Tag Archives: #china

Risk Were Inbred

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In China, the problems have spread
From property company dread
To shadow finance
Where folks took a chance
To earn more though risks were inbred

And elsewhere, the Argentine voters
Surprised governmental promoters
By choosing a man
Whose primary plan
Is ousting Peronist freeloaders

While the goal of this commentary is to remain apolitical, there are times when the politics impacts the markets and expectations for future movement so it must be addressed, though not promoted on either side.  Today, amid general summer doldrums, it seems there are more political stories around that are either having or have the potential to impact financial markets.

But first, a quick look in China where the latest problem to bubble to the surface comes from Zhongzhi Enterprise Group Company, one of the many shadow banking companies in the country.  These firms are conduits for investment by wealthier individuals and corporations who offer structured products and investments promising higher returns than the banking sector.  And they are quite large, with an estimated $2.9 trillion invested in the sector.  Well, Zhongzhi has roughly $138 billion under management and last week they apparently missed some coupon payments on several of these high-yielding investments.  While this is the first that we have heard of problems in the sector, given the terrible performance of the Chinese equity market as well as the ongoing collapse of the Chinese property market, my guess is this won’t be the last firm with a problem.  As has often been said, there is never just one cockroach when you turn on the lights.

As proof positive that there is really no difference between the Chinese and US governments, the first response by the Chinese was to set up a task force to investigate the risks at Zhongzhi and its brethren shadow banks.  That sounds an awful lot like what would happen here, no?  Anyway, depending on who is invested in Zhongzhi and whether they are politically important enough to bail out, I suspect that there will be government intervention of some sort.  Do not be surprised to hear about Chinese banks making extraordinary loans to the sector or guarantees of some kind put in place.  The last thing President Xi can afford at this time is a meltdown in a different sector of the financial space.

It can be no surprise that Chinese equity markets were under pressure again last night, with both the Hang Seng and CSI 300 falling sharply, nor that the renminbi has fallen to its weakest levels since the dollar’s overall peak last October.  I maintain that 7.50 is in the cards here and that it is simply a matter of time before we get there.  In the end, a weaker CNY is the least painful way for China to support its economy, especially since it is a big help to its export industries which remain the most important segment of the economy.  Later this week we will see the monthly Chinese data on investment and activity so it will be interesting to see how things are ostensibly progressing there.  However, this data must always be consumed with an appropriate measure of salt (or something stronger) as there is no independent way to determine its veracity.

Meanwhile, on the other side of the world, a presidential primary in Argentina resulted in a huge surprise with Javier Milei, a complete outsider and ostensible free market advocate, winning the most votes, more than 30%.  The election comes in October and the ruling Peronist party is at risk of being eliminated in the first round.  What struck a chord in the country was his plan to dollarize the economy and close the central bank as well as to shut down numerous government agencies.  Inflation there remains above 115% so it can be no surprise that someone who promised to change the process garnered a lot of support.

I raise this issue because in Germany, the AfD (Alternative für Deutschland) party is currently polling at >21%, the second largest party in the country, and that has a lot of people very concerned.  Like Senor Milei, the AfD’s platform is based on destruction of much of the current government setup.  Because this party is on the right, and given Germany’s dark history with the far right, the latest idea mooted has been to ban the party completely.  Now, certainly the idea of a resurrection of the Nazi party is abhorrent to everyone except some true extremists, but simply banning the party seems a ridiculous idea.  After all, the members will either create a new party with the same support or take over a smaller existing party and drive the platform in the desired direction.  

Support for Marine LePen in France continues to grow, as does support for right of center parties throughout Europe, especially Eastern Europe.  And of course, here in the US, the upcoming election has fostered even more polarization along partisan lines with the Republican party seeming to gain a lot of support of late.  All this implies that there is a chance of some real changes in the financial world that will accompany these political changes.  At this point, it is too early to determine how things will play out, but as we are currently in the Fourth Turning, as defined by historian Neil Howe, the part of civilization’s cycle when there is great unrest, I expect there will be a lot more change coming.  Food for thought.  And it is for this reason that hedging exposures is so critical.

Ok, last week’s inflation readings were mixed, with CPI a bit softer than forecast while PPI was a bit firmer.  But the one consistency was that Treasury yields rose regardless of the situation.  After a further 5bp rise on Friday, 10yr yields are unchanged at 4.15% this morning, an indication that inflation concerns remain front of mind for most investors.  I expect that the peak yields seen back in October will be tested again soon.  As to European sovereigns, while yields there are down a tick this morning, the trend there remains higher as well.

Equity markets, too, have had some trouble of late, sliding a few percent over the past several weeks.  While the move lower has been modest so far, there is clearly concern over a technical break lower should the indices break below their 50-day moving averages.  With yields heading higher, I fear that is the path of least resistance for now.

Oil prices are a touch softer this morning but remain well above $80/bbl and appear to be consolidating before their next leg higher.  Supply is still a consideration and given economic activity continues to outperform, I suspect higher is still the path going forward.  Metals prices are little changed this morning despite some incipient dollar strength, so keep that in mind as well.

Finally, the dollar is much stronger against its Asian counterparts and modestly stronger against most others this morning.  Continuing rises in US yields offer support for the greenback and increased turmoil elsewhere, along with the US economy seemingly outperforming all others have been the hallmarks of the dollar’s strength.  I don’t see that changing soon.

Data this week brings the following:

TuesdayRetail Sales0.4%
 -ex autos0.4%
 Empire Manufacturing-0.7
 Business Inventories0.1%
WednesdayHousing Starts1445K
 Building Permits1468K
 IP0.3%
 Capacity Utilization79.1%
 FOMC Minutes 
ThursdayInitial Claims240K
 Continuing Claims1700K
 Philly Fed-10.5

Source: Bloomberg

While Retail Sales will be watched for their economic portents, I think the Minutes will be the most interesting part of the week, especially as we have now had at least two FOMC voters, Harker and Williams, talk about cutting rates next year.  

For today, while US equity futures have edged higher so far, I feel like the dollar has legs for now.  This will be confirmed if yields continue to rise.

Good luck

Adf

Xi Jinping’s Dreams

Posted on by 
The 30-year bond was a flop
Which helped cause an interest rate pop
Though CPI rose
A bit less than pros
Expected, risk prices did drop

Then early this morning we learned
That lending in China’s been spurned
It certainly seems
That Xi Jinping’s dreams
Of rebounds might soon be o’erturned

For all the bulls out there, yesterday must be just a bit disconcerting.  First, the highly anticipated July CPI data was released at a slightly lower than expected 3.2% headline number with core falling 0.1% to 4.7%, as expected.  As always when it comes to CPI data, there were two immediate takes on the result.  On one side, inflationistas pointed out that the future will be filled with higher numbers going forward as base effects for the rest of 2024 kick in with very low comparables in 2022.  They also point to the medical care issue, a detail I have not discussed, but which has to do with a change made by the BLS that has been indicating medical care prices have fallen all year, but which will fall out of the mix starting in September, thus reversing one of the drags we have seen on CPI.  And finally, the rebound in energy prices is continuing (oil +0.4% today) and will be a much bigger part of future readings.  This story was underpinned today by the IEA reporting a new record demand for oil in July of 103 million bbl/day.  Demand continues to support prices here.

Meanwhile, the deflationistas point to the recent trend in prices, which shows that on a 3-month basis, or a 6-month basis, if annualized, CPI is really only running at 2.4% or 2.9% or something like that.  The implication is because we have seen a reduction in the monthly number lately, that will continue.  As well, they make the case that China’s deflation is a precursor to lower US inflation with, I believe, a roughly 6-month lag.  Perhaps the most interesting take I saw was that the Fed has now achieved their goal of an average PCE of 2% if you take the last 14 years of data.  The idea is that Average Inflation Targeting was designed to have the economy run hot for a while to make up for the ‘too low’ inflation that has been published since the GFC.  And now, that average is 2.07% for the past 14 years.  (To me, the last idea is a chart crime, but I digress.)

