Tag Archives: #BOJ

Numb

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It seems that nobody is willing
To trade, ere Nvidia’s spilling
The beans on their income
So, markets remain numb
Awaiting an outcome, fulfilling

 

Some days it is extremely difficult to find a noteworthy story at all, and today is one of those days.  The combination of a lack of new economic data on which to build theories and models, along with most of the central banking community taking their summer vacations has left the trading and investment communities without any new catalysts for action.  Arguably, the story that will soon drive things is this afternoon’s Nvidia earnings report, but that is far outside this poet’s lane of travel.  With this in mind, it should be no surprise that market movement overnight has been quite limited.

Perhaps the most interesting story was a speech given by BOJ Deputy Governor Ryozo Himino (the Japanese don’t typically take off all of August) describing that the BOJ would continue to “normalize” policy, albeit at an indeterminate rate.  Speaking in Yamanashi prefecture, west of Tokyo, he said [emphasis added], “The bank’s basic stance on the future conduct of monetary policy is that it will examine the impact of market developments and the July rate hike and that, if it has growing confidence that its outlook for economic activity and prices will be realized, it will adjust the degree of monetary accommodation.”  You will not be surprised after a ‘powerful’ statement like that, the Nikkei managed a 0.2% rally while JGB yields edged higher by 2bps.  Perhaps the latter qualifies as a large move although the 10yr yield there remains well below 1.00%.

Otherwise, passing comments by two different ECB bankers, one a hawk (Knot saying he wants more data before deciding on a September cut) and one a dove (Centeno saying it is clear another cut is due) were the best that we had.  Perhaps that was enough to generate some excitement as the dollar has managed to rebound from the lows seen yesterday, although that is just as likely a trading bounce as a change in sentiment.

So, with this very limited amount of new information in mind, and prospects for a quiet day ahead, let’s look at what happened overnight.  While US markets did edge slightly higher yesterday, the movement was tiny, less than 0.2%.  And that type of movement was the rule of thumb in Asian markets as well with one exception, both China (-0.6%) and Hong Kong (-1.0%) continue to lag global markets as ongoing concerns over the pace of growth in the Chinese economy weigh on markets there.  I believe one of the new concerns is that Western nations (Canada being the latest) are coming together as one with respect to tariffs on Chinese goods in an effort to prevent a massive onslaught that damages their own companies.

In fairness, European shares have seen some more positive performance, notably the DAX (+0.8%), although that is due to some slightly better than expected corporate earnings releases rather than any broader macro story.  Looking across the rest of the continent, and the UK, there is a mix of gainers and laggards with nothing more than 0.2% in either direction.  Again, not much excitement here.  As to the US, futures are essentially unchanged at this hour (7:10) as all eyes are on the tape after the close when Nvidia releases its earnings.

In the bond market, yields, which backed up a few basis points yesterday, are ceding those gains this morning.  10-year Treasuries are lower by 1bp while European sovereigns are down by as much as 4bps to 5bps.  However, that is tracking what Treasuries did yesterday afternoon after the European close.  In the end, fixed income markets in the G10 remain rangebound in yield as investors continue to try to determine the timing of the widely anticipated rate cuts.  Yields have clearly declined from levels seen in the spring, but I believe for much further movement will need to see a far more aggressive rate cutting stance by central banks.

In the commodity markets, oil (-2.0%) is giving back its recent gains as supply disruption fears that were piqued by the shutdown of part of Libya’s production seem to have dissipated, or at least have been overwhelmed by the weak demand story on slowing growth in China and Europe.  At this point, it is very difficult for me to get too bullish on oil as there appears to be ample spare production capacity in OPEC to prevent disruptions and the global economic outlook is clearly fading.  Arguably of more interest is the metals markets which are under pressure this morning with gold (-0.8%) giving back some of its recent gains, although remaining above $2500/oz, while both silver (-1.8%) and copper (-3.6%) feel far more pressure on the weak economic story.  

One other potential drag on the metals markets is the dollar, which has bounced nicely from its lows yesterday.  For instance, the euro (-0.5%) is the G10 laggard although that is after testing the round number of 1.12 again yesterday.  It seems that Klaas Knot is not seen as a viable spokesman for the ECB with visions of rate cuts coming.  But we are seeing weakness in the pound (-0.25%), yen (-0.3%) and even Swiss franc (-0.2%).  In other words, it is pretty broad-based dollar strength.  In the EMG bloc, the CE4 are all substantially weaker, more than -0.5%, while KRW (-0.6%) led most APAC currencies down.  The one exception this morning is MXN (+1.0%) which is rallying nicely on the back of Banxico comments that they will maintain restrictive monetary policy for the time being.  

The data calendar has only the EIA oil inventories coming at 10:30, with more drawdowns expected, and then much later this evening, Atlanta Fed president Bostic speaks.  As trading desks remain lightly staffed given the Labor Day holiday approaching next week and given that there is important data coming after the close as well as tomorrow (Initial Claims) and Friday (PCE), today has all the hallmarks of a sleeper.

Good luck

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Like a Stone

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When Ueda-san
Raised rates, stocks responded by
Falling like a stone
 
Now Ueda-san
Is treading lightly, lest an
Avalanche begins

 

I’m sure we all remember the day, just three weeks ago, when the Nikkei Index fell more than 12% leading to a global rout in stocks.  At that time, the proximate cause was claimed to be the combination of a more hawkish BOJ and a less dovish FOMC leading to a massive unwinding of the yen carry trade.  It was a great story, and almost certainly contained much truth.  But was it really the only thing going on?

It seems quite plausible that the dramatic market reactions at that time may have been sparked by that combination of central bank events, but the sole reason the moves were so dramatic was the fact that leverage in the markets has become a key driving force in everything that occurs.  This is the reason that central banks around the world, which continue to try to reduce their balance sheets, are forced to move so slowly.  There have already been two noteworthy accidents in balance sheet reduction processes; the September 2019 repo problem in the US and the October 2022 UK pension problem, both of which were exacerbated, if not specifically driven, by excess leverage.

With this in mind, the most recent market dislocation was the main topic of discussion last night in Tokyo when BOJ Governor Ueda was called on the carpet in a special session of the Diet to explain what he’s doing.  (As an aside, the underlying premise that cannot be forgotten is that despite all the alleged focus on economic outcomes, the only thing that gets governments exorcised is when stock markets fall sharply.  At that point, inquiries are opened!)

At any rate, last night, Ueda-san explained the following: “If we are able to confirm a rising certainty that the economy and prices will stay in line with forecasts, there’s no change to our stance that we’ll continue to adjust the degree of easing.” He followed that with, “We will watch financial markets with an extremely high sense of urgency for the time being.”  In other words, the BOJ is still set on tightening monetary policy but will continue with their major goal, which is to prevent significant market dislocation (read declines).  

The upshot here is that nothing has really changed, at least at the BOJ.  Given the pace with which the BOJ acts on a regular basis, it is not surprising that they expect to continue to tighten policy very gradually and will adjust the pace to prevent major financial market moves.  The market response to these comments was for the yen to rally initially, with the dollar falling nearly one full yen, but then reversing course as Ueda backed away from excessive hawkishness.

A graph with lines and numbers Description automatically generated

Source: tradingeconomics.com

Which takes us to Chairman Powell and his speech this morning.

There once was a banker named Jay
Whose goal was for both sides to play
When joblessness rose
The question he’d pose
Was, see how inflation’s at bay?

It is somewhat ironic to me that the most recent market ructions were a response to the combined efforts of the BOJ on a Tuesday night and the Fed on a Wednesday morning, less than 12 hours apart.  And here we are this morning with Ueda-san having spoken on a Thursday night with Chair Powell slated to speak Friday morning, although this time a bit more like 15 hours apart.  Should we be concerned that more ructions are coming?
 
As per the above, it seems as though the BOJ is going to make every effort to tighten policy, albeit slowly, given that the inflation picture in Japan is not improving in the manner they would like to see.  In fact, last night, the latest figures were released showing that headline inflation remained at 2.8% and core rose a tick to 2.7%, although that was the expected outcome.  The one bright spot was their “super-core” reading fell to 1.9%.  In the past, I was given to understand that super-core was the number that mattered the most to the BOJ, but given Ueda seems keen to continue to tighten policy, I suspect it will not be the focus for now.
 
Which takes us to the other side of this equation, the Fed.  What will Chairman Powell tell us today?  Well, yesterday we heard both sides of the argument from FOMC members with Boston’s Susan Collins and Philadelphia’s Patrick Harker both explaining that the time for cutting rates was coming soon and that the process would be gradual.  On the other side, the host of the Jackson Hole shindig, newly named KC Fed president Jeffrey Schmid, explained, “It makes sense for me to really look at some of the data that comes in the next few weeks. Before we act — at least before I act, or recommend acting — I think we need to see a little bit more.”  
 
