Tag Archives: #bondrally

More Fun Than Blondes

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In just the past week we have seen
That traders have changed their routine
They’re confident bonds
Have more fun than blondes
‘Cause rate cuts are what they now glean

Despite this, most central bank threads
Explain rate cuts ain’t in their heads
They all still maintain
Inflation’s not slain
And so now, they’re at loggerheads

There is only one story that continues to drive market activity lately, and that is bond yields.  They have become the best barometer of market sentiment we’ve seen in quite a while and the reaction function is quite clear; lower yields mean a soft landing, is coming and with it, central bank rate cuts to prevent a hard one.  While the US continues to lead the way, we are seeing yields decline around the world.  In essence, the bond markets worldwide have declared victory on behalf of the central banks.  In fact, as I look at my screen this morning, of the major economies in the world, only two, Mexico and South Africa, have seen 10yr yields climb today and that has been by 1.5bps and 0.5bps respectively.  In other words, virtually unchanged, while the rest of the world has seen declines of between 3bps and 7bps with even JGB yields lower by 5bps.

There are more and more adherents to the soft landing story as recent inflation readings have been declining steadily while economic activity is not slipping nearly as quickly.  Of course, this view is not universal as there remains a camp that points to underlying pieces of the economic puzzle like slowing bank lending growth or sliding manufacturing and are still looking for a more dramatic downturn in economic activity.  But generally, between the cheerleaders in finance ministries around the world and CNBC talking heads, all is right with the world.

Of course, if you are a central banker right now, all this positivity is working at cross purposes to your view that inflation is not actually dead and there is still further to go.  This is why we continue to hear that although progress has been made, it’s too early to take the victory lap.  We heard it from Cleveland Fed President Loretta Mester yesterday and from Austrian Central Bank chief and ECB Council Member Robert Holzmann this morning.  And we have been hearing it consistently for the past week, policy is somewhat restrictive, but we need to stay here until we are sure inflation is heading back to target.

Now, I am old enough to remember when the idea of tighter financial conditions doing the Fed’s job for them was a thing.  But in the month that has passed since that was first mooted, financial conditions are actually looser now than then.  The point is that the feedback loop between the data and the market response is now so dramatic, and occurring so rapidly, that the central bank reaction function is falling further behind the curve.  I have neither heard nor read a single thing in the past several days that implies there is a possibility the central banks are not done.  

But whether more rate hikes will do anything for inflation is no longer the issue, my sense is central banks want to make sure they are seen as in control.  I know things have been great lately with equities and bonds on fire and everybody’s 401Ks growing, but Jay doesn’t really care about your portfolio, and absent a complete collapse in economic activity in the next month, I would not be surprised by a December rate hike.  There is clearly no certainty on this, and the Fed funds futures market is currently pricing in just a 0.3% chance of it occurring.  I also know the Fed does not like to surprise markets, but I think the Fed fears the appearance of losing control more than anything else.  

However, until such time as they sound increasingly forceful, or the data starts to show inflation is not collapsing, it is hard to fight this move.  We have come a very long way in a very short period of time with respect to 10-year Treasury yields, a 60 basis point decline in slightly less than a month.  Be careful in assuming this will continue in a straight line.  As well, the fact that the yield curve’s inversion remains at -40bps is quite interesting.  Given the market is pricing 100bps of rate cuts by the end of 2024, I would have expected the front end of the curve to have fallen further in yield.

But that is where things stand as we get ready for another weekend and then, next week’s Thanksgiving holiday.  So, a quick tour of the overnight session shows that Chinese equities remain under pressure, especially in Hong Kong (-2.1%) as whatever they are doing over there is not solving their problems.  However, Japan is benefitting with modest gains and Europe is higher this morning across the board, about +0.8%.  As well, after a mixed day yesterday, US futures are pointing slightly higher, +0.2% or so at this hour (8:30).

We know the bond story so a look at commodities shows oil bouncing a bit, +1.3%, although it has been a horrific week and month for the black sticky stuff, down -15% in the past month.  Gold and silver, however, are huge beneficiaries of the decline in yields as they continue to rally and base metals are holding their own as well on the softer yield story.

Finally, it should be no surprise that the dollar remains under pressure, down 0.2% broadly (the DXY).  In the G10, JPY (+0.85%) is the leader followed by AUD (+0.5%) but all of them are firmer.  While there is a little more divergence in the EMG bloc, the broad trend remains for a softer dollar and as long as US yields remain under pressure, the dollar is likely to do so as well.  The one place I would watch carefully is the yen, as there is a growing belief it is set to rebound sharply.  On the plus side is the fact that US yields are falling, and the rate narrative is changing rapidly.  But remember, Japanese yields are also declining, and their recent GDP data was terrible, -2.1% in Q3, so the idea that the BOJ is going to tighten policy soon seems shaky at best.  There are many technical support levels on the way down, but do not be surprised of a test of 142.00 in the coming weeks if the current zeitgeist continues.

On the data front, Housing Starts (1.372M) and Building Permits (1.487M) were both released this morning pretty much on target and put paid to the idea that the housing market is collapsing. For the rest of the day, we have 5 more Fed speakers, but I doubt we hear anything new.  One other thing to remember is that Sunday, Argentina goes to the polls and the chances for the upstart candidate, Javier Milei, seem pretty good as the people there are fed up with the current government.  That could have some repercussions both financially and politically around the world, especially the latter, as it would be another step away from the current ruling class.  The point is, I do not believe that everything is better, and while right now things look good, there is more volatility in store.  Be careful and stay hedged, it is your best protection.

