Author Archives: fxpoet

Possibly Burst

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It turns out inflation’s not dead

At least in the UK, instead

With prices there surging

The market is purging

All thoughts rate cuts might be ahead

However, elsewhere, there’s concern

That soon there will be a downturn

Thus, stocks have reversed

And possibly burst

The bubble for which most folks yearn

Interestingly, inflation discussions are really beginning to diverge around the world.  What had been a global phenomenon, with prices rising everywhere on the back of pandemic lockdown induced shortages combined with massive fiscal stimulus pumping up demand, is starting to shake out a bit more idiosyncratically.  While in the US we have seen a clear reduction in the trend of prices over the past year, albeit still far above the Fed’s comfort level, elsewhere, this is not necessarily the case.  Today’s example is the UK, where CPI printed at 8.7%, far above the median forecast of 8.2%, although mercifully lower than last month’s 10.1%.  However, core CPI, which excludes energy, food, alcohol and tobacco in the UK, rose to 6.8%, a new high level for this bout of inflation and the highest in the UK since 1992.

One cannot be surprised that the market responded with Gilt yields jumping more than 6bps while the rest of global bond markets have seen yields decline in the face of a broad risk-off sentiment.  More impressively, the OIS market has immediately priced in more than 30bps of additional rate hikes before the end of the year this morning.  While UK stocks are lower, so are equity markets everywhere around the world and perhaps most surprisingly, the pound has only fallen -0.2%.  I suspect that is due to the tension of higher interest rates supporting the currency while worries over the future of policy and the economy are undermining it.  That said, year-to-date, the pound is still the best performing G10 currency vs. the dollar, with gains on the order of 2.5%.  If pressed, I would expect that the pound is likely to range trade going forward as the market continues to reprice Fed expectations higher (removing those forecast rate cuts) while the UK side remains stagnant for now.

Turning our attention to the economy writ large, there is a growing sense that the widely expected recession is coming soon to a screen near you.  Data continues to show weakening trends with, for instance, today’s German IFO Expectations falling to 88.6, far below forecasts, on the back of weakening manufacturing trends in Germany.  As well, yesterday’s US data had its lowlights with the flash manufacturing PMI falling to 48.5, while the Richmond Fed Manufacturing Index fell to -15, both well below expectations.  Layer on the background debt ceiling concerns, where the most recent word is that talks have stalled right now, and there is plenty of reason to turn pessimistic on things.  Arguably, these were keys to yesterday’s equity market declines in the US and we have continued to see red on the screens in every market in Asia and Europe. 

One of the biggest market concerns is China, where talk of slowing growth is continuing as this month’s production and investment data, released last week, was generally softer than expected with property continuing to drag things down, but fixed assets in general softening further.  There continue to be expectations that the PBOC is going to be easing monetary policy further and the renminbi’s recent slide shows no signs of stopping.  This view is also evident in commodity markets, specifically metals markets where copper (-1.5% today, -4.1% in the past week) and aluminum (-0.6%, -3.7%) are under increased pressure as concerns over slowing Chinese growth are impacting demand for these key industrial metals.  

There is, however, one place where this is not so evident, oil prices (+1.5%) as the market continues to respond to prospective production cuts by OPEC+ in the coming months.   The thing about oil is that its demand elasticity is nearly vertical.  Certainly, at the margins there can be more or less demand based on the economic conditions extant, but there is a baseline of demand that is simply not going to disappear.  It is important to remember that despite all the efforts at reduction in the use of fossil fuels, global oil demand hit a record last year.  It is also key to remember that for the past decade, investment in the production of new oil and gas reserves has been severely lacking.  The implication is that while oil prices have fallen well below the highs seen in the immediate wake of the Russian invasion of Ukraine, nothing has changed the long-term supply demand equation which greatly favors demand over supply, i.e. oil prices are likely to rise consistently, if not steadily, over the coming decades.

Summing it all up, today appears to have investors and traders thinking the worst, not the best of things going forward.

A quick look at overnight markets shows that equity market declines have largely been greater than -1.0% with the biggest markets, DAX, CAC, FTSE 100, pushing -2.0%.  There has been no place to hide here, and from a technical perspective, yesterday’s price action looks like an outside bearish reversal, which simply means that the closing level has market technicians selling for right now.  We have seen a significant equity rally in the face of a lot of negative news, so perhaps that run is now over.

Global bond yields are consolidating recent gains, with small declines today not nearly enough to offset what had been 30bp-40bp increases in the past two weeks.  In this market, clearly the debt ceiling talks are the primary story with macroeconomics a distant second for now.  There is just one week before the X-date, at least the latest one, and I suspect that we will hear of an agreement early next week helping to reduce at least some of the pressure on risk attitudes.

Lastly, the dollar is largely stronger this morning with an outlier in NZD (-1.85%) which fell sharply after the RBNZ essentially promised that last night’s 25bp rate hike, to 5.50%, is the last one coming, a big change from market expectations of a 50% probability of a 50bp hike last night.  Essentially, they explained that property market pressures and slowing consumer activity convinced them rates are appropriate to fight inflation.  Kiwi dragged Aussie (-0.5%) lower as well, but the rest of the bloc has seen far less damage with the yen (+0.15%) actually managing a small gain.  But make no mistake, over the past week and month, the dollar has regained its footing, at least against the G10.

In the emerging market bloc, the picture is more mixed with both winners and losers overnight with HUF (+0.8%) the leader, bouncing after the central bank cut its Deposit rate by 1 full percentage point yesterday, as expected and the forint fell sharply.  Meanwhile, MXN (+0.6%) is also showing signs of life after having fallen every day in the past week as the market now assumes Banxico has finished its rate hikes.  On the downside, MYR (-0.45%) and KRW (-0.4%) are both feeling the pressure of the weaker Chinese growth story given its importance to their own economies.

On the data front, the FOMC Minutes are released this afternoon and have a chance to be quite interesting given what appears to be the beginning of a split of opinions regarding the appropriate next steps.  As well, we hear from Governor Waller around lunch time, and ahead of the Minutes.  Waller certainly leans toward the hawkish end of the spectrum, so keep that in mind.

Adding it all up and the combination of declining risk appetite and a growing belief that the Fed is not going to pivot anytime soon implies that the dollar should maintain its footing for now.

Good luck

Adf

Widened the Spread

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Twixt ceilings for debt and the Fed

The market has widened the spread

Of rates here at home

Despite what Jerome

Last weekend ostensibly said

Thus, dollars remain to the fore

As traders want so many more

The megacaps rise

But in a surprise

There’s less and less talk of the war

The debt ceiling negotiations remain at the top of the market’s list of concerns as the ostensible X-date of June 1stapproaches.  Certainly, the positive aspect is that both sides are talking as opposed to merely grandstanding, but as is always the case in a political standoff with a non-political impact, it is clear no deal will be reached until the Nth hour.  The other thing to remember is that the June 1st date is not a hard deadline, it is the current estimate by Secretary Yellen and subject to change.  In the end, nothing has changed my view that a deal will be reached as both sides desperately want one, but also, no deal will be reached until both sides can explain to their supporters that they did everything possible to achieve their agendas.

However, this process is clearly having an impact on the markets, especially in the interest rate space as we have seen 10-year Treasury yields, which are higher today by 3.3bps, rise 36 basis points in the past two weeks.  In addition, the yield curve inversion, which at one point had fallen to as low as -41bps, is back to a -64bp difference.  Not only that, but the 4-week T-bill, the nearest expiry past the X-date, is now yielding 5.47%, far above Fed funds and the highest spot on the yield curve.  That is clearly a direct response to fears over a possible default.  My sense is this process will go on right through Memorial Day and US interest rates may well have further to rise between now and then.

