Already Wary

Posted on December 5, 2023 by fxpoet

In China, the news wasn’t great

As Moody’s no longer could wait

Because of a glut

Of debt, they did cut

The outlook for China’s whole state



Investors were already wary

And as such, since last January,

Afraid of more shocks

Have been selling stocks

In quantities not arbitrary

The biggest news overnight was Moody’s downgrading their outlook for Chinese debt to negative from its previous stable view. Moody’s currently rates the nation at A1, 4 notches below the best available of Aaa, but still a solid investment grade rating. However, citing the property downturn in the country and the concomitant fiscal pressures that are building on local governments’ balance sheets, it appears there is a growing concern that national debt will be issued to cover the local failures.

It must be very difficult to be a local government financial official in China as the competing pressures of ever faster growth and maintaining sound finances have become impossible to attain simultaneously. The real question is, will President Xi determine that fiscal stability is more important than economic growth? While that appeared to be his view last year, this year he seems to have changed his focus to growth. Perhaps the fact that the US economy seems to be maintaining very solid growth while China is stumbling has become too much of a bad look for him to tolerate further. (And that’s not to say things are fantastic here.)

At any rate, his efforts to encourage more widespread economic activity while simultaneously deflating the immense property bubble there is starting to run into trouble. As the pace of growth slows in the country, exacerbated by the demographic decline of the population (it is getting old and the population is shrinking), Xi appears to have thrown fiscal caution to the wind. Once again, my concern is that if the domestic economy continues to deteriorate, Xi will determine that it is time for some international adventures to shore up his support at home. I would contend that is not on anyone’s bingo card right now, but it is something to watch.

The market response to the news was to further sell Chinese equities with both onshore and Hong Kong markets suffering, each declining nearly 2%. This weighed on Japanese markets (Nikkei -1.4%) as well as Taiwan, South Korea, and Australia, with only India ignoring the story. It makes some sense that the China and India stories are uncorrelated given India is one of the few nations not reliant on China for much with respect to trade.

Away from that story, however, things have been remarkably quiet on the economic front. We saw Services PMI data from around the world with China, interestingly, one of the few nations printing above 50 (Caixin Services PMI 51.5), while all the continent remains firmly below the 50 boom-bust line save the UK which printed a much better than expected 50.9 reading. While the market is waiting for US ISM Services data (exp 52.0) as well as JOLTS Job Openings data (9.3M), there is scant little else to discuss this morning. Recall, though, as the week progresses, we will be receiving much more important data, notably the payroll report, which may help clarify the state of things now.

But, lacking anything else to discuss, let’s run down markets. Away from Asia, equity markets are mixed with continental bourses all modestly firmer, on the order of 0.3%, although the FTSE 100 is lower by -0.5% despite the better than expected PMI data. US futures are also pointing lower this morning, about -0.5% after a desultory day yesterday on Wall Street.

In the bond markets, Treasury yields have edged a bit lower this morning, -3bps, resuming what has been a powerful downtrend in yields. In Europe, though, yields have really taken a dive, with sovereign bonds there all seeing declines of between 7bps and 9bps. The weak PMI data has investors now bringing forward EB rate cuts to June. Adding to this story were comments from the ECB’s Schnabel, historically one of the more hawkish members, describing the possibility of rate cuts next year as appropriate. This seems quite similar to the Waller comments last week given Schnabel’s presumed importance on the ECB. Finally, JGB yields are 2bps softer after slightly softer than expected Tokyo CPI data was seen as a harbinger for slowing inflation across Japan. Once again, the idea that interest rate policy in Japan is due to normalize soon is being challenged by the facts on the ground.

Turning to commodities, oil (-0.3%) is slipping again as the weak PMI data encourages worries of an impending recession and the OPEC+ meeting was not taken seriously by the market as an effective manner to reduce supply. Inventories have been building lately, so further pressure seems viable. Meanwhile, metals markets are under further pressure with both copper and aluminum falling by more than -1.0% and gold, which had a remarkable session yesterday with a greater than $100 trading range, edging down a few bucks, but still well above the $2000/oz level.

Finally, the dollar refuses to obey the narrative and die. Instead, it is higher again this morning vs. almost all its counterparts, both G10 and EMG. The laggard today is AUD (-0.9%) which fell after the RBA left rates on hold, as expected, but apparently was not seen as hawkish as traders anticipated and the market has removed the pricing for any further rate hikes there. The only exception to this movement has been the yen, which is now 0.1% firmer although in the wake of the Tokyo CPI data, it fell sharply. USDJPY remains beholden to the twin narratives of declining US interest rates and normalizing monetary policy in Japan. Right now, those stories are not working in concert, so until they do so, in either direction, I expect the yen will be choppy but not really make much headway in either direction.

Aside from the ISM and JOLTS data, we only see the API Crude Oil inventory data with a draw of 2.2 million barrels expected. As there are no Fed speakers, it is shaping up to be a quiet day overall. With that in mind, look for limited activity until 10:00 when the data is released and then I suspect that we remain in a ‘bad news is good’ regime. So, weak ISM is likely to encourage risk taking on the belief the Fed will cut more aggressively and vice versa. The same is true with the JOLTS data. As to the dollar, I suspect it will follow the rate story, so strong data will help the buck and weak will see a bit of selling.

Good luck

Adf

Too Clever by Half

Posted on December 4, 2023 by fxpoet

Said Jay, “it would be premature”

To think we’ve arrived at a cure

For higher inflation

Though there’s a temptation

By some to claim that we are sure



Instead, if we think it’s correct

More rate hikes we will architect

Investors, however,

Think Jay is too clever

By half and this view did reject

As we start a new week that will culminate in the payroll report on Friday, I think it is appropriate to consider how last week finished, notably how Chairman Powell left things leading into the Fed’s quiet period ahead of their next FOMC meeting on the 13^th of this month. To my ears, the two most important comments were as follows: “The strong actions we have taken have moved our policy rate well into restrictive territory, meaning that tight monetary policy is putting downward pressure on economic activity and inflation.” A little later he explained, “It would be premature to conclude with confidence that we have achieved a sufficiently restrictive stance, or to speculate on when policy might ease. We are prepared to tighten policy further if it becomes appropriate to do so.”

Now, interpretation is a subjective idea already, but FWIW my interpretation is he clearly understands they have tightened policy quite substantially, perhaps enough to achieve their goal of 2% inflation, but in a nod to this nation’s history, and ostensibly his hero, Paul Volcker, he is not going to get fooled by a temporary respite in inflation. I believe he has made perfectly clear in the past that the Fed, or at least Chairman Powell, is willing to push the economy into a recession if he believes it is necessary to truly end inflation.

Of course, the biggest problem that he has is that the Fed is losing its ability to manage the situation as the Treasury continues to issue extraordinary amounts of new debt to fund spending. This fiscal dominance results in a situation where the Fed’s actions have a diminishing impact on the macroeconomic variables they are trying to manage. In fact, as I consider this situation it is actually a viable explanation for the fact that the market is very clearly ‘fighting the Fed’.

One of the most common refrains from the post GFC period, when the Fed first introduced QE and kept repeating the exercise, driving asset prices substantially higher, although having very limited impact on goods and services inflation, was that investors, ‘don’t fight the Fed.’ The idea was that if the Fed was going to continue to print money, whatever the macroeconomic story was had limited impact on risk asset prices. The Fed was the dominant factor and would continue to be so going forward.

And that proved to be sage advice right up until the end of 2022. The huge rally was supported by their easy money, and the reversal in 2022 was a result of them tightening policy substantially. However, since then, and especially since the debt ceiling law was suspended until 2025, the Treasury has been able to issue as much debt as they like, and the government has been spending as quickly as possible. While the Fed’s policy tightening was dramatic throughout 2022, it has slowed dramatically this year, and now it is being eclipsed, at least in a market response sense, by the flood of money entering the economy. The result is that despite the Fed’s effort to maintain tight monetary policy, they are being overwhelmed by the Treasury’s profligate ways. Hence, fighting the Fed is making sense. It has largely worked in 2023 and while higher for longer may be the Fed’s mantra, it is being trumped by Yellen’s mantra of ‘issue another $1 trillion in T-bills just in case.’

