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Bad Dreams

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In China, the property bubble
Continues to cause Xi much trouble
So, they will add on
A trillion more yuan
Of debt, as help efforts redouble

And though Chinese markets did rise
They finished well off of their highs
Investors, it seems
Are having bad dreams
‘bout growth there and seek to downsize

Poor President Xi!  Instead of focusing all his energy on his saber rattling in the South China Sea and hinting at a Taiwanese invasion, he finds himself essentially forced to deal with the economy.  This was made clear yesterday when he made a surprise visit to both the PBOC and the SAFE (State Administration of Foreign Exchange), the two top Chinese financial institutions, and then today when the government announced an effective supplemental budget spend of CNY 1 trillion (~$137 billion) to support further infrastructure investment in the country.  

This move will increase the national government’s budget deficit for the year to 3.8%, well above the 3.0% target they had been shooting for, but obviously, the concern of continuing slow growth is being seen as a growing problem for Xi.  This is also a change from the previous process where local governments would issue debt to fund infrastructure investment and ultimately repaid that debt by selling land.  Of course, that is what led to the inflation of the massive property bubble in China, so that model is now clearly broken.

Arguably, the biggest worry is that if the domestic situation continues to deteriorate, Xi will get more adventuresome internationally as the standard national leadership political playbook is to seek to distract the population from the economic failures of a government by stoking nationalism and instigating conflict overseas.  We just saw it in Russia, and quite frankly, given the support for intensifying the war effort in the US, it is also being executed here in the US.

In the end, though, a 0.8% of GDP budget boost is unlikely to have a huge impact on the economy.  The problem the Chinese have is that they, too, have a very high debt level and are trying quite diligently to prevent it from growing out of hand.  The tradeoff there is that the amount of support is going to be restricted.  Initial economist estimates are that the package will raise GDP growth by 0.1% in Q4 and up to 0.5% in 2024 overall.  

It can be no surprise that shares in China rose on the news with the Hang Seng jumping 2.5% on the news while the CSI 300 jumped 1.3% initially.  However, both faded fast and closed higher by about 0.5%, not bad, but certainly not a huge vote of confidence.  Meanwhile, the yuan just continued is weak performance, falling another 0.2% and continuing to push against its 2% band vs. the daily CFETS fixing.

Away from that news, however, it has been dullsville this morning with pretty modest movement across both equity and bond markets around the world.  Yesterday’s PMI data indicated that the massive amount of fiscal stimulus that has been enacted in the US compared to elsewhere in the world is having the desired impact, at least from a statistical point of view, as US data continues to show relative strength compared to Europe, Japan and the rest of the G10.  However, despite those efforts, the political accolades remain absent as the national attitude is consistently measured in downbeat terms. 

And consider, if the data here are relatively better and the government is not gaining any ground, how bad it is for governments elsewhere in the world where the data is clearly worse and falling.  We continue to see populist parties from both sides of the aisle gaining in strength.  Do not be surprised to see quite a few new governments around the world over the next several years as support for incumbents continues to fall.  (It will be quite interesting to see the results of the Argentine election in a few weeks and see how Javier Milei, the upstart “anarcho-capitalist” who has promised to take a chainsaw to the government and shutter the central bank while dollarizing the economy, performs.)  A victory there could well be a harbinger of future shakeups everywhere.

Turning to markets, yesterday’s solid US performance was ultimately followed by 0.5% ish gains in China and Japan, although weaker performances elsewhere in Asia with a number of regional markets declining.  European bourses are showing very modest gains this morning, on the order of 0.1% while US futures are mostly softer at this hour (8:00), down roughly -0.4%.

The massive reversal in bonds seen on Monday is now history and we are seeing yields begin to creep back higher with Treasury yields up 3bps and similar rises throughout Europe, although Italian BTPs are the true laggard with yields there rising 6bps.  JGB yields also rose 2bps last night but have been largely capped at 0.85% by the market as there was no sign of extra intervention by the BOJ.  The yield curve inversion remains at -24bps, not quite at its tightest levels but still clearly trending toward normalization.

One thing to consider about the Treasury market is the fact that the US trade deficit has been steadily shrinking amidst the efforts at reshoring and all the CHIPS act spending on manufacturing capacity, as well as the simple fact that US energy exports continue to be quite robust.  The point is that one of the key demands for Treasury bonds in the past was the recycling of all those deficits, but if the deficits shrink, then there is less to recycle and therefore less demand for Treasuries.  Combine this process with the fact that the government continues to increase the amount of issuance and it is not hard to conclude that bond yields have further to rise over time.  The fact that an oversold market responded to a major psychological level does not mean the bond market move has ended.  Rather I would argue it has simply paused and yields will once again climb going forward.

Turning to the commodity markets, oil is marginally higher this morning, up 0.3%, but that is after another sharp decline yesterday as the market appears to believe that the odds of a widening of the Israeli-Palestinian conflict are shrinking amid growing pressure from organizations around the world.  Add to that the signs of weaker economic activity which implies reduced demand, and it is easy to understand why oil has retraced. However, inventories fell again last week, and the structural issues of supply remain in place.  The big picture remains for further strength over time in my eyes.  As to the metals markets, gold continues to benefit from its haven status, edging higher by 0.25% this morning while copper is suffering on the weaker growth story, falling -0.4%.

Finally, the dollar is stronger overall with the euro > 1% lower than its recent highs Monday afternoon which were seen in the wake of the bond market rally that day.  USDJPY is right back below 150.00 although it has not yet touched the level since early this month which was followed by what appeared to be intervention.  But generally, we are seeing the dollar gain against both G10 and EMG rivals as US rates once again edge higher, 2yrs as well as 10yrs.

On the data front today, New Home Sales (exp 680K) are due at 10:00 as well as the Bank of Canada rate decision where no change is expected.  We also see EIA oil inventory data later this morning and then Chairman Powell speaks late this afternoon.  I continue to believe it is unlikely that he will add anything to his message from last week.  As such, it is a status quo day.  If yields continue higher, look for the dollar to follow.  But I have a feeling that there will be very little movement today overall.

Good luck

Adf

Waved Adios

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There once were two gents, both named Bill
Whose market views oft could be shrill
Now Ackman and Gross
Have waved adios
To shorts, with positions now nil

When others all learned of this action
The bond market really gained traction
So, does five percent
In truth, represent
The highs? Or is this a distraction?

It ought to be no surprise that the bond market had a significant hiccup yesterday after the 10-year yield finally breached the 5.0% level for the first time in more than 15 years given the market’s penchant to focus on big round numbers.  However, as can be seen in the chart below, the response by traders and investors was dramatic as it appears many were waiting for that level to ‘buy the dip’ in bonds.  As such, after climbing to a high of 5.025%, the market reversed sharply with yields falling nearly 20bps at one point, although they closed slightly off the lows.

Source: Tradingeconomics.com

Ostensibly, a key driver of this move was a Tweet by hedge fund manager Bill Ackman explaining he had covered his bond short positions.  “We covered our bond short.  There is too much risk in the world to remain short bonds at current long-term rates. The economy is slowing faster than recent data suggests.”  Similarly, former bond king, Bill Gross, tweeted that he was buying bonds across the curve after calling for a recession in the 4th quarter (that’s now!).  And that’s all it took to reverse a substantial portion of the recent sell-off in Treasuries.  Perhaps more interesting was the fact that the ongoing normalization of the yield curve was not impacted much at all.  Yesterday, the 2yr-10yr spread had fallen to -18bps and this morning it is -22bps, so not all that different.