But this begs the question, are US rates dragging up rates around the world?  I would argue the answer is yes.  Looking at European sovereigns, which have all seen yields rise by around 3bps-4bps today (Gilts are actually +8bps), they have all risen in concert with Treasury yields.  During the same time frame that Treasuries rose 36bps, Bunds are +28bps, OATS +25bps and Gilts +43bps.  Yet during that period, the dollar has gained more than 1% vs. both the euro and the pound (and all the other G10 currencies as well). 

Perhaps what we are seeing is a new safe haven asset being born, the US megacap tech stock.  The likes of Apple, Microsoft and Alphabet have seen steady strength, helping to drive the NASDAQ 100 Index up nearly 5% during this same two-week period.  In fact, a quick look at YTD performance in US equity markets shows that the Dow Jones Industrials are +0.4% YTD while the NASDAQ is up 21.5%.  In the past, there was a concept during bouts of USD strength that investors were buying dollars to buy Treasuries.  I think right now investors are buying dollars to buy Apple!  In fairness, one can see the premise as regardless of the debt ceiling outcome or timing, the belief that Apple (or Microsoft or Alphabet) shares will react to that news rather than their own positive stories generates no concerns.

Of course, those names are the exceptions to the rule as the bulk of the rest of the market has been under pressure recently on the back of all the catastrophic predictions if the debt ceiling isn’t raised and the US defaults on its debt.  This can be seen in the fact that the other major indices have seen almost no movement, just sideways trading, during the recent period in question.

Turning to the Fed, it appears that we are reaching an inflection point in the tightening process, or at least in the rate hiking cycle.  While prior to the last FOMC meeting, virtually every speaker was on the same message, we are starting to see some differences.  Most importantly, Powell, last weekend, hinted that there was some concern that the continued rate hikes were starting to impact financial stability (seriously, after 4 major bank failures it is now a concern?). But the implication is that while inflation remains job number one, there are other issues on the agenda.  That seems to be the dovishness that was attributed to Powell over the weekend.

Meanwhile, yesterday we heard from two regional Fed presidents.  James Bullard from St Louis, who said that he saw at least two more rate hikes (50bps total) as necessary to be certain they have slain the inflation dragon.  As per Bloomberg news, “I think we’re going to have to grind higher with the policy rate in order to put enough downward pressure on inflation and to return inflation to target in a timely manner,” Bullard said at an event in Florida on Monday.  “I’m thinking two more moves this year — exactly where those would be this year I don’t know — but I’ve often advocated sooner rather than later.”

However, we also heard from Minneapolis President Neel Kashkari with a different message, “I think right now it’s a close call, either way, versus raising another time in June or skipping.  What’s important to me is not signaling that we’re done.”  I guess the Eccles Building will be rocking in June when they next meet.

As it stands currently, at least according to the Fed funds futures market, the market is pricing in a 23% probability of a 25bp rate hike on June 14th.  Remember, though, between now and then we see a lot of critical data including this week’s Core PCE release, next week’s NFP data and finally the May CPI data, scheduled to be released the day before the FOMC announcement.  In the meantime, all eyes seem to be on the debt ceiling negotiations, and reasonably so, given the fallout could begin before the big data comes. 

Looking at today, the big movers overnight were the bond markets with equity markets mildly in the red in both Asia and Europe.  US futures are also edging lower, but barely -0.1% at this hour (7:45).  As to commodities, oil (+0.5%) is edging higher on word that the Saudis are going to push for another production cut, while gold (-0.5%) is sliding on the back of the strong dollar and the base metals are falling again, clearly anticipating a recession.

As to the dollar, it remains king of the hill, continuing to rally vs. virtually all its G10 counterparts with only the yen (+0.1%) managing to hold its own.  In the emerging market space, the story is similar with HUF (-1.0%) the laggard on expectations of a rate cut today and the bulk of the bloc lower.  The one outlier seems to be KRW (+0.4%) which saw substantial equity inflows as the driver.  I would be remiss if I didn’t mention that CNY has rallied substantially in my absence and is now well above 7.0500 as there is a growing belief the PBOC will continue to ease policy to support the Chinese economy.

On the data front today, we see preliminary PMI data (exp 50.0 Mfg, 52.5 Services) and New Home Sales (665K).  The European flash PMI data was slightly soft, but pretty close to expectations.  Meanwhile, only Dallas Fed President Lorie Logan is on the docket today, but don’t be surprised to hear from others on CNBC or BBG as they basically cannot shut up.

In the wake of the Silicon Valley Bank failure, I was convinced the Fed was going to be finished and accordingly, changed my views on the dollar.  I had been bullish until a clear pivot was seen and I thought that was the case.  However, it increasingly appears that no pivot is coming and that higher for longer is the future.  In that case, I have to revert to my original stance and look for continued dollar strength until we get that signal.

Good luck

Adf

Bombarded

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There once was a poet who wrote
‘Bout foreign exchange in a note
Right now he’s at home
Though, yet, he may roam
For now, though, enjoy, please, each quote

Meanwhile, for the week that has passed
The debt drama has some aghast
So, markets are guarded
While we are bombarded
With stories this drama can’t last

Since I last wrote, the dollar is broadly stronger, stocks have managed to continue to rally, and bond yields have risen to the top end of their recent trading range with the 10-year at 3.65%.  But really, it seems that despite a weak Retail Sales print last week, and some other mixed data, all eyes are really turning to Washington and the ongoing debt ceiling negotiations between President Biden and House Speaker McCarthy.  At this point, while the House has passed a bill that includes a significant, $1.5 trillion, debt ceiling increase, although combined with spending cuts over the next decade that amount to ~$4.5 trillion, the President has proffered nothing other than a resounding No.  Ultimately, this is a political calculation as to the President’s belief he can blame any negative outcome on McCarthy and the Republicans, although that remains to be seen.

At the same time, we continue to receive apocalyptic warnings from Treasury Secretary Yellen, as well as various other officials, politicians, and bank CEOs.  And there is no doubt that an actual US default would be extraordinarily bad for pretty much everyone.  However, as Winston Churchill has been credited with saying (though remains true whoever said it), Americans can always be counted on to do the right thing…once every other choice has been exhausted.  We have seen these political dramas before, and I have no doubt we will see them again in the future but in the end, nothing has changed my view that a deal will be struck and there will be no apocalypse, at least not this time.

So, what does that mean when that deal is struck?  Well, ironically, one of the drivers of recent equity market strength has been the running down of the Treasury General Account (TGA) at the Fed.  That is the Treasury’s ‘checking’ account from which they pay all the US’s bills.  As can be seen from the below chart, post the GFC, the average balance has been in the $200 billion range, although there have obviously been several enormous peaks during the Covid situation.  For context, prior to the GFC, the TGA balance averaged just $5.8 billion.  Perhaps there is no better description of what QE has done than this, as well no better signal of today’s inflation and its causes than this fact.

Data Source, FRED database

The problem is that number has been shrinking, maintaining liquidity in the market that might otherwise not be available.  In fact, one of the key concerns in the market right now is that when the debt ceiling is finally raised, the Treasury, which through its extraordinary measures has been running down balances as well as delaying payments into government pension accounts and the like, will need to issue a significant amount of new debt, perhaps up to $1 trillion pretty quickly, which will suck a lot of liquidity out of the equity market as investors look at the return on T-bills and conclude safety at a 5% yield is very attractive.  Clearly, tax receipts are another part of the puzzle, but recent receipts have been coming in lower than forecast adding more pressure to the Treasury.  

The point is that one needs to be careful in expecting that the resolution of this issue will automatically have a bullish impact on risk assets.  In fact, it could be just the opposite, so beware.

As to this morning’s markets, mixed is an apt description.  While Friday’s US equity market performance was dull, with very modest declines, Asia saw gains overnight and Europe opened in the green.  Alas, European bourses have since turned lower although US futures are currently unchanged (7:30).  Given the potential impact on financial markets in the event the US does default, it seems likely that risk assets will struggle to gain much until there is a conclusion of this drama.

