Author Archives: fxpoet

Canada’s Burning

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In Europe, the data today
Showed growth’s in a negative way
Recession is here
Though not too severe
While pundits are filled with dismay

Meanwhile in the States there’s a haze
Of smoke for the last several days
That Canada’s burning
Is somewhat concerning
As forests there still are ablaze

Arguably, the story that is getting the most press is the ongoing wildfires in Canada which has led to significant smoke issues throughout the Midwest and East Coast of the US.  In fact, at one point yesterday, the FAA closed LaGuardia Airport in New York because the smoke was so thick.  The latest that I have seen indicates these fires are likely to continue to burn for a number of days yet as they are nowhere near under control in Canada.  I guess we will need to get used to an orange sun rather than a yellow one for the time being.  While there is no evidence yet of any true behavioral changes, be alert for government edicts to prevent people from traveling or going outside and a short-term reduction in economic activity, at least in June while this is ongoing.  I fear that the willingness of government officials to declare states of emergency and take on dictatorial powers has grown since Covid, so it will be interesting to see how this plays out.  A headline across the tape just now (7:00) shows that LaGuardia is shut down for inbound flights again due to reduced visibility.  In the end, be careful as inhaling too much smoke will not be good for you.

 

But after that, which is truly wagging every tongue in NY, the other story of note is that the Eurozone has fallen into a technical recession, with the final revision of Q1 GDP falling to -0.1%, and Q4’s numbers being revised lower as well, to -0.1%, after much weaker than previously assumed data from both Germany and Ireland was incorporated into the statistics.  You may recall the argument in the beginning of 2022 when the US suffered through two consecutive quarters of negative real GDP growth, but there was a great effort to claim that was not a recession.  And officially it was not as in the US a recession is not official until the NBER declares it so in hindsight.  But Europe does not have an NBER and there is no argument at this point that the Eurozone went through quite a weak patch recently. 

 

Arguably, though, of more importance is whether this weakness will continue or whether we have just witnessed the much-anticipated recession.  This matters a great deal because next week, the ECB meets and is widely expected to raise its interest rate scheme by a further 25bps with the market pricing in an additional hike there by summer.  If the Eurozone is in recession, especially if it starts to deepen a bit more aggressively than the recent -0.1% quarterly data, will the ECB have the resolve to continue to fight inflation and keep raising rates?  Granted, their mandate is purely inflation focused, unlike the Fed’s dual mandate of inflation and employment, so they would be well within their rights to do so.  But…continuing to raise interest rates into a clear recession is a very difficult decision as it can easily be seen as a policy error.  At this point, my take is they will indeed hike next week, but I am far more skeptical about future hikes especially as the Fed is pausing skipping this meeting and may well be done.  The idea that the ECB will continue to tighten policy aggressively while the Fed is not seems pretty far-fetched based on its history.

 

Speaking of rate hikes, Canada is in the news there as well after the BOC surprised the market and unpaused (?) by hiking 25bps yesterday.  Essentially, they have concluded that economic activity is too strong to allow inflation to return to their 2% goal, the same reasoning we heard from the RBA last week when they surprised markets and raised their base rate.  While the FX market response was not quite as aggressive as in Australia (CAD rose 0.5% on the news and has basically tread water since then), the move has certainly forced rethinking the assumption that the Fed is actually going to skip this meeting.  Arguably, much will depend on next Tuesday’s CPI data with current estimates there for 4.2% headline and 5.2% core.  Any number that prints hot will get tongues wagging about the Fed continuing to raise rates with corresponding market impacts.  For now though, we can merely guess.

 

And that is the background for today’s session.  Yesterday saw a bit of a pullback in risk assets in the US with most of Asia following lower, although Chinese stocks held up.  Eurozone bourses are all marginally higher this morning, as it seems the growth data was less concerning and hopes that the ECB would be forced to stop hikes sooner have been a driving force.  As to US futures, they are all essentially unchanged this morning as everybody continues to wait for the Fed next week.

 

Bond markets, though, were a bit shaken by the BOC move with yields climbing in the US yesterday and a further 1bp rise this morning back to 3.80%.  In addition, 2yr yields are back up to 4.55%, and with the Treasury now having no debt ceiling at all, I expect we will see significant issuance driving yields higher still.  In Europe, the picture is more mixed with yields either side of unchanged as there is confusion on how to play this market.  And one final thing is in Japan, where JGB yields have edged higher by 2bps overnight and are now at 0.434%, slowing approaching the YCC cap.  That is a potential issue for the not-too-distant future so we will keep on top of it.

 

Oil prices continue their slow rebound, up 0.9% this morning and actually up 4.3% in the past week.  Perhaps the Saudi production cuts are finally being priced, or perhaps the idea that Canada has indicated stronger growth is seen as a harbinger of a better economic situation and less demand destruction.  As to metals prices, gold, which fell sharply yesterday, is rebounding slightly and the base metals are mixed.  As long as we get conflicting economic signals (weakness in Europe, strength in North America) I think these metals will have a difficult time choosing a direction.

 

Finally, the dollar is generally softer this morning, which given the higher yields in the US is a bit surprising.  But NOK (+0.7%) leads the way on oil strength, and we continue to see strength throughout the commodity bloc.  Even the euro has rallied this morning, although that feels far more like position adjustments than fundamentally driven movement.  As to the EMG bloc, ZAR (+0.7%) is once again at the head of the list, entirely on commodity movement but most of EMEA is stronger while Asian currencies were generally under a bit of pressure overnight.  At this point, I continue to believe most markets are awaiting the FOMC meeting as the next potential catalyst and so expect limited directional trading until then.

 

On the data front, Initial (exp 235K) and Continuing (1802K) Claims are on tap this morning, neither of which seem likely to move the needle.  Yesterday’s Trade data was modestly better than expected while Consumer Credit grew a bit more than expected.  In the end, though, it is still all about the Fed.  As such, I expect more back and forth but no secular movement until we hear from the FOMC.

 

Good luck

Adf

Somewhat Decreased

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The OECD has released
Its forecasts for West and for East
Alas what they’ve said
Is looking ahead
The growth story’s somewhat decreased

It’s another extremely dull day in markets as the passing of the debt ceiling crisis has left traders and investors looking for anything new at all to help catalyze trading ideas.  Granted, all market participants are anxiously awaiting next Wednesday’s FOMC meeting, but there is a lot of time between now and then to fill.  As there was a dearth of new data of importance overnight, the talk of the market is the OECD’s release of their June 2023 Report on global GDP growth as per the below:

In truth, it does not make for great reading as the estimates point to continued subdued growth, well below the pre-pandemic average of 3.4% globally.  As well, they highlight that this slower growth trajectory will be matched with higher inflation (exp 6.6% in 2023 and 4.3% in 2024), a truly unenviable situation.  Of course, just like every forecast, these must be taken with a grain of salt as the one thing we know about forecasting is…it’s really hard, especially about the future.  It is not clear that anybody altered their views on anything after the release of the report, but it has been the talk of the town.

