Category Archives: Uncategorized

Dripping Lower

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Like rain off a roof
The yen keeps dripping lower
Can it fall further?

 

On a quiet morning after a welcome rebound in equity markets around the world, there has been an uptick in discussion regarding the yen, BOJ Governor Ueda and the upcoming BOJ meeting this Friday.  One of the things that seems to have Ueda-san and the rest of the BOJ confused is that after their last meeting on March 18, where they raised interest rates for the first time in forever, the yen has continued to weaken.  A quick look at the chart below shows the relatively steady decline in the currency since that date.

Source: tradingeconomics.com

Perhaps this is a sign that Japan’s monetary policy, at least given the enormous interest rate differentials with the US, just doesn’t really matter to the traders in the FX market.  A look at relative interest rate movements in the respective 10-year bonds shows that Treasury yields have rallied about 30bps while JGB yields have risen just half that amount since that BOJ meeting.  One thing that is becoming clearer is that the pressure on Ueda-san and FinMin Suzuki to do something about the weakening yen is growing.  It seems they have finally figured out that a weak yen has a direct link to rising yen prices of energy for both home and autos, and that the people in Japan are running out of patience with those rises.

Perhaps this explains the increase in the comments by these two critical players, with both threatening action if things get out of hand.  For instance, Suzuki explained, “I think it’s fair to assume that the environment for taking appropriate action on forex is in place, though I won’t say what the action is,” when speaking to Parliament last night.  His problem is he knows that intervention by Japan only will have no long-term impact and merely allow traders a better entry point to continue to pressure the yen lower. 

Meanwhile, Ueda-san was absolutely loquacious in his comments to Parliament, explaining, “we will set our short-term interest rate target at a level deemed appropriate to sustainably and stably achieve our 2% inflation target.  If underlying inflation rises toward 2% in line with our projections, we will adjust a degree of monetary easing. In that case, we will likely raise short-term interest rates.”  

Now, does this mean that they are going to do something at their meeting this week?  I think the probability of a policy change is vanishingly small.  Quite frankly, they are very aware that their current toolkit is not fit for the purpose of strengthening the yen and so jawboning is pretty much all they have.  In fact, to the extent that they would like to see the yen strengthen, their best bet is to call Chairman Powell and plead their case that the US should cut rates, and by a lot, or the world will end.  I don’t see that happening either.

Something worth noting is that Powell is facing pressure from multiple directions as foreign central bankers are desperate for the Fed to cut so they can too, and from the administration which believes that lower rates will help them in their quest to be reelected.  But, in the end, there is no evidence that the Fed is going to reverse their recent comments and turn dovish.  As long as that is the case, the trend higher in USDJPY remains quite clear and I see no reason to expect anything other than minor pullbacks in the near future.  However, if the Fed does cut rates despite the ongoing inflation pressures in the US, look for the dollar to fall sharply while risk assets explode higher.

So, while we all await both the BOJ and the PCE data on Friday, let’s recap the overnight session.  While green was the predominant color on screens overnight with Japan (+0.3%) and Hong Kong (+1.9%) leading the way, mainland Chinese stocks continue to suffer (-0.7%) dragging down Korean shares (-0.25%).  But otherwise, India, Taiwan, Australia, Singapore, etc., were all in the green.  In Europe, there is no question that things are looking up as every market is higher, most by 1% or more after the Flash PMI data was released showing that economic activity was picking up across the continent.  While manufacturing remains in contraction, and is hardly improving, the services sector is definitely stronger.  Meanwhile, at this hour (7:30) US futures are firmer by about 0.25%.

In the bond markets, price activity has been far more muted with Treasury yields recouping the 2bps they lost yesterday, while European sovereigns are higher by 1bp across the board.  The ECB commentary continue to highlight a June hike with the most dovish acolytes calling for 100bps of cuts this year (Portugal’s Centeno) while Spain’s de Guindos reminded everyone that the Fed was still driving the bus and they need to think about the whole world, not just the US.  As you can see, Powell faces pressure from all over.

On the commodity front, the retracement from the massive bull rally in metals prices is continuing apace with gold (-1.4%), silver (-1.4%) and copper (-1.1%) all under more pressure today after having fallen sharply for the past two sessions already.  My take is that this is an overdue correction from a remarkable move higher, but that the underlying story remains intact.  Certainly, the apparent lessening of tensions in the Israel-Iran issue has helped this movement as well as its impact on the price of oil (-0.75% today, -4.65% in past week).  However, the inflation story remains front and center when it comes to pricing commodities and there is no evidence whatsoever that prices are slipping back.  As we head toward summer, I do anticipate that metals demand will return, especially if the economy continues to perform at its current levels.

Finally, the dollar is slightly softer this morning but remains above 106 on the DXY.  We have already discussed the yen, which cannot find a bid anywhere, but the pound (+0.25%) is rebounding after PMI data in the UK was also a bit better.  However, overall, there are gainers and losers in both the G10 and EMG blocs, the largest of which is the ZAR (-0.3%) which is clearly suffering alongside the slide in metals prices.  Not surprisingly, NOK (-0.2%) is feeling pressure from oil’s decline.  But the euro has edged higher, and it has taken its CE4 counterparts higher while LATAM currencies seem to be taking the day off entirely.  We need real news to change the story here.

On the data front, we see the Flash PMI data (exp Manufacturing 52.0, Services 52.0) and New Home Sales (662K) and that’s really it.  With no Fed speakers, once again the market will take its cues from earnings releases with today’s biggest likely to be Google Alphabet and Tesla.  The dollar has been on a roll lately, so it would be no surprise to see a bit of a pullback, but as long as the Fed is seen as maintaining its current tightness, it will be hard-pressed to decline very much.

Good luck

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Vexation

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The ‘conomy just keeps on humming
So, confidence, not yet is coming
How long will rates stay
Where they are today?
And will stocks keep getting a drumming?
 
The problem remains that inflation
Is causing Chair Powell vexation
It’s sticky and hot
Which really is not
What he needs to get his ovation

 

Boy, I go away for a few days and look what you’ve done to the markets!  When last I wrote, while there was a sense of shakiness in risk assets, it hardly appeared terminal.  But now…. The bears are out in force it seems, fear is rising rapidly amid investors while greed is running for its life.

I tried to ignore market goings on while I was away for the back half of last week, but the news was overwhelming.  My brief recap is simply, lots more Fed speakers have figured out that measured inflation is not heading lower, and that the decline during the second half of last year is turning into the aberration, not the rebound so far in 2024.  This week we will see the PCE report on Friday, and while that is typically between 0.5% and 1.0% lower than CPI, it is not going to come close to their target.  

As I wrote several weeks ago, following Powell’s press conference and subsequent speeches, regardless of the fact that there is no indication price pressures are abating, he is still keen to cut rates.  However, the weight of the recent data has caused many of his colleagues on the FOMC to change their tune.  The most recent was NY Fed President Williams who also indicated that a rate hike in the future cannot be ruled out.  Remember, Governor Bowman discussed that idea the week before last.  Going back to my prognostications at the beginning of the year, I had anticipated one cut at most during the first half of the year, but that rates, and bond yields, would be higher by Christmas.  I still like that call, although I am losing my enthusiasm for the cut.  And so is everybody else!

If rates simply stay where they are, I suspect that the recent equity selloff will moderate as it is clearly more fully priced into markets given the consistency with which we have heard that story in the past several weeks.  However, beware if the next step is higher.

Meanwhile, the week is off to quite a slow start with most equity markets rebounding from last week’s declines as fears of further escalation in the middle east abate.  The Israeli response to the Iranian response was muted and market participants have turned their attention elsewhere.  This can best be seen in the commodities markets as both oil (-0.5% today, -4.2% in the past week) and gold (-1.3% today, -1.0% in the past week) are retreating from their recent highs.  However, all is not completely well as we continue to see US Treasury yields on the high side and climbing (10yr +3bps) as more and more investors demonstrate concerns over inflation’s stickiness.

There was virtually no economic news overnight and a remarkably, though welcome, minimum of central bank speakers.  Remember, the Fed is in their quiet period this week up until their meeting next Wednesday, so everyone needs to make up their mind on their own.  With that in mind, here’s what we saw last night.

Equity markets in Asia rebounded nicely with the Nikkei (+1.0%) and Hang Seng (+1.75%) both performing well although shares on the mainland (CSI 300 -0.3%) didn’t join the party.  Elsewhere in the region, only Taiwan was in the red with every other nation enjoying the bounce.  As to Europe, this morning, the screen is green with gains ranging from the CAC (+0.35%) to the FTSE 100 (+1.45%) and everything in between.  Again, this certainly feels like a relief rally given the absence of new information.  Finally, the US futures markets are all higher this morning on the order of 0.5%, something I’m sure we are all happy to see.

