While many are looking ahead To Europe, Japan and the Fed Today’s PMI’s Were quite a surprise As weakness was truly widespread Meanwhile, from Beijing, what we heard Was policies they now preferred Included support For housing to thwart The story that weakness occurred While most market participants are anxiously awaiting this week’s central bank meetings for the next steps in monetary policy by the big 3 (Fed, ECB & BOJ), we did see a bit of surprising news from two sources this morning which has led to some market reactions. The first thing to note was that the Chinese remain very disappointed that they cannot will their economy to grow faster in isolation and so have announced yet another round of policies intended to foster economic growth. The key plank of this policy is to further relax property investment rules, the so-called three red lines from several years ago, in order to encourage people to start buying houses again. The property slump in China was first recognized when China Evergrande, one of the largest property development companies in the country, started down its road to bankruptcy nearly 2 years ago. Since then, it has been a slow-motion train wreck with many more firms needing to halt debt payments, restructure debt and even go out of business. Naturally, this didn’t sit well with the Chinese government, especially since property was a key part of the social safety net. (Chinese families bought property as a nest egg investment since price appreciation had been so strong for so long. Price declines have scared new investment away at the same time that many families need to cash in on their investment, adding further downward pressure to the housing market.) The other main plank of this policy change was a renewed effort to deal with local government debt. Historically, local governments would issue debt to fund economic investment and would repay that debt by selling property to investors and home buyers. But with the property market in such a slump, these local governments no longer have the cash flow available to stay current on the debt, let alone repay it. As such, the Chinese government is going to step into the market and restructure the debt in some manner with simple restructuring on the table as well as debt-swaps, where I assume debt holders will wind up with equity ownership of some extremely illiquid assets. Neither of these things points to economic strength in China so I would continue to look for further measures as well as more direct fiscal support as we go forward. As well, although CNY is little changed today, do not be surprised to see it continue its weakening trend. The other major news this morning came from the Flash PMI data across Europe, which was, in a word, putrid. While the initial data overnight from Australia and Japan was a bit soft, the continent redefined weakness. Manufacturing remains mired in a serious recession in Europe as evidenced by Germany’s 38.8 reading, far below expectations and the second lowest print in the series, exceeded only by the Covid lows in April 2020. But the weakness was widespread with France (44.5) underperforming expectations and the Eurozone as a whole (42.7) even worse. Services data, while better than Manufacturing is also softening, and the Composite readings show are sub 50 across the board. UK data was also soft, just not quite as awful, but the general takeaway is growth is slowing in the Eurozone and the UK. Later this morning we see the US numbers (exp 46.2 Mfg, 54.0 Sevices) as well as the Chicago Fed National Activity Index (exp -0.13), which will help flesh out the story of US economic activity as well. But the big picture remains that economic activity around the world is suffering, of that we can be sure. And yet, despite this weakening growth story, expectations for rate hikes by both the Fed and ECB remain a virtual lock although the BOJ seems likely to remain on hold for a while yet. We will delve into the central banking story tomorrow though. For today, markets continue to respond to the PMI data as well as the China story. And how have they reacted you may ask? Well, starting in Asia, Chinese shares did not seem to like the announcements coming from Beijing as both the Hang Seng (-2.1%) and CSI (-0.45%) suffered although the Nikkei (+1.25%) embraced the idea that the BOJ was going to continue to print as much money as possible. It should be no surprise that European bourses are in the red after that data with a particular note for Spain (-0.8%) which is also dealing with an election outcome that seems destined to result in another hung parliament. But don’t worry, US futures continue to point to modest gains at this hour (8:00) although that remains highly earnings dependent I believe. In the bond market, yields are lower across the board with Treasuries (-3.3bps) that laggard as virtually all the European sovereigns have seen yields slide by 6bps or so. Apparently, the European investment community is not willing to believe the ECB will continue to raise interest rates into a very obvious recession on the continent. We shall see if they do so. As to JGB’s, they saw yields rise 2.4bps, but are still not too close to the YCC cap. I expect that we will see a little more volatility in the JGB market ahead of Friday’s BOJ announcement as speculators try to get ahead of any potential policy change. In the commodity space, oil (+0.75%) continues its recent winning ways and is up more than 11% in the past month. Given the economic news, this has to be a supply driven story. I have written many times about the structural deficit in oil that we are likely to face given the ESG movement’s systematic underinvestment in oil production. The problem is that even with a recession, oil demand continues to grow and even the IEA, a complete convert to ESG and net-zero ideas, admits that oil demand will grow to a new record this year in excess of 102 million bbl/day globally. Rising demand and static or falling supply will drive prices higher, that much is clear. The base metals are under a bit of pressure, though, this morning, responding as would be expected to the weaker economic story and gold (+0.3%) continues to find support, arguably today on the basis of lower yields around the world. Finally, the dollar is mixed, although I would argue leaning slightly stronger today. The worst performer is CZK (-0.8%) which is suffering from weakness in its largest export market, Germany, as well as continuing to respond to central bank comments from late last week about policy ease. On the flip side, ZAR (+0.7%) as there is a growing influx of investment into rand bonds given the huge yield advantage. In the G10, JPY (+0.45%) is today’s leader, although if the BOJ stands pat, I have to believe that further weakness is in the future. Meanwhile, EUR (-0.3%) is the laggard on the back of that terrible PMI data. There is a lot of data out there this week in addition to the 3 big central bank meetings. Today Chicago Fed National Activity -0.13 Tuesday Case Shiller Home Prices -2.40% Consumer Confidence 112.0 Richmond Fed -10 Wednesday New Home Sales 725K FOMC Decision 5.50% (current 5.25%) Thursday ECB Decision 3.75% (current 3.50%) Initial Claims 235K Continuing Claims 1750K GDP Q2 (2nd look) 1.8% Durable Goods 1.0% -ex Transport 0.1% Friday BOJ Decision -0.1% (current -0.1%) Personal Income 0.5% Personal Spending 0.4% Core PCE Deflator 0.2% (4.2% Y/Y) Michigan Sentiment 72.6 Source: Bloomberg Obviously, there is plenty of information to be gleaned this week, although there are no scheduled Fed speakers after the meeting and press conference on Wednesday. I guess they are all going on vacation! My read on the current situation is that economic activity continues to slow, although perhaps not yet to a recessionary level. As well, I fear that inflationary pressures will remain stickier than we would like and that for now, the Fed is not feeling any pressure to end their current higher for longer policy. In fact, it will be next week’s NFP data that is the first really critical release, as a weak number there will start to give weight to the idea that the terminal rate has been reached. However, if we see strength in job growth, pencil in at least one more hike past Wednesday. As to the dollar, I am confident that if the US is ending their tightening cycle, the other major central banks will be ending theirs soon as well. I see no dollar collapse, nor even significant weakness for quite a while yet. Good luck Adf
Author Archives: fxpoet
Truly Mind-Blowing
