Tag Archives: #ECB

With Conceit

Posted on by

On Friday, two final Fed speakers
Explained they are both simply seekers
Of lower inflation
Hence, justification
That they’re simply policy tweakers
 
We now have nine days til they meet
When both bulls and bears will compete
To offer their vision
While casting derision
On each other’s views with conceit
 
It appears to be a slow day to start what has the potential for quite an interesting week.  While the Fed is in their quiet period, we have central bank meetings in Japan, the Eurozone, Norway and Canada as well as the first look at Q4 GDP and the all-important December PCE data.  As I said, while it is slow today, there is much to anticipate.

But first let’s finish up last week, where the equity rally continued unabated despite continued pushback from Fed speakers.  Notably, SF’s Mary Daly, who is usually a reliable dove, was very clear that it is too soon to consider cutting interest rates.  Her exact words, “We need to see more evidence that it is heading back down to 2% consistently and sustainably for me to feel confident enough to start adjusting the policy rate,” seem pretty clear that she is not ready for a cut yet.  Meanwhile, Chicago’s Austan Goolsbee was similarly confident that it is premature to consider cutting rates any time soon.  

Arguably, of more importance is the fact that the Fed funds futures market is now pricing in slightly less than a 50% probability of a rate cut in March and about 5 rate cuts this year, rather than the 6 to 7 cuts that were in the price ten days ago.  So, we heard a great deal of jawboning to remove just one rate cut from the market perception.  For the life of me, I cannot look at the recent CPI data as well as the situation in the Red Sea and the Panama Canal, where though caused by different situations, show similar outcomes in forcing a significant amount of shipping volumes to change their route to a longer, more costly one and see lower inflation in our future.  I understand that there was a disinflationary impulse, but to my eye that has ended.

Now, it is entirely possible that we see the rate of inflation decline on the back of a recession, but that is not the market narrative at this point.  Rather, the market appears to be priced for the perfection of a soft landing, where the Fed will be able to tweak rates lower while inflation continues to soften, and unemployment remains low.  Alas, I still see that as a pipe dream.  As I have written in the past, it seems far more likely that we see either one rate cut as the economy continues to perform and inflation remains stubborn or 10 or more amidst a sharp slowdown in economic activity and rising unemployment, but five doesn’t seem correct to me.

In the meantime, today is a waiting game for all the things yet to appear this week.  Looking at the overnight activity, we continue to see the dichotomy between China and Japan with the former seeing its equity markets continue to crater (CSI 300 -1.6%, Hang Seng -2.3%) while the latter has made yet another new 34 year high (Nikkei +1.6%).  Last night, the PBOC left their key Loan Prime Rates unchanged, as expected, but still a disappointment to a market that is desperate for some stimulus from the government there.  So far, all the activity has been directly in the financial markets where the Chinese have banned short-selling and “advised” domestic institutions to stop selling any equities, and yet the markets there continue to underperform.  Perhaps President Xi will decide that common prosperity requires fiscal stimulus of a significant nature, but that has not yet been the case.  Both the Hang Seng and mainland markets have fallen precipitously, but there is no obvious end game yet.  Meanwhile, European bourses are all in the green, on the order of 0.5% while US futures are higher by a similar amount at this hour (7:45).

Bond markets are having a better day around the world today with yields falling everywhere.  Treasury yields are the laggard, only down by 3bps, while European sovereigns have fallen 5bps and even JGB’s fell 1 bp overnight.  Perhaps it is the sterner talk by central bankers regarding rate cuts (ECB speakers have also pushed back hard on the idea that rate cuts are coming in March, with the June meeting the favorite now), which has investors becoming more comfortable that inflation will continue its recent declines.  As there has been exactly zero data released today, that is the most rational explanation I can find.

In the commodity markets, quiet is the word here as well with oil (+0.35%) edging higher, thus holding onto last week’s gains, while metals markets are mixed.  Gold is unchanged on the day; copper is modestly softer, and aluminum is modestly firmer.  As has been the case for the past several weeks, there is not much information to be gleaned from these markets right now.  I expect that over time, we will see commodity prices trade higher as the decade long lack of investment in the sector plays out, but in the short-term, there is little on which to see regarding price trends, absent a major uptick in the Middle East dynamics.  After all, even avoiding the Red Sea hasn’t had much impact.

Lastly, the dollar is mixed overall.  Against its G10 counterparts, JPY, GBP and NZD all have edged higher by about 0.2%, but we are seeing similar weakness in NOK and AUD.  In the EMG bloc, we actually see a few more laggards than leaders with ZAR (-0.8%), HUF (-0.5%), and KRW (-0.4%) all suffering a bit on the session while CLP (+0.5%) is the leading light in the other direction.  Ultimately, the big picture here remains the dollar is tied to the yield story and if the Fed really does maintain higher for longer, the dollar will find support.

As mentioned above, there is a lot of data to digest this week as follows:

TuesdayBOJ Rate Decision-0.1% (unchanged)
WednesdayFlash Manufacturing PMI48.0
 Flash Services PMI51.0
 Bank of Canada Rate Decision5.0% (Unchanged)
ThursdayNorgesbank Rate Decision4.5% (Unchanged)
 ECB Rate Decision4.0% (Unchanged)
 Durable Goods1.1%
 Q4 GDP2.0%
 Chicago Fed National Activity0.03
 Initial Claims200K
 Continuing Claims1828K
FridayPersonal Income0.3%
 Personal Spending0.4%
 PCE0.2% (2.6% Y/Y)
 Core PCE0.2% (3.0% Y/Y)

Source: tradingeconomics.com

So, the end of the week is when we get inundated, although the Eurozone Flash PMI data comes on Wednesday as well.  But without a major data miss, all eyes and ears will be on the central banks right up until we see Friday’s PCE data.  Regarding that, there is a growing expectation that the core number will be quite soft, with many pundits calling for an annual number below 3.0% on the core reading.  However, given what we have seen from inflation readings everywhere, including the slightly hotter than forecast CPI numbers, I would fade that view.

The one thing of which I am confident is that if the Core PCE print is soft, you can expect the futures markets to price 6 or 7 cuts into this year and more cuts everywhere with the concomitant rise in both stock and commodity prices, especially given the Fed’s inability to push back immediately.  However, my view is that the world of today is not the world of the past 15 years, and that higher inflation and higher interest rates are an integral part of the future.  As well, unless there is a financial crisis of some sort, where more banks are under pressure like last March, I remain in the very few rate-cuts camp and think the equity rally has an expiry date before the summer.  As to the dollar, I think it holds up well in that circumstance.  While I changed my view based on the Powell pivot at the December FOMC meeting, the data has not backed him up, at least not yet.

Good luck

Adf

Sufficiently

Posted on by 
Said Madame Lagarde, I don’t care

‘Bout dovishness seen over there

Though I’m not omniscient

We need rates sufficient-

Ly high til inflation is rare



The Old Lady’s governor, too

Expressed that no cuts were in view

But can both withstand

More slowing than planned

And, with their tough talk, follow through?

A little housekeeping to start this morning.  Today will be the last poetry until January 2nd when I will publish my ‘crystal ball’ viewings in a long-form poem.  For all my readers, thank you for reading and have a wonderful Christmas, Hannukah (I know it’s’ over), Kwanzaa, Festivus or whichever holiday is important as well as let’s hope 2024 is a fantastic new year.