Based on the Minutes released on Wednesday, it certainly appears that the committee is ready to cut rates next month.  The real question is at what pace will they continue once they start.  Despite all the hubbub about the NFP revisions in the Twitterverse, none of the FOMC members interviewed explained that it altered their opinions about the economy.  As I type, three hours before Powell speaks, the Fed funds futures market is pricing a 26.5% probability of a 50bp hike with a 25bp hike fully priced in.  I have read arguments by some analysts that they need to start with 50bps because the payroll revisions paint a less positive picture of the economy.  But it is hard for me to believe that Powell will want to act more than gradually absent a major dislocation in the data still due between now and the next meeting.  If NFP is <50K or the Unemployment Rate jumps to 4.5% or 4.6%, that could see a 50bp cut, but otherwise, I believe Powell will be measured and not really give us anything new today.
 
Ok, let’s look at how markets have behaved ahead of his speech.  After yesterday’s disappointing US session, the Nikkei shook off any initial concerns about Ueda’s hawkishness and rallied 0.4% on the session.  But most of the rest of the region was in the red, with Hong Kong, Korea and Australia all sliding although the CSI 300 managed a 0.4% gain.  In Europe, though, green is the theme with every major market firmer this morning led by Spain’s IBEX (+0.7%) and Germany’s DAX (+0.65%).  There was no notable data, so it is not clear the driver here.  Of course, US futures are rallying at this hour as well, with the NASDAQ futures higher by 1.0% leading the way.  Based on these markets, there is clearly a belief that Powell will be dovish.
 
In the bond markets, Treasury yields have slipped 1bp this morning but have been hanging around the 3.85% level for several sessions.  There was a dip on Wednesday after the Minutes seemed dovish, but that reversed course before the day ended and we have done nothing since.  In Europe, investors and traders are also biding their time with virtually no change in yields there.  Finally, JGB yields did rise by 3bps in response to Ueda’s marginal hawkishness.
 
In the commodity markets, oil (+1.3%) is continuing to rebound from its recent lows in what looks like a technical trading bounce although the EIA data on Wednesday did show more inventory draws than expected.  In the metals markets, while yesterday was a terrible day in the space, with metals selling off hard during the NY session, this morning they have rebounded and are higher across the board.  Nothing has changed my view that if the Fed turns dovish, metals markets, and commodities in general, will rally sharply.
 
Finally, the dollar is under pressure this morning, slipping broadly, but not deeply.  The euro is unchanged, while the pound (+0.2%) and AUD (+0.4%) pace the gainers in the G10.  In the EMG bloc, ZAR (+0.4%), MXN (+0.3%) and KRW (+0.3%) all showed modest strength as it appears traders are looking for a somewhat dovish Powell speech as well.  The dollar will be quite reactive to Powell, I believe, so watch closely.
 
In addition to Powell, and any other FOMC members that are interviewed at the symposium, we only see New Home Sales (exp 630K).  Yesterday, Existing Home Sales stopped their declines and printed as expected at 3.95M.  Claims data was also as expected although the Chicago Fed National Activity Index printed at a much lower than expected -0.34 after a revision lower to the previous month.  That is a negative economic indicator.
 
This poet’s view is Powell will try to be as middle of the road as possible, acknowledging the likelihood of a cut in September but not promising anything beyond that.  That said, I believe the market is looking for a much more dovish speech.  If he does not provide that, I expect that we could see some market negativity overall with the dollar rebounding.
 
Good luck and good weekend
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Waxes and Wanes

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The story of note for today
Is how will the BLS play
Employment revisions
And then what decisions
Will Powell be likely to weigh?
 
For now, markets still seem assured
That rate cuts will soon be secured
The doves still want fifty
But most are more thrifty
With twenty-five likely endured
 
But what if Chair Powell decides
Inflation, just like ocean tides
Both waxes and wanes
And though they’ve made gains
No rate cuts, to Fed funds, provides

 

So, the big story today, which I briefly discussed on Monday, is that the BLS is going to make benchmark revisions to their NFP data for the year through March 2024.  These revisions come from a closer analysis of the Quarterly Census on Employment and Wages (QCEW) data, which is the most comprehensive data set on jobs available.  Remember, for their monthly reports, the BLS uses a model that incorporates samples of data from respondent companies, and then includes their own adjustments based on the birth-death model of new businesses and how many jobs they create.  But the QCEW data doesn’t model things, it counts all the data from states regarding unemployment insurance and reports required to be filed by companies regarding quarterly contributions.  It is the gold standard.

Naturally, when the QCEW is released (the most recent was released in June), the analyst community goes through everything and makes their own estimates as to the changes that will occur.  Prior to any revision, the BLS data show that the economy added 2.9 million jobs in the 12 months from April 2023 through March 2024.  But analyst estimates range from a reduction in that number ranging from 300K to as much as 1 million fewer jobs.  

Given the increased importance the Fed has placed on the employment side of their mandate lately, and given that one of the reasons, if not the key reason, Powell has been willing to leave rates at current high levels is the employment situation has remained robust, if he and his colleagues were to suddenly find out that there were one million less employed people around, that would likely have a serious impact on their views as to where rates should be.

Based on the stories that I have seen on this topic over the past several days, as well as the positioning that is being revealed by the Commitment of Traders’ reports showing massive long positions in both treasury bond futures and SOFR call options, both of which are real money expressions of expectations of lower interest rates coming soon, it strikes me that the pain trade is the opposite.  In other words, what if this revision is much smaller than the largest estimates, maybe 100K or something.  Suddenly, the idea that the Fed is going to be pressured into cutting rates despite the fact that inflation, though lower, remains well above their target, is not quite as certain.  

The thing is, based on what I keep reading and hearing, it strikes me that the market is set up for a bond sell-off and higher yields today.  Either, the number is large, about 1 million jobs removed, and then we will see profit taking on the outstanding positions, or the number is small, and the entire story needs to be rewritten regarding the timing of the first rate cut, which means that positions need to be abandoned.  I’m not sure what the goldilocks number needs to be to have traders maintain their positions ahead of Friday’s Powell speech, but given that is a wild card as well, I think that is the least likely outcome, no change in positions.

Elsewhere, the only other noteworthy thing was a story about a BOJ staff paper that discussed the idea that inflation in Japan is still structural and that higher rates are still appropriate, but that is a staff paper, and not necessarily Ueda-san’s view.  The BOJ next meets on September 20, two days after the FOMC, so Ueda-san will have lots more new information to decide just how hawkish he wants to be.  Recall, the dramatic market collapse in Japan at the beginning of the month, while completely reversed now, forced their hand to back off their hawkishness.  Perhaps, the second time, if they remain hawkish, they will be able to withstand that type of movement.

So, as we all await this BLS revision, which comes at 10:00 this morning, here is how things behaved overnight.  After the first down day in the US in 9 sessions, Japanese (-0.3%) and Chinese (-0.3%) markets were also soft although the rest of the region was mixed with some gainers (India, Indonesia, Australia) and some laggards (Hong Kong, Taiwan, New Zealand).  In Europe, though, equity markets are modestly firmer this morning, somewhere between 0.25 and 0.5%, although there has been a lack of new information seemingly to drive things.  As to the US, futures at this hour (7:30) are edging higher by about 0.1%.

In the bond market, Treasury yields have edged up 1bp this morning, although they have been trending down for the past week in anticipation of this BLS employment adjustment.  European sovereign yields are essentially unchanged this morning while JGB yields dipped 1bp.  The story there remains that 10-year JGBs are yielding well less than 1.00%, the perceived key level at which more Japanese funds flow home.  I think we will need to see a much more hawkish BOJ to get that trade going.

In the commodity markets, oil (0.0%) has stopped falling for the time being, but remains under pressure overall, down more than 6.6% in the past month.  Yesterday’s API data (the private sector version of the EIA data to be released later this morning) showed a small build of inventory as opposed to the continued draws that we have seen lately and that were expected.  However, a look at the oil chart tells me that we are much closer to the bottom of its trading range for the past 3 years, than the top, and seem likely to rebound a bit.  Gold (-0.15%) is consolidating its recent gains and remains above that big round $2500/oz level but both silver (+0.5%) and copper (+0.5%) are rallying today.  I keep reading stories about how the physical shortages in both those markets, due to increased production of solar panels and batteries, is going to become the key driver going forward.  While I have believed that story, it is always hard to ascribe a given day’s movement to something like that absent a major new piece of information, and I haven’t seen that piece of the puzzle.

