Tag Archives: #bondvigilantes

Cold Growth

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Winter approaches
Both cold weather and cold growth
Plague Japan’s future

 

It’s not a pretty picture, that’s for sure.  A raft of Japanese data was released early Sunday evening with GDP revised lower (-0.6% Q/Q, -2.6% Y/Y) and as you can see from the Q/Q chart below, it is hard to get excited about prospects there.

Source: tradingeconomics.com

Of course, this is what makes it so difficult to estimate how Ueda-san will act in a little less than two weeks’ time.  On the one hand, inflation remains a problem, currently running at 3.0% and showing no signs of declining.  Recall, the BOJ has a firm 2.0% target, so they are way off base here.  Add to that the fact that inflation in Japan had been virtually zero for the prior 15 years and the population is starting to get antsy.  However, if growth is retreating, how can Ueda-san justify raising rates?

In the meantime, the punditry is having a field day discussing the yen and its broad weakness, although for the past three weeks, it has rebounded some 2% in a steady manner as per the below chart,

Source: tradingeconomics.com

As well, much digital ink has been spilled regarding the 30-year JGB yield which has traded to historic highs as per the below chart from cnbc.com.

There are many pundits who have the view that the Japanese situation is getting out of control.  They cite the massive public debt (240% of GDP), the fact that the BOJ holds 50% of the JGB market, the fact that the yen has declined to its lowest level (highest dollar value) since a brief spike in 1990 and before that since 1986 when it was falling in the wake of the Plaza Accord.

Source: cnbc.com

Add in weakening economic growth and growing tensions with China and you have the makings of a crisis, right?  But ask yourself this, what if this isn’t a crisis, but part of a plan.  Remember, the carry trade remains extant and is unlikely to disappear just because the BOJ raises rates to 0.75% in two weeks.  This means that Japanese investors are still enamored of US assets, notably Treasuries, but also stocks and real estate, as a weakening yen flatters their holdings.  Too, it helps Japanese companies compete more effectively with Chinese competitors who benefit from a too weak renminbi as part of China’s mercantilist model.  Michael Nicoletos, one of the many very smart Substack writers, wrote a very interesting piece on this subject, and I think it is well worth a read.  In the end, none of us know exactly what’s happening but it is not hard to accept that some portion of this theory is correct as well.  The one thing of which I am confident is the end is not nigh.  There is still a long time before things really become problematic.

And the yen?  In the medium term I still think it weakens further, but if the Fed gets very aggressive cutting rates, that will likely result in a short-term rally.  But much lower than USDJPY at 145-150 is hard for me to foresee.

Turning to the other noteworthy news of the evening, the Chinese trade surplus has risen above $1 trillion so far in 2025, with one month left to go in the year.  This is a new record and highlights the fact that despite much talk about the Chinese focusing more on domestic consumption, their entire economic model is mercantilist and so they continue to double down on this feature.  While Chinese exports to the US fell by 29% in November, and about 19% year-to-date, they are still $426 billion.  However, China’s exports to the rest of the world have grown dramatically as follows: Africa 26%, Southeast Asia 14% and Latin America 7.1%.  Too, French president Emanuel Macron just returned from a trip to Beijing, meeting with President Xi, and called out the Chinese for their export policies, indicating that Europe needed to take actions (raise tariffs or restrict access) before European manufacturing completely disappears.  (And you thought only President Trump would suggest such things!)

So, how did markets respond to this?  Well, the CSI 300 rose 0.8% (although HK fell -1.2%) and the renminbi was unchanged.  But I think it is worth looking at the renminbi’s performance vs. other currencies, notably the euro, to understand Monsieur Macron’s concerns.

Source: tradingeconomics.com

It turns out that the CNY has weakened by nearly 7.5% vs. the euro this year, a key driver of the growing Chinese trade surplus with Europe (and now you better understand the Japanese comfort with a weaker JPY).  My observation is that the pressure on Chinese exports is going to continue to grow going forward, especially from the other G10 nations.  Expect to hear more about this through 2026.  It is also why I see the eventual split of a USD/CNY world.

Ok, let’s look around elsewhere to see what happened overnight.  Elsewhere in Asia, things were mixed with Tokyo (+0.2%) up small, Korea (+1.3%) having a solid session along with Taiwan (+1.2%) although India (-0.7%) went the other way.  As to the smaller, regional exchanges, they were mixed with small gains and losses.  In Europe, it is hard to get excited this morning with minimal movement, less than +/- 0.2% across the board.  And at this hour (7:25) US futures are little changed.

In the bond market, yields are continuing to rise around the world.  Treasury yields (+2bps) are actually lagging as Europe (+4bps to +6bps on the continent and the UK) and Japan (+3bps) are all on the way up this morning.  This is Fed week, so perhaps that is part of the story, although the cut is baked in (90% probability).  Perhaps this is a global investor revolt at the fact that there is exactly zero evidence that any government is going to do anything other than spend as much money as they can to ensure that GDP continues to grow.  QE will be making another appearance sooner rather than later, in my view, and on a worldwide basis.

When we see that, commodity prices seem likely to rise even further, at least metals prices will and this morning that is true across the precious metals space (Au +0.3%, Ag +0.3%, Pt +1.2%) although copper is unchanged on the day.  Oil (-1.2%) though is not feeling the love this morning despite growing concerns of a US invasion of Venezuela, ongoing Ukrainian strikes against Russian oil infrastructure and the prospects of central bank rate cuts to stimulate economic activity.  One thing to note in the oil market is that China has been a major buyer lately, filling its own SPR to the brim, so buying far more than they consume.  If that facility is full, then perhaps a key supporter of prices is gone.  I maintain my view that there is plenty of oil around and prices will continue to trend lower as they have been all year as per the below chart.