So, let us review yesterday’s activity, and then, more broadly, the state of things as we come to the end of the year.

Arguably, the biggest news yesterday was not that the ECB left rates on hold, which was universally expected, but that Madame Lagarde tried very hard to continue to sound hawkish despite the Fed’s turn on Wednesday.  “Based on its current assessment, the Governing Council considers that the key ECB interest rates are at levels that, maintained for a sufficiently long duration, will make a substantial contribution to this goal. The Governing Council’s future decisions will ensure that its policy rates will be set at sufficiently restrictive levels for as long as necessary.” [emphasis added.]

As well, she explicitly mentioned that there was no discussion of interest rate cuts in the meeting.  The hawks on the committee managed to get a bone thrown their way with the announcement of a phased exit from the PEPP program starting in the second half of next year.  At the same time, their staff projections for GDP growth and inflation were all reduced slightly for 2024 and 2025 with low numbers penciled in for 2026.  She maintained that inflation has been “too high for too long”, clearly true, and has been unwilling to consider anything but their inflation fight.

Alas, this morning’s Flash PMI data releases make ugly reading with French, German and the Eurozone overall reading weaker than last month and weaker than expected.  The Eurozone growth engine has been stalling for quite a while despite falling energy costs.  And now, in the wake of the Fed turning dovish, energy costs are rebounding which will almost certainly negatively impact the continent’s growth trajectory.  Maybe Lagarde can hold out for another month, but I suspect if the data continues to erode in the manner, it has recently, the ECB will recognize that the worst is over and it’s time to alter policy, just like the Fed has done. As well, given the economy in Europe is in far worse shape than here in the US, I expect that they will be cutting more quickly as 2024 progresses.  That will not help the euro, but that is a story for some time next year, not for the remainder of this one.

At almost the same time, the BOE also maintained their policy rate and also indicated that they were not anywhere near ready to cut rates.  In fact, 3 voters wanted a 25bp rate hike, which given inflation in the UK is the highest in the western world, with core still at 5.7%, makes sense.  But, as on the continent, economic activity continues to stumble along, with manufacturing, according to this morning’s Flash PMI reading of 46.4 in recession although Services activity, 52.7 does seem to be rebounding.  However, here, too, I believe the gravitational pull of a dovish Fed is going to quickly weigh on the BOE and we are going to see a pivot in the first half of next year amid weaker growth and slowing inflation.

One final note from yesterday was that Retail Sales were a bit stronger than expected, rising 0.3% and failing to show the slowdown that would be expected to help reduce inflationary pressures.  And just think, that was before the Fed pivot, which has ignited a massive risk-on rally in assets and likely will juice things even more in the short-term.

The result of these policy decisions is that stocks are rallying pretty much everywhere in the world, bonds are rallying pretty much everywhere in the world, commodities prices are rallying, and the dollar is falling.  Not only that, I see nothing that is likely to change those views until somewhere toward the end of Q1 2024 at the earliest.

But let’s step back for a moment and consider the medium-term impacts of all this change.  Remember this, a soft-landing is merely the last stop in the cycle before a hard landing.  The soft-landing narrative is clearly the majority view and driving force in markets as 2023 comes to a close.  But is that a realistic outcome?  

I think a very strong case can be made that we have seen the bulk of the disinflationary forces that are coming as the combination of Covid driven supply chain issues being fixed and higher interest rates / QT has weighed on marginal demand.  It has been a fun story while it lasted and has certainly cheered markets.

But structural issues remain, many of which are outside any central bank’s abilities to address adequately.  Consider what I believe is the biggest structural change, the turn from capital-focused economic policies to labor focused economic policies.  This is inherently inflationary and regardless of what Powell or Lagarde or Ueda or anyone in that chair does, this change is going to continue.  It is a political change, and one that is only getting started.  Politically, we call it populism, and one need only read the papers to recognize this is the new world.

For 40 years, since the Reagan/Thatcher leadership, the world has seen low inflation from a combination of demographics and globalization creating downward pressure on wages and reduced taxation increasing the return on capital.  This led to the financialization of western, especially the US, economies and expanded the wealth/income gaps that are prevalent around the world today.  

But this is changing, and changing far more rapidly than the current governments in power would like to see or believe.  As I wrote earlier, 2016 was a test run for what is looming in 2024.  Consider the populist views of recent election outcomes in Argentina and the Netherlands as well as the rise in the polls of the National Front in France, AfD in Germany, and the strength of both Trump and RFK Jr in the US, with populism as the driving force.  2023 saw more labor unrest in the US than any time in the past 20 years and harkens back to conditions in the 60’s and 70’s.  The big difference between now and then is that union membership has declined so dramatically in the interim.  Do not be surprised to see unions rise again in popularity.

But populism drives more than labor unrest, and ultimately rising wages, it also encourages governments to consider trade barriers and tariffs, both of which drive consumer prices higher.  And populism is very easy for governments to adopt because it sounds so good.  Consider the key tenets; buy domestic goods, limit immigration and tax the rich so they pay their fair share.  We will hear some version of these policies in every country around the world in 2024, and not just western nations, but communist bloc countries as well.  

If this is the future, and I believe it is, then the current risk rally is merely a hiatus before things turn much worse.  In a populist driven society, profit margins are going to decline, and capital will flee to where it feels safest.  That may be whichever nations push back against this trend, although they will be few and far between, and things like real assets, commodities, and real estate.  While I believe this will be the general trend, from an FX perspective, given everything is relative there, strength or weakness will depend on the relative decisions made in each nation.  Arguably, the less populist the decision outcomes, the stronger the currency, but ex ante, there is no way to know how that will turn out.  If I had to bet now, I would suggest that the nation least susceptible to this wave is Japan, a truly homogenous society, and that bodes well for the yen going forward.

In the meantime, as I head off, here are today’s data points with Empire State Manufacturing just released at a much worse than expected -14.5.  We are due to see IP (exp 0.3%), Capacity Utilization (79.1%), and the Flash PMI’s (Mfg 49.3, Services 50.6).  Through the rest of the month, the most important data point will be the PCE data on the 22nd, but arguably, Powell already told us it is not going to be hot, that’s why he turned away from higher for longer.

Today is triple witching in the equity markets, with stock options, future options and futures all expiring, so volume should be high and movement can be surprising.  But the trend right now is positive for risk assets, and I believe that will continue through the holidays and into January.

Good luck, good weekend and have a wonderful holiday

Adf

Miles Off Base

Posted on by 
This poet was miles off base

As Powell, more growth, wants to chase

So, hawks have been shot

With nary a thought

While doves snap all stocks up apace.



It seems clear that Jay and the Fed

Decided inflation is dead

Through Q1 at least

Bulls will have a feast

Though after, take care where you tread

It turns out that not only were my tail risk ideas wrong, I was on the wrong side of the distribution!  Powell has decided that the soft-landing narrative is the best estimator of the future and wants to make sure the Fed is not responsible for a recession.  Concerns over inflation, while weakly voiced, have clearly dissipated within the Eccles Building.  I hope they are right.  I fear they are not.