Bond yields, meanwhile, are continuing their drift higher from last week, although Treasury yields are unchanged at this hour.  In Europe, though, sovereign yields are edging up between 1bp and 2bps.  There is one place, though, where yields remain in check, Japan, where the 10yr yield, at 0.378%, remains far below the YCC cap and is exerting no pressure on Governor Ueda.

Oil prices (+0.3%) are a touch higher this morning having bounced off their lows from the beginning of the month but remain far below the post OPEC+ production cut highs from April.  As I have been writing, the commodity market seems to be the only one that is really pricing in a recession, with metals prices also continuing under pressure, including gold despite its haven characteristics.

Finally, the dollar is showing both gains and losses today in both the G10 and EMG blocs.  CHF (+0.4%) is the leading G10 gainer on what appear to be technical trading patterns more than new information.  On the flip side, the commodity bloc (AUD, NOK, CAD) is under very modest pressure this morning, but really not much to say here.  In the EMG bloc, ZAR (+0.65%) and KRW (+0.6%) are the top of the heap, ostensibly on the back of a dovish reading of some comments by Chairman Powell over the weekend.  However, there are a number of laggards, notably MXN (-0.5%) despite those same remarks.  Arguably, if they were truly that dovish, we would see the dollar softer across the board, something that has not been the case for a while.

Until the debt ceiling drama is over, I anticipate a relatively limited amount of market movement.  And when it is finally concluded, it will depend on the actual agreement, I think, to really get a sense of any medium- or long-term impacts.  Until then, trade the range.

Good luck
Adf

Ready to Pop

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Investors are having some trouble
Determining if the stock bubble
Is ready to pop
Or if Jay will prop
It up, ere it all turns to rubble

So, volatile markets are here
Most likely the rest of this year
Then, add to this fact
A Russian attack
On Ukraine.  I’d forecast more fear

One has to be impressed with yesterday’s equity markets in the US, where the morning appeared to be Armageddon, while the afternoon evolved into euphoria.  Did anything actually change with respect to information during the day?  I would argue, no, there was nothing new of note.  The proximate cause of the stock market’s decline appeared to be fear over escalating tensions in the Ukraine.  Certainly, that has not changed.  Russia continues to mass troops on its border and is proceeding with live fire drills off the coast of Ireland.  The Pentagon issued an order for troops to be ready for rapid deployment, which Russia claimed was fanning the flames of this issue.  While the key protagonists continue to talk, as of yet, there has been no indication that a negotiated solution is imminent.  With that in mind, though, today’s market reactions indicate somewhat less concern over a kinetic war.  European equity markets are all nicely higher (DAX +0.6%, CAC +0.8%, FTSE 100 +0.75%) and NatGas in Europe (-2.4%) has retraced a bit of yesterday’s surge.  Granted, these reversals are only a fraction of yesterday’s movement, but at least markets are calmer this morning.

However, one day of calm is not nearly enough to claim that the worst is behind us.  And, of course, none of this even considers the FOMC meeting which begins this morning and from which we will learn the Fed’s latest views tomorrow afternoon.  The punditry is virtually unanimous in their view that the first Fed funds hike will come in March and there will be one each quarter thereafter.  In fact, if there are any outliers, they expect a faster pace of rate hikes with five or more this year as the Fed makes a more concerted effort to temper rising prices.

Now, we have not heard from a Fed speaker since January 13th, nearly two weeks ago, although at that time there was a growing consensus that tighter policy needed to come sooner and via both rate hikes and balance sheet reduction.  But let’s take a look at the data we have seen since then.  Retail Sales were awful, -1.9%; IP -0.1% and Capacity Utilization (76.5%) both disappointed as did the Michigan Sentiment indicator at 68.8, its lowest print since 2011.  While the housing market continues to perform well, Claims data was much higher than anticipated and the Chicago Fed Activity Index fell sharply to -0.15, where any negative reading is seen as a harbinger of future economic weakness.  Finally, the Atlanta Fed’s GDPNow indicator has fallen to 5.14%, down from nearly 10% in December.  The point is, the data story is not one of unadulterated growth, but rather of an economy that is struggling somewhat.  It is this issue that informs my decision that the Fed is likely to sound far more dovish than market expectations tomorrow,  The policy error that has been discussed by the punditry is the Fed tightening policy into an economic slowdown and exacerbating the situation.  I think they are keenly aware of this and will move far more slowly to tackle inflation, especially given their underlying view that inflation is going to return to its previous trend on its own once supply chains are rebuilt.

For now, barring live fire in Ukraine, it seems the market is quite likely to remain rangebound until we hear from Mr Powell tomorrow afternoon.  As such, it is reasonable to expect a bit less market volatility than we saw yesterday.  But, do not discount the fact that markets remain highly leveraged in all spaces and that the reduction of high leverage has been a key driver of every market correction in history.  Add that to the fact that a Fed that is tightening policy may push rates to a point where levered accounts are forced to respond, and you have the makings of increased market volatility going forward.  While greed remains a powerful emotion, nothing trumps fear as a driver of market activity.  Yesterday was just an inkling of how things may play out.  Keep that in mind as we go forward.

Touring the markets this morning, while Europe is bouncing from yesterday’s movement as mentioned above, Asia saw no respite with sharp declines across the board (Nikkei -1.7%, Hang Seng -1.7%, Shanghai -2.6%).  US futures, too, are under pressure at this hour with NASDAQ (-1.7%) leading the way, but the other main indices much lower as well.

Looking at bond markets, European sovereigns are all softer with yields backing up as risk is re-embraced (Bunds +2.1bps, OATs +1.4bps, Gilts +4.4bps) as are Treasury markets (+0.7bps), despite the weakness in equity futures.  Bond investors are having a hard time determining if they should respond to ongoing high inflation prints or risk reduction metrics.  In the end, I continue to believe the latter will be the driving force and yields will not rise very high despite rising inflation.  The Fed, and most central banks, are willing to live with rising prices if it means they can stabilize bond yields at relatively low levels.

In the commodity markets, oil (+0.1%), after falling sharply from its recent highs yesterday has rebounded slightly.  NatGas (-1.4%) in the US is also dipping although remains right around $4/mmBTU in the US and $30/mmBTU in Europe.  Gold (-0.25%) and Copper (-0.3%) continue to consolidate as prospects for weaker growth hamper gains of the latter while uncertainty over inflation continue to bedevil the former.

As to the dollar, it is stronger for a second day in a row today, with substantial gains against both G10 (NOK -0.7%, CHF -0.7%, SEK -0.6%) and EMG (PLN -0.75%, RON -0.5%, MXN -0.45%) currencies.  Clearly, the Ukraine situation remains a problem for those countries in proximity to the geography, while Mexico responds to slightly disappointing GDP growth data just released.  But in the end, the dollar remains the haven of choice during this crisis and is likely to remain well bid for now.  However, if, as I suspect, the Fed comes across as less hawkish tomorrow, look for the greenback to give up some of its recent gains.

This morning brings only second tier data; Case Shiller Home Prices (exp 18.0%) and Consumer Confidence (111.1).  So, odds are that the FX market will continue to take its cues from equities, and if the sell-off resumes in stocks, I would expect the dollar to remain firm.  For payables hedgers, consider taking advantage of this strong dollar as I foresee weakness in its future as the year progresses.

Good luck and stay safe
Adf

Becoming a Bane

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Twixt Europe and Russia, Ukraine
Is feeling incredible strain
As diplomats leave
The markets perceive
That risk is becoming a bane

The fear is that war is in view
At which time the best thing to do
Is buy francs and yen
And Treasuries, then
Be ready for stocks to eschew

While it is true that the Fed meeting on Wednesday is of significant importance to market participants, there is another, much greater concern that has risen to the top of the list today, the growing sound of war drums in the Ukraine.  Both sides seem to be increasing both their activities and their rhetoric, and financial markets are really starting to take notice.  The immediate losers have been on the Russian side as the MOEX (Russian stock market index) is down 6.1% so far this morning and 15% YTD.  In addition, RUB (-1.5%) is the worst performing EMG currency today and this year, having fallen -5.0% so far.  The implication is that international investors are fleeing given the threats of retaliation by the EU and NATO in the event Russia actually does invade.

