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Trump’s Whirlwind

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Markets have embraced
Trump’s whirlwind. Thus, Ueda
Is free to hike rates

 

Tonight, the BOJ is apparently set to hike rates by 25bps.  The market probability is essentially 100% and the key clue is that the Nikkei news organization wrote an article about it that was published after the first day of the BOJ’s two-day meeting.  At the December BOJ meeting, Ueda-san explained that if inflation remained at or above their 2.0% target (it has) and if there were no major ructions in markets after President Trump’s inauguration (there haven’t been), then the BOJ was likely to continue to move their policy rate toward what they believe is a neutral stance.  Currently, that neutral stance is mooted at 1.00%, so a 25bp hike tonight takes the overnight rate to 0.50%, somewhat closer.

With all this widely anticipated and markets pricing in the result, the key question is how what Ueda-san will say during his press conference that follows the meeting.  There are many who are looking for a so-called ‘dovish’ hike, where there is no indication of the timing of any further rate hikes and a benign view of the future.  Certainly, a look at the FX market, where the yen (unchanged today, -0.8% in the past week) doesn’t indicate a great deal of fear over a much tighter policy.

Source: tradingeconomics.com

There has been a background narrative that explains the BOJ’s ongoing tightening is going to reach a point where Japanese investors are going to repatriate much of their overseas investment, driving a forceful upward move in the yen and having major negative impacts on risk assets around the world as liquidity retreats.  This is based on the idea that the Japanese are the largest exporters of capital in the world which is one of the key reasons equity markets are rallying everywhere, so if they bring that money home, that means they will sell their foreign equity holdings and buy yen.  While I believe this is a neatly wrapped idea, I would contend Japanese investment prospects are not yet near the same as in the US, so this idea may be premature.  In fact, a look at the chart below showing 10-year US Treasury and JGB yields overlaid with USDJPY indicates that the rate differential is nowhere near where it might need to be in order to encourage that type of behavior.  My take is absent some type of multilateral agreement to weaken the dollar, this will not happen organically.

Source: FRED database

In China, though communists rule
They favor the capital tool
Of equity bourses
And so, Xi endorses
A government stock buying pool

Elsewhere in the world, as we try to get outside the maelstrom that is Donald Trump, I couldn’t help but notice that, once again, Xi Jinping has called on his finance minions to do something, anything, to support the stock market.  And I cannot help but be struck by the irony of the Chinese Communist Party being so concerned about the situation in the most capitalistic institution of all.  The WSJ had an article discussing the latest measures that are on the board, including forcing encouraging insurance companies to increase the local equity portion of their portfolios and utilizing 30% of premium income to buy stocks.  This is on top of the PBOC reducing interest rates last year for companies that want to repurchase shares.

It continues to be very difficult for me to accept the idea that the Chinese are playing 4-D chess with long-term goals in mind while the US is playing checkers.  If that is the case, then the Chinese, or at least President Xi, is a really bad player.  His economy is under dramatic pressure because the property bubble he inflated has been shrinking for the past three years, undermining both the population’s wealth (property was their store of value) and confidence, while he ramps up more beggar thy neighbor trade policies at the same time the US has just elected a president whose middle name is Tariff.  Their population is shrinking because of the ‘foresight’ of their leadership to impose a one-child policy for two generations and while millions of people will risk their lives to immigrate to the US, people are looking to leave China.  Once again, I cannot look at this situation and conclude anything other than the CNY (-0.15%) is going to gradually decline all year long, and maybe not so gradually if pressure really builds.

Ok, let’s take a look at how markets are handling the latest set of Trumpian pronouncements and reactions by targets of his ire.  After yet another rally in the US, albeit on declining volumes so not as exciting as it might otherwise have been, Japanese shares rallied (+0.8%) as investors seem to believe that the interest rate hike tonight will be accompanied by a more dovish stance at the press conference.  Mainland Chinese shares (CSI 300 +0.2%) eked out a gain after the latest news discussed above, although Hong Kong shares (-0.4%) did not follow suit.  After all, the focus is on mainland shares.  The rest of the region was widely dispersed with gainers (Taiwan, Singapore, Philippines) and laggards (Korea, Australia, Thailand), many of these moves in excess of 1%.  It appears investors don’t know which way to turn yet given the speed of changes emanating from Washington.

In Europe, most bourses are modestly firmer (DAX +0.3%, CAC +0.5%) as we continue to hear more from ECB speakers that not only are rates going to be cut, but they are increasingly certain that they will achieve their inflation target.  Maybe they will.  As to US futures, at this hour (7:00) they are mixed to slightly softer with the NASDAQ (-0.4%) the laggard.

In the bond market, the decline in yields appears to be over, at least for now, as Treasuries (+3bps) continue to bounce from their recent lows at 4.54%.  As is almost always the case, this has carried European sovereign yields higher as well, by between 1bp and 3bps across the continent and UK and we saw JGB yields gain 1bp overnight.  I would contend there is still a great deal of uncertainty as to how the Trump administration is going to handle the conundrum of reducing inflation while expanding growth.  Outside of declining energy prices, which may be coming, it will be a tall task, and inquiring minds want to know.

Speaking of energy prices, oil (+0.35%) is edging higher after a lackluster session yesterday.  As with most markets, uncertainty is rife right now although this is clearly an area where Mr Trump is focused on expanding output.  NatGas (-0.3%) is a touch softer as forecasts for the end of the current Polar Vortex keep getting moved up. Metals markets are under some pressure this morning, with gold (-0.3%) backing away from that all-time high level and both silver and copper fading as well.  However, volumes remain light here implying not much interest overall.

Finally, the dollar is a touch stronger this morning, but there are few large movers in either the G10 or EMG blocs.  In fact, every G10 currency is within 0.2% of yesterday’s closing levels and none of them are at extremes.  The biggest loser today is ZAR (-0.6%) which seems to be responding to the precious metals complex backing off a bit overnight.  It remains very difficult to get a read on the dollar with all the other things ongoing.  As it happens, this is one market that has not received any Trumpian attention at all…yet.

We finally have a smattering of data this morning with the weekly Initial (exp 220K) and Continuing (1860K) Claims to be followed by the EIA’s oil inventory data where it appears a modest net build across products is forecast.  With the Fed quiet, and very little focus on Powell and company right now, today looks to be shaping up as another equity focused day with the dollar likely taking its cues there.  While we never know what will hit the tape these days, absent a new surprise vector, there is no reason to look for significant movement today at all.

Good luck

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Cha-Ching

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It wasn’t all that long ago
When data would headline the show
As traders would wait
For each release date
And then recount trades blow-by-blow
 
But now there is only one thing
That matters, Trump’s latest cha-ching
He speaks off the cuff
Which makes it quite tough
To plan from Berlin to Beijing

 

As the morning of the third day of President Trump’s second term dawns, it is nigh on impossible to keep up with all the things he is doing and their actual and potential impacts on markets going forward.  Arguably, the main FX market driver continues to be the tariff discussion and the question of if, and when, he may be imposing said tariffs. You will recall that on Monday, the mere absence of his reaffirmation that tariffs were coming resulted in a major dollar decline, which was subsequently reversed when he finally mentioned them in the evening.

Of course, those were aimed at Canada and Mexico with China, significantly, left out of the mix.  Last night he remedied that situation declaring that China and Europe were also in his sights for tariffs, although he mooted a 10% initial level, far below the 60% he discussed during the election campaign.  Once again, I would argue it is not possible at this point to make any serious market prognostications based on the lack of information as to the products to be impacted, the exact timing and what he is seeking in return for a reduction or elimination of those threats. 

At the same time, I find the strait-laced approach that ‘tariffs are bad and a tax on Americans which will lead to inflation’ which continues to be promulgated by orthodox academic economists, typically from a left-leaning lens, to be almost comical at this point.  We all should remember that during his first term, he imposed many tariffs, especially on China, and yet inflation was quiescent, with CPI averaging 1.9% during the entire term.  This is not to say things will be identical in 2024 and beyond, just that in fairness, his record demonstrates that tariffs are not necessarily inflationary.  Below is a chart of the monthly readings showing only 8 of the 48 months he was in office that headline CPI rose more than 0.3%, implying the rest of the time it was at or below that level.  Those were the days.

