Author Archives: fxpoet

Scapegoated

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The people of Germany voted
With Friedrich Merz, at last, promoted
The nation, to lead
Though sure to misread
The sitch, with the Right still scapegoated

 

The result of the German Federal elections was very much as expected, the CDU/CSU won 28.5% of the votes and the largest share while AfD garnered 20.8%, the SPD just 16.4% (it’s worst showing in modern times) and the Greens gaining 11.6%.  A tail of other mostly very left-leaning parties made up the balance.  However, one cannot look at a map of the distribution of votes without noticing that the part of the country that was East Germany prior to the fall of the Berlin Wall, still sees things very differently than the rest of the nation.

Source: Reuters.com

Regardless of the distribution, however, the outcome will result in some sort of coalition government, almost certainly to be a combination of the CDU and SPD.  On the surface, it would seem this left-right coalition will be doomed to failure, and that could well be the case, but because the consensus amongst the ‘right-thinking’ people in politics is that AfD is the devil incarnate, or perhaps more accurately, Hitler incarnate, Herr Merz will not be able to rule with a sure majority of conservative voters.

As with virtually every election, the economy is a top priority of the voters, especially since GDP growth, as measured, has essentially been zero for the past three years as per the below chart, and is mooted to stay there on present policies.

Source: tradingeconomics.com

One of the key issues that is currently under discussion there is the constitutionally enshrined ‘debt-brake’ which prevents the German government from running deficits of greater than 0.35% of GDP in any fiscal year.  In order to change the constitution, there needs to be a 2/3’s approval in the Bundestag, but AfD holds a blocking minority and one of their policy platforms has been fiscal prudence.

Arguably, this begs a larger question, what exactly constitutes economic growth?  For instance, if government debt is rising more quickly than economic output, is that actually a growing economy?  And is that process sustainable going forward?  It is quite interesting to look at the government debt dynamics of different nations and ask that question, especially since Germany’s situation really stands out.  

Perhaps, after looking at this group of charts, it is worth reevaluating exactly how much actual growth has been occurring and how much economic activity has simply been government borrowing recycled into the economy across all these nations.  Of course, this process has not been restricted to G-7 nations, it is a global phenomenon, with China doing exactly the same thing as are virtually all nations.  In fact, Germany is unique amongst large nations for bucking the trend.

The reason this issue matters is there is a limit to how far a government can increase its leverage ratio.  At some point, investors will stop buying debt which will force the central bank to buy the debt.  Of course, they will do so by printing more money and devaluing the currency.  We know this because we have seen it happen before many times throughout history with Germany’s Weimar Republic in 1923, Argentina in the 1980’s and Zimbabwe in 2007-2008 as just the most recent examples.  In fact, the reason the Germans have the debt brake is that there is a national memory of that hyperinflation from a century ago.

Circling back to the growth question, what is it that constitutes economic growth?  If you remember your college macroeconomics classes, this is the equation that is used to calculate economic activity in an economy:

            Y = C + I + G + NX

Where:

Y = GDP

C = Consumption

I = Investment

G = Government spending

NX = Net Exports

This equation is taken as gospel in the economics and political worlds.  However, it is not often recalled that it was created in the 1930’s by John Maynard Keynes.  It is not a law of nature, but merely was Keynes’ way of expressing something that had not been effectively measured previously.  Nearly 100 years later, though, perhaps it is time to reevaluate the process.  Remember, economies grew prior to Keynes creating this equation when government activity was a much smaller proportion of the economy.  But as we can see by the dramatic rise in government debt, that is no longer the case.  Perhaps Germany is a peek behind the GDP curtain that shows absent constantly increasing government borrowing, economic growth is stagnant.  Neil Howe’s Fourth Turning could well be the conclusion of this period of government excess, where things will be extremely volatile during the change, but less government will be the norm on the other side, at least for a few generations!

Ok, sorry for the history and theoretical discussion, but that chart of German government debt vs. the rest of the world was really eye-opening.  Let’s turn to markets from the overnight session.

After Friday’s sharp downward movement in the US, the picture in Asia was far more mixed.  Japan (+0.25%) managed a small gain while Hong Kong (-0.6%) and China (-0.2%) both lagged.  Elsewhere in the region, New Zealand (-1.8%) stood out for its weakness, although Korea, India and Taiwan were all softer in the session as well.  Ironically, it seems that better than expected Retail Sales data in NZ hurt sentiment for further policy ease by the RBNZ and concerns over trade with China given US pronouncements is also hurting the situation there, at least for today.

In Europe, Germany’s DAX (+0.9%) is leading the way higher after IfO Expectation data was released a touch better than forecast at 85.4.  However, it is important to remember that while this was a positive outcome, the average reading prior to Covid was between 95 and 103.  As to the rest of Europe, there are more gainers than laggards but little of real note absent any other data.  US futures at this hour (7:00) are pointing higher by at least 0.5% across the board.

In the bond market, Friday saw a very sharp decline in yields, -10bps in Treasuries, after weak readings in the Flash PMI data, especially services at 49.7, Existing Home Sales and Michigan sentiment.  That helped bring global yields lower.  This morning, Treasuries have bounced just 1bp and we are seeing similar rises in most of Europe.  JGB yields are also unchanged and have continued to consolidate near recent highs.

In the commodity markets, after a sharp sell-off on Friday on the back of stories about increased supply from Kurdistan, oil (0.0%) is unchanged this morning.  Meanwhile gold (+0.5%) is rebounding from its regular Friday sell-off, almost as though there were efforts by some to depress the price at the end of every week.  It will be interesting to see what happens this Friday which is month end as well.  As to silver and copper, they are little changed and dull this morning.

Finally, the dollar is asleep this morning, with very limited movement vs. almost any of its counterparts.  USDJPY remains below 150, but the yen has actually fallen -0.3% on the session, while the biggest movers are in Eastern Europe (CZK +0.8%, HUF +0.4%, PLN +0.35%), perhaps on the back of the German election results offering hope for a more useful German government.  We shall see about that.  Otherwise, nobody is concerned over the dollar right now.

On the data front this week, it is a quiet one with PCE data the highlight on Friday.

TodayChicago Fed Natl Activity0.21
TuesdayCase Shiller Home Prices4.4%
 Consumer Confidence103.0
WednesdayNew Home Sales680K
ThursdayInitial Claims220K
 Continuing Claims1874K
 Q4 GDP (2nd look)2.3%
 Real Consumer Spending4.2%
 Durable Goods2.5%
 -ex Transport0.3%
FridayPersonal Income0.3%
 Personal Spending0.2%
 PCE0.3% (2.5% Y/Y)
 Core PCE0.3% (2.6% Y/Y)
 Chicago PMI41.5

Source: tradingeconomics.com

In addition to the data, we also hear from seven Fed speakers over 9 venues, but again, are they really going to change the cautious approach at this stage?  And does it even matter?  For now, financial markets are far more focused on President Trump and his cabinet’s activities than interest rate policy which seems set to remain in place for a while.

When it comes to the dollar, nothing has changed my perspective on relative interest rates in the front end, with US rates likely to be far stickier at current levels than others, but the back end has a potentially different outcome.  Recall that Bessent and Trump are focused on the 10-year yield and getting that lower and seem far less concerned over the Fed for now.  To achieve that they will need to demonstrate the ability to reduce spending and the deficit situation.  While a promising start has been seen with DOGE, we are still a long way from a balanced budget.  My take is the dollar, writ large, is going to take its cues from the 10-year yield for now, so bonds are the market to watch.  If we see yields head back toward 4.0%, the dollar will decline and any significant move higher in yields will likely see the dollar climb as well.

Good luck

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Japanese Tao

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Japanese prices
Are rising ever higher
Probably nothing!
 
Meanwhile Ueda
Explained QE can still be
The Japanese Tao

 

Japanese inflation data was released last night, and the picture was not very pretty.  In fact, let me show you.  The first chart shows the monthly readings of annual inflation for the past 5 years.  Last night’s 4.0% reading was not the highest in that period, (that distinction belongs to Feb 2023 at 4.3%), but it is pretty clear that any sense of declining inflation is beginning to dissipate and has been doing so for the past year.  PS, remember, Japanese interest rates range from 0.5% in the overnight to 1.425% in the 10-year, so real rates remain highly negative regardless of your timeframe.

