It wasn’t all that long ago When everyone forecast more woe As long as the Fed Kept moving ahead And, higher rates, still did bestow But now that is all in the past As CPI fell, at long last Below current rates So everyone waits For Jay’s monetary recast I am old enough to remember when the market was pricing in two more Fed funds rate hikes and an extended period of time at those higher interest rates as the default position. After all, the Fed has been harping on about higher for longer quite a while and at their June meeting, they explicitly published their collective forecasts that showed a median expectation of an additional 50bps of tightening and then no real decline for at least a year. That view, however, is so 24 hours old! The new theme is…BUY STONKS! This was a remarkably fast turn of opinions, even for markets that produce whiplash on a regular basis. By now, you are certainly aware that the CPI data printed a bit lower than the median forecasts with the headline at 3.0% and the core at 4.8%. These are the lowest levels since March 2021 and October 2021 respectively and are certainly encouraging news. However, we all knew that the base effects were a key part of the puzzle as to why the year over year numbers fell so much. But, in fairness to the bulls, the monthly increases were also quite low, 0.2% in both cases, and it remains to be seen if that monthly trend can continue. As I suggested yesterday, the lower-than-expected readings led to an immediate explosion higher in risk appetite with equity markets in the US having a great day which was followed by strength throughout Asia and Europe this morning. And Europe had a good day yesterday as well. Meanwhile, US futures continue to bathe in the glow of declining inflation, rising further as I type (7:00am) with NASDAQ futures up more than 1.2% at this hour. Risk is back, baby! Perhaps a better indicator of the market’s renewed vigor is the bond market, where 10-year Treasury yields are lower today by a further 4.3bps and have fallen 25bps since Friday’s close. All those fears that a 4.0% 10-year yield could lead to further economic breakage are now merely bad dreams, with no seeming basis in the new, current reality. As to European sovereigns, they have fallen even further since yesterday, with declines on the order of 10bps nearly across the board on the continent and 7bps in the UK. Granted, part of the European movement seems to be on the back of comments by uberdove Yannis Stournaras, the Greek central bank head and ECB council member, who explained this morning that they never promised a July rate hike and now that the data is softening, a pause may well be appropriate. As to yesterday’s Fed speakers, Barkin was first up and his comments, right at 8:30 when the CPI data was released, got lost in the news. So, the fact that he said inflation remains too high and they still need to do more was completely ignored. Governor Barr was entirely focused on bank capital plans, indicating that the Fed would look to tighten capital requirements going forward as the best way to improve bank solidity. In other words, nobody cared what they said from a market’s perspective. Overnight we saw some Chinese data that also spoke to slowing overall demand and economic activity, thus implying slowing inflationary pressures, as the Chinese trade data, while growing their surplus to $70.6B, exposed a much weaker export performance, with exports there falling -12.4% Y/Y. That is a strong indication of slowing global growth, hence a view that also bodes well for future inflation declines. Alas, there is one area that might have a detrimental impact on all this falling inflation euphoria, oil prices. The black sticky stuff rallied again yesterday and is higher yet again this morning, albeit just by 0.3% right now, but has risen >4% in just the pat 3 days with WTI firmly above $75/bbl while Brent crude is now above >$80/bbl. While I am no market technician, I do know that there is a huge amount of focus on the 200-day moving average and a potential break above that level which currently sits at $77.34/bbl. If one looks at the ongoing production cuts by the Saudis as the short-term impetus and combines that with the structural shortage from the lack of drilling and exploration over the past decade due to ESG focused policies, it is easy to understand the bullish case. One other thing that has not seemed to have received much press is that the Biden administration is apparently trying to refill the SPR to some extent, and so are a bid in the market as well. The one thing that we all know well is that higher oil prices tend to lead to higher gasoline prices which are a critical part of both inflation and inflation expectations. This could well throw a spanner in the works for the collapsing inflation story, as well as the Fed is finished story. It is certainly too early to draw that conclusion, but if WTI pushes above that moving average and to $80/bbl or more, just watch how quickly opinions shift. Ironically, despite concerns over slowing growth, both base and precious metals have been rallying as well, almost entirely on the back of a weaker dollar. Now, it is a chicken and egg question here as to whether the weaker dollar is driving commodity (and stock) prices higher, or whether the rally in those markets is driving the dollar down, but whichever way the causality runs, that is the current price action. Actually, it makes sense. If the declining inflation story is taken at face value, and the market has removed further rate hikes by the Fed and is actually bringing the first rate cuts closer in time, then the dollar’s attractiveness as an asset is going to be reduced. And that is exactly what has happened. The buck is down against virtually all its counterparts, both G10 and EMG and the only thing that is likely to change that trajectory is data showing inflation is rebounding in the US and the Fed will be called on for more aggressive tightening. Today’s PPI data seems highly unlikely to provide any information of that sort, so while the market continues to price in a strong likelihood of a 25bp rate hike in a few weeks, the strong belief is that will be the last. Yesterday I posited that the one scenario that was not getting much love was that a recession was imminent, rather than either being delayed into 2024 or not even showing up. But even the inflation data is somewhat indicative of reduced demand. A little mentioned outcome regarding Consumer Credit on Monday showed growth of ‘just’ $7.24B, the lowest number since coming out of the pandemic in October 2020, and, perhaps, an indication that things are not as rosy as some would have us believe. And while confirmation of weaker US economic activity is likely to weigh on the dollar and US yields, it is also likely to weigh on US equity prices, so do not forget that connection. While I don’t believe today’s PPI data will be that impactful, keep an eye on the Claims data (exp 250K Initial, 1720K Continuing) as if those numbers keep edging higher, that too will play into the Fed’s thinking. I have maintained for many months that employment is the key, not inflation per se. Rising unemployment will lead to a quick reversal of Fed policy but will also be a harbinger of much weaker economic activity and just maybe that most anticipated recession in history will finally arrive. Lastly, we have two more Fed speakers today, Daly and Waller, which are the last before the quiet period begins. Given the sudden shift in narrative and the softer CPI data, it will be very interesting to hear if they are going to fight the new narrative or adjust their tone. Daly is first at 11:10 this morning on CNBC, so all eyes will be there. I would not fight this current trend for a lower dollar and frankly, with the euro back above 1.11 for the first time since March 2022, and the pound back above 1.30, the dollar bears are firmly in control. If this dollar weakness persists for another 1%-2% I believe it could open up a much further decline, so consider what it takes to manage that kind of movement. An additional 10% is quite easy to believe on that break. Good luck Adf
Jay Will Scrape By
Today it’s about CPI As Jay and his cadre still try To push prices lower Which might mean growth’s slower But don’t worry, Jay will scrape by
This morning we see the last big data point before the Fed meets in two weeks’ time as CPI is to be released at 8:30am. According to Bloomberg’s survey, the median expectation is for both headline and core monthly prints of 0.3% with the Y/Y numbers at 3.1% headline and 5.0% core as a result. There are many who are excited about the prospect of a 2 handle on the headline number as a potential catalyst for the equity market to break out even higher. The idea seems to be that a reading that low will get the Fed to change their tune and not merely stop raising rates but start bringing rate cuts back on the table. Wishful thinking in my view, but that’s what makes markets.
Even a cursory analysis of the commentary from the plethora of Fed speakers we have heard since the last meeting shows that there is very little willingness to end the current tightening program anytime soon. Certainly, there is no indication that a cut is even remotely a consideration. But equity bulls need a story to push their thesis, so there you have it. The thing is that while this month is clearly going to show a substantial decline on a year over year basis due to the base effects (remember, June 2022 M/M CPI was +1.2%, the peak), next month has the opposite base effect with the July 2022 M/M reading at 0.0%.