The problem, though, for the bulls, is that the market’s behavior was not very bullish.  Although the initial move in Treasury yields was lower, with the 10-year yield falling 6bps right after the release, the 30-year Treasury auction that came later in the day was not nearly as well-received as the shorter dated paper seen earlier in the week.  The bid/cover ratio was only 2.42 and it seems that the market may be feeling a little indigestion from all the new paper just issued, as well as the prospects for the additional nearly $1.5 trillion left to come in 2023.  It is not hard to believe that longer end yields could rise further as the year progresses.  The upshot was 10-year yields rose 10bps on the day and are unchanged from there this morning.

Similarly, in the equity markets, the initial surge on the back of the slightly softer CPI was unwound throughout the day and though all three major indices ended the day in the green, the gains were on the order of 0.1% or less, so effectively unchanged.  Looking at futures there today, all three indices are unchanged from the close as investors and traders look for their next inspiration.  Meanwhile, I cannot ignore that overnight, Asian equity markets all fell, with the CSI 300, China’s main index, down -2.30%.  As well, European bourses are all lower this morning, mostly on the order of -1.0%.  Overall, this is not a positive risk day.

One of the things adding to the gloom is the financing data from China released early this morning.  New CNY Loans fell to CNY 345.9 billion, less than half the expected amount and down from >CNY 3 trillion in June.  M2 Money Supply there also grew more slowly than expected at just 10.7% as it seems that China’s debt woes are increasing.  China Evergrande was the first Chinese property company that gained notoriety for its problems, but Country Garden was actually the largest property company in China and now that looks to be heading toward bankruptcy.  

A quick tour of China shows it has a number of very big problems with which to contend.  Probably the biggest problem is demographics as the population begins to shrink.  However, two other critical issues are the massive amount of debt that is outstanding there (not dissimilar to the US situation) but much of it is more opaque sitting on the balance sheet of local government funding vehicles.  Just like in the West, this debt will not be repaid in full.  The question is, who is going to take the losses?  In China, the central government is trying to foist those losses on the local governments, but that will be a long-term power struggle despite President Xi’s ostensible powers.  Finally, the massive youth unemployment situation is simply dry tinder added to a very flammable mixture already.  This is not a forecast that China is going to implode, just that the claims that it is set to ascend to global superpower status may be a bit premature.

(By the way, for all of you who think a BRICS gold backed currency is on the way, ask yourself this question.  Why would India and Brazil want to link up with a nation with awful demographics and a gargantuan debt problem and link their currency to that?)

Finishing up, we have a bit more data this morning led by PPI (exp 0.7% Y/Y, 2.3% Y/Y ex food & energy) and then Michigan Sentiment (71.3) at 10:00.  With CPI already released, PPI would need to be dramatically different from expectations to have much of an impact at all.  There are no Fed speakers today, but yesterday we heard that there is still more to do by the Fed from both Daly and Bostic, and Harker did not repeat his idea that cuts were coming soon.

The dollar is mixed today, with Asian currencies under pressure, EEMEA and LATAM currencies performing well and the G10 all seeming in pretty good shape, although NOK (-0.7%) is under pressure after a much softer than expected CPI number yesterday has traders unwinding some future interest rate hikes.

Speaking of future interest rate hikes, the Fed funds futures market is down to a 10% chance of a September rate hike by the Fed, although there is still a ton of data yet to come, so that is likely to change a lot going forward.  My sense is that a little bit of fear is building in risk assets as despite some ostensible good news, with lower inflation and less chance of a Fed rate hike, risk is under pressure.  One truism is if a market cannot rally on good news, then it is likely to fall, especially if something negative shows up.  In that case, I suspect that we could see weakness in equities today, weakness in bonds and strength in the dollar before it is all over for the week.

Good luck and good weekend

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Failed to Inspire

Posted on by 
Consider poor President Xi
Whose efforts in his ‘conomy
Have failed to inspire
The quickening fire
Of growth for his people to see

It seems that the latest reports
Show signs of collapsing exports
Implying that growth
In China is sloth
And helping inspire yuan shorts

Chinese exports fell 14.5% Y/Y in July.  Imports also underperformed, falling -12.4%.  Perhaps of greater concern to President Xi is that they fell 23.1% to the US and 20.3% to the EU.  Now, they did rise aggressively to one place, Russia, where the increase was 52% Y/Y.  Alas for the Chinese, their business with Russia was always a fraction of that with the West, so, net, things are not looking too good on the mainland.  Ultimately, the problem for Xi is that despite years of effort to change the nature of the Chinese economy from a mercantilist model focused on export growth to a domestic consumption led model, they have not yet achieved that adjustment.  This has resulted in some very difficult decisions for President Xi which have yet to be made.

Consider that the Chinese growth miracle was built on three pillars, cheap labor, massive infrastructure spending and residential property investment.  For 18 years following the entry of China into the WTO this model was killer with average GDP growth over 10%.  It was remarkable in its ability to lift hundreds of millions of people out of poverty, a true humanitarian good.  But transition is always difficult, and China has now grown to the point where the old model is no longer effective and a new one needs to be implemented for the country’s future.

The first problem is the price of labor has risen in China to the point where it is no longer the cheapest place to manufacture goods as both India and Vietnam offer better value on this score.  Add to that the current tensions between China and the West and the efforts of western nations to reshore or friendshore manufacturing, and it seems unlikely that China is going to see a big boost in manufacturing for export anytime soon.

The second and third legs are intertwined in the following manner.  Historically, infrastructure spending has actually been financed by local governments, not by the national government except in some specific situations.  Those local governments would borrow money in the local bond markets and would use land sales as a means of repaying that debt over time.  So, as long as the property market was rising, these entities had access to additional investment funds.  When Beijing wanted to increase economic activity, they would simply instruct the local governments to pick up the pace of activity.

But now that the Chinese property market has been sinking for the past two years, which came to light with the problems at China Evergrande, but continue to this day, the Chinese people are not keen to continue to buy property as an investment vehicle, and in fact, many are looking to sell.  This has dramatically reduced the funds available for investment by local government entities and is weighing on economic activity.  This has hit both infrastructure and property investment and can be seen in the declining numbers for both Fixed Asset and Property investment that are released each month.

Thus, President Xi has very few levers to rekindle growth, especially if the west is heading into a recession.  Adding to his woes is the unemployment rate of the 16-24 set, which is currently > 21%.  In the end, China has only a limited ability to generate activity domestically at this point, and if things are slow elsewhere, they will remain slow there.

There are likely to be several direct impacts of this situation.  First, slowing growth in China is going to weigh on commodity prices as China has, for the past 20 years, been the largest consumer of commodities around.  As well, this will clearly be a deflationary impulse and weigh on price pressures, at least for certain parts of the economy going forward.  While I expect manufactured products will not rise much in price, it will probably not have much of an impact on services prices in the west, so don’t look for a collapse in inflation just yet.  And finally, a very common tactic for governments facing domestic difficulties is to try to distract their population with foreign issues.  I fear this elevates the chance for bigger problems in Asia, either with Taiwan or perhaps the South China Sea.  Xi needs to demonstrate he is still in charge so be wary.

As to the market response to this data, it was pretty negative all around.  Yesterday’s US equity rally had no real follow through with just the Nikkei managing a small gain overnight.  Not surprisingly, Chinese markets were lower along with the Hang Seng (-1.8%).  European bourses are all in the red this morning led by Italy’s FTSE MIB (-2.5%) after the Italian government imposed a 40% windfall profit tax on Italian banks.  Banks are in the firing line in Germany as well as the interest paid on reserves by the Bundesbank has been cut to 0.0%.  Do not be surprised to see this type of behavior in the US going forward, especially as the budget deficit swells.  US futures are also under pressure, down around -0.75% across the board at this hour (8:00).

