Juiced

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No doubt it was President Xi
Who leaned on the PBOC
To cut rates at last
And try to recast
The tone of its cash policy
 
So, mortgage rates will be reduced
While bank reserves, too, will be juiced
But will cutting rates
Be what motivates
The people and give growth a boost?

 

It’s almost as though Pan Gongsheng, head of the PBOC, read my note yesterday morning and decided that it was time to really do something big!  While obviously, we know that is not the case (at least I don’t see his name on my subscriber list), the PBOC definitely painted the tape last night with their actions.  Fortunately, Bloomberg listed them for us as per the below:

  1. The seven-day reverse repurchase rate will be lowered to 1.5% from 1.7%
  2. RRR lowered by 0.5 percentage points, unleashing 1 trillion yuan in liquidity
  3. PBOC didn’t specify when RRR cut takes effect
  4. MLF expected to be cut by 0.3 percentage points
  5. Minimum down-payment ratio cut to 15% for second-home buyers, from 25%
  6. China may cut the RRR further this year by another 0.25 to 0.5 percentage points
  7. RRR cut won’t apply to small banks
  8. LPR and deposit rates to fall by 0.2 to 0.25 percentage points
  9. The PBOC to cover 100% of loans for local governments buying unsold homes with cheap funding, up from 60%

A glossary of terms is as follows:

  • RRR is the reserve ratio requirement which describes how much leverage banks may take, with the lower the number equating to more leverage (need to hold fewer reserves).
  • MLF is the medium-term lending facility which is the program that the PBOC uses to lend money to banks in China, and the rate had been the key interest rate for policy. 
  • LPR is the loan prime rate, the rate at which banks lend to their best clients
  • Seven-day reverse repurchase rate is a relatively new rate that the PBOC uses for its monetary policy efforts, similar to the Fed funds rate, and is now deemed the PBOC’s key interest rate.

Now, that’s a lot of activity for a central bank in one day.  Consider how long it takes the Fed to decide to raise or cut the Fed funds rate and compare that to just how much was done.  

And that’s just the rate moves.  In addition, they indicated they would lend up to CNY 500 billion for funds, brokers and insurers to buy Chinese shares and another CNY 300 billion for companies to buy back their own shares.  Again, I find the irony of a strictly communist nation worrying about their stock market unbelievably delicious.  So, the government is willing to roll out significant monetary stimulus, but as yet, has not been willing to inject fiscal stimulus.  Arguably the biggest economic problem in China right now is that sentiment is weak as people are concerned over both their jobs and the value of their property, hence consumption remains weak overall.  It is not clear what Xi can do to fix that problem, but cheap money is only effective if people and companies want to borrow and spend it.  That remains to be seen, although the odds of China achieving its 5.0% GDP growth target for 2024 have improved now.

One other thought is that this likely would not have been possible for the Chinese had the Fed not cut 50bps last week.  As I have consistently explained, once the Fed gets going, central banks everywhere will feel more comfortable cutting their own rates and easing policy further.  At least in China, inflation is not a problem, so they have plenty of room to cut.  However, elsewhere inflation has proven stickier than most central bankers would like to see.  Nothing is yet carved in stone as to just how many rate cuts are in the offing.

As this was the only noteworthy story, let’s look at how it impacted markets everywhere.  It can be no surprise that shares in China exploded higher given the explicit PBOC support with both the CSI 300 and Hang Seng rallying more than 4.1% on the session.  As well, Chinese yields backed up a bit, off the lows I described yesterday, but only by a few basis points.  As seen below, CNY (+0.4%) rallied nicely, trading to its strongest level since May 2023 and commodities rallied across the board with oil (+2.1%) and copper (+2.4%) the leaders although precious metals (Au +0.3%, Ag +0.8%) are also rising.

Source: tradingeconomics.com

Perhaps the most interesting thing about this story is just how little it impacted non-Chinese markets. Japanese shares (Nikkei +0.6%) rallied but given the yen’s decline (-0.3%) overnight, that likely had a bigger impact on those shares.  And the rest of Asia saw a mix of modest gains and losses, with Taiwan (+0.6%) and Korea (+1.1%) the next best performers although India, Australia and Singapore saw no benefit whatsoever.  It appears they are awaiting the fiscal boost.

In Europe, though, shares are definitely feeling the love led by the CAC (+1.6%) although even the DAX (+0.75%) is rallying despite another series of lousy data, this time the Ifo surveys all printing weaker than last month and weaker than expectations.  I guess given the importance of China as an export market for Germany, the PBOC news trumps the Ifo surveys from earlier this month.  As to US futures, after very modest gains yesterday, although some more record highs, they are essentially unchanged at this hour (7:00).

In the bond market, Treasury yields continue to back up, higher by 3bps this morning and now 15bps off the lows pre-FOMC meeting.  European sovereign yields are higher by 1bp across the board except for UK gilts (+4bps) as concerns grow that the fiscal situation in the UK may deteriorate more rapidly given the apparent confusion in the Starmer government about what to do to pay its bills.  It is also worth noting that JGB yields have slipped 3bps this morning and are now back to levels last seen back in April before the BOJ’s policy tightening got somewhat serious. 

As to the dollar, overall, it is on its back foot this morning although other than the renminbi, most of the moves have been 0.2% or less.  Today’s story is CNY for sure.

On the data front, this morning brings Case-Shiller Home Prices (exp 5.8%) and Consumer Confidence (103.8).  While there are no Fed speakers today, yesterday we heard from three (Goolsbee, Bostic and Kashkari) all of whom agreed with the 50bp cut last week and were mostly pushing for another one before the end of the year.  It seems Goolsbee has taken the mantle of chief dove on the committee, explaining there are “hundreds” of basis points left to cut before they achieve the neutral rate, however neither of the other two indicated any hesitation to cut further.  As of this morning, it is basically a 50:50 proposition as to 25bps or 50bps at the November 7th meeting according to the Fed funds futures market.

And that’s where we stand this morning.  China has opened their coffers and are adding yet more liquidity to the global system.  This should continue to help risk assets everywhere, and ultimately feed into inflation readings, although in China that is not a problem.  But what about elsewhere?  For now, it feels like the dollar is more likely to suffer given the dovish enthusiasm from the Fed speakers, but Thursday will bring 4 more speakers, including Chairman Powell, so perhaps we need to hear that before getting too excited.

Good luck

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Juxtapose

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In Europe, the ‘conomy’s woes
Continue while some juxtapose
Their weak PMIs
With US’s rise
Expecting the buck, higher, goes
 
Meanwhile, out of China we learned
The government there is concerned
Again, they cut rates
Which just illustrates
Their efforts, thus far, have been spurned

 

As we start a new week leading into month and quarter end, the market dialog continues to be about whether a recession is imminent or has been avoided completely.  As we have seen during the past months, it remains easy to choose the data that supports your view, in either direction, and make your case.  Ultimately, my take on that is very few opinions have been changed because as soon as one positive (negative) data point is printed, the opposite arrives within 24 hours.

However, let’s look at what we learned overnight.  The first story is that the PBOC cut their 14-day reverse repo rate by 10bps, another sign that the government there recognizes things are not really up to snuff.  In fact, most pundits were surprised that they didn’t cut the loan prime rates in the wake of the Fed’s rate cut last week.  Overall, this action is not that surprising, and most analysts are anticipating further rate cuts going forward, likely following the Fed lower every step of the way.  Perhaps the best indicator that more policy ease is coming is the fact that the yield on longer-term Chinese government debt has fallen to record lows (30-year at 2.15%, 10-year at 2.045%).

While the CSI 300 (+0.35%) did finally manage a bounce in the wake of the rate cut, perhaps there is no better picture of the situation in China than the chart of that stock index, which has been falling steadily since 2021.  I realize that the stock market is not the economy, especially in a command economy like China’s, but it appears quite clear that the many problems that have manifest themselves in China as the property bubble continues to unwind have been reflected in investor appetite, or lack thereof, to own potential future growth on the mainland.  The below chart speaks volumes I believe.  It ought to be no surprise that the renminbi (-0.25%) suffered a bit after the rate cut as well.

