Tag Archives: #BOJ

News Not to Like

Posted on by 
Before we all hear from Chair Jay
This morning we’ll see QRA
The question is will
The bond market kill
The vibe all things are okay

While no one expects a rate hike
Of late, there’s been news not to like
Both housing and wages
Have moved up in stages
Though as yet, there’s not been a spike

We are definitely in a period where there is a huge amount of new information to digest on a daily basis, whether it is data or policy actions by central banks and finance ministries.  During times like this, we have historically seen slightly less liquidity in markets as the big market-makers reduce their activity to prevent major blowups.  Of course, the result is that we have periods that are quite punctuated by sharp moves on the back of the latest soundbite.

So, with that in mind, let’s look at today’s stories.  Starting last night, we saw JGB yields rise to yet another new high for the move, touching 0.98%, before the BOJ executed an unscheduled bond-buying exercise to push back a bit.  Ultimately, the 10-year JGB closed back at 0.94%, but despite the brave words from Ueda-san yesterday, it is clear there will be no collapse in the JGB market.  They simply will not allow anything like that to happen.  At the same time, USDJPY retraced about 0.3% of its recent decline, but continues to hold above 151 for now.  We did hear from Kanda-san, the new Mr Yen, that they were watching carefully, but given the rise in JGB yields has been matched by the rise in Treasury yields, it is hard to get too bullish, yet, on the yen.  

This is the first big assumption that has not played out as anticipated.  Prior to the BOJ meeting, the working assumption was that when they adjusted YCC the yen would start to rally sharply.  My view has always been that the yen won’t rally sharply until the Fed changes their tune, and that is not yet in the cards.  If the BOJ intervenes, it is probably a good opportunity to sell at those firmer yen levels as until policies change, a weaker yen remains the most likely outcome.

Turning to the US, at 8:30 this morning the Treasury is due to announce the makeup of the $776 billion of debt they will be borrowing this quarter.  The key issue is how much will be short-dated T-bills and how much will be pushed out the curve.  The higher the percentage of long-dated issuance, the more pressure we will see on the bond market going forward.  The 10-year yield is already back to 4.90% this morning, rising another 3bps, and we are seeing pressure throughout Europe as well with yields there up between 1bp and 3bps except for Italian BTPs which have seen yields rise 9bps this morning.  That has taken the Bund-BTP spread back to 200bps, the place where the ECB starts to get concerned.

But back to the US, where a second key narrative assumption has been that housing prices would be falling, thus reducing pressure on the inflation metrics over time.  Alas, that assumption, too, has been called into question after yesterday’s Case Shiller home price data showed a rise in home prices across the country, back toward the peak seen in June 2022.  While the number of transactions continues to decline, given the reduction in both supply and demand it seems that it is still a sellers’ market.  If housing prices don’t decline, then it seems even more unlikely that rents will decline and that means that inflation is going to remain much stickier than the Fed would like to see.  This does not accord well with the thesis that a slowing economy is going to help bring down housing demand followed by slowing inflation.  

As well, there was another data point yesterday, the Employment Cost Index, which rose a more than expected 1.1% Q/Q, and looking at the chart of its recent movement, shows little inclination that it is heading lower.  This is a key data point for the Fed as rising wages is something of which they are greatly afraid given the belief in its impact on prices.  While the White House may have celebrated the UAW’s ability to extract significant gains from the big three automakers, I’m guessing the Fed was a bit more circumspect on the effects those wage gains will have on overall wages in the economy and inflation accordingly.  

Adding all this up tells me that the ongoing belief that inflation is going to be declining steadily going forward, thus allowing the Fed to reduce the Fed funds rate and achieve the highly sought soft-landing is in for a rude awakening.  Rather, I remain quite concerned that monetary policy is going to remain much tighter for much longer than the market bulls believe.  And that means that I remain quite concerned equity multiples will derate lower along with equity markets overall.

Turning to the overnight price action, after a late rebound in the US taking all three major indices higher on the day, though just by 0.3% or so, we saw a big boost in Tokyo, with the Nikkei jumping 2.4%, as it seems there is joy in the idea that the BOJ may allow yields to rise further.  Either that or they were happy to see the BOJ buy bonds, I can’t tell which!  Europe, though, is a touch softer this morning with very marginal declines and US futures markets are looking to reverse yesterday’s gains, all -0.35% or so, at this hour (8:00).

Oil prices are higher this morning, up 1.8% as concerns about escalation in the Middle East seem to be growing after some comments about a wider war and further attacks by both Iranian and Hamas leaders.  Gold is little changed today but did suffer in yesterday’s month end activity although copper is firmer this morning in something of a surprise given the continuing weak PMI data we have been seeing.

Finally, the dollar continues to flex its muscles as the DXY is back just below 107 with both the euro and pound lower this morning by about -0.25%, and virtually all EEMEA currencies under pressure as well.  Other than the yen’s modest rebound, the dollar is higher vs. just about everything.

On the data front, in addition to the QRA and the FOMC later this afternoon, we see ISM Manufacturing (exp 49.0), Construction Spending (0.5%) and JOLTS Job Openings (9.25M).  Overnight we saw weaker PMI data from Japan (48.7) and China (Caixin 49.5), although for some reason, European PMI data is not released until tomorrow.

At this point, it is very much a wait and see session but as far as I can tell, the big picture has not yet changed.  Inflation remains stickier than the Fed wants, and the market seems to believe which leads me to believe we are going to see yields remain higher for quite a while yet.  I would estimate we will see 5.5% 10-year yields before we see 4.5% yields and if that is the direction of travel, equity markets are going to have a tough time while the dollar maintains its bid.

Good luck

Adf

A Loose Upper Bound

Posted on by 
One percent is now
A loose upper bound, rather
Than a key level

Yen participants
Saw a signal to sell.  Is
Intervention next?

Below is what appears, to me at least, to be the critical comment from the BOJ after last night’s policy meeting.  As well, that graphic comes straight from the BOJ presentation.

“It is appropriate for the Bank to increase the flexibility in the conduct of yield-curve control, so that long-term interest rates will be formed smoothly in financial markets in response to future developments.”

The essence of this is that YCC as we knew it, where the control part was the key, is now dead.  Instead, Ueda-san is going to allow a great deal more leeway for the market to determine the yield on the 10-year JGB, and the entire yield curve there.  While they have not yet adjusted the policy rate, which remains at -0.10%, I imagine that change is only a matter of time.  Remember, though, the BOJ currently owns somewhere around 56% of the outstanding JGBs in the market.  It is very clear they are not going to sell any.  To me the question, which I did not see answered last night, is whether they will replace the bonds in their portfolio when old ones mature.  There was no mention of QT, but I guess we will have to see.  Based on their history, however, I would expect that the current balance of JGB’s they own will remain pretty constant going forward, at least on a nominal basis.  Given the Japanese government continues to run deficits, that will eventually reduce the percentage of holdings.  Of course, I suspect that this is subject to change if things get politically uncomfortable, but we shall see.

The market response was somewhat counter to what might have been expected.  Arguably, many were looking for a yen rally as higher yields in Japan would create a greater incentive for Japanese institutional investors to bring their money home.  But that is not what happened at all.  This morning, USDJPY is firmly above 150.00 with no hint that there is intervention coming anytime soon.  It seems, at least for now, that the MOF and BOJ are going to allow markets to find a new level by themselves.  If that is the case, I expect that USDJPY is going to revert to form and follow USD interest rates.  In fact, that is really the key, and something about which I have written in the past.  When the Fed turns their policy toward easier money, at that time the dollar will come under significant pressure.  However, until then, the dollar remains the place to be.

In China, the data has shown
The ‘conomy’s not really grown
Will Xi add more cash
To try for a splash
Or will he leave things on their own?