Officials see no Urgency to rock the boat YCC ‘s still law As reported in numerous places overnight, the BOJ has let slip that they are not considering any changes to the current policy mix at their meeting next week. You may recall that there has been an uptick in discussion about the ongoing review that began just last month and the idea that Ueda-san was preparing to tweak YCC or to end YCC or something else. That has been a key driving force in the recent rise in JGB yields, which had climbed 10bps, to as high as 0.47%, during July. Short JPY positions in the currency market were getting covered in waves and we saw the yen strengthen more than 5% in the first two weeks of July. This was all part of the narrative of the dollar’s imminent decline and used in conjunction with the rising de-dollarization narrative as part of a new world order type of argument. Nobody wanted to hold dollars, and this was the proof! Oops! Maybe this narrative will need to be tweaked a bit as not only has the BOJ thrown a serious amount of cold water on the changing YCC story, with JGB yields slipping a further 2.5bps last night, but this morning we were also treated to a story about India’s Foreign Minister explaining the country will not support any common BRICS currency for trade. There is no doubt that Russia and China would like to see the dollar lose its global hegemonic status, but wishes are just that. Do not dismiss the dollar at any time in the near future, it is not going to lose its current status. However, that doesn’t mean it will stop fluctuating in FX markets, those are two different things. There once was a great big recession Forecast by the ‘nomics profession The Fed had raised rates For thirteen straight dates And so, growth seemed out of the question But so far the data is showing The ‘cononmy’s seems to be growing With joblessness sinking Quite many are thinking No landing. It’s truly mind-blowing Aside from the yen news, the market continues to try to understand the current economic cycle, which is clearly not very similar to any cycle in recent memory. Every day I read things from very accomplished analysts about the imminent decline in the US economy and how the Fed will be forced to eat crow soon enough. As well, if I scroll a bit further down my Fintwit feed, I find different accomplished analysts who explain that the no landing scenario is the best estimate and that the economy is on solid footing with inflation declining smoothly and heading back to its “natural” spot of 2%. And in fairness, one can slice the data up in many different ways to draw both conclusions. One of the most interesting features of this situation is how different asset classes are concluding very different things from the data. Broadly speaking, the US equity market is all-in on the no-landing scenario, trading higher almost every day (yesterday’s NASDAQ performance excepted and due to some weaker than expected earnings numbers), while the commodity space is far more circumspect over continued growth with base metals, especially, under broad pressure for the past several months. Given the importance of copper and aluminum in the industrial process for almost every manufactured item, the pricing certainly indicates anticipated weakness in demand. We know this because there is no excess supply on the way. As to the bond market, I fear that the signal-to-noise ratio from bond yields has greatly diminished during the period of QE. I am not one to easily dismiss the recession signal from the inverted yield curve, and as we currently sit at -100bps for the 2yr-10yr curve and -160bps for the 3m-10yr, both extremely large inversions, it is easy to conclude that a recession is on its way. But consider, if you look at all the recessions that are used as the basis for the strength of this signal, only the Covid recession occurred after the Fed began its QE program in 2009. Prior to the GFC, the Fed just never held very many long-term Treasury bonds and $0.00 of mortgage-backed securities on its balance sheet. It is not hard to believe that the Fed has substantially distorted the yield curve for the past 14 years, driving long-term rates far lower than they otherwise would have been based on economic conditions. What would 10-year Treasury yields look like if the Fed didn’t own the ~$7.25 trillion of long-dated paper that currently sits on the balance sheet? I suggest 10-year yields would be A LOT higher. 100bps? Maybe. Maybe more, maybe less, but 10-year yields are not really telling us that investors believe the economy is going to slow down. Rather, I might suggest they are telling us that many players are bidding for bonds because they must for regulatory reasons (banks and insurance companies) and that there isn’t as much supply available as the gross issuance would indicate. But, keeping that in mind, the data that gets released regularly continues to confuse. For instance, yesterday saw Initial Claims data fall further, back to 228K and below all forecasts. The rising trend that we had seen a few months ago seems to be reversing. At the same time, the Philly Fed data was weaker than expected at -13.5 and Existing Home Sales fell to 4.16M. Finally, Leading Indicators printed at -0.7%, a tick worse than forecast and the 15th consecutive negative reading of this indicator. So, which is it? Employment strength means growth? Or weakening manufacturing and housing points to weakness? As I wrote earlier this week, we need a new term to describe the current economy, as recession in the traditional view doesn’t seem right, but growth remains lackluster at best with parts of the economy, notably manufacturing, seemingly in contraction. Well, as we head into the weekend, that is a lot to consider, and perhaps inspiration will strike and we will all understand things on Monday. Just don’t count on it! Meanwhile, ending the week, equities are kind of unhappy, with the Nikkei not taking kindly to the BOJ talk and probably a few more losers than gainers in Asia. That same sentiment prevails in Europe, with both gainers and losers but leaning toward negative while US futures are bouncing from yesterday’s declines. Bond yields are drifting a bit lower this morning, but only on the order of 1bp-2bps in the US and Europe, although Gilt yields have risen 2bps on the back of much stronger than expected UK Retail Sales data released today. We’ve already discussed JGB’s, and I expect those yields to grind lower from here along with the yen. Oil, however, has continued its recent strong performance, up 1.2% this morning on supply concerns as there were larger than expected draws on inventories this week. Meanwhile, gold (-0.2%) is edging lower as the dollar regains its footing. Today, copper and aluminum are both a bit firmer, but their recent trend continues downward. Finally, the dollar is definitely in fine fettle this morning, rallying against all its G10 counterparts except NOK (+0.4%) which is obviously benefitting from oil’s rally. The yen (-1.15%) is the laggard, which given the BOJ news, is no surprise. Meanwhile, in the EMG space, it is a sea of red with THB (-1.3%) the worst performer followed by KRW (-1.1%) and TWD (-0.5%). The baht saw a setback with the ongoing political machinations as hopes for a new government have been delayed, if not dashed, while the won saw its exports fall sharply as Chinese economic activity slows. Taiwan is feeling the same effects as South Korea in that regard. And that’s really it for today. There is no data nor any speakers on the calendar, so the dollar seems likely to simply follow today’s sentiment which, given its weakness over the past several sessions, is likely to see more short covering and potentially a bit more strength. Good luck and good weekend Adf
The Citizen’s Pain
Last night, t’was Australia that showed Employment growth had not yet slowed And so, please expect The central bank sect To keep on the rate hiking road They’ll not be content til they’ve slain Inflation, and end this campaign Yet, if all along Their thesis is wrong They’ll ne’er feel the citizen’s pain On a very slow day in the markets, the most noteworthy news came from Down Under, where the Unemployment Rate fell back to 3.5% in a bit of a surprise while job growth continued at a speedier pace than analysts forecasted. The market response was immediate with the Aussie dollar jumping sharply and it is now higher by 1.0% on the session, the leading gainer across all currencies, G10 or EMG today. The rationale for the move is quite straightforward as market participants simply expect the RBA to maintain tighter policy than previously expected. In the OIS market, the probability of a rate hike at the next RBA meeting on August 1st rose to 48% from just 27% prior to the release. And correspondingly, Australian government bond yields jumped more than 8bps on the news. Ultimately, the question that must be addressed is, does strong employment growth lead to higher prices overall? As my good friend @inflation_guy has said consistently, we should all be ecstatic to have a wage-price spiral as the implication is prices rise AFTER our wages rise, so we are always ahead of the curve. But we all know, and it has been made abundantly clear in this cycle, that wages follow prices higher. One need only look at how prices continue to rise on a much more continuous basis than your salaries to see this clearly. However, this is gospel in the central banking sect of economists, that tight labor markets drive the general price level higher. You may have heard of the Phillips Curve, which was a study done in 1958 regarding the relationship between the price of labor (i.e. wages) and the unemployment rate in the UK from 1861-1957. William Phillips was the New Zealand economist who performed the analysis and basically it confirmed what we all learned in Economics 101, reduced supply of labor drove up wages while an increased supply of labor pushed wages lower. Nowhere in the study did it discuss the general price level. That came later with a litany of big name economists, finally with Milton Friedman explaining that in the long-run, there was no relation between wages and inflation, although on a short-term basis, it could evolve. As so often happens in today’s world, it