The World is Ending

Posted on August 5, 2024 by fxpoet

The world is ending
At least, that’s the way it feels
Owning equities

The narrative writers are caught
‘Cause stories those writers had wrought
No longer apply
And folks now decry
The idea that dips should be bought

Remember the idea of the summer doldrums where everybody is on vacation, so markets move very little? Yeah, neither do I! Here’s a different idea though, when risk is under pressure, all correlations go to 1.0. Look at the following three charts (source: tradingeconomics.com) and explain to me how they behave independently:

There is rioting in the streets today, perhaps not in your neighborhood directly, but in many places around the world (the UK, Bangladesh, Kenya, others), as the global order that we have known for the past X years gets tested. How big is X? There will be many different answers to that question, but in this poet’s mind, what we are witnessing in its full glory today is the beginning of the unwinding of the market excesses that began when global interest rates headed to 0.00% in the wake of the GFC in 2009, so X=15 years.

It is easy to wax philosophical on this subject, discussing the merits of moderating the business cycle and why interest rate policy is a net benefit, and you can be sure that before this week is over, we will get policy interventions. But ultimately, markets need to clear to function effectively, and I would argue that the last time markets actually cleared was in 1974. The next big opportunity to allow markets to clear was in October 1987 and the Maestro, although he had not yet earned that moniker, stepped in after that Black Monday and promised unlimited liquidity to prevent too much damage.

Ever since then, central bankers around the world, led by the Federal Reserve, but do not forget actions like Mario Draghi’s “whatever it takes” moment, have decided that they need to manage the global economy, and market responses, and that markets were only effective if they were going higher. (It’s ironic that TradFi people scoffed at the crypto maxim ‘number go up’, yet they believed exactly the same thing, only in a different wrapper.) As well, we all know that the concept of political will does not exist anymore, at least not in the West, as no elected politician will ever choose to fight for a policy that has short-term pain and long-term gain. The result of this constant intervention and guidance from policymakers is that things get overdone, and bubbles inflate. And it is much easier to inflate a bubble when you maintain policy rates at 0.00% (or negative rates in some cases).

At this point, you will read many stories about which particular catalyst drove this market reaction, whether it was last week’s BOJ meeting where Ueda-san surprised the market and hiked rates as well as promised to reduce QQE, or whether it was the fact that Chairman Powell did not cut rates, or if it was the weak payroll report. Others will point to the escalation in hostilities in Ukraine and the Middle East as flashpoints getting people to exit risk positions. But in the end, the catalyst is not important. As I wrote on Friday, and is so well explained in Mark Buchanan’s book, Ubiquity, the market was rife with ‘fingers of instability’ and an avalanche has begun.

To this poet’s eye, there needs to be more excess wrung from the market. After all, given the underlying trade of virtually the entire bull market has been the JPY carry trade, where traders and investors borrowed JPY at 0.00%, converted it to another currency and either held that currency to earn the interest rate differential, or for the truly aggressive, used the currency to buy other risky assets (NVDA anyone?), and that trade has been building for years. Deutsche Bank has estimated that it grew to $20 trillion in size. I assure you it is not completely unwound!

However, as I mentioned above, I am confident that central bankers are already getting intense pressure from their respective governments to ‘do something’ to stop the rout. But central bankers are already (save Japan) in cutting mode. And the Fed just passed on cutting rates last week. If they were to cut today, no matter what they said, it would remove any doubt that the only thing they care about is the stock market. It would destroy whatever credibility they still retain. But do not count out that response, at this stage, it’s probably 50:50 they cut this week if things continue. After all, the Fed funds futures market is now pricing in a 95% probability of a 50bp cut in September and a total of 125bps of cuts by December!

I will be the first to say I have no idea where things are going to head from here because while market internals point to further unwinding of risky assets, policy responses have not yet been seen. So, the best advice I can offer if you are not leveraged is do not panic. If you are, you have probably been stopped out already anyway. In the meantime, let’s take a look at the damage overnight.

Equity Markets in Asia:

Nikkei 225 -12.4%
Hang Seng -1.5%
CSI 300 -1.2%
ASX 300 -3.7%
KOSPI -8.8%
TAIEX -8.3%
Nifty 50 -2.7%

In other words, it was quite the rout, with tech shares getting hammered everywhere. Perhaps the most surprising thing to me as that the CSI 300 didn’t fall further, although I suspect that there was significant intervention by the government to prevent that from happening. (After all, you don’t need to be a western government to want the number to go up!)

Equity Markets in Europe:

DAX -2.6%
CAC -2.4%
FTSE 100 -2.4%
IBEX -2.8%’
FTSE MIB -3.0%

This tells me that these markets were not nearly as leveraged as Asian markets, likely because prospects throughout Europe have been relatively less interesting to many investors. After all, if you are leveraging up via borrowing yen, you want to buy growth, not value, stocks, and there aren’t that many growth names in Europe.

Finally, US futures, at this hour (7:00) are lower by:

S&P 500 -3.0%
NASDQ -4.5%
DJIA -2.1%

Bond markets are also seeing very significant movement, in the opposite direction as they are performing their safe haven role brilliantly today. While the movements today are solid, with Treasury and European sovereign yields all lower by between 5bps and 7bps, to see the real story, you need to see the move since Friday’s opening (these are all 10-year yields).

US -20bps
Germany -10bps
UK -9bps
Japan -20bps
Australia -17bps

The US yield curve, at least the 2yr-10yr measurement, is virtually flat today and 30yr yields are now higher than both of those maturities. Also, look at JGB yields, down to 0.77%, as Japanese investors take their toys and go home. The thing about this move, and the reason I don’t believe the unwinding is over yet, is that once the Japanese investment community starts to move, it takes a long time for them to get to be where they want given the amount of the assets involved. And despite all the clutching of pearls about the US ability to sell the amount of debt they need to fund themselves; it won’t be a problem for right now. Many people around the world will be all too happy to buy Treasury bonds regardless of some political foibles in the US.

Commodity markets are under pressure this morning, but not seeing the same type of pain as equity markets. The story here is that commodities are not directly impacted by the current movements (if anything declining interest rates should help them) but when margin calls come, people sell whatever they can that is liquid. So, gold (-1.6%) is being liquidated to cover margin calls, not because people don’t want it. Oil (-1.6%) is likely feeling pressure because these equity moves presage potential economic weakness and a reduction in demand, and we are seeing the same response from the industrial metals. My take is gold is the one thing, besides bonds, that people are going to be willing to hold, and will rebound first.

Finally, the dollar is under pressure, net, but we are seeing massive movements in both directions.

JPY +2.5%
EUR +0.4%
GBP -0.3%
AUD -0.9%
MXN -3.3%
NOK -1.0%
ZAR -2.0%
CNY +0.8%
CHF +0.8%
KRW -0.5%

See if you can determine which were the favorite currencies to hold long against short JPY (AUD, MXN, ZAR). Meanwhile, the renminbi is able to gain as it continues to weaken, net against the yen, its most important competitor. Remember, currencies are the outlet valves for economies when other markets cannot move enough. The thing to keep in mind, especially as a hedger, is that volatility is going to be very high for a while yet. This will not all quiet down and go away in a week’s time.

At this point, it’s fair to ask, does data matter anymore? Probably not today, but it will be key for the central banks if for no other reason than to cloak their actions in some fundamental story. Alas for the Fed, there is virtually nothing to be released this week. All we see is:

Today	ISM Services	51.0
Tuesday	Trade Balance	-$72.4B
Thursday	Initial Claims	250K
	Continuing Claims	1880K

Source: tradingeconomics.com

As well, and perhaps remarkably, so far on the calendar we only have three Fed speakers, Goolsbee, Daly and Barkin. However, it seems almost certain we will hear from others, especially if the rout continues.

Right now, fundamentals do not matter. My sense is we will see a bounce of some sort after the first wave ends, perhaps as soon as tomorrow, but the narrative of the soft landing has been discarded. Look for more political pressure on the Fed to act, and to act soon. Also, do not be surprised if the rest of the week ultimately sees a slower, but steady, decline in risk assets as those who haven’t panicked react to the situation and reevaluate just how much they love their positions. Consider, Warren Buffet sold some of his favorite positions last week and is loaded with cash to act. But there is nobody who is more patient than he.

Good luck

Adf

Like an Avalanche

Posted on August 2, 2024 by fxpoet

Like an avalanche
The Nikkei collapsed last night
Is there more to come?

The thing about markets is that they have an extraordinary ability to confound everyone. For instance, last night, the Nikkei (-5.8%) essentially collapsed, falling more than 3% on the opening and continuing lower from there. This takes the “correction” in this index to more than -16% in the past three weeks as you can see from the chart below.

Source: tradingeconomics.com

I have seen several explanations for the move but the one thing I have learned over time is that the biggest moves often lack a specific catalyst. Rather, an accurate post-mortem of the situation would indicate that prior to the collapse, the market was in a ‘critical state’, a state where there are many inherent flaws beneath the surface that can combine to drive a single significant move. (If you have not already read Ubiquity by Mark Buchanan, I cannot recommend it highly enough as it is both extremely well written and discusses this exact situation and how it plays out across all systems, including financial ones.) At any rate, the essence of the idea is that systems develop ‘fingers of instability’ within their structure over time. These can be things like the extreme concentration in the Mag 7 stocks compared to the rest of the S&P 500, or the fact that earnings for a majority of the S&P have been declining despite the index making new highs.