In the bond markets, Treasury yields are leading the way with European sovereigns also higher by between 2bps and 4bps, clearly being dragged by Treasuries.  We did hear from Banque de France president, and ECB member, Villeroy, that he felt a June cut was certain and he was looking for more afterwards.  Interestingly, he made the argument that the ECB’s job was to ensure economic activity was helped as much as possible while targeting inflation.  That is a different take than I’ve heard any ECB member discuss before, although I am sure it is what many are thinking.  

Perhaps the most interesting move last night was JGB yields climbing 4bps and moving up to 0.88%.  This is their highest level since November when they flirted with the 1.0% “cap” that required a massive bond buying exercise by the BOJ.  With USDJPY grinding ever so slowly toward 155.00, there is a school of thought that the BOJ will seek higher yields to defend the yen.  However, my take is any yen defense will be in the form of intervention and be described as a smoothing activity.  The current Mr Yen, Masato Kanda, has discussed the idea of a rise in USDJPY of 10 yen in a month as being too quick and worthy of a response.  Granted, since its recent nadir of 146.85 on March 11, that milestone has almost been reached, but that low was a very short-term dip and while the yen has declined consistently all year, as you can see from the chart below, the pace has not nearly been that quick.  In fact, I would argue the pace has been steady all year, and virtually identical to that of the dollar index which indicates this is not a yen problem, it is a dollar problem.

Source: tradingeconomics.com

Turning to the dollar, it is modestly higher overall this morning with the noteworthy mover the pound (-0.5%) after we heard from BOE member Ramsden explaining that he saw the risks of inflation remaining high were diminishing and that rate cuts were coming soon.  While one of his colleagues, Megan Greene, gave the opposite spin, apparently in a misogynistic response, the market took Mr Ramsden as the more important voice on the matter.  As well as the pound, we have seen the euro (-0.2%) and its EEMEA acolytes (PLN -0.5%, CZK -0.6%) slide.  Otherwise, there is a mixture of lesser movements with a few currencies managing to gain strength, notably AUD (+0.3%), NZD (+0.3%) and CAD (+0.2%).  Summing up the currency markets, for the time being, with the Fed sounding increasingly hawkish and other central banks turning dovish, it seems like it is hard to bet against the greenback.  That doesn’t mean we will not see a short-term selloff, just that the trend, as you can see in the chart above, remains firmly higher for the buck.

On the data front, there is not a great volume of information, but PCE will certainly keep us all riveted to the screen Friday morning.

TodayChicago Fed Nat’l Activity0.09
TuesdayFlash Manufacturing PMI52.0
 Flash Services PMI52.0
 New Home Sales668K
WednesdayDurable Goods2.5%
 -ex Transport0.3%
ThursdayInitial Claims215K
 Continuing Claims1814K
 Q1 GDP2.5%
 Q1 Real Consumer Spending2.8%
FridayPCE0.3% (2.6% Y/Y)
 -ex food & energy0.3% (2.6% Y/Y)
 Michigan Sentiment77.8

Source: tradingeconomics.com

With the absence of Fed speakers, a blessing in my view, market participants will likely be taking their cues from earnings as well as activities elsewhere.  In the end, nothing has changed my view on the dollar where higher for longer suits both the rate and dollar outcome.

Good luck

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Showing Concern

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Investors are showing concern
And, risk assets, starting to spurn
But this time, it seems
That only in dreams
Are bonds something for which they yearn
 
Instead, the two havens of note
As evidenced by every quote
Are dollars and gold
Which folks want to hold
While stock bears are starting to gloat

 

**There will be no poetry for the rest of the week as this poet will be seeking rhythm only in his golf swing for a few days.  I will return on Monday, April 22.**

It appears that investors are beginning to ask more serious questions about the macroeconomic outlook and whether the current valuations in financial markets are representative of the future.  Not only did equity markets suffer significant declines yesterday, but so did bond markets.  At the same time, geopolitical tensions continue to rise driving even more risk reticence.  While it is still far too early to claim that things have turned decisively, it is certainly worth a discussion as to whether that may be a valid explanation.

I would paint the big picture in the following manner:

  1. US economic activity remains firm although there are still pockets of weakness.
    1. Retail Sales printed much higher than expected at +0.7% with a revision higher to last month’s data up to +0.9%.
    1. Empire State Manufacturing improved from last month to -14.3 but was worse than the expected -9.0.
  2. The Fed continues to downplay the probabilities of rate cuts in the near future.
    1. Daly: “The worst thing we can do right now is act urgently when urgency isn’t necessary.  The labor market’s not giving us any indication it’s faltering, and inflation is still above our target, and we need to be confident it is on the path to come down to our target before we would feel the need – and I would feel the need – to react.”
  3. Concerns over the next step in the evolving Israel/Iran conflict have market participants (and the rest of us) on edge.
    1. Bloomberg Headline: Israel Vows Response to Iran as US and Allied Urge Restraint.
    1. Reuters headline: Iran Says Any Action Against its Interests will get a Severe Response.

Clearly, there are other issues as well, with the ongoing Russia/Ukraine conflict, the critical elections upcoming, not only in the US but in Mexico, India and several German states, and confusion on the Chinese economy.

My point is that uncertainty is very high, and rightly so.  It is a fraught time in the world.  Historically, in this situation, US Treasuries were the place to where so many global investors would run.  The dollar would often benefit from this flight to safety, while risky assets, especially stocks, would suffer.  But it appears this generation of investors did not get the memo on how they are supposed to respond.  Instead, they seem to be looking at the ongoing fiscal profligacy in the US and the very real likelihood that inflation is not going to be declining anytime soon and decided that being long duration is a losing proposition.  Instead, the things that are in demand are dollars (with the highest cash yield around) and gold, with no yield, but with a long history of maintaining its value in both good times and bad.

Quite frankly, it is hard to argue with this sentiment, at least in my view.  I have long maintained that inflation was going to be stickier than many Fed and analyst models had forecast over the past several years.  I see no reason for the Fed to cut rates anytime soon.  Rather, while I expect that there may be ample reason to consider rate hikes going forward, given their inherent bias to cut, the outcome will be Fed funds remaining at their current level for much longer than most people expect.  Think, through mid-2025 at least.  

In this situation, absent a significant economic downturn, which doesn’t appear imminent, I continue to look for a bear steepening of the yield curve with 10yr yields rising above 5.0% and possibly as high as 5.5%.  In fact, this is exactly what the US needs to address its debt problem, high nominal GDP growth, high inflation, and negative real interest rates.  My fear is that the Fed will resort to Yield Curve Control, keeping the entire interest rate structure at an artificially low level in order to speed this process along.  This was the playbook immediately after WWII and it worked.  Do not be surprised to see them repeat that strategy.

If this is the way things evolve, protecting the value of your assets will require holding commodities and precious metals, real estate and some equities.  Both cash and bonds will be terrible investments in that environment, and equity selection will be important as not all will do equally well.  Value over growth is likely to be the play.  

In the meantime, let’s look at the wreckage from last night.  After the second down day in a row in the US, with red everywhere, Asia followed suit as both Japan (Nikkei -1.9%) and Hong Kong (-2.1%) really suffered while the mainland (-1.1%) was less awful after the Chinese data dump.  Surprisingly, Q1 GDP there rose 5.3%, better than expected and more than last quarter, but Retail Sales (3.1%, exp 4.5%) and IP (4.5%, exp 5.4%) both showed weakness compared to last month as well as expectations.  It seems odd that GDP was so firm with weak underliers.  Perhaps we should take this data with a grain or two of salt!  As to the rest of the regional markets, they were all in the red as well.

The picture is no better in Europe with red across the board, mostly on the order of 1.1% or more.  The only noteworthy data was German ZEW which showed current conditions to be horrible but expectations, for some reason, brightening.  As to US futures, at this hour (7:30) they have turned slightly green, up about 0.3% across the board.

In the bond market, yields around the world continue to rise as inflation concerns remain top of mind everywhere, or at least here in the States and since the US leads the parade in the global bond markets, everyone is following.  Yesterday saw 10-year yields climb 4bps and this morning they are a further 5bps higher, now sitting at 4.64%.  European yields are also firmer, up between 2bps and 4bps throughout the continent, but did not see as much of a move yesterday.  Regardless, it is pretty clear that investors are shying away from duration.  Even JGB yields are edging higher, up 1bp overnight, although they continue to badly lag the US situation, and that continues to weigh on the yen.