The second picture takes a longer-term perspective to help us better understand the long history of inflation in Japan.  While a decade ago, inflation showed an uptick of nearly the recent magnitude, that was driven specifically by the government raising the GST (goods and services tax) which was Japan’s answer to a VAT.  It was highly controversial at the time but was also understood to have a truly transitory impact as it was a one-off rise in prices.  However, beyond that period, the Japanese have been living with inflation somewhere between -2.2% in the wake of the GFC and 2.0% since the turn of the century.  In fact, going back to the 1990’s, inflation didn’t reach current levels, and one must head back to 1981 to see significant inflation in Japan.  This means there are two generations of people who have basically never seen prices rise in the current manner.

So, what do you think the central bank is considering?  Let me give you Ueda-san’s own words, [emphasis added] “In exceptional cases where long-term interest rates rise sharply in a way somewhat different from normal movements, we will flexibly increase purchases of government bonds to promote stable formation of interest rates in the market.”  You read that correctly inflation is rising sharply, JGB yields are rising in sync and the BOJ’s response is to BUY MORE BONDS!!!  You cannot make this stuff up.  I guess old habits die hard.

The market response to this was as you might expect.  JGB yields dipped 2bps, Japanese equities managed a modest rally (+0.3%) as they seem caught between lower rates and higher inflation, and the yen ( -0.5%) weakened.  In essence, it appears the combination of a strengthening yen and rising interest rates has the potential to wreck the Japanese government’s budget, and the BOJ went back to form and discussed more QE as a response.  This is simply more proof that there isn’t a central bank in the world that truly cares about inflation.  While stable inflation may be a mandate, it is the last of their concerns.

Inflation is, however, not the last of our concerns, at least as we try to live day to day.  This is what has me concerned about Chairman Powell and his minions at the Fed, they continue to believe that the current interest rate structure is restrictive and despite the fact there is virtually no evidence prices are ever going to get back to their target of 2.0%, let alone true stability, still see cuts as the way forward.  Perhaps I am mistaken to believe that the Fed will see the light and maintain current policy levels or even tighten as inflation rebounds.  If that is the case, my entire dollar thesis is going to come under a lot of pressure!

Ok, away from the Japanese antics overnight, a brief word about China.  Last night, Premier Li Qiang explained that China will look to “vigorously” improve the services sector of the economy, specifically education, health care, culture and sports, as they once again try to adjust the balance of economic activity to a more domestic focus rather than their historical mercantilist process.  Earlier this week the PBOC reiterated their support for the property market, although for both these efforts, this is not the first time they have been discussed, and the evidence thus far is all their efforts have been fruitless.  But for one day, at least, these comments have been embraced as the Hang Seng (+4.0%) and CSI 300 (+1.3%) both rallied sharply on the news of more domestic support for the Chinese economy.  The Chinese are set to hold a key economic confab as they try to plan how to shake things up a bit, and these comments, as well as a seeming promise the PBOC is going to cut rates again, are all of a piece.  Maybe they will be successful this time, but I am not holding my breath.

Otherwise, the only other noteworthy economic news came from the Flash PMI’s across Europe which were soggy at best, certainly not indicative of significant growth coming soon.  With that in mind, let’s look at the rest of the markets’ overnight performance.  The rest of Asia’s equity markets were mixed with Taiwan’s the best performer and several modest declines elsewhere including India, Australia and New Zealand.  In Europe, though, despite those modest PMI outcomes, most markets are higher led by the CAC (+0.5%).  Perhaps, the view is the ongoing weakness will force the ECB to cut rates more quickly, and we have heard several ECB members indicate further cuts are coming.  However, counter to that, Isabel Schnabel, one of the more hawkish members, mentioned this morning that she believed they were already at neutral, and more cuts may not be necessary.  While that is not the consensus view yet, it is worth remembering.  As to the US futures market, at this hour (7:00), all three major indices are basically unchanged.

In the bond market, yields have fallen across the board with Treasuries, after sliding yesterday, down another 2bps this morning and back below 4.50% for the first time in a week.  In a Bloomberg interview yesterday, Secretary Bessent explained that although his goal is to reduce the issuance of T-bills and term out debt, given the situation which he inherited from the previous administration, that process will take longer than some had considered previously.  In other words, there won’t be a large increase in 10-year issuance any time soon. European sovereign yields are also much softer, down between -3bps and -5bps on those further rate cut hopes, or perhaps the lackluster PMI data.

In the commodity markets, oil (-0.8%) is backing off its recent rally highs, but remains quiet overall and well within its ever-tightening trading range.  It seems traders don’t know how to handicap the constant discussions from the Trump administration and whether Russian sanctions will end or not, as well as how quickly OPEC may ramp up production and what is happening to demand.  While none of these things are ever certain, right now they seem particularly fraught.  In the metals space, gold (-0.4%) is backing off from yesterday’s latest all-time highs, and taking both silver and copper with it, but the uptrend in all three of these metals remains quite strong.

Finally, the dollar is higher this morning gaining ground against all its G10 counterparts with the yen being the worst performer, but also against all its EMG counterparts with HUF (-1.0%) the true laggard although the entire CE4 are under pressure, arguably responding to the mayhem over how the Ukraine situation plays out.  After all, they are the closest in proximity and likely to be the most impacted.

On the data front, this morning brings Flash PMI data (exp manufacturing 51.5. Services 53.0), Existing Home Sales 4.12M) and Michigan Sentiment (67.8).  We also hear from two more Fed speakers, Jefferson and Daly, but again, caution and stasis are the story until further notice, and that notice is not coming from Mary Daly but rather from Jay Powell.

Perhaps the most interesting thing happening right now is that although tariffs remain a major economic force and are clearly on the table, they are not even the 4th most important topic in the market.  Back to my earlier comments, I sincerely hope that the BOJ’s overwhelming dovish stance is not a harbinger of things to come here in the States.  Right now, I don’t think so, but I am far less confident than I was earlier this week.

Good luck and good weekend

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Positioned Quite Well

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The Fed is positioned quite well
To leave rates alone for a spell
Employment is stable
Which means they are able
To try, high inflation, to quell

 

“In discussing the outlook for monetary policy, participants observed that the Committee was well positioned to take time to assess the evolving outlook for economic activity, the labor market, and inflation, with the vast majority pointing to a still-restrictive policy stance. Participants indicated that, provided the economy remained near maximum employment, they would want to see further progress on inflation before making additional adjustments to the target range for the federal funds rate.”

I would say that this paragraph effectively summarizes the Fed’s views during the January FOMC meeting and based on the comments we have heard since, nothing has really changed much.  If anything, there appeared to be more concern over the upside risks to inflation than worries over a much weaker employment picture.  As well, there was some discussion regarding the potential of tariffs impacting prices and economic activity, although they would never be so crass as to actually use the word.

I would argue we don’t know anything more about their views now than we did prior to the Minutes.  Interestingly, they continue to believe that the current policy rate is restrictive even though Unemployment has been sliding, inflation is sticky on the high side and equity and other financial markets continue to make record highs.  Personally, I would have thought the appropriate view would be policy is slightly easy, but then I’m no PhD economist, just a poet.  If we learned anything it is that they are not about to change the way they view the world.  This merely tells me they have the opportunity to double down on previous mistakes.

It’s almost as if
Japanese markets now see
Future yen glory

Meanwhile, away from the machinations and procrastinations of the Fed, if we turn East, we can see that last night the yen, for a brief moment, traded through the key 150 psychological level, although it has since edged back higher.  This is the strongest the yen has been in more than two months and, in a way, is somewhat surprising given the strong belief that tariffs imposed against a nation will result in that nation’s currency declining.  But that is not the case right now, where despite mooted tariffs on steel, autos and semiconductors, three things the Japanese export to the US, the yen is climbing again.  

Source: tradingeconomics.com

One of the interesting things about the interest rate market’s response to the FOMC Minutes is that there continues to be an expectation of 39bps of rate cuts this year in the US.  But then, I read the Minutes as somewhat hawkish, obviously a misconception right now.  Meanwhile, in Tokyo, we continue to hear comments from former BOJ members that further rate hikes are coming and the futures market there is pricing 36bps of rate hikes by the end of this year.  So, for now, the direction of travel is diametrically opposed between the Fed and the BOJ.  Last night also saw JGB yields edge higher by another 1bp, to 1.43% and another new high level for this move.  Add it all up and the rate movements are sufficient to be the current FX drivers.

Now, as per my opening discussion regarding the Fed, while I believe that the next move should be a hike, and that gained support from a WSJ article this morning telling us to expect higher rent prices ahead which implies that the shelter portion of US inflation is not going to decline anytime soon, perhaps this is another reason to consider that the dollar may decline.  After all, the textbooks all explain that a high inflation economy results in a weaker currency.  If the Fed is truly going to continue to try to ‘normalize’ rates lower despite rising inflation, that will change my broad view of the dollar, and I suspect it will weaken dramatically.  While the yen is the first place to watch this given the opposing actions by the Fed and BOJ, it could easily spread.