The question, of course, is what can we expect going forward?  The thing that continues to bother me is the ongoing supply question, and at what price will the Treasury be able to sell new bonds to price sensitive buyers rather than the Fed.  Nothing has changed that part of the equation and until the Fed ends QT, let alone restarts QE (which I do expect at some point in the future), I continue to believe bond yields will trend higher.  And this view considers the fact that some further economic slowing seems highly probable to me.  However, the supply issue is going to continue to be the dominant feature going forward.

One other issue is the ongoing Israeli-Palestinian conflict and how that could evolve, with many talking heads concerned that growth in that conflict will result in demand for more safety.  Certainly, the gold price has been a huge beneficiary of that situation with the barbarous relic having gained more than $120/oz in price since the attack while bond yields are actually higher by 6bps, even after yesterday’s sharp decline in yields.  However, my experience indicates that after the immediacy of any conflagration, whether Russia in Ukraine, or even 9/11, market behavior tends to move off that narrative and back to whatever was deemed relevant before the news.  I see no reason for this to be different, and before the attack, yields were rising on the supply story and robustness of the US economy.  That is the narrative that needs to change to reverse bond yields.

So, is there going to be a change in that narrative soon?  Well, depending on one’s view of the value of PMI data, the flash releases this morning were all pretty crummy with all of Europe and the UK remaining below the key 50.0 level and last night’s Australian and Japanese data also quite weak, although Japanese Services data did manage to hold above the 50.0 level.  As well, German GfK Consumer Confidence fell to -28.1, down from last month and below consensus expectations, so perhaps some economic weakness is coming our way.  

However, first, those are not US numbers and second, the US data has consistently shown hard data (NFP, Retail Sales, IP, etc.) firmer than any of the survey data.  So, while there continues to be gloom and doom on people’s minds, their actions have not yet matched those views.  Now, a case can certainly be made that the US hard data is all lagging and the current situation is far worse than those numbers imply, but the Fed is not going to respond to that story.  As long as the hard data offers cover for the Fed to maintain their current policy stance as they fight inflation, they are going to do so.  

Summing it all up leads me to believe that nothing has changed the big picture.  While yesterday’s bond move was certainly exciting, the fact that one hedge fund manager took profits is not enough to change the investment landscape.  I continue to expect stickier inflation going forward as well as a grind higher in 10yr yields as the curve normalizes.  

So, how did markets respond to all the new information?  Well, after a mixed day in the US yesterday, we saw a similar picture in Asia with the Hang Seng falling -1.0%, but most other markets edging a bit higher.  European bourses are slightly firmer this morning, but really no great shakes and US futures at this hour (8:30) are firmer by 0.6% or so.  Fear is not that evident today.

On the bond side, this morning has seen a modest bounce in US yields, just 2bps, but we are seeing a continuation lower in Europe with most sovereigns seeing yields fall about 2bps.  JGBs have also edged away from their recent high in yields, although that was after the BOJ had yet another unscheduled bond buying session, this one the largest of the five unscheduled ones so far implemented after they adjusted the YCC cap to 1.00%.  

On the commodity front, oil is essentially unchanged this morning although that is after a sharp decline yesterday which wiped out the previous week’s gains.  Gold, while still holding up reasonably well, is softer by -0.4% this morning and copper is bucking this trend, rising 0.6%, although still hovering just above 1yr lows.

Finally, the dollar, which fell yesterday a bit as yields decline sharply in the US, is bouncing this morning with the euro sliding back toward 1.06 and the DXY back at 106.00.  Neither JPY nor CNY really responded to yesterday’s price action, it was mostly European currencies doing the damage to the buck.  One thing to note is the question of whether the 10-year yield is still a key driver of the dollar or is it something else?  Brent Donnelly, a well-respected FX analyst, has an excellent article out discussing how the dollar appears to be more linked to the 2-year yield than the 10-year.  I had mentioned last week how that relationship between the dollar and yields seemed to be breaking down and his analysis shows that if you look at the 2yr yield, which hasn’t moved much at all compared to the 10yr lately, it makes more sense.  It is well worth the read.

With that in mind, then perhaps the dollar’s strength is unlikely to manifest itself as it did while the Fed was aggressively raising rates earlier in the year and 2yr yields were rising rapidly.  Instead, it is quite possible we are in for a period of relative quietude in the dollar, at least against the majors.  Emerging market currencies have a clear life of their own, and hedging decisions there need to be independent of views on the euro or pound.

On the data front, the Flash PMI’s are due here as well (exp 49.5 Manufacturing, 49.8 Services) and then the first look at oil inventories late this afternoon.  Interestingly, despite the Fed’s ostensible quiet period, Chairman Powell will be making Introductory Remarks at the 2023 Moynihan Lecture in Social Science and Public Policy tomorrow at 4:30pm.  Given the quiet concept, I find it difficult to believe he will focus on monetary policy but be aware.

All signs point to a quieter session today and perhaps for a while going forward, at least in the G10 currencies.  However, hedging is always a good idea!

Good luck

Adf

Wrecked

Posted on by 
There once was a Treasury note
Whose yield every trader could quote
Of late, its price dive
To yields above five
Has tongues wagging while bond bears gloat

Now, looking ahead I expect
This rise in yields could architect
More problems worldwide
As risk assets slide
And equity markets get wrecked

There is only one story in financial markets today, and that is the fact that the 10-year US Treasury note is now yielding above 5.0%.  We briefly touched that level last Thursday, and then saw a pullback in yields on Friday, but today there is no question about a breach of that key psychological level.  As a corollary to that price action, the 2yr-10yr spread is down to -12bps and looks quite clearly as though it is going to complete the normalization process this week.  The real question is, how much further will it steepen?  A quick look at the chart below from the St Louis Fed’s FRED database shows that the average steepness of this spread is somewhere around +100bps.  The implication is that if the Fed continues to hold Fed funds at their current level, and higher for longer is the way forward, then 10-year Treasury yields could easily head to 6.00% and simply be back to their long-term relationship with the 2-year Treasury.

The other thing to note is why there is so much focus on the shape of the yield curve.  As you can see from the shaded gray areas on this chart, every recession was preceded by a curve inversion (negative 2yr-10yr spread) but then when the recession was in process, the curve was steepening dramatically.  It is this history that has economists and analysts concerned given the speed with which the curve is steepening of late.

And yet…two headlines in the WSJ this morning show a completely opposite expectation.   “A Recession is no Longer the Consensus” is one of them, explaining a survey of economists now shows that fewer than half anticipate a recession will arrive at all, let alone soon.  In addition, we have “The Economy was Supposed to Slow by Now.  Instead it’s Revving Up” which describes the fact that recent data has been firmer than expected (see Retail Sales and NFP earlier this month) and now the proverbial soft landing is the new consensus call.  

Now, maybe this time really will be different, but that is always a hard pill to swallow.  There are many things that continue to haunt the economy with respect to things like bank lending standards tightening and consumer debt and delinquencies rising, neither a sign of economic strength.  In fact, there was a terrific note published this weekend on Substack by GrahamsBenjamins going into more detail.  The point is that there is a significant amount of economic stress in the economy and that combined with the rapid steepening of the yield curve has always been a sign of a looming recession.  And folks, if (when?) that recession arrives, you can be confident that risk assets are going to decline sharply in value.  Just sayin!

Ok, with that cheery opening, let’s see how markets have behaved overnight.  Following last week’s lousy price action in the US, Asian shares were lower across the board, somewhere between -0.75% and -1.0% while European bourses are also lower, perhaps a little less dramatically, with an average decline on the order of -0.5%.  US futures, too, are in the red, -0.6% or so at this hour (7:15), and not feeling very good.