Good luck and good weekend

Adf

No Longer a Threat

Posted on by 
Opinions are already set
The Fed is no longer a threat
Today’s NFP
Will help all to see
That buying stocks is the best bet

At least that’s the narrative tale
The talking heads want to prevail
The question’s, will Jay
Have something to say
If finance conditions, up, scale

To conclude what has already been a tumultuous week, this morning brings the monthly payroll report, a key piece of evidence for the Fed to determine the health of the economy.  Expectations for the readings are as follows:

Nonfarm Payrolls180K
Private Payrolls158K
Manufacturing Payrolls-10K
Unemployment Rate3.8%
Average Hourly Earnings0.3% (4.0% Y/Y)
Average Weekly Hours34.4
ISM Services53.0

Source: tradingeconomics.com

Apparently, the whisper number is a bit above 200K, but we also must pay close attention to the revisions.  Recall last month had a blowout 336K result, which was much larger than expected.  If that number retains its strength, it would certainly be indicative of a still healthy labor market.  This matters a great deal as after Powell’s press conference on Wednesday and the surprising QRA that shortened the duration of upcoming Treasury bond issuance, the market is all in on the goldilocks story, solid growth with low inflation.  The corollary to this is that the market is looking for the Fed to back off the current rate policy and begin to reduce the Fed funds rate, thus helping all the DCF models pump up the value of equities.

But even though I have been highlighting the importance of the NFP number for the past two years as a key for the FOMC, it is not clear to me that today’s is so important.  I only say this because the Fed just met two days ago, and we will see another NFP before they meet again.  Arguably, this one will get lost in the fog of memory.  

If that is the case, then it is probably a good time to recap what we have seen this week and how it has affected market sentiment.  The bulls are on a roll right now as we have seen a significant pullback in Treasury yields with 10yr down to 4.66%, down 36bps from their peak back on October 23rd.  While that is certainly a large move in a short period of time, it is in line with the types of movement we have been seeing all year, so hardly unprecedented.  But Powell’s comments, which have been read as dovish despite his best efforts to prevent that view, and the bond market movement have many market participants licking their chops for a massive equity rally going forward.

Interestingly, one of the things the talking heads have been using to pump their story has been the tightening in financial conditions that were a result of declining stock and bond prices.  The whole issue of tighter financial conditions doing the Fed’s work for them has been a key story for the past several weeks since it was first mentioned by Dallas Fed President Lorrie Logan.  However, the big rally in both stocks and bonds, as well as the decline in the dollar, are all critical features in the calculation of those financial conditions, and they are all pointing to easier conditions.  The point is, if tighter conditions was a reason for the Fed to have stopped tightening further, the fact that they are now easing implies the Fed may feel the need to raise rates again in December, although that is clearly not the consensus view.

At any rate, right now, momentum is on the bulls’ side, and it is tough to overcome.  Certainly, the economic data continues to point to a resilient economy which implies, to me at least, that the Fed will not feel any urgency to cut rates soon.  There has also been a great deal of discussion regarding the fact that the average time the Fed has held rates at a peak before cutting is just 7 months.  We are now three months into the most recent hold, and, by definition, since the next meeting is not until December, we will be at 5 months then.  My observation about Chairman Powell, though, is at this point he is unconcerned with statistics of that nature and is far more focused on achieving their objective of 2% inflation.  

One last thing about inflation before we touch on markets.  There has been a growing chorus that deflation is on its way because M2 money supply growth is currently declining.  However, for the economics majors out there, recall that the key monetary equation is M*V = P*Q.  P = prices, and Q = quantity of goods, or, combined economic output.  M = Money supply and V = Velocity of money.  It is the last piece that is often ignored but remains quite important.  My good friend @inflation_guy, has just published a piece which is well worth reading.  The essence is that while M2 may be declining, V is rising rapidly, offsetting that impact and creating conditions for much stickier inflation than many believe.  I have a feeling the Fed is going to stay on hold, if not tighten further, for a much longer time than currently anticipated.  While this week’s news has clearly been seen as bullish, the long-term trends have not yet changed in my view.

Ok, so a quick look at markets shows that after another gangbusters day in the US, where all three major indices were higher by 1.7% or more, Asian markets followed suit, with virtually every index there higher by at least 1.0%.  Europe, however, has been more circumspect with markets essentially unchanged this morning, just +/- 0.1% on the day.  US futures are ever so slightly softer at this hour (7:30) down about -0.15% on average, as investors and traders await this morning’s data.

At this point, bonds seem to be taking a rest after a huge price rally / yield decline over the past several sessions and we are seeing very little movement on the day with Treasuries and European sovereigns all within 1 basis point of yesterday’s closing.  Even JGB yields slid a bit yesterday but remain above 0.90% as of now.  As to the shape of the yield curve, that inversion is starting to show its head again, with the current 2yr-10yr spread back to -32bps.  Remember, two days ago that was at -18bps.  Broadly speaking, yield curve inversions are not signs of economic strength.

In the commodity space, oil is creeping back higher, up 0.4% this morning although still lower on the week.  Gold is basically unchanged this morning, continuing to hang out just below $2000/oz, which continues to surprise me given the sharp decline in yields, at least nominal yields.  As to the rest of the space, base metals are mixed amid small changes this morning and foodstuffs, something I have not mentioned in a while, have actually been declining with the FAO’s world food price index falling to its lowest level in more than 2 years last month.  It may not seem that way in the grocery store, but perhaps future price rises will be more muted.

