Tag Archives: #BOE

Jay’s Motivation

Posted on by

The Keynesian view of inflation
Claims growth is its major causation
If that is the case
Then given the pace
Of growth, what is Jay’s motivation?
 
Instead, ought he not be concerned
Inflation will soon have returned?
Or does he believe
That he can deceive
The market without getting burned?

 

Another week passed with another set of confusing data.  But more important than the data’s inconsistency is the inconsistency in the arguments made by those desperate for the Fed to cut rates.  For instance, former NY Fed president Bill Dudley wrote a widely read article for Bloomberg saying that he had suddenly become a convert and that the Fed needed to act this week and cut rates.  Granted, he wrote this article the day before the much hotter than expected GDP data was printed, but nonetheless, he had been a staunch hawk and changed his feathers.  And he is not alone, with a number of other high profile financial personalities (I’m looking at you Claudia Sahm) in the same camp.

But I would ask them the following: since you are strong proponents of Keynesianism which describes inflation as a direct result of strong growth and labor markets, given that GDP is running at 2.8% annualized, double Q1’s pace and above trend, and a federal government budget deficit that is approaching 7% despite that growth, and the latest PCE data showing that services inflation remains quite robust (the 6-month level has risen to 5.4%), why do you think the Fed should cut rates?  By your own thesis, inflation is more likely to rise than fall given the economic strength.  Alas, either no journalist will ask that question, or no Fed official will answer. 

At the same time, those analysts who have been calling for a recession in the near future, continue to dig through the better-than-expected data releases and find the weak points to make their case.  Here’s the thing, Powell and company cannot point to yet another subindex of the major data points and claim that is why they are cutting.  He remembers far too well his focus on so-called super core (core ex housing) with the expectation that housing was the problem and if he removed the part of the index that was rising, the rest of the index would be lower.  Alas for his finely tuned plans, that number continues to power along at 4.0% or higher.  He will not make the same mistake again and focus on some obscure view.  

At this point, there is certainly no reason for the Fed to act this Wednesday, and unless the economy essentially falls out of bed by September, it will be difficult to make that case as well.  This is not to say they won’t cut in September come hell or high water, just that if the economy proceeds as it currently appears to be doing, there will be no justification.  But just to put an exclamation point on the likelihood a cut is coming in September, this morning the Fed whisperer, Nick Timiraos, told us that is the case in his latest missive for the WSJ.

In addition to the Fed meeting this week, we also hear from Ueda-san and the BOJ on Tuesday night and Governor Bailey and the BOE on Thursday morning.  Given the near certainty that the Fed is going to remain on hold this week, arguably the BOJ is the far more interesting meeting, at least for financial market cues.  Remember, the narrative has been that the BOJ was finally going to start to “normalize” their policy, lifting interest rates above 0.0% and start to reduce their ongoing QQE program.  Now, this has been the story since last October, and while they did exit the NIRP stage back in March, there has been nothing since then.  Not only that, as I highlighted last week, inflation in Japan is already slowing with the current policy.  

In addition, the yen, while it has backed away from its recent highs (dollar lows) by about 1%, is far from its worst levels and appears to be trending slowly higher, exactly what they want.  I see no case for a rate hike here, although we will certainly hear about how they may modify their QQE actions going forward.  (As an aside, for those with JPY exposures, 152.00 is a very critical level in the market’s perception and a break below that level could well lead to a significant decline in the dollar.)

Lastly, the BOE is going to cut by 25bps.  Given that the ECB has already cut, as has Switzerland and Canada, they will not be able to hold out any further.  I don’t think we need any rationale beyond this to believe Bailey will act.

Ok, let’s look at the overnight market activities.  Friday, you may recall, US equities rebounded sharply from the short-term correction and Japanese shares (Nikkei +2.1%) followed right along, as did the Hang Seng (+1.3%) and almost every other major market in Asia save one, China (CS! 300 -0.5%) as there continues to be a distinct lack of progress on the economy there.  In Europe, the situation is mostly positive as both the DAX (+0.4%) and Spain’s IBEX (+0.6%) are rallying nicely but the French (CAC -0.1%) are suffering a bit, perhaps because of the seemingly constant mishaps regarding the Olympics and the nation’s infrastructure.  This morning, major internet connections were severed around the country, although backups are now working, which added to a dramatic blackout over the weekend and the high-speed rail terrorist arsonist attacks late last week.  But here at home, US futures are firmly in the green (+0.4%) at 6:15am.

In the bond market, euphoria is the story as virtually every major bond market has rallied with yields falling around the world.  Treasury yields are lower by -4bps while across European sovereigns, we are seeing declines of between -5bps and -7bps across the board.  Even JGB yields (-4bps) have fallen, perhaps another signal that the BOJ is unlikely to be acting this week.

In the commodity markets, oil (-0.3%) cannot seem to find any support of note despite a significant inventory draw last week and an escalation in events in the middle east over the weekend.  For the past year, oil has traded between $70/bbl and $90/bbl and we continue to trade in that range with no exit in sight.  We will need to see some very significant economic changes, either a sharp recession or a giant rebound in China, to break out of this range I believe, neither of which seems like a near-term phenomenon.  In the metals space, gold (+0.3%) continues to find support even after a sharp decline a couple of days last week, with spot hovering just below $2400/oz.  This morning, silver (+0.75%) is also rallying but copper (-1.1%) is in a sharp downtrend, despite the news that the workforce at the world’s largest copper mine, Escondida in Chile, is preparing to go on strike.  

Finally, in the currency markets, despite the lower yields everywhere and the generally positive risk environment, the dollar is higher nearly across the board.  Both the euro and pound are softer by about -0.2% and we are seeing the EEMEA currencies following suit with declines on the order of -0.4% across this bunch.  USDJPY is little changed this morning although CNY (-0.1%) is edging lower again after the PBOC’s recent efforts to prevent a sharp decline in the wake of their rate cuts.  Interestingly, the outlier this morning is NOK (+0.3%) despite oil’s decline and there is no obvious catalyst for this movement.  One other currency that is bucking this trend is AUD (+0.1%) which while not much higher this morning, given it has been falling sharply every day for the past two weeks, seems to have found a bottom.  That movement is highly linked to the JPY strength as AUDJPY is a favorite carry trade for many in both the institutional and retail spaces.  If USDJPY does break through that 152 level look for AUD to continue its decline.

On the data front, we know it is a big week, but here are the details:

TuesdayCase Shiller Home Prices6.6%
 JOLTS Job Openings8.03M
 Consumer Confidence99.5
WednesdayBOJ Interest Rate Decision0.1% (unchanged)
 ADP Employment149K
 Treasury QRA 
 Chicago PMI44.5
 FOMC Rate Decision5.5% (unchanged)
ThursdayBOE Rate Decision5.0% (-0.25%)
 Initial Claims236K
 Continuing Claims1860K
 Nonfarm Productivity1.7%
 Unit Labor Costs1.8%
 ISM Manufacturing49.5
 ISM Prices Paid52.5
FridayNonfarm Payrolls175K
 Private Payrolls150K
 Manufacturing Payrolls-2K
 Unemployment Rate4.1%
 Average Hourly Earnings0.3% (3.7% Y/Y)
 Average Weekly Hours34.3
 Participation Rate62.5%
 Factory Orders-3.0%
 -ex transport+0.3%

Source: tradingeconomics.com

Obviously, an awful lot to consume and digest this week with the central banks and then NFP.  In addition to all that, we have a significant amount of earnings data coming from some big names including Apple, Amazon, Meta and Microsoft.  Certainly, the strong expectation is for the Fed to remain on hold and prepare the market for a September cut.  That is already priced into the futures market, so much will depend on the tone of the statement and the press conference following the meeting.  As such, my sense is the real unknown is the BOJ early Wednesday morning, but I suspect they leave rates on hold.  If they do hike, I would look for USDJPY to break that key support level of 152, so that feels like the biggest risk heading into the week.