As I’m sure all of you are very clearly aware, there is essentially no evidence in our day-to-day llives that indicates prices are declining across the board. While gasoline prices have certainly fallen from their highs, they appear to have bottomed along with oil, and if you head out to a restaurant, especially one that you frequent, I’m sure you’ve seen the same steady rise in prices that I have. Remember, too, that CPI measures the change in prices on a monthly or annual basis, not the level of prices. Absent deflation, something that is incredibly unlikely in the current monetary and fiscal framework, prices are never going back to where they were prior to the pandemic. I sincerely hope wages continue to rise for all our sakes.
In the end, I continue to look at the employment situation as the critical variable for the Fed as weakness there will be the only thing that deters them from continuing their current mission. Powell clearly believes that the Silicon Valley Bank situation has been completely contained and that there will be no further concerns to distract them going forward. Maybe that is correct, but I am wary of accepting the idea that the fastest rate hikes in the Fed’s history are consistent with minimal damage to the economy. My suspicion is that there will be far more coming, it’s just that refinancings have not been necessary yet. When companies on the margin need to pay 9% to refinance their 4% coupon, it will result in an even greater uptick in bankruptcies than we have already seen this year and according to Epiq Bankruptcy, a compiler of bankruptcy information, filings have jumped by 68% this year compared to last, with a total of 2,973 in the first six months of the year. If the Fed continues to tighten, look for this number to rise further, and possibly faster.
Ahead of the data, the bulls remain in charge of the market with yesterday’s rally having been followed throughout Europe this morning although last night’s Asia session was more mixed. In fact, one of the best performing markets of the year, Japan, has seen something of a reversal in the past two weeks as the Nikkei has fallen almost 11% while the yen has rallied about 3.5%. This is no coincidence as much of Japan’s corporate profitability continues to rely on exports and the yen’s recent strength (+0.5% today with the dollar back below 140 again) has clearly been a weight around that market’s neck. Interestingly, despite the same mercantilist mindset in China, the relation between the Chinese stock market and the renminbi is far less tight. As it happens, CNY (+0.2%) is a bit firmer this morning but is less than 1% from its bottom while the Chinese stock market continues to flounder, having fallen yet again last night and continuing its downtrend for the year.
Turning to the bond market, 10-year yields have slipped another 2.5bps this morning as for now it appears the market is rejecting that 4.0% level. Of more interest is the fact that the 2yr yield has fallen faster with the curve inversion down to -90bps. This is an indication that bond investors are entertaining the idea that inflation is slowing, and the Fed will back off. Be careful if there is a high CPI print today as that will almost certainly see quite the reversal of this price action. Regarding the rest of the world, European sovereigns are following Treasuries with yields generally slipping between 2bps and 3bps, but the real surprise is Japan, where yields rose 1.9bps last night and are now at 0.467%, quite close to the YCC cap for the first time in Ueda-san’s tenure. The combination of rising JGB yields and a stronger yen has a lot of tongues wagging that a policy change is in the offing in Tokyo. It strikes me that Ueda-san is far more likely to move when the market is not expecting something rather than being seen to respond to pressure from the market. However, anything is possible there.
WTI is back above $75/bbl this morning for the first time in two months and there are many, this pundit included, who believe that we may have seen the bottom. Fundamentals like the Saudi production cuts and the Biden administration discussion of refilling the SPR are adding support, as is the fact that while recession continues to be forecast, it has not yet seemed to arrive. Do not be surprised if we see $80/bbl or higher before the summer is over. As to metals prices, gold is marginally higher this morning, benefitting from the dollar’s continuing weakness, as are both copper and aluminum.
Finally, talking about the dollar’s weakness, it is widespread with NOK (+0.65%) rallying alongside oil and SEK (+0.5%) also benefitting from commodity prices. The only G10 laggard is NZD (-0.2%) which seems to have been disappointed that the RBNZ left rates on hold last night. Speaking of central banks, this morning we hear from the BOC which is expected to raise rates again by 25bps to 5.0% at 10:00am so be attuned for any alternative outcome.
As to the emerging markets, it is a story of modest strength across almost the entire set with no real outstanding stories to highlight.
In addition to CPI, we also get the Fed’s Beige Book this afternoon and we hear from four more Fed speakers starting with Richmond’s Thomas Barkin right when CPI is released. The only thing that might be interesting is if somebody starts to change the tune, something that I find highly unlikely at this time.
We will have to see the print to have any chance of understanding the next steps, but for now, the dollar is on its heels and absent a strong print, seems likely to test its recent lows before anything else.
Good luck
Adf
Cause Regret
Again China’s leading the news With stories ‘bout financing blues So, terms on old debt Which now cause regret Have lengthened, more pain to defuse Meanwhile, from the FOMC Three speakers were clear as can be Rate hikes are in store This month, and then more On this much, they all did agree
One of the key themes earlier this year that was supposed to have a big market impact was the China reopening story. You may recall back in February when President Xi Jinping responded to the mass protests with blank papers held aloft, by deciding that permanently locking down a billion people was no longer an effective strategy, and a tacit declaration was made that there were no more Covid restrictions to be imposed or enforced. Everybody assumed that the Chinese economy would vault out of the gates and that commodity demand would rocket higher while overall global economic activity increased. Alas, that is not how things played out at all. Instead, Chinese economic activity has disappointed at every turn with an initial blip higher and then a gradual slide back to less substantial activity.
Part of the problem has clearly been the efforts made by companies and countries around the world to reduce or eliminate China’s impact on supply chains. But part of the problem, and arguably the larger part, was self-inflicted. That was the massive debt buildup on the back of a two decades long leveraging of the Chinese property market. You may recall China Evergrande, the first of the big property companies to come under pressure, but it has been an ongoing process for several years now. The problem, in a nutshell, is that the model that had been used, buy huge swathes of land from city governments with leverage, promise to build housing (whose price had been rising nonstop for two decades) and then sell these flats to people on a highly leveraged basis, collapsed along with the covid lockdowns. Suddenly, Chinese home buyers were out of work and could no longer afford the previously purchased homes. As well, the construction companies could not complete the projects given all the workers were locked up in their own homes and unable to get to the construction sites. However, debt remained a constant and was due regardless of the other issues.
The outcome was a significant slowdown in Chinese construction activity, an enormous number of unfinished (or even not yet started) apartment projects, and a lot of losses for both individuals and the property companies. Now, as China emerged from its covid lockdowns, the government did try to relax some of its previous policy strictures but things in the property sector remain quite soft. For China, where the property sector represented more than 25% of GDP, this is a problem. As such, last night we saw the next steps by the Chinese government in this process with further easing on repayment terms by extending the maturity of a large amount of debt by one year, from 2024 to 2025. It seems that the Chinese were paying attention to the Biden administration’s efforts regarding student loan payment delays and thought, we’ll do that too. Of course, there is no Supreme Court in China to overturn this policy. Do not be surprised if next summer, we hear about a further extension of these loans as can kicking is a government’s true superpower.
A perfect encapsulation of this policy was the Chinese loan data released last night where new loans rose by CNY 3.05 trillion, far more than expected and aggregate financing also exploded higher, by CNY 4.2 trillion. These are strong indications that the Chinese government is back offering substantial fiscal support to the economy in order to help get things moving again. It should be no surprise that Chinese share prices rallied, nor that the renminbi has rallied a bit as well, pulling away from its recent multi-month lows. It seems that the market has pushed things far enough to get a policy reaction rather than merely words. At this point, the big question is, have we seen the end of the recent CNY weakening trend? If the dollar continues its recent broad decline, then that is a quite probable scenario. However, if the Fed continues to hew to its higher for longer mantra, and keeps pushing rates higher, be careful, of assumptions of a dollar collapse.