 

Aside from that, I must follow up on a comment from yesterday’s note regarding the interest rate adjustments made in China, as it seems there is even more nuance involved.  The big 4 Chinese banks have reduced their onshore deposit rates for USD by about 30bps to try to discourage dollar hoarding and incremental additions to the carry trade.  With US rates now above 5%, the carry opportunity to hold dollars relative to renminbi has been quite significant and has been a key driver of the renminbi’s weakness this year.  In fact, from the renminbi’s high point this year in mid-January, it has weakened nearly 6.6%, which is quite far for a currency that traditionally runs with about a 4% annualized volatility.

 

One other thing to consider here is that the fact that Chinese banks had to lower their USD deposit rates in order to discourage the owning of dollars seems at odds with the idea that the Chinese are getting out of their dollar holdings.  Rather, it might be a signal that the Chinese people, regardless of what their government may want, seem pretty comfortable holding the greenback. 

 

And, my goodness, there is virtually nothing else marketwise to discuss from the overnight session.  Equity markets have been generally quiet overall, with modest gains or losses following yesterday’s very modest US rally.  Major European bourses are +/- 0.1% on the day although we did see the Nikkei fall -1.8% overnight, arguably on the back of the latest Policy proposal by PM Kishida which calls for more spending and debt.

 

Bond markets are also quite subdued with yields edging slightly higher in most places, but just on the order of 1bp-2bps, hardly a worry.  The one noteworthy thing here is now that the debt ceiling has been suspended, the Treasury issued just under $400 billion in T-bills yesterday and is likely to continue on that pace for the rest of the month as they refill the TGA.  The market impact is that the curve’s inversion is increasing with 2yr-10yr now back to -83bps and seemingly heading far lower again.  A test of -100bps seems entirely likely here.  Meanwhile, the 3m-10yr spread is -163bps, which is far below the levels seen even in the 1970’s and 1980’s during Volcker’s time in office.  Given the amount of issuance likely still forthcoming, I suspect this can fall further still.  It is not clear to me that this is a positive for the market.

 

Turning to commodities, oil (+1.1%) is rebounding slightly as it retraces yesterday’s losses while metals markets are a bit more positive today with copper (+0.5%) and aluminum (+0.75%) both rebounding although gold is little changed on the day.  I sense that part of this is related to the dollar softening a bit, as the growth story just does not seem that positive.

 

Speaking of the dollar, other than vs. the Turkish lira, which has collapsed nearly 7% this morning after President Erdogan’s new government took office, it is generally a bit softer on the day.  With oil’s rebound, NOK (+0.8%) is leading the G10 higher followed by SEK (+0.6%) and AUD (+0.4%) on broader commodity strength, but the whole bloc is firmer.  In the EMG bloc, ZAR (+1.0%) is the leader, also on better commodity pricing as well as an increasingly positive outlook on the power situation there, followed by the rest of the bloc (save TRY) edging up between 0.1% and 0.3%.  There really aren’t any other good stories there.

 

And that’s all she wrote.  This morning we see the Trade Balance (exp -$75.8B) and this afternoon, Consumer Credit ($22.0B), but these days, neither of those is likely to matter to the trading community.  I expect another dull day, and potentially a whole week of dull until the CPI data next Tuesday and then the FOMC meeting on Wednesday.  At this stage, the medium-term trend is for modest dollar strength, but on a given day, there doesn’t seem to be much directional impetus in either direction.

 

Good luck

Adf

Quite a Surprise

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Down Under, in quite a surprise

The RBA did analyze

Inflation of late

And then couldn’t wait

To raise rates to multi-year highs

 

Explaining inflation’s been hot

The Governor and his team thought

If we don’t act now

We may well endow

The idea, our goal, we forgot

 

You know it is a dull day when the biggest news in the market is that the RBA surprised markets and raised their base rates by 25bps last night, taking the level to 4.10% and implying in their accompanying statement that more hikes were still on the table.  The money line from Governor Lowe was as follows, “The board remains alert to the risk that expectations of ongoing high inflation contribute to larger increases in both prices and wages, especially given the limited spare capacity in the economy and the still very low rate or unemployment.”   That does not sound like a central bank that has finished their hiking efforts and the market is now pricing a 50% probability of another rate hike by August.   It should be no surprise that the Aussie dollar (+0.6%) is the leading performer in the FX markets today, especially given that the dollar remains well bid overall.

 

In China, the PBOC

Has lately begun to agree

That growth’s in a slump

So, it’s time to pump

It up with a rate cut or three

 

The other interesting news overnight was that the PBOC has asked Chinese commercial banks, notably the big five banks, to cut deposit rates to their clients by 5bps in order to help encourage more spending, and correspondingly more growth.  Clearly, all is not well in the Middle Kingdom with respect to the economic situation although it is very interesting that the PBOC is not adjusting rates themselves.  Now, the big five state-owned banks are a critical part of Chinese monetary policy transmission, so a PBOC rate cut would feed through those institutions anyway, but I believe this is more theater in an effort to separate the government’s actions from direct support for the economy.  In the end, it’s all the same, as the Chinese rebound is very clearly under pressure.  One of the key drags remains the property sector and it is just not clear how the Chinese are going to solve that problem.  As of yet, like every government, they have simply kicked the can down the road a bit.  As to the renminbi, it continues to trade on the soft side, with the dollar above 7.10, although it is certainly not collapsing. 

 

However, after these two stories, there has been a dearth of news to drive things with just some desultory Factory Orders data from Germany (-0.4% M/M, -9.9% Y/Y) helping to remind everyone that the German economy, and by extension the Eurozone, has many issues yet to overcome after the loss of their cheap Russian energy.  So, let’s take a quick tour of markets and call it a day.

 

Yesterday’s big announcement from Apple regarding their new headset was less than scintillating to the trading community and we saw US equity indices slip a bit.  Overnight, while the Nikkei (+0.9%) managed a rally, the rest of the space generally fell and Europe, this morning is all in the red as well, albeit only on the order of -0.2%.  In fact, that -0.2% describes the US futures markets at this hour (7:30) too.

 

Bond yields have edged a bit lower on this modest risk off session with Treasuries (-1.1bps) consolidating their recent losses (yield gains) while European sovereigns have seen more demand with yields there lower by about -4bps across the board.  We haven’t touched on JGBs lately because there has been absolutely nothing happening in that market with the 10yr trading at 0.42%, still well below the YCC cap, and showing no pressure higher of note.

 

The one place where we have seen real movement this morning is commodity prices with oil (-2.2%) giving up almost all its post Saudi production cut gains.  The commodity market continues to be the leading proponent of a recession as can be seen in the base metals as well with both copper and aluminum under pressure today.  Meanwhile, gold (+0.1%) continues to hold its own despite pretty consistent dollar strength, definitely an unusual outcome and perhaps a commentary on general risk attitudes being heightened.

 

As to the dollar, it should be no surprise that NOK (-0.6%) is the G10 laggard given oil’s declines, but other than that and AUD’s gains, the rest of the G10 is split with modest gains and losses, although the euro (-0.2%) seems to be feeling a little heat from those lousy German numbers.  In the EMG space, though, there is a lot more dollar buying evident with both APAC and EMEA currencies under pressure.   Part of this movement seems to be related to some softer CPI prints encouraging the belief that interest rate rises are less likely, and part of this seems to be a bit of risk-off sentiment.