The other news overnight was from China where their PMI data proved weaker than expected for both manufacturing and services with the former falling back below the key 50.0 level at 49.5 and the latter falling to its lowest print since last December during the zero-Covid policy Xi had implemented.  It seems that slowing growth around most of the world plus a limited domestic economic impulse combined with the ongoing collapse of the Chinese property market is just too much to overcome right now.  Expectations are that Xi will agree to yet more stimulus (remember earlier this month they put forth a CNY 1 trillion (~$137 billion) plan, but that has not seemed to have had the desired impact.  At least not yet.  While Japanese equities rallied on the back of the BOJ activity, Chinese equities came under pressure, especially the Hang Seng (-1.6%) although mainland shares fell as well.  As to the renminbi, it continues to grind lower (dollar higher) and remains pegged at the 2% boundary vs. the PBOC’s daily fixing rate.  Nothing has changed my view of further weakness in the renminbi going forward, at least as long as the Fed retains its current policy stance.

If I were to sum up the situation in Asia at this time, I would suggest that the two major economies there are both very busy dealing with substantial domestic economic questions, although those questions are different in nature.  Japan is trying to come to grips with rising inflation absent substantial economic growth while China has a problem defined by weakening growth with inflation not a current issue.  But lack of growth is the common denominator here and as we have seen countless times around the world, I suspect we will see further fiscal stimulus in both nations before long.  

Of course, when it comes to fiscal stimulus, China and Japan are mere pikers compared to the US which has completely rewritten the record books on this matter.  And there is nothing that indicates the US is going to back off, at least while the current administration is in place, and likely the next regardless of the letter after the president’s name.  

On this subject, though, while yesterday I described the QRA as critical, the first part of the Treasury story was revealed yesterday morning when they announced that the funding requirement for Q4 would be $776 billion, some $75 billion less than the consensus estimates before the announcement.  But the key difference was that Secretary Yellen is aiming for an average TGA balance of “only” $750 billion, far less than some estimates of $1 trillion, and less than the current balance of $835 billion.  In fact, the difference between the current balance and the target is what makes up for the difference in the issuance estimates.  Under no circumstances should anyone believe that fiscal prudence is coming soon.

But this lower number has relieved some pressure in the bond market where we have seen yields slide a few more basis points this morning with the 10-year now trading at 4.83%.  This movement has been followed by the European sovereign market, where yields have fallen by between 4bps and 6bps across the board in sympathy.  In fact, the only major market that saw yields rise was the JGB market, where the 10yr yield is now at 0.93%, up 5 more bps from yesterday’s closing levels.  I suspect that we will be trading at 1.00% soon enough, and it will be quite interesting to see just how ‘nimble’ the BOJ will be if yields start to run higher more quickly.

As to equity markets, yesterday’s US rally has been followed by the European bourses, all up between 0.6% and 1.2% despite somewhat soft economic growth data released this morning.  However, Eurozone inflation data was also slightly softer than forecast and it seems traders are looking for the ECB to reverse to rate cuts sooner rather than later.  US futures, meanwhile, are very marginally firmer this morning as all eyes now turn toward tomorrow afternoon’s FOMC outcome.

Oil prices have bounced a bit, up 0.9%, but this seems to be a trading move rather than anything either fundamental or geopolitical.  Regarding the latter, the fact that the beginnings of the Israeli ground invasion of Gaza have not produced nearly the pyrotechnics feared, nor that the conflict has spread throughout the Middle East, at least not yet, has resulted in traders returning their attention to inventories and demand.  Slowing growth in most places around the world is likely the key driver right now.  As to gold, it has maintained its recent gains and is trading right at the $2000/oz level.  Clearly, there is a fear factor there, but remember, if the equity bulls are correct and the Fed is going to tell us they are done, that will be seen as dovish and we should see a reversal in the dollar, a rally in commodities, including gold, and an initial rally in stocks and bonds.  That is not my base case, but you cannot ignore the possibilities.

Finally, the dollar is best described as mixed today as the strength in USDJPY (+1.1%) has been offset by weakness in the greenback vs the euro (+0.4%) and the pound (+0.2%), as well as a number of EMG currencies (MXN +0.4%, PLN +0.5%, ZAR +0.6%).  If one considers the DXY, that is virtually unchanged on the day.

On the data front, this morning brings the Employment Cost Index (exp 1.0%), Case Shiller Home Prices (1.6%), Chicago PMI (45.0) and Consumer Confidence (100.0).  obviously, there are no Fed speakers as their meeting starts this morning and runs through tomorrow afternoon when we will see the statement and Powell will meet the press at 2:30.  

It seems to me like traders will be cautious ahead of the FOMC tomorrow.  I would think they would want more confirmation that the Fed has finished before running back into bonds as well as reversing the recent stock declines.  While the Fed is unlikely to do anything tomorrow, it will be all about the statement and press conference.  Til then, I suspect a quiet time.

Good luck

Adf

A Havoc Nightmare

Posted on by 
While real wages fall
Kishida’s polls fall faster
Will Ueda act?

The first big thing this week is tonight’s BOJ meeting where many in the market are anticipating another tweak to the current YCC framework.  I have seen several analysts calling for a widening of the band to +/- 1.25% from the current +/- 1.00%.  While current yields have yet to reach the cap, they continue to grind higher and are currently at 0.88%, new highs for the move.  Ironically, it is likely the BOJ will need to buy even more JGB’s if they make an adjustment as the wider band would give the green light for speculators to short bonds even more aggressively.  Recall, since they widened from 0.50% to 1.00%, there have been at least five unscheduled bond buying episodes by the BOJ, with the last one, just a week ago, being the largest to date.

One thing to remember about the BOJ is that the concept of central bank independence is not as strong in Japan as it is, perhaps, elsewhere in the Western world.  (Of course, it is not that strong elsewhere either, but Japan is closer to China on this front than the US).  At any rate, the most recent polls in Japan show that PM Kishida’s approval ratings have fallen to new lows for his tenure, with an approval of just 33% according to the most recent Nikkei poll.  And this was after the announcement that he was cutting taxes to help people deal with the consistently rising inflation in Japan.  While it has not grown to levels seen in the US or Europe, it is clearly far higher than they have seen there in more than a generation.

But it doesn’t seem to be enough.  Now, there is no requirement for an election until sometime in 2025, but that doesn’t mean Kishida-san won’t feel the pressure to do more.  And arguably, one of the things they can do to fight inflation is raise rates and see if the yen can recapture some of the 35%+ that it has declined over the past two years.  

So, will they act?  My one observation on this is that unlike the Fed, which never likes to surprise the market, the BOJ has figured out that they only way they can have an impact is if they do surprise the market.  Given that an increasing number of people are starting to look for this outcome, I think the probability of a BOJ policy change tonight is quite low.  I would not be surprised, if I am correct, to see USDJPY head back through 150 and start to grind to new highs above the 152+ peak seen just before the intervention last year.

Meanwhile, for the rest of the week
Both meetings and data might wreak
A havoc nightmare
So, traders, beware
Of comments or data that’s bleak

Beyond tonight’s BOJ meeting, the week is jam-packed with other potential market moving catalysts between central bank meetings (FOMC on Wednesday, BOE on Thursday) and important data including ISM (Wednesday) and NFP on Friday.  However, there is one other thing set to be released Wednesday morning, well before the FOMC announcement and that is the Quarterly Refunding Announcement (QRA).  While, as its name suggests, this is released every quarter, it has generally been relegated to the agate type of market information as a technical feature for bond traders.  But this time, it has gained far more interest given the combination of the bond market’s performance since the last QRA (yields are higher by 80ish basis points) and the fact that the government budget deficit is continuing to grow with many new forecasts for a $2 trillion deficit this year thus a need for even more borrowing. 