Finally, the dollar is bouncing slightly this morning, although that is after a pretty straight-line decline for the past two months.  Given the hype about Fed rate cuts, especially adding in this new focus on the BLS job data adjustment, it is easy to see why traders are looking for much lower US rates and therefore selling the dollar.  But remember, in the big scheme of things, at least based on the Dollar Index, the dollar is pretty much at its long-run average, neither weak nor strong.  I will say that if the Fed does enter a serious rate cutting cycle, the dollar is likely to weaken quite a bit more, perhaps with the euro testing 1.15 – 1.20 before it ends.  However, remember, if the Fed starts cutting aggressively, so too will the ECB, BOE and BOC, so any weakness will be somewhat limited.  As to today’s price action, the dollar’s strength is universal, but pretty modest overall with the biggest mover JPY (-0.5%) although obviously there are other things ongoing there.  

Aside from that employment report revision, there is no other data to be released and there are no Fed speakers scheduled today.  Today will be driven by that revision.  The larger the revision, the more likely we see the dollar decline, although the initial reaction on interest rates may be opposite on profit taking.

Good luck

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That Trade Again

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Remember when everyone knew
That BOJ hikes would come through
The Fed would cut rates
And all the debates
Were focused on what next to do?
 
It turns out the very next thing
For those getting back in the swing
Was selling the yen
(Yes, that trade again)
And buying stuff that has more zing

 

We all know that the carry trade died two weeks ago.  After all, the BOJ hiked rates in a surprise to the markets which was followed by Chairman Powell essentially promising to cut rates.  Those actions spooked traders, and arguably algorithms as well, and we saw a dramatic decline in equity markets around the world, led by Japanese stocks.  The premise was that much of the market activity was driven by borrowing yen at near 0.0% and then converting those yen into other currencies and buying other assets, or just depositing the dollars, or Mexican pesos or Brazilian reals and earning the interest rate differential.

Now, don’t get me wrong, that was an active trade and clearly a part of the ongoing risk asset rally that was evident throughout most of the world.  But that trade took several years to build up, and the idea that it was unwound in a week is laughable.  But, that sharp move two weeks ago succeeded in doing one thing, it scared the 💩 out of the central bankers around the world.  Within days, the BOJ walked back all their tough talk about normalizing monetary policy and ending QQE.  As well, despite desperate calls from some of the punditry for an emergency rate cut, or at the very least, a guarantee of a 50bp cut in September by the Fed, the few Fed speakers we have heard continue with their mantra that while some things are looking encouraging, the time is not yet right to cut rates.

And, you know what that means?  It means that the interest rate differentials between Japan and the rest of the world remain plenty wide enough to reinvigorate that self-same carry trade that was declared dead just two weeks ago.  The obvious proof is in the equity markets which, while not quite back to the highs of July 16th, have rebounded between 6.8% (S&P500) and 8.8% (NASDAQ) from the bottoms seen at the beginning of the month.  (see chart below)

A graph of a line graph Description automatically generated with medium confidence

Source: tradingeconomics.com

But equally important to this story is the fact that the yen has declined more than 4% from its highs at the peak of the fear as investors are far less concerned about much tighter BOJ policy.  This is also evident in the JGB market, where 10-year yields, while climbing 3bps overnight, remain well below the 1.0% level that was seen as a harbinger of the new monetary framework in Japan.

A graph showing the price of a stock market Description automatically generated

Source: tradingeconomics.com

Of course, there has been other news that has abetted this price action, namely the recent US data which showed that the employment situation may not be as dire as the NFP report at the beginning of the month.  This was demonstrated yet again yesterday when Initial Claims fell to 227K, its lowest point in 5 weeks and the second consecutive decline in the result.  As well, Retail Sales were a much stronger than expected 1.0% (although the autos component seemed a bit funky), indicating that real economic activity was still growing.  Granted, the IP (-0.6%) and Capacity Utilization (77.8%) data were soft as were both the Philly Fed (-7.0) and Empire State Manufacturing (-4.7) surveys, but none of that matters when the markets get on a roll.

If I had to describe the narrative this morning it would be, everything’s fine.  The economy is still doing well, the jobs market is not collapsing, and the Fed is still on track to cut rates next month.  Goldilocks has come out of hiding and is back headlining the show.  While there are still some doubters out there, their voices are being drowned out by all the shouting to buy more stocks.

So, as we head into the weekend, let’s see how things have performed overnight.  In Asia, markets everywhere rallied following the strength in the US yesterday.  The Nikkei (+3.6%) led the way and has now rebounded more than 20% from its nadir at the height of the fear.  But the Hang Seng (+1.9%) showed strength and we saw strength throughout the region (Australia +1.3%, Korea +2.0%, India +1.7%) with one notable exception, mainland China, where shares edged up just 0.1%.  It seems that President Xi has, at the very least, a marketing problem with respect to getting investors to put money into China. In Europe, most markets are higher between 0.25% (CAC) and 0.6% (DAX) although the FTSE 100 (-0.4%) is struggling this morning after Retail Sales data there were seen as less than stellar.  As to the US, ahead of the opening futures markets are little changed at this hour (7:15).

In the bond market, yesterday’s stock euphoria played out as a sale of bonds with the corresponding rise in yields of 7bps in the US Treasuries.  However, this morning, those yields have backed off by 5bps and we have seen similar price action throughout Europe with sovereigns there showing yield declines of between 3bps and 5bps after following Treasury yields higher yesterday.  For now, bonds are certainly behaving like a haven asset.  Also, it is worth noting that the yield curve inversion is back to -17bps, edging slowing away from normalization.

In the commodity markets, after a solid performance yesterday, oil (-2.6%) is under real pressure this morning as market participants look to the lackluster Chinese economic activity and are worried that demand is not going to pick up anytime soon.  Certainly, yesterday’s Chinese data was nothing to write home about, and this morning they released their Foreign Direct Investment data showing it had decline -29.6% YTD in July.  This does not inspire confidence.  In fact, under the rubric a picture is worth 1000 words, here is a chart of that Chinese FDI.  It seems clear that something has changed in the way the world views China.

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Source: tradingeconomics.com

As to the metals markets, gold (+0.4%) continues to find support as despite the equity rally, there remains a steady interest to hold something other than USD and fiat currencies.  However, the rest of the complex is softer this morning as weaker industrial activity would indicate less demand.

Finally, the dollar is ceding some of its gains from yesterday with some pretty substantial moves in both G10 and EMG blocs.   Versus the G10, the yen, which fell sharply yesterday, has rebounded 0.75% this morning, although remains above 148.  But we have seen strength in AUD (+0.3%), NZD (+0.7%) and GBP (+0.35%) as virtually all the G10 is firmer.  The pound is a bit odd given the equity market’s response to the UK data, but the other currencies seem to be simply retracing yesterday’s weakness.  In the EMG bloc, ZAR (+0.4%) is firmer on the back of gold and the generally weak dollar, but we are seeing MXN (-0.2%) lag the move.  CNY (+0.2%) is also benefitting today as broad dollar weakness plays out far more aggressively here than it has historically.  While the dollar’s long-awaited demise is still far in the future, today it is under some pressure.

On the data front, this morning brings Housing Starts (exp 1.33M), Building Permits (1.43M) and Michigan Consumer Sentiment (66.9).  As well, this afternoon we hear from Chicago Fed president Goolsbee.  He has been one of the more dovish FOMC members so look for him to talk up the chances of a more aggressive rate cut next month.  However, there is still a lot to learn between now and then with PCE next week, then another NFP and CPI report as well as the Jackson Hole conference.  As it stands this morning, the Fed funds futures market is pricing a 27% chance of a 50bp cut, with 25bps a lock.  But if the data continues to shine, please explain why they need to cut.  I think we are in a ‘good news is good’ scenario, so strength in this morning’s data should support the dollar and weakness impair it.  We shall see.

Good luck and good weekend

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Scuppered

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There once was a time many thought
That equities had to be bought
Then, darn it, Japan
It scuppered the plan
And havoc is all that they wrought
 
So, last week, not greed, but fear, won
And risk assets ended their run
But now folks are sure
In fact, it’s de jure
That rate cuts, next month, are, deal, done

 

Congratulations everyone.  You made it through the end of the world!  I must admit, though, that on this side of that extraordinary event, things don’t really seem that different.  A quick recap reminds us that on July 31st, the BOJ surprised markets and raised interest rates by 15bps, taking their overnight funding rate to 0.25%, its highest level in 15 years.  Twelve hours later, the FOMC did not cut rates, as some had been advocating, but seemed to promise that a cut was coming in September.  Then, two days later, the US employment report showed substantially weaker jobs activity than expected.  Over the ensuing several sessions, USDJPY declined dramatically, falling nearly 10 big figures as can be seen in the first chart below.

