Losing Their Mirth

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The data of late round the earth
Is showing, of late, there’s a dearth
Of positive vibes
Which aptly describes
Why people are losing their mirth
 
Last night and this morning we learned
The PMI data has turned
Much lower worldwide
Though many bulls tried
To urge us to not be concerned

 

Are we in a recession?  That question, which several analysts have already declared to be the case, is being asked more actively of late.  While the official recession call is not made until well after the fact by the National Bureau of Economic Research (NBER), for investing and hedging purposes, that is a little late in the game. Rather, the reason analysts exist at all is to help people understand the situation in real-time, not on a historical basis.  And remember, one of the biggest problems is that, almost by definition, most data are backward looking, describing what happened already, not what will occur going forward.

Now, it is true that when it comes to economic data, it tends to trend so extrapolating that trend makes some sense, but history has shown that the timing of those changes can vary widely.  Alternatively, we can look at the Survey data like PMI, ISM or the regional Fed surveys, to try to get a sense of what business managers are expecting.  This is certainly more forward-looking, but as it is describing expectations rather than actual spending and output, can diverge from what ultimately occurs.  We have seen this frequently over the past several years as several surveys indicated slowing activity while the hard data (payrolls, GDP, Retail Sales, IP, etc.) held up well.

This brings us back to the opening question, are we in a recession?  Well, so far this week the data that has been released is not pointing to strength of economic activity.  In the US, Monday’s Chicago Fed National Activity Index printed at 0.05, down significantly from the May print of 0.23.  Then yesterday, Existing Home Sales fell to 3.89M, far below expectations and pushing back toward levels last seen during the housing crisis in the GFC.  As well, the Richmond Fed Manufacturing Index fell to -17, well below last month and expectations.  

Turning the clock on the global day, we saw Japanese Manufacturing PMI fall to 49.2, well below expectations of 50.5, although the Services PMI held in well at 53.9.  Australian PMI data was soft (47.4) and the same was true in Europe (France 44.1, Germany 42.6, Eurozone 45.6). Again, there can easily be a difference between the survey data and the hard data, but the weight of evidence is starting to lean toward slowing growth.

Another key feature of a growing economy is rising profitability of the corporate sector.  As we have entered Q2 earnings season, it is worth looking at some of the big names that have released already.  Last night, Tesla reported weak earnings, and this morning we heard a similar story from LVMH in Paris and Deutsche Bank.  UPS was weak and Alphabet (Google), even though they beat forecasts, has been punished in the aftermarket because its YouTube data was poor.  In fact, I think that is a critical issue.  The equity market, or at least the large cap space, seems priced for perfection, so even good earnings may not support current pricing.  But more importantly, if large corporations are seeing earnings declines that could well be indicative of weaker economic activity.  And that comes back to that opening question.

To recap, we have recently seen broadly weaker Survey data, the US housing market is clearly struggling, and corporate earnings are not uniformly keeping up with expectations.  Does this mean we are in recession?  Absolutely not, but it has certainly raised the probability that the most widely anticipated recession in history is closer than we would like.

What are the implications of this situation?  Well, this morning we saw Bill Dudley, former NY Fed President, write in Bloomberg that the Fed shouldn’t wait until September to cut rates, but rather should cut them next week.  The market does not believe that will be the case as futures continue to price just a 4.7% probability of such a move, although the September cut is baked in right now.  In fact, dovish analysts and former policymakers are increasingly calling for the Fed to act before it’s too late.  Personally, I don’t see that happening, although if data continues to soften, there will be increasing discussion of a 50bp move in September, mark my words.

There is one other place to look for clues about economic activity as well, the commodity markets.  Consider that slowing economic activity generally leads to reduced demand for inputs like commodities, be they energy, metals or agricultural products.  A quick look at the Goldman Sachs Commodity Index, which is widely followed as a measure of broad commodity activity, shows that throughout Q2, at least, the trend has been down.

Source: tradingeconomics.com

My point is that the odds of a recession seem to be rising and that means we are likely to see weaker equities, weaker commodities, lower yields and a softer dollar, at least at first.  But remember, the dollar is a relative trade.  If the US enters recession, you can bet that so will many other countries, and the reaction functions around the world could well result in currency weakness of even greater magnitude elsewhere and the dollar holding its own.

Ok, I rambled a bit, so let’s quickly see how the overnight session went in markets.  After a very modest sell-off in the US, Asian markets were far more reactive to some negative US earnings reports with the Nikkei (-1.1%) and Hang Seng (-0.9%) leading pretty much all indices lower here.  Adding to the woes of the Nikkei was the further strength in the yen (+0.85%, +3.3% in the past month) as Japanese exporters feel the pain.  European bourses are also under pressure with the DAX (-0.7%) and CAC (-0.9%) leading the way lower after their worse than expected Flash PMI data discussed above.  Finally, US futures are all in the red this morning led by the NASDAQ (-1.0%) at this hour (7:30).

In the bond market, yields are little changed so far this morning despite the weaker data.  In fact, in the past month, 10-year Treasury yields have not moved at all.  There continues to be confusion as to whether inflation or economic activity is going to be the driving force in central bank activities and as long as that is the case, bond traders don’t know which way to jump.  One exception is JGB yields which are creeping higher again, up 2bps overnight.  There is now much discussion that the BOJ is going to raise rates at their meeting next week, as well as start to taper its ongoing QE program.  This is likely supporting the yen (as well as short covering there) but will seemingly undermine the equity markets in Japan if this is the case.  However, I expect this story to gain traction until the BOJ meeting.

In commodity markets, oil (+0.6%) is bouncing after a very rough week as the market awaits the EIA inventory data.  The API data, which is not given as much credence, showed a larger than expected draw yesterday, which seems to be helping crude this morning.  Gold (+0.1%) continues to hold its own but copper (-0.6%) remains under pressure on the weak China and recession stories.  Remember, it is often called Dr. Copper on the theory it has a PhD in economics for its ability to forecast economic activity.

Finally, the dollar is mixed this morning with the yen the notable outlier, but strength, too, in ZAR (+0.5%) on the back of a sharp rise in South African yields this morning.  But there are more laggards, albeit with modest movements in the G10 (EUR -0.1%, AUD -0.25%. SEK -0.2%).  In the EMG bloc, HUF (-0.8%) is the laggard, although we are seeing weakness throughout the CE4 on the back of the euro’s modest decline.  This story continues to be focused on the rate differential.  The more we hear about calls for the Fed to cut sooner or more aggressively, the more likely the dollar will remain under pressure.

On the data front, we see the Goods Trade Balance (exp -$98.0B) as well as the Flash PMI data (Manufacturing 51.7, Services 55.0) and finally New Home Sales (640K).  With no Fed speakers, the data will gain more prominence, especially if it shows up weaker than expected and continues the trend discussed above.  As well, the equity market will continue its importance to overall trading as further earnings reports are released.  Net, it is starting to feel like weaker economic activity is making itself felt.  That should result in a little dollar softness, at least until other countries demonstrate the same traits.  But for today, the one thing I see is further short covering in JPY and a continuation of that trend.

Good luck

Adf

A Bummer

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The narrative writers have turned
Their focus, as markets they’ve spurned
It’s politics now
That they all endow
With ideas we need be concerned
 
And so, if the pricing is right
Come next week, the Fed will sit tight
The rest of the summer
Could well be a bummer
For traders, with volumes quite light

 

It is not uncommon for the summer months to lack interesting new information for market participants.  While the regular monthly cycle of data continues to be released, the fact remains that there seems to be less interest overall.  This is not to say there have never been summer surprises, but the very fact we call them surprises is indicative of their relative scarcity.  

This year, especially, seems likely to have even fewer financial or economic discussions than usual given the ongoing drama in the US political cycle.  And while this poet has opinions as to how things may work out (and of course what I would like to see) that is not what this morning missive is all about.  Rather, I continue to try to find the stories that drive market activity and alert you to what is happening.  But the ongoing political narrative is now so dominant, everything else pales in comparison.  And as I wrote yesterday, while political narratives can have some market impact, it is not typically that significant.

I mention this because there were exactly zero stories of any market consequence overnight.  Much was written about the US elections and there were some ‘thought’ pieces on issues like the long-term impacts of President Xi’s iron grip on China and what that means for the economy there, but there was no data to excite, there were no comments of note and basically, it was all quite dull.  For instance, I’ll bet you were unaware that the G20 is meeting in Rio de Janeiro because it is almost impossible to find a story on the meeting.  I suspect that Thursday’s GDP and Friday’s PCE data are going to be the most exciting things that occur this week.  

