Author Archives: fxpoet

Much More Afraid

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Watanabe-san,
A previous Mr Yen,
“No intervention”

As USD/JPY approaches the psychological level of 150.00, there is a growing belief in the market that the BOJ is soon going to intervene.  Recall, last week we heard about the urgency with which the MOF is watching the exchange rate.  Historically, the next step would be for the BOJ to ‘check rates’.  This is when they call around to the big Tokyo bank FX trading desks and ask for levels.  The implication is they are ready to sell dollars and defend the yen.

However, unlike the previous decline in the yen almost exactly a year ago, the recent movement has been somewhat more gradual as can be seen in the chart below (source tradingeconomics.com)

This was highlighted last night by Hiroshi Watanabe, the deputy FinMin in charge of currency policy from 2004 through 2007.  He explained that after seeing the dollar remain in a 145-150 range for much of the past year, “I don’t think authorities are worried about the outlook as much as they were last year.  There’s no sense of imminence because the dollar/yen level hasn’t changed much from a year ago, and it doesn’t seem like the yen will start to plunge even if it breaches the 150 mark.”

As is often the case when it comes to concerns about a currency’s value, the pace of its decline is far more important than the actual level.  Most countries, or at least most finance ministries, feel they can handle slow and steady.  It is the abrupt collapses that scare them.  This move has been quite steady, and as long as both the Fed and BOJ maintain their current monetary policies, a continuation seems likely.  Hedgers, keep that in mind.

Now, turning to yesterday’s trade
A message was clearly conveyed
As interest rates rise
Risk appetite dies
And people are much more afraid

The most pressing story in markets continues to be the US Treasury market where sellers outnumber buyers on a daily basis.  Yields on the 10-year rose 10bps yesterday, touching 4.70% and are continuing higher by another 2bps so far this morning.  The bear steepener continues to be the story with the 2yr-10yr spread falling to -40bps and looking for all the world like it is going to go positive before the end of the year, if not the end of the month.  And it makes sense.  There is still substantial demand for short-term paper yielding more than 5% (yesterday’s 3mo T-Bill auction cleared at 5.35%).  Meanwhile, we are seeing money flee those assets with long duration over fears that inflation has not yet been quelled and that the structural issues (ongoing massive supply meeting limited demand) has investors pulling back quickly.  Not only are Treasury bonds being sold aggressively driving yields higher, but yesterday saw utility stocks, often seen as a duration proxy given the high amount of debt on their balance sheets, fall nearly 5%.  

This activity is having the knock-on effects that one would expect as well.  Yields around the world continue to get dragged higher by Treasuries, the dollar continues to benefit, and commodity prices are suffering.  In fact, yesterday saw a sharp decline in the price of oil and it has now retraced more than 6% from the peak last week.  I had written about the simultaneous rise in yields, the dollar and oil as being a HUGE problem for global markets.  Well, it seems that oil is starting to feel the pain of higher yields and a stronger dollar.  As well, tomorrow OPEC meets in Vienna and there is some talk that the Saudis may increase their production, unwinding those unilateral cuts made back in June and continued since then.   

But make no mistake, ongoing rises in Treasury yields will continue to underpin the dollar and that will be enough of a problem for economies elsewhere even if oil prices slide some more.  And right now, there is no indication things are going to change.  Yesterday we heard from two Fed speakers, Governor Bowman and Cleveland Fed President Mester with both maintaining the hawkish views.  In fact, Bowman expressed the need for several more rate hikes in order to get inflation under control and both were clear that higher for longer was crucial.  As long as that remains the Fed attitude, until we see a substantial change in the data stream, yields are going to continue to rise.

Now, this week brings the all-important NFP report on Friday, which has been a key driver of Fed policy.  With inflation readings continuing far above the Fed’s target, as long as NFP remains positive and the Unemployment Rate remains either side of 4%, the Fed will have no reason to reconsider the current policy mix.  In their minds, they have not yet broken anything, at least not so badly that it couldn’t be fixed.  I’m sure they are straining their arms as they pat themselves on the back for the effectiveness of the Bank Term Funding Program (BTFP) which was created after the bank failures in March.  In fairness, it seems to be working for now.  However, I will warn that cans can only be kicked down the road for so long, and I fear the end of that road is nearing.

As to the rest of the session today, risk is decidedly on the back foot.  Those equity markets in Asia that were open all fell pretty sharply with the Nikkei (-1.6%) and Hang Seng (-2.7%) leading the way lower.  The story is similar in Europe with the major indices all lower by about -0.75% or so as they respond to the ongoing increase in interest rates around the world.  Finally, US futures are lower by -0.45% at this hour (7:30) with concerns growing that yields will not stop rising.

Looking at European sovereign bonds, yields there are rising alongside Treasury yields with most of them higher by 3bps-4bps and Italy higher by 9bps.  That Bund-BTP spread, currently at 193bps, is something we need to watch as 200bps is likely to be the first place the ECB really shows concern and if it heads higher than that, expect more direct actions.  As to JGB yields, they remain static at 0.76%.

We already discussed oil prices and we are seeing serious weakness across the entire metals complex lately, although today’s declines are relatively muted, on the order of -0.2%, as the moves have already been pretty large.  The lesson from the recent price activity is that yields continue to drive the market.

Finally, the dollar remains king with the euro below 1.05, USDJPY just below 150 and the pound making a run at 1.20.  Last night, the RBA met and left rates on hold, as widely expected, but the tone of new governor Michele Bullock’s first meeting was seen as somewhat dovish leading to a nearly 1% decline in the Aussie.  At the same time, the EMG bloc of currencies is also coming under pressure with declines today on the order of -0.5% across all three regions.  There is a term, the dollar wrecking ball, which is quite apt.  As it continues to rise it puts intense pressure on countries around the world as they scramble to get dollars to service the trillions upon trillions of dollars of debt outstanding.  Nothing has changed my view that this has further to run.

On the data front today, the only release is JOLTS Job Openings (exp 8.8M) a number that remains significantly larger than the number of unemployed.  We also hear from Atlanta Fed president Bostic this morning so it will be interesting if he is willing to push back against the ongoing hawkishness.

I see no catalysts to change the current trend in the dollar, so for all you receivables hedgers out there, keep that in mind.

Good luck

Adf

Waters, Uncharted

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Last quarter, chair Jay set the stage
For yields to go on a rampage
Now, Q4 has started
And, waters, uncharted
Seem dead ahead in this new age

Both oil and dollars are rising
And bond yields worldwide keep surprising
By rising as well
With efforts to quell
Those hikes what CB’s are devising

As we begin the fourth quarter it appears the trends that had been quite clear for most of Q3, rising oil prices, rising bond yields and a stronger dollar, all remain intact. Historically, when this condition has prevailed, it has been a negative, and frequently a very large negative, for risk assets.  This begs the question, is something going to change or is it different this time?  Now, we all know that it is ‘never’ different this time, the cycles of financial markets have repeated constantly throughout history with pretty clear causes and effects.  In the current circumstance, the combination of these three indicators rising simultaneously is going to reduce the ability of non-USD economies to access necessary commodities as their prices are rising even more in local terms than in dollar terms, and the rise in interest rates is forcing them to pay more interest on their outstanding debt.  And every developing country has lots of outstanding debt, so this is a universal issue.