Source: tradingeconomics.com

Beyond the tariff discussion, the bulk of his time currently seems to be focused on the size of the government workforce, which is certainly due to shrink, and the border and immigration.  What will market impacts of these issues be like?  For the former, I would suggest that less government employees will lead to less government interference in the workplace, and arguably, be beneficial for productivity if nothing else.  As to the latter, it is a much more difficult problem to solve as there will likely be reductions in both labor supply but also demand for services like housing.  It seems quite possible that there will be a reordering of the economy, although it is unclear if that will lead to a net positive or negative from an overall growth perspective, or at least an inflation perspective.  Growth, of course, is the product of the size of the workforce * productivity, so a smaller workforce, if that is the outcome, will weigh on topline GDP, but not necessarily on per capita GDP.  As I mentioned above, there are far more unknowns than knowns at this time, so forecasting the future is a mug’s game.

As we keep in mind that nobody knows anything about the future, let’s take a look at what happened overnight amid all the knee-jerk reactions to the latest Trump comments.

Yesterday saw US equity markets continue in their winning ways seemingly trying to achieve new highs.  In Asia, the follow on was broad with Japan (+1.6%), Korea (+1.2%) and India (+0.75%) all nicely higher although Chinese shares suffered.  This should be no surprise now that Trump has squarely put China on the tariff map again, but there are other things happening here as well.  Perhaps the most confusing is the word that financial workers would be seeing pay cuts of up to 50% as President Xi no longer sees them as critical workers for the nation.  I’m sure this will help rebalance the consumption-production equation…not!  So, it should be no real surprise that both mainland (-0.9%) and Hong Kong (-1.6%) shares were under pressure.

Not so the case in Europe where the DAX (+1.2%) is leading the way higher although gains are universal, after comments from several ECB bankers that rate cuts were coming next week and likely will continue during the year.  While inflation remains the sole ECB mandate, the weak economic situation plus the threat of tariffs certainly has Madame Lagarde under pressure to do something to support the economy there.  Finally, it should be no surprise that US futures are nicely higher this morning with the NASDAQ (+0.9%) leading the way at this hour (7:15).

In the bond market, yields have stabilized after their recent 20bp decline in the past week and have edged higher by 1bp this morning.  The same price action has been seen in Europe where sovereign yields are little changed to higher by 2bps across the continent.  As to JGB yields, they, too, were unchanged on the session despite an increase in chatter that the BOJ is set to hike rates on Friday.

In the commodity space, gold continues to rally and is now within 1% of its all-time highs set back in late October.  This has dragged silver along for the ride, and copper, in truth, although today copper is ceding -0.6%.  however, a look at the price movement over the past month shows all three metals nicely higher (Au +5.3%, Ag +3.7%, Cu +6.2%).  Oil (0.0%) is flat today as it consolidates its recent retracement.  Recall, for the first two weeks of the year, it rallied sharply, up nearly $10/bbl, although it seems that may have been more of a short squeeze than a fundamental shift in thinking.  Since then, it has given back about $4/bbl as market participants try to decide if the theorized Trumpian demand increase will offset the supply increase of drill, baby, drill.

Finally, the dollar is little changed this morning overall.  That said, net over the past week, it has given back about 1.5% although that was from recent highs.  This price movement feels far more like consolidation than a change in view especially given that the tariff story remains front and center.  Now, it is possible that the market pushed the dollar higher ahead of the inauguration on a ‘buy the rumor’ idea and is now selling the news, but it remains difficult to see what has changed in the US economy relative to its counterparts that would encourage a change in rate expectations.  As to today’s movement, there are more gainers than laggards vs. the dollar, but nothing of any real significance.

On the data front, the only US data is the Leading Indicators (exp 0.0%) so traders will continue to look at corporate earnings and listen to the president for the next pronouncement.  I assure you; I have no idea what that will entail.  Once again, I am a strong proponent of being hedged because the one thing we have learned lately is that markets can turn on a dime.

Good luck

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A Trump Trope

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For one day the markets expected
That tariffs were roundly rejected
But late yesterday
Trump said the delay
Was short with two nations affected
 
The upshot is all of that hope
That saw the buck slide down a slope
Has largely reversed
As dollar shorts cursed
That tariffs are not a Trump trope

 

This poet feels vindicated in not trying to anticipate what President Trump is going to do that might impact markets after yesterday’s events.  Early in the day there was a story that tariffs would be delayed and were seen as negotiating tools, not punishment.  FX traders (mis)read the room and sold the dollar aggressively, with the greenback suffering declines of more than 1% against some currencies, notably MXN.  Then, Mr Trump was inaugurated, made a speech, where he promised to make many changes within the operating system of the US, signed a load of Executive Orders and mentioned in a press conference much later in the evening that 25% tariffs on Mexico and Canada would be coming on February 1st.  The chart of USDMXN below shows the price action with the peso having given back the bulk of yesterday’s gains.

Source: tradingeconomics.com

Once again, if we learned nothing from Trump’s first term, it is that anticipation of his moves is a very fraught and dangerous way to manage market risk.  Now, will those tariffs actually be implemented?  Will they be universal if they are?  Or does he anticipate changes from behavior by both nations in the next 10 days?  The answer is, nobody knows, probably not even Trump.  The upshot is if you have financial market risk, hedging is critical to maintaining acceptable outcomes.  And, oh by the way, look for implied volatility of all financial products to rise as market makers also have no idea what is going to happen so will require hedgers to pay up for protection.

In Davos, the world’s glitterati
Are meeting, and though they are haughty
They’re losing their splendor
And edicts they render
Are sinking in value like zloty

While there is a great deal more that President Trump has promised to do immediately, the bulk of it seems likely to only have potential longer-term impacts on financial markets.  Meanwhile, in Davos, the World Economic Forum is under way and the main message that I can discern from what I’ve read is that, the members really liked it when everybody listened to what they said and are now really unhappy that President Trump is essentially raining on their parade and devaluing their views and comments.  With Trump withdrawing from the Paris Climate Accords and the WHO, key global initiatives are severely hamstrung, which means the WEF is less important.  And all their pronouncements regarding the need free trade and global cooperation has far less impact if the US has decided to focus on itself rather than the world at large.  My forecast is that by the end of Mr Trump’s term, the WEF will be a sideshow, not a headline event.

And really, at this point, that is pretty much what is happening.  Yes, UK Unemployment rose to 4.4% while wages rose 5.6%, but this has simply put the BOE in a tougher spot.  The Old Lady has only an inflation mandate, but if Unemployment is rising, they cannot ignore that, and the market is now far more convinced (82% probability) that they will be cutting the base rate by 25bps at their meeting the first week of February.  While the pound (-0.8%) is lower this morning, that seems much more about the dollar’s overall strength than this weaker than expected data point as since the release, the pound has fallen only another 0.2%.

So, let’s look around the world and see how markets responded to Trump 2.0.  Equity markets in Asia were largely in the green as neither Japan nor China were mentioned on the immediate tariff list, although the late-night proclamation regarding Canada and Mexico implies that this story has not yet been completed.  Nonetheless, gains in Japan (+0.3%), Hong Kong (+0.9%) and China (+0.1%) showed the way for most of the region with only India (-1.6%) really suffering during the session on a variety of fears regarding tariffs and interest rates despite no mentions by Trump.  In Europe, only Spain’s IBEX (-0.5%) is showing any movement of note and that appears to be specific to some slightly softer than expected corporate earnings results.  Surprisingly, Germany and the rest of the continent are little changed, as is the UK.  As to US futures, at this hour (7:10) they are pointing higher by about 0.4% in anticipation of more earnings reports today and a generally positive attitude from the new president.

In the bond market, Treasury yields have fallen 5bps overnight, seemingly on the idea that because Trump announced the government would do all it can to reduce prices, and therefore inflation, it would magically work.  While I am optimistic things will get better, that is a heavy lift in my opinion and the Fed will need to be far more emphatic on its inflation fighting actions to see this through.  In Europe, yields are basically unchanged across the board and similarly, there was no movement in Asia overnight.  Once again, the world is looking toward the US for directional cues.

In the commodity markets, oil (-1.3%) is sliding back as Trump’s promise to open up more drilling spaces on federal land as well as his overall encouragement of ‘drill, baby, drill’ has traders concerned that supply is going to come around more quickly than demand.  Last January I wrote about my view that there is plenty of oil and it is merely political will that prevents it from being accessed.  I have a feeling that is what we are going to begin to see, a change in that political will which means potentially lower prices and increased demand accordingly.  In the metals markets, gold (+0.5%) is continuing to climb as we approach month end.  There are many in this market who believe the technical picture (see chart below) is pointing to a break to new all-time highs soon.  However another, and perhaps more accurate narrative, is that there is an arbitrage between the NY, London and Shanghai exchanges for physical metal and metal is flowing into NY for delivery which begins next Friday. (H/T Alyosha)

Source: tradingeconomics.com

As to the other metals, they are little changed this morning.

