Tag Archives: #china

No Ceiling

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The narrative’s taken a turn
As traders, for lower rates, yearn
Initial Claims jumped
And that, in turn, pumped
The idea that rate hikes, Jay’d spurn

To add to the positive feeling
Inflation in China is reeling
Now bulls are all in
And to bears’ chagrin
It seems that for stocks there’s no ceiling

Well, it seems that Initial Claims can have an impact after all!  Yesterday the data series printed at 261K, the highest level since October 2021 and significantly higher than all the economists’ forecasts.  The market impact was clear as it appears there is an evolution from the narrative preceding the data release to a newer version.  For clarity’s sake, I would argue the prevailing narrative went something like this:

  • Prices were falling sharply, and inflation would soon be back at or near the Fed’s 2% target.
  • Unemployment remains low because of a significant mismatch between job openings and potential employees so consumption would remain robust
  • This economic strength will overcome further Fed tightening…so
  • Buy stocks!

 

Arguably the newer narrative is something like this:

  • Initial Claims data shows that the employment situation may be deteriorating
  • Not only will the Fed skip hiking at next week’s meeting, but at any meeting going forward
  • Rising Unemployment will force the Fed to finally pivot and cut rates…so
  • Buy stocks!

 

Granted these may be somewhat simplistic descriptions, but I would argue that they are representative of the current zeitgeist.  If nothing else, I would argue that the algorithms that implement so much trading these days are written in this manner. 

 

At any rate, the impact was far more significant than would ordinarily be expected from an Initial Claims release.  Rate hike expectations by the Fed have begun to fade, not only for next week, but for the July meeting as well.  Treasury yields fell 8bps yesterday, although they have rebounded slightly this morning by 3bps along with European government bonds.  And, of course, equity markets all rallied further yesterday with the S&P 500 ticking up to a level 20% above the October lows so now “officially” in a bull market.  In fact, that equity rally continued through into Asia as all markets there were higher led by the Nikkei (+2.0%).  Life is good!

 

Is this sustainable?  I guess so, the market for risk assets has been willing to look through every potential problem and continue to rally.  Are there flaws in the argument?  I would argue there are, but as John Maynard Keynes explained to us all, the market can remain irrational far longer than you can remain solvent.

 

One other noteworthy data point was released overnight, Chinese CPI and PPI, both of which remain quite low.  CPI rose only 0.2% in the past year while PPI fell -4.6%.  These results have market participants looking for the Chinese to ease monetary policy still further to support the economy, continuing to widen the policy differential between China and the G10 nations which, at least for now, remain in tightening mode.  As such, it should not be that surprising that the renminbi (-0.3%) fell further last night.  Given the distinct lack of inflationary pressures currently evident in China, I suspect the PBOC will be quite comfortable watching CNY weaken further still, with another 3%-5% quite realistic as the year progresses.  After all, China remains a mercantilist economy highly reliant on exports and a weaker yuan will only help their cause.

 

Now, keep in mind that everything is not positive.  We continue to see weak economic activity throughout the Eurozone with this morning’s Italian IP data (-1.9% M/M, -7.2% Y/Y) showing there are still many problems on the continent.  It is no wonder that Italian PM Meloni is so unhappy with the ECB as the Italian economy continues to stumble while the ECB continues to tighten policy.  But it certainly appears that Madame Lagarde is unconcerned about Italy at least for the time being.  However, while the ECB will almost certainly raise rates next week, if the Fed truly has finished their rate hike cycle, the ECB will not be far behind.

 

So, as we head into the weekend, the equity markets that are actually trading at this hour (7:30) are in the red with all of Europe down on the order of -0.2% to -0.4% and US futures also slightly softer.  Meanwhile, oil prices (+0.25%) are edging higher this morning, although that was after a sharp afternoon decline yesterday on inventory data.  Meanwhile, gold, which rallied sharply yesterday amid a weak dollar session, is consolidating its gains and the base metals are mixed.

 

Finally, the dollar is mixed this morning with about a 50/50 split in the G10 led by NOK (+1.1%) after CPI printed at a higher than expected 6.7% in May and the market is now pricing in further policy tightening by the Norgesbank.  This seems to fly in the face of the inflation is collapsing narrative which should make next week’s US CPI data on Tuesday that much more interesting.  After that, the rest of the commodity bloc of currencies is slightly firmer vs. the greenback while the European currencies as well as the yen are all under a bit of pressure.  However, on the week, the dollar has definitely backed off its recent strength.

 

In the EMG bloc, the pattern is similar with KRW (+1.0%) the leading gainer on the view that more Chinese policy support will help the Korean economy substantially, while we continue to see ZAR (+0.5%) rally on the commodity price gains.  On the downside, TRY (-1.25%) continues to lag despite (because of?) the appointment of a new central bank chief, Hafize Gaye Erkan, within the new government.  Perhaps her background as co-CEO of First Republic Bank did not inspire confidence given its recent demise.  But regardless, TRY has fallen more than 10% this week alone and shows no signs of stopping the slide anytime soon.

 

And that, my friends, is all there is heading into the weekend.  There is neither data nor Fedspeak to look for so the FX market will almost certainly be taking its cues from the US equity markets for the day.  As such, if equity markets decline, I would look for the dollar to gain a bit and vice versa, but until we get at least through next Tuesday’s CPI, and more likely the FOMC on Wednesday, I see more range trading overall.

 

Good luck and good weekend

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Far From a Floor

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As energy prices decline

Inflation, at least the headline,

Continues to shrink

As central banks think

Their actions have been quite benign

 

The problem is that at its core

Inflation is far from a floor

So, Christine and Jay

Ain’t ready to say

They’re done and won’t hike anymore

 

European inflation readings continue to fall alongside the ongoing decline in energy prices.  Headline numbers in France, Italy and Germany, as well as Spain and most of the Eurozone, have fallen sharply in the past month and seem likely to continue to do so.  Core inflation readings, however, for those countries that measure such things, and for the Eurozone as a whole, are demonstrating the same stickiness that we have seen here in the US.  Ultimately, the problem is that an inflationary mindset has begun to take hold in many people’s view.  While there is a great deal of complaining about rising prices, people continue to pay them, and the hangover of fiscal stimulus that was seen everywhere and continues to be pumped into economies around the world has allowed companies to raise prices while maintaining sales. 

 

There continues to be a strong disagreement within the analyst community regarding the future of inflation as there are many who have watched the trajectory of energy price declines and anticipate a return to 0%-2% inflation by the end of the year.  At the same time, there is another camp, in which the Fxpoet falls, that expects inflation to remain sticky in the 4% range for the foreseeable future.  Arguably, until such time as the massive amount of liquidity that was injected into the economy in response to Covid (and the GFC) is removed, I fear prices will err on the side of rising faster than we had become used to for so long.

 

Taking this one step further, the central bank playbook on inflation, as written by Paul Volcker in the 1980’s, was to tighten monetary policy enough to cause a severe recession and break demand.  We all know that Chairman Powell has read that book and is following it as best he can these days.  And, he has most of his team on board with that view.  Just this morning, Cleveland Fed President, and known hawk, Loretta Mester explained to the FT, “I don’t really see a compelling reason to pause – meaning wait until you get more evidence to decide what to do.  I would see more of a compelling case for bringing rates up…and then holding for a while until you get less uncertain about where the economy is going.”  These are not the words of someone who is concerned that rising interest rates are going to derail the US economy.  It is sentiment like this that has the Fed funds futures market pricing in a 64% probability of a rate hike in two weeks’ time.  It is also sentiment like this that is supporting the dollar, which has traded to its highest level in more than two months and is crushing the large, vocal contingent of dollar short positions around.