was easier to take the short-cut view, and that had an intuitive appeal, hence the current central bank mantra of we must bring wage growth down. (Will they ever get concerned over bringing money growth down? I fear not.). At any rate, this is the widely accepted view of the world and so whatever its structural merits, when employment data shows a tighter labor market, the market response is to expect higher policy interest rates. This was the story last night, hence the Aussie’s rally along with yields Down Under, and this has been the story consistently since the beginning of 2022, when global central banks embarked on the current round of policy tightening. This is also why we consistently hear Chairman Powell explain that in order for the Fed to reach its 2% inflation target, there will need to be some pain, i.e. people need to lose their jobs. But away from that, there has been very little of note ongoing. Equity markets in Asia were unable to match yesterday’s modest gains in the US, with the Nikkei (-1.25%) the laggard of the bunch. European bourses, however, have had a better go of it, with most of them higher on the order of 0.4% although Sweden’s OMX is down nearly -1.0% on the session bucking the trend. US futures this morning are softer as there were several weaker than expected earnings numbers overnight including Netflix and Tesla. In the bond market, Treasury yields have moved higher by 3bps this morning in the 10-year space, but even more in the 2-year space as the yield curve inversion gets deeper, now back above -101bps. However, European sovereign bonds are little changed on the day with no data of note and the market trying to determine just how hawkish/dovish the ECB will be one week from today. As to JGBs, their yields have stopped rising and they remain 5bps below the cap. Do not expect any BOJ action next week. Oil prices are a touch higher after a lackluster session yesterday, but remain above the key $75/bbl level. Meanwhile, gold (+0.25%) continues to edge higher and is once again closing in on $2000/oz despite obvious catalysts or lower US interest rates. As to the base metals, both copper and aluminum are nicely higher this morning as the entire commodity comlex is feeling some love. Finally, the dollar is under pressure as not only is AUD firmer, but also NOK (+1.1%) on the back of oil’s gains, and virtually the entire bloc except for the pound (-0.3%) which still seems to be suffering from yesterday’s inflation data. In the EMG bloc, CNY (+0.8%) is the leading gainer, a surprising outcome given its generally managed low volatility, but the fact that the PBOC did NOT reduce the Loan Prime Rate last night, in either the 1-year of 5-year term, was a bit of a surprise to the market as there is a growing belief the Chinese government will be adding more stimulus to a clearly slowing economy there. But in this bloc, there are also a number of laggards with MXN (-0.4%) the worst of the bunch on what appears to be some profit-taking as traders start to position for the first rate cut since October 2020. On the data front, yesterday’s housing data in the US was soft, with downward revisions to the previous month’s numbers. This morning we see Initial (exp 240K) and Continuing (1722K) Claims as well as Philly Fed (-10.0), Existing Home Sales (4.20M) and Leading Indicators (-0.6%), the last of which have been pointing to recession for nearly a year. However, once again, I expect the dollar will be beholden to the equity markets as none of these data points are likely to move the needle ahead of the FOMC next week. For now, I think choppy price action is the likely outcome until we get more clarity from Powell and the Fed, as well as Lagarde and the ECB next week. Who will be the most hawkish? That is the $64 billion question. Good luck Adf
A Bad Dream
The narrative’s gaining more steam With landings, so soft, the new theme In England today They’re trying to say Inflation was just a bad dream The problem is that on the ground, In Scotland and Wales and around, Is incomes keep lagging With purchases sagging Which pressures the Great British pound The biggest story of the morning has clearly been the UK inflation data which saw CPI fall back below 8.0% Y/Y for the first time in more than a year. Granted, 7.9% is not that far below 8% and certainly still miles above the BOE target, but the decline was substantially more than had been expected by the analyst community as well as the market. For instance, 10-year Gilt yields have tumbled -17.5bps and are now lower by 50bps since the peak two weeks’ ago and back to their lowest level since early June. 2-year Gilt yields have fallen even further, -25bps, so the market is really quite positive on this outcome. It should be no surprise that UK equity markets have rallied as well, with the FTSE 100 the leading gainer in Europe, up 1.5%, nor should it be a surprise that the pound has fallen sharply, -1.0%, as traders re-evaluate the idea about just how much the BOE is going to raise rates going forward. Prior to this release, the OIS market had been pricing in a terminal interest rate at 6.1%, implying at least 4 more rate hikes by the BOE. But this morning, traders have removed one of those hikes from the curve and the excitement over further potential declines is palpable. Now, the inflation news in Europe is not all rosy as the final release on the continent showed that core CPI turned out to be a tick higher at 5.5% in June, clearly an unwelcome result. And remember, it was just yesterday that we heard from Klaas Knot implying that while a hike next week is a given, nothing is certain past that. So, the question, currently, is will the ECB look through a revision to continue their more dovish stance? I guess we’ll find out next week. But here’s an interesting tidbit regarding Europe, and something you need to consider when it comes to both investments and market outcomes there, electricity demand is falling there amid deindustrialization on the continent. The IEA just issued their latest Electricity Market Report and the reading was not pleasant for Europe. Consider that in the US, the combination of reshoring and the impact of the (ironically named) Inflation Reduction Act, as well as the CHIPS Act, has driven a marked increase in industrialization in the US. Meanwhile, in Europe, the loss of their cheap energy from Russia combined with their climate goals has resulted in industry fleeing the continent. For everyone who is long-term bearish the dollar, you better be far more bearish the euro given this new reality. Remember, energy consumption is the mark of a growing and healthy economy. When it is declining, absent extraordinary productivity/efficiency gains, it bodes ill. If anything, the increasing reliance on less dense energy sources like wind and solar just reduces energy efficiency. Be wary. But, away from that news, things are a bit more confusing. For instance, virtually all European bourses are higher this morning, albeit not as much as the FTSE 100, but in Asia, while the Nikkei (+1.25%) had a good session, Chinese equities were under pressure. Yes, US markets yesterday continued their rally as earnings data has been able to beat the much-reduced estimates although futures this morning are essentially unchanged. But arguably, we can describe the equity picture as risk-on. The same cannot be said for the bond market though, where yields have fallen everywhere, again, just not as much as in the UK. Treasury yields are down another 2bps, and most European sovereigns are also seeing modest yield declines, not the typical risk-on behavior. In fact, given the Eurozone CPI release, it would not have been surprising to see yields climb a bit. As to the commodity space, oil is essentially unchanged on the day, but WTI is back above $75/bbl with Brent right at $80/bbl after several strong sessions. There has definitely been a renewed focus on the bullish supply story in oil as opposed to the recession discussion of late. At the same time, gold (-0.3%) which has rallied nicely during the past week, up nearly 2%, is holding the bulk of its gains. Alas, the base metals continue to lag, with both copper and aluminum softer on the day. Perhaps they didn’t get the bullish memo! Finally, the dollar is quite robust this morning, which is not what one might expect given the equity and bond moves. In fact, it is firmer vs. the entire G10, with the pound the laggard, as would be expected given the inflation data and falling UK rates. But as well, the yen (-0.8%) is under pressure along with AUD (-0.7%) and the whole lot. Regarding the yen, it has been rallying sharply of late, up more than 5% during July until yesterday. That seems to be on an increasing belief that the BOJ, which meets next Friday, is going to tweak its policy in a tighter fashion, whether that involves YCC or rates or QE. Now, these stories have not disappeared, I just think that we are seeing a bit of a breather for this move. Remember, the yen has been the funding currency of choice for every asset all year as the BOJ remains the only central bank that hasn’t tightened policy at all. This month appeared to be profit-taking ahead of potential BOJ activity, and last night appears to be a simple trading bounce. FWIW, I do not believe the BOJ is ready to adjust its policy yet as the big review has just begun. And as I have written before, it doesn’t