A graph with numbers and a line Description automatically generated

Source: tradingeconomics.com

After an initial reflexive trading bounce, it was starting to slide again when, on August 6th, BOJ vice-governor Ichida explained that the BOJ would not, in fact, be aggressively tightening policy immediately.  The result was a relief rally and now USDJPY sits about halfway between the level prior to the rate hike and the low’s plumbed afterwards.

Perhaps just as interesting is the fact that the Nikkei 225 showed virtually the identical trading pattern, with its decline last Monday, August 5th, as the second largest single-day decline in its history.

Source: tradingeconomics.com

And yet, it is not hard to see that the trading pattern for both the Nikkei 225 and USDJPY are virtually identical, with the same catalysts.  In fact, we can look at other markets, 10yr Treasury yields and the NASDAQ come to mind, and see extremely similar price action.  (Alas, I couldn’t get the BOJ and Unemployment rate points on the combined chart, but you can see it is the same pattern.)

A graph of stock market Description automatically generated

Source: tradingeconomics.com

The one truism that holds is that during a time of stress, all correlations go to one!

But perhaps it’s time to consider, once again, the idea of recession.  As of now, there are still two camps:

  1. Recession is already here and started sometime in the late spring.  This is based on the declining trend in manufacturing activity, the rise in the unemployment rate (the Sahm Rule), the rising number of bankruptcies and increasing size of household debt along with delinquencies.  Constant downward revisions of previous data releases also weigh on the view, and of course, the yield curve continues to point to lower interest rates going forward, the implication being growth is slowing.  One last feature is the dramatic difference between GDP and GDI, two different measures of US economic activity that should show the same thing, however currently, GDI (Gross Domestic Income) is printing below 1% real growth.
  • Meanwhile, the soft/no-landing scenario remains popular amongst a different set of analysts.  Perhaps the most comprehensive discussion comes from Apollo Research’s Torsten Slok as he highlights the fact that real-time indicators like air travel, restaurant seatings, income tax withholdings and Retail Sales remain quite strong.  As well, the Atlanta Fed’s GDPNow is currently running at 2.9%, which certainly doesn’t appear to be pointing to a recession.

So, which is it?  Of course, that’s the $1 trillion question.  However, let us consider a few incontrovertible truths.  First, business cycles still exist.  Despite all the efforts by finance ministries and central banks to create an ever upward trajectory in economic activity, or more accurately because of those efforts, excesses are created and at some point, that growth is no longer sustainable.  In other words, governments and central banks blow bubbles and eventually they pop.  Second, not all parts of the economy grow at the same pace and respond to the same catalysts in a similar manner.  So, certain parts of the economy may be under pressure while others are doing fine.  Third, trees don’t grow to the sky.  There are no magic beans which grow that beanstalk ever higher.  Rather, at some point, gravity becomes a stronger force, and things return to earth. 

From this poet’s viewpoint, we are continuing to see sectoral weakness that has not yet tipped into general weakness.  We’ve all heard about commercial real estate and the problems ongoing in that sector.  As well, we’ve all heard the excitement about AI and the massive (over)investment that has been focused on that sector, supporting the companies at the heart of the story.  In between, there are many shades of grey with some areas holding up better than others.  But on an economy-wide basis, it seems likely that given the amount of ongoing fiscal stimulus that is still being pumped into the economy, overall, a recession will still be delayed further.

Perhaps the bigger problem for the economy is that inflation remains a very real phenomenon. As the WSJnoted this morning, it is the prices of things with which we cannot do without (e.g., food, shelter, insurance) that continue to rise, rather than the discretionary items, which seem to see prices ebbing.  Ultimately, the downturn will come, but you can be sure that the government, and the Fed, will do all they can to prevent it happening, at least before the election.

Ok, with that in mind, let’s look at markets overnight as well as what this week’s data releases will bring.  After modest gains in the US on Friday, with the early part of last week’s dramatic declines essentially elimiated, Asian equity markets were generally stronger (Korea, Taiwan, Australia) although Chinese shares continue to lag (CSI 300 -0.2%) as data showed that investment into China has turned to divestment from China for the second quarter of the past four. (see chart below).  This is obviously not a positive story for the Chinese economy or its equity markets.  As an aside, Japanese markets were closed for a holiday last night.

A graph of a graph showing the value of a stock market Description automatically generated with medium confidence

Source: Bloomberg.com

Meanwhile, European bourses are generally little changed, +/-0.15% or less except for the UK, where the FTSE 100 is higher by 0.5% despite hawkish comments from BOE member Catherine Mann warning against complacency on inflation and pushing back against the idea of consistent interest rate cuts.  Lastly, US futures are edging higher at this hour (7:15), up about 0.2% across the board.

In the bond market, yields are edging back up this morning, with Treasuries higher by 2bps and similar gains across all of Europe.  To the extent that government bonds are serving as havens again, the idea that equity markets are rebounding would certainly imply less demand for them.  The one place where yields continue to decline is in China, where 10-year yields are trading near the historic lows seen at the end of July, and clearly still trending lower, an indication that growth expectations are falling.

A graph with a line graph Description automatically generated

Source: tradingeconomics.com

In the commodity markets, oil (+1.25%) is gaining on the growing expectation that Iran is set to finally respond to Israel and launch a significant assault with fears this can grow into a wider conflagration and impact supply.  That fear seems to be bleeding into gold (+0.5%) as well, which is back toward its historic highs, and taking the entire metals complex (Ag +1.8%, Cu +1.1%) with it.

Finally, the dollar is mixed this morning, rising strongly against the yen (-0.7%) and CHF (-0.5%) but lagging the commodity currencies (AUD +0.5%, NZD +0.5%, ZAR +0.6%).  As to the more financial currencies, like EUR, GBP, CAD, they are little changed on the session.  Ultimately, the story remains driven by expectations of Fed activity with the market currently pricing a 50:50 chance of a 50bp rate cut come September.

On the data front, we do see important things this week as follows:

TodayNY Fed Inflation Expectations3.0%
TuesdayNFIB Small Biz Confidence91.7
 PPI0.1% (2.3% Y/Y)
 -ex food & energy0.2% (2.7% Y/Y)
WednesdayCPI0.2% (2.9% Y/Y)
 -ex food & energy0.2% (3.2% Y/Y)
ThursdayInitial Claims235K
 Continuing Claims1880K
 Retail Sales0.3%
 -ex autos0.1%
 Empire State Mfg Index-6.0
 Philly Fed7.0
 IP0.1%
 Capacity Utilization78.6%
FridayHousing Starts1.35M
 Building Permits1.44M
 Michigan Sentiment66.7

Source: tradingeconomics.com

In addition, we hear from several Fed speakers, with at least three on the docket, but I imagine we will get more than that.  Last week’s fears have been memory-holed.  The vibe this morning is that it was all the BOJ’s fault and that everything is going to be great.  Maybe that will be the case, but I remain a skeptic.  Just consider, if everything is great, why would the Fed cut rates?  And the one thing that seems clear to me is that a Fed rate cut is the base case for virtually everyone. I maintain if they cut, especially 50bps, the dollar will fall sharply.  But if that recession data doesn’t start to appear soon, some folks are going to need to change their views, and positions, regarding how things unfold.

Good luck

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Flags at Half-Mast

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Twas just seven days in the past
When fears of recession forecast
Were rapidly rising
And folks analyzing
The data had flags at half-mast
 
But in a remarkable twist
Turns out that recession was missed
Instead, all is great
With not long to wait
Til worries no longer exist!

 

Until this week, I had always understood the Covid-linked recession to be the shortest on record, lasting just a few months.  But apparently, that is no longer the case.  You may recall that after last Friday’s weaker than expected NFP data and the increase in the Unemployment Rate to 4.3%, the commentariat was certain that the Fed had maintained their monetary policy too tight for too long.  The result was that the US had entered a recession, or at least was on the cusp of one.  Certainly, this appeared to be the market narrative as equity markets sold off aggressively on Friday and then again on Monday.  While there was much discussion of the impact of the BOJ’s policy adjustments and that as an additional catalyst, the key is panic was rampant.

However, it appears it was nothing more than a bad dream.  As of this morning, the S&P 500 is essentially unchanged from where it was at last Friday’s close as can be seen in the chart below.  

A graph on a white background Description automatically generated

Source: tradingeconomics.com

All of the angst that had been felt because of that NFP print (which was still positive at 114K) and all of the clutching of pearls and gnashing of teeth that analysts suffered was unnecessary as the Fed sensibly made no policy changes and the equity market absorbed some volatility and is back to flat on the week.  

Does this imply everything is fine with the world?  Absolutely not.  There are still numerous concerns for both the economy and the financial markets, notably the bond market, but the world has not ended, and equity markets are reflecting that fact.  