Good luck

Adf

Not Harebrained

Posted on by

While here in the States there’s no chance
That rate cuts, by June, will advance
In England, we learned
They’re growing concerned
The ‘conomy’s still in a trance

So yesterday, Bailey explained
By June, a rate cut’s not hairbrained
But, closer to home
The Frisco Fed gnome
Said cutting rates will be restrained

You can tell that very little continues to happen in the macro world when the key stories that are in the discussion regard secondary players and their commentary.  While it is true that Andrew Bailey is the governor of the Bank of England, the reality is that the UK is just a secondary player on the world stage.  However, after their meeting yesterday, much digital ink has been spilled over the potential for the BOE to cut rates at the June meeting.  Prior to this meeting, it seemed that the BOE was tracking the Fed rather than the ECB, but that idea has now been dispelled.  Governor Bailey indicated that come June, a rate cut “is neither ruled out nor a fait accompli.”  However, he did comment that cuts were likely “over the coming quarters” and the market took him up on the news, with yields sliding and stocks rallying.

A key to the discussion is the fact that the BOE will see two more CPI reports between now and the next meeting on June 20th.  As well, both the ECB and the Fed will have met and potentially acted before they next meet.  As such, despite the fact that the BOE’s own forecasts showed improvement in both GDP and CPI over the next 3 years with current policy, the market is all-in on the cuts for June.  Well, maybe not all-in, but has increased the probability to 50%, up from just under one-third prior to the meeting.  Regarding the pound, if we continue to hear more dovish cooing from the Old Lady, especially given the fact that the Fed is clearly on hold, I expect it could drift back toward 1.20 over time.

Which brings us to the Fed, and an unscheduled appearance by San Francisco Fed president, Mary Daly, yesterday afternoon.  The two key comments she made were as follows: “There’s considerable, now, uncertainty about what the next few months of inflation will be and what we should do in response,” and “It’s far too early to declare that the labor market is fragile or faltering.”  In essence, this is repeating everything that we have heard consistently since the FOMC meeting last week.  I would boil it down to ‘as much as we are desperate to cut rates, neither prices nor the labor market are falling quickly enough to allow us to do so soon.’

Add it all up and you get a picture of a still tight Fed with no indication of a policy ease in the next quarter, at least, while another major central bank elsewhere has opened the doors to cutting rates.  Arguably, this should be a positive for the dollar except for the fact that this has been known, and the basic narrative for a while, so is already in the price.  If these policy divergences maintain for a much longer time, through the end of the year or beyond, then perhaps we will see more aggressive dollar strength.  But for now, I think the FX markets are going to be a dull affair.  The caveat here is if we see US data move away from its current trajectory, either picking up and pushing price pressures higher, or falling more rapidly resulting in a worse employment situation.

One last thing on the prospects for the US economy; there is still a large contingent of analysts who have been parsing the data and looking at secondary indicators and sub-indices of headline data, and who believe that a recession is much closer than the market is currently pricing.  Things like credit card delinquencies and the growing number of bankruptcies, as well as the discrepancy between the establishment and household surveys in the employment data have reached levels consistent with recessions in the past.  While last year I expected that would be the case, at this point, I believe that the ongoing massive fiscal spending (budget deficits >6% of GDP) and the ongoing availability of cheap energy continuing to draw investment into the US will prevent any substantive downturn for the rest of the year, at least.

As to market activity, yesterday’s higher than expected Initial Claims data (231K, highest since October) got the bulls all excited and drove a risk rally in stocks in the US which has been followed all around the globe.  Asian markets saw gains in Japan (+0.4%), Hong Kong (+2.3%) and almost everywhere else in the region except China which was flat on the day.  Meanwhile, European bourses are all green as well, led by the UK (+0.7%) on the back of stronger GDP data as well as the hopes for lower rates in the near future.  But the entire continent is higher as well, mostly on the order of 0.5%.  As to US futures, higher by 0.25% at this hour (7:30).

In the bond market, while Treasury yields drifted lower yesterday after that claims data, this morning they are higher by 1 basis point.  In Europe, though, sovereign yields are slipping 2bps to 3bps as traders and investors get more convinced of rate cuts coming soon.  Overnight, JGB markets did nothing.

In the commodity markets, Wednesday’s declines are a distant memory as we have seen oil (+0.7%) rally again this morning despite modest inventory builds which may be being offset by concerns that Israel is ignoring the recent pressure to stop its Rafah incursion.  However, the precious metals are not ignoring that story with both gold and silver higher by more than 1% this morning and copper rising 2.4%.  The day-to-day vagaries of these markets remain confusing, but the long-term trend, I believe, remains strongly intact, and that is higher prices going forward.

Finally, the dollar is little changed this morning but maintaining its gains from earlier in the week.  Looking across my screen, no currency has moved more than 0.3% in either direction, a clear sign that very little of note is happening.  As I wrote above, absent a major change in policy, I think the dollar is range bound for now.

On the data front, this morning brings only Michigan Sentiment (exp 76) and then a few more Fed speeches from Kashkari, Bowman, Goolsbee and Barr.  Regarding the data, I believe it will need to be a big miss in either direction to get much market reaction.  Regarding the Fedspeak, given the consistency with which every speaker has thus far explained they lack the confidence that 2% is in view, I see very little is likely to be newsworthy.

For today, don’t look for much at all.  For the longer term, the dollar’s future depends on how much longer the Fed maintains its relative tightness, and if that spread widens because either the Fed brings hikes back on the table or other central banks cut more aggressively.  But for now, as we enter the summer, I don’t see much at all.

Good luck and good weekend
Adf

Adrift

Posted on by

Investors are biding their time
As Fedspeak continues to rhyme
It’s higher for longer
As long as growth’s stronger
Defining today’s paradigm

So, how might the narrative shift?
Are Jay and the Fed just adrift?
Next week’s CPI
If it prints too high
Might well, for the bears, be a gift

As promised on Monday, this week remains quite innocuous in terms of both market information and market movement.  There have been precious few pieces of news that have worked to alter the current situation.  The Fed speakers we have heard, when they discussed monetary policy, seem to be reading from the same text.  It can be boiled down to, the policy rate will remain at current levels until such time that something changes with respect to inflation or employment.  We will not rule out a hike, (despite the fact that Powell apparently did so last week) but are nowhere near ready to cut given the current inflation status.

With this in mind, it should be no surprise that markets remain extremely quiet.  After all, how can one change a view if nothing has changed?  So, the US story is pretty well understood for now and until CPI is released next Wednesday, I see no reason for any major movement in either equities or bonds here, and by extension elsewhere in the world.

Moving on from the US, Ueda-san continues to hint that the BOJ may do something, but last night’s Summary of Opinions from the BOJ (effectively their Minutes) almost implied, if you squint hard enough, that they could do it sometime soonish.  Clearly there is a bit of concern over the yen (-0.35%) which continues to drift back toward the levels seen when they intervened.  However, the very fact that just a week after they were aggressively selling dollars, it has pushed back to 156.00 tells you that absent a policy move, nothing is going to change.

As an aside here, this is quite important for the global economy, and certainly global markets.  Ultimately, Japanese monetary policy has been the driver of a huge amount of global liquidity flowing into asset markets around the world.  My understanding is that Japanese households also have somewhere on the order of $7 trillion in cash available to invest still at home, which historically was never a concern there given the complete absence of inflation in the country.  But now that inflation is rising there, and yields remain so paltry compared to elsewhere in the world, especially the US, if even a portion of that starts to flow more rapidly out of Japan, it will have an enormous impact everywhere.  On the flipside, Japan is also the largest international investor around, as a nation, and if the BOJ does allow rates to rise and that capital flows back home, that too would be a dramatic shift in global markets.  Ultimately, this is the reason we all care so much about what the BOJ does…it impacts us all.

The only other thing of note today is the BOE meeting where no change is expected in policy, but all will be searching for clues as to when they will cut rates.  The last vote was 8-1 to remain on hold with the lone holdout seeking a cut.  While expectations are for that to continue today, there is some discussion that a second dove may raise their hand for a cut.  It is widely accepted that cuts are the next move, and the real question is will they be following the ECB and cutting in June or wait until August.  FWIW, I expect a June cut by pretty much all the central banks other than the Fed (and of course the BOJ).  Economic activity is bumping along at effectively stagnation levels elsewhere in the G10 and inflation has been consistently softening everywhere except in the US.  While CPI is still higher than all their targets, central banks are desperate to get back to cutting rates and so will move with alacrity once they get started.

