No Mean Feat

Posted on by 
Nvidia managed to beat
The whispers, which was no mean feat
But PMI data
Revealed that the beta
For growth going forward’s dead meat

The upshot is pundits believe
The market will get a reprieve
Tomorrow, Chair Jay
Could possibly say
That higher for longer’s naïve

Markets have been choppy, if nothing else, for the past 24 hours as we have seen substantial moves in Treasury (and other sovereign) yields, a major rally in gold, and the dollar fall sharply and then regain almost all of its losses.  Oh yeah, equity markets continue to rally as the Nvidia story was even better than hoped by the biggest bulls out there.  Briefly, the chipmaker exceeded earnings forecasts by a large margin and guided Q3 numbers even higher as the CEO explained that things were just getting started in the AI boom.  While he is certainly correct that there will be a lot of investment in the space going forward, it remains an open question as to whether AI will actually change the course of human history.  After all, cold fusion was recently “shown” to work amidst a great deal of hype, and that hasn’t worked out quite like the bulls expected.  

More importantly, there is a long time between now and when AI is going to result in all these great leaps forward, and we need to address the here and now.  And that is where things look a little less wonderful than they did before the week began. 

Typically, the PMI data doesn’t get as much play in the US as it does in Europe and Asia since the US has their own survey, ISM, which is reported at the beginning of each month.  But after a series of weak numbers from Europe yesterday, the US PMI data was much weaker than expected with all three indicators, Manufacturing (47.0), Services (51.0) and Composite (50.4) coming in at least a point lower than estimates and indicating that while perhaps not in a recession, the US growth picture is quite subdued.  

Again, the survey data has been pointing, for some time, to economic weakness that has not yet appeared in many of the hard numbers like NFP or Retail Sales, but the market, at least the bond market, is quickly becoming of the opinion that recession is around the corner.  One need only look at 10yr yields to see the trend.  Yesterday saw 10-yr Treasury yields slide 13bps after touching a new cycle high on Tuesday.  This morning they are largely unchanged, but the day is still young.  But the picture in Europe and the UK is much more substantial, with yields, which had been rising alongside Treasuries have fallen far more sharply.  Since Tuesday’s close, German bund yields are down 19bps, Italian BTP yields have fallen 23bps and UK gilt yields are lower by 13 bps.  The market continues to reduce the terminal rate for the ECB, now below 3.80% and for the BOE, now 5.80%, as economic weakness is clearly the key concern.

Tomorrow, we will hear from Chairman Powell, but also from Madame Lagarde and then Saturday, BOE deputy governor Broadbent will make a speech.  In other words, at this point, markets are quite keen to hear if there is any change in the G3 central bank mindset.  Based on the large retracement in yields, markets are clearly expecting a dovish outcome.  While that is certainly possible, I think there is ample room for the Chairman to maintain the current view of higher for longer absent weakness in real data.

Speaking of real data, yesterday’s NFP revisions were a bit less than the whispers, with 306K jobs removed from the record.  I expect that data was also part of the bond market rally as changes there mean more than the PMI data, at least they have so far.  In the end, the dichotomy between the bond market which is beginning to believe the recession story, and the stock market, which sees no landing at all, is widening.  Commodity markets have been leaning recession, and the dollar has been strong, which would arguably be more in tune with growth than weakness.  In other words, there is no consistency here so we will need to continue to focus on the information as it comes out.

As mentioned, stocks are on fire this morning after the Nvidia earnings with yesterday’s anticipatory US rally matched by Asian gains, especially in HK which jumped >2%, and Europe is all green, but not nearly as aggressively with gains on the order of 0.3% across the board.  As to US futures, on the back of Nvidia, NASDAQ futures are higher by 1.3%, which is dragging the SPX up as well, however the Dow is little changed this morning.  It seems the Dow’s members lack that high tech sense about them.

Turning to commodities, oil (+0.3%) is bouncing off its recent lows although remains under pressure overall on the economic weakness story.  Gold (+0.2%) which exploded higher yesterday by more than 1%, remains in demand, perhaps on the back of the BRICS meeting and some discussion there, while base metals are softer, also on the recession theme.

As to the dollar, it is stronger across the board vs. its G10 counterparts on the day, but if you look at the move over the past two sessions, it is a more mixed picture.  Yesterday morning’s USD strength was reversed in the wake of the PMI and NFP revision data and the dollar fell sharply on the day against virtually all its G10 and EMG counterparts.  This morning, it is back on the way up, against both groupings, leaving an overall mixed picture.

Perhaps this would be a good time to touch on the BRICS meeting.  For those who believe in the end of the dollar, this had to be quite a disappointment given there was virtually no discussion of a new currency.  However, they did invite 5 countries to join, Saudi Arabia, Argentina, Iran, Egypt and Ethiopia, so expansion is real. (I wonder if they are going to change the name!). However, if you are Brazil, India, South Africa, Argentina or Egypt, all democracies with elected leadership, it seems a question that needs to be asked is do they really want to get into bed with a murderous thug like Putin, who coincidentally, had a key rival murdered yesterday.  That is not a very good look.  At any rate, anything that is going on in the BRICS group remains a distant question, at least from a current risk management perspective.  

Meanwhile, the dollar’s fluctuations are going to remain beholden to the perception of the US economy and the Fed.  Yesterday’s weakness was a clear response to declining yields on the weak data.  In the same vein, look for any strong data to help boost the dollar back up.

Speaking of data, today brings a good amount with Initial (exp 240K) and Continuing (1705K) Claims, Chicago Fed National Activity Index (-0.22) and Durable Goods (-4.0%, 0.2% ex transport).  Yesterday’s other data was New Home Sales, which was slightly higher than expected, but after a downward revision to the previous month, so no real net change.

Right now, stocks are the driver, tech stocks in particular, but watch the bond market.  If today’s data hints at weakness, I suspect that yields will fall further as will the dollar.  Of course, that means stocks will probably rally on the lower yield story.  

Good luck

Adf

Lacking In Gains

Posted on by 
The PMI data remains
A place clearly lacking in gains
At least cross the pond
And Asia beyond
But will the US feel those pains?

The hard data hasn’t supported
That weakness, but is it distorted?
The latest we hear
Is NFP’s near
Revisions that show growth’s been thwarted

As market participants look ahead to Friday’s Powell speech at Jackson Hole, and seemingly more importantly to Nvidia’s earnings report and forecasts this afternoon, we must look at a few things that are going on in the economy.  The most noteworthy situation is that there remains, at least in the US, a wide gap between the survey data and the actual data.  We continue to see weak readings from the regional Fed manufacturing surveys, as well as PMI and ISM data, yet the key numbers, like NFP and Retail Sales continue to perform at a better than expected rate consistently.  While we await this morning’s Flash PMI data (exp Mfg 49.0, Services 52.2, Composite 51.5), which are essentially unchanged from last month’s readings and perhaps the best in the G10, there is a story this morning that the NFP data is going to be revised down by 650K jobs at the preliminary revisions today.  That is a huge adjustment and one that would certainly call into question the ongoing strength in the labor market.

