Just Kidding

Posted on July 31, 2023 by fxpoet

Remember Friday
When one percent was declared
The top?  Just kidding

Much has been written about the BOJ’s surprising change in policy at their meeting last Friday, when they ostensibly widened the cap on their Yield Curve Control to 1.00% while explaining that flexibility in operations was the watchword. They did not touch their overnight rate, which remains at -0.10% and there is no apparent belief that they are going to adjust that anytime soon.

Neither market pricing in the OIS market nor any commentary from any BOJ official has hinted at such a move. So, the question is, did they really change their policy?

This matters a great deal for those amongst us who care about USDJPY and its potential future direction. The prevailing narrative has been that once the BOJ altered policy and allowed Japanese interest rates to rise to a more normal setting, investment would flow into JGBs, and the yen would strengthen rapidly. Remember, a big part of this process is that since the yen is the last remaining currency with negative interest rates in the front end of the curve, it remains the financing currency of choice amongst the speculative and hedge fund set. Adding to this discussion was the fact that back in December of last year, when Kuroda-san truly surprised the market by raising the YCC cap from 0.25% to 0.50%, it took less than one day for the 10-year JGB yield to test the new cap. Expectations recently had been that a similar move was likely to be seen this time around as well.

Alas, it is Monday, so some thirty-six market hours into the new policy and already the BOJ has stepped into the market to prevent a further rise in the 10-year yield once it touched 0.60%. Last night they stepped in with a ¥300 billion program of additional QE. One cannot be surprised that USDJPY (+0.9%) is higher on this news as it undermines the entire thesis about imminent JPY strength once they changed policy. And if they didn’t really change policy, as evidenced by the fact that they have already stepped into the market, then THE key pillar of the stronger yen thesis has just been removed. The other problem for the yen bulls is that the US data last week, especially the GDP and IP data, indicate that the Fed will be under no duress if they continue to tighten policy beyond current levels. Despite all the arguments about the Fed making another policy error, and there are sound arguments there, in Jay Powell’s eyes, until NFP starts to fall sharply, or Unemployment starts to rise sharply, or both, there are no impediments to a continuation of the current tightening policy.

It is with this in mind that I foresee continued strength in USDJPY, and while it seems likely that a very rapid move higher will see further intervention by the BOJ/MOF like we saw last autumn, another test of 150 is in the cards. A quick look at the chart below (from tradingeconomics.com) shows that the trend higher in the dollar remains intact with the decline in the first part of July already mostly undone. For those of you who were looking for a reversion to the 120 or 130 level, I fear that is just not in the cards for a long time to come.

Last Thursday the ECB said
That policy, looking ahead
Need not be so tight
And so, they just might
Stop raising rates, pausing instead

Though their only mandate is prices
They’ve come to a bit of a crisis
Seems growth’s really weak
And so, they will seek
A policy, sans sacrifices

The good news in Europe is that Q2 GDP was positive, which followed a negative Q4 and a flat Q1. Hooray! The bad news about the data, which showed a 0.3% rise, is that fully half that number comes from Ireland! Now, Ireland’s weight in the Eurozone economy is tiny, about 4%, so the fact that growth there represented half the entire EZ’s growth is remarkable. However, if you consider that this growth is more illusion than economic activity, it is easier to understand. The growth is a result of the large profitability of US tech companies that generate their profits, from an accounting perspective, in Ireland to take advantage of the extremely low Irish corporate tax rate of 12.5%. So, US tech companies had a good quarter driving Irish GDP higher, and by extension Eurozone GDP higher. But they didn’t really produce that much stuff.

At the same time, Core CPI in the Eurozone printed at 5.5% this morning in July’s preliminary reading, hardly indicative of a collapse and calling into question Lagarde’s seeming dovishness last week. In the end, the dichotomy between the US economy, where the latest data continues to show a robust outcome, and Europe, where the only thing rising is prices with economic activity lackluster at best, remains the key reason why the dollar’s demise is still a theory and not reality.

