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
Tag Archives: #china
Cause Regret
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
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
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
Adf
Havoc We’ll Wreak
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
Adf
4% is the New 2%
The Kingdom that’s sort of United Reported inflation’s ignited And simply won’t fall Regardless of all The rate hikes that they’ve expedited But of more importance today Is hearing what Jay has to say He’ll speak to the House Whose members will grouse Though their views will not hold much sway
Starting with the first big data point, CPI in the UK was higher than expected yet again, printing at 8.7%, unchanged from April’s reading and above the 8.4% consensus expectation. Core CPI actually rose further, to 7.1%, a new high reading for the current bout of inflation and an indication that thus far, the BOE has not been very effective in fighting inflation. The market response was mostly in line with what one would expect as the equity market sold off alongside Gilts as yields climbed further. In fact, 2yr Gilt yields are now above 5.0% for the first time since 2008 and the UK yield curve is also steeply inverted, albeit not as steeply as the US curve. As well, the OIS market is now pricing a one-third probability of a 50bp rate hike by the BOE when they meet tomorrow. But weirdly, the pound is under pressure this morning. It is the worst performing G10 currency (-0.4%) and unlike most recent market reactions, where higher interest rates lead to currency strength, it has a throwback feel to your old International Finance textbooks where higher inflation leads to currency weakness.
Arguably, the biggest problem that Governor Bailey has right now is that it doesn’t seem to matter what the BOE does, prices are continuing to rise. My sense is that interest rate hikes may not be the right medicine for the UK’s current ailments (which could well be true in the US) as the genesis of this inflation is not excessive economic growth driving demand but rather fiscal policy profligacy driving demand. If it is the latter, then higher interest rates may only exacerbate the inflation situation as the increased cost of debt service simply adds to the growing budget deficit which increases the amount of money available for people to spend. Consider, if one owns 2yr Gilts yielding 5%, the amount of income available to that person/entity is far greater than when 2yr Gilts were yielding 1% two years ago and so there is more money to spend. Just like in the US, the employment situation in the UK remains tight and wages are rising along with interest rates. In other words, there is a lot more money floating around chasing goods, a pretty surefire recipe for increasing inflation. Alas, this idea doesn’t fit well within the Keynesian dogma so I fear things will take a long time to recover in the UK.
Turning to the US, this morning we will hear from Chairman Powell for the first time since the FOMC meeting a week ago as he testifies before the House Financial Services Committee. While it is always difficult to anticipate what types of questions people like Representative Maxine Waters (who thankfully no longer chairs this committee) will ask, I expect that there will be a lot of discussion regarding whether the Fed should continue tightening policy in the face of recent softer, albeit still high, inflation readings, and what is being done about issues like bank safety and oversight. I am also quite confident that there will be questions/demands for the Fed to do something about climate change although Chairman Powell has already made clear it is not in their mandate.
However, ex ante, trying to assess what Powell is likely to say, I would estimate he will continue with the current Fed mantra of inflation remains far too high and that they are going to bring the rate of inflation back to their 2% target. He is also likely to admit that doing so will cause pain via rising unemployment, something no Congressman/woman is going to want to hear. But just like in the UK as explained above, it is entirely possible that the Fed’s reading of the current situation may not be accurate. The playbook, as written by Paul Volcker, explains that the way to squash inflation is to raise interest rates high enough to cause a recession, kill demand and watch price increases end. And that worked well in 1980-1982 as the US was dealing with both rising commodity prices as well as a demographic boom as Baby Boomers were entering the workforce along with women and there was a significant uptick in activity and productivity.
The problem for Powell, who came of age during that period, is that is not very descriptive of today’s economy. Instead, we have just come through a massive fiscal policy spend on the back of the pandemic response (similar to the end of a war) but the demographics are far less impactful as population is growing far more slowly and the working population is growing even slower. Higher interest rates have increased the income for retirees and allowed them to increase demand as they spend that newfound money. I’m not saying that cutting rates is the right path, just that raising them a lot more may not be very effective either. Fiscal discipline would be a far more effective tool to fight inflation in the current environment I believe. Alas, that is something that simply no longer exists. As such, I fear that we are going to see inflation remain much higher than we had become used to for a much longer time. I expect 4% is the new 2%.