In fairness, once again, yesterday I heard a very convincing argument that inflation was not only going to decline back to the Fed’s target of 2.0%, but it would have a 1 handle or lower by the middle of 2024 based on the weakening credit impulse that we have seen over the past 18 months.  And maybe it will.  But, while there is no question that money supply has been shrinking slowly of late, which has been a key part of that weakening credit impulse story, as can be seen from the chart below based on FRED data from the St Louis Fed, compared to the pace of M2 growth for decades, there are still an extra $3 trillion or so floating around the economy.  Iit seems to me prices will have a hard time falling with that much extra cash around.

Of course, there is one other place that money may find a home, and that is in financial assets.  So, perhaps the outcome will be a repeat of the post-GFC economy, with lackluster growth, and lots of money chasing financial assets while investors lever up to increase returns.  My guess is that almost every finance official in the world would take that situation in a heartbeat, slow growth, low inflation and rising asset prices.  The problem is that series of events cannot last forever.  As is usually the case with any negative outcome, the worst problems come from the leverage, not the idea.  When things are moving in one’s favor, leverage is fantastic.  But when they reverse, not so much.

A little data is in order here.  According to Statista, current global GDP is ~$103 trillion in current USD, current global stock market capitalization is ~$108 trillion, and the total amount of current global debt is ~$307 trillion according to the WEF.  In a broad view, the current debt/equity ratio is about 3:1 and the current debt/sales ratio is the same.  While this is not a perfect analogy, usually a debt/equity ratio of 3.0 is considered pretty high and a company that runs that level of debt would be considered quite risky.  Now, ask yourself this, if economic activity only generates $108 trillion, how will that >$300 trillion of debt ever be repaid?  The most likely answer is, it never will be repaid, at least not on a real basis.

If you wonder why central bankers favor lower interest rates, this is the primary reason.  However, at some point, there is going to be more discrimination between to whom lenders are willing to lend and who will be left out because they are either too risky, or the interest rate demanded will be too high to tolerate.  When considering these facts, it becomes much easier to understand the central bank desire to get back to the post-GFC world, doesn’t it?  And so, I would contend that Chairman Powell has just forfeited his efforts to be St Jerome, inflation slayer. 

The implication of this policy shift, and I would definitely call this a policy shift, is that the near future seems likely to see higher equity prices, higher commodity prices, higher inflation, first higher, then lower bond prices and a weaker dollar.  The one thing that can prevent the inflation outcome would be a significant uptick in productivity.  While last quarter we did see a terrific number there, +5.2%, the long-term average productivity growth, since 1948 is 2.1%.  Since the GFC, that number has fallen to 1.5%.  We will need to see a lot more productivity growth to keep goldilocks alive.  I hope AI is everything the hype claims!

Today, Madame Christine Lagarde

And friends are all partying hard

Now that Jay’s explained

Inflation’s restrained

And rate cuts are in the vanguard



This means that the ECB can

Lay out a new rate cutting plan

The doves are in flight

Which ought to ignite

A rally from Stuttgart to Cannes

Let’s turn to the ECB and BOE, as they are this morning’s big news, although, are they really big news anymore?  Both these central banks have been wrestling with the same thing as the Fed, inflation running far higher than target, although they have had the additional problem of a much weaker economic growth backdrop.  As long as the Fed was tightening policy, they knew that they could do so as well without having an excessively negative impact on their respective economies.  But given that pretty much all of Europe is already in recession, and the UK is on the verge, their preference would be to cut rates as soon as possible.  

But yesterday changed everything.  Powell’s bet on goldilocks has already been felt across European markets, with rallies in both equity and bond markets in every country.  The door is clearly wide open for Lagarde and Bailey to both be far more dovish than was anticipated before the FOMC meeting.  And you can be sure that both will be so.  While there will be no rate cuts in either London or Frankfurt today, they will be coming soon, likely early next year.  

At this point, the real question is which central bank will be cutting rates faster and further, not if they will be cutting them at all.  My money is on the ECB as there is a much larger contingent of doves there and the fact that Germany and northern European nations are already in recession means that the hawks there will be more inclined to go along for the ride.  Regardless, given the Fed has now reset the central bank tone to; policy ease is ok, look for it to happen everywhere.

Right now, this is all that matters.  Yesterday’s PPI data was soft, just adding fuel to the fire.  Inflation data that was released this morning in Sweden and Spain saw softer numbers and while Retail Sales (exp -0.1%, ex autos -0.1%) are due this morning along with initial Claims (220K), none of this is going to have a market impact unless it helps stoke the fire.  Any contra news will be ignored.

Before closing, there are two things I would note that are outliers here.  First, Japanese equity markets bucked the rally trend, with the Nikkei sliding -0.7% and the TOPIX even more (-1.4%) as they could not overcome the > 2% decline in USDJPY yesterday and the further 1% move overnight.  That very strong yen is clearly going to weigh on Japanese corporate profitability.  The other thing is that there is one country that is not all-in on the end of inflation, Norway.  This morning, in the wake of the Fed’s reversing course, the Norges Bank raisedrates by 25bps in a total surprise to the markets.  This has pushed the krone higher by a further 2.3% this morning and nearly 4% since the FOMC meeting.  

As we head toward the Christmas holidays and the beginning of a new year, it seems like the early going will be quite positive for risk assets and quite negative for the dollar.  Keep that in mind as you consider your hedging activities for 2024.

Good luck

adf

The Doves Will Be Shot

Posted on by 





Inflation was just a touch hot

And certainly more than Jay sought

So, later today

What will the Fed say?

My sense is the doves will be shot



Instead, as Jay’s made manifest

Inflation is quite a tough test

So, higher for longer

Or language much stronger

Is like what he’ll say when he’s pressed






Let’s think a little outside of the box this morning, at least from the perspective of virtually every pundit and their beliefs about what will happen at the FOMC meeting today.  At this point, most of the punditry seems to believe that Powell cannot be very much more hawkish, especially since the market is expecting comments like inflation is still too high and the Fed will achieve their goal.  So, there is a growing camp that thinks any surprise can only be dovish, since if he doesn’t push back hard enough or talk about loosening financial conditions being a concern, the equity market response will be BUY STONKS!!!





But what if, the thing Powell really wants, or perhaps more accurately needs, is not a soft landing, but a full-blown recession!  Think about it.  As I have written repeatedly, the idea that the Fed will cut rates by 125bps next year because growth is at 1.5% or 2.0% and inflation has slipped to 2.5% seems like quite an overreaction.  But given the current US debt situation ($34 trillion and counting) and the fact that the cost of carrying that debt is rising all the time, what would get the Fed to really cut rates?  And the only thing that can do it is a full-blown, multiple quarters of negative GDP growth, rising Unemployment Rate, recession.  If come February or March, we start seeing negative NFP numbers, and further layoff announcements as well as declining Retail Sales and production data, that would get the Fed to act. 





At least initially, we would likely see inflation slide as well, and with that trend plus definitive weakness in the economy, it would open the door for some real interest rate cuts, 400bps in 100bp increments if necessary. Now, wouldn’t that take a huge amount of pressure off Treasury with respect to their refi costs?  And wouldn’t that encourage accounts all over the world to buy Treasuries so there would be no supply issues?  All I’m saying is that we cannot rule out that Powell’s master plan to cut rates is to drive the economy into a ditch as quickly as possible so he can get to it.  In fact, it would open the door to restart QE as well.