Too, it is important to remember that while we have lately become accustomed to the yen trading in the 140-160 range vs. the dollar, for many years USDJPY traded between 100 and 120 as per the below chart.  While the world has certainly changed, it doesn’t mean that we cannot head back to those levels and spend another decade at 110 give or take a bit.

Source: tradingeconomics.com

Ok, with that in mind, let’s take a look at how markets have handled the new information.  Clearly US equity markets are not concerned about a Fed volte-face as they closed at yet new record highs yesterday, albeit with very modest gains of about 0.2%.  Asian markets, however, were not so sanguine with red the dominant color as the Nikkei (-1.25%) suffered amid that strengthening yen while both the Hang Seng (-1.6%) and mainland (CSI 300 -0.3%) fell despite PBOC promises of more support for the economy and the property market.  If I’m not mistaken, this is the third time the PBOC has said they will be increasing support for property markets and prices there continue to decline.  In fact, every major index in Asia fell overnight, mostly impacted by tariff fears.

Meanwhile, European bourses are all modestly firmer save the UK (-0.4%) as we see a rebound after yesterday’s declines and earnings data from Europe continues to show decent outcomes.  While there is much talk and angst over the Ukraine situation and tariffs, right now given the uncertainty of the timing of any tariffs, as well as the possibility that they may be delayed further or deals may be struck, investors seem to be laying low.  Remember, though, that European equity markets have been outperforming US markets for the past several months, although that could well be because their valuations had become so cheap, we are seeing a rotation into them for now.  As to the US markets, futures are pointing slightly lower at this hour (7:15) down about -0.25%.

In the bond market, yesterday saw Treasury yields cede their early gains and slip 2bps on the session and this morning they have fallen a further 2bps.  Meanwhile, European sovereign yields, after jumping yesterday across the board, are falling back slightly with declines on the order of -1bp or -2bps.

In the commodity market, the one constant is that the price of gold (+0.4%) continues to climb.  Whether it is because of growing global uncertainty, concerns over rising inflation, or technical questions regarding deliveries in NY, it is not clear.  Price action is not volatile, rather it has been a steady climb for more than a year.  just look at the chart below.

Source: tradingeconomics.com

As to the other metals, both silver and copper are also continuing their climb and higher by 1.0% this morning.  Oil (+0.2%) is also edging higher which seems a bit odd given the fundamental news I keep reading.  First, OPEC+ is going to begin increasing production later this year, second, the prospects of a peace deal with Russia seems likely to result in Russian oil coming back on the market sans sanctions, and third, despite talk of Chinese economic stimulus, demand from the Middle Kingdom has not been growing.  Add to this the fact that supply is expected to grow by upwards of 1mm bpd from Guyana, Brazil and Canada, and it seems a recipe for falling prices.  Just goes to show that markets are perverse.

Finally, the dollar is under pressure across the board this morning with the yen (+0.95%) leading the way but commodity currencies (AUD +0.5%, NZD +0.5%, ZAR +0.4%) also showing strength.  In fact, virtually every currency has strengthened vs. the greenback this morning.  Looking at the charts, there is a strong similarity across almost all currencies vs. the dollar and that is the dollar put in a peak back in early January and has been gradually declining since then.  This is true across disparate currencies as seen below and may well represent the market deciding that President Trump would like to see the dollar decline and will enact policies to achieve that end.  (I used USDDKK as a proxy for EURUSD since the two are linked quite closely with a correlation of about 0.99.)

Source: tradingeconomics.com 

As I wrote above, my strong dollar thesis is based on the Fed continuing to fight inflation.  If they abandon that fight, then the dollar will certainly decline!

On the data front, this morning brings Initial (exp 215K) and Continuing (1870K) Claims as well as the Philly Fed (20.0).  In addition to the Minutes yesterday we saw Housing Starts tumble although Permits were solid.  However, there is clearly some concern over the housing market writ large, with fewer first-time buyers able to afford a new home, hence the rent story above.  We have 3 more Fed speakers today but again, I ask, are they going to change their tune?  I don’t think so.  I find it hard to believe that the Fed will allow inflation to rebound sharply, but if they remain focused on rate cuts while inflation continues to creep higher, I fear that will be the outcome.  And that, as I said above, will be a large dollar negative.  We shall see.

Good luck

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Hard to Kill

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Inflation just won’t go away
As evidenced by the UK
This year started out
Removing all doubt
The Old Lady’s work’s gone astray
 
And elsewhere, the problem is still
Inflation is quite hard to kill
Though central banks want
More rate cuts to flaunt
Those goals are quite hard to fulfill

 

While most eyes remain on President Trump with his ongoing efforts to reduce the size of the US government, as well as his tariff discussions and efforts to negotiate a lasting peace in Ukraine, we cannot ignore the other things that go on around the world.  One of the big issues, which has almost universally been acclaimed a problem, is that inflation is higher than most of the world had become accustomed to pre-Covid.  As well, the virtual universal central bank goal remains the local inflation rate, however calculated, to be at 2.0%.  Alas for the central bankers in their seats today, that remains quite a difficult reach.  A quick look at the most recent headline CPI readings across the G20 shows that only 5 nations (counting the Eurozone as a bloc since they have only one monetary policy) are at or below that magic level as per the below table.

Source: tradingeconomics.com

Of those nations who are below, two, China and Switzerland, are actually quite concerned about the lack of price pressure and seeking to raise the inflation rate, and the other three (Canada, Singapore and Saudi Arabia) are right on the number, with core inflation readings tending higher than the headline reported here.

Perhaps a better way to highlight the problem is to look at the 10-year bonds of most countries and see how they have been behaving of late as an indication of whether investors are comfortable with the inflation fighting efforts by each nation.  While it is not universal, you can look at the column on the far right of the below table and see that 10-year yields have been rising for the past year.

Source: tradingeconomics.com

I only bring this up because, despite the fact that I have been downplaying central bank, especially the Fed’s, impact on markets, ultimately, every nation tasks their central bank to manage inflation.  That seems reasonable since inflation, as Milton Friedman explained to us in 1963, is “always and everywhere a monetary phenomenon.”  But perhaps you don’t believe that and are schooled in the idea that faster growth leads to higher wages and therefore higher inflation.  Certainly, Paul Samuelson’s iconic textbook (as an aside, Dr Samuelson was my Economics 101 professor in college) made clear that was the pathway.  Alas, as my good friend, @inflation_guy Mike Ashton, wrote yesterday, there is no evidence that is the case.  Read the article, it is well worth it and can help you start looking elsewhere for causes of inflation, like perhaps the growth in the money supply!

Of course, the reason that we continue to come back to inflation in our discussions is because it is critical to the outcomes in financial markets.  And that is our true focus.  It is the reason there is so much discussion regarding President Trump’s mooted tariffs and how inflationary they will be.  It is the reason that parties out of power continue to highlight any prices that have risen substantially in an effort to disparage the parties in power.  And it is the reason that central banks remain central to the plot of all financial markets, at least based on the current configuration of the global economy.  If there was only one financial lesson from the pandemic response, it is that Magical Money Tree Modern Monetary Theory is a failed concept of how to run policy.  This poet’s fervent hope is that Treasury Secretary Bessent is smart enough to understand that and will address fiscal issues in other manners.  I believe that to be the case.

Back to the UK, where CPI printed at 3.0%, 2 ticks higher than the median forecast, while core CPI printed at 3.7%.  This cannot be comforting for the BOE as most of the MPC remain committed to helping PM Starmer’s government find growth somehow and are keen to cut rates in support.  The problem they have is that inflation will not fade despite extremely lackluster GDP growth.  Recall, last week, even though the Q/Q GDP print of 0.1% beat forecasts, it was still just 0.1%.  Not falling into recession hardly seems a resounding victory for policy in the UK, especially since stagnation, or is it now stagflation, is the end result.  It should be no surprise that market participants have sold off the pound (-0.3%), Gilts (+5bps) and UK equities (-0.4%) and it is hard to find a positive way to spin any of this.  Again, while I have adjusted my views on Japan, the UK falls squarely in the camp of in trouble and likely to see a weaker currency.