It is not yet clear if it will impact the Unemployment Rate but if this story is accurate, it will almost certainly impact some of the thinking at the Eccles Building.  Consider that, after revisions, the seven NFP numbers have totaled 1807K so far this year, with the last two months showing 185K and 187K respectively.  If that 650K number is correct, and it comes from the past two months, then they will be revised into negative territory, a very different indication than anyone has considered to date.  However, even if it is more evenly spread across the year, it still represents more than one-third of the alleged jobs created.  This feels important to me.  While I have no way of determining if this story is accurate, it is important to understand it is making its way through the markets.  If this is the case, I would expect that the market’s view on the economy, as well as the Fed’s is likely to change somewhat.  

Arguably, the market response would be to alter pricing for interest rates going forward with more rate cuts priced in and priced in sooner than the middle of next year.  At the same time, though, former St Louis Fed President Bullard was interviewed by the WSJ yesterday and was crowing about how the market got the recession call wrong and the economy is doing much better than expected.  These diametrically opposed views are the norm in the markets these days, with no clear consensus that things are going to improve or worsen.  Again, it is this situation that informs why hedges for natural exposures are so important.

Turning to the other PMI’s released this morning, the story in Europe remains one of desultory growth or outright shrinkage.  The German manufacturing sector PMI printed at 39.1, better than last month’s 38.8, but still deep in recessionary territory.  While the French and Eurozone numbers were a bit better, they were both well in recession territory.  In fact, given the weakness of this data, and the fact that the ‘hard’ data in Europe has also been soft, the new narrative is the ECB is finished.  What had been a 50:50 probability for a hike in September has fallen to a one-third chance and if we continue to see weaker data, I expect that will fall further.  As to the UK, it also saw weak PMI data, with both Services and Manufacturing below the key 50 level, and the market has pulled back to just two 25bp rate hikes over the next 6 months despite the fact that inflation in the UK remains the highest in the developed world at 6.9% core, while the base rate sits at 5.25%.

It is not hard to look at this data and understand why the dollar continues to perform well.  Despite all the problems in the US, especially regarding the debt and massive interest payments, as well as the recent credit downgrade by Fitch, the US remains the most attractive opportunity around in the G10.  In fact, this is why that story about the massive downward revision in NFP data is so important.  Without it, the distinction is very clear, buy the USD, but if it is true, opinions are likely to change somewhat.

Turning to the overnight session, while most markets managed to do reasonably well in Asia, the mainland equity markets continue to suffer with the CSI 300 down -1.6%.  In Europe, the picture is mixed with some early gains being ceded and only the UK (+0.7%) managing to stay positive while the continent slips slightly into the red.  US futures, meanwhile, are barely in the green as all eyes await the Nvidia earnings after the close.

In the bond market, it is a one-way street with yields falling across the board and in a meaningful way.  Treasuries are actually the laggard with yields only down by 5bps while European sovereigns have seen yield declines of 9bps and UK gilts of 11bps.  Clearly, the bond market is responding to the weak PMI data and anticipating weakness in the US as well.  One other interesting thing is that the yield curve inversion, which had been unwinding for the past week or two, widened again yesterday and is back above the -75bp level, having traded as low as -65bps just a few days ago.

Recession is the view in the commodity space as well, at least in energy, as oil prices (-1.5%) fall again and are now back below the $80/bbl level.  Stories of more Iranian crude making its way to the market as well as fears over reduced demand are having an impact.  Interestingly, the metals markets are holding up this morning with both base and precious varieties all in the green led by copper (+1.0%).  This is a harder outcome to square with the recession fears.

Finally, the dollar is doing quite well this morning, which given the growing risk-off attitude makes some sense.  Vs. the G10, only the yen (+0.25%) has managed any gains, and they are small.  Meanwhile, the rest of the bloc is weaker across the board led by the pound (-0.9%) and NOK (-0.9%) for obvious reasons.  In the EMG bloc, ZAR (+0.5%) is the lone gainer of note after South African data implied better times ahead.  On the flipside, though, weakness is broad based with APAC, EEMEA and LATAM currencies all under pressure amidst the risk sentiment today.

Yesterday’s Existing Home Sales data was a bit softer than expected and as well as the PMI data due, we also see New Home Sales (exp 703K) and that NFP revision.  Clearly, all eyes will be on that last piece of data given the rumors of a large decrease.  So, we will need to see how that comes.  If it is benign, then I expect risk appetite may return as the bulls look for a big Nvidia story this afternoon.  However, if that huge revision appears, I suspect risk will remain in abeyance for now.

Net, nothing has changed the medium-term view of dollar strength, but the day to day remains open to the news.

Good luck

Adf

Alternate Ways

Posted on by 
In Joburg a gath’ring of nations
Is trying to firm up foundations
For alternate ways
That each of them pays
The other with no complications

Meanwhile, we are starting to hear
A story that we should all fear
The calls have come forth
Inflation that’s north
Of two percent’s where Jay should steer

The BRICS nations are meeting in Johannesburg starting today with, ostensibly, a mission to exit the dollar financial system.  While Russia has already done so involuntarily, the biggest proponent of the move is China, although the other nations are certainly willing to listen.  In addition to this goal, they will hear from many other developing nations as to whether these other nations merit inclusion in the BRICS club.

Ultimately, the problem that this disparate group of nations has is that none of them really trust any of the others.  Certainly, the historical conflict between China and India is well-known and long-lasting.  It was not that long ago that their soldiers were shooting at each other in the Himalayas.  At the same time, both Brazil and South Africa are extremely remote from the other nations and have completely different economic and political systems.  In other words, the common ground of wanting to do something about the US and its dollar, while certainly a goal, is unlikely to be enough for any of them to risk potential negative consequences of a failed concept.  

Much will be made of this meeting in the press, but we have already heard from South Africa’s FinMin, Enoch Godongwana, that it is premature for South Africa to stop using the USD and SWIFT system.  Ultimately, my strong belief is this is much ado about nothing, at least for the foreseeable future.  Perhaps in 25 years, after the 4th Turning is complete, the global currency system will be different, but not anytime soon.

Which brings us to the other story which has me far more concerned about the dollar and the US economy, the substantial increase in calls by mainstream economists to raise the Fed’s inflation target.  Understand that I have never been a fan of the target to begin with, recognizing its arbitrary nature.  However, the world in which we live has been predicated on the idea that the Fed is focused on that target and its policies are designed to maintain a relatively low rate of inflation.  Raising that target, with 3% the new favored call, is just as arbitrary as the initial level, but it changes the dynamic in the economy as well as markets.

It seems these calls are coming from the hyper-Keynesians who lean toward MMT and believe that the risk of any economic growth slowdown should be addressed ahead of all other concerns.  (It could be argued that the current administration is quite concerned that a recession next year, heading into the presidential election, would not favor President Biden’s reelection.). Now, nobody is happy when the economy slows down as it makes life difficult for us all, but one of the reasons the nation is in its current situation, with unsustainable levels of debt outstanding, is because the willingness of any politician to allow markets to actually clear (meaning asset prices fall sufficiently to hurt the 1% club) is essentially nil.  This has been the underlying driver of constant spending programs and ultimately, the cause of the ballooning budget deficits and Federal debt.  

The unspoken piece of this concept is that permanently higher inflation will reduce the real value of the outstanding debt that much more quickly, hence allowing for even more deficit spending going forward.  The fact that higher inflation is an effective tax on the bottom 99% of the income brackets, with the pain increasing more rapidly the further down that scale you look, is of no concern it seems.