 

And that’s all there is today.  There is no US data to be released and, of course, the Fed is in their quiet period ahead of next week’s FOMC meeting.  As such, when it comes to the dollar, I expect that its recent underlying strength will remain barring a complete reversal in risk sentiment.

 

Good luck

Adf

 

The Issuance Tap

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The Saudis thought oil was cheap

So, figured that they’d rather keep

More stuff in the ground

And in a profound

Move, cut back production quite steep

 

 

Meanwhile now the debt ceiling’s gone

The Treasury’s set to turn on

The issuance tap

To refill the gap

In finance that started to yawn

 

The biggest story over the weekend was the Saudi’s decision to cut oil production by 1 million barrels per day as they are concerned the pending recession is going to further destroy demand and so are aiming to keep prices supported.  No other OPEC+ members joined with the Saudis as it seems they all want the money.  And who can blame them?  Not surprisingly, oil prices are firmer this morning, up nearly 2%, but remain far below levels seen prior to the last OPEC+ production cut when WTI was pushing $80/bbl.   However, if we look back to pre-covid times, oil was trading a full $10/bbl lower than the current level of ~$73/bbl.  In the interim, we have seen significant structural changes in the oil market, and I continue to expect these changes to force prices higher over time.

 

First, the election of President Joe Biden led to an immediate change in US energy policy with a destruction in production capabilities in the name of global warming.  Second, the Russian invasion of Ukraine and the ensuing sanctions on Russian oil (and NatGas) exports have helped reduce the amount of energy molecules available to be used worldwide.  Add to this the longer-term lack of energy infrastructure investment given the ESG push for the past decade, and the supply side of the equation does not look robust. 

 

On the demand side, however, things are likely to continue to trend higher for the foreseeable future.  Despite trillions of dollars of investment in alternative sources of energy, namely wind and solar, fossil fuels continue to represent more than 80% of total energy usage worldwide.  As well, every advancement in civilization throughout history has been driven by access to cheaper energy, and all those nations that we currently call emerging markets are quite keen to continue to advance their economies to the benefit of their populations.  They are far less concerned about global warming than they are about better living standards.  According to the IEA’s most recent forecasts, 2023 will set yet another record for oil demand regardless of the recession calls and the war in Ukraine.  Ultimately, this supply/demand imbalance is going to resolve toward higher prices still.  Mark my words.

 

As to the other discussion making the rounds in markets this morning, the upcoming deluge of Treasury security issuance, there are many claiming that this may have a significant impact on risk asset pricing, notably equities.  The idea is that as the Treasury refills its TGA (checking account) with up to $500 billion to get it back to its more normal balance, it will draw liquidity from potential equity investors who decide that earning a risk-free 5+% on their money is quite attractive, thus reducing demand for stocks.  However, this is a more nuanced discussion as there are other features in the money markets that will be impacted as well, and that are likely to offset a significant portion of that impact.

 

On the surface, that argument has validity, but digging a bit deeper is worthwhile to get a better understanding here.  The Fed runs a Reverse Repo program (RRP), where they essentially pay a small subset of investors to hold their securities at the Fed funds rate.  This program currently has about $2.2 trillion in it and is widely used by Money Market funds as an investment.  And that money in the RRP program is stuck at the Fed and not available for other investment.  However, T-bills have been yielding higher than Fed funds, and it is expected that those same Money Market funds will be snapping up the newly issued T-bills while running down their RRP balances, thus absorbing a great deal of the new issuance.  If this is the case, it will reduce the amount of available risk-free assets to which the equity investors described above will have access.  In other words, the feared demand drain is likely to be far smaller than the $1 trillion that has been bandied about lately.  Do not count on this as a rationale for equity weakness, although that doesn’t mean there are no problems ahead.

 

And, as we begin another week, those are really the noteworthy stories around.  After Friday’s blowout NFP number of 339K new jobs with a revision higher in the previous months, US equities took off and had a big day.  That has mostly been followed by Asia, which saw strength almost everywhere (mainland China being the most prominent exception) although Europe has had a less robust session today.  Arguably, that is because the Services PMI data in Europe released this morning was softer than expected across the board, and they had already reacted to the US payroll data on Friday as those markets were open during the release.  Meanwhile, US futures are either side of unchanged this morning, clearly not feeling any additional love from the payroll story.

 

Of more interest is the fact that bond yields are higher around the world this morning, with Treasuries (+5.4bps) seeing selling pressure along with all of Europe (Bunds +7.2bps, OATs +7.0bps, Gilts +5.8bps, BTPs +8.1bps) as it seems the flood of issuance due from the US is being felt everywhere.  After all, given the dollar’s recent trend higher, which is very evident today, for non-USD investors, higher yielding Treasury securities are likely to be very attractive. As to domestic investors, selling ahead of significant issuance is a time-honored tradition.

 

Aside from oil, metals markets are under very modest pressure this morning, which has more to do with the rising dollar than anything specific to those markets.

 

And speaking of the dollar, it is on top of the world yet again this morning, rising against all its G10 counterparts and almost all its EMG counterparts.  SEK (-1.1%) is the worst G10 performer, after its PMI data was substantially worse than forecast with the Composite index tumbling to 47.6, a level only ever achieved during Covid, the GFC and the Eurozone banking/bond crisis.  In other words, things don’t look too good there.  But even NOK (-0.55%) is under pressure despite the strong rally in oil.  This is unadulterated USD strength.  Similarly, EMG currencies are all under pressure save ZAR (+0.6%), which seems to have responded positively to news that there would be reduced blackouts going forward. 

 

On the data front, there is not very much this week, so activity is likely to be driven by other markets given the FOMC is in their quiet period.

 

Today

Factory Orders

0.8%

 

-ex Transport

0.2%

 

ISM Services

52.4

Wednesday

Trade Balance

-$75.5B

Thursday

Initial Claims

237K

 

Continuing Claims

1802K

Source: Bloomberg

 

And that’s really all we’ve got for today.  To me, the biggest risk to markets is the fact that US equity performance is entirely reliant on 7 companies, all of which are very good companies, but whose performance has been extraordinarily outsized and does not seem representative of the economy or market as a whole.  At some point, those stocks are likely to come back to earth and that will result in a very large adjustment to views about the Fed, the economy, and the stock market.  But for now, it is hard to fight the trend, and that includes the dollar higher trend.

 

Good luck

Adf

 

 


			

	
	



				
					


	

		

			Worries Now Past
		


				

			Posted on  by 		

			


		

		
With debt default worries now past


And jobs data set for broadcast


Risk preference has grown


As folks want to own


The highest of flyers, and fast


 


 


Meanwhile, the idea that the Fed


Will raise rates this month is now dead


Inflation is sliding


And pundits are chiding


Those who think price gains are widespread


 


In what can only be surprising to those who traffic in fear porn, the Senate passed the debt ceiling bill, and it heads to President Biden’s desk today for his signature and enactment.  This outcome was always going to be the case, especially once the House passed its debt ceiling increase bill.  All the histrionics about the president’s unwillingness to negotiate were simply part of the theater that goes with the current form of politics.  However, there were enough people who bought into the drama and created hedges so that this outcome has had a market impact.  You may recall that there were fears of a US debt default and if that were to occur, equity markets would sell off sharply.  And that is likely very true, if the US were to default on its debt, that is what would happen.  However, as I wrote from the beginning, that was a highly unlikely outcome.  Nonetheless, yesterday did see a rally in equity markets in the US with the rest of the world following suit overnight.  Risk is back baby!