Source: tradingeconomics.com

Finally, nobody really cares about the FX markets this morning with the DXY exactly unchanged and all major markets, other than KRW (+0.5%) within 0.2% of Friday’s closing levels.  There is a lot of central bank activity upcoming, and I suppose traders are waiting for any sense that things may change.  It is worth noting that a second ECB member, traditional hawk Olli Rehn, was out this morning discussing the potential need for lower rates as Eurozone growth slows further and he becomes less concerned about inflation.  Expect to hear more ECB members say the same thing going forward.

On the data front, things are still messed up from the government shutdown, but here we go:

TuesdayRBA Rate Decision3.6% (unchanged)
 NFIB Small Biz Optimism98.4
 JOLTS Job Openings (Sept)7.2M
WednesdayEmployment Cost Index (Q3)0.9%
 Bank of Canada Rate Decision2.25% (unchanged)
 FOMC Rate Decision3.75% (-25bps)
ThursdayTrade Balance (Sept)-$61.5B
 Initial Claims221K
 Continuing Claims1943K

Source: tradingeconomics.com

There is still a tremendous amount of data that has not been compiled and released and has no date yet to do so.  Of course, once the FOMC meeting is done on Wednesday, we will start to hear from Fed speakers again, and Friday there are three scheduled (Paulson, Hammack and Goolsbee).

As we start a new week, I expect things will be relatively quiet until the Fed on Wednesday and then, if necessary, a new narrative will be created.  Remember, the continuing resolution only goes until late January, so we will need to see some movement by Congress if we are not going to have that crop up again.  In the meantime, there is lots of talk of a Santa rally in stocks and if I am right and ‘run it hot’ is the process going forward, that has legs.  It should help the dollar too.

Good luck

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So Mind-Blowing

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On one hand, the chorus is growing
That US debt is so mind-blowing
The ‘conomy will
Slow down, then stand still
As ‘flation continues its slowing
 
But others remind us the data
Does not show a slowing growth rate-a
And their main concerns
Are Powell still yearns
For rate cuts to help market beta

 

As many of us enjoyed the long weekend, it appears it is time to put our noses back to the proverbial grindstone.  I know that as I age, I find the meaning of the Memorial Day holiday to grow in importance, although I have personally been very fortunate having never lost a loved one in service of the nation.  However, as the ructions in the nation are so evident each day, I remain quite thankful for all those that “…gave the(ir) last full measure of devotion” as President Lincoln so eloquently remarked all those years ago.

But on to less important, but more topical things.  A week ago, an X account I follow, The Kobeissi Letter, posted the following which I think is such an excellent description of why we are all so confused by the current market gyrations.  

Prior to President Trump’s second term, I would contend that the broad narrative had some internal consistency to it, so risk-on days saw equity markets rally along with commodities while bond prices would fall (yields rise) and the dollar would sink as well.  Similarly, risk-off days would see pretty much the opposite.  And it was not hard to understand the logic attached to the process.  

But here we are, some four plus months into President Trump’s term and pretty much every old narrative has broken into pieces.  I think part of that stems from the fact that the mainstream media, who were purveyors of that narrative, have been shown to be less than trustworthy in much of what they reported during the Biden Administration, and so there is a great deal of skepticism now regarding all that they say, whether political or financial.

However, I think a bigger part of the problem is that different markets have seen participants focusing on different idiosyncratic issues rather than on the bigger picture, and so there are many mini narratives that are frequently at odds.  Add to this the fact that there continues to be a significant dichotomy between the soft, survey data and the hard, calculated data, with the former pointing toward recession or stagflation while the latter seems to be pointing to stronger economic activity, and the fact that if you ask twenty market participants about the impact of President Trump’s tariff policies, you will receive twenty-five different explanations for why markets are behaving in a given manner and what those policies will mean for the economy going forward.

It is at times like these, when there are persuasive short-term arguments on both sides that I step back and try to look at bigger picture events.  In this category I place two things, energy and debt.  Energy is life.  Economic activity is simply energy transformed and the more energy a nation has and the cheaper it is, the better off that economy will be.  President Trump has made no bones about his desire to cement the US as the number one energy producer on the planet and to allow affordable energy to power the economy forward.  As that occurs, that is a medium- and long-term bullish backdrop.

On the other hand, we cannot forget the debt situation, which is an undeniable drag on economic activity.  Forgetting the numbers per se, the fact that the US debt/GDP ratio is at wartime levels during peacetime (well, US peacetime) with no obvious end to the spending is a key concern.  But it is not just the US with a growing debt/GDP ratio.  Here is a listing from tradingeconomics.com of the G20’s ratios.  (Russia is the bottom of the list but not relevant for this discussion.)

And remember what has been promised by Germany and the Eurozone with respect to defense spending? More than €1 trillion for Germany and it sounds, if my addition is correct, like upwards of €1.7 trillion across the continent.  And all of that will be borrowed, so that is another 22% in Germany alone.  The point is the global debt/GDP ratio remains above 300% for public and private debt.  As government debt grows above 100%, at some point, we are going to see central banks, in sync, clamp down on longer-term yields.  