Setting aside, for a moment, the potential negative implications of the surge of Treasury issuance, its ability to crowd out private funding and therefore slow economic activity, from the market’s perspective, all those Federal dollars are being spent somewhere, and between the subsidies for ‘green’ energy, and the reshoring efforts across numerous manufacturing sectors, that money is circulating in the economy quite rapidly. Since the government doesn’t really care what interest rate they pay (they will just borrow more to pay that interest), there is no financial brake on this activity. It needs to be political. And given there is a presidential election next year, the incentive for the incumbent administration to slow spending is not merely zero, it is negative.

Ultimately, I believe this means that the Fed’s importance with respect to market movements overall is diminishing, although they will still have some impact. Rather, I think we need to watch the spending plans more carefully. One other thing to remember, especially for all the dollar bears out there, is that historically, a nation that runs tight monetary and loose fiscal policy winds up with a stronger currency. This alone implies that news of the dollar’s demise may be greatly exaggerated.

Ok, while last week was all about Fed speak, this week is much more data focused. Leading into the data dump, a look at markets shows that despite Friday’s strength in US equity markets, the rest of the world has been a little more suspect of things. Both Japan and China saw weakness even though a court in HK ruled that China Evergrande had another 2 months to try to work things out before liquidation, although some other markets in Asia, notably India’s Sensex, (+2.0%) performed far better. In Europe this morning, markets are mixed but I would argue are leaning slightly lower as both the FTSE 100 and CAC lower although the DAX and Spain’s IBEX are a touch firmer. Finally, US futures at this hour (7:30) are pointing lower by about -0.35% across the board.

In the bond market, Treasury yields have backed up 5bps this morning, but are still at just 4.25%. European sovereigns are also higher, albeit not quite as aggressively as Treasuries with the movement between 1bp and 3bps. UK gilts are the outlier, also higher by 5bps. Looking at Asia, while that 5bp rise was the norm Down Under, JGB yields are unchanged at 0.68%. All this discussion regarding Japanese yields normalizing certainly seems to be premature at this stage.

In the commodity markets, oil (-0.6%) is slipping again as the response to the OPEC+ meeting has been less than impressive. While production cuts were mooted, there is no clarity on which members will be cutting and by how much and for how long. As we have been observing for the past months, the commodity market is the one that is truly pricing in a recession. Equity markets are clearly on a different page although bond markets, given the magnitude of last month’s move, have certainly taken notice that things are slowing down. In the metals markets, gold is little changed from Friday’s levels this morning, although Friday saw a sharp 1.5% rally. As well, I would be remiss if I didn’t mention that in the overnight session, gold exploded to a new all-time high of $2135/oz before retracing those gains. There is a growing interest in the barbarous relic, especially with the market’s growing belief that the Fed and other central banks are going to be cutting rates soon. The rest of the metals complex, though, is under pressure this morning, once again pointing to concerns over a recession in the near future.

Finally, the dollar, overall, is slightly higher although there has been a mix in the components. Notably, the yen strengthened sharply on Friday after the Powell comments but the same cannot be said of either the euro or the pound. In fact, both of those currencies, as well as the rest of the European bloc, are under pressure as there is a growing certainty that Europe is entering, or perhaps already in, a recession, and the central banks there are going to be cutting rates soon. As to the EMG currencies, today is a broadly dollar strength day and we are seeing virtually all of them under pressure vs. the greenback. As I mentioned above, tight monetary and loose fiscal policies are a recipe for a currency’s strength.

Ok, let’s turn to the data story.

Today	Factory Orders	-2.8%
Tuesday	ISM Services	52.0
	JOLTS Job Openings	9.35M
Wednesday	ADP Employment	128K
	Trade Balance	-$64.1B
	Nonfarm Productivity	1.9%
	Unit Labor Costs	-0.9%
Thursday	Initial Claims	2223K
	Continuing Claims	1940K
	Consumer Credit	$9.0B
Friday	Nonfarm Payrolls	180K
	Private Payrolls	155K
	Manufacturing Payrolls	25K
	Unemployment Rate	3.9%
	Average Hourly Earnings	0.3% (4.0% Y/Y)
	Average Weekly Hours	34.3
	Participation Rate	62.7%
	Michigan Sentiment	62.0

Source: Tradingeconomics.com

So, a huge amount of new data with ISM to start the week and NFP to finish. Perhaps there will be a decisive trend that implies either recession is coming soon or not at all but based on everything we have seen over the last 6 months, at least, I imagine there will be both hot and cold data to absorb. Fortunately, there are no Fed speakers although keep your eyes peeled for a WSJ article from the current Fed whisperer, Nick Timiraos, if things start to point to even more aggressive rate cuts by the Fed next year (5 cuts are already priced starting in March).

For today, my take is the market seems likely to take a breather after a remarkable risk rally last month. Absent any real new news today, look for a quiet one. But we need to watch the data this week carefully for clues as to whether the goldilocks or recession narrative will dominate. Funnily enough, in either case, I feel like the dollar is likely to hold its own.

Good luck

Adf

Nirvana Sans Prayer

Posted on December 1, 2023 by fxpoet

The Fed has regaled us this week

With speakers who all tried to tweak

Their message on rates

And foster debates

On havoc their actions might wreak



Some told us their hiking was done

That, as to inflation, they’d won

But others explained

They’d not yet obtained

Relief from this price rising run



Now into this breech steps the Chair

Who later this morning will share

His views where they stand

And how he has planned

To reach rate nirvana sans prayer

As we enter the final month of 2023, the bulls are in the ascendancy. The 60/40 portfolio, which had been declared obsolete last year and certainly behaved that way most of this year, just had its best month since 1985. US equity markets rallied between 8%-10% and 10-year Treasury yields fell 40bps through the month. In other words, the price of virtually everything went higher. This includes gold (+3.0%), silver (+10.5%) and copper (+5.0%) with only oil (-7.5%) and the dollar (DXY -2.5%) as the losers in November.

To what do we owe this remarkable performance across asset classes? Or perhaps the question should be to whom do we owe this outcome? My vote is for goldilocks! Her story of everything winding up ‘just right’ remains the dominant market narrative. This has been encouraged by a plethora of Fed, and other central bank, speakers harping on the fact that inflation readings continue to decline nicely, and although nobody is ready, yet, to begin cutting interest rates, there seems to be an implicit wink, wink, nod, nod that the market is sensing rate cuts are coming soon. And maybe they are, but that is certainly not my base case.

However, my base case is not relevant here, the market viewpoint is the driver. Interestingly, yesterday we heard from NY Fed President Williams and while he has been encouraged over the recent path of inflation readings, when asked about the market’s pricing of rate cuts early next year he explained, “he wasn’t losing any sleep over the issue.” In other words, he is unconcerned with the market chatter and is focused on the data and his perception of the economy’s performance. In fact, I believe that to be the case for all the FOMC members, despite the prevailing narrative that the Fed will never surprise the market if they can avoid doing so.

This brings us to this morning’s speech by Chairman Powell. His is the last communication by a Fed member ahead of the FOMC meeting on the 13^th. At this point, it remains unknown if he will hew toward the idea that things look good and they have reached an appropriately tight level of monetary policy and financial conditions, or if he will try to continue with the higher for longer concept, highlighting that while progress has been made, the dangers of easing prematurely are grave and must be avoided at all costs. The fact that Governor Waller, earlier this week, expressed that it might be appropriate for rates to decline in 3-4 months’ time has the equity and bond bulls pawing the ground and ready to charge again. However, I would contend that Williams’s comments yesterday, indicating little concern over market pricing and greater concern that they finish the job to be just as important. Powell clearly listens to both these gentlemen closely. In the end, the one thing that Powell has explained time and again is that he will not make the Arthur Burns mistake of easing before inflation was well and truly dead. It is this consistency in his communications that leads me to believe that the bulls are a bit ahead of themselves for today.