Unless, of course, there is a real summer surprise.  It is earnings season with the Mega-cap tech companies set to report this week and next, but those are generally not market wide movers.  So, with that in mind, let’s take a look at the overnight market activity and call it a day.

After US equity markets showed their resilience yesterday, laughing off the concept of a rotation out of tech or the beginning of a serious correction, Asian markets mostly followed that same line of thinking if you ignore Japan (flat) and China (CSI 300 -2.1%, Hang Seng -1.0%) as the rest of the region was in the green, with some markets really enjoying a boost, notably Taiwan (+2.75%).  The Chinese story seems to be ongoing disappointment that the Third Plenum did nothing to indicate support for the economy and the 10bp rate cuts were seen as insufficient.  As to Japan, the tension between the rebound in tech shares and the strengthening in the yen led to no net movement.  In Europe, though, bourses are all following the US lead and rising nicely, led by the DAX (+1.2%) as hints by some ECB members indicate that a cut is coming in September despite Madame Lagarde’s insistence that no decisions have been made.  As to the US futures markets, at this hour (7:15) they are little changed overall.

Bond markets have seen yields decline this morning with Treasuries (-2bps) the laggard compared to Bunds (-4bps) and OATs (-3bps).  Of course, this follows yesterday’s session where yields edged higher by a few basis points and basically shows that investors are unwilling to take any directional views until we at least see the PCE data, if not until the FOMC next Wednesday.  Since the beginning of the month, Treasury yields have been choppy in a range of 4.15% – 4.30% and are currently sitting right in the middle.  There continue to be two longer term views, with the recessionistas calling for a sharp decline in yields as it becomes clear the US economy is slowing and the Fed will cut rates to stimulate, while the fiscal policy bears keep pointing to the massive deficits and issuance that accompanies those deficits, and explains that at some point, demand will not meet supply and yields will rise sharply.  My own view is that both of these outcomes will obtain, with the first recession signals helping to send yields lower before longer-term troubles emerge for the US fiscal picture.  But right now, it’s hard to get excited in either direction.

In the commodity space, oil (-0.3%) remains under pressure although today’s decline is far less severe than we’ve seen in the past several sessions.  Rumors of OPEC increasing production in Q4 seem to be one driver as well as forecasts for inventory builds in the US this week.  Gold (+0.6%) continues to find buyers and remains above $2400/oz as Asian demand, from both central banks and individuals remains a key driver.  Copper (-1.0%) on the other hand continues to suffer, down more than -6.0% this month, as the slowdown in China’s economy weighs on demand for the red metal.

Finally, the dollar, which has been written off more times than I can count, is firmer again, back above 104.00 on the DXY.  For all the discussion about how the dollar is set to decline, a quick look at the DXY over the past year tells me that there is no discernible downtrend at all (nor is there an uptrend).  

Source: tradingeconomics.com

There has been an uptick in the long-term ‘dollar will die’ narrative, but certainly that has not had any impact on the ordinary activity that we watch regularly.  As to today’s activity, NOK (-0.5%) is leading the G10 lower although we are seeing declines averaging -0.25% elsewhere with one exception, JPY (+0.5%) which is bucking the trend.  From a currency perspective, one might think it is a risk off day, with investors flocking to havens, but given equity market strength, that is clearly not the case.  As to the EMG bloc, ZAR (-0.9%) continues to demonstrate impressive volatility overall, suffering on weakness in commodity markets and the CE4 are also soft, tracking the euro’s decline.

On the data front, we see Existing Home Sales (exp 3.99M) at 10:00 this morning and that is all she wrote.  It is difficult to get excited about today’s market and I suspect that absent some terrible earnings data that causes a real stock market decline, tomorrow when we wake up, things will be close to where they are now.

Good luck

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No Quid

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We have now a President Joe
Whose allies had asked him to go
Reject them, he did
For there was no quid
To pay him if he gave the quo
 
But Sunday, the news was revealed
That his campaign, he would now yield
It’s, therefore, not clear
Who’s running this year
‘Gainst Trump, it’s a wide-open field

 

Of course, you are all aware by now that President Biden has decided to abandon his re-election campaign and “to focus solely on fulfilling my duties as president for the remainder of my term.”  While he has endorsed Vice-president Kamala Harris, and since the announcment, there have been more endorsements for the VP, nothing is clear yet.  If nothing else, there has been no clarity whatsoever regrading who VP Harris would select as her running mate should she be the presidential nominee.

In the end, this adds uncertainty to the political situation and is likely to add some volatility to financial markets as well.  However, remember that political impact on financial markets tends to be relatively rare and if it is going to be significant, must be a genuine surprise.  Given the drumbeat from an increasing number of Democrat politicians and donors, this cannot be considered a real surprise.  I suspect that recent volatility will continue, but it is unlikely to increase substantially because of this.  However, if, say, the Fed were to cut rates next week, that would be a genuine surprise with a major market reaction.  (That is a hypothetical, I am not forecasting that.)  All told, the circus that is the US presidential campaign seems likely to simply continue for the next four months.

In China, the Plenum has ended
And rate cuts last night were extended
But is that enough
To help Xi rebuff
The weakness with which he’s contended

In the meantime, while all eyes around the world remain on the US as both allies and enemies try to determine what is happening, and likely to happen going forward, in the US regarding its presidential politics, China’s Third Plenum has ended, and the decisions have been made public.  Reuters has given an excellent, and succinct, description of what this meeting represents and why it is seen as so important.  The link above is a worthwhile, and quick read, but the money lines are [emphasis added]: “China’s ruling Communist Party commenced its so-called third plenum on Monday, a major meeting held roughly once every five years to map out the general direction of the country’s long-term social and economic policies,” and “This week’s third plenum, described by Chinese state media as “epoch-making”, is expected to deliver major initiatives to address the risks and obstacles related to China’s long-term social and economic progress.”  

So, in essence, this is the annual meeting where Xi and his fellow senior policymakers focus on the economy for the next decade.  This is quite timely given the economy in China has been consistently disappointing over the past several years with the most recent data releases showing that GDP growth declined to 4.7%, far below expectations as well as Xi’s target, in the second quarter.  Now, the law of large numbers would indicate it will be increasingly difficult for China, a $17 trillion economy, to continue to grow at previous rates, especially since its population is shrinking.  But that will not stop Xi from trying, or at least from having the government publish numbers that indicate he is succeeding.  

Ultimately, the problem in China remains that domestic consumer demand remains lackluster, largely because of the sharp decline in the Chinese property market.  In China, property had been a key store of personal wealth as there were limited vehicles in which citizens could invest.  But with that bubble having burst, and continuing to deflate, ordinary people do not feel the confidence to continue previous consumption patterns.  This is the underlying reason why China continues to focus on industry, and the genesis of the international angst over China’s manufacturing exports.  It is also the genesis of why tariffs are so prominent in discussions around Western policy circles.  The perception that China is dumping product offshore at a loss, undermining Western companies, and therefore Western job markets, is a powerful political motive to find some way to restrict said exports.  Tariffs are the most obvious first solution.

But China knows there are problems internally and that led to last night’s surprise cuts in the Loan Prime Rates for both 1-year and 5-year, with each being cut by 10 basis points.  I would look for further rate cuts shortly after the Fed starts to cut rates here (assuming they do so) whether that is next week or in September. Ultimately, I continue to believe that the PBOC will need to allow the renminbi to weaken, but it will be a long, drawn-out process as Xi remains steadfast in his view that the currency must be seen as a stable store of value.  Ironically, I believe we are entering a timeline when pretty much every nation will seek to weaken their currency to gain a trading advantage, but of course, if that is the case, then the only thing that will change is inflation will rise.  Oh well, policymakers around the world all have the same blind spots.

And those are really the only stories of note, although naturally, the first one is massive and will be the talk of the world for at least the next month until the Democratic convention produces a presidential ticket.  So, with all that in mind, let’s look at the market responses overnight.

