggest stories over the weekend has been the sudden upsurge in articles and discussion regarding the remaining tenure for Canadian PM Justin Trudeau.  For the past several weeks, since his FinMin Krystia Freeland resigned and published a scathing resignation letter, pressure on Trudeau has increased dramatically.  It appears that it is coming to a head with articles from both Canadian and international sources indicating he may step down as soon as this week.  As well, his main political rival, conservative party leader Pierre Poilievre, is touted, according to the betting websites, as an 89% probability to be the next PM.
 
Now, we all know the dollar has been strong in its own right lately, and I suspect that while there will be bumps along the road, it will get stronger still over the year absent some major Fed rate cutting.  As such, USDCAD is higher along with everything else.  However, you can see in the chart below (the green line rising faster than the blue line since December) that it has been an underperformer for the past month, since that Freeland resignation, as investors have been shying away from Canada, given the combination of concerns over the incoming Trump administration imposing tariffs and no political leadership to address these issues.

 

Source: tradingeconomics.com

While no sitting politician is ever willing to cede power easily, and there are indications that Trudeau is going to go down kicking and screaming, ultimately, I expect that Poilievre will be the PM and will develop a strong relationship with the US.  As that becomes clearer, I expect to see the CAD appreciate modestly vs. the dollar, but much more so against other G10 currencies.

Once more, what the Chinese have said
Is stimulus is straight ahead
But so far, its talk
They ain’t walked the walk
So, bulls need take care where they tread

Another tidbit this morning comes from Beijing, where the economic planning agency there has indicated that they will expand subsidies for consumer purchases of electronic goods like cellphones, tablets and smart watches, as President Xi continues to watch his nation’s economy grind along far more slowly than he really needs to happen.  There was an excellent thread on X this morning by Michael Pettis, one of the best China analysts around, describing the fundamental problem that Xi has and why the slow motion collapse of the property market portends weakness for a long time going forward.  As is almost always the case, while tearing the proverbial band aid off quickly can hurt more at the instant, the pain dissipates more quickly.  President Xi believes he cannot afford to inflict that much pain, so their problems, which stem from decades of malinvestment in property that inflated a massive bubble, are going to last for a long time.  While CNY (+0.4%) is modestly firmer this morning, that is only because the dollar is weaker across the board, and in fact, it is significantly underperforming.

This week, the US Treasury’s Yellen
Much debt, will look forward to sellin’
The market’s responding
By active “de-bonding”
With dollars and bonds both rebellin’

The last big story of the day is clearly the upcoming Treasury auctions this week, where the US is set to sell $119 billion of debt, starting with $58 billions of 3-year notes today.  Arguably, market participants have been aware that this was going to be a necessary outcome given the massive deficits that continue to be run by the US.  Adding to the broad concept of deficits, the Biden administration appears to be trying to spend every appropriated dollar in the last two weeks in office and that requires actual cash, hence the auctions to raise that cash.  In addition, the debt ceiling comes back into force shortly, so they want to get this done before that serves to prevent further issuance.

Now, the yield curve has reverted back to a normal slope with the 2yr-10-yr spread at 34bps and 30yr bonds trading another 22bps higher than 10yr at 4.81% and bringing 5% into view.  Here’s the thing about the relationship between the dollar and yields; the dollar is typically far more correlated to short-term yield differentials, not long-term yields.  So rising 30yr bond yields is not likely to be a dollar benefit.  In fact, just the opposite as international investors will not want to suffer the pain of those bonds declining in price rapidly.  

And this is what we are witnessing this morning as the dollar, which rallied sharply at the end of last week, is correcting in a hurry today.  As mentioned above, CNY is the laggard with the euro, pound, Aussie, Kiwi and Loonie all firmer by 1% or more this morning and similar gains seen across the emerging markets, with some extending those gains as far as 1.35% or so.  Is this the end of the dollar?  I would argue absolutely not.  However, that doesn’t mean that we won’t see a further decline in the buck before it heads higher again.  A quick look at the chart below, which shows the Dollar Index, while it has just touched the steep trend line higher, it remains far above its 50-day and 100-day moving averages.  Howe er, it seems that the big story here comes from a report from the Washington Post that Trump is considering much less widespread tariff impositions with only some critical imports to be addressed.  As such, given the tariffs = higher dollar consensus, if this is true, you can understand the dollar’s retreat.

Source: tradingeconomics.com

However, today’s story is that of a weak dollar and strong equity markets, well at least in some places. Friday’s US equity rally was not followed by similar enthusiasm in Asia with the Nikkei (-1.5%) leading the way lower while both the Hang Seng (-0.4%) and China (-0.2%) also lagged.  Perhaps the mooted China stimulus helped those markets on a relative basis.  Europe, however, is in fine fettle (CAC +2.3%, DAX +1.4%, IBEX +0.9%) as PMI data released this morning was solid, if not spectacular, and the weaker dollar seems to be having a net positive impact.  US futures are also firmer, with NASDAQ (+1.1%) leading the way.

In the bond market, the big movement was in Asia overnight as JGBs (+4bps) sold off alongside virtually every other Asian bond market except China, which saw yields edge lower by 1bp to a new record low of 1.59%.  In Europe, there has been very little movement with yields +/- 1bp at most and Treasury yields, which had been firmer earlier in the overnight session, have actually slipped back at this hour and are lower by 2bps to 4.58%.

In the commodity markets, the weak dollar has helped support prices here with oil (+1.0%) continuing its rally (+9% in the past month) as the combination of Chinese stimulus hopes and cold weather seem to be providing support.  Speaking of cold weather, NatGas (+7.4%) is also in demand this morning as winter storm Barrie makes its way across the country.  In the metals markets, gold (+0.3%) is the laggard this morning with both silver (+2.3%) and copper (+2.4%) really taking advantage of the dollar’s weakness.

On the data front, there is a ton of stuff this week, culminating in NFP on Friday.

TodayPMI Services58.5
 PMI composite56.6
 Factory Orders-0.3%
TuesdayTrade Balance-$78.0B
 ISM Services53.0
 JOLTS Job Openings7.70M
WednesdayADP Employment139K
 Initial Claims217K
 Continuing Claims1848K
 Consumer Credit$12.0B
 FOMC Minutes 
FridayNonfarm Payrolls160K
 Private Payrolls134K
 Manufacturing Payrolls10K
 Unemployment Rate4.2%
 Average Hourly Earnings0.3% (4.0% Y/Y0
 Average Weekly Hours34.3
 Participation Rate62.8%
 Michigan Sentiment73.9

Source: tradingeconomics.com

In addition to all this, we hear from six more Fed speakers over seven venues with Governor Waller likely the most impactful.  Over the weekend, we heard from Governor Kugler and SF President Daly, both explaining that they needed to see more progress on inflation before becoming comfortable that things were ok.

Clearly, the tariff story is the current market driver in the dollar.  As I never saw tariffs as the medium-term driver of dollar strength, I don’t think it has as much importance.  Plus, this is a report from the Washington Post.  There are still two weeks before inauguration and many things can happen between now and then.  Nothing has changed my longer-term view that the dollar will be supported as the Fed, which is not tipped to cut rates this month and is seen only to be cutting about 40bps all year will ultimately raise rates as inflation proves far more stubborn than desired.  But that is the future.  Today, pick spots to establish dollar buys and leave orders.

Good luck

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