Not Yet Diktat

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The punditry’s now all atwitter
That joblessness is a transmitter
Of lower inflation
Thus, Powell’s flirtation
With turning into a rate slitter

But so far, the confidence that
Inflation is falling toward flat
Has not yet arrived
And could be short-lived
So, rate cuts are not yet diktat

As expected, Chairman Powell’s testimony to the Senate Banking Committee was THE story of the day yesterday.  However, it was not that interesting a story despite scads of digital ink spilled on the subject.  What was everybody so excited about?  Well, here are some key quotes and you can be the judge.  In his opening remarks, he explained, “Elevated inflation is not the only risk we face,” and “The latest data show that labor-market conditions have now cooled considerably from where they were two years ago—and I wouldn’t have said that until the last couple of readings.”  Scintillating, I know!

What does it mean?  The quick and dirty is that the Fed has become a bit more evenhanded in their views that the employment side of their mandate may soon force decisions that conflict with the inflation side of their mandate.  So, if the Unemployment Rate continues to rise going forward, even if inflation does not continue its recent downward trajectory, the Fed may decide employment is now more important and respond.

Doves everywhere are clamoring for the Fed to cut before it’s too late and the labor market collapses.  Meanwhile, hawks will explain that at 4.1%, while that is higher than the recent past, the Unemployment Rate remains quite well behaved, especially in the context of NFP results that have averaged 222K over the past six months.

But we really know that this was a nothingburger because a look at markets showed that nothing happened.  The major equity indices all closed +/- 0.15% while 10-year Treasury yields were unchanged from the morning and higher by 2bps from Monday.  Neither did the dollar or commodities move in any substantial way from their early morning levels.   So, now Powell will speak to the House Financial Services Committee today, give identical testimony and fend off whatever inane questions they ask there.  But he was clear that there would be no indications of the timing of any policy changes and that is certain to be true today as well.

And truly, that was the entire session yesterday.  There was no data released and aside from Powell, nobody cared about what other speakers said.  And as you can see above, Powell didn’t really say that much.  So, let’s take a look at the overnight session to see if there was anything interesting at all.

In equity markets, the one place that is trying to hang with the US tech sector is Japan, where the Nikkei rallied another 0.6% overnight and is now higher by 30% this year, second only to the NASDAQ’s 34% rise.  While some of this is excitement about tech, I believe a larger proportion of the gains is due to the yen’s ongoing weakness as many of the companies in the index have their JPY earnings benefit greatly from their export sales.  Elsewhere in the time zone, though, equities were under modest pressure with Chinese, Hong Kong and Australian shares all sliding a bit.  The news of note here was Chinese inflation data, which showed limited price pressures as consumption on the mainland remains lackluster, at best.

Europe, however, is in a much better mood as all the major indices around the continent are higher this morning led by Spain’s 1.0% rise but followed closely by France (+0.9%) and Germany (+0.75%).  Here, too, there has been a lack of data, so I guess the narrative has become that despite the electoral outcomes, investors have overcome their concerns that the new governments will destroy their respective economies.  I guess the one truth is that the new governments will try to spend as much money as possible as quickly as possible, and so support economic activity.  Meanwhile, the recent pattern in the US, higher NASDAQ, lower DJIA and limited movement in the S&P is playing out in the futures this morning as well.

In the bond market, Treasury yields have slipped back 2bps overnight, trading at the same levels as Monday, but there has been a much more aggressive bond rally in Europe with sovereign yields falling between 6bps and 9bps this morning.  It appears that investors are counting on the Fed to maintain its inflation fight, thus helping reduce global inflation pressures, and are responding to declining inflation from China as a rationale to add duration to their portfolios.  While the direction of travel is no surprise given the Treasury yield decline, it is a bit surprising the movement is this large.

In the commodity markets, oil (-0.2%) continues under pressure as the combination of relief that Hurricane Beryl had limited impacts and the potential for a cease-fire in Gaza have oil traders questioning the recent price action.  Arguably, a bigger concern is that slowing economic activity may begin to reduce demand, but that is not the main story today.  In the metals markets, both gold and silver are edging higher this morning while copper is essentially unchanged.  I continue to believe that the Fed is going to be the key driver in this space as if they do cut rates sooner than currently forecast, it seems likely that commodity prices will rise while the dollar declines.

But the dollar is not yet declining in any meaningful way with the DXY still trading above 105.00.  The big outlier today is NOK (-0.95%) which is not only suffering on oil’s recent declines but is also responding to this morning’s inflation data which showed more significant progress on returning it to target.  Core inflation printed at 3.4%, down from 4.1% last month and below the 3.6% estimates.  This has encouraged traders to believe the Norgesbank is going to cut rates sooner than previously expected, hence the krone’s decline.  As to the rest of the G10, NZD (-0.9%) is also under pressure as the RBNZ was less hawkish than anticipated last night, although they did leave rates unchanged.  After those two, though, the G10 is dead.  One thing to note is that USDJPY is back at 161.50, just a few pips below the most recent dollar highs seen last week, although, given the very calm nature of the move, we have not heard much from the MOF on the subject.

As to the EMG bloc, MXN (+0.45%) is continuing its rally after yesterday’s higher than expected CPI data from south of the border has traders looking for continuing policy tightness, pushing back any thoughts of an early ease.  Elsewhere, ZAR (-0.4%) continues its wild back and forth, so much so that it is difficult to pin any fundamentals to the movement.

There is no data of note today so all eyes will be on Chairman Powell when he testifies at 10:00 to the House.  In addition to Powell, we will hear from Governors Bowman and Cook as well as Chicago Fed president Goolsbee.  But really, can anything they say overshadow Powell?  I think not.

It is shaping up as another dull day as it seems unlikely Powell will tell us anything new.  As such, I would look for a quiet session as we all await tomorrow’s CPI data.

Good luck
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Some Mystique

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The Chairman is ready to speak
To Congress, and there’s some mystique
Will he indicate
The Fed’s favorite rate
Is likely soon in for a tweak?
 
Or will Chairman Powell explain
Inflation continues to drain
The ‘conomy’s health
And with it the wealth
He’s garnered through much of his reign

 

With recent elections behind us, market participants now turn their attention to Chairman Powell and his testimony today before the Senate Banking Committee and tomorrow before the House Financial Services Committee.  Of course, all eyes and ears will be searching for clues that the recent spate of softer than expected economic data has been sufficient to allow him, and his FOMC brethren, to gain the necessary confidence to cut the Fed funds rate.  Recall, to a (wo)man, every speaker has indicated that things were looking pretty good, but that they needed to see several months of this type of economic data before acting.

Lately, the punditry has become far more vocal about the possibility of a recession, with a number of well-known analysts claiming we are already in that state.  They point to the employment situation, notably the discrepancies between the establishment and household surveys.  Their argument revolves around the idea that the number of people working continues to decline despite the claim that there are more jobs being created.  It is true that job growth has been driven by an increase in part-time work, so this is not impossible.  And it is also true that when part-time work is ascendant, it typically signifies a weaker economy.

These same pundits point to the discrepancy between GDP and GDI (Gross Domestic Income) which ostensibly measure the same thing from different sides of the ledger.  Over the past year and change, as can be seen from the below chart, GDP has been growing at a faster rate than GDI with the difference between the two now at 2.3% of GDP.  

Source: St Louis Fed FRED data base

Putting that in context, the most recent Atlanta Fed GDPNow forecast for Q2 2024 has fallen to just 1.5% annual growth.  The implication is that GDP growth may well be negative.  Over time, these two measures get revised so that they are the same, but this particular discrepancy is both wider than normal and has been ongoing for a relatively long time in the history of the two.  Something is amiss and many pundits believe that the result will be GDP will be revised lower to match GDI rather than the other way around.  In other words, GDP growth is slower than reported and the chances we are currently in a recession are greater.

Of course, the other side of the story is also widely believed by other pundits who point to the consumer, which as evidenced by yesterday’s Consumer Credit data, continues to spend aggressively.  They also rely on the continued growth in the NFP data as a key indicator of economic activity and remain confident that the economy is simply in a slow patch during a continued growth period.

Now, it seems to me that the Fed are likely rooting for a bit more aggressive economic slowdown as that would give their models the signal that inflation is well and truly under control.  Perhaps Chairman Powell will give us those hints this morning, although he will certainly not explain that outright to the Senate.  (The one certainty from this morning’s testimony is that certain Senators from the Northeast are sure to rail at the current level of interest rates and berate Mr Powell for not having cut them already.)  In any event, that is really all we have on the calendar today, and likely the biggest news until Thursday’s CPI release.  After all, tomorrow’s House testimony will be identical by Powell, although we can look forward to even stupider questions from the likes of Representatives Maxine Waters and Ayanna Pressley.

