Tag Archives: #china

Already Wary

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In China, the news wasn’t great

As Moody’s no longer could wait

Because of a glut

Of debt, they did cut

The outlook for China’s whole state



Investors were already wary

And as such, since last January,

Afraid of more shocks

Have been selling stocks

In quantities not arbitrary

The biggest news overnight was Moody’s downgrading their outlook for Chinese debt to negative from its previous stable view.  Moody’s currently rates the nation at A1, 4 notches below the best available of Aaa, but still a solid investment grade rating.  However, citing the property downturn in the country and the concomitant fiscal pressures that are building on local governments’ balance sheets, it appears there is a growing concern that national debt will be issued to cover the local failures.  

It must be very difficult to be a local government financial official in China as the competing pressures of ever faster growth and maintaining sound finances have become impossible to attain simultaneously.  The real question is, will President Xi determine that fiscal stability is more important than economic growth?  While that appeared to be his view last year, this year he seems to have changed his focus to growth.  Perhaps the fact that the US economy seems to be maintaining very solid growth while China is stumbling has become too much of a bad look for him to tolerate further.  (And that’s not to say things are fantastic here.) 

At any rate, his efforts to encourage more widespread economic activity while simultaneously deflating the immense property bubble there is starting to run into trouble.  As the pace of growth slows in the country, exacerbated by the demographic decline of the population (it is getting old and the population is shrinking), Xi appears to have thrown fiscal caution to the wind.  Once again, my concern is that if the domestic economy continues to deteriorate, Xi will determine that it is time for some international adventures to shore up his support at home.  I would contend that is not on anyone’s bingo card right now, but it is something to watch.

The market response to the news was to further sell Chinese equities with both onshore and Hong Kong markets suffering, each declining nearly 2%.  This weighed on Japanese markets (Nikkei -1.4%) as well as Taiwan, South Korea, and Australia, with only India ignoring the story.  It makes some sense that the China and India stories are uncorrelated given India is one of the few nations not reliant on China for much with respect to trade.  

Away from that story, however, things have been remarkably quiet on the economic front.  We saw Services PMI data from around the world with China, interestingly, one of the few nations printing above 50 (Caixin Services PMI 51.5), while all the continent remains firmly below the 50 boom-bust line save the UK which printed a much better than expected 50.9 reading.  While the market is waiting for US ISM Services data (exp 52.0) as well as JOLTS Job Openings data (9.3M), there is scant little else to discuss this morning.  Recall, though, as the week progresses, we will be receiving much more important data, notably the payroll report, which may help clarify the state of things now.

But, lacking anything else to discuss, let’s run down markets.  Away from Asia, equity markets are mixed with continental bourses all modestly firmer, on the order of 0.3%, although the FTSE 100 is lower by -0.5% despite the better than expected PMI data.  US futures are also pointing lower this morning, about -0.5% after a desultory day yesterday on Wall Street.

In the bond markets, Treasury yields have edged a bit lower this morning, -3bps, resuming what has been a powerful downtrend in yields.  In Europe, though, yields have really taken a dive, with sovereign bonds there all seeing declines of between 7bps and 9bps.  The weak PMI data has investors now bringing forward EB rate cuts to June.  Adding to this story were comments from the ECB’s Schnabel, historically one of the more hawkish members, describing the possibility of rate cuts next year as appropriate.  This seems quite similar to the Waller comments last week given Schnabel’s presumed importance on the ECB.  Finally, JGB yields are 2bps softer after slightly softer than expected Tokyo CPI data was seen as a harbinger for slowing inflation across Japan.  Once again, the idea that interest rate policy in Japan is due to normalize soon is being challenged by the facts on the ground.

Turning to commodities, oil (-0.3%) is slipping again as the weak PMI data encourages worries of an impending recession and the OPEC+ meeting was not taken seriously by the market as an effective manner to reduce supply.  Inventories have been building lately, so further pressure seems viable.  Meanwhile, metals markets are under further pressure with both copper and aluminum falling by more than -1.0% and gold, which had a remarkable session yesterday with a greater than $100 trading range, edging down a few bucks, but still well above the $2000/oz level.

Finally, the dollar refuses to obey the narrative and die.  Instead, it is higher again this morning vs. almost all its counterparts, both G10 and EMG.  The laggard today is AUD (-0.9%) which fell after the RBA left rates on hold, as expected, but apparently was not seen as hawkish as traders anticipated and the market has removed the pricing for any further rate hikes there.  The only exception to this movement has been the yen, which is now 0.1% firmer although in the wake of the Tokyo CPI data, it fell sharply.  USDJPY remains beholden to the twin narratives of declining US interest rates and normalizing monetary policy in Japan.  Right now, those stories are not working in concert, so until they do so, in either direction, I expect the yen will be choppy but not really make much headway in either direction.

Aside from the ISM and JOLTS data, we only see the API Crude Oil inventory data with a draw of 2.2 million barrels expected.  As there are no Fed speakers, it is shaping up to be a quiet day overall.  With that in mind, look for limited activity until 10:00 when the data is released and then I suspect that we remain in a ‘bad news is good’ regime.  So, weak ISM is likely to encourage risk taking on the belief the Fed will cut more aggressively and vice versa.  The same is true with the JOLTS data.  As to the dollar, I suspect it will follow the rate story, so strong data will help the buck and weak will see a bit of selling.

Good luck

Adf

The Bond, or Not the Bond

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The bond, or not the bond, that is the question:
Whether ‘tis nobler for the Fed to consider
That long-term yields have offered outrageous fortune,
Or to take Arms against a Sea of inflation
And in opposing it: hike rates yet again

(with deepest apologies to William Shakespeare)

For some reason, the ongoing cacophony of Fedspeak regarding whether the rise in long-term yields is helping the Fed in their efforts, or whether it is merely incidental, brought this famous soliloquy to mind.  We have had no less than eight different Fed speakers from the time Dallas Fed president Logan first mentioned the idea several weeks ago through yesterday discuss the subject with the majority continuing to latch on to the benefits for the Fed, although some dismiss the issue.  Now, in any definition of financial conditions I have ever seen, long-term yields are part of the construction, so it is perfectly reasonable to take them into account.  Clearly, the Fed is aware of this as QE was created entirely to ease financial conditions and consisted of simply buying bonds to lower long-term yields.  However, now that the Fed is in QT mode, their ability to control the long end of the curve has vanished.  In fact, if anything it is simply pushing those yields higher by removing themselves, a price-insensitive buyer, from the mix.