And that’s really all we have today.  Yesterday’s lackluster US session was followed up with a mixed bag in Asian equity markets (Nikkei -0.35%, Hang Seng +1.2%, CSI 300 +0.95%) and we are seeing a similar mixed picture in Europe with gainers (Germany, Switzerland) and laggards (Spain, Italy) while the rest are basically unchanged on the day.  However, at this hour (7:00), US futures are pointing a bit lower, down -0.3% across the board.

In the bond market, yesterday’s 10-year Treasury auction was met with mediocre demand and this morning yields are higher by 2bps.  There continues to be a great deal of discussion as to whether 10-year yields are going to head back above 5.0%, where they briefly touched last October as inflation reignites fears, or whether the oft mooted recession will finally arrive, and yields will tumble as the Fed cuts.  While my take is the former is more likely, at this point, there is no conclusive evidence for either view.  It should be no surprise, however, that European sovereign yields are also higher this morning, on the order of 3bps to 4bps, as they track Treasury yields closely.  Perhaps more surprising is that JGB yields rose 3bps overnight, and are now 0.91%, once again tracking toward their highs seen in October.  Clearly, there is a growing belief that the BOJ is going to do something sooner rather than later, but I will believe it when I see it.  Of course, if they do alter policy, that will change my views on many things.

In the commodity markets, oil (+0.85%) is rising again this morning and just about touching $80/bbl again. While some will say this is being driven by the Israeli incursion into Rafah, my take is this is simply the ebb and flow of a market that is in a trading range.  Since the summer of 2022, WTI has traded between $70/bbl and $90/bbl and I believe we will need to see some major changes in the situation for that to change.  Do not be surprised to see the Biden administration tap the SPR again in the lead up to the election in an effort to depress gasoline prices.  And do not be surprised to see OPEC+ cut production further if they do.  Consider this, though, if Trump is elected, there will be a major reversal in US energy policy and ‘drill baby drill’ will be back in vogue.  I suspect energy prices may decline then.

Turning to the metals markets, after a soft session yesterday, we are seeing a modest rebound led by silver (+1.3%) with gold, copper and aluminum all barely creeping higher by 0.1% or 0.2%.

Finally, the dollar cannot be held back.  As Treasury yields edge higher, the dollar is following and this morning is firmer against most of its counterparts, albeit not dramatically so.  Aside from the yen’s ongoing weakness, the pound (-0.3%) is not responding favorably to the fact that the BOE left rates on hold, and as I suspected, hinted at cuts to come with the vote coming out 7-2 as I proposed above.  Otherwise, most movement is extremely modest with one outlier, ZAR (+0.3%) rallying on the back of the metals rebound.

On the data front, this morning we see Initial (exp 210K) and Continuing (1790K) Claims and that is all she wrote.  We don’t even have any Fed speakers today, so it is shaping up as another very quiet session.  The big picture remains the same so until the Fed turns dovish, the dollar should hold its own.

Good luck
Adf

The Dollar is King

Posted on by

The Old Lady left rates on hold
But two members changed views when polled
No longer did they
See hikes as the way
The outcome was pounds were then sold

In fact, the most noteworthy thing
Is watching the dollar’s upswing
Against all its foes
Its value has rose
And once more the dollar is king

Finalizing the commentary on central bank activity this week, while the BOE did not adjust its rates, as was universally expected, the excitement came when the votes were tallied up.  As I had mentioned on Monday, at the last meeting, the split was 1/6/2 for a cut, holding steady and a hike respectively.  It remains amazing to me that members of the committee could have viewed the data and come to completely opposite conclusions in the past.  But the big change was that the two members who had been consistently voting for a hike adjusted their view to holding steady with the outcome a single vote for a cut and the rest of the committee voting to keep policy unchanged.  Of course, in the world in which we live today, that was tantamount to a rate cut and seen as quite dovish with the result being the pound underperformed its peers and continues to do so this morning, falling another -0.6%.  The developing narrative here is that a rate cut is coming soon to the UK, certainly by the June meeting, even though inflation remains far above the BOE’s target.  Yes, the inflation readings earlier this week were a bit softer than forecast, but they are still running at 4.5% at the core level.

Arguably, the more amazing thing is that the narrative around the US seems to have subtly shifted despite Powell’s quite dovish tone at the press conference.  I have seen several analyses that indicate expectations are growing for other central banks to ease policy before the Fed.  Perhaps it was the SNB’s bold action yesterday that got people thinking the rest of the world wouldn’t wait for Powell.  Or perhaps, the punditry who push the narrative are finally considering the fact that the US economy continues to be the best performing one around with the least need for further stimulus.  For instance, yesterday’s US data showed softer than expected Unemployment Claims, higher than expected Home Sales with a huge jump in the average price, better than expected Philly Fed and better than expected Flash PMI data.

Whatever the driver, analysts all over are discussing the relative hawkishness of Powell vs. his central bank brethren.  The good news is that we will get to hear from the man himself again this morning at 9:00am so perhaps he will clarify the situation.

FWIW, which is probably not that much, I remain incredulous that the Fed can even consider cutting rates in the near future.  The data are certainly indicating that economic activity remains strong, and we have seen an increase in pricing pressures discussed in a number of the surveys, like yesterday’s Philly Fed and PMI.  As long as unemployment remains quiescent, and we don’t have a major banking catastrophe it is unclear what the motivation behind cutting rates would be on an economic basis.  And consider for a moment that home prices yesterday rose 5.7%, another dagger in the heart of the idea that the shelter component of inflation measures is going to decline.  Let’s see what he says.

Until then, a look at the overnight session shows a mixed picture after yet another record setting day in US equity markets yesterday.  Japan is keeping pace, holding on to its recent gains and drifting higher but Chinese shares had a very tough time, with the Hang Seng (-2.2%) leading the way lower while mainland shares (CSI 300-1.0%) fell as well.  Throughout the rest of the region, the tale was an amalgam of gainers (India, Taiwan, New Zealand) and losers (South Korea, Australia).  In Europe, the UK (+0.8%) is the best of the bunch after posting stronger than expected Retail Sales data, although the Y/Y numbers there are still negative.  But the change was good.  However, on the continent, it is also an amalgam of gainers (Italy, Spain, Germany) and losers (France, Greece) as despite comments from Bundesbank president Nagel that a cut was coming in June, excitement remains lacking.  US futures at this hour (7:30) are essentially unchanged.

The bond market has been a bit more positive with yields sliding across the US (2bps) and all of Europe (between 1bp and 4bps) as investors prepare for the initial move by the ECB.  JGB yields are unchanged as any idea that the BOJ’s recent action was the starting signal for a rush higher in interest rates have been completely quashed.  Perhaps the one area where there is more anticipation is in China, which has seen a very consistent decline in yields for the past year with the 10-year there now sitting at 2.3%, a historic low.  However, despite that, there are many analysts looking for further policy ease by the PBOC and the potential for yields to decline even further.

Oil prices (+0.1%) while essentially unchanged this morning are consolidating losses from the past three sessions which were driven by an increase in chatter about a ceasefire in Gaza.  At the same time, we continue to see net drawdowns of inventories as reported by the EIA which is typically a sign of future strength in the price.  After a great run, gold (-0.6%) and copper (-1.0%) are both under pressure this morning, a situation I attribute entirely to the dollar’s broad strength.

Finally, turning to the dollar, OMG it is ripping higher today.  Versus its G10 counterparts, it is nearly universal with the euro (-0.4%), AUD (-0.8%) and the Scandies (SEK -0.9%, NOK -0.95%) all under pressure.  The only currency not declining is JPY, which is flat on the day but remains at its recent lows (dollar highs) well above 151.50.  in the EMG space, ZAR (-1.15%) is leading the way lower, but the real surprise is CNY (-0.8%) a huge move for a currency with 5% volatility, as it appears the PBOC has stepped away from its efforts to support the currency.  Given the huge rate differential with the dollar, by rights, we would expect USDCNY to be closer to 7.50 than its current level of 7.28, and I expect it will continue to move in that direction.  Watch carefully, especially if/when the PBOC reduces the Reserve Ratio Requirement again in the next several months.

At any rate, you get the idea that the dollar is top of the charts today, ultimately on this renewed narrative of a relatively hawkish Fed versus relatively dovish central banks elsewhere.