Meanwhile, we already know the Treasury story, but it is important to understand that European sovereign yields are also rising rapidly, with most of them higher between 4bps and 6bps this morning.  That critical Bund-BTP spread continues to trade just north of 200bps and holds the potential to be quite destabilizing if it widens much further.  As well, we saw JGB yields creep up 2bps and are now at 0.85%. Inflation in Japan has been above 3.0% for the past 14 months,  and more and more analysts are concluding the BOJ is going to have to tweak their policy yet again.  There is far more to the bond market than just Treasuries, although Treasuries are clearly still story number one.

On the commodity front, oil (-0.6%) is a bit softer this morning although this seems a consolidation of last week’s strength.  The biggest question in this market is the tension between the possible recession and a corresponding reduction in demand, and the structural supply shortages that are currently being exacerbated by the Saudi and Russian production cuts.  My money is still on higher prices over time.  Meanwhile, gold is little changed this morning, holding up quite well in the face of rising yields and seeming to be showcasing its haven status of late.  As to the base metals, both copper and aluminum continue to grind lower with copper having fallen to its lowest level in a year and seemingly an indication of economic weakness to come.

Finally, the dollar is mixed to slightly softer this morning although slightly is the operative word.  Looking across the G10 currencies, the Skandies are under a bit of pressure, but the majors are essentially unchanged.  The real news is that the correlation between the dollar and Treasury yields seems to be disintegrating.  If that is changing, then there are certainly many reasons to believe the dollar can decline given the US fiscal situation and the continuous growth in the US debt portfolio.  As is often said, nothing matters until it matters.  Throughout my entire career, spanning > 40 years, there has been a constant drumbeat of how the dollar should decline because of the massive budget and trade deficits that the US has run consistently.  And that drumbeat has been studiously ignored for all that time.  But perhaps, it will soon matter.  While that is not my base forecast, one has to assign that outcome some real probability.

On the data front this week, this is what we see:

TodayChicago Fed National Activity-0.16
TuesdayFlash PMI Manufacturing49.5
 Flash PMI Services49.9
WednesdayNew Home Sales680K
ThursdayInitial Claims209K
 Continuing Claims1720K
 Durable Goods1.5%
 -ex Transport0.2%
 GDP Q34.2%
FridayPersonal income0.4%
 Personal Spending0.5%
 Core PCE0.3% (3.7% Y/Y)
 Michigan Sentiment63.0

Source: Tradingeconomics.com

Weirdly, while the Fed is supposed to be in its quiet period, I see three speeches scheduled, with Chairman Powell ostensibly speaking Wednesday afternoon.  I will need to confirm that as it would be highly unusual at this time.

It seems to me the big question is whether the dollar – rates correlation is breaking down.  If that is the case, then I will need to rethink, and likely adjust, my views of a stronger dollar over time, at least vs. the majors.  But tick by tick price action is not necessary for the relationship to generally hold.  I still like the dollar over time but am certainly going to review the situation more closely to see if something truly has changed.

Good luck

Adf

Dim-Witted

Posted on by 
Said Jay, though we’re strongly committed
To make sure no ‘flation’s permitted
Quite frankly we’re lost
And ‘fraid of the cost
If we screw up cause we’re dim-witted

So, we’ll watch the data releases
And act if inflation increases
But if it should fall
Then it will forestall
More hiking lest we step in feces

As expected, the Powell comments were yesterday’s highlights as he once again explained that the goal of 2% inflation remains their primary effort.  Not surprisingly, given what we have heard from the onslaught of Fed speakers over the past two weeks, he made clear that there will be no rate hike at the November meeting, but December is still in play.  When asked about the rise in long-term yields, he did indicate it could be doing some of the Fed’s work for them, just like we heard earlier this week from Lorrie Logan and others.  Somewhat surprisingly, he mentioned the rising budget deficits, describing them as on an “unsustainable” path.  Now, we all know this is true, but Powell has been extremely careful not to discuss government funding throughout his tenure as Chair.  I suspect his next testimony to Congress could be a little spicier!

Of course, the other six speakers added exactly nothing to the conversation as they merely reiterated in their own words the same message.  Perhaps of more interest was that despite effective confirmation that there was no hike upcoming and that the bar for a December rate hike was quite high, bonds continued to sell off with the 10yr yield closing at 5.0% while stocks took it on the chin again.  Methinks there is more than a little concern starting to grow amongst asset managers that the concept of the Fed put may finally be gone.  

The other really interesting outcome yesterday was the fact that gold rallied another 1.3% despite the ongoing rise in interest rates.  As there was no new news out of the Middle East of any real note, one possible explanation is that investors are simply getting quite scared overall.  

One thing is quite certain and that is if the situation changes such that Powell and company become concerned that the economy is reversing course and they have, in fact, overtightened monetary policy, any reversal of the current message is likely to lead to some very big moves.  In that case I would expect a much weaker dollar, a huge rally in gold and other commodities, an initial rally in equities and, remarkably, not much movement in bonds.  I remain of the strong belief that the supply issue is the key bond market driver, so that will only increase in the event of an economic slowdown and that cannot help the bond market, even if the Fed starts to buy them again.  But that is all hypothetical.

Turning to the overnight session, while risk continues to be shed in Asia and Europe, we did see Japanese inflation data where the headline rate declined to 3.0% and the core to 2.8% although their super core reading is still at 4.2%.  Certainly, Ueda-san must be pleased that the numbers are beginning to edge a bit lower although they remain far above the 2% target.  Of course, the very fact that they are edging lower implies that any end to QQE is even further in the future.  Recall, Ueda-san has been clear that he does not believe 2% inflation is yet sustainable in the economy and is concerned it is going to slip back below that level in the medium term.  With that attitude, he has exactly zero incentive to end YCC or QQE and seems far more likely to continue with them.  

The implication of this outcome is that the yen seems likely to weaken further.  Currently, USDJPY is trading at 149.95 and although it hasn’t touched the 150 level since that first brush on October 3rd, it has been grinding ever so slowly back there again.  This price action has all the earmarks of stealth intervention, something that may be carried out by the three Japanese mega banks at the BOJ’s behest.  However, given the ongoing trajectory in US interest rates, it seems only a matter of time before we once again breech 150.  It will be quite interesting to see the MOF/BOJ reaction at that time, although I suspect they will, at the very least, “check rates.”  For hedgers, be careful here.

And really, that’s all we’ve got to talk about today.  As mentioned above, equity markets fell in Asia overnight, with losses on the order of -0.5% or so and European bourses are all down about -1.0% this morning heading into the US open.  As to US futures, at this hour (7:00) they are off about -0.4% as we head into an option expiration session.  Thus far, earnings season has not been sufficient to excite investors and fear seems to be the driver of note.

Turning to the bond market, while we have backed off from yesterday’s closing highs of 5.0% by 5bps, we remain at multi-year highs and there is no reason to believe that we have seen the top in yields.  In fact, this move appears to be driven by rising real yields, not inflation concerns.  While real yields have already risen substantially over the past 6 months, rising from ~1.0% to the current 2.45%, history has shown that real yields can easily rise to 4% or more in the right circumstances, and these may just be those circumstance.  Again, there is no evidence that Treasury yields have topped.  As to European sovereigns this morning, they are edging lower by about -1bp after a large rally yesterday as well.  US Treasury price action continues to be the global driver for now.

Oil prices (+1.5%) continue to trade higher as concerns over a widening of the Israeli-Palestinian conflict keep traders on edge.  Combine this with the weaker production numbers from the US and the drawdown in inventories and you have the ingredients for a further price rally.  News that a US Missile Cruiser in the Red Sea shot down several drones and missiles launched from Yemen cannot have helped sentiment.  Meanwhile, gold (+0.4%, +2.6% this week) continues to play the role of safe haven.  Either that or there is a lot of short-covering ongoing.  The price is approaching $2000/oz, one of those big round numbers on which markets tend to focus so I would look for a test there if nothing else.  However, base metals are softer this morning as the price action today is not economically related.