The problem for Chairman Powell is that whatever the Fed’s reaction function is with respect to data, the market’s reaction function to any hint that the Fed has finished tightening policy is well understood by one and all; BUY STONKS!!  The reason I believe this is a concern for Powell and co. is that they fear a rally in equities will signal an all-clear on the inflation front.  And it is abundantly clear that there is nobody on the FOMC who is prepared to claim victory over inflation.  That is exclusively the stance of the CNBC bulls and the administration sycophants who are paid to make that case specifically.  Reality, however, continues to demonstrate that inflation remains a feature of our everyday lives and I suspect that the FOMC mostly understands that.  Remember, too, that the Fed is data dependent, or so they say, which implies that they are not in a position to anticipate the death of inflation, rather they will only accept that premise when they see the body.

Where does this leave us now?  I suspect that the ongoing dance between the Fed and the markets with respect to the future of inflation will continue to play out for at least another year.  In fact, nothing has changed my view that inflation will remain well above their 2.0% target for the foreseeable future, likely finding a new home in the 3.5% +/- range.  And as long as Powell is Fed Chair, I see no indication he is willing to reverse course.  While the Fed may not hike rates again, certainly the market does not believe that is going to be the case with just a 9.6% probability of a hike in December now priced, I find it extremely difficult to believe they will cut rates anytime soon absent clear signs that we are already in a recession.

Though soft-landing bulls have all scoffed
The fact that the data was soft
In China implies
It cannot surprise
If growth worldwide can’t stay aloft

So, is a recession coming soon to an economy near you?  That is the $64 trillion question and one where there are myriad views expressed daily.  The most recent inkling that economic activity is slowing more sharply than had previously been thought was the surprisingly weak Chinese trade data, where not only did their trade surplus decline substantially (to a still robust $56.5B) but exports fell in absolute terms, they did not merely rise more slowly than imports.  The implication is that global growth is slowing more rapidly than the narrative explains.  

We already know that Europe is in a world of trouble with Germany the current sick man of the continent, but we also have seen the latest Atlanta Fed GDPNow data showing that growth in the US is slowing as well with the latest reading at 1.2%.  The UK is struggling as are many Asian nations, notably South Korea and Taiwan, or at least their export industries which are the key economic drivers there.

Another clue is the recent sharp decline in the price of oil, which has fallen -5.0% this week and ~-10% in the past month.  Clearly, a part of this price decline is based on the growing belief (hope?) that the Israeli-Palestinian conflict will not spread into a wider Middle East conflagration that affects oil production.  But part of this is the fact that oil inventories are building as are gasoline and diesel inventories with the result that prices are falling sharply.  Given it wasn’t that long ago when there were shortages in these products, it appears that demand is falling sharply as well.  Remember, diesel fuel is what drives the world as essentially no industry or commerce could continue without its use.  The fact that less is being used is a clear signal of slowing activity.

Putting it all together shows that amidst what appears to be a slowing global growth impulse, markets are pricing out further central bank monetary policy tightening.  Equity markets have been looking at the second part of that equation, less tightening and potential easing, while ignoring the first part, slower growth leading to lower profits.  It is very easy, at least for me, to accept the idea that markets have not yet understood that slower economic activity will lead to lower profits and subsequently, lower equity prices.  Alas, I understand that sequence so remain quite cautious overall.

Ok, how has this translated overnight?  Well, after a modest rally in the US yesterday, equity markets in Asia were a bit softer, declining on the order of -0.35% while European bourses are edging slightly higher this morning, maybe +0.1%.  US futures at this hour (7:45) are basically unchanged as we all await Chairman Powell’s dulcet tones at 10:15 this morning.

Bond yields are also quiet this morning with Treasuries (+2bps) one of the larger movers as European sovereigns are almost all unchanged right now.  It seems that the market has found a new temporary home around the 4.60% level and the yield curve inversion continues to deepen, now at -36bps.  JGB yields, which have fallen from their recent YCC-tweak induced highs, have edged up overnight by 3bps, but are at 0.85%, still far from the 1.00% target or cap or concept, whatever they are calling it now.

We already know that oil is under pressure, having fallen sharply yesterday and another -1.2% this morning.  In fact, at $76.35/bbl, it is trading at its lowest level since mid-July.  Gold, too, has been suffering, down -0.3% this morning and drifting further away from the $2000/oz level as those Middle East fears seem to dissipate.  Copper and aluminum are also under pressure on the slowing growth story worldwide.  Foodstuffs, however, are generally bid lately, as we can all discern every time we go grocery shopping.

Finally, the dollar is back to its dominant ways again, rallying vs. almost all its counterparts in both the G10 and EMG blocs.  USDJPY is marching back toward 151 this morning, the euro is back below 1.07 and the pound back below 1.23.  Meanwhile, in the EMG space, ZAR (-1.1%) is the laggard although it has competition from CLP (-0.9%), KRW (-0.7%) and HUF (-0.7%) as virtually the entire bloc is under pressure.  In fact, CNY (-0.15%) is about the best performer as the PBOC continues to prevent any significant further declines.

Aside from Powell’s speech this morning, we hear from Williams, Barr and Jefferson, but there is absolutely no data to be released.  Given the dearth of new data on the calendar, this week is going to continue to be all about the Fedspeak.  In fact, Powell speaks again tomorrow and there are 5 more speakers as well by Friday, so rather than data, this week is about parsing language.  Of course, Powell will set the tone today, and I am confident he will continue to push back on the idea the Fed is done.  But we shall see.

In the end, it still seems to me that a higher dollar is the path of least resistance.  Manage accordingly.

Good luck

Adf

A Loose Upper Bound

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Good luck

Adf

Bad Dreams

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In China, the property bubble
Continues to cause Xi much trouble
So, they will add on
A trillion more yuan
Of debt, as help efforts redouble

And though Chinese markets did rise
They finished well off of their highs
Investors, it seems
Are having bad dreams
‘bout growth there and seek to downsize

Poor President Xi!  Instead of focusing all his energy on his saber rattling in the South China Sea and hinting at a Taiwanese invasion, he finds himself essentially forced to deal with the economy.  This was made clear yesterday when he made a surprise visit to both the PBOC and the SAFE (State Administration of Foreign Exchange), the two top Chinese financial institutions, and then today when the government announced an effective supplemental budget spend of CNY 1 trillion (~$137 billion) to support further infrastructure investment in the country.  

This move will increase the national government’s budget deficit for the year to 3.8%, well above the 3.0% target they had been shooting for, but obviously, the concern of continuing slow growth is being seen as a growing problem for Xi.  This is also a change from the previous process where local governments would issue debt to fund infrastructure investment and ultimately repaid that debt by selling land.  Of course, that is what led to the inflation of the massive property bubble in China, so that model is now clearly broken.

Arguably, the biggest worry is that if the domestic situation continues to deteriorate, Xi will get more adventuresome internationally as the standard national leadership political playbook is to seek to distract the population from the economic failures of a government by stoking nationalism and instigating conflict overseas.  We just saw it in Russia, and quite frankly, given the support for intensifying the war effort in the US, it is also being executed here in the US.

