Clearly Annoyed

In China they say speculation
And hoarding is now the causation
Of quite an ordeal
As copper and steel
See prices rise bringing inflation

(Or, the second variation on this theme)

The Chinese are clearly annoyed
That price signals have been destroyed
So, meetings were called
And price rises stalled
As punishment threats were employed

Markets are mixed this morning after a relatively quiet weekend, at least in the more mainstream markets.  Cryptocurrencies, on the other hand, continue to prove they are nothing more than speculative assets with Bitcoin declining 20% before rebounding 16% in the past 36 hours.  The proximate cause of that movement was a comment from the Chinese about cracking down on bitcoin mining, again.  Whether or not this particular initiative succeeds, the one thing that is abundantly clear when it comes to the cryptocurrency space is that more and more governments are lining up against them.  Do not underestimate government interest in regulating the crypto space out of existence, or at the very least to significantly marginalize it, as no government can tolerate a competitor for their incredibly lucrative monopoly of creating money.

Speaking of tolerance, the Chinese have also, this weekend, explained that they have “zero tolerance” for certain activities in the commodity markets like hoarding, speculating or disseminating misinformation. At a hastily called meeting of the heads of top metals producers, those words were used along with the explicit threat of severe punishment for violation of not only the letter, but the spirit, of the law.  Remember, China executed the former head of Huarong, a financial firm, for similar types of issues, so the notion of severe punishment must certainly be taken seriously.  It can be no surprise that metals prices fell in the Chinese session, with steel, iron ore, aluminum, zinc and tin all lower, although copper has maintained some of its recent gains.

From a market’s perspective, these were the only remotely noteworthy stories of the weekend.  While the inflation/deflation debate continues to rage, and rightly so given its importance, and speculation over potential central bank policy changes remains rife, as of now, we have no new information on either of these stories and so it will remain entirely opinion, not fact.  Of course, Friday we get the latest release of core PCE, which will certainly be above the 2.0% Fed target, and will certainly generate much tongue-wagging, but will have virtually no impact on the Fed.

A tour of markets this morning shows that movements have been modest and there is no direction or theme in any of them.  Asian equity markets were mixed (Nikkei +0.2%, Hang Seng -0.2%, Shanghai +0.3%) and movements were limited.  Europe has seen a bit more positivity, but only a bit (DAX +0.4%, CAC +0.1%, FTSE 100 +0.2%), hardly the stuff of dreams.  Finally, US futures are the market putting in the best performance, with gains between 0.4% and 0.6% two plus hours ahead of the opening.

Bond markets are showing even less movement than stocks at this hour with Treasury yields lower by 0.5bps while Bunds and OATs are essentially unchanged.  Gilts are the big mover, with the yields declining by 1.1 basis points.  Even peripheral nation yields are essentially unchanged.

On the back of the Chinese comments, commodity prices are mostly lower although oil will have none of it, rising 1.7% this morning.  However, while Cu is unchanged, Fe (-3.9%), Ni (-2.1%) and Zn (-1.1%) have all taken the Chinese to heart.  Precious metals are little changed although ags are a bit softer.

Finally, the dollar can only be described as mixed this morning, with an equal number of gainers and losers in both the G10 and EMG blocs.  And the thing is, those moves have been desultory, at best, with NOK (+0.25%) the leading gainer on the back of oil’s gains, while GBP (-0.15%) is the laggard, on position adjustments.  EMG currencies are seeing similar types of modest movements with nary a story to highlight.

Data this week is also pretty sparse although that core PCE number on Friday will be closely watched.

Tuesday Case Shiller Home Prices +12.55%
New Home Sales 950K
Consumer Confidence 118.9
Thursday Initial Claims 425K
Continuing Claims 3.68M
Durable Goods 0.8%
-ex transport 0.7%
Q1 GDP 6.5%
Friday Personal Income -14.8%
Personal Spending 0.5%
Core PCE 0.6% (2.9% Y/Y)
Chicago PMI 69.0
Michigan Confidence 83.0

Source: Bloomberg

There are several Fed speakers, but we already know what they are going to say, inflation is temporary, I’m sorry, transitory, and they have a significant way to go to achieve their goals.

At this time, given the central banks have all proclaimed themselves data dependent, until we get data that indicates a change in the situation, there is no reason to believe that markets will do more than chop back and forth.  There is, as yet, no clarity in the inflation debate, nor will there be for a number of months to come.  So, for now, the dollar seems likely to continue to chop around until we see a break in interest rates in one direction or the other.  That said, if the inflationist camp is correct, then the first move should be for dollar strength alongside the higher interest rates that will ensue.