In classic risk-off fashion, bond yields are falling aggressively this morning as the weak Chinese data has the recession talk back on top again.  10-year Treasury yields are lower by 10bps and now trading at 3.99%.  yield declines throughout Europe are much larger, on the order of 15bps and even JGB yields fell 3bps overnight. Suddenly there is real fear in the markets.

In keeping with the risk-off theme, commodity prices are under pressure with oil (-2.5%) leading the way and just now edging below $80/bbl.  Metals markets are also soft with copper (-2.7%) really feeling the heat although gold and aluminum are both under pressure as well.

Finally, the dollar is king of the hill this morning, rallying against all its G10 and EMG counterparts.  NOK (-1.5%) is the G10 laggard on the back of oil, but all the commodity currencies are lower by at least 1% and even the yen is softer by -0.4%.  As to the EMG bloc, again all the currencies are under pressure with the commodity bloc softest here as well.  This is a unified risk-off so buy dollars story today.

On the data front, NFIB Small Business Optimism was released at 91.9, slightly better than expected and now we await the Trade Balance (exp -$65.0B) at 8:30.  We have two speakers this morning, Philadelphia’s Harker and Richmond’s Barkin so continue to look for subtle changes in message.  Yesterday we heard from Bowman and Bostic, both indicating that more hikes might be needed to quell inflation.  I don’t believe we have seen a change there yet.

While the dollar has rallied a lot today, if equities start to retreat more aggressively, do not be surprised if this move continues.  It seems pretty clear that there is a growing concern over risk assets and, at the very least, a correction there.  That should help the dollar for now.

Good luck

Adf

Finding a Cure

Posted on by 
Apparently President Xi
Is keen to continue to be
The story du jour
While finding a cure
For China and its ‘conomy

But elsewhere, the market’s fixation
Is central bank communication
Tomorrow, Chair Jay
Seems likely to say
They’ve not yet defeated inflation

The story in China continues to be one of weakening economic activity and a government that is increasingly desperate to address the situation while maintaining their iron grip on everything that occurs in the country.  Of course, the problem with this thesis is that economic activity works far better without government interference, but that is the bed they have made.  At any rate, the word out of the CCP’s Politburo is that more support is coming with expectations now for lower interest rates as well as still looser property investment policies.  While it seems they don’t want to make direct cash injections into the economy yet, that appears to be the next step.

However, the announcements last night were sufficient for a bullish slant on everything China along with positive knock-on effects for those nations that are heavily reliant on a strong China for their own economic progress.  The result is that we saw dramatic strength in Chinese equity markets with the Hang Seng (+4.1%) and CSI (+2.9%) both having their best days in months.  Even with these moves, though, the Hang Seng remains more than 37% below its 2021 highs while the CSI is about 34% off those levels.  The point is that while last night’s session was quite positive, belief in the Chinese economic story remains a bit suspect yet.

Elsewhere, however, the PBOC is doing its level best to prevent the renminbi from declining sharply as they set the fix nearly 1% stronger than expected based on analysts’ models, and ultimately, the currency closed 0.6% stronger on the session.  Now, it remains well above the 7.00 level, but it seems quite clear that Pan Gongsheng, the freshly appointed PBOC governor, is making a statement that the renminbi should not fall dramatically.  I suspect that if the Chinese economy continues to flounder, that attitude may change, but for now, that is the party line.  As such, it should be no surprise that the rest of the APAC currency bloc performed well last night, along with AUD (+0.3%) the best G10 performer.

But away from that story, the market’s attention is turning almost entirely to the trio of central bank meetings that are starting with announcements due tomorrow afternoon (Fed), Thursday morning (ECB), and Thursday night late (BOJ).  Let us begin with the Fed, where the meeting commences shortly, and they are set to discuss the current situation in the economy as well as how things have changed since their June meeting and what their forecasts for the future look like.  

One area that is worth discussing is the Fed’s Reverse Repurchase Program (RRP or reverse repo) which serves as a low-risk investment outlet for excess funds in the system.  Prior to the debt ceiling crisis, there was a great deal of concern that when the Treasury started to issue T-bills to refill the Treasury General Account, the government’s checking account, the liquidity to buy those bills might come out of the stock market and undermine the stock market rally.  But there was another potential source, the RRP program, which prior to the debt deal had more than $2.3 trillion parked, mostly cash held by Money market funds.  However, since the TGA bottomed at the end of May, and the Treasury has been issuing T-bills at a record rate, it turns out that the entire TGA balance has been filled by a reduction in RRP.  In other words, there has been no liquidity drain from the markets, writ large, hence the equity markets continued ability to rally.  That amount has been approximately $500 Billion.  (See chart below with data from Bloomberg and the poet’s calculations)

Of course, there is a cost to this, and that is that the Treasury has been paying a higher yield on T-bills than those money market funds could get in the RRP market, and that, my friends, is adding to the already gargantuan budget deficit.  Since the start of this process, 3mo T-bill yields have risen 50bps, right alongside the Fed funds rate.  In essence, the Treasury is paying to keep the stock market higher.  

There is another short-dated money issue and that is Interest on Reserves, the rate the Fed pays banks for excess reserves that are held at the Fed.  That is currently set at 5.15%, between the Fed’s 5.00% to 5.25% band for Fed funds.  One subtle tweak the Fed could make is to alter that relative level when they raise rates tomorrow in an attempt to adjust the amount that is held there.  After all, other uses for those funds could be satisfying loan demand assuming that existed.  Arguably, a lowering of that rate would imply the Fed is seeking fewer excess reserves in the system, somewhat of a tightening exercise.  

At this stage, the 25bp rate hike is baked in the cake and is assumed by virtually every analyst with just 5 of the 108 analysts surveyed by Bloomberg calling for no hike.  Futures markets are pricing a 97% probability as well, so the reality is that all the action will be in the press conference as well as any new tweaks to the statement.  In my view, there has not yet been enough evidence of a considered slowing in inflation for the Fed to change its tune, but by the September meeting, we will have seen a lot more data and depending on how that plays out, things could be different.  But not this month.

Heading into this morning’s session, that Chinese stock rally was not really widely followed elsewhere as the Nikkei was unchanged and most of Europe is higher by just basis points.  That minimal movement is true in US futures as well.

Bond yields are a touch firmer, about 2bps across Treasuries and virtually the entire European space with only Italy (+4bps) an outlier.  The only data of note was the German IFO report, which was on the soft side, but not dramatically so.  I suspect that the yield move is in anticipation of the coming central bank activities.

In the commodity space, after another rally yesterday, oil is essentially unchanged and consolidating its recent gains.  However, the base metals have rallied sharply on the back of the China news with copper higher by almost 2% and aluminum by 1%.  Meanwhile, gold continues to trade in a very narrow range just below $2000/oz.

Finally, the dollar is slightly firmer this morning overall as the China story did not bleed over into any other areas and traders seem to be adjusting positions ahead of the Fed meeting.  Surprisingly, NOK (-0.6%) is the worst performer despite oil’s recent gains, but elsewhere, in both the G10 and EMG, it is modest dollar strength around.

This morning we see Case Shiller Home Prices (exp -2.35%) and then the Consumer Confidence reading (112.0) although typically, these do not move markets.  With no Fed speakers, the ongoing earnings calendar is likely to be the key driver of markets, although it is not until later this week when we hear from some of the Megacap names that people are getting excited.  I suspect there will be little net movement today ahead of tomorrow’s FOMC announcements.

Good luck

Adf

Quite a Surprise

Posted on by 
While many are looking ahead
To Europe, Japan and the Fed
Today’s PMI’s
Were quite a surprise
As weakness was truly widespread

Meanwhile, from Beijing, what we heard
Was policies they now preferred
Included support
For housing to thwart
The story that weakness occurred

While most market participants are anxiously awaiting this week’s central bank meetings for the next steps in monetary policy by the big 3 (Fed, ECB & BOJ), we did see a bit of surprising news from two sources this morning which has led to some market reactions.  The first thing to note was that the Chinese remain very disappointed that they cannot will their economy to grow faster in isolation and so have announced yet another round of policies intended to foster economic growth.  