I will be the first to admit I do not know the inner workings of the Nikkei at all. However, I am confident that there were numerous fingers of instability beneath the surface that led to this move. Arguably, some of those were the recent appreciation in the yen, which has rallied ~8% in the past month with a negative impact on Japanese exporter earnings. And of course, just Wednesday night the BOJ tightened policy in a surprising move, but as importantly, explained they would be reducing their QQE, and that further tightening was likely going forward. Finally, the US market, especially the tech sector, has been under some pressure as well given some lackluster earnings reports by key Mag 7 players. Combine all that and you have a situation ripe for a major correction. It’s just that it is rare to put it all together ahead of time.

With payrolls the topic today
The pundits don’t know what to say
Is good news still bad?
Or will bears be glad
If payrolls, real weakness, betray?

Cause yesterday’s markets were rough
For holders of risk-laden stuff
The data was weak
And havens were chic
Investors have had ‘bout enough

Which takes us to this morning’s payroll report. Before that discussion though, it is important to touch on what yesterday’s data revealed. It started with the highest Initial Claims data in almost a year, far higher than forecast and as you can see in the chart below, there certainly seems to be a developing trend.

Source: tradingeconomics.com

Continuing Claims were also much higher, their highest in nearly three years, and an indication that getting jobs is a lot harder these days. While the Productivity data was solid, the ISM data was anything but, printing at 46.8, the 22^nd time in the past 23 months that it has printed below the 50.0 level of growth/contraction. And Construction Spending was also weak. The point is that yesterday had the feel of a much weaker economy than what we have been seeing previously. And more importantly, the market response seems to have changed from bad news = good, to bad news = bad. Previously, weak economic data encouraged the idea that the Fed would cut, and risk assets rallied. But now that the Fed passed on their opportunity to cut this week and will not meet again until September, bad news implies the Fed is falling further behind the curve, and risk assets are suffering accordingly. Now, with that is intro, here are today’s expectations:

Nonfarm Payrolls	175K
Private Payurolls	148K
Manufacturing Payrolls	-1K
Unemployment Rate	4.1%
Average Hourly Earnings	0.3% (3.7% y/Y)
Average Weekly Hours	34.3
Participation Rate	62.5%
Factory Orders	-2.9%

Source: tradingeconomics.com

Certainly, the tone of the recent data has been soft, and the ADP Employment number was much lower than expected at 122K. This might lead one to believe that today’s number will be soft as well, with a headline print of 125K – 150K. If that happened, I don’t think anyone would be surprised. But here’s the thing about markets, they seem to exist to cause the most pain possible before heading where they are supposed to go. As such, there is a small part of me that believes we could see a better-than-expected outcome, perhaps over 200K again, just to confuse people.

However, if the report is soft, I expect that will weigh further on risk assets, and based on the US futures market at this hour (7:00), that is the general expectation with all three major US indices having fallen by more than -1.0% following yesterday’s rout. So, let’s look at how the rest of the world is handling this collapse in Japan. Every major market in Asia fell, mostly by more than -2% with notable declines in Taiwan (-4.4%), Korea (-3.6%) and Hong Kong (-2.1%) although the CSI 300 on the mainland fell only -1.0%. In Europe, the picture is all red, but the magnitude of the declines is not nearly so dramatic, DAX (-1.5%), CAC (-0.7%), FTSE 100 (-0.3%). Of course, given this seems to be related to a tech stock decline, this should be no surprise as there is no real tech in Europe.

Bond yields are lower everywhere after a sharp decline yesterday as well. Treasury yields are below 4.0% for the first time since their brief foray below that line at the beginning of the year, back when markets were pricing in 6 rate cuts this year. Net, 10-year Treasury yields have decline 13bps since yesterday morning. European sovereign yields are also declining in a similar manner, down between 8bps and 10bps from yesterday morning but the real surprise is in Japan where 10yr JGB yields have tumbled 9bps. It seems that there is more to the decline in USDJPY than simply unwinding the carry trade and covering JPY shorts. It looks as though some institutional money is heading home.

In the commodity markets, traders don’t know what to think. Will a war in the Middle East cause significant supply disruptions? Or is the evidence of a weak economy now too great to overcome and set to drive oil prices lower again. This morning, WTI is slightly softer (-0.2%) but I would come in on the side of weaker growth being a drag. Remember, there is much spare capacity in Saudi Arabia if supplies tighten. But the real story is gold (+0.5%) which has rallied to yet another new all-time high this morning and is dragging the rest of the metals complex along with it. In the end, I think in many eyes around the world, if not in the US, gold remains the ultimate safe haven, and when the fan gets hit, people want it in their portfolios.

Lastly, the dollar is under real pressure this morning, opposite its haven characteristics but for a good reason. A quick look at the CME futures shows the market is now pricing a 24% chance of a 50bp cut in September, and if the data continues to weaken, especially this morning’s NFP, I expect there will be pressure growing for an inter-meeting cut. So, the euro (+0.4%) looks healthy by comparison and USDJPY continues to trickle lower, but the big surprise is CNY (+0.55%) which has had its largest daily rally since early May. I maintain that the PBOC will be happy to allow the renminbi to strength as long as it lags the yen. And lately, every currency has been lagging the yen with the big carry trades amongst the worst performers. But the chart of CNYJPY below demonstrates that the PBOC is likely not that concerned about a little strength vs. the dollar right now.

Source: tradingeconomics.com

And that’s really all for the day. I don’t see any Fed speakers on the calendar, but given the market movements lately, I expect we will hear from at least one FOMC member. Ahead of the NFP, things will remain quiet, but that will set the tone. To my eye, this correction has further to go, and if all those analysts who have been digging into the data and claiming we are already in a recession prove to be correct, watch for the Fed to be far more aggressive than currently priced. That means the dollar has a lot of room to decline in that situation.

Good luck and good weekend

Adf

A Stock Jamboree

Posted on August 1, 2024 by fxpoet

Said Jay, there are two goals we seek
Strong job growth while prices are weak
And as I sit here
The way things appear
Come autumn, Fed funds we may tweak

The market responded with glee
Twas truly a stock jamboree
Plus, bonds joined the fun
And went on a run
The dollar, though, sank in the sea

At this point, the only question in market participants’ minds is whether the Fed will cut 25bps or 50bps in the September meeting. Yesterday afternoon, as widely expected, the FOMC left rates unchanged and tried to offer a balanced view of the future, explaining that both of their dual mandate goals were normalizing. Obviously, inflation, which has been their primary focus for the past two years, has been moving in the right direction and Chairman Powell reiterated that they are gaining ‘confidence’ that they will achieve their 2% target. But this time, Powell spent more time describing the job market and how it was now coming into balance. In other words, what had previously been a significant inflationary pressure in the Fed’s collective view, was now having less of an impact on prices.

At the press conference, Powell would not be pinned down on a September cut, although based on pricing in the Fed funds futures market, you would be hard pressed to believe that. This morning, the market is pricing more than 28bps of rate cuts (a 13.5% probability of a 50bp cut) into the September meeting, so the key will be to watch how that probability of a 50bp cut evolves. If we start to see hard data, like tomorrow’s NFP or CPI, in two weeks’ time, decline, I’m confident that the market will be calling for a 50bp cut before long.

In the end, the recent correction seen in risk asset markets seems to have been just that, a correction, and now the narrative is that there are blue skies ahead with lower rates to support things and the Fed is going to stick the soft landing. This poet is less certain that the best case will obtain, but that’s what makes markets.

So, even though we have not yet heard from the third major central bank as I write (the BOE is due to announce in a few hours’ time), I don’t think that is going to impact the global narrative. Let me start by saying that I believe they will cut rates in the UK as yesterday’s activities in the US make it all but certain a cut is coming here, and given the ECB, BOC and Riksbank have all cut already, they have plenty of company. However, let’s recap where things are now and what the market narrative is now explaining to us all.

Policy normalization is the new watchword as we hear that the BOJ is normalizing policy by raising interest rates and tightening while the rest of the G10 are normalizing policy by cutting rates and ending activities like QT. I guess the definition that the punditry ascribes to normal policy is, every country has the same interest rate! In fact, I say that only half tongue in cheek, as there is some merit to the discussion. While it is certainly true that global economies have evolved in greater synchronicity over the past decades, interest rate policy has always been based on the idiosyncrasies of each economic area. For instance, money supplies and productive capacities differ widely amongst countries, so why should we believe that the “proper” monetary policy is the same level of interest rates across the board. Of course, we shouldn’t, but for market participants, it is much easier if they have one target for everything rather than being forced to understand each economy in its own right.

But with that in mind, let’s recap where things currently stand around the major economies.