If we work under the assumption that this time is NOT different, then the question is, what is going to change and when might that occur?  This goes back to the idea that the Fed will raise rates until something breaks.  As of now, while a few things have broken (UK insurance companies, some regional US banks, Credit Suisse) it appears the economy continues to perform at a higher level than virtually everybody had anticipated it could.  As of yet, the most highly anticipated recession in history has still not occurred.  In fact, the soft-landing narrative, where the Fed manages to reduce inflation without pushing the economy into recession, has become the consensus view (alas this poet disagrees with that view and fears a much deeper recession is coming our way.)

So, what might change?  Well, last night the BOJ indicated that they are going to be performing an extra round of JGB buying in Q4 as they are growing increasingly concerned about the rise in JGB yields.  Last night, 10yr JGB’s moved up to 0.76%, after touching 0.775%, the highest level in more than a decade.  So, more QE is a clear possibility.  Now, we all know that the Fed is continuing its QT process, having reduced its balance sheet by a shade under $1 trillion so far and claiming they will continue to allow bonds to roll off without replacing them for quite a while yet.  The ECB is also engaged in this process and the BOE actually increased its target, now planning to sell £100 of gilts in 2024, up from the previous amount of £80 billion.  Will the central banks be able to continue these policies if the economy does tip into recession?  I think not, but they have maintained that the balance sheet issue is separate from their policy framework.

A direct impact of the QT programs is that bond yields are rising because of the absence of demand from what had been price insensitive buyers (aka central banks) which forces the private sector to absorb all the new issuance and they are requiring higher yields to take the paper.  Given the extraordinarily high levels of debt that exist, both on government and private balance sheets, it certainly seems like we might soon reach a breaking point here.  However, until that point is reached forcing a reversal in central bank views regarding their balance sheets, I anticipate yields will continue to rise.

The direct corollary to rising yields, especially rising Treasury yields as they are leading the way, is that the dollar is following along for the ride.  If you are looking for the dollar to reverse course, you are, almost by definition, looking for the Fed to reverse course.  Yet, there is no indication that is the case.  In fact, the only central bank that has demonstrated they are willing to end the tightening cycle is the BOJ, and let’s face it, they haven’t really started a tightening cycle, the market is simply anticipating that one is coming soon.

Oil, meanwhile, remains exogenous to the central bank story and is an OPEC story.  The poohbahs there meet this week in Vienna but there is no expectation of a change in their current production policy.  This means that the supply of oil is unlikely to rise anytime soon while demand, given the more robust than expected economic activity, continues apace.  Nothing has changed this story that a decade of misguided ESG policies has created a structural supply deficit of oil and the price is destined to continue to rise going forward.

Alas, the upshot of this set of conditions as we enter Q4 remains risk assets are likely to remain under pressure until whatever that something is finally breaks and the central banking community, notably the Fed, changes their tune.  Keep your ears peeled for that change in tune.

Now to today’s markets, where equity markets in Asia that were open, notably Japan, were a bit softer while China is on their Golden Week holiday so markets are basically closed all week.  That said, we did see their PMI data released on Friday night and Saturday and it was slightly stronger than expected, and for the first time since March, all the readings were above 50.0, albeit just barely.  Nonetheless, a positive sign.  As to Europe, weakness across the board is the description of the day, with the major bourses lower by between -0.3% and-0.6%.  US futures, which had been barely positive earlier in the evening session, are now slightly softer as well, -0.3% or so at 8:30.

Bond yields are rising again with Treasuries higher by 6bps and back above 4.60% while the bear steepening continues with the 2yr-10yr spread now “just” -47bps.  As well, throughout Europe we are seeing sovereign yields rise about 3bp-4bp across the board as this trend of still high inflation, rising oil prices and ongoing QT is working its ‘magic’.

Speaking of oil, it is back on the rise with WTI up 0.5% and above $91/bbl this morning as we have seen consistent drawdowns in inventory for the past several months as the OPEC supply cuts have really started to bite.  One thing that we need to keep an eye on going forward is NatGas, which as we come into winter and the colder weather, could well see a lot of upward pressure, especially in Europe.  Looking at the metals markets, the combination of rising prices in oil, yields and the dollar is really starting to weigh on this sector with gold down another -0.75% and getting closer to $1800/0z, down more than 5% in the past month.  Copper (-1.6%) and aluminum (-0.3%) are also under pressure today and both are feeling the weight of developing downtrends.

Finally, the dollar, which sold off slightly on Friday into month-end, has reversed course and is stronger across the board this morning with the DXY up 0.35% while some outliers are ZAR (-1.1%) and MXN (-0.7%), both suffering from the strong dollar disease.

On the data front, the PMI data from Europe was still awful, with Germany still sub 40.0 and the Eurozone at 43.4.  As to the rest of the week, we get important things culminating in Fridays NFP report.

TodayISM Manufacturing47.7
 Construction Spending0.5%
TuesdayJOLTS Job Openings8.83M
WednesdayADP Employment160K
 ISM Services53.6
 Factory Orders0.3%
ThursdayInitial Claims210K
 Continuing Claims1678K
 Trade Balance-$64.6B
FridayNonFarm Payrolls163K
 Private Payrolls160K
 Manufacturing Payrolls5K
 Unemployment Rate3.7%
 Average Hourly Earnings0.3% (4.3% Y/Y)
 Average Weekly Hours34.4
 Participation Rate62.9%
 Consumer Credit$12.5B

Source: Tradingeconomics.com

As well as all this, we hear from nine different Fed speakers across eleven events including Chairman Powell this morning at 11:00am.  And that is just what is on the schedule, I expect we will hear some BBG interviews or things like that as well.  

The question remains, is something going to change, either because of the data or the tone of Fed speeches?  There is no indication the Fed is changing their attitude and I expect that will remain the case until the data changes.  I have maintained for more than a year that the NFP report is critical to Powell and friends as it is their CYA document.  As long as the Unemployment rate remains lower than 4.2% or so, and NFP is positive, nothing will deter them on their mission against inflation.  And that means the dollar will remain underpinned.

Good luck

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Three Extra Trill

Posted on by 
Said Goolsbee, I’m, processing, still
Why bond yields keep moving uphill
Perhaps he should look
At Yellen’s full book
Of issuance, three extra trill

So, with the third quarter now ending
And core PCE, today, pending
The hope and the dream
Is next quarter’s theme
Will be ‘bout risk assets ascending

In a speech yesterday at the Peterson Institute for International Economics, Chicago Fed President Austan Goolsbee laid out his current views on the US economic situation, which he thought was generally in good shape, and warned about overtightening.  He also noted the Fed has a rare opportunity to achieve a soft landing.  All that is ordinary enough.  The odd comment came when he mentioned that he was “still processing’ why bond yields were rising so much recently.  It is always disconcerting to me when the so-called best and brightest who lead our key institutions expose themselves as being clueless in their main role.  

As I have discussed in the past, it is not very difficult to determine why long-term yields are rising in the US, it is a combination of two absolutes and one likelihood.  The absolutes are the amount of supply hitting the market and the reduced demand.  Treasury Secretary Yellen has indicated in Q4 there will be new issuance of ~$852 billion on top of current refinancing of >$1.3 trillion, hitting the market.  At the same time, the Fed continues its QT program reducing demand by $180 billion in Q4 and both China and Japan, the two largest holders of Treasuries have been slowly reducing their positions.  The point is excess supply and reduced demand will drive prices lower.  The likelihood is that the private sector that will be required to purchase these bonds is wary of inflation rebounding on the back of higher energy prices and increasing wage costs (between the UAW strike and the latest law in California that mandates a $20/hour minimum wage for fast food workers, wages seem set to rise further still), and so are demanding to be paid more to buy the paper.  It is not really that complex.