And so, to markets.  Yesterday’s lackluster US session has seen a mix of results elsewhere in the world.  In Asia, the Nikkei (+2.0%) rallied sharply to new all-time highs, on the back of tech share enthusiasm and the AI story as well as the still weak JPY.  While the BOJ is slated to meet later this month, there is no clarity as to whether they will tighten policy given the still mixed data from Japan.  As well, Chinese shares (+1.1%) and Australian shares (+0.9%) both had solid performances although the Hang Seng was unable to gain any traction and was unchanged on the day.

In Europe, all is red this morning, led by the CAC (-0.8%) as it seems investors are beginning to understand that the electoral outcomes may not have been net beneficial for both the French and UK economies.  While the two nations have different issues (no leadership in France, a socialist one in the UK) I fear that both nations will have manifest economic problems going forward when it becomes clear that increased spending is unaffordable.  But for now, absent any additional data, investors are lightening up on exposures there.  US futures, though, are edging higher at this hour (8:00).

In the bond markets, yields are starting to turn higher again despite some lackluster economic data.  Treasury yields are higher by 2bps and across the UK and Europe, yields are higher by 3bps to 4bps universally.  This means there have been no changes to the spreads of OATs to Bunds, but it may not be that welcome overall.

In the commodity markets, oil (-0.4%) remains under pressure as concerns over US production being reduced by Hurricane Beryl have diminished now that wind speeds have fallen after landfall.  It did not impact the offshore drilling significantly.  As to metals markets, after a rough day yesterday, this morning both precious and industrial metals are little changed overall, arguably awaiting the next key catalyst, whether that is from Powell or CPI or something else.

Finally, the dollar is a bit firmer this morning across the board.  Both the euro (-0.15%) and the pound (-0.15%) have performed surprisingly well lately given the political backdrop.  Perhaps that is a hint that politics is not necessarily a key short-term driver of FX rates.  However, today, along with the rest of their G10 brethren, they are under pressure.  In the EMG bloc, ZAR (-0.6%) continues to demonstrate the greatest amount of volatility amongst the most traded currencies and is under pressure alongside metals prices.  As well, both HUF (-0.3%) and CZK (-0.4%) are showing their high beta response to the euro’s weakness.  However, today appears very much to be a dollar day, not a currency day.

The NFIB Survey was released at a better than expected 91.5, although that level remains in the lowest decile of readings in the history of the series.  In addition to Powell, we hear from Vice-chair for supervision Barr as well as Governor Bowman during the day, but really, it is all about Powell.  Personally, I doubt he tells us anything new and do not expect him to hint strongly at a rate cut coming soon.  However, if he does, look for the dollar to decline sharply.

Good luck

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A Shocking Surprise

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On Wednesday the data was dreck
On Friday, twas more of a wreck
The read’s now that growth
Is set for more slowth
Will this break the Fed’s bottleneck?
 
Meanwhile, in a shocking surprise
In France, tis the Left on the rise
But no party there
Is willing to share
Their power and reach compromise
 
And while day-to-day matters greatly
The populists, worldwide, are lately
Ascending to power
And ready to shower
Their voters with cash profligately

 

This morning, the world is a very different place than it was when I last wrote.  Broadly speaking there are three key stories of note; US data was much weaker than expected, the French election surprised one and all with the coalition of hard-left parties winning the most seats, although no group is even close to a majority of the French parliament, and the questions over President Biden’s capacity to remain on the job, let alone his ability to be president for the next four years, have been coming fast and furious from the mainstream media, many Democrats in Congress and the Democratic donor base.

So, let’s address them in order.  On the US data front, arguably the best release was the Trade Balance printing at a slightly smaller deficit than forecast by the Street.  Otherwise, ISM Services was miserable at 48.8, Factory Orders fell -0.5%, -0.7% ex Transport, and Initial and Continuing Claims both rose to new high levels for the cycle.  And that was just Wednesday.  On Friday, while the headline NFP number did beat forecasts, once again, there were major revisions lower to the past 3 months, -111K, the Unemployment Rate rose to a new high for the cycle at 4.1%, its highest level since November 2021 and a continuation of the recent uptrend in the data.  A look at the chart below seems to show a defined trend higher in the Unemployment Rate, and as I explained last week, this is a statistic that tends to have momentum once it gets going.  I would argue this number is going to continue to climb higher as the year progresses.

Source: tradingeconomics.com

As well, the biggest piece of the report was an increase of 70K Government jobs, compared to just 136K Private sector jobs and a loss of -8K in Manufacturing.  The one thing we know is that government jobs do not add to economic growth as they are the least productive of all.  

The upshot is that based on the data from Wednesday and Friday, the story of still strong growth in the US has clearly been called into question.  Will Powell, who testifies before Congress this week, pay homage to the weaker data and hint that perhaps higher for longer has reached its sell-by date?  While this is only one set of data, and he has been adamant that he needs to see several months of data, the market is becoming more convinced that a September rate cut is coming as the Fed funds futures probability of that cut has risen to 75%.  It should be an interesting week given both the CPI release and the Powell testimony.

On to the French and what was truly a shocking outcome, at least on one level.  After the first-round last week, the abject fear by the press in France, and all of Europe, of the idea that a right-wing government could come to power in a key European nation resulted in the numerous parties on the Left working with President Macron’s centrists to try to prevent any such thing from happening.  As such, they strategically pulled candidates from different seats in order to prevent splitting the vote and allowing Marine Le Pen’s RN party from achieving a majority.  And they were effective in that.  Alas, they now have a completely unworkable setup where no party has anywhere close to a majority and so passing any legislation will be nigh on impossible.  

Jean-Luc Melenchon, the Left’s most well-known proponent, and leader of a sect called France Unbowed, has declared that he wants his party’s agenda implemented full-on.  That means reducing the retirement age, raising wages and establishing price controls on power and energy as well as expanding wind and solar power.  Of course, the math on that won’t work, even if they raise taxes, but that certainly never stopped a populist once in office.  

Interestingly, while on the surface it would have been easy to conclude that French OATs would see yields rise vis-à-vis German Bunds as fears of larger government deficits build, that has not yet been the case.  In fact, this morning, yields across Europe are little changed as bond traders and investors seem to be ignoring the situation.  The rationale here is that given no group has a majority, the probability of having any party’s wish list implemented by parliament is vanishingly small.  The most likely outcome is a year of muddling through, with no decisions of any substance made and another election held next summer.  (By law, President Macron must wait one year after an election to call a second one.)  In fact, it will be very interesting to see how a prime minister will even be elected in parliament as it seems unlikely that any individual will have support of a majority of the chamber. 

As to the other potential impacts of this election, neither French equities nor the euro have shown any substantive movement as traders in both these spaces see the same situation, a very low probability of any substantive policy changes given the lack of parliamentary leadership.  Ultimately, while the political ramifications in France are large, the economic ones are not as obvious yet.

This is different than in the UK, where Keir Starmer and his Labour party swept to victory as widely expected.  In the UK, Labour runs the show now and so will be able to implement whatever policies they deem appropriate.  So far, there has been little in the way of concern demonstrated by market participants for UK assets either, but I fear the risk here is greater as the policy prescriptions that Starmer favors are likely to have a much larger negative economic toll.

Finally, in what must be THE most surprising aspect of the presidential election cycle in the US, former President Trump is NOT the major topic of conversation.  Rather, in the wake of the debate 10 days ago, the only topic is President Biden’s fitness for office now, and in the future.  This is certainly not a good look for the US, especially with a key NATO meeting this week in Washington D.C., but it is the current situation.  Thus far, US risk assets have ignored all this, arguably because the fiscal spending spigot has not been turned off.  But it is not hard to imagine that there are myriad problems ahead as Secretary Yellen tests just how many bonds the US can issue and still find buyers.

So, with all that remarkable news in our memory banks, let’s look at how markets are behaving this morning and what happened overnight.  Ironically, it seems Asian investors are the ones most upset by the European elections of last week as equity markets throughout the time zone fell.  The Hang Seng (-1.55%) was the laggard, although China (-0.85%) and Australia (-0.8%) also performed quite poorly and the Nikkei (-0.3%) was a star by comparison.  There was very little in the way of economic data to drive things here, so this seems merely to be part of the usual ebb and flow of markets.  The real surprise, though, is in Europe where equity markets are higher across the board.  Despite the pressures for more spending and higher taxes that will come from both France and the UK, the CAC (+0.45%) and the FTSE 100 (+0.3%) are nonplussed by the situation.  In the UK, as laws are implemented, I expect there will be a bigger reaction, but in France, perhaps the view that there is gridlock which will prevent any new legislation of note, means equities can run higher.  As to the US, futures markets at this hour (7:00) are basically unchanged.