Source: tradingeconomics.com

As to the other noteworthy story, the Flash PMI data out of Europe was, in a word, dreadful.  Both manufacturing and services readings were below last month’s readings and below forecasts as the European growth story continues to suffer.  Given Europe’s reliance on imported energy overall, the recent rebound in oil and product prices are clearly impacting the economies there.  As well, there appears to be a growing divergence of opinion as to how different nations in the Eurozone want to move forward.  

For instance, this weekend’s elections in the German state of Brandenburg once again saw AfD make huge strides and massively complicate the coalition math, the third state to have that outcome this month.  As well, one of the keys to European convergence is the Schengen Agreement which allows for open borders within the EU.  However, the immigration situation there has now resulted in several nations closing their borders, not merely with the outside world, but internally as well as they try to cope with the massive influx of immigrants and asylum seekers that have been coming to the continent.  My point is if nations cannot agree on critical policies of this nature, it will become that much more difficult to arrive at common economic policies that are universally accepted.

Remember, last week Mario “whatever it takes” Draghi released his report on how the Eurozone could improve things with suggestions including more Eurozone debt (as opposed to individual national debt) and more government focused investment in areas where Europe lags, notably technology.  I guess the first step to correcting a problem is recognizing it exists, so credit is due that the Eurozone leadership has figured out things aren’t great for their citizens.  Alas, I fear Signor Draghi’s prescriptions, if enacted, are unlikely to solve many problems.

But that’s really all we have from the weekend, so let’s see how markets fared ahead of the US open.  Japan was closed for Vernal Equinox Day, a delightfully quaint holiday, while we’ve already discussed the mainland. The rest of Asia was generally positive, although Australian shares slid from recent all-time highs as investors await the RBA rate tonight with no change expected.  In Europe, it is a mixed picture, which given the PMI data, is better than I would have expected.  In fact, Germany (+0.5%) is the leading gainer there, although I cannot figure out any sensible catalyst driving that move.  The rest of the continent is +/-0.2%, so nothing really to note.  As to US futures, overall, they are slightly firmer at this hour (7:00), maybe 0.15%.

In the bond market, Treasury yields have edged higher by 1bp, continuing their rise from last week just ahead of the FOMC decision and now 13bps off the lows.  My sense is that yields will continue to slowly grind higher as a more aggressive Fed will open the door for a rebound in inflation.  As to European sovereigns, all are seeing yields slide between 2bps and 4bps this morning as it becomes clearer that the growth situation there is fading.

Oil prices (+0.3%) continue their slow rebound from the lows seen two weeks ago, although this looks much more like market internals and positioning than fundamental news.  Some claim that the escalation between Israel and Hezbollah is behind this, but given how little the market has seemed to care about the entire situation there for the past year, virtually, that doesn’t make much sense to me.  As to the metals markets, gold is unchanged this morning, sitting on its new all-time high although we have seen a retracement in both silver (-1.7%) and copper (-0.7%), though both remain in uptrends for now.

Finally, the dollar is mixed this morning with the euro (-0.4%) feeling the weight of the lousy PMI data but the commodity bloc mostly performing well (AUD +0.3%, NZD +0.25%, CAD +0.2%).  One exception here is NOK (-0.3%) and we are seeing far more weakness in EMG currencies as well (PLN -0.6%, HUF -0.9%, MXN -0.4%, KRW -0.5%).  The outlier here is ZAR (+0.25%) where investors are becoming increasingly comfortable with the pro-business attitude of the recently elected government and inward investment continues to grow.

On the data front this week, there is plenty as well as a number of Fed speakers

TodayChicago Fed Nat’l Activity-0.6
 Flash Manufacturing PMI48.5
 Flash Services PMI55.3
TuesdayCase-Shiller Home Prices5.8%
 Consumer Confidence103.8
WednesdayNew Home Sales700K
ThursdayInitial Claims225K
 Continuing Claims1832K
 Durable Goods-2.6%
 -ex Transport0.1%
 Q2 GDP3.0%
 GDP Final Sales2.2%
FridayPersonal Income0.4%
 Personal Spending0.3%
 PCE0.1% (2.3% Y/Y)
 Core PCE0.2% (2.7% Y/Y)
 Michigan Sentiment69.3

Source: tradingeconomics.com

Given the Fed’s pivot to employment from inflation, I suspect there will be a lot of scrutiny on the Claims data, especially since last week’s numbers were so surprisingly low.  If the labor market is behaving better, the need for rate cuts diminishes.  In addition to the data, we also hear from 7 Fed speakers including Chairman Powell Thursday morning.  As well, Treasury Secretary Yellen speaks on Thursday, no doubt to explain how great a job she has done.

Summing it all up, we continue to see signs of weakness elsewhere in the world while thus far, the headline data in the US continues to hold up reasonably well.  While I have consistently explained that as the Fed starts cutting rates, the dollar would suffer, the decline may be quite gradual if the rest of the world is in worse shape than the US.

Good luck

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Sayonara Yen

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Ueda did not
Accept the challenge and hike
Sayonara yen

 

Market excitement has ebbed after yesterday’s massive risk rally around the world, especially with limited new information released.  The one place where there was a chance for excitement was Tokyo, where the BOJ was meeting.  Heading into the meeting, the analyst community anticipated no policy changes although it seems clear that there were at least some market participants who thought Ueda-san would take this opportunity to surprise markets once more.  However, in this case, the analysts were correct.  Policy was left as is, with the overnight rate remaining at 0.25%, and there was no discussion regarding the reduction of QE at all, in fact, the most noteworthy thing about the policy statement was the frequency with which they used the term ‘moderate’ or variations thereof.  

They explained that the Japanese economy’s recovery, overseas economies’ growth, corporate profits, private consumption, business fixed investment, and inflation expectations have all been increasing moderately.  As such, the unanimous decision was that policy was just fine already with no imminent concern over rising inflation and no need to do anything.  The upshot is that the Nikkei (+1.5%) continues its recent rebound rally, JGB yields didn’t budge and the yen (-0.9%) fell sharply, proving to be the worst performing currency in the session.  See if you can figure out when the BOJ news was released based on the chart below.  This is what I meant when I said while analysts weren’t looking for any policy changes, clearly FX traders were.

Source: tradingeconomics.com

However, beyond the BOJ nonevent, there has been very little to discuss overall.  There is still a sense of euphoria around equity markets as congratulations abound for Chairman Powell and his bold action on Wednesday, at least from the Keynesian audience.  The one other thing to mention is that the barbarous relic (+1.0%) has absorbed all this information and traded to yet another new all-time high, well above $2600/oz, dragging the rest of the metals complex along for the ride.

Some days, there is just not much to discuss, so I will recap markets and let us all start the weekend early.

Following the big rally in the US yesterday, alongside Japan, Hong Kong (+1.35%) stocks rallied as did most of Asia (Korea, India, Australia, Malaysia) although there were a few laggards (Indonesia and New Zealand stick out).  As to mainland Chinese shares (+0.15%), they did edge higher, which given their performance of late is clearly a positive, but the news from China continues to disappoint.  Last night, the PBOC left their 1yr and 5yr loan rates unchanged, unwilling to take advantage of the Fed’s rate cut to help try to boost the domestic economy.  There is talk that the government there is going to ease the Hukuo restrictions, a type of internal passport that restricts what citizens there can do, to try to goose the property market, but no confirmation of that.  

But there was also news that the youth unemployment rate rose again, up to 18.8%.  You may recall that last summer, when the numbers started to really get bad, rising above 25%, they simply stopped publishing them.  Well, they rejiggered the data and brought them back at the beginning of the year, and now they are rising once again.  China still has many intractable problems and the equity market there seems likely to remain under pressure for a while yet.  As to US futures, at this hour (7:00) they are backing off a bit from recent highs, down -0.25% or so.

In the bond market, it is an extremely quiet session everywhere, with Treasury yields edging higher by 1bp and similar moves in some European sovereign markets while others remain unchanged.  It seems that with central bank meetings now behind us, there is no reason to anticipate the next move yet, so no reason to rock the boat.  I assume that as more data shows up, NFP, inflation, etc., we will see more movement, but for now, likely very little activity.