1.     US – economic activity is slowing, but the pace of that slowdown is very modest, at least based on the recent GDP reading. Inflation is slowly receding but has not yet achieved the Fed’s target and the jobs market has, to date, held up reasonably well. Of course, we will know more about that tomorrow. On the flip side, the manufacturing portion of the economy has been the laggard, with PMI and regional Fed surveys pointing to subpar activity. There seems to be a disconnect between the slowing economy and the roaring equity market, but markets have a life of their own.
2.     Europe – economic activity overall is modest with a reversal in the weak vs. strong players as Germany is the sick man of Europe and the PIGS economies are all faring far better. Inflation here is a bit stickier than it seems in the US as evidenced by yesterday’s higher than expected readings and remains well above the 2% target here. Most nations are seeing more substantial weakness in their manufacturing sectors, although for some (I’m looking at you Germany) it is self-inflicted based on insane energy policies driving energy costs much higher.
3.     Japan – recent growth signs have been quite poor with a negative GDP release just last week indicating things are not going well. This has been accompanied by above target inflation, which while seeming to slow, is slowing very gradually. In fact, this is the one place where the FX rate seems to really have had an impact, with the yen’s previous weakness adding to inflationary pressures and offsetting their very modest monetary policy tightening. However, the combination of the BOJ hiking and the Fed seeming to promise a cut has led the yen to recoup nearly 8% over the past several weeks and now that USDJPY is below 150, I expect to see this move continue. That should help ameliorate some of the inflation pressures, although it is not clear to me it will help economic growth.
4.     China – last night’s Caixin Manufacturing PMI was a disappointing 49.8, down two points and below expectations. The indication is that economic activity in China remains hampered by the lack of consumer activity. China’s long-term policy of mercantilism is running into its limits as nations around the world are unwilling to take their excess production freely, and the domestic economy remains in the doldrums, still suffering from the ongoing deflation of the property bubble. While the PBOC did reduce interest rates recently, the fact that neither the Third Plenum nor the Politburo were willing to inject real stimulus into the economy indicates that things are going to remain lackluster going forward.

Arguably, the lesson from this recap is that economic activity is in a downtrend and that inflation is also in a downtrend, just a shallower one. Policy makers around the world are struggling to find the right mix because oftentimes, the right mix means something politically difficult. Net, I expect this process will continue and that we will see more and more efforts to turn around the economic trend while ignoring the inflation trend.

Ok, this has turned into more than I expected, so let’s be quick on markets today. Yesterday’s Fed led to a huge tech sector rally in the US but that was not enough to help the rest of the world. Despite that optimism, Japanese shares (-2.5%) were down sharply on the continued strength of the yen, while Chinese shares, in both Hong Kong (-0.25%) and the mainland (-0.7%) saw no love either. In fact, the whole region was under water. The same is true in Europe this morning with all the continental bourses lower on average by -0.65% or so after continued weak PMI data was released this morning. The only exception here is the UK, where the FTSE 100 is now higher by 0.3% after the BOE, as I expected, cut rates by 25bps at 7:00am. As to US futures, euphoria is still alive and they are all higher at this hour, just past 7:00.

In the bond market, yields are declining around the world led by Treasury yields which fell 10bps yesterday, although they have rebounded by 2bps this morning. 2yr yields also fell a similar amount so the yield curve’s inversion remains at -23bps this morning. In Europe, yields also slid yesterday, albeit not as much as in the US and are a further 2bps lower this morning as they try to catch up. The exception here is the UK, again, as 10yr Gilt yields are lower by 5bps this morning in the wake of the BOE cut. JGB yields overnight fell 1bp, although given the move in Treasury yields, that gap has still narrowed substantially.

In the commodity markets, oil (+0.9%) continues to rally as fears over an Iranian retaliation against Israel grow with no clear idea where this will stop. Consider, though, WTI remains below $80/bbl still, so right in the middle of its longer term range. I imagine we could see a bump higher, but remember, OPEC has a lot of spare capacity, so if some countries are forced to stop producing, the Saudis can turn on the taps. Gold (-0.4%) is backing off the new all-time highs it reached yesterday, but remains far above $2400/oz. In fact, all the metals markets saw gains yesterday and this morning they are ceding some of those gains, but I don’t think this story has changed; if the Fed gets more aggressive, I expect these commodity prices to rise further.

Finally, the dollar is on fire this morning, rallying against everything but the Swiss franc right now. The pound (-0.7%) is under the most pressure in the G10 after the rate cut, but we are seeing weakness everywhere else but Norway and Switzerland. Even the yen, which had broken through the 150 level earlier this morning is now back below (dollar above) that level, although I expect there are further declines to come here in the dollar. One other surprisingly large mover is CNY (-0.4%) which has given back more than half its gains from the activities last week involving the PBOC rate cuts and intervention. Remember, if the yen continues to strengthen, the renminbi will be able to do so at a very gradual rate and maintain increased competitiveness vs. Japanese exports.

On the data front, this morning brings Initial (exp 236K) and Continuing (1860K) Claims, Nonfarm Productivity (1.7%), Unit Labor Costs (1.8%) and ISM Manufacturing (48.8). Remarkably, there are no Fed speakers on the schedule, but I imagine they will not be able to keep quiet for long. However, while there is a definite glow amongst investors, all eyes will turn to tomorrow’s NFP data, where a hot number will not be taken well, at least not at first, but if we print below NFP expectations, look for stocks to rock on a growing expectation of 50bps in September. That will also hurt the dollar, which should retrace some of today’s gains.

Good luck
Adf

New Shibboleth

Posted on July 31, 2024 by fxpoet

A second rate hike
By Japan has resulted
In strong like bull yen

Last night, Governor Kazuo Ueda and the BOJ raised their overnight call rate to 0.25% from the previous level of between 0.00% and 0.10%. This move was forecast by several analysts but was certainly not the base case for most, nor what this poet expected. However, it appears that the gradual slowing in inflation in Japan was not seen as sufficient and so they moved. By far, the biggest reaction came in the FX markets where the yen jumped sharply, now higher by 1.5% compared to yesterday’s NY close. A look at the longer-term chart of USDJPY below shows that at its current level just above 150.00 (obviously a big round number), the currency has reached a double support level based on its 50-week moving average (the curved line) and the trend line that starts from the time the Fed began raising interest rates in March 2022.

Source: tradingeconomics.com

Surprisingly, given the sharp move seen overnight, there has been virtually no discussion as to whether the MOF asked the BOJ to intervene and further push the yen higher (dollar lower) in concert with its recent strategy of pushing a market that is moving in its favor rather than fighting a market that is moving against its goals. Regardless, the 150 level is going to be a very important technical support, and any break below may open up another 10 yen decline in the dollar.

What, you may ask, would lead to such a move? How about the Fed?

The pundits are holding their breath
With “cut Jay” their new shibboleth
But will Chairman Powell
Now throw in the towel
On prices and channel Macbeth?

Of course, this afternoon, the big news is the FOMC meeting wraps up and at 2:00 they release their statement which is followed by the Chairman’s press conference at 2:30. As of this morning, the probability of a cut today is down to 3.1% according to the CME’s futures market. However, that market has a 25bp cut locked in for September with a further 10% probability of a 50bp cut then and is pricing in a total of 66bps of cuts by the December meeting, so, a bit more than a 60% probability of three 25bp cuts by the end of the year. That pricing continues to feel aggressive to this poet as the data has not yet shown that the economy is clearly in trouble. Remember, too, the Fed is always reactive, despite any of their comments on trying to get ahead of the curve.

Continuing our observations of mixed data, yesterday saw that home prices, as per the Case-Shiller Index, remain robust, rising 6.8% in May (this data is always lagging), but there is little indication that the shelter component of the inflation statistics is set to decline sharply. As well, the JOLTs Job Openings data printed at a higher than expected 8.184M, indicating that there is still labor demand out there. Finally, the Consumer Confidence number rose a touch more than expected to 100.3. My point is there continues to be strength in many parts of the economy and prices are nowhere near declining. Granted, this Friday’s NFP report will take on added importance as if the numbers there start to decline and Unemployment continues its recent trend higher, there will be far more urgency to cut rates. Perhaps this morning’s ADP Employment report (exp 150K) will help clear up some things, but I’m not confident that is the case.

Interestingly, there are still a number of analysts who are clamoring for the Fed to cut today, claiming they can get ahead of the curve and stick the soft landing. However, history has shown that the Fed lives its life behind the curve, and there is no indication that is about to change.

There is one other thing to consider, though, and that is the politics of the situation. While the Fed is adamant they are apolitical and only trying to achieve their mandated goals, we all know that in order to even be considered to reach the FOMC as a named member of the committee, one needs to be highly political. Does that mean that partisan politics enters the arena? These days, it is almost impossible for that not to be the case.