Good luck and stay safe
Adf

Waiting for Jay

Investors are waiting for Jay
Their fears, about rates, to allay
They want it made clear
That rates will be here
From now ‘til we reach judgement day

From the market’s perspective, the world has essentially stopped spinning, at least until we finally hear the words of wisdom due from Chairman Powell beginning at 9:10 this morning.  Trading volumes across products are currently running at 50%-70% of recent average activity, highlighting just how little is ongoing.  And remember, too, as it is the last week of August, summer holidays are in full swing with most trading desks, on both the buy and sell sides, more lightly staffed than usual.  In other words, liquidity is clearly impaired right now, although by 10:00 this morning I expect that things will be back closer to normal.

As discussed yesterday, the working assumption of most analysts and investors is that Jay is going to explain the benefits of targeting average inflation over time.  The implication being that the Fed’s new policy framework, when officially announced later this year, is going to include that as a KPI.  Of course, the big question about this policy is the average over exactly which period.

Consider, it has been 102 months since then-Chairman Bernanke established the target for core PCE at 2.0%.  During that time, core PCE has been between 1.9% and 2.1% just 12 times with 89 of the other 90 readings below 1.9% and a single print above 2.1%, which happens to have been the first print after the announcement.  Meanwhile, this past April’s reading of 0.931% is the lowest reading.  The average of the two extremes is 1.53%.  Is the Fed going to be happy if core PCE jumps to 2.47% and stays there for a while?  The average of all periods since January 2012 is 1.633%, does that mean we can expect the Fed to target 2.367% core PCE readings for the next eight plus years? The point is, without some specificity on what average inflation means, it is very difficult to understand how to incorporate the idea into investment and trading decisions.

But what if Chairman Powell does not bring clarity to the discussion, merely saying that average inflation over time seems like a good future benchmark.  How might different markets react to such a lack of specificity?

Starting with equity markets, certainly those in the US will rally because…well that’s all they do these days.  Good news, bad news, no news, none of that matters.  The rationale will be stocks are a good inflation hedge if inflation goes higher (they’re not) or stocks will benefit from ongoing low interest rates if inflation remains below target.  Parabolic markets are frightening, but there is no indication that Powell’s comments are going to change that situation.  We need a different catalyst here.

Now let’s look at the bond market and what might happen there.  Specificity on how much higher the Fed is going to target inflation is going to be a pretty distinct negative.  If you own 10-year Treasuries that are yielding 0.68% (today -1bp), and the Fed explains that they are going to push inflation above 2.0%, there is going to be a pretty spectacular decline in the price of your bond should they achieve their goal.  Will investors be willing to hold paper through that type of decline?  It would not be a surprise to see a pretty sharp sell-off in Treasuries on that type of news.  Remember, too, that Treasury yields have backed up nearly 20 basis points in the past three weeks, perhaps in anticipation of today’s comments.  If Powell delivers, there is likely far more room to run.  If he doesn’t, and there is no clarity, bond investors will be back to reading the economic tea leaves, which continues to be remarkably difficult at this time.

How about the gold market?  Well, here I think the case is quite straight forward.  Clarity as to the Fed’s efforts to drive inflation higher will result in anticipation of lower real yields, and that will be an unalloyed benefit (pun intended).  A lack of clarity and gold will likely continue to consolidate its recent gains.

And finally, what about the dollar?  How will it respond to the Chairman’s speech?  Consider that despite the dollar’s recent rebound, short dollar positions remain at near record levels against both the euro and the DXY futures.  The market scuttlebutt is that the hedge fund community, which was instrumental in the dollar’s recent modest strength as they pared short dollar positions, is ready and raring to buy euros on the idea that higher US inflation will lead to a weaker dollar à la economic theory.  Certainly, if Treasuries sell off, the dollar will see some downward pressure, but one of the things that does not get as much press in the FX market is the equity market impact.  Namely, as long as US equity indices continue to set records, international investors are going to continue to buy them, which will underpin the dollar.

But what if the speech is a dud?  If there is no clarity forthcoming, then the dollar story will revert to its recent past. The bear case continues to be that the Fed’s largesse will dwarf all other nations’ policy easing and so the dollar should resume its decline.  The bull case is that the US economy, at least by recent data, appears to continue to be outperforming its major counterparts, and thus inward investment flows will continue.  That current account deficit is only a problem if international investors don’t want to fund it, and with US equity markets amongst the best performing asset classes globally, that funding is easy to find.  I know I’m not a technician, but recent price action certainly appears to have created a top at the highs from last week, and a further pullback toward 1.1650 seems quite viable.

It is difficult to draw many conclusions from today’s market activity, which is why I have largely ignored it.  Equity markets are leaning a bit lower, although the movement is not large, less than 1%, and the dollar is mixed against both the G10 and EMG blocs.

Arguably, the biggest market risk is that Powell doesn’t tip his hand at all, and that we are no wiser at 10:10 than we are now.  If that is the case, I think the dollar’s consolidation will continue, and by the end of the day, I imagine stock prices will have recouped their early losses.

But for today, it is all about Jay.

Good luck and stay safe
Adf