Friday’s continued weakness in the US equity markets was mostly followed in Asia with the Nikkei (-1.2%) continuing its recent retracement from the highs made a week and a half ago.  And that red ink was seen throughout the region with one exception, the Hang Seng (+1.25%) as it responded to the PBOC’s rate cuts.  Interestingly, the onshore markets (CSI 300 -0.7%) did not.  However, in Europe, this morning, equities are having a great day with strong gains across the board.  While part of this is certainly simply a rebound from last week’s declines, it seems that there is a thesis brewing regarding Europeans now gaining confidence that Mr Trump will not be re-elected and so attracting some bullish views.  I don’t necessarily agree with that, but that seems to be the take.  As to US futures, they are firmer this morning as well, although given the sharp declines at the end of last week, this seems a reflexive bounce

In the bond markets, Treasury yields, which backed up despite the equity market declines on Friday, are softening a bit this morning, down 2bps, while European sovereign yields are mostly little changed from Friday’s levels, down about 1bp in most nations.  Right now, there is very little excitement in this space.

In the commodity space, oil prices are continuing their decline from last week with WTI back below $80/bbl as this market seems to believe that Mr Trump will win in November and that he is very serious about ‘drill baby, drill’.  Certainly, I would anticipate a Trump administration will be quite focused on increasing energy output and that should undermine prices.  As to the metals markets, gold (+0.5%) continues to find buyers although it did sell off sharply on Friday, but the rest of the space is under pressure, notably copper (-1.25%) as that Third Plenum did not encourage anyone that China would be subsidizing further economic activity and driving up demand for the red metal.

Finally, in the FX markets, the dollar is under modest pressure overall, although not universally so.  JPY (+0.4%) is the leading gainer in the G10 space as hopes for a Fed cut continue to impact views on the carry trade here.  However, the euro (+0.1%) and pound (+0.25%) are also edging higher, albeit on much less information.  Perhaps, the idea that Trump has been vocally calling for a weaker dollar is part of this movement, but that seems awfully early in the process.  On the flip side, AUD (-0.3%) is being weighed down by the decline in commodity prices.  In the EMG bloc, MXN (+0.35%) is the biggest gainer on the day although the CE4 currencies are all demonstrating their high beta with the euro as they have gained about 0.25% across the board.  Lacking new information, it appears that the peso is acting as a broad EMG proxy for traders wanting to short the dollar.

On the data front, the important stuff all comes at the end of the week with GDP on Thursday and PCE on Friday.

TodayChicago Fed National Activity0.3
TuesdayExisting Home Sales3.99M
WednesdayGoods Trade Balance-$98.0B
 Flash Mfg PMI51.7
 Flash Services PMI54.4
 New Home Sales640K
ThursdayInitial Claims239K
 Continuing Claims1869K
 GDP Q21.9%
 Durable Goods0.4%
 -ex Transport0.2%
FridayPersonal Income0.4%
 Personal Spending0.3%
 PCE0.1% (2.4% Y/Y)
 Core PCE0.1% (2.5% y/Y)
 Michigan Sentiment66.5
Source: tradingeconomics.com

Mercifully, there will be no Fedspeak at all this week as they remain in the quiet period.  The expected declines in PCE inflation will continue to support the September rate cut expectation which remains at a virtual 100% probability according to the CME Fed funds futures pricing.  That would be in concert with everything we heard from Fed speakers in the past several weeks, although the stronger than expected Retail Sales data has some claiming the Fed will remain on hold.  My read is there are fewer people discussing an impending recession, although that may be more about the cacophony of political discussion drowning things out, than a real change in sentiment.  Alas, I find myself far more concerned about an economic slowdown, although not necessarily with a corresponding decline in inflation.  Meanwhile, the dollar, while under some modest pressure, remains pretty solid and I wouldn’t look for a significant change, at least not until Friday’s data.

Good luck

Adf

A Bruising

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While many consider AI
The future, and can’t wait to buy
The stocks that convey
The future’s today
Perhaps that result’s not yet nigh
 
For instance, today’s biggest news
Is Windows is stuck with, screen, blues
What’s happened is that
A bug, not a gnat
Disrupted what most people use

Oops!  That seems to be the response so far by Microsoft and Crowdstrike as they try to troubleshoot and fix an apparent bug in the most recent release of their software.  The result of this bug is that computers all over the world that use Microsoft Windows as their operating system have, this morning, the dreaded ‘blue screen of death’, something with which far too many of us are familiar.  This problem has affected airports, airlines, banks and businesses of all stripes, essentially shutting down key processes and by extension the businesses themselves.  And consider, this is allegedly because of a single bug in a new rollout of security software.
 
We all know that bugs are an inherent part of the computing world, and most of us have lived through glitches in the past.  The difference this time, though, is that as more and more businesses move more and more of their computing operations into the cloud, the impact of any imperfection in the computer code grows exponentially.  This will not stop the migration of business operations to the cloud, of that I am certain.  But perhaps it will force some businesses to rethink what it means to be secure.
 
Additionally, given the hype surrounding AI, and the growing belief amongst a subset of businesses and investors, that companies which are not utilizing AI are going to wither and die due to its absence, perhaps this situation will cause some to rethink the pace of that utilization.  Remember, the essence of the AI hype is that the computers will be able to replace humans in many jobs, thus increasing efficiency and with it, profitability.  However, not only is the jury still out, but I would contend it has not yet started deliberations as; to date, I have not seen a single application where the results from AI are so superior to human actions, that the vast expenses to train and run AI applications make economic sense.  There is no killer app. 
 
Rather, the best analogy I have seen is that AI represents an advance similar to Microsoft Excel, where prior to the existence of spreadsheets, calculations by hand were incredibly time consuming and correspondingly expensive, but once Excel came along, analyzing data became a routine and much less expensive task.  The difference is Excel was cheap to buy and didn’t use much power to run.  AI is hugely expensive to train and then to run as well.  And bringing this full circle, removing operations from human oversight opens the door to situations like today, where things just don’t work.  Also, consider that Nvidia has sold ~$60 billion of chips in the past year, which means that companies like Microsoft, Alphabet, Apple and Meta have spent that much money on those chips as they build out their AI capabilities.  However, their revenues have not increased by nearly that much, certainly not from any AI initiatives.  Maybe the “killer” in killer app refers to what it is going to do to company profitability for those firms trying to lead this charge.
 
And, since this is a note about money and finance, let’s consider one other issue, the drive by many governments to eliminate cash.  Consider how things would be if cash was gone and all payments were electronic, but then a bug in the system resulted in banking and payments software shutting down.  Exactly how will firms conduct business?  I’m not talking about large-scale manufacturing operations, but rather about the grocery store or the McDonalds or pizza place where you want to get something to eat.  If there is no cash, what do you do?  Money is truly a remarkable invention and until the point when computer systems work 100% of the time, not 99.9%, the absence of a physical medium of exchange has the potential to be devastating to many people if the network goes down.  Just sayin’.
 
For many it was quite confusing
That stocks could absorb such a bruising
But data keeps hinting
That nobody’s minting
More profits, they just might be losing
 
Ok, let’s take a look at markets as we try to prepare for today’s activities.  It seems that as of 7:00am in NY, the bug has been fixed and things are starting to get back to normal.  But this is going to leave a mark.  Yesterday saw the first down day across the board in US markets in weeks with the DJIA (-1.3%) leading the way lower.  Most of Asia followed this move although Japanese declines (Nikkei -0.2%) were mitigated by the release of CPI data that showed no acceleration in prices in Japan.  The Hang Seng (-2.0%) reflected the tech sell-off and equities throughout the region were lower with one exception, mainland Chinese shares rose 0.5% after the end of the Third Plenum.  While many had hoped for some new economic stimulus, it seems that President Xi believes he is already on the right path and will not change.  As to European bourses, they are all lower this morning, following the trend started in the US yesterday while US futures are little changed right now.
 
Treasury yields, which traded higher during yesterday’s session despite the sharp sell-off in stocks, are unchanged this morning and European sovereigns, which closed before the full move was complete in the US have edged up the last 1bp to 2bps to maintain their relative spreads.  The ECB left rates on hold, as universally expected, but Madame Lagarde disappointed the doves by not promising a cut in September.  Despite weakening growth on the continent, inflation remains uncomfortably high it seems.  The same is not true in the US, though, where more Fed speakers gave the same message that things are going well, they are watching unemployment, and a rate cut is likely coming in the not too distant future.
 
In the commodity markets, oil edged lower yesterday after a nice rally Wednesday, and is continuing that this morning, down a further -0.5%.  But the pain trade is in metals with gold (-1.2%) and silver (-1.8%) leading the way lower on what appears to be some market technical issues rather than specific fundamental questions.  Both copper and aluminum are also softer this morning, but that is reflective of the continued concerns over economic growth.
 