 

But, heading back to the recession argument, the data that we continue to receive shows no clear signs in either direction, rather it shows lots of conflict.  Yesterday I mentioned the decline in GDI, a seeming harbinger of weaker growth.  Meanwhile, yesterday’s data releases perfectly encapsulated the issue, with Consumer Confidence printing at a higher than expected 102.3, while the Dallas Fed Manufacturing Index fell to a wretched -29.1, far worse than expected and a level only reached during recessions in the past.  And there’s more to this story as last night China’s PMI data was all released at worse than expected levels (Manufacturing 48.8, Non-manufacturing 54.5, Composite 52.9) with all 3 readings slowing compared to April and an indication that the Chinese reopening story seems well and truly dead. 

 

This poses a sticky problem for President Xi as the clearly slowing Chinese economy seems likely to require further stimulus, whether fiscal, monetary, or both, with the ‘smart money ‘betting on monetary easing.  However, the renminbi (-0.4%) fell again last night and has been sliding pretty steadily since January.  Now, firmly above 7.10, it is fast approaching levels that the PBOC has previously indicated are inappropriate.  The question is, what will they do?  Easing monetary policy opens the door to rising prices, a potentially severe problem in China, while standing pat will likely result in further economic decline, not exactly what Xi is seeking.  My money is on easier policy and if necessary, price controls, something at which the Chinese government excels.

 

One cannot be surprised that with news like this, risk is taking a breather today, despite the ongoing euphoria over NVDA and AI.  Yesterday’s mixed performance in the US led to substantial weakness overnight in Asia, with all main indices falling by at least -1.0%.  Meanwhile, Europe this morning is also largely in the red, albeit only to the tune of -0.5%, and at this hour (8:00) US futures are pointing lower by -0.3% across the board. 

 

At the same time, the combination of falling inflation rates in Europe and the fact that a debt ceiling deal appears to be coming together has yields continuing to slide with Treasuries (-4.4bps) actually underperforming European sovereign yields which are all lower by between 7bps and 8bps.  The other thing to note here is that the yield curve inversion in the US, currently back to -78bps, is showing no signs of righting itself soon.  It has been nearly one year since the curve inverted, and recession alarms have been ringing everywhere, although one has not yet been sighted.  I expect continued volatility in this market as the debt ceiling bill will allow for a significant uptick in issuance right away and the question is, who will buy all this debt? 

 

Oil prices (-2.8%) continue to point to slowing economic activity and that is confirmed by weakness in the base metals as well.  While the Fed sees no signs of a recession, it seems pretty clear that some markets disagree.  Do not be surprised to see another production cut by OPEC+ as the summer progresses.

 

Finally, the dollar is king again, rising against virtually all its G10 and EMG counterparts, with the G10, sans JPY, all falling between -0.4% and -0.6%.  This is a broadscale risk-off move and one which is likely to continue as long as we see the combination of tough talk from the Fed and slowing economic data.

 

Speaking of economic data, today brings Chicago PMI (exp 47.2), JOLTS Job Openings (9.4M) and the Fed’s Beige Book this afternoon.  It is pretty clear that manufacturing activity remains in the doldrums here but pay close attention to the JOLTS data as the Fed is watching it closely for clues as to labor market tightness.  A weak number there is likely to have a bigger market impact than anything else today.

 

Net, I see no reason to dispute the dollar’s strength at the current time.  Talk to me when the Fed changes its tune, and we can see a dollar reversal.  Until then, higher for longer is both the interest rate and USD mantra.

 

Good luck

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Possibly Burst

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It turns out inflation’s not dead

At least in the UK, instead

With prices there surging

The market is purging

All thoughts rate cuts might be ahead

However, elsewhere, there’s concern

That soon there will be a downturn

Thus, stocks have reversed

And possibly burst

The bubble for which most folks yearn

Interestingly, inflation discussions are really beginning to diverge around the world.  What had been a global phenomenon, with prices rising everywhere on the back of pandemic lockdown induced shortages combined with massive fiscal stimulus pumping up demand, is starting to shake out a bit more idiosyncratically.  While in the US we have seen a clear reduction in the trend of prices over the past year, albeit still far above the Fed’s comfort level, elsewhere, this is not necessarily the case.  Today’s example is the UK, where CPI printed at 8.7%, far above the median forecast of 8.2%, although mercifully lower than last month’s 10.1%.  However, core CPI, which excludes energy, food, alcohol and tobacco in the UK, rose to 6.8%, a new high level for this bout of inflation and the highest in the UK since 1992.

One cannot be surprised that the market responded with Gilt yields jumping more than 6bps while the rest of global bond markets have seen yields decline in the face of a broad risk-off sentiment.  More impressively, the OIS market has immediately priced in more than 30bps of additional rate hikes before the end of the year this morning.  While UK stocks are lower, so are equity markets everywhere around the world and perhaps most surprisingly, the pound has only fallen -0.2%.  I suspect that is due to the tension of higher interest rates supporting the currency while worries over the future of policy and the economy are undermining it.  That said, year-to-date, the pound is still the best performing G10 currency vs. the dollar, with gains on the order of 2.5%.  If pressed, I would expect that the pound is likely to range trade going forward as the market continues to reprice Fed expectations higher (removing those forecast rate cuts) while the UK side remains stagnant for now.

Turning our attention to the economy writ large, there is a growing sense that the widely expected recession is coming soon to a screen near you.  Data continues to show weakening trends with, for instance, today’s German IFO Expectations falling to 88.6, far below forecasts, on the back of weakening manufacturing trends in Germany.  As well, yesterday’s US data had its lowlights with the flash manufacturing PMI falling to 48.5, while the Richmond Fed Manufacturing Index fell to -15, both well below expectations.  Layer on the background debt ceiling concerns, where the most recent word is that talks have stalled right now, and there is plenty of reason to turn pessimistic on things.  Arguably, these were keys to yesterday’s equity market declines in the US and we have continued to see red on the screens in every market in Asia and Europe. 

One of the biggest market concerns is China, where talk of slowing growth is continuing as this month’s production and investment data, released last week, was generally softer than expected with property continuing to drag things down, but fixed assets in general softening further.  There continue to be expectations that the PBOC is going to be easing monetary policy further and the renminbi’s recent slide shows no signs of stopping.  This view is also evident in commodity markets, specifically metals markets where copper (-1.5% today, -4.1% in the past week) and aluminum (-0.6%, -3.7%) are under increased pressure as concerns over slowing Chinese growth are impacting demand for these key industrial metals.  

There is, however, one place where this is not so evident, oil prices (+1.5%) as the market continues to respond to prospective production cuts by OPEC+ in the coming months.   The thing about oil is that its demand elasticity is nearly vertical.  Certainly, at the margins there can be more or less demand based on the economic conditions extant, but there is a baseline of demand that is simply not going to disappear.  It is important to remember that despite all the efforts at reduction in the use of fossil fuels, global oil demand hit a record last year.  It is also key to remember that for the past decade, investment in the production of new oil and gas reserves has been severely lacking.  The implication is that while oil prices have fallen well below the highs seen in the immediate wake of the Russian invasion of Ukraine, nothing has changed the long-term supply demand equation which greatly favors demand over supply, i.e. oil prices are likely to rise consistently, if not steadily, over the coming decades.

Summing it all up, today appears to have investors and traders thinking the worst, not the best of things going forward.

A quick look at overnight markets shows that equity market declines have largely been greater than -1.0% with the biggest markets, DAX, CAC, FTSE 100, pushing -2.0%.  There has been no place to hide here, and from a technical perspective, yesterday’s price action looks like an outside bearish reversal, which simply means that the closing level has market technicians selling for right now.  We have seen a significant equity rally in the face of a lot of negative news, so perhaps that run is now over.

Global bond yields are consolidating recent gains, with small declines today not nearly enough to offset what had been 30bp-40bp increases in the past two weeks.  In this market, clearly the debt ceiling talks are the primary story with macroeconomics a distant second for now.  There is just one week before the X-date, at least the latest one, and I suspect that we will hear of an agreement early next week helping to reduce at least some of the pressure on risk attitudes.