Finally, the dollar is generally biding its time ahead of the data, although leaning lower overall.  In the G10, the average gain of a currency is about 0.2% while in the EMG bloc we have seen a few outliers, notably KRW (+1.2%) but a more general rise of 0.4% or so.  You already know that my view has changed given the seeming change in the underlying drivers.  For now, and likely through the end of the year at least, I think the dollar will be under pressure.

Aside from the data this morning, we get our first Fed speaker, Supervision Vice-Chair Michael Barr, this afternoon, but the topic is the Community Reinvestment Act, which makes it unlikely he will swerve into monetary policy.  So, as is often the case, the data will see a flurry of activity at 8:30 and then I suspect the recent trends will reassert themselves in a slower session overall.  We will need to see an extraordinarily strong NFP print to help reverse the dollar’s current malaise.

Good luck and good weekend

Adf

Bulls’ Fondest Dreams

Posted on by 
While everyone focused on Jay
The earlier news of the day
Showed Janet would not
The long bond, allot,
Too much, thus yields faded away

Combining that news with the Fed
And all of the things that Jay said
It certainly seems
The bulls’ fondest dreams
Are likely to still be ahead

While most of the headlines yesterday afternoon and this morning revolve around the FOMC meeting and, more importantly, Powell’s press conference, I would argue that as I discussed yesterday, the biggest story was the QRA early in the morning.  Historically, the Treasury has tried to keep T-Bill issuance between 15% and 20% of total Treasury issuance.  However, a look at the current mix shows that Secretary Yellen already has that ratio up to 22.6%.  One of the big questions was how that would play out going forward.

Recall, one of the narratives that has been invoked for the Treasury bond sell-off with corresponding rising yields, has been the supply story.  You know, the US is running massive budget deficits and needs to issue more debt to fund it, so there is a lot more supply coming.  A key assumption in this story was that the mix of debt, which already favored T-Bills, would not change much so the new debt would be forced into the back end of the curve.  Well, that’s not how things worked.  The QRA indicated that the Treasury was going to issue a lot more T-Bills, a total of $1.1 trillion over the next two quarters, raising the proportion of T-Bills to 23.2%, even further above the old ceiling.  Of course, the result is much less issuance in the 5yr and longer space, thus undercutting the excess supply argument.

The results cannot be surprising as even before Powell started speaking, 10-year yields had fallen 11bps although they continued to decline afterwards as well, finishing the day lower by 16bps or so.  All in all, an impressive bond rally.  But let’s consider for a moment a different consequence of yesterday’s announcements, the shape of the yield curve.  Prior to the QRA and the Fed, the yield curve, as measured by the 2yr-10yr spread had fallen from a low of -108bps to just -15bps and it seemed almost certain that it would normalize soon.  However, now that the QRA has shown there will be more issuance out to 2yrs and less beyond, the immediate impact is the curve is going to go back to inverting further, (it is already back to -22bps) at least until such time as the Fed actually does cut rates.  I have a feeling that we are going to hear a lot more about recession again even though Powell explicitly said the Fed was not expecting one.  In fact, Powell and the Fed may be the only people not expecting a recession at this point!

A quick look at the Fed funds futures market shows that for the December FOMC meeting, the market is currently pricing a 20% probability of a 25bp rate hike.  That is slightly lower than before the FOMC meeting yesterday, but within the margin of error.  However, at this point, the market has a 43% probability of a rate cut in May, with that probability growing as you head out further in time.  One of the things Powell reiterated yesterday is that the committee is not even discussing the idea of a rate cut.  Of course, he also said that they don’t believe a recession is coming so it is not surprising the market has a different rate view than the Fed.

In the end, I think this is a seminal shift in policy with the combination of Treasury and Fed actions indicative of a much easier policy stance going forward.  I have built my views based on the Fed maintaining its higher for longer stance and continuing to stress the system which remains massively leveraged.  However, if he is no longer going to follow that path, and I think we learned yesterday that the inflection point is here, then we need to rethink the future.  One consequence of this policy change, though, is that inflation, which I have maintained is going to remain far stickier than many anticipate, is going to become an even bigger problem down the road.  I just don’t know how far down the road that will be.  But for now, I think we are going to continue to see equities rebound into year end, bond yields fall, the dollar fall, and commodity prices rebound.  This is going to be a classic risk-on scenario through the end of the year in my view.

And despite, or perhaps because of, continued weaker data, that is what we are seeing in markets around the world.  Yesterday’s ISM Manufacturing data was quite soft at 46.7, and this morning the PMI data from the rest of the world was generally awful with all European readings between 40 and 45.  Yesterday’s ADP Employment data was soft, at 113K which just added fuel to the policy easing fire and though the JOLTS Job Openings data was still strong, the net perception is slower times are ahead, and with them, lower interest rates.

A look around markets shows that after yesterday’s US rally, with the NASDAQ leading the way higher by 1.6%, Asian shares rallied (Nikkei +1.1%, Hang Seng +0.75%) and we are seeing strength across the board in Europe with all major indices higher by at least 1.25%.  And don’t worry, US futures are pushing higher again, up about 0.5% at this hour (7:15).

It is, of course, no surprise that bond yields around the world are lower with European sovereigns declining by between 7bps and 12bps after both Australia and New Zealand saw yields tumble 16pbs and 25bps respectively.  Even JGB yields are softer by 3bps.  In fact, Dutch central bank president Klaas Knot, one of the most hawkish ECB members, is on the tape this morning with the following quote, “We should be a little patient and not raise rates too much.”  That may be the most dovish thing he has ever said.  The point here is that until such time as inflation really comes roaring back (and I fear that day will come), the direction of travel in interest rates is lower.