As mentioned above, the metals markets are rocketing this morning but the same is not true in energy with oil (-0.3%) and NatGas (-0.6%) both slipping a bit.  However, both have had strong weekly rallies, so this feels much more like a profit taking response as traders head into the weekend than anything fundamental.  After all, escalation in the Middle East doesn’t seem to faze traders, nor in Russia/Ukraine. 

Finally, the dollar is a touch higher overall, but really, in the G10 other than the yen, most currency movements have been very modest.  In the emerging markets, CNY (+0.25%) is the outlier, with those looking for a cut unwinding their short positions, but we have seen weakness elsewhere (KRW -0.65%, MXN -0.25%, ZAR -0.25%) all of which seem to be a reaction to the dollar’s sharp decline of the past two sessions.  Again, profit-taking on a Friday with no data is pretty common.

And that’s really it.  There is no data and only one Fed speaker, Philly Fed president Harker, who will be the first post-FOMC speaker we hear.  It is hard to get excited about anything in the markets today.  I expect that we will see more profit taking in those markets which moved significantly, like equities and eventually metals by the close.  In fact, if the metals markets don’t retrace, I think that could be a signal that there is a larger move in that space coming our way.

Good luck and good weekend

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Recalibration

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All week we had heard many clues
That fifty is what Jay would choose
And that’s what he cut
With only one but
From Bowman, who shuns interviews
 
The key is now recalibration
In order to tackle inflation
Without driving higher
The joblessness spire
So, trust us, it’s all celebration

 

“Recent indicators suggest that economic activity has continued to expand at a solid pace. Job gains have slowed, and the unemployment rate has moved up but remains low. Inflation has made further progress toward the Committee’s 2 percent objective but remains somewhat elevated.” [emphasis added]

Reading the opening paragraph of the FOMC Statement, it might be confusing as to why they needed to cut rates 50bps.  After all, the economy is expanding at a solid pace (In fact, after the Retail Sales data on Tuesday, the Atlanta Fed’s GDPNow reading for Q3 is up to 3.0%!)  unemployment remains low and inflation is still somewhat elevated.  I know I am a simple poet, but the plain meaning of those words just doesn’t lead my thinking to, damn, we better cut 50 to get started.  But I guess that is just another reason I am not a member of the FOMC.

Perhaps the more interesting thing was the Summary of Economic Projections and the dot plot which showed that while expectations were for rates to fall far more dramatically than in June, the longer run expectations continue to rise.  In fact, Chairman Powell specifically addressed the SEP in the press conference, “If you look at the SEP you’ll see that it’s a process of recalibrating our policy stance away from where we had it a year ago when inflation was high and unemployment low to a place that’s more appropriate, given where we are now and where we expect to be, and that process will take place over time.” [emphasis added] In fact, there was a lot of recalibrating going on as that appears to be the Chairman’s new favorite word, using it 8 times in the press conference.

Source: federalreserve.cgov

Notice that their current forecasts are for GDP to slow to 2.0% with Unemployment edging only slightly higher while PCE inflation magically returns to their 2.0% target.  And take a look at the last two lines, with the Fed funds rate projections falling substantially for the next three years, far more quickly than their previous views, although they think the long-run level will be higher.  

I wonder about that last issue.  Historically, the thought was that the long run Fed funds rate would be inflation (2.0%) + real interest rate (0.5%) and they pegged it at 2.5% for years.  Now that they see it at 2.9%, is that because they think inflation is going to be higher (not according to their projections) which means that for some reason they think real interest rates are going to be higher.  However, when asked, Chairman Powell and every member of the board has been unable to explain this change.

But what really matters is how have markets responded to this earth-shattering news?  The initial movement was as expected, with stocks rallying sharply (see chart below) and yields sliding along with the dollar while commodities rallied.

Source: Bloomberg.com

But a funny thing happened on the way to the close, as can be seen in the chart.  Stocks gave back all their gains and then some, with all three major indices lower on the session while 10yr Treasury yields backed up 7bps and the dollar rebounded.  Arguably, this was a sell the news response, but we need to be careful.  Remember, there are many analysts who believe the economy is in deep trouble already and by starting off with a big cut, those with paranoia may be wondering what the Fed knows that the data, at least the headline data, is not really showing.

So much for yesterday, now let’s look at markets this morning beyond the initial knee-jerk responses.  Absent any other major news or data (Norgesbank leaving rates on hold doesn’t count as major), markets have played out far more along the lines of what would have been expected in the wake of a 50bp cut.  In other words, the dollar has fallen sharply against almost all its counterparts, equity markets have rallied around the world, commodity prices have rallied sharply, and bond yields are…unchanged? 

Which brings us to the question that has yet to be answered.  Which market is right, stocks or bonds?  They appear to be telling us different stories with stocks pushing to new highs amid rising multiples and rising profit growth expectations while bonds are pricing in another 200bps of rate cuts by the end of 2025, an outcome that would only seem to make sense in the event the economy fell into a recession.  But if we are in a recession, corporate earnings seem highly unlikely to rise as much as currently forecast and typically, P/E multiples contract.  Meanwhile, if the economy is humming along such that current equity pricing is warranted, what will be the driver for the Fed to cut rates as that will almost certainly reignite inflation.  

History has shown that the bond market tends to get these big questions right when they are pointing in different directions, but that doesn’t mean that risk assets will stop rallying right away.  In fact, this will likely take quite a while to play out.

Ok, so let’s put a little more detail on the market activity overnight.  Tokyo rocked (+2.0%) as did Hong Kong (+2.0%), Taiwan (+1.7%), Singapore (+1.1%) and even mainland China (+0.8%) managed to rally some.  It appears that investors around the world believe the Fed has opened the floodgates for a much lower interest rate environment everywhere.  European bourses, too, are sharply higher led by the CAC (+2.1%) but with strength across the board (DAX +1.5%, FTSE 100 +1.3%).  And US futures have shaken off the late selloff yesterday and are firmly higher this morning led by the NASDAQ (+2.2%).

Bond yields, though, are largely unchanged on the day, with yesterday’s backup in Treasury yields maintained and European sovereigns all within 1bp of yesterday’s close.  It appears that bond investors are less confident in a soft landing than equity investors.  Interestingly, JGB yields rose 2bps last night as Japanese markets prepare for the BOJ meeting tonight.

In the commodity markets, oil (0.75%) is continuing its recent rebound after another massive inventory draw was revealed by the EIA yesterday prior to the Fed meeting.  There is a growing concern that inventories in Cushing, Oklahoma are falling to a point where products like gasoline and diesel will not be able to be produced.  As an example, gasoline futures have risen far more than crude futures this week on that fear.  As to the metals markets, gold briefly touched $2600/oz yesterday immediately in the wake of the FOMC but sold off hard afterwards.  This morning, however, it is back pushing up to that level again and the entire metals complex is rising nicely.

Finally, the dollar, has been a whipsaw of late.  Post the FOMC, it fell sharply across the board, and then into yesterday’s close it rebounded to close higher on the day.  However, this morning it has given back all those late gains and then some, and is now sitting at its lowest level, at least per the DXY, since April 2022.  This morning, in the G10, we are seeing many currencies rally between 0.5% (EUR) and 1.3% (NOK) vs the dollar and everywhere in between.  The one exception to that is the yen (-0.2%) which is biding its time ahead of the BOJ meeting.  The working assumption is that the BOJ will do nothing tonight, but now that the Fed has cut 50bps, and given Ueda-san’s history of actively trying to surprise markets to achieve outcomes he wants, we cannot rule out another rate hike in Japan.  Monday morning, USDJPY fell below 140 for the first time in 18 months.  My take is Ueda-san is quite comfortable with it heading back to the 130 level, if not the 120 level.  If he were to surprise markets and raise the base rate by even 10bps tonight, I think we would see a sea change in sentiment and a much lower dollar.  And given inflation in Japan seems to have stalled at 2.8%, well above their 2.0% target, he has a built-in excuse.