All joking aside, the economy continues to show a mixed picture and arguably the biggest medium-term concern should be the willingness of investors to continue to finance the US deficit.  This is a fundamental that cannot be ignored forever and one that revealed itself again this week as both the 10-year and 30-year auctions had tails* of more than 3 basis points.  The implication of those outcomes is that demand for US Treasury debt at current levels could be waning, and that is a genuine problem.  

Consider that, already, interest payments by the Treasury on its debt exceed $1 trillion annually.  If buyers in the market demand higher interest rates and there are no expenditure reductions (which seems likely regardless of the election outcome), either yields will rise, or other buyers will need to be found.  Who might those other buyers be?  Well, obviously, the Fed is the number one suspect, although if they were to restart QE with inflation running above target, I suspect it would be very difficult to hide and the impact on inflation would likely be to push it higher, clearly not their goal.  Therefore, as I have written before, be ready for regulatory changes that require banks and insurance companies to hold larger portfolios of Treasury securities as part of their capital buffers.  This process would be far more opaque politically but would create the price insensitive bid that the Treasury needs.

To recap, the recession has not yet arrived, investors are climbing out of their foxholes and there are potential concerns regarding the bond market and natural demand for the ongoing increases in issuance.  While next week’s CPI data will be closely scrutinized, my sense is the equity narrative is going to be far more focused on production and consumption than on prices. 

In the meantime, let’s review last night’s session and see how things are behaving as we head into the weekend.  After yesterday’s impressive rally in the US, where all Monday’s fears were erased because the Initial Claims number seemed to indicate the job market wasn’t collapsing, Asian markets had a pretty good session as well.  The Nikkei (+0.6%) and Hang Seng (+1.2%) both followed the US higher as did virtually every other market in Asia except mainland Chinese shares (CSI 300 -0.35%) after Chinese inflation figures printed a touch higher than forecast.  It does seem to feel like the Chinese market is decoupling from the rest of the world.  Meanwhile, European bourses are all firmer this morning led by Spain’s IBEX (+0.9%) and the CAC (+0.5%) in Paris.  Clearly, fears over Monday’s meltdown have abated everywhere.  Lastly, at this hour (7:30), US futures are pointing slightly higher as well.  As I said above, Monday was just a bad dream.

In the bond markets, yields are declining almost everywhere with 10-year Treasuries falling 4bps and all European sovereigns seeing yields decline by between -3bps and -5bps.  Whatever fears existed during the auctions seem to have abated somewhat, at least for now.  But the bigger picture concerns over Treasury supply remain in place, if in the background today.

In the commodity markets, oil (+0.4%) continues to creep higher and has now retraced all its losses from the week.  However, the big picture here remains that oil is rangebound between $70/bbl and $90/bbl.  While the Middle East situation continues to cause some concerns, the absence of a widely anticipated strike by Iran on Israel has left traders on edge, but not actively hedging the prospects.  As to the metals markets, both gold and silver, which had very strong rebounds yesterday, are little changed on the morning, consolidating those gains.  Interestingly, copper (+1.6%) is showing a bit of life, perhaps on the view that the recession has not yet arrived, or more likely because traders who had shorted the red metal are closing positions ahead of the weekend.

Finally, the dollar is mixed this morning with a variety of gainers and laggards across both the G10 and EMG blocs.  In the former, AUD (-0.3%) is lagging as it adjusts after yesterday’s strong gains based on a more hawkish RBA view.  At the same time, JPY (+0.5%) is higher this morning although it has been trading either side of 147.00 for the past three sessions with no obvious directional bias.  Given the importance of monetary policy decisions to this currency pair, the fact that the BOJ walked back their hawkishness and the Fed speakers we have heard this week have continued the mantra of the time is not yet right for a cut, although September may be good, it shouldn’t be that surprising that it has found a new short-term equilibrium.

In the emerging markets, the chart below showing the relative moves of ZAR, MXN and BRL, the three key risk proxies, shows that all have strengthened from their worst levels on Monday, an indication that traders are returning to the carry trade.

A graph of stock market Description automatically generated

Source: tradingeconomics.com

It is also worth noting that CNY (+0.2%) continues to track the yen at a slower pace.  The idea that the PBOC is willing to let the renminbi trade in a more volatile manner as long as it does not strengthen aggressively vs. the yen remains intact.

There is no data on the docket today and once again there are no Fed speakers scheduled either.  To my eyes, the market is exhausted after the wild moves at the beginning of the week.  I expect that there is limited appetite for aggressive price action in any market today and absent either an Iranian attack on Israel or a true black swan event, my best guess is it will be a quiet session heading into the weekend. 

Good luck and good weekend

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*A tail in a bond auction simply describes how much higher the actual results were than the market’s anticipation of those results prior to the auction’s completion as priced in the when-issued market.  Typically, for 10-year bonds, that tail is close to zero, and even 30-year bonds average about 1bp.  A 3bp tail is considered quite wide and concerning as it indicates a lack of buying interest by investors of all stripes.

A New Boogeyman

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Confusion today is what reigns
As no pundit clearly explains
Why previous claims
Have gone up in flames
And how much more pain still remains
 
They still blame the Bank of Japan
With spoiling their well thought out plan
And too, yesterday
When bonds went astray
It gave them a new boogeyman

 

Yesterday started out so well for all those who were convinced that it was the BOJ’s surprising and extreme actions last week that led to an unwarranted selloff in stocks and other risk assets.  First off, the BOJ, via one of its members Ichida-san, basically apologized for their actions and said that they would not be making any other changes after all.  That led to a rally in equities and a sell-off in bonds as risk assets were suddenly back in favor.  Alas, by the end of the day, that was no longer the case.

But let’s look at what the BOJ actually did last week.  On the interest rate front, they raised their base rate to 0.25% and regarding their balance sheet, they indicated they had a plan to slow down its growth at a very gradual pace.  Remember, they did not say they were going to sell JGBs, they said that by 2026 they would be buying half as many JGBs as they do today.

Also, let’s remember that inflation in Japan is currently measured at 2.8%, so the base rate remains deeply negative in real terms.  I understand the signaling impact of what they did as any change in the status quo while there is a significantly leveraged market can have major impacts.  And that is what we saw during the past week.  It is also important to remember that given the length of time that the Japanese have maintained their ZIRP/NIRP monetary policy, the opportunity for very large institutions to build up very large positions was, to be succinct, very large.  The chart below shows for just how long Japanese interest rates have been near zero, more than twenty years.

Source: tradingeconomics.com

My point is that Japanese investors have been seeking alternative opportunities for an entire generation.  As well, the concept of the carry trade has been in place for that same amount of time.  It will take a long time for these ideas to be changed and the positions along with them.  Now, according to a Bloomberg article, JPMorgan’s analysts claimed that three-quarters of the carry trade has already been unwound.  And maybe they are right about that.  But I assure you that three-quarters of Japanese investors have not adjusted their positions in the fixed income market.  We have not come to the end of this road.

So, analysts found another cause for yesterday’s negative outcomes, the 10-year bond auction.  It turns out that investors are seeking more yield than the market had anticipated ahead of the auction.  This led to a 3 basis point tail, meaning that the auction cleared at a yield, 3.96%, 3 basis points higher than traders were pricing ahead of time (typical 10-year tails are well less than 1bp.)  There were less bids than anticipated, and generally this is not a good story for Secretary Yellen and the Treasury.  The story that circulated was that the reason stocks fell in the afternoon was the weak auction.  Alas, the timing of that does not make sense.  Equity markets had already given back their morning gains before the auction results were announced and were lower on the day at 1:00pm.  But narrative writers need a story, and that was a good one.

So, what really happened?  Who knows?  But FWIW this poet has seen enough market action during his career to recognize that while fundamentals matter in the long-run, daily changes are often completely random, or at least seemingly so.  Large orders can drive markets, especially when liquidity is lower because of holiday schedules and the time of year.  And lately, the combination of algorithmic trading and extreme retail speculation will also move markets in surprising directions.

I believe that we remain in a period of change.  Monetary policies around the world are adjusting to the realities of inflation remaining stickier than policymakers want to believe.  In addition, the political cycle continues to be difficult to forecast, notably in the US, with market perceptions of very different economic policies to be implemented depending on the next US president.  And finally, I believe the best way to describe the global economy is that it is in transition.  After a decade or more of easy money policies around the world, as those policies start to change, they impact different segments of the economy at different rates.  This means that some parts of an economy can be in recession while other parts can be doing fine.  And that gives rise to confusing data with no broad trend.  This may explain why manufacturing survey data is so weak while service survey data has held up well.  

My best guess is that we are going to continue to see confusion until policy makers are more aligned.  In fact, that is why there are so many calls for the Fed to start cutting rates soon, so they can catch up and unify monetary policies around the world.