Oil prices, which rallied yesterday are consolidating those gains and edging lower this morning, down -0.4%.  The geopolitical concerns remain top of mind for traders, but economic forecasts are also key.  After all, if China truly is growing, that implies an uptick in demand which should be supportive overall.  Thus far, the middle east conflict has not targeted oil infrastructure, but if that changes, watch for much higher prices.  In the metals markets, yesterday saw strength across the board which is reverting this morning.  The biggest change in this market is that it has become far more volatile than its recent history.  I expect that will be the case in all markets going forward as uncertainty remains a key feature of the entire macro story.  Net, the metals have been rallying sharply for the past month or more, so this morning’s modest declines are more corrective than indicative in my view.

Finally, the dollar is ‘strong like bull!’  At least that has been the case for the past week or more as, especially the yen (-0.3% today, -1.9% in the past week), continues to lack buyers anywhere.  While I believe that the BOJ/MOF are less worried about the actual rate, the reality is that the yen is starting to decline pretty quickly.  If I were a hedger who needed to sell yen to hedge assets or revenues, I would be using options here, probably zero-premium collars, as you cannot be surprised if intervention is on the table.  We are just a shade below 155.00 and market talk is of a push to 160.00.  I have to believe that FinMin Suzuki and Governor Ueda are starting to get a little uncomfortable.   Now, the dollar is rising against all its counterparts, having risen more than 2% against many in the past week, but still, the yen’s decline has been consistent for more than two years and is starting to look unruly.

As to the rest of the currencies, this morning sees MXN (-0.6%) and PLN (-0.7%) as the laggards while the euro (+0.15%) has reversed losses from earlier in the session but is still lower by more than 2% since last Wednesday.  As the market continues to price Fed cuts out of the future while other central banks are seen still on track to cut, the dollar will likely keep going.

While we see Housing Starts (exp 1.48M) and Building Permits (1.514M) early and then IP (0.4%) and Capacity Utilization (78.5%) a bit later, the big news is that Chairman Powell will be speaking at the Spring IMF conference this afternoon at 1:15pm.  As well we will hear from Governor Jefferson, NY Fed president Williams and BOE Governor Bailey and BOC Governor Macklem before the day is through.  In other words, there will be a lot of words to digest.  However, none will be as important as Powell’s. if he acknowledges that inflation is hotter than they want and turns more hawkish, watch out for more severe risk asset declines.  But if he doesn’t, it could be even worse!

Good luck for the rest of the week

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Obliteration

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The chance of a much wider war
Is something we need to plan for
Thus, havens ought be
A key thing we’ll see
Demanded, as prices will soar
 
The thing is that war and inflation
Have partnered through history’s duration
While prices may rise
Most nations surmise
That’s better than obliteration

 

The weekend just passed saw what could be the next step to a wider war in the Middle East after Iran launched a massive air assault on Israel.  While it seems to have been fully repelled, with limited damage and injury, the world is waiting on tenterhooks to see if there will be a counterattack by the Israelis.  In a different time, with a different set of leaders around the world, perhaps the next steps would be talks and negotiations designed to stop the madness.  But in the current world, with the current global leadership, there is no sign that anyone is capable of driving that particular outcome.

With this in mind, I think it is important to remember one very real truism, war is inflationary.  It always has been, and it always will be.  Consider that every nation at war will spend as much as they can to produce and procure the weaponry they need to combat that war.  And they will borrow the money as that is the fastest way to move that process forward.  Second, scarcities will develop across an economy as inputs that would otherwise have gone toward ordinary consumer goods will be repurposed and commandeered toward the war effort.  The upshot is that demand will rise while supply will dimmish, a perfect recipe for inflation.

If we take that set of generalities and apply it to today’s situation, the starting point is already sticky high inflation with a massive debt load, at least in the US.  Elsewhere in the world, inflation appears to be starting to ebb, although the numbers remain well above the near-universal 2.0% target.  On the debt question, pretty much everybody has too much of that!  Of course, the situation in the US is the most important because it is the nation that is likely going to be financing a large proportion of any increase in hostilities despite the recent comments that the US will not take part in any Israeli retaliation.

Ultimately, though, even if we see a de-escalation of this situation, nations everywhere are going to be building up their war making capabilities given the overall level of uncertainty in the current world.  While Russia/Ukraine continues apace, and Israel is still fighting in Gaza, those are simply the issues that make the headlines.  Fighting continues throughout Africa (Nigeria, South Sudan Mali, Somalia, Congo) as well as in Iraq, Syria, Yemen and Pakistan.  This may be one of the least reported and most consistent drivers of global inflation that exists.  All I’m saying is that the combination of the current geopolitical situation and the still lingering effects from pandemic era policies has virtually ensured that inflation is not going to fall, at least not very far.  That means that haven assets and hard assets, often the same assets, remain high on the list of investments that are likely to perform well going forward.  Keep that in mind as you establish both your planning and your hedging.

With those cheery thoughts in mind, let’s see how markets have handled the next step up this escalator. Friday’s US equity market declines, which some have attributed to tax selling (today is Tax Day after all) was followed by weakness throughout most of Asia.  The exception was mainland China, which saw the CSI 300 rise 2.1%.  But elsewhere in the time zone, red was the color of the day, with Japan (-0.75%), HK (-0.75%), Australia (-0.5%), South Korea (-0.5%) and virtually every other regional equity market declining.  It seems that investors there are not so sanguine about a war in the Middle East.  

In Europe, though, as there is rising hope that things won’t get worse in the Middle East, equity markets are rebounding with most major indices higher by between 0.5% and 1.0%.  While that may be an optimistic reading of the situation, it is spreading as we have also seen early some gains in commodity prices back off.  The one exception here is the UK (-0.5%), but there is no obvious catalyst that is different for the outcome.  As I always say, sometimes markets are simply perverse.  Lastly, US futures markets are pointing higher as well, about 0.4% across the board at this hour (7:00).

Turning to the bond markets, it appears that inflation fears are greater than haven demand this morning. Treasury yields are higher by 5bps after a modest decline on Friday, while European sovereigns are seeing similar gains in yield, between 5bps and 7bps across the board.  While I understand the Treasury reaction given rising inflation expectations according to the Michigan Survey data released Friday, the European one is more confusing.  Even uber-hawk Robert Holtzmann agreed that a cut in June is likely, although future moves will be data dependent, and he is the most hawkish member of the ECB.  While inflation data throughout Europe has been declining, perhaps the bond markets are telling us they don’t believe that will continue.  Something doesn’t jibe with the recent comments and price action, and in that case, I always assume the pricing is correct.

In the commodity markets, oil (-0.8%) is lagging today as the ebbing fears of a wider Middle East conflict weigh on the black sticky stuff.  With that in mind, remember that oil prices are higher by nearly 4% over the past month, so this bull run does not appear dead yet.  However, metals remain in demand as we are seeing gains across gold (+0.7%), silver (+2.1%), copper (+1.2%) and aluminum (+2.1%).  I believe this story remains a combination of supply concerns as well as stories about excess demand from China, where copper stockpiles have been growing rapidly.  While it is not clear why they are buying copper, it is just one of several metals, notably gold, that China has been acquiring aggressively over the past months.  I maintain that this space has much further to run higher.

Finally, the dollar is under pressure this morning, although not universally so.  While the bulk of the G10 is modestly firmer, on the order of 0.2%, JPY (-0.5%) continues to suffer and is now pushing toward 154.00.  The last time USDJPY traded at this level was June 1990.  However, as long as the monetary policies between the US and Japan remain on divergent paths, the only thing that will stop this is concerted intervention, and the US seems unlikely to take part in such a move.  In the EMG bloc, the dollar is also on its back foot with MXN (+0.5%) the leading gainer and most of the rest of these currencies higher by much smaller amounts.  I would note CNY has rallied a touch after the PBOC withdrew CNY70 billion of liquidity as part of their money market operations today.  The Chinese are caught between the need for more stimulus to support the economy and the fear that more stimulus will lead to lower rates and capital flight, something which they have worked very hard to prevent.

On the data front, as exciting as last week was, this week should have some pretty good follow-ups.