To summarize the information that we have received from around the world in the past several days, Japan is unwilling to allow interest rates to rise very far, European growth is staggering, US growth is accelerating, the ECB is inclined to stop hiking rates and the Fed continues with ‘higher for longer’. All of this points to the dollar maintaining its value and likely rising further. I have yet to see anything persuasive in the dollar bear case to address all these issues.

Now, those are the big picture views, but let’s take a quick tour of the overnight session. Equities rallied in Asia following the US performance on Friday, but Europe has been a bit more circumspect with a couple of markets showing gains, notably France and Italy, but the rest doing nothing at all. At the same time, US futures are little changed at this hour (7:30).

Arguably, though, it is the bond market where things are really interesting as yields continue to rebound. US Treasuries are higher by 1.5bps and pushing back to that all important 4.00% level this morning. There is a growing belief that if 10-year yields push above 4.10%, that may signal a new framework, a breakout in technical terms, and we could see much higher yields from there. The Fed is likely to welcome such an event as it will help tighten financial conditions, something that they have been unable to achieve thus far. However, I do not believe the equity markets would take kindly to that type of movement, so beware. As to European sovereigns, they are mostly higher by about 1bp-2bps this morning and of course, JGBs saw yields finish higher by 6bps, just below 0.60%.

Oil prices (+1.0%) continue to rise on an organic basis. By this I mean there have been no announcements, no disruptions and no news of any sort that might indicate a change in the current situation. In other words, there is just a lot of buying going on. WTI is well above $81/bbl and we have seen a gain of more than 16% in the past month. Headline inflation will not be sinking on this news. We are also seeing a little strength in the metals space this morning with gold, copper and aluminum all firmer as the week begins. The base metals are responding to continued indications that China is going to support their economy, although direct fiscal payments don’t yet seem likely. Just wait a few months.

Finally, the dollar is net, little changed, although we have a wide array of gainers and losers today. In the G10, AUD (+0.9%) and NZD (+0.75%) are the leaders, rallying alongside the commodity rally, while JPY (-0.8% now), is the laggard based on the discussion above. As to the rest of the bloc, there are more gainers than losers, but the movement has been far less impactful. In the EMG space, MYR (+1.1%) has been the leading gainer on significant (for Malaysia) equity market inflows of ~$40mm -$50mm last night. After that, though, the gainers have mostly been EEMEA currencies, and they have not moved that much. On the downside, ZAR (-0.7%) is the laggard on limited news, implying more of a trading action rather than a fundamental shift. But on this side of the ledger as well, things haven’t moved that far and net, the space is little changed.

It is an important week for data in the US culminating in the payroll report on Friday.

Today	Chicago PMI	43.4
	Dallas Fed Mfg	-22.5
Tuesday	JOLTS Job Openings	9600K
	ISM Manufacturing	46.9
Wednesday	ADP Employment	183K
Thursday	Initial Claims	227K
	Continuing Claims	1723K
	Unit Labor Costs	2.5%
	Nonfarm Productivity	2.2%
	Factory Orders	2.1%
	ISM Services	53.0
Friday	Nonfarm Payrolls	200K
	Private Payrolls	175K
	Manufacturing Payrolls	5K
	Unemployment Rate	3.6%
	Average Hourly Earnings	0.3% (4.2% Y/Y)
	Average Weekly Hours	34.4
	Participation Rate	62.6%

Source: Bloomberg

In addition to this, we get the first post-FOMC Fedspeak with just two speakers, Goolsbee and Barkin, on the calendar this week although the pace picks up next week. As long as the data remains strong, I see no reason for the Fed to change its tune nor any reason for the dollar to back off its recent net strength.