This is not to say that this is what is going to happen, just that it is not impossible, and I would contend is not on anyone’s bingo card.  Now, Powell will never say this out loud, but it doesn’t mean it is not the driving force of his actions.  Powell is incredibly concerned with his legacy, and he has made abundantly clear that he will not allow his legacy to be the second coming of Arthur Burns.  Instead, he has his sights on the second coming of Paul Volcker, the man who killed the 1970s inflation dragon.  St Jerome Powell, inflation slayer, is what he wants as his epitaph.  And causing a recession to kill inflation and then cut rates is a very clever, non-consensus solution.





How will we be able to tell if I’m completely nuts or if there is a hint of truth to this?  It will all depend on just how hard he pushes back on the current narrative.  Yesterday’s CPI results could best be described as ‘sticky’, not rebounding but certainly not declining further.  Shelter costs continue apace at nearly 6% Y/Y and have done so for more than 2 years.  I was amused this morning by a chart on Twitter (I refuse to call it X) that showed CPI less shelter rose at just 1.4% with the implication that the Fed needs to start cutting rates right away.  The problem with that mindset is that shelter is something we all pay, and there is scant evidence that housing markets are collapsing.  In fact, according to the Case Shiller index, they are rising again.  I would contend that there is plenty of evidence to which Powell can point that makes his case for an economy that is still running far too hot to allow inflation to slide back to their target.  And that’s what I expect to hear this afternoon.





Speaking of recession, let us consider the situation in China, where despite the CCP’s annual work conference just concluding with some talk of building a “modern industrial system” the number one goal this year, thus boosting domestic demand, they announced exactly zero stimulus measures to help the process.  Data from China overnight showed that their monthly financing numbers were all quite disappointing compared to expectations and the upshot was a further decline in Chinese and Hong Kong equity markets.  This ongoing economic weakness and the lack of Xi’s ability or willingness to address it continues to speak to my thesis that commodity prices will remain on the back foot.  If you combine the high interest rate structure in the G10 with a weaker Chinese economy, the direction of travel for energy and base metals is likely to be lower.  The one exception here is Uranium, where there is an absolute shortage of available stocks and a renewed commitment around the world to build more nuclear power plants.





At the same time, Europe remains pretty sick as well, with Germany leading the entire continent into recession, and likely dragging the UK with it.  Germany, France, Norway, the UK and others are all sliding into negative growth outcomes.  While Chairman Powell will continue to push back on the idea of rate cuts soon, I expect that tomorrow, when both the ECB and BOE meet, they will open the door to rate cuts early next year.  Inflation in both places has been falling sharply and there is no evidence that Madame Lagarde or Governor Bailey is seeking to be the next Paul Volcker.  Both will blink with the result that both the euro and the pound should feel pressure.





Summing it all up, today I think we get maximum hawkishness from the Fed with Powell pushing back hard on the market pricing.  Initially, at least, I expect we could see yields rise a bit and stocks sell off while the dollar continues its overnight rise.  But I also know that there are far too many people invested in the idea that the Fed must cut soon, and they will be back shortly, buying that dip until they are definitively proven wrong.  





As to the rest of the overnight session, aside from China’s weak performance, South Korea also lagged, but the rest of the APAC region saw modest gains.  Europe, meanwhile, is all green, although it is a very pale green with gains on the order of 0.2%, so no great shakes.  Finally, US futures are firmer by 0.1% at this hour (7:15) after yesterday’s decent gains.





Bond yields are sliding this morning, down 2bps in the US and falling further in Europe with declines of between -3bps and -6bps on the continent as investors and traders there start to price in a more aggressive downward path for interest rates by the ECB.  UK yields are really soft, -9bps, after GDP data this morning was disappointing across the board, especially the manufacturing data.





Oil prices (+0.45%) which got slaughtered yesterday, falling nearly 4%, are stabilizing this morning, as are gold prices, which fell yesterday, but not quite as much as oil.  However, the base metals complex continues to feel the pressure of weak Chinese demand.  I continue to believe that there are structural supply issues, but right now, the macro view of weak economic activity is the main driver, and it is driving prices lower.





Finally, the dollar is firmer this morning as weakness elsewhere in the world leaves fewer choices for where to park funds.  While the movement has not been overly large, it is quite uniform across both G10 and EMG currencies.  The laggards have been NZD (-0.6%) after a softer than expected CPI reading and ZAR (-0.6%) on the back of weakening metals prices.  If I am correct about the path going forward, the dollar should perform well right up until the Fed responds to much weaker economic activity and starts to cut rates aggressively.  At that point, we can see a much sharper decline in the greenback.





Ahead of the FOMC meeting, this morning we get November PPI (exp 1.0%, 2.2% core) which would represent a small decline from last month’s data.  We will also see the EIA oil inventory data, which has shown a recent history of builds helping to drive the oversupply narrative there.





At this point, it is all up to Jay.  I suspect that markets will be quiet until then, and it will all depend on the statement, the dot plot and the presser.





Good luck





Adf

			

	
	



				
					


	

		

			The New Allegory
		


				

			Posted on  by 		

			


		

		

On Friday, the data surprised

With job growth more than advertised

So, bonds took a bath

And stocks strode a path

Where growth is what’s now emphasized



But what of the soft landing story?

Will rate cuts now be dilatory?

If Jay just stands pat

Will stocks all go splat?

Or is this the new allegory?






Well, this poet was clearly wrong-footed by Friday’s employment report where not only were non-farm payrolls stronger than anticipated at 199K, but hours worked rose and the Unemployment Rate fell 2 ticks to 3.7%.  While revisions to previous reports were lower, as they have been all year, the report did not point to an imminent slowing of the economy nor a recession in the near-term.  Arguably, the soft-landing crowd made out best, as equity markets, which initially plunged on the report following Treasury prices, rebounded as investors decided that growth is a better outcome than not.  Yields jumped higher, as would be expected, rising 8bps in the US with larger gains throughout Europe before they went home for the weekend.  And finally, the dollar flexed its muscles again, rallying universally with gains against 9 of the G10 currencies, averaging 0.4% (only CAD (+0.1%) managed to hold its own) and against most of the EMG bloc with a notable decline by ZAR (-1.1%), although MXN (+0.6%) bucked the trend.





Does this mean the soft landing is coming?  As we start the last real data intensive week of 2023, it remains the favored narrative, but is by no means assured.  After all, before the end of this week we will have seen the latest CPI reading in the US (exp 3.1% headline, 4.0% core) and we will have heard from the FOMC, ECB and BOE as well as several smaller central banks like the Norgesbank and the SNB.  And let us not forget that the BOJ meets next Monday.  So, there is plenty of new, important information that is coming soon and will almost certainly drive potential narrative changes.





Perhaps an important part of the discussion is to define what we mean by a soft landing, or at least what the ‘market’ means by the concept.  My best understanding is as follows: GDP slides to 1% or so, but never goes negative.  Unemployment may edge higher than 4.0%, but only just, with a cap at the 4.2% or 4.3% area, and inflation, as measured by Core PCE finds a home between 2.0% and 2.5%.  This result, measured inflation falling back close to target while the growth and employment story just wobbled a bit, would be nirvana for Powell and friends.  