TodayEmpire state Mfg Index-9.0
 Retail Sales0.3%
 -ex autos0.4%
 Business Inventories0.3%
TuesdayHousing Starts1.48M
 Building Permits1.514M
 IP0.4%
 Capacity Utilization78.5%
WednesdayFed’s Beige Book 
ThursdayInitial Claims214K
 Continuing Claims1820K
 Philly Fed0.8
 Existing Home Sales4.2M
 Leading Indicators-0.%

Source: tradingeconomics.com

As well as this, we hear from eleven more Fed speakers, including Chairman Powell tomorrow afternoon at the IMF spring meetings.  It will be quite interesting to hear how he handles the three consecutive hotter than expected CPI prints and whether there is going to be a subtle change in tone.  If he were to ignore it, I think that will be quite negative for bonds as it becomes a clearer indication that the 2% target is dead.

The thing about the 2% target is if the Fed abandons it, you can be sure that every other central bank will do the same.  That means that more rate cuts will be coming more quickly.  That, my friends, is a recipe for higher inflation, higher commodity prices and a much weaker bond market.  As to the dollar in that scenario, my take is it will still be the proverbial ‘cleanest shirt in the dirty laundry’ and will hold its own.

Good luck

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Still Premature

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The talk of the town has been gold
Whose rally, by some, was foretold
While Christine and Jay
Would give it away
Elsewhere it’s what folks want to hold
 
Under the rubric, a picture is worth a thousand words, have a look at the chart of the price of gold over the past twelve months below:

Source: tradingeconomics.com

That red arrow is pointing to the closing price on February 13, at $1988/oz, more than $400 lower than this morning’s market price.  There are many theories as to what is happening to drive this remarkable move in a commodity that has had a very limited role in the macroeconomic discussion for the past 53 years, ever since Nixon closed the gold window in 1971.  But the rally has been so strong it has fostered a host of theories as to what is driving it.  The latest is that there is a large, price-insensitive buyer acquiring large amounts outside the NY/London trading axis, with many people of the belief it is China and/or Russia preparing for a more complete break from the USD-based global monetary system.

Perhaps that is the case as we know from official reports that China has continued to acquire large amounts of gold over the past year.  But that has too much of a whiff of conspiracy theory in it for my taste.  My strong belief is that conspiracies are extremely difficult to maintain because people simply talk too much.  Rather, four decades of experience in financial markets, specifically FX and precious metals markets, has taught me that sometimes, markets move a long way on the basis of underlying fundamentals that have heretofore been ignored.  A simpler explanation could be that given its millennia-long history of being an able store of value and the fact that inflation remains rampant around most of the world while central bankers remain keen to cut interest rates and stop any efforts to fight it, many folks have decided it is a good idea to hold some portion of their personal wealth in the barbarous relic.  I know I do and have done so for quite a while.  I do not believe I am alone in that mindset.  Speaking of central bankers…

Said Christine, it’s still premature
To cut rates cause we’re not yet sure
Inflation is dying
Though we’re falsifying
It’s death from the Po to the Ruhr

At yesterday’s ECB meeting, as expected, there were no policy changes.  Madame Lagarde commented as follows: “If the Governing Council’s updated assessment of the inflation outlook, the dynamics of underlying inflation and the strength of monetary policy transmission were to further increase its confidence that inflation is converging to the target in a sustained manner, it would be appropriate to reduce the current level of monetary policy restriction.“  

That represents a lot of ten-dollar words to say, we want to cut rates, but we’re afraid if we do inflation might return so we are going to wait longer.  However, what was clear was that there is a wide range of views on the council.  For instance, this morning, Yannis Stournaris, the Greek central banker, said he thought that 4 cuts this year made sense.  At the same time, the last we heard from Robert Holtzmann of Austria, one cut was probably enough.  

Once again, Lagarde explained they are not waiting for the Fed, which is a good thing given the Fed seems less and less likely to cut this year at all, and Europe is in a recession already and needs lower rates.  This morning, the euro has fallen even further, down another -0.7%, and is back to levels last seen in early November.  It is becoming increasingly clear that monetary policies in the US and Europe are going to diverge further than currently priced and that does not bode well for the single currency going forward.

And those are really the big stories.  Yesterday’s PPI was a tick softer than expected, but the explanation was that in the calculation, the BLS seasonally adjusts the price of gasoline, so it showed a reduction despite the fact that gasoline prices, as we all know, have been rising steadily of late.  In any event, the market shook it off as we saw US equity markets perform well with both the S&P and NASDAQ reversing Thursday’s declines.  In Asia, however, while the Nikkei (+0.2%) managed a small gain, Chinese shares, and especially those in HK (-2.2%) had a lot more difficulty.  Chinese trade data was quite disappointing with the Trade balance shrinking dramatically (granted it is still >$50B) but both imports and exports declining.  And truthfully, all the other regional markets were lower to close the week.

European bourses, though, are all in the green, and nicely so, as investors and traders listen to the ECB doves and see more rate cuts, not less, coming.  This was confirmed with final pricing data showing the trend lower in inflation remains intact.  As to the US futures market, at this hour (7:50), they are lower by about -0.25% after weaker than expected earnings from JPM were released this morning.

In the bond market, after a week that has seen yields climb dramatically around the world, this morning Treasury yields are lower by 6bps, although still above 4.50%.  European sovereigns have seen yields decline even more, between 9bps and 11bps as the hope for rate cuts springs eternal.  Arguably, this is why the euro is under such pressure, the market narrative is gelling around the idea that the Fed won’t cut, and the ECB will be more aggressive.  One last thing, JGB yields are lower by 2bps this morning, but that is after a sharp rise seen in the wake of the US inflation report.  In fact, like many markets, with 10-year yields back at 0.84%, we are seeing levels not seen since November.

Turning to commodities, we have already discussed gold, and ignored silver (+2.0%) which is rallying even more aggressively, and copper (+1.80%) which is gaining on a combination of concerns over supply and a growing belief that China is going to add more stimulus to their economy.  Oil (+1.4%), too, is on the move, rebounding on growing concerns that the Middle East situation is getting even more dangerous with all eyes on Iran and any potential retaliation for Israel’s actions in Syria last week that resulted in the death of a key Iranian commander.  Historically, commodity rallies of this nature were accompanied by a weaker dollar, but not this time.  If this price action continues, there are going to be a lot of problems in nations all around the world that need to acquire commodities while their respective currencies are weakening.  Do not be surprised to see more market intervention in many places.

Finally, the dollar is back on top, rallying vs. virtually every currency this morning in a substantial manner.  In the G10, SEK (-1.3%) is the laggard, but the euro, pound, Aussie, Kiwi and Nokkie are all weaker by -0.6% or more.  In fact, only the yen (0.0%) is holding up, but that is after it blew through the previous ‘line-in-the-sand’ at 152.00 and is now above 153.00.  emerging market currencies are also uniformly weaker, although some are holding in better than others.  ZAR (-0.1%) is clearly benefitting from the metals rally, but not quite enough to rally on its own.  But KRW (-1.0%), MXN (-0.5%), BRL (-0.45%) and PLN (-0.65%) give a flavor of the overall price action.  Frankly, this is likely to continue until/unless we see a significant change in the data flow with US economic activity slowing, or at the very least, we get a consensus from all the Fed speakers that they are going to cut regardless of the data.

Speaking of the data, today we see only Michigan Sentiment (exp 79.0) and hear from two more Fed speakers, Bostic and Daly.  it doesn’t strike me that the data will matter that much, but market participants are quite keen to get more clarity from Fed speakers.  There is still a mix of views, although the one consistency is they have no confidence that inflation is falling toward their target sustainably.  However, some see a reversal higher as quite possible while others are holding out hope that this is a temporary bump in the road.  We will still see a significant amount of data before the FOMC meeting on May 1st including Retail Sales next week and the PCE data at the end of the month.  We will also hear much more from Fed speakers, so as of now, while there is no consensus, perhaps one will coalesce.  

Yesterday’s data did result in futures markets very slightly increasing the rate cut probabilities, with June now a 25% chance and 45bps priced for the rest of 2024.  I remain in the no-cut camp and so expect the dollar will continue to perform well vs. its brethren.  However, I see no reason for the commodity markets to back off either.  Bonds, however, are likely to see more pain going forward.

Good luck and good weekend

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Smokin’

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The CPI data was smokin’
So, Jay and the doves are now chokin’
He’s lost the debates
And they can’t cut rates
Without, higher prices, provokin’

As such, it should be no surprise
That traders, risk assets, despise
So, bond yields exploded
While stocks all eroded
And dollars made new five-month highs

Welp, the inflation data was not merely a little hot, it was a lot hot.  Measured prices rose 0.4% on both the headline and ex food & energy readings for the month of March with the annual rises ticking higher to 3.5% and 3.8% respectively.  Too, you will not likely hear the inflation doves and those who had been concerned with deflation talking about the trend for the past 3 months or 6 months, as both of those are now running well above 4%.