 


Meanwhile, we got further confirmation that the Fed is going to pause skip a rate hike this meeting and the Fed funds futures market has now fallen to a 25% probability of any movement.  One of the interesting things about this ongoing repricing is that the data is not showing any signs of a slowdown that would help reduce inflationary pressures.  For instance, yesterday’s ADP Employment data was a much stronger than expected 278K, beating forecasts by more than 100K, while Initial Claims data continue to slide from their recent peak in March.  In other words, as we await today’s NFP data, the latest data points show continued strength in the US labor market.  Helping that story was the employment sub index of the ISM report, which while the headline remains weak at 46.9, saw the employment index rise to 51.4.  In other words, companies, at least manufacturing companies, are still looking for employees.


 


So, what is on the cards for today?  Here are the latest median forecasts according to Bloomberg:


 








Nonfarm Payrolls




195K








Private Payrolls




165K








Manufacturing Payrolls




5K








Unemployment Rate




3.5%








Average Hourly Earnings




0.3% (4.4% Y/Y)








Average Weekly Hours




34.4








Participation Rate




62.6%








 


Certainly, none of this data is vaguely representative of a recession, at least in the traditional definition, where growth turns negative, and Unemployment rises sharply.  While Powell and company may skip a hike this meeting, looking at this data, as well as at the fact that the inflation data, whether CPI or PCE, continues to run well above their target, even if that target is an average, certainly does not indicate the Fed is done hiking.  And remember, while we had all gotten quite used to the idea that interest rates at 0% or 1% were the norm, that is not the long-term reality.  Going back to 1970 (all the data I have), the average Fed funds rate has been 4.92%, essentially where we are today, with a peak of 20.0% in March 1980 and of course a floor of 0.0%, which was the level until the recent hiking cycle for the bulk of the previous 13 years. 


 


My point is that anticipation of the Fed stopping because Fed funds are so much higher than they were for the last decade is a serious mistake.  Rates can go much higher, and at this point, as long as the Unemployment rate remains at or near its current level, all the evidence of this Fed points to higher rates in the future.  In fact, it has been this thesis that drives my dollar expectations for continued strength because I believe the US economy is far better placed to handle higher rates than are most others, and these high rates will continue to support the greenback.  Once again, this is why I continue to believe the NFP data is far more important than CPI, as NFP will be the trigger for a policy change, not CPI (or PCE).


 


As we await the data, the market is clearly in a good mood.  As mentioned above, equity markets worldwide have rallied nicely with every virtually every major market higher by 1% or more (the Hang Seng jumped 4% last night on rumors of further Chinese government support for its still faltering economy.)  Naturally, US futures are also pointing higher this morning as well, with all three major indices up at least 0.5%.


 


Meanwhile, bond yields have edged higher this morning with Treasury yields up less than 1bp while European sovereigns are seeing yields creep up 2bp-3bps.  This has all the feel of a risk-on move with investors moving from fixed income to equity investments at the margin.  After all, no US default combined with a Fed pause skip is as good as it gets!


 


In a reversal of recent moves, commodity prices are feeling quite frisky this morning with oil (+1.5%) and copper (+1.5%) both benefitting from the same story that helped the Hang Seng, further Chinese stimulus on the way.  Meanwhile, gold (+0.1%) is holding onto yesterday’s sharp gains as the dollar is under pressure this morning.


 


Speaking of the dollar, despite my medium-term view of pending strength, it is definitely on its back foot this morning. The bulk of the G10 is firmer, with the highest beta currencies leading the way (SEK +0.85%, AUD +0.75%, NOK +0.6%) as commodity strength feeds through the market.  In addition, there is a growing belief that the RBA may have one more hike in them if data continues to show strength.  In the emerging markets, the story has largely been the same with almost the entire bloc firmer vs. the dollar led by KRW (+1.25%) and ZAR (+1.0%).  The rand story is clearly a commodity one, while the won story is in sync with the Chinese stimulus idea given how dependent South Korea is on Chinese growth.  I should note the renminbi has also rallied about 0.5% this morning on that very same story.


 


And that’s really it.  At this point, all we can do is wait for the labor market data to be released.  Until then, don’t look for any movement of note.  If we see another strong NFP print, something like last month’s 253K, I expect that the dollar should benefit and reverse some of its overnight losses, although equities may very well remain supported on the soft landing scenario that continues to reappear.  FWIW, this poet sees continued NFP strength for now, but we shall see shortly.


 


Good luck and good weekend


Adf


 










			

	
	



				
					


	

		

			This Time They’ll Skip
		


				

			Posted on  by 		

			


		

		
Twas clearly much more than a quip


When several Fed speakers did flip


The narrative’s tune


‘Bout rate hikes in June


Implying that this time they’ll skip


 


However, don’t think that they’re done


As they know that in the long run


Inflation’s not dead


And Jay Powell’s said


They’ll not stop til this battle’s won


 


We learned some important new things yesterday regarding the economy and the Fed’s current reaction function, namely that the Labor market continues to be pretty hot and, more importantly, that despite that fact, the Fed is almost certainly going to forego a rate hike this month.  Regarding the Labor market, yesterday’s JOLTs Job Openings data printed back above 10 million openings after a dip below that level in the previous two months indicated that there was less labor demand.  This is crucial because the Fed clearly watches this number closely as part of their employment situation dashboard, and more openings implies more wage pressure higher, the key thing Powell and friends are trying to ameliorate.  After the release, stocks, which had opened lower already, fell a further 0.5% as expectations for a 25bp rate hike in two weeks rose further.


 


But never fear, when it comes to supporting financial markets, the Fed is always there to help and yesterday was no different than normal.  While, as noted yesterday, non-voter and uber-hawk Loretta Mester was clear she saw no reason to pause, we subsequently heard from two other Fed speakers, Philadelphia’s Patrick Harker and Governor (and vice-chairman select) Phillip Jefferson, that now would be a good time to pause skip a meeting and look around at how the already 500 basis points of rates hikes are impacting the economy. 


 


“I am in the camp increasingly coming into this meeting thinking that we really should skip, not pause, but skip an increase.  A pause would mean the Fed is going to hold its policy interest rate steady for a while.  It is too soon to make that call,” explained Harker at the OMFIF* Economic and Monetary Policy Institute. [emphasis added]


 


Meanwhile, Philip Jefferson explained, “a decision to hold our policy rate constant at a coming meeting should not be interpreted to mean that we have reached the peak rate for this cycle.  Indeed, skipping a rate hike at a coming meeting would allow the Committee to see more data before making decisions about the extent of additional policy firming.” [emphasis added]


 


Rounding out the guidance was an article from the Fed Whisperer, the WSJ’s Nick Timiraos, highlighting these two speeches and clearing any doubt that a rate hike on June 14th is a dead issue.  So, summing things up, the Fed is going to hold fire in two weeks but fully well expects to tighten policy further starting in July unless something really significant occurs.  It should be no surprise that the Fed funds futures market has adjusted its pricing to a 30% probability of a hike in June (down from ~65% yesterday morning) and an additional 45% probability of one by July.  I am confident, that barring a remarkably strong NFP number on Friday, that we will see that June probability shrink even further, likely to around 20%.