As mentioned above, bond yields throughout Europe have been limited in their movement while Treasury yields have rebounded 2bps from last week’s declines.  While I was out, the weak data certainly encouraged bond investors to increase allocations as visions of a Fed rate cut grow.  For now, the bond markets are not signaling any concerns over the electoral outcomes.  My take is that may be appropriate for France and the continent, but I would be wary of UK Gilts given the likelihood of a downturn in the fiscal situation as more spending is implemented by parliament.

In the commodity markets, the end of last week saw sharp rallies in the metals markets, perhaps on those fears of a RN electoral victory in France, or perhaps on expectations of quicker Fed rate cuts, but this morning, commodities across the board are softer, with oil (-1.3%) leading the way, although WTI remains well above $82/bbl.  As to the metals, both precious (Au -0.7%, Ag -0.7%) and industrial (Cu -0.2%, al -0.1%) are giving back some of those gains.

Finally, the dollar is somewhat higher than it closed on Friday, although not very much.  In the G10, NOK (-0.5%) is suffering on oil’s decline which has dragged SEK (-0.4%) along with it.  The yen (-0.1%) which fell to near 162 vs. the dollar last Wednesday recouped some of those losses into the weekend but seems to have bounced with 160.00 now showing technical support in USDJPY.  In the EMG bloc, HUF (-0.8%) is the laggard as despite a lack of data, it seems markets are looking at the right-leaning politics of PM Orban and see continued friction between Hungary and the rest of the EU, specifically when it comes to subsidy payments.  KRW (-0.5%) is softer as the government’s efforts to expand trading hours in the currency have not yet borne fruit although it is still early days.  They are trying to improve onshore currency trading in order to allow more convertibility for equity investors and thus get Korean stock markets included in more global indices.

On the data front, while the calendar is not packed, it is impactful.

TodayConsumer Credit$10B
TuesdayNFIB Small Biz Optimism89.5
 Powell Testimony 
WednesdayPowell Testimony 
ThursdayInitial Claims240K
 Continuing Claims1860K
 CPI0.1% (3.1% Y/Y)
 -ex food & energy0.2% (3.4% Y/Y)
FridayPPI0.1% (2.3% Y/Y)
 -ex food & energy0.2% (2.5% Y/Y)
 Michigan Sentiment68.5
Source: tradingeconomics.com

In addition to Powell, 5 other Fed speakers are slated, but clearly all eyes will be on Powell.  And the CPI reading.  After last week’s soft data, there is a growing expectation that price pressures are going to fall back further and allow the Fed to cut rates.  Certainly, if CPI prints soft, I expect to see a rally in risk assets, but we must wait to hear Powell’s spin ahead of those numbers.

Net, the market is seemingly turning toward a more dovish approach with visions of rate cuts coming fast and furious once they get started.  That seems excessive to me, but for now, it is hard to like the dollar’s status as rate cut expectations build, especially given the market has ignored potential problems elsewhere.

Good luck

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Not Yet Sealed the Deal

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Said Powell, the progress is real
And though there are many with zeal
To quickly cut rates
Our dual mandates
Explain we’ve not yet sealed the deal
 
Meanwhile, as the holiday nears
Investors, ‘bout some stuff, have fears
The UK will vote
And Labour will gloat
Then Payroll, on Friday appears
 
At this stage, the Payroll report
Is forecast to, last month, fall short
But if the U Rate
Once more does inflate
The doves, for rate cuts, will exhort

The Fed whisperer himself, the WSJ’s Nick Timiraos, did an excellent job covering the Chairman’s speech in Sintra, Portugal at a big ECB confab yesterday, so let me give it to you straight from him.  [emphasis added]

“We’ve made a lot of progress,” Powell said Tuesday on a panel with other central bankers at a conference in Portugal. After serious shortages two years ago that sent wages up sharply, the labor market has “seen a pretty substantial move toward better balance,” he said.

The Fed leader’s remarks underscored a sense of cautious optimism that had faded after disappointing inflation readings in April. He alternately said the economy had made “significant progress,” “real progress” and “quite a bit of progress” toward cooler inflation with stable growth.

Apparently, progress toward their stated goals has been substantial.  And while that is fantastic, he also mentioned, later in his speech, that they were now also looking far more carefully at the labor market, which is starting to slow down.  “You can see the labor market is cooling off, appropriately so, and we’re watching it very carefully.”  You may recall that SF Fed president Daly also focused on the labor market late last week and I am confident that it is on every FOMC members’ radar. 

Of course, that’s why Friday’s Payrolls report is going to be so important.  Arguably, while the NFP data gets all the press, the Unemployment Rate is really going to matter this time as it ticked up to 4.0% last month.  A rise from here will start to call into question just how strong the labor situation remains.  For instance, while yesterday’s JOLTS data showed a modest rise to just over 8M job openings, that is after the previous month’s data was revised down substantially, by nearly 240K jobs.  One of the things about the Unemployment Rate is that once it starts to move in one direction or the other, it tends to really build momentum for a while.  As you can see from the long-term chart below, once it starts to rise, it tends to go a lot higher. 

Source: tradingeconomics.com

I have maintained that the payrolls have been a key all along as it is quite easy for the Fed to parry complaints from Congress about ‘too high’ interest rates if the job market is tight.  But if it starts to loosen too quickly, Congress will be howling every day and night and make the Fed’s life quite miserable.  As such, my eye is on the Unemployment Rate rather than NFP come Friday.

Now, this is not the only story around, but from a market perspective, I believe it is the most important by far.  However, let’s touch on some others before highlighting the ongoing risk rally.  While most of the oxygen in US newsrooms is consumed by the debate on whether President Biden is fit to, and will, be the Democratic nominee, there are several other key elections coming this week.  

Tomorrow, the UK heads to the polls (was the July 4th date chosen to commemorate the last big English loss?) where the current Tory government, led by PM Rishi Sunak, is forecast to be decimated by the voters.  Apparently, the good folks of the UK are fed up with the same inflation and immigration issues that are apparent elsewhere in the Western world and are looking for a change.  Interestingly, a look at UK markets doesn’t really indicate that investors are greatly concerned over the change as Gilt yields, the FTSE 100 and the British pound have all been range trading for the past month.  Certainly, there is no indication a Labour government is going to be fiscally responsible, but they have promised to raise taxes to try to fund their spending.  In the end, I don’t see the change in government having an immediate impact on financial markets in the UK.  Rather, I expect that the US story on rates and economic activity is still going to be the main driver of things.

Come Sunday, the French head back to the polls for the second round of their parliamentary election and virtually every story you can read about it describes the lengths to which the coalition of left-wing parties and the current Macronist parties are going to try to prevent Marine Le Pen’s RN party from gaining a working majority.  I find it instructive that rather than considering why so many people were drawn to the RN message of restricting immigration and enhancing public safety, the other parties simply demonize the RN as a reincarnation of the Nazis.  (sounds familiar, no?).  The current market narrative seems to be that the RN will not be able to capture an absolute majority by themselves with the result that a caretaker government will be appointed with limited powers.  This has been seen as a great leap forward from the fear of an RN led government, and so we have seen French equity markets rebound from their worst levels last week, while French OAT yields have compressed vs. their German counterparts by about 15bps from the widest levels seen just before last Sunday’s first round votes.

In a related note, this morning I have seen several articles describing the recent rise in US yields as a response to the presidential debate last week, where suddenly there is concern that Mr Trump may win and spend trillions of dollars, rather than a Biden win where the government would spend trillions of dollars.  Frankly, there is no indication that either party is going to rein in spending, it is far more a question of their spending priorities.  But that is the story that is all over the press this morning.

Ok, a quick look at the overnight session shows that yesterday’s US equity rally was largely followed by shares in Asia (Nikkei +1.25%, Hang Seng +1.2%) although Chinese shares remain lackluster.  In Europe, as well, shares are higher across the board with the CAC (+1.55%) in Paris leading the way on this renewed narrative of a caretaker government.  I suppose if the RN does win a majority that come Monday, French shares, and most of Europe as well, will see sharp declines.  As to US futures, at this hour (7:30), they are edging very slightly higher, just 0.1%, ahead of this morning’s data dump.