In truth, if the Fed was both data dependent and actually still fighting inflation, rate hikes would be on the table again as there is absolutely no indication that either wages or rental/housing prices are heading back to the levels necessary to see an overall inflation rate of 2.0%.  Alas, it is also clear that politics is a part of the decision process and the concept of fiscal dominance, where fiscal policy overwhelms monetary policy, remains the order of the day.

Fed funds futures adjusted their probabilities instantly with the idea of a June cut now down to just 16% while there are less than 40bps of cuts now priced in for the rest of 2024.  Given this price action, it is no surprise that bond yields rose dramatically, with the 10-year closing the session at 4.54%, up 18bps and the highest close since November 2023.  My sense is it has further to go.  Meanwhile, 2-year yields rose back to 4.97%, a more than 21bp rise to levels also last seen in November 2023.  One other aspect of the bond market was the worst 10-year auction in more than a year as the tail was 3.1bps, the third largest tail in history, with a lousy bid-to-cover ratio (2.33) and much less foreign interest (61.4%) than we have been seeing lately.  The last 5bps of the yield rally came after the auction result.

Adding to the general gloom, equity prices fell about -1.0% across the board, but closed above their session lows.  It is the dollar, though that really saw a big move with a greater than 1% move against most of its major counterparts.  USDJPY blasted through the 152.00 level that many had thought was a line in the sand for the MOF/BOJ and is a full big figure higher.  Meanwhile, European currencies all declined by more than -1.0% and Aussie (-1.8%) was the absolute laggard across both G10 and EMG blocs.

With this as backdrop, the ECB sits down this morning and must decide if it is too early to cut interest rates.  The economic data continues to underwhelm, and the inflation data is actually trending lower, rather than the situation in the US where it has turned back higher.  But the sharp decline in the euro yesterday has got to be a warning to Lagarde and her minions as a cut, especially since it is not priced at all, would likely see another sharp euro decline, something they are certainly keen to avoid.

One other thing, the Minutes of the March FOMC meeting were released in the afternoon, and it seems the committee is coming to an agreement that they are going to slow the roll-off of Treasury securities, likely cutting it in half to $30 billion/month although they are not going to touch the mortgage-backed part of the balance sheet since that is barely declining at all.  It appears that this may take place at the June or July meeting, but clearly before too long.

Enough about yesterday.  Overnight saw Chinese CPI data fall back to -1.0% M/M, reversing the previous month’s rise, as it becomes ever clearer that China will never be able to consume as much as it is able to produce.  That is the very crux of the trade issues that are becoming more heated as China ultimately dumps all its excess production overseas, or at least tries to.  This is an issue that is not going to disappear anytime soon, and one that will have major political and economic ramifications going forward.  I suspect that the tariff situation will only get worse, and I would not be surprised to see further absolute restrictions on Chinese trade regardless of who wins the US election in November.  As to the market impacts of this story, for now, I believe Xi is more fearful of a capital flight if he allows the yuan to weaken substantially, than he is of annoying the US and the rest of the world because the yuan is too weak.  But, given the clear difference in the trajectories of the US and Chinese economies and inflation stories, pressure for yuan weakness is going to continue.

Turning to this morning’s session, Madame Lagarde and her crew meet, and the market is not pricing in any movement.  June remains the odds-on favorite for the first rate cut, and given the fact that the Eurozone, as a whole, is stagnant from an economic growth perspective, and that price pressures there have been ebbing more quickly, that certainly makes sense.  Of course, after yesterday’s CPI, June is off the table in the US so the ECB will have to act without the ‘protection’ of the Fed.  As mentioned above, the euro declined by more than -1.0% yesterday and is edging lower this morning as well, down -0.1%.  Lagarde’s risk is she follows the path of lower rates, the euro declines more sharply, perhaps to parity or beyond, and that invites a resurgence in imported inflation.  Remember, energy is still priced in USD, so that a weak euro would raise the price of oil products across the continent.  Alas for Madame Lagarde, it’s not clear her political nous will allow her to solve this problem.

Recapping markets overnight, following the US declines yesterday, the Nikkei (-0.35%) also fell, but I think the yen weakness helped mitigate the declines.  Chinese shares were lackluster, slipping slightly both in HK and on the mainland and the rest of the time zone saw a mix of modest gains and losses.  Meanwhile, European bourses are all in the red this morning, with Spain (-0.9%) the laggard, but the average decline probably around -0.5%.  US futures, too, are softer at this hour (7:00), down about -0.3% across the board.  Clearly, there is grave concern that the Fed is not going to help ease global monetary policies.

As further proof that US yields drive global bond markets, yesterday’s CPI data pushed European sovereign yields higher by about 10bps across the board!  This despite the fact that inflation is going in the other direction in Europe.  This morning, those yields are continuing to grind higher, up between 2bps and 4bps across the board.  However, Treasury yields have stalled after yesterday’s dramatic rise.  Let me say that if the PPI data released this morning is hot, I fear things could move much further.

In the commodity space, oil rallied yesterday on stories that Iran was preparing for a more substantial retaliation against Israel and despite the fact that EIA inventory data showed surprising builds in crude and products.  However, this morning it is edging lower, -0.5%.  Perhaps more interesting is gold (+0.2%) which is a touch higher this morning but was able to rebound off its worst levels of the session after the CPI print to close nearly unchanged on the day.  In the end, the market remains quite concerned about inflation regardless of the Fed’s response, and gold continues to get love on that basis.  As to the base metals, yesterday’s rate induced declines were cut in half, but this morning both Cu and Al are drifting lower by about -0.2%.

It is the dollar, though that had the most impressive movement yesterday and this morning, it is holding onto most of those gains.  Absent a hawkish message from the ECB this morning, something which I believe is highly unlikely, the euro feels like it has further to decline.  The BOC left policy on hold and sounded fairly non-committal regarding its first rate cut there.  The Loonie suffered yesterday and has seen no rebound at all.  In fact, the only currencies showing any life this morning are AUD and NZD, both higher by 0.25%, which seems much more of a trading reaction after their dramatic declines yesterday, than a fundamental story.  As long as the Fed remains the most hawkish, the dollar should hold its bid.

Turning to the data today, PPI (exp 0.3% M/M, 2.2% Y/Y) and core PPI (0.2%, 2.3%) lead alongside Initial (215K) and Continuing (1792K) Claims.  Those numbers will arrive 15 minutes after the ECB policy decision is announced with no movement expected there.  Madame Lagarde has her press conference at 8:45 this morning.  We hear from Williams, Collins and Bostic over the course of the day, so it will be quite interesting to find out how far their thinking has changed.  I would be particularly concerned if there is further talk of rate hikes again.  Remember, Bowman intimated that might occur when she spoke last week, and Bostic has been in the one-cut camp so could turn as well.  Let me just say the market is not pricing in that eventuality at all!

At the beginning of the year, I opined that there would be at most one rate cut and rates would be higher by Christmas.  As of this morning, I see no cuts and a very real chance of hikes.  Keep that in mind for its impact on all asset classes going forward.

Good luck
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Less Keen

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While holding our breath has been fun
For CPI, soon we’ll be done
So far through this year
Each reading’s been dear
Can’t wait to see how today’s spun
 
A hot reading’s likely to mean
On rate cuts, Jay will be less keen
But if the print’s cool
It’s likely to fuel
A rally like we’ve never seen!

 

The number we have all been breathlessly awaiting is finally to arrive this morning at 8:30. The March CPI readings are expected as follows: Headline (0.3% M/M, 3.4% Y/Y) and core (0.3% M/M, 3.7% Y/Y).  As can be seen in the below chart from the WSJ, the question of whether inflation is continuing its slow decline or has bottomed is like a Rorschach Test.  Those who are all-in on the soft-landing thesis, notably every administration economist and spokesperson, see the ongoing decline of the core rate (the purple line) as the direction of travel.  However, those who are in the sticky inflation camp and who have made the case that the so-called last mile is going to take much longer than desired look at the headline rate (the gray line) and explain that the bottom seems to be in.