 


How will this impact markets?  Well, yesterday saw the first equity weakness in a while, although US markets only fell about -0.6% on the day.  However, we are already seeing a rebound as Asian markets were broadly higher, albeit not dramatically so, and we are seeing real strength in Europe this morning with the DAX higher by more than 1.1% and leading the way.  The interesting thing about Europe is that early this morning we saw the PMI Manufacturing data releases and it was not a pretty picture.  Germany (43.2) was the laggard, but the Eurozone as a whole (44.8) was hardly something to write home about.  In fact, these PMI readings have been sub-50 since last July, a pretty strong indication of a recession.  Adding to the dysfunction was German April Retail Sales, falling -8.6% Y/Y, back to Covid levels, and before that, last seen in 1980!  Arguably, this ongoing weakness in economic data is going to stay Madame Lagarde’s hand when it comes to the ECB’s policy tightening.  The combination of lower headline CPI data and clearly weaker economic activity will make any more rate hikes, especially in the face of a Fed that is not hiking this month, much more difficult.


 


As to bond yields, this morning they have stabilized after their recent sharp declines.  Right now, we are looking at slightly higher yields, on the order of 1bp to 2bps, which seems to be merely a trading reaction to the previous week’s decline of 18bps.  With the House having passed the debt ceiling bill last night (it now moves to the Senate), that market drama seems to have ended so I expect we will get back to talking about the economy and the Fed again, as well as, of course, inflation.


 


Oil prices (-0.4%) are continuing their downward slide as regardless of any supply questions, this market sees demand as cratering as we head into a recession.  It is, of course, this price action, that has the deflationistas back crowing again about the inevitable collapse of CPI and how the Fed will need to reverse course quickly.  I am not in that camp, but only time will tell.  Meanwhile, gold (+0.25%) and copper (+2.3%) are telling a different story, especially copper.  It is hard to make sense of a rising copper price, the metal most closely associated with economic activity, and a simultaneous decline in oil.  But hey, nobody ever said markets made sense.  This will resolve itself at some point, but clearly not today.


 


Finally, the dollar is a non-event today, with about half the G10 and EMG blocs rising and the other half sliding, none more than about 0.3%.  Movement like this is hard to define as anything more than position adjustments and trading activity with no real catalysts seen.


 


On the data front, we get a bunch of releases today as follows:


 


    

  • ADP Employment 170K
    • 

  • Nonfarm Productivity -2.4%   
    • 

  • Unit Labor Costs 0%    
    • 

  • Initial Claims 235K   
    • 

  • Continuing Claims 1800K
    • 

  • ISM Manufacturing 0
    • 

  • ISM Prices Paid 3
    • 



 


The ADP number is a day late due to the Memorial Day holiday on Monday, but I cannot help but look at the productivity and ULC data and consider how negative that is for the economy writ large.  As well, we hear again from Patrick Harker, the last scheduled speaker before the FOMC meeting on the 14th.  Of course, we heard his views yesterday so I doubt there will be anything new.


 


A skip is not a pause, and I believe that the Fed will not be deterred from their mission at this stage.  This means that the market will continue to price in tighter Fed policy and the dollar is likely to benefit accordingly.


 


Good luck


Adf


 


 


 


*OMFIF is the Official Monetary and Financial Institutions Forum, a think tank devoted to banking and central banking.  I, too, have never heard of this before.









			

	
	



				
					


	

		

			Far From a Floor
		


				

			Posted on  by 		

			


		

		

As energy prices decline





Inflation, at least the headline,





Continues to shrink





As central banks think





Their actions have been quite benign





 










The problem is that at its core





Inflation is far from a floor





So, Christine and Jay





Ain’t ready to say





They’re done and won’t hike anymore





 





European inflation readings continue to fall alongside the ongoing decline in energy prices.  Headline numbers in France, Italy and Germany, as well as Spain and most of the Eurozone, have fallen sharply in the past month and seem likely to continue to do so.  Core inflation readings, however, for those countries that measure such things, and for the Eurozone as a whole, are demonstrating the same stickiness that we have seen here in the US.  Ultimately, the problem is that an inflationary mindset has begun to take hold in many people’s view.  While there is a great deal of complaining about rising prices, people continue to pay them, and the hangover of fiscal stimulus that was seen everywhere and continues to be pumped into economies around the world has allowed companies to raise prices while maintaining sales. 





 





There continues to be a strong disagreement within the analyst community regarding the future of inflation as there are many who have watched the trajectory of energy price declines and anticipate a return to 0%-2% inflation by the end of the year.  At the same time, there is another camp, in which the Fxpoet falls, that expects inflation to remain sticky in the 4% range for the foreseeable future.  Arguably, until such time as the massive amount of liquidity that was injected into the economy in response to Covid (and the GFC) is removed, I fear prices will err on the side of rising faster than we had become used to for so long.





 





Taking this one step further, the central bank playbook on inflation, as written by Paul Volcker in the 1980’s, was to tighten monetary policy enough to cause a severe recession and break demand.  We all know that Chairman Powell has read that book and is following it as best he can these days.  And, he has most of his team on board with that view.  Just this morning, Cleveland Fed President, and known hawk, Loretta Mester explained to the FT, “I don’t really see a compelling reason to pause – meaning wait until you get more evidence to decide what to do.  I would see more of a compelling case for bringing rates up…and then holding for a while until you get less uncertain about where the economy is going.”  These are not the words of someone who is concerned that rising interest rates are going to derail the US economy.  It is sentiment like this that has the Fed funds futures market pricing in a 64% probability of a rate hike in two weeks’ time.  It is also sentiment like this that is supporting the dollar, which has traded to its highest level in more than two months and is crushing the large, vocal contingent of dollar short positions around.





 





But, heading back to the recession argument, the data that we continue to receive shows no clear signs in either direction, rather it shows lots of conflict.  Yesterday I mentioned the decline in GDI, a seeming harbinger of weaker growth.  Meanwhile, yesterday’s data releases perfectly encapsulated the issue, with Consumer Confidence printing at a higher than expected 102.3, while the Dallas Fed Manufacturing Index fell to a wretched -29.1, far worse than expected and a level only reached during recessions in the past.  And there’s more to this story as last night China’s PMI data was all released at worse than expected levels (Manufacturing 48.8, Non-manufacturing 54.5, Composite 52.9) with all 3 readings slowing compared to April and an indication that the Chinese reopening story seems well and truly dead. 





