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So Puissant

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Ueda explained
When NIRP disappears, ZIRP is
His view of the world

“Even if we end minus rates, the accommodative financial conditions will likely continue.”  This was the key comment from Kazuo Ueda’s testimony in parliament last night, which followed a similar comment from BOJ Deputy Governor Shinichi Uchida on Thursday.  It should be no surprise that this is the case as the recent data from Tokyo, notably the inflation data, has been softening quickly and reducing the need for tighter policy.  After all, for two decades the BOJ has been trying to overcome a generational view that deflation is a given and instill an inflationary mindset in the populace there.  If inflation readings are falling, they will definitely not be in a hurry to raise interest rates.

It appears, from these comments, that while the BOJ may lift the key deposit rate from its current -0.10% level, it would be a mistake to look for very much movement.  My money is on either 0.00% or +0.10% as the peak.  It should also be no surprise that the yen has suffered further on these comments with USDJPY having traded as high as 149.55 overnight, although it has since slipped back to unchanged at 149.40.  There remains a great deal of belief that the BOJ is highly focused on 150.00 as a line in the sand to prevent further weakness.  Personally, I think their line in the sand is higher, at least at 152.00 and perhaps even higher than that.  They are very consciously making dovish comments while listening to every Fed speaker reiterate higher for longer and no rate cuts in the US anytime soon.  They know the yen will fall further and are already prepared for that outcome; I assure you.

The talk of the market today
Is whether revisions display
That CPI’s recent
Decline is so puissant
Or if tis a ‘flation doomsday

It should not be that surprising that in a market bereft of serious data, traders and analysts are turning over every stone to find something on which to hang their hat.  Today’s story is the annual CPI revisions that are due from the Bureau of Labor Statistics at 8:30 this morning.  The reason this is getting so much play is that last year, the revision was dramatic, adjusting the annualized rate up to 4.3% from its pre-revision level of 3.1%, and casting doubt on just how much progress the Fed had actually made in their inflation battle.  But last year was a dramatic outlier with respect to revisions as historically, the average adjustment is something like 3 basis points, so the different between 3.10% and 3.13%.  In other words, nothing.

However, the concerns come from the fact that ever since Covid changed so much in the economy, measuring the data has become far more complex leading to potentially larger revisions.  I have no way of knowing what will happen here, and I suspect there is an equal chance of the revisions showing CPI has actually been lower than reported, but the point is, this obscure data adjustment has become the topic du jour on an otherwise quiet day.

What we can do is game out how markets may respond to a surprisingly large adjustment in either direction.  If, like last year, the revisions show inflation is running hotter than previously reported, I would look for bonds to sell off further, especially the 2-year, as it would push the probability of a rate cut further into the future.  This would likely weigh on stocks and support the dollar overall.  Oil has been in its own world, rallying on the increased middle east tensions, but metals would suffer, I think.  And if the revision is substantially lower, just turn around all those movements.  Any large revision will be a binary event.

But really, those were the major discussion points overnight.  Turning to the markets, after another set of records in the US (although the S&P 500 couldn’t quite make 5000), Japanese equities rallied further on the interest rate story from above, setting new 34-year highs and approaching the 1989 bubble peak.  Chinese shares are closed for a while now, but the Hang Seng, in a half-day session, managed to slide another -0.8%.  However, the rest of Asia was in the green.  In Europe, there is very little net movement this morning as we continue to hear from ECB speakers that rates will not be cut soon, although it is not clear anybody believes them given the overall economic weakness.  Lastly in the US, futures are a touch higher at this hour (7:45), but only about 0.2%.

In the bond market, yields continue to edge higher with Treasuries up 2bps, and most European sovereigns higher by just 1bp.  Interestingly, despite the Ueda comments overnight, JGB yields have crept 2bps higher along with everything else.  It is hard to know if bond investors are more concerned with sticky inflation or massive issuance, but something has them uncomfortable this morning.

Oil, which has rallied all week is unchanged this morning as the market digests the fact that there will be no cease-fire between Israel and Hamas, and the Houthis continue to fire missiles into the Red Sea.  As to the latter, given that ship traffic has fallen to near zero, that seems like a waste of ammunition, but so be it.  Metals markets, meanwhile, are a touch softer this morning with copper the underperformer (-0.5%) although precious metals have edged lower as well.

Finally, the dollar continues to perform well overall, as we have already discussed the yen, but are also seeing it edge higher against most of its counterparts in the G10.  The exception is NZD (+0.6%) which seems to believe that the RBNZ, after having paused in their rate hiking cycle, may raise rates yet again.  On the EMG side, the most noteworthy mover is ZAR (-0.35%) suffering from metals weakness although we are seeing a bit of strength from the LATAM bloc with both MXN and BRL edging higher this morning.

And that’s really it today.  Not only is there no additional data, but no Fed speakers are scheduled either.  Next week will see a number of holidays around the world as Carnival begins alongside the Chinese New Year.  Really, Tuesday’s CPI is the next key data point for us all.  Until then, I expect that traders will want to close the S&P over 5000 but do not see an explosive move higher coming.  As to the dollar, there is no reason for it to cede its recent gains.

Good luck and good weekend
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Turns to Sh*t

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The FOMC’s out in force
Explaining the still likely course
Of rates is to stay
Where they are today
Unless there’s some hidden dark horse
 
Investors, though, don’t give a whit
As Spooz seem quite likely to hit
Five thousand quite soon
Then onto the moon
Take care lest this view turns to sh*t

 

The WSJ led with an interesting article today with the below graphic as the teaser.  This is called a hair chart, for obvious reasons, with those light blue lines describing Fed funds futures curves and comparing them to the subsequent actual Fed funds rate over time.  The article’s point, which is important to understand, is that the futures market tends not to get things right very often.  In other words, just because the market is pricing in 5 or 6 rate cuts today does not mean that is what will occur over time.  In fact, looking at the chart, it almost seems that 5 or 6 cuts is the least likely outcome.  One need only look at the past several years to see that while they were pricing cuts, the Fed was still hiking.

Of course, this fits with my thesis that the Fed funds futures market is actually reflecting a bimodal outcome of either zero cuts or 10.  But regardless of my view, the equity market is all-in on the idea that the Fed is going to be cutting rates soon as evidenced by the fact that the S&P 500 is now trading just a hair below 5000 after yesterday’s 0.8% gain.  

In the meantime, yesterday we heard from four more Fed speakers and to a wo(man) they all said effectively the same thing; progress has been made on the inflation front but they still don’t have confidence that 2% inflation on a sustainable basis has been achieved.  In fact, several mentioned that the recent hot GDP and NFP data indicated more caution is warranted.  By the way, if we look at the Atlanta Fed’s GDPNow forecast, it currently sits at 3.4%, hardly a level of concern, while their Wage Growth Tracker remains at 5.0%.  Again, that is not data that indicates inflation is collapsing.  It remains very difficult for me to expect inflation to fall given the recent totality of the data.  In other words, nothing has changed my view that inflation will remain stickier than currently priced and very likely start to creep higher again, and that will ultimately have a negative impact on risk assets.  But not today!

The other news overnight was that Chinese CPI rose less than expected in January, just 0.3%, which took the annual change to -0.8%.  As China heads into their two-week Lunar New Year holiday, welcoming the Year of the Dragon, the question for investors around the world is, will Xi do anything to halt the decline?  Thus far, his efforts have been weak and insufficient as evidenced by the equity markets in Hong Kong and on the mainland both having fallen sharply over the past year with little net movement this year despite several efforts at support and stimulus.  Now, Xi has nearly two weeks to come up with a new plan to get things going when markets return on February 20th, but for the past several years he has been unwilling to fire a big fiscal bazooka.  Will it be different this time?  Remember, they still have a catastrophic mess in the property market there which will impinge on anything they do.  I expect there will be some more half-hearted measures, but nothing sufficient to turn things around.  Ultimately, while they don’t want to see the renminbi fall sharply, I suspect it may have a bit more weakness in it before things are done, especially if the Fed really does stay higher for longer.