Yesterday, after printing at 4.68%, a new high for the move, the 10-year yield fell back a bit, which is much more about market technicals and an oversold condition rather than a change in the underlying issues discussed above.  This morning, that yield is lower still, but just by 2bps and currently trading at 4.55%.  Of equal interest is the fact that the yield curve continues to bear steepen with the 2yr-10yr curve inversion now down to -50bps.  While we are likely to see a little trading bounce, this trend remains clear, and the fundamentals support higher yields.  I expect the 10-year yield to reach 5% by the end of 2023 and somewhere between 5.5% and 6.0% by the election next year.

If we look elsewhere in the world, we are seeing yields rise right alongside Treasury yields.  Perhaps the only place that is lagging is Japan, where the BOJ executed an unscheduled JGB buying operation last night of¥300 billion to help moderate recent movement.  This was interesting given the data out of Japan last night, notably weaker Retail Sales and a lower-than-expected Tokyo CPI at 2.8% (2.5% core) implies that the BOJ is not likely to feel much pressure to tighten.  With the Fed still all-in on higher for longer and the BOJ able to point to softening inflation as a reason to continue QE and loose policy, USDJPY will continue to be the outlet valve in the economy, and it should rise (yen weaken) still further.

Meanwhile, the most important spread in Europe, the bund-BTP spread in the 10-year space is back to 200bps.  This is the level at which the ECB has demonstrated concern in the past and I am confident that there is much discussion ongoing today.  We did hear from one of the ECB hawks overnight, Nagel, who was clear that another rate hike might be appropriate, but I assure you, if that spread widens much further, rate hikes are not going to be the ECB’s approach.  All in all, we are likely to see much future stress in bond markets.  And to think, none of this even touches on the potential government shutdown tomorrow!

And yet, equity markets bounced yesterday into month/quarter end and European bourses and US futures are all in the green today as the bulls are now telling us that things are oversold, and a rip-roaring rally is imminent.  Clearly, we have seen some pretty weak behavior in the risk asset space lately and a technical bounce is not surprising.  However, it remains very difficult for me to see the upside for stocks as long as bond yields are rising along with oil and inflation remains sticky.  Too, the dollar, while it also reversed course yesterday after a remarkable run higher over the past two plus months, is still quite firm overall, and as long as US yields rise, I look for the dollar to follow.

On the lighter side, the best non-sequitur correlation I have seen is that Top Gun was released in May 1986 and Black Monday, which saw the largest equity market selloff in history occurred in October 1987.  Well, Top Gun II was released in May 2022.  Should we be looking for a massive market decline in the next two weeks?  The starting conditions are not actually that different with an overvalued stock market, rising rates, rising oil prices and a rising dollar.  Just sayin!

As we look to the calendar today, the Core PCE data is set to be released at 8:30 and expected at 0.2% M/M, 3.9% Y/Y.  Many analysts continue to use the concept of annualizing last month’s data and pointing to the Fed achieving its target, or excluding the rise in prices of certain segments beyond food and energy and claiming not only is inflation falling, but deflation is coming.  Clearly, if you exclude the prices that are rising in the index, then the index will demonstrate falling prices, however it is not clear to me what that tells us.  We also get the Goods Trade Balance (exp -$95.0B), that excludes services, and we see Chicago PMI (47.6) and Michigan Sentiment (67.7).  Yesterday’s GDP data was a touch softer than expected at 2.1% with the most concerning part that Real Consumer Spending rose only 0.8% Q/Q, half the level of forecasts and down from 3.8% in Q1. On the flipside, Initial Claims fell to 204K, back to levels seen in January, and certainly no indication of economic weakness.

And that’s how we are heading into the weekend.  While yesterday saw trading reversals of the recent trends, there is no indication that those trends have ended.  The reversal and consolidation may last through today’s quarter end trading and into early next week but look for the longer term trends of a higher dollar, higher bond yields, higher oil prices and lower risk asset prices to resume before too long.

Good luck and good weekend

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Into the Abyss

Posted on by 
In Washington, something's amiss
As hardliners say with a hiss
Let government close
As we don’t oppose
A tumble into the abyss

The reason that markets might care
Is data will then become rare
Thus, how will the Fed
Keep looking ahead
If rear-facing data’s not there?

As this is not a political commentary, I generally try not to focus on these issues.  However, periodically, they impact the economics and the markets so I must.  As we approach the fiscal year-end for the US this Saturday, there are still a number of appropriation bills that have not passed Congress and been signed into law.  Some of the hardliners in the Republican majority in the House seem to be willing to die on this particular hill, although as we are talking politics, and there are still two days left before it becomes a fait accompli, things are subject to change.  

But the issue for markets has far less to do with the actuality of the government shutting down and entirely to do with the fact that the Bureau of Labor Statistics and Commerce Department, the source of most government data, will be shut down and so not be able to publish the monthly numbers.  Given that the Fed has repeatedly told us that they are data dependent, on what will they base their decisions if there is no fresh data to help guide them?  

The inherent problem with data dependence is that all the data published by the government is backward looking, reporting what happened in the past week/month/quarter, and the Fed uses its numerous econometric models to extrapolate how that will play out in the future.  History shows us, though, that the Fed’s models, especially lately, have not been terribly accurate.  Does anyone remember transitory inflation?  (Every time I go to the grocery store and see the price of staple items it crosses my mind.  How about you?)  Thus, if I were to analogize their process, it is like driving a car forward while looking only in the rearview mirror and the steering mechanism doesn’t work properly. 

At any rate, this story is going to dominate for a while.  Chairman Powell speaks this afternoon at a townhall with educators and he will be taking questions from the audience.  You can be sure that reporters will be there and there will be a question about how the Fed will handle the lack of data in the event of a shutdown.  This is unlikely to dominate the market narrative quite yet, but if the shutdown does happen, Monday could see some impact.  We shall see.

In the meantime, risk remains under pressure around the world as there are three current market features that are dissuading investors from jumping in, and in many cases pushing them to the sidelines.  

First is the price of oil, which rose 4% yesterday and is basically unchanged this morning, retaining all of this gains.  We are now back to levels not seen since July 2022 when oil was falling from the post Ukraine invasion spike while the Biden administration was flooding the market with SPR reserves.  Given the SPR is back to levels last seen in 1983, shortly after it was initiated, it seems there is less room for the Administration to repeat this performance.  At the same time, there has been no indication that OPEC+, and the Saudis specifically, are getting set to open the taps again.  Rising oil prices impact everything as they are an excellent proxy for the price of energy writ large.  And everything requires energy to keep going.  If it costs more to keep the lights on or ship products, it is going to work its way into the price of retail items.

Second is US yields, which we proxy with the 10-year Treasury bond.  This morning it is trading at 4.65%, continuing its recent move and, in truth, looking like it is accelerating it.  Since the beginning of September, the 10-year yield is higher by 55bps, a very large move, and that is dragging yields higher around the world.  For instance, German bunds, French OATs, and UK gilts are all trading at decade-plus high yields, and even worse for the ECB, Italian BTPs, are seeing their spread to bunds widen back toward 200bps.  You may recall that in July 2022 the ECB created a program called the Transmission Protection Instrument (TPI) which was designed to essentially roll maturing bund positions from the ECB’s balance sheet into Italian BTPs to support that market and prevent the euro from exploding.  Once that got going it was quite effective at moderating that spread, and things seemed fine.  But recently, the Italian fiscal situation has become increasingly weakened and the market is pushing on this issue again.  The point is the market is focusing on more risks and thus risk appetite is waning.