 





This poses a sticky problem for President Xi as the clearly slowing Chinese economy seems likely to require further stimulus, whether fiscal, monetary, or both, with the ‘smart money ‘betting on monetary easing.  However, the renminbi (-0.4%) fell again last night and has been sliding pretty steadily since January.  Now, firmly above 7.10, it is fast approaching levels that the PBOC has previously indicated are inappropriate.  The question is, what will they do?  Easing monetary policy opens the door to rising prices, a potentially severe problem in China, while standing pat will likely result in further economic decline, not exactly what Xi is seeking.  My money is on easier policy and if necessary, price controls, something at which the Chinese government excels.





 





One cannot be surprised that with news like this, risk is taking a breather today, despite the ongoing euphoria over NVDA and AI.  Yesterday’s mixed performance in the US led to substantial weakness overnight in Asia, with all main indices falling by at least -1.0%.  Meanwhile, Europe this morning is also largely in the red, albeit only to the tune of -0.5%, and at this hour (8:00) US futures are pointing lower by -0.3% across the board. 





 





At the same time, the combination of falling inflation rates in Europe and the fact that a debt ceiling deal appears to be coming together has yields continuing to slide with Treasuries (-4.4bps) actually underperforming European sovereign yields which are all lower by between 7bps and 8bps.  The other thing to note here is that the yield curve inversion in the US, currently back to -78bps, is showing no signs of righting itself soon.  It has been nearly one year since the curve inverted, and recession alarms have been ringing everywhere, although one has not yet been sighted.  I expect continued volatility in this market as the debt ceiling bill will allow for a significant uptick in issuance right away and the question is, who will buy all this debt? 





 





Oil prices (-2.8%) continue to point to slowing economic activity and that is confirmed by weakness in the base metals as well.  While the Fed sees no signs of a recession, it seems pretty clear that some markets disagree.  Do not be surprised to see another production cut by OPEC+ as the summer progresses.





 





Finally, the dollar is king again, rising against virtually all its G10 and EMG counterparts, with the G10, sans JPY, all falling between -0.4% and -0.6%.  This is a broadscale risk-off move and one which is likely to continue as long as we see the combination of tough talk from the Fed and slowing economic data.





 





Speaking of economic data, today brings Chicago PMI (exp 47.2), JOLTS Job Openings (9.4M) and the Fed’s Beige Book this afternoon.  It is pretty clear that manufacturing activity remains in the doldrums here but pay close attention to the JOLTS data as the Fed is watching it closely for clues as to labor market tightness.  A weak number there is likely to have a bigger market impact than anything else today.





 





Net, I see no reason to dispute the dollar’s strength at the current time.  Talk to me when the Fed changes its tune, and we can see a dollar reversal.  Until then, higher for longer is both the interest rate and USD mantra.





 





Good luck





Adf





 

			

	
	



				
					


	

		

			The New Bling
		


				

			Posted on  by 		

			


		

		

Though pundits on all sides maintained





A debt default soon was ordained





Instead, what we got





Was spending a lot





Of cash sans debt issues restrained





 





So, fear has now faded away





While risk preference is on display





AI is the thing





That is the new bling





And everyone wants it today!





 





This poet is in no position to discuss the particular merits, or lack thereof, regarding the debt ceiling deal that was reached over the weekend.  The only thing that ultimately matters is that a deal was reached and that despite a great deal of huffing and puffing yet to come, will almost certainly be passed and signed into law this week thus preventing any chance of a debt default by the US Treasury.  As such, another “crisis” has been averted and the market can go back to focusing on its favorite topic, the Fed.  Or is AI the market’s new favorite topic?





 





Having been around long enough to well remember the dot com bubble of 2000-2001, the AI discussion certainly seems to have a lot of parallels to that time.  Essentially, look for company after company to announce they are utilizing AI to improve their productivity and enhance the features of their products as they try to share the current positive attitude investors have on the subject.  And this is not to dispute that AI has the potential to be very beneficial over time as its strengths and weaknesses are better understood, it is just a comment that in the early stages of a new mania, association with the ‘thing’ is just as important as how that ‘thing’ is used.  I have a sense that like in the gold rush in 1849 in California, the ones making money will not be the miners (all those companies claiming AI is part of their process), but rather the sellers of the picks and shovels and supplies (NVDA and other semiconductor manufacturers) who are building the pieces needed to create AI.  But that doesn’t mean that equity markets won’t rally a bunch from here, regardless of valuations.  Be wary.





 





However, let’s head back to the macro discussion, an area more in tune with poetry.  Starting with the debt ceiling deal, as with all compromises, neither side is happy as both feel they gave away too much.  But the important thing is that, as always, the time pressure was sufficient to force movement on both sides and whatever the final shape of the bill, it will be passed.  This is especially true because you can be sure that now that a compromise has been reached, any failure to complete the process will be squarely blamed on the House Republicans by the entire global media complex regardless of the particulars.





 





With that out of the way, a quick look back to Friday’s PCE data shows that despite a growing sentiment that inflation is heading back down to, and below, 2% shortly, the Core PCE reading was a tick higher than forecast at 0.4% M/M and 4.7% Y/Y.  Meanwhile, the rest of the data Friday showed relative economic strength.  Durable Goods rose sharply, +1.0%, while Personal Income and Spending remained robust.  Not only that, but the Advance Goods Trade Balance widened to a -$96.8B deficit, indicating a lot of imports coming in, and Michigan Sentiment rose to 59.2, still largely awful, but above forecasts.





 





But all this data was in conflict with other data, notably Gross Domestic Income (GDI).  As per the below from Investopedia, GDI measures the amount of earnings while GDP measures the amount of production:





    

  • GDI = Wages + Profits + Interest Income + Rental Income + Taxes – Production/Import Subsidies + Statistical Adjustments
    • 




  • GDP = Consumption + Investment + Government Purchases + Exports – Imports
    • 






 





The fudge factor is Statistical Adjustments, but GDP has been the benchmark as the data tends to be more recent.  In theory, they should be equal, but that is just not the case, largely because of the timing of data releases.  Here’s the thing, the GDI data released last week, alongside the GDP data, showed that in Q1, GDI fell -2.3% while Q4 2022 GDI was revised lower to -3.3%.  That is two consecutive quarters of negative GDI, a situation that, when it has occurred in the past, has always happened during a recession.  So, once again we are seeing conflicting data with some numbers indicating ongoing economic strength while others are indicating the opposite.





 





What’s a risk manager to do?  The beauty of hedging is that when done properly, it helps mitigate large movement in whatever is being hedged, whether that is profitability, cash flow or expenses.  However, if pressed, it remains very difficult to believe that we can have the Fed raise interest rates as quickly and as far as they have already done without having some negative economic consequences coming down the line.  Remember, monetary policy works with ‘long and variable lags’ which has historically varied between 6 and 29 months from the onset of policy changes.  We are only 14 months into this process (first rate hike in March 2022), and while the housing market has clearly felt an impact, it is not clear that the rest of the economy has seen that much yet.





 





Looking ahead, there is still a huge wall of debt refinancing to come with rates much higher than before thus, at the very least, significant cost pressures on companies bottom lines.  And there will be those companies that cannot find financing at a level allowing continued operations.  In fact, bankruptcies have already been running at a record rate with more than 230 so far this year (counting companies with >$50 million in liabilities).  There is no reason to believe that trend will slow down as the Fed continues to raise rates.