The key plank of this policy is to further relax property investment rules, the so-called three red lines from several years ago, in order to encourage people to start buying houses again.  The property slump in China was first recognized when China Evergrande, one of the largest property development companies in the country, started down its road to bankruptcy nearly 2 years ago.  Since then, it has been a slow-motion train wreck with many more firms needing to halt debt payments, restructure debt and even go out of business.  Naturally, this didn’t sit well with the Chinese government, especially since property was a key part of the social safety net.  (Chinese families bought property as a nest egg investment since price appreciation had been so strong for so long.  Price declines have scared new investment away at the same time that many families need to cash in on their investment, adding further downward pressure to the housing market.)

The other main plank of this policy change was a renewed effort to deal with local government debt.  Historically, local governments would issue debt to fund economic investment and would repay that debt by selling property to investors and home buyers.  But with the property market in such a slump, these local governments no longer have the cash flow available to stay current on the debt, let alone repay it.  As such, the Chinese government is going to step into the market and restructure the debt in some manner with simple restructuring on the table as well as debt-swaps, where I assume debt holders will wind up with equity ownership of some extremely illiquid assets.  Neither of these things points to economic strength in China so I would continue to look for further measures as well as more direct fiscal support as we go forward.  As well, although CNY is little changed today, do not be surprised to see it continue its weakening trend.

The other major news this morning came from the Flash PMI data across Europe, which was, in a word, putrid.  While the initial data overnight from Australia and Japan was a bit soft, the continent redefined weakness.  Manufacturing remains mired in a serious recession in Europe as evidenced by Germany’s 38.8 reading, far below expectations and the second lowest print in the series, exceeded only by the Covid lows in April 2020.  But the weakness was widespread with France (44.5) underperforming expectations and the Eurozone as a whole (42.7) even worse.  Services data, while better than Manufacturing is also softening, and the Composite readings show are sub 50 across the board.  UK data was also soft, just not quite as awful, but the general takeaway is growth is slowing in the Eurozone and the UK.

Later this morning we see the US numbers (exp 46.2 Mfg, 54.0 Sevices) as well as the Chicago Fed National Activity Index (exp -0.13), which will help flesh out the story of US economic activity as well.  But the big picture remains that economic activity around the world is suffering, of that we can be sure.

And yet, despite this weakening growth story, expectations for rate hikes by both the Fed and ECB remain a virtual lock although the BOJ seems likely to remain on hold for a while yet.  We will delve into the central banking story tomorrow though.  For today, markets continue to respond to the PMI data as well as the China story.

And how have they reacted you may ask?  Well, starting in Asia, Chinese shares did not seem to like the announcements coming from Beijing as both the Hang Seng (-2.1%) and CSI (-0.45%) suffered although the Nikkei (+1.25%) embraced the idea that the BOJ was going to continue to print as much money as possible.  It should be no surprise that European bourses are in the red after that data with a particular note for Spain (-0.8%) which is also dealing with an election outcome that seems destined to result in another hung parliament.  But don’t worry, US futures continue to point to modest gains at this hour (8:00) although that remains highly earnings dependent I believe.

In the bond market, yields are lower across the board with Treasuries (-3.3bps) that laggard as virtually all the European sovereigns have seen yields slide by 6bps or so.  Apparently, the European investment community is not willing to believe the ECB will continue to raise interest rates into a very obvious recession on the continent.  We shall see if they do so.  As to JGB’s, they saw yields rise 2.4bps, but are still not too close to the YCC cap.  I expect that we will see a little more volatility in the JGB market ahead of Friday’s BOJ announcement as speculators try to get ahead of any potential policy change.

In the commodity space, oil (+0.75%) continues its recent winning ways and is up more than 11% in the past month.  Given the economic news, this has to be a supply driven story.  I have written many times about the structural deficit in oil that we are likely to face given the ESG movement’s systematic underinvestment in oil production.  The problem is that even with a recession, oil demand continues to grow and even the IEA, a complete convert to ESG and net-zero ideas, admits that oil demand will grow to a new record this year in excess of 102 million bbl/day globally.  Rising demand and static or falling supply will drive prices higher, that much is clear.  The base metals are under a bit of pressure, though, this morning, responding as would be expected to the weaker economic story and gold (+0.3%) continues to find support, arguably today on the basis of lower yields around the world.

Finally, the dollar is mixed, although I would argue leaning slightly stronger today.  The worst performer is CZK (-0.8%) which is suffering from weakness in its largest export market, Germany, as well as continuing to respond to central bank comments from late last week about policy ease.  On the flip side, ZAR (+0.7%) as there is a growing influx of investment into rand bonds given the huge yield advantage.  In the G10, JPY (+0.45%) is today’s leader, although if the BOJ stands pat, I have to believe that further weakness is in the future.  Meanwhile, EUR (-0.3%) is the laggard on the back of that terrible PMI data.

There is a lot of data out there this week in addition to the 3 big central bank meetings.

Today	Chicago Fed National Activity	-0.13
Tuesday	Case Shiller Home Prices	-2.40%
	Consumer Confidence	112.0
	Richmond Fed	-10
Wednesday	New Home Sales	725K
	FOMC Decision	5.50% (current 5.25%)
Thursday	ECB Decision	3.75% (current 3.50%)
	Initial Claims	235K
	Continuing Claims	1750K
	GDP Q2 (2nd look)	1.8%
	Durable Goods	1.0%
	-ex Transport	0.1%
Friday	BOJ Decision	-0.1% (current -0.1%)
	Personal Income	0.5%
	Personal Spending	0.4%
	Core PCE Deflator	0.2% (4.2% Y/Y)
	Michigan Sentiment	72.6
Source: Bloomberg

Obviously, there is plenty of information to be gleaned this week, although there are no scheduled Fed speakers after the meeting and press conference on Wednesday.  I guess they are all going on vacation!  

My read on the current situation is that economic activity continues to slow, although perhaps not yet to a recessionary level.  As well, I fear that inflationary pressures will remain stickier than we would like and that for now, the Fed is not feeling any pressure to end their current higher for longer policy.  In fact, it will be next week’s NFP data that is the first really critical release, as a weak number there will start to give weight to the idea that the terminal rate has been reached.  However, if we see strength in job growth, pencil in at least one more hike past Wednesday.  As to the dollar, I am confident that if the US is ending their tightening cycle, the other major central banks will be ending theirs soon as well.  I see no dollar collapse, nor even significant weakness for quite a while yet.

Good luck
Adf

A Series of Fails

Posted on by 
The narrative that we’ve been fed
Explains a soft landing’s ahead
With CPI falling
And job growth enthralling
The equity bulls lack all dread

But part of this thesis entails
That Chinese expansion prevails
Alas for that view
The data that’s new
Shows Xi’s had a series of fails

Pop quiz: what do you call an economy that demonstrates anemic economic output with relatively high inflation yet relatively low unemployment?  The future.  In truth, I don’t think economists have come up with a new descriptor for the situation to where we are headed.  Stagflation may be appropriate, but the key outlier in this scenario is the low unemployment situation.  To help better understand how a recession is defined in the US (as opposed to the shorthand view of 2 consecutive quarters of negative real GDP growth), here is an excerpt directly from the NBER’s website describing the things they consider [emphasis added]:

“Because a recession must influence the economy broadly and not be confined to one sector, the committee emphasizes economy-wide measures of economic activity. The determination of the months of peaks and troughs is based on a range of monthly measures of aggregate real economic activity published by the federal statistical agencies. These include real personal income less transfers, nonfarm payroll employment, employment as measured by the household survey, real personal consumption expenditures, wholesale-retail sales adjusted for price changes, and industrial production. There is no fixed rule about what measures contribute information to the process or how they are weighted in our decisions. In recent decades, the two measures we have put the most weight on are real personal income less transfers and nonfarm payroll employment.”