Finally, the dollar continues to rise.  Using the Dollar Index (DXY) as a proxy, it is currently trading well above 106 and taken out much technical resistance.  While it is a bit softer this morning, with the euro (+0.4%) and pound (+0.5%) both bouncing a bit along with the yen (+0.2%), this trend remains very clear.  (see graph courtesy tradingeconomics.com)

In fact, last night USDJPY touched 149.70, a new high for the move and that triggered some further comments from Japanese FinMin Suzuki that indicated he was close to the next stage of intervention known as “checking rates”.  This is the process by which the BOJ calls out to the big banks in Tokyo asking for a price in USDJPY but does not deal.  However, the simple fact of asking for the price gets these banks to sell dollars for their own accounts and they then spread the word that the BOJ is “checking rates” which all in the market know is a sell signal.  So, last night, when the dollar hit that high level, Suzuki was on the tape saying that might be the next step and the dollar fell back a bit.

Remember, though, intervention will only matter if it is concerted, with all the central banks, especially the Fed involved, and really only if monetary policies change.  And it is the latter that seems the least likely right now.  So, if when the dollar trades above 150 expect some fireworks, but unless there are other changes, it will be temporary.  Hedgers, be prepared.

And that is the situation as we head into today’s session.  There is a bunch of data coming this morning starting with Initial (exp 215K) and Continuing (1675K) Claims, as well as our third look at Q2 GDP (2.1%).  In addition to Chair Powell this afternoon, we hear from Chicago Fed president Goolsbee this morning and Governor Cook early this afternoon.  The most recent comments from both of them indicate that more rate hikes may well be necessary, and neither is in a hurry to cut rates.  

Yesterday saw a pretty flat day in the equity markets in the US and futures this morning are also little changed.  however, there is growing concern, as I outlined above, that risk is becoming riskier and that the safety of short-dated US paper, which currently yields 5.5% or more, is a very good place to be invested for the time being.  To my eye, the trends outlined above, higher oil, yields and a stronger dollar, remain intact.  As long as that is the case, equity markets are going to struggle.  As to the dollar, we will need substantial policy changes to turn that ship around, and right now, there is no sign that is on the horizon.

Good luck

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Feel More Pain

Posted on by 
The data continues to show
That growth seems increasingly slow
But Fed speakers say
That rates need to stay
Still higher for longer, you know

Meanwhile market stress has increased
With both stock and bond love deceased
Can this trend maintain
As folks feel more pain?
Or will Jay soon let the bulls feast?

Yesterday’s US data was pretty lousy with the key pieces, New Home Sales (675K vs. exp 700K) and Consumer Confidence (103 vs. exp 105.5) both missing pretty badly.  The news overnight was also worse than forecast with Japanese Leading Indicators falling alongside German GfK Consumer Confidence and French Employment.  In other words, weakening data is not a US-only phenomenon.  Yesterday’s equity market performance was certainly in sync with the downward view with markets selling off around the world.  All in all, bad news seems to be everywhere.

The interesting thing this morning is how many pundits are bottom fishing, at least rhetorically.  I have seen numerous comments on the idea that as the data continues to fade and markets come under pressure that is the signal that the central banks are going to be forced to pivot and cut rates soon.  Part and parcel of that argument is the slowing economic activity is going to not merely slow inflation but cause a deflationary crisis!  I guess if you are going to make the case, you need to be as hyperbolic as possible to get those clicks.

From this poet’s view, which incorporates far too many years of observation, I think it is quite premature to believe that the downward trend in risk assets is going to change anytime soon.  Remember this, Chairman Powell has repeatedly said that he expects there would need to be some economic pain in order for the Fed to achieve their goal of 2% core PCE inflation.  And he was not talking about market pain, he was referring to rising unemployment and slowing economic activity.  However, it seems that similar to the situation when he told us all that he would be raising rates to fight inflation regardless of the market’s response back at the beginning of this process in March 2022, and everybody (including this poet) doubted his conviction, he has been very clear that he is willing to accept some pain to achieve their goals.  I do not doubt him at this stage based on his actions to date and I think it would be a mistake for others to do so.  

The one thing that we know about the history of inflation is it is never transitory.  While past policy responses have resulted in either limited impact and a strong upward trajectory, or short-term impacts with increasing waves of inflation over time, there has never been a case where inflation rose, rates were raised, and things got better.  At least not once it hit 5%.  Powell has made it very clear that he is going to do everything he can to be the first to kill inflation with one shot, but that means the shot is going to be long and difficult to withstand.  FWIW, which may not be that much, the answer to my final question above is no, there is no rate cut on the horizon and that slower activity as well as rising unemployment are going to be a feature of the economy for at least another year.  I am sure that the Biden administration will be quite unhappy, but my sense is Powell is not really a Biden fan anyway (although interestingly he is a raging Dead Head!)

So, based on my thesis that higher for longer really means what it says, and that we are nowhere near longer yet, the fact that today has seen a very modest reprieve in risk assets is simply a function of a trading bounce, not a fundamental shift in views.  Let’s take a look.

Asian markets were broadly higher, but only just, with gains on the order of 0.1% – 0.25%, not nearly enough to offset recent weakness.  In Europe, most markets are actually a touch softer, not even able to bounce, but the losses are of similar magnitude, -0.1%.to -0.3%.  In fact, US futures, at this hour (7:30) are the best performing markets and they are only higher by 0.25% or so.  This has all the earmarks of a dead cat bounce.

In the bond market, yields have edged lower in the 10yr space by 2bp-3bp mostly, but remain very close to the recent 10 year plus highs.  It remains very difficult for me to look at the amount of issuance that is going to be necessary globally ($trillions) and combine that with the fact that central banks are no longer price insensitive buyers of bonds and come up with a scenario where yields can decline in the near term.  Add to this the ongoing inflation fears and the fact that curve inversions have allowed investors to buy short-term paper and gain better returns and I suspect that the clearing price for 10-year paper is going to be much higher yields, 5.5% or higher is not unreasonable.  

Now, understand that at some point, the pressure will become too great and central banks will reverse course, but I sense we are still early days in the process.  I do believe that the Fed, and all the major central banks will join the BOJ in their YCC activities at which point yields will fall sharply.  But we ain’t there yet!

In the commodity markets, oil (+2.0%) continues to rally and is back above $92/bbl this morning.  I know there is a great deal of belief that if we see slowing economic growth that will limit demand and prices will decline.  But the ongoing supply/demand mismatch is extreme and the fact that Russia has banned the export of diesel fuel, perhaps the most critical product that comes from a barrel of oil, has helped maintain an ongoing tightness in markets. 

One other thing to note is that the much-vaunted energy transition is showing the first signs of falling apart, or at least being subject to significant delays, as we have recently heard from the UK and Sweden that they would be delaying the ban on sales of ICE cars and gas boilers.  Remember, the transition is a key part of the lower oil price thesis.  It turns out that politicians have found that the reality of reducing energy consumption or transitioning to a source that is insufficient for current societal needs is a lot tougher when people feel the pain of the process.  Last year, in the wake of the Covid pandemic policies of infinite fiscal spending, there was limited concern about subsidizing the use of energy but this year as the budget numbers look uglier and uglier, that tune is changing.  I maintain it will be a very, very, very long time before fossil fuels are eliminated.  In fact, I suspect the dollar will be replaced before fossil fuels are, and you know I don’t foresee that for decades, at least.