Source: WSJ

Perhaps the most frustrating part of this is that even after the release, neither side will be able to truly declare victory, although I’m sure one side will try to do so.  And to add insult to injury, the arguments are going to rely on the second decimal place, a level of precision that is meaningless in the context of economic data collection.  So, a 0.33% print will get the hawks all riled up while a 0.27% print will have the doves cooing that cuts are on their way soon.  But I challenge anyone to demonstrate that precision of that magnitude has any real meaning.  Clearly, the BLS can calculate numbers to whatever level of precision they desire but given the frequency or revisions to the big number, everything else is just narrative.

But this is where we are.  My take is that the market response will play out very much as expected, at least initially.  This means a hot print, even at the second decimal, will see bonds and equities sell off while the dollar rallies.  Funnily, my sense is that commodities will not suffer greatly on this as they are the current vogue for protecting against inflation.  Similarly, a cool number will lead to a risk asset rally and a dollar decline.  This will probably hurt commodities as well.

One of the interesting things is to observe positioning heading into big data points like this and there are two noteworthy items in the interest rate space.  First, yesterday there was a massive SOFR futures trade where one account bought 75,000 December contracts, the largest single trade ever in the contract according to the CME where it trades. (SOFR = Secured Overnight Funding Rate and is the replacement for LIBOR).  That is either a very large bet that the data is going to be soft, or somebody covered a very large short position, but either way, they are protecting against cooling inflation.  The other interesting thing has been the reduction in short bond positions.  There has been a significant decline in the number of short bond futures positions as well as short cash positions in the bond market, again an indication that many are looking for a benign reading this morning.

This poet has no formal inflation model and therefore can only estimate based on personal experience. Ultimately, nothing I have seen indicates that the rate of inflation is decreasing very rapidly at all.  As I remain in the sticky camp, my best guess is that we will lean toward the hot side this morning.

Turning to the overnight session, there was some interesting news to cover.  In Asia, Fitch put China on negative watch on its recent rise in debt.  Not surprisingly, Chinese shares suffered a bit on the news, but HK shares did not, as the Hang Seng (+1.9%) was the leading gainer in the time zone.  Elsewhere, the RBNZ left rates on hold, as expected, but the statement indicated zero rate cuts in 2024 and a continued hawkish bias.  Surprisingly, NZ equities rallied a bit on the news.  Finally, Ueda-san testified to the Diet again and the most interesting thing he said was that while they watch the FX rate, they will not adjust monetary policy simply to address any weakness in the yen.  Apparently, stock traders didn’t like that much as the Nikkei fell -0.5% on the session.

The story in Europe, though, is much better as all markets are firmer, somewhere between +0.4% and +0.7%. There was some data released, all of which pointed to slowing growth and inflation and therefore increasing the odds the ECB could act as soon as tomorrow, but certainly by June.  Norwegian CPI fell more than expected, Swedish GDP and IP were both quite weak as was Italian Retail Sales.  The point is the ongoing reduction in activity across the continent is going to allow (force?) Madame Lagarde to prove she isn’t waiting on the Fed.  After another limited movement day yesterday, US futures remain unchanged at this hour (7:00).

In the bond market, while Friday and Monday morning saw a sharp decline in prices and rise in yields, yesterday saw yields drift back further and this morning Treasuries are lower by -1bp with similar price action throughout Europe.  Thus far, the net retracement from the yield peak has been 10bps, with all eyes on this morning’s CPI print.  One other interesting tidbit is that the Treasury is auctioning $39 billion in 10-year notes today with the yield highly dependent on the CPI data.

Turning to the commodity market, oil (+0.6%) after a slight dip yesterday on a larger than expected inventory build, is rebounding.  The EIA released a report increasing expected supply and demand numbers for 2024 and 2025 as well.  Gold (-0.25%) is settling in just below its new highs although copper (+0.5%) and aluminum (+1.1%) continue to rally strongly on the rebounding manufacturing story as well as the structural supply shortages.

Finally, the dollar remains in the doldrums, little changed ahead of this morning’s data.  The biggest mover is MXN (+0.5%) which is a continuation of its yearlong price activity as Banxico maintains amongst the highest real interest rates around.  Surprisingly, NZD (+0.2%) is just barely higher despite the hawkish rhetoric from the central bank last night and after that, pretty much all the movement is +/- 0.1% or less.

In addition to the CPI data this morning, we get the Bank of Canada rate meeting where they are expected to leave policy on hold although given the slowing economy, they may set the table for a rate cut at the next meeting.  I would not be surprised to see them cut today, though, in an effort to get ahead of the curve.  The FOMC Minutes are also released this afternoon and we hear from Governor Bowman and Chicago Fed president Goolsbee, with both having been amongst the most hawkish Fed speakers lately.  Given all the talk from Fed speakers since the March meeting, it is hard to believe that the Minutes will matter that much.

And that’s what we have for today.  The CPI will set the tone and we will circle back tomorrow to see how things landed.

Good luck

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A Kite in the Wind

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One time on the FOMC
A guy was as ‘hawk’ as can be
But now that he’s gone
His view’s to call on
Chair Jay to cut, times, one, two, three
 
You may remember Jim Bullard as the president of the St Louis Fed for a very long time.  While in that role, he had become the most hawkish FOMC member on the committee, consistently decrying the rise in inflation and the Fed’s delayed response during the ‘transitory’ phase.  But he retired from that role last year to join Purdue University as president, and more power to him.  The interesting thing is that despite the fact he is no longer part of the discussion, he feels it necessary to get his opinions out there anyway.  Last night, at a conference in Hong Kong he explained that the Fed has stuck the landing, the soft landing that is, and that three cuts are appropriate. 
 
The first thing I will point out is this is proof positive that FOMC members speak far too frequently.  The fact that we know the names of ex-regional Fed presidents, as well as their monetary policy stances, seems crazy. We have already seen the damage that forward guidance has inflicted on the economy when after several years of ‘rates will never go up’, the Fed pivoted to hiking aggressively and blew up a number of regional banks while putting the commercial real estate market in dire straits.  My observation is that these members have become so conditioned to being in the spotlight, and have grown to like it so much, that they cannot stop even when their views have no bearing on the conversation.
 
The second thing is that these comments seem to run counter to the evolving views of both recent Fed speakers and market pricing.  A conspiracy theorist might think that the administration requested he add to the discussion because it seems like the Fed is moving away from that position, a position that the administration deems more beneficial to its reelection chances.
 
In the end, despite the headlines that drove this discussion, I don’t believe the market really cares very much what Jim Bullard has to say anymore.  Tomorrow’s CPI is so much more important which is likely why there has been no discernible movement in anything in the wake of this ‘news.’
 
Ueda remains
More like a kite in the wind
Than a solid rock

Last night, in testimony to the Japanese parliament, BOJ Governor Ueda once again tried to imply that tighter policy could be coming but was unwilling to commit.  He said, “We have to consider reducing the degree of monetary easing if the underlying price trend rises along with our outlook.  We will carefully consider this at every policy meeting as it depends on incoming data.”  So, does that mean they are going to tighten soon?  Who knows!  Funnily enough, I think that is a much better stance than the current Fed/ECB/BOE policy of trying to be so deterministic.  At least he has not promised anything at all.  Of course, in today’s zeitgeist, a central bank not promising is seen as quite the negative.  

The upshot is that the lack of commitment for further policy tightening has focused attention on the fact that the yen, while unchanged this morning, remains just pips away from its 35-year lows (dollar highs) and the big round number of 152.00.  Many in the market believe that the MOF is going to intervene if the dollar touches that level, although that view is starting to lose some adherents, at least based on a recent assessment of options positioning.  Personally, I am inclined to believe FinMin Suzuki that their concern is not the level so much as it is the pace of decline and volatility.  Say what you will about the yen being weak, but since March 19, the range for USDJPY has been less than 1%, hardly a sign of volatility.

Source: tradingeconomics.com

But that is all the barrel scraping I am going to do this morning to find stories of note.  As we await tomorrow’s CPI data, markets are collectively holding their breath.  Well, equity and FX markets are anyway.  The inflation story is clearly impacting both bonds and commodities so let’s take a look.

After yesterday’s complete lack of movement in the US equity markets, the Nikkei (+1.1%) rallied, arguably on the idea that tighter policy is not a promise.  The rest of Asia, though, was far less upbeat with a mix of modest gainers and losers.  That also describes the European session, with some gainers and some laggards, although the laggards are a bit worse, down about -0.5% on average.  US futures, though, are still in the doldrums, trading either side of unchanged all evening.