Based on this description, if the unemployment rate remains low, recession is not on the cards.  Now, politically, the current administration will spend a lot of time during the current election cycle touting their achievements, but will this situation, where inflation continues to plague the economy amid very slow growth, really feel like times are good?  The employment situation appears to be a structural change with a large reduction in the workforce in the wake of the pandemic and related policies.  While this seems likely to keep unemployment low, it will also keep upward pressure on inflation.  This will be good for the nation’s fiscal stance, as high nominal activity along with high inflation (exactly the situation I foresee) will do wonders for reducing the real value of the outstanding debt.  However, it is not clear it will do much for the nation’s psyche.  

One of the key features of the soft landing scenario is that economic activity will be widespread.  Now, we know that Europe and the UK are both struggling, but of equal, if not greater importance, is the stituaiton in China.  There has been a near universal view that the post zero-Covid economy in China would revive quickly and that growth there would be sufficient to support the entire world.  Last night, though, we got some bad news on that front as Chinese data was generally weaker than expected, specifically the GDP result where growth rose just 0.8% on the quarter (5.5% Y/Y) far below economists’ forecasts.  It seems that the China reopening is not nearly as impressive as previously expected.  Property investment continues to fall (-7.9%), Retail Sales continue to slide (3.1%) and IP remains far below historic levels.  Oh yeah, while the Surveyed Jobless Rate remained unchanged at 5.2%, youth unemployment (people between ages 16-24) rose still further to 21.3%!  This is not the sign of an expanding economy.

It seems that the combination of slowing world activity and ongoing trade wars is starting to really take a toll.  Exports fell last month, and apparently, the Chinese consumer is not picking up the slack.  Now, the latter should be no surprise as there was precious little fiscal policy support for the Chinese people by the Xi government during covid, and their largest source of savings, housing, has been collapsing for at least 2 years, so it is not clear why anyone should expect an uptick in activity.  The Chinese people just don’t have the money for it.  Despite Xi’s earnest desire to have the economy pivot away from export-led growth to consumption led growth, it just ain’t gonna happen real soon.  And if Chinese economic activity remains in the doldrums, we could be in for a longer period of overall slow growth around the world.  That will not help the soft-landing scenario at all.  

Maybe things will be much better, but I cannot get over the view that the worst of this economic cycle is yet to come.  Beware.

How are markets responding to the latest news?  Pretty much as you might expect with risk assets under pressure and bond markets rallying.  For instance, after Friday’s mixed picture in the US, Chinese equity markets were under pressure, although the rest of Asia was pretty benign.  European bourses, though, are all in the red led by the CAC (-1.25%).  As to US futures, at this hour (7:30) they are all slightly softer as the market awaits earnings, this week’s Retail Sales data and, of course, next week’s FOMC.

Bond markets, though, are unambiguous in their views with yields falling sharply across the board.  Treasury yields are down 5bps, as are virtually all European sovereigns and UK gilts.  The decline in US CPI last week is clearly spilling over, as is the weaker Chinese growth data.  While central banks have insisted that they are not done fighting inflation by raising interest rates, markets are pretty clearly expressing the view that yes another hike may be coming soon, but that by early next year, they will be cutting rates quickly.  

As to the commodity markets, oil, which had really rallied nicely over the past week or so, has fallen again this morning, down -1.20%, and we are seeing weakness in the base metals as well with both copper and aluminum lower by about -2.0%.  Only gold is managing to maintain a little bid as the dollar remains under some pressure this morning.

Finally, the dollar is mixed this morning, with about half its counterparts in both the G10 and EMG blocs higher and the other half lower.  Given the Chinese data, it is no surprise CNY and several other Asian currencies are weaker this morning.  Perhaps a little more surprising is that the ZAR is stronger despite softer metals prices.  But given that there has been a broad-based theme of dollar weakness in the wake of the CPI data last week, my sense is traders are simply adjusting positions ahead of the Fed next week.  This idea is bolstered by the fact that the yen remains one of the best performing currencies of late as the yen continues to be the favored funding currency for short positions given its still negative interest rate structure, but as the long dollar idea fades, traders are forced to cover those short yen positions.  I suspect that there is further to go in this trade.

On the data front, Retail Sales is the highlight of the week, although there is a decent amount of stuff, as follows:

Today	Empire Manufacturing	-3.5
Tuesday	Retail Sales	0.5%
	-ex autos	0.4%
	IP	0.0%
	Capacity Utilization	79.5%
Wednesday	Housing Starts	1475K
	Building Permits	1490K
Thursday	Initial Claims	241K
	Continuing Claims	1730K
	Phily Fed	-10.0
	Existing Home Sales	4.21M
Source: Bloomberg

With no Fed speakers, I expect that the market will be focused on the Retail Sales data from an economic perspective, but we are also entering the earning period, so it is likely that is going to have a bigger impact on all markets without any Fed narrative.  Barring extreme results in either data or earnings, I suspect a quiet week as all eyes focus not only on the 25bp hike coming next week from Powell and company, but more importantly, the tone of the statement and the press conference.  

Good luck
Adf

Cause Regret

Posted on by 
Again China’s leading the news
With stories ‘bout financing blues
So, terms on old debt
Which now cause regret
Have lengthened, more pain to defuse

Meanwhile, from the FOMC
Three speakers were clear as can be
Rate hikes are in store
This month, and then more
On this much, they all did agree

One of the key themes earlier this year that was supposed to have a big market impact was the China reopening story.  You may recall back in February when President Xi Jinping responded to the mass protests with blank papers held aloft, by deciding that permanently locking down a billion people was no longer an effective strategy, and a tacit declaration was made that there were no more Covid restrictions to be imposed or enforced.  Everybody assumed that the Chinese economy would vault out of the gates and that commodity demand would rocket higher while overall global economic activity increased.  Alas, that is not how things played out at all.  Instead, Chinese economic activity has disappointed at every turn with an initial blip higher and then a gradual slide back to less substantial activity.

 

Part of the problem has clearly been the efforts made by companies and countries around the world to reduce or eliminate China’s impact on supply chains.  But part of the problem, and arguably the larger part, was self-inflicted.  That was the massive debt buildup on the back of a two decades long leveraging of the Chinese property market.  You may recall China Evergrande, the first of the big property companies to come under pressure, but it has been an ongoing process for several years now.  The problem, in a nutshell, is that the model that had been used, buy huge swathes of land from city governments with leverage, promise to build housing (whose price had been rising nonstop for two decades) and then sell these flats to people on a highly leveraged basis, collapsed along with the covid lockdowns.  Suddenly, Chinese home buyers were out of work and could no longer afford the previously purchased homes.  As well, the construction companies could not complete the projects given all the workers were locked up in their own homes and unable to get to the construction sites.  However, debt remained a constant and was due regardless of the other issues.

 

The outcome was a significant slowdown in Chinese construction activity, an enormous number of unfinished (or even not yet started) apartment projects, and a lot of losses for both individuals and the property companies.  Now, as China emerged from its covid lockdowns, the government did try to relax some of its previous policy strictures but things in the property sector remain quite soft.  For China, where the property sector represented more than 25% of GDP, this is a problem.  As such, last night we saw the next steps by the Chinese government in this process with further easing on repayment terms by extending the maturity of a large amount of debt by one year, from 2024 to 2025.  It seems that the Chinese were paying attention to the Biden administration’s efforts regarding student loan payment delays and thought, we’ll do that too.  Of course, there is no Supreme Court in China to overturn this policy.  Do not be surprised if next summer, we hear about a further extension of these loans as can kicking is a government’s true superpower. 