In the bond market, Treasury yields are unchanged this morning, but Europe has seen virtually all sovereigns rally slightly vs. Bunds as the French narrative seems to have longer tails than one might imagine.  So, spreads are narrowing a bit.  The one consistency in bond markets, though, has been Japan which saw yields edge higher by another basis point overnight and are now 18bps higher in the past two weeks.  Remarkably, despite the rise in Japanese yields, the yen continues to get punished daily.

In the commodity markets, oil is little changed on the day, but has rallied more than 2% in the past week on rumors of a significant inventory drawdown to be reported later this morning, as well as the pending shut in of production in the Gulf of Mexico.  However, metals markets are rallying this morning with both precious (Ag +0.6%, Ag +1.8%) and base (Cu +1.6%, Al +0.7%) finding support amid the equity/risk rally and the dollar’s softer tone today.

Speaking of the dollar, other than the yen (-0.25%) which is now pushing to 162.00, the rest of the G10 bloc is modestly firmer, between 0.1% and 0.25%.  Meanwhile, in the EMG bloc, ZAR (+0.65%) is again the biggest mover, rallying on metals strength along with broad dollar weakness.  One must be impressed with the ongoing volatility in the rand, which seems to be the leading mover in one direction or the other every day.  However, away from that, while most EMG currencies are a bit firmer, the movement has been much less dramatic.

On the data front, it is a busy day as tomorrow’s holiday has forced much info onto today’s calendar.  As well, since there will be no poetry on Friday morning, I will include the current estimates of the payroll data as well

TodayADP Employment160K
 Trade Balance-$76.2B
 Initial Claims235K
 Continuing Claims1840K
 ISM Services52.5
 Factory Orders0.2%
 -ex Transport0.3%
 FOMC Minutes 
FridayNonfarm Payrolls190K
 Private Payrolls160K
 Manufacturing Payrolls5K
 Unemployment Rate4.0%
 Average Hourly Earnings0.3% (3.9% Y/Y)
 Average Weekly Hours34.3
 Participation Rate62.7%
Source: tradingeconomics.com

In addition to all this, we hear from NY Fed president Williams this morning, but given that Powell continued to highlight the lack of confidence that inflation was quickly going to reach their target, I doubt Williams will say anything different.  My concern is that we are going to see the Unemployment Rate rise to 4.1% or 4.2% and that will change the narrative greatly.  Suddenly, there will be a lot more pressure to allow inflation to stay at current levels or even go higher to address the employment side of the mandate.  As I have written in the past, any rate cuts before inflation is well and truly vanquished will likely result in a much weaker dollar and much higher commodity prices.  Be on the watch for Friday’s data to be the first step in that direction.

Good luck and have a good holiday weekend

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Equity’s Epitaph

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Each day as more data arrives
And pundits perform their deep dives
The talk of recession
Has forced some to question
How anyone bullish survives
 
But stock bulls have had the last laugh
Just look at a stock market graph
However, fixed income
Has started to look glum
Is this equity’s epitaph?
 
The only thing one can say about the recent data is that there is no clear direction of travel.  For instance, in the past week we have seen better than forecast results from Consumer Confidence, Durable Goods, Chicago PMI and Michigan Confidence while the Richmond Fed, New Home Sales. Building Permits, Personal Income and ISM Manufacturing all printed on the soft side of things.  The biggest data point, PCE, was essentially right on the money, so didn’t alter this equation.  However, perhaps the best way to sum up this mix of data is to look at the Atlanta Fed’s GDPNow calculation, and as can be seen in the chart below, it is heading lower.

 

Source: Atlantafed.org

The history of this calculation is that early in the quarter, it has limited predictive ability, but as the quarter ends, which it just did on Friday, it becomes a much better predictor of the actual results to come.  If I were to characterize this statistic it shows that the economy is slowing down but is not yet looking at a recession.

Is this the fabled goldilocks outcome of a soft landing?  Perhaps, but personally, I have my doubts.  To explain, let’s discuss the yield curve for a moment.  As you are all well aware by now, when the yield curve inverts (short end rates are higher than long end rates) that has been a reliable indication that a recession is coming.  We continue to be in that situation and in fact, the current inversion between the 2yr and 10yr Treasury, one of the most common measures, has been inverted for a record long period, more than 16 months.  

However, one thing that is widely misunderstood about the yield curve signal is that it is not a description of a current recession, rather it is a harbinger of a future one.  That recession tends to be coincident with the steepening of the yield curve back to its more normal shape.  And the question right now is, will the yield curve steepen because the front end of the curve sees rates decline, a so-called bull steepener, or because the back end of the curve sees rates rise, a much more uncomfortable situation known as a bear steepener.  

The soft-landing view is that the former is in our future as the Fed will cut rates to help stabilize the economy while 10yr yields hang around the 3.5% – 4.0% level.  It certainly appears that has been a critical piece of the equity market bullish story.  However, the alternative, where long end rates rise despite economic weakness, seems equally probable right now, and based on the bond market’s moves over the past several sessions, may well be taking over the narrative.  In this situation, the Fed continues to see inflationary pressures as too great to ignore and maintains higher for longer.  At the same time, the fiscal profligacy that is evident right now, and shows no signs of ending regardless of the election outcome, starts to bite.  Investors demand ever higher yields to hold Treasuries for any extended length of time and the 10yr rises to 5.0% – 5.5% or higher.

While the Fed’s record of preventing a recession by cutting rates is quite poor (perhaps one positive outcome in their history in 1995), their record of seeing a recession hit when they don’t cut rates, or even raise them to fight stubborn inflation, is even worse.  While two days is not yet a trend, it is certainly important of us to watch how the bond market behaves.  If long end rates start to rise more aggressively, that would be a signal that investors are turning more negative on the future.  It is at this point where we will learn the answer to the question of exactly how the Fed’s reaction function works.  History has shown that the unemployment rate rises with bear steepeners, and that is what forces the Fed to respond by cutting rates.

However, remember, if inflation remains stubbornly high and the Fed decides to cut rates to address unemployment, I believe that is the worst of all worlds.  We would be in a weakening economy with high inflation and a Fed that is far behind the curve amid a government that is spending money with no limits.  In that scenario, which, alas, has a reasonably high probability of occurring, the dollar should decline, bonds will decline (yields rise), commodities will rally, and equities will likely start to rise, but as earnings falter, so will prices.  This is not where we want to go.

We are not there yet, so let’s look at how things played out overnight instead.  Japanese shares continue to rally (+1.1%) with the Nikkei reclaiming the 40K level.  This continues to be on the back of the uber-weak yen (discussed below) as so many companies are exporters and benefit from the weak yen.  However, Chinese shares did not fare as well, edging lower as investors begin to wonder what will come from the Third Plenum due to take place in two weeks’ time.  Elsewhere in the region, there was far more red than green on the screens.  The red seems to have been contagious as all of Europe is under water this morning, with most falling more than -1.0%.  This is not really a data story, rather this seems to be a re-evaluation of this weekend’s French second round elections and growing fears that Marine Le Pen and her RN party are going to win the day.  We just saw a right-wing party take power in the Netherlands and have seen the same throughout Scandinavia.  I continue to be baffled at why investors are more concerned regarding spending by right leaning governments than left leaning ones, but that is clearly the current situation.  As to US futures, at this hour (7:30) they are sliding by -0.45% or so.

Bond markets are consolidating after yesterday’s rout with Treasury yields unchanged this morning while most of Europe has seen yields edge higher by just one or two basis points.  However, global bond markets have been under pressure all this week and while today may provide a respite, I sense further stress to come.  JGB yields rallied 3bps overnight and are now at their highest level since July 2011.  Alas, these higher Japanese yields have not helped the yen.

In the commodity markets, oil (+0.7%) continues to rally although the current story is focused on Hurricane Beryl which is heading into the Caribbean and the Gulf of Mexico and likely to shut in some offshore production there for a while, reducing supply.  However, precious metals are under pressure amid a rising dollar though copper (+0.6%) is holding its own on inventory concerns.

Finally, the dollar is firmer this morning against virtually all its counterparts in both G10 and EMG blocs.  The euro (-0.15%), which had rallied a bit on Monday amid hopes that the RN would not capture a majority in France, has given that back as the story ebbs and flows.  But really, JPY (-0.1% today, -1.2% in the past week) is the story as traders gain confidence that the MOF is not ready to respond yet and with US yields climbing, the carry trade continues to be extremely attractive.  Today’s dollar rally is broad, but the large moves are limited with ZAR (-0.6%) the worst performer although there are numerous currencies that have slipped -0.25% or so.  But it’s a dollar thing today.