How likely is this outcome?  Ultimately, history is not on their side as arguably the only time the Fed ‘engineered’ a soft landing was in 1995, and on an analogous basis they had already started cutting rates by this time in the cycle.  The fact that we are still discussing higher for longer implies that there is much more pain likely to come than the optimists believe.  We have already seen the first signs of trouble as the number of bankruptcies soar and stories about non-investment grade companies needing to refinance their debt at much higher interest rates than the previous round fill the news.  Certainly, Friday’s employment data is encouraging for the economic situation, but the chink in the armor was the wage data which showed more resilience (+0.4%) than expected.  Given the Fed’s focus on wages and their impact on inflation, the fact that wage growth remains well above the levels the Fed deems appropriate to meet their inflation target is not a sign that policy ease is coming soon.





And ultimately, I believe that is the critical feature here.  The economy has held in remarkably well considering the pace and size of the interest rate changes we have already seen.  The big unknown is how much of that interest rate change has really been felt by the economy.  Obviously, the housing market has felt the impact, and to some extent the auto industry, but otherwise, it is not as clear.  Do not be surprised if this period of slow economic activity extends for a much longer time than in the past as the drip of companies that find themselves unable to refinance at affordable rates slowly grows.  By 2025, about $1 trillion of corporate debt that was issued at much lower interest rates will need to be refinanced.  I’m not worried about Apple refinancing their debt, but all the high-yield debt that was snapped up with a 4% or 5% handle during the period of ZIRP will now be at 10% or so and it is an open question if those business models will be functional with financing that expensive.  





So, perhaps, the story will be as follows:  economic activity is going to muddle along at low rates for an extended period, another 2 or 3 quarters, until such time as the debt ‘time-bomb’ explodes with refinancing rates high enough to force many more bankruptcies and start a more aggressive recessionary cycle with layoffs leading to rapidly rising Unemployment rates and economic activity falling more sharply.  In this timeline, we are talking about the recession becoming clear in Q3 of 2024, a time when most of that $1 trillion of corporate debt will be current.    While interest rates will certainly be slashed at some point, this does not bode well for risk assets in the second half of 2024.  For now, though, it certainly seems like the current narrative is going to continue.





There’s no urgency

To change policy quite yet

But…some day we will






A quick story about the BOJ which last night pushed back firmly against the growing narrative that they were about to start normalizing interest rate policy with a rate hike in either December or January.  Instead, several stories were released that described the recent decline in both GDP and inflation as critical and the fact that they still don’t have enough information with respect to wages in Japan, given the big spring wage negotiation has not yet happened, to make a decision.  In other words, the BOJ was successful at convincing markets to behave as the BOJ wants, not as the rest of the world wants.  The upshot was that the yen weakened sharply (-0.9%) while the Nikkei rose 1.5% and JGB yields were unchanged.  The BOJ pivot remains one of the biggest themes in the macro community, mostly because it is seen as the place where the largest profits can be made by traders.  But my experience (4 years working for a Japanese bank) helps inform my view that whatever they do will take MUCH longer to happen than the optimists believe.





Ok, let’s try a quick trip around markets here for today.  Aside from Japan, most of Asia had a good equity session with Hong Kong (-0.8%) the only real laggard.  Remember, a key story there remains the Chinese property sector as many of those firms are listed in HK.  Meanwhile, European bourses are mixed although movements haven’t been very large in either direction.  The worst situation is the UK (FTSE 100 -0.5%), while we are seeing some gains in the CAC and DAX, albeit small gains.  Finally, US futures are pointing a bit lower, -0.2%, at this hour (7:45).





In the bond market, after Friday’s dramatic price action, Treasury yields are continuing to rise, up 5bps this morning, although European sovereign yields are little changed on the day, with the bulk of them slipping about 1bp.  Given most saw quite large moves on Friday, and given the imminent policy decisions by the big 3 central banks, I suspect traders are going to be quiet for now.  





Oil prices (-0.3%) are slipping slightly this morning but are mostly consolidating Friday’s gains.  On the metals front, though, everything is red with gold, silver, copper and aluminum all under pressure.  Again, this is the one market that has been pricing a recession consistently for the past several months while certainly equity markets have a completely different view.





Finally, the dollar is continuing to rebound on the strength of rising Treasury yields.  While the euro is little changed on the day, the yen is driving price action in Asia with weakness also seen in CNY, KRW and TWD.  As well, ZAR (-0.8%) continues to suffer on weaker commodity pricing and both MXN and BRL are under pressure leading the LATAM bloc lower.  At this point, I would say the FX market has more faith in Powell’s higher for longer mantra than some other markets.





As mentioned, there is a lot of data this week:





TodayNY Fed Inflation Expectations3.8%
TuesdayNFIB Small Biz Optimism90.9
 CPI0.0% (3.1% Y/Y)
 -ex food & energy0.3% (4.0% Y/Y)
WednesdayPPI0.1% (1.0% Y/Y)
 -ex food & energy0.2% (2.3% Y/Y)
 FOMC Rate Decision5.5% (unchanged)
ThursdayECB Rate Decision4.5% (unchanged)
 BOE Rate Decision5.25% (unchanged)
 Retail Sales-0.1%
 -ex autos-0.1%
 Initial Claims221K
 Continuing Claims1891K
FridayEmpire State Manufacturing2.0
 IP0.3%
 Capacity Utilization79.2%
 Flash PMI Manufacturing49.1
 Flash PMI Services50.5





Source tradingeconomics.com





Thursday also has the Norges Bank and SNB, both of whom are expected to leave rates on hold.  For today, it strikes me that the discussion will continue as pundits try to anticipate what the FOMC statement will say and how Powell sounds in the press conference.  As such, it is hard to get excited that there is going to be a big move in either direction.  With all that in mind, my overall read on the economy is that while we may muddle along in the US for a while yet, it will be better than many other places in the world, notably the EU, the UK and China, and so the dollar is likely to hold up far better than most expect…at least until Powell changes his tune.





Good luck





Adf

			

	
	



				
					


	

		

			Aghast
		


				

			Posted on  by 		

			


		

		

The BOJ did
Absolutely nothing new
Can we be surprised?

The last of the key central bank meetings finished last night with the BOJ not only leaving policy on hold, as expected, but not even hinting that changes were in the offing.  Much had been made earlier this month about a comment from Ueda-san that they may soon have enough information to consider policy changes.  This was understood to mean that YCC might be ending soon.  Oops!  If that is going to be the case, it was not evident last night.  Rather, the status quo seems the long-term view in Tokyo right now.  Not surprisingly, the yen suffered accordingly, selling off another -0.5% overnight and is now back at its weakest point (highest dollar) since October 2022 when the BOJ intervened actively.

Also, not surprisingly, after the yen weakened further, we started to hear from the MOF trying to scare the market.  FinMin Shunichi Suzuki once again explained that he would not rule out any actions with respect to the currency market if volatility (read depreciation) increased too much.  But as of yet, there have been no BOJ sightings and I suspect they will not enter the market until 150.00 is breached once again.  Maybe next week.

With central bank meetings now past
The markets’ response has been fast
It seems there’s a pox
On both bonds and stocks
And owners of both are aghast

While further rate hikes may be rare
Investors feel some small despair
No rate cuts are planned
Throughout any land
And bond yields are now on a tear

Turning to the rest of the G10, what was made clear over the past two weeks is that policy rates are not anticipated to fall anytime soon.  While some central banks seemed to finish for sure (ECB, SNB, BOE) others seem like there may be another in the pipeline (Fed, Riksbank, Norgesbank, BOC, RBA), but in no case is there a discussion that inflation has reached a place of comfort for any central bank.  Rather, even those banks on hold seem comfortable that policy rates need to remain at current levels in order to continue to battle the scourge of inflation.  If anything, the hawks from most central banks continue to push for further tightening, although I suspect that will be a difficult hill to climb given the inherent dovishness of most central bank chiefs.