Ok, let’s look at markets elsewhere overnight.  The Nikkei (+2.0%) rallied sharply after comments by a BOJ member indicating that even when rates get back above zero, they will not move very much higher, and it will take time.  This saw the yen weaken further while stocks benefitted.  Meanwhile, the only loser in Asia overnight was India, where investors were disappointed that the RBI left rates on hold rather than cutting them (see a pattern here?).  Otherwise, everything followed the US rally yesterday.  The same is broadly true in Europe with decent gains, about 0.5%, almost everywhere except the UK, which is flat on the day after comments by a BOE official that cuts may not come as soon as hoped.  As to the US, at this hour (7:30) futures are basically unchanged.

In the bond market, after a generally quiet session yesterday, yields are starting to creep higher again with Treasuries +2bps and European sovereign yields rising a similar amount across the board.  Once again, the global bond markets revolve around Treasury yields with the only exception being JGB’s which saw the yield decline 1bp after those BOJ comments.

In the commodity markets, oil (+0.9%) is higher once again with Brent trading back above $80/bbl, as Secretary of State Blinken returned to the US with no real improvement in the Israeli-Hamas war and no prospects for a cease-fire.  Meanwhile, the US was able to kill the Iranian commander who allegedly led the attack on a US base that killed three soldiers, certainly not the type of thing to cool down tensions in the region.  Between the rise in cost of shipping oil from the Mideast to the rest of the world because of the Red Sea situation, and the lack of hope for an end to the fighting, it seems oil may have some legs here.  As to the metals markets, there is a split with both gold and copper under some pressure but aluminum seeing a bid this morning.  Quite frankly, I understand the former two rather than the gains in aluminum, but in the end, none of these metals has moved very much over the past months and remain trendless for now.

Finally, the dollar is starting to assert itself this morning as though the yen (-0.75%) is leading the way lower, pretty much every G10 and EMG currency is weaker vs. the greenback at this time.  Again, I would contend this is all about the ongoing Fed message of caution and confidence regarding inflation’s disposition, and the prospects of higher for longer.  FWIW, the current probability of a March cut is 18.5%.  barring a collapse in the CPI data next week, I expect that to head toward zero over time.

As to the data situation, we only see the weekly Initial (exp 220K) and Continuing (1878K) Claims data first thing and then it is Fedspeak for the rest of the day.  I expect that traders are going to push the S&P 500 over 5000 early this morning, if for no other reason than to say it was done, but what happens after is far less certain.  Earnings data has been generally ok, but some pretty bad misses have had quite negative impacts on individual names.  As to the dollar, the more I hear Fed speakers urge caution in the idea for rate cuts soon, the better its prospects.

Good luck

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Singing the Blues

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Here’s what’s underlying most views
Inflation is yesterday’s news
But what if it’s not
And starts to turn hot?
Those bulls will be singing the blues
 
So, care must be taken, I think
As in the bulls’ armor, a chink
Is wages keep rising
While homes are surprising
Be careful, the Kool-Aid, you drink

 

Market activity has generally been benign as investors and traders await the next big news.  Arguably, that is next Tuesday’s US CPI data given the dearth of new information otherwise due to be released this week.  The one thing we have in spades this week is central bank speakers, with three from the Fed yesterday and four more today, including the first comments I have seen from the newest Governor, Adriana Kugler.  As well we have been regaled by ECB, BOE and BOC speakers and they will continue all week as well.

Thus far, the message has been pretty consistent with the general theme that inflation has fallen nicely and is expected to continue to do so.  However, in a great sign of some humility, they are unwilling to accept that because price levels have fallen for the past 3 months that their job is done.  Obviously, the recent NFP and ISM data have shown no indication that the economy is even teetering on the brink of a slowdown, let alone desperate for rate cuts for support.  And for this, I applaud them.

But in this case, the central bank community seems to be in a small minority of economic observers who are not all-in on the idea that rate cuts are necessary right now.  Because, damn, virtually every other analyst seems to be on that train.  

There is a very good analyst group that calls themselves Doomberg, which mostly write about energy policy and its impacts on everything else, but in this morning’s article, I want to highlight a more general comment they made which I think is really important:

“How can you tell the difference between an analyst and an advocate? It is all in the handling of data that runs counter to assertion. To an analyst, being wrong is disappointing, but it is primarily an opportunity to learn—an expected element in a feedback loop of continuous improvement. When knowledge is your only objective, there is no such thing as a bad fact, only one which you do not yet understand. Not so for the advocate. The advocate has tied their hopes (and often their livelihoods) to a specific outcome and feels compelled, whether consciously or not, to rationalize away or attack inconvenient realities. It is advocacy when every perturbation in the weather is tagged as evidence of climate change, each squiggle of unfavorable price action is declared market manipulation, and no act or utterance from a favored politician is disqualifying.”

First, I cannot recommend their writings highly enough as they are consistently thoughtful, well-researched and important.  But second, I think this point is exactly in tune with the Goldilocks welcoming committee as they will ignore every piece of data that runs counter to their narrative and double down by saying the Fed is overtightening because inflation is collapsing, and deflation is going to be the economic problem soon.

While I am often quite critical of the Fed and their comments, and still think they speak far too much, right now, I am very happy to see them maintain a reluctance to cut rates just because the market is pricing in those cuts.  Certainly, to my eye, looking at the totality of the data (as Chairman Powell likes to say) there is little indication that prices are collapsing.  In fact, the super-core data, which was all the rage last year, has turned higher.  I understand why Wall Street analysts are better described as Wall Street advocates, but for the independent analysts out there, and over the past several years those numbers have exploded higher, it is remarkable to me that more of them are not suspect on the idea that rates need to be cut and cut soon.  In fact, at this point, one month into the year, I continue to like my 2024 forecasts of perhaps one cut in the first half of the year, but a reversal as inflation reignites.

Yes, the futures market is now only pricing five cuts into 2024, but nothing has changed my view that the pricing is bimodal, either 0 or 10 cuts will be the outcome, with the former if the economy continues along its recent pace and the latter if the recession finally arrives.  Given that interest rates, led by Treasury yields, are the clear driver of global market movements, and given that inflation is going to play a critical role in their movement going forward, I have altered my view as to the most important piece of data.  Whereas I used to believe it was NFP, it is now entirely CPI/PCE.  As I wrote yesterday, if next week’s print is at 0.4% M/M, watch out for a significant repricing.

But now, let’s turn to today.  President Xi continues to have problems with his stock market and is seemingly getting a bit more desperate aggressive in his efforts to prevent a complete implosion.  Last night, the head of the CSRC (China’s SEC analog) was replaced as blame needs to be placed on others for Xi’s policy errors.  It ought not be surprising that Chinese shares, after a weak start, rebounded on the news and closed higher by about 1%.  However, the Hang Seng could not manage any gains and the Nikkei edged lower as well.  All in all, it was not a great session overnight.  In Europe this morning, the markets are lower by between -0.25% and -0.5% as once again we saw weak German data (IP -1.6%) continuing to point to a recession on the continent.  Finally, US futures are basically flat at this hour (7:30).

In the bond market, yields, which all slid a bit yesterday on what seemed to be a profit-taking move after that massive runup following the NFP and ISM data, are a bit higher this morning, with Treasury yields up by 3bps and most of Europe seeing similar movements, between 2bps and 4bps.  As I wrote above, this story remains all about inflation’s future, and as data comes in to add to the conversation, I suspect that will be the key mover going forward.