Speaking of the Fed, yesterday saw three Fed speakers, Barr, Daly and Mester, all explain that more tightening was still needed to push inflation back to their target. [emphasis added.]
Michael Barr: “we’ve made a lot of progress in monetary policy, the work that we need to do, over the last year. I would say we’re close, but we still have a bit of work to do.”
Mary Daly: “We’re likely to need a couple more rate hikes over the course of this year to really bring inflation back into a path that along a sustainable 2% path.”
Loretta Mester: “in order to ensure that inflation is on a sustainable and timely path back to 2%, my view is that the funds rate will need to move up somewhat further from its current level and then hold there for a while as we accumulate more information on how the economy is evolving.”
It’s almost as if they are all reading from the same script! At any rate, it seems very clear that regardless of tomorrow’s CPI print, they are going to hike by 25bps later this month. The real question is, will the data continue to show the strength necessary to drive several more hikes after that? As I have repeatedly explained, NFP is the most important number. As long as Powell and the Fed can point to the employment situation and say there is no jobs recession, they will have cover to continue to tighten policy, maybe much higher. 6% or even higher is not out of the question.
And yet, despite the ongoing hawkishness from the Fed, the market is no longer concerned, at least that seems to be the case today. Equity markets in the US managed to eke out gains yesterday and overnight saw Asia with bolder moves higher (Japan excepted as the strengthening yen is weighing on Japanese corporate profitability.). European bourses are higher, although the FTSE 100 is under pressure after mildly disappointing UK labor data this morning where the Unemployment Rate jumped to 4.0% for the first time since December 2021 when it was falling post covid. US futures are a touch higher at this hour (8:00) but seem to be biding their time for tomorrow’s CPI data.
Bond markets, though, have rallied with 10-year Treasury yields lower today by a further 3bps and now back below the all-important 4.0% level, albeit just barely. European sovereigns are also seeing some demand with yields sliding between 1bp and 2bps across the continent. Even JGB yields edged a bit lower in a global bond buying spree.
Commodity prices are broadly higher with oil (+0.6%) continuing its rebound of the past week, while gold (+0.5%) is feeling a little love on the back of the dollar’s broad weakness today. As to the base metals, they are ever so slightly firmer, retaining yesterday’s gains.
And finally, the dollar is softer across the board this morning as it seems to be following treasury yields lower and ignoring the Fed commentary. The dollar’s weakness is evident in both the G10 and EMG blocs with JPY and NOK (both +0.6%) the leading gainers while only NZD (-0.4%) is under any pressure as traders prepare for the RBNZ meeting this evening and seem to be reducing their positions. As to the emerging markets, KRW (+1.0%) was the leading gainer on the back of the Chinese fiscal policy story, although we saw strength throughout the APAC bloc. Both EMEA and LATAM are a bit more mixed with much less significant movement, so seemingly following the bigger trend.
Today’s only data point has already been released, the NFIB Small Business Optimism Index, which printed at a higher than expected 91.0. While this is a good sign, it is important to understand that the long history of this index shows an average near 100 and the current readings still mired near the lowest levels in its history, only surpassed by the massive recessions of 1980-1982 and the GFC in 2009.
There are no Fed speakers scheduled today, although we get a bunch more tomorrow after the CPI report is released. For now, the market is looking askance at the dollar while Treasury yields sink. My take is there is further upside in yields and therefore in the dollar. However, that is not today’s trade.
Good luck
Adf
Deflation’s Emerged
Inflation in China is sliding Which now has some pundits deciding Elsewhere round the globe The deeper you probe DEFLATION’s emerged from its hiding For equity bulls it’s a sign That US rates soon will decline But thus far Chair Jay Keeps pounding away That higher for longer is fine
By far the story that has gotten the most press from the overnight session has been the Chinese inflation readings. For good order’s sake, they showed that the Y/Y CPI rate fell to 0.0%, down 2 ticks from last month and 2 ticks below expectations, while the Y/Y PPI rate fell to -5.4%, far below last month’s -4.6% reading and the lowest level since the end of 2015.
There have been numerous takes on the implications of this data. In the short-term column, we have seen weakness in AUD (-0.7%) and NZD (-0.5%) as the narrative explains the falling inflation indicates falling demand and slowing growth in China, thus reducing the need for Antipodean exports. Interestingly, this take does not effectively explain commodity price movements as although oil (-0.7%) is a bit lower this morning, both copper (+1.3%) and aluminum (+0.8%) are having quite a solid session. Of course, the entire China reopening is bullish for the global economy and inflation story has been a disappointment from the get-go, so it is not clear why this is suddenly changing any opinions.
However, if you listen to the longer-term takes on this data, pundits are implying this is proof that the inflation genie is getting stuffed back into its lamp, and that soon, as inflation tumbles in the US, the Fed will finally pivot, and stock prices will run to new highs. Quite frankly, I have a much harder time accepting the long-term take than the equity bulls seem to have.
A key part of this narrative is that come Wednesday, CPI in the US will be declining sharply to 3.1%, at least according to the current median Bloomberg estimate. It is widely known this decline is due to the base effect as expectations are for a M/M outcome of 0.3%. However, -ex food & energy, CPI is still forecast to print at 5.0%, well above the Fed’s target, and the number that Chairman Powell has been highly focused on of late. It seems that the current narrative, at least in the equity world, is that China’s falling inflation will soon spread around the world and allow interest rates to head lower again thus supporting stock prices.
The thing is, this is an equity market narrative, not a bond market one. Turning to the bond market shows that yields remain quite firm with the 10-year still solidly above 4.00% (currently 4.05%, -1bp on the day), and the 2yr right near 5.0%. Fed funds futures markets continue to price in a rate hike at the end of July with a 50% chance of another one by the November meeting, and no thoughts of a rate cut until June 2024. In other words, while the equity cheerleaders are extrapolating from weak Chinese inflation to weak US (and global) inflation right away, the bond market continues to see the world quite differently. This dichotomy in world view has been extant for many months now and eventually will be resolved. The key question is, will the resolution be a sharp decline in bond yields? Or a sharp decline in equity prices? And that, of course, is the $64 billion question.
For what it’s worth, and it may not be much, I continue to lean toward an eventual equity market correction rather than a reversal of Fed policy and much lower US yields. Well, I guess what I expect is that the air will come out of the equity bubble as the long-awaited recession finally arrives at which point the Fed will indeed feel cutting rates is appropriate. However, there is just no indication this part of the cycle is imminent. Remember, that on a long-term basis, equity multiples remain well above average and a reversion to the mean, at least, ought not be surprising. As the earnings season for Q2 kicks off soon, there is ample opportunity for disappointment and the beginnings of a change of heart. I couldn’t help but notice that Samsung, the largest chipmaker in the world, reported a 96% decline in profits in Q2 on Friday, hardly a sign of ongoing strength, AI be damned. And while one company is not a trend, this one is certainly a tech bellwether and should not be ignored.
The point is that a correction in equity markets ought not be a huge surprise based on the ongoing, and rising, interest rate structure in the US, along with the very clear manufacturing recession in which the US, and most of the world, finds itself.
Adding to this less optimistic view would be Friday’s NFP report which saw a weaker than expected headline print for the first time in more than a year, with significant revisions lower for the past two months. The underlying metrics were not terrible, and on the inflation front, Average Hourly Earnings remain at 4.7%, well above the level the Fed believe is appropriate to allow them to achieve their 2% inflation target. In other words, nothing about this report screams the Fed is done. In fact, just the opposite, as those earnings numbers continue to pressure inflation higher. Concluding, I believe it is premature to expect any Fed policy change and I am beginning to sense that we are observing the first cracks in the bull market thesis. We shall see.