Too, watch the CNY (+0.45%) as it is now trading at its highest level (weakest dollar) in more than a year, and is approaching the big, round number of 7.00.  the linkage between JPY and CNY is tight as they constantly compete in markets, especially now in autos and electronics.  If the Fed is really going to cut as much as markets are pricing, both these currencies should strengthen much further.

It is almost anticlimactic to discuss the data today but here goes.  First, the BOE left rates on hold, as expected and the market impact was limited.  Expectations are they will cut next in November.  As to data, we see Initial (exp 230K) and Continuing (1850K) Claims, Philly Fed (-1.0) and Existing Home Sales (3.90M).  None of that is likely to change any views.  Prior to the BOJ meeting, at 7:30 this evening we see Japanese CPI, which may change views there.

For now, the dollar is very likely to remain on its back foot as enthusiasm builds for multiple rate cuts by the Fed going forward.  However, if the data continues to impress like it has lately, that enthusiasm will need to be tempered.

Good luck

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Fednesday

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Well, Fednesday is finally here
And traders, for fifty, still cheer
But arguably
The prices we see
Account for a half-point rate shear
 
So, if they just cut twenty-five
Prepare for a market nosedive
The doves will all scream
Jay’s killing the dream
While hawks everywhere all will thrive

 

First, I did not create the term Fednesday, I saw it on Twitter but thought it quite appropriate.  In fact, looking, I cannot determine who did create it but kudos to them.

As I have already written twice on the subject of today’s meeting, I will be brief this morning, especially because not much has changed.  Yesterday’s stronger than expected Retail Sales data resulted in Fed funds futures reducing the probability of a 50bp hike during the session, but overnight, we have returned to the 65%/35% probability spectrum for a 50bp cut.  I continue to believe that will be the case based on the number of articles we have seen in the mainstream media about the merits of a 50bp cut, mostly centering on the idea that rates are “too” high despite the fact that growth continues apace, the employment situation remains solid, if cooling somewhat, and inflation remains well above target.  Perhaps the big surprise will be that there will be a dissent on the vote, something we have not seen in two years.  (In fact, the last time a governor dissented was 2006 I believe).  

But something I have not touched on is the dot plot which will give us an idea as to the members’ collective belief for the rest of the year.  For instance, if the dot plot indicates Fed funds will be at 4.5% by year end, then 25bps today will be followed by at least one 50bp cut.  That should be net equity bullish and bearish for the dollar.  If the dot plot indicates only 75bps of cuts, so 4.75% at year end, my take is that will be seen as somewhat hawkish overall, and we should see risk assets decline while the dollar rallies.  Finally, if it is more than 100bps expected, I think that could be a situation of the market asking, what does the Fed know that we don’t?  That would not be a positive for risk assets but would also hammer the dollar.  Bonds would rally as would gold.  At least those are my views.

Moving on, tomorrow brings a BOE meeting where the current expectation is for no cut, although one is priced for the next meeting in the beginning of November.  Early this morning, the UK released its inflation report which showed headline CPI at 2.2%, as expected while the core rate rose to 3.6%, a tick more than expectations and up 0.3% from the July reading.  Arguably, that is what has the BOE concerned, the fact that despite the decline in energy prices which has taken headline CPI lower, the underlying stickiness of inflation remains extant within the UK.  As well, the UK also released its PPI data, all of which showed declines greater than expected, if nothing else implying that UK corporate margins should be healthy.  The pound (+0.35%) has rallied on the news, although the dollar is weaker overall, so just how much of this move is UK related is open to debate.  I guess we can say that the short-term differences in central bank stance is likely to continue to help the pound for a while.  In fact, the pound is back to levels last seen in summer 2022 and there is a growing bullish sentiment for the currency based on current perceptions of the divergence between the Fed and BOE.  My view is the BOE will fall in line pretty quickly so this will change, but for now, especially with the dollar under broad pressure, the pound has further to go.

On Friday we’ll learn
If Ueda can once more
Surprise one and all

The other central bank meeting this week is the BOJ early Friday morning.  Currently, there is no expectation of a BOJ policy change although many analysts are looking for a rate hike by December.  However, I think it is worth looking at USDJPY in relation to the policy adjustments we have seen by both central banks over the past several years.  Hopefully you can see in the chart below that the exchange rate here has returned to the level when the Fed last raised rates in July 2023.  

Source: tradineconomics.com

Since then, after a dramatic further decline in the yen, with both policy rates on hold, the BOJ first adjusted the cap on YCC higher (from 0.50% to 1.0%) then eventually raised the policy rate from -0.1% to +0.25% where it is today.  During that time, Ueda-san has surprised markets several times, and has had help from the MOF regarding intervention, taking a completely different approach to the process than the Fed, who never wants to surprise markets. With this in mind, we must be prepared for another surprise on Friday.  One thing to remember is that the BOJ meeting announcement occurs after the market in Tokyo closes, so even though other markets, and of course the FX market will be able to respond, the Tokyo equity and JGB markets won’t be able to move until Monday.  The point is the reaction may take time to play out.  In this situation, I don’t have enough information to take a view, but I will say that if he tightens policy in any manner, USDJPY is likely to fall much further.

One other thing I realize is that I have not discussed QT/QE.  If the Fed changes that process, the current $25 billion/month of balance sheet runoff, that will be extremely dovish and be quite a boost for stocks, bonds and commodities while the dollar will get run over.

Ok, heading into this morning, and after a mixed and lackluster session yesterday in the US, Asian equity market all rallied with Japan (+0.5%) continuing its recent rally, while even mainland Chinese shares (CSI 300 +0.4%) managed a gain today.  However, European bourses are all softer this morning with the FTSE 100 (-0.6%) lagging after the higher-than-expected inflation data driving concerns the BOE won’t cut rates much.  But screens everywhere are red, albeit only modestly so.  US futures are currently (7:45) edging slightly higher as I continue to believe traders and investors are looking for a 50bp cut.

In the bond market, yields are higher across the board as the euphoria we have seen lately seems to be running into a bit of profit taking with Treasury yields higher by 3bps and European sovereign yields all higher by between 4bps and 6bps.  Perhaps the one surprise is that JGB yields are unchanged this morning as there seems to be no anticipation of a BOJ move, at least not yet.

In the commodity markets, oil (-1.0%) is giving back some of its recent gains but remains above $70/bbl.  It seems that the stories of a massive military strike by Ukraine deep in Russia have raised concerns amongst the punditry of an escalation of the war there, but it has not concerned energy markets, at least not yet.  In the metals markets, gold (+0.2%), which sold off yesterday, continues to find support while copper has been on a roll and has risen once again.  

Finally, as mentioned above, the dollar is softer overall against all its G10 counterparts and most EMG currencies as well. The one outlier here was KRW (-0.35%) where traders are starting to price in rate cuts by the BOK after yet another mild inflation report earlier this week.

Ahead of the Fed we see Housing Starts (exp 1.31M) and Building Permits (1.41M) as well as the EIA oil inventory data where expectations are for no real changes.  Until the FOMC release, look for quiet markets. Afterwards, I’ve given my views above.

Good luck

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Lately Downturned

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The story is still ‘bout the Fed
And whether, when looking ahead
They see skies are blue
And so, they eschew
A rate cut the bears will all dread
 
But if they are growing concerned
The ‘conomy’s lately downturned
Then fifty will be
What we all will see
And bears, once again, will be spurned

 

As we move closer to the FOMC announcement and Powell press conference, the nature of the discussion has focused entirely on the size of the rate cut that will be announced tomorrow.  Yet again this morning, the Fed whisperer, Nick Timiraos at the WSJ, published an article on the subject, once again making the case for 50 basis points.  The money quote is below:

“Fed officials aren’t likely to regret a larger rate cut this week if the economy chugs along between now and their next meeting, in early November, because rates will still be at a relatively high level, he said. But if the Fed makes a smaller move and the labor market deteriorates more rapidly, officials will feel greater regret.”