At any rate, ahead of the Powell comments, which begin at 10:00am, this is what we’ve seen overnight. Japanese equities continue to rock, rising again and now up nearly 29% YTD in yen terms. The Nikkei has reached its highest level since December 1989, although has not yet passed the peak set in September of that year. However, Chinese equities are on a completely different trajectory right now, with both the Hang Seng and mainland indices down on the year. It seems investors are not enamored of President Xi’s economic leadership right now. As to Europe, it is mostly softer, albeit not by much and US futures are similarly down slightly ahead of the opening.
Bond yields are edging higher outside of the UK with Treasuries back up 3bps and most of the continent up around 1bp. Looking at Treasury activity lately, it has been choppy but not trending either higher or lower and sits in the middle of the 3.50% – 4.0% range that has defined trading since September.
Oil prices are little changed this morning and are also hanging about in a range lately as the market tries to determine the supply/demand function. Is China growing enough to increase demand substantially? How much oil is Iran getting into the market? These are the questions that have no clear answers so visibility into trends is limited. Meanwhile, gold got clobbered yesterday on dollar strength and the base metals had a similar response.
Finally, the dollar remains stronger rather than weaker overall, rallying yesterday against most of its counterparts and holding the bulk of those gains. Today’s outlier is KRW (-0.9%) which suffered after the release of its export data showed a 12.5% decline of exports to China. In truth, this bodes ill for both currencies, the won and the renminbi, which saw the offshore version trade through 7.20 last night for the first time in this move. As I have written before, this has further to go.
There is no data today so basically, all eyes will be on the tape at 10:00 to hear what Powell has to say and how he responds to the questions. For now, the market is losing conviction that another rate hike is coming, although there is no indication from Fed speakers that they have changed their view. Next week, we will see the PCE data, and I suspect much will depend on how that prints before any new views can be expressed. In the meantime, the dollar is caught between a sense of risk-off and a sense the Fed may be done. Choppy is the name of the game.
Good luck
Adf
Policy Lies
In China Xi’s growing concerned That growth there will not have returned Ere folks recognize His policy lies And seek changes for which they’ve yearned So, last night they cut interest rates While hoping it’s this that creates The growth that is needed So, Xi’s unimpeded In ending all future debates
It has been another relatively dull session in markets as we are well and truly amid the summer doldrums despite solstice not arriving until tomorrow. After an action-packed week with numerous central bank meetings as well as key inflation readings, this week is looking a lot less interesting. From a market perspective, the most noteworthy news from overnight was the reduction in the Loan Prime Rate in China by 10 basis points, matching what we saw in their repo rates last week. This is a very clear signal that there is a growing concern at the top in China regarding the growth trajectory of the country.
Perhaps the most interesting part of this situation is the reversal of previous policy attempts to reduce property speculation with the latest message encouraging people to buy a second home! It was only a few years ago when China, having massively leveraged its economy to generate their much vaunted 6% growth rate, realized that too much debt could turn into a problem. This led to a policy change that discouraged property investment and ultimately led to the decimation of the property sector. China Evergrande was the first major problem revealed, but there have been numerous other companies whose business model collapsed along with many people’s life savings.
However, lately that story has been just background noise and represented just one of the many industries that the Xi government helped undermine. You may recall the education (tutoring) companies that were turned into non-profits overnight, and the fight against the large tech companies like Alibaba and TenCent, which were deemed to be getting too powerful. But a funny thing about a state-controlled economy is that business decisions made by government actors are typically abysmal and lead to further problems. So, when the government decided that property speculation was bad, they cracked down hard. But now that they are figuring out that much of the country’s wealth was tied up in the market they cracked down on, and that people reduced their economic activity accordingly, they realize that perhaps things were better with that speculation, at least politically. Hence the reversal where the government is now encouraging that purchase of a second home. You can’t make this stuff up.
