Tag Archives: #10yearyields

Recession in Sight

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There once was a policy view
That tariffs, we all should eschew
But President Trump
Explained on the stump
To this idea, he wouldn’t hew
 
And so, as the clock struck midnight
Trump’s tariffs once more saw the light
Most analysts say
The tariffs will weigh
On growth, with recession in sight

 

By now you are all aware that as of 12:01 EST this morning, 25% tariffs have been imposed on all imports from both Canada and Mexico except energy products, which have seen 10% tariffs imposed.  As well, all Chinese imports have been hit with an additional 10% tariff.  Once again, President Trump has proven to be a man of his word, promising these tariffs during his election campaign and imposing them now.

The mainstream view is that these tariffs are a disaster and will send the economy into a recession.  In fact, the International Chamber of Commerce said a depression was likely.  As well, there is much concern that inflation will rise during the recession, which for Keynesians must be a very difficult concept to grasp given their strongly held belief that a recession will result in declining inflation.

Now remember, I am just a poet, so please take that into account when I offer my views here.  First, we have no idea how things will play out.  The one thing about which I am extremely confident is that there will be numerous behavioral changes by everyone because of these tariffs.  The first question is who will absorb the cost of the tariffs.  Remember, essentially the definition of a recession is that demand is declining.  Will companies be able to pass through the higher costs?  In some instances, they likely will, but in others probably not.  Anecdotally, there was a story in the WSJ that Chipotle will see its costs rise because of the tariff on avocados from Mexico but will not change their prices to account for that.  I’m confident they are not the only company who will absorb those costs.

However, there will certainly be companies that believe they can raise prices and maintain their sales and will try to do that.  My point is each company will evaluate the environment under which they operate and respond in the profit-maximizing manner, but each company’s scenario will be different.

Second, let’s consider the reason that President Trump is such a strong believer in tariffs.  He sees them as the stick to achieve his goals.  I would argue there are two goals in sight.  With Canada and Mexico, he is still unsatisfied with their efforts on the border and with fentanyl smuggling and is very keen to push that to completion.  However, the broader goal is to return manufacturing to America from its decampment overseas, mostly to Southeast Asia, during the past forty years.  And remember, he is seeking to implement a carrot as well, looking to cut corporate taxes to 15% going forward, which would put the US in the lowest quartile of corporate tax rates in the world.  While this morning the headlines are all about the tariffs and their potential destruction, just yesterday, Taiwan Semiconductor announced they would be investing $100 billion to build new fabrication plants in Arizona.  That is exactly the response Trump is seeking.

We all recognize that the world today is very different than it was even two months ago as President Trump has taken an extraordinary number of steps to implement the ideas upon which he was elected.  Interestingly, a large majority of the public remains strongly in his camp with approval ratings for many of his policies well above 60% and as high as 80%.  While markets are clearly unhappy as they have no idea how things will play out, and companies are now faced with far more uncertainty as they attempt to plan for their future, there is no reason to believe this process is going to change anytime soon.  

Keep one other thing in mind, unlike Trump’s first term in office, where he was constantly touting the strength of the stock market as a vote of confidence, this time around he and Treasury Secretary Bessent have been entirely focused on the 10-year yield and getting that rate down.  After a 7bp decline yesterday, he has been successful there. (see chart below) I would be surprised if Trump speaks about the stock market much at all for a while.

Source: tradingeconomics.com

With that in mind, let’s see how markets have been handling the tariff imposition.  After yesterday’s rout in the US, where a higher open morphed into a sharply lower close on the day, we saw red throughout Asia (Nikkei -1.2%, Hang Seng -0.3%, CSI 300 -0.1%) and Europe (DAX -2.1%, CAC -1.2%, IBEX -2.3%).  In fact, it is far harder to find a market that has rallied at all, although US futures at this hour (6:40) are pointing slightly higher.  However, after the sharp declines, an early bounce is not uncommon though not necessarily a harbinger of activity for the day.  All of this makes sense as public companies are likely going to see impacts on their profitability either because of reduced sales or reduced margins, or both, with tariffs now in place.  (Well, private companies are going to feel the same pressures, but there are no markets for them to worry about.). The worry for investors is given the extremely high price multiples that currently exist across so many companies, margin pressures can be problematic for stock prices.  For the near term, it is easy to make the case that equities have further to fall.