 

A perfect encapsulation of this policy was the Chinese loan data released last night where new loans rose by CNY 3.05 trillion, far more than expected and aggregate financing also exploded higher, by CNY 4.2 trillion.  These are strong indications that the Chinese government is back offering substantial fiscal support to the economy in order to help get things moving again.  It should be no surprise that Chinese share prices rallied, nor that the renminbi has rallied a bit as well, pulling away from its recent multi-month lows.  It seems that the market has pushed things far enough to get a policy reaction rather than merely words.  At this point, the big question is, have we seen the end of the recent CNY weakening trend?  If the dollar continues its recent broad decline, then that is a quite probable scenario.  However, if the Fed continues to hew to its higher for longer mantra, and keeps pushing rates higher, be careful, of assumptions of a dollar collapse.

 

Speaking of the Fed, yesterday saw three Fed speakers, Barr, Daly and Mester, all explain that more tightening was still needed to push inflation back to their target. [emphasis added.]

Michael Barr: “we’ve made a lot of progress in monetary policy, the work that we need to do, over the last year.  I would say we’re close, but we still have a bit of work to do.”

Mary Daly: “We’re likely to need a couple more rate hikes over the course of this year to really bring inflation back into a path that along a sustainable 2% path.”

Loretta Mester: “in order to ensure that inflation is on a sustainable and timely path back to 2%, my view is that the funds rate will need to move up somewhat further from its current level and then hold there for a while as we accumulate more information on how the economy is evolving.”

 

It’s almost as if they are all reading from the same script!  At any rate, it seems very clear that regardless of tomorrow’s CPI print, they are going to hike by 25bps later this month.  The real question is, will the data continue to show the strength necessary to drive several more hikes after that?  As I have repeatedly explained, NFP is the most important number.  As long as Powell and the Fed can point to the employment situation and say there is no jobs recession, they will have cover to continue to tighten policy, maybe much higher.  6% or even higher is not out of the question.

 

And yet, despite the ongoing hawkishness from the Fed, the market is no longer concerned, at least that seems to be the case today.  Equity markets in the US managed to eke out gains yesterday and overnight saw Asia with bolder moves higher (Japan excepted as the strengthening yen is weighing on Japanese corporate profitability.). European bourses are higher, although the FTSE 100 is under pressure after mildly disappointing UK labor data this morning where the Unemployment Rate jumped to 4.0% for the first time since December 2021 when it was falling post covid.  US futures are a touch higher at this hour (8:00) but seem to be biding their time for tomorrow’s CPI data.

 

Bond markets, though, have rallied with 10-year Treasury yields lower today by a further 3bps and now back below the all-important 4.0% level, albeit just barely.  European sovereigns are also seeing some demand with yields sliding between 1bp and 2bps across the continent.  Even JGB yields edged a bit lower in a global bond buying spree.

 

Commodity prices are broadly higher with oil (+0.6%) continuing its rebound of the past week, while gold (+0.5%) is feeling a little love on the back of the dollar’s broad weakness today.  As to the base metals, they are ever so slightly firmer, retaining yesterday’s gains.

 

And finally, the dollar is softer across the board this morning as it seems to be following treasury yields lower and ignoring the Fed commentary.  The dollar’s weakness is evident in both the G10 and EMG blocs with JPY and NOK (both +0.6%) the leading gainers while only NZD (-0.4%) is under any pressure as traders prepare for the RBNZ meeting this evening and seem to be reducing their positions.  As to the emerging markets, KRW (+1.0%) was the leading gainer on the back of the Chinese fiscal policy story, although we saw strength throughout the APAC bloc.  Both EMEA and LATAM are a bit more mixed with much less significant movement, so seemingly following the bigger trend.

 

Today’s only data point has already been released, the NFIB Small Business Optimism Index, which printed at a higher than expected 91.0.  While this is a good sign, it is important to understand that the long history of this index shows an average near 100 and the current readings still mired near the lowest levels in its history, only surpassed by the massive recessions of 1980-1982 and the GFC in 2009.

 

There are no Fed speakers scheduled today, although we get a bunch more tomorrow after the CPI report is released.  For now, the market is looking askance at the dollar while Treasury yields sink.  My take is there is further upside in yields and therefore in the dollar.  However, that is not today’s trade. 

 

Good luck

Adf

Deflation’s Emerged

Posted on by 
Inflation in China is sliding
Which now has some pundits deciding
Elsewhere round the globe
The deeper you probe
DEFLATION’s emerged from its hiding

For equity bulls it’s a sign
That US rates soon will decline
But thus far Chair Jay
Keeps pounding away
That higher for longer is fine

By far the story that has gotten the most press from the overnight session has been the Chinese inflation readings.  For good order’s sake, they showed that the Y/Y CPI rate fell to 0.0%, down 2 ticks from last month and 2 ticks below expectations, while the Y/Y PPI rate fell to -5.4%, far below last month’s -4.6% reading and the lowest level since the end of 2015.

 

There have been numerous takes on the implications of this data.  In the short-term column, we have seen weakness in AUD (-0.7%) and NZD (-0.5%) as the narrative explains the falling inflation indicates falling demand and slowing growth in China, thus reducing the need for Antipodean exports.  Interestingly, this take does not effectively explain commodity price movements as although oil (-0.7%) is a bit lower this morning, both copper (+1.3%) and aluminum (+0.8%) are having quite a solid session.  Of course, the entire China reopening is bullish for the global economy and inflation story has been a disappointment from the get-go, so it is not clear why this is suddenly changing any opinions.

 

However, if you listen to the longer-term takes on this data, pundits are implying this is proof that the inflation genie is getting stuffed back into its lamp, and that soon, as inflation tumbles in the US, the Fed will finally pivot, and stock prices will run to new highs.  Quite frankly, I have a much harder time accepting the long-term take than the equity bulls seem to have.

 

A key part of this narrative is that come Wednesday, CPI in the US will be declining sharply to 3.1%, at least according to the current median Bloomberg estimate.  It is widely known this decline is due to the base effect as expectations are for a M/M outcome of 0.3%.  However, -ex food & energy, CPI is still forecast to print at 5.0%, well above the Fed’s target, and the number that Chairman Powell has been highly focused on of late.  It seems that the current narrative, at least in the equity world, is that China’s falling inflation will soon spread around the world and allow interest rates to head lower again thus supporting stock prices. 

 

The thing is, this is an equity market narrative, not a bond market one.  Turning to the bond market shows that yields remain quite firm with the 10-year still solidly above 4.00% (currently 4.05%, -1bp on the day), and the 2yr right near 5.0%.  Fed funds futures markets continue to price in a rate hike at the end of July with a 50% chance of another one by the November meeting, and no thoughts of a rate cut until June 2024.  In other words, while the equity cheerleaders are extrapolating from weak Chinese inflation to weak US (and global) inflation right away, the bond market continues to see the world quite differently.  This dichotomy in world view has been extant for many months now and eventually will be resolved.  The key question is, will the resolution be a sharp decline in bond yields?  Or a sharp decline in equity prices?  And that, of course, is the $64 billion question.

 

For what it’s worth, and it may not be much, I continue to lean toward an eventual equity market correction rather than a reversal of Fed policy and much lower US yields.  Well, I guess what I expect is that the air will come out of the equity bubble as the long-awaited recession finally arrives at which point the Fed will indeed feel cutting rates is appropriate.  However, there is just no indication this part of the cycle is imminent.  Remember, that on a long-term basis, equity multiples remain well above average and a reversion to the mean, at least, ought not be surprising.  As the earnings season for Q2 kicks off soon, there is ample opportunity for disappointment and the beginnings of a change of heart.  I couldn’t help but notice that Samsung, the largest chipmaker in the world, reported a 96% decline in profits in Q2 on Friday, hardly a sign of ongoing strength, AI be damned.  And while one company is not a trend, this one is certainly a tech bellwether and should not be ignored.

 

The point is that a correction in equity markets ought not be a huge surprise based on the ongoing, and rising, interest rate structure in the US, along with the very clear manufacturing recession in which the US, and most of the world, finds itself. 