Lastly, the dollar is largely stronger this morning with an outlier in NZD (-1.85%) which fell sharply after the RBNZ essentially promised that last night’s 25bp rate hike, to 5.50%, is the last one coming, a big change from market expectations of a 50% probability of a 50bp hike last night.  Essentially, they explained that property market pressures and slowing consumer activity convinced them rates are appropriate to fight inflation.  Kiwi dragged Aussie (-0.5%) lower as well, but the rest of the bloc has seen far less damage with the yen (+0.15%) actually managing a small gain.  But make no mistake, over the past week and month, the dollar has regained its footing, at least against the G10.

In the emerging market bloc, the picture is more mixed with both winners and losers overnight with HUF (+0.8%) the leader, bouncing after the central bank cut its Deposit rate by 1 full percentage point yesterday, as expected and the forint fell sharply.  Meanwhile, MXN (+0.6%) is also showing signs of life after having fallen every day in the past week as the market now assumes Banxico has finished its rate hikes.  On the downside, MYR (-0.45%) and KRW (-0.4%) are both feeling the pressure of the weaker Chinese growth story given its importance to their own economies.

On the data front, the FOMC Minutes are released this afternoon and have a chance to be quite interesting given what appears to be the beginning of a split of opinions regarding the appropriate next steps.  As well, we hear from Governor Waller around lunch time, and ahead of the Minutes.  Waller certainly leans toward the hawkish end of the spectrum, so keep that in mind.

Adding it all up and the combination of declining risk appetite and a growing belief that the Fed is not going to pivot anytime soon implies that the dollar should maintain its footing for now.

Good luck

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Lest Things Implode

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The central banks all through the West
Are trying to figure how best
To, policy, tighten
But not scare or frighten
Investors and so they are stressed

Meanwhile from Beijing data showed
That Chinese growth actually slowed
With prospects now dimmed
The central bank trimmed
Two interest rates, lest things implode

There is a new contest amongst the punditry to see who can call for the most shocking rate policy by the Fed this year.  With the FOMC in their quiet period, they cannot respond to comments by the likes of JPM Chair Jamie Dimon (the Fed could raise rates 7 times this year!) or hedge fund manager and noted short seller Bill Ackman (the Fed should raise rates by 50 basis points in March to shock the market), and so those comments get to filter through the market discussion and creep into the narrative.  A quick look at Fed funds futures shows that the market is now pricing in not only a 25bp rate hike, but a probability of slightly more at the March meeting.

Now, don’t get me wrong, I think the Fed is hugely behind the curve, as evidenced by the fact they are still purchasing assets despite raging inflation, and think an immediate end to asset purchases would be appropriate policy, as well as raising rates in 0.5% increments or more until they start to make a dent in the depth of negative real yields, but I also know that is not going to happen.  Time and again they have effectively explained to us all that while inflation is certainly not a good thing, the worst possible outcome would be a decline in the stock market.  Their deference to investors rather than to Main Street has become a glaring issue, and one that does not reflect well on their reputation.  And yet, Chairman Powell has never given us a reason to believe that he will simply focus on inflation, which is currently by far the biggest problem in the economy.

However, with the market having already priced in a 0.25% rate hike for March, it is entirely realistic they will raise rates at that meeting.  The key question, though, is will they be able to continue to tighten policy when equity markets start to respond more negatively?  For the past 35 years (since Black Monday in 1987) the answer has been a resounding NO.  Why does anybody think this time is different?

Interestingly, at the same time virtually every Western central bank is trying to figure out the best way to fight the rapidly rising inflation seen throughout the world, the Middle Kingdom has their own, unique, issues, namely disappointing economic growth and expanding omicron growth leading up to the Winter Olympics.  Of course, the last thing that President Xi can allow is any inkling that things in China are not running smoothly, and so after the release of weaker than expected IP, Fixed Asset, Retail Sales and GDP data for Q4, the PBOC cut both its Medium-Term Lending and 7-day Reverse Repo rates by 0.10% last night.  In addition to the weaker data came the news that yet another property developer, Logan Group, may have made guarantees that do not appear on their balance sheet to the tune of $812 million.  I have lost count of the number of property developers in China that are now under growing pressure ever since the initial stories about China Evergrande.  But that is the point, the entire property sector is under huge pressure of imploding and property development has been somewhere between 25%-30% of the Chinese GDP growth.  This does not bode well for Chinese GDP growth going forward, which does not bode well for global growth.  PS, one last thing to mention here is the Chinese birth rate fell to its lowest level since 1950!  Only 10.62 million babies were born in 2021, despite significant efforts by the government to encourage family growth.  As demographics is destiny, unless the Chinese change their immigration policies, the nation is going to find itself in some very difficult straits as the population there ages rapidly and the working population shrinks.  Just sayin’.

Ok, with that out of the way, a look around today’s holiday markets shows that risk is on!  Aside from the Hang Seng (-0.7%) overnight, which is where so many property firms are listed, every other major market is in the green.  The Nikkei (+0.75%) and Shanghai (+0.6%) were both solid performers as that PBOC rate cut was seen as encouraging.  In Europe, the DAX (+0.4%), CAC (+0.6%) and FTSE 100 (+0.6%) are all firmer as are the peripheral markets.  Even US futures (+0.1% across the board) are firmer although there is no trading here today due to the MLK holiday.

Bond markets, on the other hand, are under pressure everywhere as Treasury futures are down 13 ticks or about 3 basis points higher, while European sovereigns (Bunds +1.7bps, OATs +2.0bps, Gilts +2.8bps) are all seeing higher yields as well.  In fact, 10-year Bunds are approaching 0.0% for the first time since May 2019.  Asia was no different with only China (-0.8bps) seeing a yield decline and sharp rises in Australia (+6.7bps) and South Korea (+9.7bps).

In the commodity markets, WTI (0.0%) is flat although Brent (-0.3%) is edging down from its multi-year highs.  NatGas (-0.6%) is also edging lower and European gas prices are falling even more significantly as a combination of LNG cargoes and warmer weather eases some pressure on that market.  Gold (+0.2%) is firmer, despite what appears to be a risk-on day, although copper (-0.7%) is under a bit of pressure.  In other words, the noise is overwhelming the signal here.

As to the dollar this morning, mixed is the best description as there are gainers and losers in both G10 and EMG blocs.  Interestingly, despite oil’s lackluster trading, both NOK (+0.3%) and CAD (+0.2%) are the leading gainers in the G10 while JPY (-0.25%) is following its risk history, selling off as equities gain.  In the emerging markets, RUB (-0.55%) is the worst performer as there seems to be growing concern over the imposition of tighter sanctions in the event Russia does invade the Ukraine.  KRW (-0.45%) is next in line after North Korea launched yet two more ballistic missiles, raising tension on the peninsula.  On the plus side, THB (+0.4%) has been continuing its recent gains as the nation opens up more completely from Covid lockdowns.

It is a relatively light data week with Housing the main focus, and with the Fed in their quiet period, we won’t be getting help there either.

Tuesday Empire Manufacturing 25.0
Wednesday Housing Starts 1650K
Building Permits 1700K
Thursday Initial Claims 220K
Continuing Claims 1521K
Philly Fed 19.8
Existing Home Sales 6.41M
Friday Leading Indicators 0.8%

Source: Bloomberg

In truth, it is shaping up to be a quiet week.  Next week brings the central bank onslaught with the Fed, BOJ and BOC, but until then, we will need to take our cues from equities and geopolitical tensions to see if anything occurs that may inspire the jettisoning of risk assets in a hurry.  My gut tells me we will not be seeing anything of that nature, and so a range bound week for the dollar seems in store.