Oil prices (+1.0%) are continuing their modest recent rebound with WTI touching $74/bbl this morning and Brent above $79/bbl.  Comments by the Biden administration that they would continue to attack Iranian proxy groups seems to have traders worried about an escalation.  But a more concerning story is that Ukraine has been targeting Russian refineries in an effort to degrade Putin’s cash flow.  They have already hit several and reduced capacity by 4%-5%.  If that continues successfully, then oil prices are going to go much higher.  This doesn’t seem to be in the bigger narrative right now, so beware.  As to the metals markets, they are all slightly softer this morning, but movement has been tiny.

Finally, the dollar is under a modest amount of pressure this morning, which given the rising yields and softer commodities, seems out of character.  Granted, the movements are small, with most currencies just 0.1% – 0.2% firmer vs. the dollar.  And this could also be profit-taking given the dollar’s recent rally.  After all, the euro remains below 1.08 and USDJPY above 148.00 so this is hardly a collapse.

Turning to the data today, the Trade Balance (exp -$62.2B) is this morning’s release and then after oil inventories, at 3:00 we get Consumer Credit ($16.0B).  As mentioned above, we have many more Fed speakers as well, and I sense that will be of far more interest to market participants.  I don’t anticipate anybody straying from the current theme of inflation has been falling nicely but they are not yet convinced.  If someone strays, that could move markets, but again, I see little to drive things today, or this week.

Good luck

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Ain’t Hunky-Dory

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For President Xi it appears
The stock market’s shed enough tears
So, he’s set to meet
The finance elite
And likely to box all their ears

As such, I expect we shall see
The Hang Seng will start on a spree
With New Year’s approaching
A little more coaching
By Xi, for a rally, is key

The big news overnight was that Chinese equity markets rebounded sharply (Hang Seng +4.0%, CSI 300 +3.5% CSI 1000 +7.0%) after the news that President Xi Jinping would be meeting with market regulators to find out what is going on there.  Banning short sales has not yet been effective nor has increased purchases by specific state funds.  According to Morgan Stanley, foreign investors sold $2.4 billion in Chinese equities in January, arguably a key driver of the market’s recent weakness there.  But the fact that Xi is getting involved directly has traders believing that more support from the government is on its way, hence today’s big rally.

While that is all fine and well for equity investors, the far more important question for the rest of us is will this stock market support help the Chinese economy as well?  Or will that continue to meander along at a weak growth pace?  Of course, it is far too early to know the answer to this question but given that the preponderance of Chinese individual wealth is tied up in real estate, not equities, I expect that this will have far less impact on the economy there than is hoped by both Xi and the traders.  After all, one of the key reasons so many in the US care about the stock market is that so much of our 401K investments are in equities, a rally shows up in our accounts daily.  But in China, that same situation does not hold.  Will a rally in stocks, if it even comes, be enough to sway the average person’s thinking there that things are getting better?  I have my doubts.

A turn to the interest rate story
Shows things there just ain’t hunky-dory
Yields just won’t stop rising
And that’s neutralizing
The thought rate cuts are mandatory

Friday morning, 10-year Treasury yields traded as low as 3.82% prior to the release of the NFP report.  This morning, they are trading at 4.16%, 34 basis points higher and the largest two-day yield rally since the covid volatility in March 2020.  Prior to that, it was 1981 when yields moved that far that fast.  Adding to Friday’s NFP story, yesterday’s ISM Services report was not only stronger than expected at 53.4, but the Prices index jumped to 64.0, its highest in a year and hardly a comforting thought for Chairman Powell and his fight against inflation.

At this point, the Fed funds futures market has lowered the March rate cut probability to 16.5%, and some of the punditry, although not yet any Fed speakers, have raised the question if another hike might be in order if things continue on their recent trajectory.  I assure you that the equity market has not priced in the possibility of a rate hike anywhere in the next 2 years at least.  Let’s just say that next week’s CPI report is going to be quite closely watched by everyone as if what I have seen as recent stickiness continues to exert itself, and with the economy seeming to be ticking over quite nicely, then the narrative could well change.  It is not impossible for the Fedspeak to turn even more hawkish if we were to see CPI rise 0.4%, a rate that is far too high for Fed comfort.  And that, my friends, would likely not be well-received by the equity market or risk assets overall.  While I have no special insight into how this data is going to evolve, I think the reaction function is clear.

Ok, let’s look at the overnight session beyond Chinese stocks.  In what cannot be that surprising after US equities struggled and given its recent negative correlation to Chinese stocks, the Nikkei fell -0.5% while the rest of Asia was mixed with some gainers (India, Taiwan) and some laggards (Korea, Australia).  However, the story in Europe is a little brighter with gains most everywhere except Germany, which is flat on the day after mixed data, with a blowout Factory Orders result of +8.9%, but the Construction PMI falling to 36.3.  Contradictory data leading to no movement.  As to US futures, at this hour (7:45) they are essentially unchanged on the day.

In the bond market, it seems traders are sitting on the sidelines after the bloodbath described above as 10-year Treasury yields are unchanged on the day and in Europe, the sovereign bonds are higher by a mere 1bp-2bps across the board.  We saw a similar lack of movement in Asia as well, despite the fact that the RBA, at their meeting last night, sounded somewhat hawkish although left policy rates on hold as universally expected.  As the treasury market is clearly leading the way globally, we will need to get some new information here, I think, before we see any substantive movement again.  Since the next big piece of data is CPI in one week’s time, it could be a quiet week for bonds.

In the commodity market, oil (+0.6%) is bouncing slightly this morning although it remains far lower than levels seen last week.  Gold (+0.1%) is also edging higher along with the industrial metals although there has been no strong catalyst here today given the lack of substantive rate movement.  Perhaps there is some optimism from the Chinese stimulus story, but that feels quite premature.

Finally, the dollar is a touch softer this morning, although only just.  While the euro has been unable to bounce, we have seen some modest gains in the pound (+0.25%) and Aussie dollar (+0.25%) as well as the renminbi (+0.3%).  In addition, the LATAM bloc is very modestly firmer this morning but generally, most of the movement is of that 0.25% magnitude or less.  This feels very much like a trading response to a powerful rally over the past two days.

There is no hard data to be released today but we do hear from three more Fed speakers, Kashkari, Collins and Mester, all this afternoon.  Yesterday, Chicago Fed president Goolsbee strayed from the Powell message, indicating he still believed a cut in March was possible, but he is not a voter this year and nobody really paid any attention.  After yesterday’s data, it would be hard to believe that any of these three would sound dovish, but you never know.

Overall, when looking at the dollar, as long as the inflation story has reawakened and is driving yields in the US, it is hard to see coming weakness.  This is especially true given the economic weakness we continue to see elsewhere in the world.  Today feels like a reaction, not a trend in the making, and I expect that the dollar has better days ahead for as long as inflation is once again the driving force.

Good luck
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Not Quite Mawkish

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On Friday, in quite the surprise
Our payrolls did massively rise
At least that’s what printed
But where those jobs minted?
Or will, next month’s data revise?
 
Perhaps Chairman Jay had a sense
And that’s why his press confer-ence
Was ever so hawkish
Although not quite mawkish
So, traders, more buys, did commence

 

I would contend that nobody was anticipating the NFP data on Friday which printed so much higher than forecasts it was remarkable.  A headline number of 353K with a revision up for December of 116K is huge and certainly puts paid to any thoughts of the economy slowing.  As well, Average Hourly Earnings rose a more than expected 0.6%, certainly good for workers, but another nail in the coffin of a quick rate cut by the Fed.  Of course, none of that seems to matter anymore to equity investors as despite every indication that given the recent data, the Fed will remain higher for longer, stocks rocked higher.  Bonds did not fare quite as well, though, as 10-year yields rocketed 15bps higher by the close.