Ok, let’s look elsewhere to see how things behaved overnight.  After a very modest rise in US equity indices yesterday, the Asian markets were mixed with the Nikkei (-0.3%) and Hang Seng (-0.15%) slacking off a bit although the CSI 300 (+0.7%) managed to find buyers after President Xi met with business leaders and the expectation is for further government stimulus, as well as a reduction in regulations, to help support the economy.  Australia (-0.7%) is still under pressure despite yesterday’s RBA rate cut as the post-meeting statement was quite hawkish, indicating caution is their approach for now given still sticky inflation.  (Where have we heard that before?)

In Europe, the only color on the screen is red with declines of between -0.4% and -0.9% as investors seem to be taking some profits after a solid run in most of these markets.  I guess the fact that European governments have been shown to be powerless in the world has not helped investor sentiment either as it appears these nations may be subject to more outside forces than they will be able to address adequately.  Lastly, US futures are unchanged at this hour (7:40).

In the bond market, as per the table above, yields are higher across the board with Treasuries (+2bps) the best performer as virtually all European sovereign issues have seen yields rise between 5bps and 7bps.  It simply appears that confidence in the Eurozone is slipping and demand for Eurozone assets is falling alongside that.

In the commodity markets, it should be no surprise that gold (+0.1%) continues to edge higher.  The barbarous relic continues to find price support despite the fact that interest in gold, at least in Western economies, remains lackluster at best.  There is much discussion now about an audit of the US’s gold reserves at Fort Knox and in the NY Fed, something that has not been performed since 1953.  Not surprisingly, there are rumors that there is much less gold in storage than officially claimed (a little over 8 tons) and rumors that there is much more which has not been reported but was obtained via seizures throughout history.  This story has legs as despite the lack of institutional interest in the US, it is picking up a retail following and we are seeing the punditry increasingly raise their price forecasts for the coming years.  As to oil (+0.8%) it is higher again this morning but remains in a tight trading range with market technicians looking at the $70/bbl level as a key support to hold.  A break there could well see a quick $5/bbl decline.

Finally, the dollar is modestly firmer this morning against most of its counterparts with most G10 currencies showing declines similar to the pound’s -0.2%, although the yen (+0.15%) is bucking that trend.  However, versus its EMG counterparts, the dollar is having a much better day, rising vs. PLN (-0.9%), ZAR (-0.7%) and BRL (-0.5%) on various idiosyncratic stories.  The zloty seems to be suffering from its proximity to Ukraine and the uncertainty with the future regarding a potential peace effort.  The rand is falling after the FinMin delayed the budget speech as internal squabbling in the governing coalition seems to be preventing a coherent message while the real is under pressure as inflation remains above target and the central bank’s tighter policy has been negatively impacting growth in the economy.

On the data front, this morning brings Housing Starts (exp 1.4M) and Building Permits (1.46M) and then this afternoon we see the FOMC Minutes from the January meeting.  That will be intensely parsed for a better understanding of what the committee is thinking.  We do hear from Governor Jefferson after the market closes, but generally, the cautious stance remains the most popular commentary.

Has anything really changed?  The market remains uncertain over Trump’s moves, the Fed remains on hold and cautious, and data shows that the economy continues to tick along nicely with price pressures unwilling to dissipate.  I see no reason to abandon the dollar at this point.

Good luck

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A Fifth Wheel

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Confusion is clearly what reigns
As even the punditry strains
To understand whether
Investors will tether
Their future to stocks or take gains

 

As there was no activity in the US financial markets yesterday, it seems there was time for analysts to consider the current situation and make pronouncements as to investor behavior.  Ironically, we saw completely opposite conclusions from two major players.  On the one hand, BofA posted the following chart showing that investors’ cash holdings are at 15-year lows, implying they remain fully invested and quite bullish.

Meanwhile, the WSJ this morning has a lead article on how bearish investors are, claiming they are the most bearish since November 2023 according to the American Association of Individual Investors.  Apparently, 47.3% of investors surveyed believe stock prices will fall over the next 6 months.

So, which is it?  Are investors bullish or bearish?  To me this is a perfect description of the current situation.  Everyone is overloaded with information, much of which is contradictory, and so having a coherent view has become extremely difficult.  This is part and parcel of my view that the only thing we can clearly expect going forward is an increase in volatility.  In fact, someone said that Donald Trump is the avatar of volatility, and I think that is such an apt description.  Wherever he goes, mayhem follows.  Now, I also believe that people knew what they were voting for as change was in demand.  But for those of us who pay close attention to financial markets, it will take quite the effort to keep up with all the twists and turns.

Fed speakers are starting to feel
Like they have become a fifth wheel
So, let’s get prepared
For Fed speaking squared
As they work, their views, to reveal

Away from the conundrum above, the other noteworthy thing is that FOMC members are starting to feel left out of the conversation.  Prior to President Trump’s inauguration, market practitioners hung on their every word, and they apparently loved the power that came with that setting.  However, now virtually every story is about the President and his policies with monetary policy falling to a distant issue on almost all scorecards.  Clearly, for a group that had grown accustomed to moving markets with their words, this situation has been deemed unacceptable.  The solution, naturally, is to speak even more frequently, and I fear believe this is what we are going to see (or hear) going forward.  

Yesterday was a perfect example, where not only, on a holiday, did we have multiple speakers, but they actually proffered different messages.  From the hawkish side of the spectrum, Governor Michelle Bowman, the lone dissenter to the initial 50bp rate cut back in September, explained caution was the watchword when it comes to acting alongside President Trump’s mooted tariff and other policies, “It will be very important to have a better sense of these policies, how they will be implemented, and establish greater confidence about how the economy will respond in the coming weeks and months.”  That does not sound like someone ready to cut rates anytime soon.

Interestingly, from the dovish side of the spectrum, Governor Christopher Waller, an erstwhile hawk, explained in a speech in Australia (on the day the RBA cut rates by 25bps for their first cut of the cycle and ending an 18 month period of stable rates) that, “If this wintertime lull in progress [on inflation] is temporary, as it was last year, then further policy easing will be appropriate.”  I find it quite interesting that Governor Waller suddenly sounds so dovish as many had ascribed to him the intellectual heft amongst the governors.  This is especially so given that is not the message that Chairman Powell articulated either after the last meeting or at his Humphrey-Hawkins testimony recently.  

So, which is it?  Is the Fed staying hawkish or are they set for a turn?  That will be the crux of many decision-making processes going forward, not just in markets but also in businesses.  We will keep tabs going forward.

Ok, on to the market’s overnight performances.  Lacking a US equity market to follow, everybody was on their own last night which showed with the mixed results.  Japan (+0.25%) showed modest gains while the Hang Seng (+1.6%) rocketed higher on the belief that President Xi is going to be helping the economy, notably the tech firms in China, many of which are listed in Hong Kong.  Alas, the CSI 300 (-0.9%) didn’t get that memo with investors apparently still concerned over the Trump tariff situation.  Elsewhere in the region, Korea and Taiwan rallied while Australia lagged despite the rate cut.  In Europe, unchanged is the story of the day with most bourses just +/-0.1% different than yesterday’s close.  Right now, in Europe, the politicians are trying to figure out how to respond to the recent indication that the US is far less interested in Europe than in the past, and not paying close attention to financial issues.  As to the US, futures at this hour (7:25) are pointing higher with the NASDAQ leading the way, +0.5%.

In the bond market, yields are climbing led by Treasuries (+4bps) with most of Europe seeing yields edge higher by 1bp or 2bps as well.  Remember, yesterday European sovereign yields rose smartly across the board.  Also, I must note JGB yields (+4bps) which have made further new highs for the move and continue to rise.  It appears last night’s catalyst was a former BOJ member, Hiroshi Nakaso, explained he felt more rate hikes were coming with the terminal rate likely to be well above 1.0%.  While I believe the Fed will be cautious going forward, I still think they are focused on rate cuts for now.  With that in mind and the ongoing change in Japanese policy, I am increasingly comfortable with my new stance on the yen.

In the commodity markets, last Friday’s sell-off in the metals markets is just a bad memory with gold (+0.5%) rallying again and up more than 1% since Friday’s close.  I continue to believe those moves were positional and not fundamental.  Too, we are seeing gains in silver (+0.2%) and copper (+0.6%) to complete the triad.  Meanwhile, oil (-0.25%) continues to lag, holding above its recent lows but having a great deal of difficulty finding any buying impulse.  Whether that is due to a potential peace in Ukraine and the end of sanctions on Russian oil, or concerns over demand growth going forward is not clear to me, but the trend, as seen in the chart below, is clearly downward and has been so for the past year.