At any rate, the one thing that is very clear is that the Chinese economy is continuing to drag and that the most natural outlet remains the renminbi, which weakened further last night (-0.3%) and continues to push toward the renminbi lows (dollar highs) seen in November 2022. Given inflation remains extremely low there and given that the only model that the Chinese really know, the mercantilist export driven process, benefits from a weaker CNY, I would look for this trend to continue for quite a while going forward.
Otherwise, last night saw the release of the RBA Minutes which indicated that the surprise rate hike of a couple weeks ago was a much more closely debated outcome than previously thought. This has led traders to downgrade their assessment of a rate hike next month and Aussie (-0.9%) fell accordingly.
Beyond those stories, though, there is precious little to discuss today. Risk is on its back foot with equity markets in Europe mostly under pressures, and Chinese markets, especially, seeing weakness led by the Hang Seng’s -1.5% performance. US futures are also a bit lower at this hour (7:30) following Friday’s lackluster session. As discussed yesterday, there remains an active dialog between the bulls and the bears, with the bulls having the better of it for now, but the bears unwilling to give in. My working assumption is we need that to occur before things can turn around, so we shall see.
As to the interest rate outlook, opposite the Chinese rate cuts, the Western markets continue to price in further rate hikes as inflation remains far above target levels throughout 6 of the G7 with only Japan maintaining their current QE/NIRP policies. I think of greater concern for many economists is the fact that the inversion of the Treasury curve is not only substantial but has been increasing lately and is pushing back to -100bps for the 2yr-10yr spread. Perhaps, after 11 months of this price action, the question needs to be asked if this is a natural occurrence and a clear signal for a recession in the not too distant future, or if there is something else happening, perhaps an artificial bid in the back end via Japanese QE, maintaining much lower than realistic long-term rates as a way to prevent the US government’s interest expenses from rising too rapidly. With that as backdrop, though, it must be noted that European sovereign markets are much firmer this morning with 10-year yields all sharply lower, 6bp-7bp on the continent and 14bps lower in the UK after a new issuance with the highest coupon (4.5%) in decades drew substantial demand.
In the commodity markets, oil is relatively flat today having recaptured the $70/bbl level last month and to my mind seems to have found a bottom. While gold is flat and continuing its consolidation, base metals markets are under a bit of pressure on this risk off day.
Finally, the dollar is generally a bit stronger, at least vs. its G10 counterparts, with only the yen (+0.4%) showing its haven characteristics while essentially the rest of the bloc has fallen about -0.35%. In the emerging markets, the picture is more mixed with about half the currencies slightly stronger and half weaker but none having moved more than 0.3% in either direction, an indication that this is positional not newsworthy.
Looking ahead, this week brings mostly housing data but of more importance, we hear from Chairman Powell twice as he testifies to both the House Financial Services Committee and the Senate Banking Committee tomorrow and Thursday respectively. We also hear from the BOE on Thursday with another 25bp rate hike expected there.
|
Today |
Housing Starts |
1400K |
|
|
Building Permits |
1425K |
|
Thursday |
Chicago Fed National Index |
-0.10 |
|
|
Initial Claims |
260K |
|
|
Continuing Claims |
1785K |
|
|
Existing Home Sales |
4.25M |
|
|
Leading Indicators |
-0.8% |
|
Friday |
Flash PMI Manufacturing |
48.5 |
|
|
Flash PMI Services |
54.0 |
|
|
Flash PMI Composite |
53.5 |
Source: Bloomberg
I think we can expect Powell to continue the hawkish rhetoric and he will do so until either inflation is very clearly lowered, as measured by the regular data, or until the Unemployment rate starts to rise sharply. However, the market is becoming of the opinion that Madame Lagarde and Governor Bailey will be more hawkish than Powell. This has been the driver for the dollar’s relative softness over the past month. In contrast, I remain quite confident that if Powell does pivot, it won’t be long before both the ECB and BOE do the same.