 





Speaking of the Fed, the market is now pricing a 60% probability of a 25bp rate hike in June, up from just 30% one week ago, 13% two weeks ago and 0% immediately following the last meeting.  In addition, the market is removing its pricing of rate cuts as well, with now just 2 rate cuts priced in one year from now.  That number had been upwards of 150bps of cuts last month.  The point is that the market is finally taking the Fed at their word that rates will remain higher for longer, and that another hike or two are well within the realm of possibility.





 





It remains difficult for me to see how risk assets can continue to outperform with ongoing monetary policy tightening as well as slowing growth elsewhere in the world, notably Germany, which is already in recession, and China, where growth continues to lag forecasts and models as the property market, which had been a primary mover for decades, continues to flounder.





 





As to markets today, risk is mixed with modest gains in Asia overnight, a mixed bag in Europe this morning and US futures pointing to continued NASDAQ gains while the rest of the market stagnates.  Bond markets have seen yields decline sharply as fears over that debt default disappear with Treasury yields falling 8.3bps and similar size yield declines throughout Europe.  In the commodity space, oil (-2.0%) is falling on concerns slowing economic growth will continue to undermine demand while both gold (+0.8%) and copper (+4.5%) are rallying, the former on a bit of dollar weakness while the latter has been getting a huge amount of press regarding the structural shortages that will be exacerbated by the attempts to electrify everything.





 





Finally, the dollar is mixed, largely stronger vs. most of the EMG basket, albeit not hugely so, while the G10 has been outperforming this morning with GBP (+0.6%) the leader after BRC shop prices hit a new all-time high of 9.0% encouraging belief the BOE will need to tighten further.





 





This is a big week for data as we get the payroll report on Friday but plenty before then.





 







Today



Case Shiller Home Prices



-1.60%




 



Consumer Confidence



99.0




 



Dallas Fed Manufacturing



-18.0




Wednesday



Chicago PMI



47.2




 



JOLTS Job Openings



9439K




 



Fed’s Beige Book



 




Thursday



ADP Employment



165K




 



Initial Claims



235K




 



Continuing Claims



1803K




 



Nonfarm Productivity



-2.6%




 



Unit Labor Costs



6.3%




 



ISM Manufacturing



47.0




 



ISM Prices Paid



52.5




Friday



Nonfarm Payrolls



193K




 



Private Payrolls



173K




 



Manufacturing Payrolls



5K




 



Unemployment Rate



3.5%




 



Average Hourly Earnings



0.3% (4.4% Y/Y)




 



Average Weekly Hours



34.4




 



Participation Rate



62.6%







Source: Bloomberg





 





Clearly, all eyes will be on NFP on Friday, but there is much to be gleaned between now and then.  On the Fed speaker front, we hear from 5 more speakers ahead of the beginning of the quiet period starting Friday.  I maintain that the NFP data is the key for the Fed.  As long as it remains strong, Powell has cover to raise rates as much as he likes.  But once it cracks, look out below.  For now, nothing has changed my dollar view of continued strength until such time as policies change. 





 





Good luck





Adf





 





 






			

	
	



				
					


	

		

			On the Spot
		


				

			Posted on  by 		

			


		

		
This morning, it’s Core PCE


That markets are waiting to see


If it keeps on falling


More folks will be calling


For rate cuts ere end ‘Twenty-three




But what if the data is hot


That could put the Fed on the spot


Instead of a pause


That reading may cause


At least one more hike than was thought




As we head into the Memorial Day weekend, the market is awaiting some more key data points for the Fed’s calculus on inflation.  Today brings a plethora of things as follows (median expectations from Bloomberg):


    

  • Personal Income (exp 0.4%)
    • 

  • Personal Spending (0.5%)
    • 

  • Core PCE Deflator (0.3%, 4.6% Y/Y)
    • 

  • Durable Goods (-1.0%)
    • 

  • -ex Transport (-0.1%)
    • 

  • Michigan Sentiment (58.0)
    • 





Given the Fed’s preference for the Core PCE as their key inflation indicator, this data point is always a critical feature of the monthly slate.  However, since the FOMC Minutes were released on Wednesday, the market has already adjusted its views on the Fed’s future path.  Since the release, the market has removed another full 25bp cut from the medium-term outlook, with pricing for January 2024 rising from 4.50% to 4.735%.  It appears that the market is truly beginning to believe the Fed that it is going to remain higher for longer.




So, let’s look at the consequences of that policy stance and the market’s grudging acceptance.  Over the course of the past 3 weeks, 10-year Treasury yields have risen from 3.38% to 3.78% after giving up 3bps this morning. Meanwhile, 2-year Treasury yields have risen from 3.89% to 4.49%, increasing the curve inversion again, and highlighting the market view that a recession remains in the not-too-distant future.




Generally speaking, the combination of higher interest rates and recessionary indicators tends to undermine the equity market, but that picture is more nuanced these days as the incredibly narrow breadth of the price leaders has been able to overcome a more general malaise.  For instance, yesterday’s S&P 500 gain of 0.88% was largely the result of just three key tech names, NVDA, MSFT and AVGO, with the rest of the group mostly thrashing around.  This continues the trend of a handful of companies driving the value of the “broad” market indices, a situation that cannot go on forever, but for now, it seems fine.  Of course, the NASDAQ is even doing better since all those high performers are NASDAQ names.




However, one needs to ask, if the Fed continues to tighten policy further, and the market is now pricing a one-third probability that they hike another 25bps next month, and the result is a further slowdown in the economy, can these companies continue to perform?  Maybe they can, but history is not on their side.




Other markets, too, have been impacted by the slow realization that the Fed means what they have been saying all along, higher for longer.  While oil prices (+0.5%) are edging higher today, they have been significant underperformers along with base metals as concerns over future economic growth weigh on the sector.  Both copper and oil have been falling for the last several months as the largest importer of both, China, seems to find itself with its own economic malaise.  This is merely another input into the recession story.




Weakening growth in China and higher interest rates in the West to fight still too-high inflation do not bode well for economic activity for now.  Add to these factors the potential outcome from the debt ceiling negotiations, reduced Federal spending in the US, and you have a trifecta of reasons for a negative equity and risk market outlook.




Speaking of the debt ceiling, this morning’s headlines indicate that the two sides are getting closer, but that spending cuts are part of the process.  Naturally, this is controversial on the left side of the aisle, but the fact that not all the spending cuts included in the bill already passed by the House are going to be seen is controversial on the right side of the aisle.  If anything, this sounds like an excellent outcome, where neither side is happy, but both agree something must be done.  It is certainly no surprise to me that they are getting closer to agreement as this all has been part of the Congressional Kabuki that we regularly see on critical issues.  Remember, though, avoiding a debt default is not a huge positive sign, it is merely the absence of a negative one.