In the bond market, after yesterday’s Treasury yield decline, there has been a modest 1bp bounce, although as per the above chart, the trend remains lower.  In Europe, the news just hit the tape that the Eurozone is creating a plan to rearm the continent allowing for European countries to exceed debt restrictions to enable them to borrow and spend the money on this task.  The mooted amount is €800 billion, meaning that markets can expect that much new debt issuance across the continent in the coming months and years.  However, it appears investors are viewing the situation overall and are far more concerned with potential slowing growth than on increased issuance as yields have slipped one or two basis points across all nations in Europe.  Perhaps that is a signal that there is little belief in the likelihood of this new plan coming to fruition.

In the commodity markets, oil (-1.4%) continues its slide as a combination of worries over future growth due to the US tariffs and the OPEC+ announcement that they would start to bring production back online beginning in April (just 138K bbl/day, but the signal is quite clear that more is on the way) has traders unnerved.  Certainly, this is part of what President Trump is seeking, lower oil prices to help keep a lid on inflation, and there is no doubt he has pressured OPEC+ on the issue.  Remember, too, that if gasoline prices fall at the pump, that is a key driver of inflation perceptions for everyone.  As to the metals markets, we are seeing a split this morning with precious (Au +1.0%, Ag +0.65%) rallying on uncertainty and fear while copper (-1.2%) seems to be suffering on recession fears.

Finally, the dollar is lower again this morning with the DXY breaking back below 106 for the first time since early December as a signal of the broad trend.  This is interesting as the textbooks claim that if the US imposes tariffs, the dollar will strengthen, or more accurately other currencies will weaken, to offset those tariffs, and yet this morning CNY (+0.55%) and CAD (+0.45%) are bucking that trend although MXN (-0.2%) is behaving as most would expect.  But the dollar’s weakness is broad based, and my take is given the movement in interest rates, which are suddenly declining far more rapidly than anticipated just a week ago (Fed funds futures are now pricing in 75bps of cuts this year with a 11% probability of a cut in March, up from 2% last week) the dollar bull case is under real pressure.  I have maintained all along that if the Fed reignited their easing policy, the dollar would suffer.  Funnily enough, despite any angst between Chairman Powell (remember him?) and President Trump, they both may see lower rates as their preferred outcome.  In that case, the dollar has further to fall.

There is no hard data set to be released today although we do hear from NY Fed President Williams this afternoon.  This could be the first hint that the Fed’s caution is abating, and further rate cuts are in store.  Of course, with Powell on the calendar for Friday, if there is a change in tone, most market participants will be waiting to hear it from him.

The watchword has shifted from caution to uncertainty.  The tariffs have thrown sand into the gears of the economy and markets.  It remains to be seen how much impact they will have, but for now, fear is rising although the dollar is not following suit.  I think Trump must be happy, but I’m not sure how many in the markets are.

Good luck

Adf

Ain’t Hunky-Dory

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For President Xi it appears
The stock market’s shed enough tears
So, he’s set to meet
The finance elite
And likely to box all their ears

As such, I expect we shall see
The Hang Seng will start on a spree
With New Year’s approaching
A little more coaching
By Xi, for a rally, is key

The big news overnight was that Chinese equity markets rebounded sharply (Hang Seng +4.0%, CSI 300 +3.5% CSI 1000 +7.0%) after the news that President Xi Jinping would be meeting with market regulators to find out what is going on there.  Banning short sales has not yet been effective nor has increased purchases by specific state funds.  According to Morgan Stanley, foreign investors sold $2.4 billion in Chinese equities in January, arguably a key driver of the market’s recent weakness there.  But the fact that Xi is getting involved directly has traders believing that more support from the government is on its way, hence today’s big rally.

While that is all fine and well for equity investors, the far more important question for the rest of us is will this stock market support help the Chinese economy as well?  Or will that continue to meander along at a weak growth pace?  Of course, it is far too early to know the answer to this question but given that the preponderance of Chinese individual wealth is tied up in real estate, not equities, I expect that this will have far less impact on the economy there than is hoped by both Xi and the traders.  After all, one of the key reasons so many in the US care about the stock market is that so much of our 401K investments are in equities, a rally shows up in our accounts daily.  But in China, that same situation does not hold.  Will a rally in stocks, if it even comes, be enough to sway the average person’s thinking there that things are getting better?  I have my doubts.