Remember, too, we will see the NFP report next Friday, and the November CPI report the day before the FOMC announcement, as well as a bunch of other data to help fill in some blanks. In fact, yesterday’s PCE data, both headline and core, were right on expectations as was virtually everything else except Continuing Claims, which at 1927K, was the highest since early 2022, and another sign that the labor market is loosening up. Countering that, though was a dramatically higher than expected Chicago PMI print of 55.8, pointing to strong growth. Again, the data continues to lack a unifying direction at this stage. And so, regardless of Powell’s comments today, the FOMC will still have much to digest before they decide.

As to how this will impact markets, my take is the following: goldilocks is still the predominant narrative which means that weaker economic data will be seen as bullish news for both stocks and bonds because it will cement the view that the Fed is not only finished but that cuts are coming soon. Correspondingly, strong data will be much harder to swallow as it will renew concerns that the Fed is not done hiking yet. But until Powell speaks this morning at 11:00, we are in the dark.

Reviewing the overnight activity shows that equity markets in Asia were mostly lower with the Hang Seng (-1.25%) continuing to feel the pressure of the weak Chinese property market. The story is that China Evergrande has until Monday to avoid liquidation with further potential ramifications for other property developers. Alas, President Xi has not been able to find a Chinese solution for taking on too much debt and blowing a bubble that does not include popping that bubble. As to Europe, after a strong November in equity markets there as well, this morning is seeing gains across the board on the order of +0.7% while US futures are currently (8:00) ever so slightly softer, -0.2%.

In the bond market, after a rip-roaring month around the world as the prevailing narrative grew that the peak in inflation, and therefore, yields has been seen, this morning is starting off quietly. The yield on the 10yr Treasury is higher by just 1bp and in Europe, we are actually seeing modest yield declines, 1bp-2bps, as investors respond to still weak PMI data across the continent. While the uber-hawks on the ECB are unwilling to discuss rate cuts, given the slowing growth in the Eurozone and the fact that inflation readings there are declining much more rapidly than in the US, the market is quite confident that rate cuts are coming soon.

Oil prices are slightly softer this morning, -0.5%, which takes them right back to where they started the week. However, they have fallen for the previous 5 weeks. The OPEC+ meeting was something of a dud, with what appears to be a further production cut, but there was certainly no unanimity of action there. Gold prices are unchanged on the day, maintaining most of their recent gains and copper prices (+0.6%) are actually edging higher again. To the extent that copper is an accurate harbinger of future economic activity, it certainly seems that prospects are improving and a recession will be avoided.

Finally, the dollar, which has seen universal hatred based on the decline in 10yr Treasury yields as well as the narrative that the Fed is going to be cutting rates early next year, continues to hold its own. In fact, it is slightly firmer in the past week overall, although we have seen a mix of movements depending on the currency. Among the weakest has been the euro, which while it peaked above 1.10 earlier this week for a brief time, is now back below 1.09 as traders start to understand that whatever the Fed may do with interest rates, the ECB is going to be cutting sooner than the Fed. At the same time, we have seen some strength in the commodity bloc over the past week, with AUD, NZD, CAD, NOK and ZAR all showing solid performances on the back of the recent commodity strength.

And lastly, we cannot ignore the yen, the currency that everyone was certain was set for a major rally as the diverging paths of the Fed (imminent cuts) and the BOJ (ending QE and tighter money) would finally change the trend. Oops! While the yen is a bit stronger this week, about 0.8%, that barely covers the negative carry of the position and with 10yr JGB yields back in the 60bps range, there is really no evidence that Japan is actually preparing to tighten policy. While I personally think they do need to start doing so as inflation has remained above their 2% target for more than a year, things work differently in Tokyo than elsewhere. For hedgers, I have to believe that JPY puts are the best protection around, relatively inexpensive and allowing for any significant rallies in the yen without locking in bad rates.

Leading up to Powell’s speech this morning, we see ISM Manufacturing (exp 47.6) although after yesterday’s blowout Chicago PMI number, don’t be surprised to see a bit higher. Canadian Employment data was just released, largely in line with expectations as the Unemployment Rate ticked up to 5.8% as forecast. Again, we continue to see a mixed picture with regard to the future of the economy. I think that is why we put so much stock into central bank speakers, but also why things remain so confused. After all, they don’t have any better models or insight than the rest of us and are just winging it anyway!

Big picture is, if Powell is hawkish and pushing back on the narrative, I expect the dollar to edge back higher. However, if he does not push back, look for another serious equity and bond rally and for the dollar to sink.

Good luck and good weekend

Adf

Gradually Growing

Posted on November 30, 2023 by fxpoet

Two giants have recently passed

Who both, did a century last

Charles Munger went first

Whose wit was well-versed

Then Kissinger, quite the contrast



Meanwhile, recent data is showing

Economies worldwide are slowing

But pundits still think

The world will not sink

Instead t’will keep gradually growing

If there is any truth to the concept that things happen in threes, keep your eyes peeled for another well-known individual to pass away soon. In the past week, both Charlie Munger, Warren Buffet’s partner at Berkshire Hathaway, and the one with the sharp wit, passed at 99 and, last night, Henry Kissinger passed away after 100 years on this earth. Both were highly accomplished and extraordinary individuals, and the world is a lesser place for their passing. May they rest in peace.

But back to the market saga, or perhaps it is the economic saga, that we have been both watching and through which we are living. The soft-landing narrative remains strong as we continue to see economic activity data slide slowly lower, although it is certainly not collapsing. In fact, that is the whole point, the idea that the central banks have been able to engineer a sufficient slowdown in growth such that inflation pressures recede but economic activity remains strong enough so unemployment doesn’t rise too far. While historically this has been a very rare occurrence, perhaps they will achieve it this time.

If we are to look at the recent data, certainly the forward looking data, it certainly seems like growth is slowing. We can ignore yesterday’s upward revision in Q3 GDP as that is already behind us, although it is impressive in its own right. But for things that are more current, or the surveys that look ahead like PMI, the news is not quite so robust. For instance, yesterday saw weakness in Spanish Retail Sales, Swedish Business Confidence and Eurozone Industrial Sentiment. Overnight, we saw weaker Korean IP and Retail Sales, weak Japanese Retail Sales, a further decline in Australian Building Permits and Chinese PMI data continuing to slide with Manufacturing slipping to 49.4 and Non-Manufacturing falling to 50.2, both the lowest levels in a year. The point is, looking all around the world, the trend is pretty clearly for slowing economic activity.

The flip side of this story is the one that the central banks are really watching, the inflation situation, and there the central banks are starting to feel better. Eurozone CPI was released this morning with headline falling to 2.4% and core to 3.6%. Given the declines in CPI we have seen this month around the world (remember energy prices fell sharply), this should be no surprise. And of course, later this morning we will see the Fed’s favorite, Core PCE (exp 0.2% M/M, 3.5% Y/Y). While this reading remains well above their target, the trend has clearly been beneficial of late.

This idea has been largely reinforced by central bank speakers this week, notably with Chris Waller’s comments on Tuesday that in a few months, if inflation continues this trend, it could be time to cut rates, but also mostly from the other speakers, with even uber-hawk Mester, yesterday, saying the Fed is in a good place to wait and watch. Talk of additional hikes if inflation resurfaces is scarce now and the market is really looking for Chairman Powell to reiterate that message when he speaks tomorrow morning at 11:00. But the market will not wait for confirmation, they are already onboard with the message as it suits the narrative of BUY STONKS! So, we have seen Fed funds futures rally further with the market now looking for 125bps of cuts by the end of 2024 with a 50/50 chance of the first coming in March. Wow!

So, how should we think about this situation? To me, there are two issues with which to contend. First, my take is much of the CPI decline is due to energy and the one really sticky piece of inflation, at least in the US, the price of housing, is not showing any signs of declining. I think the Case Shiller Home Price index remains the best measure and it is continuing to go higher. While existing home sales have been crashing, it is because of a lack of supply, not a lack of demand. So, prices remain firm, and that is going to feed into inflation data for a while. My point is, while recent readings have shown CPI falling, we remain well above target, and I expect that we are going to stay above target, although not anywhere near where things were last summer.