Back in August at the last QRA, the Treasury increased issuance more than anticipated which has been seen as one of the drivers of the recent bond market decline.  If they were to increase it significantly again, there is certainly concern that bond yields can move much higher still.  Now, the Treasury could issue more short-term T-bills to take pressure off the bond market but bills already represent about 22% of the total debt outstanding.  That is a couple of points higher than the top of the historic range of 15%-20% and may be seen as a point of contention.  The positive is that given T-bill yields are all above 5.3%, there will be plenty of demand for their issuance.  However, on the flip side, that means that refinancing will need to occur far more frequently and that makes it subject to market dislocations and disruptions.

Another key part of the discussion will be just how large Secretary Yellen wants to keep the Treasury General Account (TGA), which is the government’s ‘checking’ account at the Fed.  As of Thursday, it held $835 billion and there has been talk she wants to increase it to $1 trillion to make sure the government has ample liquidity going forward, especially if there is another issue regarding government financing in Congress.  Historically, the Treasury has issued bills when they are seeking to build up balances in the TGA, which would tend toward seeing even more bills issued rather than substantial growth in the longer-dated maturities.  All in all, it is possible the QRA is going to have the largest potential impact on markets this week so beware.

In truth, the overnight session has been somewhat dull.  While the Israeli-Palestinian situation has seemed to enter a new phase regarding Israel’s incursion into Gaza, markets are non-plussed over the matter with bond yields little changed across the board, the dollar little changed across the board and oil prices sliding (-1.5%) this morning.  Even gold (-0.6%), which has been the best performer in the wake of the middle east crisis, has slipped back below the $2000/oz level, although remains higher by almost 10% in the past month.

In fact, the one area where things are moving is in equity space where we are seeing gains across the board in Europe, somewhere between 0.5% and 1.1%, in the major bourses as inflation data there showed that price rises have begun to slow down and Germany’s economy “only” shrunk by -0.1% in Q3, a much better than expected outcome!  US futures are also higher at this hour (7:15), up by 0.5% or so after a pretty awful week last week.  In fact, the only real outlier was Japan where the Nikkei slid -0.5% as Chinese shares were stronger along with most of the APAC markets.

As mentioned earlier, though, we do have a lot of news coming out this week so let’s go through it here:

TuesdayBOJ Rate Decision-0.1% (unchanged)
 BOJ YCC+ / – 1.00% (unchanged)
 Case Shiller Home Prices1.6%
 Chicago PMI45
 Consumer Confidence100
WednesdayADP Employment150K
 QRA$114 billion (+$11 billion)
 ISM Manufacturing49.0
 JOLTS Job Openings9.2M
 Construction Spending0.4%
 FOMC Decision5.5% (unchanged)
ThursdayBOE Decision5.25% (unchanged)
 Initial Claims210K
 Continuing Claims1795K
 Nonfarm Productivity4.0%
 Unit Labor Costs0.8%
 Factory Orders1.9%
FridayNonfarm Payrolls188K
 Private Payrolls145K
 Manufacturing Payrolls0K
 Unemployment Rate3.8%
 Average Hourly Earnings0.3% (4.0% Y/Y)
 Average Weekly Hours34.4
 ISM Services53.0

Source: tradingeconomics.com

So, as you can see, there is a lot of stuff coming our way starting tonight in Tokyo.  What that tells me is that we are not likely to see very much movement today as traders and investors await the plethora of new information that is due.  However, by the end of the week, we could have a very different narrative.  

Good luck

Adf

Problems Squared

Posted on by 
As the yen weakens
Suzuki-san tries to warn
This time he means it!

Another day, another new low for the Japanese yen.  USDJPY traded above 149.00 early this morning for the first time since October 2022 (chart below) and this clearly has the Finmin, Shunichi Suzuki spooked.  While I don’t understand the actual comment he made, “As I said at the morning press conference, I’m watching market trends with a high sense of urgency,” based on the fact the dollar did pull back a bit, I guess market participants got the message.  But how can you watch something urgently?  

Source: Tradingeconomics.com

Regardless of his fractured English, the fact remains that USDJPY has risen near the levels it reached last autumn and which resulted in aggressive intervention in the FX markets.  The point is we know they will step into the market so for those of you with immediate needs, be wary.

However, there is exactly zero indication that the BOJ is going to alter its monetary policy stance at this time, nor any indication that the Fed is going to do so either.  Ultimately, those diverging policies are the driver here and without a change in the underlying conditions, this trend should continue.  Perhaps Ueda-san will recognize that CPI running at 3.3% for the past twelve months is an indication that it is sustainable at these levels and change his tune.  But not so far.  With spot at this level, I am a strong proponent of utilizing options to hedge against further yen weakness.  Using them will allow hedgers to take advantage of a pullback, if it comes, but remain protected in the event that their new target is 160, for example.

Said Dimon, nobody’s prepared
And frankly, we all should be scared
A quick rates ascent
To seven percent
Will end up with our problems squared

I guess the question becomes, to whom should we listen, Jamie Dimon or Jay Powell?  In an interview with the Times of India yesterday, Dimon indicated he thought Fed funds could rise as high as 7% and that nobody was prepared for that outcome.  I certainly agree nobody is prepared for that outcome (I wonder if JPM is?) but of more interest is the fact that his comments are quite different than what we have heard from the ostensible powers-that-be at the FOMC.  Last week Chair Powell indicated they remained data dependent but that another hike was reasonable.  Yesterday we heard from erstwhile dove, Austan Goolsbee, the Chicago Fed president, that higher for longer was appropriate, a sign that even the doves are willing to wait a long time before pushing for rate cuts.  But Dimon was clear he thought things would play out differently.

Considering the two sources, I am more inclined to accept Dimon’s worldview than Powell’s as Dimon has fewer political restrictions.  In addition, given JPMChase is the largest bank in the nation, he is likely privy to a lot of information that may not be clear to the Fed.  But, boy, 7% would really throw a monkey wrench into the works.  While equity markets have worked very hard to ignore the ongoing rise in interest rates thus far, Fed funds at 6%, let alone 7% would seem to be a bridge too far.  If the Fed does feel forced to keep raising rates because CPI/PCE continues above target and the Unemployment Rate remains low, 4% or lower, it feels to me like the equity market would reprice pretty dramatically lower.  This is not my base case, but at this point, I would not rule out any outcome.

So, how have markets behaved with this new information?  Well, equity markets, which had a late rally in the US yesterday, have been under pressure around the world.  Meanwhile, bond yields continue to rise and the dollar remains in fine fettle.  Let’s take a look.

Asia was almost entirely in the red last night, certainly all the major markets were down led by the Nikkei (-1.1%) but all Chinese and Korean shares as well.  As to Europe, while the FTSE 100 has managed to stay relatively unchanged, the continent is entirely under water with losses on the order of -0.6% or so.  Finally, US futures are currently (7:30) lower by -0.3% or so, although that is off the worst levels of the overnight session.  It seems that the continued grind higher in yields around the world is taking its toll on the equity bull story.

Speaking of yields, yesterday saw the 10yr Treasury yield touch 4.56%, a new high for the move, although it has since backed off a few basis points and is currently around 4.50%.  But Treasury yields aren’t the only ones rising as we are seeing German bund yields at their highest levels since 2011, during the Eurozone bond crisis, and the same is true with French OATs and most of the continent.  Gilts, too, are pressing higher overall, and while this morning they have backed off 3bps-5bps, the trend remains clearly higher.