A turn to the interest rate story
Shows things there just ain’t hunky-dory
Yields just won’t stop rising
And that’s neutralizing
The thought rate cuts are mandatory

Friday morning, 10-year Treasury yields traded as low as 3.82% prior to the release of the NFP report.  This morning, they are trading at 4.16%, 34 basis points higher and the largest two-day yield rally since the covid volatility in March 2020.  Prior to that, it was 1981 when yields moved that far that fast.  Adding to Friday’s NFP story, yesterday’s ISM Services report was not only stronger than expected at 53.4, but the Prices index jumped to 64.0, its highest in a year and hardly a comforting thought for Chairman Powell and his fight against inflation.

At this point, the Fed funds futures market has lowered the March rate cut probability to 16.5%, and some of the punditry, although not yet any Fed speakers, have raised the question if another hike might be in order if things continue on their recent trajectory.  I assure you that the equity market has not priced in the possibility of a rate hike anywhere in the next 2 years at least.  Let’s just say that next week’s CPI report is going to be quite closely watched by everyone as if what I have seen as recent stickiness continues to exert itself, and with the economy seeming to be ticking over quite nicely, then the narrative could well change.  It is not impossible for the Fedspeak to turn even more hawkish if we were to see CPI rise 0.4%, a rate that is far too high for Fed comfort.  And that, my friends, would likely not be well-received by the equity market or risk assets overall.  While I have no special insight into how this data is going to evolve, I think the reaction function is clear.

Ok, let’s look at the overnight session beyond Chinese stocks.  In what cannot be that surprising after US equities struggled and given its recent negative correlation to Chinese stocks, the Nikkei fell -0.5% while the rest of Asia was mixed with some gainers (India, Taiwan) and some laggards (Korea, Australia).  However, the story in Europe is a little brighter with gains most everywhere except Germany, which is flat on the day after mixed data, with a blowout Factory Orders result of +8.9%, but the Construction PMI falling to 36.3.  Contradictory data leading to no movement.  As to US futures, at this hour (7:45) they are essentially unchanged on the day.

In the bond market, it seems traders are sitting on the sidelines after the bloodbath described above as 10-year Treasury yields are unchanged on the day and in Europe, the sovereign bonds are higher by a mere 1bp-2bps across the board.  We saw a similar lack of movement in Asia as well, despite the fact that the RBA, at their meeting last night, sounded somewhat hawkish although left policy rates on hold as universally expected.  As the treasury market is clearly leading the way globally, we will need to get some new information here, I think, before we see any substantive movement again.  Since the next big piece of data is CPI in one week’s time, it could be a quiet week for bonds.

In the commodity market, oil (+0.6%) is bouncing slightly this morning although it remains far lower than levels seen last week.  Gold (+0.1%) is also edging higher along with the industrial metals although there has been no strong catalyst here today given the lack of substantive rate movement.  Perhaps there is some optimism from the Chinese stimulus story, but that feels quite premature.

Finally, the dollar is a touch softer this morning, although only just.  While the euro has been unable to bounce, we have seen some modest gains in the pound (+0.25%) and Aussie dollar (+0.25%) as well as the renminbi (+0.3%).  In addition, the LATAM bloc is very modestly firmer this morning but generally, most of the movement is of that 0.25% magnitude or less.  This feels very much like a trading response to a powerful rally over the past two days.

There is no hard data to be released today but we do hear from three more Fed speakers, Kashkari, Collins and Mester, all this afternoon.  Yesterday, Chicago Fed president Goolsbee strayed from the Powell message, indicating he still believed a cut in March was possible, but he is not a voter this year and nobody really paid any attention.  After yesterday’s data, it would be hard to believe that any of these three would sound dovish, but you never know.

Overall, when looking at the dollar, as long as the inflation story has reawakened and is driving yields in the US, it is hard to see coming weakness.  This is especially true given the economic weakness we continue to see elsewhere in the world.  Today feels like a reaction, not a trend in the making, and I expect that the dollar has better days ahead for as long as inflation is once again the driving force.