On the data front, today only brings JOLTS Job Openings data (exp 7.91M) although perhaps more importantly, we hear from Chairman Powell this morning at 9:30.  The thing is, I don’t see any reason for him to have gained confidence that inflation is reliably heading back to target, and until we see Friday’s payroll report, there is no reason to believe that they are concerned about that.  In fact, that brings up the issue that Friday’s data release is likely to be extremely important to the narrative and has the chance to be quite disruptive given the high likelihood that staffing across all desks in the US will be light.  Remember, too, that the UK election will be held on Thursday, so more change is afoot.

Right now, the dollar seems healthy, but there is much to be learned this week and it will help inform how things evolve.

Good luck

Adf

Thwarted?

Posted on by

For those of the dovish persuasion
Last Friday was quite the occasion
At zero percent
Those doves are now bent
On writing a new Fed equation
 
If PCE really is nil
It’s likely that Chair Powell will
Be forced to cut rates
And shut down debates
Inflation is bothersome still
 
Meanwhile, out of France its reported
Macron’s government’s been aborted
Will Madame Le Pen
Now lead all Frenchmen
Or will her success soon be thwarted?

 

A funny thing happened on the way to lower interest rates on Friday; the long end of the curve, from 10-year to 30-year Treasury yields, exploded higher by 15bps from their post PCE nadir.  While the initial reaction to the PCE data, which, by the way, was exactly in line with forecasts, was to see a modest decline in yields as all those pushing for Fed rate cuts were out in force making their case again, by the end of the day, the damage was done with yields 10bps higher despite the data.  

Now, part of that move might be blamed on the fact that Chicago PMI printed at a much better than expected 47.4, indicating that last month’s horrendous figure of 35.4 was the true aberration.  And part might be blamed on the Michigan Consumer sentiment, having barely fallen, to 68.2, rather than the expected 3+ point fall the analysts had forecast.  Of course, there were those who raised the question of the outcome of the US elections in November after Thursday night’s debate and the disastrous Biden performance seemed to open the door for a Trump victory.  For some reason, bond investors seem to think that Trumpian spending is worse than Bidenomics spending although both are likely to be far too much overall.

Or perhaps, this is the first step toward a growing concern that the trajectory of US government spending is becoming problematic writ large.  After all, there is no indication that whoever is the next president is going to rein in spending and run an austerity budget.  While they may spend on different things, it will still require the Treasury to borrow trillions more dollars.  Perhaps the biggest buyers of Treasury debt, be they foreign governments, hedge funds or individual investors do not believe that the Fed is going to do, as Mario Draghi once promised, “whatever it takes” to achieve their 2.0% inflation target.  If this is the case, then beware as yields will be able to rise much further.  I’m not saying this is what is happening, just that it is one possible explanation.

While there is much yet to discern in the US, we must, at this stage, turn to France, where the first round of President Macron’s snap election was held yesterday and the results were largely as expected, although Marine Le Pen’s RN party did not quite achieve quite the heights that some had feared forecasted.  However, she did win more than one-third of the vote relegating Macron to just over 20% and the awkward coalition of the Left, the so-called New Popular Front, to 29% or so. (Maybe they aren’t as popular as they thought!)

The upshot is that there are now all types of maneuvering between the New Popular Front and Macron to figure out a way to prevent Le Pen’s RN from winning an outright majority of 289 seats.  That vote comes this Sunday so we will have to wait and see what happens, but between now and then, there is an enormous amount of new information due to arrive including the results of the UK elections on July 4th and then the US employment report on July 5th.  This week has the opportunity to be quite volatile given the news forthcoming and the fact that in the US, there will be many trading desks that are lightly staffed due to the holiday.

So, let’s take a look at how markets are behaving given all the new information.  The first thing to note is that despite a strong start in US equity markets Friday, all three major indices closed in the red, not dramatically so, but certainly a concerning reversal of fortune.  This, of course, coincided with the melt down in Treasury prices.  However, in Asia, there is far more green than red on the screen led by China (+0.5%) and India (+0.5%) with most other markets showing less enthusiasm and Australia following the US markets as the only nation with equity declines.  Japanese Tankan data was largely in line with expectations with one outlier, the Non-Manufacturing Outlook was much weaker than expected.  Chinese Manufacturing PMI data was unchanged at 49.5, still hovering below the growth/slowdown line while the Non-Manufacturing Index fell to 50.5, down 0.6 and indicative of the fact that economic growth in China is slowing more quickly than expected.  It appears that market participants are now looking for more stimulus from the government, hence the support in the equity markets.

In Europe, markets are powering ahead this morning led by the CAC (+1.25%) in Paris as the new story is there is hope that Le Pen’s RN party will not win an outright majority of Parliament and therefore be unable to implement their policies.  It is not clear why a caretaker government, which would be the result in that case, is seen as so positive, although arguably, this is simply a modest retracement of the CAC’s 8% decline over the past six weeks as fears over a Le Pen victory rose.  However, the rest of the continent is also moving higher this morning despite (because of?) PMI data showing that the continent remains in the economic doldrums.  I guess the view is ongoing weakness will reduce inflationary pressures and thus allow the ECB to cut rates more aggressively.  Finally, US futures at this hour (6:00) have edged higher by 0.1% or so.

The bond market, though, is where there has been far more activity as following Friday’s massive sell-off in the US, we are seeing European yields climb, although there are idiosyncratic stories here as well.  For instance, German Bunds have seen yields jump 8bps, while French OATs are only higher by 2bps and Italian BTPs are unchanged.  It appears that bond investors have taken equal solace in the fact that the RN party may not win an outright majority on Sunday coming, and so are modestly less worried about more pressure in the Eurozone.  However, it cannot be overlooked that yields are generally higher this morning across the board than they were las Monday, and the market appears far more concerned over the future.

In the commodity markets, oil (+0.55%) is modestly higher this morning as are the metals markets with both precious and base metals all in the green.  While oil has had a life of its own lately, responding to idiosyncratic features of the market, the metals have lately been closely linked to the dollar, rallying when the dollar is under pressure and vice versa.  Today is a perfect example of that movement with the dollar largely weaker across the board.

The biggest mover in the dollar, at least vs. the G10 currencies, is the euro (+0.35%) as traders and investors follow French stocks and have shown some relief in the fact that an RN victory may not be forthcoming.  (Just be prepared for a major reversal if RN does win an outright majority.). This has helped virtually all the other G10 currencies except the yen (-0.15%) and CHF (-0.3%), both of whom have lost some of that haven status this morning.  In the EMG bloc, things are largely as you would expect with the CE4 all gaining and ZAR (+0.8%) gaining slightly more with the help of metals markets.  As to APAC currencies, they are essentially sitting out the French elections and are little changed across the board this morning.

On the data front, as it is the first week of the month, there is much to await.

TodayISM Manufacturing49.1
 ISM Prices Paid55.9
TuesdayJOLTS Job Openings7.85M
WednesdayADP Employment 170K
 Initial Claims235K
 Continuing Claims1841K
 Trade Balance-$76.0B
 ISM Services52.5
 Factory Orders0.3%
 -ex Transport0.3%
 FOMC Minutes 
FridayNonfarm Payrolls195K
 Private Payrolls169K
 Manufacturing Payrolls5K
 Unemployment Rate4.0%
 Average Hourly Earnings0.3% (3.9% Y/Y)
 Average Weekly Hours34.3
 Participation Rate62.7%
Source: tradingeconomics.com

In addition to all this, we hear from Chairman Powell tomorrow morning and NY Fed president Williams on Wednesday and Friday.  Given Friday’s PCE data moved closer to their target, there are many looking for a clear signal that rate cuts are coming soon.  The Fed funds futures market has not really changed its pricing with a bit more than a 10% probability of a July cut and a roughly two-thirds probability for September.  And remember, virtually every Fed speaker in the past two weeks has looked through the data and indicated they need to see more of it moving in their direction to consider it to be time to ease policy.  I suspect that Friday’s NFP and Unemployment Rate are going to be critical at this juncture although certainly Chairman Powell can change the tone of the narrative all by himself.

One last thing, Thursday, the UK will hold an election with the Labour Party is so far ahead in the polls, it appears a foregone conclusion that they will win, ousting the Tories after 14 years in power.  As such, the market has already made their peace with that.  In the end, the hopes and prayers of many are that inflation is truly ebbing and that the Fed will be able to take their foot off the brakes.  Certainly, if the NFP is weak, we need to look for them to hit the gas and rate cuts will be back in play for this month.  In that case, look for the dollar to tumble and stocks to rock.  But if NFP and Unemployment remain solid, there is little cause for the Fed to change the current higher for longer.