However they couch it, and however they do it, whether actual yield curve control, through regulations requiring banks and insurance companies to hold more government bonds on their balance sheets with no capital charges, or through adjustments to tax driven accounts like IRA’s and 401K’s, requiring a certain amount of government debt in the portfolio to maintain the tax deferred status, I expect that is what we are going to see.  And even with oil prices declining, which I think remains the trend, inflation is going to be with us for a long time to come as debt will be monetized.  It is the only solution absent a depression.  And every central bank will be in on the joke.  Which takes us to this morning…

As yields were soaring
The BOJ kept quiet
Until yesterday

Apparently, the bond vigilantes have spent the past decades learning Japanese.  At least that is what I conclude from the price action, and more importantly, the BOJ’s recent response in the JGB market. As you can see in the chart below, there has been a significant reversal in 30-year JGB yields with similar price action in both the 20-year and 40-year varieties.

Source: tradingeconomics.com

You may recall that last week, the Japanese government issued 20-year bonds, and the auction went quite poorly, with yields rising sharply (that was the large green candle six sessions ago). Well, it seems that the BOJ (along with the Ministry of Finance) have figured out that the bond situation in Japan is reaching its limits. After all, in less than two months, 30-year JGB yields rose 100 basis points from a starting point of about 2.2%.  That is an enormous move.  Now, if we look at the table above, we are reminded that Japan’s debt/GDP ratio is the highest in the developed world at well over 200%.  In addition, the BOJ owns more than 53% of all JGBs outstanding.  Quite frankly, it is easy to make the case that the BOJ has been monetizing Japanese debt for years.  

As it happens, last week the BOJ held one of their periodic (actually, the 22nd) “Bond Market Group” meetings in which they discuss with various groups of market participants the situation in the JGB market regarding liquidity and trading capabilities and the general functioning of the market.  The two charts below, taken from the BOJ’s website (H/T Weston Nakamura) demonstrate that there is growing concern in the market as to its ability to continue along its current path.

The concern demonstrated by market participants is a clear signal, at least to me, that we are entering the end game.  For all the angst about the situation in the US, with excessive fiscal expenditures and too much debt, Japan has that on steroids.  And while Japan has the benefit of being a net creditor country, the US has the advantage of having both the strongest military in the world and issuing the world’s reserve currency.  As well, the US neighborhood is far less troublesome than Japan’s in East Asia with two potential protagonists, China and North Korea.  All I’m saying is that after decades of kicking the can down the road, it appears that the road may be ending for Japan and difficult policy decisions regarding spending, deficits and by extension JGB issuance are coming soon.

It’s funny, many economists have, in the past, described the US situation as Japanification, with rising debt and slowing growth.  But perhaps Japanification will really be the road map for how to respond to the first true limits on the issuance of government debt for a major economy.  Last night, JGB yields fell across the board, dragging global yields down with them.  The yen (-0.8%) weakened sharply, reversing its trend of the past two weeks, while the Nikkei (+0.5%) rallied.  Perhaps market participants are feeling comforted by the fact the Japanese government seems finally ready to recognize that things must change.  But this is the beginning of that process, not the end, and there will be many twists and turns along the way.  Stay tuned.

Ok, I really ran on, but I feel it is critical for us all to recognize the debt situation and that there are going to be changes coming.  As to other markets overnight, this is what we’ve seen.  Asia was mixed with gainers (Hong Kong, Australia, Singapore) and laggards (China, Korea, India, Taiwan) but nothing moving more than 0.5% in either direction.  Europe, on the other hand, has been the beneficiary of President Trump delaying the tariffs on the EU until July 9th, with all the major indices higher led by the DAX (+0.8%) which also rallied more than 1% yesterday.  Say what you will about President Trump, he has gotten trade discussions moving FAR faster than ever before in history.  US futures, at this hour (6:15) are also pointing nicely higher, more than 1.3% across the board.

We’ve already discussed bond yields where 10yr Treasury yields have backed off by 5bps this morning although European sovereign yields have not benefitted quite the same way with declines of only 2bps on average.  But the trend in all cases is for lower yields right now.  Hope springs eternal, I guess.

In the commodity space, with the new view on tariffs, risk is abating and gold (-1.5%) is being sold off aggressively.  Not surprisingly, this has taken the whole metals complex with it.  As to oil (+0.1%) it continues to trade in its recent $60 – $65 range and while the trend remains lower, it is a very slow trend.

Source: tradingeconomics.com

Finally, the dollar is perking up this morning, not only against the yen, but across the board.  On the haven front, CHF (-0.6%) is sinking and the commodity currencies (AUD -0.6%, NZD -0.8%, SEK -0.6%) are also under pressure.  But the euro (-0.4%) is lower and taking the CE4 with it.  In fact, every major counterpart currency is lower vs. the dollar this morning.

On the data front, this morning brings Durable Goods (exp -7.8%, -0.1% ex-transport), Case Shiller Home Prices (4.5%), and Consumer Confidence (87.0). We also hear from NY Fed President Williams this evening.  Chairman Powell spoke at the Princeton graduation ceremony but said nothing about policy.  I will review the rest of the week’s data tomorrow.

Bonds are the thing to watch for now, especially if we are going to see more active policy adjustments to address what has long been considered an unsustainable path.  The question is, will there be fiscal adjustments that help?  Or will central banks simply soak up the bonds?  While I hope it is the former, I fear it is the latter.  Be prepared.