Good luck

Adf

A Suggestion

Posted on July 28, 2023 by fxpoet

Nought point five percent
Is not a rigid limit
It’s a suggestion

At least that is the word we got last night from Kazuo Ueda, BOJ Governor when he announced some surprising policy changes. No longer would 10-yr JGBs be targeted to yield 0.0% +/- 0.50%, which in practice had meant a 0.50% cap. Going forward, the BOJ would buy an unlimited amount of JGBs at 1.0%, if necessary, as its new framework. Perhaps the most humorous part of the concept was the suggestion that they always saw the 0.50% cap “as references, not as rigid limits, in its market operations.” That’s right, after 7 years of a seemingly explicit cap on JGB yields, with the BOJ willing to buy unlimited amounts in order to prevent yields from climbing, now they mention it was merely a suggestion, a guideline rather than a hard limit. It is commentary of this nature that tends to undermine investor trust in central bankers.

Given the surprising nature of the policy changes, although they left their O/N financing rate at -0.10%, it should be no surprise that the market had some large, short-term responses. JGB yields jumped 10bps on the news, trading to a new 9-year high at 0.575% before slipping back a few bps to close the week. The Nikkei, meanwhile, fell nearly 2.5% in the immediate aftermath of the decision, but rallied back all afternoon there to close lower by just -0.4%. It turns out the financial sector benefitted greatly as higher rates really helps them. As to the yen, it saw substantial short-term volatility, as ahead of the meeting it weakened nearly 1.75%, trading above 141.00, but very quickly reversed course and rallied > 2% as the dollar briefly fell to 138.00. In the end, though, the yen is just a hair stronger on the day now, back near 139.50 where things started.

The lesson, I think, is that policy shifts tend to have very immediate consequences, but the longer term impacts, especially in the currency market where we have a lot of moving pieces between the Fed, ECB and BOJ, will take longer to play out.

In Europe, inflation remains
The issue that’s caused the most pains
But growth there is stalling
So, Christine is calling
For slowing the rate hike campaigns

“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,” Lagarde said.It was with these words that Madame Lagarde informed us the rate hiking cycle in the Eurozone may have ended. Despite the fact that core CPI remains above 5.0% while their deposit rate is now at 3.75%, seemingly not high enough to effectively combat the inflation situation, it is becoming ever clearer that the European growth story is starting to slide. This is in direct contrast to the US growth story, which based on yesterday’s extremely robust data, shows no signs of fading.

But as I have written numerous times in the past, once the Fed is perceived to have stopped raising interest rates, it was clear the ECB would be right behind them. The entire basis of my stronger dollar thesis has been that other central banks will find it very difficult to tighten policy aggressively to fight inflation if the Fed has stopped doing so.

In the end, no country really wants a strong currency as the mercantilist tendencies of every country, seeking to increase exports at the expense of their domestic inflation situation, remains quite strong. Faster growth with higher inflation is a much preferred economic outcome for essentially every government than slower growth with low inflation. Inflation can always be blamed on someone else (greedy companies, Ukraine War, OPEC+, supply chain disruptions) while faster growth can be ‘owned’ by the government.

So, between the ECB and BOJ, we did see further policy tightening in line with the Fed’s actions on Wednesday. Arguably, the difference is that the US economic data continues to be quite strong, at least on the surface. Yesterday’s first look at Q2 GDP printed at 2.4%, much higher than expected and showing no signs of the ‘most widely anticipated recession in history.’ The strength was seen in Government spending (IRA and CHIPS Act), Private Domestic Investment (which is directly related to that as companies build out new plant infrastructure) and Services, i.e. travel and restaurants. Once again, I will say that as long as the US economy continues to show growth of this nature, and especially as long as the Unemployment Rate doesn’t rise sharply, the Fed will have free rein to continue to raise rates going forward if inflation does not settle back to their 2% target.

One thing to consider regarding the central bank comments and guidance is that virtually every one of them has ended the strict forward guidance we had seen in the past. Rather, data dependence is the new watchword as none of them want to be caught out doing the wrong thing. Alas, the result is that, by definition, if they are looking at trailing data, they will always be doing the wrong thing. I expect that one of the key features of the past 40 years, ever reducing volatility in markets, is going to be a victim of the current framework. It is with this in mind that I suggest hedging financial exposures, whether FX, rates, or commodities, will be far more important to company balance sheets and bottom lines than they have been in the past.