Oil prices, which remained under some pressure in the past week, have bounced 1.4% this morning with the movement seeming to be a response to the policy changes while gold (+0.3%) is also climbing, although a bit slower than I might have expected.  But we are seeing strength throughout the commodity complex on the lower rate story with copper (+0.5%) rallying despite the prospects of a recession.

Finally, the dollar is under pressure across the board with the DXY down -0.7% led by the euro (+0.6%), AUD (+0.7%) and NZD (+0.95%).  The yen (+0.4%) is a bit of a laggard today, though remains above the 150 level, but I suspect that we are going to see dollar weakness continue going forward.  Against EMG currencies, we are also looking at a weaker greenback with KRW (+1.0%) leading the way, but strength through APAC and EEMEA and MXN (+0.6%) firmer as the only representative of LATAM that is trading at this hour.  Yesterday Banco Central do Brazil cut their SELIC rate by 50bps to 12.25% as widely expected and BRL rallied 2% on the day.  Again, the theme is now a weaker dollar going forward.

To show how big a deal yesterday was, the BOE meets this morning, and nobody is even discussing it.  Expectations are for no policy change, although perhaps given the sudden dovishness breaking out worldwide, they will consider a cut!  We also see a bunch of US data as follows: Initial Claims (exp 210K), Continuing Claims (1800K), Nonfarm Productivity (4.1%), Unit Labor Costs (0.7%) and Factory Orders (2.4%).   There are no Fed speakers on the schedule today, but they get started again tomorrow.  Remember, tomorrow we also see NFP, so still some fireworks potentially.

For now, though, the new trend is risk on, dollar down.  

Good luck

Adf

Waved Adios

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

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

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

Source: Tradingeconomics.com

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

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

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

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

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

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

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

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

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

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

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

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

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

Good luck

Adf

T’won’t be a Disaster

Posted on by

The Minutes explained that the Fed

Continues, when looking ahead

To brush off inflation

And seek job creation

Though prices keep rising instead

Meanwhile, there’s a new policy






That came from Lagarde’s ECB





T’won’t be a disaster





If prices rise faster





So, nothing will stop more QE





There is no little irony in the fact that the one-two punch of the Fed and ECB reconfirming that ‘lower for longer’ remains the driving force behind central bank policy has resulted in a pretty solid risk-off session this morning.  After all, I thought ‘lower for longer’ was the driver of ongoing risk appetite.





However, that is the case, as yesterday the FOMC Minutes essentially confirmed that while there are two camps in the committee, the one that matters (Powell, Clarida, Williams and Brainerd) remain extremely dovish.  Inflation concerns are non-existent as the transitory story remains their default option, and although several members expressed they thought rates may need to rise sooner than their previous expectations, a larger group remains convinced that current policy is appropriate and necessary for them to achieve their goals of average 2% inflation and maximum employment.  Remember, they have yet to achieve the undefined ‘substantial further progress’ on the jobs front.  Funnily enough, it seems that despite 10 years of undershooting their inflation target, there are several members who believe that the past 3 months of overshooting has evened things out!  Ultimately, my take on the Minutes was that the market’s initial reaction to the meeting 3 weeks ago was misguided.  There is no hawkish tilt and QE remains the norm.  In fact, if you consider how recent data releases have pretty consistently disappointed vs. expectations, a case can be made that we have seen peak GDP growth and that we are rapidly heading back toward the recent trend levels or lower.  In that event, increased QE is more likely than tapering.





As to the ECB, the long-awaited results of their policy review will be released this morning and Madame Lagarde will regale us with her explanations of why they are adjusting policies.  It appears the first thing is a change in their inflation target to 2.0% from ‘below, but close to, 2.0%’.  In addition, they are to make clear that an overshoot of their target is not necessarily seen as a problem if it remains a short-term phenomenon.  Given that last month’s 2.0% reading was the first time they have achieved that milestone in nearly 3 years, there is certainly no indication that the ECB will be backing off their QE programs either.  As of June, the ECB balance sheet, at €7.9 trillion, has risen to 67.7% of Eurozone GDP.  This is far higher than the Fed’s 37.0% although well behind the BOJ’s 131.6% level.  Perhaps the ECB has the BOJ’s ratio in mind as a target!





Adding up the new policy information results in a situation where…nothing has changed.  Easy money remains the default option and, if anything, we are merely likely to hear that as central banks begin to try to tackle issues far outside their purview and capabilities (climate change and diversity to name but two) there is no end in sight for the current policy mix. [This is not to say that those issues are unimportant, just that central banks do not have the tools to address them.]





But here we are this morning, after the two major central bank players have reiterated their stance that no policy changes are imminent, or if anything, that current ultra-easy monetary policy is here to stay, and risk is getting tossed aside aggressively.





For instance, equity markets around the world have been under significant pressure.  Last night saw the Nikkei (-0.9%), Hang Seng (-2.9%) and Shanghai (-0.8%) all fall pretty substantially.  While the Japanese story appears linked to the latest government lockdowns imposed, the other two markets seem to be suffering from some of the recent actions by the PBOC and CCP, where they are cracking down on international equity listings as well as the ongoing crackdown on freedom in HK.  European bourses are uniformly awful this morning with the DAX (-1.7%) actually the best performer as we see the CAC (-2.25%) and FTSE 100 (-1.9%) sinking even further.  Even worse off are Italy (-2.7%) and Spain (-2.6%) as investors have weighed the new information and seemingly decided that all is not right with the world.  As there has been no new data to drive markets, this morning appears to be a negative vote on the Fed and ECB.  Just to be clear, US futures are down uniformly by 1.4% at this hour, so the risk-off attitude is global.