The latest headline from the EU is, FURTHER MILITARY AGGRESSION TO COME AT SEVERE COST.  You can see why owning Russian assets seems quite risky here as on a military basis, there is probably very little the EU or NATO can do in response to an invasion.  But they can certainly impose much more severe economic sanctions and even boot Russia from the SWIFT system, removing the nation’s access to dollars for any transactions.  Of course, given the fact that Germany is so reliant on Russia for its natural gas supply, which by the way has seen prices explode higher this morning in Europe by 12.3%, it does seem unlikely that the most severe sanctions will be imposed.

Will this devolve into war?  There is no way to know at this time.  My take is neither side wants a hot war as those are extremely expensive and difficult to prosecute, but President Putin has an agenda with respect to the West’s attitude toward the Ukraine and what constitutes the Russian sphere of influence.  Arguably, one of the big concerns is that leadership in the West lacks both real world experience and any mandate to “protect” the Ukraine.  However, they also don’t want to look either foolish or weak to their own constituents.  I fear that pride and hubris on both sides could result in a much worse outcome than needs to occur.  For a long time, I read the Ukraine tensions as a negotiating tactic by Putin to achieve a greater buffer zone around Russia.  Alas, the situation seems to have deteriorated pretty severely and pretty quickly.  At this time, one must be prepared for a more dramatic and negative outcome, one which is likely to see traditional havens like yen, Swiss francs, the dollar, and Treasuries rise dramatically.

Apparently, President Xi
Does not like the FOMC
As Jay keeps implying
That rates will be flying
And Xi can’t force growth by decree

While Covid has been an extraordinary burden on the world in so many different ways, as with all things, there has been a modicum of good as a result as well.  For instance, the WEF has been downgraded to a bunch of Zoom calls with no elite hobnobbing and very little press overall.  However, that elite cadre persist in their efforts to rule the world by decree and I thought it worth highlighting something that didn’t get much press last week when it occurred but offers an indication of China’s current economic thinking.  President Xi’s speech included the following, (emphasis added) “Second, we need to resolve various risks and promote steady recovery of the world economy. The world economy is emerging from the depths, yet it still faces many constraints. The global industrial and supply chains have been disrupted. Commodity prices continue to rise. Energy supply remains tight. These risks compound one another and heighten the uncertainty about economic recovery. The global low inflation environment has notably changed, and the risks of inflation driven by multiple factors are surfacing. If major economies slam on the brakes or take a U-turn in their monetary policies, there would be serious negative spillovers. They would present challenges to global economic and financial stability and developing countries would bear the brunt of it.”

Boiled down, this comes to Xi Jinping basically asking (telling?) Jay Powell to avoid raising rates as that would be a problem for China, as well as other EMG economies.  Now, I don’t believe that Chairman Powell is overly concerned about China, but I do believe that while the tightening of policy is very likely to start, it will be short-lived as the economic situation proves to be less robust than currently thought.  However, I thought it instructive as backdrop for recent actions by the PBOC and as a harbinger of the future, where interest rates there are likely to continue declining.  However, nothing has changed my view that the renminbi (+0.2%) is going to continue to strengthen this year.

Ok, so a tour of markets makes for some pretty sad reading this morning.  While the Nikkei (+0.25%) managed to eke out a gain, the Hang Seng (-1.25%) could not despite ostensible positive news regarding Chinese property developers being able to sell some properties.  Europe, though, is bleeding badly on the Russia/Ukraine story (DAX -1.8%, CAC -1.7%, FTSE 100 -1.2%) with the UK clearly the least impacted for now.  Meanwhile, US futures, which had spent the bulk of the evening in the green, are now lower by -0.25% across the board.

Treasuries are playing their haven role like Olivier, rallying further with yields declining another 2.5bps, taking them 15bps from recent highs.  Bunds (-2.4bps), OATs (-1.9bps) and Gilts (-3.3bps) are all seeing strong demand as well as investors flee to the relative safety of fixed income.

Turning to commodities, oil (-0.2%) is in consolidation mode, although the uptrend remains strong.  NatGas in the US (-1.0%) is clearly dislocated from that in Europe but feels very much like it is developing a base around $4/mmBTU.  Gold (+0.4%) is proving more of a haven these days despite the dollar’s strength, although industrial metals (Cu -1.8%, Al -0.85%) are under pressure today.

And finally, the dollar is showing its traditional haven characteristics as well, rallying against all its G10 counterparts and most EMG currencies.  SEK (-0.8%) and NOK (-0.75%) are leading the way lower, arguably because of the proximity of those nations to the Ukraine and the escalation of military and naval activity in the Baltic and North Seas with both Russian and NATO ships and submarines seen.  AUD (-0.7%) is obviously feeling the impact of weakening commodity prices as well as the general dollar strength.  The rest of the bloc is all weaker, just not quite to this extent.

Aside from the RUB (now -2.0%), PLN (-0.9%), ZAR (-0.9%) and CZK (-0.85%) are the worst performers this morning in the EMG bloc.  The zloty story is interesting given central bank comments that “Polish rates should rise more than the market expects”, which would ordinarily be seen as currency bullish, however, given Poland’s proximity to the Ukraine, one cannot be surprised to see investors selling the currency.  The same is true of CZK, although frankly, other than a pure risk-off play, I can see no news from South Africa.

This is a big data week with far more than the Fed on tap.

Today PMI Manufacturing 56.7
PMI Services 54.8
Tuesday Case Shiller Home Prices 18.2%
Consumer Confidence 111.8
Wednesday New Home Sales 765K
FOMC Decision 0.00% – 0.25%
Thursday Initial Claims 260K
Continuing Claims 1650K
Durable Goods -0.5%
-ex Transport 0.3%
Q4 GDP 5.3%
Q4 Personal Consumption 2.9%
Friday Employment Cost Index 1.2%
Personal Income 0.5%
Personal Spending -0.6%
PCE Deflator 0.4% (5.8% Y/Y)
Core PCE Deflator 0.5% (4.8% Y/Y)
Michigan Sentiment 68.8

Source: Bloomberg

So, while of course the FOMC meeting is the primary piece of data, both the Claims and PCE data is going to be carefully scrutinized as well for indicators of the current economic situation and the Fed’s likely reaction function.  As of now, no Fed speakers are scheduled after the meeting for the rest of the week, although I imagine we will hear from several by the end of the week.

As to the dollar, right now, its haven status is all that matters.   Look for it to continue to perform will unless there is a real de-escalation of the Ukraine situation.

Good luck and stay safe
Adf

Selling Aggression

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There once was a time when the dip
Was what people bought ere the rip
As equity prices
Would brush off all crises
And FAANGs showed incredible zip
 
But this year there is a new theme
That’s more like a nightmare than dream
The end of each session
Sees selling aggression
As bearishness moves to mainstream
 
There has been an evolution in the market narrative recently that is growing in strength.  After a very long period where BTFD (buy the f***ing dip) was the mantra of algorithms and day traders alike, backed up with don’t fight the Fed, it seems that market price action has turned around to sell every rally you see.  While there is not yet an acronym in place (and I’m sure there will be one soon, perhaps AS for Abandon Ship), what has become abundantly clear is that the sentiment that inflated the broad asset bubble in which we have been living is starting to change.
 
Arguably, the Fed is the cause of this change, which is to be expected as it was their monetary policies that inflated the everything bubble in the first place.  Consider that since the GFC, the Fed has increased the size of its balance sheet by $8 trillion, and the US economy has expanded by another $7.3 trillion (already a problem that the balance sheet grew faster than the economy), while the S&P500 has grown by $28.2 trillion, nearly twice as fast again.  It is certainly difficult to continue to justify the valuation premiums attributed to the equity market if there are any concerns about future growth rates.  And there are plenty of concerns about future growth rates, especially if the Fed is true to its word and actually tightens monetary policy.   
 