The current narrative on this subject is that a rate cut will help the current administration, and by extension the candidacy of VP Harris. I’m not sure I understand that given inflation, which remains a major topic of conversation around the country, especially at the proverbial kitchen table, is so widely hated across the board. The most interesting poll results I saw were that a majority of those questioned indicated they hated inflation far more than a recession. This surprised the economic PhD set, but as inflation is an insidious cancer on everyone’s wellbeing, it is no surprise to this poet. My point is that a rate cut now will do exactly zero to help support growth before the election, but it will almost certainly boost the price of commodities, notably energy and gasoline, and that will show up in inflation post haste. Thus, does the narrative even make sense? If Powell is truly partisan (and I don’t think that is the case), he would refrain from cutting rates until September as any impact, other than in financial markets, will not be felt until long after the election. FWIW, I agree with the market there will be no cut today, but absent a major decline in the employment situation by September, I see only 25bps there.

Ok, a bit too long to start today, but obviously there is much of importance to understand. So, let’s look at how markets have responded to the BOJ while they await the FOMC. As earnings season continues, the tech sector in the US continues to struggle as evidenced by the sharp decline in the NASDAQ yesterday, although the DJIA managed to gain 0.5%. In Asia, though, tech concerns were overwhelmed by the excitement of the BOJ’s action and the strength in the yen. Perhaps the surprising thing is the Nikkei (+1.5%) rose so much given a strong yen generally undermines the index, but the rate hike boosted bank shares by 5% or more across the board. And that strong yen was welcomed everywhere else in Asia with Chinese shares (Hang Seng +2.0%, CSI 300 +2.2%) and almost every regional exchange gaining real ground on the back of a less competitive Japan given the higher yen.

In Europe, most markets are much firmer as well this morning, led by the CAC (+1.4%) and FTSE 100 (+1.4%) although Spain’s IBEX (-1.0%) is lagging on uninspiring corporate earnings results. I would contend these markets are being helped by that stronger yen as well, given Japan’s status as a major exporter. Lastly, US futures are higher at this hour (7:20) after some better-than-expected results from chipmaker AMD, although MSFT’s numbers were less impressive. Net, though, NASDAQ futures are up 1.6% this morning dragging everything else along for the ride.

In the bond market, Treasury yields continue to edge lower, down -1bp this morning and European sovereign yields are all lower by between -2bps and-3bps. That is somewhat interesting given the flash Eurozone inflation data printed higher than expected at 2.6% headline, 2.9% core, but the market is clearly going all-in on the rate cutting narrative. The big moves in this market, though, came in Asia with JGB yields jumping 5bps after the rate hike and the BOJ’s announcement they would be reducing their monthly purchases by 50%…OVER THE NEXT TWO YEARS! They are not exactly rushing to tighten policy. However, even more impressive was the -16bp decline in Australian 10yr bond yields after softer than expected inflation data overnight got the market thinking about rate cuts instead of the previous view of rate hikes being the next move.

In the commodity markets, things have really broken out. Oil (+3.5%) is finally paying attention to the escalation of hostilities in the Middle East after Hamas leader Haniyeh was killed while in Iran. While Israel has not officially claimed the act, that is the assumption and concerns are elevated that there will be a more dramatic response impacting many oil producing nations. This has encouraged the rally in precious metals with gold (+0.4%) continuing its rally after a >1% gain yesterday, and support for both silver and copper as well. Frankly, the copper story doesn’t make that much sense given the ongoing lackluster economic growth story, but with the metal’s recent sharp decline, this could simply be a trading bounce.

Finally, the dollar is all over the place this morning. As mentioned above, the yen is today’s big winner, but we have seen strength in CNY (+0.25%) and KRW (+0.85%) as well, with both those currencies directly aided by yen strength. Meanwhile, AUD (-0.5%) has responded to the quickly evolving rate story Down Under and is cementing its position as the worst performing G10 currency in July. Not surprisingly, the commodity linked currencies are having a good day with ZAR (+0.6%) and NOK (+0.5%) both stronger, but after that, the financially linked currencies are not doing very much, so the euro, pound, Loonie and Swiss franc are all only marginally changed on the day.

In addition to the ADP and the FOMC, this morning also brings the Treasury’s QRA, although there is little interest in that report this time around as expectations remain that there will be no major change to the recent mix of debt, i.e., mostly T-bills. We also see Chicago PMI (exp 44.5) and get the EIA oil data, although the latter will have a hard time competing with a pending war in the Middle East.

All told, not only has a lot happened, but there is also room for a lot more to occur before we go home today. Quite frankly, I don’t see anything extraordinary coming from Powell, but the risk, to me, is he is more dovish than required and the dollar falls more broadly while commodity prices rise. Keep your eye on that 150 level in USDJPY, as a break there can really get things moving.

Good luck

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German Malaise

Posted on July 30, 2024 by fxpoet

With central bank meetings ahead
Tonight BOJ, then the Fed
The discourse today’s
On German malaise
And why vs. the PIGS its widespread

As investors await the news from Ueda-san tonight and Chairman Powell tomorrow, the market discussion has revolved around the potential problems that Madame Lagarde is going to have going forward given the split in economic outcomes within the Eurozone. As can be seen in the below graph, German GDP growth (grey bars) has been running at a negative rate for the past 4 quarters. But you can also see that the situation in both Spain (red bars) and Italy (blue bars) has been the opposite, with both of those nations maintaining a steady pace of growth.

Source: tradingeconomics.com

So, while Germany is the largest single economy within the Eurozone, its current trajectory is very different than much of the rest of the bloc, ironically specifically the PIGS. Should the ECB ignore German weakness and manage monetary policy toward the overall group? Or should they ease more aggressively in order to support the Germans while risking a rebound in still sticky inflation?

Perhaps the first thing to answer is why Germany has been suffering for so long. This is an easy question to answer. Germany’s energy policy, Energiewende, has been an unmitigated disaster. Their efforts to address climate change have led to the highest energy costs in Europe which, not surprisingly, has resulted in a massive reduction in manufacturing activity. Areas where Germany had been supreme, like chemicals and autos, are hugely energy intensive industries, so as their cost of production rose, the companies moved their activities elsewhere. Adding to the insanity was the policy to shutter their nuclear fleet, which had produced 10% of the nation’s electricity, during the post Ukraine invasion energy crisis. And ultimately, this is the problem. The cost of money is not Germany’s economic problem, it is their policies which have undermined their own growth ability. While the ECB cannot ignore Germany outright, there is nothing they can do that will help the nation rebound in any meaningful way. With that in mind, I would contend Lagarde needs to focus on the rest of the bloc to make sure policy suits them. But that is a political discussion.

What are the likely impacts of this situation? Eurozone growth, overall, surprised on the high side despite the lagging German data. As well, inflation readings released thus far this month have shown that prices remain sticky on the continent. With that in mind, the idea the ECB needs to cut aggressively seems to make little sense. This is not to say they will maintain tighter policy, just that it doesn’t seem justified to ease. But right now, the market zeitgeist is all about easing monetary policy (except in Japan) so I expect they will do just that going forward. With this in mind, it strikes that the euro (+0.15%) is going to struggle to rally from current levels absent a dramatic shift in Fed policy to aggressive rate cuts. As to European bourses, I suspect that they will reflect each nations’ own circumstances, so the DAX seems likely to lag going forward.

Will he, or won’t he?
Though inflation’s been falling
Hiking pressure’s real

A quick thought regarding tonight’s BOJ meeting and whether Ueda-san believes that further rate hikes are appropriate for the Japanese economy. As with many things Japanese, the proper move is not necessarily the obvious one. A dispassionate view of the recent data trends shows that inflation (2.8%) has been sliding slowly, GDP growth (-0.5%) has been falling more quickly and Unemployment (2.5%) remains at levels consistent with the economy’s situation given the shrinking population. On the surface, this does not seem like a situation where hiking is desperately needed except for one thing, the yen remains broadly weak. The chart below shows that since the advent of Abenomics in 2011, the yen has lost 50% of its value.

Source: tradingeconomics.com

Now, initially, that was a key plank of the Abenomics platform, weakening the yen to end deflation. Well, kudos to them, 13 years later they have achieved that result. But where do they go from here? There is a growing belief that the BOJ is going to hike by 15bps tonight and bring their base rate up to 0.25%. I disagree with this theory given the very clear recent direction of travel in the inflation data in Japan as despite the yen’s weakness, it dispels any notion that a rate hike is needed to push things along. One positive of the weak yen is that the balance of trade has returned to surplus in Japan.

Source: tradingeconomics.com

For decades, Japan ran a large positive trade balance but since the GFC, that situation has been far less consistent. However, the trade balance remains an important domestic signal as to the strength of the economy and its recent return to surplus is welcomed by the Kishida government. It is not clear how raising interest rates will help that situation. Net, with inflation sliding and the economy under pressure, hiking interest rates does not make any sense to me.

Ok, let’s take a look at how markets have behaved overnight. Yesterday’s lackluster US equity market performance was followed by very modest strength in Japan (+0.15%), although weakness throughout the rest of Asia with the Hang Seng (-1.4%) the laggard, although mainland Chinese (-0.6%) and Australian (-0.5%) shares also suffered. Meanwhile, in Europe this morning bourses on the continent are higher by about 0.4% across the board after the Eurozone GDP data seemed to encourage optimism. The UK (FTSE 100 -0.2%), however, is under a bit of pressure amid ongoing discussions in the new Labour government about the need for austerity. At this hour (7:20) US futures are edging higher by about 0.25%.