Thus far, Chairman Powell has been adamant that there is no change to the goal on the table.  But I assure you that the longer it takes for inflation to retreat to its former levels, the more we will hear about this idea.  When I combine this concept with my belief that inflation is going to remain sticky in the 3%-4% range going forward for quite a while, it does not paint a promising picture.  The Fed already has credibility issues; moving the goalposts in the middle of their inflation fight would really destroy any remaining credibility they have, and that would be a real problem for monetary policy activities going forward.

But these problems are far too forward looking for today’s markets.  Instead, the future is…Nvidia!  At least, that seems to be the case right now.  As investors await their Q2 earnings release tomorrow afternoon, the working thesis seems to be that they will beat the currently inflated analyst expectations and drive the next leg of the equity bull market higher.  Now, remember, they currently trade at a 228 P/E ratio, which seems pretty high in the scheme of things, regardless of the promise of AI going forward.  (You can tell AI didn’t write this as I call into question its value here).  There has been much talk of a big ‘beat’ in earnings and that has been the catalyst for today’s equity rally.  Well, that and the fact that the Chinese seem to have instructed their ‘plunge protection team’ to get back to buying Chinese stocks as well as the yuan.  Regardless of the rationale, though, risk is definitely in favor today.

Asian equity markets were higher across the board, with the big ones all higher by just under 1%.  European bourses are similarly situated, all higher by about 1% while US futures, at this hour (7:30) are lagging a bit, only up by about 0.5%, although that was after a pretty solid performance yesterday.  Woe betide the equity markets if Nvidia misses its numbers!

At the same time, bond yields are generally lower this morning with 10yr Treasuries down 2bps from yesterday’s new closing high near 4.35%.  European sovereign bonds have also seen demand with yields sliding between 4bps (Germany) and 7bps (Italy) as a combination of mildly positive UK Public Sector Finance news and a very large Eurozone Current Account surplus seem to have bond investors quite excited.  Asia, however, did not share this excitement with JGB yields rising 2bps and getting to their highest level (0.663%) since the change of policy last month.  

On the commodity front, oil (-0.2%) has edged back below $80/bbl, representing a sharp decline yesterday afternoon after signs of increased supply started to show up in the market.  The metals markets, however, are in much better shape this morning with gold (+0.4%) back above $1900/oz and the base metals both firmer as well.  It seems that mildly lower yields and a weaker dollar are having quite a positive effect.

Speaking of the dollar, it is under broader pressure this morning vs. most of its G10 and EMG counterparts.  In the G10, NZD, AUD and SEK have all gained about 0.5% with NOK +0.4% as commodity prices find some support, and the China renewal story helps the overall global growth story this morning.    While the euro is little changed on the day, the rest of the bloc has edged higher as well.  Meanwhile, in the EMG bloc, ZAR (+1.1%) is the biggest gainer on the day, perhaps getting a little boost from positive BRICS vibes, but more likely from positive commodity vibes.  As to the rest of the bloc, APAC currencies have benefitted from the China story and THB (+0.65%) has benefitted from the resolution of the political crisis with a new PM finally being named.

On the data front, we see Existing Home Sales (exp 4.15M) and Richmond Fed Manufacturing (-10) and we hear from several Fed speakers.  However, with Powell on the calendar for Friday morning, I don’t think a great deal of attention will be paid to any other Fed speaker until he’s done.  There is a strong belief he is going to lay out the policy framework going forward, but I have a suspicion that he is happy with the current ‘guidance’ of higher for longer and may not say much at all.

Right now, risk is to the fore, and as such, the dollar is likely to remain under pressure until that changes.  It may be this way all week, or if Nvidia misses its numbers, don’t be surprised to see the dollar reverse course higher after that.

Good luck

Adf

Simply a Bummer

Posted on by 
As tiresome as it may be
To talk about China and Xi
The doldrums of summer
Are simply a bummer
With nothing else worthy to see

However, come Friday we’ll turn
To Jackson Hole where we should learn
If Jay and the Fed,
When looking ahead,
Decide rate hikes soon can adjourn

The biggest news overnight was that the PBOC cut interest rates again, but this time somewhat less than expected.  You may recall that last week, they cut the 1-yr Lending Facility rate by 15bps in a surprising move.  In fact, this is what started the entire chain of events last week that resulted in China dominating the macroeconomic news.  Well, last night they cut the 1yr Loan Prime rate by a less than expected 10bps with the market looking for a 15bp cut.  And they left the 5yr Loan Prime rate, the rate at which most mortgages in China are priced, unchanged at 4.20% rather than implementing the 15bp cut that the market had anticipated.  The result is that so far, Chinese support for their economy remains tepid at best.

At the same time, there continues to be a grave concern in Beijing regarding the exchange rate as, once again, the daily fixing was far below the market rate, and once again, the renminbi fell anyway.  It has become abundantly clear that the PBOC is quite concerned over a ‘too weak’ renminbi, hence the maintenance of the 5yr interest rate.  As well, it was widely reported that Chinese state-owned banks were actively selling USDCNY in the market to prevent further weakness in their currency.  

Perhaps this is a good time to briefly discuss the concept of the end of the dollar again, a topic that continues to make headlines.  One of the key pillars of this thesis is that the PBOC has reduced the number of dollars on its balance sheet substantially over the past several years which is seen as an indication that they are preparing to support some new reserve asset.  However, as last night’s price action indicated, it is quite possible, if not likely, that the only change has been one of location, rather than amount.  As the PBOC reduced the dollars on its balance sheet, the big state-owned banks all increased the amount on their balance sheets.  So now, the PBOC can direct those banks to intervene on their behalf whenever they want to do something.  At the same time, the PBOC has the appearance of decoupling, something they are clearly trying to demonstrate.  

This week is the big BRICS meeting where the stories are that they are going to unveil a new BRICS currency, allegedly to be gold-backed, as these nations try to undermine US power as well as offer an alternative to non-aligned nations.  The thing to remember about this group of widely disparate nations is that it has never been a cohesive bloc, it was simply an acronym created by a Goldman Sachs analyst in 2001 to describe a group of fast-growing emerging markets.  However, other than China and Russia, which have become closer since Russia’s invasion of Ukraine, they really have very little in common.  They are geographically widely diverse, have very different governing structures as well as very different financial and monetary policies.  In other words, there is nothing to suggest they can act as a cohesive group for any major decision.  While I am certain there will be some announcement of some sort at the end of the conference, an alternative to the dollar will not be coming anytime soon.

As to Jackson Hole, since Powell’s speech isn’t until Friday morning, we have plenty of time to touch on that topic later in the week.  In the meantime, risk is arguably in modest demand this morning.  While Chinese shares suffered significantly overnight on the disappointing rate news, European bourses are all nicely higher, generally between 0.75% and 1.00%.  Too, US futures are firmer this morning by about 0.5% after a late day rally Friday brought the major indices back near unchanged on the day from earlier lows in the session.