Another interesting anomaly was in the Fed funds futures market where in the immediate wake of the FOMC meeting, the probability of a March rate cut (which you may recall Powell specifically took off the table) fell to 20% from a coin toss earlier.  But Friday, that closed back at 38%! (PS, this morning it is down to 15.5%, so remains quite volatile.)  Rounding out the asset classes, the dollar followed yields, with the euro falling nearly 1% and other currencies close behind.  As to oil, that slid about $1, but it has been softening all week, so there are obviously other issues there.  What gives?

The first thing to recall is that January data tends to be pretty sloppy.  My good friend, Mike Ashton (aka @inflation_guy) made the point eloquently as follows:

This is not to say that the adjustments WILL be huge, just that over time, that has been the case.  Recall that almost every reading last year was revised lower in subsequent reports.  All I’m saying is that as terrific as that number was, add at least a pinch of salt, I think.

The other thing that doesn’t seem to square is that so many other employment indicators are trending in the opposite direction.  After all, ADP was only 107K, and the employment reading in the ISM fell last month along with the employment readings in many of the regional Fed surveys.  As well, continuing claims have been trending higher for the past several months, generally not a good sign for employment.  Again, all I am trying to highlight is that this number may not be quite as robust as it seems on the surface.  At the same time, for the Fed, if they need an excuse to leave policy at current levels, the combination of strong job growth and rising wages is plenty of ammunition.

Sunday night, Chairman Powell was interviewed on 60 Minutes but really didn’t tell us anything new.  Essentially, I would say he repeated his Wednesday press conference with one exception, he did, when asked, indicate that the current fiscal profligacy would be a problem in the long run.  To date, he has been reluctant to even discuss the issue, so perhaps that is a signal of something, but of what I have no idea.

Moving on from Friday, finally, the weekend saw the Biden administration’s retaliation for the deaths in Jordan of 3 US soldiers, however, that is not a market impactful event.  Coming into the new week, the Services PMI data has been released everywhere and we are awaiting ISM Services this morning in NY.  In aggregate, the data showed that some nations are doing better than others.  In the positive camp, India (61.8 final) was by far the nation with the highest reading, but Japan, China, Spain, Italy and the UK all showed growth above 50.  On the other side of the ledger, Australia, Germany, France and the Eurozone overall remain well below 50, although seem to have found a bottom for now.  As to the US, the current forecast is for a 52.0 print, up from December’s number of 50.6.

Is this really telling us that much?  Remember, the question that is asked in these surveys is, how do things compare this month to last month?  Remember, too, that recent data has shown weakness across the surveys with strength in the hard data.  Friday’s NFP is the perfect encapsulation of that idea.  Perhaps the one thing we can consider is that if today’s ISM is quite strong, it will be enough to completely remove March from the rate cut schedule.  Of course, my question is, if today’s data is strong, why exactly will the Fed feel the need to cut rates at all?  I simply do not understand this baseline assumption that interest rates are “too high”.  In fact, based on the evidence provided by GDP and NFP data, they seem to be just fine.  And, hey, isn’t it better for all of us to earn 5% in our Money Market Fund accounts than 0.0% like we did for years?  In fact, based on the common view that there are several trillion dollars of “excess” savings in the economy, it seems the holders of those savings must be quite happy with rates where they are.

Ok, let’s tour overnight market behavior quickly before we finish up.  In the equity space, Japanese stocks continue to rise with the Nikkei up another 0.5% while Chinese stocks continue to struggle.  While the CSI 300 managed a 0.6% gain, the small-cap CSI 1000 fell 8% as small cap stocks around the world remain unloved.  However, the Chinese government is definitely concerned as rumors of another rescue package are all over the tape.  As to Europe, modest gains are the order of the day, with most markets higher by about 0.25%.  meanwhile, US futures, they are ever so slightly softer at this hour (7:15), down about -0.1%.

Turning to the bond market, apparently everybody is turning away from the bond market!  Yields are higher across the board with Treasuries leading the way, up a further 7bps, but all European sovereign yields higher by between 3bps and 5bps as well.  The story in Asia was even more impressive with JGB’s (+5bps) and Australia (+12bps) all catching up to the Treasury story.  Ultimately, the issue I see is that while growth in the US remains strong, pretty much all of Europe is in recession.  This seems likely to lead to the ECB cutting rates before the Fed as they will have a reason to do so, while as I ask above, what is the Fed’s rationale for a cut?

The higher interest rate story has weighed heavily on commodity prices with oil sliding -0.8% this morning, although it has been falling for a week.  But we see metals prices under pressure as well with gold (-0.6%), copper (-0.4%) and aluminum (-0.6%) all sliding this morning amid the move in yields.

Not surprisingly, the dollar has been a major beneficiary of the higher yield story, following Friday’s sharp rally with a continuation across the board.  The euro is back to 1.0750, a level not seen since mid-November, while USDJPY is back above 148.50 and USDCNY above 7.21.  In fact, the only currency bucking the trend today is KRW (+0.4%) which managed to rally despite any obvious macro catalysts.  Equities fell there alongside Chinese stocks, so it was not investment inflow.  Sometimes, currencies just move, that much we know.

Turning to the data this week, there is much less on the docket than we saw last week with, arguably, today’s Services ISM the most important number.

TodayISM Services52.0
WednesdayTrade Balance-$62.2B
 Consumer Credit$15.0B
ThursdayInitial Claims220K
 Continuing Claims1902K

Source: tradingeconomics.com

However, we do hear from 10 different Fed speakers this week starting with Atlant’s Raphael Bostic and then inundated rhoguhout the week.  But I ask you, will they really stray far from Powell’s message?  Especially after the blowout NFP number?  Higher for longer still lives, and if we continue to get strong data, May will soon start losing its appeal for a rate cut.  This will not help the bond market, that’s for sure, but it will help the dollar.

Good luck

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Beware

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It wasn’t all that long ago
When Powell commanded the show
At least so it seemed
But maybe we dreamed
Those attributes we did bestow
 
But now traders seem not to care
That Wednesday, Chair Jay said beware
No rate cuts next meeting
Instead, they are treating
That warning’s though it wasn’t there
 
The upshot is bonds are on fire
And stocks turned around and went higher
Today’s NFP
Will help us to see
If Jay is still leading the choir

 

Well, it seems that Chair Powell’s hawkish message resonated with investors for about 12 hours, at which point they decided to forget all he said and side with Treasury Secretary Yellen and her spending plans.  Or maybe the trading community just doesn’t believe he can pull it off, keep policy rates at 5.5% while the government needs to borrow so much money.

There are other possible explanations as well.  The NYCB meltdown yesterday may have opened some eyes regarding the commercial real estate (CRE) problems that certainly exist everywhere in the world, but notably here in the US.  If reclassifying just two loans was enough for a $100 billion bank to cut their dividend completely and increase loan loss reserves nine-fold, what about all the other CRE loans that are also under pressure on other bank balance sheets?  Perhaps the bond market is sniffing out the next banking crisis in front of our eyes.  For the conspiracy theorists, the Fed did remove the following line from their statement yesterday, “The U.S. banking system is sound and resilient.”  Perhaps that was a hint that it is not sound and resilient.

Regardless of the driver, yesterday saw a ripping rally in the bond market with the 10-year yield touching 3.82% before bouncing, nearly as low as it reached following Powell’s ultra-dovish performance in December.  That certainly doesn’t square easily with the hawkish statement and comments on Wednesday.