In the bond market, after yesterday’s sharp decline in yields around the world, it has been far less exciting with Treasury yields edging down another basis point and European sovereigns either unchanged or 1bp lower. Perhaps the most interesting things is that JGB yields fell 2bps overnight and the 10yr yield is now back below 1.00%. That doesn’t seem like a market preparing for a rate hike there.

In the commodity space, everybody still hates commodities with oil (-0.5%) continuing its recent slide. In fact, it is down nearly 10% in the past month (which is good for us as we refill our gas tanks). In the metals markets, copper continues to slide, down another -1.5% this morning as optimism over economic and manufacturing activity around the world remains absent, especially in China. For instance, the Politburo there met yesterday and pledged to help the domestic economy, although they did not lay out specific actions they would take. Recall last week’s Third Plenum was also a disappointment, so until the market perceives China is back and growing rapidly, or that the global growth impulse without them is picking up, it seems that industrial metals will remain under pressure. Gold (+0.4%) however, remains reasonably well bid as continued Asian central bank buying along with retail interest in Asia props up the price.

Finally, the dollar is generally under modest pressure although the outlier is the yen (-0.6%) which does not appear to be expecting a BOJ hike tonight. But elsewhere, the movements in both the G10 and EMG blocs have been pretty limited overall, on the order of 0.15% – 0.35%. It is hard to find an interesting story about any particular currency as a driver today.

On the data front, this morning brings the Case-Shiller Home Price Index (exp +6.7%), JOLTs Job Openings (8.0M) and the Consumer Confidence Index (99.7). I keep looking at that Case-Shiller index and wondering when the housing portion of the inflation readings is going to decline given its consistent strength. But really, I suspect that all eyes will be on Microsoft’s earnings this afternoon along with the other hundred plus names that are reporting today. With the Fed coming tomorrow, macro is not important right now. So, more lackluster trading seems the most likely outcome today, although with the opportunity for some fireworks starting around midnight when the BOJ statement comes out.

Good luck

Adf

Jay’s Motivation

Posted on July 29, 2024 by fxpoet

The Keynesian view of inflation
Claims growth is its major causation
If that is the case
Then given the pace
Of growth, what is Jay’s motivation?

Instead, ought he not be concerned
Inflation will soon have returned?
Or does he believe
That he can deceive
The market without getting burned?

Another week passed with another set of confusing data. But more important than the data’s inconsistency is the inconsistency in the arguments made by those desperate for the Fed to cut rates. For instance, former NY Fed president Bill Dudley wrote a widely read article for Bloomberg saying that he had suddenly become a convert and that the Fed needed to act this week and cut rates. Granted, he wrote this article the day before the much hotter than expected GDP data was printed, but nonetheless, he had been a staunch hawk and changed his feathers. And he is not alone, with a number of other high profile financial personalities (I’m looking at you Claudia Sahm) in the same camp.

But I would ask them the following: since you are strong proponents of Keynesianism which describes inflation as a direct result of strong growth and labor markets, given that GDP is running at 2.8% annualized, double Q1’s pace and above trend, and a federal government budget deficit that is approaching 7% despite that growth, and the latest PCE data showing that services inflation remains quite robust (the 6-month level has risen to 5.4%), why do you think the Fed should cut rates? By your own thesis, inflation is more likely to rise than fall given the economic strength. Alas, either no journalist will ask that question, or no Fed official will answer.

At the same time, those analysts who have been calling for a recession in the near future, continue to dig through the better-than-expected data releases and find the weak points to make their case. Here’s the thing, Powell and company cannot point to yet another subindex of the major data points and claim that is why they are cutting. He remembers far too well his focus on so-called super core (core ex housing) with the expectation that housing was the problem and if he removed the part of the index that was rising, the rest of the index would be lower. Alas for his finely tuned plans, that number continues to power along at 4.0% or higher. He will not make the same mistake again and focus on some obscure view.

At this point, there is certainly no reason for the Fed to act this Wednesday, and unless the economy essentially falls out of bed by September, it will be difficult to make that case as well. This is not to say they won’t cut in September come hell or high water, just that if the economy proceeds as it currently appears to be doing, there will be no justification. But just to put an exclamation point on the likelihood a cut is coming in September, this morning the Fed whisperer, Nick Timiraos, told us that is the case in his latest missive for the WSJ.

In addition to the Fed meeting this week, we also hear from Ueda-san and the BOJ on Tuesday night and Governor Bailey and the BOE on Thursday morning. Given the near certainty that the Fed is going to remain on hold this week, arguably the BOJ is the far more interesting meeting, at least for financial market cues. Remember, the narrative has been that the BOJ was finally going to start to “normalize” their policy, lifting interest rates above 0.0% and start to reduce their ongoing QQE program. Now, this has been the story since last October, and while they did exit the NIRP stage back in March, there has been nothing since then. Not only that, as I highlighted last week, inflation in Japan is already slowing with the current policy.

In addition, the yen, while it has backed away from its recent highs (dollar lows) by about 1%, is far from its worst levels and appears to be trending slowly higher, exactly what they want. I see no case for a rate hike here, although we will certainly hear about how they may modify their QQE actions going forward. (As an aside, for those with JPY exposures, 152.00 is a very critical level in the market’s perception and a break below that level could well lead to a significant decline in the dollar.)

Lastly, the BOE is going to cut by 25bps. Given that the ECB has already cut, as has Switzerland and Canada, they will not be able to hold out any further. I don’t think we need any rationale beyond this to believe Bailey will act.

Ok, let’s look at the overnight market activities. Friday, you may recall, US equities rebounded sharply from the short-term correction and Japanese shares (Nikkei +2.1%) followed right along, as did the Hang Seng (+1.3%) and almost every other major market in Asia save one, China (CS! 300 -0.5%) as there continues to be a distinct lack of progress on the economy there. In Europe, the situation is mostly positive as both the DAX (+0.4%) and Spain’s IBEX (+0.6%) are rallying nicely but the French (CAC -0.1%) are suffering a bit, perhaps because of the seemingly constant mishaps regarding the Olympics and the nation’s infrastructure. This morning, major internet connections were severed around the country, although backups are now working, which added to a dramatic blackout over the weekend and the high-speed rail ~~terrorist~~ arsonist attacks late last week. But here at home, US futures are firmly in the green (+0.4%) at 6:15am.

In the bond market, euphoria is the story as virtually every major bond market has rallied with yields falling around the world. Treasury yields are lower by -4bps while across European sovereigns, we are seeing declines of between -5bps and -7bps across the board. Even JGB yields (-4bps) have fallen, perhaps another signal that the BOJ is unlikely to be acting this week.

In the commodity markets, oil (-0.3%) cannot seem to find any support of note despite a significant inventory draw last week and an escalation in events in the middle east over the weekend. For the past year, oil has traded between $70/bbl and $90/bbl and we continue to trade in that range with no exit in sight. We will need to see some very significant economic changes, either a sharp recession or a giant rebound in China, to break out of this range I believe, neither of which seems like a near-term phenomenon. In the metals space, gold (+0.3%) continues to find support even after a sharp decline a couple of days last week, with spot hovering just below $2400/oz. This morning, silver (+0.75%) is also rallying but copper (-1.1%) is in a sharp downtrend, despite the news that the workforce at the world’s largest copper mine, Escondida in Chile, is preparing to go on strike.

Finally, in the currency markets, despite the lower yields everywhere and the generally positive risk environment, the dollar is higher nearly across the board. Both the euro and pound are softer by about -0.2% and we are seeing the EEMEA currencies following suit with declines on the order of -0.4% across this bunch. USDJPY is little changed this morning although CNY (-0.1%) is edging lower again after the PBOC’s recent efforts to prevent a sharp decline in the wake of their rate cuts. Interestingly, the outlier this morning is NOK (+0.3%) despite oil’s decline and there is no obvious catalyst for this movement. One other currency that is bucking this trend is AUD (+0.1%) which while not much higher this morning, given it has been falling sharply every day for the past two weeks, seems to have found a bottom. That movement is highly linked to the JPY strength as AUDJPY is a favorite carry trade for many in both the institutional and retail spaces. If USDJPY does break through that 152 level look for AUD to continue its decline.