As to the rest of the market picture overnight, Friday’s US weakness was matched in Japan (-0.6%) and Australia, but Chinese shares rallied by a similar amount. It seems there is growing belief that the Chinese government is going to offer more support for the economy there. European bourses are in the green this morning, on the order of 0.5%, while US futures are essentially unchanged at this hour (8:00). At this point, all eyes are on Wednesday’s CPI report so don’t be surprised if we have a couple of quiet sessions until then.
As to the rest of the bond market, European sovereigns have all sold off slightly with yields edging higher by between 1bp and 2bps although there has been no data of note released. Perhaps more interesting is the fact that JGB yields are creeping higher, up 3bps overnight and now at 0.454%, much closer to the YCC cap of 0.50% than we have seen since April, immediately after Ueda-san took the helm. There has been a lot of chatter about Japan doing something as they are ostensibly becoming uncomfortable with the yen’s ongoing weakness, so this is something to keep on the radar.
Speaking of the yen, while it is unchanged overnight, there has been no continuation from Friday’s sharp rally in the currency which was built on rumors of a BOJ policy adjustment or perhaps direct intervention. But this is an area that must be watched closely as recall, last October, the BOJ was actively selling dollars to halt the yen’s slide then. Elsewhere, though, the dollar is ever so slightly firmer on the day, with both gainers and losers in the EMG bloc, although none having moved very far. Here, too, I feel like the market is awaiting the CPI data for its next catalyst.
A look at the data for this week shows the following:
|
Today |
Consumer Credit |
$20.0B |
|
Tuesday |
NFIB Small Biz Optimism |
89.9 |
|
Wednesday |
CPI |
0.3% (3.1% Y/Y) |
|
|
-ex food & energy |
0.3% (5.0% Y/Y) |
|
|
Fed’s Beige Book |
|
|
Thursday |
Initial Claims |
250K |
|
|
Continuing Claims |
1720K |
|
|
PPI |
0.2% (0.4% Y/Y) |
|
|
-ex food & energy |
0.2% (2.6% Y/Y) |
|
Friday |
Michigan Sentiment |
65.5 |
Source: Bloomberg
In addition to the CPI and PPI data, we hear from seven Fed speakers across nine events this week, with this morning being particularly busy as four different speakers will be on the tape between 10 and noon. If you recall, there seemed to be the beginnings of dissent based on the Minutes we saw last week, so perhaps the message will get mixed, but as of now, I see no reason to believe that Powell will wait before hiking again. In fact, the June 2022 M/M inflation print was the highest of the cycle at 1.2%, hence the base effect issue for this month. Meanwhile, the July M/M reading will be compared to last July’s 0.0% reading, so I expect next month’s CPI will be much higher on Y/Y basis. This will not be lost on Powell and the Fed.
In the end, there has been nothing to change my view that the Fed is going to stay on course and that they will continue to drive the currency world overall with the dollar likely still the biggest beneficiary over time.
Good luck
Adf
Much Wronger
There once was a theory on rates Explaining, that, here in the States Recession would cause Chair Powell to pause And end all soft-landing debates But data of late has been stronger Encouraging ‘higher for longer’ At this point it seems Recessionist dreams Could not have been very much wronger Which leads to today’s NFP The data point all want to see If once more it’s high Look for yields to fly If low, look for stocks filled with glee
Recently, the US data releases have been anything but benign as they show continued economic strength in the face of many headwinds. Yesterday’s numbers were overwhelmingly positive with the ADP Employment Change +497K, more than twice expectations and the highest since February 2022. There is certainly no indication from this data series that companies are cutting back on their hiring. As well, the ISM Services results were firmer than expected, with the headline jumping to 53.9, up nearly 3 points on the month and more than 2 points higher than forecast. But more impressively, both the Employment and New Orders readings were much higher than last month indicating a more robust economy than many had been both describing and expecting.
But this is all simply a leadup to today’s NFP report, the data point upon which I have been most highly focused as the key for understanding the Fed’s reaction function. As I have consistently highlighted, if NFP continues to grow and the Unemployment rate remains low, the Fed has ample cover to continue to tighten policy via both higher interest rates and balance sheet reduction (QT) without concern over political blowback. After all, if jobs remain plentiful and wages continue to grow, complaints of overtightening will have no credibility.
Heading into the number, here are the latest consensus forecasts according to Bloomberg:
|
Nonfarm Payrolls |
230K |
|
Private Payrolls |
200K |
|
Manufacturing Payrolls |
5K |
|
Average Hourly Earnings |
0.3% (4.2% Y/Y) |
|
Average Weekly Hours |
34.3 |
|
Participation Rate |
62.6% |
While the headline is, of course, just that, the number that will get the most press, it is worthwhile watching the Weekly Hours data which, as can be seen in the below Bloomberg chart, has been declining steadily since early 2021. The key, though, is to recognize that the only time we have been below 34.3 is during the past two recessions, so a continuation lower in the recent trend may bode ill for future economic activity. The thesis here is that companies will reduce the hours of their staff before actually firing them given the expense of bringing on and training new staff in the next up cycle.
In the meantime, investors and traders are taking their cues from the data already seen and are increasingly accepting of the higher for longer thesis the Fed has promulgated for the past year. Yesterday’s price action was dramatic with Treasury yields surging through 4.0% in the 10-year and 5.0% in the 2-year. This morning that trend continues with yields higher by another 3bps and you can be sure that if the overall employment report is strong, they will go higher still.
At the same time, equity markets are starting to feel a little pressure after what has been a remarkable rally in the first half of 2023, as the 4.0% level in 10-year Treasury yields has led to the breakage of things consistently during this cycle. It started with the UK pension problems and Gilt market collapse in September 2022, was followed by the BOJ being forced to intervene to prevent the yen’s collapse in October 2022, then the FTX collapse in November 2022 and finally Silicon Valley Bank’s demise in March 2023. In each of these cases, the 10-year yield traded above 4.0% ahead of the problem and was taken back down in the wake of the outcome. This chart from the Gryning Times makes the case eloquently:
As such, it should be no surprise that equity markets fell yesterday in the US and overnight in Asia as we are clearly reaching a pain point in the market.
Of course, the question is, will this time be different? Have investors priced in higher yields already and still comfortable paying extremely high multiples for stocks? History has shown that this time is never different when it comes to investor behavior. Euphoric predictions are followed by reality setting in and eventually prices adjust lower, reverting to long-term means, especially with respect to earnings mulitples. But that is not to say things will be unable to defy gravity for longer. As Keynes famously told us all, markets can remain irrational longer than you can remain solvent.
Based on all the data we have seen recently, there is no reason to believe that today’s NFP number is going to be weak, nor that the Unemployment Rate is going to rise sharply. Rather, a higher than consensus number seems quite viable as a baseline expectation.
Remember, too, that the Fed continues to hammer home its message of higher for longer with Dallas Fed President Lorie Logan the latest to say so yesterday, “I remain very concerned about whether inflation will return to target in a sustainable and timely way. I think more restrictive monetary policy will be needed to achieve the Federal Open Market Committee’s goals of stable prices and maximum employment.” There is nothing ambiguous about that language, that is for sure.
Perhaps the most surprising thing about markets this morning is the fact that despite the rise in Treasury yields, the dollar is mixed at best, and arguably slightly lower. Certainly, versus its G10 counterparts, it is broadly softer with the yen the biggest gainer, 0.5%. This behavior is somewhat incongruous given the close relationship the dollar has had to US yields. The dollar-yield relationship is much clearer in the EMG bloc where the greenback is stronger vs. virtually the entire segment. And I expect that we are going to see a continuation of the dollar gains if US yields continue higher.
But for now, all we can do is sit back and await the data.