Oil prices are finally backing off a bit, down 1.1% this morning and 2% in the past week, although they remain quite high overall.  This movement has all the earmarks of a trading correction rather than a fundamental shift in the supply/demand balance.  The latest data that is out shows that global daily demand is up to ~102 mm bbl/day while supply is just under 100 mm bbl/day.  That trend cannot continue without oil prices rising substantially over time.  As to the metals markets, base metals continue to feel the pressure of a weakening economy while gold continues to suffer on the back of high interest rates, although it remains firmly above $1900/oz.

Lastly, the dollar is just a touch softer this morning although it remains near its recent highs.  We discussed the yen above, which is now unchanged on the day, although off earlier session highs for the dollar.  The euro has regained 1.06, although its grip there seems tenuous and a fall to 1.05 and below seems likely as the autumn progresses.  The pound, meanwhile, is below 1.22 and looking at the charts, a move to 1.18 or so seems very realistic, especially if we continue to hear hawkishness from the Fed.

As to emerging market currencies, the PBOC continues to try to hold back the yuan, although it is trading quite close to its 2% band from the CFETS fixing.  Meanwhile, KRW (-0.8%), IDR (-0.6%) and THB (-0.4%) are all falling as they are not getting that central bank support.  EEMEA currencies are also under pressure led by ZAR (-1.25%) which is suffering on the commodities market selloff.

On the data front, we see our first data of note this week with Case Shiller Home Prices (exp -0.3%), Consumer Confidence (105.5) and New Home Sales (700K).  We also hear from Fed Governor Bowman this afternoon and will see oil inventories late in the day, where continued drawdowns are expected.

Market sentiment is not happy with concerns growing that the Fed really means what they are saying and that interest rates are going to remain at these or higher levels for a while yet.  While the big data points continue to show the economy is hanging on, there are a growing number of ancillary data points that indicate a less robust economic future.  Unfortunately, I think that is going to be the outcome, although it will not be enough to drive inflation down to acceptable levels.  The coming stagflation should see weakness in both bonds and equities while the dollar continues to find buyers all around the world.

Good luck

Adf

Aghast

Posted on by 
The BOJ did
Absolutely nothing new
Can we be surprised?

The last of the key central bank meetings finished last night with the BOJ not only leaving policy on hold, as expected, but not even hinting that changes were in the offing.  Much had been made earlier this month about a comment from Ueda-san that they may soon have enough information to consider policy changes.  This was understood to mean that YCC might be ending soon.  Oops!  If that is going to be the case, it was not evident last night.  Rather, the status quo seems the long-term view in Tokyo right now.  Not surprisingly, the yen suffered accordingly, selling off another -0.5% overnight and is now back at its weakest point (highest dollar) since October 2022 when the BOJ intervened actively.

Also, not surprisingly, after the yen weakened further, we started to hear from the MOF trying to scare the market.  FinMin Shunichi Suzuki once again explained that he would not rule out any actions with respect to the currency market if volatility (read depreciation) increased too much.  But as of yet, there have been no BOJ sightings and I suspect they will not enter the market until 150.00 is breached once again.  Maybe next week.

With central bank meetings now past
The markets’ response has been fast
It seems there’s a pox
On both bonds and stocks
And owners of both are aghast

While further rate hikes may be rare
Investors feel some small despair
No rate cuts are planned
Throughout any land
And bond yields are now on a tear

Turning to the rest of the G10, what was made clear over the past two weeks is that policy rates are not anticipated to fall anytime soon.  While some central banks seemed to finish for sure (ECB, SNB, BOE) others seem like there may be another in the pipeline (Fed, Riksbank, Norgesbank, BOC, RBA), but in no case is there a discussion that inflation has reached a place of comfort for any central bank.  Rather, even those banks on hold seem comfortable that policy rates need to remain at current levels in order to continue to battle the scourge of inflation.  If anything, the hawks from most central banks continue to push for further tightening, although I suspect that will be a difficult hill to climb given the inherent dovishness of most central bank chiefs.

So, what are we to expect if this is the new home for interest rates rather than the ZIRP/NIRP to which we had become accustomed for the past 15 years?  The first thing to consider is that despite the higher rate structure, the financial position of the private sector, at least in the US, remains strong.  Corporates termed out debt and tend toward being cash rich, so for now, they are benefitting from high interest rates as they locked in low financing and are earning the carry.  Many households are in the same position, having refinanced home mortgages at extremely low rates so are not feeling the pain of the recent rise in mortgage rates.  Of course, this has reduced the amount of activity in the housing market and is a problem for first-time buyers, but that is not the majority, so net, the pain is not so great.

However, the US is unique in this situation as most of the rest of the world are beholden to short-term rates in their financing.  This is true in the commercial sector, where bank lending is a far more important part of the capital structure than public debt.  Those loans are floating, which is also true in the household sector where most mortgages elsewhere have 5-year fixed terms and so are already repricing higher and impacting homeowners.  In fact, if you want one reason as to why the US is likely to outperform the rest of the world, this would be a good place to start.  Despite much higher interest rates, the pain is not being felt across much of the US economy while it is being felt acutely throughout Europe and the UK.  

The upshot of this process is that inflation is likely to remain with us for quite a while going forward.  This means that central banks are going to have a great deal of difficulty reversing course absent a major crash in economic activity.  Given the US tends to lead the world’s capital markets, it also means that the combination of continuing gargantuan issuance by the Treasury to finance the never-ending budget deficits along with the stickiness of inflation implies that interest rates need to be higher.  We saw this price action yesterday with 10yr Treasury yields jumping to 4.5%, another new high for the move, and importantly, a larger move than the 2yr yield.  This is the ‘bear steepening’ that I have been writing about, with longer end yields rising faster than shorter yields.  Ultimately, this will be quite a negative for risk assets, especially paper ones, although hard assets ought to benefit.  The world that we knew has changed, so we all need to adjust accordingly.

Turning to the overnight session, yesterday’s US weakness was followed by Japan (-0.5%) but Chinese shares bucked the trend, rising strongly on hopes that the recent data shows the worst is past for the mainland.  That seems odd given the lack of additional stimulus forthcoming from the government, but that is the story.  European shares are mostly a bit lower this morning after flash PMI data was released showing growth in the Eurozone remains elusive.  Germany is still in dire straits with its Manufacturing PMI <40, but the whole of Europe is sub 50 for the past four months at least.  Finally, US futures are bouncing slightly this morning, but that seems like a trading reaction to two consecutive days of sharp losses rather than new optimism.

Other than YK Gilts, which traded at much higher levels back in August, European sovereigns are following Treasury yields to their highest level in more than a decade.  And despite the weak economic story, the fact remains that sticky inflation is the clear driver for now.  Consider that the ECB has essentially explained they have finished raising rates with their policy rate at 4.0% while CPI is running at 5.2% headline and 5.3% core.  Those numbers do not inspire confidence that the ECB has done its job.  I continue to look for higher long-term yields going forward.

Part of the reason for this is that oil (+0.9%) continues to find support.  While it had a couple of days of a modest pullback, we are back above $90/bbl and the news remains bullish the outcome.  The latest is the Russia is halting deliveries of diesel fuel, a particular sore spot as there are already tight supplies around the world, especially here in the US.  I see no reason for oil to decline structurally, and that is going to continue to pressure inflation higher.  Perhaps of more interest is the fact that the metals complex is rallying today, despite the rise in interest rates.  Gold (+0.3%), silver (+1.3%), copper (+0.8%) and aluminum (+1.1%) are all in the green.  Again, I would say that owning hard assets is going to be a better outcome than paper ones.

Finally, the dollar is mixed this morning, showing gains against the euro, pound and yen, but softer vs. the commodity bloc with AUD, NZD, CAD and NOK all firmer this morning.  As well, EMG currencies are having a better session, rising a bit vs. the greenback, but recall, the dollar has had quite a good run lately.  My take is there is a lot of profit-taking as we head into the weekend given the lack of fundamental stories that would undermine the buck.  Nothing has changed my view it has further to rise.