Good luck

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Clouded and Blurry

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The Minutes explained twenty-five
Would likely still let markets thrive
But Powell demanded
A half, lest they landed
The ‘conomy in a crash dive

 

Yesterday’s release of the FOMC Minutes was enlightening to the extent it showed Chairman Powell did not have everybody in agreement for his 50bp rate cut last month.  In the Fed’s own words, “…a substantial majority of participants supported lowering the target range for the federal funds rate by 50 basis points to 4-3/4 to 5 percent.  However, noting that inflation was still somewhat elevated while economic growth remained solid and unemployment remained low, some participants observed that they would have preferred a 25 basis point reduction of the target range at this meeting, and a few others indicated that they could have supported such a decision.”  

Remember, too, that this meeting was held two days prior to the NFP report which changed a great deal of thinking on the subject, not least by the Fed funds futures market which as of this morning is pricing a 20% probability of no cut at the November meeting.  Looking at the GDPNow calculation from the Atlanta Fed, that NFP number increased the estimate to 3.4%, although recent inventory data has seen it slip back a tick as you can see below.  

Source: atlantafed.org

Despite that last little dip, though, the estimate remains far stronger than economists’ forecasts and paints a picture of a resilient economy.  (Perhaps adding $1.8 trillion via the budget deficit has something to do with that, but that is a story for a different time.). While the Fed is clearly anxious, if not desperate, to cut rates further, the economic case, with inflation remaining above their targets and the employment situation looking better amid solid economic growth, seems to be waning.

Three weeks ago, Jay and the Fed
Said joblessness was their, flag, red
Explaining inflation
Had taken vacation
So, more cutting rates was ahead
 
This morning we’ll learn if that’s true
Or if, like employment, their view
Is clouded and blurry
Which could cause some worry
For bulls and for Biden’s whole crew

Which leads us to the other key market story today (clearly the devastation from Hurricane Milton is the most important news of the day and my thoughts and prayers go to all those in its path), the CPI report.  Current consensus expectations are for a 0.1% rise in the monthly headline reading which translates to a 2.3% Y/Y increase and a 0.2% rise in the monthly core reading which translates into a 3.2% Y/Y increase.  

Looking at some obvious pieces of the puzzle, gasoline prices fell 8.4% in September, which is one of the reasons the headline number is below the core number.  The thing is, gasoline prices this morning are almost exactly where they were at the beginning of September, which informs us that the headline number could easily retrace somewhat next month.  The point is, we need to keep our eye on the core number (after all, the reason they created it was because food and energy prices were volatile and monetary policy’s impact on them virtually nonexistent, so they needed something that might give them a better feel for the reality elsewhere).  And I don’t know about you, but if the target is 2.0% then 3.2% doesn’t seem that close.  I know they are focused on core PCE, but even that remains well above their target.

One of the stories around this morning is that used car prices have stopped declining and that could have an outsized impact resulting in a higher than otherwise reading.  But in reality, I question whether this matters at all.  What we have learned from the Fed over the past month is that they are going to cut rates no matter what.  While the pace of those cuts may be faster or slower depending on some data, every Fed speaker this week, and even a review of the Minutes, points to the fact that they are all desperate to keep cutting rates.

But you know who is taking exception to that stance?  The bond market.  Perhaps the bond vigilantes of late 90’s fame have been resurrected, or perhaps investors are simply looking at the fiscal situation in the US, where deficit spending continues to increase which means more and more Treasury debt will need to be issued and decided that even 4.0% is no longer a reasonable nominal return on their investment.

As you can see below, 10-year Treasury yields have risen 46bps since just before the last FOMC meeting as the stronger US data combined with the Fed’s clear focus on cutting rates has made investors nervous.  

Source: tradingeconomics.com

You may recall the discussion about the inverted yield curve, where 2yr yields traded above 10yr yields for more than two full years, a record amount of time.  This fostered many recession calls as historically this has been a harbinger of a future recession.  However, a key question was whether the disinversion would be a bull (falling 2yr yields) or bear (rising 10yr yields) steepener.  Things started as a bull steepener with the Fed cutting rates, but lately, as we watch 10yr yields rise, fears are growing that inflation is making a comeback and the bond bears are going to drive this process.  A bear steepening is not going to be a welcome result for Powell and friends, nor especially for Ms Yellen, as the cost of debt will continue to rise.  It also speaks to concerns that the Fed has lost control of the narrative.  It is still too early to declare the outcome, but the original, widely held view of a bull steepener is fraying at the seams.

Ok, let’s quickly touch on overnight markets.  Yesterday’s US rally saw follow through in Japan (+0.25%) alongside a weakening yen (-0.75% yesterday, +0.2% this morning) and in China (+1.1%) and Hong Kong (+3.0%) after the PBOC detailed the support they would be giving to equity market players and indicated that more could follow.  As to the rest of the region, there were more gainers than laggards but nothing of real note.  In Europe, although most markets are little changed on the day, if leaning slightly lower, Spain’s IBEX (-0.9%) is the outlier on what seems to be profit taking ahead of the US CPI number after a strong 5-day run higher.  And at this hour (7:10) US futures are pointing slightly lower, about -0.2%.

In the bond market, yields continue to climb around the world with Treasuries adding 1bp and most of Europe seeing yields rise 2bps – 3bps.  The largest mover there, though is the UK (+6bps) as the market there prepares for Chancellor Rachel Reeves’ first budget and implies they are not expecting fiscal prudence.  In Japan, JGB yields rose 2bps and are now at 0.94% as given the turnaround in rates globally, expectations are growing for the BOJ to consider another hike.  In fact, ex-BOJ member Kazuo Momma was quoted last night saying that if USDJPY goes back above 150, the BOJ is likely to move before the January meeting currently expected.