Ok, let’s see how investors are behaving today as we head into the weekend. We’ve already discussed the Japanese market, but Chinese shares, both onshore and in HK, had a very strong day as there was more talk of official policy support for the property market there. Ultimately, it is very clear they are going to need to spend a lot more money to prevent an even larger calamity. European shares, though, are generally little changed this morning with investors preparing to take the month of August off, as usual there. Finally, US futures are higher this morning after what turned out to be a surprising fall in all three major indices yesterday. The overall positive data plus indication that the Fed may be done seemed to be the right conditions for further gains. But markets are perverse, that much we know. We shall see if US markets can hold onto these premarket gains. I would say that a lower close on the day would be quite a negative for the technicians.

In the bond market, yesterday saw US 10-year yields jump 15bps, its largest rise this year, although it is giving back about 4bps of that this morning. European sovereigns, though, are little changed this morning and have not been subject to the same volatility as the Treasury market given the far less exciting economic picture there. If the ECB is truly finished, my take is yields there could slide a little over time.

In the commodity markets, oil (-0.35%) is a touch lower this morning, but the uptrend continues. This certainly seems to be more about reduced supply than increased demand, although with the US data, the demand picture looks better. Interestingly, both gold (+0.6%) and copper (+1.0%) are higher this morning despite the dollar holding its own. Yesterday saw a sharp decline in both and I think there is a realization that was overdone.

Speaking of the dollar, it is modestly softer today after a strong gain yesterday. In the G10, GBP (+0.6%) is the leader followed by NOK (+0.5%) although AUD (-0.6%) and NZD (-0.3%) are taking the opposite tack. The pound seems to be benefitting from anticipation of next weeks’ BOE meeting where 25bps is a given, but the probability of a 50bp hike seems to be creeping up. Meanwhile, NOK is just following oil’s broad trend with WTI just below $80/bbl now. Meanwhile, Aussie seems to be suffering some malaise from the BOJ actions, at least that’s what people are saying although I’m not sure I understand the connection. Perhaps it is the idea that higher JPY yields will result in unwinding the large AUDJPY carry trades that are outstanding.

However, the emerging markets have seen a much wider dispersion of performance with much of the APAC bloc under pressure last night on the back of the strong dollar performance yesterday, while we are seeing strength in LATAM and EEMEA currencies this morning, which really looks an awful lot like simple trading activity with positions getting reduced after yesterday’s dollar performance.

In addition to the GDP data yesterday, we saw a lower-than-expected Initial Claims print at 221K while Durable Goods orders blew out on the high side at 4.7%! Again, lots to like about the US data right now. Today we see Personal Income (exp 0.5%) and Spending (0.4%) along with the Core PCE Deflator (0.2% M/M, 4.2% Y/Y) and finally Michigan Sentiment (72.6). based on yesterday’s results, I would expect the Income and Spending data to be strong along although PCE is probably finding a bottom here.

In the end, even if the Fed has stopped hiking, although with the economy still showing strength that is not a guaranty, I find it hard to believe that the ECB will go any further, and the tendency around the world will be to slow or stop tightening as well. I still like the dollar in the medium term.

Good luck and good weekend

Adf

A Bad Dream

Posted on July 19, 2023 by fxpoet

The narrative’s gaining more steam
With landings, so soft, the new theme
In England today
They’re trying to say
Inflation was just a bad dream

The problem is that on the ground,
In Scotland and Wales and around,
Is incomes keep lagging
With purchases sagging
Which pressures the Great British pound

The biggest story of the morning has clearly been the UK inflation data which saw CPI fall back below 8.0% Y/Y for the first time in more than a year. Granted, 7.9% is not that far below 8% and certainly still miles above the BOE target, but the decline was substantially more than had been expected by the analyst community as well as the market. For instance, 10-year Gilt yields have tumbled -17.5bps and are now lower by 50bps since the peak two weeks’ ago and back to their lowest level since early June. 2-year Gilt yields have fallen even further, -25bps, so the market is really quite positive on this outcome.