At the same time, bond yields continue to rally with 10-year Treasury yields back at 4.30%, up 4bps this morning, while European sovereign yields are all higher by between 4bps and 5bps.  It seems the bond market is not completely on board with the soft-landing narrative even though an increasing number of analysts are coming around to that view.  I think what we have learned thus far is that the US economy is not nearly as interest rate sensitive as it used to be.  The post-Covid period of QE and ZIRP saw a massive refinancing of debt, both mortgage and corporate, into longer-dated, low fixed rates.  With yields higher, there is much less need for refinancing, at least not yet, and so many of the problems that have been widely expected just have not happened yet.  At some point, when debt needs to be refinanced, if rates are still at current levels, it is likely to prove problematic for the companies and the economy writ large.  But that could still be some time from now.  In the meantime, I continue believe the yield curve inversion, which is now down to -67bps, could disappear completely by 10yr yields continuing to rise.  That is clearly not the consensus view.

Turning to commodities, they are generally looking good today led by oil (+1.2%) which has rebounded over the past several sessions and is back above $82/bbl.  The metals, too, are looking good with gold up at the margin, although hovering just below $1900/oz, while copper also has a bit of support today, up 0.3%.  For the industrial metals, China remains a key question mark.  If the Chinese economy continues to slow, then demand for these commodities is likely to be disappointing and prices seem likely to come under short-term pressure.  But remember, the long-term story remains one where many of these are essential for the mooted energy transition, and there simply is not enough of the stuff to satisfy the demand.  Longer term, prices still have room to rise.

Finally, the dollar is starting to slide as I type.  An earlier mixed picture has seen buyers of NOK (+0.75%) as oil continues to rebound, but also in essentially all of the G10 with only the yen (-0.3%) lagging.  In fairness, this is classic risk-on price action.  Turning to emerging market currencies, Asian currencies were mostly under pressure last night after the China rate news, but this morning EEMEA currencies are looking much better as they follow the euro (+0.3%) higher.  It appears that fear is taking a day off today.

On the data front, there is not much of real interest this week:

TuesdayExisting Home Sales4.15M
WednesdayFlash Manufacturing PMI49.0
 Flash Services PMI52.0
 New Home Sales704K
ThursdayInitial Claims240K
 Continuing Claims1700K
 Chicago Fed Nat’l Index-0.20
 Durable Goods-4.0%
 -ex transports0.2%
FridayMichigan Sentiment71.2
 Powell Speech 

Source: Bloomberg

Given the number of market participants on summer holiday, I suspect that there will be very little activity this week until we hear from Chairman Powell.  I would look for a little bit of choppiness, but no real directional moves until we know the Fed’s latest views.  And there is a real chance that he doesn’t tell us anything new, which means that we would then be waiting for NFP a week from Friday.  Net, until the Fed’s hawkishness breaks, I still like the dollar best.

Good luck

Adf

Problems Galore

Posted on by 
The story continues to be
The China of President Xi
Has problems galore
With more still in store
So, traders, as such, want to flee

The issue for markets elsewhere
Is knock-on effects aren’t rare
Protecting the yuan
Means it is foregone
Bond sales will send yields on a tear

For yet another day, China is offering the biggest market stories.  In no particular order we have seen the following overnight; China Evergrande filed for Chapter 15 bankruptcy, a process by which foreign entities can access the US bankruptcy court system, regarding $19 billion of their offshore debt; the PBOC set their CFETS fixing more than 1000 pips lower than market expectations, the largest gap since the process began in 2018, in their effort to arrest the yuan’s consistent decline; and Chinese police visited the homes of the protesters who were complaining about Zhongzhi’s missed payments (I wrote about these Monday in Risks Were Inbred).  And this doesn’t include the fact that Country Garden, the largest property developer in China is losing money quite rapidly and may also be on the brink of bankruptcy.  It seems the Chinese property bubble is deflating.

Ultimately, there appear to be two main impacts of the gathering storm in China, market participants are increasingly leery of taking on risk in general, and the PBOC’s efforts to stem the decline of the yuan means they must sell their holdings of Treasuries to generate the dollars to deliver into the FX market thus adding downward pressure to the bond market.  Of course, one of the typical outcomes of a risk-off attitude is that bond markets rally as investors exit equities and run to bonds.  This stands at odds to the recent bond market behavior, although it is quite evident this morning.  In fact, after touching yields above 4.30% in the 10yr Treasury yesterday, this morning we have seen a half-point rally with yields declining about 5bps in the US.  In Europe, the yield declines have been even greater, mostly around -10bps, so this is a real reprieve for bond markets everywhere.

The key question here is whether we have seen the worst, or if other potential selling catalysts will appear.  Consider for a moment the fact that between China and Japan, they represent >26% of foreign owned US Treasury debt, and that both of these nations are dealing with rapidly weakening currencies.  Not only that, but both have demonstrated they are quite willing to intervene in FX markets to arrest those declines, and as mentioned above, that typically requires selling Treasuries.  It’s a self-reinforcing cycle as higher yields beget currency sales which beget Treasury sales to intervene, which results in higher yields starting the cycle all over.  

With this in mind, we need to consider, what can break the cycle?  Well, if the Fed were to turn dovish and indicate they agreed with the futures markets that rate cuts are coming early next year, I suspect the dollar would fall against most currencies, especially these two, and the cycle would break.  Alternatively, China could step up and guarantee the debt of Countrywide and Evergrande thus removing the investor risk and reduce pressure dramatically.  Finally, I suppose the Fed could make a deal with the BOJ and PBOC and directly absorb their bond sales, so they never hit the market while restarting QE.  That, too, would likely end the cycle.  It is possible there are other ways to break the cycle, but I doubt we will see any of these occurring anytime soon and so the cycle will have to wear out naturally.  That will occur when either or both of the currencies decline far enough so the market believes the trade has ended and unwinds their short positions.  In other words, none of this has changed my view that 7.50 is on the cards for USDCNY as the year progresses, very possibly with 10yr yields getting to 4.5% or more.  And don’t be surprised if we see another move to 150.00 in USDJPY.

But, away from the China connection, things are very much in the summer doldrums.  Equity markets have been treading fearfully and continue to do so this morning.  However, while we have seen several days of declines, there has been no panic selling of note.  So, yesterday’s US weakness was followed by selling throughout Asia and this morning in Europe with most markets down about -1.0%.  US futures, too, are softer, down about -0.5% at this hour (8:00).

Oil prices (-0.85%) which stabilized yesterday, are back under a bit of pressure on the overall negative risk sentiment as they continue to trade either side of $80/bbl.  Metals prices, meanwhile, are mixed with precious metals finding a bit of support while base metals suffer today.  The most interesting story here I saw today was that CODELCO, the world’s largest copper miner in Chile, may be going bankrupt as previous projects didn’t pan out.  That strikes me as a very large potential problem, but one for the future.  

Finally, the dollar is mixed this morning.  It had been softer overall in the overnight session, but as risk is getting marked down, the dollar is gaining strength.  The biggest mover has been PHP (+1.1%) which rallied after the central bank indicated they were going to put a floor under the currency and adjust rates accordingly.  After that, the EMG bloc has not done very much, +/- 0.25% type activity.  However, just recently, G10 currencies started to slide with NOK (-0.8%) the laggard as oil slides, but the entire bloc now coming under pressure.  This is all about risk off.  

There is no US data today nor are there any Fed speakers.  As such, the dollar will take its cues from the equity markets, and the bond market to some extent.  Right now, equity weakness is driving the risk attitude and that means the dollar is likely to remain bid into the weekend.  Next week brings the Fed’s Jackson Hole meeting where everybody will be looking for any policy hints by Chairman Powell on Friday morning.  But for now, the dollar is on top of the mountain.