In the end, though, a 0.8% of GDP budget boost is unlikely to have a huge impact on the economy.  The problem the Chinese have is that they, too, have a very high debt level and are trying quite diligently to prevent it from growing out of hand.  The tradeoff there is that the amount of support is going to be restricted.  Initial economist estimates are that the package will raise GDP growth by 0.1% in Q4 and up to 0.5% in 2024 overall.  

It can be no surprise that shares in China rose on the news with the Hang Seng jumping 2.5% on the news while the CSI 300 jumped 1.3% initially.  However, both faded fast and closed higher by about 0.5%, not bad, but certainly not a huge vote of confidence.  Meanwhile, the yuan just continued is weak performance, falling another 0.2% and continuing to push against its 2% band vs. the daily CFETS fixing.

Away from that news, however, it has been dullsville this morning with pretty modest movement across both equity and bond markets around the world.  Yesterday’s PMI data indicated that the massive amount of fiscal stimulus that has been enacted in the US compared to elsewhere in the world is having the desired impact, at least from a statistical point of view, as US data continues to show relative strength compared to Europe, Japan and the rest of the G10.  However, despite those efforts, the political accolades remain absent as the national attitude is consistently measured in downbeat terms. 

And consider, if the data here are relatively better and the government is not gaining any ground, how bad it is for governments elsewhere in the world where the data is clearly worse and falling.  We continue to see populist parties from both sides of the aisle gaining in strength.  Do not be surprised to see quite a few new governments around the world over the next several years as support for incumbents continues to fall.  (It will be quite interesting to see the results of the Argentine election in a few weeks and see how Javier Milei, the upstart “anarcho-capitalist” who has promised to take a chainsaw to the government and shutter the central bank while dollarizing the economy, performs.)  A victory there could well be a harbinger of future shakeups everywhere.

Turning to markets, yesterday’s solid US performance was ultimately followed by 0.5% ish gains in China and Japan, although weaker performances elsewhere in Asia with a number of regional markets declining.  European bourses are showing very modest gains this morning, on the order of 0.1% while US futures are mostly softer at this hour (8:00), down roughly -0.4%.

The massive reversal in bonds seen on Monday is now history and we are seeing yields begin to creep back higher with Treasury yields up 3bps and similar rises throughout Europe, although Italian BTPs are the true laggard with yields there rising 6bps.  JGB yields also rose 2bps last night but have been largely capped at 0.85% by the market as there was no sign of extra intervention by the BOJ.  The yield curve inversion remains at -24bps, not quite at its tightest levels but still clearly trending toward normalization.

One thing to consider about the Treasury market is the fact that the US trade deficit has been steadily shrinking amidst the efforts at reshoring and all the CHIPS act spending on manufacturing capacity, as well as the simple fact that US energy exports continue to be quite robust.  The point is that one of the key demands for Treasury bonds in the past was the recycling of all those deficits, but if the deficits shrink, then there is less to recycle and therefore less demand for Treasuries.  Combine this process with the fact that the government continues to increase the amount of issuance and it is not hard to conclude that bond yields have further to rise over time.  The fact that an oversold market responded to a major psychological level does not mean the bond market move has ended.  Rather I would argue it has simply paused and yields will once again climb going forward.

Turning to the commodity markets, oil is marginally higher this morning, up 0.3%, but that is after another sharp decline yesterday as the market appears to believe that the odds of a widening of the Israeli-Palestinian conflict are shrinking amid growing pressure from organizations around the world.  Add to that the signs of weaker economic activity which implies reduced demand, and it is easy to understand why oil has retraced. However, inventories fell again last week, and the structural issues of supply remain in place.  The big picture remains for further strength over time in my eyes.  As to the metals markets, gold continues to benefit from its haven status, edging higher by 0.25% this morning while copper is suffering on the weaker growth story, falling -0.4%.

Finally, the dollar is stronger overall with the euro > 1% lower than its recent highs Monday afternoon which were seen in the wake of the bond market rally that day.  USDJPY is right back below 150.00 although it has not yet touched the level since early this month which was followed by what appeared to be intervention.  But generally, we are seeing the dollar gain against both G10 and EMG rivals as US rates once again edge higher, 2yrs as well as 10yrs.

On the data front today, New Home Sales (exp 680K) are due at 10:00 as well as the Bank of Canada rate decision where no change is expected.  We also see EIA oil inventory data later this morning and then Chairman Powell speaks late this afternoon.  I continue to believe it is unlikely that he will add anything to his message from last week.  As such, it is a status quo day.  If yields continue higher, look for the dollar to follow.  But I have a feeling that there will be very little movement today overall.

Good luck

Adf

Growth Dynamo

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The data continues to show
Economies still want to grow
Here in the US
The Retail success
Came ere China's growth dynamo

The upshot is all of the talk
That bonds are where people should flock
Turns out to be wrong
Then those who went long
Are likely to soon be in shock

Wow!  That’s all you can say about the data from yesterday where Retail Sales were hot and beat on every measure (headline 0.7%, ex-autos 0.6%, control group 0.6%) while IP (0.3%) and Capacity Utilization (79.7%) also indicated that economic activity remains quite robust in the US.  On the data front, this was followed by last night’s Chinese data dump where every one of their monthly indicators; GDP (4.9%), IP (4.5%), Retail Sales (5.5%), Fixed Asset Investment (3.1%), Capacity Utilization (75.6%) and Unemployment (5.0%), was better than expected.

Perhaps the idea that a recession is right around the corner needs to be reconsidered.  And remember, I have been in that camp as well, but the data is the data and needs to inform our opinions.  The immediate reaction to yesterday’s US data was a sharp decline in both stocks and bonds, while oil rallied, gold edged higher and the dollar tread water.  Of this movement, I was most surprised at the dollar’s lack of dynamism given the rate situation.  Unremarkably, given the ongoing belief in the Fed pivot, by the end of the day, US equities were tantamount to unchanged.  But the bond market remains under severe pressure with yields having risen another 12bps in the 10-year and having now reversed the entire safe haven move on the back of the Israeli-Hamas war situation.  

I continue to believe that yields have much further to rise and stronger data will only add to the case.  My view had been based on the combination of stickier inflation than the punditry describes along with massive amounts of new issuance requiring a lower price (higher yield) to clear markets.  But if we are going to continue to see strong economic growth, then there is an added catalyst for yields to rise.