Source: tradingeconomics.com

Finally, in the FX markets, the dollar is firmer this morning rising against all its G10 counterparts with NZD (-0.6%) the laggard.  But losses of -0.2% are the norm this morning.  In the EMG bloc, we are seeing similar price behavior in most markets although MXN (+0.2%) is bucking the trend, seemingly benefitting from what appears to be a hawkish stance by Banxico and the still highly elevated interest rate differential in the peso’s favor.

On the data front, Empire State Manufacturing (exp -1.0) is the only data point although we will hear from two more Fed speakers, Daly and Barr.  I cannot believe that they have really changed their tune and expect that caution will remain their guiding principle for now, although I expect to hear that repeated ad nauseum as they try to regain their place in the spotlight.

Aside from my yen view, I still find it hard to be excited about many other currencies for now.  There is still no indication the Fed is going to move anytime soon, and other central banks are clearly in easing mode.  That bodes well for the dollar going forward.

Good luck

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Soaring Like Eagles

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Soaring like eagles
Japanese growth beats forecasts
Are rate hikes coming?

 

On this President’s Day holiday, when US markets are closed, arguably the most interesting financial story around is in the Land of the Rising Sun where Q4 GDP was released last night at 0.7%, significantly higher than forecast (0.2%) and Q3’s outcome (0.4%).  Japanese markets responded about as might be expected with the yen (+0.6%) rising alongside JGB yields (+3bps) with the 10yr now at 1.38%, its highest level since March 2010.  As to equity markets, the Nikkei (+0.1%) was caught between the positive GDP news and the stronger JPY.  Of course, much has been made of the BOJ’s overnight rate, which now sits at 0.50% after several hikes during the past year.  As well, expectations are for further hikes this year, with several analysts calling for a rate over 1.00% before the end of 2025.

But let us consider, for a moment, what the Japanese rate structure looks like in the context of the current inflation story in Japan.  As can be seen below, this is the current shape of the Japanese government bond yield curve, with 2yr yields at 0.80% while 30yr yields are up to 2.30%.

Source: Bloomberg.com

However, when looking at these yields, which as you can see from the column furthest to the right have risen substantially in the past 12 months, we must also remember the pace of inflation in Japan.  Since April 2022, every monthly CPI print in Japan has been above the target of 2.0%, with all but two of them above 2.5%.  In fact, as you can see from the chart below, the most recent data, as of December 2024 with the January data to be released Thursday night, shows the headline at 3.6%.  That is nearly three years of inflation data running above their target, yet the BOJ is unwilling to say inflation is stably at 2.0%.  I guess they are correct, it is stably at about 3.0%!

Source: tradingeconomics.com

But let’s add up this conundrum and perhaps we will better understand why GDP is growing so robustly in Japan.  If 10yr JGB yields are 1.38% and inflation is 3.60%, then real yields are running at… -2.22%.  That is a pretty loose monetary policy and one in which it is no surprise that economic activity is humming along.  In fact, unless we see a substantial decline in inflation, with no indication that is on the horizon, the BOJ has ample room to raise interest rates while maintaining accommodative monetary policy.

I know that there is much discussion regarding President Trump’s tariffs and whether Japan will be affected like other nations thus increasing uncertainty.  But the economic reality is that the BOJ remains highly stimulative to the economy which has been a driver of both economic growth and inflation.  I also know that this poet has been negative on the yen for a long time, in fact calling for USDJPY to reach 170 by the end of the year.  But as I observe the current situation, take into account the fact that President Trump very clearly wants the dollar to decline, and see more hints that the Japanese government is becoming more concerned over rising inflation in Japan, I am changing my tune here.  Add to these indications the fact that the yen, on any accounting, remains significantly undervalued, with estimates of as much as 50% (Big Mac Index claims it is 44% undervalued) and the case for yen strength is growing on me.

While over the past year, the yen has, net, done very little, the more recent trend is for yen strength as per the 1-month chart below.  My take is that we need to see a break below 150 before the fireworks start, but if that is the case, do not be surprised if we trade back to 130 before the year is over.

Source tradingeconomics.com

And really, that is the story of the evening.  The Chinese NPC will be meeting next week to discuss their economic plans and policies for the upcoming year, so that will be important.  As well, Europe has been put on notice by recent speeches from VP JD Vance and Secretary of State Marco Rubio that the relationship with the US is changing.  However, at this time, it is very difficult to discern if that means the euro will weaken further or rebound on increased internal activity.

Ok, let’s look at markets overnight.  It appears that with the US on holiday, many markets were reluctant to demonstrate leadership in any direction with not only Tokyo virtually unchanged, but the same being true throughout Asia (Hong Kong, 0.0%, China +0.2%, Australia -0.2%) and most of Europe with only the German DAX (+0.8%) showing any life at all.  It seems that several German defense contractors are benefitting from the idea that Europe may be increasing its defense expenditures locally.  US futures are little changed, although of course the market will not be open today.

Treasury bonds are also unchanged this morning with no trading but in Europe, yields are higher by between 3bps and 5bps, also on the rising defense expenditure story as there is an idea now floating around that there will be pan-European debt issuance to help fund that expenditure, thus adding supply to the market.  Certainly, despite the ECB maintaining a somewhat dovish stance, if European yields climb higher, that will likely support the single currency.

In the commodity markets, after Friday’s rout in the metals, where both precious and industrial metals sold off sharply, seemingly on no news, but more likely on position adjustments, this morning we are seeing a rebound, at least in gold (+0.5%) and silver (+0.6%) although copper (-1.3%) remains under pressure.  As to energy prices, oil (-0.35%) is continuing to hover closer to the bottom than top of its recent trading range as there is no clarity at all regarding how a potential Ukrainian peace will impact Russian production.  The one consistency is that European NatGas continues to decline on hopes that Russian gas deliveries will resume going forward.

Finally, the dollar is doing mixed this morning with the yen the outlier showing strength against the greenback, but ZAR (-0.5%) and MXN (-0.4%) showing weakness.  The rest of the G10 has seen only modest movement and that is generally true for the rest of the EMG bloc.  Traders remain highly uncertain over the future that President Trump will usher in.

On the data front, it is a pretty light calendar overall.

TuesdayEmpire State Manufacturing0.0
WednesdayHousing Starts1.4M
 Building Permits1.46M
 FOMC Minutes 
ThursdayInitial Claims215K
 Continuing Claims1860K
 Philly Fed16.3
 Leading Indicators-0.1%
FridayFlash Manufcturing PMI51.2
 Flash Services PMI53.2
 Existing Home Sales4.13M
 Michigan Sentiment67.8

Source: tradingeconomics.com

As well as this data, we see the EIA oil inventories and hear from 11 more Fed speakers.  But again, after Powell made clear they are on hold for now, and there has been no data to change that perception, and President Trump continues to dominate the spotlight, I don’t anticipate any new information here.

With the holiday today, I anticipate things will be quite slow.  Traders will take advantage of the time off to rest given the rising volatility we have seen.  Going forward, I will be reevaluating my longer-term views based potential changes in fiscal policies around the world.  But for now, other than the yen, I don’t see any clear changes yet.

Good luck

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Having a Fit

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Seems Europe is having a fit
‘Cause Putin and Trump may submit
A plan for the peace
Where there’s an increase
In spending the Euros commit
 
Remarkably, though peace would seem
The basis of many a dream
Seems many despise
The fact that these guys
Don’t care Europe can’t stand this scheme

 

Here’s the thing about President Trump, you never know what he is going to do and how it is going to impact market behavior.  A case in point is the growing momentum for further peace negotiations between the US and Russia, with Ukraine basically going to be told how things are going to wind up.  On the one hand, you can understand Ukraine’s discomfort as they don’t feel like they are getting much say in the matter.  On the other hand, it seemed increasingly clear that the end game, if there is no US intervention of this nature, would be for Russia to bleed Ukraine of its fighting age population while systematically destroying its infrastructure.

The thing I find most remarkable is the number of pundits who hate this outcome despite the end result of the cessation of the fighting and destruction.  After three years of conflict, and with other nations willing to allow Ukrainians to die on the front lines while they preened about saving democracy, there was no serious push to find a solution.  I have no strong opinion on the terms that have been floated thus far, and I don’t believe rewarding a nation for aggressive action is the best outcome, but Russia has proven throughout history that they are willing to sacrifice millions of their own citizens in warfare, and the case for a Ukrainian victory seemed remote at best.  As experienced traders well understand, sometimes you have to cut your position so you can focus on something else.  Seems like a good time to cut the positions here.