On the data front, the only releases are the flash PMIs here (exp 48.0 Manufacturing, 50.6 Services) and we get our first Fed speaker, Governor Lisa Cook, a confirmed dove.  We have already had a lot of activity this week so I suspect that heading into the weekend, it is going to be a quiet session as traders and investors start to plan for next week’s excitement.

Good luck and good weekend
Adf

Concerns Are Severe

Posted on by 
One look at the dot plot makes clear
Inflation concerns are severe
So, higher for longer
Is growing still stronger
And Jay implied few cuts next year

First, let’s recap the FOMC meeting.  The term hawkish pause had been used prior to the meeting as an expectation, and I guess that was a pretty apt description.  While they left policy on hold, as expected, the change in the dot plots, as seen below, indicate that even the doves on the Fed see fewer rate cuts next year, with just two now priced in from four priced in June.

Source: Fedreserve.gov

A quick reading shows that a majority of members expect one more hike this year, and now the median expectation for the end of 2024 has moved up to 5.125%, so 50bps lower than the median expectation for the end of 2023 and 50bps higher than the June plot.  To me, what is truly fascinating is the dispersion of expectations in 2025 and 2026, where there are clearly many opinions.  And finally, the longer run expectation has risen to 2.5% with many more members thinking it should be even higher than that.  The so-called neutral rate estimations seem to be creeping higher.  If you think about it, that makes some sense.  After all, given the ongoing forecasts for continued labor market tightness due to demographic concerns, and add in the massive budget deficits leading to significantly higher Treasury debt issuance, there is going to be pressure on rates to find a higher level.

The market response was quite negative, albeit not immediately, only after Powell started speaking.  But in the end, equity markets fell across the board in the US, with the NASDAQ taking the news the hardest, down -1.5%, as its similarity to long duration bonds was made evident.  Asian markets all fell overnight as well, with most tumbling more than -1.0% and European bourses are all under similar pressure, down -1.0% or so as well.  The one exception in Europe is Switzerland, where the SNB surprised the market and left rates on hold resulting in a weaker CHF and a very modest gain in their equity market.

However, the bigger market response was arguably in bonds, where yields rose to new highs for the move with the 2yr at 5.15% and the 10yr at 4.43%.  Once again, I point to the significant increase in debt that will be forthcoming from the US Treasury as they need to fund those budget deficits.  I have been making the case that a bear steepener would be the more likely outcome for the US yield curve.  That is where long-term rates rise more quickly than short-term rates due to the US fiscal policy and shrinking demand for US debt by key players, notably the Fed, but also China and Japan.  Nothing has changed that view.

Then early this morning, up north
Both Sweden and Norway brought forth
A quarter point hike
To act as a dike
Preventing price rises henceforth

After the Fed’s hawkish pause, we turn our attention to Europe, where the early movers, Sweden and Norway, both hiked twenty-five basis points, as expected, while both hinted that further hikes are not out of the question.  Inflation remains higher than target in both nations and in both cases, the currency has been relatively weak overall.  Switzerland left rates on hold, pointing to the fact that for the past three months, inflation has been within their target range, and they are beginning to see downward pressure on economic activity which they believe will keep that trend intact.

And lastly, from London we’ve learned
Another rate hike has been spurned
Though voting was tight
They said they’re alright
With waiting to see if things turned

As to the bigger story, the UK, expectations were split on a hike after yesterday’s tamer than expected CPI report while the pound fell ahead of the news.  And the change in expectations was appropriate as in a 5-4 vote, the BOE opted to remain on hold for the first time in two years.  They see that inflation may be easing more rapidly than previously expected, and they are concerned about overtightening.  While I have a hard time understanding how a 5.15% Base rate is tight compared to CPI running at 6.7% and core at 6.2%, I am clearly not a central banker.  At any rate, the pound fell further on the news and is now at its lowest level since March, while the FTSE 100 rallied back and is close to flat on the day from down nearly -1.0% before the announcement.  Gilt yields, however, are moving higher as the bond market there doesn’t seem to believe that the BOE is serious about fighting inflation.

And really, those are today’s key stories.  Late yesterday, Banco Central do Brazil cut the SELIC rate by 0.50%, as expected, and at the same time the BOE announced, the Central Bank of Turkey raised their refinancing rate by 5 full percentage points, to 30.0%, exactly as expected.  And to think, we get concerned over rates at 5%!

As to the rest of the day, there is a bunch of US data as follows: Philly Fed (exp -0.7), Initial claims (225K), Continuing Claims (1695K), Existing Home Sales (4.1M) and Leading Indicators (-0.5%).  As is typical, there are no Fed speakers scheduled the day after the FOMC meeting, but we will start to hear from them again tomorrow.

Putting it all together tells me that the Fed is not nearly ready to back off their current stance and will need to see substantial weakness in economic activity before changing their mind.  Meanwhile, last week’s ECB meeting and this morning’s BOE meeting tell me that the pain of higher interest rates in Europe is becoming palpable and the central banks are leaning more toward inflation as an outcome despite their mandates.  This continues to bode well for the dollar as the US remains the place with the highest available returns in the G10.

Tonight, we hear from the BOJ, where no change is expected.  I would contend, though, that the risk is there is some level of hawkishness that comes from that meeting as being more dovish seems an impossibility.  As such, there is a risk that the yen could see some short-term strength.  Keep that in mind as you look for your hedging levels.  

Good luck

Adf

Some Dismay

Posted on by 
While everyone’s certain that Jay
Will leave rates alone come Wednesday
The curve’s longer end
Is starting to trend
Toward rates that might cause some dismay

The problem remains his frustration
That he can do naught ‘bout inflation
As oil keeps rising
It’s demoralizing
For Jay and his rate formulation

The overnight session was quite dull overall with virtually no new data or information on the macroeconomic front and a limited amount of commentary from the central banking and financial poohbahs of the world.  Friday’s desultory US equity market performance was followed by a mixed session in Asia while European bourses are all in the red after the Bundesbank indicated that Germany would have negative growth in Q3.  As well, after last week’s ECB rate hike, we did hear from one of the more hawkish members that further hikes are possible, although listening to Madame Lagarde’s comments, that seems quite a high bar at this time.

So, given the limited amount of new information, it seems that it is time for central bank prognostications.  The first thing to note is that while the Fed is certainly the main act this week, there are no less than a dozen other major interest rate decisions due this week including the BOE, BOJ, PBOC, Swedish Riksbank, Norgesbank, SNB and Banco Central do Brazil.  

While much has been written about the FOMC on Wednesday, with the current market pricing just less than a 1% probability of a hike, the European banks that are meeting are all expected to follow the ECB and hike by 25bps.  Meanwhile, the PBOC remains caught between a rock (slowing economic growth) and a hard place (a weakening currency) and seems highly likely to follow the Fed’s lead and leave rates on hold.  

The BOJ is also very likely to leave their rate structure on hold, but questions keep arising regarding any other potential tweaks to the YCC framework.  However, given the relatively strong denials of anything like that from Ueda-san at the end of last week, I am inclined to believe they are comfortable where they are.  

Finally, a look down south shows that Brazil is forecast to cut the SELIC rate (their Fed funds equivalent) by 50bps to 12.75% with a handful of analysts calling for a 75bp cut.  Of course, inflation in Brazil has fallen from effectively 12% last summer to 4.65% now, so real rates are still remarkably high there which is the key reason the real has been such a great performer over the past twelve months, having risen ~8%.