One of the problems about which we hear constantly these days is the fact that there are no more natural buyers of US Treasury debt, at least not at current yield levels.  Many point to the decline in ownership by both Japan and China, the two largest foreign holders of Treasuries, and claim they are both selling their holdings.  However, I have a quibble with that thesis and would contend that perhaps, they are merely suffering the same mark-to-market losses that the banks are.  For instance, according to the US Treasury Department, holdings by these two nations from July 2022 through July 2023 declined by -9.6% (Japan) and -12.5% (China) respectively as can be seen in the chart below.  (data source US Treasury)

But ask yourself what has happened to interest rates over the past year?  They have risen dramatically (10yr yields +85bps) and that means the price of bonds has declined.  As a proxy, in the past 12 months, TLT (the long bond ETF) has declined by more than 13% in price.  So, if you have the exact same amount of bonds and their prices declined by 13%, it is not hard to understand how when you measure the value of your portfolio it has shrunk by upwards of 13%.  I have no idea what the maturity ladders for Japan and China look like, and it is likely they own a mix of short and long-dated bonds, but it is not at all clear to me they have actually been selling Treasuries.  Likely, they are simply holding tight, and I would not be surprised, given the dramatic rise in yields here, if they roll maturities into new bonds.  All I’m saying here is that the narrative about everybody fleeing bonds may not be correct.  In fact, regarding the TLT, which is a pretty good proxy for bond demand of the retail investor, there is a case to be made that demand is quite high.  My understanding is that calls on the TLT are amongst the most active contracts in the options market, and people don’t buy calls if they are bearish!

With that in mind, though, the underlying point is US yields continue to rise and that is going to be the driver for all markets.  In global bond markets, the US unambiguously leads the way and we have seen European sovereigns show similar movement to the US with large moves higher in yields yesterday, on the order of 10bps – 15bps depending on the nation, and consolidation today with virtually no movement, the same as Treasuries.  Last night, JGB yields managed to rally 3bps as well, another indication that as goes the US, so goes the world.

But the more interesting thing to me is the ability of the equity market to hold onto its gains.  The fact that US markets rallied back nearly one full percent from the immediate post-data lows was quite impressive.  Consider that the leadership of the US stock market has been the so-called magnificent 7 tech stocks (Apple, Microsoft, Google, Amazon, Nvidia, Meta (nee Facebook), and Tesla) most of which are essentially long duration assets with their extreme values based on a belief that they will continue to grow at incredible rates.  But with yields rising, the present value of those anticipated earnings continues to decline which should generally be a negative for their price.  So far, they have held up reasonably well, but cracks are definitely starting to show.  I suspect that at some point in the not-too-distant future if yields continue on their current trajectory, that equity market comeuppance will arrive and these stocks will feel the brunt of it.  But not yet apparently.  Interestingly, despite the positive Chinese data, equities in Hong Kong and the mainland both declined about -0.5%.  And looking at Europe, weakness is the theme with all the major bourses lower by -0.5%.  As to US futures, -0.25% covers the situation at this hour (8:00).

Meanwhile, the escalation in Israel and concerns about a wider Mideast war have joined with the stronger economic data, especially from China, to push oil prices higher again this morning, up 1.8%.  And that war theme has gold rocking as well, up 1.3% to new highs for the move with both copper and aluminum rising on the better economic data.  High nominal growth and high inflation (so low real growth) is going to be a powerful support for commodity prices.

Finally, turning to the dollar, this is where I lose my train of thought.  Given the higher yields and seeming increased worries about a wider Mideast war, I would have expected the dollar to continue to rally.  But that has not been the case.  Instead, it has been stable, stuck in a tight range against most of its major and emerging market counterparts.  Perhaps this market is waiting to hear from Chairman Powell tomorrow before traders take a view, but I need to keep looking for a reason to sell the dollar as the evidence to buy it seems strong, higher yields and safety.

Today’s data brings Housing Starts (exp 1.38M) and Building Permits (1.45M) as well as the EIA oil inventory data.  We also hear from a bunch more Fed speakers; Waller, Williams, Bowman Harker and Cook, so it will be interesting to see if there are more definitive views on a pause, especially after the recent hot data.  I have not changed my view that the dollar has further to rise, but its recent relative weakness is a potential warning that something else is driving things.  I will continue to investigate, but for now, higher still seems the better bet.

Good luck

Adf

Dreamlike

Posted on by 
The ECB hiked twenty-five
But Madame Lagarde tried to drive
The idea they’d hike
Again was dreamlike
And so, euro-dollar did dive

Then last night some Chinese reports
Showed there was some growth there, of sorts
The PBOC’s
Continuous squeeze
Of rates, too, has hammered yuan shorts

Starting with a quick recap of the ECB meeting, as I had believed, they hiked rates by 25bps which takes the Deposit rate to 4.00%, the highest level since the euro was created in 1999.  It seems Madame Lagarde’s rationale was similar to my own, which was essentially, this was the last chance to raise rates before the recession in Europe really gets going at which point further rate hikes will be incredibly difficult politically.  However, by essentially explaining they were done, with inflation running well above both the current interest rate structure as well as their 2.0% target, Lagarde undermined any support for the single currency which fell sharply yesterday after the announcement and has been unable to show any signs of life since then.  Current market pricing shows a 38% probability of another hike this year before an eventual reduction in the rate structure by the middle of 2024.  However, my take is that if the recession spreads further, the ECB will be quick to cut rates.  Ultimately, I continue to believe the euro is going to have a very difficult time going forward.

Turning our attention east, the Chinese monthly data dump was released last night and virtually every single measure beat expectations, even the property investment.  None of the beats were very large, but I guess the question has become are analysts and investors overly bearish on China (or perhaps the question is can we trust Chinese data)?  For instance, IP rose 4.5% Y/Y, vs. 3.9% expected; Retail Sales rose 4.6% Y/Y vs. 3.0% expected; Property Investment fell -8.8% Y/Y vs. -8.9% expected and the Unemployment Rate fell to 5.2% rather than remaining unchanged at 5.3%.  The only outlier was Fixed Asset Investments which rose 3.2% rather than the 3.3% expected.  The market response to this was quite interesting.  The yuan was little changed, although it remains well above its recent lows with USDCNY hovering around 7.2800.  The CFETS fixing continues to be pushed toward a lower dollar, although the spread between the fixing and the onshore market has narrowed slightly to 1.4% from its recent levels above 1.9%.

As I mentioned yesterday, the Chinese cut their RRR by 0.25% trying to inject more liquidity into the economy and they have also been pushing up offshore CNY interest rates which are now equal to USD interest rates so there is no carry benefit in shorting the CNY offshore.  This, too, will help eliminate some of the downward pressure on the yuan.  In fact, it appears that much of the recent policy focus has been to prevent the yuan from weakening much further.  I guess if you are trying to convince other countries that they can use the yuan for payments and holding it is safe, it really cannot be seen falling sharply.  I suspect that the PBOC will be doing everything they can to support the currency going forward.  In a bit of a surprise, Chinese shares were the worst performers overnight, with all the main indices there in the red while markets elsewhere in Asia (Nikkei +1.1%, Hang Seng +0.75%, ASX 200 +1.3%) and Europe (DAX +1.0%, CAC +1.6%, FTSE 100 +0.8%) are all higher.  As it happens, US futures are little changed this morning after a strong equity performance yesterday.  So, all in all, I would say risk is in favor today.