Good luck
Adf

Bad Dreams

Posted on by 
In China, the property bubble
Continues to cause Xi much trouble
So, they will add on
A trillion more yuan
Of debt, as help efforts redouble

And though Chinese markets did rise
They finished well off of their highs
Investors, it seems
Are having bad dreams
‘bout growth there and seek to downsize

Poor President Xi!  Instead of focusing all his energy on his saber rattling in the South China Sea and hinting at a Taiwanese invasion, he finds himself essentially forced to deal with the economy.  This was made clear yesterday when he made a surprise visit to both the PBOC and the SAFE (State Administration of Foreign Exchange), the two top Chinese financial institutions, and then today when the government announced an effective supplemental budget spend of CNY 1 trillion (~$137 billion) to support further infrastructure investment in the country.  

This move will increase the national government’s budget deficit for the year to 3.8%, well above the 3.0% target they had been shooting for, but obviously, the concern of continuing slow growth is being seen as a growing problem for Xi.  This is also a change from the previous process where local governments would issue debt to fund infrastructure investment and ultimately repaid that debt by selling land.  Of course, that is what led to the inflation of the massive property bubble in China, so that model is now clearly broken.

Arguably, the biggest worry is that if the domestic situation continues to deteriorate, Xi will get more adventuresome internationally as the standard national leadership political playbook is to seek to distract the population from the economic failures of a government by stoking nationalism and instigating conflict overseas.  We just saw it in Russia, and quite frankly, given the support for intensifying the war effort in the US, it is also being executed here in the US.

In the end, though, a 0.8% of GDP budget boost is unlikely to have a huge impact on the economy.  The problem the Chinese have is that they, too, have a very high debt level and are trying quite diligently to prevent it from growing out of hand.  The tradeoff there is that the amount of support is going to be restricted.  Initial economist estimates are that the package will raise GDP growth by 0.1% in Q4 and up to 0.5% in 2024 overall.  

It can be no surprise that shares in China rose on the news with the Hang Seng jumping 2.5% on the news while the CSI 300 jumped 1.3% initially.  However, both faded fast and closed higher by about 0.5%, not bad, but certainly not a huge vote of confidence.  Meanwhile, the yuan just continued is weak performance, falling another 0.2% and continuing to push against its 2% band vs. the daily CFETS fixing.

Away from that news, however, it has been dullsville this morning with pretty modest movement across both equity and bond markets around the world.  Yesterday’s PMI data indicated that the massive amount of fiscal stimulus that has been enacted in the US compared to elsewhere in the world is having the desired impact, at least from a statistical point of view, as US data continues to show relative strength compared to Europe, Japan and the rest of the G10.  However, despite those efforts, the political accolades remain absent as the national attitude is consistently measured in downbeat terms. 

And consider, if the data here are relatively better and the government is not gaining any ground, how bad it is for governments elsewhere in the world where the data is clearly worse and falling.  We continue to see populist parties from both sides of the aisle gaining in strength.  Do not be surprised to see quite a few new governments around the world over the next several years as support for incumbents continues to fall.  (It will be quite interesting to see the results of the Argentine election in a few weeks and see how Javier Milei, the upstart “anarcho-capitalist” who has promised to take a chainsaw to the government and shutter the central bank while dollarizing the economy, performs.)  A victory there could well be a harbinger of future shakeups everywhere.

Turning to markets, yesterday’s solid US performance was ultimately followed by 0.5% ish gains in China and Japan, although weaker performances elsewhere in Asia with a number of regional markets declining.  European bourses are showing very modest gains this morning, on the order of 0.1% while US futures are mostly softer at this hour (8:00), down roughly -0.4%.

The massive reversal in bonds seen on Monday is now history and we are seeing yields begin to creep back higher with Treasury yields up 3bps and similar rises throughout Europe, although Italian BTPs are the true laggard with yields there rising 6bps.  JGB yields also rose 2bps last night but have been largely capped at 0.85% by the market as there was no sign of extra intervention by the BOJ.  The yield curve inversion remains at -24bps, not quite at its tightest levels but still clearly trending toward normalization.