So, what are we to expect if this is the new home for interest rates rather than the ZIRP/NIRP to which we had become accustomed for the past 15 years?  The first thing to consider is that despite the higher rate structure, the financial position of the private sector, at least in the US, remains strong.  Corporates termed out debt and tend toward being cash rich, so for now, they are benefitting from high interest rates as they locked in low financing and are earning the carry.  Many households are in the same position, having refinanced home mortgages at extremely low rates so are not feeling the pain of the recent rise in mortgage rates.  Of course, this has reduced the amount of activity in the housing market and is a problem for first-time buyers, but that is not the majority, so net, the pain is not so great.

However, the US is unique in this situation as most of the rest of the world are beholden to short-term rates in their financing.  This is true in the commercial sector, where bank lending is a far more important part of the capital structure than public debt.  Those loans are floating, which is also true in the household sector where most mortgages elsewhere have 5-year fixed terms and so are already repricing higher and impacting homeowners.  In fact, if you want one reason as to why the US is likely to outperform the rest of the world, this would be a good place to start.  Despite much higher interest rates, the pain is not being felt across much of the US economy while it is being felt acutely throughout Europe and the UK.  

The upshot of this process is that inflation is likely to remain with us for quite a while going forward.  This means that central banks are going to have a great deal of difficulty reversing course absent a major crash in economic activity.  Given the US tends to lead the world’s capital markets, it also means that the combination of continuing gargantuan issuance by the Treasury to finance the never-ending budget deficits along with the stickiness of inflation implies that interest rates need to be higher.  We saw this price action yesterday with 10yr Treasury yields jumping to 4.5%, another new high for the move, and importantly, a larger move than the 2yr yield.  This is the ‘bear steepening’ that I have been writing about, with longer end yields rising faster than shorter yields.  Ultimately, this will be quite a negative for risk assets, especially paper ones, although hard assets ought to benefit.  The world that we knew has changed, so we all need to adjust accordingly.

Turning to the overnight session, yesterday’s US weakness was followed by Japan (-0.5%) but Chinese shares bucked the trend, rising strongly on hopes that the recent data shows the worst is past for the mainland.  That seems odd given the lack of additional stimulus forthcoming from the government, but that is the story.  European shares are mostly a bit lower this morning after flash PMI data was released showing growth in the Eurozone remains elusive.  Germany is still in dire straits with its Manufacturing PMI <40, but the whole of Europe is sub 50 for the past four months at least.  Finally, US futures are bouncing slightly this morning, but that seems like a trading reaction to two consecutive days of sharp losses rather than new optimism.

Other than YK Gilts, which traded at much higher levels back in August, European sovereigns are following Treasury yields to their highest level in more than a decade.  And despite the weak economic story, the fact remains that sticky inflation is the clear driver for now.  Consider that the ECB has essentially explained they have finished raising rates with their policy rate at 4.0% while CPI is running at 5.2% headline and 5.3% core.  Those numbers do not inspire confidence that the ECB has done its job.  I continue to look for higher long-term yields going forward.

Part of the reason for this is that oil (+0.9%) continues to find support.  While it had a couple of days of a modest pullback, we are back above $90/bbl and the news remains bullish the outcome.  The latest is the Russia is halting deliveries of diesel fuel, a particular sore spot as there are already tight supplies around the world, especially here in the US.  I see no reason for oil to decline structurally, and that is going to continue to pressure inflation higher.  Perhaps of more interest is the fact that the metals complex is rallying today, despite the rise in interest rates.  Gold (+0.3%), silver (+1.3%), copper (+0.8%) and aluminum (+1.1%) are all in the green.  Again, I would say that owning hard assets is going to be a better outcome than paper ones.

Finally, the dollar is mixed this morning, showing gains against the euro, pound and yen, but softer vs. the commodity bloc with AUD, NZD, CAD and NOK all firmer this morning.  As well, EMG currencies are having a better session, rising a bit vs. the greenback, but recall, the dollar has had quite a good run lately.  My take is there is a lot of profit-taking as we head into the weekend given the lack of fundamental stories that would undermine the buck.  Nothing has changed my view it has further to rise.

On the data front, the only releases are the flash PMIs here (exp 48.0 Manufacturing, 50.6 Services) and we get our first Fed speaker, Governor Lisa Cook, a confirmed dove.  We have already had a lot of activity this week so I suspect that heading into the weekend, it is going to be a quiet session as traders and investors start to plan for next week’s excitement.

Good luck and good weekend
Adf



			

	
	



				
					


	

		

			Dreamlike
		


				

			Posted on  by 		

			


		

		

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

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






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





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





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





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





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





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





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





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





Good luck and good weekend





Adf

			

	
	



				
					


	

		

			Results May Be Dire
		


				

			Posted on  by 		

			


		

		

It turns out inflation was higher
Though no one would call it on fire
The problem, alas
Is food, rent and gas
Show future results may be dire

But CPI’s yesterday’s news
Today it’s Christine and her views
Will she hike once more
Though growth’s on the floor
Or will, all the hawks, she refuse?






Yesterday’s CPI report could be termed luke-warm, I think, as the headline number was a tick higher than expected at 3.7%, while the core M/M number was also a tick higher than expected at 0.3%, although the Y/Y core number was right at the 4.3% expectation.  This provided fodder for both sides of the inflation discussion, with the inflationistas all claiming that higher CPI is coming, and we have bottomed while the deflationistas claimed that the results were insignificantly different from expectations and, oh yeah, rental prices are still falling so they are certain CPI will follow lower.  My go-to on this subject is always @inflation_guy and he explained (here) that some areas were hot and some not so much but does agree that any further declines in the CPI are likely to be quite small if they come at all.  I am in the camp that the new inflation level is somewhere in the 3.5%-4.0% area and short of a drastic recession, it will be extremely difficult to change that.





The stock market was certainly confused by the data as it initially sold off 0.5%, rebounded through most of the day only to see another late day decline and finish up very slightly higher overall.  In other words, it certainly doesn’t seem as though opinions were changed.  Treasury yields did edge a bit lower, falling 3bps, although this morning they have backed up by 1bp.  And the dollar finished the day net stronger vs. the G10, but actually net weaker vs. the EMG bloc.  All in all, I would argue we didn’t learn that much.





This brings us to today’s key story, the ECB meeting.  After the leaked story about the newest ECB forecasts calling for CPI above 3.0% next year, the market priced a greater probability of a hike today, it is still 65%, but net, have only one more hike priced in before the ECB is finished.  Madame Lagarde’s problem is that inflation is running hotter than in the US while their interest rate structure is 150bps lower and growth is very clearly rolling over.  The stickiness of European inflation has been quite evident and shows no signs of changing.  So what will she do?





Given Lagarde’s political background, as opposed to any central banking background, I expect that she will see the writing on the wall with respect to economic activity in the Eurozone, and if the ECB is going to be able to raise rates at all, this is probably the last chance.  By the October meeting, the European recession will be quite evident and her ability to hike rates then will be heavily circumscribed.  As such, I see 25bps today and that is the end, regardless of what her comments afterwards are.  