Finally, the dollar is firmer again this morning, despite the modestly more hawkish discussion from the ECB and despite the ongoing belief that the Fed is preparing to cut rates at the September meeting.  Yesterday saw some impressive movement with BRL (-1.0%) and CLP (-2.0%) amid that broad-based dollar strength.  However, this morning, the worst performers are SEK (-0.6%) and NOK (-0.4%) with the rest of both the G10 and EMG blocs within 0.2% of Thursday’s closing levels.  The NOK is clearly following oil lower, and SEK is following NOK, as there has been no news or commentary from either nation that would offer a solid rationale for the move.  As I often explain, sometimes currency markets are simply perverse.
 
There is no US data due this morning, but we do hear from two more Fed speakers, Williams and Bostic. However, both have already spoken this week and there certainly hasn’t been any data that would likely have changed their views.  It seems all eyes will be on the equity markets this morning.  If they follow yesterday’s moves lower, I think we may see a more traditional risk-off outcome, but even if stocks rebound, it is hard to get too negative on the greenback.
 
Good luck and good weekend
Adf
 
 
 
 
 
 
 

Birds of a Feather

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We all know that birds of a feather
Eventually will flock together
So, yesterday’s color
From Williams and Waller
Implied cuts are when and not whether

 

As I described yesterday morning, and have been observing since Chairman Powell’s Congressional testimony, all the members of the FOMC are on the same page.  Yesterday it was NY Fed president John Williams and Governor Chris Waller who explained that [Williams] “It is not really a story about a ‘last mile’ or some part that’s particularly sticky.”  [Different inflation measures are] “all moving in the right direction and doing that pretty consistently,” and [Waller] “The time to lower the policy rate is drawing closer.  Right now, the labor market is in a sweet spot.  We need to keep the labor market in this sweet spot.”

This is the same message Powell gave us in his testimony and on Monday.  It is what we have heard from Barkin, Kugler, Daly and Goolsbee so far this week and are likely to hear from Daly and Williams again today and Bowman and Bostic before they all go quiet ahead of the July 31st meeting.  While there are those who are calling for a cut at the July meeting (Goldman Sachs analysts explained their reasons and in this morning’s WSJ, pundit Greg Ip did the same), and, even though I think it is an interesting risk/reward opportunity, with less than a 5% probability currently priced into the market, I do not believe that the FOMC is going to cut even if next week’s PCE data is extremely soft.  

Consider, though, that between now and the September FOMC meeting, we will receive two more each of CPI, PCE and payroll reports as well as hear all the talk from the Jackson Hole Symposium.  If, and it’s a big if, the economy shows that it is slowing more rapidly than currently seems to be the case, I would not rule out a 50bp cut then, although that is clearly not my base case.

I think it says a great deal about the market’s narrative overall that the ECB is meeting as I write and will release their policy statement and actions, if any, shortly and it is not a top ten topic of conversation right now. There is no expectation of movement, and the market has lined up for a September cut there as well.  In other words, everything remains all about the Fed.

Well, the Fed and the US stock market.  Since its high print a week ago, the NASDAQ is down by 4% with some of its key constituents (NVDA -14.3%, MSFT -5.1%, GOOGL -5.6%) having fallen much further.  At the same time, the DJIA has rallied 3.7% as the new discussion is a rotation from growth to value stocks as the latter will ostensibly be better served by the Fed’s now-imminent rate cuts.  At least, that’s the story that has become the universal belief set.  It certainly sounds good and is logical so let’s go with it.  However, I guess the question we need to answer is, can it continue?  

Can it continue for another day or two?  Certainly, given positioning that exists and the fact this new idea has developed some momentum, it can go a bit further.  But is this the beginning of an entirely new trend?  Somehow, I do not see that being the case.  Remember, the Magnificent-7 story had evolved from an idea into a cult, not dissimilar to the Bitcoin story.  People believed and were rewarded for doing so.  Plus, they had the benefit of feeling like they were taking part in the cutting edge of technology and economic activity.  But buying the Dow Jones, the very definition of old-line manufacturing and traditional service companies, is not something that inspires that same fervor.  My take is this narrative will soon end.  The thing for which we must all watch out, though, is that investors have now seen that their golden stocks, specifically NVDA, can go down, and go down quickly.  The thing about momentum is that once it gets going in either direction, it can continue for quite a while.  Stay alert.

Ok, let’s see how all this has impacted markets elsewhere in the world.  In Asia, the Nikkei (-2.4%) continued its recent struggles even though the yen (-0.5%) has slipped a bit overnight.  But just like in the US, the momentum in the Nikkei seems to be pointing lower for now as it tracks the NASDAQ.  Meanwhile, Chinese stocks showed modest gains with the rest of the region showing wildly disparate outcomes, (Korea -0.7%, Taiwan -1.6%, India +0.8%, Indonesia +1.3%) so it is hard to take a consistent message from here.  However, European bourses are all in the green this morning as they resemble the DJIA far more than the NASDAQ.  Granted, the gains have been modest (CAC +0.5%, FTSE 100 +0.7%, DAX +0.2%) but that is better than the red they have been showing lately.  Lastly, US futures at this hour (7:15) are reverting to the DJIA under pressure while the NASDAQ futures are higher by 0.4%.

In the bond market, yields are edging higher, pretty much by 2bps across the board in both Treasuries and European sovereigns.  However, I would contend that price action here has been a mere consolidation over the past several sessions after a sharp decline in yields since the beginning of the month.  In truth, during the past 3 sessions, there has been no net movement.

Commodity markets are mostly little changed this morning as oil, which rallied yesterday on further inventory draws according to the EIA, is unchanged and gold and silver are also unchanged this morning.  The one outlier is copper (-1.8%) which is continuing its recent declines as it seems the market is calling into question the demand side of the story.  While supply is currently adequate, Chinese economic weakness has been a major drag on the perception of demand.  I suspect that will change over time, but right now, the chart looks awful.

Source: tradingeconomics.com

Finally, the dollar is rebounding a bit this morning with modest gains against most of its G10 counterparts, although other than the yen, those gains are on the order of 0.1% to 0.2%.  In the EMG bloc, it is basically the same story, very modest USD gains with no outliers of which to speak.  One broader picture comment is that there have been several analysts who have discussed the dollar selling off sharply recently and how that is a harbinger of the end of the dollar’s dominance as the world’s reserve currency.  To put things in context, using the DXY as our proxy (which is very imperfect), for the past year, the DXY has traded between 101 and 107 and this morning it is trading at 103.8.  This is neither the story of a major move in either direction, nor of a trend of any consequence.  In order for things to change, we will need to see the Fed change its policy at a much different pace than the rest of the world’s central banks, and that is not yet an obvious outcome.

On the data front this morning, we get the weekly Initial (exp 230K) and Continuing (1860K) Claims data as well as Philly Fed (2.9) and the Leading Indicators (-0.3%).  I think we already know what the Fed speakers are going to tell us, as per the opening monologue, so absent some new piece of news, today is shaping up to be a very dull one.  The summer doldrums are clearly here.

Good luck

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No Choice

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Data indicates
The BOJ intervened
Did they have no choice?

 

Last night, Masato Kanda, the Vice Minister of Finance for International Affairs, colloquially known as Mr Yen explained, “I have no choice but to respond appropriately if there are excessive moves caused by speculators.”  He also explained, “We are communicating very closely with the authorities of each country and complying with international agreements, so there has been no criticism from other countries.”  In other words, while he did not actually come out and say that the BOJ intervened on behalf of the MOF, it seems pretty clear that is the case.  Certainly, a look at the price action again last night, as per the below chart, shows that is a viable reality.

Source: tradingeconomics.com

You may recall that USDJPY fell sharply in the wake of the CPI data last week and there was substantial question as to whether there was intervention at the time.  My view was the BOJ would not have been able to act on a timely basis and attributed the move to an overly long dollar positioned market and some algorithmic selling.  However, it appears that data from the BOJ’s accounts have since been released showing approximately ¥6 trillion (~$38.4 billion) was spent at the end of last week.  Now, given the Kanda comments above, the reality is that the MOF is drawing a line in the sand at 162.  