It should be no surprise that UK equity markets have rallied as well, with the FTSE 100 the leading gainer in Europe, up 1.5%, nor should it be a surprise that the pound has fallen sharply, -1.0%, as traders re-evaluate the idea about just how much the BOE is going to raise rates going forward. Prior to this release, the OIS market had been pricing in a terminal interest rate at 6.1%, implying at least 4 more rate hikes by the BOE. But this morning, traders have removed one of those hikes from the curve and the excitement over further potential declines is palpable.

Now, the inflation news in Europe is not all rosy as the final release on the continent showed that core CPI turned out to be a tick higher at 5.5% in June, clearly an unwelcome result. And remember, it was just yesterday that we heard from Klaas Knot implying that while a hike next week is a given, nothing is certain past that. So, the question, currently, is will the ECB look through a revision to continue their more dovish stance? I guess we’ll find out next week.

But here’s an interesting tidbit regarding Europe, and something you need to consider when it comes to both investments and market outcomes there, electricity demand is falling there amid deindustrialization on the continent. The IEA just issued their latest Electricity Market Report and the reading was not pleasant for Europe. Consider that in the US, the combination of reshoring and the impact of the (ironically named) Inflation Reduction Act, as well as the CHIPS Act, has driven a marked increase in industrialization in the US. Meanwhile, in Europe, the loss of their cheap energy from Russia combined with their climate goals has resulted in industry fleeing the continent. For everyone who is long-term bearish the dollar, you better be far more bearish the euro given this new reality. Remember, energy consumption is the mark of a growing and healthy economy. When it is declining, absent extraordinary productivity/efficiency gains, it bodes ill. If anything, the increasing reliance on less dense energy sources like wind and solar just reduces energy efficiency. Be wary.

But, away from that news, things are a bit more confusing. For instance, virtually all European bourses are higher this morning, albeit not as much as the FTSE 100, but in Asia, while the Nikkei (+1.25%) had a good session, Chinese equities were under pressure. Yes, US markets yesterday continued their rally as earnings data has been able to beat the much-reduced estimates although futures this morning are essentially unchanged. But arguably, we can describe the equity picture as risk-on.

The same cannot be said for the bond market though, where yields have fallen everywhere, again, just not as much as in the UK. Treasury yields are down another 2bps, and most European sovereigns are also seeing modest yield declines, not the typical risk-on behavior. In fact, given the Eurozone CPI release, it would not have been surprising to see yields climb a bit.

As to the commodity space, oil is essentially unchanged on the day, but WTI is back above $75/bbl with Brent right at $80/bbl after several strong sessions. There has definitely been a renewed focus on the bullish supply story in oil as opposed to the recession discussion of late. At the same time, gold (-0.3%) which has rallied nicely during the past week, up nearly 2%, is holding the bulk of its gains. Alas, the base metals continue to lag, with both copper and aluminum softer on the day. Perhaps they didn’t get the bullish memo!

Finally, the dollar is quite robust this morning, which is not what one might expect given the equity and bond moves. In fact, it is firmer vs. the entire G10, with the pound the laggard, as would be expected given the inflation data and falling UK rates. But as well, the yen (-0.8%) is under pressure along with AUD (-0.7%) and the whole lot. Regarding the yen, it has been rallying sharply of late, up more than 5% during July until yesterday. That seems to be on an increasing belief that the BOJ, which meets next Friday, is going to tweak its policy in a tighter fashion, whether that involves YCC or rates or QE. Now, these stories have not disappeared, I just think that we are seeing a bit of a breather for this move. Remember, the yen has been the funding currency of choice for every asset all year as the BOJ remains the only central bank that hasn’t tightened policy at all. This month appeared to be profit-taking ahead of potential BOJ activity, and last night appears to be a simple trading bounce. FWIW, I do not believe the BOJ is ready to adjust its policy yet as the big review has just begun. And as I have written before, it doesn’t appear that the rising inflation pressures in Japan have yet become a major political liability for PM Kishida, so there is only limited pressure to make a change. For now, I would rather be short than long the yen.