Good luck

Adf

Deep-Rooted

Posted on by

We have now a president, Biden
Who lately, has taken much chidin’
Last night he debated
A man who he hated
Alas, polls against him did widen
 
The market response, though, was muted
With not many trades prosecuted
Instead, we await-a
The PCE data
To learn if inflation’s deep-rooted

 

While it was painful to watch, I did last through most of the debate.  Unfortunately, it didn’t help me sleep any better!  Clearly the top story around the Western world today is the performance of President Biden and the concerns it raised over his abilities to not merely execute the responsibilities of the President if he is re-elected, but to complete his current term.  There have been numerous calls by high profile Democratic strategists and pundits for him to step down from the ticket.  We shall see what happens, but my personal take is he will not willingly step aside regardless of the situation and that those closest to him will not force him to do so.

The upshot is that in the betting markets, Mr Trump is now a 60% favorite with Mr Biden at 22% and a host of other Democrats making up the difference, at least according to electionbettingodds.com.  Arguably, though, the question that most concerns all of us is how will this outcome impact markets going forward.  And remember, there is a very big election this weekend in France that is also going to have a major impact, not just in France, but in all of Europe.

Perhaps the most surprising thing to me is the non-plussed manner that markets have behaved in the wake of the debate.  Equity markets around the world have traded higher as have US futures.  Bond yields have traded modestly higher and so has oil, metals markets and the dollar.  Clearly, investors do not appear to be concerned that the leader of the free world is in such dire physical condition.  While I would not have expected a collapse, it doesn’t seem hard to foresee a chain of events that results in less positive economic outcomes.  

Or…perhaps the market has absorbed this outcome and determined that central banks, and especially the Fed, are going to be starting to err on the side of easy money to ensure that economies don’t fall into disarray, so all that rate cutting that has been discussed, hypothesized and, frankly, dreamed about may be coming sooner than the hawkish central bankers themselves had considered previously.  I understand that political events typically don’t have a big market response, but the depth and breadth of the damage that last night’s debate had on ideas about President Biden’s mental competence and acuity are stunningly large.  That cannot inspire confidence in investors.  

Of course, of far more importance to the market, obviously, is today’s PCE data release and the corresponding Personal Income and Spending figures.  So, let’s take a look at expectations there.

PCE0.0% (2.6% Y/Y)
Core PCE0.1% (2.6% Y/Y)
Personal Income0.4%
Personal Spending0.3%
Chicago PMI40.0
Michigan Final Sentiment65.8

Source: tradingeconomics.com

Of this grouping of data, the Core PCE reading is the most important as it represents the Fed’s North Star on inflation.  (While we all live in a CPI world, the Fed apparently found out that their models worked better with core PCE and so that became the benchmark.)  At any rate, forecasts are that prices, ex food & energy, did not rise in May.  That was not my lived experience, and I will wager not many of yours either, but we don’t really matter in this context.  However, the Bureau of Economic Analysis, when they are calculating GDP also calculate their own PCE figure for the quarter.  That was released yesterday with the Core PCE printing at 3.7% while GDP was raised to 1.4%.  In total, that implies nominal GDP was at 5.1% in Q1, a slight decline from Q4’s reading of 5.4%.  It should not be surprising that both these PCE measures track one another well, and as per the chart below, that seems to be the case.

Source: tradingeconomics.com

However, I cannot help but look at this chart and see that the blue line (the quarterly BEA data, RHS numbers) is not trending lower at all.  Perhaps it turns around, but perhaps the forecasts for this morning’s numbers are a bit too optimistic.  After all, we saw higher inflation in Canada and Australia this month.  As well, we have seen a continuation in the rise in the price of housing and energy.  None of those are perfect analogs for the PCE data this morning, but I sense that we may have found the lows in inflation.

Ahead of the data, as I discussed briefly above, markets are in fine fettle.  After a modestly positive session in the US yesterday, virtually every market in Asia was in the green as well, with the Nikkei (+0.6%) leading the way and smaller gains, on the order of 0.1% – 0.2% across the rest of the major markets in the region.  In Europe, the CAC (-0.3%) is bucking the trend as investors continue to leave the market ahead of the elections this weekend, but the rest of the bourses are all decently firmer, on the order of 0.35% – 0.55%.  I suppose the reason French investors are concerned is the possibility of a hung Parliament, where no party has a majority and therefore no new legislation will be able to be enacted under a caretaker government for at least a year.  Of course, there are also those who are concerned that a ‘cohabitation’ between President Macron and the RN might have trouble governing as well.  As to US markets, they continue to rally with futures higher across all three major indices this morning, roughly by 0.35%.

In the bond market, yields are higher across the board after they traded up yesterday as well.  This morning, Treasury yields are +2bps while European yields have risen between 3bps (Germany, Netherlands) and 9bps (Spain) with French and Italian yields 6bps higher.  This is the most straightforward explanation as investors demonstrate their concern with a further split between Germany and the rest of Europe regarding fiscal policies.  As to JGB’s they have slipped 2bps lower overnight, despite Tokyo CPI data printing a tick higher than expected at 2.3% headline, 2.1% core.

Oil prices (+0.75%) continue to rally as summer driving demand is now the story of the market despite the large inventory builds seen this week.  In a bit of a conundrum, metals markets are also firmer across the board despite the higher yields, although in the past hour or so, the dollar has reversed some of its earlier gains, so that is giving some support.  However, I suspect that these markets will be subject to a dislocation in the event that we see a surprising PCE report.

Finally, the dollar has edged a bit lower this morning with modest declines vs. the G10 bloc, on the order of 0.1% – 0.2%, and a few outliers vs. EMG currencies like ZAR (+1.4%) and KRW (+0.6%).  The won has benefitted from the upcoming increase in onshore trading hours as the country attempts to increase trading volumes and get more activity and more market participants to help the currency’s international standing.  As to the rand, it appears that the sharp rally today in the Johannesburg stock exchange has drawn in outside investors and supported the currency.

In addition to the data, we hear from both Governor Bowman, again, and SF Fed president Daly this afternoon.  Bowman has already explained, twice, that she would be amenable to raising rates if inflation rebounded, while you may recall Daly exhibited concern over the labor market and what to do if it deteriorates.  Well, labor is a discussion for next week when the NFP report is released.  Today is all about PCE.  My sense is it will be higher than forecast which will probably undermine equities to some extent and keep pressure on bonds while supporting the dollar.  In that situation, I see commodities suffering as well.

Good luck and good weekend

Adf

The Fat Lady

Posted on by

Is the fat lady
Starting to sing?  Listen for
More threats to be sure

 

Tell me if you’ve heard this one before, “It’s desirable for exchange rates to move stably. Rapid, one-sided moves are undesirable. In particular, we’re deeply concerned about the effect on the economy.”

Or this one, “We are watching moves with a high sense of urgency, analyzing the factors behind the moves, and will take necessary actions.”

Of course, the answer is yes, these are essentially verbatim of what Shunichi Suzuki, Japanese FinMin, said earlier this week, as well as several times back in April prior to their last bout of intervention.  It is probably step 3 on the 7-step program that leads to eventual intervention by the MOF/BOJ.   And those are his direct comments from last night in the wake of USDJPY trading to yet another new high (160.88) for the move.  The last time the currency was that weak vs. the dollar was in 1986.  

Now, perhaps I can help him analyze the factors behind the moves.  Why look, the entire interest rate complex in Japan remains significantly below the same metrics anywhere else in the world, but from a G10 perspective, specifically vs. the US.  As well, the commentary from the various Fed speakers we have heard just this week continues to indicate higher for longer remains the play.  Recall, Governor Bowman even suggested the possibility of raising rates if circumstances dictated.  I might suggest to Suzuki-san, that as long as the BOJ maintains ZIRP, and continues to hold 50% of the JGB market, the yen will remain under pressure. 

The question remains, just how high can USDJPY go?  And the answer remains much higher.  I continue to believe that we will need to see a quick move to 163, at least, before the MOF tries to slow things down again, meaning by Monday latest.  If, instead, the market simply hangs around at this new level, I expect more jawboning but no action.  The one caveat is that next Thursday is July 4th, when all banks in NY will be closed and market liquidity will be extremely suspect.  It would not be a surprise if they were to take advantage of those thin markets and aggressively sell dollars then.  It would certainly have an outsized impact.  We shall see.