 

Adding to this less optimistic view would be Friday’s NFP report which saw a weaker than expected headline print for the first time in more than a year, with significant revisions lower for the past two months.  The underlying metrics were not terrible, and on the inflation front, Average Hourly Earnings remain at 4.7%, well above the level the Fed believe is appropriate to allow them to achieve their 2% inflation target.  In other words, nothing about this report screams the Fed is done.  In fact, just the opposite, as those earnings numbers continue to pressure inflation higher.  Concluding, I believe it is premature to expect any Fed policy change and I am beginning to sense that we are observing the first cracks in the bull market thesis.  We shall see.

 

As to the rest of the market picture overnight, Friday’s US weakness was matched in Japan (-0.6%) and Australia, but Chinese shares rallied by a similar amount.  It seems there is growing belief that the Chinese government is going to offer more support for the economy there.  European bourses are in the green this morning, on the order of 0.5%, while US futures are essentially unchanged at this hour (8:00).  At this point, all eyes are on Wednesday’s CPI report so don’t be surprised if we have a couple of quiet sessions until then.

 

As to the rest of the bond market, European sovereigns have all sold off slightly with yields edging higher by between 1bp and 2bps although there has been no data of note released.  Perhaps more interesting is the fact that JGB yields are creeping higher, up 3bps overnight and now at 0.454%, much closer to the YCC cap of 0.50% than we have seen since April, immediately after Ueda-san took the helm.  There has been a lot of chatter about Japan doing something as they are ostensibly becoming uncomfortable with the yen’s ongoing weakness, so this is something to keep on the radar.

 

Speaking of the yen, while it is unchanged overnight, there has been no continuation from Friday’s sharp rally in the currency which was built on rumors of a BOJ policy adjustment or perhaps direct intervention.  But this is an area that must be watched closely as recall, last October, the BOJ was actively selling dollars to halt the yen’s slide then.  Elsewhere, though, the dollar is ever so slightly firmer on the day, with both gainers and losers in the EMG bloc, although none having moved very far.  Here, too, I feel like the market is awaiting the CPI data for its next catalyst.

 

A look at the data for this week shows the following:

 

Today

Consumer Credit

$20.0B

Tuesday

NFIB Small Biz Optimism

89.9

Wednesday

CPI

0.3% (3.1% Y/Y)

 

-ex food & energy

0.3% (5.0% Y/Y)

 

Fed’s Beige Book

 

Thursday

Initial Claims

250K

 

Continuing Claims

1720K

 

PPI

0.2% (0.4% Y/Y)

 

-ex food & energy

0.2% (2.6% Y/Y)

Friday

Michigan Sentiment

65.5

Source: Bloomberg

 

In addition to the CPI and PPI data, we hear from seven Fed speakers across nine events this week, with this morning being particularly busy as four different speakers will be on the tape between 10 and noon.  If you recall, there seemed to be the beginnings of dissent based on the Minutes we saw last week, so perhaps the message will get mixed, but as of now, I see no reason to believe that Powell will wait before hiking again.  In fact, the June 2022 M/M inflation print was the highest of the cycle at 1.2%, hence the base effect issue for this month.  Meanwhile, the July M/M reading will be compared to last July’s 0.0% reading, so I expect next month’s CPI will be much higher on Y/Y basis.  This will not be lost on Powell and the Fed. 

 

In the end, there has been nothing to change my view that the Fed is going to stay on course and that they will continue to drive the currency world overall with the dollar likely still the biggest beneficiary over time.

 

Good luck

Adf

Double Secret Inflation

Posted on by 
In Sintra, each central bank head
From Europe, Japan and the Fed
Explained all was well
Amongst their cartel
So, ideas of changing were dead

However, in Asia it seems
The PBOC’s latest schemes
To strengthen the yuan
Have failed to catch on
Look, now, for a change in regimes

The panel in Sintra that mattered had the three key central bank heads on the dais, Powell, Lagarde and Ueda, and each one held true to their recent word.  Both Powell and Lagarde insisted that inflation remains too high and that the surprising resilience in both the US and European (?) economies means that they would both be continuing their policy tightening going forward.  Powell hinted at a July hike and Lagarde promised one a few weeks ago.  At the same time, Ueda-san explained that while headline inflation was higher than their target, given the lack of wage growth, the BOJ’s ‘double-secret’ core inflation reading was still below 2% and so there would be no policy changes anytime soon.  He did explain that if this key reading moved sustainably above 2%, it would be appropriate to tighten monetary policy, but quite frankly, my take (and I’m not alone) is that all three of these central bank heads are very happy with the current situation.

 

Why, you may ask, are they happy?  Well, politically, inflation remains the biggest headache for both Powell and Lagarde, and quite frankly most of the rest of the world, while in Japan, recent rises in inflation have not raised the same political ire.  At the same time, as long as the BOJ continues YCC and QE with negative rates, the flood of liquidity into the market there helps offset the liquidity withdrawn by the Fed and ECB.  The result of this policy mix is a very gradual reduction in total global liquidity along with an ongoing demand for US and European sovereign issuance.  It should be no surprise that Japan is now the largest holder of US Treasuries outside the Fed.  As well, the policy dichotomy has resulted in a continued depreciation of the yen which supports the mercantilist aspects of the Japanese economy.  And finally, higher inflation in Japan helps erode the real value of the 250% of GDP worth of JGBs outstanding, allowing eventual repayment of that debt to proceed more smoothly.  Talk about a win, win, win!  Until we see a material change in the macroeconomic statistics in one of these three areas, it would be a huge surprise if policies changed.

 

The upshot of this analysis is that it seems unlikely that we are going to see any substantive movement in yields, either up or down, given the relative offsets in policy, and that the yen is likely to continue to erode in value.  Last autumn, the yen fell very sharply, breaching 150 for a short time and generating serous angst at the BOJ and MOF.  We saw intervention and the idea was there was a line in the sand at that level.  However, my take is that as long as the move remains gradual, and it has been gradual as the yen has steadily, but slowly depreciated for the past 5 months, about 2%/month, we are likely to see more verbal intervention, but not so much in the way of actual activity.  In the end, unless policies change, actual intervention simply serves to moderate the move.

 

Speaking of failed intervention, we can turn to China which has a similar problem to Japan, weakening growth and low inflation.  As I have written before, a weak renminbi is the best outlet valve they have, and the market has been doing the job.  However, here the movement has been a bit faster than the PBOC would like thus resulting in more overt and covert intervention.  On the overt side, we continue to see the PBOC try to fix the onshore currency strong (dollar lower) than the market would indicate as they try to get the message across that they don’t want the currency to collapse.  On the covert side, there has been an increase in the number of stories regarding Chinese banks, like China Construction Bank and Bank of China, actively selling USDCNH, the offshore renminbi in an effort to slow the currency’s depreciation.  But the story that is circulating is that all throughout Africa and Asia, nations that were encouraged to accept CNY for sales of commodities are now quite unhappy with the CNY’s weakness and are quickly selling as much as they can in order to preserve their reserve’s value.  My sense is this process will continue as the dichotomy between a stronger than expected US economy and a weaker than expected Chinese one continues to push the renminbi lower.  PS, for everyone who was concerned about the dollar losing its reserve currency status to the renminbi or some theoretical BRICS backed currency, this should help remind you of why any change to the dollar’s global status is very far in the future.

 

And those are today’s stories.  Yesterday’s mixed US risk picture has been followed overnight with Chinese shares, both Mainland and Hong Kong, suffering but the Nikkei eking out a gain.  In Europe, the FTSE 100 is under pressure, but we are seeing strength on the continent despite what I would consider slightly worse than expected data prints in German State CPIs as well as Eurozone Confidence measures.  However, the one place where inflation slowed sharply was Spain, where headline fell to 1.9%!  While that was a touch higher than forecast, it is the first reading of any country in the Eurozone below the 2% level since early 2021.  Alas, what is not getting much press is the fact that core CPI there fell far less than expected to 5.9% and remains well above targets.  The ECB has a long way to go.