Finally, the dollar continues to tread water this morning with most of the major currencies within +/- 0.2% of yesterday’s closing levels while EMG currencies seem to be edging a bit lower, down on the order of -0.3%.  The renminbi is little changed this morning despite (because of?) the PBOC injecting CNY733 billions of fresh liquidity into the market/economy there overnight.  Again, just like the yen, the diametrically opposed monetary policy of China and the US should lead to further currency weakness here over time.  Now, the PBOC doesn’t like to see sharp movement and will continue to prevent a blowout move, but the spot rate is currently trading right at its 2% band vs. the CFETS fixing, so something has got to give soon.  In the end, the dollar trend remains intact, but I must admit I am surprised it is not a bit stronger given the underlying fear in the market.

On the data front, there are no statistics released and we hear from two more Fed speakers, Harker and Mester, to finish things off before the quiet period begins.  It seems hard to believe that anything they say will be seen as more important than Powell’s comments yesterday.  As such, looking at today’s market activity, while there will be tape-watching regarding the Middle East and any escalation in hostilities, I suspect the equity market will have the most influence on things.  At this point, further weakness seems the most likely outcome, especially as traders will be reluctant to be overly long risk heading into the weekend.  

Good luck and good weekend

Adf

Five Percent

Posted on by 
The number one story today
Is that 10-year bond yields soon may
Trade to five percent
As bond bulls lament
Their theory’s no longer in play

As I write this morning at 6:45, 10-year Treasury yields are now trading at 4.95% having touched 4.98% a few hours ago.  This has become the biggest story of the day given the psychological impact of yields rising to that level and the fact 5.00% is such a big round number.  There is a lot of sentiment regarding round numbers in markets, so things like parity in EURUSD or $100/bbl in oil or even stock indices (e.g., S&P at 4000) take on a life of their own whether or not there is any fundamental driver of a particular situation.  But let’s face it, the market is all about psychology, so if people care, it matters. 

If (when) we trade through 5.00% will anything have changed?  Unlikely, but it is definitely today’s narrative.  It appears that the drivers are anticipation of yet more supply next week as well as continued confirmation that the Fed is going to maintain Fed funds at current levels for quite a while, even if there are no more rate hikes.  We also continue to hear stories of selling by major holders although I addressed that yesterday.  Certainly, part of the market zeitgeist is the idea that the continued strong US economic data are the seeds for ongoing inflation pressures leading to higher yields.  But in the end, the only thing of which we are sure is that demand for paper, despite the highest yields in more than sixteen years, is underwhelming.  At least relative to the supply of paper that is available and due to come soon.

For now, I expect that as yields continue to climb, we are going to see ongoing struggles in the equity market, dollar strength and commodity prices struggling.  Of course, gold continues to buck that trend as it is holding up extremely well in the face of higher yields. 

In the meantime, it is worth remembering the Fed stance, which clearly still matters.  

Said Waller, we’ll “wait, watch and see”
How things in the broad ‘conomy
Evolve before moving
And if they’re improving
More rate hikes will be the decree

Said Williams, the time’s not arrived
To alter the rates we’ve contrived
Though, progress we’ve made
We’re still quite afraid
That falling inflation’s short-lived

It is becoming abundantly clear from the comments by all the Fed speakers during the past two weeks that there will be no policy rate movement at the next meeting.  Of course, Chairman Powell has yet to offer his views, which are due today at noon.  However, it seems difficult to believe that this overwhelming agreement of a pause to, as Governor Waller put it, “wait, watch and see,” the evolution of the economy has not been approved by the Chairman.  Nonetheless, you can be sure that his words will be parsed especially carefully later today.

Of course, the data continues to show that the economy is not slowing down in any substantive fashion and the bond vigilantes are out in force.  After yesterday’s 8bp yield rally above 4.90%, this morning’s movement should be no surprise.  We also saw European sovereign yields explode higher yesterday with UK Gilts up 15bps and continental bonds up between 5bps and 10bps.  As I have been consistently writing, this move is nowhere near over.  One other thing that has not yet garnered much attention is that the Bund-BTP spread is now at 206bps after the Italian government just passed a financing bill that includes a 4.2% government deficit, well above the 3.0% EU limit and above the promises made when PM Meloni first entered office.  Concerns are growing that Italian finances may soon become a real problem, not just for Italy, but for Europe as a whole.

We should also discuss the JGB market where the 10-year yield is now at 0.85%, creeping ever closer to their new alleged line in the sand at 1.00%.  Recall, the BOJ is the only major central bank that is explicitly buying bonds and has promised to buy an unlimited amount to prevent yields from rising above that 1.00% level. In fact, 1.00% JGB yields is the only round number that has any true significance.

Ultimately, the current interest rate / yield story is the key driver across all markets.  In addition to the dramatic movement we have seen in bond markets, yesterday saw pronounced weakness in equity markets and strength in the dollar.  After falling more than -1.0% here, Asian markets fell even more sharply, between -1.5% and -2.0%.  European bourses are also under pressure this morning, but not quite to the same extent as they suffered somewhat yesterday in their afternoon sessions.  As to US futures, they are unchanged at this hour (7:15) awaiting Powell’s comments.

Oil prices (-1.25%) are backing off a bit from their recent rally after news that the administration has relaxed sanctions on Venezuela indicating that there will be a bit more supply available.  However, yesterday’s inventory data showed significant drawdowns and cannot be ignored as a fundamental driver which would imply higher prices going forward.  Gold, after another spike yesterday of more than 1% is creeping still higher this morning with the best explanation a growing concern over a much more uncertain future.  After all, if investors are losing their faith in Treasury bonds, and as evidenced by the ongoing selling pressure, that is one possible explanation, gold has always served as the ultimate safe haven.  As to the base metals, they are also firmer this morning, arguably on the back of still surprisingly strong US economic data.

Finally, the dollar is mixed this morning, with gains vs. the pound and the commodity bloc while the euro has managed to edge higher.  USDJPY remains stuck just below the 150 level as though someone is working very hard to prevent that level from trading again.  In fact, we have traded between 149.40 and 149.85 for the past week, an extremely tight range that looks quite artificial.  Do not be surprised if we finally breech the 150 level for a time and then see another bout of intervention by the MOF/BOJ driving it back down again.  Ultimately, though, if the BOJ maintains its current stance, the yen is going to trend weaker.  

A quick look at the EMG bloc shows that CNY is trading to its weakest point in more than a month as news that Country Garden, the erstwhile largest property developer in China, failed to make a coupon payment yesterday for the second time and is set to file for bankruptcy has raised concerns over the entire economic process there.  Elsewhere, IDR (-0.5%) fell during its session although I would expect some strength tonight as the central bank there surprised the market and raised their base rate by 25bps after the market closed.  In general, the EMG bloc has seen weakness across the board with the dollar ‘wrecking ball’ wreaking havoc for those companies and countries that need to service their USD debt.

On the data front we see Initial (exp 212K) and Continuing (1710K) Claims as well as the Philly Fed (-6.4) and then Existing Home Sales (3.89M).  In addition to Chairman Powell, we hear from six other Fed speakers, although with Powell speaking and the second in the lineup, I don’t imagine the other comments will matter much.  Remember, after tomorrow, the Fed enters its quiet period as well.

Looking at the totality of the situation, it would be shocking if Powell added anything new to the debate.  At this point, I expect that the bond market will remain the driver of everything.  I also expect that 10-year yields above 5.00% are coming soon to a screen near you and that the normalization of the yield curve will be completed before the end of the year.  Right now, the 2yr-10yr spread is down to -28bps and an eventual move to +50bps – +100bps would put us back in ‘normal’ territory.  In other words, 10-year yields could rise much further!  In that situation, I still like the dollar overall.  I will need to see something substantial change before the dollar’s bullish trend turns around.