Good luck and stay safe
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Quite a Surprise

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This morning’s report on inflation
Is forecast as verification
The Fed is behind
The curve and must find
The will to cease accommodation

While last night from China we learned
The trend in inflation has turned
In quite a surprise
It fell from its highs
A positive for all concerned

Ahead of this morning’s CPI report (exp 7.0%, 5.4% ex food & energy) investors around the world have been feeling positively giddy about the current situation.  Sure, China’s growth forecasts have been cut due to omicron infection outbreaks and the Chinese response of further lockdowns, but that just means that combined with the first downtick in PPI there since February 2020 (10.3%, exp 11.3%, prev 12.9%), talk has turned to the PBOC cutting interest rates next week by between 5 and 10 basis points.  So, while many other nations are aggressively fighting inflation (Brazil, Mexico, Hungary) or at least beginning to tighten policy (UK, Sweden, Canada), the market addiction to ever increasing liquidity may now be satisfied by China.  While it is still too early to know if lower interest rates are coming from Beijing, what is clear is that the credit impulse in China (the amount of lending) seems to have bottomed and is starting to reverse higher.  That alone augers well for future global growth; so, buy Stonks!

Meanwhile, I think it is valuable to consider what we heard from Chairman Powell yesterday at his renomination hearings, as well as what the two erstwhile hawks, Esther George and Loretta Mester, had to say about things.  Mr Powell, when asked why the Fed was continuing to purchase assets with inflation well above target and unemployment near historic lows inadvertently let the cat out of the bag as to the most important thing for the Fed, that if they were to move at a more aggressive pace, it could upset markets and there could be declines in both the stock and bond markets.  Apparently, the unwritten portion of the Fed’s mandate, prevent markets from falling, remains the most important goal.  While Powell paid lip service to the idea that the Fed would seek to prevent the inflationary mindset from becoming “entrenched”, he certainly didn’t indicate any sense of urgency that the Fed’s glacial pace of change was a problem.

Perhaps more surprisingly, neither Mester nor George were particularly hawkish, with both explaining that the Dot Plot from December was a good guide and there was no reason to consider a rate hike as soon as March.  Regarding QT, neither was anxious to get that started either although both wanted to see it eventually occur.  Finally, this morning, former NY Fed President (and current Fed mouthpiece) Bill Dudley explained in a Bloomberg column that there was no hurry to reduce the size of the balance sheet and that when it begins, the impact would be “like watching paint dry.”  Now, where have we heard that before?  Oh yeah, I remember.  Then Fed Chair Yellen used those exact same words to describe the last attempt to shrink the balance sheet right up until Powell was forced to pivot after the equity market’s sharp decline in 2018.  Apparently, the dynamics of drying paint are more interesting than we have been led to believe.

For those seeking proof that investors welcomed yesterday’s comments, one need only look at market behavior in their wake.  US equity markets rallied after the testimony and never looked back all day.  Treasury bonds did very little, with the sharp trend higher in yields having hit a key resistance and unable to find the will to push through.  Finally, the dollar took it on the chin, declining vs virtually every major and emerging market currency yesterday with many of those moves continuing overnight.  Recapping: higher stocks, unchanged bonds and a weaker dollar are not a sign that the market expects much tighter policy from the Fed.

Ok, so how are things looking this morning?  Well, in the equity market, the screen is entirely green. Last night, Asia followed the US lead  with gains across the board (Nikkei +1.9%, Hang Seng +2.8%, Shanghai +0.8%), and European bourses are also higher (DAX +0.35%, CAC +0.5%, FTSE 100 +0.7%) as data from the continent showed much better than expected Eurozone IP growth (2.3% vs 0.2% exp) as well as the first indication that inflation might be peaking in Germany with PPI there “only” printing at 16.1%, down from last month’s record 16.6%.  As to US futures, they are modestly higher ahead of the data, between 0.1%-0.2%.

In the bond market, while 10-year Treasury yields have edged higher by 0.7bps at this hour, they remain just below 1.75% and have shown no inclination, thus far, of breaking out much higher.  Arguably this implies that market participants are not yet full believers in the Fed tightening policy aggressively, and after yesterday’s performances, I think that is a good bet.  Meanwhile, European sovereign bonds are all rallying with yields falling nicely (Bunds -1.8bps, OATs -1.7bps, BTPs -1.3bps) as it remains clear that there is not going to be any tightening of note by the ECB this year.

On the commodity front, we continue to see strength in energy (WTI +0.5%, NatGas +5.2%) as well as industrial metals (Cu +2.9%, Zn +2.2%) although both gold -0.2%, and silver -0.2% are consolidating after strong moves higher yesterday.

Looking at FX markets, I would say the dollar is modestly weaker overall, albeit only in a few segments.  In the G10, NOK (+0.7%) and CAD (+0.2%) are the largest movers, by far, with both benefitting from oil’s continued rise.  The rest of the bloc, quite frankly, is tantamount to unchanged this morning.  In emerging markets, the picture is a bit more mixed with both gainers and losers about evenly split.  However, only 3 currencies have shown any real movement, BRL (-0.4%), KRW (+0.4%) and CLP (+0.3%).  The real seems to be consolidating some of its massive gains from yesterday, when it rallied 1.7% on the back of central bank comments implying that though inflation would fall back in 2022, it would require continued tight policy to achieve that outcome.  On the flip side, the won benefitted from a better than expected employment report showing more than 770K jobs added in the last year and indicating better economic growth going forward.  Finally, the Chilean peso seems to be benefitting from copper’s strong rally today.

Aside from this morning’s CPI report, we also see the Fed’s Beige Book at 2:00pm which has, in the past, been able to move markets if the narrative was strong enough.  Only one Fed speaker is on the docket, Kashkari, and even he, an uber-dove, is calling for 2 rate hikes this year as per his last comments.

The Fed tightening narrative is definitely having some difficulty these days which implies to me that the market has fully priced in its expectations and those expectations are that the Fed will not be able to tighten policy very much.  If the Fed is restrained, and tighter policy continues to get pushed further out in time, the dollar will suffer much sooner than I anticipated.  For those with opex and capex needs, perhaps moving up the timetable to execute makes some sense.

Good luck and stay safe
Adf

Out of Place

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The holiday season has passed
And this year the reigning forecast
Is for higher rates
Right here in the States
Thus, dollars will soon be amassed

But frequently, as is the case
Consensus is, here, out of place
Though some nations will
Raise rates, like Brazil
The Fed soon will turn about-face

Reading the many forecasts that are published this time of year, the consensus certainly appears to be that the Fed is going to continue to tighten policy and the only question is how soon they will begin raising interest rates; March, May or June?  The Fed narrative has evolved from there is no inflation, to inflation is transitory to inflation is persistent and we will address it with our tools.  But will they?  Since Paul Volcker retired as Fed Chair (1979-1987) we have had a steady run of people in that seat who like to talk tough, but when there is any hiccup in the market, are instantly prepared to add more liquidity to the system.  Starting with the Maestro himself, in the wake of the October 1987 stock market crash, to Bennie the Beard, the diminutive Ms Yellen and on up to today’s Chair Powell, history has shown that there is always a reason NOT to tighten policy because the consequences of doing so are worse than those of letting things run hotter.  Ultimately, I see no reason for this time to be any different than the past 35 years and expect that as interest rates begin to climb here, and equity markets reprice assumptions, the Fed will not be able to withstand the pain.

But for now, the higher US interest rate story remains front and center.  This was made clear yesterday when 10-year yields rallied 12 basis points in a thin session, trading back to levels last seen in November.  Perhaps not surprisingly, the dollar reversed its late year losses as well, rallying vs. almost all its counterparts with the yen (-0.7%) by far the worst performer in the G10.  It seems that the Japanese investor community has decided that a 155 basis point spread in the10-year, in an environment where expectations for a stronger dollar are rampant is a sufficient reason to sell yen and buy dollars.