Good luck
Adf
The Battle’s Been Won
‘Bout Jay and the FOMC The market has come to agree The battle’s been won And hiking is done So, buy stocks with verve and with glee In Europe, though, Madame Lagarde Is finding that things are still hard Inflation’s not tamed And she will be blamed If prices, she cannot retard Meanwhile on the world’s other side Where growth has begun to backslide The PBOC More cash will set free As Xi tries to hold back the tide
When looking at the market activity yesterday, it is easy to conclude that the market believes the Fed has instituted their last hike. This was evident in the equity market’s performance where all three major indices rallied more than 1% and it was evident in the FX market where the dollar was pummeled, falling by 1% or more against 7 of its G10 counterparts as well as about half the EMG bloc. In addition, Treasury yields fell sharply as the idea that the Fed is going to continue hiking, as implied by Chairman Powell in his comments on Wednesday, seems to have faded from memory.
But that’s not all! While key markets are beginning to discount any further Fed activity, the ECB not only raised their rate structure by 25bps as expected, but Madame Lagarde essentially promised another hike in July and this morning the ECB’s hawks are circling and hinting that a September rate hike is quite possible as well.
Now, we already know that the Fed’s dot plot is calling for 2 more rate hikes this year, but the Fed funds futures market is not in accord with that view. Rather, it is pricing a 70% probability of a July hike as the final move. But, will they hike again? Clearly, between now and the end of July we will all have seen a great deal more data, including both an NFP and CPI report, and that will have a major impact on the Fed. But after yesterday’s US data dump, which showed Retail Sales holding up far better than expected while both the Import and Export Price Indices showed price declines, there has been a significant increase in the chatter of the Fed pulling off a soft landing after all. And, if the landing is soft, do they need to hike more?
Although the manufacturing side of the economy remains lackluster, Services have been killing it. There is one other reason to believe the Fed will remain on hold as well, and that is the employment situation. While we have seen a much hotter than forecast NFP print basically each month for the past year, we are starting to see Initial Claims data tick higher. Yesterday’s 262K was both higher than expected and the highest print since October 2021 when claims were tumbling during the post-pandemic recovery. More ominously, the 4-week and 13-week moving averages (analyzed to seek a trend and remove the weekly choppiness) are both clearly trending higher. If that number continues to rise, the Fed’s confidence in the economic recovery continuing is likely to be impaired. In fact, I think this is the feature that is most likely to cause the Fed to stop hiking.
If we pivot to Asia for a moment, we see a completely different set of concerns in both China and Japan. Starting with China, after cutting their lending rates earlier this week, the PBOC is still struggling to figure out how to support what is a clearly softening economy. Although there has been much lip service paid to the fact that China will no longer prop up the property market and investment and is instead seeking to generate more domestic consumption, the fact that the youth unemployment rate is at a record 20.8% and that the only playbook the Chinese really understand is infrastructure spending and leveraged property speculation, they are falling back into that trap. Rumors abound that the government is going to put forth a CNY1 trillion (~$140B) spending package and that the PBOC is going to ease restrictions on property lending, removing the ban on second home purchases in small cities. Remember, property speculation was a critical part of China’s rapid growth as people there have little confidence in a social safety net and were using those second homes as an investment to secure their nest egg. Alas, with China’s population shrinking, that may no longer be an interesting investment for the middle class. So, while China’s problems are different, they are no less severe than those in the West.
Uncertainty is “Extremely high” over both Wages and prices So, Ueda-san Will keep liquidity flows Like flooding rivers
As to Japan, I’m old enough to remember when there was a growing belief that once Kuroda-san stepped down as BOJ head, his replacement would have free rein to tighten policy. Boy, were we ever wrong about that. After last night, while there was no policy adjustment as expected, Ueda-san’s comments can only be construed as strongly dovish and the market got the message. JGB yields slid a few basis points and are back below 0.40% while the yen is the only currency that is underperforming the dollar. Meanwhile, the Nikkei (+0.65%) continues its recent strong performance as the second best major index after only the NASDAQ.