Turning to the EMG bloc, only THB (+0.5%) is firmer this morning as the political machinations continue there in the wake of the recent election. In a nutshell, the winner of the election to replace the military junta is clearly not favored by the powers-that-be, and is being disqualified on a technicality, but another member of the coalition seems to be getting closer to taking the reins, with optimism building. But aside from that story, the dollar is firmer vs. the entire bloc as we are seeing a solid trading bounce in the greenback after several days/weeks of weakness.

On the data front, yesterday’s Retail Sales data was disappointing, and the IP and Capacity Utilization data were awful. Obviously, that didn’t hurt equities which remain disconnected from any macro data at this point. This morning brings the Housing Starts (exp 1480K) and Building Permits (1500K) data, although if Retail Sales didn’t have an impact, it is hard to believe the housing data will.

I remain uncomfortable with the equity market’s ongoing rally as I fail to see the underlying strength in the economy or earnings. Certainly, recent dollar weakness has helped goose the stock market a bit, but I would not be surprised to see things start to turn around in the near term, meaning the dollar rebounding after its recent sell-off and the equity market seeing some profit-taking.

Good luck
Adf

Havoc We’ll Wreak

Posted on June 27, 2023 by fxpoet

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

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

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

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

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

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

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

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

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

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

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

Good luck

Adf

Confusion Reigns

Posted on June 26, 2023 by fxpoet

Investors and traders are caught
Twixt data which shows that they ought
Be uber concerned
Although they have learned
That fighting momentum is fraught

And so, it’s confusion that reigns
Reminding us of Maynard Keynes
Though logic dictates
We’re in dire straits
That doesn’t prevent further gains

One of the remarkable things about the current situation across markets and macroeconomics is that every piece of new information seems to add to the confusion rather than any sense of clarity. As such, both the bulls and the bears, or perhaps the hawks and the doves, have constant reinforcements for their views. As John Maynard Keynes famously told us all in 1920, “the market can stay irrational longer than you can stay solvent,” and right now, there are many who are flummoxed by the seeming irrationality of the markets.

Data continues to print demonstrating economic weakness, with this morning’s German IFO results simply the latest. Expectations fell sharply to 83.6, a level whose depths had only been plumbed in the past during the GFC, at the beginning of Covid and when Russia invaded Ukraine. Too, the Business Climate fell to 88.5, mirroring the Expectations index in futility. In other words, this is an indication that businesses in Germany are not merely in a recession currently but see no escape soon. And why would they? After all, Madame Lagarde promised another rate hike next month and there is talk of further hikes later. So, it appears there will be no short-term relief for the citizens there. And yet, despite a very modest amount of equity market selling at the end of last week, most equity markets remain solidly higher halfway through 2023.

This morning’s data begs the question, can the global economy, or really any industrialized nation’s economy, avoid a recession if the manufacturing sector is declining. We are all aware that most of the G10 economies are services oriented, while we see much larger proportions of GDP driven by manufacturing in larger emerging markets. The following table, with data from the World Bank shows what these proportions as percentages of GDP were in 2021 (latest data available):

Australia	6
Brazil	10
Canada	10
China	27
Germany	19
India	14
Ireland	35
Japan	20
Korea	25
Mexico	18
South Africa	12
Spain	12
Sweden	13
UK	9
US	11

It should be no surprise that China, given their mercantilist policies, are at 27%, nor that South Korea (25%) and Mexico (18%) have relatively large manufacturing sectors. But both Germany (19%) and Japan (20%) are also quite manufacturing focused. As such, it should not be that surprising they both had run large trade and current account surpluses given that’s what mercantilist policies generate. The point is, if manufacturing is heading into a slump, or perhaps already in one, can the broader economy maintain overall growth?