And the truth is that given inflation is a global phenomenon these days, there are only a handful of nations where expectations don’t include higher interest rates.  For instance, Japan, though they have stopped QE are not even contemplating higher interest rates.  The ECB has indicated QE will be reduced to some extent (they claim cut in half, but I will believe that when I see it) but is certainly not considering higher interest rates.  Turkey is kind of a special case as President Erdogan continues to try his unorthodox inflation fighting methodology, but if the currency reprises the late 2021 collapse, which is entirely realistic, if not probable, that is subject to change.

However, there is one more nation of note that is almost certainly going to be working against the grain of higher interest rates this year, China.  President Xi has a growing list of economic problems that will result in further policy ease regardless of any inflationary consequences at this time.  The fundamental flaw is the Chinese property market, which has obviously been under severe pressure since the problems at China Evergrande came to light.  This is fundamental because it represents more than 30% of the Chinese economy and has been THE key reason that Chinese GDP has been growing as rapidly as it has over the past two decades.  With Evergrande and several (many?) other property developers going to the wall, the property sector is going to have a much slower growth trajectory, if it is positive at all, and that is going to drag on the entire economy.  After all, if they are not going to build ghost cities (Evergrande’s specialty), they don’t need as much concrete, steel, copper, etc., and the whole support framework that has been created for the industry will slow down as well.  The upshot is that the PBOC seems highly likely to continue to ease policy in various ways including RRR cuts, as well as reductions in interest rates.

On the surface, one would expect that to work against CNY strength and fit smoothly with the stronger dollar thesis.  However, the competing view is that President Xi is more focused on the long-term viability of the renminbi as a stable store of value and strong currency, and I expect that imperative will dominate this year and in the future.  Thus, while your textbooks would explain the renminbi should fall, I beg to differ this year.  We shall see as things evolve.

Ok, starting the year, there is clearly a solid risk appetite.  Yesterday saw strong gains in the US equity market which was followed by the Nikkei (+1.8%) last night, although Shanghai (-0.2%) and the Hang Seng (0.0%) failed to follow suit.  Europe (DAX +0.7%, CAC +1.4%, FTSE 100 +1.4%) are all bullish this morning as are US futures (+0.35% across the board).  Record Covid infections are clearly not seen as a problem anymore.

After yesterday’s dramatic sell-off in Treasuries, this morning yields there have consolidated and are essentially unchanged.  In Europe, though, there has been a mixed picture with Gilts (+8.3bps) following the US lead, while the continent (Bunds -1.5bps, OATs -2.5bps) are clearly more comfortable that interest rates have no reason to rise sharply there anytime soon.

In the commodity markets, oil (+0.3%) is continuing its run higher from last year and, quite frankly, shows no sign of stopping.  This is a simple supply demand imbalance with not nearly enough supply for ongoing demand.  NatGas (+1.8%) continues to trade well as cold weather in the NorthEast and much of Europe and a lack of Russian deliveries to the continent continue to demonstrate the supply demand imbalance there as well.  Gold (+0.25%) has bounced after getting roasted yesterday, although it spent the last weeks of the year grinding higher, so we remain around $1800/oz.  Industrial metals, though, are mixed with copper (-0.8%) under some pressure while aluminum (+1.4%) and zinc (+2.4%) are both having good days.

As to the dollar, aside from the yen’s sharp decline, the rest of the G10 is +/- 0.15% or less, not enough to consider for a story rather than position adjustments at the beginning of the year.  In the EMG space, though, the dollar has had a bit more positivity with ZAR (-0.9%) and RUB (-0.8%) the worst performers (I need to ignore TRY given the insanity ongoing there).  In both cases, rapidly rising inflation continues to outpace the central bank efforts to rein it in and the currency is weakening accordingly.  In fact, that is largely what we are seeing throughout this bloc, with central banks throughout lagging the rise in prices.  In the EMG space, this trend has room to run.

On the data front, we get a decent amount of stuff this week, culminating in the payroll report:

Today ISM Manufacturing 60.0
ISM Prices Paid 79.3
JOLTS Job Openings 11,100K
Wednesday ADP Employment 420K
FOMC Minutes
Thursday Initial Claims 195K
Continuing Claims 1682K
Trade Balance -$81.0B
Factory Orders 1.5%
-ex transport 1.1%
ISM Services 67.0
Friday Nonfarm Payrolls 424K
Private Payrolls 384K
Manufacturing Payrolls 35K
Unemployment Rate 4.1%
Average Hourly Earnings 0.4% (4.2% Y/Y)
Average Weekly Hours 34.8
Participation Rate 61.9%

Source: Bloomberg

In addition to the data, we start to hear from FOMC members again with Kashkari, Bullard, Daly and Bostic all on the calendar this week.  My impression is that investors and traders will be looking for hints as to the timing of rates liftoff.  But we are a long way from that happening yet.

For now, though, the narrative is clear, and a firmer dollar seems the most likely outcome in the near term.

Good luck and stay safe
Adf

Not Quite Right

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The data from China last night
Could, President Xi, give a fright
While IP was fine
Consumption’s decline
Show’s everything there’s not quite right

Now, turning our focus back home
The question that’s facing Jerome
Is should he increase
The speed that they cease
QE?  Or just leave it alone?

Clearly, the big news today is the FOMC meeting with the statement to be released at 2:00 and Chair Powell to face the press 30 minutes later.  As has been discussed ad nauseum since Powell’s Congressional testimony two weeks ago, expectations are for the Fed to reduce QE purchases more quickly than the previously outlined $15 billion/month with many looking for that pace to double.  If that does occur, QE will have concluded by the end of March.  This timing is important because the Fed has consistently maintained that they would not raise the Fed funds rate while QE was ongoing.  Hence, doubling the pace of reduction opens the door for the first interest rate hike as soon as April.

And let’s face it, the Fed has fallen a long way behind the curve with the latest evidence yesterday’s PPI data (9.6%, 7.7% core) printing much higher than expected and at its highest level since the series was renamed the PPI from its previous Wholesale Price Index in 2010.  Prior to that, it was in the 1970’s that last saw prices rising at this rate.  So, ahead of the meeting results, investors are trying to analyze just how quickly US monetary policy will be changing.  Recall, yesterday I made a case for a slower reduction than currently assumed, but as of now, nobody really knows.

What we do know, however, is that the economic situation in China is not playing out in the manner President Xi would like.  Last night China released its monthly growth data which showed Retail Sales (3.9% Y/Y) Fixed Asset Investment (5.2% Y/Y) and Property Investment (6.0% Y/Y) all rising more slowly than forecast and more slowly than last month. Only IP (3.8% Y/Y) managed to grow.  As well, Measured Unemployment rose to 5.0%, higher than expected and clearly not the goal.  For the past several years China has been ostensibly attempting to evolve its economy from the current mercantilist state, where production for export drives growth, to a more domestically focused consumer-led economy like the West.  Alas, they have been unable to make the progress they would have liked and now have to deal with not only Covid, but the ongoing meltdown in the property sector which will only serve to hold the consumer back further.  Interestingly, the PBOC did not adjust the Medium-term Lending Rate as some pundits had expected, keeping it at 2.95%, and so, it should not be that surprising that the renminbi has maintained its strength, although has appeared to stop rising.  A 2.95% coupon in today’s world remains quite attractive, at least for now, and continues to draw international investment.

Aside from these stories, the other headline of note was UK inflation printing at 5.1%, its highest level since 2011 and clearly well above the BOE’s 2.0% target.  Remember, the BOE (and ECB) meet tomorrow and there remains a great deal of uncertainty surrounding their actions given the imminent lockdown in the UK as the omicron variant spreads rapidly.  Can the BOE really tighten into a situation where growth will clearly be impaired?  It is this uncertainty that has pushed the timing of the first interest rate hike by the BOE back to February, at least according to futures markets.  But as you can see, the BOE is in the same position as the Fed, inflation is roaring but there are other concerns that prevent it from acting to stem the problem.  In sum, the betting right now is the Fed doubles the pace of taper and the BOE holds off on raising rates until February, but either, or both, of those remain far less than certain.  Expect some more market volatility across all asset classes today and tomorrow.