Today’s likely to be at peace
As folks eye tomorrow’s release
Of PCE data
And so, options’ theta
Is vanishing like Credit Suisse

The truth is, away from the yen story, there is very little of consequence ongoing as the market sets its sights on tomorrow’s PCE data.   This evening’s Presidential debate will certainly be interesting and likely be entertaining, but it is not clear it will impact markets.  And while we continue to see gyrations in various markets, the big themes remain stable.  The Fed is not about to change its stripes as we have heard repeatedly since the FOMC meeting, the economy continues to move along, albeit at a somewhat slower pace than Q1, but not showing any hint of recession at this stage, and the geopolitical situation is constant with Russia/Ukraine and Israel/Gaza continuing to wreak havoc and destruction mostly in the background.  As such, I expect that we are going to be subject to more idiosyncratic movements in markets for now.
 
So, let’s look at what happened overnight.  After yesterday’s very limited equity moves in the US, most of Asia was in the red led by the Hang Seng (-2.1%) as tech shares were under pressure.  But the Nikkei (-0.8%) and Shanghai (-0.75%) also fell with the former a bit surprising given both the weaker yen and the surprisingly better than expected Retail Sales data released, while the latter seemed to respond to declining Industrial Profit data that was released.  As it happens, Australia shares were also softer as inflation data there continues to show stubborn strength squashing any ideas of an RBA rate cut soon.  In Europe, red is also the most common color with the CAC (-0.5%) and IBEX in Spain (-0.5%) leading the way lower.  Most other markets are softer although the DAX (+0.1%) is bucking the trend, despite lacking an obvious catalyst for the move.  And let’s face it, 0.1% is not really relevant to anything.  At this hour (7:00), US futures are pointing slightly lower ahead of the weekly Claims data.
 
In the bond markets, yields in the US backed up by 5bps and have stayed there this morning.  in Europe, the markets closed before the US move finished, so this morning, yields across the continent are higher by 3bps or so as they catch up to the US.  In Asia, the movement was stronger with JGBs +5bps and Australian bonds +10bps on the back of the US move as well as Australia’s growing inflation concerns (Consumer Inflation Expectations rose to 4.4%).  It strikes me, looking at the chart below, that yields have been in a wide range, about 90 basis points, for the past year and that we are currently pretty much in the middle of that range.  It is hard to get too excited about things until we break this range in my view.

Source: tradingeconomics.com

In the commodity space, oil (+0.35%) is rebounding slightly this morning after weakness in the wake of larger than expected inventory data released yesterday, with an over 6-million-barrel increase compared to expectations of a 5.5-million-barrel drawdown.  As to the metals markets, gold (+0.7%), which suffered on the back of the strong dollar yesterday, is rebounding and taking silver with it, although the industrial metals remain under pressure.

Finally, the dollar, which was king of the hill yesterday, with the Dollar Index trading back above 106 for a while, is softening a touch this morning, probably about 0.2% or so against its major counterparts.  However, while that is the general result today, there is one outlier, ZAR (-1.15%) which continues to demonstrate remarkable volatility amidst the political situation with no cabinet yet named.  Perhaps the driver this morning was the softening inflation picture enticing traders to believe that SARB may be considering rate cuts soon.

On the data front, this morning brings the weekly Initial (exp 236K) and Continuing (1820K) Claims data along with Durable Goods (-0.1%, +0.2% ex Transport), final Q1 GDP (1.4%) and its components of note like Final Sales (1.7%) and its Price Index (3.3%).  Remarkably, there are no Fed speakers due today either.  I think we need to keep a close eye on the employment situation as it has been slowly worsening overall.  It wasn’t that long ago when Initial Claims were pegged at 212K every week.  Now they have grown by more than 20K and any lurch higher will be noticed.  Next week’s NFP is going to be critical with the potential for a significant impact as it will be released the day after the July 4th holiday, a day when trading desks will be very lightly staffed.

For today, it is hard to get excited about anything, but if we continue to see the slow deterioration of US data, that will eventually feed into the rate picture and the dollar’s value as well.

Good luck

Adf

To Oblivion

Posted on by

The yen continues
To grind ever so slowly
To oblivion

 

Well, for all those who were either concerned or anxiously awaiting USDJPY’s move to and above 160, we got there early this morning, and the world has not ended.  Not only that, but there is no sign of the BOJ/MOF, nor do I believe will there be for a while yet.  As I explained on Monday, history has shown, and the MOF has been explicit, that they are far more concerned with the pace of any movement in the currency, rather than the specific level at which it trades.  So this much more gradual decline in the yen, while potentially somewhat uncomfortable given its possible impact on inflation going forward, is just not alarming.  You can expect to hear Kanda-san or Suzuki-san reply when asked about the currency that they are watching it closely and prefer a stable currency, but I believe they are fairly relaxed about the situation this morning.

A look at the chart below from tradingeconomics.com shows the trend has been steady all year (which given the interest rate differential between the two currencies makes perfect sense) and that only when things accelerated back at the end of April did it generate enough concern for the MOF to act.  If we see another sharp movement like that, you can look for another round of intervention.  But, at the current pace, likely all we will get is some commentary about stable movement and vigilance.

Source: tradingeconomics.com

While many worldwide want to think
Inflation is starting to shrink
The data released
Shows it has increased
Down Under with Quebec in sync

With all eyes on Friday’s PCE data as a harbinger of the next Fed activity, it is worthwhile, I think, to mention what we have just seen from two other G10 nations regarding their inflation situation.  Starting north of the border, you may recall that earlier this month the Bank of Canada cut their base rate by 25bps in anticipation of achieving their 2% target given the prior direction of travel of their CPI statistics.  Oops!  Yesterday revealed that both the headline and core readings rose a much higher than forecast 0.6% in May, bringing the annual readings to 2.9% and 1.8% respectively.  As well, they focus on the Trimmed-Mean annual number, which also surprisingly rose to 2.9%.  now, one month does not a trend make, but Governor Macklem may have some ‘splainin’ to do the next time he speaks.  It is possible that inflation has not turned the corner after all.

Meanwhile, Down Under, the RBA must be feeling a bit better as they have maintained a more hawkish stance overall, arguably the most hawkish of any G10 member, and last night’s CPI reading of 4.0%, a 0.4% rise from the April data and 0.2% higher than forecast, is a reminder that inflation can be difficult to conquer for all central banks.  Since December, the readings Down Under had been in the low 3’s and many pundits were anticipating that the next leg was lower there as well.  Oops again!

With this in mind, it can be no surprise that the two Fed speakers yesterday, Bowman and Cook were both leaning toward the hawkish end of the spectrum.  In fact, Bowman even raised the possibility of future rate hikes as follows [emphasis added], “Reducing our policy rate too soon or too quickly could result in a rebound in inflation, requiring further future policy rate increases to return inflation to 2% over the longer run.”  At the same time (well actually, 2 hours earlier) Governor Cook did explain she sees rate cuts coming, just not the timing.  To wit, “With significant progress on inflation and the labor market cooling gradually, at some point it will be appropriate to reduce the level of policy restriction to maintain a healthy balance in the economy.  The timing of any such adjustment will depend on how economic data evolve and what they imply for the economic outlook and balance of risks.” 

It strikes me that no matter how you parse these comments, right now, there is no indication that pretty much anybody on the FOMC is considering rate cuts soon.  Futures markets have not really changed their pricing lately with a 10% probability of a July move and a 64% probability of a September cut.  However, one interesting tidbit is that in the SOFR futures options market, there has been a very substantial position building in March 2025 97.75 SOFR calls.  For these to pay off, Fed funds would need to fall about 300bps between now and March, far more than is discussed or priced right now.  While this could certainly be a position hedge of some sort, it does have many tongues wagging.

Ok, a review of the overnight session shows that we are still amid the summer doldrums overall, with some movement in markets, but nothing very dramatic and no real trends developing.  In Asia, the Nikkei (+1.25%) rallied on the back of the weak yen and is back approaching the 40K level, although a look at the chart shows simply choppy price action with no direction.  Hong Kong was flat, Shanghai (+0.65%) rose and Australia (-0.7%) fell on the back of that inflation data and the realization that the RBA is not cutting rates anytime soon.  In Europe, the movement has been weaker, rather than stronger, with French (-0.55%) and Spanish (-0.4%) shares both softer although German and UK shares are essentially unchanged today.  Finally, US futures are mixed with small gains for the NASDAQ and S&P while DJIA futures are following through on yesterday’s index declines.