Good luck

Adf

Growth Dynamo

Posted on by 
The data continues to show
Economies still want to grow
Here in the US
The Retail success
Came ere China's growth dynamo

The upshot is all of the talk
That bonds are where people should flock
Turns out to be wrong
Then those who went long
Are likely to soon be in shock

Wow!  That’s all you can say about the data from yesterday where Retail Sales were hot and beat on every measure (headline 0.7%, ex-autos 0.6%, control group 0.6%) while IP (0.3%) and Capacity Utilization (79.7%) also indicated that economic activity remains quite robust in the US.  On the data front, this was followed by last night’s Chinese data dump where every one of their monthly indicators; GDP (4.9%), IP (4.5%), Retail Sales (5.5%), Fixed Asset Investment (3.1%), Capacity Utilization (75.6%) and Unemployment (5.0%), was better than expected.

Perhaps the idea that a recession is right around the corner needs to be reconsidered.  And remember, I have been in that camp as well, but the data is the data and needs to inform our opinions.  The immediate reaction to yesterday’s US data was a sharp decline in both stocks and bonds, while oil rallied, gold edged higher and the dollar tread water.  Of this movement, I was most surprised at the dollar’s lack of dynamism given the rate situation.  Unremarkably, given the ongoing belief in the Fed pivot, by the end of the day, US equities were tantamount to unchanged.  But the bond market remains under severe pressure with yields having risen another 12bps in the 10-year and having now reversed the entire safe haven move on the back of the Israeli-Hamas war situation.  

I continue to believe that yields have much further to rise and stronger data will only add to the case.  My view had been based on the combination of stickier inflation than the punditry describes along with massive amounts of new issuance requiring a lower price (higher yield) to clear markets.  But if we are going to continue to see strong economic growth, then there is an added catalyst for yields to rise.

One of the problems about which we hear constantly these days is the fact that there are no more natural buyers of US Treasury debt, at least not at current yield levels.  Many point to the decline in ownership by both Japan and China, the two largest foreign holders of Treasuries, and claim they are both selling their holdings.  However, I have a quibble with that thesis and would contend that perhaps, they are merely suffering the same mark-to-market losses that the banks are.  For instance, according to the US Treasury Department, holdings by these two nations from July 2022 through July 2023 declined by -9.6% (Japan) and -12.5% (China) respectively as can be seen in the chart below.  (data source US Treasury)

But ask yourself what has happened to interest rates over the past year?  They have risen dramatically (10yr yields +85bps) and that means the price of bonds has declined.  As a proxy, in the past 12 months, TLT (the long bond ETF) has declined by more than 13% in price.  So, if you have the exact same amount of bonds and their prices declined by 13%, it is not hard to understand how when you measure the value of your portfolio it has shrunk by upwards of 13%.  I have no idea what the maturity ladders for Japan and China look like, and it is likely they own a mix of short and long-dated bonds, but it is not at all clear to me they have actually been selling Treasuries.  Likely, they are simply holding tight, and I would not be surprised, given the dramatic rise in yields here, if they roll maturities into new bonds.  All I’m saying here is that the narrative about everybody fleeing bonds may not be correct.  In fact, regarding the TLT, which is a pretty good proxy for bond demand of the retail investor, there is a case to be made that demand is quite high.  My understanding is that calls on the TLT are amongst the most active contracts in the options market, and people don’t buy calls if they are bearish!

With that in mind, though, the underlying point is US yields continue to rise and that is going to be the driver for all markets.  In global bond markets, the US unambiguously leads the way and we have seen European sovereigns show similar movement to the US with large moves higher in yields yesterday, on the order of 10bps – 15bps depending on the nation, and consolidation today with virtually no movement, the same as Treasuries.  Last night, JGB yields managed to rally 3bps as well, another indication that as goes the US, so goes the world.

But the more interesting thing to me is the ability of the equity market to hold onto its gains.  The fact that US markets rallied back nearly one full percent from the immediate post-data lows was quite impressive.  Consider that the leadership of the US stock market has been the so-called magnificent 7 tech stocks (Apple, Microsoft, Google, Amazon, Nvidia, Meta (nee Facebook), and Tesla) most of which are essentially long duration assets with their extreme values based on a belief that they will continue to grow at incredible rates.  But with yields rising, the present value of those anticipated earnings continues to decline which should generally be a negative for their price.  So far, they have held up reasonably well, but cracks are definitely starting to show.  I suspect that at some point in the not-too-distant future if yields continue on their current trajectory, that equity market comeuppance will arrive and these stocks will feel the brunt of it.  But not yet apparently.  Interestingly, despite the positive Chinese data, equities in Hong Kong and the mainland both declined about -0.5%.  And looking at Europe, weakness is the theme with all the major bourses lower by -0.5%.  As to US futures, -0.25% covers the situation at this hour (8:00).

Meanwhile, the escalation in Israel and concerns about a wider Mideast war have joined with the stronger economic data, especially from China, to push oil prices higher again this morning, up 1.8%.  And that war theme has gold rocking as well, up 1.3% to new highs for the move with both copper and aluminum rising on the better economic data.  High nominal growth and high inflation (so low real growth) is going to be a powerful support for commodity prices.

Finally, turning to the dollar, this is where I lose my train of thought.  Given the higher yields and seeming increased worries about a wider Mideast war, I would have expected the dollar to continue to rally.  But that has not been the case.  Instead, it has been stable, stuck in a tight range against most of its major and emerging market counterparts.  Perhaps this market is waiting to hear from Chairman Powell tomorrow before traders take a view, but I need to keep looking for a reason to sell the dollar as the evidence to buy it seems strong, higher yields and safety.

Today’s data brings Housing Starts (exp 1.38M) and Building Permits (1.45M) as well as the EIA oil inventory data.  We also hear from a bunch more Fed speakers; Waller, Williams, Bowman Harker and Cook, so it will be interesting to see if there are more definitive views on a pause, especially after the recent hot data.  I have not changed my view that the dollar has further to rise, but its recent relative weakness is a potential warning that something else is driving things.  I will continue to investigate, but for now, higher still seems the better bet.

Good luck

Adf

Much Maligned

Posted on by 
Though pundits worldwide have opined
The world’s in a terrible bind
Investors don’t seem
Concerned ‘bout that theme
With naysayers still much maligned

But trees cannot grow to the sky
And rallies, at some point, must die
If Jay and his kin
Do not soon begin
To cut rates, bulls will start to cry

I guess the hint at peace negotiations in the Israeli-Palestinian conflict was enough to get the bulls back in front of the move.  Or perhaps it was the comments from Philly Fed president Patrick Harker, who seems to be one of the most dovish on the FOMC these days.  After explaining, “Small firms are really struggling with access to capital,” and “some of the bankers I’ve talked to are concerned that their business plans just aren’t going to be able to make it at the higher rates” he gave us the money line (my emphasis), “This is why we should hold rates steady, we should not at this point be thinking about any increases, because if that’s true – and it is true – then we should let that ride out.”  So here is the first clear signal for an FOMC member that they are done.  Now, Harker is a voter, so that matters, but it seems pretty clear that nobody is expecting a rate hike in early November.  Arguably, the big question is what will happen in December and that is still very far away.

However, that signal implying the Fed is well and truly done was sufficient to boost risk assets, well at least to boost equity markets with US markets all higher by 1% or so while European bourses had smaller gains, on the order of 0.3%.  Bond markets, meanwhile, remain under pressure as the hint of peace talks removed some of the need for a haven, and our Treasury Secretary explained that “we can certainly afford two wars.”  If you were wondering what the fiscal situation was, she seems to have things under control.  However, beware that paying for two wars by issuing yet more debt seems like it may have a significant negative impact on bond prices.  With this attitude in Washington, perhaps we should be looking for 6% in the 10-year Treasury yield soon.