Where does this leave us?  Overall, the data remains mixed at best, with manufacturing indicators weakening, service indicators holding up, inflation remaining stickily high and the Fed continuing to pound its one main tool, the hammer of interest rate hikes on the economy.  Perhaps the most interesting data situation is that of Initial Claims, which yesterday printed at a much lower than expected 229K.  The fairly steady increases in layoffs that had been seen since the beginning of the year seem to be abating now.  In fact, the 4-week moving average of claims data has fallen back sharply to 231.8K, an indicator that the trend higher may be ending.  If this is the case, and the NFP data going forward remains robust, the Fed will have every reason to continue to tighten policy further, much further than is currently priced into the market.  As I have written in the past, I continue to believe that NFP is the most important data point.  As long as Unemployment remains low and jobs are created, the Fed will have all the cover it needs to maintain tight monetary policy.  Just be prepared for some other things to break, à la SVB and First Republic.




Finally, a word about the dollar, which while modestly softer today remains in a clear uptrend off the lows seen early in the month.  As long as the Fed maintains its current policy stance, one which is still being priced into the market, the dollar has further to rally.  Although other central banks have been tightening policy as well, notably the ECB and BOE, the Fed remains the leader of the pack.  Until the Fed finally halts, those two will lag and the dollar should remain strong.  It is only when the Fed finally reverses course, which may not be until the middle of next year on current pace, when we should see any substantial dollar weakness.  I would not hold my breath.




In the end, it all comes back to inflation.  Until the central banks believe that they have defeated inflation’s threats, barring a calamitous economic collapse, I would look for bond yields around the world to continue to drift higher, for equity markets to struggle, although further gains cannot be ruled out, and for the dollar to maintain its overall strength.




Good luck and good weekend


Adf



			

	
	



				
					


	

		

			Much Pain
		


				

			Posted on  by 		

			


		

		

There once was a nation quite strong





Whose policies worked for so long





But war in Ukraine





Inflicted much pain





And now it seems they were all wrong





Relying on, energy, cheap





They rose to the top of the heap





But when prices rose





They’d naught to propose





‘Bout how to, advantages, keep





It turns out that Germany has fallen into a recession after all.  The German Statistics office revised down their Q4 2022 GDP reading from stagnation at 0.0%, to a -0.5% reading after adjusting for a substantial decline in government spending.  Meanwhile, Q1 GDP growth fell -0.3%, so Germany is solidly in a recession, at least based on the traditional definition of two consecutive quarters of negative GDP growth.  It certainly is remarkable that an economy that predicated itself on levering cheap, imported energy into the manufacture of steel, chemicals and machinery would encounter any problems simply because it became totally reliant on raw materials from a communist regime…NOT!  But in fairness, the Germans have hamstrung themselves by spending hundreds of billions of euros in their Energiewende program to reduce greenhouse gas emissions.  Unfortunately, this included shuttering their entire nuclear power fleet, which had produced upwards of 25% of their electricity with zero emissions and replacing it with heavily subsidized solar and wind power generation.  (By the way, whoever thought that solar power was a good idea in Northern Europe?  Arizona I get, Germany not so much.)





Granted, prior to Vladimir Putin invading Ukraine, things were going along swimmingly.  China was soaking up so much of what Germany was producing, and of course the rest of Europe were huge customers as well.  But it turns out risk management is a real thing, and not just when it comes to your foreign exchange or interest rate risks.  If we learned nothing else from the Covid pandemic it is that surety of supply of critical products or inputs is worth a lot, perhaps just as much as the price of that supply.  





Once Russia invaded, though, the world changed dramatically, and a critical flaw in the German economy was exposed.  Prior to the invasion, because of Energiewende, German electricity prices were the highest in Europe and approaching the highest in the world.  And that included cheap Russian gas as a source.  Now those prices are higher still and major manufacturers are picking up stakes and moving their facilities to places where they can get reliable, and relatively inexpensive, energy.  BASF moving key production to both China and Saudi Arabia is merely indicative of the problems Germany will have going forward.  It strikes me that Germany has a long road to hoe in order to get their economy back working as effectively as it had in the past.  This does not bode well for the euro (-0.2%) which is continuing its slow grind lower this morning, as the dollar continues to buck the majority analyst view of USD weakness.





The future belongs to AI





At least that’s what bulls glorify





So, last night we learned





Nvidia earned





A ton helping futures to fly





Obviously, this is not an equity piece and so I rarely cover specific names, but the buzz on Nvidia’s earnings is having a significant impact on markets overall.  The most instructive thing is to look at the performance of the NASDAQ vs. that of the Dow, at least in the pre-market futures trading.  At this hour (7:30), NASDAQ futures are higher by 2.0% while Dow futures are lower by -0.4%.  This dichotomy continues to grow on a daily basis, with the tech megacaps generating virtually all of the equity market performance seen this year, hence the relative outperformance of the NASDAQ vs. both the S&P 500 and the Dow.  The narrowing breadth of the market’s performance, with 7 names accounting for more than the entire S&P 500 gains this year means the other 493 names are actually lower.  From a more macro point of view, historically, price action of this nature has preceded significant bear markets every time it has occurred.  It is very easy to look at the totality of information including still high US inflation, softening growth metrics and a stock market that is reliant on just 7 names for its performance, and conclude a reckoning is coming.  Oh yeah, did I mention that the Fed remains committed to keeping its policy at current, relatively tight levels?  It is no wonder that the recession that is forecast to come soon is so widely forecast.





Quickly, the FOMC Minutes yesterday indicated that while there was a lot of discussion as to whether or not rates needed to go higher, there was zero discussion that rates would need to decline anytime soon.  The commentary we have heard since the last meeting has certainly had a less conclusive tone regarding further hikes, with several members indicating they thought a pause for observation was worthwhile.  But unless the economy craters, and Unemployment spikes much higher, there is no reason  to believe the Fed is going to change course.  And that, my friends, will continue to support the greenback for quite a while.





As to the overnight session, after a weak US equity performance yesterday, Asia was mixed and most European bourses are edging lower on the order of -0.2%.  It is certainly no surprise that the DAX is falling, and we have also seen lackluster data from France weighing on the CAC.  The problem for Europe is they don’t have any megacap tech stocks to support the indices.





Bond yields continue to mostly edge higher with gains on the order of 1bp this morning although there was a standout here, Gilt yields have risen by 9bps, still feeling the hangover from yesterday’s inflation data.





Meanwhile, in commodities, recession is the watchword as oil prices (-1.2%) are giving back some of their recent gains, although copper has seen a trading bounce.  





And finally, in the FX markets, the dollar continues to perform well, rising against all its G10 and most EMG counterparts.  Remarkably, the debt ceiling concerns seem to be the driver as the dollar is still considered the safest of havens despite the issues here.  There have been no outstanding stories to note other than the risk-off nature of things.





On the data front, we see Initial (exp 245K) and Continuing (1800K) Claims as well as the second look at Q! GDP (1.1%).  Also, Chicago Fed  National Activity (-0.2) is released, which has been pointing to slowing economic growth for a while now.   Two Fed speakers, Barkin and Collins are on the slate today, but I feel that mixed message continues unabated and won’t be changed here.





Ultimately, until the Fed backs off, the dollar is going to continue to perform well, keep that in mind.





Good luck





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