The one thing that we know is that things do not seem to be evolving as per much of the consensus from earlier this year. While there is still a long way to go before this cycle ends, and I still expect a more significant economic slowdown globally, the possibility that Chairman Powell pulls off a soft landing cannot be dismissed. And as I saw on Twitter yesterday, if he does so, he will be hailed as the greatest Fed chair ever, even more so than Paul Volcker. Alas, I fear things will not work out that way. Remember that monetary policy works with long and variable lags, and I would contend that the economy is likely just beginning to feel the true impacts of tighter policy. Now, this may only happen in the manufacturing sector, where the cost of capital is such a critical input, but history has shown if that sector stumbles, it drags the economy down with it. Remember that so much of the service economy exists to service manufacturing, so the two are quite intertwined.
Remember, too, there are potential exogenous shocks, both positive and negative, that can have a big impact. What if the Ukraine war ended? What if China invaded Taiwan? What if there was an escalation of fighting in the Middle East with a dramatic reduction in oil production? All I am pointing out is that myopically focusing on just the economic data is not sufficient for a risk manager. Sh*t happens and it can matter a lot.
Ok, as to today, we already know that risk is on. The data coming out this morning is Michigan Sentiment (exp 60.0) and of the three Fed speakers, two have already commented with Governor Waller not talking economics or policy, but rather bank regulation and Bullard was more theoretical than policy focused, so really there has been nothing new there either. In a little while, Richmond’s Barkin will discuss inflation, so that could be interesting. But for right now, the market has made up its mind. Everything is right as rain so add risk. That means the dollar is likely to remain under pressure with a test of its lows (EUR 1.11, DXY 102) coming soon to a screen near you.
Heading into a bank holiday weekend, I expect positions to be lightened but the recent dollar weakening trend to remain intact.
Good luck and good weekend
Adf
Which One Means More?
The question is, which one means more? The headline inflation? Or core? The former declined But please bear in mind The latter rose more than before Which brings us today to the Fed Where skipping a rate hike is said To be what they’ll try Then come late July Will hike ere more water they tread
By now you are all aware that CPI’s release yesterday was a bit of a mixed bag with the headline number falling slightly more than expected to 4.0% while the core (ex food & energy) fell slightly less than expected to 5.3%. As always, my go-to source on inflation is @inflation_guy, who in yesterdays’ post clearly laid out that there is very limited evidence that core inflation is going to decline sharply from these levels anytime soon. In a nutshell, the key issue is that the housing portion of the index remains robust and that represents slightly more than one-third of the entire reading.
Ask yourself the following question; why would a landlord reduce his asking rents if his costs are rising (taxes and maintenance) and his potential customers are all seeing wages rise healthily, at least as per measured by the BLS and the Fed? Of course, the answer is that landlord is unlikely to reduce rents, but rather raise them, and that is not going to feed into lower inflation. One other thing to note is the price of energy, which was the key driver of the decline in headline CPI, has the earmarks of a bottom here. Not only have we seen production cuts from OPEC+, but it appears the Biden administration is beginning the process of finally refilling the SPR which means they have likely mapped the bottom of oil prices which have rebounded more than 5% from the lows seen Monday after the news broke.
As expected, the equity market took this news as a huge positive and continued its recent rally as it is almost certain that the Fed will be holding rates unchanged when they announce their policy update this afternoon. The Fed funds futures market has reduced its pricing for a rate hike to just 9% this morning although the implied probability of a hike in July has risen to 71% now. As an aside, the futures market is still pricing in the first rate cut by December or January 2024, although I suspect we will need to see a more significant decline in economic activity with much higher Unemployment for that to come to fruition.
This afternoon’s FOMC statement, and more importantly Chairman Powell’s press conference are the next critical features for the market. There is much talk of this being a ‘hawkish pause’ where they will not change rates but really play up the still hot core inflation data to make sure that everyone knows they are not going soft on inflation. As I have repeatedly explained, I continue to look at NFP as the most critical data point these days because as long as that number keeps printing solidly and beating expectations, the Fed will not be overly concerned a recession is coming and will feel comfortable tightening further if inflation starts to tick higher again. And so, at this time, all we can do is wait for the outcome at 2pm.