Turning to the bond market, it should be no surprise that with risk being jettisoned, bonds are in high demand.  Treasury yields have fallen 6.5bps this morning, taking the move since Friday to 21bps with the 10-year now yielding 1.25%, its lowest level since February.  Is this really a vote for transitory inflation?  Or is this a vote for assets with some perceived safety? My money is on the latter.  European sovereigns are also rallying with Bunds (-4.1bps), OATs (-2.7bps) and Gilts (-4.8bps) all putting in strong performances.  The laggards here this morning are the PIGS, where yields are barely changed.





In the commodity space, yesterday saw a massive reversal in oil prices, with the early morning 2% rally completely undone and WTI finishing lower by 1.7% on the day (3.6% from the peak).  This morning, we are lower by a further 0.4% as commodity traders are feeling the risk-off feelings as well.  Base metals, too, are weak (Cu -1.75%, Al -0.3%, Sn -0.4%) but gold (+0.7%) is looking quite good as real yields tumble.





As to the dollar, in the G10 space, commodity currencies are falling sharply (NZD -0.75%, AUD -0.7%, CAD -0.6%, NOK -0.6%) while havens are rallying (CHF +0.9%, JPY +0.8%).  The euro (+0.45%) is firmer as well, which given the remarkable slide in USD yields seems long overdue.





Emerging market currencies are seeing similar behavior with the commodity bloc (MXN -0.75%, RUB -0.5%) sliding along with a number of APAC currencies (THB -0.65%, KRW -0.6%, MYR -0.5%).  It seems that Covid is making a serious resurgence in Asia and that has been reflected in these currencies.  On the plus side, the CE4 are all firmer this morning as they simply track the euro’s performance on the day.





On the data front, our last numbers for the week come from Initial (exp 350K) and Continuing (3.35M) Claims at 8:30 this morning.  Arguably, these numbers should be amongst the most important given the Fed’s focus on the job situation.  However, given the broad risk off sentiment so far, I expect sentiment will dominate any data.  There are no further Fed speakers scheduled this week, which means that the FX markets are likely to take their cues from equities and bonds.  Perhaps the correlation between yields and the dollar will start to reassert itself, which means if the bond market rally continues, the dollar has further to decline, at least against more haven type currencies.  But if risk continues to be anathema to investors, I expect the EMG bloc to suffer more than the dollar.





Good luck and stay safe





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			Likely to Fade
		


				

			Posted on  by 		

			


		

		

The bond market’s making it clear





Inflation, while higher this year,





Is likely to fade





Just like Jay portrayed





While bottlenecks soon disappear















The data though’s yet to support





Inflation’s rise will be cut short





Perhaps CPI





Next week will supply





The data the Fed does purport





For the past month, virtually every price indicator in the G20 has printed higher than forecast, which continues a multi-month trend and has been a key support of the inflationist camp.  After all, if the actual inflation readings continue to rise more rapidly than econometric models indicate, it certainly raises the question if there is something more substantial behind the activity.  At the same time, there has been a corresponding increase of commentary by key central bank heads that, dammit, inflation is transitory!  Both sides of this debate have been able to point to pieces of data to claim that they have the true insight, but the reality is neither side really knows.  This fact is made clear by the story-telling that accompanies all the pronouncements.  For instance, the transitory camp assures us that supply-chain bottlenecks will soon be resolved as companies increase their capacities, and so price pressures will abate.  But building new plant and equipment takes time, sometimes years, so those bottlenecks may be with us for many months.  Meanwhile, the persistent camp highlights the idea that the continued rise in commodity prices will see input costs trend higher with price rises ensuing.  But we have already seen a significant retreat from the absolute peaks, and it is not clear that a resumption of the trend is in the offing.  The problem with both these stories is either outcome is possible so both sides are simply talking their books.





While I remain clearly in the persistent camp, my take is more on the psychological effects of the recent rise in so many prices.  After all, even the Fed is focused on inflation expectations.  So, considering that recency bias remains a strongly inbred human condition, and that prices have risen recently, there is no question many people are expecting prices to continue to rise.  At the same time, one argument that had been consistently made during the pre-pandemic days was that companies could not afford to raise prices due to competition as they were afraid of losing business.  But now, thanks to multiple rounds of stimulus checks, the population, as a whole, is flush with cash.  As evidenced by the fact that so many companies have already raised prices during the past year and continue to sell their wares, it would appear that the fear of losing business over higher prices has greatly diminished.





And yet…the bond market has accepted the transitory story as gospel.  This was made clear yesterday when both Treasury and Gilt yields tumbled 8 basis points while Bund and OAT yields fell 6bps.  That is not the behavior of a bond market that is worried about runaway inflation.  





So, which is it?  That, of course, is the $64 trillion question, and one for which nobody yet has the answer.  What we can do, though, is try to determine how markets may move in either circumstance.





If inflation is truly transitory it would seem that we can look forward to a continued bull flattening of yield curves with the level of rates falling alongside the slope of the yield curve.  Commodity prices will arguably have peaked as new production comes online and equity markets will benefit significantly from lower interest rates alongside steady growth.  As to the dollar, it seems unlikely to change dramatically as lower yields alongside lower inflation means real yields will be stable.