appear that the rising inflation pressures in Japan have yet become a major political liability for PM Kishida, so there is only limited pressure to make a change. For now, I would rather be short than long the yen. Turning to the EMG bloc, only THB (+0.5%) is firmer this morning as the political machinations continue there in the wake of the recent election. In a nutshell, the winner of the election to replace the military junta is clearly not favored by the powers-that-be, and is being disqualified on a technicality, but another member of the coalition seems to be getting closer to taking the reins, with optimism building. But aside from that story, the dollar is firmer vs. the entire bloc as we are seeing a solid trading bounce in the greenback after several days/weeks of weakness. On the data front, yesterday’s Retail Sales data was disappointing, and the IP and Capacity Utilization data were awful. Obviously, that didn’t hurt equities which remain disconnected from any macro data at this point. This morning brings the Housing Starts (exp 1480K) and Building Permits (1500K) data, although if Retail Sales didn’t have an impact, it is hard to believe the housing data will. I remain uncomfortable with the equity market’s ongoing rally as I fail to see the underlying strength in the economy or earnings. Certainly, recent dollar weakness has helped goose the stock market a bit, but I would not be surprised to see things start to turn around in the near term, meaning the dollar rebounding after its recent sell-off and the equity market seeing some profit-taking. Good luck Adf
A Rate Hike Boycott
Said Yellen, the job market’s cooling Not faltering, but it’s stopped fueling Inflation, and so You all need to know More rainbows are coming, no fooling! Meanwhile, from the EU, Herr Knot Was strangely less hawkish than thought Inflation’s plateaued Which opens the road To starting a rate hike boycott As we await today’s US Retail Sales data, and far more importantly, next week’s FOMC and ECB meetings, it seems that there is a concerted effort to talk inflation down by both the US and European governments. For instance, yesterday, Treasury Secretary Yellen was explaining how, “the intensity of hiring demands on the part of firms has subsided. The labor market’s cooling without there being any real distress associated with it.” Now, I have no doubt that Secretary Yellen would dearly love that to be the case, although her proof on the subject remains scant. Perhaps she is correct and that is the situation but given her track record regarding forecasting economic activity (abysmal while at the Fed and in her current role), I remain skeptical. Certainly, while last month’s NFP data was slightly softer than forecast, it did not speak to a significant change in the labor market situation. She proceeded to add how inflation was clearly coming down, although was careful to warn against reading too much into one month’s numbers, kind of like she was doing. One thing she was not discussing was how the ongoing surge in deficit spending by the government, which she was personally overseeing, was having any impact on inflation. Alas, history shows that there is a strong link between large deficits and rising inflation. Maybe this time is different, but I doubt it. But as I said, there seems to be a concerted effort to start to talk down inflation, especially as the efforts to actually address it are increasingly politically painful. The next example comes from the Eurozone, where Klaas Knot, Dutch central bank chief and number one hawk on the ECB Governing Council suddenly changed his tune regarding a rate hike in September. It was just a month ago, in the wake of the ECB’s last rate hike, when Madame Lagarde essentially promised a July hike, that he was on the tape explaining that a September hike was also critical and certain. But now, his tone has changed dramatically, with comments like “[it] looks like core inflation has plateaued,” and he’s “optimistic to see inflation hitting 2% in 2024.” Again, maybe that outlook is correct and inflation in the Eurozone is going to come crashing down (remember, it is currently 5.4% on a core basis, far above the 2% target), but this also seems unlikely. For instance, this morning’s headline, FRANCE TO RASE REGULATED ELECTRCITY PRICES BY 10%, would seem to be working against the idea that inflation is going to fall sharply. In fact, one of the key reasons inflation ‘only’ rose as high as it did in the Eurozone, peaking at 10.6% last year, was that virtually every government subsidized skyrocketing energy prices for their citizens much to their national fiscal detriment. Now that energy prices have come off the boil, they are ending those subsidies and hence, prices are rising to reflect the current reality. So, the inflation they prevented last year will simply bleed into the statistics this year. Politically, what makes inflation so difficult for governments is the fact that regardless of how they try to spin the situation, the population sees rising prices in their everyday lives and are unlikely to believe the spin. However, that will not stop governments from doing their best to change attitudes via words rather than deeds. Of course, given the prevailing Keynesian view that there is a direct tradeoff between employment and inflation, that puts politicians in a very difficult spot. No politician is going to encourage rising unemployment just to get inflation down hence the ongoing attempts to jawbone inflation lower. Ultimately, nothing has changed my view that inflation, as measured by CPI or PCE, is going to find a base in the 3.5%-4% area and be extremely difficult to push past those levels absent a catastrophic event. And I certainly don’t wish for that! But let’s take a look at how markets are responding to the renewed attempts to talk inflation lower, rather than actually push it lower. Certainly, yesterday’s US equity performance showed no concerns over mundane issues like inflation as all 3 major indices continued to rally to new highs for the year. Alas, there is less joy elsewhere in the world as Chinese stocks suffered along with most of Asia, although the Nikkei did eke out a small gain. In Europe this morning, while the screen is virtually all red, the movements have been infinitesimal, on the order of -0.1% across the board. And US futures at this hour (7:45) are showing similarly sized tiny declines. The real news is in the bond market, which has taken this new government push to heart, and we now see yields falling across the board, in some cases quite sharply. Treasury yields are down -4.5bps, but that pales in comparison to European sovereigns, all of which are lower by at least 7bps with Italian yields tumbling 12.5bps. This newfound ECB dovishness is clearly a welcome relief for European governments, French electricity prices be damned. In the commodity space, the base metals continue to signal a recession is on its way as both copper and aluminum continue to slide, but oil seems to have found a base for now, and is still higher on the month. As to gold, it should be no surprise that it is rallying this morning, pushing back above $1960/oz as the combination of lower yields and a lower dollar are both tail winds for the barbarous relic. Turning to the dollar, excluding the Turkish lira, which has tumbled 2.5% in anticipation of another underwhelming monetary policy response this week when the central bank meets, the rest of the EMG bloc is firmer, led by THB (+1.2%) on the combination of a broadly weaker dollar and hopes that the political stalemate in the wake of the recent election there is soon to be solved with a new candidate coming forward. But the strength is broad-based across all 3 regions. In the G10, NZD (-0.7%) is the only real laggard as market participants position themselves for tonight’s CPI release there with growing concerns that the central bank is not doing enough to support the currency and economy. Otherwise, the bloc is generally firmer, albeit not dramatically so. On the data front, Retail Sales (exp 0.5%, 0.3% ex autos) leads the way followed by IP (0.0%) and Capacity Utilization (79.5%) at 9:15. There are still no Fed speakers, so while a big miss in Retail Sales could have an impact, I continue to expect that the equity earnings schedule is going to be the driving force in markets until the Fed meets next week. So far, the first sets of numbers have been positive, but there is a long way to go. For now, the dollar remains on its heels, and I suspect that is where it will stay until next Wednesday at least. Good luck Adf
A Series of Fails