The upshot is that investors have been paying an increasing premium for the same dollar of earnings during the past 14 years and we appear to be reaching the breaking point.  The key thing to remember about markets is that their behavior in a rally and in a decline tend to be very different.  Rallies are made of steady, albeit sometimes sharp, moves higher with much buying at the end of each session to insure that asset allocators have their proper proportions in various sectors.  Declines are characterized by mayhem, where sellers often seek to sell anything that is liquid and as quickly as possible.  So, in the vernacular, stocks ride the escalator up and fall down the elevator shaft.  And quite frankly, having witnessed some of the biggest market declines in history (Oct 1987 anyone?) price action recently has started to take on those negative characteristics. 
 
Just think, too, this is happening before the Fed has actually even begun to tighten.  In fact, this week, their balance sheet rose to a new record high!  How will things perform when they actually raise rates, let alone start to allow the balance sheet to shrink.  For those of you who disagree with my thesis that any Fed tightening will be small and short-lived, this market reaction function is exactly how I have arrived at my conclusions.
 
Earlier this week I explained that I believe we are at peak Fed hawkishness, where market expectations have moved to the first (of four) rate(s) hike in March (some calling for 50bps) while balance sheet reduction (QT) will start this summer and proceed to the tune of $40-$60 billion per month thereafter.  Arguably, QT will be much more damaging to the equity markets than a 50-basis point rise in Fed funds, but neither will help.  Many analysts believe that next week’s FOMC meeting will result in a clear timetable for the Fed’s future actions, but I disagree.  Between the recent equity decline and the softening data, the Fed will not want to lock itself into a tightening schedule.  As I wrote earlier, look for Wednesday’s meeting to appear dovish compared to current expectations.  However, that is unlikely to help change risk attitudes that much.
 
Risk is off and has further to go.  Yesterday’s US price action was abysmal as equity markets were higher all day until the last hour and then turned around and fell between 1.5%-2.0% to close with sharp losses.  Asia generally followed that line of reasoning with both the Nikkei (-0.9%) and Shanghai (-0.9%) falling although the Hang Seng was unchanged on the day.  In fact, the Hang Seng was the only bright spot around.  Europe is much softer (DAX -1.6%, CAC -1.4%, FTSE 100 -0.9%) with the only data being weaker than expected Retail Sales in the UK (-3.7%, exp -0.6%).  It can be no surprise that US futures are also under pressure, with the NASDAQ (-0.7%) leading the way at this hour, but all in the red.
 
Remember when the bond bears were certain that the 10-year was getting set to trade through 2.0%?  Yeah, me too. Except, that is not what is going on as this morning, the 10-year Treasury has seen yields decline by another 1.6bps, taking it more than 10bps from its recent high yield.  European bonds are rallying as well with Bunds (-3.0bps), OATs (-2.2bps) and Gilts (-2.4bps) all behaving as havens this morning, and even the PIGS’ bonds performing well.  It is abundantly clear that heading into the weekend, the marginal investor does not want to own risky assets.
 
Today’s risk-off theme is alive and well in commodities too with oil (-1.9%) leading the way lower but weakness in precious metals (Au -0.3%, Ag -0.4%) and industrials (Cu -1.8%, Al -0.8%).  The only outlier is NatGas (+2.8%) which based on the 13-degree temperature at my house this morning seems driven by the weather and not risk.
 
Finally, looking at the dollar this morning it is difficult to discern a strong theme.  In the G10, gainers and losers are split 5:5 with the commodity currencies (AUD -0.4%, NZD -0.4%) leading the way lower while the financials (CHF (+0.4%, SEK +0.35%) are rising.  Given commodity price weakness, this should not be that surprising.  As to the financial side, with Treasury yields declining, those suddenly seem more attractive.
 
However, that same thesis does not appear to be valid for the EMG bloc where the leading gainers (ZAR +0.5%, CLP +0.4%, MXN +0.3%) are all commodity focused while the laggards, aside from TRY which has its own meshugas (look it up), are all commodity importers (TWD -0.25%, THB -0.25%, HUF -0.2%).  In other words, it is difficult to tell a coherent story about the FX markets right now although the one thing that is very clear is that volatility across virtually all currencies has been moving higher.  Old correlations seem to be breaking down, which is leading to the increased volatility we are observing.
 
On the data front, only Leading Indicators (exp +0.8%) are due this morning at 10:00.  Yesterday’s US data was kind of awful with Initial and Continuing Claims both printing far higher than forecast (although attributed to omicron’s impacts) while Existing Home Sales also fell far more than expected which was attributed to a lack of inventory.  However, I would contend that the US growth trajectory is definitely pointing lower as evidenced by the Atlanta Fed’s GDPNow Forecast which is currently at 5.14%, down from 9.7% just one month ago. 
 
As we all await next week’s FOMC meeting, the dollar’s cues are likely to continue to come from the equity markets, and given how poor they currently look, if nothing else, I expect the haven currencies to continue to perform reasonably well.
 
Good luck, good weekend and stay safe
Adf
 
 
 

Every Reason

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While prices in Europe are leaping
According to Christine’s bookkeeping
She’s got “every reason”
To keep on appeasin’
The ECB doves who are sleeping

So, rather than look to the Fed
She’s focused on China instead
Where they just cut rates
As growth there stagnates
And Covid continues to spread

One has to wonder exactly what Christine Lagarde is looking at when she makes comments like she did this morning.  Specifically, she said the following in a radio interview in France, [emphasis added] “We have every reason to not react as quickly and as abruptly as we could imagine the Fed might, but we have started to respond and we, of course, stand ready to respond with monetary policy if figures, data, facts, require it.”  Remember, the ECB has a single mandate, achieving price stability which they define as 2% inflation over the medium term.  With this in mind, let me recount this morning’s data, which clearly has Madame Lagarde nonplussed: German Dec PPI +5.0% M/M and +24.2% Y/Y, the highest figures ever in the history of German record keeping back to 1949.  Eurozone Dec CPI +0.4% M/M and 5.0% Y/Y, also the highest since the creation of the Eurozone.  I realize I am a simple FX salesman, but to my uneducated eye, those indications of inflation seem somewhat above 2.0%.  Perhaps mathematics in France is different than here in the US, but I would challenge Madame Lagarde to explain a bit more carefully why, despite all evidence to the contrary, she thinks the ECB is acting in accordance with their mandate.  I suspect there are about 83 million people in Germany who may be wondering the same thing.

Certainly, traders do not believe her or her colleagues when they say, as Pablo Hernandez de Cos did “an increase in interest rates is not expected in 2022.”   De Cos is the head of the Spanish central bank and a Governing Council member and clearly not a hawk.  Yet, the OIS market in Europe is pricing in 0.20% of rate hikes by the end of 2022 (the ECB has been moving in 10 basis point increments), so two rate hikes.  I also realize that there appear to be many econometric models around that are forecasting a return to much lower inflation within the next twelve months, certainly those are the models the central banks themselves are using.  It seems that the real question is at what point will the central banks, specifically the Fed and ECB, recognize that their models may not be a very accurate representation of reality?  And I fear the answer is, never!

Perhaps Madame Lagarde was channeling Yi Gang, the PBOC’s Governor, although the situation on the ground in China is clearly different than that in Europe.  For instance, after cutting two important interest rates last Friday, the PBOC cut two different interest rates last night, the 1-year loan prime rate by 0.10% down to 3.70%, and the 5-year rate was cut by 5 basis points to 4.60%.  China continues to struggle with their zero covid policy.  They continue to fall behind the curve there as the omicron variant is so incredibly transmissible.  But what is clear is that China is growing increasingly concerned over the pace of growth in the economy and so the PBOC has begun to act even more aggressively.  While 5 and 10 basis point moves may not seem like a lot, given how infrequently the PBOC has been willing to cut interest rates, they are an important signal to market participants that support is at hand.  This was made clear by the equity markets last night where the Hang Seng, home to so many property companies, exploded higher by 3.4% although Shanghai’s market was quite subdued, actually slipping 0.1%.