In the bond markets, higher yields are the order of the day with Treasuries and virtually all of Europe higher by 3bps.  Overnight, JGBs saw a similar rise in yields which has now taken the 10yr yield there back above that 1.00% pivot.  The outlier here is Australia, which given the CPI data there, not surprisingly saw yields jump more, in this case by 11bps.

In the commodity markets, oil (+0.6%) is rebounding from yesterday’s modest declines which came about after API inventory data showed a modest build instead of the expected decline.  Gold (-0.4%) is under pressure along with most metals on the back of the dollar’s strength today.  In fact, my sense is the dollar is the driver right now.

So, speaking of the greenback, the only G10 currency to make a gain this morning is AUD (+0.15%) based on the higher yields Down Under.  Otherwise, the rest of the space is weaker between -0.2% and -0.5% with SEK the laggard.  In the EMG space, there is only one currency managing to hold its own, ZAR (+0.5%), which looks more like a trading bounce than a fundamental shift as there has been no data and no news yet on the political front regarding President Ramaphosa’s cabinet appointments.  Otherwise, the noteworthy move is that USDCNY has breached 7.30 for the first time since November as the pressure of higher US rates and an overall stronger dollar are too much to prevent continued weakness in the renminbi.

The only data this morning is New Home Sales (exp 640K) and the EIA oil inventories, which while important for the price of oil generally don’t have a macro impact otherwise.  As well, there are no Fed speakers on the calendar, but I cannot believe that at least one of them will want to hit the airways somehow.

So, the dollar has legs this morning and unless we get pushback that inflation is falling more clearly, I suspect that yields and the dollar will remain well bid.  It doesn’t feel like there is something that can change opinions due today.  Tomorrow and Friday, though, have that opportunity, so we shall see.

Good luck

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Things Went to Hell

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There once was a company, strong
Whose shares, everyone had gone long
But things went to hell
Nvidia fell
And folks wonder now, were they wrong?
 
The narrative hasn’t adjusted
Though certainly some are disgusted
AI, after all
To which they’re in thrall
Is perfect, so why’s it seem busted?

 

Times are tough for macro pundits and analysts, like this poet, as there is so little ongoing at the moment.  Data releases are sparse, and generally of a secondary nature and even commentary has been less active.  Truly, the summer doldrums have arrived.

With this in mind, perhaps it is a good time to consider what the broad risk asset narrative looks like these days, especially since the most recent version was exceedingly clear; Nvidia is the only company that matters in the world and its stock price should go to 10,000.  While there had been pushback on this idea, with the naysayers comparing the stock to Cisco and Qualcomm during the dot com bubble in 2000, the true believers countered with the fact that Nvidia was wildly profitable and given the race by companies all over the world to embrace AI, would continue to grow at its extraordinary recent pace.  But consider…

Back in the 1970’s, there was a group of companies described as the Nifty Fifty that represented the growth companies of the time.  And they were great companies, with most of them still around today including American Express, Coca-Cola, IBM and Walt Disney, to name just a few.  The thesis at the time was that these companies represented the future, and that if an investor didn’t own them, they were missing out.  The thing that was ignored at the time (and in truth is ignored in every bubble) is there is a difference between the company and its share price.  Overpaying for a good company can result in poor investment performance even if the underlying company continues to have magnificent results.

I mention this era as there are certainly parallels to the current mania for the Supremes (Nvidia, Apple, Microsoft) and the narrative at that time.  There is nothing inconsistent with understanding that these companies, and especially Nvidia, have created something special, but that they cannot possibly sustain their current valuations and so their share prices may fall.  And they can fall a lot.  After all, Nvidia has retraced 13% in just 3 sessions.  As much momentum as these shares have had on the way up, they can have that much and more on the way back down.  I’m not saying this is what is going to happen today, simply highlighting that trees don’t grow to the sky.  Perhaps we have now seen how tall they can grow.  

One thing I sense is that if this correction continues, it is likely to broaden out.  Perceptions are funny things, and if the zeitgeist changes, even if the companies continue to put up terrific numbers, the share prices can go a lot lower.  Consider that if the Supremes each fall 50%, they will still have market caps of $1.5 trillion and be amongst the largest companies in the world.  In fact, if they fall 50%, I’m pretty confident so would most of the rest of the market, so they would likely maintain their relative crowns of size, just at a smaller number. 

At any rate, this is an important discussion as the equity markets have been key drivers of all markets, and a change there will naturally result in some different opinions elsewhere.  Arguably, the biggest question is, if the stock market falls sharply, but the economic data don’t respond in the same way, will the Fed really cut rates?  There are many who remain firmly in the camp that the ‘Fed put’ is still intact, and they will come to the rescue.  Personally, my take is if there is a Fed put, the strike price is a lot lower, maybe S&P 3500, not S&P 5000.  Chairman Powell has enough other problems to address so that the value of the S&P is probably not job one.  In fact, it could become quite a political problem for him if the Fed is seen as rescuing Wall Street again while so many on Main Street struggle.

Ok, it’s time to look at the freshly painted wall and watch it dry overnight session.  Yesterday’s US session was unusual for its composition as the DJIA had a solid day, gaining 0.7%, while the NASDAQ suffered, falling -1.0%.  Asia, too, had an interesting session with the Nikkei (+1.0%) and Australia (+1.3%) both rallying while the Hang Seng was little changed and China (-0.5%) fell.  One possible explanation is that the tech sectors are getting unwound while money flows into less exciting areas like natural resources and manufacturing.  Of course, given there are no tech shares of which to speak in Europe, the fact that every bourse on the continent, and the UK as well, is lower, led by the DAX’s -1.0% decline, I am searching for another explanation.  At this hour (7:20) US futures are a touch firmer, 0.3%, but I don’t put much stock in this given the past several sessions.

In concert with the risk-off theme, bond markets are seeing a bid with corresponding yield declines.  Treasury yields are lower by 1bp with European sovereigns lower by between -2bps and -4bps.  There is still a great deal of anxiety, at least according to the press, about the French elections, but given the political bias of most mainstream media, which is decidedly against the idea that Marine Le Pen’s RN should win, it is possible that the actual situation is far less concerning.  The fact that the Bund-OAT spread continues to narrow at the margins tells me that there are fewer concerns than immediately following Macron’s call for the snap election.

Oil prices (-0.6%) are retracing yesterday’s modest gains as there continues to be uncertainty over the demand situation and whether economic activity is slowing offset by what appears to be a modest escalation in the Russia/Ukraine war with concerns that could impact supply.  As to the metals markets, prices there are little changed this morning after having edged higher yesterday.  My take here is that traders are keenly focused on Friday’s PCE data as an indication to whether the Fed will be cutting sooner rather than later.  The sooner the cut, the better metals prices should perform.

Finally, the dollar is almost unchanged this morning after having fallen modestly yesterday.  All eyes continue to focus on USDJPY, although it has slipped back this morning to 159.50.  Right now, my sense is there are many ‘tourists’ in the FX market trying to play for the next intervention, but as I said yesterday, I do not believe the MOF is going to be as concerned as they were in April/May given the pace of the move has been so much more modest.  For instance, last night FinMin Suzuki explained, “[the MOF] will continue to respond appropriately to excessive FX moves.  It is desirable for FX to move stably.”  Now, aside from the oxymoron of stable movement, this type of commentary is typically not indicative of any immediate concerns.  As to the rest of the G10, modest gains and losses define the day although we have seen both MXN (-0.65%) and ZAR (-0.4%) slide this morning, although given the amount of money involved in the carry trade for both these currencies, this is likely just positions adjusting rather than a fundamental change.

This morning brings more tertiary data with the Chicago Fed National Activity Index (exp -0.4), Case Shiller Home Prices (6.9%) and Consumer Confidence (100).  We also hear from two speakers, Governors Cook and Bowman.  Perhaps the most interesting thing yesterday was that SF Fed President Daly specifically touched on Unemployment in her comments, explaining that though there was still insufficient confidence that inflation was declining to target, she was paying close attention to the Unemployment rate, “so far, the labor market has adjusted slowly, and the unemployment rate has only edged up. But we are getting nearer to a point where that benign outcome could be less likely.”  I have a feeling that the employment report a week from Friday is going to have a lot more riding on it than in the recent past.  Any weakness there could really change the tone of the market regarding the economy and the Fed’s actions.

It is difficult to get too excited about today although if the recent correction in Nvidia continues and widens to some other names (a distinct possibility) do not be surprised if there are some fireworks later on.  In that case, I would look for a traditional risk-off session with the dollar higher while bond yields and stocks fall.

Good luck

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