In fairness, this seems a propitious time to do so given the growing certainty that the Fed is finally going to begin its policy easing.  Of course, the main reason that the yen had weakened so much is that, not only had the interest rate differential widened substantially, allowing for, and even encouraging, the growth of the ‘carry trade’ where investors were happy to simply hold long forward USDJPY positions and wait for the time to pass and the profits to roll in.  But as well, there was no indication that the Fed was going to change its stance while the BOJ, though it had threatened to begin tightening policy, was doing so at a glacial pace.  However, that CPI number has dramatically altered opinions, not only of the trading community, but more importantly, of the Fed.  All the Fed comments we have heard since that data point have indicated a much greater willingness to consider easing policy.  Talk about both the goods and labor markets coming into balance are indicators they are ready to roll.  

We still have seven more Fed speakers this week ahead of the quiet period and I would wager that to a (wo)man, they will all say their confidence is growing that price pressures are receding, and they are watching the employment situation carefully.  As I wrote yesterday, the CME Fed funds futures market is pricing a 100% probability of a 25bp cut in September with some folks looking for 50bps.  Given the totality of the recent data where the probability of a recession seems to be growing, I agree a September cut looks likely.  This is not to say every data point is going to be pointing to weaker economic activity (e.g., yesterday’s Retail Sales data was much stronger below the headline number), just that will be the broad trend.

In this situation, with the market starting to believe that higher for longer is truly dead, the initial reaction will be for further dollar weakness.  Of course, once it is clear the Fed has begun to ease policy, we will see other central banks increase their pace of policy ease at which point the dollar’s decline will likely slow or stop.  Remember, FX is a relative game, so if everybody is easing policy at the same time, those interest rate differentials are not going to change very much at all.  However, commodity prices, especially precious metals prices, are likely to be the biggest beneficiaries.  As to stocks and bonds, the former have a much less certain path given the impact of declining inflation on profits, especially for the mega cap names, but bonds should perform well (yields declining) at least as long as inflation remains tame.  Just beware of a slow reversal of the inflation story.  Nothing has changed my view that 3.0% is the new 2.0%.

Aside from the yen news, last night was decidedly lacking in new information.  We saw UK inflation data print at the expected levels showing it has fallen back close to their target of 2%.  We saw final Eurozone inflation also confirming a 2.5% inflation rate.  While the ECB has essentially ruled out a rate cut tomorrow, a September cut seems highly likely at this time, especially if they have confidence the Fed is going to cut then as well.

So, let’s look at the overnight session.  After more record highs in the US, with the DJIA approaching 41K, the tone in Asia was more mixed.  Japanese shares (Nikkei -0.4%) fell as the yen’s strength continues to hamper profit expectations for the many exporters in the index.  Chinese shares, both in Hong Kong and on the mainland, edged higher by less than 0.1% as investors continue to wait to hear the results of the Third Plenum.  As to the rest of the region, gains in Australia and New Zealand were offset by losses in South Korea with most other markets little changed.  however, in Europe this morning, the screens remain red with losses across the board, albeit not as significant as we have seen in the past several sessions.  The DAX (-0.4%) is the laggard although all the major markets are lower.  Finally, at this hour (7:20), US futures are suffering led by the NASDAQ (-1.5%) although they are all under pressure.  It seems that the story about increased tariffs on Chinese goods as well as a ban on selling additional semiconductors to China doesn’t help the prospects of semiconductor companies that rely on China for their sales.

Interestingly, the bond market has seen yields edge higher this morning with Treasuries higher by 2bps and most of Europe up by 1bp.  Given the small size of the movement, I wouldn’t attribute much fundamental thought to today’s price action, and after all, 10-year Treasury yields have fallen 30bps since the first of the month, so a lack of continuation is not that surprising.

In the commodity markets, oil (+0.5%) is rebounding after a rough couple of days.  The weakening economy story is weighing on perceived demand and there is ample supply around.  Gold (+0.1%) is continuing to rally after closing at another all-time high yesterday while silver (-0.9%), which followed gold yesterday, is giving back a bit this morning.  Industrial metals are little changed this morning as they await further confirmation of the economic situation.

Finally, the dollar is under pressure this morning, falling substantially against almost all of its major counterparts, both G10 and EMG.  Aside from the yen (+1.1%) which we discussed above, the pound (+0.5%) is leading the way along with SEK (+0.6%) although the euro (+0.35%) is also firm.  In fact, the pound has risen above 1.30 for the first time in a year while the euro pushes the top of its 1.0650/1.0950 2024 trading range.  The laggard in the G10 space is CAD, which is unchanged on the day as market participants tie its performance directly to the dollar and anticipate the BOC to match the Fed going forward.  In the EMG bloc, though, there are two outliers which have suffered today, despite the dollar’s broad weakness, MXN (-0.6%) and ZAR (-0.7%).  The peso seems to be feeling the effects of weaker than expected economic data lately which has put Banxico into a difficult position as inflation remains above their target.  Will they cut to support the economy and undermine the currency?  That is the question.  As to the rand, aside from its status as the most volatile currency, the market seems to be reacting to a sharp decline in Retail Sales last month, -0.7%.

On the data front, this morning brings Housing Starts (exp 1.3M), Building Permits (1.4M), IP (0.3%) and Capacity Utilization (78.4%) along with the EIA oil inventories.  In addition, we will hear from Richmond’s Thomas Barkin and Governor Waller and then at 2:00 the Fed’s Beige Book will be released.  The current market narrative has quickly shifted to rate cuts, and more tariffs.  The upshot is the dollar is likely to remain under pressure while equities will have a more difficult time going forward.  If inflation remains quiescent, then bonds can do well, but the big winner through it all should be commodities.

Good luck

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Ending Debates

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There once was a banker named Jay
Who lived deep inside the Beltway
His words, when he spoke
Would sometimes evoke
A dovish response on the day
 
On Monday, we all got to hear
His views, and to some he was clear
Quite soon he’ll cut rates
Thus, ending debates
‘Bout ‘flation the rest of the year

 

While the market awaits this morning’s Retail Sales data (exp 0.0%, 0.1% ex autos), the focus for most traders and investors has been on Chairman Powell’s speech and discussion yesterday at the Economic Club of Washington DC.  The following headlines came from his prepared remarks and were highlighted all over the tape:

*POWELL: LAST THREE INFLATION READINGS DO ADD TO CONFIDENCE 

*POWELL: LABOR MARKET ESSENTIALLY NO TIGHTER THAN PRE-PANDEMIC 

*POWELL: JOB MARKET DOESN’T HAVE SLACK, ESSENTIALLY EQUILIBRIUM 

Then, following up in a Q&A, the money lines were these, “Now that inflation has come down and the labor market has indeed cooled off, we’re going to be looking at both mandates.  They’re in much better balance.”  

Not surprisingly, the market took this as confirmation that rate cuts are coming soon, although the futures market continues to price September as the likely first move.  While the meeting in 2 weeks has only a 9% probability priced in for a 25bp cut, looking at September’s pricing, 25bps are guaranteed and there are now some traders/investors looking for a 50bp cut, with that probability at 12.5%.  

Personally, I think there is a better chance of a July cut, especially if the PCE data next week are as soft as the CPI data were last week, than a 50bp cut in September.  My sense is that to get 50bps in September we would need to see the Unemployment Rate rise to 4.7% by that meeting with NFP pushing toward zero.  And while anything is possible, that seems highly unlikely in terms of the speed of the adjustment for those economic data series.  Other than the pandemic, even during deep recessions in the past, the rate didn’t rise that quickly.

As such, the market is now quite comfortable with the idea that the long-awaited initial rate cut will be here before the Autumnal equinox.  So, if that is the case, what does it mean?

One cannot be surprised that equity markets remain buoyant as we continue along the goldilocks trail of solid growth with slowing inflation.  Cutting rates into this environment will just add fuel to the equity fire.  There has been much made in financial discussions about the recent performance of small-cap stocks during the past several sessions.  It seems they have finally awoken from their deep slumber and have performed quite well, better even than the mega-cap tech names.  This has generated great excitement and we have seen several analysts raise their equity forecasts ever higher.  It seems that S&P 500 at 6000 is now a conservative view!

In the Treasury market, the yield curve has been slowly reverting to its more normal shape with 2-year yields falling more rapidly than 10-year yields.  This is the bull steepening that many had been anticipating, where yields overall decline, it’s just that the front end of the curve falls faster than the back.  History has shown that this type of movement typically foreshadows a recession, as the steepening accelerates when the Fed is slashing rates as the economy heads into a tailspin.  But maybe this time is different.  Ultimately, it can be no surprise that the yield curve is moving back to its normal shape of long-term yields higher than short-term yields.  After all, this inversion has been the longest in history.  I am just concerned that the speed of the onset of the coming recession may be much faster than most people assume.