And that’s really the crux of the issue, it seems that the stock market and the bond market are pricing very different outcomes.  Stocks continue to trade well as we enter earnings season and investors remain sanguine about any potential economic downturn.  There is a great deal of belief that if the economy does reverse course from its recent apparent strength, the Fed will step right back into the market, cut rates and end QT, if not restart QE.  Meanwhile, the bond market continues to look at the still too hot inflation data and combines that with the prospect of still more debt issuance as Secretary Yellen funds two wars and more social programs and is quite concerned.  Perhaps it is my age and experience, but alas, I fear the bond market is correct.  The prospects for better investment performance in the near-term seem limited to me.

For now, given the lack of significant new news or data, as well as the anticipation of Chairman Powell’s comments come Thursday, markets in Europe and US futures are biding their time.  Remember, too, that we see US Retail Sales as well as Canadian CPI this morning at 8:30, so either of those could well be a new catalyst.  But until then, a look at markets shows that equities are mixed in Europe with the FTSE 100 slightly higher while continental bourses are slightly softer while US futures are a touch softer at this hour (6:30), down about -0.3%, as they consolidate after yesterday’s rally.

Bond markets, however, continue to fade as the benefits accorded to stocks (potential end to Israeli war and hoped for better earnings) are anathema to bond investors.  Treasury yields are higher by 5bps this morning, leading the way higher while European sovereigns are all higher by between 3bps and 6bps with the Bund-BTP spread widening back above 200bps.  Last night saw JGB yields edge higher to 0.77%, as the new Mr. Yen, Kanda-san, once again explained that intervention was possible as was the idea of raising interest rates.  (Yes, I know that the MOF doesn’t control interest rates, but apparently, he doesn’t.)

Turning to commodities, oil continues to consolidate its recent gains, essentially unchanged today, but still above $85/bbl with a major concern that any escalation in fighting in Israel may spread to OPEC producers.  That certainly cannot be ruled out, and remember, the US has already wasted utilized its SPR so there is no additional supply likely to emerge in that situation.  As to the metals markets, gold (+0.2%) continues to consolidate after last week’s impressive rally while both copper and aluminum are softer this morning on economic concerns.  Here too, there seems to be a disconnect between investors and traders in stocks and commodities with the former remaining quite bullish overall while the latter are anything but.

Finally, the dollar is also biding its time this morning although it is beginning to creep higher.  Two particular movers are the pound (-0.5%) which has responded to slightly softer payrolls and wages data opening some room for the BOE to back off a bit from its tightening schedule, and NZD (-0.7%), where CPI was quite a bit softer than forecast.  Meanwhile, USDJPY seems frozen just below 150 as the threats of intervention are currently sufficient to offset the ongoing carry opportunities.  In this case, I continue to see room for the dollar to rise as intervention is only ever a temporary solution and I cannot see a reason why the Fed would object to a strong dollar given its inflation fighting impact.  

In the EMG space, the dollar is broadly higher with the renminbi back above 7.32 and pushing toward the lows (dollar highs) seen last month.  But KRW, THB, TWD and SGD are all softer as well.  Meanwhile in LATAM, we are seeing the same general price action in BRL and MXN both having weakened more than 9% through August and September and both now edging a bit higher lately.  However, there is no indication that the broader dollar strengthening trend has ended.

As mentioned above, this morning we see Retail Sales (exp 0.3%, 0.2% ex autos) and Canadian CPI (exp 4.0%, core 3.3%).  We also hear from Williams, Bowman, Barkin and Kashkari throughout the day as virtually every FOMC member wants to get on the tape before the quiet period begins on Friday.  In the end, consolidation seems the likely activity for now barring something new in Israel or a blowout number this morning.  Net, I still like the dollar overall.

Good luck

Adf

Not Quite Yet Dead

Posted on by 
Inflation is not quite yet dead
And that has some thinking the Fed
May now have concern
That there’ll be no turn
And possibly more hikes instead

Last week, though, more Fedspeak, we heard
And three speakers’ comments sent word
That higher long rates
Have altered the fates
Now they think hikes could be deferred

Before I touch on the markets, I must acknowledge the heinous acts that occurred last weekend in Israel.  It is abundantly clear that this will not be ending soon, and it seems likely that it may ultimately have an impact on financial markets.  However, this commentary revolves around how global markets move, what new catalysts are driving things and how we might consider all the information when trying to determine the best way to hedge outstanding FX exposures.

So, before we talk about the overnight session, let’s quickly recap my week away.  Inflation, in both the guise of PPI and CPI, was a bit hotter than expected which has put a crimp in the Paul Krugman ‘inflation battle is won’ narrative.  I am constantly amazed at the disingenuity of analysts explaining that if you ignore food, energy, rent, used cars and any other thing that rose, then inflation is back at the Fed’s target.  It is not clear to me if they don’t eat, use energy, or pay for living expenses, but that is simply ridiculous.  The consumer confidence data makes clear that folks are extremely unhappy with the current economic situation and too high inflation remains the primary cause.  Regardless of the data points, people are feeling it when they buy gas and groceries, or if they go out for dinner, let alone buying other stuff.  

I have maintained this is not going to end soon and that 3.5% – 4.0% is going to be the new normal inflation rate.  While Daly, Logan and Jefferson all explained that the steepening of the yield curve with long end rates rising more rapidly than short end rates was helping the Fed’s cause, not one of them indicated they were even thinking about thinking about cutting rates.  In fact, my money is on at least one more hike, probably in December at this point, and I cannot rule out further hikes in 2024.  And folks, higher rates are going to wind up breaking more things.  Do not believe the soft-landing narrative, things are going to get worse, almost certainly.  Arguably, that sums up last week.

Turning to the overnight session, there was limited new news in the way of data or commentary.  Market participants continue to focus on central banks and any potential adjustments in their policies, economic data and clues as to whether the long-anticipated recession is finally coming, and the trajectory of inflation and whether the price of oil is going to have a longer-term impact on that trajectory.

Regarding the first of these issues, in addition to the above-mentioned Fedspeak, the market is anxiously awaiting Chairman Powell’s comments to be made Thursday afternoon just before the Fed’s quiet period begins.  While we will hear from ten other Fed speakers over sixteen different venues (!), the reality is that Powell’s words are the most important.  However, given the seeming unanimity in the new message about the long end of the curve helping the Fed, I suspect that Powell will touch on that subject as well.  To my mind, this is not an indication they are unhappy with the bond market selloff, rather that they are quite comfortable and will not do anything to stop it.  That could well give the bond market vigilantes a signal to sell even more aggressively so be prepared.

Last night we did hear from Kanda-san of the MOF who explained that rate hikes are one option when excessive forex moves are seen.  Now, that seems a bit of a surprise in that the BOJ is ostensibly the one controlling interest rates, but this shows that the concept of central bank independence is quite tenuous in Japan, and probably in most places.  You may recall a few weeks ago when USDJPY touched 150 and immediately reversed and fell 2% in mysterious fashion as no intervention was confirmed.  Do not be surprised if we see similar price action at various levels higher in the dollar, although helpfully, there was a comment that the fundamentals (meaning interest rate differentials) were responsible for much of the movement in FX.  Nothing has changed my view that USDJPY has higher to go.