This risk attitude is evident in bond yields as well as they are rising with investors moving from bonds to stocks.  Treasury yields are higher by 3.5bps, while in Europe, yields are all higher at least 6bps with Italian BTPs seeing the most selling and a rise of 7.5bps.  Arguably, if the ECB has finished its tightening cycle, which it seems to have done, and inflation remains as high as it is, the value of bonds should decline.  This movement is logical based on what appears to be the new narrative. 

A quick aside on Japan, where you may recall that on Monday, the yen strengthened and JGB yields rose after comments from BOJ Governor Ueda regarding the possibility that they would have enough information to potentially end ZIRP there.  It turns out that was not Ueda-san’s intention, and rather he thought his comments were benign.  It seems there is no intention to adjust policy anytime soon.  The market response was seen in FX where the yen fell -0.3% and is now pressing to 148.  I suspect 150 is coming soon, although further intervention at that level cannot be ruled out.

Turning to commodities, oil (+0.5%) continues to rally and is now solidly above $90/bbl.  The other gainer today is gold (+0.4%) but base metals are softer.  A possible train of thought here is that rising oil prices will both force interest rates higher through the inflation channel as well as undermine economic growth, so the industrial sector is getting double-whammied in the short-term.  As with energy, the long-term prospects remain quite positive for base metals as production is just not going to be able to keep up with demand given the lack of investment in the sector since the ESG movement began a decade ago.  Even if it is recognized that this must change, it will take years before new production can come online which should continue to be supportive of the sector overall.

Finally, the dollar is mixed this morning, with the EMG bloc seeing half gainers and half laggards although the largest movement is less than 0.2%.  In other words, nothing is going on here.  Similarly, in the G10, other than the yen mentioned above, movement has been mixed with no real substance in either direction.  Given the FOMC meeting next week, it appears that traders are unwilling to position themselves too much in either direction.  Net, this week, the dollar did fall a bit, but remains well above its recent lows.

Yesterday’s Retail Sales data was once again quite hot, rising 0.6% for headline and ex-autos, which just goes to show that there is a lot of money still sloshing around the system.  As well, the Claims data was solid again with 220K Initial Claims, less than forecast and certainly not showing any weakness in the labor market.  Today brings a bunch of secondary data with Empire Manufacturing (exp -10.0), IP (0.1%), Capacity Utilization (79.3%) and Michigan Sentiment (69.0).  The Citi Surprise Index continues to push higher which continues to indicate that economic activity in the US remains solid.  While a recession is clearly going to arrive at some point, for now, it remains a distant prospect.  With that in mind, do not think that the Fed is going to go soft anytime soon and that ongoing higher for longer is very likely to help support the dollar overall.

Good luck and good weekend

Adf

Weakness is Fate

Posted on by 
The punditry’s all of a piece
That growth in the future will cease
But ‘flation still reigns
And Jay’s been at pains
To force prices, soon, to decrease

There is a website, Seeking Alpha, that publishes a great deal of macroeconomic and market commentary on a daily basis.  Yesterday morning’s top headlines under the Economy section included the following list.

  1. Is Recent GDP Data Overestimating U.S. Growth?
  2. U.S. Stagflation Risks Rise as Service Sector Falters Alongside Manufacturing Downturn
  3. Global PMI Shows Recovery Fading Further in August as Developed World Output Falls
  4. The Unemployment Rate Just Signaled that a Recession May Occur Within the Next 6 Months
  5. German Industrial Production Goes from Bad to Worse
  6. The Economy is Not ‘Running Hot’
  7. U.S Labor Market Activity: Slowing, Not Weakening

The authors ranged from Investment firms like Neuberger Berman and ING to individuals with decent reputations and large numbers of followers (for whatever that is worth.)  My point is there is a lot of negativity in the analyst community regarding the near-term future of economic activity.  My question is, are people really concerned about the growth trajectory?  Or are they just trying to make the case that the Fed will consider cutting interest rates sooner rather than later in an effort to support the equity market?  

While I understand the negativity based on anecdotal evidence, the headline data continues to print at better than expected levels.  For instance, yesterday’s Initial and Continuing Claims data both fell sharply during the most recent week, indicating that the labor market remains quite robust.  It remains very difficult for me to see a case for the Fed to even consider cutting anytime soon.  Rather, the case for another rate hike seems to be growing, and if next week’s CPI print is at all hot, look for that to be the market discussion going forward.  

Of course, my opinions don’t sway markets.  The important voices are those of the Fed members themselves and yesterday, we heard from several of them that a pause is in the offing.  Based on the comments from John Williams (voter), Lorrie Logan (voter), Raphael Bostic (non-voter) and Austan Goolsbee (voter), it seems that the market pricing of < 7% probability of a hike on September 20th is appropriate.  However, the views of Fed actions in the ensuing meetings are beginning to diverge.  There are those (Logan, Bowman and Waller) who have been clear that further rate hikes past September may still be appropriate depending on the totality of the data.  Meanwhile, there are others who are quite ready to call the top and one (Harker) who is already calling for cuts in 2024.  In the end, though, Chairman Powell’s views remain the most important and the last we heard from him was that higher for longer remains the story and more hikes are possible.

The pressure’s been simply too great
For Xi’s central bank to dictate
The yuan shouldn’t sink
Which led them to blink
And now further weakness is fate

The PBOC cried uncle last night when they fixed the renminbi at its weakest level since early July as the pressures had simply grown too great to withstand.  The onshore yuan fell further and the spread between the fix and the spot rate there remains just below 2%.  The offshore market shows an even weaker CNY and looks like it will soon be trading more than 2% weaker.  As well, the CNY lows (dollar highs) seen in October 2022 are in jeopardy of being breeched quite soon.  Clearly, there is a steady flow of capital out of China at the current time and given the lackluster economic performance there along with the structural problems in the property market, it is hard to make a case that China is a good spot for investment right now.  And just think, this is all happening while the market belief is the Fed is finished raising rates.  What happens if we do see hotter inflation data and the Fed decides another hike is appropriate?  As I have maintained for quite a while, I expect the renminbi to continue to slide and a move to 7.50 or beyond to occur over the rest of 2023.  In fact, today I saw the first analyst say 8.00 is in the cards before this move is over.  Hedgers beware.

So, what comes next?  Well, on a day with no noteworthy economic data and no Fed speakers scheduled, with the FOMC set to enter their quiet period, market participants will be forced to look elsewhere for catalysts.  My take on the current zeitgeist is that the negativity seen in those headlines listed above is seeping into risk attitudes overall.  Not only that, but that there is nothing in the near-term that will serve to change that viewpoint.  We will need to see a very cool CPI print next Wednesday to get people excited and given the combination of base effects and oil’s recent price trajectory, that seems unlikely.  Anyway, let’s look at the overnight sessions results.