Good luck and good weekend
Adf
Inflation’s Fate’s Sealed
The Minutes revealed that the Fed When pondering their views ahead Are no longer all Completely in thrall With hiking til more ink is red However, they also revealed That some felt a still higher yield Was proper for June And want more hikes soon To make sure inflation’s fate’s sealed
Yesterday’s FOMC Minutes were interesting for the fact that after more than a year of the committee remaining completely in sync, it appears we have finally reached the point where there is a more robust discussion of the next steps. The hawkish pause skip was very clearly an uneasy compromise between those members who thought it was appropriate, after 10 consecutive rate hikes, to step back and see if things were actually playing out in the manner their models predicted and those that remained adamant it was inappropriate to delay their process as there has been far too little progress on the reduction in services inflation. Remember, the Fed’s models are entirely Keynesian in that they assume higher interest rates reduce demand by forcing financing costs higher. It is why Chairman Powell has repeatedly explained that in order to achieve their goals, a little pain is going to be required.
But consider the nature of the current bout of inflation. Was this driven by excess money being created in the banking sector and spent on business investment, or even share buybacks? Or was this inflation driven by excess money being created, and then handed directly to the public in order to help everyone during the government-imposed lockdowns, thus spent immediately on goods, and eventually on services once the lockdowns were lifted?
I would argue that the latter is a more accurate representation of the current situation, one more akin to the post WWII economy than the 1970’s oil embargo led economy. If this is the situation, then perhaps continuing to raise interest rates may not be the best solution to the problem. In fact, as Lynn Alden indicates in her most recent piece, it could well be counterproductive. If this inflation is fiscally (meaning government led) driven rather than monetarily (meaning bank lending led) driven, higher interest rates simply add to the amount of money available to spend by the public. In fact, this process becomes circular as higher interest rates increase the amount of interest paid to bondholders adding to their disposable incomes, while simultaneously increasing the size of the fiscal deficit, thus increasing debt issuance, and driving interest rates higher still. This is an unenviable place for the Fed to find itself, especially since its models don’t really accept this premise. Rather, they continue to fight the 1970’s inflation via the Volcker playbook, which may only exacerbate the situation.
My growing concern is that the Fed is fighting the wrong enemy, and in fact, has no tools to fight the excessive fiscal spending which is currently the key driver of demand. As such, it is very realistic to expect inflation, whether measured as PCE or CPI, is going to remain elevated on a core basis for quite a while yet. When combining this thesis with both deglobalization and incremental labor shortages, the case for higher inflation for longer becomes even more compelling. We have already seen that the housing market has not behaved at all in the manner expected by the Fed’s (or anybody’s) models, with prices holding up far better than anticipated given the dramatic rise in interest rates over the past 18 months. It is not hard to believe that other variables in the Fed’s models are equally wrong. In the end, this is further confirmation, to me, that the Fed will be fighting its inflation battle for a very long time.
How have markets reacted to this new information? Not terribly well with financial assets falling in value around the world. This is true in equities, where yesterday’s modest US declines were followed by much sharper falls in Asia and Europe with the Hang Seng (-3.0%) the laggard but all of Europe down by more than -1.0% today. US futures are also under pressure, down about -0.4% as I type (7:30).
But despite the fall in equity markets, bond prices are tumbling as well with yields rising around the world. Treasury yields are actually the best performers, rising only 4bps this morning, although that has taken them tantalizingly close to the 4.00% level which has proven to be a more significant hurdle for equities in the recent past. But in Europe and the UK, bond yields are screaming higher with Gilts (+10bps) leading the way, but all Continental sovereigns seeing yields rise by at least 6bps. This is interesting given the fact that the only data released today was Construction PMI data which was incredibly weak across all of Europe and the UK. Clearly, the prospect of higher Fed funds is one of the driving forces here as higher for longer gets more deeply embedded in the market belief set.
Speaking of higher Fed funds, the market is currently pricing an 85% probability of a hike later this month and then only a slight chance of a second one, despite the Fed’s comments. In Europe, the situation is similar, with a 90% probability priced for July but only one more hike in total by the end of the year. And remember, the ECB is 125bps behind the Fed in terms of the level of rates, and inflation remains higher in the Eurozone than in the US. It feels like there will be more changes to come in these markets.
Oil prices, meanwhile, continue to be supported with the rationale being the Saudi’s continued production cuts. While there is a story that Iran has been pumping more oil into the market, the price action has certainly been a bit more bullish lately. Structurally, there is still going to be a shortage of oil over time, but for now, that doesn’t seem to matter. Meanwhile, base metals are edging lower this morning, after the weak construction data, and gold remains stuck in its consolidation.
As to the dollar, it is generally, though not universally, lower this morning with the yen (+0.6%) the leading gainer on fading risk sentiment, although there is also a building story that Ueda-san is going to be making some adjustments in the near future in order to mitigate the recent weakness. While it has been relatively slow and steady, as it approaches 145, it clearly seems to be generating some discomfort. But in the G10, the weakness is broad. However, in the EMG bloc, the dollar has had a much better showing rising against a majority of the group with ZAR (-0.9%) the laggard on the weaker metals’ prices, but weakness throughout APAC and LATAM currencies as well. If we continue to see US rates climb higher, I expect that the dollar will be dragged along for the ride.
On the data front today, there is a lot of stuff, starting with ADP Employment (exp 225K) and followed by the Trade Balance (-$69.0B), Initial Claims (245K), Continuing Claims (1734K), JOLTS Job Openings (9885K) and finally ISM Services (51.2) at 10:00. I saw a story that there has been a seasonal adjustment issue with the Claims data because of the Juneteenth holiday, which is quite new, and so not necessarily properly accounted for in the release. Over time, these things will smooth out, but do not be surprised if today’s Claims print is higher than expected. And of course, this all leads up to tomorrow’s NFP report, something I will discuss then. Dallas’s Lori Logan speaks today, but she is not currently a voter. Next week, however, we hear from a lot of Fed speakers, so perhaps some fireworks are on the horizon.
Overall, I think there is a case to be made that the Fed is looking in the wrong direction and that they will continue to raise the Fed funds rate and drive all yields higher without having the desired disinflationary impact. In that scenario, I think the dollar still looks the best of the bunch.
Good luck
In For a Bruising
The data’s still somewhat confusing As hard numbers claim growth is cruising But surveys keep showing That growth should be slowing And bears think we’re in for a bruising
Another month, another series of weaker than expected PMI/ISM data with limited corresponding weakness in the ‘hard’ numbers. On Monday, ISM Manufacturing fell to 46.0, basically a point worse than last month and expectations. The sub-indices were no better with weakness across Prices, Employment and New Orders. This is hardly the sign of a strong economy. In fact, we are at levels consistent with recession. The same story has been playing out internationally, with weakness across virtually the entire Eurozone and weakness in China as well. In fact, this morning’s bearish risk tone seems to have been driven by the weakness in the Caixin PMI overnight which fell to 52.5 on much weaker Services activity. At least that is the current story making the rounds.
The confusion comes from the fact that the hard data, measurement of actual activity and output rather than surveys of what people or businesses are planning or expecting, remains far better than the Survey data implies. Consider that the average reading of the regional Fed manufacturing surveys in June was -9.86, a pretty clear indication that manufacturing is in recession territory. Meanwhile, the Citi Economic Surprise Index remains at a solidly positive 57.5, which is a level consistent with solid GDP growth.
So, which is it? Has the Fed achieved its objective of a soft landing, with inflation heading back to the 2% target while growth continues apace? Or is the survey data truly descriptive of the future with a more dramatic slowing of growth soon to appear on our screens?