Finally, as mentioned at the top, the dollar is much firmer across the board this morning with the peso and NOK (-1.0%) leading the way lower although most currencies seem to be down by at least -0.5%.  (Yes, PLN is weaker by -0.6%).  This is all dollar-driven with no other idiosyncrasies of note right now.  We shall see how this evolves over time.

On the data front, the rest of the week looks like the following:

WednesdayLeading Indicators0.0%
ThursdayInitial Claims218K
 Continuing Claims1860K
FridayFlash Manufacturing PMI49.6
 Flash Services PMI56.6
 Existing Home Sales4.16M
 Michigan Sentiment73.2

Source: tradingeconomics.com

The Fed is in its quiet period so with the lack of data, I suspect that markets will have heightened awareness to every Trump pronouncement with volatility the new normal.  Remember, consistency is not his strong suit, at least when it comes to commentary about how he may respond to things.

From the market’s perspective, as long as tariffs are still seen as the likely outcome, look for the dollar to remain well bid while equities will see a mixed performance depending on the nature of the company/industry with importers likely suffering.  

Good luck

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Trump 2.0

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Today begins Trump 2.0
And pundits are trying to show
Their ideas are sound
As how he’ll redound
On policies he will bestow
 
But this poet can’t comprehend
How anyone thinks what they’ve penned
Is likely to be,
To any degree,
Correct. ‘Stead, let’s look at the trend

 

As Donald Trump prepares to take the oath of office today, there has been a non-stop barrage of pundits putting forth their views as to how policy proposals that were made during the campaign, and even since the election, are going to impact the economy as well as equity, bond and FX markets.  But I would take exception to all these as, if we learned nothing else from Trump’s first term in office, we have no idea how he may try to do the things he says he is going to do.  Are tariffs a funding process?  Are they negotiating tactics?  Are they punishment?  Since we have no idea at this point (all three of those ideas have been floated by “insiders” and pundits), how can we meaningfully forecast the impact tariffs may have going forward?  So, I won’t even try.

Rather, I think there is much to be learned from looking at the long-term trends in markets and perhaps trying to come up with reasons that these trends may be changing, or not, going forward.  As such, take a look at the charts below, all from tradingeconomics.com, where I have tried to highlight the long-term trend in the dollar (EURUSD), the S&P 500, 10-Year Treasury Notes, oil and gold.

My first observation is that over the past twenty-five years, oil has traded both higher and lower with no discernible direction.  Certainly, we are higher now than 25 years ago, but we have been both much higher and lower in the interim.  Now, if Trump is successful at freeing up more drilling opportunities, removing the offshore drilling ban that Biden imposed last week, and reducing the regulatory structure such that the cost of drilling declines, my take is increased supply will result in some downward pressure.  As well, if he is successful at bringing an end to the Ukraine war, it seems probable that Russian oil may no longer be sanctioned, and that, too, would pressure prices lower.  But will he impose tariffs on Canada, a key source of sour crude used to refine diesel?  That could easily pressure prices higher.  And what of Venezuela?  As I said, no way to know.  In the end, my take is that the most likely outcome is that oil will continue to demonstrate its inherent price volatility given its price inelasticity.  I think you can equally make the case for $50 oil as well as $100 oil based on many idiosyncratic issues that have nothing to do with Trump.

The only noteworthy change we have seen is in 10-Year Treasury yields, which after a 40-year downtrend following the back-to-back recessions in 1980-1982 and Fed Chair Volcker’s policy tightening, look very clearly to have reversed course.  I am not the first to notice this but believe that it is an important feature of markets going forward.  There are virtually two generations of traders and investors who have only ever seen interest rates decline and have created their mental investment models on that underlying thesis.  If the future is going to bring about higher interest rates over time (and given my view that inflation is not going to disappear and that will be a key driving force), then investment models in a higher inflation, higher yield environment are going to be different than what we have seen up through 2022.  

One of the keys is that the idea behind the 60/40 portfolio, where declines in stock prices were offset by rises in bond prices, turns out to only really be true in a low inflation environment, sub 2.5%.  If inflation is going to run at 3.5% – 4.5% going forward, then all the strategies that incorporated that 60/40 basis are going to have an awfully difficult time, again, regardless of what Trump does.  The one caveat here is if he is successful in driving inflation back to that <2.0% level, but that seems highly unlikely in the near term given how sticky inflation has proven to be even without any new policies.

Now, if we look at the dollar, that trend has been very consistent and remains in place with the dollar seemingly set to continue to appreciate.  Given Trump’s stated desire to reshore American manufacturing and reduce the trade deficit, he almost certainly would like to see the dollar decline.  However, at this point, it’s not clear what policies are going to drive that.  Historically, loose monetary and tight fiscal policy will weaken a currency, and that could well be what we see, except that is likely to create a burst of inflation before the tight fiscal policy reins that in.  And you know as well as I that Trump will be very displeased with that outcome.

It is certainly possible that the Treasury could intervene to weaken the dollar, but that is also something that is exceedingly rare in this country.  Perhaps the most likely situation here would be a Mar-a Lago (?) Accord, or something like that akin to the Plaza Accord of 1985, where the G7 at the time all agreed that the dollar needed to decline.  Now, on the one hand, given the weakness in the other G10 economies currently when compared to the US, my take is those nations are pretty happy to have weak currencies to help support their domestic industries.  On the other hand, I suspect the EMG bloc who have funded themselves in USD are really interested in seeing a weaker dollar to help them get easier access to dollars to service and repay their debt.  My take is that until there is a definitive policy pronouncement, and this will require something like that as quiet policy adjustments are likely to be missed by the FX market, this trend will remain intact.

Finally, a look at both equities and gold shows basically the same chart, with both showing accelerating price increases and both now significantly above their long-term trend lines.  The question, of course, is can this continue?  Keynes was reputed to have told us that markets can remain irrational longer than you can remain solvent, implying just because market pricing doesn’t make fundamental sense doesn’t mean it cannot continue further.  But in the end, trees don’t grow to the sky, and corrections in these markets seem somewhat overdue.  Consider the S&P 500 chart, where we see the sharp decline in 2022.  Many remember that as the worst market since the GFC crash, and yet on the chart, it looks like a modest correction.  Consider also, that if the market were to decline to the trend line I have drawn, it would be nearly a 50% correction, and that just puts it back on trend!  Again, volatility seems the watchword going forward, but until we see something that is going to change opinions, the trend in both stocks and gold seems higher.

OK, as we await the official change in presidency here, let’s review the overnight price action, which was generally positive following Friday’s US equity rally.  Remember, too, it is MLK Day, and markets are closed in the US.

Asian markets saw broad gains with the Nikkei (+1.2%) and Hang Seng (+1.75%) leading the way while mainland shares (+0.45%) lagged but were still in the green.  Away from the major markets, there were far more gainers than laggards, but the biggest moves were on the order of 0.4%, nothing of real note.  Positive Japanese data was the driver in Tokyo (Machinery Orders +3.4%) while HK and Chinese shares benefitted from the news that Presidents Trump and Xi spoke, hopefully in a prelude to less tension.  In Europe, markets are essentially unchanged across the board this morning as it seems investors cannot discern whether Mr Trump will be beneficial for the continent or not.  Certainly, I continue to read about a number of European leaders who are unhappy at the prospects of a Trump presidency (specifically PM Starmer who has ostensibly said the US-UK relationship is destined to diminish).  While that may be true, my take is it will not help the UK very much.  And, while US markets are closed today, US futures are pointing modestly higher this morning.

In the bond market, yields are edging higher in Europe, up between 1bp and 2bps on the continent while UK Gilt yields are higher by 3bps.  Overnight saw JGB yields slip 1bp and, of course, with banks closed in the US, Treasury yields are unchanged in the cash market.  However, bond futures are pointing to a 1bp rise as well.

In the commodity markets, oil is little changed on the day while NatGas (-4.4% after a -6.0% decline on Friday) is falling on news that weather models, which had been calling for another cold spell in February, have changed and are now saying temperatures will be milder then.  In the metals markets, gold (+0.3%) is edging higher while both silver (-0.3%) and copper (-0.4%) are slipping a touch, but given their inherent volatility, arguably these are unchanged on the day.