Commodity markets are taking a breather from their recent rout with oil (+1.4%) leading the energy group higher while gold (+0.4%) leads the metals complex.  It has been a rough week for commodity bulls (this poet included) but nothing has changed the long-term picture in my view.  This is especially true if the Fed does cut rates regardless of the stronger data.

Finally, the dollar is continuing to show strength with the DXY pushing back to 103 and the euro back down near 1.09.  It seems clear the market is adjusting its views as to how much the Fed is going to cut based on the data, not the Fedspeak, and that turn, from an uber dovish Fed to one less dovish is going to support the greenback.  ZAR (+0.45%) is this morning’s outlier as it follows gold prices higher, but that is the largest movement across either the G10 or EMG blocs.  It seems everybody is awaiting the CPI data.

In addition to the CPI, we see the weekly Initial (exp 230K) and Continuing (1830K) Claims data and we hear from Gvoernor Lisa Cook, one of the more dovish Fed governors.  But for now, it is all CPI all the time.  My take is a soft number will be seen as a signal the Fed will be cutting aggressively and help stocks and commodities while undermining the dollar with a strong number doing the opposite.  Bonds, though, are much trickier here as I think there are a lot of fiscal concerns being priced in, and lower inflation won’t solve that problem in the short run.

Good luck

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Unchained

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The data, on Friday, revealed
The job market’s mostly been healed
As such, any thought
The Fed really ought
Cut rates, simply must be repealed
 
In fact, two Fed speakers explained
That rate cuts were not yet ordained
Should prices keep rising
It won’t be surprising
If higher rates soon are unchained

 

Wow!  Once again, the NFP report was significantly hotter than any analysts forecast, with a top line number of 303K while the previous 2 months were revised higher as well.  The Unemployment Rate fell back a tick, to 3.8%, while wages continue to grow above 4%.  In other words, it seems quite difficult to make the case that the economy is in a state that requires rate cuts.  After all, if the Fed’s focus has turned from inflation specifically to employment now, and employment continues to rock, why cut?

However, the impression from the cacophony of Fedspeak we heard last week is that many members are still of a mind to cut the Fed funds rate, likely in June.  Just not all of them.  We heard from two more speakers Friday, Governor Michelle Bowman and Dallas Fed President Lorie Logan, and neither seemed in a cutting frame of mind.  [Emphasis added]

Bowman: “While it is not my baseline outlook, I continue to see the risk that at a future meeting we may need to increase the policy rate further should progress on inflation stall or even reverse.”

Logan: “In light of these risks, I believe it’s much too soon to think about cutting interest rates.  I will need to see more of the uncertainty resolved about which economic path we’re on.” She followed that with, “To be clear, the key risk is not that inflation might rise — though monetary policymakers must always remain on guard against that outcome — but rather that inflation will stall out and fail to follow the forecast path all the way back to 2 percent in a timely way.”

Now, it is very difficult for me to read these comments and think, damn, rate cuts are coming soon!  By now, you are all aware that I have been in the sticky inflation camp from the get-go and certainly Friday’s data did nothing to change my mind.  But my views don’t really matter. However, if we start seeing a majority of FOMC members talking about fewer cuts than expected/assumed in March, and even hikes, we need to pay attention. I don’t think it is yet a majority, and clearly Chair Powell is very keen to cut, but there is a long time between now and the June meeting, with much data to come.  Unless that data starts to really back off and hint at a substantial slowing of the economy, my sense is that June will morph into November or December, with the median dot pointing at just one cut this year.

A quick look at the Fed funds futures shows that traders are growing even less confident in those rate cuts being implemented.  As of this morning, the June probability has fallen slightly below 50% and there are a total of 61bps priced in by the December meeting, just over two cuts.  This is quite a contrast to the Eurozone, where the market has fully priced in a June cut and is beginning to consider a 50bp reduction to get things going there.  On the surface, this makes a great deal of sense as the Eurozone economy’s growth continues to lag that of the US and inflation has been ebbing more rapidly there than in the States.  And don’t forget, the ECB meets this Thursday, so at the very least we should have a better sense of what will happen in June, and we cannot rule out a cut this week, regardless of market pricing.

Trying to step back for a broader perspective on the economy and the future of policy rates as well as market movements, there continue to be several conundrums in markets compared to historical trends.  For instance, what is the meaning of the price of gold rising consistently alongside a rise in interest rates, both nominal and real?  Historically, there has been a strong negative correlation between the two, but something has changed in the past two years as evidenced by the BofA Research chart below.

Is this a signal that the market is getting indigestion over the amount of sovereign debt that is outstanding, led by Treasuries?  Is this an indication that investors are losing faith in fiat currencies and the current global monetary structure?  Or is this simply a temporary anomaly that will correct over the course of the next several years?  Unfortunately, there is no way for anyone to know the answer to these questions at this point in time.  Anyone who says otherwise is not being honest.  

However, my suspicion is that the consequences of monetary and fiscal policies around the world during the Pandemic and since has more and more people, and institutions, starting to hedge their bets on the future and its outcomes.  From a more benign view that the authorities will be able to kick the can down the road, this relationship seems to indicate more than a few folks think that the fiscal and monetary authorities are about to stub their collective toe on the next kick.  Ouch!