There is no hard (or soft) data from the US today, all the new information comes from the speakers, with Powell leading off, and then, Jefferson, Barr and Bostic.  I guess everything will depend on Powell.  Will he try to walk back some of the dovishness that was seen in the press conference or will he double down.  It appears the market expects a less dovish voice.  As such, if he doubles down on the idea rate cuts are coming soon, despite all the data, I would look for the dollar to reverse course.  However, if he tries to but the dove back into its cage, I expect risk assets to be under some pressure and the dollar to hold its gains.

Good luck and good weekend
Adf

Some Regrets

Posted on by

Six central bank meetings this week
Will give us a new inside peak
At their dedication
To wipe out inflation
And just how much havoc they’ll wreak
 
Investors have made all their bets
And so far, today, risk assets
Show green on the screen
Ere any convene
Methinks, though, there’ll be some regrets

 

It is central bank week as we hear from more than half of the G10 between tomorrow and Thursday.  The BOJ kicks things off followed by the RBA, FOMC, Norgesbank, the SNB and finally the BOE.  A great deal of stock has been put into these meetings by both traders and investors as everyone is seeking clues for the future. Alas, looking for central banks, whose crystal balls are cloudier than most, to give solid clues is probably not the best idea.  But let’s take a quick look at each meeting and expectations:

BOJ – next to the Fed, this is the meeting that has gotten the most press both because Japan is the largest of the other economies, but also because there is much talk that they are going to raise their base rate for the first time in 17 years!  At this point, despite the most recent dovish comments from Ueda-san two weeks’ ago, the best indicator seems to be Nikkei News, which has had several articles (courtesy of Weston Nakamura’s Across the Spread substack) declaring that rate hike is coming.  Apparently, they have a perfect record in these forecasts, so it looks a done deal.

Arguably, the question is will they do anything else beyond moving from NIRP to ZIRP?  There are several analysts who believe they will adjust YCC as well, either eliminating it completely, or changing the terms to buy a fixed amount each period rather than responding to market conditions.  As well, they continue to buy equity ETFs and REITs so it is quite possible they end those programs.

The funny thing is so many believed that when the BOJ finally started their tightening cycle that would be the signal for selling JGBs and buying yen.  Well, if that has been your strategy going into the meeting, it has not worked out that well.  JGB yields (-3bps) have been consolidating around the 0.75% level virtually all year while the yen, which did have a little pop higher at the beginning of the month, is now back close to 150 again.  Regarding the yen, the driver in the currency continues to be US interest rates and the incremental adjustment by the BOJ is just not enough to move the needle absent a firm commitment by Ueda-san to hike regularly going forward.  And there is no evidence of that.  As to JGB yields, a slow grind higher seems possible, but a run up above 1.0% seems highly unlikely, especially given the economic cycle has just turned down with two consecutive quarters of negative real GDP activity.

RBA – there is no policy movement anticipated here for this meeting as both growth and inflation remain above targets but have not been relatively stable.  In fact, there is a minority looking for a cut, but that seems unlikely right now simply based on the inflation data.  Generically, I find it extremely difficult to believe that any central bank will be able to cut their rates with inflation running well above the target and, in most places, looking like it has found a bottom.  I realize there is a significant desire to cut rates by virtually all central bankers, but given the current economic situation, if they want to salvage whatever credibility they may have left, it is a hard case to make to cut right now.  

One other thing to remember is that Australia is more dependent on China than any other G10 nation and China last night published better than expected economic data with IP jumping to 7.0%, far better than expected and its fastest pace in two years.  If China is starting to pick up again, that will be a net benefit for Australia and put upward pressure on commodity prices and prices in general Down Under.  I think they remain on hold for a while yet.

FOMC – suffice to say no change in rate policy but we will discuss the other features tomorrow regarding the dot plot and potential guidance.

SNB – The Swiss may be the other central bank to move this time as inflation there has fallen to 1.2%, well below the ceiling of their 0% – 2% target range.  While the market consensus remains no change and the franc has softened nearly 4% vs. the euro so far this year, we cannot forget that it remains far stronger than its historic levels and the opportunity to weaken the currency a bit to help its export industries while inflation remains quiescent is something that may appeal to SNB President Jordan.  Keep an eye out here.

Norgesbank – No change here as inflation remains far too firm, ~5%, while oil’s recent rebound has helped the currency rebound.  I don’t think there is anything to be learned from this outcome.

BOE – Here, too, no change is expected and there is no press conference.  As such, the most interesting question will be the vote split.  Last time, the split was 1-6-2 for a cut, hold and hike respectively.  (Talk about not seeing things the same way!  How is it possible that two committee members can look at the same data and believe opposite conclusions?  Seems there is some ideology in play there.). At any rate, a change in the vote count will be a signal.  Recent data has shown that wages are still hot, but slowing down, while inflation is similarly hot but slowing.  The latest CPI data will be released on Wednesday so the BOE will have that to account for as well as everything else.  At this point, I’m in the no move camp with the same split of votes the outcome.

With that recap, let’s look at the overnight session briefly.  As mentioned above, equities are green everywhere with the Nikkei (+2.7%) leading the way around the world and pushing back close to the key 40K level.  But there was strength in every market in Asia.  Europe, too, is all green, albeit less impressively, with gains on the order of 0.25% while US futures are looking good at this hour (7:45) with the NASDAQ leading the way, up 1.0%.  (Here, many are counting on more amazing news from Nvidia as they have a weeklong conference starting today.)

After last week’s rush higher in yields on the strength of the hotter inflation prints from the US, this morning is seeing very little movement overall ahead of the central bank meetings this week.  Basically, every market is within 1bp of Friday’s closing levels, with a few higher and others lower.  One other thing I failed to mention was the PBOC will be revealing their 5-year Loan Prime Rate on Tuesday night, and while no change is forecast, it was last month when they cut this to help the property market that kicked off the idea more stimulus was coming.

Oil prices continue to perform well on the back of several different factors.  First, we have seen inventory draws much greater than expected in the US.  At the same time, Ukraine has damaged several Russian refineries thus reducing the supply of products and we still have OPEC+ maintaining their production restrictions.  Add to this China’s apparent rebounding growth supporting demand and that is a recipe for higher prices.  As to the metals markets, despite the dollar’s recent rebound, gold continues to hold its own and copper is still rising consistently.  In fact, the red metal is higher by 5% in the past week, a potential harbinger of better global growth.

Finally, the dollar is a touch softer this morning, but only a touch.  The biggest mover is ZAR (-0.6%) which is opposite the broader trend of very slight dollar weakness.  While South African equities have been drifting lower of late, today’s move feels more like an order in the market than a fundamental change.  Away from that, though, no currency of note has moved more than 0.2% on the day as traders await the onslaught of central bank news.

Speaking of news, we have other things beyond the central banks as follows:

TuesdayHousing Starts1.43M
 Building Permits1.50M
ThursdayInitial Claims216K
 Continuing Claims1815K
 Philly Fed-2.5
 Current Account-$209.5B
 Existing Home Sales3.95M
 Flash PMI Manufacturing51.7
 Flash PMI Services52.0
Source: tradingeconomics.com

In addition, starting Thursday, the first Fed speakers will be back on the tape to reinforce whatever message Chair Powell articulates on Wednesday.

From my vantage point, it appears that the BOJ’s rate hike has been accepted and priced in already, while the biggest surprise could be Switzerland.  However, the fate of the dollar lies in the hands of Powell, and that is an open question we will discuss tomorrow.  For today, don’t look for too much of anything in any market.

Good luck

Adf

Finally Dead

Posted on by

It’s been, now, two weeks since the Fed
Said rate cuts were not straight ahead
Their confidence lacked
Support to abstract
Inflation was finally dead
 
Which brings us now to CPI
Where analysts identify
Used cars and soft gas
As just ‘nuff to pass
The test and wave ‘flation bye-bye

 

Finally, the CPI report will be released this morning so we will be able to collectively exhale!  The current consensus forecasts are for a 0.2% M/M rise in the headline, leading to a 2.9% Y/Y outcome and a 0.3% M/M rise in the ex-food & energy reading leading to a 3.7% Y/Y increase.  Those annual numbers would be down from 3.4% and 3.9% respectively.