As well, the futures market is growing more and more certain 50bps is coming as evidenced by the pricing this morning as per the below chart from the CME:

The interesting thing is that an unbiased (if such a thing exists) look at the data does not scream out to me that the economy is collapsing such that an aggressive start to an easing cycle is necessary.  Unemployment remains in the lowest quintile of outcomes over the past 76 years.  For reference, the median reading since January 1948 has been 5.5%, the average has been 5.7% and today it is at 4.2%.  The chart below shows the distribution of outcomes over the entire data series from the FRED database.

Data source: FRED database; calculation: fx_poetry.com

It is difficult to look at this chart and think the economy is imploding.  And let us consider another thing, the widely mentioned long and variable lags by which monetary policy impacts the economy.  Whatever the Fed does tomorrow, the impact on almost the entire economy will not be felt for at least a year, if not much longer than that.  After all, do companies really make a borrowing decision based on the marginal 25bps of interest cost per annum?  I would argue that most corporate borrowing is based entirely on their current schedule of maturing debt and any forecast needs for capex or other funding.  It strikes me that whether the Fed funds rate is 5.25% or 5.00% is not going to change much in the real economy.

Markets, of course, are a different kettle of fish in this discussion, but let’s face it, the bond market has already priced in 250 basis points of cuts in the next twelve months, so whether they start with 25 or 50 seems less relevant than the destination.  Certainly, the equity market will try to goose things on a 50bp cut, and will almost certainly fall if the cut is only 25bps, at least initially, but again, will corporate profits change that much in the short-run because of this move?

In the end, I fear we make far too much of the outcome, at least in this case.  Now, if Powell and the Fed were to decide that the recent call for a 75bp cut by three senators was an eloquent argument and did that, the market surprise would be substantial and the initial move in risky assets would be higher.  But something like that would also engender fears that the Fed knows something bad about the economy that the rest of us have missed, and that would result in its own negative consequences. I guess the good news is we only have another 30 hours or so before we find out.

As to the market activity overnight, yesterday’s mixed US equity performance, with the DJIA making new all-time highs while the NASDAQ fell -0.5%, led to weakness in Tokyo (Nikkei -1.0%) as tech shares underperformed, but strength in HK (+1.4%) and much of the rest of Asia that was open.  Both China and South Korea remained closed for holidays.  In Europe, though, given the virtual lack of technology shares available, the DJIA was the template with all markets higher this morning led by Spain’s IBEX (+1.25%)), but with robust gains elsewhere on the order of +0.6% to +0.8%.  As to US futures, at this hour (7:30), they are higher by about 0.25%.

In the bond market, yields continue to edge lower overall.  While Treasuries are unchanged this morning, that follows another 2bp decline yesterday afternoon.  In Europe this morning, sovereign yields are all lower by between -1bp and -3bps, catching up (down?) to the Treasury market as well as responding to pretty awful German ZEW numbers (Sentiment 3.6 vs. 17.0 expected and 19.2 last month; Current Conditions -84.5 vs. -80.0 expected and -77.3 last month).  Germany remains the sick man of Europe and there is no doubt that they need to see the ECB start to cut rates more aggressively to help support their withering manufacturing sector.  And one more thing, JGB yields fell -2bps last night and are now at 0.81% in the 10yr.  While the focus will turn to the BOJ at the end of the week after the FOMC announcement tomorrow, the market does not appear to be particularly concerned over aggressive tightening there.

In the commodity markets, WTI (+0.15%) has crept back above $70/bbl for the first time in nearly two weeks as the big story in the market revolves around the net speculative Comex positioning which has turned negative for the first time ever.  That means that hedge funds and speculators are net short oil futures.  While they may have a negative outlook, the positioning does indicate there is an opportunity for a massive short-squeeze sometime going forward.  As to the metals markets, they are little changed this morning, broadly holding their recent gains with both precious and industrial metals all showing healthy gains in the past week.  A 50bp cut should support prices across the board here.

Finally, the dollar is softer again this morning, but by a modest amount, about -0.1% across the board.  Those are the types of gains we have seen across the G10 and most of the EMG currencies with one outlier, MXN (-0.9%).  However, the peso, which had strengthened nearly one full peso in the past four trading sessions looks more like it is responding to that movement than to any fundamental changes.  The judicial review story is now old news although there may be some concerns that Banxico will cut more aggressively next week if the Fed does so tomorrow.

On the data front, this morning brings Retail Sales (exp -0.2%, ex autos +0.2%) as well as IP (0.2%) and Capacity Utilization (77.9%).  We also hear from Dallas Fed president Logan this morning.  It’s funny, a strong Retail Sales number could well weigh on the chances for a 50bp cut as further evidence that things continue to be moving along fine.  Remember, even though inflation has been trending lower, it is not yet nearly at its target.  Retail Sales strength would indicate that employment remains robust as people spend money more readily when they have a paycheck, so the need for more stimulus may just not be that critical.

In the end, my best take is the Fed is going to cut 50bps tomorrow and the market is going to increasingly price that in as the session unfolds.  This will be especially true if Retail Sales is weaker than forecast, but even if it surprises on the upside, I remain convinced Powell wants to cut 50bps based on the number of articles discussing the idea in the mainstream press.  Ultimately, I think the dollar will suffer a bit further on that move and commodities will be the big winners.

Good luck

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More Than a Pen

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Twas just about two months ago
When President Trump was laid low
As bullets were flying
With somebody trying
To end his campaign in one blow
 
And now, yesterday, once again
A shooter used more than a pen
To try to rewrite
The vote that’s so tight
Enthused to act by CNN
 
By now, you are all aware of the second assassination attempt on former president Donald Trump’s life, this time while he was playing golf at his course in Palm Beach.  The difference, this time, is the alleged shooter was caught alive, so it will be very interesting to hear what he says under questioning and as this situation progresses.  While this is obviously newsworthy, it did not have a major market impact as investors are far more focused on the Fed coming Wednesday and then the BOJ on Friday.  As such, as I write (6:20) US equity futures are mixed with modest movements of +/-0.2%.
 
In China, poor President Xi
Is finding that his ‘conomy
Is not really growing
In fact, it is slowing
Much faster than he’d like to see

While last night there were different holidays in China, Japan and South Korea, causing all three markets to be closed, Saturday morning, the Chinese released their monthly data drop regarding IP (4.5%), Retail Sales (2.1%) and Fixed Asset Investment (3.4%) along with the Unemployment Rate (5.3%).  Then on Saturday evening here, they released their Foreign Direct Investment (-31.5%) with every one of those figures worse than the previous reading and worse than forecasts.  The evidence continues to show that the Chinese economy is slowing and seems to be slowing more quickly than previously anticipated.  In truth, from my perspective, the biggest concern Xi has is the FDI decline, which as can be seen below, has been falling (net, foreign investors are exiting China) for the past 15 months, and at an accelerating rate. 

Source: tradingeconomics.com

This bodes ill for President Xi’s 5.0% GDP growth target for 2024 and the working assumption amongst the market punditry is that he will soon announce fiscal stimulus in order to get things back on track.  Of course, one of the key problems is that not only are economies elsewhere in the world slowing down, thus reducing demand for Chinese exports, but as well, the expansion of tariffs on Chinese goods by the West continues apace, slowing that data even further.  I saw an estimate this morning that Chinese families have seen $18 trillion of wealth evaporate as the property market in China continues to decline which undoubtedly weighs on consumer sentiment and activity.  But Xi is going to have to do something to prevent a revolution, because remember, the basic Chinese Communist Party contract with the people is we will bring you economic betterment and you let us rule.  If they don’t achieve better economic growth, the population, especially the millions of unemployed young men, may get restless.  While I am not forecasting a revolution, this is typically a precursor to the process.

On Wednesday, the time will arrive
When Jay and his minions contrive
To try to explain
Their easing campaign
And hope stocks don’t take a swan dive

Now to the most important market story this week, will the Fed cut rates by 25bps or 50bps?  It’s funny, if you read independent economic analysis, both sides make their case, and not surprisingly, given the mixed data we have received over the past several months, each case makes some sense.  But…that is not the information you get when reading the press.  The WSJ, inparticular, is really banging the drum for a 50bp cut and many more to follow.  You will recall that Friday, the Fed whisperer was out with his latest piece discussing the merits of a 50bp cut.  Well, this morning there are two more articles, one by pundit Greg Ip basically begging for a 50bp cut, and one by a trio of authors laying out the case and coming down strongly on the side of 50bps.  