The only market that is really showing much movement is oil, which is higher yet again this morning, by another 0.5% and now above $91/bbl.  It is becoming very clear that the OPEC+ production cuts are having the impact that MBS desired, with tightening supply meeting ongoing demand growth, despite slowing economic activity.  The one thing that should remain abundantly clear to all is that no amount of effort by Western governments to reduce demand for fossil fuels is going to have the desired impact as developing nations will not be denied their opportunities to improve their own economic situation and that generally takes access to energy.  To date, fossil fuels continue to prove to be the most cost-effective and efficient sources, so that demand will just not abate.  Oil prices are going to continue to head higher, mark my words.

And truthfully, on this rainy Monday morning in NY, that is pretty much all the excitement that we have ongoing.  The data this week is focused on Housing and expectations are as follows:

TuesdayHousing Starts1437K
 Building Permits1440K
WednesdayFOMC Rate Decision5.50% (current 5.50%)
ThursdayInitial Claims225K
 Continuing Claims1695K
 Philly Fed-1.0
 Existing Home Sales4.10M
 Leading Indicators-0.5%
FridayFlash PMI Manufacturing48.2
 Flash PMI Services50.6

Source: Bloomberg

A side note regarding the data is that the Leading Indicators Index is forecast to decline again, which will be the 17th consecutive decline, a very strong indication that future economic activity seems likely to suffer.  Of course, this is just one of the numerous signals of an impending recession (inverted yield curve, ISM/PMI sub 50.0, etc.) that have yet to play out as they have done historically.  Perhaps the UAW strikes will be enough to tip things over, especially if they widen in scope, but that seems premature. 

In addition, we are beginning to hear more about a potential government shutdown as the House has not yet completed its funding bills but my take here is that while the rhetoric may heat up, the reality is that a continuing resolution will be passed and that this is just another tempest in a teapot in Washington, SOP really.

When looking a little further ahead, I continue to see a far better chance that the Fed remains the most hawkish of the major central banks, and that higher for longer really means just that.  Economic activity elsewhere, notably in Europe and China, is suffering far more acutely than in the US, at least statistically, and that implies that this week’s rate hikes across the UK and the continent are very likely the end of the cycle.  I am not convinced that the Fed is done.  That combination leads me to continue to look for relative dollar strength over time.  For asset/receivables hedgers, keep that in mind.

Good luck

Adf

Goldilocks Dream

Posted on by 
It seems many thought the word ‘could’
Was feeble when posed against ‘would’
The fact Chairman Jay
Had phrased things that way
Last month, for the bulls, is all good

And so, the new narrative theme
Is Jay is convincing his team
No more hikes are needed
And they have succeeded
In reaching the Goldilocks dream

The following quote from a weekend WSJ article by Fed whisperer Nick Timiraos is almost laughable in my mind.  

            This is apparent from how Fed Chair Jerome Powell recently described the risk that firmer-than-expected economic activity would slow recent progress on inflation. Last month, he twice used the word “could” instead of the more muscular “would” to describe whether the Fed would tighten again.Evidence of stronger growth “could put further progress at risk and could warrant further tightening of monetary policy,” he said in Jackson Hole, Wyo.

Talk about parsing language to the nth degree!  I bolded the line that I found the most ridiculous, but as we all know, my view does not drive the markets nor policy.  However, as I had written last week, we have definitely seen a shift amongst some of the FOMC members with respect to the idea of another rate hike this year.  Timiraos is widely believed to have the inside track to Chairman Powell, and now that the FOMC is in their quiet period ahead of the September 20th meeting, this will be the mode of communication.  

I guess the big risk of going all in on the Fed is done is we are still awaiting CPI Wednesday morning and with energy prices continuing to climb, I fear the opportunity for a high surprise is very real.  Literally every story that is written in the mainstream media these days tries to talk up the prospects of the economy and, correspondingly, for further equity market gains.  To me, there is a lot of whistling past the graveyard here, but so far, equities have held in despite some weaker data.  The one thing I would highlight is the market feels quite complacent with implied volatility across numerous markets, stocks, bonds, commodities and FX, all quite low.  Hedge protection is cheap here, if you need to hedge something, don’t wait for the move.

Ueda explained
We may soon understand if
Inflation is back

“If we judge that Japan can achieve its inflation target even after ending negative rates, we’ll do so,” said Ueda.  This was the key sentence in a weekend interview published last night.  The market response was immediate with the yen jumping more than 1% in the early hours of Asian trading before ceding a large portion of those gains when Europe walked in the door.  However, regardless of today’s price action, there is a longer-term signal here that is important to understand.  It has become clear that the BOJ is becoming somewhat uncomfortable with the speed of the yen’s decline.  Prior to last night’s session, the yen had fallen 7.75% from July’s levels, which is a pretty big move for less than 2 months.  There is no secret to why the yen continues to decline, the vast policy differences between the US and Japan are sufficient reason.  While Ueda-san made no promises, this was very clearly a signal that a change is coming soon.  In the near-term, hedgers need to be very careful and those who are hedging JPY assets or revenues should really consider buying JPY puts outright or via collars as there is every reason to believe that further yen strength is coming by the end of the year.

Meanwhile, on the western edge of the Yellow Sea, the PBOC was quite vocal last night as well.  On the back of Chinese monetary data that showed a larger rebound than forecast in New Loan data as well as Aggregate Financing data, the PBOC issued the following statement, “Participants of the foreign exchange market should voluntarily maintain a stable market.  They should resolutely avoid behaviors that disturb market orders such as conducting speculative trades.”  That is very clear language that the PBOC is unhappy with the recent CNY performance.  In addition, the PBOC issued new regulations regarding large purchases of dollars telling banks that any corporate client that wants to purchase more than $50 million will need to get approval to do so, and that approval will take quite some time to be forthcoming.

It should be no surprise that the renminbi is stronger this morning, having rallied 0.65% and thus closing the gap with the CFETS fix for the first time in months.  Of course, given the double whammy of Japanese and Chinese policy implications, it should be no surprise that the dollar is softer overall.  Especially when considering the WSJ article explaining that the Fed may be finished hiking rates.  So, we have seen the dollar fall against all its counterparts in the G10 and most in the EMG blocs.  Aside from the yen (+0.65%), we have seen the most strength in AUD (+0.8%) which has benefitted from the overall Chinese story, both the currency issues and the better data, as well as the rise in commodity prices.  Kiwi (+0.55%) and SEK (+0.45%) are next on the list as there is broad-based dollar weakness today after an eight-week run higher.

In the emerging markets, ZAR (+1.1%) is actually the best performer on the commodity story as well as the general dollar weakness, but after that and CNY, HUF (+0.6%) is the only other currency in the bloc with substantial gains.  The story here is what appears to be a shift from zloty to forint as the market continues to punish PLN (-0.35%) after the surprisingly large rate cut last week by the central bank there.  Net, however, the dollar is clearly under pressure this morning.

If we turn to other markets, though, things don’t seem to make as much sense.  For instance, oil prices (-0.4%) are a bit softer while metals prices (AU +0.4%, CU +1.7%, AL +1.0%) are all firmer.  Now, the metals seem to be behaving well on the back of the dollar’s weakness, but oil’s decline is not consistent with that view.

In the equity markets, last night saw a mixed picture in Asia with the Nikkei (-0.4%) and Hang Seng (-0.6%) both under pressure while the CSI 300 (+0.75%) and ASX 200 (+0.5%) both responded well to the news.  For the Nikkei, the combination of prospects of higher rates and a stronger yen are both negative for Japanese stocks, while much of the rest of APAC benefitted from the Chinese story.  In Europe, the bourses are all green, averaging about +0.5% as investors continue to believe the ECB is done hiking rates with the market now pricing less than a 40% probability of a hike this week and not even one full hike priced into the curve over time.  US futures are also green as investors embrace the WSJ article’s hints that the Fed is done.