As to commodity markets and the dollar, if the Fed is moving into a policy easing cycle, then commodity prices, especially precious metals and energy, ought to rally from here.  There may be a delay in industrial metals as a weak economy will weigh on demand there.  And the dollar will likely have a considerable down leg as well, although it will be tempered as central banks elsewhere around the world feel emboldened to be more aggressive with their own policy easing.

So, with that as a framework ahead of any potential future Fed actions, let’s look at what happened in the immediate wake of the Powell comments.  (As an aside, SF Fed President Daly also spoke yesterday and reiterated her concerns over the rise in the Unemployment Rate, indicating she was ready to cut.  Too, Chicago Fed president Goolsbee explained he was on the same page.)

Of course, given the Powell commentary, it is no surprise that US equity markets rallied yesterday with a new record high close from the DJIA although neither the NASDAQ nor S&P 500 could hold their record highs into the close.  Nonetheless, it was a strong day in the US markets.  In Asia, though, the picture was more mixed with the Nikkei (+0.2%) edging higher alongside a small move higher in USDJPY, and mainland Chinese shares (CSI 300 +0.6%) also gaining on hopes for some positivity from the Third Plenum.  But the Hang Seng (-1.6%) fell on fears of a Trump victory and the imposition of more tariffs on goods from there. The rest of the APAC space saw mixed reviews with some gainers (Taiwan, New Zealand, Korea) and some laggards (Australia, Malaysia, Singapore) although most of this movement was in small increments, 0.25%-0.35%.

European bourses, though, are having a tougher day as they are all lower on the session.  It seems that concerns over a Trump victory are manifesting themselves in concerns over European sales into the US or the imposition of tariffs here as well.  Adding to the misery, German ZEW data revealed a turn back down after several positive months, as concerns over the political situation in France and declining exports there weighed on the reading.  The upshot is that there is weakness everywhere, led by the CAC (-0.8%) in Paris and the IBEX (-0.8%) in Madrid.  (I think I wrote that exact sentence yesterday!). In the end, after a nice run as investors started to bet on ECB rate cuts, that story seems to be diminishing.  As to US futures, at this hour (7:30) they are modestly firmer, 0.2% or so.

In the bond market this morning, it appears that everyone around the world is excited about the possibility of Fed rate cuts as yields are lower across the board.  Treasury yields are down 6bps and European sovereign yields have fallen between 3bps and 5bps.  Even JGB yields slid 3bps overnight.  As has been the case for quite a while, the US yield story leads the global yield story.  If the Fed is going to start to cut, I expect that yields around the world are going to decline further, at least until inflation returns.

In the commodity markets, oil (-1.6%) is under pressure after weak oil demand data from China overnight undermined hopes that the Third Plenum would result in more government stimulus from the Xi government. This weakness is evident in industrial metals as well with both Cu (-0.65%) and Al (-1.0%) sliding further. However, precious metals are responding as one would expect to rate cuts, especially with inflation still around, as both gold and silver higher by 0.7% this morning, taking gold to new all-time highs.

Finally, the dollar continues to range trade overall with the DXY little changed on the day and hanging out just above 104, which happens to be its 60-year average!  While most currencies in both the G10 and EMG blocs are within +/-0.2% of yesterday’s closes, the one outlier is ZAR (+0.8%), which seems to be responding to some domestic plans to increase infrastructure investment in conjunction with private companies.

Other than the Retail Sales data mentioned above, there is nothing of note on the calendar today, although we will hear from new Fed governor Adriana Kugler.  At this point, I think it is becoming clear that the entire FOMC is on the same page; higher for longer is dead, long live the beginning of policy ease.  It is setting up to be a quiet session although I expect to see continues support for rate sensitive products like equities and precious metals.  The dollar, though, seems stuck as every central bank is ready to cut!

Good luck

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Fight!

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When fired upon, his response
Was jumping back up at the nonce
His cry was to “Fight!”
And some on the right
Now claim he’s a man, renaissance!

 

As John Lennon told us in 1977:

Nobody told me there’d be days like these
Strange days indeed

While this poet tries to keep politics largely out of the discussion, during these strange days, it is THE story of note.  Of course, by now you all not only have heard of the assassination attempt on former President Trump’s life on Saturday at a political rally in Butler, PA, but you all almost certainly have your own opinions about all the different theories, conspiracy and otherwise, so I will not go down that road.  I will simply note that it speaks poorly of the current political zeitgeist.  And while cooler heads are calling for a step away from the abyss, I have not yet seen the public take that step backwards.  Maybe soon.

In the meantime, my efforts are designed to help make sense of how both the political and economic storylines may impact the markets, and correspondingly, try to help those of you who need to hedge financial exposures, with a little understanding.  But history shows, when politics leads the news, the degree of difficulty goes up significantly.

The first thing to note is that sometimes, when momentous things occur in the real world, any financial implications take some time to manifest themselves.  With that in mind, I thought I would take a 30,000 foot view of the macroeconomic situation as we head into the new week.

The data of late calls into question
If we are now in a recession
With joblessness rising
And prices downsizing
Perhaps growth is seeing regression
 
And it’s not just here in the States
Where growth appears in dire straits
In China, as well,
Things have gone to h*ll
As data of late demonstrates

The question that is being asked more frequently is, are we currently in a recession?  While the data that has been released of late has been slowing, in the US it has not generally reached levels consistent with inflation, although there are some outliers that do point in that direction.  For instance, Friday’s Michigan Sentiment reading was pretty lousy at 66.0, well below expectations, and as can be seen in the below chart from the FRED data base, seemingly heading toward, if not already at, levels consistent with recessions (gray shaded areas).

Source: FRED Data base

As well, a look at the Citibank Economic Surprise Index, an index that tracks the difference between the actual data releases and the consensus forecasts ahead of time, shows that data is consistently failing to meet expectations.

Source: Yardeni.com

Here, too, the data does not appear to have quite reached levels seen in the previous two recessions, but recall that those two recessions were not garden-variety, with the GFC the deepest recession since the global depression in 1929, and the Covid recession remarkably short and sharp in the wake of the unprecedented government shutdowns that occurred in early 2020.  But going back in time, it is generally true that if data released consistently underperform expectations, it is a signal of overall economic weakness.

There are many other data points that are showing similar tendencies like the Unemployment Rate, which I have discussed lately, and is gaining momentum in its move higher.  As well, a look at almost all production factors or Retail Sales, which are reported in nominal terms, shows that when they are deflated by the inflation data of the past several years, real activity has been minimal or even declining.  A look at the below chart shows Retail Sales in both nominal and real terms with the latter actually declining since 2021 despite the rising nominal figures.  In other words, people are simply paying more for the same amount or less of stuff.

Source: brownstone.org

And this is not just a US situation.  As is typically the case, if the US is slowing, the rest of the world is going to suffer given its place as both the largest economy overall, and the largest mass consumer of everybody else’s stuff.  So, last night when China released its latest data, it showed the Q2 GDP disappointed, printing 4.7% while Retail Sales rose only 2.0%, far below Industrial Production, which grew 5.3%.  

Source: Bloomberg.com

In fact, this chart is the graphic representation of why nations around the world are calling for more tariffs on Chinese goods.  The combination of a still-collapsing property market there with the absence of significant government stimulus and a massive debt overhang has led President Xi to seek to increase industrial output and exports (remember the trade data from last week where exports soared, and imports actually declined) thus flooding other markets with goods and harming local manufacturing in other nations.  This is merely one more issue that policymakers must navigate amid a growing global concern over both political and economic unrest.

Summing it all up, I believe the case for there being a recession is growing strongly, and while nominal GDP is likely to remain positive, especially in the US given the government’s nonstop spending spree, real economic activity is suffering.  This has major implications for markets, especially as they appeared to still be priced for that perfect 10-point landing.  As I have written consistently, if (when) things turn more sharply, the Fed will respond quickly and cut rates and the impact on markets will be significant, especially for the dollar which will almost certainly decline sharply.  Just be nimble here.