Good luck and good weekend

Adf

A Raw Deal

Posted on by 
The Minutes according to Jay
Explained more rate hikes are in play
At least that’s the spin
From media kin
But could that lead us all astray?

Yesterday’s key news was the release of the FOMC Minutes.  The market read, at least the headline read, was that they were hawkish which played a key role in the equity market decline in the afternoon, as well as the bond market decline leading to the highest 10yr yields since 2008.  Below is what I believe is the key paragraph from the Minutes with my emphasis.

“With inflation still well above the Committee’s longer-run goal and the labor market remaining tight, most participants continued to see significant upside risks to inflation, which could require further tightening of monetary policy. Some participants commented that even though economic activity had been resilient and the labor market had remained strong, there continued to be downside risks to economic activity and upside risks to the unemployment rate; these included the possibility that the macroeconomic effects of the tightening in financial conditions since the beginning of last year could prove more substantial than anticipated. A number of participants judged that, with the stance of monetary policy in restrictive territory, risks to the achievement of the Committee’s goals had become more two sided, and it was important that the Committee’s decisions balance the risk of an inadvertent overtightening of policy against the cost of an insufficient tightening.” 

It strikes me that based on the fact we have already heard from two FOMC voting members, Harker and Williams, that rate cuts are on their mind for 2024, and the lines I have highlighted above, the once unanimous view of a hawkish Fed is beginning to fall apart.  Now, if the data continues to outperform expectations like it has recently (consider the Retail Sales data from Tuesday) I expect the FOMC to maintain their hawkishness.  The Atlanta Fed’s GDPNow forecast has just risen to 5.75%, far above trend growth and certainly no implication for the end of tightening.  But remember, that is a volatile series, and we are a long way from the end of Q3.  Ultimately, I suspect that a growing number of FOMC members are starting to get queasy over the higher for longer mantra given the equity market’s recent shudders.  We shall see.

The Chinese are starting to feel
That Xi’s given them a raw deal
The yuan keeps on falling
While growth there is stalling
And values of homes are unreal

The PBOC was pretty vocal last night as they explained all the things they are going to do to manage a clearly deteriorating situation in China.  Here are some of the comments they released:

PBOC: TO MAKE CREDIT GROWTH MORE STABLE, SUSTAINABLE

PBOC: TO USE VARIOUS TOOLS TO KEEP REASONABLY AMPLE LIQUIDITY

PBOC: TO RESOLUTELY PREVENT OVER-ADJUSTMENT IN EXCHANGE RATE

PBOC: TO OPTIMIZE PROPERTY POLICIES AT APPROPRIATE TIME

PBOC: CHINA IS NOT IN DEFLATION RIGHT NOW

PBOC: LOCAL FISCAL BALANCE PRESSURE INCREASING

PBOC: HAS EXPERIENCES, TOOLS TO SAFGUARD STABLE FOREX MARKET

Which was followed by the following headline, CHINA TOLD STATE BANKS TO ESCALATE YUAN INTERVENTION THIS WEEK.

Add it all up and the Chinese are getting increasingly worried.  There is a great chart in Bloomberg today that shows the change in house prices across China, which puts paid to the official narrative that prices have fallen just 2.4% from the August 2021 highs.  They have clearly fallen a lot more as evidenced by this chart and the comments above.

In the end, the Chinese have a lot of work to do to keep their economy going.  While they remain concerned over the weakening CNY, it is clearly one of the best relief valves they have, and it will slowly weaken further.  Money is leaving the country.

An attitude change
Is becoming apparent
No JGBs please!

And finally last night the BOJ auctioned off some 20yr JGBs and the auction results were awful.  The tail was the widest, at nearly 8bps, since 1987, while the spread between 10yr and 20yr bonds widened by nearly 5bps.  It seems that demand was not nearly as robust as had been expected.  Given that nominal yields in the 20yr are 1.35% and CPI is 3.2% core, it is not that surprising.  Bonds everywhere are losing their luster, at least longer duration bonds, and I see no reason for that trend to end until economic activity is clearly declining.  China’s woes have not yet bled to either the US or Japan, while inflation remains sticky.  Today, globally yields are higher by between 4bps and 6bps.  This process still has more to go in my estimation.

Which brings us to the rest of the overnight session, where after another weak equity performance in the US, we saw Japan and non-China Asia soften, although Chinese markets held in on the back of the PBOC comments and promises of more support for the economy there.  European bourses are somewhat softer this morning but nothing dramatic and at this hour (7:30) US futures are higher by about 0.25% across the board.

Oil prices (+0.9%) have rebounded and after a brief foray below $80/bbl have recaptured that key level.  Metals prices are also firmer this morning across the board as both base and precious varieties see demand.  This seems largely in line with the fact the dollar is under modest pressure this morning.

And the dollar is under modest pressure this morning, at least vs. the G10, where every currency is firmer, but the moves are very small.  NOK (+0.4%) is the leader on the back of the oil move, but everything else is higher by between 0.1% and 0.25%.  In the emerging markets, the picture is a bit more mixed, with some gainers (ZAR +0.45%, HUF +0.35%) and some laggards (MYR -0.55%, PHP -0.5%) with both those currencies feeling pressure from concerns their respective central banks will not maintain the inflation fight.

On the data front, we see Initial (exp 240K) and Continuing (1700K) Claims as well as Philly Fed (-10.4) and Leading Indicators (-0.4%).  The data continues to have both highs and lows with yesterday’s IP jumping 1.0%, much better than expected, but the Empire Mfg data on Tuesday a very weak -19.  There are no Fed speakers today so I expect much will depend on whether or not dip buyers emerge in the equity markets.  It feels like we are teetering on the edge of a bigger risk-off move with another 10% down in equities entirely possible.  In that event, I do like the dollar to show resolve.

Good luck

Adf

Angina

Posted on by 
This week all the problems in China
Have given the markets angina
Last night, we are told
Stocks oughtn’t be sold
While Xi tries to hold a hard line-a

For the third day in a row, China is the story du jour.  Two stories from last night illustrate the problems in the Chinese economy are either spreading more widely or simply becoming more widely known outside China.  The litany of issues are as follows: Chinese authorities requested that investment funds not be net sellers of equities this week; the PBOC added the most cash to the economy via reverse repos in six months; investors who have not been repaid by Zhongrong International Trust were seen outside the company’s Beijing HQ protesting openly; and the yuan continues to slide despite PBOC efforts to moderate the currency’s decline.

A brief recap of the process in the onshore CNY market shows that each morning the PBOC sets a central rate for the day (the CFETS rate), ostensibly based on a basket of currencies they follow, and when the market starts trading, it must remain within a +/- 2% band around that central rate.  Historically, when the PBOC wanted to signal that the currency was getting too strong or too weak, that CFETS rate would be set further in their desired direction than the model implied to help guide the market.  Well, lately, the PBOC has been setting the CFETS rate for a much stronger than expected CNY, but the market has largely been ignoring that. Bloomberg has an excellent chart showing the rising discrepancy that I have reprinted below.

The bars on the chart represent the difference, in pips on the RHS axis, between the actual CFETS fix and the estimates from analysts’ models.  Notice that from November 2022 through the beginning of July, that difference was virtually nil.  The point is the models have proven themselves over time to be accurate, so these big discrepancies are policy choices.