Finally, the big conundrum is the bond market, which is selling off across the board.  Or perhaps it is not such a conundrum.  If both the Fed and ECB are done hiking despite inflation continuing at a pace far above target, then the attractiveness of holding duration wanes dramatically.  Add to that the gargantuan amount of debt yet to be issued and the fact that the biggest buyers of the past decades, China and Japan, seem to be backing away from the market, and it will require much higher yields for these issues to clear.  Of course, one could also look at this as a risk-on session with stocks higher and bonds getting sold along with the dollar, so perhaps that is today’s explanation.  Just beware the movement here.  10-Year Treasury yields (+3bps) are back to 4.30%, and if the story is no more Fed tightening thus higher inflation, that is unlikely to be a long-term positive for equities.  At least that’s what history has shown.

On the data front, the back half of the week brings the interesting stuff.

TuesdayNFIB Small Biz Optimism91.5
WednesdayCPI0.6% (3.6% Y/Y)
 -ex food & energy0.2% (4.3% Y/Y)
ThursdayECB Rate Decision3.75% (current 3.75%)
 Initial Claims227K
 Continuing Claims1695K
 Retail Sales0.1%
 -ex autos0.4%
 PPI0.4% (1.3% Y/Y)
 -ex food & energy0.2% (2.2% Y/Y)
FridayEmpire Manufacturing-10.0
 IP0.1%
 Capacity Utilization79.3%
 Michigan Sentiment69.2

Source: Bloomberg

As we are in the Fed quiet period, there will be no Fedspeak, so it is all about the data this week.  Beware a hot CPI print as that will pressure the narrative of the soft landing.  This poet’s view is no soft landing is coming, rather a much harder one is in our future, but at this point, probably not until early next year.  Until then, and despite today’s news cycle, I still think the dollar is best placed to rally not fall.

Good luck

Adf

Quickly Slowing

Posted on by 
We will take action
Threatened Vice FinMin Kanda
If you speculate

“If these moves continue, the government will deal with them appropriately without ruling out any options.”  So said Vice FinMin Masato Kanda, the current Mr Yen.  Based on these comments, one might conclude that ‘evil’ speculators were taking over the FX market and distorting the true value of the yen.  One would be wrong.  The below chart shows the yields for 10yr JGBs vs 10yr Treasuries.  You may be able to see that the most recent readings show a widening in that yield spread in the Treasury’s favor.  It cannot be a surprise that investors continue to seek the highest return and the yen most certainly does not offer that opportunity.

While I don’t doubt there is a place where the BOJ/MOF will intervene, they know full well that the yen’s weakness is a policy choice, not a speculative outcome.  They simply don’t want to admit it.  The upshot is that the yen edged a bit higher overnight, just 0.2%, as market realities are simply too much for words to overcome.  The yen has further to fall unless/until the BOJ changes its monetary policy and ends YCC while allowing yields in Japan to rise.  Until then, nothing they can say will prevent this move.

While ECB hawks keep on screeching
More rate hikes are not overreaching
The data keeps showing
That growth’s quickly slowing
So, comments from Knot are just preaching

“I continue to think that hitting our inflation target of 2% at the end of 2025 is the bare minimum we have to deliver.  I would clearly be uncomfortable with any development that would shift that deadline even further out.  And I wouldn’t mind so much if it shifted forward a little bit.”   These are the words of Dutch central bank chief and ECB Governing Council member Klaas Knot.  As well, he intimated that the market might be underestimating the chance of a rate hike next week, which at the current time is showing a 33% probability. Another hawk, Slovak central bank chief Peter Kazimir also called for “one more step” next week on rates.  

The thing about these comments is they came in the wake of a German Factory Orders number that was the second worst of all time, -11.7%, which was only superseded by the Covid period in March 2020.  Otherwise, back to 1989, Factory Orders have never fallen so quickly in a month.  This is hardly indicative of an economy that is going to grow anytime soon.  Rather, it is indicative of an economy that has inflicted extraordinary harm to itself through terrible energy policies which have forced producers to leave the country.  

The key unknown is whether the slowing economic growth will also slow price growth.  Given oil’s continued recent strength, with no reason to think that process is going to change given the supply restrictions we have seen from the Saudis and Russia, I fear that Germany is setting up for a very long, cold winter in both meteorological and economic terms.  With the largest economy in the Eurozone set to decline further, it is very difficult to be excited at the prospect of a stronger euro at any point in time.  It feels to me like the late summer downtrend in the single currency has much further to go.  

This is especially true if the US economy is actually as resilient in Q3 as some economists are starting to say.  Yesterday, I mentioned the Atlanta Fed GDPNow number at 5.6%, but we are seeing mainstream economists start to raise their Q3 forecasts substantially at this point given the strength that was seen in July and August.  Not only will this weigh on the single currency, and support the dollar overall, but it may also put a crimp in the view that the Fed is done hiking rates.  Consider, if GDP in Q3 is 3.5% even, it will not encourage the Fed that inflation is going to slow naturally.  And while they may pause again this month, it seems highly likely they would hike again in November with that type of data.

Which takes us to the markets’ collective response to all this news.  Risk is definitely under some pressure as the combination of stickier inflation and slowing growth around the world is weighing on investors’ minds.  The only market to manage a gain overnight was the Nikkei (+0.6%) which continues to benefit from the weaker yen, ironically.  But China, which is also growing increasingly concerned over the renminbi’s slide, remains under pressure as do all the European bourses and US futures.  Good news is hard to find right now.

Meanwhile, bond investors are in a tough spot.  High inflation continues to weigh on prices, but softening growth, everywhere but in the US it seems, implies that yields should be softening with bond buyers more evident.  This morning, 10yr Treasury yields are lower by 2bp, but that is after rallying 16bps in the past 3 sessions, so it looks like a trading pullback, not a fundamental discussion.  But in Europe, sovereign yields are edging higher as concern grows the ECB will not be able to rein in inflation successfully.  As to JGB yields, they seem to have found a new home around 0.65%, certainly not high enough to encourage yen buying.

Oil prices (-0.1%) while consolidating this morning, continue to rally on the supply reduction story and WTI is back to its highest level since last November.  Truthfully, there is nothing that indicates oil prices are going to decline anytime soon, so keep that in mind for all needs.  At the same time, metals prices are mixed this morning with copper a bit softer and aluminum a bit firmer while gold is unchanged.  It seems like the base metals are torn between weak global economic activity and excess demand from the EV mandates that are proliferating around the world.  Lastly a word on uranium, which continues to trend higher as more and more countries recognize that if zero carbon emissions is the goal, nuclear power is the best, if not only, long term solution.  The price remains below the marginal cost of most production but is quickly climbing to a point where we may see new mining projects announced.  For now, though, it seems this price is going to continue to rise.

Finally, the dollar is mixed this morning, having fallen slightly vs. most G10 currencies, but rallied slightly vs. most EMG currencies.  This morning we will hear from the Bank of Canada, with expectations for another pause in their hiking cycle, but promises to hike again if needed.  Meanwhile, the outlier in the EMG bloc is MXN (-0.7%) which seems to be a victim of the overall risk situation as well as the belief that its remarkable strength over the past year might be a bit overdone.  In truth, this movement, five consecutive down days, looks corrective at this stage.

On the data front, we see the Trade Balance (exp -$68.0B) and ISM Services (52.5) ahead of the Beige Book this afternoon.  We also hear from two FOMC members, Boston’s Susan Collins and Dallas’s Lorrie Logan.  Yesterday, Fed Governor Waller indicated that while right now, the data doesn’t point to a compelling need to hike, he is also unwilling to say they have finished their task.  However, that is a far cry from the Harker comments about cutting in 2024 seems appropriate.  I suspect Harker is the outlier for now, at least until the data truly turns down.