As to the metals markets, both base and precious are lower this morning as higher yields, slowing economic activity and a strong dollar help undermine their short-term value.

Speaking of the dollar, rumors of its demise seem to have been greatly exaggerated as well.  Once again, this morning, it is higher with the euro (-0.3%) edging closer to 1.05 and the yen (-0.1%) solidly above 149.  USDCNY is pushing to 7.32 despite the PBOC’s continued efforts to drive it lower via the daily fix, and despite the fact that local banks were seen selling dollars aggressively onshore, apparently at the PBOC’s behest.  The only currency outperforming is NOK (+0.3%) which given oil’s rally makes perfect sense.  The same situation obtains in the emerging market blocs with most currencies weaker and a few simply treading water.  The dollar has rallied for the last 11 consecutive weeks, which is a pretty long streak in the broad scheme of things, so a pullback one week wouldn’t be a shock.  But right now, this does not seem like the week it is going to happen.

On the data front, today brings Durable Goods (exp -0.5%, 0.1% ex Transports) and then the EIA oil data later this morning.  There are no scheduled Fed speakers, so today’s price action is likely to continue based on risk appetite.  I still don’t see risk appetite as improving in the short term which implies lower stock and bond prices and the dollar maintaining its strength.

Good luck

Adf

Problems Squared

Posted on by 
As the yen weakens
Suzuki-san tries to warn
This time he means it!

Another day, another new low for the Japanese yen.  USDJPY traded above 149.00 early this morning for the first time since October 2022 (chart below) and this clearly has the Finmin, Shunichi Suzuki spooked.  While I don’t understand the actual comment he made, “As I said at the morning press conference, I’m watching market trends with a high sense of urgency,” based on the fact the dollar did pull back a bit, I guess market participants got the message.  But how can you watch something urgently?  

Source: Tradingeconomics.com

Regardless of his fractured English, the fact remains that USDJPY has risen near the levels it reached last autumn and which resulted in aggressive intervention in the FX markets.  The point is we know they will step into the market so for those of you with immediate needs, be wary.

However, there is exactly zero indication that the BOJ is going to alter its monetary policy stance at this time, nor any indication that the Fed is going to do so either.  Ultimately, those diverging policies are the driver here and without a change in the underlying conditions, this trend should continue.  Perhaps Ueda-san will recognize that CPI running at 3.3% for the past twelve months is an indication that it is sustainable at these levels and change his tune.  But not so far.  With spot at this level, I am a strong proponent of utilizing options to hedge against further yen weakness.  Using them will allow hedgers to take advantage of a pullback, if it comes, but remain protected in the event that their new target is 160, for example.

Said Dimon, nobody’s prepared
And frankly, we all should be scared
A quick rates ascent
To seven percent
Will end up with our problems squared

I guess the question becomes, to whom should we listen, Jamie Dimon or Jay Powell?  In an interview with the Times of India yesterday, Dimon indicated he thought Fed funds could rise as high as 7% and that nobody was prepared for that outcome.  I certainly agree nobody is prepared for that outcome (I wonder if JPM is?) but of more interest is the fact that his comments are quite different than what we have heard from the ostensible powers-that-be at the FOMC.  Last week Chair Powell indicated they remained data dependent but that another hike was reasonable.  Yesterday we heard from erstwhile dove, Austan Goolsbee, the Chicago Fed president, that higher for longer was appropriate, a sign that even the doves are willing to wait a long time before pushing for rate cuts.  But Dimon was clear he thought things would play out differently.

Considering the two sources, I am more inclined to accept Dimon’s worldview than Powell’s as Dimon has fewer political restrictions.  In addition, given JPMChase is the largest bank in the nation, he is likely privy to a lot of information that may not be clear to the Fed.  But, boy, 7% would really throw a monkey wrench into the works.  While equity markets have worked very hard to ignore the ongoing rise in interest rates thus far, Fed funds at 6%, let alone 7% would seem to be a bridge too far.  If the Fed does feel forced to keep raising rates because CPI/PCE continues above target and the Unemployment Rate remains low, 4% or lower, it feels to me like the equity market would reprice pretty dramatically lower.  This is not my base case, but at this point, I would not rule out any outcome.

So, how have markets behaved with this new information?  Well, equity markets, which had a late rally in the US yesterday, have been under pressure around the world.  Meanwhile, bond yields continue to rise and the dollar remains in fine fettle.  Let’s take a look.

Asia was almost entirely in the red last night, certainly all the major markets were down led by the Nikkei (-1.1%) but all Chinese and Korean shares as well.  As to Europe, while the FTSE 100 has managed to stay relatively unchanged, the continent is entirely under water with losses on the order of -0.6% or so.  Finally, US futures are currently (7:30) lower by -0.3% or so, although that is off the worst levels of the overnight session.  It seems that the continued grind higher in yields around the world is taking its toll on the equity bull story.

Speaking of yields, yesterday saw the 10yr Treasury yield touch 4.56%, a new high for the move, although it has since backed off a few basis points and is currently around 4.50%.  But Treasury yields aren’t the only ones rising as we are seeing German bund yields at their highest levels since 2011, during the Eurozone bond crisis, and the same is true with French OATs and most of the continent.  Gilts, too, are pressing higher overall, and while this morning they have backed off 3bps-5bps, the trend remains clearly higher.

Oil prices are finally backing off a bit, down 1.1% this morning and 2% in the past week, although they remain quite high overall.  This movement has all the earmarks of a trading correction rather than a fundamental shift in the supply/demand balance.  The latest data that is out shows that global daily demand is up to ~102 mm bbl/day while supply is just under 100 mm bbl/day.  That trend cannot continue without oil prices rising substantially over time.  As to the metals markets, base metals continue to feel the pressure of a weakening economy while gold continues to suffer on the back of high interest rates, although it remains firmly above $1900/oz.

Lastly, the dollar is just a touch softer this morning although it remains near its recent highs.  We discussed the yen above, which is now unchanged on the day, although off earlier session highs for the dollar.  The euro has regained 1.06, although its grip there seems tenuous and a fall to 1.05 and below seems likely as the autumn progresses.  The pound, meanwhile, is below 1.22 and looking at the charts, a move to 1.18 or so seems very realistic, especially if we continue to hear hawkishness from the Fed.

As to emerging market currencies, the PBOC continues to try to hold back the yuan, although it is trading quite close to its 2% band from the CFETS fixing.  Meanwhile, KRW (-0.8%), IDR (-0.6%) and THB (-0.4%) are all falling as they are not getting that central bank support.  EEMEA currencies are also under pressure led by ZAR (-1.25%) which is suffering on the commodities market selloff.

On the data front, we see our first data of note this week with Case Shiller Home Prices (exp -0.3%), Consumer Confidence (105.5) and New Home Sales (700K).  We also hear from Fed Governor Bowman this afternoon and will see oil inventories late in the day, where continued drawdowns are expected.

Market sentiment is not happy with concerns growing that the Fed really means what they are saying and that interest rates are going to remain at these or higher levels for a while yet.  While the big data points continue to show the economy is hanging on, there are a growing number of ancillary data points that indicate a less robust economic future.  Unfortunately, I think that is going to be the outcome, although it will not be enough to drive inflation down to acceptable levels.  The coming stagflation should see weakness in both bonds and equities while the dollar continues to find buyers all around the world.