On the data front, we know it is a big week, but here are the details:

Tuesday	Case Shiller Home Prices	6.6%
	JOLTS Job Openings	8.03M
	Consumer Confidence	99.5
Wednesday	BOJ Interest Rate Decision	0.1% (unchanged)
	ADP Employment	149K
	Treasury QRA
	Chicago PMI	44.5
	FOMC Rate Decision	5.5% (unchanged)
Thursday	BOE Rate Decision	5.0% (-0.25%)
	Initial Claims	236K
	Continuing Claims	1860K
	Nonfarm Productivity	1.7%
	Unit Labor Costs	1.8%
	ISM Manufacturing	49.5
	ISM Prices Paid	52.5
Friday	Nonfarm Payrolls	175K
	Private Payrolls	150K
	Manufacturing Payrolls	-2K
	Unemployment Rate	4.1%
	Average Hourly Earnings	0.3% (3.7% Y/Y)
	Average Weekly Hours	34.3
	Participation Rate	62.5%
	Factory Orders	-3.0%
	-ex transport	+0.3%

Source: tradingeconomics.com

Obviously, an awful lot to consume and digest this week with the central banks and then NFP. In addition to all that, we have a significant amount of earnings data coming from some big names including Apple, Amazon, Meta and Microsoft. Certainly, the strong expectation is for the Fed to remain on hold and prepare the market for a September cut. That is already priced into the futures market, so much will depend on the tone of the statement and the press conference following the meeting. As such, my sense is the real unknown is the BOJ early Wednesday morning, but I suspect they leave rates on hold. If they do hike, I would look for USDJPY to break that key support level of 152, so that feels like the biggest risk heading into the week.

Good luck

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Quite Vexatious

Posted on July 26, 2024 by fxpoet

The data remains quite vexatious
As some shows that growth is bodacious
But other releases
Are closer to feces
Implying the first stuff’s fallacious

For instance, the GDP print
At two point eight offered no hint
Recession is nearing
Yet stocks aren’t cheering
For bears, in their eyes, there’s a glint

But Durable Goods was abysmal
At minus six plus, cataclysmal
And more survey data
Implied that pro rata
The story ‘bout growth’s truly dismal

In the past week, we have seen a decent amount of data, and the upshot is that there is still no clarity on the US economic condition. Many analysts accept the data at face value, and with today’s GDP print as the latest installment, dismiss the idea of a recession coming soon. Others look at the headline, and then the underlying pieces and detect that ‘something is rotten in ~~Denmark~~ the US’.

A quick review of the recent data shows the housing market is weakening further, with both New and Existing Home Sales declining on a monthly and annual basis. As well, the Survey data showed the Richmond and Kansas City Fed’s Manufacturing Indices falling deeper into negative territory as well as a weak Flash PMI Manufacturing print. Durable Goods headline fell -6.6%, which while it is a volatile series (depending largely on airplane deliveries by Boeing), was still a terrible outcome. Absent transports, though, it rose 0.5%, which seems more in line with the first look at Q2 GDP, showing a 2.8% annualized growth rate. (One thing to watch in that GDP report is the PCE index that is implied and showed a surprising rise. Keep this in mind for tomorrow’s PCE report.). Alas, final Sales in the GDP report only rose 2.0%, a potential harbinger of future weakness.

If we go back and look at the CPI data, which was soft, or the NFP data, which was strong, there continue to be underlying pieces of almost every report which indicate weakness compared to headline strength or vice versa. So, which is it, recession or no?

Unfortunately, we will not know until the next recession has likely finished given the NBER’s methodology of declaring a recession. (It is important to understand in the US, the rule of thumb, two consecutive quarters of negative real GDP growth is not the definition.) Regardless, we haven’t even had one quarter of negative growth. This poet’s view is that the economy is clearly slowing down with respect to activity but does not seem like it has yet tipped into recession. Perhaps things will be clearer in Q3, but for now, the arguments are going to continue.

Tokyo prices
Keep on decelerating
Why will they tighten?

Tokyo CPI data was released overnight and once again, it was a touch softer than expected with both headline and core printing at 2.2%. In fact, the ex-food & energy index rose only 1.1% Y/Y! The Tokyo data is typically a harbinger of the national number and when looking at the data, it is easy to understand why Ueda-san is reluctant to tighten further. As per the chart below, the trend here remains toward lower inflation without any further policy adjustments.

Source: tradingeconomics.com

So, why would they move next week? This is especially so given the yen has rebounded nearly 6% over the past several weeks, relieving pressure on the biggest current concern. I know it is fashionable to think that the BOJ is going to tighten policy while the Fed cuts, but it is not difficult to make the case that the US economy is continuing to tick along and so higher for longer remains appropriate, while in Japan, price pressures are easing without any further policy tightening. There is increasing analyst discussion the BOJ is going to move, but I remain suspect, at least at this point. Rather, I expect that there is probably more short-covering to come in the JPY and that is going to further relieve pressure on the BOJ to act.

This morning, we get PCE
The data most pundits agree
Will license the Fed
To cut rates ahead
At least that’s the stock market’s plea

The final big story today is the release of the PCE data. As we all know by now, this is the inflation metric the Fed uses in their models. Current median expectations are as follows: Headline (+0.1% M/M, 2.5% Y/Y) and Core (+0.1% M/M, 2.5% Y/Y). In both cases, that would represent a tick lower in the annual number compared to last month, and based on the current narrative, would add to the Fed’s confidence that inflation is coming under control. And maybe that will be the case. After all, the past two inflation reports have come in below the median expectations.

However, there is another PCE report that is published alongside the GDP data. Essentially, it is the number that determines how much of nominal GDP is actual growth and how much is price growth. As part of yesterday’s GDP release, the core PCE index rose at a 2.9% rate, lower than Q1 but above expectations. I’m merely pointing out that as seen above, there is a lot of conflicting data out there. It would be premature to assume that inflation is under complete control in my view, although that is the growing market belief.

Ok, let’s look at what happened overnight. Equity markets are trying to figure out what everything means right now. Yesterday’s US performance was mixed, with Tech stocks still under pressure although the DJIA managed to gain on the day. Overnight, Japanese stocks (-0.5%) continued their recent decline, following the NASDAQ lower, but both Hong Kong and China managed small gains on the session. As to Europe, most major indices are in the green led by the CAC (+0.85%) despite the terrorist attacks on the high-speed rail network as the Olympics begin there. But after several down days, investors feel like the correction has run its course and are coming back. This is evidenced by US futures which are higher by upwards of 1% at this hour (6:30).

After yesterday’s more aggressive risk-off session, this morning bond yields are little changed to slightly higher around the world. Treasuries are unchanged and European sovereigns have seen yields rise by either one or two basis points. JGB yields, too, are higher by 1bp, as it appears investors have been exhausted by this week’s volatility. Of course, a surprising number this morning will almost certainly get things moving again.

In the commodity markets, oil, which managed to rebound at the end of the day yesterday, is lower by -0.4% this morning. Given the volatility across all markets right now, it is difficult to come up with a coherent story about the situation here in the short run. Gold (+0.4%) which got decimated yesterday, has run into technical support and is rebounding, but the same is not true for silver or copper, both of which remains near their recent lows. I will say this about copper; as it remains one of the most important industrial metals, its weakness does not seem to bode well for economic growth going forward, and yet as we saw yesterday, US GDP is running above trend. This is simply more evidence that confusion reigns in market views.

Finally, the dollar is generally lower this morning. While the yen (-0.55%) is giving back some of its recent gains, almost all of the other major currencies in both the G10 and EMG blocs are a touch stronger. MXN (+0.7%) is the leader followed by ZAR (+0.5%) with most others gaining much smaller amounts. The thing is, aside from the US data, there has been precious little other data of note that would drive things. One might make the argument that the rebound in gold is helping the rand, but that seems tenuous. Right now, with risk being re-embraced, my take is the dollar is simply softening a bit.

In addition to the PCE data we also see Personal Income (exp 0.4%) and Personal Spending (0.3%) and then at 10:00 we get the Michigan Sentiment Index (66.0). But all eyes will be on PCE. I look at the GDP data and think we could see something a bit hotter than currently forecast and desperately hoped for. If that is the case, I suspect that stocks may falter and bonds as well although the dollar should regain ground.

Good luck and good weekend
Adf

Destined for Sloth

Posted on July 25, 2024 by fxpoet

The Chinese are starting to worry
That if they don’t act in a hurry
Their ‘conomy’s growth
Is destined for slowth
Explaining their rate cutting flurry

Sunday night, the PBOC surprised markets by cutting both their 1-year and 5-year Loan Prime Rates by 10 basis points each. As well, they cut the rate on their newly developed 7-day repo rate by 10bps as they endeavor to shorten the maturity of their money market operations. At the time, it was taken as a response to the Third Plenum and the only concrete action seen as new support for the economy. As its name suggests, those rates represent the cost to borrow for credit worthy companies. A quick look at the history of this rate (the blue line), which was first tracked toward the end of 2013, shows that over time, it has done nothing but decline. I have overlayed a chart of USDCNY in the chart (the grey line) to help appreciate the long-term trend in that as well which, not surprisingly, shows a steady weakening of the renminbi (rise in the dollar).

Source: tradingeconomics.com

But the reason I bring this up is that last night, the PBOC surprised markets yet again by cutting its One-Year Medium-Term Lending Facility by 20 basis points, to 2.30%. Not only was this the largest cut since the pandemic, but it was also done at an extraordinary meeting and combined with an injection of CNY235 billion (~$32B) into the economy. Arguably, this is the most aggressive monetary policy stance that has been effected by the PBOC since the summer of 2015 when they surprisingly devalued the renminbi 2%. Apparently, the PBOC is trying to adjust its policy actions to be more in line with the G7 where central banks use short term rates as their tools. One other thing this implies is that President Xi remains steadfastly against any fiscal stimulus of substance at this point. On the one hand, you must admire that effort, but I fear that the domestic Chinese economy remains so weighed down by the ongoing property sector problems, achieving their 5.0% GDP growth target is going to become that much more difficult as the year progresses.