As the PBOC watches the currency of its closest ally, Russia, collapse in slow-motion, it is clearly concerned about its own situation.  The added pressure of slowing growth and the problems in the investment sector are making things more difficult.  The fact that China is on a monetary easing path while the rest of the world is still tightening is naturally going to undermine the value of the renminbi, but the great fear in China is a rapid devaluation.  

The biggest problem the PBOC has is that unlike the situation with youth unemployment, where they simply decided to stop publishing the data, they don’t really have that choice in this situation.  They cannot hide what they are doing and expect that the FX market will be able to function realistically.  And China needs an FX market because of the huge portion of their economy that is reliant on international trade.  

There is no easy answer for the Chinese here.  If they seek to support the domestic economy with easier monetary policy, the renminbi is very likely to continue to fall as locals seek to get their money out of the country and invest in higher yielding assets.  The fact that the Chinese equity markets have been slumping simply adds more pressure to the situation.  There is a well-known idea in international finance called the impossible trilemma which states that no country can have the following three things simultaneously:

  1. A fixed foreign exchange rate 
  2. Free capital movement
  3. Independent monetary policy

China’s situation is that while the FX rate is not actually fixed, it is carefully and closely managed; while there are significant capital controls, there is still a steady flow of funds leaving the country, often via international real estate investments, so there is some freedom of flows; although of course, there is no attempt at independence by the central bank.  However, what we can readily observe is that even maintaining control of the currency while there is any ability to move capital offshore is virtually impossible these days.  Nothing has changed my view that we are headed to 7.50 and beyond over time.  And, to think, I didn’t even have to discuss weak earnings from Tencent or further concerns about Country Garden going bankrupt.

With that as our backdrop, it cannot be surprising that risk is under some pressure.  After all, the Chinese economy remains the second largest in the world.  The big change for markets is that after two decades of China being the fastest growing major economy in the world, now it is much slower than both Japan and the US (Europe is still in the dumps) and portfolio adjustments are still being made.

Looking at the overnight session, after a weak US market, with all three major indices lower by more than -1.0%, Asia followed suit completely, with markets there also under significant pressure, falling by -1.0% or more pretty much throughout the time zone.  European bourses, though, have edged higher after a weak performance yesterday, but the gains are di minimis, and in the UK, after inflation data showed the BOE’s job is not nearly done, the FTSE is a bit softer.  US futures are little changed this morning as the market awaits the FOMC Minutes this afternoon.

Treasury yields have backed off a bit, down about 2bps, and we are seeing similar movements in Europe. However, 10yr Treasury yields remain well above 4.0% and certainly seem like they are trending higher.  In the wake of the much stronger than expected Retail Sales data yesterday morning, 10yr yields spiked to 4.26%, their highest level since last October, and tantalizingly close to the highest levels seen in more than 15 years.

Oil prices (+0.3%) which have been sliding for the past week, consolidating their strong move over the past two months, seem to be stabilizing above $80/bbl for now.  We are also seeing modest strength in the metals complex today, although the movement has been very tiny.  Gold has managed to hold the $1900/oz level, but its future performance will depend on the dollar writ large I think.

And finally, the dollar, which has been quite strong overall lately, is softening a touch this morning, with only two weaker currencies in the EMG bloc, KRW (-0.5%) and CNY (-0.1%) as both respond to the problems mentioned above.  But elsewhere, this seems to be a bit of a relief rally with the dollar sagging broadly.  The G10 space is seeing similar price action with only CHF (-0.2%) and JPY (-0.1%) lagging slightly, while the rest of the bloc edges higher.  But movement of this tiny magnitude tends to mean very little.

On the data front, Housing Starts (exp 1450K) and Building Permits (1463K) come first thing with IP (0.3%) and Capacity Utilization (79.1%) at 9:15.  Finally, at 2:00 the Minutes from the July FOMC meeting will be released and given the change in tone we have heard from several members lately, with cuts now on the table for next year, it will be interesting to see how that plays out.

Today feels like a consolidation day, without any significant catalysts, so I expect a quiet session overall.  Unless the Minutes change everyone’s views regarding the next steps by the Fed, I maintain my view of dollar strength over time.  At least until the Fed actually turns things around.

Good luck

Adf

Growth Will, Fall, Free

Posted on by 
In China when data is weak
And nothing implies there’s a peak
The answer is to
Remove it from view
And henceforth, no more of it speak

But just because President Xi
Decided there’s nothing to see
That will not prevent
The wid’ning extent
Of views China’s growth will, fall, free

Last night China released their monthly series of economic statistics, all of which were lousy.  Briefly, Retail Sales (2.5%), IP (3.7%), Fixed Asset Investment (3.4%), Property Investment (-8.5%) and Unemployment (5.3%) all missed the mark with respect to economists’ forecasts and all indicated much weaker growth than previously expected.  Conspicuously there was one data point that was missing, youth unemployment, which had been rising rapidly over the past months and in June reached a record high of 21.3%.  However, given the amount of negative press coverage that particular data point was receiving, especially in the West, it seems that President Xi decided it was no longer relevant and it will not be published going forward.  Given the broad-based weakness in all the other data, as well as the fact that there are many new graduates who would have just entered the workforce, one can only assume the number was pretty substantially higher than 21.3%.

The other news from China was that the PBOC cut their 1yr Medium-Term Lending Facility rate by 15bps in a complete surprise to the market.  As well, the 1wk repo rate was also cut by 10bps as the government there tries to address the very evident weakening economic picture without blanket fiscal stimulus.  One cannot be surprised that the renminbi weakened further, falling another -0.4% onshore with the offshore version currently -0.5% on the session.  One also cannot be surprised that Chinese equity markets were all under pressure as prospects for near-term growth continue to erode.  FYI, the renminbi is within pips of its weakest point in more than 15 years and, quite frankly, there is no indication it is going to stop sliding anytime soon.  I continue to look for 7.50 before things really slow down.

As growth increases
And inflation remains high
Can QE remain?

In contrast to the Chinese economic data, we also saw Japanese data overnight and it was a completely different story.  Q2 GDP was estimated at 6.0% on an annual basis, much higher than expected and an indication that Japan is finally benefitting from its policy stance.  While inflation data will not be released until Thursday, the current forecasts are for little change from last month’s readings.  However, remember every inflation indicator in Japan is above the BOJ’s 2% target so the question remains at what point is QE going to end?  For the FX market this matters a great deal as USDJPY is back above 145 again, and if you recall the activities last October, when USDJPY spiked above 150 briefly and the BOJ/MOF felt forced to respond with significant intervention, we could be headed for some more fireworks.  However, despite the BOJ’s YCC policy adjustment at the last BOJ meeting in July, the JGB market has remained fairly well-behaved, so it doesn’t appear there is great internal pressure to do anything yet.  The flipside of that is the US treasury market, where 10yr yields are back above 4.20% and that spread to JGBs keeps widening.  As the Bloomberg chart below demonstrates, the relationship between 10yr Treasury yields and USDJPY remains pretty tight.  Given there is no indication 10yr yields are peaking, I suspect USDJPY has further to rise.

All this, and we haven’t even touched on Europe or the UK, where UK employment data showed higher wages and a higher Unemployment Rate, a somewhat incongruous outcome.  The Gilt market has sold off on the news, with yields climbing about 6bps, but the rest of the European sovereign market is much worse off, with yields rising between 8bps and 12bps.  Treasuries are the veritable winner with yields this morning only higher by 3.5bps.