Good luck

Adf

Bright or Bleak

Posted on by 
As we look ahead to this week
Til Thursday, when Jay’s set to speak
There’s little of note
That’s like to promote
A change in one’s views, bright or bleak

Then Friday, we’ll get PCE
When traders are waiting to see
If there’s any chance
The Fed’s hawkish stance
May change and they’ll restart QE

Some days there is less happening than others, and today is one of those days.  There has been very limited data released with the German Ifo the most notable statistic and it showed virtually no change from last month, still quite negative on the German economy.  Given that Germany is in a recession, I guess that shouldn’t be a big surprise, but the depth of the gloom has only been surpassed by the Covid situation and the GFC.  Even the Eurozone bond crisis in 2012 never saw this indicator so weak.  However, beyond that, there is really very little to discuss.

Thus, let us focus on how things may look going forward.  There continues to be an underlying negative perception across most macroeconomic indicators with the US economy the last bastion of any sort of strength.  China remains in the doldrums with the property sector still under huge pressure and the government there not yet willing to truly bail it out.  Germany is leading Europe lower with other nations beginning to see accelerating weakness as evidenced by last week’s flash PMI data, and emerging markets are beholden to global growth as they do not yet have the ability to drive things on their own.  If the situation in the US is one of a slide into recession, then I expect that the EMG nations will find themselves under further pressure.

And what, you may ask, is driving this process?  Clearly it is the G10 central bank mantra of higher for longer as inflation continues to run rampant around the world.  This results in a situation where investors and hedgers need to determine how much longer the Fed and its brethren central banks will be able to hold the line.  The problem here is this is a political question, not an economic one and political answers are extremely difficult to forecast.

Given that there is a presidential election in the US in 2024 and that the UK will be going to the polls as well with PM Sunak’s stint in office on the line, I expect that there will be significant pressure from both those governments to have the central banks back off the policy tightening and support economic activity.  However, it is unclear when that pressure will really increase and how long either Powell or Bailey will be able to hold the current line.  One of the biggest problems for the Biden administration is that a Republican House of Representative seems unlikely to pass significant stimulus to help the president when recession arrives.  This can be seen in the current fight over the completion of the funding bills for next fiscal year and the potential for a government shutdown at the end of the month.  As such, for Biden, he will be entirely reliant on monetary stimulus which, right now, doesn’t seem forthcoming.

The UK situation will be different, as the Tories control Parliament, however, they are extremely unpopular right now, and it is not clear what they can do to change that situation.  Certainly, if the BOE were to ease policy, it might be a positive but remember, inflation in the UK is the highest in the developed world and so driving inflation higher will not be seen as a positive at all.  My understanding is inflation remains the major pub talking point throughout the UK.  And not in a good way!

In the end we are going to need to see some policy changes to change market behaviors and right now, that seems a fairly distant prospect.  For all of us holding risk assets, that may lead to an uncomfortable time as we have seen over the past week or two and as we see continuing this morning.  Unfortunately, the prospects for a reversal seem as gloomy as this morning’s NY weather.

Anyway, let’s turn to the markets and take stock.  The Nikkei (+0.85%) was the outlier overnight as it managed to rally while the rest of Asia, notably Chinese and Hong Kong shares, all fell pretty sharply.  As to Europe, it is all red there with most bourses pushing lower by about -1.0%.  It seems there is no reprieve yet.  US futures at this hour (8:00) are also under pressure after a lousy week last week, with all three major indices lower by about -0.3%.

However, don’t look for any support in the bond market with yields higher virtually across the board.  Treasury yields are now north of 4.50% and show no sign of slowing down while the 2yr note is not rising in sync.  The curve inversion is down to -60bps now, as the bear steepening continues.  But yields are higher across Europe as well as concerns over inflation continue to grow.  The only exception here is Japan, where JGB yields have edged down 1bp.

In the commodity space, it should be no surprise that the base metals are softer this morning given the economic gloom. As to oil, it was higher for most of the overnight session although it has slipped back to unchanged as New York gets going.  One interesting story is that Eastern Russian crude is now trading above Brent prices near $100/bbl, far, far above the G7 price cap of $60/bbl that was imposed last year.  I guess the G7 didn’t have the market power implicit with that ridiculous idea.

Finally, the dollar is firmer this morning against most of its counterpart currencies.  In the G10 the one outlier is SEK (+0.9%) which has rallied on the idea that the Riksbank has further to tighten than previously expected.  But otherwise, USDJPY is pushing toward 149 and clearly getting close to an uncomfortable level for the BOJ/MOF.  In the EMG space, the story is similar, with the dollar broadly higher across the board.  This has all the appearances of a straight dollar story on the back of rising yields.

On the data front, as mentioned earlier, there is not much on the docket:

TodayChicago Fed Nat’l Activity0.15
TuesdayCase Shiller Home Prices-1.0%
 New Home Sales700K
 Consumer Confidence105.6
WednesdayDurable Goods-0.4%
 -ex Transport0.2%
ThursdayInitial Claims217K
 Continuing Claims1675K
 Q2 GDP Final2.2%
FridayPersonal Spending0.5%
 Personal Income0.4%
 Core PCE0.2% (3.9% y/Y)
 Chicago PMI47.4
 Michigan Sentiment67.7

Source: Tradingeconomics.com

As well as the data, we hear from five Fed speakers beyond Chairman Powell, but clearly all eyes will be on him Thursday afternoon.  It is very difficult to look at the sweep of data and feel confident that the economy is going to avoid a recession.  However, as long as we continue to see strength in the payroll data, I think the Fed has the cover to maintain higher for longer.  Next week’s NFP is going to be crucial with the early estimates at 145K, still positive but sliding down from the past several years.  In the meantime, especially as yields continue to climb in the US, the dollar should remain underpinned against all its counterparts.

Good luck

Adf

Aghast

Posted on by 
The BOJ did
Absolutely nothing new
Can we be surprised?

The last of the key central bank meetings finished last night with the BOJ not only leaving policy on hold, as expected, but not even hinting that changes were in the offing.  Much had been made earlier this month about a comment from Ueda-san that they may soon have enough information to consider policy changes.  This was understood to mean that YCC might be ending soon.  Oops!  If that is going to be the case, it was not evident last night.  Rather, the status quo seems the long-term view in Tokyo right now.  Not surprisingly, the yen suffered accordingly, selling off another -0.5% overnight and is now back at its weakest point (highest dollar) since October 2022 when the BOJ intervened actively.

Also, not surprisingly, after the yen weakened further, we started to hear from the MOF trying to scare the market.  FinMin Shunichi Suzuki once again explained that he would not rule out any actions with respect to the currency market if volatility (read depreciation) increased too much.  But as of yet, there have been no BOJ sightings and I suspect they will not enter the market until 150.00 is breached once again.  Maybe next week.

With central bank meetings now past
The markets’ response has been fast
It seems there’s a pox
On both bonds and stocks
And owners of both are aghast

While further rate hikes may be rare
Investors feel some small despair
No rate cuts are planned
Throughout any land
And bond yields are now on a tear

Turning to the rest of the G10, what was made clear over the past two weeks is that policy rates are not anticipated to fall anytime soon.  While some central banks seemed to finish for sure (ECB, SNB, BOE) others seem like there may be another in the pipeline (Fed, Riksbank, Norgesbank, BOC, RBA), but in no case is there a discussion that inflation has reached a place of comfort for any central bank.  Rather, even those banks on hold seem comfortable that policy rates need to remain at current levels in order to continue to battle the scourge of inflation.  If anything, the hawks from most central banks continue to push for further tightening, although I suspect that will be a difficult hill to climb given the inherent dovishness of most central bank chiefs.