With all that in mind, here’s a quick look at markets overnight.  Equities in Asia (Nikkei +0.1%, Hang Seng -0.9%, Shanghai -0.4%) mostly followed the US declines of yesterday, although Japan did manage to eke out a small gain and stop its recent trend lower.  Europe, on the other hand, is having a better go of it with the DAX (+0.3%) and CAC (+0.6%) both performing well as inflation data there was largely in line with expectations, albeit far higher than targets, and there is little concern the ECB is going to do anything tomorrow to rock the boat.  In the UK, however, that higher inflation print is weighing on equities with the FTSE 100 (-0.2%) underperforming the rest of Europe.  Ahead of the open, and the FOMC, US futures are little changed in general, although NASDAQ futures continue to slide, down (-0.25%) as I type.

The rally in European stocks has encouraged a risk-on attitude and so bond markets are selling off a bit with yields edging higher.  Well, edging except in the UK, where Gilts (+3.7bps) are clearly showing their concern over the inflation print.  But in the US (Treasuries +0.3bps), Germany (Bunds +1.2bps) and France (OATs +0.9bps) things are far less dramatic.  Given the imminent rate decisions, I expect that there is a chance for more movement later and most traders are simply biding their time for now.

The commodity picture is a little gloomier this morning with oil (-1.2%) leading the way lower and weakness in metals (Cu -1.5%, Ag -0.5%, Al -1.4%) widespread.  Gold is little changed on the day and only NatGas (+2.1%) is showing any life.  These markets are looking for a sign to help define the next big trend and so are also awaiting the FOMC outcome today.

Finally, the dollar continues to consolidate its recent gains but has been range trading for the past month.  The trend remains higher, but we will need confirmation from the FOMC today to really help it break out I believe.  In the G10, the biggest gainer has been AUD (+0.4%), but that appears to be positional, as Aussie has been sliding for the past week and seems to be taking a breather.  Otherwise, in this bloc there are an equal number of gainers and laggards with none moving more than 0.2%, so essentially trendless.

In the emerging markets, TRY (-2.1%) continues its decline toward oblivion with no end in sight.  Elsewhere, ZAR (-0.6%) has suffered on continue high inflation and the SARB’s unwillingness to fight it more aggressively.  INR (-0.5%) suffered on the back of a record high trade deficit and concerns that if the Fed does tighten, funding their C/A gap will get that much more expensive.  Beyond those, though, there has been far less movement and far less interest overall.

We do have some important data this morning led by Empire Mfg (exp 25.0) and Retail Sales (0.8%, 0.9% ex autos) at 8:30 and then Business Inventories (1.1%) at 10:00 before the FOMC at 2:00.  The inventory data bears watching as an indication of whether companies are beginning to stockpile more and more product given the supply chain issues that remain front and center across most industries.

And that’s really what we have at this point in time.  A truly hawkish Fed should help support the dollar further, while anything else is likely to see the dollar back up as hawkish is the default setting right now.

Good luck and stay safe
Adf

Somewhat Weak

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In China, the PBOC
Whose policy, previously
Consisted of planks
Instructing the banks
To buy more and more renminbi

Has seemingly now changed its mind
With prop trading now much maligned
Instead, what they seek
Is yuan, somewhat weak
And banks that object will be fined

Let’s face it, constantly harping on inflation is getting tiresome.  While it remains the biggest topic in the market, we have discussed it extensively, and in fact, until there is some clarity as to the next Fed chair, it is very difficult to even try to determine how the Fed will respond going forward.  The word is that President Biden will be revealing his nomination tomorrow at which point we can game out potential future scenarios.

In the meantime, we have seen large movements in some emerging market currencies, and we have heard about some potential changes in policies underlying one of the less volatile ones, the Chinese renminbi.  One of the more surprising features of the dollar’s rally since summertime has been the fact that the renminbi has actually strengthened about 0.6% while the euro has declined nearly 8%.  In fairness, the euro has many self-inflicted problems that have been underlying its recent weakness, but the dollar, as measured by the Bloomberg dollar index, has risen by nearly 6%, implying there has been a lot of broad-based dollar strength.  This begs the question, why hasn’t the renminbi followed suit?

There are several potential answers to this question with the likelihood that each has been a part of the process.  Remember, for a mercantilist economy like China’s, a weaker currency tends to be the goal in an effort to improve the competitiveness of its exporters.  So, acceptance of a stronger currency demonstrates other priorities.

If nothing else, China plays the long game, historically willing to sacrifice short-term economic performance for the sake of a longer-term goal, often a political one.  And one of the things China is very keen to achieve is de-dollarization of its economy.  Given the growing antagonism between the US and China, President Xi has determined his nation is better served by an alternative to the US dollar in as many areas as possible.  One of those areas is in trade with other developing nations.  To the extent that the Chinese can convince other Asian, Middle Eastern or African nations to accept renminbi in exchange for their products, rather than dollars, it both strengthens Xi’s grip on those nations’ economies as well as reduces his reliance on the US led SWIFT system thus preventing any interference by the US.  As such, it is incumbent upon Xi to insure that CNY is a strong and stable currency, the exact words the PBOC uses to describe the renminbi in almost every press release.

Now, while this may have been at odds with short-term potential benefits, Xi understood the long-term benefits of removing as much of the Chinese economy from the dollar’s global sphere of influence as possible.  And it seems, that a major tool used to help maintain the renminbi’s strength has been the encouragement of local Chinese banks prop trading desks to continue to buy the currency.  There have long been stories of the PBOC whispering in the ear of Chinese banks to do just that, with the implication that the PBOC would prevent any significant weakness.

But that was then.  It seems now that the ongoing malaise in the Chinese economy, where growth forecasts continue to slide and expectations for another 50 basis point RRR cut are growing, has the PBOC apparently cracking down on prop desks buying too much CNY.  They have been instructed to monitor client activity and keep it at more ‘normal’ levels.  Some see that as a tacit admission that the previous policy, which was never explicit, was in fact a reality.  In addition, much will be made of the fixing, which last night was printed 0.2% weaker than expected.  Now, while 0.2% may not seem like much, in a currency with historical volatility around 3%, it is a signal.  In addition, the PBOC indicated that it would be ready to allow a “more flexible currency”, their code for weakness.  This is not to say the CNY is going to collapse, just that the unusual strength we have seen over the past six plus months is likely coming to an end.  Be warned.

Turning to the rest of the market this morning, the situation is somewhat mixed, with equity markets showing both gains and losses, although bond markets are under universal pressure.  Starting with equities, Asia gave no directional cues with the Nikkei (+0.1%) little changed while the Hang Seng (-0.4%) and Shanghai (+0.6%) gave confusing signals.  It seems that there is a very large sell order making the rounds in Evergrande stock, which is weighing on HK, while Shanghai responded to the first hints of easing by the PBOC.  Europe, which was modestly higher earlier in the session, has drifted to a mixed performance as well with the DAX (-0.1%) and CAC (-0.2%) both a touch softer although the FTSE 100 (+0.1%) has eked out a gain.  In the absence of any data releases, it seems that traders are biding their time for the next big thing.  US futures, on the other hand, are all firmer by about 0.35%, despite talk of a faster taper by more Fed speakers late last week.

Bond markets, though, are having a rougher time of things with Treasuries (+3.3bps) leading the way, but Bunds (+1.3bps) and Gilts (+2.5bps) both following along.  OATs are unchanged on the day, although have spent the bulk of the session with modestly higher yields.  The thing about yields, though, is that they remain range-bound and have shown little impetus to trend in either direction.  This is a market waiting for the next central bank discussion.

In the commodity space, oil continues under pressure as the thought of SPR releases in a coordinated manner from a number of nations continues to dog the price.  NatGas (-5.4%), interestingly, has tumbled after a larger than expected build in inventories, something US homeowners will welcome.  In the metals space, gold (-0.2%) is slightly softer and copper (-0.6%) is feeling a bit more strain.  However, aluminum (+0.6%) and nickel (+2.1%) show that this is not a universal issue.