Finally, the dollar is under some pressure this morning with then euro (+0.5%) leading the G10 higher although similar sized gains are seen across the board with only JPY (0.0%) failing to go along for the ride.  EMG currencies are also picking up led by HUF (+2.0%) as it seems there is excitement in Hungary regarding the inauguration as PM Orban seems to share many of President Trump’s views on various geopolitical issues.  But CZK (+0.9%) and PLN (+0.6%) are also rallying alongside KRW (+0.5%), although MXN (-0.3%) seems to be showing concerns regarding how that relationship will evolve.  Certainly, as I mentioned above, President Trump will not be unhappy to see the dollar slide a little, but I don’t see this as the beginning of a new trend.

With no data today, and a light week in general, and given how long this missive has already become, I will lay out the data releases tomorrow.  Today, all eyes will be on the ~200 Executive Orders President Trump will sign and I expect it will take a little time to digest it all, so we will see how things really begin tomorrow.

Good luck

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Deceit

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Though many will claim it’s deceit
The Chinese declared they did meet
The target that Xi
Expected to see
Though skeptics remain on the Street
 
In fact, it appears there’s a trend
That data surprises all tend
To flatter regimes
And their stated dreams
As policy faults they defend

 

Last night, the Chinese released their monthly data barrage with final 2024 numbers as part of the mix. Despite numerous indications that Chinese growth is slowing, somehow, they managed to show a 5.4% annualized GDP growth rate for Q4 and a 5.0% GDP growth rate for all of 2024, right on President Xi’s target.  

Now, the government did add some stimulus in Q4 as they recognized things are not going well, and I continue to read articles that President Xi is starting to feel increased pressure from CCP insiders as to his stewardship of the nation and the economy.  Statistics like electricity usage and travel don’t really jive with the data, although it is certainly possible that ahead of the mooted tariffs that President Trump has threatened to impose starting next week, many companies preordered extra inventory to beat the rush, and that goosed growth.  

But there are a couple of things that continue to drag on the Chinese economy, with the primary issue the continuing implosion of the property market there.  For instance, while house price declines have been slightly slower, (only -5.3% last month) it has basically been three years since there was any gain at all as shown in the chart below.

Source: tradingeconomics.com

As well, one of the key concerns about China has been Foreign Direct Investment, which has not merely slowed down but has actually been reversing (companies leaving China) over the past two years as per the next chart.

Source: tradingeconomics.com

Meanwhile, a WSJ headline, China’s Population Fell Again Despite a Surprise Rise in Births, highlights yet another issue President Xi faces, the ongoing aging and shrinking of his nation.  Remember, GDP is basically the product of the number of people working * how much they each produce.  If that first number is shrinking, and the working age population in China is doing just that, it is awfully difficult to generate GDP growth.  Finally, I couldn’t help but notice in yesterday’s confirmation hearings for Treasury secretary, where Scott Bessent offered his view that China is actually in a recession, with massive deflation and are struggling to export their way out of the problems, rather than address their internal imbalances.  This is a theme that has been discussed widely in the past, and ostensibly, China has admitted they want to be more consumption focused in their economy, but it doesn’t appear that is the direction they are heading.

I raise these points in the context of the Chinese renminbi and how we might expect it to behave going forward.  The question of tariffs remains open at this stage, although I daresay we will learn more next week.  If they are imposed, there is a strong belief that the renminbi will weaken to offset the terms.  As it is, the currency remains within pips of its weakest level in 18 years and the trend, both short-term and for the past decade, has been for it to weaken further. 

Source tradingeconomics.com

Xi remains caught between the need for the currency to weaken to maintain competitiveness in the face of threatened tariffs from the US, and his desire to demonstrate that the renminbi is a stable store of value that other nations can trust to hold and use outside the global dollar network.  In the end, I expect the immediate competitiveness needs are going to overwhelm the long-term aspirations, especially if it is true that Xi is feeling internal pressure because of an underperforming economy.  Nothing has changed my view that we approach 8.00 by the end of the year.

Ok, and that’s really the big news overnight.  As an aside, it was interesting to watch Mr Bessent dismantle the attempts by the Democrat senators for a ‘gotcha’ moment.  As I wrote yesterday, it wasn’t really a fair fight given his intelligence, experience and understanding of markets and the economy compared to the Senators.

Let’s start in the equity world where US markets opened higher but ultimately slid all day long to close on their lows.  An uninspiring performance to say the least.  That performance weighed on much of Asia with the Nikkei (-0.3%) sliding alongside Australia, Korea and India.  On the plus side, modest gains were shown in China (Hang Seng and CSI 300 both +0.3%) and some positive numbers were seen in Taiwan, Malaysia and Singapore.  But overall, the movements were not substantial in either direction.  In Europe, though, markets are starting to anticipate more aggressive ECB rate cuts as data continues to show weakness in economic activity.  Weak UK Retail Sales data has the FTSE 100 (+1.3%) leading the way higher as hopes for a BOE cut grow.  Meanwhile, the CAC (+1.0%) and DAX (+1.0%) are both rallying on the thesis that Chinese growth is going to attract imports from both nations.  Meanwhile, US futures are higher by 0.4% at this hour (7:40).

In the bond market, all the inflation fears seem to have abated.  Either that or we continue to see a massive short squeeze and position unwinding.  But the result is yields are lower across the board with Treasury yields down 3bps further, and below 4.60% while European sovereign yields have fallen between -3bps and -5bps as investors take heart that the ECB and BOE are going to be cutting rates soon.  Perhaps the market is showing faith that Mr Bessent will be able to address the US fiscal financing crisis.  After all, he did explain in no uncertain terms that the US would not default on its debt.  But my sense is the market narrative about rising inflation and higher yields had really pushed too far, and this is simply the natural bounce back.  While this week’s inflation data was not as hot as feared, nothing has changed my view that inflation remains a problem going forward.

In the commodity markets, oil is unchanged on the day, having given back some of its substantial gains over the past two sessions, although it remains right near $79/bbl this morning.  Apparently, there are rumors Trump will end Russian oil sanctions as part of the Ukraine negotiations, but that doesn’t sound like something he would offer up initially, at least to me.  Meanwhile, NatGas (-4.0%) though slipping this morning, remains above $4/MMBtu as the US prepares for a major arctic cold snap next week.  In the metals markets, my understanding is there has been a lot of position adjustment and arbitrage between NY and London as we approach futures contract maturities, and that has been a key driver of the recent rally in metals (H/T Alyosha at Market Vibes, a very worthwhile trading Substack), but may be coming to an end in the next several sessions.  However, here, too, nothing has changed my longer-term view of higher prices over time.

Finally, the dollar is a tad stronger this morning, rallying vs. the pound (-0.4%), Aussie (-0.4%), NOK (-0.5%) and NZD (-0.5%) as all those ECB and BOE rate cut stories weigh on those currencies.  Interestingly, JPY (-0.3%) is also weaker this morning despite an article overnight signaling the BOJ will be raising rates next Friday.  On the flip side, looking at the EMG bloc, I see very modest gains by many of the key players (MXN +0.15%, ZAR +0.1%), although those moves feel far more like position adjustments than fundamentally driven changes in view.

On the data front, this morning brings Housing Starts (exp 1.32M) and Building Permits (1.46M) and then IP (0.3%) and Capacity Utilization (77.0%) later on.  There are no Fed speakers on the docket, and tomorrow is the beginning of the quiet period.  The last thing we heard from Cleveland Fed president Hammack was that inflation remains a concern and they have not yet finished the job.

For the day, I don’t think the data will have much impact.  Rather, as we are now in earnings season, I suspect that stocks will take their cues there and FX will remain in the background for now.

Good luck and good weekend

Adf

Shortsighted

Posted on by

The CPI data delighted
Investors, who in a shortsighted
Response bought the bond
Of which they’re now fond
And did so in, time, expedited
 
But does this response make much sense?
Or is it just way too intense?
I’d offer the latter
Although that may shatter
The narrative’s current pretense

 

Leading up to yesterday’s CPI data, it appeared to me that despite a better (lower) than expected set of PPI readings on Tuesday, the market was still wary about inflation and concerned that if the recent trend of stubbornly sticky CPI prints continued, the Fed would soon change their tune about further rate cuts.  Heading into the release, the median expectations were for a 0.3% rise in the headline rate and a 0.2% rise in the core rate for the month of December which translated into Y/Y numbers of 2.9%% and 3.3% respectively. At least those were the widely reported expectations based on surveys.  

However, in this day and age, the precision of those outcomes seems to be lacking, and many analysts look at the underlying indices prepared by the BLS and calculate the numbers out several more decimal places.  This is one way in which analysts can claim to be looking under the hood, and it can, at times, demonstrate that a headline number, which is rounded to the first decimal place, may misrepresent the magnitude of any change.  I would submit that is what we saw yesterday, where the headline rate rose to the expected 2.9% despite a 0.4% monthly print, but the core rate was only 3.24% higher, which rounded down to 3.2% on the report. Voila!  Suddenly we had confirmation that inflation was falling, and the Fed was right back on track to cut rates again.