Equities continue to perform poorly overall as yesterday’s broad weakness in the US was followed by weakness in Asia across the board while European bourses are also all in the red.  In fairness, the European session, while uniform in direction, has not seen significant declines.  Rather, markets are down by -0.25% or so on average.  Alas, US futures are still under pressure at this hour (7:30), but here, too, the losses are modest so far.

Bond markets are not doing very much this morning as yields in the US and Europe are within 1 basis point of yesterday’s closing levels.  Yesterday we did see 10yr Treasury yields slide 4bps, but we remain at 4.25%, a level that is not indicative of expectations of rapidly declining inflation.  The odd thing about this is that if you look at inflation expectation metrics, they almost all are looking at inflation heading back to the 2% level within a year or two.  Something seems amiss here although exactly what is not clear.

Oil prices are rebounding this morning as the recent uptrend resumes.  If we continue to see better than expected US data and the soft landing or no landing thesis remains in play, it is hard to accept the idea that oil demand will decline very much.  Add to that the very clear efforts by OPEC+ to push prices higher and it seems there is further room to rise here.  But once again, the rest of the commodity space is telling a different story with base metals softer along with agricultural prices in general.  That is much more of a recession story than a growth one.  This is just another of the many conundra in markets these days.

Lastly, the dollar is softer this morning overall, although not dramatically so, at least not against its major counterparts.  The biggest gainer today is MXN (+0.7%) which is benefitting from one thing, the highest real yields available for investment at 5.5%, while overcoming another, comments from the opposition presidential candidate, Xochitl Galvez, that the peso is too strong and is hurting exports.   (There is a presidential election next year in Mexico and AMLO is prohibited from running as they have a one-term limit in place there.)  Regarding the peso, unless Banxico starts to cut rates aggressively, of which there is no sign, I expect it will continue to perform well.  As to the rest of the EMG bloc, there are more gainers than losers, but the movements have not been substantial.  In the G10, it is no surprise that NOK (+0.4%) is higher on the back of the rise in oil prices, and we have also seen NZD (+0.5%) rally, although that looks more like a trading rebound than a fundamental move.  Given the dollar’s relative strength over the past several sessions, it is no surprise to see it drift back at the end of the week.

There is no data of consequence on the docket and no Fed speakers.  This implies that the FX market will be looking for its catalysts elsewhere and that usually means the stock market.  If we continue to see weakness in equities, I suspect the dollar will regain a little ground, but in truth, ahead of next week’s key CPI data, I don’t anticipate very much activity at all today.

Good luck and good weekend

Adf

On the Schneid

Posted on by 
While data at home is robust
In Europe and China the thrust
Is weakness abounds
Which seems to be grounds
For traders, their risk, to adjust

So, equities are on the schneid
While bond yields have been amplified
The dollar’s on fire
Continuing higher
And oil’s climb won’t be denied

Another day, another wave of bad economic news from elsewhere in the world.  However, the US continues to surprise with better than expected results.  Yesterday’s ISM Services data was far better than forecast with a headline print of 54.5, 2 points above both last month and expectations for this month, while the sub-indices all showed significant strength, including the Prices Paid index.  The latter is clearly a concern for Chairman Powell and his crew as it is an indication that inflationary tendencies have not yet been snuffed out.  Ultimately, the market response was to sell stocks and bonds while increasing the probability of a November Fed funds rate hike a few points.  Interestingly, the market pricing for a September hike has fallen to just a 7% probability despite the hotter than expected data.  My sense is that the big market adjustment is going to come as traders come to understand that higher for longer means no cuts until 2025 on the current basis, especially if we continue to see data like the ISM print yesterday.

But the US storyline is clearly not the same as the storyline elsewhere in the world.  Last night, for example, Chinese trade data was released and both imports (-7.3%) and exports (-8.8%) fell sharply again, with the Trade Surplus falling to $68.3B.  Granted, the declines were not as bad as last month, nor quite as bad as expectations, but there is no way to spin the data as indicating a positive economic impulse in China right now.  While Chinese equity markets fell sharply (Hang Seng and CSI 300 both -1.4%) we also saw further weakness in the renminbi.  

The PBOC is still desperately trying to prevent the renminbi from weakening too quickly, but they are having a hard time at this stage.  The difference between the CFETS fixing and the onshore spot market is now 1.8%, dangerously close to the 2.0% boundary.  At the same time, the offshore renminbi, CNH, is pushing back to its highs from last October, now trading above 7.3400, which is 1.97% above the fixing.  This is a losing battle for the PBOC unless they change their monetary policy, but given the Chinese economy’s weakness, tighter money seems an unlikely step.  7.50 is still on the cards here.

China, though, is not the only problem.  European data this morning was uniformly lousy with German IP (-0.8%) and Eurozone GDP (Q2 revised lower to 0.1% Q/Q, 0.5% Y/Y) highlighting the problems facing the old world.  Alas, price pressures have not yet abated there, and stagflation is the new watchword on the continent.  

When the US was faced with stagflation in the 1970’s, Paul Volcker opted to fight inflation first, sending the country into a double dip recession in 1980 and 1981-82, before things turned around.  But that was a different time…and Christine Lagarde is no Paul Volcker!  Is it even possible for an “independent” central bank to knowingly create a recession to slay inflation these days?  I suspect inflation would need to be far higher, stable in double digits, before politicians would accept that it is a bigger problem than a recession, at least electorally.  The upshot of this scenario is that the ECB, despite ongoing higher than targeted inflation, is very likely at the end of its hiking cycle.  This, combined with the overall weak economy there, is going to continue to undermine support for the euro.  While the movement will be gradual, I expect that the single currency will slide below 1.05 and possibly get to parity by the end of the year.

And I would be remiss if I didn’t touch quickly on Japan, where they released their Leading Indicators at a weaker than expected 107.6, continuing the two-year downtrend.  Slowing growth in Japan and still extraordinarily loose monetary policy is going to continue to weigh on the yen.  While it has bounced slightly this morning, 0.2%, it continues to weaken steadily closer to the psychological 150.00 level.  

So, with all that happy news, let’s tour the overnight session to see the results.  The rest of the APAC equity markets also were under pressure overnight with Japan, Australia and South Korea all in the red as well.  In Europe this morning, the picture is more mixed with some gainers and some losers but no large movements overall, mostly +/- 0.2%.  US futures, after a lousy session yesterday, are all pointing lower at this hour (7:30) as well.

In the bond market, Treasury yields are essentially unchanged on the day, holding onto their gains for the past week and just below the 4.30% level.  European sovereigns, though, are seeing a bit of support as the weak economic data has engendered hope that inflation will stop rising and the ECB will be okay to pause.  The latter remains to be seen.  I cannot get over the idea that the uninversion of the yield curve is going to come because long rates are going to rise, not because short rates are going to be cut, and I’m pretty sure nobody is ready for that outcome.