As to the dollar, in the G10 the story is mixed with AUD (+0.3%) the best performer while SEK (-0.4%) is the worst.  However, these appear to be flow related movements as there has been no data or commentary from either nation.  The rest of the bloc has barely moved, +/- 0.1% for most of them, as traders await the next big idea.  In the emerging markets, CLP (+3.0%) is the big gainer as yesterday’s presidential election resulted in the conservative candidate performing far better than expected and investors now hoping that the country will maintain its investment friendly policies.  On the downside, RUB (-1.3%) and HUF (-0.6%) are in the worst shape with the former feeling pain based on concerns recent troop movements near the Ukraine border will result in an invasion and potential further sanctions, while the forint is suffering despite a more aggressive central bank as inflation there continues to ramp higher.  Expectations are growing for yet another rate hike as the fear is they are falling further behind the curve.

With the holiday before us, data is all crammed into the first three days this week, and most of it is on Wednesday:

Today Existing Home Sales 6.18M
Tuesday Manufacturing PMI 59.1
Services PMI 59.0
Wednesday Initial Claims 261K
Continuing Claims 2052K
GDP 2.2%
Durable Goods 0.2%
-ex Transport 0.5%
Personal Income 0.2%
Personal Spending 1.0%
Core PCE 0.4% (4.1% Y/Y)
New Home Sales 800K
Michigan Sentiment 66.9
FOMC Minutes

Source: Bloomberg

Consider that on the day before Thanksgiving, we are going to see some of the most important data of the month, and there will be relatively few people around.  If there is any surprise, we could see significant volatility.  In fact, for the week as a whole, the lack of liquidity is likely to result in a choppier market.  Keep that in mind if you need to execute anything of substance, but overall, the dollar’s recent rally seems likely to continue.

Good luck and stay safe
Adf

A Touch of Despair

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The Beige Book detected the fact
That bottom lines all have been whacked
As wages explode
While growth, somewhat, slowed
Inflation, it seems, ain’t abstract

Meanwhile we heard from a vice-Chair
Whose words had a touch of despair
It seems he now thinks
There just might be links
Twixt QE and price everywhere

Chairman Powell’s comments due tomorrow are taking on much greater importance than just a few days ago as the Fed narrative is seemingly in the middle of a change.  While many have been willing to dismiss the fact that the regional Fed presidents have been more hawkish lately, leading the charge for the beginning of tapering, the Fed governors had been far more sanguine on the subject, at least until very recently.  Tuesday, we heard from Governor Waller about his concerns that inflation could be more persistent, especially if one looked at the headline measures as he dismissed the other measures as efforts at manipulation.  Yesterday it was vice-Chair Quarles’ turn to put the market on notice that inflation’s persistence has begun to become troublesome and while he still felt price pressures would abate next year, his level of confidence in that forecast was clearly declining.  Both of them hinted at the possible need for rate hikes sooner than previously expected.

Yesterday, too, the release of the Fed’s Beige Book presented a clear picture of two issues: wages were rising rapidly, and growth was slowing.  The problem stems from the fact that despite wage increases of 20% or more, companies are still having a problem staffing up to desired levels and that has led to reduced output.  It has also led to business after business explaining that they would be raising prices to offset increased costs for not just wages, but raw materials and shipping.  In your Economics 101 textbook (likely Samuelson’s) this was the very definition of a wage-price spiral.

It is this recent hawkish turn by several Fed governors that brings even greater attention to Chairman Powell’s comments tomorrow.  The market is already assuming that tapering will begin next month, but the question remains, will the Fed be able to continue along that line if economic activity continues to slide?  I raise this issue because after Tuesday’s weaker than expected housing data, the Atlanta Fed’s GDPNow indicator has fallen to 0.533% for Q3.  And that’s an annual rate, down from Q2’s 6.8% GDP growth.  It appears the Fed may have a difficult decision to make in the near future; fight rapidly rising inflation or fight rapidly slowing growth. As I’ve written before, stagflation is a b*tch.

Adding to the economic problems is the continued slowing of growth in China where ongoing power shortages combined with a resurgence of Covid related shutdowns and the implosion of China Evergrande have resulted in the slowest, non-Covid, growth in decades.  At the same time, the PBOC continues to drain liquidity from the economy in an effort to reduce leverage which has the effect of further slowing activity there.  Given China has been the global growth engine for at least the past decade, a slowdown there means we are going to see slower activity everywhere else.  Alas, for the central banking community, it is not clear that will help price pressures abate, not as long as energy and raw material prices continue to rise.

Summing it all up shows that growth worldwide is falling from Q2’s peak while price pressures are flowing from commodities to shipping and now wages.  All this is occurring with interest rates broadly at their lowest levels in history. (I know some countries have raised rates a bit, but the reality is there is far less room to ease policy than tighten overall.)  Given this backdrop, it remains amazing to me that equity markets worldwide have been able to continue to perform well.  And yet, they continue to do so broadly, albeit not last night.  However, I believe that interest rate markets are beginning to recognize that the future may not be so rosy as we are seeing yields continue to climb and inflation breakevens rise to levels not seen in nearly a decade.  Remember, there is no perpetual motion machine and no free lunch.  Central banks have spent the entire post GFC period continually supporting markets while allowing significant imbalances to develop across all segments of the economy and, ironically, markets.  I have often said the Fed’s biggest problem will arrive when they announce a policy change and the market ignores the announcement.  I fear that time is growing much nearer.

With those cheery thoughts to support us, let’s take a look at the overnight session.  It seems that risk is having a bit of a struggle today with most of Asia (Nikkei -1.9%, Hang Seng -0.5%, Shanghai +0.2%) under pressure and Europe (DAX -0.1%, CAC -0.4%, FTSE 100 -0.6%), too, having difficulty this morning.  US futures are also pointing lower, -0.3% or so across the major ones, which implies pressure at the opening at the very least.  China continues to be a drag on the global markets as other Chinese real estate companies are starting to fall and the word is Evergrande’s sales have fallen 97%.  I guess buying from a bankrupt company is not that attractive a proposition.

In a bit of a surprise, European sovereign bond yields are rising this morning (Bunds +1.6bps, OATs +1.2bps, Gilts +3.7bps) as ordinarily one would expect a rush into safe havens when risk is on the run.  However, as the EU begins another summit, it is likely to simply highlight the ongoing problems across the continent, notably in energy, and that seems to be sapping confidence from investors.  Treasury yields are very marginally softer on the day, so far, but with more and more Fed members talking up inflation worries, I expect they are likely to continue to rise for a while yet.

Commodity markets are under pressure today as well with oil (WTI -0.8%) and NatGas (-1.7%) leading the way, but weakness, too, in copper (-2.9%), aluminum (-0.3%) and all the main agriculturals (soy -0.7%, wheat -0.7%, corn -0.5%).  By contrast, gold’s unchanged price is looking good!

As to the dollar, it is broadly, though not universally, stronger this morning.  In the G10, AUD (-0.3%) and NZD (-0.3%) lead the way down with the rest of the commodity bloc also suffering a bit.  On the plus side, JPY (+0.25%) is the only gainer, which given equity price action seems pretty standard.  In the emerging markets, TRY (-2.4%) is the outlier after the central bank cut interest rates by 2.0%, double the expected outcome, to 16.0%, despite inflation running at 19.6% in September.  You may recall that President Erdogan fired several central bankers last week as they were clearly not willing to do his bidding.  There is nothing promising about the lira these days.  Aside from that, the rest of the space is softer led by ZAR (-0.7%) on weaker commodity prices, and PLN (-0.4%) as investors’ concerns grow that the EU is going to try to punish Poland for its recent court ruling that said EU law does not reign supreme in Poland.  Other movers have been less significant but are spread across all three geographies.