Trying to consider how the markets will react to this leads me to believe that European equities will soften a bit, although ahead of the meeting they are higher by about 0.3% across the board.  It also implies to me that we could see European sovereign yields creep higher (although right now they are lower by about 1bp across the board) as the inflation fighting stance alters before inflation retreats, and ultimately, I think the euro suffers as investors decide that there are better places to put their money.  In fact, I expect this opens the door for the next leg lower in the single currency, perhaps down to 1.05 before it finds a new ‘home’.





But wait, there’s more!  In fact, we have a plethora of data being released today in the US as follows:





Retail Sales0.1%
-ex Autos0.4%
Initial Claims225K
Continuing Claims1693K
PPI0.4% (1.3% Y/Y)
-ex food & energy 0.2% (2.2% Y/Y)





Source: Bloomberg





For the market, and the Fed, I expect the Retail Sales number will be critical as last month we saw a very hot read, 0.7% while the market was looking for just 0.4%, and the ex Autos number was even hotter at 1.0%.  If we were to see another strong number here, especially if the Claims data continues to point to strength in the labor market, the Fed will certainly take note.  And while they may not hike next week, it would likely increase the odds of a November hike substantially.





Those are the key macro stories to watch today but there is one micro story that is worth noting and that is that the PBOC has been quite active recently in its efforts to prevent further renminbi weakness.  This morning they cut the reserve requirement ratio by a further 0.25% for banks in China and they also increased the issuance of bills offshore in Hong Kong thus pushing CNY rates higher there and pressuring those who would short the currency.  Finally, it appears that they have instructed several of the large state-owned banks to essentially intervene in the spot market at their direction, although the banks are the ones holding the risk.   So far, all their activity this week has pushed USDCNY lower by just 1.0%, so having some effect, but hardly reversing the longer-term trend weakness in the currency.  My take is, like the Japanese, they are more worried about the pace of any decline than the decline itself.  But in the end, unless we see some macro policy changes by either or both China and the US, the trend here remains for a weaker renminbi.





Ahead of the ECB meeting, markets have been quiet overall.  The dollar is mixed with an equal number of gainers and losers in both the G10 and EMG blocs and none of the movement more than 0.3%.  We have already discussed both stocks and bonds which leaves only commodities, which is the exception to the rule of limited movement today as oil (+1.5%) has jumped further with WTI pushing to just below $90/bbl.  While metals markets are mixed and little changed overall, the oil story is going to be a problem for both central bankers and politicians alike if the price continues to rise.  As we head into election season in the US, rising gasoline prices, and they are rising fast, will likely cause panic in the current administration.  Alas, they no longer have an SPR to offset the OPEC+ production cuts, they used that bullet, so the only hope for lower prices seems to be a dramatic decline in demand, and that will only occur if we have a deep recession, something else that politicians are desperate to avoid.  I remain bullish on oil overall, although we have seen a pretty big move over the past month, nearly 11%, so some consolidation wouldn’t be a big surprise.





And that’s really it for today.  At 8:15, the ECB releases its decision and statement.  At 8:30 the US data drops and then at 8:45 Madame Lagarde holds her press conference.  So, plenty to look forward to in the next hour or so.





Good luck





Adf

			

	
	



				
					


	

		

			Having Some Fits
		


				

			Posted on  by 		

			


		

		

While all eyes are on CPI
Some other news may now apply
The Germans and Brits
Are having some fits
As they both, to growth, wave bye-bye

The other thing that we have heard
Is ECB forecasts have stirred
What was 3%
They’ve had to augment
So, Thursday, a hike is the wor






Clearly, the top story today will be the release of the August CPI data with the following expectations: Headline 0.6% M/M, 3.6% Y/Y and ex food & energy 0.2% M/M, 4.3% Y/Y.  The headline number has been boosted by the rise in energy prices, although it is important to understand that the bulk of the gains in oil’s price are not going to be in this number, but in next month’s release.  As well, oil prices continue to rise, up another 0.65% this morning and now above $89/bbl.  Too, gasoline prices, the place where we feel this rise most directly, continue to climb right alongside crude.  This release will have the chance to alter some views on the Fed meeting next week, but it will need to be a big miss one way or the other to really have an impact, I think.  While I am not modeling inflation directly, certainly my anecdotal evidence is that prices are continuing to rise at better than a 4% clip for ordinary purchases, whether in the supermarket or at a restaurant or retail store.





But perhaps, the more interesting things today have come from Europe and the UK, with three key, somewhat related stories.  The first was the release of the UK monthly GDP data which fell -0.5%, far worse than anticipated as IP (-0.7%), Services (-0.5%), and Construction (-0.5%) all were released with negative numbers for July.  What had been a seemingly improving outlook in the UK certainly took a hit today and has placed even more pressure on the BOE.  Despite the weaker than expected growth situation, there is, as yet no evidence that inflation is really slowing down very much leaving Bailey and company in a pickle.  Tightening further to fight inflation while the economy declines is a very tough thing to do.  But letting inflation run is no bowl of cherries either.  It should be no surprise that both the pound (-0.2%) and the FTSE 100 (-0.5%) are under pressure today.





The other two stories come from Frankfurt where, first, the German government is apparently set to downgrade its outlook for full-year 2023 GDP to -0.3% from its previous assessment of +0.4%, which was quite weak in its own right.  Apparently, poorly designed energy policy is coming back to haunt the nation as manufacturing activity continues to diminish under the pressure of the highest energy prices in Europe.  Unfortunately for Germany, and likely for Europe as a whole, unless they adjust their energy policies such that they can actually generate relatively cheap power and create a hospitable environment for manufacturing, I fear this could be just the beginning of a longer-term trend.





The other story here is not an official change, but a leak from ECB sources, which indicates that the ECB’s inflation estimate for 2024 will now be above 3.0%, from its last estimate right at 3.0%.  The implication is that the hawks continue to push for another rate hike at tomorrow’s council meeting.  In the OIS market, the probability of a hike tomorrow has risen to 67% from about 50% yesterday.  As a reminder, this is what Madame Lagarde told us back in July, “We have an open mind as to what decisions will be in September and subsequent meetings…We might hike, and we might hold. And what is decided in September is not definitive, it may vary from one meeting to another.”  With this in mind, it appears that some members are trying to put their thumb on the scales and get a push toward one more hike.  Especially given weakness in German economic activity, if they don’t hike tomorrow, it will get increasingly difficult to justify more hikes later, so in the hawks’ minds, it’s now or never.





In truth, I think that is an accurate representation because if we continue to see slowing growth in Europe, Madame Lagarde, who is a dove by nature, will be quite unwilling to weigh on growth and push up unemployment even if inflation won’t go away.  With this in mind, I’m on board to see the final ECB rate hike tomorrow.





Not surprisingly, today’s news did not help risk appetites at all.  Equity markets, after yesterday’s US declines (especially in the tech sector) were lower throughout most of Asia and are currently lower across all of Europe.  In fact, the losses on the continent are worse than in the UK, with an average decline of about -0.9%.  Pending higher interest rates amid weakening growth are definitely not a positive for equities.