I have no good explanation for the movements, and I would argue neither does anyone else.  As has been the case for the past year, at least, economic data is simply a Rorschach test for your underlying views and biases.  Once again, the financial markets appear to be fighting the Fed tooth and nail.  Perhaps one clue was the fact that gold prices rallied yesterday, as did bitcoin.  Now, it is possible that is simply because lower yields enhance the willingness to hold those assets, or perhaps it is because the market smells a banking crisis coming and wants to hide.

Fortunately, we get new and important information this morning with the release of the NFP data at 8:30.  Here are the current median forecasts:

Nonfarm Payrolls180K
Private Payrolls155K
Manufacturing Payrolls5K
Unemployment Rate3.8%
Average Hourly Earnings0.3% (4.1% Y/Y)
Average Weekly Hours34.3
Participation Rate62.4%
Factory Orders0.2%
Michigan Sentiment78.9

Source: tradingeconomics.com

As well, the BLS will be releasing their annual revisions to their data, so everything will be a mess.  However, traders, and trading algorithms, only ever look at the headlines.  The fact that 11 of the past 12 NFP numbers have been revised lower over time seems not to be a major concern to investors, although it is certainly not a positive signal for the economy writ large.

In the end, we are all beholden to this data point and the market’s reaction function.  Based on what we have seen since the FOMC meeting I would suggest that a weak number will be seen as risk-on because it will encourage more rate cut talk and bring March back into view.  (FYI, the current probability of a March cut according to the futures market is 34.5%.  Sub 100K and I would look for that to go back to 50% at least.)  At the same time, a strong print, > 200K, and I expect a risk-on response as it will encourage the earnings growth story and reduce the probability of a recession.  In fact, after the strong earnings reports from Meta and Apple last night, the only way I think we see a risk-off outcome today is if NFP is sharply negative, enough so it forces people to put recession back on their bingo cards.  We shall see.

In the meantime, a quick look at the overnight session shows that Asian equity markets are back on the buy Japan / sell China train with the CSI 300 falling to its lowest level since 2019 as investors remain unimpressed by Xi’s efforts to fix things in China.  But away from China, the rest of the markets in Asia all had good session, up between 0.5% and 1.5%.  In Europe, green is the theme as well with every market higher on average by 0.7% or so.  Not surprisingly given the earnings reports, US futures are green as well, with the NASDAQ +1.0% at this hour (7:10).

Bond markets are all over the map this morning.  Treasury yields are unchanged from the closing level yesterday, although they bounced 5bps from that intraday low print mentioned above.  As to European sovereigns, yields have edged higher by 1bp-2bps on the continent although UK Gilts are higher by 6bps which is a bit strange given the BOE yesterday seemed far more dovish than many expected.  While leaving rates on hold, they explained they expected inflation to temporarily get back to their 2% target in Q2 before bouncing a bit, and the vote included one vote to cut rates, 6 to maintain and 2 to raise, a more dovish tilt.  And yet here we are, with Gilts selling off.  If you were interested, JGB yields have fallen as well, down 2bps and falling away from any ideas of policy changes in Tokyo.

Oil is little changed this morning after getting crushed yesterday on unconfirmed rumors of a cease-fire in the Israel-Gaza conflict.  It seems the betting is that if there is a cease-fire, the Houthis will stop attacking ships in the Red Sea and things will improve everywhere.  However, as of yet, no cease-fire has been reached.  As to the metals markets, gold is little changed after a more than 1% rally yesterday, while both copper and aluminum are softer this morning, although the movements have been small and may be meaningless.

Finally, the dollar is a bit softer this morning with AUD (+0.5%) the leading G10 gainer on the back of the ASX 200 reaching a new all-time high closing level overnight.  But the movement here is broad and shallow, most currencies are a bit stronger vs. the dollar, but that 0.5% move is the largest by far.  My take is that as long as US yields remain under pressure, the dollar will be on its back foot as well.  Hence, a strong NFP this morning could see yields bounce and the dollar along with it.

And that is all we have today.  It has been quite a week between the QRA, the FOMC and Powell presser and now today’s NFP.  While there was a great deal of uncertainty as the week began, at this point, it seems clear that the market has decided that rates are coming lower regardless of what Powell has to say.  We have yet to hear from any other Fed speakers, although I imagine we will be getting a full dose next week.  And Sunday night, on 60 Minutes, Powell will be interviewed so that will be closely watched for any clues.  Until then…

Good luck and good weekend

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Led to Dismay

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The first thing we saw yesterday
Was ADP led to dismay
But Treasury news
Adjusted some views
And stocks started trading okay
 
However, t’were two things we learned
First NYCB stock was spurned
Now, you may recall
That their greatest haul
Was Signature Bank, which was burned
 
And lastly Chair Powell, at two
Explained what he’s likely to do
They’re not cutting rates
As both their mandates
Remain far ahead in their view
 
Just when you thought it was safe to go back in the water…
 
I am old enough to remember when there was a growing certainty that not only was the Fed virtually guaranteed to cut rates by the May meeting, but the March meeting was very much on the table.  After all, inflation was below their 2.0% target (if you look at the recent 6-month run rate anyway) and therefore they just had to cut rates or stock prices might fall!  Or something like that.  But somehow, Jay and the FOMC missed that memo.  Instead, what they told us was [my emphasis];
 
“The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. The Committee judges that the risks to achieving its employment and inflation goals are moving into better balance. The economic outlook is uncertain, and the Committee remains highly attentive to inflation risks.
In support of its goals, the Committee decided to maintain the target range for the federal funds rate at 5-1/4 to 5-1/2 percent. In considering any adjustments to the target range for the federal funds rate, the Committee will carefully assess incoming data, the evolving outlook, and the balance of risks. The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent. In addition, the Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities, as described in its previously announced plans. The Committee is strongly committed to returning inflation to its 2 percent objective.”
 
In other words, while it is highly unlikely that they will need to hike rates further, unlike the markets or the punditry, Powell has little confidence that they have won the inflation battle and rate cuts remain merely a distant prospect.  Certainly, there was no obvious concern that interest rates are “too” high at this time.  In other words, this was a much more hawkish statement, and Powell’s answers in the press conference were in exactly the same vein.  Memories of the dovish December meeting have faded from view.    And this was the denouement to quite a day, one which gave us so much new information.
 
Things started with a weaker than expected ADP Employment result, just 107K, although that data point’s correlation to NFP has been diminishing of late.  Regardless, it was the type of softness that got people primed for a dovish Fed.  Then, the QRA indicated that the Treasury will be issuing what appears to be about $45-$50 billion in new coupons this quarter to fund a $400 billion or $500 billion budget deficit.  The balance of that will be via T-bills which means that while the ratio is not as aggressively leaning toward T-bills as last quarter, it is still miles above the historical rate of 20% ish.  Those two stories got bond bulls hyped, although equity markets struggled on some weak earnings numbers. 
 
And then we heard from New York Community Bank (NYCB), which you may recall, was the lucky recipient of the Signature Bank assets last March.  Well, it turns out they made a hash of things, losing a bunch of money with some pretty bad loan impairments added on to increased capital requirements because they grew to a new, larger risk-weighting tier after the acquisition.  At this time, there is no indication they are about to go bust, but the question has been asked a lot as the stock cratered and investors ran into Treasury debt just to be safe.  As it happens, the stock, which had basically doubled over the past year after buying Signature, has reverted to its pre-acquisition price and that added jitters to everyone’s views.  PS, those loan impairments were CRE based which naturally leads to the question of what is going on with other regional banks.
 
Finally, during the press conference, Chairman Powell was clear that a March rate cut was highly unlikely and that was the final nail in the equity market’s coffin.  So, the NASDAQ led the way lower, falling -2.2% while the S&P 500 tumbled -1.6%.  At the same time, 10-year yields dropped like a stone, down 12bps to 3.91%.
 