On the data front, this morning brings the weekly Initial (exp 297K) and Continuing (2548K) Claims numbers as well as Philly Fed (25.0), Leading Indicators (+0.4%) and Existing Home Sales (6.09M).  Of this group, I expect the Philly number will give the most information, but in truth, I believe traders and investors are more interested in hearing from Chris Waller again as well as NY Fed president Williams this morning to try to get any more information about the evolving Fed story.

Broadly speaking, I believe the US interest rate story continues to underpin the dollar and I see nothing to change that view.  The dollar has been trending higher since summer and while the last week has seen marginal dollar softness, I believe it is merely a good time to take advantage and buy dollars for receivables hedgers.

Good luck and stay safe
Adf

Protests Are Growing

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In China the growth impulse waned
As policy makers have strained
To maintain control
While reaching the goal
Of growth that Xi has preordained

In other news protests are growing
By pundits that markets are showing
Too much in the way
Of rate hikes today
Since wags think inflation is slowing

Risk is getting battered this morning, but interestingly, so are many havens.  It seems that the combination of slowing growth and higher inflation is not all that positive for assets in general, at least not financial ones.  Who would have thunk it?

Our story starts in China where Q3 GDP was released at a slower than expected 4.9% down from 7.9% in Q2 and 18.3% in Q1.  If nothing else, the trend seems to be clear.  And, while Retail Sales there rose a more than expected 4.4%, IP (3.1%) and Fixed asset Investment (7.3%), the true drivers of the Chinese economy, both slumped sharply from last quarter and were well below estimates.  In other words, the Chinese economy is not growing as quickly as the punditry, and arguably, the market had expected.  This is made clear by the ongoing lackluster performance in Chinese equity markets which are also being accosted by President Xi’s ongoing transformation of the Chinese economy to one more of his liking.  (In this vein, the latest is the attack on the press such that all media must now be state-owned.  Clearly there is no 1st Amendment there.)  Of course, if the press is state-controlled, it is much easier for the government to prevent inconvenient stories about things like Evergrande from becoming widespread inside the country.  That being said, we know the Evergrande situation is under control because the PBOC told us so!

Ultimately, this matters to markets because China has been a significant growth engine for the global economy and if it is slowing more rapidly than expected, it doesn’t bode well for the rest of the world.  Apparently ongoing energy shortages in China continue to wreak havoc on manufacturing companies and hence supply chains around the world.  But don’t worry, factory gate inflation there is only running at 10.7%, so there seems little chance of inflationary pressures seeping into the rest of the world.  In the end, risk appetite is unlikely to increase substantially if the narrative turns to one of slower growth ahead, unable to support earnings expectations.

With this in mind, it is understandable why equity markets are under pressure this morning which has been true in almost every major market; Nikkei (-0.15%), Shanghai (-0.1%), DAX (-0.5%), CAC (-0.8%), FTSE 100 (-0.2%). US futures (-0.3%), with only the Hang Seng (+0.3%) bucking the trend.  Funnily enough, though, bond markets are also under universal pressure (Treasuries +4.4bps, Bunds +4.4bps, OATs +4.7bps, Gilts +6.7bps, Australia GBs +9.0bps, China +5.3bps, and the pièce de résistance, New Zealand +15.5bps) as it seems investors are beginning to fret more seriously over inflation and ensuing policy action by central bankers.

Yesterday, BOE Governor Andrew Bailey explained that the BOE will “have to act” to curb inflationary forces.  That is a pretty clear statement of intent and one based on the reality that inflation is well above their target and trending higher.  Interest rate markets quickly priced in rate hikes in the UK with the first expected next month and a second by February.  In fact, by next September, the market is now pricing in 4 rate hikes, expecting the base rate to be 1.00% vs. the current rate of 0.10%.  In New Zealand, meanwhile, CPI printed at 4.9% last night, well above the expected 4.2% and the market quickly adjusted its views on interest rates there as well, with a 0.375% increase now price for the late November meeting and expectations that in one year’s time, the OCR (overnight cash rate) will be up at 1.95% compared to today’s 0.50%.

Naturally, this price action doesn’t suit the central bank narrative and so there has been a concerted push back on the higher inflation story from many sectors.  My personal favorite is from the pundits who are focusing on the Fed staff economists with the claim that they are far more accurate than the Street and their current forecast of 2022 inflation of 1.7% should be the baseline.  But we have heard from others with vested interests in the low inflation narrative like Blackrock (who gets paid by the Fed to manage the purchases of assets) as well as a number of European central bankers (Villeroy and Vizco) who maintain that it is critical the ECB keep policy flexibility when PEPP ends.  This appears to be code for ignore the inflation and keep buying bonds.

The point of today’s story is that the carefully controlled narrative that has been fostered by the central banking community is under increasing pressure, if not falling apart completely.  Markets are pricing in rate hikes despite protests by central bankers, as they see rising inflation trends as becoming much more persistent than those central bankers would like you to believe.  At this point, no matter what inflation statistic you consider (CPI, PCE, trimmed-mean CPI, median CPI, sticky CPI) all are running well above the Fed’s 2.0% target and all are trending higher.  The same situation obtains in almost every major nation as the combination of 18 months of excessive money-printing and significant fiscal spending seems to have done the trick with respect to reviving both inflation and inflation expectations.  If I were the Fed, I’d be taking a victory lap as they have been fighting deflation for a decade.  Clearly, they have won!

So, if stocks and bonds are both falling, what is rising?  I’m sure you won’t be surprised that oil (+1.6%) is leading the way higher as demand continues to rise while supply doesn’t.  OPEC+ has refused to increase production any further and the US production situation remains under pressure from Biden administration policies.  While NatGas in the US is softer (-1.8%), in Europe, it is much firmer again (+16.2%) as Russia continues to restrict supply.  Precious metals remain unloved (Au -0.2%, Ag -0.2%) but industrial metals are firm (Cu +0.9%, Al +0.45%, Sn +1.2%) along with the agriculturals.

Finally, the dollar is definitely in demand rising against 9 of its G10 brethren (only NOK has managed to hold its own on the back of oil’s rally) but with the rest of the bunch falling between 0.1% and 0.5% on general dollar strength. After all, if neither NZD (-0.1%) nor GBP (-0.15%) can rally after interest rate markets have jumped like they have, what chance to other currencies have today?

EMG currencies are also under pressure this morning led by ZAR (-1.0%) and followed by MXN (-0.6%) with both falling despite rising oil and commodity prices.  Both seem to be suffering from a general malaise regarding EMG currencies as concerns grow that rising inflationary pressures are going to slow growth domestically, thus pressuring their central banks to maintain easier policy than necessary to fight rising inflation.  Stagflation is a b*tch.

Turning to the data front, this week sees much less of interest with housing being the focus:

Today IP 0.2%
Capacity Utilization 76.5%
Tuesday Housing Starts 1615K
Building Permits 16680K
Wednesday Fed Beige Book
Thursday Initial Claims 300K
Continuing Claims 2550K
Philly Fed 25.0
Leading Indicators 0.4%
Existing Home Sales 6.08M

Source: Bloomberg

On the Fed front, 10 more speakers are on the docket across a dozen different venues including Chairman Powell on Friday morning.  At this point, with inflation rising more rapidly than expected everywhere in the world and the market pricing in rate hikes far more aggressively than central banks deem appropriate, the case can be made that the central banks have lost control of the narrative.  I expect this week’s onslaught of commentary to try very hard to regain the upper hand.  However, as I have long maintained, at some point the Fed will speak and act and the market will not care.  We could well be approaching that point.  In that event, the only thing that seems certain is that volatility will rise.

As to the dollar today, I think we need to see some confirmation that this modest corrective decline is over, but for now, the medium-term trend remains for a higher dollar.  I see nothing to change that view yet.

Good luck and stay safe
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