The narrative that we’ve been fed Explains a soft landing’s ahead With CPI falling And job growth enthralling The equity bulls lack all dread But part of this thesis entails That Chinese expansion prevails Alas for that view The data that’s new Shows Xi’s had a series of fails Pop quiz: what do you call an economy that demonstrates anemic economic output with relatively high inflation yet relatively low unemployment? The future. In truth, I don’t think economists have come up with a new descriptor for the situation to where we are headed. Stagflation may be appropriate, but the key outlier in this scenario is the low unemployment situation. To help better understand how a recession is defined in the US (as opposed to the shorthand view of 2 consecutive quarters of negative real GDP growth), here is an excerpt directly from the NBER’s website describing the things they consider [emphasis added]: “Because a recession must influence the economy broadly and not be confined to one sector, the committee emphasizes economy-wide measures of economic activity. The determination of the months of peaks and troughs is based on a range of monthly measures of aggregate real economic activity published by the federal statistical agencies. These include real personal income less transfers, nonfarm payroll employment, employment as measured by the household survey, real personal consumption expenditures, wholesale-retail sales adjusted for price changes, and industrial production. There is no fixed rule about what measures contribute information to the process or how they are weighted in our decisions. In recent decades, the two measures we have put the most weight on are real personal income less transfers and nonfarm payroll employment.” Based on this description, if the unemployment rate remains low, recession is not on the cards. Now, politically, the current administration will spend a lot of time during the current election cycle touting their achievements, but will this situation, where inflation continues to plague the economy amid very slow growth, really feel like times are good? The employment situation appears to be a structural change with a large reduction in the workforce in the wake of the pandemic and related policies. While this seems likely to keep unemployment low, it will also keep upward pressure on inflation. This will be good for the nation’s fiscal stance, as high nominal activity along with high inflation (exactly the situation I foresee) will do wonders for reducing the real value of the outstanding debt. However, it is not clear it will do much for the nation’s psyche. One of the key features of the soft landing scenario is that economic activity will be widespread. Now, we know that Europe and the UK are both struggling, but of equal, if not greater importance, is the stituaiton in China. There has been a near universal view that the post zero-Covid economy in China would revive quickly and that growth there would be sufficient to support the entire world. Last night, though, we got some bad news on that front as Chinese data was generally weaker than expected, specifically the GDP result where growth rose just 0.8% on the quarter (5.5% Y/Y) far below economists’ forecasts. It seems that the China reopening is not nearly as impressive as previously expected. Property investment continues to fall (-7.9%), Retail Sales continue to slide (3.1%) and IP remains far below historic levels. Oh yeah, while the Surveyed Jobless Rate remained unchanged at 5.2%, youth unemployment (people between ages 16-24) rose still further to 21.3%! This is not the sign of an expanding economy. It seems that the combination of slowing world activity and ongoing trade wars is starting to really take a toll. Exports fell last month, and apparently, the Chinese consumer is not picking up the slack. Now, the latter should be no surprise as there was precious little fiscal policy support for the Chinese people by the Xi government during covid, and their largest source of savings, housing, has been collapsing for at least 2 years, so it is not clear why anyone should expect an uptick in activity. The Chinese people just don’t have the money for it. Despite Xi’s earnest desire to have the economy pivot away from export-led growth to consumption led growth, it just ain’t gonna happen real soon. And if Chinese economic activity remains in the doldrums, we could be in for a longer period of overall slow growth around the world. That will not help the soft-landing scenario at all. Maybe things will be much better, but I cannot get over the view that the worst of this economic cycle is yet to come. Beware. How are markets responding to the latest news? Pretty much as you might expect with risk assets under pressure and bond markets rallying. For instance, after Friday’s mixed picture in the US, Chinese equity markets were under pressure, although the rest of Asia was pretty benign. European bourses, though, are all in the red led by the CAC (-1.25%). As to US futures, at this hour (7:30) they are all slightly softer as the market awaits earnings, this week’s Retail Sales data and, of course, next week’s FOMC. Bond markets, though, are unambiguous in their views with yields falling sharply across the board. Treasury yields are down 5bps, as are virtually all European sovereigns and UK gilts. The decline in US CPI last week is clearly spilling over, as is the weaker Chinese growth data. While central banks have insisted that they are not done fighting inflation by raising interest rates, markets are pretty clearly expressing the view that yes another hike may be coming soon, but that by early next year, they will be cutting rates quickly. As to the commodity markets, oil, which had really rallied nicely over the past week or so, has fallen again this morning, down -1.20%, and we are seeing weakness in the base metals as well with both copper and aluminum lower by about -2.0%. Only gold is managing to maintain a little bid as the dollar remains under some pressure this morning. Finally, the dollar is mixed this morning, with about half its counterparts in both the G10 and EMG blocs higher and the other half lower. Given the Chinese data, it is no surprise CNY and several other Asian currencies are weaker this morning. Perhaps a little more surprising is that the ZAR is stronger despite softer metals prices. But given that there has been a broad-based theme of dollar weakness in the wake of the CPI data last week, my sense is traders are simply adjusting positions ahead of the Fed next week. This idea is bolstered by the fact that the yen remains one of the best performing currencies of late as the yen continues to be the favored funding currency for short positions given its still negative interest rate structure, but as the long dollar idea fades, traders are forced to cover those short yen positions. I suspect that there is further to go in this trade. On the data front, Retail Sales is the highlight of the week, although there is a decent amount of stuff, as follows: Today Empire Manufacturing -3.5 Tuesday Retail Sales 0.5% -ex autos 0.4% IP 0.0% Capacity Utilization 79.5% Wednesday Housing Starts 1475K Building Permits 1490K Thursday Initial Claims 241K Continuing Claims 1730K Phily Fed -10.0 Existing Home Sales 4.21M Source: Bloomberg With no Fed speakers, I expect that the market will be focused on the Retail Sales data from an economic perspective, but we are also entering the earning period, so it is likely that is going to have a bigger impact on all markets without any Fed narrative. Barring extreme results in either data or earnings, I suspect a quiet week as all eyes focus not only on the 25bp hike coming next week from Powell and company, but more importantly, the tone of the statement and the press conference. Good luck Adf
Just a Dream
Inflation is clearly passé As traders and markets display Remarkable trust The Fed will adjust The path of rate hikes come what may The upshot is there’s a new meme A landing so soft it would seem No jobs will be lost And there is no cost Alas I fear it’s just a dream I’m not sure if you saw the announcement yesterday, but everything is beautiful! Inflation is a thing of the past, the economy continues to tick over quite nicely with employment remaining robust and the idea of recession is just a figment of the permabears’ imagination. At least that’s what it seems like based on market movements of late. Yes, PPI printed lower than forecast, which after the somewhat softer CPI and the known base effects, was not hugely surprising. Perhaps a bit more surprising was that the Claims data, both on an Initial and Continuing basis, printed lower than expected. The implication here is that the labor market remains quite robust with those folks who have been laid off able to find new employment quite rapidly. While there is still plenty of data pointing to a manufacturing recession (ISM, IP, Factory Orders), the Services situation remains far better with increased activity and rising wages still apparent. So, perhaps the optimists have it nailed, and believe Chairman Powell has managed to create a soft landing, where inflation comes back to target without having to cause a recession. However, it feels like it is still a little early to take that victory lap. After all, the inflation data was literally one data point driven largely by base effects and regardless of your view, one data point does not a trend make. Certainly, the equity market is all-in on the soft-landing scenario. The Treasury market, at least since the CPI print on Wednesday has rallied dramatically (another 10bps yesterday) and is now 29bps lower over the past week. In fact, the 2yr Treasury has rallied even further, with yields there falling by 35bps over the same period. To say that the market has adjusted its views on the Fed’s future activities would be an understatement. There is still a 91% probability priced into a 25bp rate hike this month, but there are no more hikes after that priced at this stage and the first cut is seen in either March or May next year, at least according to the Fed funds futures market. And what of the dollar? While it is bouncing a little