So, what are we to expect if this is the new home for interest rates rather than the ZIRP/NIRP to which we had become accustomed for the past 15 years?  The first thing to consider is that despite the higher rate structure, the financial position of the private sector, at least in the US, remains strong.  Corporates termed out debt and tend toward being cash rich, so for now, they are benefitting from high interest rates as they locked in low financing and are earning the carry.  Many households are in the same position, having refinanced home mortgages at extremely low rates so are not feeling the pain of the recent rise in mortgage rates.  Of course, this has reduced the amount of activity in the housing market and is a problem for first-time buyers, but that is not the majority, so net, the pain is not so great.

However, the US is unique in this situation as most of the rest of the world are beholden to short-term rates in their financing.  This is true in the commercial sector, where bank lending is a far more important part of the capital structure than public debt.  Those loans are floating, which is also true in the household sector where most mortgages elsewhere have 5-year fixed terms and so are already repricing higher and impacting homeowners.  In fact, if you want one reason as to why the US is likely to outperform the rest of the world, this would be a good place to start.  Despite much higher interest rates, the pain is not being felt across much of the US economy while it is being felt acutely throughout Europe and the UK.  

The upshot of this process is that inflation is likely to remain with us for quite a while going forward.  This means that central banks are going to have a great deal of difficulty reversing course absent a major crash in economic activity.  Given the US tends to lead the world’s capital markets, it also means that the combination of continuing gargantuan issuance by the Treasury to finance the never-ending budget deficits along with the stickiness of inflation implies that interest rates need to be higher.  We saw this price action yesterday with 10yr Treasury yields jumping to 4.5%, another new high for the move, and importantly, a larger move than the 2yr yield.  This is the ‘bear steepening’ that I have been writing about, with longer end yields rising faster than shorter yields.  Ultimately, this will be quite a negative for risk assets, especially paper ones, although hard assets ought to benefit.  The world that we knew has changed, so we all need to adjust accordingly.

Turning to the overnight session, yesterday’s US weakness was followed by Japan (-0.5%) but Chinese shares bucked the trend, rising strongly on hopes that the recent data shows the worst is past for the mainland.  That seems odd given the lack of additional stimulus forthcoming from the government, but that is the story.  European shares are mostly a bit lower this morning after flash PMI data was released showing growth in the Eurozone remains elusive.  Germany is still in dire straits with its Manufacturing PMI <40, but the whole of Europe is sub 50 for the past four months at least.  Finally, US futures are bouncing slightly this morning, but that seems like a trading reaction to two consecutive days of sharp losses rather than new optimism.

Other than YK Gilts, which traded at much higher levels back in August, European sovereigns are following Treasury yields to their highest level in more than a decade.  And despite the weak economic story, the fact remains that sticky inflation is the clear driver for now.  Consider that the ECB has essentially explained they have finished raising rates with their policy rate at 4.0% while CPI is running at 5.2% headline and 5.3% core.  Those numbers do not inspire confidence that the ECB has done its job.  I continue to look for higher long-term yields going forward.

Part of the reason for this is that oil (+0.9%) continues to find support.  While it had a couple of days of a modest pullback, we are back above $90/bbl and the news remains bullish the outcome.  The latest is the Russia is halting deliveries of diesel fuel, a particular sore spot as there are already tight supplies around the world, especially here in the US.  I see no reason for oil to decline structurally, and that is going to continue to pressure inflation higher.  Perhaps of more interest is the fact that the metals complex is rallying today, despite the rise in interest rates.  Gold (+0.3%), silver (+1.3%), copper (+0.8%) and aluminum (+1.1%) are all in the green.  Again, I would say that owning hard assets is going to be a better outcome than paper ones.

Finally, the dollar is mixed this morning, showing gains against the euro, pound and yen, but softer vs. the commodity bloc with AUD, NZD, CAD and NOK all firmer this morning.  As well, EMG currencies are having a better session, rising a bit vs. the greenback, but recall, the dollar has had quite a good run lately.  My take is there is a lot of profit-taking as we head into the weekend given the lack of fundamental stories that would undermine the buck.  Nothing has changed my view it has further to rise.

On the data front, the only releases are the flash PMIs here (exp 48.0 Manufacturing, 50.6 Services) and we get our first Fed speaker, Governor Lisa Cook, a confirmed dove.  We have already had a lot of activity this week so I suspect that heading into the weekend, it is going to be a quiet session as traders and investors start to plan for next week’s excitement.

Good luck and good weekend
Adf

Concerns Are Severe

Posted on by 
One look at the dot plot makes clear
Inflation concerns are severe
So, higher for longer
Is growing still stronger
And Jay implied few cuts next year

First, let’s recap the FOMC meeting.  The term hawkish pause had been used prior to the meeting as an expectation, and I guess that was a pretty apt description.  While they left policy on hold, as expected, the change in the dot plots, as seen below, indicate that even the doves on the Fed see fewer rate cuts next year, with just two now priced in from four priced in June.

Source: Fedreserve.gov

A quick reading shows that a majority of members expect one more hike this year, and now the median expectation for the end of 2024 has moved up to 5.125%, so 50bps lower than the median expectation for the end of 2023 and 50bps higher than the June plot.  To me, what is truly fascinating is the dispersion of expectations in 2025 and 2026, where there are clearly many opinions.  And finally, the longer run expectation has risen to 2.5% with many more members thinking it should be even higher than that.  The so-called neutral rate estimations seem to be creeping higher.  If you think about it, that makes some sense.  After all, given the ongoing forecasts for continued labor market tightness due to demographic concerns, and add in the massive budget deficits leading to significantly higher Treasury debt issuance, there is going to be pressure on rates to find a higher level.

The market response was quite negative, albeit not immediately, only after Powell started speaking.  But in the end, equity markets fell across the board in the US, with the NASDAQ taking the news the hardest, down -1.5%, as its similarity to long duration bonds was made evident.  Asian markets all fell overnight as well, with most tumbling more than -1.0% and European bourses are all under similar pressure, down -1.0% or so as well.  The one exception in Europe is Switzerland, where the SNB surprised the market and left rates on hold resulting in a weaker CHF and a very modest gain in their equity market.

However, the bigger market response was arguably in bonds, where yields rose to new highs for the move with the 2yr at 5.15% and the 10yr at 4.43%.  Once again, I point to the significant increase in debt that will be forthcoming from the US Treasury as they need to fund those budget deficits.  I have been making the case that a bear steepener would be the more likely outcome for the US yield curve.  That is where long-term rates rise more quickly than short-term rates due to the US fiscal policy and shrinking demand for US debt by key players, notably the Fed, but also China and Japan.  Nothing has changed that view.

Then early this morning, up north
Both Sweden and Norway brought forth
A quarter point hike
To act as a dike
Preventing price rises henceforth

After the Fed’s hawkish pause, we turn our attention to Europe, where the early movers, Sweden and Norway, both hiked twenty-five basis points, as expected, while both hinted that further hikes are not out of the question.  Inflation remains higher than target in both nations and in both cases, the currency has been relatively weak overall.  Switzerland left rates on hold, pointing to the fact that for the past three months, inflation has been within their target range, and they are beginning to see downward pressure on economic activity which they believe will keep that trend intact.