On the economic data front, obviously last week’s inflation data had an impact with Treasury yields shaking off their safe-haven bid due to the Israeli-Palastinian conflict and rising again this morning.  While they are not yet back at the highest levels seen two weeks ago, I expect we will get back there and move higher still going forward.  This week’s Retail Sales data (exp 0.3%, 0.2% ex autos) is the big print and recall, it has been running hotter than expected for a while now.  Understand that Retail Sales counts the dollars spent, not the items bought, so rising inflation will drive this number higher even if things aren’t improving.  But for now, there is scant evidence that the economy is slowing rapidly, at least based on the headline data we have been seeing for the past months.

Finally, the inflation story is part and parcel of all the discussions.  Oil’s rise on the back of the Israeli-Palestinian conflict has been pronounced and this morning it remains some 7% higher than before things started there.  There is a growing concern that if the conflict widens, OPEC could consider an embargo of some sort, just like in 1973 in the wake of the Yom Kippur War, which would likely drive oil prices much higher, at least to $150/bbl.  Obviously, that would have a dramatic impact on financial markets as well as on our everyday lives.  It would also have a dramatic impact on inflationary readings.  But the other concern is that despite some of the more Pollyanna-ish narratives about the Fed has already achieved its goals, the reality appears to be that core inflation is simply not falling any further and ultimately, this is going to weigh on equity multiples and earnings as well as further on bond prices.  I would contend that inflation remains the primary issue for the foreseeable future.

With all this in mind, a quick look at the overnight session shows that after a mixed session in the US on Friday, Asian equity markets were all lower by at least -1.0%.  European bourses, however, have managed to eke out very modest gains, on the order of 0.2% and US futures are currently (7:30) higher by about 0.25%.

Meanwhile, Treasury yields are higher by 9bps this morning and we are seeing yields on European sovereigns all higher by between 4bps and 5bps.  Clearly inflation concerns are rampant, as are concerns over continuing increases in supply as every major nation runs a growing budget deficit.  Of course, the exception to this rule is Japan, where yields are unchanged on the day and currently sitting at 0.75%, their high point for the past decade, although still well below the current YCC cap of 1.00%.

Turning to commodities, with oil quiet this morning focus is turning to the metals markets where gold (-0.8%) is retracing some of last week’s 5.0% rally as the combination of rising inflation and fear seems to have underpinned the barbarous relic.  As to base metals, they are mixed this morning with copper a touch higher and aluminum a touch lower, a perfect metaphor for the confusion on the economic situation.

Finally, the dollar is clearly not dead yet.  While this morning it is consolidating last week’s gains and has edged lower about 0.15%, last week saw gains in excess of 1% vs. most major counterparts.  The dollar, despite all the problems in the US, continues to be the haven of choice for most investors.

On the data front, aside from Retail Sales and the remarkable amount of Fedspeak, we see the following:

TodayEmpire Manufacturing-7
TuesdayRetail Sales0.3%
 -ex autos0.2%
 IP0.0%
 Capacity Utilization79.6%
WednesdayHousing Starts1.38M
 Building Permits1.455M
ThursdayInitial Claims213K
 Continuing Claims1707K
 Philly Fed11.1
 Existing Home Sales3.89M

Source: TradingEconomics.com

For my money, barring something surprising from the Middle East, like an OPEC move, I expect that the market will be entirely focused on Powell’s speech Thursday at noon.  We are also at the beginning of earnings season, so we could get some surprises there.  However, the big picture remains sticky inflation, massive new supply of Treasuries and higher yields along with a higher dollar overall.

Good luck

Adf

Worse Than Just Sloth

Posted on by 
With payrolls on everyone’s mind
The overnight range was confined
The bulls live in fear
That job growth’s still clear
While bears worry payrolls declined

But, looking beyond NFP
There’s something the bulls fail to see
Liquidity’s growth
Is worse than just sloth
It’s shrinking to quite a degree

Before I start this morning, please know I will be on vacation next week so there will be no poetry again until the 16th.

Now, to start this morning, all eyes are on the payroll report where the market is definitely in the ‘bad is good’ frame of mind.  Median analyst expectations are as follows:

Nonfarm Payrolls170K
Private Payrolls160K
Manufacturing Payrolls5K
Unemployment Rate3.7%
Average Hourly Earnings0.3% (4.3% Y/Y)
Average Weekly Hours34.4
Participation Rate62.9%

Source: tradingeconomics.com

We know that Wednesday’s ADP number was quite weak, and we know that Tuesday’s JOLTS number was quite strong.  Yesterday’s Initial Claims data was also a harbinger of strength with the weekly number falling to 207K.  If we look at the ISM employment sub-indices, both showed relative strength with the Manufacturing number rising above 50 for the first time in 5 months while the Services employment index remains at a healthy 53.4 level.  Much of what I have read over the past several weeks has focused on the idea that companies are still reluctant to lose employees as they remember how difficult it was to hire post the Covid fiasco.   I have a funny feeling we are going to see a better than expected number this morning, as between the JOLTS and Claims data it feels like we’re due for a pop.  However, I believe we need to see a print above 200K to have a meaningful impact on the markets.

To be clear, if I am correct, I would look for bond yields to retest their recent highs, equities to fall and the dollar to rebound from its recent consolidation/correction.

But let’s discuss the dollar for a moment and a data point that gets short shrift these days, the Trade Balance.  A brief history lesson shows that once upon a time, the Trade Balance was the most important monthly release for the FX market.  This was during the Reagan years when US policy was highly focused on the trade deficit with Japan and concerns over whether Japan was going to replace the US as the preeminent global economy.  (We know how that worked out!). But the point is trade data used to matter.  One of the things that gets little attention these days but is directly impacted by the trade data is the amount of global USD liquidity that exists. Despite all the hyperventilation over the concept of dedollarization, the reality is that the dollar has never been a more integral part of the global financial system than now.  The reason for this is the fact that there is somewhere north of $275 trillion of USD debt outstanding around the world, according to the IMF, and the US portion is only on the order of $95 trillion.  This means the rest of the world needs to service $180 trillion of debt, paying USD interest.   

How, you may ask, does everybody get those dollars to pay the interest on that debt?  Well, one of the keys had been the US running a massive trade deficit, buying stuff and sending dollars all over the world.  Those dollars were used to service the debt.  But lately, the US trade deficit has been declining pretty steadily, with yesterday’s better than expected reading of -$58.3 billion a continuation of the last two years’ trend from the worst print of -$105B in March 2022.   The thing is, if the US trade deficit is shrinking, we are not sending as many dollars out into the world for everyone else to use.  There has also been a great deal of discussion lately about how M2 money supply has been shrinking at an unprecedentedly fast rate, yet another sign that liquidity is drying up.  One consequence of these two factors, shrinking M2 and a shrinking trade deficit, is that foreigners need to bid more aggressively for the dollars they need to service and repay their USD notional debt.  This has been a key driver in the dollar’s recent strength and there is no sign this is going to change in the near future.

But shrinking liquidity also weighs on other things, notably risk assets.  Again, think about the post GFC era when QE’s 1 through infinity were ongoing and all the calls for inflation to ramp up never materialized.  Well, as I wrote during that time and is becoming clearer today, there was plenty of inflation, it was just concentrated in asset prices like stocks, bonds and real estate, as opposed to everyday items like groceries, clothing and dining out.  At this point, we realize that the Covid fiscal stimulus around the world is what unleashed the recent bout of inflation, and that central banks are working feverishly to halt this trend.  Combine the Fed leading the way, having raised rates the furthest of the major central banks, and the fact that there are less dollars around due to shrinking money supply and trade deficits, and you come up with a good understanding of why the dollar remains well bid.  Regardless of the short-term impact of numbers like today’s NFP, the underlying structural effects continue to point to dollar strength.