All this has helped push Fed funds futures to a 59% probability of a 50bp cut as of this morning.  As some have pointed out on X(fka Twitter), in the past, when there was uncertainty about a Fed move, they managed to get the word out as to what they wanted to do during the quiet period via articles like the ones above and sway markets to their preferred outcome.  As such, at this point I assume we are going to see a 50bp cut on Wednesday.

I guess the real question is what will the impact on markets be?  This morning, we are already seeing the impact in the FX market, with the dollar under pressure across the board.  Versus its G10 counterparts, it has declined by between 0.4% and 0.6% against all except CAD, which remains very tightly linked to the dollar and has gained just 0.1% this morning.  But this movement seems entirely a result of the belief that 50bps is coming.  In the EMG bloc, though, the picture is more mixed with some significant gainers (KRW +0.8%, CE4 +0.5%, ZAR +0.6%) but most other currencies little changed overall.  Nevertheless, the market is clearly pricing for 50bps across the board now and I expect that by Wednesday morning, the Fed funds futures market will reflect that as well.

But a weaker dollar is probably not the Fed’s goal.  After all, dollar weakness can help reignite inflation, so they will be wary.  Of more interest to them is the bond market which also appears to be in agreement as the 2yr yield has now fallen to 3.56%, 10bps below the 10yr yield and a clearer sign that the two plus year inversion is behind us.  Of course, as I pointed out Friday, with 2yr yields nearly 200bps below Fed funds, it can be interpreted that the market is anticipating a recession, something I’m pretty sure the Fed wants to avoid if it can.  Perhaps you can see in the chart below how the 2yr yield (in green) fell sharply this morning, almost exactly when those WSJ articles were published.  Go figure!

Source: tradingeconomics.com

At any rate, that is the current zeitgeist, the Fed has leaked they want 50bps and are pushing the levers so when they cut 50bps on Wednesday afternoon, nobody is surprised.  The Fed hates surprises.  It will, however, be very interesting to hear Chairman Powell’s comments given that economic data remains pretty strong overall.

As to the other markets beyond bonds and FX, equity markets, after Friday’s US strength, were generally positive in those countries in Asia not celebrating a holiday (Hong Kong +0.3%, Australia +0.3%, Taiwan +0.4%).  In Europe, though, the picture is more mixed with the DAX (-0.3%) lagging while Spain’s IBEX (+0.3%) is higher although other major markets are virtually unchanged on the session.

Finally, in the commodity markets, oil prices (+0.4%) are edging higher this morning as Libya’s production has been completely shut in due to ongoing internal military conflict.  In the metals markets, gold (+0.2%) remains the biggest beneficiary of the global central bank rate cutting theme as it continues to trade at new all-time highs virtually every day.  Silver (+0.7%) is getting dragged along for the ride with many pundits calling for a much more substantial rally there and copper (+0.4%) is responding to a combination of lower rates and lower inventories in exchange warehouses raising the specter of supply shortages.

On the data front, this week is mostly about central banks, but we do get some other important numbers.

TodayEmpire State Manufacturing-3.9
TuesdayRetail Sales0.2%
 -ex autos0.3%
 IP0.0%
 Capacity Utilization77.9%
WednesdayHousing Starts1.25M
 Building Permits1.41M
 FOMC rate decision5.25% (-0.25% still median)
 Brazil interest rate decision10.75% (+0.25%!)
ThursdayBOE rate decision5.0% (no change)
 Initial Claims230K
 Continuing Claims1851K
 Philly Fed2.4
 Existing Home Sales3.85M
FridayBOJ rate decision0.25% (unchanged)

Source: tradingeconomics.com

Clearly Retail Sales will be closely scrutinized as evidence that the economy is still growing.  I would estimate that a weak number there would insure a 50bp cut, while a strong number may give some pause to those on the fence.  The other very interesting aspect of this week will be the BOJ’s communication in the wake of their meeting Friday.  They went from tough talk to just kidding in less than a week back in August.  What will Ueda-san try this time?  Japanese inflation data is released just hours before their announcement, and it remains well above the 2% target.  My sense here is they want to raise rates, they just need to prepare the market more effectively before doing so.

The dollar is already pricing a bunch of cuts as is the bond market.  If the Fed truly gets aggressive, I believe it can fall further, but if the Fed gets aggressive, you can be certain that so will the BOE, ECB and BOC at the very least.  When they start to catch up, the dollar’s decline will slow to a crawl at most.

Good luck

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Powell’s Dream Team

Posted on by

The punditry’s dominant theme
Is whether Chair Powell’s dream team
Will cut twenty-five
And try to contrive
A reason a half’s a pipe dream
 
But there’s something getting no press
The balance sheet shrinking process
They’re still in QT
But what if QE
Is something they’ll now reassess?

 

With all the data of note now passed (PPI was largely in line although tending a bit higher than forecast) and the ECB having cut their deposit facility rate by 25bps, as widely expected, the market discussion is now on whether the Fed will cut by one-quarter or one-half percent next week.  The Fed funds futures market, which you may recall had been pricing as little as a 15% probability for that 50bp cut earlier this week, is currently a coin toss between the two outcomes.  In addition, the Fed whisperer, Nick Timiraos of the WSJ, had a front page article on the subject this morning, although he drew no conclusions.

But something that is getting virtually no airtime is the Fed’s balance sheet and its ongoing shrinkage.  You may recall that the current level of QT is $25 billion/month, which was reduced from the original amount of $60 billion/month back in June as the FOMC started to grow cautious regarding the appropriate amount of reserves and liquidity in the system.  

The issue is nobody knows what number constitutes the right amount of reserves.  Fed research is of the belief that somewhere between 10% and 12% of GDP (currently about $2.7 trillion to $3.3 trillion) should be sufficient to ensure that economic activity does not grind lower due to a lack of liquidity.  This has been the rationale behind the slow reduction in balance sheet assets.  But that research may not be accurate, and the underlying assumption was that the economy continued to grow at its trend rate.  In the event of a slowdown or recession, you can be sure that the Fed will add liquidity back as well as cut rates.

Now, working against my thesis is the Fed has not discussed this idea at all, at least publicly, and so a complete surprise is not their typical MO.  However, they have found themselves in a place where the market is pricing in more than 100 basis points of cuts over the next three meetings, including next week’s, which if they stick to their 25bp increments, means that one of these meetings needs a 50bp cut.  As I have written before, the bond market is pricing nearly 200bps of cuts in the next two years (see chart below), which would indicate that the likelihood of an economic slowdown is high.  

Source: tradingeconomics.com

At the same time, equity markets are trading near all-time highs with earnings estimates indicating that economic growth expectations remain quite robust.  Both of those scenarios cannot be true at the same time.

Source: LSEG

This is the landscape through which Chairman Powell must navigate the Fed’s policies as well as his communication of those policies.  In Jackson Hole, he virtually promised a rate cut was coming next week, and one is certainly on its way.  The magnitude of that cut, though, will offer the best clues as to the Fed’s thinking with respect to the future trajectory of the economy and which market, stocks or bonds, is right. 

There is one other thing to consider, though, as an investor. Given the bond market is pricing a significant slowdown, if that is your view, bonds will not offer much return if you are correct.  And if you are wrong, and growth is strong, it will be ugly.  Similarly, if you are of the view that there is no recession, but rather a soft- or no-landing is the likely outcome, then being long stocks, which have already priced for that outcome will likely have only a modest benefit.  However, in the event that the economy does fold and recession arrives, stocks are likely to sell-off sharply.  Arguably, the best positioning for a trader is to be short both stocks and bonds, as whichever outcome prevails, one asset will fall substantially while the other has limited upside, at least for a while.  For a hedger, this is the time that options make a lot of sense as the asymmetry they provide is what allows a hedger to prevent locking in the worst outcomes.