Source: tradingeconomics.com

Now, I cannot look at the above chart of core CPI and take away that the rate of inflation is clearly heading back to 2% as the Fed claims to be the case.  But don’t just take my word for it.  On matters inflation I always refer to Mike Ashton (@inflation_guy) who has a better grasp on this stuff than anyone I know or read.  As he points out in his note yesterday, 3.5% is the new 2.0% and that did not change after yesterday’s data.

However, markets and investors did not see it that way and the response was impressive.  Treasury yields tumbled 13bps and took all European sovereign yields down by a similar amount, equity markets exploded higher with the NASDAQ soaring 2.5% and generally, the investment world is now in nirvana.  Growth remains robust but that pesky inflation is no longer a problem, thus the Fed can continue cutting rates to support equity prices even further.  At least that’s what the current narrative is.  

Remember all that concern over Treasury yields?  Just kidding!  Inflation is dying and Trump’s tariffs are not really a problem and… fill in your favorite rationale for remaining bullish on risk assets.  I guess this is where my skepticism comes to bear.  I do not believe yesterday’s data reset the clock on anything, at least not in the medium and long term.

Before I move on to the overnight, there is one other thesis which I read about regarding the recent (prior to yesterday) global bond market sell-off which has some elements of truth, although the timing is unclear to me.  It seems that if you look at the timing of the recent slide in bond markets, it occurred almost immediately after the fires in LA started and were realized to be out of control.  This thesis is that insurers, who initially were believed to be on the hook for $20 billion (although that has recently been raised to >$100 billion) recognized they would need cash and started selling their most liquid assets, namely Treasuries and US equities.  In fact, this thesis was focused on Japanese insurers, the three largest of which have significant exposure to California property, and how they were also selling JGB’s aggressively.  Now, the price action before yesterday was certainly consistent with that thesis, but correlation and causality are not the same thing.  If this is an important underlying driver, I would expect that there is more pressure to come on bond markets as almost certainly, most insurance companies don’t respond that quickly to claims that have not yet even been filed.

Ok, let’s see how the rest of the world responded to the end of inflation as we know it yesterday’s CPI data. Japanese equities (+0.3%) showed only a modest gain, perhaps those Japanese insurers were still out selling, or perhaps the fact that the yen (+0.3%) is continuing to grind higher has held back the Nikkei.  Hong Kong (+1.25%) stocks had a good day as did almost every other Asian market with the US inflation / Fed rate cuts story seemingly the driver.  The one market that did not participate was China (+0.1%) which managed only an anemic rally.  In Europe, the picture is mixed as the CAC (+2.0%) is roaring while the DAX (+0.2%) and IBEX (-0.4%) are both lagging as is the FTSE 100 (+0.65%).  The French are embracing the Fed story and assuming luxury goods will be back in demand although the rest of the continent is having trouble shaking off the weak overall economic data.  In the UK, GDP was released this morning at 1.0% Y/Y after just a 0.1% gain in November, slower than expected and adding pressure to the Starmer government who seems at a loss as to how to address the slowing economy.  As to US futures, at this hour (7:30) they are pointing slightly higher, about 0.2%.

In the bond market, after yesterday’s impressive rally, it is no surprise that there is consolidation across the board with Treasury yields higher by 2bps and similar gains seen across the continent.  Overnight, Asian government bond markets reacted to the Treasury rally with large gains (yield declines) across the board.  Even JGB yields fell 4bps.  The one market that didn’t move was China, where yields remain at 1.65% just above their recent historic lows.

In the commodity markets, oil (-1.0%) is backing off yesterday’s rally which saw WTI trade above $80/bbl for the first time since July as despite ongoing inventory builds in the US, and ostensibly peace in the Middle East, the market remains focused on the latest sanctions on Russia’s shadow tanker fleet and the likely inability of Russia (and Iran) to export as much as 2.5 million barrels/day going forward.  NatGas (+0.75%) remains as volatile as ever and given the polar vortex that seems set to settle over the US for the next two weeks, I expect will remain well bid.  On the metals side of things, yesterday’s rally across the board is being followed with modest gains this morning (Au +0.3%) as the barbarous relic now sits slightly above $2700/oz.

Finally, the dollar doesn’t seem to be following the correct trajectory lately as although there was a spike lower after the CPI print yesterday, it was recouped within a few hours, and we have held at that level ever since.  In fact, this morning we are seeing broader strength as the euro (-0.2%), pound (-0.4%) and AUD (-0.5%) are all leaking and we are seeing weakness in EMG (MXN -0.6%, ZAR -0.6%) as well.  My take is that the bond market, which had gotten quite short on a leveraged basis, washed out a bunch of positions yesterday and we are likely to see yields creep higher on the bigger picture supply issues going forward.  For now, this is going to continue to underpin the dollar.

On the data front, this morning opens with Retail Sales (exp 0.6%, 0.4% -ex autos) and Initial (210K) and Continuing (1870K) Claims.  We also see Philly Fed (-5.0) to round out the data.  There are no Fed speakers today, although in what cannot be a surprise, the three who spoke yesterday jumped all over the CPI print and reaffirmed their view that 2% was not only in sight, but imminent!  As well, today we hear from Scott Bessent, Trump’s pick to head the Treasury so that will be quite interesting.  In released remarks ahead of the hearings, he focused on the importance of the dollar remaining the world’s reserve currency, although did not explicitly say he would like to see it weaken as well.  The one thing I know is that he is so much smarter than every member of the Senate Finance committee, that it will be amusing to watch them try to take him down.

And that’s really it for now.  If Retail Sales are very strong, look for equities to see that as another boost in sentiment, but a weak number will just rev up the Fed cutting story.  Right now, the narrative is all is well, and risk assets are going higher.  I hope they are right; I fear they are not.

Good luck

Adf

Will It Matter?

Posted on by

Will Japan hike rates?
How much will it matter if
They do?  Or they don’t?

 

Market activity and discussion has been somewhat lacking this week as the real fireworks appear to be in Washington DC where President-elect Trump’s cabinet nominees are going through their hearings at the Senate.  Certainly, between that and the ongoing fires in LA, the news cycle is not very focused on financial markets in the US.  This, then, gives us a chance to gaze Eastward to the Land of the Rising Sun and discuss what is happening there.

You may recall yesterday I mentioned a speech by BOJ Deputy Governor Himino where he explained that given the inflation situation as well as the indication that wages would continue to rise at a more robust clip in Japan, a rate hike may be appropriate.  Well, last night, Governor Ueda basically told us the same thing.  Alas, it seems that the BOJ takes a full day to translate speeches into English because there are no quotes from Ueda, but we now have the entire Himino speech from the day before.

Regardless, the essence of the story is that the BOJ is carefully watching the data and awaiting the Trump inauguration to see if there are any surprise tariff outcomes against Japan (something that has not been discussed) while they await their own meeting at the end of next week.  Market pricing now has a 72% probability of a 25bp rate hike next week, up from about 60% yesterday, and last night the yen did rally, climbing 0.7%.  However, a quick look at the chart below might indicate that the market is not overly concerned about a major yen revaluation.

Source: tradingeconomics.com

In fact, since the last BOJ meeting in December, when they sounded a bit more dovish than anticipated, the yen has done very little overall, treading water between 156.50 and 158.50.  While a BOJ rate hike would likely support the yen somewhat, there is another dynamic playing out that would likely have the opposite effect.  At the beginning of the year I prognosticated that the Fed may well hike rates by the end of 2025 as inflation seems unlikely to cooperate with their prayers belief that 2.0% was baked in the cake.  At the time, that was not a widely held view.  However, in a remarkably short period of time, market participants are starting to discuss the idea that may, in fact, be the case.  Even the WSJ today had a piece on the subject from James Mackintosh, one of their economics writers laying out the case.  The point here is that if tighter monetary policy by the Fed is in the cards, I suspect the yen will have a great deal of difficulty climbing much further.  Let’s keep an eye on the 156.00 level for clues that things are changing.