Bonds are a bigger story as yesterday saw the 10-year Treasury yield touch 4.465% although it has since backed off a few bps and is now right at 4.40%.  However, the trend remains very much higher for US yields as market participants appear to be responding to several different concerns.  The first is that the US economy continues to outperform, as evidenced by Friday’s blowout payroll data, so the need for rate cuts is dissipating, but the second is a bigger issue, the idea that monetary policy activities since the pandemic alongside massive fiscal stimulus has impugned the longer-term value of all fiat currencies and securities denominated in those currencies.  This has investors looking elsewhere for effective stores of value like commodities and precious metals and is forcing a rethink of where interest rates are going to settle in the long-term.  The Fed’s way to describe this is that the long-term neutral rate is much higher than had previously been thought.  Recall, the last dot plot showed the long-term rate rising from 2.50% to 2.65%.  Look for that number to continue to rise going forward and that will not help the bond market.

Speaking of commodities, while oil started the day lower yesterday, it rebounded and closed higher on the session by a small amount.  This morning it is little changed, but one of the stories that had led to lower prices, a reduction in stress in the Middle East, seems to have faded this morning.  At this point, there is no evidence that we have seen the top in oil prices.  You won’t be surprised to hear that the metals markets are continuing their rally, with gold (+0.7%) making further new all-time highs while copper (+0.4%) continues its run and has crested $4.30/pound.  There is ample room for these to continue higher, especially gold given the growing question of the value of holding fiat currencies at all.

Finally, in the fiat realm, the dollar is a touch softer this morning, although that seems a response to the commodity price strength we are seeing.  Or perhaps, commodities are rallying because of the weak dollar although my sense is the commodities are driving things.  At any rate, ZAR (+0.8%) is the leader in the clubhouse but we are seeing strength in AUD (+0.3%) and NZD (+0.5%) as well.  Too, BRL (+0.3%) is showing a little strength after its slow decline all year.  As to the euro and pound, both are slightly firmer and the yen remains unchanged, as discussed above.

On the data front, we have already received the NFIB Small Business Optimism Index, printing at 88.5, its lowest level in more than 12 years and well below expectations.  The dichotomous economy continues to confound, with some aspects seeming to be doing well, while others are lagging badly.  There are no Fed speakers on the docket today, so I expect there will be a bit of toing and froing as we all look forward to tomorrow’s CPI print.

Good luck

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Unchained

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The data, on Friday, revealed
The job market’s mostly been healed
As such, any thought
The Fed really ought
Cut rates, simply must be repealed
 
In fact, two Fed speakers explained
That rate cuts were not yet ordained
Should prices keep rising
It won’t be surprising
If higher rates soon are unchained

 

Wow!  Once again, the NFP report was significantly hotter than any analysts forecast, with a top line number of 303K while the previous 2 months were revised higher as well.  The Unemployment Rate fell back a tick, to 3.8%, while wages continue to grow above 4%.  In other words, it seems quite difficult to make the case that the economy is in a state that requires rate cuts.  After all, if the Fed’s focus has turned from inflation specifically to employment now, and employment continues to rock, why cut?

However, the impression from the cacophony of Fedspeak we heard last week is that many members are still of a mind to cut the Fed funds rate, likely in June.  Just not all of them.  We heard from two more speakers Friday, Governor Michelle Bowman and Dallas Fed President Lorie Logan, and neither seemed in a cutting frame of mind.  [Emphasis added]

Bowman: “While it is not my baseline outlook, I continue to see the risk that at a future meeting we may need to increase the policy rate further should progress on inflation stall or even reverse.”

Logan: “In light of these risks, I believe it’s much too soon to think about cutting interest rates.  I will need to see more of the uncertainty resolved about which economic path we’re on.” She followed that with, “To be clear, the key risk is not that inflation might rise — though monetary policymakers must always remain on guard against that outcome — but rather that inflation will stall out and fail to follow the forecast path all the way back to 2 percent in a timely way.”

Now, it is very difficult for me to read these comments and think, damn, rate cuts are coming soon!  By now, you are all aware that I have been in the sticky inflation camp from the get-go and certainly Friday’s data did nothing to change my mind.  But my views don’t really matter. However, if we start seeing a majority of FOMC members talking about fewer cuts than expected/assumed in March, and even hikes, we need to pay attention. I don’t think it is yet a majority, and clearly Chair Powell is very keen to cut, but there is a long time between now and the June meeting, with much data to come.  Unless that data starts to really back off and hint at a substantial slowing of the economy, my sense is that June will morph into November or December, with the median dot pointing at just one cut this year.

A quick look at the Fed funds futures shows that traders are growing even less confident in those rate cuts being implemented.  As of this morning, the June probability has fallen slightly below 50% and there are a total of 61bps priced in by the December meeting, just over two cuts.  This is quite a contrast to the Eurozone, where the market has fully priced in a June cut and is beginning to consider a 50bp reduction to get things going there.  On the surface, this makes a great deal of sense as the Eurozone economy’s growth continues to lag that of the US and inflation has been ebbing more rapidly there than in the States.  And don’t forget, the ECB meets this Thursday, so at the very least we should have a better sense of what will happen in June, and we cannot rule out a cut this week, regardless of market pricing.

Trying to step back for a broader perspective on the economy and the future of policy rates as well as market movements, there continue to be several conundrums in markets compared to historical trends.  For instance, what is the meaning of the price of gold rising consistently alongside a rise in interest rates, both nominal and real?  Historically, there has been a strong negative correlation between the two, but something has changed in the past two years as evidenced by the BofA Research chart below.

Is this a signal that the market is getting indigestion over the amount of sovereign debt that is outstanding, led by Treasuries?  Is this an indication that investors are losing faith in fiat currencies and the current global monetary structure?  Or is this simply a temporary anomaly that will correct over the course of the next several years?  Unfortunately, there is no way for anyone to know the answer to these questions at this point in time.  Anyone who says otherwise is not being honest.  

However, my suspicion is that the consequences of monetary and fiscal policies around the world during the Pandemic and since has more and more people, and institutions, starting to hedge their bets on the future and its outcomes.  From a more benign view that the authorities will be able to kick the can down the road, this relationship seems to indicate more than a few folks think that the fiscal and monetary authorities are about to stub their collective toe on the next kick.  Ouch!

In many ways, I think that the change in this relationship is an excellent encapsulation of the problems currently faced by monetary and fiscal authorities.  As such, I will be watching it closely as a key indicator of market sentiment overall.

Ok, let’s look at the overnight session.  After Friday’s solid US equity performance, the picture elsewhere has been slightly less positive, although positive overall.  In Asia, the Nikkei (+0.9%) followed the US price action although Chinese shares had a less positive session, falling on the mainland with the HK market staying flat.  Treasury Secretary Yellen was in China trying to smooth things over, but the following two statements, I think, are a great description of how confused things are:

Talk about mixed messages!  Meanwhile, in Europe, most bourses are a bit higher this morning, but on the order of 0.5%, half what we saw in the US on Friday.  It seems that some traders are betting that the ECB, when it meets this Thursday, is going to cut rates.  Lastly, at this hour (7:20), US futures are essentially flat.

The bond market, though, has seen far more activity lately as it appears the bond vigilantes, last seen in the 1990’s are reawakening.  This morning, 10-year Treasury yields are back to 4.45%, their highest level since November when yields were falling in the wake of the Fed’s perceived pivot and the reduced amount of coupon issuance just announced at that time.  This is 13bps higher than the yield just before the NFP data was released, 8bps on Friday and another 5bps this morning.  Similarly, European sovereign yields hare higher by between 3bps and 5bps this morning, being dragged higher by Treasuries, but lagging as bets get made that the ECB acts sooner than the Fed.

In the commodity space, oil (-0.8%) is backing off its recent highs this morning as there appears to be an easing in some concerns over the Middle East, at least that is the story making the rounds.  Meanwhile, metals prices continue to flourish despite the rise in interest rates with both precious (Au +0.4%, Ag +0.9%) and base (Cu +0.7%, Al +0.3%) all continuing their recent climbs.  Another conundrum here is the fact that these metals prices are rising despite the dollar remaining reasonably well bid.

Turning to the dollar, it is little changed, on net, this morning although we have seen some strength against the CHF (-0.5%) and KRW (-0.4%).  The former is the only currency seemingly following the interest rate story as the recent SNB rate cut plus low inflation readings indicates that the policy divergence between Switzerland and the US is set to widen further.  The won, on the other hand, looks to be a proxy for China, which the PBOC refuses to allow to weaken despite many economic reasons it should.  On the flipside, ZAR (+0.4%) is rallying on the back of those metals’ prices.  One of the things that is confusing is the fact that the euro remains reasonably well bid despite the changing tone of the interest rate policies between the Fed and ECB.  While the single currency has generally been declining over the past month, in truth, since the beginning of April, it has rebounded about 1% and held strong since then.  Given the changing market perceptions, I would have anticipated the euro to continue its declining ways, but right now, that is not the case.