One thing to consider about the Treasury market is the fact that the US trade deficit has been steadily shrinking amidst the efforts at reshoring and all the CHIPS act spending on manufacturing capacity, as well as the simple fact that US energy exports continue to be quite robust.  The point is that one of the key demands for Treasury bonds in the past was the recycling of all those deficits, but if the deficits shrink, then there is less to recycle and therefore less demand for Treasuries.  Combine this process with the fact that the government continues to increase the amount of issuance and it is not hard to conclude that bond yields have further to rise over time.  The fact that an oversold market responded to a major psychological level does not mean the bond market move has ended.  Rather I would argue it has simply paused and yields will once again climb going forward.

Turning to the commodity markets, oil is marginally higher this morning, up 0.3%, but that is after another sharp decline yesterday as the market appears to believe that the odds of a widening of the Israeli-Palestinian conflict are shrinking amid growing pressure from organizations around the world.  Add to that the signs of weaker economic activity which implies reduced demand, and it is easy to understand why oil has retraced. However, inventories fell again last week, and the structural issues of supply remain in place.  The big picture remains for further strength over time in my eyes.  As to the metals markets, gold continues to benefit from its haven status, edging higher by 0.25% this morning while copper is suffering on the weaker growth story, falling -0.4%.

Finally, the dollar is stronger overall with the euro > 1% lower than its recent highs Monday afternoon which were seen in the wake of the bond market rally that day.  USDJPY is right back below 150.00 although it has not yet touched the level since early this month which was followed by what appeared to be intervention.  But generally, we are seeing the dollar gain against both G10 and EMG rivals as US rates once again edge higher, 2yrs as well as 10yrs.

On the data front today, New Home Sales (exp 680K) are due at 10:00 as well as the Bank of Canada rate decision where no change is expected.  We also see EIA oil inventory data later this morning and then Chairman Powell speaks late this afternoon.  I continue to believe it is unlikely that he will add anything to his message from last week.  As such, it is a status quo day.  If yields continue higher, look for the dollar to follow.  But I have a feeling that there will be very little movement today overall.

Good luck

Adf

Waved Adios

Posted on by 
There once were two gents, both named Bill
Whose market views oft could be shrill
Now Ackman and Gross
Have waved adios
To shorts, with positions now nil

When others all learned of this action
The bond market really gained traction
So, does five percent
In truth, represent
The highs? Or is this a distraction?

It ought to be no surprise that the bond market had a significant hiccup yesterday after the 10-year yield finally breached the 5.0% level for the first time in more than 15 years given the market’s penchant to focus on big round numbers.  However, as can be seen in the chart below, the response by traders and investors was dramatic as it appears many were waiting for that level to ‘buy the dip’ in bonds.  As such, after climbing to a high of 5.025%, the market reversed sharply with yields falling nearly 20bps at one point, although they closed slightly off the lows.

Source: Tradingeconomics.com

Ostensibly, a key driver of this move was a Tweet by hedge fund manager Bill Ackman explaining he had covered his bond short positions.  “We covered our bond short.  There is too much risk in the world to remain short bonds at current long-term rates. The economy is slowing faster than recent data suggests.”  Similarly, former bond king, Bill Gross, tweeted that he was buying bonds across the curve after calling for a recession in the 4th quarter (that’s now!).  And that’s all it took to reverse a substantial portion of the recent sell-off in Treasuries.  Perhaps more interesting was the fact that the ongoing normalization of the yield curve was not impacted much at all.  Yesterday, the 2yr-10yr spread had fallen to -18bps and this morning it is -22bps, so not all that different.

The question, of course, is what can we expect going forward?  The thing that continues to bother me is the ongoing supply question, and at what price will the Treasury be able to sell new bonds to price sensitive buyers rather than the Fed.  Nothing has changed that part of the equation and until the Fed ends QT, let alone restarts QE (which I do expect at some point in the future), I continue to believe bond yields will trend higher.  And this view considers the fact that some further economic slowing seems highly probable to me.  However, the supply issue is going to continue to be the dominant feature going forward.