Looking ahead, I wonder how all those folks who were certain the Fed HAD to cut because policy was just TOO TIGHT for their liking will reframe their narrative.  To my eye, yesterday’s equity declines are a blip and will not even register at the Eccles Building.  There is a bit of irony in that the doves need now eat so much crow.
 
Ok, on to this morning, where the overnight price action saw another mixed picture in Asia, but this time with Japan (Nikkei -0.75%) sliding while Chinese shares (Hang Seng +0.5%, CSI +0.1%) edging higher.  There was yet another announcement of a bit of further fiscal support from the Chinese government, but Xi remains reluctant to bring out the bazookas.  European shares are also mixed with gains in the UK and Spain and losses in France and Germany.  PMI data showed that the Flash numbers were pretty much spot on and all of Europe remains well below 50.0 except Norway (50.7) which benefits from its oil industry.  It remains very difficult to get excited about the Eurozone’s economic prospects these days which should ultimately weigh on the ECB to cut rates sooner and the euro to suffer in that case.  As to US futures, after a wipeout yesterday, this morning they are firmer by about 0.5% at this hour (6:45).
 
In the bond market, after yesterday’s Treasury yield collapse, 10-year yields are higher by 3bps this morning and European sovereigns have risen about 4bps on average.  This movement is more a response to the large move yesterday rather than a result of new information.  Overnight, JGB yields slipped 4bps, clearly following in the footsteps of Treasury yields. 
 
As to commodities, oil (+1.0%) has bounced after a weak session yesterday that was driven by demand worries.  But tensions in the Middle East seem to be reasserting themselves with several stories in the press this morning regarding the danger to the world from a potential collapse in shipping capabilities.  The ongoing Houthi attacks in the Red Sea are starting to really take their toll on supply chain situations.  This is not only bad for inflation readings but could well impair the ultimate delivery of critical things like oil, thus driving its price even higher.  As to the metals markets, they are all under pressure this morning with gold holding on best given its haven status but all the industrial metals lower by 1% or more.
 
Finally, the dollar is coming up roses this morning.  While in the early going yesterday, before the FOMC meeting, the dollar broadly sold off on the softer ADP and dovish QRA, Powell changed everything, and the dollar reversed course in the middle of the day and rallied back nicely.  This is true against virtually all its G10 and EMG counterparts.  The weakest members are AUD (-0.7%) after weak housing data Down Under added to thoughts of a rate cut coming soon.  As well, we see GBP (-0.4%) just ahead of the BOE meeting where expectations are for a more dovish statement although no policy change.  But we are seeing weakness in CLP (-1.3%) on the back of that weak copper price and weakness in ZAR (-0.4%) on the weak metals complex as well.  Given the hawkish tilt from Powell yesterday, unless there is a concerted effort by the Fed speakers that will be flooding the tape over the coming weeks to reverse that course, I suspect the dollar will benefit in the near-term.
 
On the data front, this morning brings Initial (exp 212K) and Continuing (1840K) Claims, Nonfarm Productivity (2.5%), Unit Labor Costs (1.6%) and ISM Manufacturing (47.0).  With NFP tomorrow, I expect that the productivity and ULC data should be of the most interest as they will play most deeply into the Fed’s thinking.  Improved productivity implies that there is less reason to cut interest rates as the “neutral rate” should be higher than previously thought.  In fact, that dynamic would be very positive for the dollar, and interestingly, for the equity market as well as it would be a clear boost to earnings potential.  We shall see how it turns out.
 
Good luck
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Nary a Doubt

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The two things we’re watching today
Are Jay and the new QRA
The pundits are out
With nary a doubt
That easing is coming our way

But what if this faith is misplaced
And Jay, at the presser, bald-faced
Says policy ease
Is not what we please
And we’ll not get there in great haste

Reading the Fed Whisperer, Nick Timiraos of the WSJ, this morning was enlightening only to the extent that everybody he interviewed demonstrated they have no idea what will happen, and merely described what they would like to see.  Now, in fairness, I don’t think Powell himself really knows how things are going to play out as we continue to see mixed pictures on the economy.  For every strong datapoint (e.g., GDP, JOLTS, Case Shiller) indicating that there are many potential inflationary pressures extant, we see some softer data points (e.g., PCE, Empire Manufacturing, Dallas Fed) that indicate policy is excessively restrictive.  While it is very clear that the Fed will not adjust policy today, a look at Fed funds futures shows that the market is pricing in a 45% chance of a cut in March.  A month ago, that was over 70%, so Powell must be a bit happier, but 6 weeks is such a long time in this context, anything can happen between now and then.  And, oh yeah, the market is still pricing in 6 cuts this year.

Of course, long before the FOMC statement and Powell presser this afternoon, the Treasury will release its QRA and the market will learn if Secretary Yellen is going to continue down her recent path of leaning toward more T-bills and less coupons.  Based on her continuous comments that the soft landing has been achieved and inflation is no longer a problem, it seems quite clear that she wants to see the Fed cut rates soon.  After all, lower interest rates take pressure off the budget deficit, which is entirely her baby at this point.  Interestingly, she could essentially force Powell’s hand in this situation as follows:

1.     Issuing a high percentage of T-bills will lead to
2.     Reducing the RRP balances and bank reserves which will
3.     Force the Fed to respond by slowing/ending QT to prevent any systemic problems like seen in September 2019

Remember, we have already heard from Powell, as well as Dallas Fed President Lorie Logan, whose previous role was at the NY Fed overseeing the Fed’s reserve portfolio, that the time to discuss slowing or ending QT was fast arriving.  By itself, that is a policy ease, but it would also be a signal that further changes were on their way.  In fact, a continued heavy reliance on T-bill issuance would have two vectors to support the bond market; ending QT reduces the amount of bonds the market needs to absorb and reducing new supply by itself will do exactly the same thing.  At least for as long as inflation remains quiescent.  And in the end, that remains the biggest unknown, inflation.  All these plans and ideas revolve around the premise that the Fed has won its inflation fight.  But I ask you, what if they haven’t?

Too much digital ink has been spilled already on the inflation question and the two camps remain at distinct odds.  Forgetting all the conspiracy theorists who claim inflation is really 10% or more, and looking only at serious economists and analysts, while all agree that the rate of inflation has fallen from its peak levels in the summer of 2022, there is still a pretty even split between the two sides.  While I fall on the side of stickier inflation than the market is pricing, I can understand the other side of the story.  But the point is, there are two very real sides to the story and the outcome remains unwritten.  However, if inflation does remain stickier than the doves believe, it will destroy their entire thesis of why the Fed should be easing policy.  Given the stock market is making new highs regularly, I suspect investors and traders have largely bought into the ‘inflation is over’ view.  Just be careful if it’s not.

Ok, as we await today’s activities, let’s look at what happened overnight.  Following a mixed session in the US yesterday, Asian markets turned back the clock a few weeks with the Nikkei (+0.6%) continuing its longer-term rally while both the Hang Seng (-1.4%) and CSI 300 (-0.9%) revert to their losing ways.  It seems that investors simply do not believe that President Xi has either the ability or willingness to do anything to support the stock market there, at least, if not the economy.  I believe it would be a mistake to believe he is not willing, which calls into question exactly what they are going to do to prevent things from starting to impact the economy more negatively.  And perhaps we have seen the first steps.  The other noteworthy story in the WSJ this morning was about how Chinese authorities are “discouraging” negative takes on the economy from being published and instead telling news outlets to publish stories about the bright prospects there.