The second thing is that as evidenced by the litany of weaker data we are seeing around the world, economic activity is pretty clearly slowing everywhere. In this situation, waiting for the Fed to cut first may be a mistake as other central banks may find themselves with more dire economic circumstances before the US gets there. And, if that is the case, all the bearishness that is building around the dollar because of the renewed belief the Fed is going to cut rates soon could well be misplaced. Remember, the FX markets are relative, so if the ECB cuts before the Fed, that seems unlikely to help the euro. The same is true with the BOE or BOC or any other central bank. My point is, while the dollar has retraced some of its recent gains on the belief the Fed is ready to cut, even if the Fed does cut, they will not do so in isolation.

Remember, too, the wise words from Hemingway’s The Sun Also Rises. “How did you go bankrupt? Two ways, gradually and then suddenly”. It is very possible, if not likely, that we are currently in the gradually phase of economic slowdown, with the suddenly phase yet to come. Just beware.

Ok, in the meantime, a quick look at markets shows that after another lackluster session in the US, Asian markets were able to rally a bit with the Hang Seng and mainland indices shaking off the weak PMI data while European bourses are clearly benefitting from the soft CPI data this morning out of Frankfurt. At this hour (7:45) US futures are also a bit firmer, about 0.4% or so.

In the bond market, yields are rebounding a bit with Treasury yields up 4bps and European sovereigns a little less dynamic, higher between 1bp and 3bps. However, we have come a long way this month, with 10yr Treasury yields down 64bps, their largest monthly decline since 2008. My take is we will need to see confirmation from Powell tomorrow for there to be another leg lower in yields, but if he pushes back, look for a few fireworks there.

Oil prices are continuing their rebound as OPEC+ is meeting, up another 1% this morning and 4% on the week. The whispers are another production cut is coming, and we also have seen the inventory builds slow down. Meanwhile, gold is slightly softer this morning, but remains well above $2000/oz with many looking for a test of that all-time high at $2080. As to the base metals, they are under a bit of pressure, which given the economic data, makes some sense.

Finally, the dollar is firmer this morning, recouping about 0.4% of its recent losses with strength largely across the board. Ultimately, relative interest rates remain the key driver in this space and for now, while dollar yields have declined, they have not done so in isolation. As such, until they start to fall more sharply than rates elsewhere, I think the dollar will be treading water in a range.

On the data front, aside from PCE we also see Personal Income (exp 0.2%), Personal Spending (0.2%), Initial Claims (220K), Continuing Claims (1872K) and Chicago PMI (45.4). We hear from John Williams this morning as well, so it will be interesting to see if he backs up the recent shift of the Fed is done and things are going well.

My take is Williams will, indeed, hew that new line and we will see a bit more positivity in equities and bonds while the dollar fluctuates and perhaps gives up some of this mornings gains. But really, all eyes are on Powell tomorrow.

Good luck

Adf

Now Estranged

Posted on November 29, 2023 by fxpoet

“Something appears to be giving”
Said Waller, the true cost of living
So, bonds rallied hard
The dollar was scarred
But stocks were quite unreactive-ing

The narrative clearly has changed
With hawks on the Fed now estranged
Is everything better?
As world’s largest debtor
We need low rates to be arranged

Fed Governor Chris Waller, one of the erstwhile hawks on the FOMC was covered in white feathers yesterday as he explained his latest perception that the Fed was on a path to achieving their 2% inflation goal as Q3’s expansive GDP was clearly an outlier and the data he cited showed economic growth slowing toward trend just below 2%. The other Fed speakers on the day did not back him up specifically, and in fact, Governor Bowman explained her base case was the Fed needed to hike still further to be certain inflation was under control. However, the market only had eyes for Waller and has heard the following message from the Fed, ‘we have finished hiking, and the next move will be a cut.’ Although this had been a building narrative, until yesterday there had been consistent pushback from virtually every Fed speaker with the higher for longer mantra. However, the current belief set is that higher for longer has just been buried and that lower rates are in our future. Let the celebrations begin because the Fed has achieved the much discussed, though rarely achieved, soft-landing.

However…it is still a bit premature, to my mind, to celebrate accordingly. In fact, just yesterday the Case Shiller Home Price Index showed an annual rise of 3.9%, which although 0.1% less than forecast, also shows that the widely claimed decline in house prices due to higher yields, has not materialized. And consider, if yields are set to go lower, the idea that house prices are going to fall and feed into lower inflation seems ~~absurd~~ unlikely.

But logic has never been an important part of any market narrative, and this time is no different. The fact that declining bond yields (Treasuries fell 6bps yesterday and a further 5bps in the aftermarket) and the fact that the dollar, as measured by the DX, fell 0.5% led by USDJPY falling nearly 1.5% to its lowest level since September, has eased financial conditions thus supporting economic activity and inflation, is of no importance to the narrative. Once again, we have heard from some big-name traders, Bill Ackman in this case, claiming that the Fed is now going to cut well before the market is pricing, predicting the first cut in March 2024. The market response to this has been for Fed funds futures to price a 40% chance of a March cut and a 75% chance of one at the May meeting.

And maybe all this is correct. However, as I wrote yesterday, I believe that we are going to see a significant additional amount of federal government largesse to help prop up the economy, and that is not going to push inflationary pressures lower, the opposite in fact. As is always the case, nothing matters until it matters, and right now, the only thing that matters is that the narrative is all-in on rate cuts coming soon to a screen near you. While we could easily see further short-term weakness in equity markets as portfolios rebalance after a huge equity rally this month, it certainly seems like a push higher in risk assets is on the cards into Christmas.

As we consider the price action from yesterday and overnight, the thing that really stands out is that the US equity markets did so little on this very clear change in tone from a key Fed speaker. Had you told me this was going to be Waller’s attitude prior to the session, I would have expected US equity markets to rally by 1+% each, with the NASDAQ really embracing the idea of lower rates. But while the three major indices all closed in the green, it was only at the margin, +0.1% – +0.3% with a very late day rally. Yes, futures are pointing higher this morning, up about 0.3% across the board, but again, this is somewhat unimpressive. Perhaps the market has already priced in this idea, hence the 10% rally in November.

There is another wrinkle in this narrative as well, and that is that APAC shares are underperforming in both China and Japan. Regarding the former, the Hang Seng (-2.0%) fell again as continuing concerns over Chinese corporate growth and profitability weigh on the index with Meituan reporting poor results. On the mainland, despite hopes that the government was going to do more to support the property market, thus far it has been all talk, and no action and investors are getting tired of waiting. Europe, however, is having a better go of it this morning, excluding the UK, where continental indices are all nicely higher, at least 0.5% with some as much as 0.9%.

Not surprisingly, European debt markets are rallying as European sovereigns are following the US lead, ignoring the pleas from ECB speakers that higher for longer remains the path forward. As such, we are seeing further declines on the order of 4bps – 6bps across the continent, matching US yield declines for the past two days. Yields in Asia, though, are quite interesting with some very different narratives playing out there. Starting with Japan, which saw yields fall 9bps last night, back to their lowest level since September, we heard from BOJ member Seiji Adachi that it was premature to consider exiting ultra-loose monetary policy amid global economic uncertainties and the end of the aggressive rate hikes in the US. That seems counter to what had been the building narrative regarding Ueda-san’s next move. Australia saw yields decline 14bps but in New Zealand, the decline was much more muted, just 2bps, after the RBNZ left rates on hold, as expected, but was far more hawkish in their statement than expected and hinted at potential further rate hikes.

Turning to the commodity markets, oil continues to rebound, rallying another 1.8% this morning and recouping all its recent losses as confusion still reigns over the OPEC+ meeting tomorrow, or perhaps to be delayed again. As well, it seems that a massive early winter storm closed ports in the Baltic and so oil shipments have been interrupted there for the time being. Gold, though, has been the big story in commodity markets as it exploded higher yesterday after the Waller comments, jumping $30/0z (1.5%) to levels last seen in May and once again approaching its all-time highs of $2085/oz. The market technicians are getting quite excited as they see a break there as having potential for a much larger run higher. A case can be made that this is not a vote of confidence in the Fed’s anticipated future handling of inflation, but for now, we can simply attribute it to lower interest rates around the world.