What about equities, you may ask, after yesterday’s positive US performance.  The disconnect between the NASDAQ’s ongoing strength in the face of rising US yields remains confusing to many, this poet included, as the NASDAQ, with all its tech led growth names, seems to be an extremely long duration asset.  But, another 1% rally was seen yesterday, ostensibly on the strength of Nvidia which rallied after a number of analysts raised their price target on the company amid news that Saudi Arabia and the UAE both have been buying up the fastest processors the company makes.  Well, while Japanese equities managed gains after the strong data, all of Europe is in the red, all by more than 1% and US futures are currently (7:30) lower by about -0.5%.  If US yields continue to rise, and there is no indication they are going to stop doing so in the near future, I find it harder and harder to see equity prices continue to rise as well.  Something’s gotta give.

Interestingly, the commodity space seems to be out of step with the securities markets.  Or perhaps not.  Oil (-1.0%) is down for the third day in four, hardly the sign of economic strength, as arguably the combination of rising interest rates and slowing growth in China would seem to weigh on demand.  And yet, the soft-landing narrative remains the highest conviction case among so many analysts.  So, which is it?  Soft landing with continued growth and energy demand?  Or a hard landing with energy demand falling sharply?  My money is on a harder landing, although I think energy demand will surprise on the high side regardless.  Meanwhile, both base and precious metals are under pressure today with copper (-1.6%) the laggard of the group.  Remarkably, despite ongoing USD strength, gold is still above $1900/oz, but at this point, just barely.

Speaking of the dollar, today is a perfect indication of why the dollar index (DXY) is not a very good estimator of the overall trend.  As I type, DXY is lower by about -0.2%, yet the dollar has risen against virtually every APAC currency and the entire commodity bloc in the G10.  In fact, the only currencies rising today are the euro and pound, both higher by about 0.2%.  At any rate, there is no indication that the dollar’s rebound is ending either.  This is especially true for as long as US yields continue to climb.  Think of it this way, global investors need to buy dollars in order to buy the high yielding Treasuries we now have, so demand is likely to remain robust for now.  

On the data front, Retail Sales (exp 0.4%, 0.4% ex autos) is the big number but we also see Empire Manufacturing (-1.0) and the Import and Export Price Indices.  In addition, we hear from Minneapolis Fed President Kashkari at 11:00, which is likely to have taken on more importance now that we have seen the first split on the concept of higher for longer.  Which camp will he fall into and how vocal will he be regarding the potential to cut rates next year?

But, putting it all together right now, risk is under pressure, and I see no reason for that to change today.  I guess a blowout Retail Sales number, something like 1.0% could get the bulls juices flowing, but that would likely push yields even higher and that is going to be a drag.  Either way, I like the dollar to continue to perform well here overall, especially against EMG currencies.

Good luck

Adf

Risk Were Inbred

Posted on by 
In China, the problems have spread
From property company dread
To shadow finance
Where folks took a chance
To earn more though risks were inbred

And elsewhere, the Argentine voters
Surprised governmental promoters
By choosing a man
Whose primary plan
Is ousting Peronist freeloaders

While the goal of this commentary is to remain apolitical, there are times when the politics impacts the markets and expectations for future movement so it must be addressed, though not promoted on either side.  Today, amid general summer doldrums, it seems there are more political stories around that are either having or have the potential to impact financial markets.

But first, a quick look in China where the latest problem to bubble to the surface comes from Zhongzhi Enterprise Group Company, one of the many shadow banking companies in the country.  These firms are conduits for investment by wealthier individuals and corporations who offer structured products and investments promising higher returns than the banking sector.  And they are quite large, with an estimated $2.9 trillion invested in the sector.  Well, Zhongzhi has roughly $138 billion under management and last week they apparently missed some coupon payments on several of these high-yielding investments.  While this is the first that we have heard of problems in the sector, given the terrible performance of the Chinese equity market as well as the ongoing collapse of the Chinese property market, my guess is this won’t be the last firm with a problem.  As has often been said, there is never just one cockroach when you turn on the lights.

As proof positive that there is really no difference between the Chinese and US governments, the first response by the Chinese was to set up a task force to investigate the risks at Zhongzhi and its brethren shadow banks.  That sounds an awful lot like what would happen here, no?  Anyway, depending on who is invested in Zhongzhi and whether they are politically important enough to bail out, I suspect that there will be government intervention of some sort.  Do not be surprised to hear about Chinese banks making extraordinary loans to the sector or guarantees of some kind put in place.  The last thing President Xi can afford at this time is a meltdown in a different sector of the financial space.

It can be no surprise that Chinese equity markets were under pressure again last night, with both the Hang Seng and CSI 300 falling sharply, nor that the renminbi has fallen to its weakest levels since the dollar’s overall peak last October.  I maintain that 7.50 is in the cards here and that it is simply a matter of time before we get there.  In the end, a weaker CNY is the least painful way for China to support its economy, especially since it is a big help to its export industries which remain the most important segment of the economy.  Later this week we will see the monthly Chinese data on investment and activity so it will be interesting to see how things are ostensibly progressing there.  However, this data must always be consumed with an appropriate measure of salt (or something stronger) as there is no independent way to determine its veracity.

Meanwhile, on the other side of the world, a presidential primary in Argentina resulted in a huge surprise with Javier Milei, a complete outsider and ostensible free market advocate, winning the most votes, more than 30%.  The election comes in October and the ruling Peronist party is at risk of being eliminated in the first round.  What struck a chord in the country was his plan to dollarize the economy and close the central bank as well as to shut down numerous government agencies.  Inflation there remains above 115% so it can be no surprise that someone who promised to change the process garnered a lot of support.

I raise this issue because in Germany, the AfD (Alternative für Deutschland) party is currently polling at >21%, the second largest party in the country, and that has a lot of people very concerned.  Like Senor Milei, the AfD’s platform is based on destruction of much of the current government setup.  Because this party is on the right, and given Germany’s dark history with the far right, the latest idea mooted has been to ban the party completely.  Now, certainly the idea of a resurrection of the Nazi party is abhorrent to everyone except some true extremists, but simply banning the party seems a ridiculous idea.  After all, the members will either create a new party with the same support or take over a smaller existing party and drive the platform in the desired direction.  

Support for Marine LePen in France continues to grow, as does support for right of center parties throughout Europe, especially Eastern Europe.  And of course, here in the US, the upcoming election has fostered even more polarization along partisan lines with the Republican party seeming to gain a lot of support of late.  All this implies that there is a chance of some real changes in the financial world that will accompany these political changes.  At this point, it is too early to determine how things will play out, but as we are currently in the Fourth Turning, as defined by historian Neil Howe, the part of civilization’s cycle when there is great unrest, I expect there will be a lot more change coming.  Food for thought.  And it is for this reason that hedging exposures is so critical.

Ok, last week’s inflation readings were mixed, with CPI a bit softer than forecast while PPI was a bit firmer.  But the one consistency was that Treasury yields rose regardless of the situation.  After a further 5bp rise on Friday, 10yr yields are unchanged at 4.15% this morning, an indication that inflation concerns remain front of mind for most investors.  I expect that the peak yields seen back in October will be tested again soon.  As to European sovereigns, while yields there are down a tick this morning, the trend there remains higher as well.