On the other hand, if prices rise persistently for the next quarters (or years), financial markets are likely to respond very differently.  At some point the bond market will become uncomfortable with the situation and yields will start to rise more sharply amid a steeper yield curve as the Fed will almost certainly remain well behind the curve and continue to suppress the front end.  Commodity prices will have resumed their uptrend as they will be a key driver in the entire inflationary story.  Energy, especially, will matter as virtually every other product requires energy to be created, so higher energy prices will feed into the economy at large.  Equity markets may find themselves in a more difficult situation, especially the high growth names that are akin to very long duration bonds, although certain sectors (utilities, staples, REITs) are likely to hold their own.  And the dollar?  If, as supposed, the Fed remains behind the curve, the dollar will suffer significantly, as real yields will decline sharply.  This will be more evident if we continue to see policy tightening from the group of countries that have already begun that process.





In the end, though, we are all just speculating with no inside knowledge of the eventual outcome.  It is for this reason that hedging is so important.  Well designed hedge strategies help moderate the outcome regardless of the eventual results, and that is a worthy goal in itself. Hedging can reduce earnings/cash flow volatility.





Onward to today’s markets.  Starting with bonds, after yesterday’s huge rally, we continue to see demand as, though Treasury yields are unchanged, European sovereign yields have fallen by between 0.3bps (Gilts) and 1.5bps (Bunds), with the rest of the major nations somewhere in between.





Equity markets have been more mixed but are turning higher.  Last night saw the Nikkei (-1.0%) and Hang Seng (-0.4%) follow the bulk of the US market lower, but Shanghai (+0.7%) responded positively to news that the PBOC may soon be considering cutting rates to support what is a clearly weakening growth impulse in China.  (Caixin PMI fell to 50.3 in Services and 51.3 in Manufacturing, both far lower than expected in June.)  European markets have been in better stead with the DAX (+0.9%) leading the way and FTSE 100 (+0.5%) putting in a solid performance although the CAC (+0.1%) is really not doing much.  The big news here was the European Commission publishing their latest forecasts for higher growth this year and next as well as slightly higher inflation.  Finally, US futures markets are all pointing higher with the NASDAQ (+0.5%) continuing to lead the way.





Commodity prices are definitely higher this morning with oil (+1.5%) a key driver, but metals (Au +0.6%, Ag +1.0%, Cu +2.0% and Al +0.3%) all finding strong bids.  Agricultural products are also bid this morning and there is more than one analyst who is claiming we have seen the bottom in the commodity correction with higher prices in our future.





As to the dollar, it is somewhat mixed, but arguably, modestly weaker on the day.  In the G10, NZD (+0.4%), NOK (+0.3%) and AUD (+0.3%) are the leaders with all three benefitting from the broad-based commodity rally.  SEK (-0.25%) is the laggard as renewed discussion of moderating inflation pressures has investors assuming the Riksbank will be late to the tightening party thus leaving the krona relatively unattractive.





In the EMG bloc, ZAR (+0.5%), MXN (+0.35%) and RUB (+0.25%) are the leading gainers, with all three obviously benefitting from the commodity story this morning.  CNY (+0.25%) has also gained after investor inflows into the Chinese bond market supported the renminbi.  On the downside, KRW (-0.7%) and PHP (-0.6%) fell the most although the bulk of those moves came in yesterday’s NY session as the dollar rallied across the board and these currencies gapped lower on the opening and remained there.  Away from these, though, activity has been less impressive with few stories to drive things.





Two pieces of data today are the JOLTS Job Openings (exp 9.325M) and the FOMC Minutes this afternoon.  The former will simply serve to highlight the mismatch in skills that exists in the US as well as the fact that current policy with enhanced unemployment insurance has kept many potential workers on the sidelines.  As to the Minutes, people will be focused on any taper discussion as well as the conversation on interest rates and why views about rates changed so much during the quarter.





Our lone Fed speaker of the week, Atlanta Fed President Bostic, will be on the tape at 3:30 this afternoon.  To date, he has been in the tapering sooner camp, so I would expect that will remain the situation.  





Yesterday’s dollar rally was quite surprising given the decline in both nominal and real yields in the US.  However, it has hardly given back any ground.  At its peak in early April, the dollar index traded up to 93.4 and the euro fell to 1.1704.  We would need to break through those levels to convince of a sustained move higher in the dollar.  In the meantime, I expect that the odds are the dollar can cede some of its recent gains.





Good luck and stay safe





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			Hard to Explain
		


				

			Posted on  by 		

			


		

		
For those who believe that inflation


Is soon to explode ‘cross the nation


It’s hard to explain


Why yields only wane


Resulting in angst and vexation


But there is a possible clue


That might help the bond bears’ world view


In Q1 Ms. Yellen


Had Treasury sellin’


More bonds than the Fed could accrue


However, that’s no longer true


As Powell, through all of Q2


Will buy more each week


Than Janet will seek


To sell.  Lower yields then ensue.


With the FOMC meeting on the near horizon, traders are loath to take large positions in case there is a major surprise.  At this point, the market appears to broadly believe that any tapering talk is not going to happen until the Jackson Hole meeting in August, so the hawks are not expecting a boost.  At the same time, there is virtually no expectation that the Fed would consider increasing QE, thus the doves remain reliant on the transitory inflation narrative.  As it stands, the doves continue to hold the upper hand as while last week’s CPI print was shockingly high,  there has been much written about the drivers of that number are all due to level off shortly, and inflation will soon head back to its old 1.5%-2.0% range.