Moving on to Europe, the main indices have moved very little thus far today after a mixture of data showing inflation in Germany and France continue to decline but Retail Sales in Germany (-1.6%) and Switzerland (-0.8%) and Industrial Sales in Italy (-1.0%) all falling sharply in December.  Given the weak GDP data yesterday on the continent, none of this can be surprising.  Finally, US futures are mostly lower this morning, led by the NASDAQ (-1.0%) despite (because of?) what seemed to be solid earnings from Microsoft and Alphabet.  In the end, though, I sense that investors are far more focused on the QRA and FOMC right now.

Treasury yields are unchanged this morning but that is after a 4bp decline yesterday and we have seen European sovereign yields slide this morning as well, between 1bp and 3bps, which seems to be a catch up move to the Treasuries.  I must mention Australian government bonds, which saw yields tumble 13bps overnight on the back of a much softer than expected CPI reading which has the market talking rate cuts there again.  Finally, JGB yields edged 2bps higher, despite weaker than expected Retail Sales and IP data.

Oil prices (-1.1%) are backing off this morning after another positive day yesterday and a very strong month of January, where WTI rose > 9%.  (My take is that will not help the CPI data when it comes out in a few weeks’ time.)  Meanwhile, metals prices are trading near unchanged on the day as traders here are also awaiting the new information.

It should be no surprise that the dollar is, net, little changed this morning on the same premise of waiting for Godot Powell.  Looking at my screen, I don’t see any currency that has moved more than 0.3% in either direction so really no information yet today.

In addition to the QRA and FOMC meeting, we see the ADP Employment Report (exp 145K), the Employment cost Index (1.0%) and Chicago PMI (48.0).  Careful attention should be paid to the ECI as the Fed focuses on that metric for wage inflation data.  As an indication, prior to the pandemic, that index averaged around 0.6%, but since then, it is more like 1.0% on a quarterly basis.  That annualizes to more than 4% and will maintain upward pressure on inflation if it stays there.  Just something else to keep in mind.

If pressed, I believe that the QRA will show reduced coupon issuance and Powell will be more dovish than not.  While we know the Treasury is political, by definition, and will do everything in its power to stay in power and get re-elected, my take is the Fed is in that camp as well.  I would not be surprised to see a more dovish take this afternoon after the QRA this morning.  And initially, at least, that tells me the dollar will trade back toward its recent lows ceteris paribus.

Good luck
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There’ll Be No Crash

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Said Janet, I know we’ve been spending
Too much, but you’re not comprehending
I’ve plenty of cash
So, there’ll be no crash
Instead, stocks will keep on ascending

Til Wednesday, we’ll keep the suspense
But really, it’s just common sense
Chair Powell and I
Will help the Big Guy
And policy ease will commence

Well, the first shoe dropped yesterday afternoon as the Treasury explained that they would “only” be borrowing $760 billion in Q1, a solid $56 billion less than had been expected by the market as of yesterday morning.  With that significant reduction in potential Treasury issuance, the bulls went nuts and both stocks (+0.75%) and bonds (-7bps) rallied.  A cynic might believe that Secretary Yellen was trying to manipulate the stock market higher, but we all know that could never be the case.  At any rate, this sets us up for Wednesday when first thing in the morning we will see the Quarterly Refunding Announcement (QRA), where Yellen will describe the ratio of short-dated T-bills to long-dated coupon issuance, and then at 2:00, the FOMC Statement will be released with Chairman Powell speaking at the press conference 30 minutes later.

Given the excitement over yesterday’s events, I suspect that at least one of the two events tomorrow will be dovish rates/bullish equities but have no idea which way it will play out.  In the end, though, it doesn’t really matter.  Ultimately what we have learned is that Yellen is running the show, and all Powell can do is respond.  The one thing I have to wonder is, what if the government spends more than the $760 billion in Q1?  Where will that money come from, and what will the impact be on the markets?  (Obviously, they will simply borrow more, but it will not be an issue as there is no limit these days, nor for an entire year going forward.)  However, for now, that is just a concern for grumpy old men like me.

In China, though they have announced
More stimulus and stocks first bounced
It seems traders feel
Xi ain’t got that zeal
So, sellers once more have all pounced

You may recall last week when the Chinese stock market rallied sharply after a series of announcements regarding government support.  First there was the story of CNY 2 trillion of cash that would be coming home and invested in equities and then the PBOC cut the RRR by 50 basis points, freeing up another CNY 1 trillion.  These moves were supposed to demonstrate that Xi was going to fix things.  And he did…for a week.  But now, equity markets in both Hong Kong (-2.7%) and on the mainland (-1.8%) are falling again as it seems market participants have come to believe that there are too many problems for a mere CNY 3 trillion to fix.  And they could well be correct.

After all, China has been inflating their economy for decades and the property bubble they have blown is not nearly popped yet.  While this could be a modest correction in the beginning of a trend higher, I have a feeling that the fundamentals have a long way to go before they make sense for international investors.  With the European economy having stagnated for the past 5 quarters and the US moving an increasing amount of business to Mexico from China, it will be tough sledding in China, I fear.  Ultimately, I continue to believe the renminbi will suffer as it will be the most likely outlet valve.  But for now, I guess they can stand the pain.

And those are today’s stories as the market braces itself for tomorrow’s QRA and FOMC, Thursday’s BOE and Friday’s NFP data.  In the meantime, let’s recap the rest of the overnight action.

Despite the robust performance in the US yesterday, only Japan and Australia managed to show any signs of life in Asia overnight as China dragged down all the other regional markets.  This cannot be too surprising given the importance of the Chinese economy there, and if it is lagging other nations are going to struggle as well.  Europe, however, is having a much better go of it, with gains across the board, led by Spain’s IBEX (+1.25%) after both real and nominal GDP rose more than expected with inflation ticking higher alongside economic activity.  That may not bode well for the inflation story in Europe, but for now, everyone’s happy and the ECB comments have all pointed to rate cuts by the middle of the year.  As to US futures, at this hour (7:45) they are just barely on the red side of unchanged, with no market even -0.1%.

You will not be surprised that European yields slipped yesterday after the US bond rally as the combination of a prospect of lower yields in the US alongside the slightly more dovish talk from the ECB speakers was plenty of catalyst for a bond rally there.  While yields have edged back higher by 2bps or 3 bps this morning, they remain below yesterday morning’s levels.  In the US, Treasury yields have continued their decline, down another 1bp overnight while JGB yields have edged down another 1bp as well.  One other market to note, China, saw yields slip 3bps overnight and they are now at their lowest level since the early 2000’s as the market anticipated further policy ease from the government and PBOC.

Oil prices (-0.65%) are off a bit this morning as they continue to consolidate last week’s gains.  Clearly there is still concern regarding the US response to the attacks on its base in Jordan over the weekend as the intensity of that response is still completely unknown.  Weakness in China is not helping the oil market and European GDP data has also worked against the demand story, so uncertainty remains the watchword.  As to gold, it is continuing to creep higher but remains in its recent 2020/2060 trading range.  Lastly, the base metals are a touch softer this morning, but only a touch.

Finally, the dollar is a bit softer this morning after a benign day yesterday.  In a way, this is surprising as I would have expected the greenback to slide alongside Treasury yields, but I guess given the broader dovishness from ECB and other central bankers, on a relative basis not much changed.  As well, traders are reluctant to take large positions ahead of tomorrow’s big QRA and FOMC announcements.  As such, I suspect that we are going to see a very quiet session here across the board, just like we had overnight.

On the data front, while not as exciting as tomorrow, we do see Case Shiller Home Prices (exp 5.8%), JOLTS Job Openings (8.75M) and Consumer Confidence (115.0) this morning.  I keep listening to all the people who are telling me that falling housing prices are going to drive inflation lower, and the only reason the CPI and PCE calculations aren’t already lower is because they both have them at a lag.  Then I look at Case Shiller and say, what falling housing prices?  Anecdotally, in my neighborhood, we continue to see bidding wars and homes selling above asking.  If rates are really going to come down further, I suspect that will only drive that process even further.  The deflation story just makes no sense to me.  But anyway, probably not much today and all eyes are on tomorrow.