In many ways, I think that the change in this relationship is an excellent encapsulation of the problems currently faced by monetary and fiscal authorities.  As such, I will be watching it closely as a key indicator of market sentiment overall.

Ok, let’s look at the overnight session.  After Friday’s solid US equity performance, the picture elsewhere has been slightly less positive, although positive overall.  In Asia, the Nikkei (+0.9%) followed the US price action although Chinese shares had a less positive session, falling on the mainland with the HK market staying flat.  Treasury Secretary Yellen was in China trying to smooth things over, but the following two statements, I think, are a great description of how confused things are:

Talk about mixed messages!  Meanwhile, in Europe, most bourses are a bit higher this morning, but on the order of 0.5%, half what we saw in the US on Friday.  It seems that some traders are betting that the ECB, when it meets this Thursday, is going to cut rates.  Lastly, at this hour (7:20), US futures are essentially flat.

The bond market, though, has seen far more activity lately as it appears the bond vigilantes, last seen in the 1990’s are reawakening.  This morning, 10-year Treasury yields are back to 4.45%, their highest level since November when yields were falling in the wake of the Fed’s perceived pivot and the reduced amount of coupon issuance just announced at that time.  This is 13bps higher than the yield just before the NFP data was released, 8bps on Friday and another 5bps this morning.  Similarly, European sovereign yields hare higher by between 3bps and 5bps this morning, being dragged higher by Treasuries, but lagging as bets get made that the ECB acts sooner than the Fed.

In the commodity space, oil (-0.8%) is backing off its recent highs this morning as there appears to be an easing in some concerns over the Middle East, at least that is the story making the rounds.  Meanwhile, metals prices continue to flourish despite the rise in interest rates with both precious (Au +0.4%, Ag +0.9%) and base (Cu +0.7%, Al +0.3%) all continuing their recent climbs.  Another conundrum here is the fact that these metals prices are rising despite the dollar remaining reasonably well bid.

Turning to the dollar, it is little changed, on net, this morning although we have seen some strength against the CHF (-0.5%) and KRW (-0.4%).  The former is the only currency seemingly following the interest rate story as the recent SNB rate cut plus low inflation readings indicates that the policy divergence between Switzerland and the US is set to widen further.  The won, on the other hand, looks to be a proxy for China, which the PBOC refuses to allow to weaken despite many economic reasons it should.  On the flipside, ZAR (+0.4%) is rallying on the back of those metals’ prices.  One of the things that is confusing is the fact that the euro remains reasonably well bid despite the changing tone of the interest rate policies between the Fed and ECB.  While the single currency has generally been declining over the past month, in truth, since the beginning of April, it has rebounded about 1% and held strong since then.  Given the changing market perceptions, I would have anticipated the euro to continue its declining ways, but right now, that is not the case.

On the data front, the week starts out slowly, but we get the critical US CPI data on Wednesday.

TuesdayNFIB Small Biz Optimism89.5
WednesdayCPI0.3% (3.4% Y/Y)
 -ex food & energy0.3% (3.7% Y/Y)
 Bank of Canada Rate Decision5.0% (unchanged)
 FOMC Minutes 
ThursdayInitial Claims215K
 Continuing Claims1792K
 PPI0.3% (2.3% Y/Y)
 -ex food & energy0.2% (2.3% Y/Y)
 ECB Rate Decision4.5% (unchanged)
FridayMichigan Sentiment79.0
Source: tradingeconomics.com

In addition to the data and other central bank decisions, we hear from seven more Fed speakers this week, which given the recent more hawkish commentary, could well be quite interesting.  If Wednesday’s CPI data is hotter than expected again, I suspect it will become increasingly difficult for the doves to spread their wings.  As it happens, six of the seven speak after the CPI, so we could well see things evolve further.  In the meantime, relative to other currencies, I continue to look at the rate picture and believe the dollar should remain firm.  However, versus ‘stuff’ not so much.

Good luck

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Not Much Mystique

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In looking ahead to this week
Eleven Fed members will speak
And Core PCE
On Thursday, we’ll see
But otherwise, not much mystique
 
And one other thing we will hear
Is maybe a shutdown is near
But history shows,
And everyone knows,
Investors, this problem, don’t fear

 

After a dull session on Friday across all markets, the weekend delivered exactly zero new information that might alter investor perspectives.  Hence, we are in the same place we left things before the weekend.  Of more concern for traders, although not for hedgers or investors, is that there are few potential catalysts on the horizon for at least the first part of the week.  Thursday’s Core PCE data is clearly the biggest data release, but there will be ample time to discuss that as we get closer.

In the meantime, based on everything we have seen of late; the entire narrative will remain focused on NVIDIA as well as AI in general in the stock market.  For bond junkies, there will be more questions about the sustainability of the current spending plans in the US and whether the market will absorb all the issuance that is coming.  Planned this week are auctions for $398 billion of T-bills, 2-year, 5-year, and 7-year notes.  That’s a lot of issuance, and there is no sign that it is going to slow down at any point in the near future.  Last week, the 20-year bond auction had its worst outcome in its history, with a 3.3bp tail, an indication that investors are getting full or at the very least concerned in some manner and need higher yields to be persuaded to continue investing. 