Speaking of positions, let us consider what peace in Europe may mean for financial markets.  Yesterday I discussed how European NatGas prices have more than doubled since the war began.  If they return to their pre-war levels, that dramatically enhances Europe’s economic prospects, despite their ongoing climate policies.  Clearly, the FX market got that memo as the euro has rallied back to its highest level since December 2024 save for a one-day spike just after Trump’s inauguration.  In fact, it is not hard to look at the chart below and see a bottom forming in the single currency.  While the moving average I have included is only a short-term, 5-day version, you have to start somewhere.  While the fundamentals still seem to point to further downside in the single currency, between the Fed’s pause and more hawkish stance opposite the ECB’s ongoing policy ease, the medium-term picture could be far better for the Europeans.  If the war truly does end, it would likely see a significant uptick in investment and economic activity as they seek to rebuild Ukraine, and we could see substantial capital flows into the European economies.

Source: tradingeconomics.com

As well, oil prices, continue to trade near the bottom of their recent trading range as the working assumption seems to be that with a peace treaty, Russian oil would no longer be sanctioned, enhancing global supplies.  A look at the trend line in the chart below seems to indicate that is the direction of the future.

Source: tradingeconomics.com

The other remarkable thing is the decline in yields, where yesterday, despite a very hot PPI number, which followed Wednesday’s hot CPI number, Treasury yields fell back 7bps.  While there are likely some other aspects to this move, notably the ongoing story regarding DOGE and the attack on waste and fraud in the US, yesterday’s move was not indicative of fear, rather I read it as a positive sign that investors are betting on a chance that President Trump can be successful with respect to reducing the massive overspending by the government.  Clearly, this is early days regarding President Trump’s ability to get a handle on spending, and it could all blow up as legislative compromises may significantly water down any benefits, but I contend the market is showing hope right now, not fear.

And that, I would contend, is the big underlying driver of markets right now.  The prospects for peace and the potential impacts are the focus.  While tariffs are still a big deal, and yesterday’s talk about reciprocal tariffs is simply the latest in a long line of these discussions and pronouncements, the market seems to be getting tired of that conversation.  If we recap the current situation, central bank activities have lost their importance amid a huge uptick in governmental actions, both fiscal and geopolitical.  In many ways, I think this is great, the less central bank, the better.

Ok, let’s see how markets continue to absorb these daily haymakers from President Trump and the responses from other governments.  Clearly, the US equity market remains far more fixated on Trump’s actions than on higher inflation potentially forcing the Fed to raise rates.  In fact, despite the hot PPI print, the futures market has actually increased its expectation for rate cuts this year to 35bps.  That doesn’t make sense to me, but I’m just an FX poet. 

If we turn to Asian markets, Hong Kong (+3.7%) was the big winner overnight as a combination of growing expectations for more Chinese government stimulus to be announced soon, along with the ongoing tech positivity in the wake of the DeepSeek announcement got investors excited.  On the mainland, shares (CSI 300 +0.9%) were also higher, but not as frothy.  Meanwhile, the weaker dollar hindered the Nikkei (-0.8%) as the yen has gained 1.3% since the CPI data on Wednesday.  In Europe, the picture is mixed with the CAC (+0.4%) the best performer and the DAX (-0.4%) the worst performer.  Eurozone GDP surprised on the upside in Q4, growing…0.1%!! Talk about an explosive economy.  However, that was better than forecast and helped avoid a recession.  The interesting thing about European equity markets, though, is that despite a dismal economic backdrop, most major markets are trading at or near all-time highs.  Further proof that the market is not the economy.  As to US futures, ahead of this morning’s Retail Sales data, they are flat.

After several days of substantial movement in the bond market, it seems that traders have taken a long weekend given the virtual absence of movement here.  Treasury yields are unchanged on the day and European sovereign yields are higher by 1bp.  

In the commodity markets, on the day, oil prices are unchanged, although as per the above chart, it appears the trend is lower.  US NatGas (+1.8%) is rallying on forecasts for another cold spell, but European NatGas (-4.85%) continues to fall as prospects for peace indicate new supplies, or perhaps, renewed supplies.  In the metals markets, gold (+0.15%) is continuing its positive momentum but the big mover today is silver (+2.7%) which seems to be responding to some large option expirations in the SLV ETF (h/t Alyosha) which seem set to drive substantial demand for delivery.  

Finally, the dollar remains under pressure overall, although the movement has generally not been that large today.  The big outlier in the G10 is NZD (+0.9%) which has responded to the delay in the reciprocal tariff implementation until April.  Elsewhere in this bloc, gains are universal, but modest with movement between just 0.1% and 0.2%.  In the EMG bloc, the dollar is also under pressure with ZAR (+0.65%) a major gainer as precious metals continue to be in demand.  CLP (+1.15%) is also continuing to benefit from copper’s ongoing rally.  The exception to this movement has been Asia where most regional currencies are modestly softer this morning, KRW, TWD, INR, as the tariff talks still seem to be the driving force in these markets.

On the data front, we finish the week with Retail Sales (exp -0.1%, +0.3% ex autos), then IP (0.3%) and Capacity Utilization (77.7%).  Yesterday’s PPI data was several ticks hotter than forecast and seems to put paid to the idea that inflation is heading back to the Fed’s target.  This afternoon we hear from Dallas Fed president Lorrie Logan, but again, it is hard to make the case that the Fed is the driver of anything right now.

Fundamentals still point to dollar strength, I would argue, but the market is not paying attention. Rather peace and the peace dividend are now the driver in the FX markets and to me, that implies we are set to see the dollar give back some of its gains from the past 6 months.

Good luck and good weekend

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Shattered His Dreams

Posted on by

The data was hot yesterday
And that put the pressure on Jay
It shattered his dreams
‘Bout all of his schemes
To help keep inflation at bay

 

By now, I am sure you are aware that the CPI data was higher than forecast, and certainly higher than would have made Chairman Powell comfortable.  The outcome, showing Headline rising to 3.0% and core rising to 3.3% with correspondingly higher monthly rises was sufficient to alter the narrative at least a little bit.  Chair Powell even mentioned it in his House testimony, noting, “We are close, but not there on inflation…. So, we want to keep policy restrictive for now.”  Essentially, the data makes clear that the Fed is not going to be cutting the Fed funds rate anytime soon.  The futures market got the message as it is now pricing just 29bps of cuts this year, with December the likely date.

It will be no surprise that the stock market’s initial response was to sell off substantially, but as per the chart below, it spent the rest of the day clawing back the losses and wound up little changed on the day.  This morning, it remains basically unchanged as well.

Source: tradingeconomics.com

Treasury bonds, though, had a less fruitful session, falling (yields rising) sharply on the print, but never really regaining their footing with yields jumping almost 15bps at one point although finishing the day about 10bps higher and have given back 2bps more this morning.

Source: tradingeconomics.com

Now, we all know that the Fed doesn’t target CPI, but rather PCE.  However, after this morning’s PPI data release, most economists (although not poets) will be able to reasonably accurately estimate that data point for later this month, as will the Fed.  And that number is not going to be moving closer to their 2.0% target.  What seems very clear at this point is that every Fed speaker for the time being is going to be harping on the caution with which they are going to move forward.

If we look at this from a political perspective, something which is unavoidable these days, it is important to remember that Treasury Secretary Bessent has made clear that he and the president are far more focused on the 10-year yield than on the Fed funds rate.  To that end and given the fact that all this data was from a time preceding President Trump’s inauguration, I don’t think they are too worried.  I would look for the President to continue his drive to reduce waste and fraud in the government and attack that deficit.  Certainly, the news to date is there is a great deal of both waste and fraud to reduce, and if the president is successful, I believe that will play out in significantly lower 10-year yields, if for no other reason than the deficit is reduced or closed.  This story is just beginning to be written.

Now, Putin and Trump had a call
As Trump tries to end Russia’s brawl
They’re slated to meet
So, they can complete
A treaty with Europe awol

Under any interpretation, I believe the news that Presidents Trump and Putin are going to meet in an effort to hammer out an end to the Russia/Ukraine war is good news.  Beyond the simple fact that less war is an unadulterated good, I think it is very clear that this particular war has had significant market impacts, hence our interest here.  Obviously, energy prices have been impacted, as both oil and NatGas prices are higher than they would otherwise be given the removal of some portion of Russia’s exports from the global markets and economy.  As such, the end of this conflict, with one likely consequence being Western Europe reopening themselves to Russian energy imports, is likely to see prices decline.  