In the end, it is clear that global synchronicity is not an appropriate way to think about the current macroeconomic situation.  Given the dramatically different ways that different nations approached the Covid pandemic, it should be no surprise that there are huge differences in rates of growth and inflation around the world.  The hedging implications of this outcome are that it will require more specific analysis of each country in which there is an exposure to determine the best way to mitigate risks there.

With that in mind, let us take a look at markets this morning.  Despite Shanghai’s lackluster performance, the rest of Asia was actually quite solid with the Nikkei (+1.1%) rounding out the top markets.  Europe, on the other hand, has been less positive with the DAX (+0.1%) edging higher while both the CAC (-0.1%) and FTSE 100 (-0.1%) are slipping a bit.  I guess more promises of ongoing policy ease were not enough to overcome the soaring inflation story on the continent.  US futures are all pointing higher at this hour, with NASDAQ (+0.9%) leading the way although that index has fallen by 10% from its highs, so has more room to catch up.

Looking at the bond market, I can’t help but wonder if we have seen peak hawkishness earlier this week, at least for the Fed.  After the long weekend, we saw the 10-year Treasury yield trade up to 1.88%, but since then it has slipped back with today’s price action seeing yields fall an additional 2.7 basis points and placing us 4bps off those highs.  Now, this could simply be a short-term correction, but with the Fed announcement next week, it really does feel like the market has gotten way ahead of itself.  At this point, the only way next week’s FOMC could be seen as hawkish would be if they actually raised rates, something to which I ascribe a zero probability.  One other thing to recall is that recent surveys continue to show a large contingent of fund managers believe that inflation is transitory which implies that they are likely to take advantage of the current rise in yields and prevent things from running away.

On the commodity front, oil (-0.4%) has stopped running higher, although this pause seems much more like a consolidation than a change in views.  NatGas (-1.5%) is also a bit softer today in both the US and Europe as seasonal or higher temperatures continue to reduce marginal demand.  Turning to metals markets, gold (-0.2%) is slightly softer this morning, but overall, despite rising interest rates, has held up quite well lately and remains well above the $1800/oz level.  Interestingly, silver (0.0% today +4.6% this week) seems to be having a much better time of things and technically looks to have broken out higher.  Arguably, this information blends well with the thought that bond yields may have peaked, but we shall see.

As to the dollar, it is mixed this morning with both gainers and losers in both the G10 and EMG spaces.  The funny thing is, other than RUB (-0.6%) which is leading the way lower today on the back of threats of more substantial sanctions in the event Russia does invade the Ukraine, the rest of the story is much harder to pin down.  For instance, from a news perspective Bank Indonesia met last night and left rates on hold, as expected, but indicated that it would begin normalizing monetary policy in March, returning its RRR to its pre-covid levels, but the rupiah only rose 0.2%.  In fact, today’s leading gainer is ZAR (+0.75%), but given the dearth of either data or news, the best bet here seems to be a response to precious metals strength.  One other thing to remember is that despite easing by the PBOC, the renminbi continues to edge higher.  Frankly, I see no reason for it to weaken anytime soon, especially with my view the dollar will be suffering going forward.

On the data front, Initial Claims (exp 225K), Continuing Claims (1563K), Philly Fed (19.0) and Existing Home Sales (6.43M) are on the calendar.  Remember, Empire Manufacturing was a huge bust earlier this week, so watch the Philly Fed number for any indication of weakness and slowing growth here at home.  In fact, it is that scenario that will allow the Fed to remain on the dovish side, although I fear it will not slow down the inflation train.

If there are any inklings that the Fed is not going to be as hawkish as had seemed to be believed just a few days ago, I expect that the dollar will come under further pressure.  In fact, in order to change that view we will need to see a very hawkish outcome from next Wednesday’s FOMC, something I do not anticipate.  Payables hedgers, I fear the dollar may be near its peak, so don’t miss out.

Good luck and stay safe
Adf

Confidence Wilts

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As central banks worldwide prepare
To raise rates investors don’t dare
Buy bonds, bunds or gilts
While confidence wilts
Defining Jay Powell’s nightmare

The upshot is negative rates
Are no longer apt for long dates
But we’re still a ways
From NIRP’s end of days
While Christine and friends have debates

Whatever else you thought mattered to markets (e.g. Russia/Ukraine, oil prices, omicron) you were wrong.  Right now, there is a single issue that has every pundit’s tongue wagging; the speed at which the Fed tightens policy.  Don’t get me wrong, oil’s impressive ongoing rally feeds into that discussion, but is clearly not the driver.  So too, omicron’s impact as it spreads rapidly, but seems clearly to be far less dangerous to the vast majority of people who contract the disease.  As to Russia and the widespread concerns that it will invade the Ukraine shortly, that would certainly have a short-term market impact, with risk appetite likely reduced, but it won’t have the staying power of the Fed tightening discussion.

So, coming full circle, let’s get back to the Fed.  The last official news we had was that tapering of asset purchases was due to end in March with the Fed funds rate beginning to rise sometime after that.  Based on the dot plot, expectations at the Eccles Building were for three 0.25% rate increases this year (Jun, Sep and Dec).  Finally, regarding the balance sheet, expectations were that process would begin at a modest level before the end of 2022 and its impact would be minimal, you remember, as exciting as watching paint dry.  However, while the cat’s away (Fed quiet period) the mice will play (punditry usurp the narrative).

As of this morning, the best I can figure is that current market expectations are something along the following lines: QE will still end in March but the first of at least four 0.25% rate hikes will occur at the March FOMC meeting as well.  In fact, at this point, the futures market is pricing in a 12.5% probability that the Fed will raise rates by 0.50% in March!  In addition, regarding the balance sheet, you may recall that in 2017, the last time the Fed tried to reduce the size of the balance sheet, they started at $10 billion/month and slowly expanded that to $50 billion/month right up until the stock market tanked and they reversed course.  This time, the punditry has interpreted Powell’s comments that the runoff will be happening more quickly than in 2017 as a starting point of between $40 billion and $50 billion per month and rising quickly to $100 billion/month as they strive to reach their target size, whatever that may be.

The arguments for this type of action are the economy is much stronger now than it was in 2017 and, more importantly, inflation is MUCH higher than it was in 2017, as well as the fact that the balance sheet is more than twice the size, so bigger steps are needed.  Now, don’t get me wrong, I am a strong proponent of the Fed disentangling itself as much as possible from the markets and economy, however, I can’t help but wonder if the Fed moves according to the evolving Street narrative, just how big an impact that will have on asset markets.  Consider that since the S&P 500 traded to its most recent high on January 4th, just 2 weeks ago, it has fallen 5.0%.  The NASDAQ 100 has fallen 10.5% from its pre-Thanksgiving high and 8.5% from its level on January 4th.  Ask yourself if you believe that Jay Powell will sit by and watch as a much deeper correction unfolds in equity markets.  I cannot help but feel that the narrative has run well ahead of reality, and that next week’s FOMC meeting is going to be significantly more dovish than currently considered.  We have seen quite substantial market movement in the past several weeks, and if there is one thing that we know for sure it is that central banks abhor sharp, quick movement in markets, whether higher (irrational exuberance anyone?) or lower (Powell pivot, “whatever it takes”.)

The argument for higher interest rates is clear with inflation around the world (ex Japan) soaring, but central bankers are unlikely, in my view, to tighten as rapidly as the market now seems to believe.  They simply cannot stand the pain and more importantly, fear the onset of a recession for which they will be blamed.  For now, though, this is the only story that matters, so we have another week of speculation until the FOMC reveals their latest moves.