Oil (-0.5%) is consolidating its recent gains with WTI north of $87/bbl and showing no signs of backing off.  If OPEC+ keeps a lid on production, you have to believe that prices will continue to rise.  In the metals markets, both copper and aluminum are soft today, responding to the weak Chinese and German data, while gold, after a selloff this week, is bouncing slightly.

Finally, the dollar remains king of the hill, stronger against virtually all its counterparts in both the G10 and EMG blocs.  I’m old enough to remember when the prevailing narrative was the dollar was dead and would be replaced by the euro, or the yuan, or a BRICS currency and yet, it continues to be subject to more demand than virtually every other currency around.  The broad story is the US economy continues to lead the global economy and the prospects for Fed rate cuts are diminished relative to other nations.  Tight monetary and loose fiscal policy combinations have historically been very supportive of a currency and clearly that is the current US state.

Two quick stories in the EMG bloc are from Poland (-0.7%), where yesterday’s surprising 75bp rate cut has undermined the zloty amid concerns that inflation is going to remain unhindered there, and MXN (+0.75%) where traders are unwinding some positions after a sharp decline over the past week.  The peso has been one of the few currencies that has outperformed the dollar this year as Banxico has been ahead of the curve on inflation and tight monetary policy.  However, with an election upcoming it appears there may be a change in attitude there.  If that is the case, then look for the dollar to regain some lost ground.

On the data front, Initial (exp 234K) and Continuing (1719K) Claims are released along with Nonfarm Productivity (3.4%) and Unit Labor Costs (1.9%).  As traders and investors bide their time ahead of next week’s CPI and the following week’s FOMC meeting, it is not clear that today’s numbers will have much impact.  As such, I see no reason for the dollar to cede its recent gains, especially if equities remain under pressure.

Good luck

Adf

A Crack in the Sheen

Posted on by 
Ahead of the holiday flight
The payroll report is in sight
This week we have seen
A crack in the sheen
That everything still is alright

So right now, bad news is all good
But there seems a high likelihood
That worsening data
Could impact the beta
And bad news turn bad, understood?

As we wake up on this Payrolls Friday, the market is biding its time ahead of the release this morning.  As I have been writing for a number of months now, I continue to believe the NFP number is the most important on the Fed’s radar as its continued strength has given Chairman Powell all the cover he needs to continue tightening monetary policy.  If job growth is averaging near 200K per month and the Unemployment Rate has a 3 handle, the doves have no solid case to make that policy is too tight.  With that in mind, here are the current median analyst expectations according to Bloomberg:

Nonfarm Payrolls170K
Private Payrolls148K
Manufacturing Payrolls0K
Unemployment Rate3.5%
Average Hourly Earnings0.3% (4.3% y/Y)
Average Weekly Hours34.3
Participation Rate62.6%
ISM Manufacturing47.0
ISM Prices Paid44.0
Course: Bloomberg

So far this week, we have received three pieces of employment data with a mixed outcome.  JOLTS Job Openings was much lower than expected and that encouraged the bad news is good phenomenon.  ADP Employment was weaker on the headline by a bit but had a very large revision higher to last month, so mixed news.  Meanwhile, Initial Claims were lower than expected and any sense of a trend higher in this series is very difficult to discern.  Anecdotally, I have to say I expect a softer number today, not a firmer one, but I believe it is anybody’s guess.

With that in mind, I believe a weak number, whether lower payrolls or a jump in the Unemployment Rate, will be met with an equity rally into the holiday weekend.  Investors are looking for ‘proof’ that the Fed is done so they can get on with rate cuts and support the stock market.  However, remember, if the data is weak and we are heading into recession sooner rather than later, all that bad news will likely not be taken well by equity investors as money will flow back to bonds as a haven.  At least, that has been the history.  So, a really bad number could well result in ‘bad news is bad’ and an equity market decline.  Alas, nothing is straightforward in markets.

One other thing to keep in mind is the relative Unemployment situation which can be seen below in the chart created with data from Bloomberg.  Structural unemployment in the Eurozone remains substantially higher than in either the US or the UK.  If you are wondering why I continue to have a favorable outlook on the dollar, this is one part of that puzzle.  Despite all the policy blunders questions that have been raised, things in the US remain far better than elsewhere.

In China, despite what they’ve done
To try to support the short-run
It’s not been enough
So, they did more stuff
Last night, though investors still shun

It wouldn’t be a day in the markets if there wasn’t yet another action by the Chinese to try to fix their myriad problems.  Today is not different as last night the PBOC reduced the FX RRR to 4% from its previous level of 6%.  This required reserve ratio defines the amount of reserves Chinese banks need to hold against their FX positions.  Reducing that number effectively boosts the amount of foreign currency available locally, and therefore takes pressure off market participants to horde their dollars, thus weakening the buck.  

And it worked…for about an hour as the renminbi initially rallied about 0.5%.  However, it has since ceded all those gains and is essentially unchanged on the day.  At the same time, the government has reduced the size of the down payment needed to buy a home while encouraging banks to lend more to home buyers to try to support the crumbling property market.  While certainly welcome relief to an extent, it does not appear to be enough to change the current trajectory, which is definitely lower.  At this point, we know that the PBOC is quite concerned over potential renminbi weakness and the central government is quite concerned over broad economic weakness led by the property sector.  We have not seen the last of these moves.

President Xi did, however, get one piece of positive news overnight, the Caixin Manufacturing PMI rose to 51.0, up 2 points from last month and well above expectations.  The combination of those factors helped the CSI 300 gain 0.7% last night, but that seems weak sauce overall.  As to the rest of the market’s risk appetite, I guess you would consider things mildly bullish.  While Hong Kong was weaker, the Nikkei managed a small gain and most of Europe is in the green, notably the UK (+0.7%) after weaker than expected House Price data encouraged belief that inflation may be ebbing sooner than previously expected.  As well, the UK revised higher its GDP data to show that they have, in fact, recovered all the Covid related losses.  US futures, meanwhile, are edging higher at this hour (7:00).

Bond yields are mixed this morning, but the moves have been small, generally +/- 1bp from yesterday’s close.  And yesterday’s closing levels, at least in Treasuries, was little changed from Wednesday.  Granted, European sovereigns saw yields decline yesterday on the order of 5bps, so this morning’s 1bp rise is not that impactful I would contend.

Turning to the commodity markets, they have embraced the Chinese stimulus efforts with oil (+1.5%) rising again and pushing close to $85/bbl, while metals markets are also robust with gold (+0.25%), copper (+1.6%) and aluminum (+1.3%) all seeing demand this morning.  While I have doubts about the effectiveness of the Chinese moves, for now the market is quite pleased.