For our purposes, though, the story is all about the CNY (+0.7%), which rallied sharply after the announcement, continuing its movement from the Monday rate cuts which totals 1.1%. Now, ordinarily one might think that a country cutting its rates would lead to a weaker currency, ceteris paribus, However, given the market outcome, there is much discussion about how the PBOC “requested” Chinese banks to more aggressively buy CNY to support the currency. Interestingly, the fixing rate on shore overnight (7.1321) continues to weaken ever so slightly overall, but now the spread between the fix and the market has fallen to just over 1%, well within the +/- 2% band and an indication there is less pressure on the currency. My take is this is just window dressing, but I would not fight it. I expect that we will see USDCNY slowly return to higher levels over time, with the key being it will take lots of time.

The ongoing rout
In tech stocks has another
Victim, dollar-yen

Under the guise, a picture is worth a thousand words, the below chart showing the NASDAQ 100 (blue line) and USDJPY (green line) overlaid is quite interesting.

Source: Tradingeconomics.com

While there is an ongoing argument amongst market practitioners as to whether it is the decline in the tech sector that is driving USDJPY’s decline or the other way round, what is clear is that there is a strong correlation between the two. If you think about what the USDJPY trade represents, it is the purest form of a carry trade, shorting the cheapest currency and using the funds to buy a much higher yielding currency with maximum liquidity. But another thing to do with those funds obtained from borrowing yen and buying dollars was to use the dollars to jump on the tech stock bandwagon. After all, that added another 30% to the trade since the beginning of the year.

However, over the past two weeks, nearly one-third of the NASDAQ gains have been erased and that has been made worse by the >6% rise in the yen. At this stage, it no longer matters which is driving which, the reality is that we are seeing significant short covering in the yen with sales in other assets required to unwind the trade. Arguably, this is why we are seeing virtually every risk asset lower this morning, although bonds are holding up as havens, as all have been funded with short yen. Given that relationship, I am coming down on the side of the yen being the driver, but as I said, I don’t think it matters.

The real question is can it continue? It is important to understand that when markets achieve excessive levels like we saw in USDJPY, they rarely simply unwind to some concept of fair value. Rather they typically overshoot dramatically in the other direction. As such, if we assume PPP is fair value, and PPP for USDJPY is currently around 110.00, it appears there is ample room for USDJPY to decline much further. Consider, this movement has happened, and the Fed has not even started to cut rates. If we do, indeed, fall into recession, the Fed will respond, and I expect that we could see a very sharp decline in USDJPY. Something to consider looking ahead.

While that was a lot about the currency markets, they seem to be the current drivers, so are quite important. But let’s look at everything else.

Equity market pain has been universal with Japan (-3.3%), Hong Kong (-1.8%) and China (-0.6%) all following the US lower overnight and in Europe, this morning, it is no better with the CAC (-2.2%) the worst performer, but all the major indices falling sharply. US futures are little changed at this hour (7:00), but remember, we are awaiting key GDP data and more earnings numbers, which have been the driver.

As mentioned above, bond markets are rallying with Treasury yields lower by 5bps and most European sovereigns seeing declines of -3bps or -4bps. Credit is an issue as Italian BTPs are the laggard this morning, with yields there only lower by 1bp. Equally of interest is the fact that the US yield curve inversion has been reduced to just 14bps and has been normalizing dramatically for the past several sessions. One thing to remember about the yield curve is that when it inverts, it indicates a recession is coming, but when it uninverts, it indicates the recession has arrived! This is all of a piece with softer economic data and expectations of Fed policy ease coming soon to a screen near you.

In the commodity markets, nobody wants to own anything. Oil (-1.3%) is continuing its recent poor performance despite EIA data showing significant inventory reductions. This is not a sign of strong demand. But we are also seeing weakness across the entire metals space with gold (-1.0%) breaking back below $2400/oz and silver and copper under severe pressure. Right now, nobody wants to hold these, although I suspect that the long-term supply/demand situation remains bullish.

Finally, the dollar is mixed overall. While we have seen strength in JPY and CNY, as discussed above, and CHF (+0.8%) is also showing its haven status and use as a funding currency, there are numerous currencies under pressure, notably AUD (-0.8%), NOK (-0.8%), MXN (-0.8%), ZAR (-0.7% and SEK (-0.6%) all of which are commodity linked to some extent. Yesterday, the BOC cut rates by 25bps, as expected, but the Loonie has been steadily weakening for the past two weeks, so yesterday’s decline and today’s is just of a piece with that. Ultimately, we are watching a serious risk-off event, and I expect the dollar will hold its own vs. most currencies, although JPY and CHF seem to have room to run yet.

On the data front, once again yesterday’s data was on the soft side with the Flash Manufacturing PMI falling to 49.5, well below expectations and New Home Sales slipping to 617K. In fact, it is difficult to find the last strong piece of data, perhaps the ex-autos Retail Sales number from last week. This morning, we see Initial (exp 238K) and Continuing (1860K) Claims, Q2 GDP (2.0%), and Durable Goods (0.3%, 0.2% ex transport). The Atlanta Fed’s GDPNow tool is indicating GDP in Q2 was 2.6%, well above the forecasts. However, I think of much more interest will be to see how it starts out for Q3. We have had a spate of weak data, and those recession calls are growing louder.

This is a tough market, but I expect we have not yet seen the last of the risk-off trade (just consider how long the risk-on trade has been going on) so further dollar strength against most currencies, except for JPY and CHF, and further weakness in commodities and equities seem the most likely direction.

Good luck

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Losing Their Mirth

Posted on July 24, 2024 by fxpoet

The data of late round the earth
Is showing, of late, there’s a dearth
Of positive vibes
Which aptly describes
Why people are losing their mirth

Last night and this morning we learned
The PMI data has turned
Much lower worldwide
Though many bulls tried
To urge us to not be concerned

Are we in a recession? That question, which several analysts have already declared to be the case, is being asked more actively of late. While the official recession call is not made until well after the fact by the National Bureau of Economic Research (NBER), for investing and hedging purposes, that is a little late in the game. Rather, the reason analysts exist at all is to help people understand the situation in real-time, not on a historical basis. And remember, one of the biggest problems is that, almost by definition, most data are backward looking, describing what happened already, not what will occur going forward.

Now, it is true that when it comes to economic data, it tends to trend so extrapolating that trend makes some sense, but history has shown that the timing of those changes can vary widely. Alternatively, we can look at the Survey data like PMI, ISM or the regional Fed surveys, to try to get a sense of what business managers are expecting. This is certainly more forward-looking, but as it is describing expectations rather than actual spending and output, can diverge from what ultimately occurs. We have seen this frequently over the past several years as several surveys indicated slowing activity while the hard data (payrolls, GDP, Retail Sales, IP, etc.) held up well.

This brings us back to the opening question, are we in a recession? Well, so far this week the data that has been released is not pointing to strength of economic activity. In the US, Monday’s Chicago Fed National Activity Index printed at 0.05, down significantly from the May print of 0.23. Then yesterday, Existing Home Sales fell to 3.89M, far below expectations and pushing back toward levels last seen during the housing crisis in the GFC. As well, the Richmond Fed Manufacturing Index fell to -17, well below last month and expectations.

Turning the clock on the global day, we saw Japanese Manufacturing PMI fall to 49.2, well below expectations of 50.5, although the Services PMI held in well at 53.9. Australian PMI data was soft (47.4) and the same was true in Europe (France 44.1, Germany 42.6, Eurozone 45.6). Again, there can easily be a difference between the survey data and the hard data, but the weight of evidence is starting to lean toward slowing growth.

Another key feature of a growing economy is rising profitability of the corporate sector. As we have entered Q2 earnings season, it is worth looking at some of the big names that have released already. Last night, Tesla reported weak earnings, and this morning we heard a similar story from LVMH in Paris and Deutsche Bank. UPS was weak and Alphabet (Google), even though they beat forecasts, has been punished in the aftermarket because its YouTube data was poor. In fact, I think that is a critical issue. The equity market, or at least the large cap space, seems priced for perfection, so even good earnings may not support current pricing. But more importantly, if large corporations are seeing earnings declines that could well be indicative of weaker economic activity. And that comes back to that opening question.

To recap, we have recently seen broadly weaker Survey data, the US housing market is clearly struggling, and corporate earnings are not uniformly keeping up with expectations. Does this mean we are in recession? Absolutely not, but it has certainly raised the probability that the most widely anticipated recession in history is closer than we would like.

What are the implications of this situation? Well, this morning we saw Bill Dudley, former NY Fed President, write in Bloomberg that the Fed shouldn’t wait until September to cut rates, but rather should cut them next week. The market does not believe that will be the case as futures continue to price just a 4.7% probability of such a move, although the September cut is baked in right now. In fact, dovish analysts and former policymakers are increasingly calling for the Fed to act before it’s too late. Personally, I don’t see that happening, although if data continues to soften, there will be increasing discussion of a 50bp move in September, mark my words.