The issue here stems from the fact that interest payments are utilizing an increasing part of the Federal budget and as old debt matures and is rolled over at current yields, those payments will continue to grow.  While theoretically, the Treasury can simply continue to issue more debt in order to pay off whatever comes due, that means the stockpile of debt continues to grow, and with it, the interest needed to be paid each year.  Alternatively, the Fed can change their QT back to QE, purchase Treasury securities and cap rates or drive them lower.  However, if Powell goes down that road, the results are very likely to be a serious uptick in inflation and a serious decline in the dollar.  The point is the current pace of issuance is not sustainable in the long run.  Although, to be fair, people have been saying the same thing about Japan for the past twenty years, so it could still go on for a while.

I continue to believe that a bear-steepening outcome is the most likely, with bond yields rising above current the Fed funds target and the excessive supply of new bonds is one of the things driving that view.  However, that seems more like a late summer or autumnal issue, not something for right now.

But away from the bond discussion, there is little else to note.  A quick recap of the overnight session shows that Asian equity markets were on the sleepy side with Japan up a bit, 0.4% or so, while Chinese shares resumed their longer-term trend declines with the Hang Seng (-0.5%) and CSI 300 (-1.0%) both ceding ground, as there were no new stimulus programs announced.  It is seeming increasingly as though absent stimulus; Chinese shares are a sale.  In Europe, the action is mixed with both gainers and losers but nothing moving very far at all, 0.3% being the largest change on the day.  It is the same story in the US, with futures at this hour (7:30) basically unchanged from Friday’s closing levels.

In the bond market, Treasury yields (-1bp) are edging lower this morning, although we are seeing the opposite tendency in Europe with most sovereigns gaining 1bp in yields.  The outlier here is the UK, where 10-year Gilts have seen yields climb 6bps after a better-than-expected CBI Retail Sales print added to the Flash PMI data from last week and is pointing to a somewhat better economic outlook.  A quick look east shows that JGB yields slipped 3bps overnight as investors, looking ahead to tonight’s CPI data are expecting a soft print and less incentive for the BOJ to tighten policy.

Oil prices (-0.6%) continue to slide slowly as production continues apace but there are questions about demand given the weakness seen in Europe, the UK and China.  A stronger US economy is not enough, by itself, to drive oil prices higher.  In the metals markets, copper is the big loser, down -1.4%, as concerns over Chinese economic resurgence continue to dog the red metal.  It appears the relationship between copper and the CSI 300 is tightening up a bit.

Finally, the dollar is under modest pressure this morning as US yields continue to soften slightly after Friday’s decline.  But to indicate just how modest things are, the biggest mover today is the euro (+0.3%).  Literally every other major currency, whether G10 or EMG has had less movement than that.  In other words, there is no story here.  We need to see some monetary policy changes before this is going to heat up again.

On the data front, as indicated above, it is a pretty quiet week as follows:

TodayNew Home Sales680K
 Dallas Fed Manufacturing-8.0
TuesdayDurable Goods-4.5%
 -ex transport0.2%
 Case Shiller Home Prices6.0%
 Consumer Confidence115
WednesdayQ4 GDP3.3%
ThursdayInitial Claims210K
 Continuing Claims1874K
 Personal Income0.4%
 Personal Spending0.2%
 PCE0.3% (2.4% Y/Y)
 Core PCE0.4% (2.8% Y/Y)
 Chicago PMI48.0
FridayISM Manufacturing49.5
 ISM Prices Paid53.0
 Michigan Sentiment79.6
Source: tradingeconomics.com

Looking at everything, although there seems to be a lot of stuff, most of it is just not really that important.  I have to remark on the Case Shiller data as recall, a big piece of the disinflation theory is the decline in housing prices.  A 6.0% Y/Y print does not feel like it is declining to me, but then I am just an FX poet.  Obviously, all eyes will be on the PCE data Thursday morning.  In addition to this, we hear from eleven different Fed speakers including Waller and Williams, two of the more important voices, although Chairman Powell remains mum.

Nothing we have seen over the past weeks has changed my longer-term views and quite frankly, the first part of the week is shaping up as a sleeper.  Quiet markets are a boon to hedgers as executing is greatly eased, and banks will compete hard for your business.  In the end, the dollar continues to follow the yield story, so, if yields in the US slide from current levels, the dollar will likely follow.  The opposite is also true.

Good luck

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Fears to Assuage

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When calendars all turned the page
To ‘Twenty-One, clearly the rage
Was bets on reflation
And more legislation
For stimulus, fears to assuage

The dollar was slated to fall
The yield curve, to grow much more tall
While stocks were to rally
And Covid’s finale
Was forecast, a popular call

But so far, while stocks have edged higher
And bond yields are truly on fire
The dollar remains
Ensconced in its gains
Its meltdown has yet to transpire

One cannot be but impressed with the dollar’s resilience so far this year amid such surety by so many that it was destined to fall sharply.  Consensus views at the beginning of January were that the vaccines would lead to significant reflation in the global economy, equity markets would benefit greatly, bond yields would rise amid trillions of dollars of new issuance, and the dollar would fall.  As I said from the start, higher bond yields and a steeper yield curve did not typically lead to dollar weakness.  And that is what we have begun to see in the past several sessions.

Global bond markets have really started to reprice the current situation.  While the US story is easy to understand; huge new stimulus bill with no tax increases means huge new Treasury issuance to pay for things and supply overwhelms demand, one needs to ask what is driving the price declines throughout Europe and Asia as well. Stimulus efforts elsewhere have been less substantial despite more severe lockdowns by most of Europe and many Asian nations.  So, perhaps it was not merely the supply-demand imbalance that had bond investors concerned, perhaps it was also inflation expectations.