Ok, let’s see how things looked overnight.  After yesterday’s reversal and lower closes in the US, that theme was extended largely around the world.  Japanese shares fell (-0.75%) as did shares everywhere else in Asia (Korea, India, Australia, etc.) except in China, where both mainland and Hong Kong shares were essentially flat.  The story is no better in Europe where shares are lower by between -0.7% (DAX ) and -1.1% (CAC, FTSE 100) as investors demonstrate they are concerned with the future.  As to the US, at this hour (7:15) futures are very slightly lower.

In the bond market, after yesterday’s poor auction, and ahead of today’s 30-year Treasury auction, yields have fallen from their highest points.  Treasury yields (-3bps) are pacing the European sovereign market (Bunds -3bps, OATs -3bps, Gilts -1bp, BTPs -2bps) as the fear factor on stocks seems to be encouraging some haven buying.  But the most interesting thing was that JGB yields fell -5bps overnight and are now back down to 0.84%.  The BOJ Summary of Opinions (effectively their Minutes) was released last night and clarified that they are not interested in a rapid tightening of policy.  Given GDP growth was negative last quarter, this can be no surprise.

In the commodity markets, oil is little changed this morning but has recouped most of its losses from the past week and sits back at $75/bbl.  This is still a range-bound situation, and we need something really big to change that.  Gold (+1.1%) is making a comeback and back over $2400/oz as the fear factor seems to be playing a role here today.  However, copper (-0.2%) continues to demonstrate short-term concerns over economic activity around the world.

Finally, the dollar is having a much less volatile session than we have seen recently.  AUD (+0.5%) is the biggest mover I can find after hawkish comments from the RBA, claiming they will not hesitate to raise interest rates again if inflation reappears.  However, the yen (+0.15%) seems like it has found at least a temporary home, perhaps gaining some support on what appears to be a risk off day.  Funnily, though, the major risk proxies in the EMG space, ZAR and MXN are virtually unchanged this morning.  I believe that like most markets today, more clues are sought before views are expressed.

Speaking of clues, this morning brings the other US data with Initial (exp 240K) and Continuing (1870K) Claims at 8:30.  Richmond Fed president Barkin speaks at 3:00 this afternoon, the same time we will hear from Banxico on their rate decision (no change expected).  But once again, there is not much new information expected, so markets are going to respond, in my view, to equity activity.  If US stocks can find support, look for other markets to follow along.  However, that does not feel like today’s message.  As to the dollar, against the majors, I think it has found a temporary range.

Good luck

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The World is Ending

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The world is ending
At least, that’s the way it feels
Owning equities
 
The narrative writers are caught
‘Cause stories those writers had wrought
No longer apply
And folks now decry
The idea that dips should be bought
 


Remember the idea of the summer doldrums where everybody is on vacation, so markets move very little? Yeah, neither do I!  Here’s a different idea though, when risk is under pressure, all correlations go to 1.0.  Look at the following three charts (source: tradingeconomics.com) and explain to me how they behave independently:

There is rioting in the streets today, perhaps not in your neighborhood directly, but in many places around the world (the UK, Bangladesh, Kenya, others), as the global order that we have known for the past X years gets tested.  How big is X?  There will be many different answers to that question, but in this poet’s mind, what we are witnessing in its full glory today is the beginning of the unwinding of the market excesses that began when global interest rates headed to 0.00% in the wake of the GFC in 2009, so X=15 years.  

It is easy to wax philosophical on this subject, discussing the merits of moderating the business cycle and why interest rate policy is a net benefit, and you can be sure that before this week is over, we will get policy interventions.  But ultimately, markets need to clear to function effectively, and I would argue that the last time markets actually cleared was in 1974.  The next big opportunity to allow markets to clear was in October 1987 and the Maestro, although he had not yet earned that moniker, stepped in after that Black Monday and promised unlimited liquidity to prevent too much damage. 

Ever since then, central bankers around the world, led by the Federal Reserve, but do not forget actions like Mario Draghi’s “whatever it takes” moment, have decided that they need to manage the global economy, and market responses, and that markets were only effective if they were going higher.  (It’s ironic that TradFi people scoffed at the crypto maxim ‘number go up’, yet they believed exactly the same thing, only in a different wrapper.) As well, we all know that the concept of political will does not exist anymore, at least not in the West, as no elected politician will ever choose to fight for a policy that has short-term pain and long-term gain.  The result of this constant intervention and guidance from policymakers is that things get overdone, and bubbles inflate.  And it is much easier to inflate a bubble when you maintain policy rates at 0.00% (or negative rates in some cases).  

At this point, you will read many stories about which particular catalyst drove this market reaction, whether it was last week’s BOJ meeting where Ueda-san surprised the market and hiked rates as well as promised to reduce QQE, or whether it was the fact that Chairman Powell did not cut rates, or if it was the weak payroll report.  Others will point to the escalation in hostilities in Ukraine and the Middle East as flashpoints getting people to exit risk positions.  But in the end, the catalyst is not important.  As I wrote on Friday, and is so well explained in Mark Buchanan’s book, Ubiquity, the market was rife with ‘fingers of instability’ and an avalanche has begun.

To this poet’s eye, there needs to be more excess wrung from the market.  After all, given the underlying trade of virtually the entire bull market has been the JPY carry trade, where traders and investors borrowed JPY at 0.00%, converted it to another currency and either held that currency to earn the interest rate differential, or for the truly aggressive, used the currency to buy other risky assets (NVDA anyone?), and that trade has been building for years.  Deutsche Bank has estimated that it grew to $20 trillion in size.  I assure you it is not completely unwound!

However, as I mentioned above, I am confident that central bankers are already getting intense pressure from their respective governments to ‘do something’ to stop the rout.  But central bankers are already (save Japan) in cutting mode.  And the Fed just passed on cutting rates last week.  If they were to cut today, no matter what they said, it would remove any doubt that the only thing they care about is the stock market.  It would destroy whatever credibility they still retain.  But do not count out that response, at this stage, it’s probably 50:50 they cut this week if things continue.  After all, the Fed funds futures market is now pricing in a 95% probability of a 50bp cut in September and a total of 125bps of cuts by December!

I will be the first to say I have no idea where things are going to head from here because while market internals point to further unwinding of risky assets, policy responses have not yet been seen.  So, the best advice I can offer if you are not leveraged is do not panic.  If you are, you have probably been stopped out already anyway.  In the meantime, let’s take a look at the damage overnight.

Equity Markets in Asia:

  • Nikkei 225       -12.4%
  • Hang Seng       -1.5%
  • CSI 300            -1.2%
  • ASX 300           -3.7%   
  • KOSPI               -8.8%
  • TAIEX               -8.3%
  • Nifty 50           -2.7%

In other words, it was quite the rout, with tech shares getting hammered everywhere.  Perhaps the most surprising thing to me as that the CSI 300 didn’t fall further, although I suspect that there was significant intervention by the government to prevent that from happening.  (After all, you don’t need to be a western government to want the number to go up!)

Equity Markets in Europe:

  • DAX                 -2.6%   
  • CAC                 -2.4%
  • FTSE 100         -2.4%
  • IBEX                 -2.8%’
  • FTSE MIB         -3.0%

This tells me that these markets were not nearly as leveraged as Asian markets, likely because prospects throughout Europe have been relatively less interesting to many investors.  After all, if you are leveraging up via borrowing yen, you want to buy growth, not value, stocks, and there aren’t that many growth names in Europe.

Finally, US futures, at this hour (7:00) are lower by:

  • S&P 500          -3.0%
  • NASDQ            -4.5%
  • DJIA                 -2.1%

Bond markets are also seeing very significant movement, in the opposite direction as they are performing their safe haven role brilliantly today.  While the movements today are solid, with Treasury and European sovereign yields all lower by between 5bps and 7bps, to see the real story, you need to see the move since Friday’s opening (these are all 10-year yields).

  • US                    -20bps
  • Germany         -10bps
  • UK                   -9bps
  • Japan               -20bps
  • Australia          -17bps

The US yield curve, at least the 2yr-10yr measurement, is virtually flat today and 30yr yields are now higher than both of those maturities.  Also, look at JGB yields, down to 0.77%, as Japanese investors take their toys and go home.  The thing about this move, and the reason I don’t believe the unwinding is over yet, is that once the Japanese investment community starts to move, it takes a long time for them to get to be where they want given the amount of the assets involved.  And despite all the clutching of pearls about the US ability to sell the amount of debt they need to fund themselves; it won’t be a problem for right now.  Many people around the world will be all too happy to buy Treasury bonds regardless of some political foibles in the US.