Finally, the dollar has taken a straight-right to the chin and is reeling against virtually all its counterparts, both G10 and EMG. While we have seen a bit of a rebound this morning, since Monday’s close, EUR (+0.3%), GBP (+0.5%) and JPY (0.65%) have all rallied nicely, and that is after giving up some of those gains overnight. We saw similar movement in the EMG bloc with CNY (+0.3%), PLN (+0.3%) and BRL (+0.8%) all responding positively to the Waller comments. As I have been saying recently, if the Fed is truly done, then the dollar is likely to suffer, at least until such time as the other central banks fall in line.

On the data front, in addition to the Case Shiller Home Prices yesterday, we saw Richmond Fed Manufacturing which disappointed at -5.0 (exp 1.0), yet another sign that growth is waning. It is data like this that has Waller in the mindset that slowing growth will lead to lower inflation. Of course, rising home prices would certainly be a crimp in that theory. Today we see the second look at Q3 GDP (exp 5.0%) with Real Consumer Spending expected at +4.0%. We also get the Fed’s Beige Bok at 2:00pm and Cleveland Fed president Mester speaks at that time. It will be interesting to hear if Mester, a very clear hawk, confirms the Waller thoughts or tries to push back alongside Governor Bowman.

For now, while the dollar has bounced slightly this morning, as long as the narrative remains the Fed is done and that cuts are coming soon, you have to believe the dollar is going to fall further from here. If pressed, I would suggest USDJPY has the furthest to decline, but the fact that we have already had pushback from the BOJ implies that they are not that unhappy it remains weak. After all, it supports their corporate sector and helps keep inflation higher, which remains one of their goals.

Good luck

Adf

Talk the Talk

Posted on November 28, 2023 by fxpoet

It seems that investors are waiting
For Powell, and so they’re debating
Will he be a hawk
And still talk the talk
Or will he be accommodating?

The punditry seems unpersuaded
Another rate hike could be slated
So, most views expressed
Say; time to invest!
And bearish ideas must be faded

It is almost as if we are still on holiday given the lack of price movement across most markets so far this week. In fact, other than the Chinese markets (Hang Seng -1.0%), which are continuing to suffer from the ongoing implosion of their property bubble, market activity yesterday in the US, overnight through the rest of Asia and in Europe this morning has been quite muted. Perhaps the tone has been very mildly bearish, with declines on the order of -0.25% or so, but that comes in the wake of gains as much as 10% or more through the month of November. As such, it should be no surprise to see a bit of portfolio rebalancing. Certainly, there is a lot more discussion about the soft/no-landing scenario and we are beginning to see S&P 500 prognostications for the end of 2024 being above 5000.

The premise seems to be that inflation has been defeated, and that while the Fed may wait a few more months before cutting rates, by this time next year they will be celebrated for having achieved the elusive soft-landing. The implication is that once they are more comfortable that inflation is dead, they will start to cut rates because…? And that is where I get lost. If the economy continues to grow with rates at 5%, exactly why should the Fed consider cutting them? The only reason I can see is that the pressure from the administration grows too intense as the cost of refinancing the currently outstanding and growing debt continues to rise dramatically. The problem with this outcome, however, is that if the Fed is seen to be cutting rates under pressure from the administration to reduce financing costs, it is likely to signal to the market that fiscal policy is in complete control (yesterday’s discussion on fiscal dominance is apropos here). Historically, when that happens, inflation is not merely, not dead, it is ready to roar.

The implications of this policy direction are unlikely to be welcome in government, in boardrooms or in households, as rising inflation and a declining currency are a toxic mix for economic success. Let’s think this through before cheering it on.

As we progress toward the 2024 presidential election, it is abundantly clear that the federal government is going to seek to spend as much money as possible. Not only that but I am confident they learned the lessons from the GFC and Covid that QE simply pumps up asset prices while helicopter money is far more effective in getting cash into the hands of the voters. Given the recent surveys that show 80% of the country believes they are worse off than prior to President Biden’s election, the recipe to address this is quite clear; give more money directly to the people. And so, you can be sure that there will be numerous fiscal giveaways as 2024 unfolds.

The problem is that these giveaways do not create organic growth in the economy, rather they are the antithesis of organic growth. As such, tax revenues will continue to lag, and the deficit will continue to grow ever larger. Already, the cost of funding the outstanding ~$34 trillion in debt has reached $1 trillion, more than the government spends on defense, the largest non-entitlement program. As well, the average tenor of US Treasury debt continues to decline with almost half needing to be refinanced by the end of 2025. If interest rates remain at 5.5% and the Treasury continues to skew toward T-bills rather than coupons, that $1 trillion bill is going to grow to $2 trillion pretty quickly. That will require even more debt issuance to repay, and the cycle will grow ever larger and faster.

It doesn’t take much imagination to see where this could be headed and there is a history of how it has worked in the past, notably with Weimar Germany in 1921-1923 and more recently, in Zimbabwe in 2008-2009 and again in 2019, and, of course, Argentina today. The classic response to this problem is to institute yield curve control so that those debt payments are contained. Of course, that means that government debt will pay negative real yields, and the Fed will wind up owning most of it*. The natural consequence here will be that the dollar will likely decline sharply, at least against ‘real’ stuff like commodities, and a little less-so against quasi-real stuff** like equities. Versus other currencies it is much harder to tell because if the US is in this situation, other countries are likely to be in difficult straits as well, so the FX value of the dollar may not collapse. Of course, other countries may not have the same debt dynamics as the US, and those currencies will likely hold up better than the rest.

My fear is this is the new direction of travel. It is not a given by any stretch, but it is going to seem quite attractive to politicians of every stripe, regardless of their political affiliation or ostensible principals because, remember, to an elected politician, the most important policy is one that gets them re-elected and they will vote for anything that they believe will help them in that cause, principals be damned.

Will this have any impact today? Very unlikely. But it is important to remember this possible path as we await to hear more Fed speakers, but notably Chairman Powell on Thursday morning. Any hint that the pressure to cut is working (and I am sure there is plenty of pressure for that from Treasury and the executive branch) and we will see a massive rally in equities, bonds and commodities as the dollar declines. At least at first. In fact, it is for this reason that I believe that we are going to hear much more hawkish rhetoric from all the Fed speakers this week, and that Powell will be particularly so. They understand the potential ramifications of capitulation and are not yet ready to allow it.

As to today’s markets, bond yields are within 1bp of yesterday’s closes but leaning lower right now, US equity futures are basically unchanged as are gold and the entire metals complex although oil is edging higher on the news that Saudi Arabia is pushing for another 1mm bbl/day production cut at Thursday’s OPEC+ meeting.

On the data front, yesterday’s New Home Sales data was quite weak, with both prices and volumes falling. This morning we see Case Shiller Home Prices (exp 4.0%) and Consumer Confidence (101.0) and we hear from four Fed speakers, Goolsbee, Waller, Bowman and Barr. Look for that hawkish tilt. It is also supomatsu, the day when spot FX settles on month end, so I expect FX volumes to pick up a bit, but historically, this is more of a swap exercise than a directional one, and so looking for directional movement based on this would be a mistake in my view.

If I am correct and hawkishness is the Fed mantra today, I expect the dollar will be able to edge a bit higher along with yields, but until Powell speaks, I suspect we will remain fairly muted overall.

Good luck

Adf

*There is another possibility with regards to ownership of treasury debt to prevent the Fed from owning all of it, new rules can be instituted that require banks, insurance companies and even your 401K or IRA accounts to maintain a certain percentage of assets in treasury bonds. So, in the latter case, which has already been discussed in Washington, you could see 20% or 30% of your retirement next egg forced into negative real yielding assets for a long time. I assure you that will not help your retirement situation!

** I use the term quasi-real stuff as equities represent shares in a real business, so there is underlying value to that business and its assets, although not quite the same as owning the actual hard assets they represent.

Clearly the Rage

Posted on November 27, 2023 by fxpoet

While AI is clearly the rage
Where Mag 7 try to engage
Consider the fact
That during this act
They’re fighting each other backstage

Just a little aside regarding the situation in equity markets, which in the US really means the Magnificent 7 these days. One of the key features of their cumulative success was that these companies had no significant overlap regarding their business models. Online shopping, iphones, EV’s, search, GPUs, streaming services and a social network clearly intersected to some extent, but the main focus of all these companies was spread out in different directions. Yes, Amazon prime competes with Netflix, as does Apple TV, and yes, Amazon Web Services, Microsoft Azure and Google Cloud are all in the same business, but there is a huge amount in that particular segment that is still unfulfilled, so competition but not cutthroat.