A key part of the thesis for the ongoing decline is that Used Car prices will continue to fall as well as gasoline prices, which fell about 30 cents/gallon on the NYMEX exchange.  However, rent increases remain stubbornly high and any declines in foodstuffs seem to have ended.  There was a ‘brilliant’ article by a UC Berkeley economist, Ulrike Malmendier, that determined most people’s view of inflation was skewed by the prices of things they bought most frequently, rather than the ‘proper’ economists’ view of the totality of prices.  Who would have thunk it?  Honestly, it is hard to believe that some of these people have degrees at all.

At any rate, the market is highly fixated on the number and there is no doubt that many are looking for a soft outcome and, perhaps, sufficient proof for the Fed to gain enough confidence to cut rates in March.  As it stands, right now the Fed funds futures market is pricing a 15.5% probability of a March cut and a 57.5% probability of a May cut.  But the pining for this cut is palpable.  I will reiterate my view that based on the current trajectory of economic data, there is no reason for the Fed to cut at all absent a major downturn.  Clearly, given the government’s ongoing fiscal largesse, economic activity continues to move along.  While price rises have been slowing over time, I would contend there is no risk of a major deflationary event.  

The flip side of this argument is that the Federal government cannot afford to continue with interest rates this high.  Much has been made of the fact that interest payments on the Federal debt are now in excess of $1 trillion per annum, more than either defense spending or Medicare, and trending inexorably higher.  While they remain <5% of GDP, the fact that the government is running a budget deficit of >7% of GDP and slated to do so for the foreseeable future, there will come a time when this process will be unsustainable.  However, as Japan has proven over the past twenty years, things previously thought impossible are not necessarily so if the population tolerates them.  Right now, the major financial problem for the government is not the deficit, but inflation.  So that is where the attention is focused.  Eventually, something will have to give, but it is not clear that will occur within the next several political cycles, and ultimately, that’s the only time things like this will be addressed.  So, look for more of the same for now.

Turning back to markets, ahead of the CPI report, most markets around the world have remained quiet, with one notable exception, Japanese equities which have continued their impressive rally.  After a mixed and lackluster session yesterday in the US, the Nikkei rose nearly 3.0% overnight as the ongoing yen weakness and a growing suspicion that the BOJ is not going to act anytime soon continues to support things there. Chinese markets remain closed all week for the New Year holiday but the rest of the APAC markets had solid sessions.  European bourses, however, are under some pressure this morning with all of them lower by between -0.3% and -0.6%.  The data from the UK showed that the employment situation was better than expected, with lower Unemployment and firmer wage growth.  This will not encourage the BOE to consider cutting rates anytime soon.  As to US futures, at this hour (7:45) they are somewhat lower with the NASDAQ (-0.75%) leading the way down.

Meanwhile, in the bond market, yields have edged lower everywhere except the UK (+2bps and see employment data for explanation) as Treasuries (-2bps) show the way and most of Europe has followed directly in its footsteps with similar yield declines.  Interestingly, JGB yields were unchanged overnight despite the equity rally and yen weakness.

Oil prices (+0.75%) are bouncing this morning as any hopes of a ceasefire in the Middle East have faded for now but we are also seeing broad-based strength across the metals markets with gold (+0.4%), copper (+0.75%) and aluminum (+0.3%) all finding support this morning.  Perhaps this is on the back of dollar weakness in anticipation of a cool CPI print.

Speaking of the dollar, it is broadly softer, albeit not dramatically so.  GBP (+0.4%) is the leading G10 currency although CHF (-0.4%) has fallen on the back of a much lower than expected CPI reading there, just 1.3% Y/Y, with market participants now looking for rate cuts sooner rather than later.  In the EMG bloc, things are mixed although there are more gainers than laggards with ZAR (+0.5%) the leader of the pack on those strong metals prices.

Looking at this week’s data beyond today shows the following:

ThursdayInitial Claims220K
 Continuing Claims1880K
 Retail Sales-0.1%
 -ex autos0.2%
 Empire State Manufacturing-15
 Philly Fed-8
 IP0.3%
 Capacity Utilization78.8%
 Business Inventories0.4%
FridayPPI0.1% (0.6% Y/Y)
 Ex Food & energy0.1% (1.6% Y/Y)
 Housing Starts1.46M
 Building Permits1.509M
 Michigan Sentiment80.0

Source: tradingeconomics.com

As well, today we already saw the NFIB Small Business Optimism Index show a little less optimism printing at 89.9, down 2 points from last month.  Of course, things would not be complete without a bit more Fedspeak, with 6 more on the calendar including Governor Waller, perhaps the 3rd most important voice there.

Overall, while I don’t think the rate of inflation has much further to fall, and in fact, I expect it to rise again as the spring and summer progress, today’s number feels like it could be soft.  Here’s the thing, the market is anticipating that soft number so it is not clear to me how much further they can drive risk assets higher on this news.  They need something new.  However, if it is hot, look for a sharp down day in risk assets and higher yields and a higher dollar.

Good luck

Adf

Sufficiently

Posted on by 
Said Madame Lagarde, I don’t care

‘Bout dovishness seen over there

Though I’m not omniscient

We need rates sufficient-

Ly high til inflation is rare



The Old Lady’s governor, too

Expressed that no cuts were in view

But can both withstand

More slowing than planned

And, with their tough talk, follow through?

A little housekeeping to start this morning.  Today will be the last poetry until January 2nd when I will publish my ‘crystal ball’ viewings in a long-form poem.  For all my readers, thank you for reading and have a wonderful Christmas, Hannukah (I know it’s’ over), Kwanzaa, Festivus or whichever holiday is important as well as let’s hope 2024 is a fantastic new year.

So, let us review yesterday’s activity, and then, more broadly, the state of things as we come to the end of the year.

Arguably, the biggest news yesterday was not that the ECB left rates on hold, which was universally expected, but that Madame Lagarde tried very hard to continue to sound hawkish despite the Fed’s turn on Wednesday.  “Based on its current assessment, the Governing Council considers that the key ECB interest rates are at levels that, maintained for a sufficiently long duration, will make a substantial contribution to this goal. The Governing Council’s future decisions will ensure that its policy rates will be set at sufficiently restrictive levels for as long as necessary.” [emphasis added.]

As well, she explicitly mentioned that there was no discussion of interest rate cuts in the meeting.  The hawks on the committee managed to get a bone thrown their way with the announcement of a phased exit from the PEPP program starting in the second half of next year.  At the same time, their staff projections for GDP growth and inflation were all reduced slightly for 2024 and 2025 with low numbers penciled in for 2026.  She maintained that inflation has been “too high for too long”, clearly true, and has been unwilling to consider anything but their inflation fight.

Alas, this morning’s Flash PMI data releases make ugly reading with French, German and the Eurozone overall reading weaker than last month and weaker than expected.  The Eurozone growth engine has been stalling for quite a while despite falling energy costs.  And now, in the wake of the Fed turning dovish, energy costs are rebounding which will almost certainly negatively impact the continent’s growth trajectory.  Maybe Lagarde can hold out for another month, but I suspect if the data continues to erode in the manner, it has recently, the ECB will recognize that the worst is over and it’s time to alter policy, just like the Fed has done. As well, given the economy in Europe is in far worse shape than here in the US, I expect that they will be cutting more quickly as 2024 progresses.  That will not help the euro, but that is a story for some time next year, not for the remainder of this one.

At almost the same time, the BOE also maintained their policy rate and also indicated that they were not anywhere near ready to cut rates.  In fact, 3 voters wanted a 25bp rate hike, which given inflation in the UK is the highest in the western world, with core still at 5.7%, makes sense.  But, as on the continent, economic activity continues to stumble along, with manufacturing, according to this morning’s Flash PMI reading of 46.4 in recession although Services activity, 52.7 does seem to be rebounding.  However, here, too, I believe the gravitational pull of a dovish Fed is going to quickly weigh on the BOE and we are going to see a pivot in the first half of next year amid weaker growth and slowing inflation.

One final note from yesterday was that Retail Sales were a bit stronger than expected, rising 0.3% and failing to show the slowdown that would be expected to help reduce inflationary pressures.  And just think, that was before the Fed pivot, which has ignited a massive risk-on rally in assets and likely will juice things even more in the short-term.

The result of these policy decisions is that stocks are rallying pretty much everywhere in the world, bonds are rallying pretty much everywhere in the world, commodities prices are rallying, and the dollar is falling.  Not only that, I see nothing that is likely to change those views until somewhere toward the end of Q1 2024 at the earliest.