today, that is clearly modest position adjustment amid profit-taking as it is sharply lower on the week against all its G10 counterparts and almost all its EMG brethren. There is, of course, one fly in the ointment, oil prices, and commodities in general. One of the key features of markets over time is that they tend to be self-correcting. The saying, the solution to high prices is high prices is trying to explain the idea that high prices result in additional supply coming to market (to take advantage of those high prices) which results in prices falling back to earlier, lower levels. The same process occurs with low prices as well, where low prices inspire increased demand and reduced supply thus driving prices higher again. Well, oil is exhibit A for this process. Since oil continues to be priced and traded largely in dollars, when the dollar is strong, non-dollar countries (basically everybody else) finds that oil is expensive and so demand wanes a bit resulting in softening oil prices. However, when the dollar declines, as we have seen in the past week, that opens the door for oil, and most commodities which are priced in dollars, to rally sharply. Of course, if you are the Fed and continue to try to dampen price pressures, the last thing you want is a weak dollar and high commodity prices as both lead directly to rising inflation. In fact, one reason that US inflation did not reach the levels seen in Europe and the UK is that the dollar remained quite strong throughout this period thus reducing inflationary pressures. But right now, that dynamic is reversing with the dollar under pressure and commodity prices rising. That bodes ill for continued declines in CPI and PPI which is certainly not part of the new narrative. (As an aside, it is this very feature that drives the de-dollarization narrative as you can easily understand why China, who is the largest importer of oil in the world, would like to see the dollar dethroned so they can pay for their imports with their own currency (printed as necessary) rather than have to earn dollars elsewhere to pay for their oil and other commodity imports.) At any rate, I feel it is very important for everyone to remember that it is never the case when all signals point in the same direction. It is only the case that the market responds to a group of signals that reinforce their underlying view, happily ignoring the rest. As another saying accurately makes clear, nothing matters until it matters. Ok, as we head into the weekend with a week’s worth of euphoria behind us, what is today shaping up to be? Well, equity markets are muddling about with most ever so slightly higher but some sliding after the previous two days’ strong rallies. US futures are also lackluster at this hour (8:00) barely higher as traders prepare for another summer weekend. Bond markets, too, are quiet after a raucous week, with yields little changed on the day in the US and throughout Europe and in Japan. One cannot be surprised by the market response to the CPI data and now that this new narrative of rainbows, unicorns and lollipops is making its way around to every corner of the market, there is no reason to think that much will change in the near term. Arguably, even if inflation is beaten and is heading back to 2%, a big IF, there is precious little reason for 10-year yields to fall very far as they would currently be offering a 1.75% real yield, a very normal situation throughout history. Although, there would certainly be cause to believe the 2yr is set to see yields decline further and the yield curve normalize. But again, I believe it is very early to take that as gospel. Commodity markets are following the same pattern here, consolidation after a week of strong rallies in all the major commodities so the question is, will those rallies continue next week? Or have we reached the end. This story is true of the dollar as well, which is intimately linked to the commodity story. Will today’s Michigan Sentiment (exp 65.5) change any views? I doubt it although if the reading is quite strong, and given the growing bullish zeitgeist, it could certainly pump risk assets further. However, a soft reading seems unlikely to derail the current risk attitude at this point. With the Fed commentary under wraps until the FOMC meeting, today is likely to be entirely equity focused. To that end, the big banks have been reporting Q2 earnings this morning and so far, they have all beaten (dramatically reduced) forecasts. I expect that is all that is needed for risk to retain its luster, so do not be surprised to see the dollar continue its recent slide and stocks and commodities finish higher on the day. Good luck and good weekend adf
More Woe
It wasn’t all that long ago When everyone forecast more woe As long as the Fed Kept moving ahead And, higher rates, still did bestow But now that is all in the past As CPI fell, at long last Below current rates So everyone waits For Jay’s monetary recast I am old enough to remember when the market was pricing in two more Fed funds rate hikes and an extended period of time at those higher interest rates as the default position. After all, the Fed has been harping on about higher for longer quite a while and at their June meeting, they explicitly published their collective forecasts that showed a median expectation of an additional 50bps of tightening and then no real decline for at least a year. That view, however, is so 24 hours old! The new theme is…BUY STONKS! This was a remarkably fast turn of opinions, even for markets that produce whiplash on a regular basis. By now, you are certainly aware that the CPI data printed a bit lower than the median forecasts with the headline at 3.0% and the core at 4.8%. These are the lowest levels since March 2021 and October 2021 respectively and are certainly encouraging news. However, we all knew that the base effects were a key part of the puzzle as to why the year over year numbers fell so much. But, in fairness to the bulls, the monthly increases were also quite low, 0.2% in both cases, and it remains to be seen if that monthly trend can continue. As I suggested yesterday, the lower-than-expected readings led to an immediate explosion higher in risk appetite with equity markets in the US having a great day which was followed by strength throughout Asia and Europe this morning. And Europe had a good day yesterday as well. Meanwhile, US futures continue to bathe in the glow of declining inflation, rising further as I type (7:00am) with NASDAQ futures up more than 1.2% at this hour. Risk is back, baby! Perhaps a better indicator of the market’s renewed vigor is the bond market, where 10-year Treasury yields are lower today by a further 4.3bps and have fallen 25bps since Friday’s close. All those fears that a 4.0% 10-year yield could lead to further economic breakage are now merely bad dreams, with no seeming basis in the new, current reality. As to European sovereigns, they have fallen even further since yesterday, with declines on the order of 10bps nearly across the board on the continent and 7bps in the UK. Granted, part of the European movement seems to be on the back of comments by uberdove Yannis Stournaras, the Greek central bank head and ECB council member, who explained this morning that they never promised a July rate hike and now that the data is softening, a pause may well be appropriate. As to yesterday’s Fed speakers, Barkin was first up and his comments, right at 8:30 when the CPI data was released, got lost in the news. So, the fact that he said inflation remains too high and they still need to do more was completely ignored. Governor Barr was entirely focused on bank capital plans, indicating that the Fed would look to tighten capital requirements going forward as the best way to improve bank solidity. In other words, nobody cared what they said from a market’s perspective. Overnight we saw some Chinese data that also spoke to slowing overall demand and economic activity, thus implying slowing inflationary pressures, as the Chinese trade data, while growing their surplus to $70.6B, exposed a much weaker export performance, with exports there falling -12.4% Y/Y. That is a strong indication of slowing global growth, hence a view that also bodes well for future inflation declines. Alas, there is one area that might have a detrimental impact on all this falling inflation euphoria, oil prices. The black sticky stuff rallied again yesterday and is higher yet again this morning, albeit just by 0.3% right now, but has risen >4% in just the pat 3 days with WTI firmly above $75/bbl while Brent crude is now above >$80/bbl. While I am no market technician, I do know that there is a huge amount of focus on the 200-day moving average and a potential break above that level which currently sits at $77.34/bbl. If one looks at the ongoing production cuts by the Saudis as the short-term impetus and combines that with the structural shortage from the lack of drilling and exploration over the past decade due to ESG focused policies, it is easy to understand the bullish case. One other thing that has not seemed to have received much press is that the Biden administration is apparently trying to refill the SPR to some extent, and so are a bid in the market as well. The one thing that we all know well is that higher oil prices tend to lead to higher gasoline prices which are a critical part of both