One of the things to which the doves all point is the 10-year yield and how it has done nothing but decline since the beginning of the quarter.  Now, that is a fair point, but the timing is also quite interesting.  While pundits on both sides of the discussion continue to point to inflation expectations and supply chain breakages and qualitative measures, there is something that has gotten far less press, but could well account for the counterintuitive movement in Treasury yields amid much higher inflation prints: the amount of Treasuries purchased by the Fed vs. the amount of new Treasuries issued by the Treasury.


In Q1, the US government issued net $342 billion while the Fed bought $240 billion in Treasury securities as part of QE.  (Remember, the other $120 billion was in mortgage-backed securities).  Given that foreign government buying of Treasuries has virtually disappeared, it should be no surprise that yields rose in order to attract buyers.  Q2, however, has seen a very different dynamic, as the US government has only issued $70 billion this quarter while the Fed continues to buy $240 billion each quarter.  With a price insensitive buyer hoovering up all the available securities and more, it is no surprise that Treasury yields have fallen.  Why, you may ask, has the Treasury only issued $70 billion in new debt?  Two things are driving that situation; first, Q2 is the big tax payment quarter of the year, so lots of cash flows into the Treasury; and second, the Treasury at the end of last year had $1.6 trillion in cash in their General Account at the Fed, which is essentially the government’s checking account.  However, they have drawn those balances down by half, thus have not needed to issue as much debt.


It’s funny how the move in yields just might be a simple supply/demand story, but that is not nearly as much fun as the narrative game.  So, let’s take a glimpse into Q3 planned Treasury issuance, which is widely available on the Treasury’s own website.  “During the July – September 2021 quarter, Treasury expects to borrow $821 billion in privately-held net marketable debt, assuming an end-of-September cash balance of $750 billion.”  The Fed, of course, is expected to buy another $240 billion in Treasuries in Q3, however, that appears to be a lot less than expected issuance.  My spidey-sense is tingling here, and telling me that come July, we are going to start to see yields turn higher again.  Far from the idea of tapering, if yields are rising sharply akin to Q1’s price action, we could see the Fed increase QE!  After all, somebody needs to buy those bonds.  And while this will be going on in the background, what we will largely read about is the changes in the narrative and inflation expectations.  As Occam pointed out with his razor, the simplest explanation is usually the best.


If this, admittedly, rough analysis has any validity, it is likely to have some very big impacts on markets in general, and on the dollar in particular.  In fact, if yields do reverse and head higher, especially if we move toward that 2.0% 10-year yield (or further) look for the dollar to find a lot of support.


As to market activity today, things remain fairly quiet with the recent positive risk attitude intact, but hardly excessively so.  Starting with equities in Asia, the Nikkei (+0.75%) had a nice gain after a better than expected IP print but was lonely with a holiday in China and through much of the continent keeping other markets closed.  Europe is in the green, but the gains are mostly modest (DAX +0.2%, CAC +0.2%, FTSE 100 +0.4%) as a slightly better than expected IP print along with continued dovish comments from Madame Lagarde help underpin the equity markets there.  Meanwhile, US futures are also modestly higher, but the NASDAQ’s 0.3% rise is by far the largest.


Turning to the bond market this morning, Treasury yields have backed up 0.8bps, but remain well below the 1.50% level which was seen as key support.  As per the above, I imagine that it will be a month before the real fireworks begin.  In Europe, while we did hear from Lagarde, we also heard from uber-hawk Robert Holtzmann, Austria’s central bank president, who was adamant that barring another Covid related shutdown, the PEPP will end in March.  Italian BTP’s were the most impacted bond from those comments with yields rising 2.0bps, while the main markets are seeing virtually no movement this morning.


In the commodity space, there is a real dichotomy today with oil (+0.7%) continuing its recent rally while gold (-1.1%) has fallen sharply.  Base metals have been mixed with relatively modest movement, but agricultural prices have fallen sharply (Soybeans -0.8%, Wheat -2.6%, Corn -2.8%) which appears to be a response to improved weather conditions.


Finally, the dollar has no real direction this morning.  NOK (+0.35%) is the leading gainer in the G10 on the back of oil’s rally but after that, there is a mix of gainers and losers, none of which have moved 0.2% implying no real new driving forces.  In the EMG bloc, last night saw KRW (-0.5%) catch up to Friday’s dollar rally, and this morning we see ZAR (-0.45%) as the worst performer on what seems to be market technicals, with traders beginning to establish new ZAR shorts after a very strong rally during the past year.  Some think it has gone too far.  But really, the FX market is not terribly interesting right now as we all await the Fed on Wednesday.


On the data front, there is some important information coming as follows:






Tuesday
Retail Sales
-0.6%





-ex autos
0.4%





PPI
0.5% (6.2% Y/Y)





-ex food & energy
0.5% (4.8% Y/Y)





IP
0.6%





Capacity Utilization
75.1%




Wednesday
Housing Starts
1640K





Building Permits
1730K





FOMC Decision
0.00% – 0.25%




Thursday
Initial Claims
360K





Continuing Claims
3.42M





Philly Fed
31.0





Leading Indicators
1.3%






Source: Bloomberg


So, while tomorrow will see much discussion regarding the growth narrative after Retail Sales, the reality is everybody is simply focused on the Fed on Wednesday.  Until then, I expect range trading.  After that…


Good luck and stay safe


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			Most Pundits Agree
		


				

			Posted on  by 		

			


		

		
No matter what skeptics might say

The Old Lady didn’t delay

They boosted QE

So, Sunak, Rishi

Can spend more each night and each day


But here, when the FOMC

Meets later, most pundits agree

They will not arrange

A policy change

Instead, for more fiscal they’ll plea


As markets are wont to do, they have effectively moved beyond the uncertainty of the US election outcome to the next big thing, in this case central bank activity.  You may recall that on Tuesday morning we learned the RBA cut interest rates again, down to 0.10% and installed a QE program of A$100 billion.  And while these days, A$100 billion may not seem like much, it does represent more than 5% of the Australian economy.  Of course, that action was mostly lost in the election fever that gripped markets at that time.  However, that fever has broken, and the market has come to terms with the fact there is no blue wave.  This has forced participants to collectively create a new narrative which seems to go as follows: gridlock in the US is good for markets because the Fed will be required to do even more, and thus monetary policy will remain easy for an even longer time.  This, as well as the expected lack of a massive stimulus package, is the driver behind the Treasury rally, which is continuing this morning as 10-year yields have fallen a further 3 basis points (30-year yields have fallen even more as the curve continues to flatten.)