Ok, with that behind us, let’s look at the overnight session to see how things followed yesterday’s risk rally in the US.  In Asia, the Nikkei (-0.7%) has been struggling lately on the back of continued JPY strength.  As you can see from the below chart, that relationship has been pretty strong for a while, and last night, USDJPY traded to new lows for the year, erasing the entire gain (yen decline) that peaked at the end of June.

Source: tradingeconomics.com

As to the rest of Asia, mainland Chinese shares (CSI 300 -0.4%) continue to underperform although HK shares managed a rally (+0.75%) while most of the rest of the region showed very modest strength, certainly nothing like the US performance, but at least in the green.  In Europe, equity markets are all higher this morning with Spain’s IBEX (+0.8%) leading the way although solid gains of 0.3% – 0.5% prevalent elsewhere.  As to US futures, at this hour (7:45) they are creeping higher by about 0.1%.

In the bond market, Treasury yields are lower by 2bps this morning and European sovereign yields are generally little changed to lower by 2bps across the continent.  Yesterday’s ECB outcome was universally expected, and Madame Lagarde explained they remain data dependent and promised no timeline for potential further rate cuts, if they are even to come (they will).  As to JGB yields, they too fell 2bps last night, once again confusing those who are looking for policy tightening in Tokyo.

In the commodity markets, oil (+1.4%) is rallying for the third consecutive day as Hurricane Francine shut in about 40% of gulf production and the timing of its return is still uncertain.  Despite the US equity markets’ clear economic bullishness, the weak growth/demand story is still a major part of this discussion.  In the metals markets, gold (+0.3% overnight, +3.2% in the past week) continues to set new price records daily with a story making the rounds that SAMA, Saudi Arabia’s central bank, secretly bought 160 tons of gold last quarter, soaking up much supply.  This has helped drag silver back above $30/oz although copper (-0.5%) is stumbling a bit this morning.

Finally, it should be no surprise that the dollar is under some pressure this morning as the talk of more aggressive Fed easing grows.  While the euro and pound are little changed, JPY (+0.5%) is leading the way in the G10 with AUD (+0.45%), NZD (+0.4%), NOK (+0.2%) and SEK (+0.3%) all firmer on the back of commodity strength.  In the EMG bloc, the story is a bit more nuanced with ZAR (-0.15%) bucking the trend on domestic political concerns, although we saw strength in KRW (+0.5%) overnight and MXN (+0.35%) as the Fed rate cut story plays out across most currencies.

On the data front, only Michigan Sentiment (exp 68.0) is on the docket so once again, the dollar will be subject to the equity market behavior and the strength of narrative regarding just how dovish the Fed will wind up behaving next week.  I will say that a 50bp cut is likely to see some short-term dollar weakness, probably enough for it to fall to multi-year lows vs. its major counterparts.  But remember, if the Fed starts getting aggressive, other central banks will feel comfortable following that lead, so the dollar’s weakness may not be that long-lived.

Good luck and good weekend

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The New Norm

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The CPI data was warm
But not warm enough to deform
The view that the Fed
Was moving ahead
With rate cuts which are the new norm
 
While fifty seems out for next week
Investors, by year end, still seek
A full percent cut
Just when, though, is what
Defines why we need Jay to speak

 

It turns out that core CPI printed a tick higher than expected on the monthly result, although the Y/Y number was right in line with most forecasts.  In the broad scheme of things, it is not clear to me that a 0.1% difference in one month matters all that much, but markets are virtually designed to overreact to ‘surprising’ data.  At least, the algorithms that drive so much trading are designed to do so, or so it seems.  However, as can be seen by the chart below, it was a pretty short-lived dip and then the march higher in equity prices continued.

Source: tradingeconomics.com

While Fed funds futures pricing has adjusted the probability of a 50bp cut next week by the Fed down to just 15%, that market is still pricing in 100bps of cuts by the December meeting which means that there needs to be a 50bp cut in either November or December as they are the only two meetings left after next week.  As @inflation_guy highlighted in his always perceptive writeups on the CPI report, yesterday’s number ought not have changed the Fed’s thinking.  And perhaps that is exactly what we saw from the equity market, the realization that 50bps is still on the table for next week, especially since there is a growing feeling that’s what Powell wants to do.  I’m confident if Powell pushes for 50bps, he will have no trouble gaining quick acceptance around the table.

Ultimately, I think the problem with focusing on CPI is that the Fed doesn’t focus on CPI, even when they are worried about inflation.  However, especially now that they seem to believe they have achieved victory in that part of their mandate, it strikes me that the numbers about which they really care are the employment numbers.  Last week’s NFP report was mixed at best, although the actual NFP data was the weakest part of the report.  This morning, we get the weekly Claims data (exp Initial 230K, Continuing 1850K), but those numbers have been very stable of late, and not pointing to serious difficulties at all.  To my eye, from the perspective of the economic data that we continue to see, there is limited reason for the Fed to cut at all, especially with inflation still well above their target, but Powell promised a cut, and we have seen nothing since his Jackson Hole speech that could have changed view.  

A better question is, are they really going to cut 250bps by the end of 2025?  That would imply, at least to me, that the economy has slowed substantially, and likely headed into recession.  And, if the data turns recessionary, I can assure you that the Fed will have cut far more than 250bps by the end of next year, probably more like 350bps-400bps.  My point is I cannot look at the market pricing of interest rates and make it fit with the economic outlook at this time.  What I can do, however, is feel confident that if the Fed starts to cut rates aggressively with economic activity at current levels (remember, the GDPNow forecast is at 2.5% for Q3), inflation is likely to pick back up more quickly than people anticipate and the dollar, and bond market, will suffer while commodities and gold rise.

In the meantime, in a short while we will hear from Madame Lagarde as she follows up the almost certain 25bp rate cut they will declare today with her press conference.  I would argue the bigger news out of Europe is the ongoing discussion about increasing Eurozone debt issuance, as suggested by Mario (whatever it takes) Draghi in his report I discussed on Monday.  A look at the recent data from the continent shows that Unemployment is currently at historic lows for Europe, although that is still 6.4%, and inflation has fallen to 2.2%, just barely above their 2.0% target.  As such, here too it seems that the data is not screaming out for action.  Now, the punditry is looking for a so-called hawkish cut, one where the commentary does not discuss future cuts as a given, and I think that would be a sensible outcome.  But not dissimilar to the US situation, where a key driver of rate cut desires is the governments who are the biggest borrowers, there is intense political pressure to cut rates and reduce interest expense.  In fact, I believe that is a key reason behind Draghi’s report, to gain support and remove some of that direct interest rate expense from certain countries’ cost structure.  Thinking it through, net this should benefit the euro in the FX market as the Fed seems hell-bent on cutting and the ECB a bit less so.  We shall see,

Ok, so let’s turn to the overnight sessions to see where things are now.  After the US rebounded yesterday afternoon on the back of strength in the tech sector, we saw a huge rally in Tokyo (Nikkei +3.4%) on the same premise.  And while the Hang Seng (+0.8%) had a good session, once again, mainland Chinese shares (CSI 300 -0.4%) did not participate.  In fact, most of Asia was in the green, once again highlighting the weakness in the Chinese market, and the perception of that weakness in the Chinese economy.  As to Europe, it too has seen strength everywhere with gains between 0.8% (FTSE 100, CAC) and 1.20% (DAX).  This story is one of following the US, hopes for a bit more dovishness from the ECB, and a growing story about the potential for bank mergers in Europe with news that Italy’s UniCredit Bank has taken a stake in, and is considering buying, Germany’s Commezbank.  As to the US futures market, at this hour (7:20) they are all very modestly in the green.

In the bond markets, yields continue to back up slowly from the lows seen earlier this week with both Treasury (+2bps) and most European sovereign (Bunds +2bps, Gilts +2bps, OATs +1bp) slightly higher this morning.  Overnight, we saw JGB yields tick up only 1bp despite a relatively hawkish speech from BOJ member Naoki Tamura.  He indicated that rates should be raised to 1.0% by the end of their current forecast cycle, which sounds like a lot until you realize that is the end of 2027!  Maybe the 1bp move is appropriate after all.