I am sorry for the extended opening, but obviously, there is much ongoing.  So, let’s take a look at how things are behaving this morning.  At the opening of trading on Sunday evening, arguably the market that was showing the most impact was FX, where the dollar, which had fallen sharply at the end of last week in the wake of that CPI data, had rebounded a bit.  The narrative seems to be that the assassination attempt will secure President Trump’s reelection and the dollar will benefit from the economic policies that are believed to come with that.  As well, at this hour, (6:30) we are seeing US equity futures rallying, up 0.4% across the board.  That’s quite the contrast with the overnight session where the Nikkei (-2.5%) came under severe pressure as investors grow concerned over potential JPY strength.  Too, the Hang Seng (-1.5%) fell sharply although mainland shares have behaved better, little changed overnight, as investors look toward the Third Plenum with hopes that President Xi will unveil something to help the Chinese economy.

In Europe, though, this morning sees red across the screens, albeit not dramatically so.  The CAC (-0.4%) in Paris and the IBEX (-0.5%) in Madrid are the laggards, unwinding some of last week’s rebound, but every major market is under pressure this morning.  The lone piece of data released was Eurozone IP (-0.6%) which fell back into negative territory for the 6th time in the past twelve months.  Certainly, this is not pointing to a robust economy in Europe.

In the bond market, Treasury yields have backed up 4bps, also on the “Trump” trade, as investors believe that a Trump victory will result in more aggressive growth policies and higher US yields.  However, in the Eurozone, and in Asia, government bond yields are essentially unchanged from Friday’s levels as I don’t think foreign investors know what to think now about the US and how it may impact other nations going forward.  After all, if the US does grow more quickly in response to a Trump victory, will that mean more or fewer opportunities for tariffs and other mechanisms to affect foreign nations?

In the commodity markets, things are quiet with oil essentially unchanged this morning, as it consolidates at its recent highs.  Market technicians are looking for a break above $85.00/bbl, but I think that will require some substantially better economic data, which as explained above, does not seem to be in our immediate future.  In the metals markets, precious metals are little changed with gold consolidating above the $2400/oz level near its recent all-time highs, although copper (-0.9%) and aluminum (-0.8%) are both under pressure on the weaker economic picture.

Finally, the dollar is little changed overall this morning from Friday’s levels.  The early dollar strength seen last night has ebbed a bit although we still are seeing some strength against peripheral currencies like ZAR (-1.2%), NOK (-0.5%) and SEK (-0.5%).  The rand story seems to be more about local politics and the inability to get the new government up and running, while deeper investigation into the Skandies shows that this is a phantom move based on an unusual close on Friday.  My sense is there has really been no net movement here, as we have seen in the euro and the pound, both of which are mere pips from Friday’s closing levels.

On the data front this week, there is some important news as well as a series of Fed speeches starting with Chairman Powell this afternoon at 12:30.

TodayEmpire State Manufacturing-6.0
TuesdayRetail Sales0.0%
 -ex autos0.1%
 Business Inventories0.3%
WednesdayHousing Starts1.31M
 Building Permits1.39M
 IP0.3%
 Capacity Utilization78.6%
ThursdayECB Rate Decision4.25% (unchanged)
 Initial Claims235K
 Continuing Claims1855K
 Philly Fed2.9
 Leading Indicators-0.3%
Source: tradingeconomics.com

While there is not as much information due as we saw last week, I think the Retail Sales data will be instructive as another indicator of whether the economy is starting to roll over.  As well, watch for revisions from previous data releases as history shows that revisions to weaker numbers are another signal of a recession.  It will be quite interesting to see if Powell hints at a cut at the end of the month.  Certainly, the Fed funds futures market is not looking for that with <5% probability currently priced in although the September meeting is now a near-lock at 94%.  Remember, too, that after Friday’s speeches conclude this week’s group of 10 Fed comments, they will enter their quiet period and we won’t hear anything else until the FOMC meeting on July 31st.

While there is much to digest, my take is that we have rolled over in the economy.  The real question is about inflation and its ability to continue to decline.  Friday’s PPI data was the opposite of the CPI data on Thursday, showing hot prints for both headline and core, and indicative of resurging price issues.  Alas, I don’t rule out more stagflationary outcomes.  Funnily, I think that will ultimately help the dollar after an initial dip.

Good luck

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Unfair-ish

Posted on by

Well, Jay and the doves got their wish
As CPI data went squish
In fact, it’s not clear
Why cuts aren’t here
Already, it’s just unfair-ish
 
But something surprising occurred
‘Cause rallies in stocks weren’t spurred
But yields and the buck
Got hit by a truck
While gold was both shaken and stirred
 
Chairman Powell must be doing his happy dance this morning as the CPI data was the softest seen since May 2020 during the height of the Covid shutdowns.  Now, after four years of steadily rising prices, the Fed is undoubtedly feeling better.  One look at the chart below, though, shows that the inflation rate since the end of Covid was clearly much higher than that to which the population became accustomed prior to Covid.

 

Source: tradingeconomics.com

While the annualized data for both core and headline readings remains above 3.0%, there was certainly good news in that shelter and rental costs rose more slowly than they have in nearly three years.  However, for market participants, they are far less concerned over the whys of the soft reading than in the fact that the reading was soft and so they can now anticipate a rate cut even sooner than before.  As of this morning, the Fed funds futures market is now pricing a 92.5% probability that the Fed cuts in September and a total of 61bpsof cuts by the end of the year.  

In truth, I was only partially joking at my surprise they didn’t call an emergency meeting and cut yesterday. While the market is only pricing a 6% chance of a cut at the end of this month, I think that is a pretty good bet. Speaking of bets, the trader(s) who established that big SOFR options position earlier in the week is set to have a really good weekend!

To recap, we’ve had the softest inflation reading in 4 years and the market is anticipating the end of higher for longer.  As I have written consistently, my take is when the Fed starts cutting, the dollar will fall, commodity prices will rise, yields will start to decline, but if (when?) inflation reasserts itself, those yields will head higher.  And finally, stocks are likely to see support, but a very good point was made today that if prices stop rising, then so to do profit margins at companies and profits in concert.  Perhaps, slowing inflation is not so good for the stock market, even if it means that rates can be lowered.  Ultimately, there is still a lot to learn, and this was just one number, but boy, is everyone excited!

Did the BOJ
Take advantage of the news
And sell more dollars?

In the FX markets, the biggest mover, by far, was the yen, which at its high point of the session (dollar’s lows) had risen 4 full yen, or 2.5%.  The move was virtually instantaneous as can be seen in the chart below, and it is for that reason that I do not believe the BOJ/MOF was involved in the market.

Source: tradingeconomics.com

While I understand that the BOJ is pretty good at their jobs, it seems highly unlikely that the MOF made a decision in seconds and was able to convey that decision to Ueda-san’s team to sell dollars.  Rather, my sense is that since the short yen trade is so incredibly widespread as the yen has served as a funding currency for virtually every asset on the planet, the fact that the story about higher for longer may be ending led to instant algorithmic selling by hedge funds everywhere and a massive rally in the yen.  When the MOF was asked about intervention, Kanda-san, the current Mr Yen, gave no hint they were in and said only that people will find out when they release their accounts at the end of the month, by which time this episode will have been forgotten.  Remember, too, the yen has fallen, even after today’s rally, nearly 13% thus far in 2024.  It needs to rally a great deal further before it has any macroeconomic impact on Japan’s economy.  For my money, this was just a market that was caught long dollars and weak hands got stopped out, although Bloomberg is out with an article this morning claiming data showing it was intervention.  One thing in favor of the intervention story, though, is that this morning, USDJPY is higher by 0.6% and pushing 160.00 again.

And lastly, the story in China
Continues to give Xi angina
Domestic demand
Is stuck in quicksand
So, trade is his only lifeline-a
 
The other story that is on market minds this morning is about the Chinese data that was released last night.  The Trade Balance there expanded to $99B, much larger than last month and forecast.  A deeper look also shows that not only did exports grow more than expected but imports actually declined.  Declining imports are a sign of weak domestic demand, a harbinger of weak economic growth.  Later, they released their monetary data showing that loan growth, along with M2 growth, continue to slide as Chinese companies are reluctant to take on debt to expand.  While Xi’s government is pushing some money into the system, it is apparent that the collapsing property market remains a major obstacle to any sense of balanced economic activity in China.
 
Of course, this is a problem because of the international relation problems it continues to raise, notably with respect to charges of Chinese dumping of manufactured goods, and the proposed responses from both the US and EU on the subject.  While my crystal ball is somewhat cloudy, when viewing potential future outcomes of this situation it seems increasingly likely that both the US, regardless of the election outcomes in November, and the EU are going to impose tariffs and other restrictions on Chinese goods, if not outright bans.  Neither of these two can afford the social disruption that comes with domestic companies being forced out of business by subsidized Chinese competition.  While inflation looks better this morning than it did last month, its future is far less certain given this growing political attitude.
 