However, investors have not been running to bonds as a substitute.  Instead, bond yields are higher pretty much across the board, with Treasury yields up 2.5bps while European sovereigns have seen yields climb between 3.5bps (Bunds) and 7.0bps (BTPs).  This has all the feel of rising inflation fears that are not likely to be addressed in the near term.





I already touched upon oil prices leading the energy space higher, but given the sliding views of economic activity, it is no surprise to see metals prices softer this morning with both precious and base metals under pressure.  While the long-term prospects for commodities overall, I believe, remain quite bullish, if (when) we do go into recession, I expect a further price correction.





Finally, the dollar is a bit stronger against all its G10 counterparts and most EMG counterparts this morning.  Granted, the movement has been modest so far, which given the importance of today’s data release, should be no surprise.  But my take is that a hot CPI print, especially in the core, will see the dollar rise further as the market starts to price in at least one more rate hike by the Fed, probably in November.  At the same time, if the CPI number is cool, then look for the dollar to give back a bunch of its recent gains as market participants go all in on rate cuts in the near future.  It is that last part of the concept with which I strongly disagree.  While the Fed may have reached its terminal rate, there is no evidence that they are even thinking about thinking about cutting rates.  However, that is my sense of how today will play out.





Good luck





Adf

			

	
	



				
					


	

		

			Quickly Slowing
		


				

			Posted on  by 		

			


		

		

We will take action
Threatened Vice FinMin Kanda
If you speculate






“If these moves continue, the government will deal with them appropriately without ruling out any options.”  So said Vice FinMin Masato Kanda, the current Mr Yen.  Based on these comments, one might conclude that ‘evil’ speculators were taking over the FX market and distorting the true value of the yen.  One would be wrong.  The below chart shows the yields for 10yr JGBs vs 10yr Treasuries.  You may be able to see that the most recent readings show a widening in that yield spread in the Treasury’s favor.  It cannot be a surprise that investors continue to seek the highest return and the yen most certainly does not offer that opportunity.










While I don’t doubt there is a place where the BOJ/MOF will intervene, they know full well that the yen’s weakness is a policy choice, not a speculative outcome.  They simply don’t want to admit it.  The upshot is that the yen edged a bit higher overnight, just 0.2%, as market realities are simply too much for words to overcome.  The yen has further to fall unless/until the BOJ changes its monetary policy and ends YCC while allowing yields in Japan to rise.  Until then, nothing they can say will prevent this move.





While ECB hawks keep on screeching
More rate hikes are not overreaching
The data keeps showing
That growth’s quickly slowing
So, comments from Knot are just preaching






“I continue to think that hitting our inflation target of 2% at the end of 2025 is the bare minimum we have to deliver.  I would clearly be uncomfortable with any development that would shift that deadline even further out.  And I wouldn’t mind so much if it shifted forward a little bit.”   These are the words of Dutch central bank chief and ECB Governing Council member Klaas Knot.  As well, he intimated that the market might be underestimating the chance of a rate hike next week, which at the current time is showing a 33% probability. Another hawk, Slovak central bank chief Peter Kazimir also called for “one more step” next week on rates.  





The thing about these comments is they came in the wake of a German Factory Orders number that was the second worst of all time, -11.7%, which was only superseded by the Covid period in March 2020.  Otherwise, back to 1989, Factory Orders have never fallen so quickly in a month.  This is hardly indicative of an economy that is going to grow anytime soon.  Rather, it is indicative of an economy that has inflicted extraordinary harm to itself through terrible energy policies which have forced producers to leave the country.  





The key unknown is whether the slowing economic growth will also slow price growth.  Given oil’s continued recent strength, with no reason to think that process is going to change given the supply restrictions we have seen from the Saudis and Russia, I fear that Germany is setting up for a very long, cold winter in both meteorological and economic terms.  With the largest economy in the Eurozone set to decline further, it is very difficult to be excited at the prospect of a stronger euro at any point in time.  It feels to me like the late summer downtrend in the single currency has much further to go.  





This is especially true if the US economy is actually as resilient in Q3 as some economists are starting to say.  Yesterday, I mentioned the Atlanta Fed GDPNow number at 5.6%, but we are seeing mainstream economists start to raise their Q3 forecasts substantially at this point given the strength that was seen in July and August.  Not only will this weigh on the single currency, and support the dollar overall, but it may also put a crimp in the view that the Fed is done hiking rates.  Consider, if GDP in Q3 is 3.5% even, it will not encourage the Fed that inflation is going to slow naturally.  And while they may pause again this month, it seems highly likely they would hike again in November with that type of data.





Which takes us to the markets’ collective response to all this news.  Risk is definitely under some pressure as the combination of stickier inflation and slowing growth around the world is weighing on investors’ minds.  The only market to manage a gain overnight was the Nikkei (+0.6%) which continues to benefit from the weaker yen, ironically.  But China, which is also growing increasingly concerned over the renminbi’s slide, remains under pressure as do all the European bourses and US futures.  Good news is hard to find right now.





Meanwhile, bond investors are in a tough spot.  High inflation continues to weigh on prices, but softening growth, everywhere but in the US it seems, implies that yields should be softening with bond buyers more evident.  This morning, 10yr Treasury yields are lower by 2bp, but that is after rallying 16bps in the past 3 sessions, so it looks like a trading pullback, not a fundamental discussion.  But in Europe, sovereign yields are edging higher as concern grows the ECB will not be able to rein in inflation successfully.  As to JGB yields, they seem to have found a new home around 0.65%, certainly not high enough to encourage yen buying.





Oil prices (-0.1%) while consolidating this morning, continue to rally on the supply reduction story and WTI is back to its highest level since last November.  Truthfully, there is nothing that indicates oil prices are going to decline anytime soon, so keep that in mind for all needs.  At the same time, metals prices are mixed this morning with copper a bit softer and aluminum a bit firmer while gold is unchanged.  It seems like the base metals are torn between weak global economic activity and excess demand from the EV mandates that are proliferating around the world.  Lastly a word on uranium, which continues to trend higher as more and more countries recognize that if zero carbon emissions is the goal, nuclear power is the best, if not only, long term solution.  The price remains below the marginal cost of most production but is quickly climbing to a point where we may see new mining projects announced.  For now, though, it seems this price is going to continue to rise.





Finally, the dollar is mixed this morning, having fallen slightly vs. most G10 currencies, but rallied slightly vs. most EMG currencies.  This morning we will hear from the Bank of Canada, with expectations for another pause in their hiking cycle, but promises to hike again if needed.  Meanwhile, the outlier in the EMG bloc is MXN (-0.7%) which seems to be a victim of the overall risk situation as well as the belief that its remarkable strength over the past year might be a bit overdone.  In truth, this movement, five consecutive down days, looks corrective at this stage.





On the data front, we see the Trade Balance (exp -$68.0B) and ISM Services (52.5) ahead of the Beige Book this afternoon.  We also hear from two FOMC members, Boston’s Susan Collins and Dallas’s Lorrie Logan.  Yesterday, Fed Governor Waller indicated that while right now, the data doesn’t point to a compelling need to hike, he is also unwilling to say they have finished their task.  However, that is a far cry from the Harker comments about cutting in 2024 seems appropriate.  I suspect Harker is the outlier for now, at least until the data truly turns down.





Net, the big picture remains that the US economy is outperforming the rest of the world and the Fed is likely to retain the tightest monetary policy around, hence, the dollar still has legs in my view.





Good luck





Adf