Helping along the new narrative, and right on cue, the Bank of England stepped in and increased their QE program by a more than expected £150 billion this morning, allowing Chancellor of the Exchequer, Rishi Sunak, the leeway to expand fiscal support for the economy as the government there imposes a month long lockdown to try to arrest the spread of Covid-19.  Thus, in the UK, the monetary and fiscal policies are aligned in their efforts to prevent an economic collapse while fighting the effects of Covid.  Naturally, markets have voted in favor of further central bank largesse, and as expectations grow for even more support to come, equity investors are buying as quickly as they can.


Which leads us to the FOMC meeting today.  Cagily, they arranged for this meeting to be two days after the election, as they clearly don’t want to become the big story.  Rather, I’m certain that despite each members’ penchant to speak constantly, this is one time they will be as quiet as possible.  Part of this is due to the fact that there is exactly zero expectation that there will be any change in policy.  Rates are already at the effective lower bound, and thus far the Fed has not been willing to countenance the idea of negative rates.  Not only that, their forward guidance has been clear that rates will not be ‘normalized’ until at least 2023, and then, only if it makes sense to do so.  As to QE, they are already engaged in an unbounded program, purchasing $80 billion of Treasuries and $40 billion of Mortgage-backed securities each month.  Certainly, they could increase those numbers, but given the US Treasury has just significantly revised their expected issuance lower, (given the lack of a stimulus bill to fund), the Fed is already scooping up a huge percentage of the paper that exists.  With all that in place, what more can they do?  After all, if they say they won’t raise rates until 2024, will that actually matter?  I think not.  Instead, the one thing on which we can count is that the Statement, and Chairman Powell in the press conference, will repeat the point that more fiscal stimulus is what is needed.


The upshot is that, the most important par of the election outcome, is with regards to the Senate, which while it seems clear the Republicans have held their majority, could possibly turn blue.  But unless that happens, at this stage, the market has clearly turned its attention beyond the election and is voting favorably for more central bank support.  So, let’s see how things are behaving this morning.


After a strong US rally yesterday, especially in the NASDAQ, Asia took the baton and sprinted ahead as well with the Nikkei (+1.7%), Hang Seng (+3.25%) and Shanghai (+1.3%) all having strong sessions.  In fact, as I look through every APAC market, only Vietnam and Laos had negative days, otherwise every Asian nation rallied across every one of their indices.  Europe is no different, with every market in the green (DAX +1.7%, CAC +1.25%, FTSE 100 +0.5%, as well as all the sundry others), and US futures (DOW +1.4%, SPX +1.9%, NASDAQ +2.6%) are pointing to another big day here.


Bonds, as mentioned above, are also still feeling the love as only the UK appears to be adding to the fiscal mix and so central bank support will continue to drive activity until that changes.  This means that while Bunds, OATS and Gilts are all only marginally changed, the PIGS are seeing substantial demand with yields falling 3 basis points for all of them


Gold is doing well, up $15/oz on what seems to be the idea that fiat currencies will continuously be devalued and so something else will serve as a better store of value.  (Bitcoin, by the way, is also rallying sharply, +5% this morning, as many continue to see it as an alternative to gold.)  Oil, on the other hand, is a bit lower this morning, -1.0%, although that is after having rallied nearly 16% so far this week, so a modest correction doesn’t seem out of order.


Finally, the big loser today has been the dollar, which is weaker vs. essentially every other currency.  In the G10, NOK (+1.1%) is the leader, despite the fact that oil is correcting.  More interestingly, EUR (+0.7%) is rallying despite the fact that there is no expectation for Fed activity, and the relative stances of the Fed and ECB remains unchanged.  Now if there is not going to be a blue wave, and therefore no massive fiscal expansion in the US, I’m at a loss as to why the dollar should be sold.  Today, however, selling dollars is the story.


The same is true in the EMG bloc, with RUB (+2.2%) the runaway leader, but 1% or greater gains seen throughout EMEA and LATAM currencies.  Even IDR (+1.3%) which last night posted worse than expected GDP growth, has seen strength.  As long as the narrative continues to be that election uncertainty is a dollar negative, it appears the dollar has further to fall.  That said, I see no cause for a collapse of any type.


Aside from the FOMC today, we see some data as follows: Initial Claims (exp 735K), Continuing Claims (7.2M), Nonfarm Productivity (5.6%) and Unit Labor Costs (-11.0%).  Yesterday, amidst the election discussion, we missed the fact that ADP Employment rose a much less than expected 365K, and the ISM Services number printed at a worse than expected 56.6.  Perhaps, belatedly, that negative news has been impacting the dollar.  But my sense is this is narrative driven and unless the Fed truly shocks one and all, I expect the dollar can drift lower still for the rest of the session.


Good luck and stay safe

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