Ok, so yesterday was a massive risk-off day, with equities getting clobbered while bonds sold off sharply on fears of central bank actions.  In fact, the only things that performed well were oil, which rose 2.7% (and another 1.5% this morning) and the dollar, which rallied against virtually all its G10 and EMG counterparts.  Overnight saw the Nikkei (-2.8%) follow in the footsteps of the US markets although the Hang Seng (+0.1%) and Shanghai (-0.3%) were far more sanguine.  Interestingly, European bourses are mostly green today (DAX +0.25%, CAC +0.55%, FTSE 100 +0.25%) despite further data showing inflation is showing no sign of abating either on the continent (German CPI 5.7%) or in the UK (CPI 5.4%, RPI 7.5%).  As to US futures, +0.2% describes them well at this hour.

Bond markets remain under severe pressure with yields higher everywhere except China and South Korea.  Treasuries (+1.4bps) continue their breakout and seem likely to trade to 2.0% sooner rather than later.  Bunds (+2.6bps and yielding +0.003%) have traded back to a positive yield for the first time since May 2019.  Of course, with inflation running at 5.7%, that seems small consolation.  OATs (+2.4bps) and the rest of the continental bonds are showing similar yield rises while Gilts (+5.2bps) are leading the way lower in price as investors respond to the higher than already high expectations for inflation this morning.  Remember, the BOE is tipped to raise the base rate as well next week, but the global impact will be far less than whatever the Fed does.

Oil prices continue to soar as the supply/demand situation continues to indicate insufficient supply for growing demand.  This morning, the IEA released an update showing they expect demand to grow by an additional 200K barrels/day in 2022 while OPEC+ members have been unable to meet their pumping quotas and are actually short by over 700K barrels/day.  I don’t believe it is a question of IF oil is going to trade back over $100/bbl, it is a question of HOW SOON.  Remember, with NatGas (-0.5% today) still incredibly expensive in Europe, utilities there are now substituting oil for gas as they try to generate electricity, adding more demand to the oil market.  And remember, none of this pricing includes the potential ramifications if Russia does invade the Ukraine and the pipelines that run through Ukraine get shut down.

Finally, the dollar is retracing some of yesterday’s substantial rally, falling against all its G10 brethren (NOK +0.45%, AUD +0.4%, CAD +0.3%) led by the commodity currencies, and falling against most of its EMG counterparts with RUB (+1.4%) and ZAR (+1.05%) leading the way.  The former is clearly benefitting from oil’s sharp rally, but also from rising interest rates there.  Meanwhile, a higher than expected CPI print in South Africa, (5.9%) has analysts calling for more rate hikes there this year and next with as much as 250bps expected now.

On the data front, yesterday saw a horrific Empire Manufacturing outcome (-0.7 vs. exp 25.0), clearly not a positive sign for the economic outlook.  This morning brings only Housing Starts (exp 1650K) and Building Permits (1703K), neither of which seem likely to move the needle.

With the Fed silent, the narrative continues to run amok (an interesting visual) but that is what is driving markets right now.  This is beginning to feel like an over reaction to the news we have seen, so I would be wary of expecting a continuation of yesterday’s risk-off sentiment.  While we will almost certainly see some more volatility before the FOMC announcements next week, it seems to me that we are likely to remain within recent trading ranges in the dollar rather than break out for now.

Good luck and stay safe
Adf

Bears are All Thrilled

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Kuroda explained
The future is like the past
Ergo, rates unchanged

The BOJ concluded their latest policy meeting last night and the results were…nothing changed.  Well, that’s not strictly true.  Their economic and inflation forecasts were tweaked to arrive at a revised path to the same outcome.  So, instead of faster growth this year, they decided it would be delayed a year before falling back to its long-term 1.0% trend while inflation is now forecast to jump up to… 1.1% for the next two years, from a previous expectation of 1.0%. Now that’s precision!  Kuroda-san’s term expires in April 2023 and despite 12 years of extraordinarily easy money, with QE, YCC and NIRP all employed to drive inflation higher, at this time it seems likely that he will have failed dismally in his only task.  (As an aside, I would wager if you surveyed the Japanese population, there would be scant few demands for higher prices in their purchases.  Just sayin’.)  As to the yen, it is essentially unchanged on the day and when asked about the currency, Kuroda explained it should move stably (whatever that means), but that a weaker yen would ultimately be desired.  Plus ça change.

Excitement has started to build
And bond market bears are all thrilled
With One point Eight breached
The story they’ve preached
Is finally being fulfilled

Arguably, however, the biggest story today is that the US 10-year yield has finally traded above 1.80% (as I type it is +3.2bps at 1.816%) for the first time since before the pandemic in February 2020.  For those market participants who have been preaching that rising inflation would lead to higher yields, this is a clear milestone.  Regarding the transitory vs. persistent inflation narrative, this also indicates a growing number of investors are moving toward the persistent side of the argument.  The key question, of course, is why has this happened today?  Are there specific catalysts or was it simply time?

Perhaps the first place to look is the oil market, where WTI (+1.2%) has rallied more than $1.00/bbl and is trading back above $85/bbl for the first time since October 2014.  We all know that higher oil prices tend to have a very clear impact on both actual prices and price expectations.  Today’s oil rally seems to be the result of a few different issues.  First has been the news that there was a drone attack on oil facilities in the UAE raising the specter of market disruptions from the Middle East.  A background story there is that the amount of spare capacity available in OPEC+ members may also be somewhat overstated as evidenced by the fact that OPEC’s last production increase of 400K barrels per day fell short because several members simply couldn’t pump enough to meet their quotas.  Meanwhile, demand seems pretty robust as 1) the omicron variant is quickly becoming seen as akin to the common cold and so not too disruptive; and 2) with NatGas prices so high in Europe and Asia, utilities are turning to both oil and coal to power their countries adding to oil demand.

Of course, the other key feature of the US interest rate market is forecasting what the Fed is going to do this year and how that will impact things.  It is worth noting that while 10-year yields have jumped 3+ basis points this morning, 2-year yields are higher by more than 6 basis points and back above 1.0% for the first time since before the pandemic as well.  But that means that the yield curve continues to flatten, a harbinger of slower future growth.  Now, one might expect that slower future growth would help reduce inflationary fears and ordinarily that would be a good thought.  However, there is nothing ordinary about the current policy settings nor their recent history and it is those features that are likely to drive market sentiment for at least a little longer.

Remember, monetary policy works with “long and variable lags” which historically has been calculated as somewhere between 24 and 30 months.  This implies that whatever action the Fed takes next week will not start to impact the economy until 2024.  It also means that the actions they took at the beginning of the pandemic, about 22 months ago, are likely starting to be felt in the real economy.  Money supply rose >35% for many months throughout 2020 and the early part of 2021, and it is fair to expect that the impact of all that extra cash floating around has not yet completely been seen.  The point is that inflation remains built up in the system and is likely to be with us for quite some time to come.  With this in mind, it is easy to see why yields are rising.

And there is one more thing to add to the puzzle, QT.  Remember, too, comments from a number of FOMC members hinted at an increasing desire to start reducing the size of their balance sheet.  If they do follow through with that process, it seems likely that Treasury yields will move even higher across the curve as the only price insensitive buyer leaves the market.  The question then becomes, at what point do yields rise enough to make the Treasury uncomfortable when it comes to refinancing the current debt?  I make no claims that I know where that level lies, but I remain confident that as soon as carrying costs for debt start to climb as a percentage of GDP, QT is going to end.  Summing up, there is a lot happening and it feels like we may be at the beginning of some significant trend changes.

How has all this activity impacted markets today?  You will not be surprised to know that risk has been significantly reduced across the board.  Looking at equity markets, red is the predominant color on screens this morning with only one exception, Shanghai (+0.8%) as traders react to easing monetary policy and support for property markets in China.  Otherwise, it is not pretty (Nikkei -0.3%, Hang Seng -0.4%, DAX -1.0%, CAC -1.0%, FTSE 100 -0.6%).  US futures are also under severe pressure led by the NASDAQ (-1.8%) although both the DOW and SPX are lower by -1.0% at this hour.  It seems that rising yields are pretty bad for growth stocks and I believe that story has legs.