Good luck
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Not One Whit

Posted on by

Both headline and core PCE
Were softer, with both below three
But under the hood
It’s not quite as good
As housing and transport are key
 
The narrative, though, will not quit
Assuring us all this is it
Rate cuts will come soon
And stocks to the moon
But so far, for proof, not one whit.
 
There is a very good analyst who writes regularly on the macroeconomic story named Wolf Richter.  In the wake of Friday’s PCE data release, he published an article that had the following table:

It is not hard to look at this table and see a bit of the reality we all face, rather than the widely touted headline numbers regarding inflation.  Housing continues to be sticky at much higher inflation rates than target, as well as transportation services, recreation services and financial services.  But even the other stuff, seems to be running above the elusive 2.0% level.  Now, this is the annualized rate of the past 6 months’ average readings.  But as I highlighted last week regarding CPI, this seems to be the new benchmark.  My point is that while the narrative is really working hard to convince us all that inflation is collapsing and the Fed is massively over-tight in its policy and needs to CUT RATES NOW, this breakdown doesn’t look quite the same.  My belief is the Fed remains on hold much longer than the market is expecting/hoping for, and that at some point, equity markets and risk assets are going to come to grips with that reality.  Just not quite yet.

Of course, maybe the narrative is spot on, and inflation is going to smoothly decline back to the 2% level while economic growth continues its recent above-trend course.  But personally, I have to fade that bet.  Based on the amount of continued fiscal stimulus, as well as the Fed’s discussion of slowing QT and their indication of rate cuts later this year, I believe that while the growth story is viable, it will be accompanied with much hotter inflation than is currently priced.  The fact that breakeven inflation rates are priced at 2.50% in the 10-year does not mean that is what is going to happen.  Just like the fact that the Fed funds futures market is currently pricing between 5 and 6 rate cuts in 2024 does not mean that is what is going to happen.  Let’s face it, nobody knows how the rest of the year is going to play out.  The one thing, however, of which we can be sure is that Treasury Secretary Yellen will spend as much money as possible in her effort to get President Biden re-elected.  That alone tells me that inflation is set to rebound.

And there is one other thing to remember, as things heat up in the Red Sea, and shipping avoids the area completely, the cost of transiting stuff from point A to point B continues to rise.  The cost is measured both in the dollars charged for the service and the extra 10-14 days it takes to complete the trip around the Cape of Good Hope in South Africa.  It seems that the Biden Administration’s foreign policy has unwittingly had a negative impact on its economic policy plans.  

In sum, when I look at both the data and the activities around the world, it remains very difficult to accept the narrative that inflation is collapsing so quickly that the Fed MUST cut rates and cut them soon.  The combination of still robust US growth on the back of excessive fiscal stimulus and the increased tensions in the oil market lead me to a very different conclusion.

With that in mind, let’s see what happened overnight.  Equity markets in Asia were mixed as Japan (Nikkei +0.8%) and Hong Kong (Hang Seng +0.8%) both rallied but mainland Chinese shares (CSI -0.9%) fell.  This was somewhat surprising as China, in their continuing efforts to prop up their stock markets, have restricted the lending of any securities for short sales while a HK court ruled Evergrande (remember them?) should be liquidated completely.  Perhaps the Chinese real estate situation is not quite fixed yet after all.  I suspect that we will see other liquidations as well before it is all over.  In the meantime, European bourses are mixed with the DAX (-0.4%) lagging while the FTSE 100 (+0.25%) is top dog today.  There’s been no news of which to speak so this seems like position adjustments ahead of the Fed’s activities later this week.  US futures, too, are mixed and little changed at this hour (7:15).

Bond markets, though, are really loving all the rate cut talk and are growing more confident that they will be coming soon as inflation collapses.  Treasury yields are lower by 3bps this morning and the entire European sovereign market has rallied with yields down an impressive 5bps-7bps today.  The only outlier is the JGB market, which saw the 10-year benchmark yield edge up 1bp.  It is much easier for me to believe that the ECB is going to cut as inflation in the Eurozone slows alongside the faltering growth story than to believe that the Fed is going to cut into an economy growing 3+%.  But that’s just me.

In the commodity markets, oil (+0.3%) continues to find support as the tensions in the Middle East expand after an attack in Jordan killed three US servicemen there.  Oil is higher by 5% in the past week and more than 11% in the past month.  It seems to me that will not help the inflation story.  At the same time, we are seeing demand for precious metals as gold (+0.5%) and sliver (+1.0%) are both rallying on the increased nervousness around the world.  Perhaps more interestingly is that copper is marginally higher this morning, something that would seem contra to the escalating tensions.

Finally, the dollar has rallied a bit this morning on net, although it is not a universal move by any stretch.  For instance, while European currencies are broadly weaker, in Asia and Oceania, we are seeing strength with AUD and NZD (both +0.4%) and JPY (+0.2%) fimer.  As to the rest of the world, it is a mixed session with minimal movement.  Feels like a wait and see situation given all the data and info coming this week.

Speaking of the data this week, there is much to absorb.

TodayTreasury Funding Amount$816B
 Dallas Fed Manufacturing-23
TuesdayCase Shiller Home Prices5.8%
 JOLTS Job Openings8.75M
 Consumer Confidence115
WednesdayADP Employment135K
 Treasury QRA 
 Employment Cost Index1.1%
 Chicago PMI48
 FOMC Meeting5.5% (unchanged)
ThursdayInitial Claims210K
 Continuing Claims1835K
 Nonfarm Productivity2.5%
 Unit Labor Costs1.7%
 ISM Manufacturing47.3
 Construction Spending0.5%
FridayNonfarm Payrolls173K
 Private Payrolls145K
 Manufacturing Payrolls2K
 Unemployment Rate3.8%
 Average Hourly Earnings0.3% (4.1% Y/Y)
 Average Weekly Hours34.3
 Participation Rate62.4%
 Factory Orders0.2%
 Michigan Confidence78.8

Source tradingeconomics.com

The first thing to understand is that this morning, the Treasury will be releasing how much funding they expect to need in Q1 of this year, currently expected at $816 billion, but Wednesday’s QRA will describe the mix of the borrowings.  Recall that last quarter, Secretary Yellen changed the mix of short-dated paper to long-dated coupons substantially and completely reversed the bond market rout that was ongoing at the time.  If she continues to issue far more bills than coupons, it should support the bond market and help continue to juice risk assets.  Any substantial increase in coupon issuance is likely to be met with a significant stock and bond market sell-off.  So, which do you think she will do?

Otherwise, looking at the other data, certainly there is no indication that housing prices are moderating.  The Fed will not change rates on Wednesday, but everyone is waiting to see if they will remove the line in their statement about potentially needing to raise rates going forward.  Perhaps there will be a little two-step where the QRA points to more bond issuance, but the Fed sounds more dovish to offset that news.  And of course, Friday’s NFP data will be keenly watched by all observers as any signs that the labor market is cracking will get the rate cut juices flowing even faster.

All in all, we have a lot of new information coming to our screens this week.  At this point, it is a mug’s game to try to guess how things will play out.  However, if we see dovishness from the Fed or the QRA (more bill issuance) then I expect risk assets to perform well and the dollar not so much.  The opposite should be true as well, a surprisingly hawkish Fed or more coupon issuance will not be welcomed by the bulls, at least not the equity bulls.  The dollar bulls will be happy.

Good luck

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