But AI is a different kettle of fish. All of them are actively investing in their own AI programs and working to integrate them into their current services and products. And we are already seeing announcements of new GPU’s to directly compete with Nvidia and bring that supply chain in-house for the other users. The point is, there is going to be a lot more investment, if not overinvestment, in this space with, arguably, quite a while before whatever AI does starts to really help the bottom line. In other words, do not be surprised to see margins start to decline in these companies which is unlikely to help drive their share prices higher. As well, with investment focused on this new area, we need to expect to see a reduction in share repurchases, removing one of the key bids to the market.

All I’m saying is that even in a soft or no landing scenario, it strikes me that the Magnificent 7 may be running out of room to continue their amazing run of share price gains. And if they start to stumble, just the very nature of the equity indices, where their capital weightings are so large combined, > 30%, I suspect the indices themselves may find themselves under a lot of pressure, regardless of whether the Fed cuts rates or not. And if the Fed cuts rates because the economy is slipping into recession, or has already gotten there, that cannot be good for margins either. While timing is everything in life, this is something that needs to be on everyone’s radar, because it will change the risk narrative, and that matters for all markets. Just sayin’.

While last week was mercif’ly free
Of Fedspeak, the FOMC
This week will explain
Again and again
Why higher for longer’s the key

As the market returns to full strength, at least from a staffing perspective, post the Thanksgiving holiday, things are opening fairly quietly. A quick recap of the data since I last wrote shows that the mix of good and bad continues to leave prospects uncertain going forward. This has allowed both the soft/no landing camp and the recession camp to point to specific things and claim they are on the right track. So, Durable goods were pretty lousy in October and Michigan Sentiment also fell sharply, but Initial Claims fell as well, indicating that the labor market remains robust overall. In other words, uncertainty continues to reign.

One of the interesting things is that different markets appear to be pricing very different outcomes. For instance, commodity markets, or at least energy markets, are clearly in the recession camp as oil prices remain under pressure, falling another 1.5% this morning as the market awaits the outcome of Thursday’s delayed OPEC+ meeting. Talk is that there could be another 1 million bbl/day production cut to help support prices, but nothing is yet certain. At the same time, both copper and aluminum remain under pressure, sliding a bit further last week and this morning while gold (+0.5%) is back firmly above $2000/oz, hardly a sign of a positive future.

However, as dour as the commodity markets feel, equity markets remain quite resilient overall. Although this morning, we are seeing modest declines around the world, with European bourses lower by -0.2% or -0.3%, and US futures are currently (8:00) down by -0.15%, the month of November has been a big winner almost everywhere. Gains, ranging from 5% – 11% are the order of the month as equity investors have gone all-in on the idea of a soft landing and that the major central banks are going to be slowly reducing interest rates to ensure economic growth continues.

In truth, bond markets are of a similar mind as equities with 10-year yields lower by between 25bps and 40bps during November throughout the G10 (Japan excepted but even there lower by 10bps). Clearly, all this can be traced back to the QRA released back on November 1^st when Treasury Secretary Yellen let it be known that there would not be as much coupon issuance as had been anticipated, and that more of the Federal government’s borrowing would take place in the T-Bill market. That was the starting gun for the bond market rally and the ensuing stock market rally.

So, which of these two views is correct? That, of course, is the $64 trillion question, and one with no clear answer yet. As I have written numerous times, and as we saw last week, the data continues to be mixed, with both positive and negative signs. While the Fed, and virtually every other G10 central bank continues to harp on the idea that they will not be cutting rates anytime soon, markets are pricing in rate cuts starting in early Q2 of 2024.

Ultimately, there will be a winner of this battle, but the game is still afoot. FWIW, while I have long been concerned that the imbalances in the economy were going to lead to a more significant correction in equity prices, there is another side to the story that is worth exploring, and that is the concept of fiscal dominance.

According to the St Louis Fed, a good definition of fiscal dominance is: “…the possibility that accumulating government debt and deficits can produce increases in inflation that dominate central bank intentions to keep inflation low.” The corollary here is that the Fed is losing its power over one of its key mandates, stable prices, because the Federal government’s fiscal impulse is so great as to overwhelm the Fed’s actions.

With 2024 a presidential election year, and with the TGA currently at $725 billion plus negotiations for more spending on Ukraine, Israel and the southern border, there will be no shortage of additional Federal moneys flowing into the economy. Add to this the fact that the surge in T-Bill issuance will move savings from a “dead zone” in the standing RRP facility, which is still at $935 billion, to more active money, able to be used in the real economy, and it is easy to see how economic activity is going to be supported throughout 2024. Whatever your views on the appropriateness of these policies, the reality on the ground is that the current administration will do everything in its power to be re-elected and that includes spending as much money as possible. Remember, too, that there is no operable debt ceiling, so they can issue as much debt as they want to fund whatever they can get legislated.

If the Fed has lost control of the narrative, and it does appear to be slipping through their fingers, then we will need to start to focus elsewhere to find market drivers. Of course, if the Fed is losing its grip, do not think for a moment they will go meekly into the sunset. Instead, I could see several more rate hikes as they continue to try to fight for price stability amid an economy flush with cash. In other words, this story is nowhere near finished.

At this point, let’s take a look at this week’s data, which will bring updated GDP and PCE readings amongst other things.

Today	New Home Sales	723K
	Dallas Fed Manufacturing	-17
Tuesday	Case Shiller Home Prices	4.0%
	Consumer Confidence	101.0
Wednesday	Q3 GDP	5.0%
	Goods Trade Balance	-$85.7B
Thursday	Initial Claims	220K
	Continuing Claims	1872K
	Personal Income	0.2%
	Personal Spending	0.2%
	Core PCE	0.2% (3.5% Y/Y)
	Chicago PMI	45.4
Friday	ISM Manufacturing	47.6

Source: Tradingeconomics.com

Despite Friday being the first of December, payrolls are not released until next week due to the holiday last week. Plus, in addition to the data above, we hear from seven different Fed speakers over ten venues including Chairman Powell Friday morning. That will be the last Fed speaker until the next FOMC meeting, so it will be keenly watched. However, I would wager a great deal it will continue to harp on progress made but higher for longer to prevent any resurgence in inflation.

As to the dollar, right now, it is softening as market participants focus on the idea of Fed cuts and simultaneously reduce large, long USD positions. For now, I feel like lower is the way forward, but if we start to see increased hawkishness again because there is no landing, merely continued growth, look for the dollar to return to its winning ways.

Good luck

Adf

Somewhat Sedate

Posted on November 22, 2023 by fxpoet

Nvidia’s earnings were great
The Minutes were somewhat sedate
At OpenAI
They got back their guy
And traders, for closing, can’t wait

In Europe, they’re still quite concerned
Inflation’s not been overturned
But positive news
Twixt Arabs and jews
A truce for four days has been earned

As we head into the holiday weekend, the truth is the macroeconomic story is quite dull. Not only has there been a dearth of Fedspeak (which is a good thing I think) but the data has been second-tier, at best, and sparse overall. The fact that Existing Home Sales fell further given the current mortgage market situation cannot be surprising. After all, folks are quite reluctant to give up the 3% mortgage on their current house to buy a new house and pay 7.5%. As to the Minutes of the last FOMC meeting on November 1^st, they were deemed hawkish by some, although they are so out of date, it is not clear why any attention is paid to them.

Arguably, of much more interest to most every market participant were the earnings results from Nvidia, which beat lofty expectations as the AI phenomenon continues to grow. In that same vein, the OpenAI saga, where Sam Altman, one of the founders, was ostensibly fired, set to go to work at Microsoft and bring his entire team with him, but now is back at OpenAI has been garnering the lion’s share of market bandwidth. But I ask, does that really have a macro impact? I would argue not at all.