There is one other place to look for clues about economic activity as well, the commodity markets. Consider that slowing economic activity generally leads to reduced demand for inputs like commodities, be they energy, metals or agricultural products. A quick look at the Goldman Sachs Commodity Index, which is widely followed as a measure of broad commodity activity, shows that throughout Q2, at least, the trend has been down.

Source: tradingeconomics.com

My point is that the odds of a recession seem to be rising and that means we are likely to see weaker equities, weaker commodities, lower yields and a softer dollar, at least at first. But remember, the dollar is a relative trade. If the US enters recession, you can bet that so will many other countries, and the reaction functions around the world could well result in currency weakness of even greater magnitude elsewhere and the dollar holding its own.

Ok, I rambled a bit, so let’s quickly see how the overnight session went in markets. After a very modest sell-off in the US, Asian markets were far more reactive to some negative US earnings reports with the Nikkei (-1.1%) and Hang Seng (-0.9%) leading pretty much all indices lower here. Adding to the woes of the Nikkei was the further strength in the yen (+0.85%, +3.3% in the past month) as Japanese exporters feel the pain. European bourses are also under pressure with the DAX (-0.7%) and CAC (-0.9%) leading the way lower after their worse than expected Flash PMI data discussed above. Finally, US futures are all in the red this morning led by the NASDAQ (-1.0%) at this hour (7:30).

In the bond market, yields are little changed so far this morning despite the weaker data. In fact, in the past month, 10-year Treasury yields have not moved at all. There continues to be confusion as to whether inflation or economic activity is going to be the driving force in central bank activities and as long as that is the case, bond traders don’t know which way to jump. One exception is JGB yields which are creeping higher again, up 2bps overnight. There is now much discussion that the BOJ is going to raise rates at their meeting next week, as well as start to taper its ongoing QE program. This is likely supporting the yen (as well as short covering there) but will seemingly undermine the equity markets in Japan if this is the case. However, I expect this story to gain traction until the BOJ meeting.

In commodity markets, oil (+0.6%) is bouncing after a very rough week as the market awaits the EIA inventory data. The API data, which is not given as much credence, showed a larger than expected draw yesterday, which seems to be helping crude this morning. Gold (+0.1%) continues to hold its own but copper (-0.6%) remains under pressure on the weak China and recession stories. Remember, it is often called Dr. Copper on the theory it has a PhD in economics for its ability to forecast economic activity.

Finally, the dollar is mixed this morning with the yen the notable outlier, but strength, too, in ZAR (+0.5%) on the back of a sharp rise in South African yields this morning. But there are more laggards, albeit with modest movements in the G10 (EUR -0.1%, AUD -0.25%. SEK -0.2%). In the EMG bloc, HUF (-0.8%) is the laggard, although we are seeing weakness throughout the CE4 on the back of the euro’s modest decline. This story continues to be focused on the rate differential. The more we hear about calls for the Fed to cut sooner or more aggressively, the more likely the dollar will remain under pressure.

On the data front, we see the Goods Trade Balance (exp -$98.0B) as well as the Flash PMI data (Manufacturing 51.7, Services 55.0) and finally New Home Sales (640K). With no Fed speakers, the data will gain more prominence, especially if it shows up weaker than expected and continues the trend discussed above. As well, the equity market will continue its importance to overall trading as further earnings reports are released. Net, it is starting to feel like weaker economic activity is making itself felt. That should result in a little dollar softness, at least until other countries demonstrate the same traits. But for today, the one thing I see is further short covering in JPY and a continuation of that trend.

Good luck

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A Bummer

Posted on July 23, 2024 by fxpoet

The narrative writers have turned
Their focus, as markets they’ve spurned
It’s politics now
That they all endow
With ideas we need be concerned

And so, if the pricing is right
Come next week, the Fed will sit tight
The rest of the summer
Could well be a bummer
For traders, with volumes quite light

It is not uncommon for the summer months to lack interesting new information for market participants. While the regular monthly cycle of data continues to be released, the fact remains that there seems to be less interest overall. This is not to say there have never been summer surprises, but the very fact we call them surprises is indicative of their relative scarcity.

This year, especially, seems likely to have even fewer financial or economic discussions than usual given the ongoing drama in the US political cycle. And while this poet has opinions as to how things may work out (and of course what I would like to see) that is not what this morning missive is all about. Rather, I continue to try to find the stories that drive market activity and alert you to what is happening. But the ongoing political narrative is now so dominant, everything else pales in comparison. And as I wrote yesterday, while political narratives can have some market impact, it is not typically that significant.

I mention this because there were exactly zero stories of any market consequence overnight. Much was written about the US elections and there were some ‘thought’ pieces on issues like the long-term impacts of President Xi’s iron grip on China and what that means for the economy there, but there was no data to excite, there were no comments of note and basically, it was all quite dull. For instance, I’ll bet you were unaware that the G20 is meeting in Rio de Janeiro because it is almost impossible to find a story on the meeting. I suspect that Thursday’s GDP and Friday’s PCE data are going to be the most exciting things that occur this week.

Unless, of course, there is a real summer surprise. It is earnings season with the Mega-cap tech companies set to report this week and next, but those are generally not market wide movers. So, with that in mind, let’s take a look at the overnight market activity and call it a day.

After US equity markets showed their resilience yesterday, laughing off the concept of a rotation out of tech or the beginning of a serious correction, Asian markets mostly followed that same line of thinking if you ignore Japan (flat) and China (CSI 300 -2.1%, Hang Seng -1.0%) as the rest of the region was in the green, with some markets really enjoying a boost, notably Taiwan (+2.75%). The Chinese story seems to be ongoing disappointment that the Third Plenum did nothing to indicate support for the economy and the 10bp rate cuts were seen as insufficient. As to Japan, the tension between the rebound in tech shares and the strengthening in the yen led to no net movement. In Europe, though, bourses are all following the US lead and rising nicely, led by the DAX (+1.2%) as hints by some ECB members indicate that a cut is coming in September despite Madame Lagarde’s insistence that no decisions have been made. As to the US futures markets, at this hour (7:15) they are little changed overall.

Bond markets have seen yields decline this morning with Treasuries (-2bps) the laggard compared to Bunds (-4bps) and OATs (-3bps). Of course, this follows yesterday’s session where yields edged higher by a few basis points and basically shows that investors are unwilling to take any directional views until we at least see the PCE data, if not until the FOMC next Wednesday. Since the beginning of the month, Treasury yields have been choppy in a range of 4.15% – 4.30% and are currently sitting right in the middle. There continue to be two longer term views, with the recessionistas calling for a sharp decline in yields as it becomes clear the US economy is slowing and the Fed will cut rates to stimulate, while the fiscal policy bears keep pointing to the massive deficits and issuance that accompanies those deficits, and explains that at some point, demand will not meet supply and yields will rise sharply. My own view is that both of these outcomes will obtain, with the first recession signals helping to send yields lower before longer-term troubles emerge for the US fiscal picture. But right now, it’s hard to get excited in either direction.

In the commodity space, oil (-0.3%) remains under pressure although today’s decline is far less severe than we’ve seen in the past several sessions. Rumors of OPEC increasing production in Q4 seem to be one driver as well as forecasts for inventory builds in the US this week. Gold (+0.6%) continues to find buyers and remains above $2400/oz as Asian demand, from both central banks and individuals remains a key driver. Copper (-1.0%) on the other hand continues to suffer, down more than -6.0% this month, as the slowdown in China’s economy weighs on demand for the red metal.

Finally, the dollar, which has been written off more times than I can count, is firmer again, back above 104.00 on the DXY. For all the discussion about how the dollar is set to decline, a quick look at the DXY over the past year tells me that there is no discernible downtrend at all (nor is there an uptrend).

Source: tradingeconomics.com

There has been an uptick in the long-term ‘dollar will die’ narrative, but certainly that has not had any impact on the ordinary activity that we watch regularly. As to today’s activity, NOK (-0.5%) is leading the G10 lower although we are seeing declines averaging -0.25% elsewhere with one exception, JPY (+0.5%) which is bucking the trend. From a currency perspective, one might think it is a risk off day, with investors flocking to havens, but given equity market strength, that is clearly not the case. As to the EMG bloc, ZAR (-0.9%) continues to demonstrate impressive volatility overall, suffering on weakness in commodity markets and the CE4 are also soft, tracking the euro’s decline.

On the data front, we see Existing Home Sales (exp 3.99M) at 10:00 this morning and that is all she wrote. It is difficult to get excited about today’s market and I suspect that absent some terrible earnings data that causes a real stock market decline, tomorrow when we wake up, things will be close to where they are now.

Good luck

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fxpoetry

Explaining the rhyme and rhythm of the FX markets each day

Author Archives: fxpoet

The World is Ending

Like an Avalanche

A Stock Jamboree

New Shibboleth

German Malaise

Jay’s Motivation

Quite Vexatious

Destined for Sloth

Losing Their Mirth

A Bummer