Ahead of that, here’s what’s been happening: risk has largely been in favor as yesterday’s US equity rally was followed by strength in Japan (+1.5%) and Australia (+0.3%) although many other APAC markets, notably China and South Korea, fell. The China situation is quite interesting as there is news that the Chinese government has convened several meetings with business leaders to get ideas as to how to improve the economy there. Not surprisingly, according to a Bloomberg story, the discussions focused on more market-oriented actions and less state planning as well as better coordinated fiscal and monetary policy stimulus. My guess is that President Xi is not keen to let the market do the work as he will not control that, so it will be interesting to see how things there progress. Meanwhile, European bourses are all much stronger this morning, even the FTSE 100 (+0.6%) despite a modestly weaker than expected set of GDP and IP data being released. And of course, US futures continue to edge higher, at least NASDAQ futures do, although it would be quite surprising to see any large movement ahead of the FOMC this afternoon.
Of much greater interest to me is that bond yields rose so sharply yesterday with 10yr Treasuries rising 7 bps yesterday and another 1.5bps this morning, despite (because of?) the CPI data being soft. The curve inversion remained essentially unchanged at -85bps, so I guess the story I saw that might have been the driver was when Treasury secretary Yellen was asked in Congressional testimony about the Fed and Treasury being prepared if China were to liquidate their entire portfolio of Treasuries, which is ~$875 billion. That seems highly unlikely to me, but I guess anything is possible. European sovereign yields are also rising after gains yesterday, which seems at odds with the equity markets that clearly believe in lower inflation. Things are quite confusing these days. As well, there will be much attention paid to China tonight to see if the PBOC follows through with a 10bp rate cut in the 1yr lending facility, or perhaps, if they are concerned about economic weakness, opts for more.
As mentioned, oil prices continue to rebound, pushing back to $70/bbl while gold got crushed yesterday seemingly in response to the rise in Treasury yields. This morning the barbarous relic is ever so slightly firmer but in a bigger picture view, remains relatively unchanged over the past month. Copper has continued its recent countertrend rally, but I expect that we will need to see real signs of an economic rebound for the red metal to get back to levels seen earlier this year above $4.00/pound.
Finally, the dollar remains under modest pressure overall, sliding about 0.25% against most of its G10 counterparts and a bit further against several EMG currencies. Notably, ZAR (+1.0%) is the best performer today, after a solid Retail Sales print this morning. As well, we see PLN (+0.7%) rising on rising zloty yields after the government increased the budget deficit on increased spending. On the downside, KRW (-0.55%) is the laggard, falling after several days of a sharp rally has led to profit-taking.
Ahead of the Fed, we see PPI this morning (exp 1.5%, 2.9% ex food & energy) although that seems anti-climactic after yesterday’s CPI. Add to that the Fed is coming and I cannot believe it will have any impact at all.
So, it is all about the Fed and how they sound since it seems pretty clear that they will not be adjusting rates today. Look carefully at the dot plot as well, for clues to their forward-looking beliefs. As to the dollar’s response, nothing has changed my big picture view that higher rates here will continue to support the greenback.
Good luck
Adf
Desperate Straits
Ahead of today’s CPI Jobs data from England showed why Inflation remains The greatest of pains That central banks can’t wave good-bye Despite all their hiking of rates In seeking to reach their mandates The job market’s growing Which seems to be showing Their models are in desperate straits
Today’s key feature is the monthly CPI report from the US where expectations are for a 4.1% headline reading and 5.2% core reading, with both still far higher than the Fed’s 2.0% target. While the headline number is certainly good news, the Fed’s problem is that the core reading continues to bump along pretty steadily above 5.0% and is not showing any indication of a sharp move lower. While an exceptionally weak headline reading will almost certainly result in a further rally in risk assets on the premise that the Fed’s pause skip is now baked in, the greater question is how long can the Fed tolerate such a high core CPI reading before resuming their rate hikes? As we head into the data, the Fed funds futures market is currently pricing just under a 25% chance of a hike tomorrow but nearly an 87% chance of at least one hike by July. However, that is the peak with a cut then assumed by December.