Global bond markets had all been much softer earlier in the session but have since recouped their losses so that European sovereigns are essentially unchanged at this hour.  The one outlier, again, in Asia was China, where CGB’s saw yields decline 4.4bps last night as investors pile in looking for further policy ease.

On the commodity front, we have already discussed oil, which is by far the most interesting thing out there.  NatGas in the US is little changed on the day and actually slightly lower in Europe.  Gold (-0.3%) has fallen which should be no surprise given the rise in yields across the curve, and copper (-0.85%) is also under pressure as the flatter curve and declining stocks hint at weaker future growth.

As to the dollar, it is generally firmer this morning although not universally so.  SEK (-0.5%) is the laggard in the G10 on a combination of residual belief the Riksbank will remain relatively dovish and the beginnings of concern over election outcomes when the Swedes go to the polls in September.  After that, AUD (-0.4%) and NZD (-0.4%) are next in line, both suffering from weakness in metals and agricultural markets.  The rest of the bloc is softer by about 0.2% or so save CAD (+0.1%) which is benefitting from oil’s rise.

In the emerging markets, TRY (-0.8%) volatility continues to dominate, but INR (-0.45%), PHP (-0.45%) and HUF (-0.45%) are all under pressure as well.  The first two are feeling the effects of higher Treasury yields as well as concerns over potential CNY weakness after PBOC comments about preventing one-way trading (meaning continued strength).  As to HUF, it and the rest of the CE4 look simply to be displaying their relatively high betas with respect to the euro (-0.2%).

On the data front, Empire Manufacturing (exp 25.0) is today’s only number of note and we will need a big surprise in either direction to have a market impact.  Rather, today’s trend seems pretty clear, higher yields, weaker stocks and a stronger dollar.  Will it continue much longer?  That, of course, is the key question.

Good luck and stay safe
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Lest Things Implode

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The central banks all through the West
Are trying to figure how best
To, policy, tighten
But not scare or frighten
Investors and so they are stressed

Meanwhile from Beijing data showed
That Chinese growth actually slowed
With prospects now dimmed
The central bank trimmed
Two interest rates, lest things implode

There is a new contest amongst the punditry to see who can call for the most shocking rate policy by the Fed this year.  With the FOMC in their quiet period, they cannot respond to comments by the likes of JPM Chair Jamie Dimon (the Fed could raise rates 7 times this year!) or hedge fund manager and noted short seller Bill Ackman (the Fed should raise rates by 50 basis points in March to shock the market), and so those comments get to filter through the market discussion and creep into the narrative.  A quick look at Fed funds futures shows that the market is now pricing in not only a 25bp rate hike, but a probability of slightly more at the March meeting.

Now, don’t get me wrong, I think the Fed is hugely behind the curve, as evidenced by the fact they are still purchasing assets despite raging inflation, and think an immediate end to asset purchases would be appropriate policy, as well as raising rates in 0.5% increments or more until they start to make a dent in the depth of negative real yields, but I also know that is not going to happen.  Time and again they have effectively explained to us all that while inflation is certainly not a good thing, the worst possible outcome would be a decline in the stock market.  Their deference to investors rather than to Main Street has become a glaring issue, and one that does not reflect well on their reputation.  And yet, Chairman Powell has never given us a reason to believe that he will simply focus on inflation, which is currently by far the biggest problem in the economy.

However, with the market having already priced in a 0.25% rate hike for March, it is entirely realistic they will raise rates at that meeting.  The key question, though, is will they be able to continue to tighten policy when equity markets start to respond more negatively?  For the past 35 years (since Black Monday in 1987) the answer has been a resounding NO.  Why does anybody think this time is different?

Interestingly, at the same time virtually every Western central bank is trying to figure out the best way to fight the rapidly rising inflation seen throughout the world, the Middle Kingdom has their own, unique, issues, namely disappointing economic growth and expanding omicron growth leading up to the Winter Olympics.  Of course, the last thing that President Xi can allow is any inkling that things in China are not running smoothly, and so after the release of weaker than expected IP, Fixed Asset, Retail Sales and GDP data for Q4, the PBOC cut both its Medium-Term Lending and 7-day Reverse Repo rates by 0.10% last night.  In addition to the weaker data came the news that yet another property developer, Logan Group, may have made guarantees that do not appear on their balance sheet to the tune of $812 million.  I have lost count of the number of property developers in China that are now under growing pressure ever since the initial stories about China Evergrande.  But that is the point, the entire property sector is under huge pressure of imploding and property development has been somewhere between 25%-30% of the Chinese GDP growth.  This does not bode well for Chinese GDP growth going forward, which does not bode well for global growth.  PS, one last thing to mention here is the Chinese birth rate fell to its lowest level since 1950!  Only 10.62 million babies were born in 2021, despite significant efforts by the government to encourage family growth.  As demographics is destiny, unless the Chinese change their immigration policies, the nation is going to find itself in some very difficult straits as the population there ages rapidly and the working population shrinks.  Just sayin’.

Ok, with that out of the way, a look around today’s holiday markets shows that risk is on!  Aside from the Hang Seng (-0.7%) overnight, which is where so many property firms are listed, every other major market is in the green.  The Nikkei (+0.75%) and Shanghai (+0.6%) were both solid performers as that PBOC rate cut was seen as encouraging.  In Europe, the DAX (+0.4%), CAC (+0.6%) and FTSE 100 (+0.6%) are all firmer as are the peripheral markets.  Even US futures (+0.1% across the board) are firmer although there is no trading here today due to the MLK holiday.

Bond markets, on the other hand, are under pressure everywhere as Treasury futures are down 13 ticks or about 3 basis points higher, while European sovereigns (Bunds +1.7bps, OATs +2.0bps, Gilts +2.8bps) are all seeing higher yields as well.  In fact, 10-year Bunds are approaching 0.0% for the first time since May 2019.  Asia was no different with only China (-0.8bps) seeing a yield decline and sharp rises in Australia (+6.7bps) and South Korea (+9.7bps).

In the commodity markets, WTI (0.0%) is flat although Brent (-0.3%) is edging down from its multi-year highs.  NatGas (-0.6%) is also edging lower and European gas prices are falling even more significantly as a combination of LNG cargoes and warmer weather eases some pressure on that market.  Gold (+0.2%) is firmer, despite what appears to be a risk-on day, although copper (-0.7%) is under a bit of pressure.  In other words, the noise is overwhelming the signal here.

As to the dollar this morning, mixed is the best description as there are gainers and losers in both G10 and EMG blocs.  Interestingly, despite oil’s lackluster trading, both NOK (+0.3%) and CAD (+0.2%) are the leading gainers in the G10 while JPY (-0.25%) is following its risk history, selling off as equities gain.  In the emerging markets, RUB (-0.55%) is the worst performer as there seems to be growing concern over the imposition of tighter sanctions in the event Russia does invade the Ukraine.  KRW (-0.45%) is next in line after North Korea launched yet two more ballistic missiles, raising tension on the peninsula.  On the plus side, THB (+0.4%) has been continuing its recent gains as the nation opens up more completely from Covid lockdowns.

It is a relatively light data week with Housing the main focus, and with the Fed in their quiet period, we won’t be getting help there either.

Tuesday Empire Manufacturing 25.0
Wednesday Housing Starts 1650K
Building Permits 1700K
Thursday Initial Claims 220K
Continuing Claims 1521K
Philly Fed 19.8
Existing Home Sales 6.41M
Friday Leading Indicators 0.8%

Source: Bloomberg

In truth, it is shaping up to be a quiet week.  Next week brings the central bank onslaught with the Fed, BOJ and BOC, but until then, we will need to take our cues from equities and geopolitical tensions to see if anything occurs that may inspire the jettisoning of risk assets in a hurry.  My gut tells me we will not be seeing anything of that nature, and so a range bound week for the dollar seems in store.

Good luck and stay safe
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