And lastly, from London we’ve learned
Another rate hike has been spurned
Though voting was tight
They said they’re alright
With waiting to see if things turned

As to the bigger story, the UK, expectations were split on a hike after yesterday’s tamer than expected CPI report while the pound fell ahead of the news.  And the change in expectations was appropriate as in a 5-4 vote, the BOE opted to remain on hold for the first time in two years.  They see that inflation may be easing more rapidly than previously expected, and they are concerned about overtightening.  While I have a hard time understanding how a 5.15% Base rate is tight compared to CPI running at 6.7% and core at 6.2%, I am clearly not a central banker.  At any rate, the pound fell further on the news and is now at its lowest level since March, while the FTSE 100 rallied back and is close to flat on the day from down nearly -1.0% before the announcement.  Gilt yields, however, are moving higher as the bond market there doesn’t seem to believe that the BOE is serious about fighting inflation.

And really, those are today’s key stories.  Late yesterday, Banco Central do Brazil cut the SELIC rate by 0.50%, as expected, and at the same time the BOE announced, the Central Bank of Turkey raised their refinancing rate by 5 full percentage points, to 30.0%, exactly as expected.  And to think, we get concerned over rates at 5%!

As to the rest of the day, there is a bunch of US data as follows: Philly Fed (exp -0.7), Initial claims (225K), Continuing Claims (1695K), Existing Home Sales (4.1M) and Leading Indicators (-0.5%).  As is typical, there are no Fed speakers scheduled the day after the FOMC meeting, but we will start to hear from them again tomorrow.

Putting it all together tells me that the Fed is not nearly ready to back off their current stance and will need to see substantial weakness in economic activity before changing their mind.  Meanwhile, last week’s ECB meeting and this morning’s BOE meeting tell me that the pain of higher interest rates in Europe is becoming palpable and the central banks are leaning more toward inflation as an outcome despite their mandates.  This continues to bode well for the dollar as the US remains the place with the highest available returns in the G10.

Tonight, we hear from the BOJ, where no change is expected.  I would contend, though, that the risk is there is some level of hawkishness that comes from that meeting as being more dovish seems an impossibility.  As such, there is a risk that the yen could see some short-term strength.  Keep that in mind as you look for your hedging levels.  

Good luck

Adf

If Doves Seduced

Posted on by 
The British inflation release
Showed prices did not quite increase
As much as expected
Though still they’re projected
To stay at a level, obese

But truly, all eyes have now turned
To Jay, when past two, we’ll have learned
If hawks rule the roost
Or if doves seduced
The Chairman with more rate hikes spurned

As New York walks into the office this morning, all thoughts are on how the FOMC meeting will play out.  The current expectation is for no rate movement today and still about a 50% chance of one more hike either in November or December.  More remarkably, as I wrote yesterday, is the belief that there will be 100 basis points of cuts next year despite the growing belief of either a soft landing or no landing.  Again, I ask, why would the Fed cut rates if the economy continues to grow with the current monetary policy?  However, at this point, all we can do is wait.

FWIW, which may not be much, I continue to see the outcome as follows; no movement today, 25bps in November and then a reassessment in December based on how the data continues to flow.  Nothing Powell has said indicates that he is comfortable that the Fed has vanquished inflation, and similar to the idea that every politician only cares about one thing, his reelection, I believe Powell is completely focused on just one thing, killing inflation.  He has made it abundantly clear in the past that he expected some economic pain would be necessary in order to achieve that outcome, and he is not going to be deterred at this stage.  It would not surprise me if Fed funds remained at the year-end 2023 rate, whether that is 5.50% of 5.75%, for all of 2024.  In fact, absent a very significant recession, that is what I believe will occur.  One man’s view.

Anyway, turning to the only other data of note today, UK CPI surprisingly fell to 6.7%, down from last month’s 6.8% reading and forecasts for a 7.0% outcome today based on rising energy and food prices.  Even better for Governor Bailey, the core rate fell to 6.2%, well below last month’s level of 6.9% and forecasts of 6.8%.  The pound dipped on the news, but only by -0.2%, as the entire FX complex remains in thrall to the FOMC outcome later this afternoon.  However, this inflation result has pundits asking whether Governor Bailey will be able to skip tomorrow’s rate hike, just like the Fed, and wait until November if they deem it still necessary.  My view here is that will not be the case.  Given the overall weakness in the UK economy, Bailey is clearly running out of room to hike rates, and tomorrow is likely to be his last chance to raise rates before the evidence of sustained weakness becomes clear.  Just like the rest of Europe, I expect the BOE will hike tomorrow and be done.

Once again, I will point out that the basis of my dollar views remains that the US is going to be the most hawkish of all the major economies, maintaining tighter monetary policy far longer than other nations, and that the dollar will naturally see investment flows continue.  After all, the combination of higher yields and potentially better growth prospects will be far too much for international investors to ignore.

For now, though, we wait for 2:00pm and the FOMC statement along with their new Summary of Economic Projections, and then for Chairman Powell’s presser at 2:30.  As such, until then I expect a pretty dull day.

Overnight, Asian equity markets were under pressure with losses in both Japanese and Chinese shares, as well as generally throughout the region.  The only noteworthy news was that the PBOC left rates on hold, which was widely expected, although there were those who thought they might cut again to support the weakening Chinese economy.  European bourses, though, are having a much better day, with all markets higher by at least 0.5% and several southern European nations seeing gains greater than 1%.  Meanwhile, at this hour (7:30), US futures are edging higher by 0.2% or so after modest declines yesterday.

In the bond market, yesterday’s closing level for 10yr Treasuries was the highest, at 4.36%, since October 2007, and although the yield is lower today by about 2bps, this trend remains intact.  The big mover today, though, is UK Gilts which have seen yields drop 8bps after that CPI report.  This has helped drag European sovereign yields lower by about 2bps as traders want to believe that the rate hikes are over everywhere in Europe, and cuts are the next step.  While that’s not my view, it is gaining traction.

In the commodity markets, oil (-1.0%) has finally had a pullback of substance after a rumor yesterday that the Biden administration was going to completely empty the SPR.  There has been no source for that story and no corroboration but given the move that oil has seen over the past 3 months, up more than 35%, a pullback is no surprise.  While there is likely to be a further short-term retreat here, the long-term prospects for oil remain significantly positive in my view.  As to the metals markets, industrials are a bit firmer this morning, perhaps on the idea that the rate hiking cycle in Europe is ending, while gold is unchanged.

Finally, the dollar is a bit softer this morning, but not very much.  The euro remains either side of 1.07 while USDJPY is pushing the 148 level, very close to the key 150 point where many participants believe the BOJ will step back into the market.  As to CNY, its home has been the 7.30 level despite all the effort that the PBOC has expended to strengthen the yuan.  The biggest winners today have been the Antipodeans, with both AUD and NZD firmer by 0.5% after the Minutes of the RBA meeting indicated that they were considering another rate hike at the last meeting although decided to hold off.  The implication is another hike could be in the cards.

On the data front, really the FOMC meeting is today’s only activity of note, although we will see the EIA oil inventories as well.  Until the meeting ends, I expect very little to occur.  Once the announcement is out, and even more importantly, once Powell starts to speak, be prepared for more volatility.

Good luck

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