inflation and inflation expectations. This could well throw a spanner in the works for the collapsing inflation story, as well as the Fed is finished story. It is certainly too early to draw that conclusion, but if WTI pushes above that moving average and to $80/bbl or more, just watch how quickly opinions shift. Ironically, despite concerns over slowing growth, both base and precious metals have been rallying as well, almost entirely on the back of a weaker dollar. Now, it is a chicken and egg question here as to whether the weaker dollar is driving commodity (and stock) prices higher, or whether the rally in those markets is driving the dollar down, but whichever way the causality runs, that is the current price action. Actually, it makes sense. If the declining inflation story is taken at face value, and the market has removed further rate hikes by the Fed and is actually bringing the first rate cuts closer in time, then the dollar’s attractiveness as an asset is going to be reduced. And that is exactly what has happened. The buck is down against virtually all its counterparts, both G10 and EMG and the only thing that is likely to change that trajectory is data showing inflation is rebounding in the US and the Fed will be called on for more aggressive tightening. Today’s PPI data seems highly unlikely to provide any information of that sort, so while the market continues to price in a strong likelihood of a 25bp rate hike in a few weeks, the strong belief is that will be the last. Yesterday I posited that the one scenario that was not getting much love was that a recession was imminent, rather than either being delayed into 2024 or not even showing up. But even the inflation data is somewhat indicative of reduced demand. A little mentioned outcome regarding Consumer Credit on Monday showed growth of ‘just’ $7.24B, the lowest number since coming out of the pandemic in October 2020, and, perhaps, an indication that things are not as rosy as some would have us believe. And while confirmation of weaker US economic activity is likely to weigh on the dollar and US yields, it is also likely to weigh on US equity prices, so do not forget that connection. While I don’t believe today’s PPI data will be that impactful, keep an eye on the Claims data (exp 250K Initial, 1720K Continuing) as if those numbers keep edging higher, that too will play into the Fed’s thinking. I have maintained for many months that employment is the key, not inflation per se. Rising unemployment will lead to a quick reversal of Fed policy but will also be a harbinger of much weaker economic activity and just maybe that most anticipated recession in history will finally arrive. Lastly, we have two more Fed speakers today, Daly and Waller, which are the last before the quiet period begins. Given the sudden shift in narrative and the softer CPI data, it will be very interesting to hear if they are going to fight the new narrative or adjust their tone. Daly is first at 11:10 this morning on CNBC, so all eyes will be there. I would not fight this current trend for a lower dollar and frankly, with the euro back above 1.11 for the first time since March 2022, and the pound back above 1.30, the dollar bears are firmly in control. If this dollar weakness persists for another 1%-2% I believe it could open up a much further decline, so consider what it takes to manage that kind of movement. An additional 10% is quite easy to believe on that break. Good luck Adf
Jay Will Scrape By
Today it’s about CPI As Jay and his cadre still try To push prices lower Which might mean growth’s slower But don’t worry, Jay will scrape by
This morning we see the last big data point before the Fed meets in two weeks’ time as CPI is to be released at 8:30am. According to Bloomberg’s survey, the median expectation is for both headline and core monthly prints of 0.3% with the Y/Y numbers at 3.1% headline and 5.0% core as a result. There are many who are excited about the prospect of a 2 handle on the headline number as a potential catalyst for the equity market to break out even higher. The idea seems to be that a reading that low will get the Fed to change their tune and not merely stop raising rates but start bringing rate cuts back on the table. Wishful thinking in my view, but that’s what makes markets.
Even a cursory analysis of the commentary from the plethora of Fed speakers we have heard since the last meeting shows that there is very little willingness to end the current tightening program anytime soon. Certainly, there is no indication that a cut is even remotely a consideration. But equity bulls need a story to push their thesis, so there you have it. The thing is that while this month is clearly going to show a substantial decline on a year over year basis due to the base effects (remember, June 2022 M/M CPI was +1.2%, the peak), next month has the opposite base effect with the July 2022 M/M reading at 0.0%.
As I’m sure all of you are very clearly aware, there is essentially no evidence in our day-to-day llives that indicates prices are declining across the board. While gasoline prices have certainly fallen from their highs, they appear to have bottomed along with oil, and if you head out to a restaurant, especially one that you frequent, I’m sure you’ve seen the same steady rise in prices that I have. Remember, too, that CPI measures the change in prices on a monthly or annual basis, not the level of prices. Absent deflation, something that is incredibly unlikely in the current monetary and fiscal framework, prices are never going back to where they were prior to the pandemic. I sincerely hope wages continue to rise for all our sakes.
In the end, I continue to look at the employment situation as the critical variable for the Fed as weakness there will be the only thing that deters them from continuing their current mission. Powell clearly believes that the Silicon Valley Bank situation has been completely contained and that there will be no further concerns to distract them going forward. Maybe that is correct, but I am wary of accepting the idea that the fastest rate hikes in the Fed’s history are consistent with minimal damage to the economy. My suspicion is that there will be far more coming, it’s just that refinancings have not been necessary yet. When companies on the margin need to pay 9% to refinance their 4% coupon, it will result in an even greater uptick in bankruptcies than we have already seen this year and according to Epiq Bankruptcy, a compiler of bankruptcy information, filings have jumped by 68% this year compared to last, with a total of 2,973 in the first six months of the year. If the Fed continues to tighten, look for this number to rise further, and possibly faster.
Ahead of the data, the bulls remain in charge of the market with yesterday’s rally having been followed throughout Europe this morning although last night’s Asia session was more mixed. In fact, one of the best performing markets of the year, Japan, has seen something of a reversal in the past two weeks as the Nikkei has fallen almost 11% while the yen has rallied about 3.5%. This is no coincidence as much of Japan’s corporate profitability continues to rely on exports and the yen’s recent strength (+0.5% today with the dollar back below 140 again) has clearly been a weight around that market’s neck. Interestingly, despite the same mercantilist mindset in China, the relation between the Chinese stock market and the renminbi is far less tight. As it happens, CNY (+0.2%) is a bit firmer this morning but is less than 1% from its bottom while the Chinese stock market continues to flounder, having fallen yet again last night and continuing its downtrend for the year.
Turning to the bond market, 10-year yields have slipped another 2.5bps this morning as for now it appears the market is rejecting that 4.0% level. Of more interest is the fact that the 2yr yield has fallen faster with the curve inversion down to -90bps. This is an indication that bond investors are entertaining the idea that inflation is slowing, and the Fed will back off. Be careful if there is a high CPI print today as that will almost certainly see quite the reversal of this price action. Regarding the rest of the world, European sovereigns are following Treasuries with yields generally slipping between 2bps and 3bps, but the real surprise is Japan, where yields rose 1.9bps last night and are now at 0.467%, quite close to the YCC cap for the first time in Ueda-san’s tenure. The combination of rising JGB yields and a stronger yen has a lot of tongues wagging that a policy change is in the offing in Tokyo. It strikes me that Ueda-san is far more likely to move when the market is not expecting something rather than being seen to respond to pressure from the market. However, anything is possible there.
WTI is back above $75/bbl this morning for the first time in two months and there are many, this pundit included, who believe that we may have seen the bottom. Fundamentals like the Saudi production cuts and the Biden administration discussion of refilling the SPR are adding support, as is the fact that while recession continues to be forecast, it has not yet seemed to arrive. Do not be surprised if we see $80/bbl or higher before the summer is over. As to metals prices, gold is marginally higher this morning, benefitting from the dollar’s continuing weakness, as are both copper and aluminum.