Commodity markets are under pressure this morning, but not seeing the same type of pain as equity markets. The story here is that commodities are not directly impacted by the current movements (if anything declining interest rates should help them) but when margin calls come, people sell whatever they can that is liquid.  So, gold (-1.6%) is being liquidated to cover margin calls, not because people don’t want it.  Oil (-1.6%) is likely feeling pressure because these equity moves presage potential economic weakness and a reduction in demand, and we are seeing the same response from the industrial metals.  My take is gold is the one thing, besides bonds, that people are going to be willing to hold, and will rebound first.

Finally, the dollar is under pressure, net, but we are seeing massive movements in both directions.

  • JPY       +2.5%
  • EUR     +0.4%
  • GBP     -0.3%   
  • AUD     -0.9%
  • MXN    -3.3%
  • NOK     -1.0%
  • ZAR      -2.0%
  • CNY     +0.8%  
  • CHF      +0.8%
  • KRW    -0.5%

See if you can determine which were the favorite currencies to hold long against short JPY (AUD, MXN, ZAR). Meanwhile, the renminbi is able to gain as it continues to weaken, net against the yen, its most important competitor.  Remember, currencies are the outlet valves for economies when other markets cannot move enough.  The thing to keep in mind, especially as a hedger, is that volatility is going to be very high for a while yet.  This will not all quiet down and go away in a week’s time. 

At this point, it’s fair to ask, does data matter anymore?  Probably not today, but it will be key for the central banks if for no other reason than to cloak their actions in some fundamental story.  Alas for the Fed, there is virtually nothing to be released this week.  All we see is:

TodayISM Services51.0
TuesdayTrade Balance-$72.4B
ThursdayInitial Claims250K
 Continuing Claims1880K

Source: tradingeconomics.com

As well, and perhaps remarkably, so far on the calendar we only have three Fed speakers, Goolsbee, Daly and Barkin.  However, it seems almost certain we will hear from others, especially if the rout continues.

Right now, fundamentals do not matter.  My sense is we will see a bounce of some sort after the first wave ends, perhaps as soon as tomorrow, but the narrative of the soft landing has been discarded.  Look for more political pressure on the Fed to act, and to act soon.  Also, do not be surprised if the rest of the week ultimately sees a slower, but steady, decline in risk assets as those who haven’t panicked react to the situation and reevaluate just how much they love their positions.  Consider, Warren Buffet sold some of his favorite positions last week and is loaded with cash to act.  But there is nobody who is more patient than he.  

Good luck

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New Shibboleth

Posted on by

A second rate hike
By Japan has resulted
In strong like bull yen

 

Last night, Governor Kazuo Ueda and the BOJ raised their overnight call rate to 0.25% from the previous level of between 0.00% and 0.10%.  This move was forecast by several analysts but was certainly not the base case for most, nor what this poet expected.  However, it appears that the gradual slowing in inflation in Japan was not seen as sufficient and so they moved.  By far, the biggest reaction came in the FX markets where the yen jumped sharply, now higher by 1.5% compared to yesterday’s NY close.  A look at the longer-term chart of USDJPY below shows that at its current level just above 150.00 (obviously a big round number), the currency has reached a double support level based on its 50-week moving average (the curved line) and the trend line that starts from the time the Fed began raising interest rates in March 2022.

Source: tradingeconomics.com

Surprisingly, given the sharp move seen overnight, there has been virtually no discussion as to whether the MOF asked the BOJ to intervene and further push the yen higher (dollar lower) in concert with its recent strategy of pushing a market that is moving in its favor rather than fighting a market that is moving against its goals.  Regardless, the 150 level is going to be a very important technical support, and any break below may open up another 10 yen decline in the dollar.

What, you may ask, would lead to such a move?  How about the Fed?

The pundits are holding their breath
With “cut Jay” their new shibboleth
But will Chairman Powell
Now throw in the towel
On prices and channel Macbeth?

Of course, this afternoon, the big news is the FOMC meeting wraps up and at 2:00 they release their statement which is followed by the Chairman’s press conference at 2:30.  As of this morning, the probability of a cut today is down to 3.1% according to the CME’s futures market.  However, that market has a 25bp cut locked in for September with a further 10% probability of a 50bp cut then and is pricing in a total of 66bps of cuts by the December meeting, so, a bit more than a 60% probability of three 25bp cuts by the end of the year.  That pricing continues to feel aggressive to this poet as the data has not yet shown that the economy is clearly in trouble.  Remember, too, the Fed is always reactive, despite any of their comments on trying to get ahead of the curve.

Continuing our observations of mixed data, yesterday saw that home prices, as per the Case-Shiller Index, remain robust, rising 6.8% in May (this data is always lagging), but there is little indication that the shelter component of the inflation statistics is set to decline sharply.  As well, the JOLTs Job Openings data printed at a higher than expected 8.184M, indicating that there is still labor demand out there.  Finally, the Consumer Confidence number rose a touch more than expected to 100.3.  My point is there continues to be strength in many parts of the economy and prices are nowhere near declining.  Granted, this Friday’s NFP report will take on added importance as if the numbers there start to decline and Unemployment continues its recent trend higher, there will be far more urgency to cut rates.  Perhaps this morning’s ADP Employment report (exp 150K) will help clear up some things, but I’m not confident that is the case.

Interestingly, there are still a number of analysts who are clamoring for the Fed to cut today, claiming they can get ahead of the curve and stick the soft landing.  However, history has shown that the Fed lives its life behind the curve, and there is no indication that is about to change.

There is one other thing to consider, though, and that is the politics of the situation.  While the Fed is adamant they are apolitical and only trying to achieve their mandated goals, we all know that in order to even be considered to reach the FOMC as a named member of the committee, one needs to be highly political.  Does that mean that partisan politics enters the arena?  These days, it is almost impossible for that not to be the case.  

The current narrative on this subject is that a rate cut will help the current administration, and by extension the candidacy of VP Harris.  I’m not sure I understand that given inflation, which remains a major topic of conversation around the country, especially at the proverbial kitchen table, is so widely hated across the board.  The most interesting poll results I saw were that a majority of those questioned indicated they hated inflation far more than a recession.  This surprised the economic PhD set, but as inflation is an insidious cancer on everyone’s wellbeing, it is no surprise to this poet.  My point is that a rate cut now will do exactly zero to help support growth before the election, but it will almost certainly boost the price of commodities, notably energy and gasoline, and that will show up in inflation post haste.  Thus, does the narrative even make sense?  If Powell is truly partisan (and I don’t think that is the case), he would refrain from cutting rates until September as any impact, other than in financial markets, will not be felt until long after the election.  FWIW, I agree with the market there will be no cut today, but absent a major decline in the employment situation by September, I see only 25bps there.

Ok, a bit too long to start today, but obviously there is much of importance to understand.  So, let’s look at how markets have responded to the BOJ while they await the FOMC.  As earnings season continues, the tech sector in the US continues to struggle as evidenced by the sharp decline in the NASDAQ yesterday, although the DJIA managed to gain 0.5%.  In Asia, though, tech concerns were overwhelmed by the excitement of the BOJ’s action and the strength in the yen.  Perhaps the surprising thing is the Nikkei (+1.5%) rose so much given a strong yen generally undermines the index, but the rate hike boosted bank shares by 5% or more across the board.  And that strong yen was welcomed everywhere else in Asia with Chinese shares (Hang Seng +2.0%, CSI 300 +2.2%) and almost every regional exchange gaining real ground on the back of a less competitive Japan given the higher yen.

In Europe, most markets are much firmer as well this morning, led by the CAC (+1.4%) and FTSE 100 (+1.4%) although Spain’s IBEX (-1.0%) is lagging on uninspiring corporate earnings results.  I would contend these markets are being helped by that stronger yen as well, given Japan’s status as a major exporter.  Lastly, US futures are higher at this hour (7:20) after some better-than-expected results from chipmaker AMD, although MSFT’s numbers were less impressive.  Net, though, NASDAQ futures are up 1.6% this morning dragging everything else along for the ride.

In the bond market, Treasury yields continue to edge lower, down -1bp this morning and European sovereign yields are all lower by between -2bps and-3bps.  That is somewhat interesting given the flash Eurozone inflation data printed higher than expected at 2.6% headline, 2.9% core, but the market is clearly going all-in on the rate cutting narrative.  The big moves in this market, though, came in Asia with JGB yields jumping 5bps after the rate hike and the BOJ’s announcement they would be reducing their monthly purchases by 50%…OVER THE NEXT TWO YEARS!  They are not exactly rushing to tighten policy.  However, even more impressive was the -16bp decline in Australian 10yr bond yields after softer than expected inflation data overnight got the market thinking about rate cuts instead of the previous view of rate hikes being the next move.