Alas, it is very difficult for me to view the total picture and see the soft landing as anything but a tiny probability. The term ‘long and variable lags’ was created because they are just that, long and variable. There is no consistency as to the time between the Fed’s policy actions and their impact on the economy, with examples of the adjustment being anywhere between 9 and 27 months. Arguably, this time we have seen some unusual timing given the starting point of the economy and all the unique policies that were a consequence of the pandemic response. And as of today, we are 15 months into the tightening cycle, so plenty of time yet to remain within the historical landscape here.
For instance, the dramatic rise in interest rates were assumed to have been devastating to the housing market and home builders yet that has not been the case. Instead, the result that was generally unforeseen, was that the supply of existing homes on the market shrank dramatically as people are now ‘locked into’ extremely low mortgage rates (having refinanced during the ZIRP period) and either cannot afford to, or simply will not give them up. The result is that housing demand is largely being satisfied by new homes, thus home builders are killing it while consistent housing demand results in higher prices.
Similarly, fiscal policy has been pumping money into the economy at a far faster rate than during previous recessions with Congress passing the ironically named Inflation Reduction Act, as well as the CHIPS act and various other spending measures. At the same time, the student loan forbearance has resulted in millions of people having much greater disposable income than they otherwise would have been able to spend, thus supporting demand. However, it appears that the student loan situation may be changing after the recent Supreme Court ruling and the debt ceiling deal also included some spending reductions. The point is that the taps may be slowly turning off in two areas that have been broadly economically supportive thus reducing overall demand and correspondingly economic activity.
This week, however, we get some of the most important ‘hard’ data with both the Trade Balance and the employment report. In fact, I have maintained that NFP is the single most important piece of data currently as its continued strength has been the key reason the Fed has been able to defend its policy choices. As long as Unemployment remains low, Chairman Powell can point to that and rightly claim that the economy can withstand higher interest rates and the Fed will continue their quest to drive inflation to their 2% target. This is not an argument for their policies, just an observation that they will not change until there is a sufficient catalyst to do so. Hence, I continue to watch the weekly Initial Claims data as crucial. It has already started to move higher, with the 4-week moving average having risen to 257.5K from a low point of 190.5K back in September 2022. While this number is not recessionary in its own right, the trend is clearly a concern.
Ultimately, I remain in the camp that the widely forecast recession is still coming down the tracks, it has just taken the scenic route. In the meantime, a quick look at the overnight session shows risk is under pressure everywhere with Asian equity markets all in the red and Europe seeing the same thing. As mentioned above, today’s narrative is about the Caixin PMI printing a weak number, but we also saw weakness throughout Europe in today’s PMI releases. US futures are also under pressure at this hour (8:00), currently down about -0.5%.
Bonds are seeing some haven demand with yields sliding a bit across the continent, somewhere in the 1bp-2bps area, although Treasury yields are essentially unchanged this morning, maintaining the gains from the much higher than expected GDP print last week. If we continue to see strong economic data, I expect that Treasury yields can head higher still. The yield curve inversion is now at -105bps, its lowest point during this period and an indication that the market is more accepting of the Fed’s higher for longer comments. Remember, this remains a very powerful recession indicator as well, and it has been inverted for just over a year at this point.
Oil prices have rebounded 2% this morning and are back above $70/bbl after Saudi Arabia indicated they were going to continue at their recently reduced production level and there is word that the Biden administration may tender for more oil to start refilling the SPR. Remember, though, oil remains far lower than it has been in the past year, so there is plenty of room for it to move higher. Metals prices are mixed this morning with gold rejecting a sell-off below $1900/oz and both copper and aluminum still trending lower.
Finally, the dollar is broadly stronger today but in truth is mixed since I last wrote on Friday. In the G10, the commodity bloc is suffering most with AUD (-0.45%) and NOK (-0.4%) the laggards although all currencies are softer on the day. In the EMG bloc, HUF (-0.9%) and BRL (-0.5%) are the laggards with the forint responding to both budget cuts and expectations of central bank interest rate cuts, while the real appears to be tracking the broader risk-off sentiment.
On the data front, it is obviously an important week with the following on the docket:
|
Today |
Factory Orders |
0.8% |
|
|
FOMC Minutes |
|
|
Thursday |
ADP Employment |
223K |
|
|
Initial Claims |
245K |
|
|
Continuing Claims |
1750K |
|
|
Trade Balance |
-$69.0B |
|
|
JOLTS Job Openings |
9900K |
|
|
ISM Services |
51.3 |
|
Friday |
Nonfarm Payrolls |
225K |
|
|
Private Payrolls |
200K |
|
|
Manufacturing Payrolls |
5K |
|
|
Unemployment Rate |
3.6% |
|
|
Average Hourly Earnings |
0.3% (4.2% Y/Y) |
|
|
Average Weekly Hours |
34.3 |
|
|
Participation Rate |
62.6% |
Source: Bloomberg
While everybody will be looking forward to the payroll report, this afternoon’s FOMC Minutes should be interesting as well. Given the entire skip/pause question, there is heightened interest as to how that conversation played out. But ultimately, this is all about payrolls this week. Aside from the Minutes, we hear from two other Fed speakers, NY’s Williams and Dallas’s Logan, with the market still trying to determine just how high higher for longer really means.
The funny thing about the FX market is that despite my growing belief that the US is still due a recession, I believe that the dollar may well hold up as Europe and many emerging markets find themselves in the same situation. As such, the description of, the cleanest dirty shirt in the laundry still applies to the buck.
Good luck
Adf
Growth Vs. Shrink
The data continue to show That things ain’t so bad, don’t you know So why do folks feel The bad stuff is real With growth steady, though somewhat slow? Apparently, there is a link Twixt wage growth and what people think As real wages fall They cast a great pall O’er viewpoints on growth versus shrink
That much anticipated recession seems like it will have to wait at least another quarter or two before landing as yesterday’s 3rd revision of the GDP data jumped to 2.0% annualized, much higher than forecast, with strength continuing to be seen in both personal and government consumption. As well, the Initial Claims data fell to 239K, far below expectations and an indication that the steady drumbeat of layoffs may just be slowing down a bit. It should be no surprise that equity markets rallied on the news, although the NASDAQ was the definitive laggard on the day. It was not a tech story or an AI story, but a straight up growth story getting investors back into the game. As today is quarter end, it is also important to remember that many investment managers who had been underweight equities were actively buying to achieve the appropriate window dressing for their clients.
Of more interest, in my view, was the bond market response where yields exploded higher by 15bps in the 10yr as traders priced in even higher for even longer than had been seen before the release. Here, too, the recession call remains a mirage, or at least very uncertain in the mists. The 2yr yield rose even further, 18bps, taking the curve inversion to -103bps. Fed funds futures are now pricing an 85% chance of a rate hike next month, up from a 70% probability prior to the release as pretty much everyone is now on board the rate hike train.
One of the key conundrums is the idea that the Fed continues to tighten policy while equity markets continue to rally. Historically, rate hikes of this speed and magnitude would have seen a very different reaction, but this time that is just not the case. For those who remain suspect of the market’s euphoria, there seem to be a number of potential time bombs littering the landscape, notably commercial real estate (CRE) and housing. In the case of CRE, there are two concerns. First is that there is a huge overhang of debt that needs to be rolled over in the next 18 months, >$1.5 trillion, which currently has coupons far below today’s interest rate levels. Adding to the concern is the WFH trend and how many of these buildings, especially office properties in big cities, are not generating the same cash flows as before. So, higher rates with lower cash flows are a recipe for default and fears are growing that there are going to be many defaults on these outstanding loans. The fact that the small regional banks have a large proportion of their assets in the CRE class also bodes ill for their ultimate situation. So far, we have seen several high-profile buildings sell at extremely low valuations and we have also seen landlords walk away from several buildings, with two large hotels in San Francisco the current bellwethers.