Certainly, these have been rising sharply with US 5yr-5yr breakevens now at 2.40% this morning, the highest level since March 2013, and not merely trending higher, but exploding higher.  (Germany, too, has seen a sharp rise in breakeven inflation, albeit to much lower levels, rising from 0.2% at the lows last March to 1.06% today.)  While last week’s CPI readings were a touch softer than expected on a headline basis, the reality is that higher inflation remains almost assured going forward.  This is partly because of the way the data is calculated, where last year’s pandemic induced lows will fall out of the calculation to be replaced by this year’s much higher readings.  It is also evident in the rising price of commodities, specifically oil (+1.0% this morning) which is higher by 25% this year.  In fact, the entire energy sector has seen prices rise by roughly that amount, and we have seen gains across the board in both base metals and all agricultural products.  In other words, stuff costs more.

Perhaps, of more concern is the insouciance toward inflation shown by the Fed.  For example, just yesterday, SF Fed President Mary Daly, when asked about inflation getting out of hand replied, “I don’t think that’s a risk we should think about right now.  We should be less fearful about inflation around the corner and recognize that fear costs millions of jobs.”  If you think the Fed is going to respond to any inflation data, anytime soon, you are mistaken.  They have made it very clear that the only part of their mandate that currently matters is employment.

So, let’s recap; the price of stuff is going higher while the Fed is adamant that tighter policy is inappropriate at this time.  Bonds are doing their job, or perhaps that is; the bond vigilantes are doing their job.  They are forcing yields higher, and left unabated, probably have much further to go.  But will they be left unabated?  I think the definitive answer is, no, the Fed will not allow Treasury yields to rise very much further.  And this, of course, drives my view that the dollar, while strong now, will eventually reverse course, as the Fed halts the rise in Treasury yields.

But for now, those higher yields are attracting investors into dollar products, and by extension, into dollars.  And this story can play out for a while yet.  It is a mug’s game to try to guess at what point the Fed will become uncomfortable with Treasury yields, with current guesses ranging from 1.50% to 3.0% in the 10-year.  My sense is it will be toward the lower end of that range that will encourage the extension and expansion of QE, perhaps 1.75%-2.0%.  But I remain confident that at some point, they will respond.  And with inflation showing no signs of abating, it will happen sooner than you think.

What about the rest of the world?  Well, the one thing we know is that neither the ECB nor the BOJ can afford for their currencies to strengthen too much.  While Japan has shown more stoicism lately, I can easily envision Madame Lagarde, in the context of alleged lack of inflationary pressures, pushing the ECB to expand their largesse as well, at least enough to try to offset the Fed.  Will it work?  That, of course, is the $64 trillion question.

On to today’s activity.  Risk is under a bit of pressure this morning after what were truly impressive bond market declines yesterday.  but those declines were not so much risk on, as fear starting to spread.  So, a quick tour of equity markets shows that after a mixed US session, the Nikkei shed 0.6% overnight, although the Hang Seng managed a 1.1% gain.  Shanghai reopens tonight.  In Europe, screens are red wit the DAX (-0.55%) leading the way lower, although the CAC (flat) and the FTSE 100 (-0.1%) are not suffering that greatly.  Meanwhile, at this hour, US futures are essentially unchanged.

Bond yields, which rose sharply around the world yesterday (11bps in the US, 5-8bps throughout Europe) are consolidating a bit.  Treasuries are lower by 1.9 basis points, but they have already backed up from earlier levels.  In Europe, we see the same thing, where early yield declines have been virtually erased.  Bunds are flat, OATs are higher by 0.6bps and Gilts, one of the worst performers yesterday, have seen yields fall 1.0bp, but that is well off the levels earlier this morning. The point is, even if equities are under pressure, funds don’t appear to be flowing into bonds.

Rather, commodities are the market of choice, with oil now above $60/bbl (+1.0%) and base metals higher along with almost all agricultural products.  In fact, the only real laggards here are gold (-0.3%) and silver (-0.5%), which are arguably suffering from higher yields as a competitor.

Finally, the dollar is definitely feeling its oats this morning, rising against all its G10 brethren, with the weakest link SEK (-0.45%), although other than CAD (-0.1%) and JPY (-0.05%), the rest of the bloc is lower by at least 0.3%.  This is a broad dollar strength story, with virtually no idiosyncratic national issues to drive things.  In fact, the only data of note was UK inflation, which printed a tick higher than expected.

Emerging market currencies are similarly under pressure across the board, led lower by ZAR (-0.8%) and MXN (-0.8%), although there is broad weakness in APAC and CE4 currencies as well.  Again, one needn’t look too far afield to determine why these currencies are weak, it is simply a dollar strength day.

On the data front, we start the morning with Retail Sales (exp 1.1%, 1.0% ex autos), move on to IP (0.4%) and Capacity Utilization (74.8%) and finish the afternoon with the FOMC Minutes from the January meeting.  It seems hard to believe that the Minutes will have much impact as there were neither policy shifts nor even dissension in the ranks. Perhaps we will learn if YCC or QE extension has been a discussion topic, which would be hugely bond bullish and dollar bearish.  But I doubt it.

Rather, this dollar rebound, much to my surprise, seems to have a little more behind it and could well extend a bit further.  Looking at the euro, the technicians will focus on 1.2000, the 100-day moving average and 1.1950, the low touched in last week’s sell-off.  But if the Treasury curve continues to steepen, the euro could well move back to the 1.1750 level last seen prior to the US election in November.  That is not my base case, but the probability has certainly grown lately.

Good luck and stay safe
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