But let’s step back for a moment and consider the medium-term impacts of all this change.  Remember this, a soft-landing is merely the last stop in the cycle before a hard landing.  The soft-landing narrative is clearly the majority view and driving force in markets as 2023 comes to a close.  But is that a realistic outcome?  

I think a very strong case can be made that we have seen the bulk of the disinflationary forces that are coming as the combination of Covid driven supply chain issues being fixed and higher interest rates / QT has weighed on marginal demand.  It has been a fun story while it lasted and has certainly cheered markets.

But structural issues remain, many of which are outside any central bank’s abilities to address adequately.  Consider what I believe is the biggest structural change, the turn from capital-focused economic policies to labor focused economic policies.  This is inherently inflationary and regardless of what Powell or Lagarde or Ueda or anyone in that chair does, this change is going to continue.  It is a political change, and one that is only getting started.  Politically, we call it populism, and one need only read the papers to recognize this is the new world.

For 40 years, since the Reagan/Thatcher leadership, the world has seen low inflation from a combination of demographics and globalization creating downward pressure on wages and reduced taxation increasing the return on capital.  This led to the financialization of western, especially the US, economies and expanded the wealth/income gaps that are prevalent around the world today.  

But this is changing, and changing far more rapidly than the current governments in power would like to see or believe.  As I wrote earlier, 2016 was a test run for what is looming in 2024.  Consider the populist views of recent election outcomes in Argentina and the Netherlands as well as the rise in the polls of the National Front in France, AfD in Germany, and the strength of both Trump and RFK Jr in the US, with populism as the driving force.  2023 saw more labor unrest in the US than any time in the past 20 years and harkens back to conditions in the 60’s and 70’s.  The big difference between now and then is that union membership has declined so dramatically in the interim.  Do not be surprised to see unions rise again in popularity.

But populism drives more than labor unrest, and ultimately rising wages, it also encourages governments to consider trade barriers and tariffs, both of which drive consumer prices higher.  And populism is very easy for governments to adopt because it sounds so good.  Consider the key tenets; buy domestic goods, limit immigration and tax the rich so they pay their fair share.  We will hear some version of these policies in every country around the world in 2024, and not just western nations, but communist bloc countries as well.  

If this is the future, and I believe it is, then the current risk rally is merely a hiatus before things turn much worse.  In a populist driven society, profit margins are going to decline, and capital will flee to where it feels safest.  That may be whichever nations push back against this trend, although they will be few and far between, and things like real assets, commodities, and real estate.  While I believe this will be the general trend, from an FX perspective, given everything is relative there, strength or weakness will depend on the relative decisions made in each nation.  Arguably, the less populist the decision outcomes, the stronger the currency, but ex ante, there is no way to know how that will turn out.  If I had to bet now, I would suggest that the nation least susceptible to this wave is Japan, a truly homogenous society, and that bodes well for the yen going forward.

In the meantime, as I head off, here are today’s data points with Empire State Manufacturing just released at a much worse than expected -14.5.  We are due to see IP (exp 0.3%), Capacity Utilization (79.1%), and the Flash PMI’s (Mfg 49.3, Services 50.6).  Through the rest of the month, the most important data point will be the PCE data on the 22nd, but arguably, Powell already told us it is not going to be hot, that’s why he turned away from higher for longer.

Today is triple witching in the equity markets, with stock options, future options and futures all expiring, so volume should be high and movement can be surprising.  But the trend right now is positive for risk assets, and I believe that will continue through the holidays and into January.

Good luck, good weekend and have a wonderful holiday

Adf

Miles Off Base

Posted on by 
This poet was miles off base

As Powell, more growth, wants to chase

So, hawks have been shot

With nary a thought

While doves snap all stocks up apace.



It seems clear that Jay and the Fed

Decided inflation is dead

Through Q1 at least

Bulls will have a feast

Though after, take care where you tread

It turns out that not only were my tail risk ideas wrong, I was on the wrong side of the distribution!  Powell has decided that the soft-landing narrative is the best estimator of the future and wants to make sure the Fed is not responsible for a recession.  Concerns over inflation, while weakly voiced, have clearly dissipated within the Eccles Building.  I hope they are right.  I fear they are not.

In fairness, once again, yesterday I heard a very convincing argument that inflation was not only going to decline back to the Fed’s target of 2.0%, but it would have a 1 handle or lower by the middle of 2024 based on the weakening credit impulse that we have seen over the past 18 months.  And maybe it will.  But, while there is no question that money supply has been shrinking slowly of late, which has been a key part of that weakening credit impulse story, as can be seen from the chart below based on FRED data from the St Louis Fed, compared to the pace of M2 growth for decades, there are still an extra $3 trillion or so floating around the economy.  Iit seems to me prices will have a hard time falling with that much extra cash around.

Of course, there is one other place that money may find a home, and that is in financial assets.  So, perhaps the outcome will be a repeat of the post-GFC economy, with lackluster growth, and lots of money chasing financial assets while investors lever up to increase returns.  My guess is that almost every finance official in the world would take that situation in a heartbeat, slow growth, low inflation and rising asset prices.  The problem is that series of events cannot last forever.  As is usually the case with any negative outcome, the worst problems come from the leverage, not the idea.  When things are moving in one’s favor, leverage is fantastic.  But when they reverse, not so much.

A little data is in order here.  According to Statista, current global GDP is ~$103 trillion in current USD, current global stock market capitalization is ~$108 trillion, and the total amount of current global debt is ~$307 trillion according to the WEF.  In a broad view, the current debt/equity ratio is about 3:1 and the current debt/sales ratio is the same.  While this is not a perfect analogy, usually a debt/equity ratio of 3.0 is considered pretty high and a company that runs that level of debt would be considered quite risky.  Now, ask yourself this, if economic activity only generates $108 trillion, how will that >$300 trillion of debt ever be repaid?  The most likely answer is, it never will be repaid, at least not on a real basis.

If you wonder why central bankers favor lower interest rates, this is the primary reason.  However, at some point, there is going to be more discrimination between to whom lenders are willing to lend and who will be left out because they are either too risky, or the interest rate demanded will be too high to tolerate.  When considering these facts, it becomes much easier to understand the central bank desire to get back to the post-GFC world, doesn’t it?  And so, I would contend that Chairman Powell has just forfeited his efforts to be St Jerome, inflation slayer. 

The implication of this policy shift, and I would definitely call this a policy shift, is that the near future seems likely to see higher equity prices, higher commodity prices, higher inflation, first higher, then lower bond prices and a weaker dollar.  The one thing that can prevent the inflation outcome would be a significant uptick in productivity.  While last quarter we did see a terrific number there, +5.2%, the long-term average productivity growth, since 1948 is 2.1%.  Since the GFC, that number has fallen to 1.5%.  We will need to see a lot more productivity growth to keep goldilocks alive.  I hope AI is everything the hype claims!

Today, Madame Christine Lagarde

And friends are all partying hard

Now that Jay’s explained

Inflation’s restrained

And rate cuts are in the vanguard



This means that the ECB can

Lay out a new rate cutting plan

The doves are in flight

Which ought to ignite

A rally from Stuttgart to Cannes

Let’s turn to the ECB and BOE, as they are this morning’s big news, although, are they really big news anymore?  Both these central banks have been wrestling with the same thing as the Fed, inflation running far higher than target, although they have had the additional problem of a much weaker economic growth backdrop.  As long as the Fed was tightening policy, they knew that they could do so as well without having an excessively negative impact on their respective economies.  But given that pretty much all of Europe is already in recession, and the UK is on the verge, their preference would be to cut rates as soon as possible.  

But yesterday changed everything.  Powell’s bet on goldilocks has already been felt across European markets, with rallies in both equity and bond markets in every country.  The door is clearly wide open for Lagarde and Bailey to both be far more dovish than was anticipated before the FOMC meeting.  And you can be sure that both will be so.  While there will be no rate cuts in either London or Frankfurt today, they will be coming soon, likely early next year.  