Turning to housing, the overriding view has been that the Fed would kill the market given that mortgage rates have risen from ~3% to ~7% alongside higher prices thus more than doubling the average monthly cost of owning a home. However, two things have conspired to prevent a collapse in this market so far. First, is the fact that many people who refinanced to a 3% mortgage during ZIRP are simply unwilling to move thus reducing the supply of existing homes on the market, hence keeping prices elevated. Second is that given the structural reduction in the labor force and the increased demand for construction workers for industrial activity (which has exploded on the back of the Inflation Reduction Act), the housing market remains far more robust than would have been expected. Add to this the fact that builders are buying down mortgage rates (paying a part of the mortgage so the rate is more like 5% than 7%) and things are working just fine. Again, it is possible that this time bomb has been defused.
So why the long faces everywhere? The best explanation I have seen, which apparently has some academic workbehind it, indicates that the evolution of real wages very accurately tracks economic sentiment. In other words, if real wages are rising, people remain relatively bullish on the economy whereas if they are falling (and they have been negative since April 2021), people tend to have a much more dour view of things. Politically, if real wages rise it will change the entire population’s view on everything, so if I were in office, it would be the only thing I targeted. This also explains why inflation is such a major problem for the administration in office.
So, with this as background, perhaps we have a better understanding of what the prospects are for the future, or maybe a roadmap to watch for key signals.
Meanwhile, the data continue to come out fast and the spin doctors are working overtime. For example, in Europe this morning, CPI printed a tick lower than forecast (5.5% vs. 5.6%) with core CPI doing the same thing (5.4% vs. 5.5%), and people are raving about the better result. But remember, the target is 2.0%, so there is no evidence they have improved things at all, nor that they are going to be able to slow the tightening process. However, equity markets across Europe are all higher on the day, most by more than 1%. Go figure. The narrative remains the key, and as long as the central banks can control the narrative and get people to believe that things are getting better, markets will respond accordingly.
Bond yields in Europe did not move as far as in the US yesterday but are all modestly higher this morning as well, except for Gilts +8bps on a massive Current Account deficit result generating concerns over the UK’s finances.
As to commodities, oil bounced back toward $70/bbl yesterday and is holding those gains, although not adding to them, but the metals markets continue to suffer with both aluminum and copper falling again today. Gold, too, is under pressure from higher yields. Commodities remains the place where recession is seen looming.
Finally, the dollar can best be described as mixed this morning, with a 50:50 split in the G10 although no movers have even made it 0.25% away from yesterday’s close. In the emerging markets, ZAR (-1.2%) is the lone outlier, falling on the back of the metal market weakness. However, away from the rand, a split in performance without any outliers is the best description. However, I must point out that USDCNH, the offshore renminbi, has traded above 7.28 and continues its slow march higher (to 7.50 and beyond!)
On the data front, there is a bunch of stuff today starting with Personal Income (exp 0.3%) and Spending (0.2%) along with core PCE (0.3% M/M, 4.7% Y/Y) at 8:30, then Chicago PMI (43.8) and Michigan Sentiment (63.9) later in the morning. It seems that the Fed has begun their July 4th holiday weekend already with no speakers on the calendar until the 5th. The market remains very data focused so more strong data should see higher US yields and a firmer dollar, although it depends on which data is strong as to how equities respond. Strong spending and income data should help, but a high surprise on PCE will not.
And that’s really it heading into the long weekend. I, too, will take Monday off so no poetry until Wednesday next week, ahead of the NFP report.
Good luck and good weekend
Adf
Double Secret Inflation
In Sintra, each central bank head From Europe, Japan and the Fed Explained all was well Amongst their cartel So, ideas of changing were dead However, in Asia it seems The PBOC’s latest schemes To strengthen the yuan Have failed to catch on Look, now, for a change in regimes
The panel in Sintra that mattered had the three key central bank heads on the dais, Powell, Lagarde and Ueda, and each one held true to their recent word. Both Powell and Lagarde insisted that inflation remains too high and that the surprising resilience in both the US and European (?) economies means that they would both be continuing their policy tightening going forward. Powell hinted at a July hike and Lagarde promised one a few weeks ago. At the same time, Ueda-san explained that while headline inflation was higher than their target, given the lack of wage growth, the BOJ’s ‘double-secret’ core inflation reading was still below 2% and so there would be no policy changes anytime soon. He did explain that if this key reading moved sustainably above 2%, it would be appropriate to tighten monetary policy, but quite frankly, my take (and I’m not alone) is that all three of these central bank heads are very happy with the current situation.
Why, you may ask, are they happy? Well, politically, inflation remains the biggest headache for both Powell and Lagarde, and quite frankly most of the rest of the world, while in Japan, recent rises in inflation have not raised the same political ire. At the same time, as long as the BOJ continues YCC and QE with negative rates, the flood of liquidity into the market there helps offset the liquidity withdrawn by the Fed and ECB. The result of this policy mix is a very gradual reduction in total global liquidity along with an ongoing demand for US and European sovereign issuance. It should be no surprise that Japan is now the largest holder of US Treasuries outside the Fed. As well, the policy dichotomy has resulted in a continued depreciation of the yen which supports the mercantilist aspects of the Japanese economy. And finally, higher inflation in Japan helps erode the real value of the 250% of GDP worth of JGBs outstanding, allowing eventual repayment of that debt to proceed more smoothly. Talk about a win, win, win! Until we see a material change in the macroeconomic statistics in one of these three areas, it would be a huge surprise if policies changed.
The upshot of this analysis is that it seems unlikely that we are going to see any substantive movement in yields, either up or down, given the relative offsets in policy, and that the yen is likely to continue to erode in value. Last autumn, the yen fell very sharply, breaching 150 for a short time and generating serous angst at the BOJ and MOF. We saw intervention and the idea was there was a line in the sand at that level. However, my take is that as long as the move remains gradual, and it has been gradual as the yen has steadily, but slowly depreciated for the past 5 months, about 2%/month, we are likely to see more verbal intervention, but not so much in the way of actual activity. In the end, unless policies change, actual intervention simply serves to moderate the move.
Speaking of failed intervention, we can turn to China which has a similar problem to Japan, weakening growth and low inflation. As I have written before, a weak renminbi is the best outlet valve they have, and the market has been doing the job. However, here the movement has been a bit faster than the PBOC would like thus resulting in more overt and covert intervention. On the overt side, we continue to see the PBOC try to fix the onshore currency strong (dollar lower) than the market would indicate as they try to get the message across that they don’t want the currency to collapse. On the covert side, there has been an increase in the number of stories regarding Chinese banks, like China Construction Bank and Bank of China, actively selling USDCNH, the offshore renminbi in an effort to slow the currency’s depreciation. But the story that is circulating is that all throughout Africa and Asia, nations that were encouraged to accept CNY for sales of commodities are now quite unhappy with the CNY’s weakness and are quickly selling as much as they can in order to preserve their reserve’s value. My sense is this process will continue as the dichotomy between a stronger than expected US economy and a weaker than expected Chinese one continues to push the renminbi lower. PS, for everyone who was concerned about the dollar losing its reserve currency status to the renminbi or some theoretical BRICS backed currency, this should help remind you of why any change to the dollar’s global status is very far in the future.
And those are today’s stories. Yesterday’s mixed US risk picture has been followed overnight with Chinese shares, both Mainland and Hong Kong, suffering but the Nikkei eking out a gain. In Europe, the FTSE 100 is under pressure, but we are seeing strength on the continent despite what I would consider slightly worse than expected data prints in German State CPIs as well as Eurozone Confidence measures. However, the one place where inflation slowed sharply was Spain, where headline fell to 1.9%! While that was a touch higher than forecast, it is the first reading of any country in the Eurozone below the 2% level since early 2021. Alas, what is not getting much press is the fact that core CPI there fell far less than expected to 5.9% and remains well above targets. The ECB has a long way to go.