Finally, talking about the dollar’s weakness, it is widespread with NOK (+0.65%) rallying alongside oil and SEK (+0.5%) also benefitting from commodity prices. The only G10 laggard is NZD (-0.2%) which seems to have been disappointed that the RBNZ left rates on hold last night. Speaking of central banks, this morning we hear from the BOC which is expected to raise rates again by 25bps to 5.0% at 10:00am so be attuned for any alternative outcome.
As to the emerging markets, it is a story of modest strength across almost the entire set with no real outstanding stories to highlight.
In addition to CPI, we also get the Fed’s Beige Book this afternoon and we hear from four more Fed speakers starting with Richmond’s Thomas Barkin right when CPI is released. The only thing that might be interesting is if somebody starts to change the tune, something that I find highly unlikely at this time.
We will have to see the print to have any chance of understanding the next steps, but for now, the dollar is on its heels and absent a strong print, seems likely to test its recent lows before anything else.
Good luck
Adf
Cause Regret
Again China’s leading the news With stories ‘bout financing blues So, terms on old debt Which now cause regret Have lengthened, more pain to defuse Meanwhile, from the FOMC Three speakers were clear as can be Rate hikes are in store This month, and then more On this much, they all did agree
One of the key themes earlier this year that was supposed to have a big market impact was the China reopening story. You may recall back in February when President Xi Jinping responded to the mass protests with blank papers held aloft, by deciding that permanently locking down a billion people was no longer an effective strategy, and a tacit declaration was made that there were no more Covid restrictions to be imposed or enforced. Everybody assumed that the Chinese economy would vault out of the gates and that commodity demand would rocket higher while overall global economic activity increased. Alas, that is not how things played out at all. Instead, Chinese economic activity has disappointed at every turn with an initial blip higher and then a gradual slide back to less substantial activity.
Part of the problem has clearly been the efforts made by companies and countries around the world to reduce or eliminate China’s impact on supply chains. But part of the problem, and arguably the larger part, was self-inflicted. That was the massive debt buildup on the back of a two decades long leveraging of the Chinese property market. You may recall China Evergrande, the first of the big property companies to come under pressure, but it has been an ongoing process for several years now. The problem, in a nutshell, is that the model that had been used, buy huge swathes of land from city governments with leverage, promise to build housing (whose price had been rising nonstop for two decades) and then sell these flats to people on a highly leveraged basis, collapsed along with the covid lockdowns. Suddenly, Chinese home buyers were out of work and could no longer afford the previously purchased homes. As well, the construction companies could not complete the projects given all the workers were locked up in their own homes and unable to get to the construction sites. However, debt remained a constant and was due regardless of the other issues.
The outcome was a significant slowdown in Chinese construction activity, an enormous number of unfinished (or even not yet started) apartment projects, and a lot of losses for both individuals and the property companies. Now, as China emerged from its covid lockdowns, the government did try to relax some of its previous policy strictures but things in the property sector remain quite soft. For China, where the property sector represented more than 25% of GDP, this is a problem. As such, last night we saw the next steps by the Chinese government in this process with further easing on repayment terms by extending the maturity of a large amount of debt by one year, from 2024 to 2025. It seems that the Chinese were paying attention to the Biden administration’s efforts regarding student loan payment delays and thought, we’ll do that too. Of course, there is no Supreme Court in China to overturn this policy. Do not be surprised if next summer, we hear about a further extension of these loans as can kicking is a government’s true superpower.
A perfect encapsulation of this policy was the Chinese loan data released last night where new loans rose by CNY 3.05 trillion, far more than expected and aggregate financing also exploded higher, by CNY 4.2 trillion. These are strong indications that the Chinese government is back offering substantial fiscal support to the economy in order to help get things moving again. It should be no surprise that Chinese share prices rallied, nor that the renminbi has rallied a bit as well, pulling away from its recent multi-month lows. It seems that the market has pushed things far enough to get a policy reaction rather than merely words. At this point, the big question is, have we seen the end of the recent CNY weakening trend? If the dollar continues its recent broad decline, then that is a quite probable scenario. However, if the Fed continues to hew to its higher for longer mantra, and keeps pushing rates higher, be careful, of assumptions of a dollar collapse.
Speaking of the Fed, yesterday saw three Fed speakers, Barr, Daly and Mester, all explain that more tightening was still needed to push inflation back to their target. [emphasis added.]
Michael Barr: “we’ve made a lot of progress in monetary policy, the work that we need to do, over the last year. I would say we’re close, but we still have a bit of work to do.”
Mary Daly: “We’re likely to need a couple more rate hikes over the course of this year to really bring inflation back into a path that along a sustainable 2% path.”
Loretta Mester: “in order to ensure that inflation is on a sustainable and timely path back to 2%, my view is that the funds rate will need to move up somewhat further from its current level and then hold there for a while as we accumulate more information on how the economy is evolving.”
It’s almost as if they are all reading from the same script! At any rate, it seems very clear that regardless of tomorrow’s CPI print, they are going to hike by 25bps later this month. The real question is, will the data continue to show the strength necessary to drive several more hikes after that? As I have repeatedly explained, NFP is the most important number. As long as Powell and the Fed can point to the employment situation and say there is no jobs recession, they will have cover to continue to tighten policy, maybe much higher. 6% or even higher is not out of the question.
And yet, despite the ongoing hawkishness from the Fed, the market is no longer concerned, at least that seems to be the case today. Equity markets in the US managed to eke out gains yesterday and overnight saw Asia with bolder moves higher (Japan excepted as the strengthening yen is weighing on Japanese corporate profitability.). European bourses are higher, although the FTSE 100 is under pressure after mildly disappointing UK labor data this morning where the Unemployment Rate jumped to 4.0% for the first time since December 2021 when it was falling post covid. US futures are a touch higher at this hour (8:00) but seem to be biding their time for tomorrow’s CPI data.
Bond markets, though, have rallied with 10-year Treasury yields lower today by a further 3bps and now back below the all-important 4.0% level, albeit just barely. European sovereigns are also seeing some demand with yields sliding between 1bp and 2bps across the continent. Even JGB yields edged a bit lower in a global bond buying spree.
Commodity prices are broadly higher with oil (+0.6%) continuing its rebound of the past week, while gold (+0.5%) is feeling a little love on the back of the dollar’s broad weakness today. As to the base metals, they are ever so slightly firmer, retaining yesterday’s gains.
And finally, the dollar is softer across the board this morning as it seems to be following treasury yields lower and ignoring the Fed commentary. The dollar’s weakness is evident in both the G10 and EMG blocs with JPY and NOK (both +0.6%) the leading gainers while only NZD (-0.4%) is under any pressure as traders prepare for the RBNZ meeting this evening and seem to be reducing their positions. As to the emerging markets, KRW (+1.0%) was the leading gainer on the back of the Chinese fiscal policy story, although we saw strength throughout the APAC bloc. Both EMEA and LATAM are a bit more mixed with much less significant movement, so seemingly following the bigger trend.
Today’s only data point has already been released, the NFIB Small Business Optimism Index, which printed at a higher than expected 91.0. While this is a good sign, it is important to understand that the long history of this index shows an average near 100 and the current readings still mired near the lowest levels in its history, only surpassed by the massive recessions of 1980-1982 and the GFC in 2009.
There are no Fed speakers scheduled today, although we get a bunch more tomorrow after the CPI report is released. For now, the market is looking askance at the dollar while Treasury yields sink. My take is there is further upside in yields and therefore in the dollar. However, that is not today’s trade.
Good luck
Adf
fxpoetry 