Net, the big picture remains that the US economy is outperforming the rest of the world and the Fed is likely to retain the tightest monetary policy around, hence, the dollar still has legs in my view.

Good luck

Adf

Just Kidding

Posted on by 
Remember Friday
When one percent was declared
The top?  Just kidding

Much has been written about the BOJ’s surprising change in policy at their meeting last Friday, when they ostensibly widened the cap on their Yield Curve Control to 1.00% while explaining that flexibility in operations was the watchword.  They did not touch their overnight rate, which remains at -0.10% and there is no apparent belief that they are going to adjust that anytime soon. 

Neither market pricing in the OIS market nor any commentary from any BOJ official has hinted at such a move.  So, the question is, did they really change their policy?

This matters a great deal for those amongst us who care about USDJPY and its potential future direction.  The prevailing narrative has been that once the BOJ altered policy and allowed Japanese interest rates to rise to a more normal setting, investment would flow into JGBs, and the yen would strengthen rapidly.  Remember, a big part of this process is that since the yen is the last remaining currency with negative interest rates in the front end of the curve, it remains the financing currency of choice amongst the speculative and hedge fund set.  Adding to this discussion was the fact that back in December of last year, when Kuroda-san truly surprised the market by raising the YCC cap from 0.25% to 0.50%, it took less than one day for the 10-year JGB yield to test the new cap.  Expectations recently had been that a similar move was likely to be seen this time around as well.

Alas, it is Monday, so some thirty-six market hours into the new policy and already the BOJ has stepped into the market to prevent a further rise in the 10-year yield once it touched 0.60%.  Last night they stepped in with a ¥300 billion program of additional QE.  One cannot be surprised that USDJPY (+0.9%) is higher on this news as it undermines the entire thesis about imminent JPY strength once they changed policy.  And if they didn’t really change policy, as evidenced by the fact that they have already stepped into the market, then THE key pillar of the stronger yen thesis has just been removed.  The other problem for the yen bulls is that the US data last week, especially the GDP and IP data, indicate that the Fed will be under no duress if they continue to tighten policy beyond current levels.  Despite all the arguments about the Fed making another policy error, and there are sound arguments there, in Jay Powell’s eyes, until NFP starts to fall sharply, or Unemployment starts to rise sharply, or both, there are no impediments to a continuation of the current tightening policy.

It is with this in mind that I foresee continued strength in USDJPY, and while it seems likely that a very rapid move higher will see further intervention by the BOJ/MOF like we saw last autumn, another test of 150 is in the cards.  A quick look at the chart below (from tradingeconomics.com) shows that the trend higher in the dollar remains intact with the decline in the first part of July already mostly undone.  For those of you who were looking for a reversion to the 120 or 130 level, I fear that is just not in the cards for a long time to come.

Last Thursday the ECB said
That policy, looking ahead
Need not be so tight
And so, they just might
Stop raising rates, pausing instead

Though their only mandate is prices
They’ve come to a bit of a crisis
Seems growth’s really weak
And so, they will seek
A policy, sans sacrifices

The good news in Europe is that Q2 GDP was positive, which followed a negative Q4 and a flat Q1.  Hooray! The bad news about the data, which showed a 0.3% rise, is that fully half that number comes from Ireland! Now, Ireland’s weight in the Eurozone economy is tiny, about 4%, so the fact that growth there represented half the entire EZ’s growth is remarkable.  However, if you consider that this growth is more illusion than economic activity, it is easier to understand.  The growth is a result of the large profitability of US tech companies that generate their profits, from an accounting perspective, in Ireland to take advantage of the extremely low Irish corporate tax rate of 12.5%.  So, US tech companies had a good quarter driving Irish GDP higher, and by extension Eurozone GDP higher.  But they didn’t really produce that much stuff.

At the same time, Core CPI in the Eurozone printed at 5.5% this morning in July’s preliminary reading, hardly indicative of a collapse and calling into question Lagarde’s seeming dovishness last week.  In the end, the dichotomy between the US economy, where the latest data continues to show a robust outcome, and Europe, where the only thing rising is prices with economic activity lackluster at best, remains the key reason why the dollar’s demise is still a theory and not reality.  

To summarize the information that we have received from around the world in the past several days, Japan is unwilling to allow interest rates to rise very far, European growth is staggering, US growth is accelerating, the ECB is inclined to stop hiking rates and the Fed continues with ‘higher for longer’.  All of this points to the dollar maintaining its value and likely rising further.  I have yet to see anything persuasive in the dollar bear case to address all these issues. 

Now, those are the big picture views, but let’s take a quick tour of the overnight session.  Equities rallied in Asia following the US performance on Friday, but Europe has been a bit more circumspect with a couple of markets showing gains, notably France and Italy, but the rest doing nothing at all.  At the same time, US futures are little changed at this hour (7:30).

Arguably, though, it is the bond market where things are really interesting as yields continue to rebound.  US Treasuries are higher by 1.5bps and pushing back to that all important 4.00% level this morning.  There is a growing belief that if 10-year yields push above 4.10%, that may signal a new framework, a breakout in technical terms, and we could see much higher yields from there.  The Fed is likely to welcome such an event as it will help tighten financial conditions, something that they have been unable to achieve thus far.  However, I do not believe the equity markets would take kindly to that type of movement, so beware.  As to European sovereigns, they are mostly higher by about 1bp-2bps this morning and of course, JGBs saw yields finish higher by 6bps, just below 0.60%.

Oil prices (+1.0%) continue to rise on an organic basis.  By this I mean there have been no announcements, no disruptions and no news of any sort that might indicate a change in the current situation.  In other words, there is just a lot of buying going on.  WTI is well above $81/bbl and we have seen a gain of more than 16% in the past month.  Headline inflation will not be sinking on this news.  We are also seeing a little strength in the metals space this morning with gold, copper and aluminum all firmer as the week begins.  The base metals are responding to continued indications that China is going to support their economy, although direct fiscal payments don’t yet seem likely.  Just wait a few months.

Finally, the dollar is net, little changed, although we have a wide array of gainers and losers today.  In the G10, AUD (+0.9%) and NZD (+0.75%) are the leaders, rallying alongside the commodity rally, while JPY (-0.8% now), is the laggard based on the discussion above.  As to the rest of the bloc, there are more gainers than losers, but the movement has been far less impactful.  In the EMG space, MYR (+1.1%) has been the leading gainer on significant (for Malaysia) equity market inflows of ~$40mm -$50mm last night.  After that, though, the gainers have mostly been EEMEA currencies, and they have not moved that much.  On the downside, ZAR (-0.7%) is the laggard on limited news, implying more of a trading action rather than a fundamental shift.  But on this side of the ledger as well, things haven’t moved that far and net, the space is little changed.

It is an important week for data in the US culminating in the payroll report on Friday.

TodayChicago PMI43.4
 Dallas Fed Mfg-22.5
TuesdayJOLTS Job Openings9600K
 ISM Manufacturing46.9
WednesdayADP Employment183K
ThursdayInitial Claims227K
 Continuing Claims1723K
 Unit Labor Costs2.5%
 Nonfarm Productivity2.2%
 Factory Orders2.1%
 ISM Services53.0
FridayNonfarm Payrolls200K
 Private Payrolls175K
 Manufacturing Payrolls5K
 Unemployment Rate3.6%
 Average Hourly Earnings0.3% (4.2% Y/Y)
 Average Weekly Hours34.4
 Participation Rate62.6%
Source: Bloomberg

In addition to this, we get the first post-FOMC Fedspeak with just two speakers, Goolsbee and Barkin, on the calendar this week although the pace picks up next week.  As long as the data remains strong, I see no reason for the Fed to change its tune nor any reason for the dollar to back off its recent net strength.

Good luck

Adf