Equity markets, too, have had some trouble of late, sliding a few percent over the past several weeks.  While the move lower has been modest so far, there is clearly concern over a technical break lower should the indices break below their 50-day moving averages.  With yields heading higher, I fear that is the path of least resistance for now.

Oil prices are a touch softer this morning but remain well above $80/bbl and appear to be consolidating before their next leg higher.  Supply is still a consideration and given economic activity continues to outperform, I suspect higher is still the path going forward.  Metals prices are little changed this morning despite some incipient dollar strength, so keep that in mind as well.

Finally, the dollar is much stronger against its Asian counterparts and modestly stronger against most others this morning.  Continuing rises in US yields offer support for the greenback and increased turmoil elsewhere, along with the US economy seemingly outperforming all others have been the hallmarks of the dollar’s strength.  I don’t see that changing soon.

Data this week brings the following:

TuesdayRetail Sales0.4%
 -ex autos0.4%
 Empire Manufacturing-0.7
 Business Inventories0.1%
WednesdayHousing Starts1445K
 Building Permits1468K
 IP0.3%
 Capacity Utilization79.1%
 FOMC Minutes 
ThursdayInitial Claims240K
 Continuing Claims1700K
 Philly Fed-10.5

Source: Bloomberg

While Retail Sales will be watched for their economic portents, I think the Minutes will be the most interesting part of the week, especially as we have now had at least two FOMC voters, Harker and Williams, talk about cutting rates next year.  

For today, while US equity futures have edged higher so far, I feel like the dollar has legs for now.  This will be confirmed if yields continue to rise.

Good luck

Adf

Xi Jinping’s Dreams

Posted on by 
The 30-year bond was a flop
Which helped cause an interest rate pop
Though CPI rose
A bit less than pros
Expected, risk prices did drop

Then early this morning we learned
That lending in China’s been spurned
It certainly seems
That Xi Jinping’s dreams
Of rebounds might soon be o’erturned

For all the bulls out there, yesterday must be just a bit disconcerting.  First, the highly anticipated July CPI data was released at a slightly lower than expected 3.2% headline number with core falling 0.1% to 4.7%, as expected.  As always when it comes to CPI data, there were two immediate takes on the result.  On one side, inflationistas pointed out that the future will be filled with higher numbers going forward as base effects for the rest of 2024 kick in with very low comparables in 2022.  They also point to the medical care issue, a detail I have not discussed, but which has to do with a change made by the BLS that has been indicating medical care prices have fallen all year, but which will fall out of the mix starting in September, thus reversing one of the drags we have seen on CPI.  And finally, the rebound in energy prices is continuing (oil +0.4% today) and will be a much bigger part of future readings.  This story was underpinned today by the IEA reporting a new record demand for oil in July of 103 million bbl/day.  Demand continues to support prices here.

Meanwhile, the deflationistas point to the recent trend in prices, which shows that on a 3-month basis, or a 6-month basis, if annualized, CPI is really only running at 2.4% or 2.9% or something like that.  The implication is because we have seen a reduction in the monthly number lately, that will continue.  As well, they make the case that China’s deflation is a precursor to lower US inflation with, I believe, a roughly 6-month lag.  Perhaps the most interesting take I saw was that the Fed has now achieved their goal of an average PCE of 2% if you take the last 14 years of data.  The idea is that Average Inflation Targeting was designed to have the economy run hot for a while to make up for the ‘too low’ inflation that has been published since the GFC.  And now, that average is 2.07% for the past 14 years.  (To me, the last idea is a chart crime, but I digress.)

The problem, though, for the bulls, is that the market’s behavior was not very bullish.  Although the initial move in Treasury yields was lower, with the 10-year yield falling 6bps right after the release, the 30-year Treasury auction that came later in the day was not nearly as well-received as the shorter dated paper seen earlier in the week.  The bid/cover ratio was only 2.42 and it seems that the market may be feeling a little indigestion from all the new paper just issued, as well as the prospects for the additional nearly $1.5 trillion left to come in 2023.  It is not hard to believe that longer end yields could rise further as the year progresses.  The upshot was 10-year yields rose 10bps on the day and are unchanged from there this morning.

Similarly, in the equity markets, the initial surge on the back of the slightly softer CPI was unwound throughout the day and though all three major indices ended the day in the green, the gains were on the order of 0.1% or less, so effectively unchanged.  Looking at futures there today, all three indices are unchanged from the close as investors and traders look for their next inspiration.  Meanwhile, I cannot ignore that overnight, Asian equity markets all fell, with the CSI 300, China’s main index, down -2.30%.  As well, European bourses are all lower this morning, mostly on the order of -1.0%.  Overall, this is not a positive risk day.

One of the things adding to the gloom is the financing data from China released early this morning.  New CNY Loans fell to CNY 345.9 billion, less than half the expected amount and down from >CNY 3 trillion in June.  M2 Money Supply there also grew more slowly than expected at just 10.7% as it seems that China’s debt woes are increasing.  China Evergrande was the first Chinese property company that gained notoriety for its problems, but Country Garden was actually the largest property company in China and now that looks to be heading toward bankruptcy.  

A quick tour of China shows it has a number of very big problems with which to contend.  Probably the biggest problem is demographics as the population begins to shrink.  However, two other critical issues are the massive amount of debt that is outstanding there (not dissimilar to the US situation) but much of it is more opaque sitting on the balance sheet of local government funding vehicles.  Just like in the West, this debt will not be repaid in full.  The question is, who is going to take the losses?  In China, the central government is trying to foist those losses on the local governments, but that will be a long-term power struggle despite President Xi’s ostensible powers.  Finally, the massive youth unemployment situation is simply dry tinder added to a very flammable mixture already.  This is not a forecast that China is going to implode, just that the claims that it is set to ascend to global superpower status may be a bit premature.

(By the way, for all of you who think a BRICS gold backed currency is on the way, ask yourself this question.  Why would India and Brazil want to link up with a nation with awful demographics and a gargantuan debt problem and link their currency to that?)

Finishing up, we have a bit more data this morning led by PPI (exp 0.7% Y/Y, 2.3% Y/Y ex food & energy) and then Michigan Sentiment (71.3) at 10:00.  With CPI already released, PPI would need to be dramatically different from expectations to have much of an impact at all.  There are no Fed speakers today, but yesterday we heard that there is still more to do by the Fed from both Daly and Bostic, and Harker did not repeat his idea that cuts were coming soon.

The dollar is mixed today, with Asian currencies under pressure, EEMEA and LATAM currencies performing well and the G10 all seeming in pretty good shape, although NOK (-0.7%) is under pressure after a much softer than expected CPI number yesterday has traders unwinding some future interest rate hikes.

Speaking of future interest rate hikes, the Fed funds futures market is down to a 10% chance of a September rate hike by the Fed, although there is still a ton of data yet to come, so that is likely to change a lot going forward.  My sense is that a little bit of fear is building in risk assets as despite some ostensible good news, with lower inflation and less chance of a Fed rate hike, risk is under pressure.  One truism is if a market cannot rally on good news, then it is likely to fall, especially if something negative shows up.  In that case, I suspect that we could see weakness in equities today, weakness in bonds and strength in the dollar before it is all over for the week.

Good luck and good weekend

Adf