At this point, the real question is which central bank will be cutting rates faster and further, not if they will be cutting them at all.  My money is on the ECB as there is a much larger contingent of doves there and the fact that Germany and northern European nations are already in recession means that the hawks there will be more inclined to go along for the ride.  Regardless, given the Fed has now reset the central bank tone to; policy ease is ok, look for it to happen everywhere.

Right now, this is all that matters.  Yesterday’s PPI data was soft, just adding fuel to the fire.  Inflation data that was released this morning in Sweden and Spain saw softer numbers and while Retail Sales (exp -0.1%, ex autos -0.1%) are due this morning along with initial Claims (220K), none of this is going to have a market impact unless it helps stoke the fire.  Any contra news will be ignored.

Before closing, there are two things I would note that are outliers here.  First, Japanese equity markets bucked the rally trend, with the Nikkei sliding -0.7% and the TOPIX even more (-1.4%) as they could not overcome the > 2% decline in USDJPY yesterday and the further 1% move overnight.  That very strong yen is clearly going to weigh on Japanese corporate profitability.  The other thing is that there is one country that is not all-in on the end of inflation, Norway.  This morning, in the wake of the Fed’s reversing course, the Norges Bank raisedrates by 25bps in a total surprise to the markets.  This has pushed the krone higher by a further 2.3% this morning and nearly 4% since the FOMC meeting.  

As we head toward the Christmas holidays and the beginning of a new year, it seems like the early going will be quite positive for risk assets and quite negative for the dollar.  Keep that in mind as you consider your hedging activities for 2024.

Good luck

adf

The Doves Will Be Shot

Posted on by 





Inflation was just a touch hot

And certainly more than Jay sought

So, later today

What will the Fed say?

My sense is the doves will be shot



Instead, as Jay’s made manifest

Inflation is quite a tough test

So, higher for longer

Or language much stronger

Is like what he’ll say when he’s pressed






Let’s think a little outside of the box this morning, at least from the perspective of virtually every pundit and their beliefs about what will happen at the FOMC meeting today.  At this point, most of the punditry seems to believe that Powell cannot be very much more hawkish, especially since the market is expecting comments like inflation is still too high and the Fed will achieve their goal.  So, there is a growing camp that thinks any surprise can only be dovish, since if he doesn’t push back hard enough or talk about loosening financial conditions being a concern, the equity market response will be BUY STONKS!!!





But what if, the thing Powell really wants, or perhaps more accurately needs, is not a soft landing, but a full-blown recession!  Think about it.  As I have written repeatedly, the idea that the Fed will cut rates by 125bps next year because growth is at 1.5% or 2.0% and inflation has slipped to 2.5% seems like quite an overreaction.  But given the current US debt situation ($34 trillion and counting) and the fact that the cost of carrying that debt is rising all the time, what would get the Fed to really cut rates?  And the only thing that can do it is a full-blown, multiple quarters of negative GDP growth, rising Unemployment Rate, recession.  If come February or March, we start seeing negative NFP numbers, and further layoff announcements as well as declining Retail Sales and production data, that would get the Fed to act. 





At least initially, we would likely see inflation slide as well, and with that trend plus definitive weakness in the economy, it would open the door for some real interest rate cuts, 400bps in 100bp increments if necessary. Now, wouldn’t that take a huge amount of pressure off Treasury with respect to their refi costs?  And wouldn’t that encourage accounts all over the world to buy Treasuries so there would be no supply issues?  All I’m saying is that we cannot rule out that Powell’s master plan to cut rates is to drive the economy into a ditch as quickly as possible so he can get to it.  In fact, it would open the door to restart QE as well.





This is not to say that this is what is going to happen, just that it is not impossible, and I would contend is not on anyone’s bingo card.  Now, Powell will never say this out loud, but it doesn’t mean it is not the driving force of his actions.  Powell is incredibly concerned with his legacy, and he has made abundantly clear that he will not allow his legacy to be the second coming of Arthur Burns.  Instead, he has his sights on the second coming of Paul Volcker, the man who killed the 1970s inflation dragon.  St Jerome Powell, inflation slayer, is what he wants as his epitaph.  And causing a recession to kill inflation and then cut rates is a very clever, non-consensus solution.





How will we be able to tell if I’m completely nuts or if there is a hint of truth to this?  It will all depend on just how hard he pushes back on the current narrative.  Yesterday’s CPI results could best be described as ‘sticky’, not rebounding but certainly not declining further.  Shelter costs continue apace at nearly 6% Y/Y and have done so for more than 2 years.  I was amused this morning by a chart on Twitter (I refuse to call it X) that showed CPI less shelter rose at just 1.4% with the implication that the Fed needs to start cutting rates right away.  The problem with that mindset is that shelter is something we all pay, and there is scant evidence that housing markets are collapsing.  In fact, according to the Case Shiller index, they are rising again.  I would contend that there is plenty of evidence to which Powell can point that makes his case for an economy that is still running far too hot to allow inflation to slide back to their target.  And that’s what I expect to hear this afternoon.





Speaking of recession, let us consider the situation in China, where despite the CCP’s annual work conference just concluding with some talk of building a “modern industrial system” the number one goal this year, thus boosting domestic demand, they announced exactly zero stimulus measures to help the process.  Data from China overnight showed that their monthly financing numbers were all quite disappointing compared to expectations and the upshot was a further decline in Chinese and Hong Kong equity markets.  This ongoing economic weakness and the lack of Xi’s ability or willingness to address it continues to speak to my thesis that commodity prices will remain on the back foot.  If you combine the high interest rate structure in the G10 with a weaker Chinese economy, the direction of travel for energy and base metals is likely to be lower.  The one exception here is Uranium, where there is an absolute shortage of available stocks and a renewed commitment around the world to build more nuclear power plants.





At the same time, Europe remains pretty sick as well, with Germany leading the entire continent into recession, and likely dragging the UK with it.  Germany, France, Norway, the UK and others are all sliding into negative growth outcomes.  While Chairman Powell will continue to push back on the idea of rate cuts soon, I expect that tomorrow, when both the ECB and BOE meet, they will open the door to rate cuts early next year.  Inflation in both places has been falling sharply and there is no evidence that Madame Lagarde or Governor Bailey is seeking to be the next Paul Volcker.  Both will blink with the result that both the euro and the pound should feel pressure.





Summing it all up, today I think we get maximum hawkishness from the Fed with Powell pushing back hard on the market pricing.  Initially, at least, I expect we could see yields rise a bit and stocks sell off while the dollar continues its overnight rise.  But I also know that there are far too many people invested in the idea that the Fed must cut soon, and they will be back shortly, buying that dip until they are definitively proven wrong.  





As to the rest of the overnight session, aside from China’s weak performance, South Korea also lagged, but the rest of the APAC region saw modest gains.  Europe, meanwhile, is all green, although it is a very pale green with gains on the order of 0.2%, so no great shakes.  Finally, US futures are firmer by 0.1% at this hour (7:15) after yesterday’s decent gains.





Bond yields are sliding this morning, down 2bps in the US and falling further in Europe with declines of between -3bps and -6bps on the continent as investors and traders there start to price in a more aggressive downward path for interest rates by the ECB.  UK yields are really soft, -9bps, after GDP data this morning was disappointing across the board, especially the manufacturing data.





Oil prices (+0.45%) which got slaughtered yesterday, falling nearly 4%, are stabilizing this morning, as are gold prices, which fell yesterday, but not quite as much as oil.  However, the base metals complex continues to feel the pressure of weak Chinese demand.  I continue to believe that there are structural supply issues, but right now, the macro view of weak economic activity is the main driver, and it is driving prices lower.





Finally, the dollar is firmer this morning as weakness elsewhere in the world leaves fewer choices for where to park funds.  While the movement has not been overly large, it is quite uniform across both G10 and EMG currencies.  The laggards have been NZD (-0.6%) after a softer than expected CPI reading and ZAR (-0.6%) on the back of weakening metals prices.  If I am correct about the path going forward, the dollar should perform well right up until the Fed responds to much weaker economic activity and starts to cut rates aggressively.  At that point, we can see a much sharper decline in the greenback.





Ahead of the FOMC meeting, this morning we get November PPI (exp 1.0%, 2.2% core) which would represent a small decline from last month’s data.  We will also see the EIA oil inventory data, which has shown a recent history of builds helping to drive the oversupply narrative there.





At this point, it is all up to Jay.  I suspect that markets will be quiet until then, and it will all depend on the statement, the dot plot and the presser.