In the commodity markets, oil (+1.7%) is continuing yesterday’s rally as questions about how quickly Gulf of Mexico production will restart in the wake of Hurricane Francine are driving markets.  While the weak demand story still has proponents, the reality is that oil prices have fallen more than 12% in the past month, a pretty large decline overall, so a bounce cannot be surprising.  In the metals markets, after a solid session yesterday, metals prices are higher in both the precious and industrial spaces.

Finally, the dollar is doing very little this morning, but if forced to define the move, it would be slightly softer.  While most currencies in both the G10 and EMG blocs are just a touch firmer, between 0.1% and 0.2%, the biggest mover, ironically is a decline, ZAR (-0.4%), although other than short term trading and positioning, there doesn’t seem to be a clear catalyst for the decline.

On the data front, in addition to the Claims data noted above, we see PPI (exp headline 0.1% M/M, 1.8% Y/Y; core 0.2% M/M, 2.5% Y/Y). Of course, there are no Fed speakers, but after the ECB announcement and press conference, we will hear from some ECB speakers as well.  Right now, the dichotomy between what the bond market is expecting (much lower rates anticipating weaker economic activity) and the stock market is expecting (ever higher earnings growth amid economic strength) remains wide.  While there are decent arguments on both sides, my sense is the bond market is more likely correct than the stock market.  And that is probably a dollar negative, at least at first.

Good luck

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Feelings of Doubt

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Two candidates took to the stage
But neither of them could assuage
The feelings of doubt
‘bout how things turn out
And how we can all turn the page
 
Meanwhile there’s news south of the border
Where AMLO, the courts, did reorder
This has raised some fears
That in coming years
The nation will lack law & order

 

Before I start, please take a moment to remember those 2,977 nnocent lives lost on this horrible day 23 years ago, this generation’s day of infamy.

Now, on to the market discussion.  I don’t know about you, if you watched the debate, but frankly I was pretty bored and disappointed by the whole thing.  I heard many platitudes from both sides, many accusations from both sides, and couldn’t help but notice how the moderators interjected themselves consistently in favor of Vice-president Harris via their “fact-checking”.  All in all, I don’t think we learned that much, although Harris is certainly more coherent than Biden was.  My guess is that very few undecided voters changed their minds.  As to the market’s reaction, perhaps the only notable result was that gold rallied slightly as no matter who wins the election, the idea that fiscal prudence is on the agenda remains anathema to both sides.  Equity futures were slightly lower when the debate started, and still slightly lower when it ended, as well as this morning.  It ought not be surprising as the impact of politics on equity markets has always been unclear in the short run.

The other political story of note was that in Mexico, AMLO, who remains president for a few more weeks, was able to finally get the change to the constitution he has been seeking his entire term, which now allows for judges, including supreme court justices there, to be elected rather than appointed.  The concern is that this will politicize the judicial system.  An independent judiciary is a key ingredient for international investors as they seek some comfort that business decisions can be fairly considered.  However, judicial elections may call that into question and that is likely to have a longer-term negative impact on the Mexican economy.  As you can see from the chart below, the peso has been massively underperforming since April, falling more than 22% and breaching the 20.00 peso level for the first time in more than 2 years, as concerns over this issue have grown.  Add to this the fact that inflation in Mexico has drifted slowly lower and expectations are rising for more aggressive rate cuts by Banxico, and you have the recipe for a weaker currency.  While the peso has bounced 0.9% this morning, this trend lower remains clear for now.

Source: tradingeconomics.com

With all that out of the way, it is time to turn to this morning’s big news, the August CPI report.  Current median expectations are for a 0.2% M/M, 2.6% Y/Y rise in the headline number and a 0.2% M/M, 3.2% Y/Y rise in the ex-food & energy reading.  However, I have seen estimates ranging from 0.0% M/M to 0.3% M/M based on various subcomponents like used cars, apparel and shelter.  Ahead of the release, I have no further information than that, but let’s consider what can happen in either situation.

First, we know that the Fed is going to cut rates next week, regardless of the number today.  Currently, the Fed funds futures market is pricing a 29% probability of a 50bp cut.  A quick look at the below table from the CME shows this is close to the lower end of the range of expectations over the past month, which back in August were at 51%.

source: cmegroup.com

The current working assumption seems to be that a soft number will virtually assure a 50bp cut regardless of any other economic data, while a 0.3% print will lock in a 25bp cut.  Once again, given the apparent resilience of the economy, the rationale for cutting rates aggressively remains elusive.  The cynic in me might point to the fact that Chairman Powell is a private equity guy, someone who made his fortune in that space, and he has been receiving pressure from all his old friends and colleagues to cut rates to help resurrect the sales activity in that market.   While that may seem glib, given the way things work in the corridors of power in Washington, it cannot be ruled out.  However, history has shown that when the Fed begins a cutting cycle with 50 bps, it is generally because they are behind the curve and recession is already here.  If that is the situation, while next week a 50bp cut may be well received by equity investors, the medium-term outlook is not nearly as bright.  At this point, the question is, how will markets respond to the data.

Let’s start with looking at how things behaved overnight.  Yesterday’s mixed US session, with the DJIA slipping while both the S&P and NASDAQ rallied was followed by uniform weakness in Asia.  Perhaps nobody there was enamored of the debate, which was taking place while those markets were open, but we saw the Nikkei (-1.5%) fall sharply with weakness also in the Hang Seng (-0.75%) and CSI 300 (-0.3%). In fact, only Singapore (+0.5%) managed any gains during the session with every other regional market declining.  But that is not the story in Europe, where all markets are higher, albeit not that much higher.  Spain’s IBEX (+0.65%) is the leader with other markets showing gains of between 0.1% (FTSE 100) to 0.3% (DAX).  For those who are concerned that a Trump victory may isolate Europe more than a Harris victory, perhaps there was more encouragement she could win after the debate.

In the bond market, after some significant declines in yields yesterday, where Treasury yields fell nearly 10bps, this morning they have fallen a further 2bps and are now back to their lowest level since June 2023.  At 3.6%, nearly 200bps below Fed funds, the bond market seems to be pricing in a recession.  Interestingly, neither stocks nor credit spreads are pricing that same outcome.  European sovereign yields also fell sharply yesterday, although not as much as Treasury yields, more like 5bps, and this morning they are a bit lower again, somewhere between -1bp and -3bps.  Perhaps the most interesting outcome is that JGB yields have slipped 4bps, once again delaying the idea that the BOJ is going to tighten policy soon.

In the commodity markets, oil (+2.6%) has rebounded sharply this morning as concerns over Hurricane Francine shutting in Gulf of Mexico production rise ahead of expected landfall later today.  However, the trend here remains lower as demand concerns remain front and center and supply continues to grow.  My sense is that the declining demand is a signal that economic activity is slowing, but it will return with a return to more robust global growth.  In the metals markets, everything is back in the green with gold (+0.2%) once again pushing toward its recent all-time highs, while both silver and copper show strength this morning.  I believe those moves are related to the anticipation of larger cuts by the Fed and other central banks coming soon.

Finally, the dollar is under pressure across the board this morning, also playing along with the theme of the Fed cutting rates more aggressively going forward.  In fact, literally every currency in both the G10 and EMG blocs are stronger today with most modestly so, on the order of 0.2%, although we have seen MXN (+0.85%) rebounding from its recent declines discussed above, and ZAR (+0.45%) benefitting from the strength in metals markets.

Aside from the CPI data, the only other news is the EIA oil inventories, where last week saw a large draw overall, and the only forecast I see is for a modest build of <1mm barrels.  However, CPI will determine today’s price action.  I think we are in a ‘good news is good’ scenario so a soft number should see a rally in stocks, bonds and commodities while the dollar suffers further.  On the flip side, a high print should see the opposite reaction.

As I reread my note, it appears to be an accurate description of the fact that there are features in the data pointing to further economic strength and other pointing to weakness.  Truly, nobody knows what lies ahead.

Good luck

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