In England, inflation is rising
Less quickly than some theorizing
Meanwhile in the States
Jay and his teammates
Are hoping for data downsizing

Turning now to the inflation story, European releases were generally right on forecast except for the UK, where the headline rate fell to 2.5% while the core fell to 3.2%, 1 tick and 2 ticks lower than expected respectively.  Certainly, that is good news for the beleaguered people in the UK and it has now increased the odds that the BOE cuts rates at their next meeting on February 6th.  However, we cannot forget that the BOE’s inflation target, like that of the Fed, is 2.0%, and there is still limited belief that they will achieve that level even in 2025. But the markets did respond to the data with the FTSE 100 (+0.75%) leading the European bourses higher while 10-year Gilt yields (-8bps) have seen their largest decline in several weeks and are also leading European sovereign yields lower.  Interestingly, the pound has been left out of this movement as it is essentially unchanged on the day.  Perhaps there is a message there.

Which brings us to the US CPI data this morning.  after yesterday’s PPI data printed softer than expected at both the headline and core levels, excitement is building for a soft print and the resumption of the Fed cutting cycle.  However, it is important to remember that despite the concept that these prices should move together, the reality is they really don’t.  Looking at the monthly core movements below, while the sign is generally the same, the relationship is far weaker than one might imagine.

Source: tradingeconomics.com

In fact, since January 2000, the correlation between the two headline series is 0.04%, or arguably no relationship at all.  I would not count on a soft CPI print this morning based on yesterday’s PPI.  Rather, I am far more concerned that the ISM Services Prices Paid index last week was so hot at 64.1, a better indicator that inflation remains sticky.  But I guess we will all learn in an hour or two how it plays out.

Ahead of that, let’s look at the rest of the overnight session.  Yesterday’s mixed US equity performance (the NASDAQ lagged) was followed by mixed price action overnight with the Nikkei (-0.1%) edging lower on the modestly stronger yen and talk of a rate hike, while the Hang Seng (+0.3%) managed a gain on the back of Chinese central bank activity as the PBOC added more than $130 billion in liquidity ahead of the Lunar New Year holiday upcoming.  However, mainland shares (CSI 300 -0.6%) did not share the Hong Kong view.  Elsewhere in the region Taiwan (-1.25%) was the laggard while Indonesia (+1.8%) jumped on a surprise rate cut by the central bank there.

In Europe, though, all is green as gains of 0.4% (CAC) to 0.8% (DAX) have been driven by ECB comments that rate cuts are coming as concerns grow over the weakness of the economies there.  Germany released its GDP data and in 2024, Germany’s GDP shrank by -0.2%, the second consecutive annual decline and the truth is, given the combination of their insane energy policy and the fact that China is eating their proverbial lunch with respect to manufacturing, especially in the auto sector, it is hard to look ahead and see any positivity at all.  Meanwhile, US futures are higher by 0.5% or so at this hour (7:00) clearly with traders looking for a soft CPI print.

In the bond market, Treasury yields are lower by 3bps this morning but remain just below 4.80% and the 5.0% watch parties are still hot tickets.  European yields have also softened away from Gilts, with the entire continent lower by between -2bps and -4bps.  Right now, with dreams of a soft CPI, bond bulls are active.  We shall see how that plays out.

In the commodity space, oil (+0.3%) is modestly firmer after a reactionary sell-off yesterday.  The IEA modestly raised its demand forecast and supplies in the US, according to the API, were a bit tighter yesterday, so that seems to be the support.  NatGas is little changed right now while metals markets (Au +0.4%, Ag +0.5%, Cu +0.4%) are edging higher although mostly remain in a trading range lately.  Activity here has been lackluster with no new story to drive either direction.

Finally, the dollar is a touch softer overall, but away from USDJPY, most movement is of the 0.1% variety. Right now, the FX markets are not garnering much interest overall.

On the data front, expectations for CPI are as follows: Headline (0.3%, 2.9% Y/Y) and Core (0.2%, 3.3% Y/Y).  As well, we see Empire State Manufacturing (3.0) and then the Beige Book at 2:00pm.  We also have three Fed speakers, Williams, Kashkari and Barkin, but are they really going to alter the cautionary message?  I doubt it and the market continues to price a single 25bp cut for all of 2025.  The real fireworks will only come if/when price hikes start to get priced in as discussed above.

It is hard to get excited for market activity today as all eyes remain on the confirmation hearings and LA.  As such, I suspect there will be very little to see today.

Good luck

Adf

In the “Know”

Posted on by

According to those in the “know”
It’s certain that tariffs will grow
But now some are saying
The timing is straying
From instant to something more slow

 

In what has been a generally quiet evening in the markets, the story that President-elect Trump is considering imposing all those tariffs on a gradual basis, rather than instantaneously when he is inaugurated, was taken as a bullish sign by investors.  This seems to have been the driving force behind yesterday afternoon’s modest rebound in equity markets as the current market narrative is tariffs = bad, no tariffs = good.  From what I can determine, these are anonymous comments not directly attributed to Trump or his incoming economics team and, in fact, Trump denied that possibility.

But the market impact was real as not only did equity markets rebound a bit, but the dollar, which had soared yesterday, has given back some of those gains and is modestly lower this morning.  If we learned nothing else from President Trump’s first term, it should be clear that there is frequently a great deal of bombast emanating from the White House and responding to each and every comment is a recipe for exhaustion and disaster. While this cannot be ruled out, if one were to ascribe a Trumpian gospel it would be that tariffs are beautiful so slow-rolling them doesn’t really accord with that view.  I guess we will all find out more next week.

Now, turning to data releases
This week its inflation showpieces
Today’s PPI
Is tipped to be high
While Wednesday the core rate increases

Away from that story, though, there has been little else of note overnight.  As such, let’s focus on the PPI data this morning and CPI tomorrow as they ought to help inform our views on the Fed’s actions going forward. Expectations are for headline to rise to 3.4% Y/Y while core jumps to 3.8% Y/Y.  It is difficult to look at a chart of these readings and not conclude that the bottom is in and the trend is higher.

Source: tradingeconomics.com

This is not to say that we are going to see price rises like we did back in 2022 as the waves of Covid spending washed through the economy, but the Fed’s mantra that inflation is going to head back to 2.0% over time is not obvious either.  In fact, if I were a betting man, I would estimate that we are likely to continue to see inflation run between 3.5% and 4.5% for the foreseeable future.  There is just nothing around to prevent that in the short run.  Now, if we do see significant productivity enhancements, those numbers will decline, but my take is the best opportunity for that, more effective and widespread use of AI, is still several years away.

Remember, too, that the government writ large, whether headed by R’s or D’s is all-in on inflation as it is the only opportunity they have to reduce the real value of the outstanding government debt.  Perhaps the Trump administration will take a different tack, but it is not clear they will be able to do so.  The only time inflation is a concern is when it becomes a political liability.  For the two decades leading up to Covid, it was not a daily concern of the population and central banks around the world were terrified of deflation!  In fact, there are so many comments by folks like Yellen, Bernanke and other Fed governors and presidents decrying the fact that their key regret was not getting inflation high enough, it is difficult to count them.  But as evidenced by the chart below of CPI, we no longer live in that world.

Source: tradingeconomics.com

Summing up, the current situation is that inflation has likely bottomed, the government continues to run massive fiscal deficits and given the $36 trillion in debt outstanding, the government needs to reduce the interest rate they pay on their debt.  If pressed, I would expect that we will see synthetic yield curve control (YCC) enabled by regulatory changes requiring banks and insurance companies to own a greater percentage of Treasury notes and bonds in their portfolios to ensure there is sufficient demand for issuance.  That can have the effect of turning long-term real yields negative, exactly the outcome the government wants. Remember, from 1944-1951, the Fed enacted YCC directly and it worked wonders in reducing the debt/GDP ratio.  They know this tool and will not be afraid to use it.

Ok, let’s take a look at what little action there was overnight.  After yesterday’s late rebound resulted in a mixed close with the NASDAQ still lower but the other two indices closing in the green, Asian equity markets also had a mixed picture.  The Nikkei (-1.8%) was the laggard, seemingly following last week’s US market movement after reopening from a holiday weekend.  However, Chinese shares (Hang Seng +1.8%, CSI 300 +2.6%) rallied sharply on the latest news that more Chinese stimulus was coming soon.  This time the Ministry of Commerce claimed they would be looking to boost consumption this year, but neglected to mention how they will do so.  Regardless, investors liked the story and when added to the gradual tariff story, it was all green.

European bourses are also in fine fettle this morning with gains across the board (CAC +1.2%, DAX +0.8%, IBEX +0.6%) and even the FTSE 100 (+0.1%) has managed to rally a bit.  This price movement, and that of the rest of Asia where gains were seen, seems all to be a piece with the slower tariff story discussed above.  As to US futures markets, at this hour (6:40), they are pointing modestly higher, 0.45%.