Good luck





Adf

			

	
	



				
					


	

		

			The New Allegory
		


				

			Posted on  by 		

			


		

		

On Friday, the data surprised

With job growth more than advertised

So, bonds took a bath

And stocks strode a path

Where growth is what’s now emphasized



But what of the soft landing story?

Will rate cuts now be dilatory?

If Jay just stands pat

Will stocks all go splat?

Or is this the new allegory?






Well, this poet was clearly wrong-footed by Friday’s employment report where not only were non-farm payrolls stronger than anticipated at 199K, but hours worked rose and the Unemployment Rate fell 2 ticks to 3.7%.  While revisions to previous reports were lower, as they have been all year, the report did not point to an imminent slowing of the economy nor a recession in the near-term.  Arguably, the soft-landing crowd made out best, as equity markets, which initially plunged on the report following Treasury prices, rebounded as investors decided that growth is a better outcome than not.  Yields jumped higher, as would be expected, rising 8bps in the US with larger gains throughout Europe before they went home for the weekend.  And finally, the dollar flexed its muscles again, rallying universally with gains against 9 of the G10 currencies, averaging 0.4% (only CAD (+0.1%) managed to hold its own) and against most of the EMG bloc with a notable decline by ZAR (-1.1%), although MXN (+0.6%) bucked the trend.





Does this mean the soft landing is coming?  As we start the last real data intensive week of 2023, it remains the favored narrative, but is by no means assured.  After all, before the end of this week we will have seen the latest CPI reading in the US (exp 3.1% headline, 4.0% core) and we will have heard from the FOMC, ECB and BOE as well as several smaller central banks like the Norgesbank and the SNB.  And let us not forget that the BOJ meets next Monday.  So, there is plenty of new, important information that is coming soon and will almost certainly drive potential narrative changes.





Perhaps an important part of the discussion is to define what we mean by a soft landing, or at least what the ‘market’ means by the concept.  My best understanding is as follows: GDP slides to 1% or so, but never goes negative.  Unemployment may edge higher than 4.0%, but only just, with a cap at the 4.2% or 4.3% area, and inflation, as measured by Core PCE finds a home between 2.0% and 2.5%.  This result, measured inflation falling back close to target while the growth and employment story just wobbled a bit, would be nirvana for Powell and friends.  





How likely is this outcome?  Ultimately, history is not on their side as arguably the only time the Fed ‘engineered’ a soft landing was in 1995, and on an analogous basis they had already started cutting rates by this time in the cycle.  The fact that we are still discussing higher for longer implies that there is much more pain likely to come than the optimists believe.  We have already seen the first signs of trouble as the number of bankruptcies soar and stories about non-investment grade companies needing to refinance their debt at much higher interest rates than the previous round fill the news.  Certainly, Friday’s employment data is encouraging for the economic situation, but the chink in the armor was the wage data which showed more resilience (+0.4%) than expected.  Given the Fed’s focus on wages and their impact on inflation, the fact that wage growth remains well above the levels the Fed deems appropriate to meet their inflation target is not a sign that policy ease is coming soon.





And ultimately, I believe that is the critical feature here.  The economy has held in remarkably well considering the pace and size of the interest rate changes we have already seen.  The big unknown is how much of that interest rate change has really been felt by the economy.  Obviously, the housing market has felt the impact, and to some extent the auto industry, but otherwise, it is not as clear.  Do not be surprised if this period of slow economic activity extends for a much longer time than in the past as the drip of companies that find themselves unable to refinance at affordable rates slowly grows.  By 2025, about $1 trillion of corporate debt that was issued at much lower interest rates will need to be refinanced.  I’m not worried about Apple refinancing their debt, but all the high-yield debt that was snapped up with a 4% or 5% handle during the period of ZIRP will now be at 10% or so and it is an open question if those business models will be functional with financing that expensive.  





So, perhaps, the story will be as follows:  economic activity is going to muddle along at low rates for an extended period, another 2 or 3 quarters, until such time as the debt ‘time-bomb’ explodes with refinancing rates high enough to force many more bankruptcies and start a more aggressive recessionary cycle with layoffs leading to rapidly rising Unemployment rates and economic activity falling more sharply.  In this timeline, we are talking about the recession becoming clear in Q3 of 2024, a time when most of that $1 trillion of corporate debt will be current.    While interest rates will certainly be slashed at some point, this does not bode well for risk assets in the second half of 2024.  For now, though, it certainly seems like the current narrative is going to continue.





There’s no urgency

To change policy quite yet

But…some day we will






A quick story about the BOJ which last night pushed back firmly against the growing narrative that they were about to start normalizing interest rate policy with a rate hike in either December or January.  Instead, several stories were released that described the recent decline in both GDP and inflation as critical and the fact that they still don’t have enough information with respect to wages in Japan, given the big spring wage negotiation has not yet happened, to make a decision.  In other words, the BOJ was successful at convincing markets to behave as the BOJ wants, not as the rest of the world wants.  The upshot was that the yen weakened sharply (-0.9%) while the Nikkei rose 1.5% and JGB yields were unchanged.  The BOJ pivot remains one of the biggest themes in the macro community, mostly because it is seen as the place where the largest profits can be made by traders.  But my experience (4 years working for a Japanese bank) helps inform my view that whatever they do will take MUCH longer to happen than the optimists believe.





Ok, let’s try a quick trip around markets here for today.  Aside from Japan, most of Asia had a good equity session with Hong Kong (-0.8%) the only real laggard.  Remember, a key story there remains the Chinese property sector as many of those firms are listed in HK.  Meanwhile, European bourses are mixed although movements haven’t been very large in either direction.  The worst situation is the UK (FTSE 100 -0.5%), while we are seeing some gains in the CAC and DAX, albeit small gains.  Finally, US futures are pointing a bit lower, -0.2%, at this hour (7:45).





In the bond market, after Friday’s dramatic price action, Treasury yields are continuing to rise, up 5bps this morning, although European sovereign yields are little changed on the day, with the bulk of them slipping about 1bp.  Given most saw quite large moves on Friday, and given the imminent policy decisions by the big 3 central banks, I suspect traders are going to be quiet for now.  





Oil prices (-0.3%) are slipping slightly this morning but are mostly consolidating Friday’s gains.  On the metals front, though, everything is red with gold, silver, copper and aluminum all under pressure.  Again, this is the one market that has been pricing a recession consistently for the past several months while certainly equity markets have a completely different view.





Finally, the dollar is continuing to rebound on the strength of rising Treasury yields.  While the euro is little changed on the day, the yen is driving price action in Asia with weakness also seen in CNY, KRW and TWD.  As well, ZAR (-0.8%) continues to suffer on weaker commodity pricing and both MXN and BRL are under pressure leading the LATAM bloc lower.  At this point, I would say the FX market has more faith in Powell’s higher for longer mantra than some other markets.





As mentioned, there is a lot of data this week:





TodayNY Fed Inflation Expectations3.8%
TuesdayNFIB Small Biz Optimism90.9
 CPI0.0% (3.1% Y/Y)
 -ex food & energy0.3% (4.0% Y/Y)
WednesdayPPI0.1% (1.0% Y/Y)
 -ex food & energy0.2% (2.3% Y/Y)
 FOMC Rate Decision5.5% (unchanged)
ThursdayECB Rate Decision4.5% (unchanged)
 BOE Rate Decision5.25% (unchanged)
 Retail Sales-0.1%
 -ex autos-0.1%
 Initial Claims221K
 Continuing Claims1891K
FridayEmpire State Manufacturing2.0
 IP0.3%
 Capacity Utilization79.2%
 Flash PMI Manufacturing49.1
 Flash PMI Services50.5





Source tradingeconomics.com





Thursday also has the Norges Bank and SNB, both of whom are expected to leave rates on hold.  For today, it strikes me that the discussion will continue as pundits try to anticipate what the FOMC statement will say and how Powell sounds in the press conference.  As such, it is hard to get excited that there is going to be a big move in either direction.  With all that in mind, my overall read on the economy is that while we may muddle along in the US for a while yet, it will be better than many other places in the world, notably the EU, the UK and China, and so the dollar is likely to hold up far better than most expect…at least until Powell changes his tune.





Good luck





Adf