One other issue is the ongoing Israeli-Palestinian conflict and how that could evolve, with many talking heads concerned that growth in that conflict will result in demand for more safety.  Certainly, the gold price has been a huge beneficiary of that situation with the barbarous relic having gained more than $120/oz in price since the attack while bond yields are actually higher by 6bps, even after yesterday’s sharp decline in yields.  However, my experience indicates that after the immediacy of any conflagration, whether Russia in Ukraine, or even 9/11, market behavior tends to move off that narrative and back to whatever was deemed relevant before the news.  I see no reason for this to be different, and before the attack, yields were rising on the supply story and robustness of the US economy.  That is the narrative that needs to change to reverse bond yields.

So, is there going to be a change in that narrative soon?  Well, depending on one’s view of the value of PMI data, the flash releases this morning were all pretty crummy with all of Europe and the UK remaining below the key 50.0 level and last night’s Australian and Japanese data also quite weak, although Japanese Services data did manage to hold above the 50.0 level.  As well, German GfK Consumer Confidence fell to -28.1, down from last month and below consensus expectations, so perhaps some economic weakness is coming our way.  

However, first, those are not US numbers and second, the US data has consistently shown hard data (NFP, Retail Sales, IP, etc.) firmer than any of the survey data.  So, while there continues to be gloom and doom on people’s minds, their actions have not yet matched those views.  Now, a case can certainly be made that the US hard data is all lagging and the current situation is far worse than those numbers imply, but the Fed is not going to respond to that story.  As long as the hard data offers cover for the Fed to maintain their current policy stance as they fight inflation, they are going to do so.  

Summing it all up leads me to believe that nothing has changed the big picture.  While yesterday’s bond move was certainly exciting, the fact that one hedge fund manager took profits is not enough to change the investment landscape.  I continue to expect stickier inflation going forward as well as a grind higher in 10yr yields as the curve normalizes.  

So, how did markets respond to all the new information?  Well, after a mixed day in the US yesterday, we saw a similar picture in Asia with the Hang Seng falling -1.0%, but most other markets edging a bit higher.  European bourses are slightly firmer this morning, but really no great shakes and US futures at this hour (8:30) are firmer by 0.6% or so.  Fear is not that evident today.

On the bond side, this morning has seen a modest bounce in US yields, just 2bps, but we are seeing a continuation lower in Europe with most sovereigns seeing yields fall about 2bps.  JGBs have also edged away from their recent high in yields, although that was after the BOJ had yet another unscheduled bond buying session, this one the largest of the five unscheduled ones so far implemented after they adjusted the YCC cap to 1.00%.  

On the commodity front, oil is essentially unchanged this morning although that is after a sharp decline yesterday which wiped out the previous week’s gains.  Gold, while still holding up reasonably well, is softer by -0.4% this morning and copper is bucking this trend, rising 0.6%, although still hovering just above 1yr lows.

Finally, the dollar, which fell yesterday a bit as yields decline sharply in the US, is bouncing this morning with the euro sliding back toward 1.06 and the DXY back at 106.00.  Neither JPY nor CNY really responded to yesterday’s price action, it was mostly European currencies doing the damage to the buck.  One thing to note is the question of whether the 10-year yield is still a key driver of the dollar or is it something else?  Brent Donnelly, a well-respected FX analyst, has an excellent article out discussing how the dollar appears to be more linked to the 2-year yield than the 10-year.  I had mentioned last week how that relationship between the dollar and yields seemed to be breaking down and his analysis shows that if you look at the 2yr yield, which hasn’t moved much at all compared to the 10yr lately, it makes more sense.  It is well worth the read.

With that in mind, then perhaps the dollar’s strength is unlikely to manifest itself as it did while the Fed was aggressively raising rates earlier in the year and 2yr yields were rising rapidly.  Instead, it is quite possible we are in for a period of relative quietude in the dollar, at least against the majors.  Emerging market currencies have a clear life of their own, and hedging decisions there need to be independent of views on the euro or pound.

On the data front, the Flash PMI’s are due here as well (exp 49.5 Manufacturing, 49.8 Services) and then the first look at oil inventories late this afternoon.  Interestingly, despite the Fed’s ostensible quiet period, Chairman Powell will be making Introductory Remarks at the 2023 Moynihan Lecture in Social Science and Public Policy tomorrow at 4:30pm.  Given the quiet concept, I find it difficult to believe he will focus on monetary policy but be aware.

All signs point to a quieter session today and perhaps for a while going forward, at least in the G10 currencies.  However, hedging is always a good idea!

Good luck

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