In the bond market, the only place where yields have moved significantly today is in Japan, where JGB yields have jumped 5bps and are now at their highest point since February 2011.  This followed comments from Deputy Governor Himino that the board was likely to debate a rate hike at their meeting next week and market pricing has a 60% probability priced in for the move.  There is much talk of wage increases in Japan, and Himino-san also raised questions about what the Trump administration will do and how it will impact yields.  Interestingly, despite the more hawkish rhetoric, the yen (-0.25%) actually declined today, not necessarily what you would expect.  As to the rest of the bond market, everything is within 1bp of Monday’s closing levels.

In the commodity markets, oil (-0.3%), which has been rocking lately on the increased Russia sanctions, is consolidating this morning although remains higher by nearly 6% this week and 12% in the past month. (As an aside, I don’t understand the Biden theory that sanctions driving up prices is going to be a detriment to Putin as he will make up for the loss of volume with higher prices, but then, I’m not a politician.). Meanwhile, NatGas (-3.2%) has backed off its recent highs as storage concerns ebb, although the ongoing cold weather appears to have the opportunity to push prices higher again.  As well, the latest dunkelflaute throughout Europe is driving demand for LNG.  In the metals markets, yesterday’s declines have been arrested, and we are basically unchanged this morning.

Finally, the dollar is mixed this morning, edging higher against some G10 counterparts (GBP -0.3%, JPY -0.4%) but sliding against others (NZD +0.6%).  Versus the EMG bloc, again the picture is mixed today with gainers (ZAR +0.4%, KRW +0.3%) and laggards (CZK -0.2%) although overall, I would argue the dollar is a touch softer on the back of the gradual tariff story.

On the data front, this morning’s PPI data (exp 0.3% M/M, 3.4% Y/Y) headline and (0.3% M/M, 3.8% Y/Y) core is the extent of what is to come.  Interestingly, the NFIB Index jumped to 105.1, the highest print since October 2018, as small businesses are clearly excited about the prospects of a Trump administration and the promised regulatory cuts.

Right now, both the dollar and Treasury yields are pushing to levels that have caused market problems in the past.  If these trends continue, be prepared for some more significant price action.  That could manifest as a sharp decline in equity markets, or some surprising Fed activity as they try to address any potential market structural problems that may arise.  But there is nothing due to stop the trends right now.

Good luck

Adf

Quite Clearly Concerned

Posted on by

The data on Friday exceeded
All forecasts, and has now impeded
The idea the Fed
When looking ahead
Believes further rate cuts are needed
 
Meanwhile from the Chinese we learned
Their exports are still widely yearned
But imports are falling
As growth there is stalling
And Xi is quite clearly concerned

 

Under the rubric, even a blind squirrel finds an acorn occasionally, my prognostications on Friday morning turned out to be correct as the NFP number was much stronger than expected, the Unemployment Rate fell, and signs of labor market strength were everywhere.  One of the most interesting is the number of quits rose to 13.8%, its highest level in several years and an indication that there is growing confidence amongst the labor force that jobs are available if needed.  As well, as you all are certainly aware, the market responded by selling equities and bonds while reducing the probability of Fed rate cuts this year.  In fact, this morning, the market is pricing in just 24 basis points of cuts for all of 2025, in other words, one cut only.  

Meanwhile, the bond market continues to sell off with yields rising another 2bps this morning.  the chart below shows the dichotomy between Fed funds and 10-year Treasury yields.  Historically, when the Fed was cutting or raising rates, the bond market followed.  But not this time.

Source: tradingeconomics.com

There have been many explanations put forth by analysts as to why this is the case, but to me, the most compelling is that investors disagree with the Fed’s analysis of the economy and, more specifically, with their pollyannaish tone that inflation is going to magically return to 2% because their models say so.  In fact, when looking back over the past 50-years of data, this is the only time that I can see when this dichotomy even existed.

Source: tradingeconomics.com

If I had to guess, there is going to be a lot more volatility coming as previous market signals, and more importantly, Fed market tools, no longer seem to be working as desired.  Nothing has changed my view that 10-year yields head to 5.5%, and if I am correct, look for equity markets to suffer, perhaps quite a bit.

The other story of note overnight was the Chinese trade surplus, which expanded to $104.8 billion in December which took the 2024 surplus to $1.08 trillion.  Now, much of this seems to be preordering of Chinese goods ahead of Trump’s inauguration and the promised tariffs.  But China’s surplus with other Asian economies also grew dramatically last year.  Remember, President Xi is desperate to achieve 5% growth (even on their accounting) and since the Chinese public remains unenthusiastic about spending any money given the $10 trillion hole in their collective savings accounts due to the property market collapse, Xi is reliant on exporting as much as possible.  While this is not making him any friends anywhere else in the world, it is an existential issue for him, so he doesn’t really care.  It will be very interesting to see just how the Trump-Xi relationship moves forward and what concessions are made on either side.

In the end, while the renminbi is basically unchanged this morning, it remains pegged against its 2% limit vs. the CFETS fixing onshore and is 2.35% weaker in the offshore market.  That pressure is going to continue until either the Chinese step up, apply significant stimulus to the domestic economy and start to rebalance the trade process or the PBOC lets the currency go.  Remember, too, Xi is in a tough position because he continuously explained that the renminbi is a good store of value and has been asking his trading partners to use it rather than the dollar.  But if he lets it slide, that will destroy that entire narrative, a real loss of face at the very least, and potentially a much bigger economic problem.  Interesting times.

And so, let us turn to the overnight market activity and see how things are shaping up for today and the rest of the week.  Friday’s sharp decline in US equity indices was followed by similar price action throughout Asia (Nikkei -1.05%, Hang Seng -1.0%, CSI 300 -0.3%, Australia -1.25%) as the narrative is struggling to come up with a positive spin absent further US rate cuts.  European bourses have also come under pressure (DAX -0.7%, CAC -0.8%, IBEX -0.7%, FTSE 100 -0.4%) despite the fact that ECB talking heads continue to explain that more rate cuts are coming, they just won’t be coming quite as quickly as previously expected.  At this point, the market is pricing in 84bps of cuts by the ECB this year.  And yes, US futures are also in the red at this hour (7:00), falling between -0.5% (DJIA) and -1.1% (NASDAQ).

It seems that the narrative writers are struggling to put together a bullish story right now as inflation refuses to fall while growth, at least in Europe, continues to abate.  At least, a bullish story for equities and bonds.  The dollar, on the other hand, has gained many adherents.

Turning to bonds, yields continue to climb across the board with European sovereign yields rising between 2bps (Germany) and 8bps (Greece) and everything in between.  It seems nobody wants to hold bonds right now.  The same was true overnight in Asia where the best performer was the JGB, which was unchanged, but other regional bond markets all saw yields rise between 3bps (Korea) and 9bps (Australia).  Even Chinese yields edged higher by 1bp!

In the commodity space, oil (+2.0%) is en fuego, as the impact of further sanctions on the Russian tanker fleet is being felt worldwide.  It seems the Biden administration has added another 150 Russian tankers to the sanctions list along with insurance companies, and so China and India, who have been the main recipients of Russian oil, are seeking supplies elsewhere.  As long as this continues, it appears oil has further to run.  Meanwhile NatGas (+3.8%) has blasted through $4.00/MMBtu and is now at its highest level since December 2022.  Despite all those global warming fears, the recent arctic blast has increased demand dramatically!

As to the metals markets, the story is different with gold (-0.5%) sliding alongside silver (-2.1%) and copper also trickling lower (-0.15%).  Part of this is clearly the dollar’s strength, which is impressive again today, and part is likely concern over how things are going to play out going forward between the US and China as well as the overall global economy.  Certainly, a case can be made that growth is going to be much slower going forward.

Finally, the dollar is king again, rallying sharply against the euro (-0.5%) and pound (-0.8%) with smaller gains against the rest of the G10 (JPY excepted as it rallied 0.2% on haven flows).  But we are also seeing gains against virtually all EMG currencies (CLP -0.6%, PLN -0.7%, ZAR -0.4%, INR -0.6%) as concerns grow that these other nations will not be able to ably fund their dollar debt as the dollar continues to rise.  FYI, the DXY (+0.35% to 110.07) is at its highest level since October 2022 and looking for all the world like it is going to take out the highs of that autumn at 113.20.

On the data front, this week brings CPI and PPI as well as Retail Sales.  In addition, I was mistaken, and the Fed is not in their quiet period so we will hear a lot more from them this week as well.