Finally, the dollar is mixed and little changed net this morning.  In the G10, not surprisingly, NOK (+0.3%) is the leading gainer on the back of oil’s rally, but the rest of the bloc is +/- 0.1% or less, so essentially unchanged.  In the EMG bloc, I guess there are a few more laggards than gainers with HUF (-0.6%) the worst performer as traders prepare for a ratings downgrade from Moody’s after the close today, while MXN (-0.6%) suffered after Banxico indicated it would be winding down its forward FX program where it consistently supplied the market with dollars, buying pesos.  On the plus side, ZAR (+0.8%) is the lone outlier on the back of the commodities rally.

We hear from Bostic and Mester today, with Bostic already having told us he thinks it’s time to pause, although I doubt we will hear the same from Mester.  But in reality, it is all about the employment report.  For now, I believe bad news is good and vice versa, but that is subject to change with enough bad news.

Good luck and have a good holiday weekend.  There will be no poetry on Monday.

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Further Downhill

Posted on by 
The data from China is still
Desultory and likely will
Result in support
In order, quite short,
Lest Xi’s plans go further downhill

Perhaps, though, he’ll find a reprieve
If Jay and his brethren perceive
Employment is slowing
And risks are now growing
Recession they’re soon to achieve

Poor President Xi.  Well, not really, but you have to admit his plans for widespread prosperity in China have certainly not lived up to the hype lately.  Last night, PMI data was released, and like the Flash PMI data we saw last week in Europe and the US, it remains quite weak.  Specifically, Manufacturing PMI printed at 49.7, slightly better than expectations but still below the key 50.0 level.  Non-manufacturing PMI printed at 51.0, continuing its slide toward recession and indicative that there is no strong growth impulse coming from any portion of the economy there.

Remember, manufacturing remains a much larger piece of the Chinese economy (28%) than that of the US economy (11%), so weakness there is really problematic for the overall economic situation.  And while the PBOC continues to try to prevent excessive weakness in the renminbi, Chinese exporters clearly need the support of a weaker currency to thrive.  Finally, given the slowing economic situation in Europe, which is now China’s largest export market, demand for their products is simply weak.  

To date, the Chinese government has not really provided substantial support to the economy, certainly there has been no fiscal ‘bazooka,’ and monetary efforts have been at the margin.  In the current environment, it remains hard to make a case for China’s natural rebound until the rest of the global economy rebounds.  And woe betide Xi if (when) the US goes into recession.  Things there will only get worse.  The FX market is uninterested in the PBOC’s views of where USDCNY should trade, maintaining a 1.5% dollar premium vs. the daily fixing rate.  At some point, the PBOC is going to have to relent and USDCNY will go higher, in my view to 7.50 or beyond.

Speaking of recession, while the Atlanta Fed’s GDPNow forecast for Q3 is at 5.90% (a remarkably high number in my view), yesterday we saw Q2 GDP revised lower to 2.1%, with the Personal Consumption component falling to 1.7%.  At the same time, Gross Domestic Income (GDI) in Q2 was released at +0.5%, substantially lower than GDP.  (GDI and GDP are supposed to measure the same thing from different sides of the equation.  GDP represents expenditures while GDI represents income.  Eventually, they must be equal, by definition, but the estimates until all the data is finally received can vary.  In fact, looking at GDI, it was negative in Q4 and Q1 and is just barely growing now.  This is another reason many are looking for a US recession soon.) 

In this vein, Richmond Fed president but non-voter, Raphael Bostic, in a speech overnight in South Africa said, “I feel policy is appropriately restrictive.  We should be cautious and patient and let restrictive policy continue to influence the economy, lest we risk tightening too much and inflicting unnecessary economic pain.  However, that does not mean I am for easing policy any time soon.”  So, this is not exactly the same message we heard from Chairman Powell last week, but the caveat of not cutting is certainly in line.  I suspect, especially if we start to see weaker labor market data, that more FOMC members are going to feel comfortable that rates have gone high enough.  At least that will be the case as long as inflation remains quiescent.  However, if it starts to pick up again, that will be a different story.

Ok, let’s look at the overnight session.  It should be no surprise, given the Chinese data, that equity markets there were underwater, with losses on the order of -0.6% in Hong Kong and on the mainland.  However, the Nikkei (+0.9%) was the star performer across all markets on the strength of strong Retail Sales data.  As to Europe, the DAX (+0.5%) is managing some gains, but the rest of the space is little changed on the day.  It seems the CPI data that has been released from Europe, showing higher prices in Germany, France and Italy despite weakening growth has raised concerns about another ECB rate hike.  As to US futures, at this hour (7:30) they are little changed to slightly higher.

Bond yields are falling today, especially in Europe where they are lower by about 5bp-6bp across the board.  It seems that there is more concern over the growth story, or lack thereof, than the inflation story right now.  In the Treasury market, yields are lower by 2bps as well, although remain well above the 4.0% level.  This has been a response to yet another weak headline labor number with yesterday’s ADP Employment figure reported at 177K.  It seems that the huge revision higher to the previous month, a 47K increase, was ignored.  However, this is setting the stage for tomorrow’s NFP, that’s for sure.

Oil prices (+0.8%) continue to rebound after another huge inventory draw last week and despite concerns over an impending recession.  Gold (+0.1%) has been performing extremely well given the dollar’s rebound, but the base metals remain recession focused, or at least focused on Chinese weakness, and are under pressure again today.

Finally, the dollar is firmer this morning, with only the yen (+0.2%) gaining in the G10 bloc as even NOK (-0.65%) is falling despite oil’s rally.  In fact, this move looks an awful lot like a risk-off move, especially when considering the rally in Treasuries, except the equity market didn’t get the memo.  In the emerging markets, the situation is similar, with many more laggards than gainers and much larger movement to the downside.  ZAR (-0.75%) is the worst performer followed by HUF (-07%) and CZK (-0.6%) although the entire EEMEA bloc is down sharply.  However, these currencies are simply showing their high beta attachment to the euro, which is lower by -0.5% this morning.  Again, given the data from Europe, this can be no surprise.

On the US data front, this morning brings the weekly Initial (exp 235K) and Continuing (1706K) Claims data as well as Personal Income (0.3%), Personal Spending (0.7%), the all-important Core PCE (0.2% M/M, 4.2% Y/Y) and finally Chicago PMI (44.2).  Yesterday’s data was soft and if that continues into today’s session, I suspect the ‘bad news is good’ theme will play out.  That should entail a further decline in yields and the dollar while equities continue higher.  However, any strength is likely to see the opposite.  Remember, too, tomorrow is the NFP report, so given the holiday weekend upcoming, it seems likely that positioning is already quite low and trading desks are thinly staffed.  In other words, liquidity could be reduced and moves more exaggerated accordingly.  However, until we see that recession and drop in inflation, my default view remains the dollar is better off than not.

Good luck

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