In the commodity markets, things have really broken out.  Oil (+3.5%) is finally paying attention to the escalation of hostilities in the Middle East after Hamas leader Haniyeh was killed while in Iran.  While Israel has not officially claimed the act, that is the assumption and concerns are elevated that there will be a more dramatic response impacting many oil producing nations.  This has encouraged the rally in precious metals with gold (+0.4%) continuing its rally after a >1% gain yesterday, and support for both silver and copper as well.  Frankly, the copper story doesn’t make that much sense given the ongoing lackluster economic growth story, but with the metal’s recent sharp decline, this could simply be a trading bounce.

Finally, the dollar is all over the place this morning.  As mentioned above, the yen is today’s big winner, but we have seen strength in CNY (+0.25%) and KRW (+0.85%) as well, with both those currencies directly aided by yen strength.  Meanwhile, AUD (-0.5%) has responded to the quickly evolving rate story Down Under and is cementing its position as the worst performing G10 currency in July.  Not surprisingly, the commodity linked currencies are having a good day with ZAR (+0.6%) and NOK (+0.5%) both stronger, but after that, the financially linked currencies are not doing very much, so the euro, pound, Loonie and Swiss franc are all only marginally changed on the day.

In addition to the ADP and the FOMC, this morning also brings the Treasury’s QRA, although there is little interest in that report this time around as expectations remain that there will be no major change to the recent mix of debt, i.e., mostly T-bills.  We also see Chicago PMI (exp 44.5) and get the EIA oil data, although the latter will have a hard time competing with a pending war in the Middle East.

All told, not only has a lot happened, but there is also room for a lot more to occur before we go home today.  Quite frankly, I don’t see anything extraordinary coming from Powell, but the risk, to me, is he is more dovish than required and the dollar falls more broadly while commodity prices rise.  Keep your eye on that 150 level in USDJPY, as a break there can really get things moving.

Good luck

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German Malaise

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With central bank meetings ahead
Tonight BOJ, then the Fed
The discourse today’s
On German malaise
And why vs. the PIGS its widespread
 


As investors await the news from Ueda-san tonight and Chairman Powell tomorrow, the market discussion has revolved around the potential problems that Madame Lagarde is going to have going forward given the split in economic outcomes within the Eurozone.  As can be seen in the below graph, German GDP growth (grey bars) has been running at a negative rate for the past 4 quarters.  But you can also see that the situation in both Spain (red bars) and Italy (blue bars) has been the opposite, with both of those nations maintaining a steady pace of growth.

 

Source: tradingeconomics.com

So, while Germany is the largest single economy within the Eurozone, its current trajectory is very different than much of the rest of the bloc, ironically specifically the PIGS.  Should the ECB ignore German weakness and manage monetary policy toward the overall group?  Or should they ease more aggressively in order to support the Germans while risking a rebound in still sticky inflation?

Perhaps the first thing to answer is why Germany has been suffering for so long. This is an easy question to answer. Germany’s energy policy, Energiewende, has been an unmitigated disaster.  Their efforts to address climate change have led to the highest energy costs in Europe which, not surprisingly, has resulted in a massive reduction in manufacturing activity.  Areas where Germany had been supreme, like chemicals and autos, are hugely energy intensive industries, so as their cost of production rose, the companies moved their activities elsewhere.  Adding to the insanity was the policy to shutter their nuclear fleet, which had produced 10% of the nation’s electricity, during the post Ukraine invasion energy crisis.  And ultimately, this is the problem.  The cost of money is not Germany’s economic problem, it is their policies which have undermined their own growth ability.  While the ECB cannot ignore Germany outright, there is nothing they can do that will help the nation rebound in any meaningful way.  With that in mind, I would contend Lagarde needs to focus on the rest of the bloc to make sure policy suits them.  But that is a political discussion.

What are the likely impacts of this situation?  Eurozone growth, overall, surprised on the high side despite the lagging German data.  As well, inflation readings released thus far this month have shown that prices remain sticky on the continent.  With that in mind, the idea the ECB needs to cut aggressively seems to make little sense.  This is not to say they will maintain tighter policy, just that it doesn’t seem justified to ease.  But right now, the market zeitgeist is all about easing monetary policy (except in Japan) so I expect they will do just that going forward.  With this in mind, it strikes that the euro (+0.15%) is going to struggle to rally from current levels absent a dramatic shift in Fed policy to aggressive rate cuts.  As to European bourses, I suspect that they will reflect each nations’ own circumstances, so the DAX seems likely to lag going forward.

Will he, or won’t he?
Though inflation’s been falling
Hiking pressure’s real
 
A quick thought regarding tonight’s BOJ meeting and whether Ueda-san believes that further rate hikes are appropriate for the Japanese economy.  As with many things Japanese, the proper move is not necessarily the obvious one.  A dispassionate view of the recent data trends shows that inflation (2.8%) has been sliding slowly, GDP growth (-0.5%) has been falling more quickly and Unemployment (2.5%) remains at levels consistent with the economy’s situation given the shrinking population.   On the surface, this does not seem like a situation where hiking is desperately needed except for one thing, the yen remains broadly weak.  The chart below shows that since the advent of Abenomics in 2011, the yen has lost 50% of its value. 

 

Source: tradingeconomics.com

Now, initially, that was a key plank of the Abenomics platform, weakening the yen to end deflation.  Well, kudos to them, 13 years later they have achieved that result.  But where do they go from here?  There is a growing belief that the BOJ is going to hike by 15bps tonight and bring their base rate up to 0.25%.  I disagree with this theory given the very clear recent direction of travel in the inflation data in Japan as despite the yen’s weakness, it dispels any notion that a rate hike is needed to push things along.  One positive of the weak yen is that the balance of trade has returned to surplus in Japan.  

Source: tradingeconomics.com

For decades, Japan ran a large positive trade balance but since the GFC, that situation has been far less consistent.  However, the trade balance remains an important domestic signal as to the strength of the economy and its recent return to surplus is welcomed by the Kishida government.  It is not clear how raising interest rates will help that situation.  Net, with inflation sliding and the economy under pressure, hiking interest rates does not make any sense to me.

Ok, let’s take a look at how markets have behaved overnight.  Yesterday’s lackluster US equity market performance was followed by very modest strength in Japan (+0.15%), although weakness throughout the rest of Asia with the Hang Seng (-1.4%) the laggard, although mainland Chinese (-0.6%) and Australian (-0.5%) shares also suffered.  Meanwhile, in Europe this morning bourses on the continent are higher by about 0.4% across the board after the Eurozone GDP data seemed to encourage optimism.  The UK (FTSE 100 -0.2%), however, is under a bit of pressure amid ongoing discussions in the new Labour government about the need for austerity.  At this hour (7:20) US futures are edging higher by about 0.25%.

In the bond market, after yesterday’s sharp decline in yields around the world, it has been far less exciting with Treasury yields edging down another basis point and European sovereigns either unchanged or 1bp lower.  Perhaps the most interesting things is that JGB yields fell 2bps overnight and the 10yr yield is now back below 1.00%.  That doesn’t seem like a market preparing for a rate hike there.

In the commodity space, everybody still hates commodities with oil (-0.5%) continuing its recent slide.  In fact, it is down nearly 10% in the past month (which is good for us as we refill our gas tanks).  In the metals markets, copper continues to slide, down another -1.5% this morning as optimism over economic and manufacturing activity around the world remains absent, especially in China.  For instance, the Politburo there met yesterday and pledged to help the domestic economy, although they did not lay out specific actions they would take.  Recall last week’s Third Plenum was also a disappointment, so until the market perceives China is back and growing rapidly, or that the global growth impulse without them is picking up, it seems that industrial metals will remain under pressure.  Gold (+0.4%) however, remains reasonably well bid as continued Asian central bank buying along with retail interest in Asia props up the price.

Finally, the dollar is generally under modest pressure although the outlier is the yen (-0.6%) which does not appear to be expecting a BOJ hike tonight.  But elsewhere, the movements in both the G10 and EMG blocs have been pretty limited overall, on the order of 0.15% – 0.35%.  It is hard to find an interesting story about any particular currency as a driver today.

On the data front, this morning brings the Case-Shiller Home Price Index (exp +6.7%), JOLTs Job Openings (8.0M) and the Consumer Confidence Index (99.7).  I keep looking at that Case-Shiller index and wondering when the housing portion of the inflation readings is going to decline given its consistent strength.  But really, I suspect that all eyes will be on Microsoft’s earnings this afternoon along with the other hundred plus names that are reporting today.  With the Fed coming tomorrow, macro is not important right now.  So, more lackluster trading seems the most likely outcome today, although with the opportunity for some fireworks starting around midnight when the BOJ statement comes out.

Good luck

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