This matters for more reasons than the fact it will be cheaper to fill up your tank at the gas (petrol) station, it is very likely to have a very positive impact on inflation writ large.  As you can see from the chart below, there is a very strong correlation between the price of oil and US inflation expectations.  Declining oil prices are very likely to help people perceive a less inflationary future and will reduce the rate of inflation by definition.  

Source: ISABELNET

Inflation is an insidious process, and once entrenched is very hard to reduce, just ask Chairman Powell.  I also know that there has been much scoffing at President Trump’s claims he will reduce inflation, especially with his imposition of tariffs all over the place. (It is important to understand that tariffs are not necessarily inflationary by themselves as well explained by my friend the Inflation guy in this article.). However, between his strong start on reducing government expenditures and the potential for an end to the Russia/Ukraine war leading to lower energy prices, these are longer term effects that may do just that.

Ok, let’s move on to the market activities in the wake of yesterday’s CPI and ahead of this morning’s PPI data.  As discussed above, yesterday’s US markets rebounded from their worst levels of the morning and closed modestly lower with the NASDAQ actually unchanged.  In Asia, Japanese shares (+1.3%) had a solid day as the weak yen helped things along although Chinese shares (HK -0.2%, CSI 300 -0.4%) did not fare as well on the day with tariffs still top of mind.  Elsewhere in the region, other than Korea (+1.4%) movement was mixed and modest.  In Europe, the possibility of peace breaking out in Ukraine has clearly got investors excited as both Germany (+1.5%) and France (+1.2%) are seeing strong inflows. The UK (-0.7%) however, continues to suffer from economic underperformance with no discernible benefits shown from the governments weak efforts to right the ship.  GDP was released this morning and while they avoided recession, it’s very hard to get excited over 0.1% Q/Q growth.  As to the US futures market, at this hour (7:20), they are essentially unchanged.

In the bond market, we’ve already discussed Treasury yields, but another benefit of the prospects for a Ukrainian peace is that sovereign yields have fallen substantially, between -5bps and -8bps, throughout the continent.  Once again, the impact of that phone call between Trump and Putin has been quite significant.  Consider that not only are energy prices likely to slide, but the required government spending to prosecute the war is likely to diminish as well.

In the commodity markets, it should be no surprise that oil (-1.3%) prices are sliding as are NatGas prices in Europe (TTF -7.5%) as the opportunity for cheap Russian gas to flow to Europe is once again in view.  To highlight the impact that this has had on Europe, prior to the Ukraine war and the halting of gas flows, the TTF contract hovered between €5 and €25 per MWh.  Since the war broke out, even after the initial shock, it has been between €25 and €55 per MWh.  This is all you need to know about why Europe, and Germany especially, is deindustrializing.  As to the metals markets, after a few days of consolidation, gold (+0.4%) is on the move again although it has not yet recaptured the highs seen early Tuesday morning.  Give it time.  Copper (+0.6%), too, is back on the move and indicating that economic activity is set to continue to grow.

Finally, the dollar is mixed this morning, although arguably a touch softer overall, as the Russia news has traders looking for less negativity in Europe.  So modest gains in the euro and pound, about 0.15% each is offsetting larger losses in AUD (-0.3%) and NZD (-0.6%), although given the much smaller market size of the latter two, they matter much less.  JPY (+0.4%) is rebounding after yesterday’s sharp decline on the back of the jump in Treasury yields, and it is noteworthy that CHF (+0.65%) is gaining after its CPI data showed a decline in prices last month.  In the EMG bloc, CLP (+0.7%) is stronger on that copper rally, while ZAR (+0.1%) seems to be edging higher as gold continues to perform well. MXN (-0.4%) though is still struggling with the potential negative impact of tariffs and otherwise, there is not much to report.

This morning brings PPI (exp 0.3%. 3.3% Y/Y headline; 0.3%, 3.5% Y/Y core) as well as the weekly Initial (215K) and Continuing (1880K) Claims data.  There are no Fed speakers on the docket, but at this point, I expect the Fed will be fading into the background since they are clearly on hold and President Trump commands the spotlight.  Unless the data starts to veer dramatically away from what we have seen, it appears that the market is going to continue to respond to Trumpian headlines, which of course are impossible to predict.  But remember, most of the rest of the world is still in cutting mode so the dollar should continue to hold its own.

Good luck

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Not in a Rush

Posted on by

Said Powell, we’re not in a rush
To cut rates as we try to crush
Remaining inflation
And feel the sensation
Of drawing an inside straight flush
 
Up next is the CPI data
Though not one on which we fixate-a
The surveys explain
That people remain
Quite certain that we’re doing great-a

 

Chairman Powell testified to the Senate Banking Committee yesterday and the key comments were as follows, “Inflation has eased significantly over the past two years but remains somewhat elevated relative to our 2 percent longer-run goal. Total personal consumption expenditures (PCE) prices rose 2.6 percent over the 12 months ending in December, and, excluding the volatile food and energy categories, core PCE prices rose 2.8 percent. Longer-term inflation expectations appear to remain well anchored, as reflected in a broad range of surveys of households, businesses, and forecasters, as well as measures from financial markets.” [Emphasis added.] He followed up, “With our policy stance now significantly less restrictive than it had been and the economy remaining strong, we do not need to be in a hurry to adjust our policy stance.  We know that reducing policy restraint too fast or too much could hinder progress on inflation.”  This is largely what was expected as virtually every Fed speaker since the last FOMC meeting has said the same thing, there is no rush to further cut rates. Powell did admit that the neutral rate had risen compared to where it was before inflation took off in 2022 but maintains that current policy is still restrictive. 

However, let’s examine the highlighted comment above a little more closely.  Two things belie that statement as wishful thinking rather than an accurate representation of the current situation.  The first is that the most recent survey released from Friday’s Michigan Sentiment surveys, shows that inflation expectations for the next year jumped dramatically, one full percent to 4.3% as per the below chart.

Source: tradingeconomics.com

Looking over the past 10 years of data, that is a pretty disturbing spike, taking us right back to the 2022-23 period when inflation was roaring.  In addition to that little jump, it is worth looking at those market measures that Powell frequently mentions.  Typically, they are either the 5-year or 10-year breakeven rate.  That rate is the difference between the 5-year Treasury yield and the 5-year TIPS yield (or correspondingly the 10-year yields).  A quick look at the chart below shows that since the Fed first cut rates in September 2024, the 5-year breakeven rate has risen 78bps to 2.64%.  Certainly, looking at the chart, the idea of ‘well anchored’ isn’t the first description I would apply.  Perhaps, rocketing higher?

At any rate, it appears quite clear that the Fed is on hold for a while yet as they await both the evolution of the economy and further clarity on President Trump’s policies on tariffs.  While there is no doubt that we will continue to hear from various Fed speakers going forward, I maintain that the Fed is not seen as the primary driver in markets right now, rather that is President Trump.

Of course, data will still play a role, just a lesser one I believe, but we cannot ignore the CPI report due this morning.  First, remember, the Fed doesn’t focus on CPI, but rather on PCE which is typically released at the end of the month and calculated by the Commerce Department, not the BLS.  But the rest of us basically live in CPI land, so we all care.  If nothing else, it gives us something to complain about as we look incredulously at the declining numbers despite what we see with our own eyes every time we go shopping.

As it is, here are this morning’s median expectations for the data, headline CPI (+0.3% M/M, 2.9% Y/Y) and core CPI (+0.3% M/M, 3.1% Y/Y).  Once again, I believe there is value in taking a longer view of this data for two reasons; first to show that we are not remotely approaching the levels to which we became accustomed prior to the Covid pandemic and government response, and second to highlight that if your null hypothesis is CPI continues to decline, that may not be an appropriate view as we have spent the past 8 months in largely the same place as per the below chart.  Too, note the similarity between the Michigan Survey chart above and this one.

Source: tradingeconomics.com

OK, those are really the stories of the day since there have not, yet, been any new tariffs imposed by President Trump, and traders need to focus on something.  Let’s take a look at how things behaved overnight.

After a mixed US equity session, the strength was in Hong Kong (+2.6%) and China (+1.0%), seemingly on the back of several stories.  First is that China is looking at new ways to address the property bubble’s implosion, potentially allocating more support there, as well as this being a reflexive bounce from yesterday’s decline and the story that President’s Xi and Trump have spoken with the hope that things will not get out of hand there.  As to Japan, the Nikkei (+0.4%) has edged higher as the yen (-0.7%), despite a lot of talk about higher rates in Japan and the currency being massively undervalued, continues to weaken.  In Europe, once again there is limited movement overall with very tiny gains of less than 0.2% the norm although Spain’s IBEX (+0.7%) is the big winner today on some positive earnings results.  US futures are little changed at this hour (7:15).