Bonds are under pressure across the board today, with yields higher by about 3bps-4bps in Treasuries and across Europe. This seems to be a response to the idea that a) neither the Fed nor ECB is going to stop raising rates and b) inflation is not falling as quickly as hoped. JGB yields, though, remain well below the YCC cap at 0.38% so there is no pressure on Ueda-san to change his tune.
Oil prices are creeping higher this morning but remain below $70/bbl and in truth have not done very much lately. The big picture of structural supply deficits vs. concerns over shorter term demand deficits due to the coming recession continue to play out as choppy markets but no direction. Copper has fallen sharply this morning and is down more than 5% in the past week. Its recent rally appears to have been a short squeeze more than a fundamental view. Gold, meanwhile, continues to consolidate just above $1900/oz.
Finally, the dollar is mixed on the day, with both gainers and losers across the EMG space although it is broadly lower vs the G10. AUD (+0.5%) is the leading major currency after better-than-expected Retail Sales data was released overnight but the rest of the bloc, while higher, is just barely so. In the EMG, PLN (+0.75%) is the best performer, but that is very clearly a position rebalancing after a week of structural weakness. On the downside, KRW (-0.75%) is the worst performer after weaker Chinese data impacted the view of Korea’s future. Otherwise, most currencies are relatively unchanged on the day.
We get some important data today starting with Initial Claims (exp 265K) and Continuing Claims (1765K) as well as Q1 GDP (1.4%). Frankly, since this is the third look at GDP, I expect that the Claims data, which has been trending higher lately, is the most critical piece. If we see another strong print, be prepared for the recession narrative to come back with a vengeance, but if it is soft, then there will be nothing stopping the Fed going forward.
Powell made some comments this morning in Madrid, but they were about bank stability not economic policy, and we hear from Bostic this afternoon. But frankly, I see little reason for a change in sentiment anywhere on the Fed given the data continues to show surprising economic strength. As such, I still like the dollar medium term.
Good luck
Adf
Inflation’s at Bay
While waiting to hear more from Jay Investors keep socking away More assets that need Low rates to succeed With clues, now, inflation’s at bay In Europe, the money supply Although really still very high Is starting to fall As well, there’s a call To start waving PEPP bonds bye-bye
Overall, it has been an uneventful session in the markets with risk assets generally performing well amid clues that all the central bank efforts to tame inflation may be starting to work. The first sign was the release of lower-than-expected Italian CPI data at 6.7%, down sharply from last month’s 8.0% reading. As well, Italian PPI continues its recent negative trend, printing at -6.8% Y/Y, widely seen as a harbinger of future CPI activity. In addition, money supply data has continued to fall rapidly as per the below chart from the ECB, with M1 growth falling to -6.4%, its lowest reading ever.
Yesterday I mentioned the idea that the ECB was turning into a closet monetarist institution as they continue to see their balance sheet shrink and today’s data helps bolster that view. In addition, there is increasing discussion at Sintra that the ECB should consider actually selling some of the bonds from their QE programs, APP and PEPP, rather than simply let them roll off without reinvesting. Recall, that while the Fed is allowing $95 billion / month to mature without reinvestment, the ECB’s pace is a mere €15 billion / month. Granted, the ECB also has the benefit of having a large slug of TLTRO loans maturing this week (approximately €500 billion) which has been the driving force behind their balance sheet’s decline, but whatever is driving the process, it seems like the ECB is tightening monetary policy more aggressively than the Fed.
The big difference between the US and Europe, though, is that Europe is already clearly in a recession while the US, despite a widely anticipated slowdown, continues to perform quite well. For instance, yesterday’s data releases were uniformly better than expected. Durable Goods, Home Prices, New Home Sales, Consumer Confidence and the Richmond Fed Manufacturing Index all printed at better levels than expected. This goes back to the Citi Surprise Index, which jumped nearly 17 points yesterday after the releases and sits firmly in positive territory in an uptrend. Meanwhile, the same measure in the Eurozone is collapsing, deep in negative territory. The below Bloomberg chart is normalized at 100 from one year ago. It is quite easy to see the remarkable gap between the US (blue line) and Eurozone (white line) with respect to relative economic performance.
Arguably, one would expect that given the US economy’s seeming resilience, the Fed would be the more aggressive of the two central banks, but that is just not the case, at least based on the behavior of their respective balance sheets.
The big question is, can this dichotomy continue? With the Eurozone already in a recession and showing no signs of coming out of it, can the ECB continue to tighten policy in the same manner they have to date? As well, can the US equity market continue to perform well despite no indication that the Fed has any reason to pivot to easier money in the near future? Logically, at least based on previous logic, one would have thought these conditions could not continue very long. And yet, here we are with no obvious end in sight.
My sense, and my fear, is that the ‘long and variable lags’ with which monetary policy impacts economic activity have not yet been felt in the US economy and that much more stress is still in the not-too-distant future. If I had to select a particular weak spot it would be commercial real estate, especially the office sector, as already we have seen a number of high-profile mortgage defaults, and given the change in working conditions for so many people and companies, are likely to see many more. The GFC was driven by the retail mortgage sector imploding. It is not hard to imagine the next financial downturn being driven by the inability of commercial mortgage holders to refinance over the next year or two as they are currently upside down on their properties and cash flows are suffering dramatically to boot. If this sector is the genesis of the problems, then given local and community banks are quite exposed to the sector all over the country, we are likely to be in for a rough ride, both in the economy and the stock market. Be wary.
As to the overnight session, generally speaking, equity markets followed yesterday’s US rally with gains. Japan was the leader with the Nikkei rallying 2% and only mainland China suffered as there was less clarity that the Chinese government was going to support the economy, and the currency. European bourses are all nicely higher although US futures, especially the NASDAQ, are a bit softer after the Biden administration indicated further restrictions on semiconductor sales to China.
Bond yields are sliding a bit this morning but not too much, 2bp-3bp and quite frankly, all remain in a fairly narrow trading range. Despite the Treasury issuance onslaught that has been proceeding since the debt ceiling was eliminated, yields have not moved very far at all. It would seem that as issuance is pushed further out the maturity ladder, we would see higher yields, but that has not been evident yet. Meanwhile, the yield curve remains massively inverted, right at -100bps this morning.
Oil prices are stabilizing this morning but have fallen more than 6% in the past week as this is the one market that truly believes the recession story. Gold is also under pressure, falling further and pushing toward $1900/oz. Higher yields continue to undermine the barbarous relic. As to base metals, copper is under pressure, but aluminum is holding in reasonably well.
Finally, the dollar is rebounding from a few days of softness with strength virtually across the board this morning. Every G10 currency is weaker led by NZD (-1.3%) and AUD (-0.95%) as concerns over Chinese economic activity weigh on the antipodeans. But the whole bloc is under pressure. Meanwhile, in the EMG space, the picture is the same, virtual unanimity in currency weakness led by ZAR (-1.0%) and THB (-0.95%) with CNY (-0.3%) reversing course after the PBOC was absent from the market last night. Despite hawkish comments from the SARB, the rand continues to suffer over concerns about the broader economy while the baht is suffering from political concerns. This is an interesting story as Pita Limjaroenat was the surprise victor in recent elections but was not backed by the military. Not surprisingly they are not happy, and he is having trouble putting a government together.
There is no major data today, so we are all awaiting Chairman Powell’s comments at 9:30 to see if he has any further nuance to impart. At this point, I have to believe he will continue to push the higher for longer mantra as the data has certainly done nothing to dissuade him. As such, I still like the dollar over time.
Good luck
Adf
fxpoetry 