TuesdayNFIB Small Biz Optimism100.8
 PPI0.3% (3.4% Y/Y)
 Ex food & energy0.3% (3.7% Y/Y)
WednesdayCPI0.3% (2.8% Y/Y)
 Ex food & energy0.2% (3.3% Y/Y)
 Empire State Manufacturing4.5
 Fed’s Beige Book 
ThursdayInitial Claims214K
 Continuing Claims1870K
 Retail Sales0.5%
 Ex autos0.4%
 Philly Fed-4.0
FridayHousing Starts1.32M
 Building Permits1.46M
 IP0.3%
 Capacity Utilization76.9%

Source: tradingeconomics.com

As well, we hear from five Fed speakers over six venues.  Now, the message from the Fed has been pretty unified lately, that caution and patience are appropriate regarding any further rate cuts but that to a (wo)man they all believe that inflation is heading back down to 2.0%.  I’m not sure why that is the case because if you look at the data, it certainly has the feeling that it has bottomed, and inflation rates are turning higher as you can see from the below chart of core CPI.

Source: tradingeconomics.com

And this is before taking into account that energy prices have been soaring lately!  I realize I’m not smart enough to be an FOMC member, but they certainly seem to be willfully blind on this issue.

At any rate, certainly all things still point to a higher dollar going forward, and I imagine we are going to test some big levels soon enough (parity in the euro, 1.20 in the pound) but I am beginning to get uncomfortable as so many analysts have come around to my view.  Historically, if everybody thinks something is going to happen, typically the opposite occurs.  Remember, markets are perverse!

Good luck

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A Future Quite Noeth

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All eyes will be on NFP
As pundits are hoping to see
A modest result
That can catapult
The market to its apogee
 
If strong, the concern is that growth
Will strengthen and Jay will be loath
To cut rates once more
Which bulls will deplore
Implying a future quite noeth
 
If weak, then the problem for stocks
Is earnings will suffer a pox
So even if rates
Are cut in the States
The NASDAQ may still hit the rocks

 

It’s payroll day and especially after yesterday’s day of respect for the late President Carter closed equity markets in the US, investors are anxious to get back to business.  Here are the latest consensus estimates for the key figures to be released

Nonfarm Payrolls160K
Private Payrolls135K
Manufacturing Payrolls5K
Unemployment Rate4.2%
Average Hourly Earnings0.3% (4.0% Y/Y)
Average Weekly Hours34.3
Participation Rate62.8%
Michigan Sentiment73.8

Source: tradingeconomics.com

As well, there will be annual revisions to the household report today, which is the portion of the process that calculates the Unemployment Rate.  Next month we will see the annual revisions to the NFP, where estimates are already circulating that the number of jobs created in 2024 will be revised down by more than 1 million, nearly one-half of the claimed number (~2.2 million) created.

But ultimately, the reason this data point gets so much press is that it is half of the Fed’s mandate and so is closely watched by the FOMC as they consider any policy stance.  Yesterday, St Louis Fed president Musalem became the seventh or eighth Fed speaker since the last meeting to explain that more caution was warranted as the Fed tries to reduce what they still believe is a modest tightening bias.  “… [rate reductions] have to be gradual – and more gradual than I thought in September,” according to Musalem.  So, caution remains the watchword for every member of the FOMC and accordingly, the market is pricing just a 5% probability of a rate cut later this month.

The thing that has really changed over the past several months is the market’s reaction function to the data.  Part of this is based on the fact that it appears the Fed’s reaction function has changed a bit, and part of this is because the economic situation remains so confusing.

Regarding the Fed, given the fact that the data since they started cutting rates in September has been quite robust and given the fact they no longer have a political/partisan motive to cut rates, it strikes me it will be far harder for Powell and friends to justify further rate cuts from here.  After all, if GDP is growing at 3.0% and inflation is running at 3.3%, absent all other information, that data would truthfully argue for rate hikes.  However, there remains a large camp of analysts that continue to expect a significant slowdown in economic activity, with a number of well-respected voices claiming that we are already in a recession and have been in one since sometime in 2024.  

My view is that this confusion remains best explained by the concept of the K-shaped recovery where a smaller portion of the population, notably those with assets and investments in the markets, have been huge beneficiaries of Fed policies as they not only have seen their portfolios climb in value, but their cash is earning a nice return.  Meanwhile, a much larger percentage of the population, although a group that receives far less press from the financial reporters, continues to struggle given still rising prices and less overall opportunity for advancement.  This is the genesis of the labor strife we have seen, but there are many who remain left behind.  The problem for the Fed is they don’t really see this second cohort as their constituents, at least based on their policy actions.

As to today’s release, if we look at the recent Initial Claims data, it is consistent with a stronger number rather than a weaker one.  However, from a market perspective, I believe that a strong NFP number, something like 200K, will see a risk sell-off as the market continues to remove pricing for any rate cuts in 2025.  This will hurt stocks and likely bonds, although it will help the dollar and, surprisingly, commodities, as the market is likely to see increased demand forthcoming.

Elsewhere, aside from the wildfires in LA, which are a terrible tragedy, the other story in markets today revolves around the ongoing, slow motion disintegration of any remaining credibility in the UK government and its ability to address the many problems there.  Gilt yields continue to rise sharply, although I continue to hear many rationales as to why this is NOT like the October 2022 Gilt crisis.  Alas, while certainly the speed of this decline in Gilts is not quite as dramatic as we saw back then, the duration of the problem is far greater, and we have moved further now than then.  As you can see from the below chart, Gilt yields have risen 110bps since the middle of September, outpacing even Treasury yields and 10yr Gilts now yield 15bps more than Treasuries.  

Source: tradingeconomics.com

In fact, UK 10-year yields are the highest in the G10, although in fairness, they are not yet approaching levels like Mexico (10.6%), Brazil (14.75%) or Turkey (26.4%).  Perhaps Chancellor Reeves has those targets in mind.

OK, let’s see how markets behaved in the lead-up to the data this morning.  There was no joy in Mudville Asia last night as the Nikkei (-1.05%) slid amid new stories that the odds of a BOJ rate hike in two weeks are rising, while Chinese shares (Hang Seng -0.9%, CSI 300 -1.2%) were also under pressure amid news that the PBOC would stop buying bonds (ending QE) and additionally might be selling some to reduce liquidity in Hong Kong as they attempt to slow the decline of the renminbi.  The rest of the region was similarly under pressure across the board. 

In Europe, the picture is more nuanced with the DAX (+0.4%) and CAC +0.3%) showing some modest gains after slightly better than expected French IP data.  However, the FTSE 100 (-0.4%) and other continental bourses (IBEX -0.9%) are not quite as positive, with the FTSE clearly feeling pressure from the overall negative sentiment on the UK, while mixed data elsewhere is undermining any investor sentiment.  US futures at this hour (7:15) are pointing lower by about -0.25% across the board.  Fears of a strong number?

In the bond market, Treasury yields continue to climb, as they are holding onto yesterday’s rise of 5bps and this morning we are seeing European sovereign yields all creep higher by 1bp to 2bps.  JGB yields also rose 2bps overnight as part of that BOJ rate hike story.  In fact, the only market that didn’t see yields rise is China, where they remain within 2bps of their recent all-time lows

In the commodity markets, oil (+3.2%) is skyrocketing as continued cold weather increases heating demand while the reduction in inventories in Cushing, Oklahoma (the main point for NYMEX contract settlements) has raised concern over available supply of crude.  Meanwhile, metals prices continue to climb steadily with gold (+0.3%) continuing its run alongside silver (+0.8%) and copper (+0.45%).  The demand for “stuff” remains strong as nations around the world slowly lose confidence in government bonds as an effective store of value.

Finally, the dollar is, net, little changed this morning with some gains and some losses although few large moves.  On the dollar’s plus side we see KRW (-0.5%), ZAR (-0.55%) and BRL (-0.35%) while the yen and renminbi have both seen modest gains (+0.1%) on the back of the liquidity reduction stories in both nations.  However, we must keep in mind the dollar, as measured by the DXY, remains above 109 and continues to strongly trend higher.  My take is the highs seen in autumn 2022 are the next target, so look for the euro to sink below parity and the pound well below 1.20, probably 1.15, before too long.

There are no Fed speakers on the schedule today, although I imagine we will hear from somebody after the data since they cannot seem to shut up.  However, after today, they head into their quiet period ahead of the next FOMC meeting, so until then we will need to rely on Nick Timiraos from the WSJ to understand what Powell is thinking.

While nothing is that clear, and we could easily see a weak NFP report, my take is we are far more likely to see a strong one with stocks and bonds selling off and the dollar rising further.

Good luck and good weekend

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