With that structural backdrop in mind, a look at today’s price activity shows modest net activity ahead of the data.  Asian equity markets that were open had a mixed session with the Nikkei sliding while the Hang Seng managed some solid gains (+1.6%) and mainland Chinese markets remained closed, set to reopen on Monday.  European bourses, though, are having an ok day, with gains on the order of 0.5% or so after better than expected Factory Orders data from Germany.  As to US futures, they are currently (7:30) higher by 0.1% and trading in a tight range.

Bond yields are backing up again with Treasuries and most of Europe higher by 3bps or so.  One move that has been growing lately is the Bund-BTP spread, which is now 202bps, right at the level where the ECB has historically started to get a bit nervous.  If this spread continues to widen look for more ECB talk about, first, how the market is wrong, and then second, how the TPI, their program to buy BTPs and sell Bunds, is likely to be appropriate.  At 250bps, their hair will be on fire, but that still feels pretty far off.

Oil prices, which are unchanged today, appear to be consolidating after a hellacious week where they fell >$10/bbl.  The thing is demand data continues to point to growth and supply data continues to point to limits.  The recent price action has all the earmarks of Russian disinformation a trading response to the massive run higher through the summer where a lot of trend followers got into the market too late.  Longer term, the direction here remains higher in my view.  As to the metals markets, they also are consolidating after a rough period with gold unchanged though silver, copper and aluminum are all higher between 0.3% and 0.9% this morning.  Again, we have seen a pretty sharp decline here, so this feels like a trading reaction, not a fundamental thing.

Finally, the dollar is a bit firmer this morning as we await the data.  USDJPY continues to hold the 149 level and it looks to be merely a matter of time before we test 150 again.  According to the flow data from the BOJ, there was no indication that they intervened earlier this week which implies there was some rate checking.  However, it is very clear they remain quite concerned over the movement.  One currency that has really seen some movement lately is MXN, which after a long period of strength on the back of a very stout monetary policy by Banxico, has given back 10% in the past 5 weeks.  Interestingly, the US is running a growing trade deficit with Mexico, which should help alleviate some pressure on the peso, but right now, the difference in tone between the Fed’s higher for longer and Banxico’s we are done is the driver.

Aside from payrolls this morning we see consumer Credit (exp $11.7B) and hear from Governor Waller at noon.  Yesterday’s Fed speak was much of a muchness with no changes in tone overall.  At this point, all we can do is wait.

Good luck, good weekend and until Monday October 16th

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Two-Faced

Posted on by 
On Tuesday the market was JOLTed
And buyers of assets revolted
But then ADP
Said, no, look at me
And bulls, toward risk assets, all bolted

Now those numbers offer a foretaste
Of how market prices are two-faced
But really the key
Is Sep’s NFP
Ahead of which, traders will stay chaste

Remember all the carnage on Tuesday?  Never mind!  In truth, it is remarkable that the market response to the Tuesday JOLTS data was so strong, given the number has historically not been a key market driver. At the same time, yesterday’s weaker than expected ADP Employment data, just 89K new jobs, had the exact opposite impact on the market.  So, bonds rallied, and yields declined sharply, with 10-yr Treasury yields lower by 14bps from the highs seen yesterday pre-data, while stocks rallied nicely, led by the NASDAQ’s 1.4% gains although the other two indices lagged that badly.

My first thought was to determine what type of relationship both numbers have with the NFP data which is set for release tomorrow morning.  I ran some simple regressions for the past year and as it happens, the R2 between NFP and ADP is 0.5 while between NFP and JOLTS it is 0.65.  I do find it interesting that the JOLTS data, which has a bigger lag built in, has the stronger relationship, but I also remember that ADP changed its model and formulation and since they have done that, the fit to NFP is far less impressive.

It is anyone’s guess as to what tomorrow’s data is actually going to be like, but it is clearly instructive that the market was so keen to react to both of these data points so dramatically ahead of the release.  Ostensibly, the market has come around to my view that NFP is the data point on which the Fed is relying to continue their higher for longer mantra.  As such, a weak number (something like 100K or lower) seems very likely to soften the tone of Fedspeak and result in an immediate rip-roaring rally in the stock market.  Correspondingly, a strong number (200K or higher) seems more likely to bring out the hawkishness that remains widely evident on the FOMC.  The consensus view appears to be 160K, but then consensus for ADP was 150K and that missed badly.

The point is, for now, the market is hyper focused on the NFP number, and I suspect that between now and then, we are unlikely to see too much movement.  As an aside, one of the best indicators of the employment situation is Initial Claims, which is more frequent and thus timelier, and that number, which is expected at 210K this morning, has clearly been trending lower, a sign of a strong jobs market.  I believe we will need to see a lot of convincing evidence for the Fed to alter their current stance, but tomorrow’s NFP will certainly be important.

Away from that, right now other fundamentals just don’t seem to matter very much.  The dysfunction in Washington is a big issue in Washington, but not in financial markets, at least not yet.  I guess if we wind up in a situation where there is a government shutdown it may wind up mattering, but we know there is six weeks before that will come up again.  Next week is the Treasury refunding auction with $102 billion of notes and bonds coming to market.  I believe a key part of the bond market’s recent downward trend is the concern over the massive supply that is coming to market.  Next week’s realization, plus the fact that there is no end in sight should continue to weigh on bond prices and support yields.  And as long as US yields are forced higher, so too will be European sovereign, and truthfully, global yields.

On the oil front, the OPEC+ meeting came and went without incident as the production cuts that the Saudis initiated back in June are to remain in place through December, at least, with the group set to revisit the issue later in the year.  While oil (-2.0%) has been slumping badly during the past week, falling $10/bbl in that short time frame, I would contend the trend remains higher.  Remember, oil is a highly volatile commodity, both in reality and from a market price perspective.  We have heard nothing to alter my long-term conclusion that oil demand is going to continue to grow and oil supply remains constricted.  In truth, if I were a hedger, I would be looking to take advantage of the current price action, especially since the market is in backwardation (future prices are lower than current spot prices) so hedging is quite cost effective.  It’s kind of like earning the points in FX.

At the same time, metals prices remain under pressure with gold suffering from the combination of still high US yields and a strong dollar, while industrial metals like copper and aluminum are both pointing to weaker economic activity.  I continue to believe this is a short-term fluctuation in a broader long-term move higher in commodities in general, but again, if I were a hedger, current prices would be interesting.

A look at equity markets overnight showed that the Nikkei (+1.8%) approved of the US price action and that dragged much of the rest of Asia along for the ride although, recall, mainland China remains closed for their Golden Week holidays.  In Europe, today has been far less impressive with very modest gains across the continent averaging about 0.2% while US futures are little changed at this hour (7:30).  As I said before, I anticipate a slow day ahead of tomorrow’s NFP report.

Turning to the dollar, it, too, is little changed this morning after a bit of a sell-off yesterday.  For instance, the euro, which has rebounded from its recent lows, is still just barely above 1.05 and higher by just 0.1% this morning.  And those gains are similar across all the major currencies.  Now, if we look at the EMG bloc, despite the dollar’s pullback against some G10 counterparts, we see MXN (-1.0%) and ZAR (-1.25%) leading the way lower as both of those nations have large commodity sectors and the decline in prices there is more than sufficient to offset any benefit of a little bit of dollar weakness broadly.  Here, too, I see no reason to change my view on the dollar following yields higher, and the fact that yields have backed off for a day does not change the underlying reality.

In addition to the Initial Claims data, we see the Trade data (exp -$62.3B) and we hear from three more Fed speakers, Mester, Daly and Barr.  ADP did not change the world.  We will need to see more data demonstrating that growth, at least as defined by the Fed, is slowing before they are going to change their tune.  Today is shaping up as quite dull, but tomorrow, at least immediately after the 8:30 data print, could be interesting.  Remember, too, that Monday is Columbus Day, so markets will have less liquidity and be susceptible to larger movements.

Good luck

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