In fact, I would say that the market is quite ready for the Thanksgiving holiday, as most participants are far more concerned about the travel conditions than the market conditions. Yes, the ECB keeps trying to threaten that they are not done hiking interest rates, although given growth there is fading fast, this feels much more like brave talk than a precursor to action. And thankfully, it appears there is going to be a four-day cease fire agreement in Gaza with a release of some of the hostages, so that is clearly a good thing.

But really, it is very difficult to get too excited about too much at all today. There is some data due this morning, with Initial (exp 225K) and Continuing (1875K) Claims, Durable Goods (-3.1%, +0.1% ex Transports) and Michigan Sentiment (60.5). But none of it seems very enticing as a rationale to change any opinions or positions.

Reviewing markets, after yesterday’s very modest pullback in the US equity markets, Asia saw mixed price action with Tokyo a bit firmer while China was under pressure. In Europe this morning, other than the UK (-0.2%) there are modest gains despite a lack of new data. The UK story seems a reaction to a much weaker than expected CBI Industrial Trends report, indicating much slower growth ahead. As to US futures, they are a bit firmer at this hour (8:00), arguably benefitting from those Nvidia earnings.

In the bond market, Treasury yields continue to drift lower, down 3bps this morning and currently at 4.36%, just above that first key support level. European sovereigns are also rallying with yields down by between 3bps and 5bps across the board. The outlier here was Japan overnight, where yields rebounded 3bps after what had been a very quick decline given all the discussion about how the BOJ was set to tighten policy. For now, there is a great deal of enthusiasm over the soft-landing scenario which I believe is a key driver of the bond market rally. However, the future here will be highly dependent on the Fed’s actions going forward, and I, for one, continue to believe in the higher for longer story. Unless growth really drops quickly, or unemployment skyrockets, I don’t see a rate cut anytime soon.

In the commodity markets, oil (-2.0%) seems to be falling on the back of the de-escalation in the Middle East, as well as word that Russia is exporting diesel fuel again. Gold prices captured the $2000/oz level yesterday and are still hanging on, although copper and aluminum are both under pressure this morning, down about -0.5% each. Broadly, I would say that the commodity sector has been the one area most actively considering a recession is coming with the overnight price action merely a reflection of this.

Finally, the dollar is a touch firmer this morning, halting its recent declines with both USDJPY and USDCNY higher by about 0.2% this morning. Given the lack of news, this seems much more like a trading event, with traders closing positions ahead of the long holiday weekend. I maintain my view that if the Fed is actually done and beginning to lean toward easier monetary policy, the dollar will decline a bit further. But that is a big if in my mind. It is very difficult to get excited about the prospects of most other currencies given the inherent weakness in economies around the world. However, a change in Fed policy will definitely have an impact on the buck.

And that’s really all for today. There will be no poetry until Monday as I, too, will be taking a break from the action.

Good luck and have a wonderful holiday

Adf

Vaporized

Posted on November 21, 2023 by fxpoet

The powers-that-be are concerned
That Argentine voters have spurned
Advice they’ve provided
And rather decided
It’s time some new lessons were learned

And so, we cannot be surprised
The media pundits advised
Milei should step back
And take a new tack
Lest talking points get vaporized

It has been quite a slow session overnight. There has been precious little new in the way of data or commentary of note with respect to the current economic story. At the same time, the Thanksgiving holiday has trading desks thinly staffed and the Fed is noteworthy in its absence from the tape. As such, the news cycle has been filled with the OpenAI saga, something far outside the scope of this poet, the ongoing political infighting that is a constant thrum in the background, and one very interesting thing, the mainstream response to the election of Javier Milei as president of Argentina.

Given the dearth of other news, and the fact that I believe this has the opportunity to be quite impactful going forward, I thought I would take a little time and discuss this further.

According to Wikipedia, which in this case I have no reason to disbelieve, Milei, while new to politics, is a serious economist. He has earned two masters degrees in the subject, taught at university and is a widely published author on the subject. The point is, he has very clear ideas on how economies work from a theoretical perspective and having grown up in Argentina during one of its earlier hyperinflations, from a practical aspect as well.

What makes all this so fascinating is the deluge of articles that have been published in the WSJ, Bloomberg, CNN, the New York Times, et al. which are quite keen to highlight that his views are highly unorthodox and will fail dramatically, dragging the nation into an even deeper hole. In fact, I cannot find a single mainstream media source that believes his ideas will succeed. However, 56% of the voters in Argentina, who are actually living through the economic disaster of the mainstream views, thought differently.

Perhaps the clearest signal of this disagreement is that the Merval, Argentina’s main equity index, rose 7.1% yesterday on the news of his election. One need not be a conspiracy theorist to understand that if Milei is successful in righting the Argentine ship by throwing out the current orthodoxies, it will call into question everything that finance ministries throughout the G10 have been claiming and doing. As I wrote yesterday, I believe this election has the potential to signal a beginning of a significant change in the make-up of governments around the world. Do not be surprised when there is significant support for 3^rd party candidates in the US; when AfD wins an outright majority in a state election or two in Germany; and if Mexico throws the ruling PRI out of office. As Neil Howe and William Strauss wrote in their tour de force, The Fourth Turning, this is the time when major upheavals occur. Be prepared for more volatility in financial markets as these changes make their way into the system. In other words, stay hedged!

Ok, back to the markets as they currently sit. Yesterday’s strong US equity performance found limited follow-through around the world. Asian indices were mostly slightly lower and European indices are mixed with the DAX (+0.2%) edging higher while the CAC (-0.25%) and FTSE 100 (-0.5%) are both under pressure. As to US futures this morning, at this hour (7:30), they are ever so slightly softer, -0.1%.

In the bond market, Treasury yields edged lower yesterday amid a relatively quiet session and are a further 1bp softer this morning. European sovereign yields are also a touch softer, somewhere between -2bps and -4bps, generally speaking, while JGB yields fell a further 5pbps overnight and are now down to 0.69%. This is certainly a far cry from the idea of tighter Japanese policy, although the yen continues to strengthen. Two noteworthy aspects in the Treasury market are that the 20yr auction yesterday went off without a hitch as the tail was actually negative (the highest yield was lower than the when-issued price) and dealers only took down 9.5% of the auction. This is a far cry from the terrible 30-year auction we saw last week. But the other thing that is not getting much press is the fact that the yield curve continues to reinvert with the 2yr-10yr spread back to -48bps this morning. Recall, this had fallen as low as -15bps and looked like it was about to normalize just a few weeks ago. Arguably, investors are telling us that the prognosis for future growth is declining although they are still uncertain as to when the Fed will begin cutting rates.

Oil prices, which have rallied for the past several sessions, are a touch softer this morning as the market has become confused to the key drivers. Does OPEC+ and its production matter more than economic activity? Are supplies tight or loose? I expect that we are going to continue to see uncertainty and volatile price action until something clearer shows up. As to the metals markets, gold and silver have both rallied this morning with gold creeping back toward that $2000/oz level, although not yet breaking through. But base metals are mixed with very minor movement. While equity investors remain convinced the soft landing is a given, the commodity space is far less certain.

Finally, the dollar remains under pressure as sliding Treasury yields weigh on the greenback. Once again JPY (+055%) is the leading gainer in the G10 and remarkably, CNY (+0.35%) is leading the way in the EMG space. What is quite interesting here is that the spot USDCNY rate in the market has fallen below the fixing rate for the first time since June. You may recall that the spot rate had been hovering at the 2% band limit for quite a while. This is another indication that the near-term outlook for the dollar remains lower.

On the data front, we get the Chicago Fed National Activity Index (exp 0.02) and Existing Home Sales (3.9M) this morning and then the FOMC Minutes at 2:00 this afternoon. You may recall that the Statement in the beginning of the month was seen as hawkish, but the press conference was seen as dovish and they talked about how financial conditions had tightened and helped the Fed along. But now, those conditions have eased again. Also, we have heard from so many Fed speakers in the interim, it is hard to believe that whatever they said three weeks ago is newsworthy.

So, with more eyes on the clock ,as folks want to get away for the holiday and are worried about travel conditions, than market conditions, I suspect today, and tomorrow and Friday, will be very quiet indeed.