Of course, the thing that is not getting any attention at this point is what happens if the reading is hot? I have literally not read a single analysis that anticipates a higher outcome showing inflation has become even more intractable than it had seemed for the past several months. My take is a higher-than-expected reading, especially in the core print, could see the market substantially increase their pricing for a rate hike tomorrow as well as another one or two before the year is over, and that may not be a positive for risk assets.
And that’s where the UK’s employment data comes into the discussion, as it is showing the same characteristics as the US employment data, surprising strength. Briefly, instead of a rising Unemployment Rate, it fell to 3.8% with wages rising by 6.5% Y/Y, well above last month’s and well above forecasts. There was a reduction in the number of jobless claims and a significant growth in employment of 250K on a quarterly basis, also far above forecasts. In other words, despite a lot of doom and gloom regarding the UK economy and the irreparable damage that Brexit has done to the nation, it seems that there is continued economic activity at a decent pace and businesses are still hiring and paying up to do so. I have to say that sounds suspiciously like the commentary regarding the US economy, where despite an ongoing belief that Unemployment is set to rise, each monthly data point has been surprising on the high side, often by a significant amount. As I have written before, perhaps it is time for the central banking community to review the efficacy of their models as they no longer seem to represent any sense of reality.
The other noteworthy news overnight was that the PBOC reduced their 7-day Reverse Repo rate by 10bps to 1.90% in a surprising move. Tomorrow night the PBOC has their monthly meeting and expectations are for a 10bp reduction in their medium-term lending facilities as the Chinese government struggles with a much slower than expected rebound from their latest Covid reopening. In fairness, it is not just the Chinese government that is surprised as one of the main themes we have seen for the past several months was the expectation that China’s rebound would result in a significant increase in demand for commodities and that has just not occurred. However, the fact remains that China is easing policy, both fiscal and monetary, while the G7 remains in a tightening phase. The natural outcome here is that the renminbi has continued to slide. While the onshore market closed little changed, with CNY -0.1%, the initial reaction upon the announcement of the rate cut was a little more substantial. Net, though, the renminbi has been weakening steadily all year long and given recent very low inflation data, it is abundantly clear that the PBOC is not concerned at current levels. I expect that USDCNY and USDCNH have much further to climb as the summer progresses, especially if CPI continues to run hot here in the US.
And those are really the key stories as we await that CPI print shortly. Asian equity markets followed the US higher last night with the Nikkei continuing its sharp rally, rising 1.8%, and the rest of the markets trailing along behind. Europe, though, is having a less formidable session with minimal movement as the major indices are +/-0.1% from yesterday’s closing levels. As to US futures, only NASDAQ futures are showing any movement, gaining 0.3% at this hour (7:30).
Bond markets are similarly dull, save the Gilt market which has seen 10yr yields rise 5.7bps, as both Treasuries and the rest of the European sovereign market are within 1bp of yesterday’s prices. The Fed continues to be active in the Treasury market, taking down a significant portion of the issuance yesterday, albeit not directly as they bought off-the-run bonds instead of the issuances. However, today’s data could easily have a significant impact as traders try to reassess the Fed’s response to a data surprise.
Oil prices have stopped falling and have bounce 1.8% from yesterday’s lowest levels of just below $67/bbl, although the trend continues to be lower. As I have repeatedly written, this is the one market that is all-in on the recession call. Gold (+0.4%) has been pretty uninteresting lately as it stopped falling but has basically flat-lined for the past month just below $2000/oz. Meanwhile, copper has rallied 2% this morning but is still well below highs seen earlier this year. However, I think a large part of these movements are the fact that the dollar is generally softer this morning.
Versus its G10 counterparts, the dollar is softer across the board with GBP (+0.5%) the leading gainer but decent strength everywhere. Versus the EMG bloc, there is a bit more variety with KRW (+1.3%) by far the leading gainer on a combination of reported corporate repatriation of overseas cash flows as well as hopes that China’s rate cut will support further growth in Korean exports. However, after that, the bloc is basically split between gainers and laggards with the biggest moves just 0.3% either way, not enough to get excited about.
And that’s really it for today. It is all about CPI this morning and depending on the data, we have the opportunity to get a better sense of how the Fed might behave tomorrow.
Good luck
Adf
fxpoetry 