 

Bonds are under pressure across the board today, with yields higher by about 3bps-4bps in Treasuries and across Europe.  This seems to be a response to the idea that a) neither the Fed nor ECB is going to stop raising rates and b) inflation is not falling as quickly as hoped.  JGB yields, though, remain well below the YCC cap at 0.38% so there is no pressure on Ueda-san to change his tune.

 

Oil prices are creeping higher this morning but remain below $70/bbl and in truth have not done very much lately.  The big picture of structural supply deficits vs. concerns over shorter term demand deficits due to the coming recession continue to play out as choppy markets but no direction.  Copper has fallen sharply this morning and is down more than 5% in the past week.  Its recent rally appears to have been a short squeeze more than a fundamental view.  Gold, meanwhile, continues to consolidate just above $1900/oz.

 

Finally, the dollar is mixed on the day, with both gainers and losers across the EMG space although it is broadly lower vs the G10.  AUD (+0.5%) is the leading major currency after better-than-expected Retail Sales data was released overnight but the rest of the bloc, while higher, is just barely so.  In the EMG, PLN (+0.75%) is the best performer, but that is very clearly a position rebalancing after a week of structural weakness.  On the downside, KRW (-0.75%) is the worst performer after weaker Chinese data impacted the view of Korea’s future.  Otherwise, most currencies are relatively unchanged on the day.

 

We get some important data today starting with Initial Claims (exp 265K) and Continuing Claims (1765K) as well as Q1 GDP (1.4%).  Frankly, since this is the third look at GDP, I expect that the Claims data, which has been trending higher lately, is the most critical piece.  If we see another strong print, be prepared for the recession narrative to come back with a vengeance, but if it is soft, then there will be nothing stopping the Fed going forward.

 

Powell made some comments this morning in Madrid, but they were about bank stability not economic policy, and we hear from Bostic this afternoon.  But frankly, I see little reason for a change in sentiment anywhere on the Fed given the data continues to show surprising economic strength.  As such, I still like the dollar medium term.

 

Good luck

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Havoc We’ll Wreak

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Said Christine, we’ve not reached the peak
Of rate hikes, more pain we still seek
So, come this July
A hike we’ll apply
To see how much havoc we’ll wreak

The ECB summer retreat began this morning and ECB President Lagarde kicked things off with the following comments, “It is unlikely that in the near future the central bank will be able to state with full confidence that the peak rates have been reached.  Barring a material change to the outlook, we will continue to increase rates in July.”  That seems like a pretty clear signal that there is no pause on the horizon.  Remarkably, the OIS market in Europe is only pricing in a 90% probability of a hike, despite a virtual guarantee from Lagarde.  Overall, the market has two more hikes total priced in, with a terminal rate of ~3.90%.  If you think about it, that is remarkable considering that core CPI in the Eurozone currently sits at 5.3%!  There is an awful lot of belief that despite both lower interest rates and higher inflation readings compared to the US, the ECB is nearly done.

 

Working in Lagarde’s favor is the fact that Europe appears to be slipping into a recession with Germany already there and the overall data output of late consistently underperforming rapidly declining expectations.  In fact, a look at the Citi Surprise Index for the Eurozone shows a reading of -140.20, lower than anytime other than the Covid collapse and the GFC.  This is even lower than during the Eurozone bond crisis in 2011-12, which given the dire straits at the time, is really impressive.  So, maybe Lagarde and the ECB anticipate a deep recession that will help crush demand and price pressures as well.  Of course, she can never actually say that, but who knows what she actually believes.  Or…perhaps the ECB have become closet monetarists and are relying on the fact that, unlike the Fed, their balance sheet has actually fallen substantially in size this year, > €1.1 trillion and is tracking lower still.  Compare this to the Fed where the balance sheet has only fallen by half as much and perhaps there is hope yet for the ECB. 

 

At any rate, the overall market response to these comments has been nonplussed.  It has certainly not engendered concerns in the equity market as European bourses are essentially unchanged on the day.  It has not engendered concerns in the bond market as European sovereigns are less than one basis point different than yesterday’s closes, and as far as the currency markets, the euro has edged higher by 0.3%, continuing its recent trend of bouncing off its lows ever so slowly.  For the rest of the day, we hear from various ECB speakers and several BOE members, but Powell doesn’t speak until tomorrow, and as we can see from today’s price action, he remains THE man when it comes to moving markets.

In China, they’re getting annoyed
That analysts there have employed
Some logic and said
When looking ahead
That stock value will be destroyed

If you want to understand the dangers of recent efforts to censor mis- or disinformation, look no further than China, where last night, three prominent finance writers were banned suspended from their Weibo accounts (China’s version of Twitter) for spreading “negative and harmful information” about the stock market.  In other words, after a 20% decline since the beginning of the year and no indication that the government was going to do anything substantive to try to address a clearly slowing economy, they didn’t exhort the public to buy stocks, but rather seemingly indicated they could fall further.  Apparently, that analysis is not appropriate hence the banning.  At the same time, the PBOC fixed the onshore renminbi much higher (dollar lower) than expected in an effort to slow the ongoing decline in the currency.  Since January 16th, prior to last night, CNY had declined more than 8%, pretty much in a straight line.  As I have written consistently, with inflation remaining quite low on the mainland, the PBOC seemed fairly relaxed about the currency’s weakness, but I guess that started to get a little out of hand.  It remains to be seen if they are going to intervene more aggressively, but the pressures clearly remain for a weaker renminbi.  The interest rate differential significantly favors the dollar and that is not going to change anytime soon.  As such, given the significant carry advantage for the dollar, I continue to expect USDCNY to rally to 7.50 and beyond as the year progresses.

 

Otherwise, it’s been a fairly dull session with no other noteworthy news and no critical data.  Risk has had a mixed picture with China and Hong Kong rebounding from recent lows on rumors that China was going to add some support, but Japan is continuing its recent correction from a massive run up this year.  European bourses are edging a bit lower at this hour (8:00) while US futures are mixed, albeit not really having moved very much. 

 

Bond yields, as mentioned above, are little changed with Gilts (+2.2bps) the only outlier of note.  There has been no data from the UK, so I expect this movement is position related more than anything else.

 

In the commodity space, oil (-1.6%) is once again under pressure as it remains the only market that truly is pricing for declining growth, although most base metals are under pressure today as well.  Gold, however, seems to be forming a new bottoming pattern above the $1900/oz level, although given reduced geopolitical fears and, more importantly, still high and rising interest rates, it will be tough for the yellow metal to rise in the current environment.

 

Finally, the dollar is under pressure again with a bit more universal negativity today.  The euro, now +0.45%, leads the way with the rest of the G10 showing far less impetus higher and NOK (-0.1%) unable to shake oil’s weakness.  As to the EMG space, ZAR (+1.2%) is the leading gainer followed by PLN (+0.7%) and PHP (+0.7%) showing that the gains are widespread.  LATAM currencies are also firmer, but by much smaller amounts.  As to the drivers, some hawkish talk from the SARB has traders looking for higher rates for longer, with similar commentary from the Polish Central Bank a key support there.  Completing this trio, a change at Bangko Sentral Pilipinas has been coming but the outgoing governor expressed his view that policy would not change, thus keeping relative tightness there as well.  I sense a theme.  Higher for longer is the central bank mantra virtually everywhere in the world with just China and Japan not playing along.

 

On the data front, Durable Goods just printed at a much better than expected 1.7% with the ex Transport reading at 0.6%, also firmer than expected.  That is certainly a different story than the survey data we have been seeing for the past several months, but it is also going to be confirmation for the Fed that they need to continue to raise rates.  Later this morning we will see Case Shiller House Prices (exp -2.40%), New Home Sales (675K), Consumer Confidence (104.0) and Richmond Fed (-12).  There are no Fed speakers on the calendar, so I expect that we will take our cues from equities and anything surprising out of Sintra.  Right now, the dollar is under gradual pressure, but over time, I continue to believe it will find support on the back of a Fed which is likely to be the most hawkish of all.

 

Good luck

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