Good luck

Adf

Could Cause Contraction

Posted on November 20, 2023 by fxpoet

A story that’s gained lots of traction
Is Jay will soon jump into action
By cutting the rates
They charge for short dates
Cause high real rates could cause contraction

In fact, this idea ‘s gone mainstream
And it’s now a favorite theme
But history shows
The ‘conomy grows
Despite real rates high with esteem

After a spate of slightly softer than expected data in the US, it is very clear the consensus in markets is that not only is the Fed finished raising rates, but that cuts are coming soon. At this point, based on pricing on the CME for Fed funds futures, the Fed is going to cut rates by 100 basis points next year. While I’m certainly no PhD economist (thank goodness!), this strikes me as a mistake. Consider the following:

If the economy really does go into recession in Q1 or Q2 of next year, where GDP turns negative and the Unemployment Rate rises close to 5.0%, it strikes me that the Fed is going to cut a lot more than 100bps. In fact, the one thing we know is that Fed funds tend to decline much more rapidly than they rise as the Fed is usually responding late to some crisis. So, a simple model can be created that shows 100bps of rate cuts is made up of a 20% probability of no movement at all; a 60% probability of 50bps of cuts next year as they try to tweak policy at the margin, and a 20% probability of 350bps of cuts as they respond to a recession and get aggressive. Now, you can adjust those probabilities in any number of ways, but that seems reasonable to me. However, that is not the market narrative. Rather, the narrative is that the Fed is going to start to cut rates because policy is already overtight (real rates are positive) and they will want to get ahead of the curve.
However, exactly why will the Fed need to cut, absent a full-blown recession? Going back to 1982, these are the highest and lowest levels for real 10Yr yields, real Fed funds (defined as Fed funds – CPI) and Y/Y GDP each quarter:

	Real 10Yr	Real Fed funds	GDP Y/Y
Max	7.60%	8.30%	9.60%
Min	-0.35%	-7.90%	-2.20%

Data: FRED database, calculations Fxpoet

So, we have seen real yields, both short- and long-term much higher and much lower than the current situation. But the funny thing is, the relationship between GDP growth and real interest rates, whether 10Yr or overnight, is basically zero. In fact, I ran the numbers and came up with an R² of just 0.03 which tells me that there is no relationship of which to speak. My point is just because real rates have risen to a positive level in the past year does not mean that the Fed has ‘overtightened’. It just means that they have tightened policy trying to address what they still see as too high inflation. It also does not indicate that because real yields have risen over the past quarters, that the economy is about to crash. That’s not to say we are going to necessarily avoid recession, but the point is it will take much more than modestly higher real interest rates to push us over the edge. At least that’s my view.

But for now, most markets are getting quite excited about the idea that peak interest rates are behind us and that the upcoming lower interest rates are going to support risk assets, especially equities, aggressively. I feel a lot can go wrong with that model, but then I’m just an FX guy.

The Argentine people have spoken
As they want to fix what’s been broken
So, starting today
The new prez, Milei
Must change more than merely a token

A brief comment on this electoral outcome. While Argentina’s economy is quite small on the global scale, I believe this is a harbinger of far more electoral shake-ups in 2024 and 2025. We need only go back to 2015 when the Austrian presidential election was initially called for the complete outlier candidate, a non-politician as well as a right-wing firebrand, before being overturned by the courts there. That story preceded the Brexit vote and then, of course, the election of Donald J Trump as US President in 2016. People were very clearly tired of the political elite explaining why the masses needed to suffer while the elite got along just fine.

The ensuing resistance by the entrenched politicians was fierce and so we saw Trump lose his reelection bid amidst great turmoil and then the election and collapse of Liz Truss in the UK. But it appears that things have gotten worse in the broad populace’s collective mind, with inflation remaining stubbornly high, and perceptions of opportunity shrinking. Combining those features with a growing distrust of media and government pronouncements after the Covid situation, where vaccines did not prove as efficacious as promised and, in fact, seemed to result in at least as many harms as benefits, and people are ready for a new look.

So, be prepared for some more non-traditional electoral winners next year. Presidential elections are due in Taiwan, Mexico and the US with major regional elections throughout Germany, Canada, South Korea, India and the UK as well as the European Parliament. Many people are quite pissed off at the incumbents around the world so look for more fragmentation and new faces.

This implies that much of how we consider the macroeconomic picture could well change. And that means market volatility seems likely to increase further. Just something to keep in mind, and an even more important reason to maintain hedges for major exposures, whether FX or interest rates.

Ok, it was easy to spend time on these issues as there is really nothing else going on. Overnight, the only news was that the PBOC left their Loan Prime rates unchanged, as expected, so not really newsworthy. Else, the biggest news over the weekend was arguably the Argentine elections.

It should not be surprising that market movement has been quite muted with the biggest equity move in Hong Kong (+1.85%) which is just a retracement of its recent woes. Otherwise, Japanese markets fell somewhat (-0.6%) and the rest of APAC was very muted. In Europe, there is a mix of gains and losses with nothing more than +/- 0.25%, so no real news and US futures are essentially unchanged at this hour (7:00).

Bond yields are, overall, a touch firmer this morning with Treasury and most European sovereign yields up 3bps. But that is after another decline on Friday, and the 10yr remains quite close to its new home of 4.50%. The ‘inflation is dead’ theme had a lot of proponents last week, but as we head into this, holiday shortened, week with limited new economic data, I suspect that things are going to be quiet without any new trends taking hold. The market technicians explain that 4.33% and then 4.00% are the key yield supports. So far, the first has held and I expect we will need to see much softer data to break it.

Oil prices are rebounding further this morning, up 1.5%, as there is talk that OPEC+ may be set to cut production even further with the price now below the level when they first initiated cuts in the summer. There seems to be a disconnect between the official supply and demand data and the price, where the data would indicate prices should be higher. One possible explanation has been that more Iranian oil has been reaching the market than officially allowed and so weighing on prices. Alas, that is a very hard story to prove. As to the metals markets, precious metals are softer this morning, but still retain the bulk of their recent gains while copper (+0.4%) is higher after Chinese demand indicators started to show strength.

Finally, the dollar is starting to edge lower this morning as NY walks in the door after a very quiet overnight session. USDJPY is the leader here, falling -0.8%, and we are seeing a large decline in USDCNY (-0.55%) as well. Recently, there has been a distinct uptick in the number of pundits who are calling for a sharp decline in USDJPY. Much is predicated on reading between the lines on Ueda-san’s pronouncements and expecting that QQE is finally going to end there. Ironically, 10yr JGB yields are down to 0.74%, well below the highs seen at the beginning of the month and do not appear to be headed higher, at least for now. To the extent that the Japanese MOF actually does want a stronger yen, something about which I am not at all certain, one must beware the idea that they could come in and intervene now, when they are jumping on the bandwagon rather than trying to stop a rush against them. It would certainly be a lot more effective and would likely change a lot of opinions. The one thing I have learned in my time in the markets is that when USDJPY starts to move lower, it can do so very quickly and for quite a long way.

Away from those two currencies, both Aussie and Kiwi are firmer by about 0.6%, benefitting from strength in the renminbi as well as most commodity prices. Not surprisingly, NOK (+0.5%) is rallying although it is a bit more surprising that CAD is essentially unchanged on the day. Also remarkable is that CNY is the biggest mover in the EMG space, with most other currencies just barely changed on the day.

During this holiday week, there is very little data to be released with Existing Home Sales (exp 3.9M) tomorrow along with the FOMC Minutes and then Durable Goods (-3.2%, +0.1% ex transport) on Wednesday along with the Claims data. Happily, it appears that the FOMC has taken this week off and will not be adding to their recent commentary.

Overall, the short-term trend appears to favor softness in interest rates leading to modest strength in risk assets and weakness in the dollar. I am not yet convinced that is the long-term view, but for this week, I think that’s a fair bet.

Good luck

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fxpoetry

Explaining the rhyme and rhythm of the FX markets each day

Author Archives: fxpoet

Already Wary

Too Clever by Half

Nirvana Sans Prayer

Gradually Growing

Now Estranged

Talk the Talk

Clearly the Rage

Somewhat Sedate

Vaporized

Could Cause Contraction