Ok, let’s see how markets have behaved in the wake of all the new information.  Arguably, the biggest surprise is that the US equity markets did not really have a good day with the NASDAQ tumbling -2.0% although the DJIA eked out a 0.1% gain.  Given the yen’s strength, it is no surprise that the Nikkei (-2.5%) fell sharply, and given the Chinese trade data, it is no surprise that the Hang Seng (+2.6%) rallied sharply.  But mainland shares were lackluster, and the rest of APAC was mixed with some gainers (Australia, India, New Zealand) and some laggards (South Korea, Taiwan, Malaysia).  European bourses, though, are all in the green as traders and investors there look to the increased odds of the US finally cutting rates, therefore allowing the ECB and other central banks to do the same, as distinct positives.  As to US futures, at this hour (7:00), they are unchanged to slightly higher.
 
In the bond market, after US yields fell sharply yesterday, with 10yr yields closing lower by 8bps, although they traded as low as 4.17%, a 12bp decline from the pre-data level, this morning, we are seeing a modest rebound with yields 1bp higher.  European sovereign yields are all firmer this morning as well as markets there closed before the US yields started to creep back up.  So, this morning’s 4bp-5bp moves are simply catching up to the US activity.  Lastly, JGB yields dipped 2bps last night as traders sought comfort in the decline in US yields.
 
In the commodity markets, yesterday saw a sharp rally immediately after the CPI print with gold jumping nearly $40/oz and back above $2400/oz, while oil had a more gradual rise, although is higher by nearly $1/bbl since the release.  This is all perfectly in line with the idea that the Fed is going to start to cut rates soon.  However, gold (-0.4%) is giving back some of those gains today.
 
Finally, the dollar, which fell sharply against all currencies after the CPI print, notably against the yen, but also against the rest of the G10 and most EMG currencies, is slightly softer overall this morning with both the euro (+0.15%) and pound (+0.3%) doing well and offsetting the yen’s weakness this morning.  Elsewhere throughout the G10 and EMG blocs the picture is far less consistent with CE4 currencies all following the euro higher although ZAR is unchanged as it suffers on gold’s weakness this morning. 
 
On the data front, this morning brings PPI (exp 0.1% M/M, 2.3% Y/Y) and its core (0.2% M/M, 2.5% Y/Y) although given yesterday’s surprisingly low CPI data and the ensuing market movements, it doesn’t feel like this number has the potential for much surprise.  After all, a soft reading would already be accounted for by the CPI and a strong one would be ignored.  We also see Michigan Sentiment (exp 68.5) at 10:00, but that, too, seems unlikely to shake things up.  There are no Fed speakers scheduled and really, the big thing today is likely to be the Q2 earnings releases from the big banks.
 
It has been an eventful week with Powell’s testimony being overshadowed by yesterday’s CPI data.  While the market is almost fully priced for a September cut, I think the best risk reward is to expect the Fed to act at the end of July.  Next week we hear from 10 Fed speakers, including Chairman Powell on Monday afternoon.  I would not be surprised to hear them start to guide markets to a July cut which would bring dollar weakness alongside commodity price strength.  As to bonds and equities, the former should do well to start, but as yesterday showed, and history has shown, equities tend to underperform when the Fed starts cutting rates.
 
Good luck and good weekend
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If Forecasts Ain’t True

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Chair Powell repeated his views
That if Unemployment accrues
The time to cut rates
To meet their mandates
Could very well soon lead the news

Investors have taken this cue
And built up positions, beaucoup,
Designed for a peak
If CPI’s weak
Beware, though, if forecasts ain’t true

It is not clear to me why the punditry is more convinced this morning than they were yesterday morning that Chairman Powell and the Fed are now more focused on the Unemployment situation.  After all, Powell’s opening remarks in front of both the Senate on Tuesday and the House yesterday were identical, and everybody knew going in that would be the case.  But it seems, based on the commentary this morning, that suddenly things that were still blurry before became crystal clear.

Look, it can be no surprise that as the Unemployment Rate rises, the Fed is going to pay attention.  Not only is it part of their mandate, but it is also a touchpoint for politicians as they preen in front of their constituents.  But, in the end nothing has changed since Tuesday’s testimony when Powell highlighted that he and the FOMC were closely watching the evolution of the labor market as well as prices.

At least, nothing has changed on the policy front.  However, the market narrative, as is its wont, has suddenly turned to a far more bullish stance on fixed income in general, and on short-term rates in particular.  It appears that, not for the first time this year, there have been some very large options positions established in the SOFR market looking for a Fed funds rate cut sooner rather than later and a total of three cuts this year.  A quick look at the Fed funds futures market continues to show that the probability of a September cut remains just north of 71% with another cut likely by December.  As such, the fact that somebody is risking $2 million in premium on a third cut implies a great deal of conviction.  A key for this position’s success will be today’s CPI report as a benign outcome will very clearly drive more traders into the camp of more cuts this year.

So, let’s turn our attention to CPI.  Current median expectations are for a 0.1% M/M rise in the headline number, leading to a 3.1% Y/Y outcome and a 0.2% M/M rise in the core number leading to a 3.4% Y/Y outcome.  The broad story is the ongoing analyst belief that shelter costs are set to decline (although they have been incorrectly forecasting that for more than 2 years), along with the continued decline in used car prices and auto insurance, will more than offset any pesky things like food and energy costs rising.  This poet does not have an inflation model to tweak so I can only offer my lived experience, and that remains highly doubtful that prices have stopped rising.  But, the only thing that matters is the numbers, regardless of how we all feel about them, so we will be awaiting, with baited breath, to see if the BLS has determined if the pace of our cost of living has slowed.

As we turn our attention to the rest of the world, apparently everybody believes that to be the case, as risk assets are rising all over.  I cannot find an equity market anywhere that has sold off in the session with the Nikkei (+0.95%) rising to a new all-time high and the Hang Seng (+2.1%) rebounding smartly from yesterday’s levels.  The same is true throughout Asia with Chinese (+1.1%) and Australian (+0.9%) shares also having good days.  In Europe, the gains have been less impressive, on the order of +0.2% to 0.3%, but they are consistent as everybody followed yesterday’s strong US equity performance where all three major indices rose more than 1%.  While US futures this morning are tinged slightly red, the losses are tiny, less than -0.1%.  It seems that everybody is all-in on the idea that the Fed is cutting rates soon.

In the bond market, though, things are slightly different.  While Treasury yields have edged lower by 1bp this morning, all European sovereign yields are moving in the opposite direction, with rises of between 2bps and 3bps.  The inflation data that was released from the continent this morning certainly didn’t demonstrate a rebound, so this seems more akin to a trading response to recent yield declines.

In the commodity markets, oil prices (+0.3%) are continuing their rebound from yesterday after EIA data showed larger inventory draws than expected.  Precious metals markets are also benefitting this morning from the Fed story as the idea of rate cuts generally supports that sector.  The only laggards are industrial metals with both copper and aluminum under a bit of pressure today, but that is after a few solid sessions.

Finally, not surprisingly, the dollar is a touch softer on the idea that US yields may soon be declining.  While the bulk of the movement has been modest, it is fairly consistent with the euro and the pound both higher by 0.15% (the pound benefitting from somewhat stronger than expected GDP data this morning) while most of the rest of the G10 is little changed.  The one exception is NOK (-0.9%) which still seems to be suffering from yesterday’s softer than expected CPI data.  In the EMG bloc, the bulk of the movement has been for stronger currencies with the most notable, in my view, CNY (+0.2%) which has been steadily depreciating but has reversed course on the lower US rate narrative.  I maintain my view that if the Fed is prepping the market for cuts, the dollar has a good distance to fall.

In addition to the CPI data, we see the weekly Initial (exp 236K) and Continuing (1860K) Claims data at 8:30.  The Atlanta Fed’s Raphael Bostic speaks later this morning, but again, after Powell just opened the doors for easier policy based on the employment situation, I don’t foresee this having a big impact.

The risk today is that the CPI data is hotter than expected as everybody is lined up for a soft reading.  If the data is soft, look for the current trends to extend, so higher risk assets and lower yields.  But, if CPI prints higher than expected, there will be a very quick reversal of views, at least for the short run, and I expect we can see a pretty sharp correction, at least for today.

Good luck
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