On the data front, the week starts out slowly, but we get the critical US CPI data on Wednesday.

TuesdayNFIB Small Biz Optimism89.5
WednesdayCPI0.3% (3.4% Y/Y)
 -ex food & energy0.3% (3.7% Y/Y)
 Bank of Canada Rate Decision5.0% (unchanged)
 FOMC Minutes 
ThursdayInitial Claims215K
 Continuing Claims1792K
 PPI0.3% (2.3% Y/Y)
 -ex food & energy0.2% (2.3% Y/Y)
 ECB Rate Decision4.5% (unchanged)
FridayMichigan Sentiment79.0
Source: tradingeconomics.com

In addition to the data and other central bank decisions, we hear from seven more Fed speakers this week, which given the recent more hawkish commentary, could well be quite interesting.  If Wednesday’s CPI data is hotter than expected again, I suspect it will become increasingly difficult for the doves to spread their wings.  As it happens, six of the seven speak after the CPI, so we could well see things evolve further.  In the meantime, relative to other currencies, I continue to look at the rate picture and believe the dollar should remain firm.  However, versus ‘stuff’ not so much.

Good luck

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Hell or High Water

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Though Jay was as clear as a bell
That rate cuts were coming through hell
Or high water, it seems
Not all the Fed’s teams
Are ready to cut rates as well
 
A group of the regional Feds
Seems at, with Chair Jay, loggerheads
They think maybe two,
Or one, cut could do
Now, traders are sh**ting their beds!

 

Yesterday morning, I claimed that it didn’t matter what the plethora of Fed speakers were going to say given that Chairman Powell had seemed to clear the decks for a rate cut by June.  He swept away concerns about ‘too hot’ inflation and was clearly ready to go forward.  It seems that I didn’t read the market zeitgeist that well after all.

It turns out during the day, we heard from four different Fed regional presidents, Chicago’s Goolsbee, Minneapolis’s Kashkari, Cleveland’s Mester and Richmond’s Barkin, and not one of them sounded like they were ready to cut rates anytime soon.  While only two, Barkin and Mester, are voters this year, the story we consistently hear is that everybody’s voice is heard during the meetings.  Listening to those voices yesterday, it certainly doesn’t sound like everybody is ready to move in June.

Mester: “I don’t think the pace of disinflation this year will match what we saw last year as we need to see a reduction in the demand side this year.  Although if the economy evolves as I envision, we should be able to lower the Fed funds rate later this year.”   

And that was the most dovish we heard.

Barkin: “It is smart for the Fed to take our time.  No one wants inflation to re-emerge.”

Kashkari: “If inflation continues to move sideways, that would make me question whether we needed to do those rate cuts at all.”

Goolsbee: “I had been expecting it [inflation] to come down more quickly than it has.  The biggest danger to the inflation picture is continued high inflation in housing services.”

It is very hard to look at these comments and conclude that a June rate cut is a given.  And yet, the Fed funds futures market is now pricing a 64% probability of a June cut although is still pricing less than three full cuts for the rest of the year.

Risk assets were not enamored of these comments and the result was we saw a serious pullback in the equity markets in the US with all three major indices falling by between 1.25% and 1.40%.  Treasury yields fell as well, down 4bps, with its haven status making a comeback as did that status for both the yen (+0.4%) and Swiss franc (+0.6%).

Remember this, there are many different stories around the current market situation between the macroeconomics, the geopolitics of both Israel/Gaza and Russia/Ukraine and the central bank activities, not only with the Fed, but also the BOJ and ECB.  The point is markets are feeling many crosscurrents and it would not be surprising to see a more material breakout in one direction or the other on some seemingly less important piece of news.  In truth, when major moves begin, we rarely have a specific catalyst to which we can point.  I have a feeling the next big move will be confusing for a while.

While words have power
Policies ultimately
Matter much, much more
 
As summer passes
The transition to autumn
Should see prices rise

 

Adding to the cacophony of new information were comments from BOJ Governor Ueda that he believes the central bank may achieve its inflation target by late summer or early autumn as the impact of the recent wage negotiations begins to feed into the economy.  This story, Ueda’s first comments since the BOJ raised rates last month, has helped revive the yen bulls’ confidence that…this time it’s different!  Given the enormous size of the short yen positions outstanding, it is very possible that we see a sudden, sharp rise in the currency, but for the outcome to be more permanent, we will need to see much more aggressive BOJ tightening, or much more aggressive Fed easing.  Right now, I don’t believe either is in the cards, at least not until winter at the earliest.  This is especially true since when asked about the BOJ’s balance sheet, he indicated there was no reason for an immediate adjustment (sale) to ETF positions or their current, continued, ¥60 billion per month of JGB purchases.

Which brings us to this morning, when the monthly payroll report is set to be released at 8:30.  The latest consensus forecasts are as follows:

Nonfarm Payrolls200K
Private Payrolls160K
Manufacturing Payrolls5K
Unemployment Rate3.9%
Average Hourly Earnings0.3% (4.1% Y/Y)
Average Weekly Hours34.3
Participation Rate62.5%
Source: tradingeconomics.com

We have seen three consecutive reports above 200K, albeit replete with all types of revisions.  However, 200K new jobs per month is historically, a pretty good outcome.  It is certainly not indicative of a major decline in economic activity.  As well, yesterday’s Initial Claims data, at 221K, while a few thousand higher than expected, remains in a very comfortable place from the perspective of economic growth.  The point is the Fed’s concern over sticky inflation makes perfect sense when looking at these numbers.  After all, if people continue to work, they will continue to spend.

As it happens, my take today is we are setting up for a potential large ‘good news is bad’ type day and vice versa.  If the headline number is above 200K, and especially if the Unemployment Rate were to dip lower by a tick or two, I suspect that traders will quickly assume that the hawks are in control and any probability of a rate cut by June will dissipate.  Equity markets will not like this, nor will bond markets.  However, the dollar should continue to perform and, ironically, I see commodities doing the same thing.  We shall see how it plays out.

A quick recap of the overnight session shows that yesterday’s US selloff set the tone with declines throughout Asia (Nikkei -2.0%, China still closed) and Europe (DAX -1.45%, CAC -1.4%) as concerns grow regarding the future of monetary policy.  US futures, though, are modestly higher ahead of the data at this hour (7:00).

Ahead of the release, Treasury yields have reversed half of yesterday’s decline, currently higher by 2bps, and we are seeing similar movement across Europe with all markets seeing yields rise by between 1bp and 3bps.  Yesterday the ECB released their ‘minutes’ explaining they had seen further progress in their mission and the key elements, but that was before oil rebounded 10% from levels seen back then.  As has become the norm everywhere, there continues to be conflicting data and price movement clouding the picture for future policy actions.

Speaking of oil, this morning it is holding onto its gains from yesterday with WTI above $86/bbl and Brent crude at $91/bbl.  The ongoing tensions in the Middle East are clearly not helping things here as concerns grow that Iran is going to retaliate more directly to Israel’s actions earlier in the week, killing a senior Iranian general in Syria.  Of course, the entire combination of events continues to support gold prices, which are little changed this morning, but have absorbed all the selling pressure anyone can muster.  Copper and aluminum are also firmer this morning as the commodity sector seems on a mission right now.

Finally, the dollar is a touch higher this morning heading into the data.  While it has backed off its recent highs from Tuesday, the DXY remains above 104 and USDJPY remains above 151.  With that in mind, we must note ZAR (+0.65%) which continues to benefit from the rally across the entire metals complex and NOK (+0.3%) which is clearly benefitting from oil’s recent performance.  However, traders here are all anxiously awaiting this morning’s number alongside everyone else for more clarity on the next direction of travel.

Aside from the data this morning, we hear from three more Fed speakers to round out the week.  While Barkin is a repeat from yesterday, we also get some new perspectives from Boston’s Collins and Governor Bowman.  Yesterday’s market response to the hawkish views was quite surprising to me as I was very sure that Powell had set the tone.  If today’s data points to strength, do not be surprised to see equities sell off further alongside bonds.  However, a weak number is likely to signal the all-clear for the bulls to get back to business.

Good luck and good weekend

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