In the bond market, Treasury yields are unchanged this morning, retaining the 4bps they added yesterday, and in Europe, sovereign yields are also little changed with German Bunds (+2bps) the biggest mover in the session.  JGB yields did rise 3bps overnight, but that seems to be following US yields as there was precious little new news there.

In the commodity markets, yesterday’s metal market declines are mostly continuing this morning with gold (-0.6%) down again, although still hanging around $2900/oz.  Silver has slipped although copper (+0.3%) has arrested its decline.  Oil (-1.1%) is giving back some of yesterday’s gains and continues to trade in the middle of its trading range with no real direction.  One thing I haven’t highlighted lately is European TTF NatGas prices, which while softer this morning (-1.9%) have risen 15% in the past month as storage levels in Europe are declining to concerning levels and global warming has not resulted in enough warm days for the winter.

Finally, the dollar is mixed away from the yen’s sharp decline with the euro (+0.1%) and CHF (+0.2%) offsetting the AUD (-0.3%) and NOK (-0.5%).  It is interesting that many of the financial and trading accounts that I follow on X (nee Twitter) continue to point to JPY and CAD as critical and are anticipating strength in both those currencies imminently.  And yet, neither one is showing much tendency to strengthen, at least for the past month or two.  I guess we shall see, but if the Fed is going to remain on hold, and especially if more tariffs are coming, I suspect the default direction of the dollar will be higher.  As to the EMG bloc, there is virtually nothing happening here, with a mix of gainers and laggards, none of which have moved 0.2% in either direction.

Other than the CPI data, Chairman Powell testifies to the House Financial Services Committee, and we will see EIA oil inventories with a modest build anticipated.  We also hear from two other Fed speakers, but again, with Powell in the spotlight, they just don’t matter.

Markets overall are pretty quiet, seemingly waiting for the next shoe to drop.  My money is on that shoe coming from the Oval Office, not data or Powell, which means we have no idea what will happen.  Stay hedged, but until further notice, I still don’t see a strong case for the dollar to decline.

Good luck

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Norms to Eschew

Posted on by

For market practitioners, Trump
Is more than a modest speed bump
His willingness to
Most norms to eschew
Can force long-term views to go bump
 
Meanwhile, as the markets prepare
For Powell to sit in his chair
In front of the Senate
A popular tenet
Is more rate cuts he will foreswear

 

It is very difficult to keep up with the news these days as President Trump really does address so many disparate issues in such short order, it is hard to know which ones will potentially impact markets and which will simply be headline fodder.  Obviously, the tariff discussions remain front and center, but even those plans seem to be evolving at a very fast pace, and while yesterday he did invoke 25% tariffs on steel and aluminum imports, that has literally become old news already.  The next question is what will occur with the latest idea of reciprocal tariffs, where the US will charge the same tariff on imports from other nations as those nations charge on imports from the US.

Generally speaking, US tariffs are the lowest overall around the world, which arguably is exactly what Trump wants to address.  I am not going to argue the merits or detractions of tariffs, that is pointless.  The only thing to consider is if they are implemented, what are the potential impacts.  One of the key things to remember about the effectiveness of tariffs is the price elasticity of the products being tariffed.  If, for instance, a product has substantial competition and is easily replaced, the nation being tariffed is likely going to absorb the bulk of the pain.  Consider Colombia and how quickly they caved regarding the deportations.  While I am not a coffee drinker, and I am sure there are those who believe Colombian coffee is the best, coffee also comes from Brazil, Vietnam, Hawaii and Indonesia, and as none of those nations (and obviously Hawaii) were subject to tariffs, Colombia would have paid the freight had they been implemented.

But, for a product like solar panels, where there are few suppliers other than the Chinese, to the extent the demand remained in place, the purchaser would see higher prices.  Turning to steel and aluminum, the below graphic shows the top 10 global steel producing nations and how much they produced in 2024.  This graphic says all you need to know about why President Trump is unhappy with China and their trade policies.  (well, this and the next one)

Source: worldsteel.org

And while this is not an exact apples-to-apples comparison, the below chart shows forecasts for steed demand in 2023 and 2024.  The mismatches are clear as China, South Korea and Japan have a significant surplus to export while the US and India need imports.

Source: mrssteel.com.vn

The point is President Trump is seeking to address that imbalance and is of the mind that the US would be better off if we make our own steel.  In fact, this is simply part of his entire philosophy to reshore US manufacturing capabilities.

Now, steel is a traded commodity, although in financial markets, not so much.  But changes in the flows of imports and exports will have an impact on FX markets, while tariffs could well also impact investment flows. In fact, it is not hard to see why Nippon Steel wants to buy US Steel.  if they own a steel manufacturer in the US, they can increase production with no concerns over tariffs.

Remember, too, this issue is merely a microcosm of the potential chaos that will be seen across industries and nations, both of which will impact financial markets.  Once again, I harp on the idea that a robust hedging program is a necessity these days.

Turning to today’s activities, Chairman Powell will be testifying before the Senate Banking Committee this morning.  On the one hand, I wonder if he is upset by the fact that virtually nobody is concerned about what he says these days as Trump continues to dominate every conversation.  For someone who has become quite accustomed to being the center of attention with respect to markets, this may well be a blow to his vanity and ego.  On the other hand, it is also quite possible that maintaining a low profile is precisely his strategy here, and if that is the case, I expect we will not learn anything new at all.  The Fed mantra is currently that they will be cautious before implementing any further rate cuts.  Remember, CPI is released tomorrow as well, so when he goes before the House, they will have that information in hand.  But to Powell’s benefit, Treasury Secretary Bessent made clear he and President Trump are far more concerned about the 10-year yield than Fed funds.  This may be the most amazing transformation of all, a Fed chair who becomes a wallflower!

Ok, after yesterday’s US equity rally, the story in Asia was far less positive.  Japan and Australia were unchanged while the Hang Seng (-1.1%) and CSI 300 (-0.5%) both suffered, perhaps on the tariff impositions.  Elsewhere in the region, Taiwan and South Korea both had solid sessions while weakness was evident in Indonesia, India and the Philippines.  In fact, all three of those markets have been declining steadily since October, with declines between 15% and 20% as prospects in those economies seem concerning, especially with Trump’s tariff mania.  In Europe, virtually every market is unchanged this morning as the EU quickly explained they would retaliate against any US tariffs.  Of course, that is what makes Trump’s reciprocal tariff structure so interesting.  How can Europe complain that other nations impose the same level of tariffs they do?  Meanwhile, at this hour (7:05), US futures are pointing slightly lower, about -0.25%.

In the bond market, yields are climbing with Treasuries higher by 3bps, now 12bps above the lows seen early last week, while in Europe, yields are substantially higher, with France (+10bps) leading the way, but the rest of the continent showing rises of between 4bps and 6bps.  Part of this move on the continent is driven by a catch up to yesterday afternoon’s US yield rally.  As to the French, seemingly their Unemployment Report, which showed a much better than expected 7.3%, may have investors concerned about quickening growth and inflation.  That feels like a lot, but there are no real explanations I have seen.

In the commodity markets, oil (+1.5%) is continuing to rebound off its recent lows, although still looks like it is in the middle of its trading range.  Gold (-0.7%) and silver (-1.2%) are both finally retracing some of the extraordinary rally that we have been witnessing for the past two months.  Copper (-2.7%), too, is under pressure this morning, unwinding some of its recent spectacular gains.

Finally, the dollar is very modestly softer, but not universally so.  For instance, the euro (+0.2%) and yen (-0.2%) seem to offset each other while most other G10 currencies have moved even less.  In the EMG bloc, though, INR (+0.9%) is the biggest gainer as the RBI has been intervening to address what had been an acceleration in the rupees decline in the past few weeks (see below).

Source: tradingeconomics.com

Elsewhere in the space, gains are less impressive, with moves on the order of +0.4% (PLN and HUF) or smaller.

On the data front, the NFIB Small Business Optimism Index was released at a softer than expected 102.8 as it seems the Trumpian chaos is having an effect for now.  Otherwise, the only thing is Powell and three other Fed speakers, but again, given the relative lack of discussion regarding Powell, the other three will get even less press in my view.

It is difficult to claim nothing has changed lately, but perhaps more accurately, there is no clear directional change at this point.  We need to start seeing some consistency in the policy impacts and that is likely to take months.  Until then, volatility is the watchword across all markets.

Good luck

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