Arguably, there is a significant portion of the services economy that is highly dependent on manufacturing as well. Consider things like financial services for those companies, transportation of manufactured goods as well as raw materials to factories and food and janitorial services at factories. Those are not part of the equation, but if factories close down in ‘service oriented’ economies, all those services will shrink as well. The point is even in the US, where manufacturing technically represents only 11% of GDP, a slump in that sector will have wide ranging impacts. And what we have seen just this month is a litany of lousy data on the manufacturing side. ISM Manufacturing (46.9), Kansas City Fed (-12), Philly Fed (-13.7), Dallas Fed (-29.1) and Chicago PMI (40.4) all point to severe weakness in the US manufacturing sector. Can the US economy really grow strongly with a key sector under such pressure? Can any economy? Germany is already in a recession, and we know that their manufacturing sector is sliding. China, too, has shown weaker data consistently and the government there is trying to figure out how to support the economy to prevent a severe slowdown. These are the arguments for why an official recession is coming to the US and all of Europe and probably the world.

And yet, equity market bullishness remains intact. At least based on the major indices. Despite the fastest set of interest rate hikes in history by the Fed, ECB and BOE amongst others, equity indices are higher throughout the G10 this year, led by the NASDAQ’s remarkable 29% rally. In addition, as we approach month/quarter end this week investment managers who have not been willing to close their eyes and buy are finding themselves forced into that situation. Meanwhile, inflation data, while slowing from its peak seen 6mo-9mo ago remains well above central bank targets indicating that there is further monetary policy tightening to come.

So, who do you believe? The data that shows key sectors of the global economy are slowing? Or the data that shows ongoing strong employment means overall economic activity is continuing to rise? It is easy to understand why so many analysts are forecasting a recession. It is also easy to understand why investors don’t respond that way as they watch market performance. And this, of course, is why Keynes’ words were so prescient, right now, markets do not seem rational, but they are what they are.

Arguably the one thing that is not frequently discussed but has been shown to be true over time is that G10 governments do not like to see recessions at all and will do anything they can and spend any amount, to prevent one from occurring. As long as central banks continue to monetize the debt required to do so, this structure can continue. But at some point, the debt will overwhelm the system and a correction will occur. It is anybody’s guess as to when that might happen, but it certainly feels like that day is slowly coming into view. At some point, investors will ignore what the central banks say and there will be a very significant correction. But there’s nothing to say it can’t wait five more years. As I said, confusion reigns.

Turning to the market activity overnight, After Friday’s down session in the US, Asia continued that trend with Chinese equity markets the weakest of the bunch, but screens red across the region. Europe, which had been uniformly negative earlier in the session has now seen a very modest bounce back to basically unchanged although US futures remain slightly in the red.

That risk-off feeling is being seen in bond markets with yields lower across the board this morning as both Treasuries and European sovereigns find themselves with yields sitting between 3bps and 4bps softer than Friday’s closing levels. The 2yr-10yr yield curve inversion remains -102bps, certainly not a positive economic sign, and we are seeing European curves invert as well. Even JGB yields are a touch lower this morning.

Oil prices are a touch higher this morning although WTI remains below $70/bbl and metals prices are also a bit firmer, bouncing off recent lows. However, that seems more to do with dollar weakness than commodity strength.

Which is a bit odd as during a classic risk-off session, the dollar tends to do quite well, yet today it is softer vs. all its G10 counterparts led by NOK (+0.9%) and many EMG currencies. Forgetting TRY (-2.7%), the other losers are CNY (-0.7%) which is catching up after a few days of Mainland holidays, and TWD (-0.3%). However, there is a long list of gainers led by ZAR (+0.9%) and HUF (+0.6%). Arguably, falling Treasury yields are hurting the dollar somewhat, but quite frankly, I’m not convinced that is the driver here.

On the data front, as it is the last week of the month, we will get updated GDP and PCE figures as well as an array of things:

Today	Dallas Fed	-20.0
Tuesday	Durable Goods	-0.9%
	-ex transportation	0.0%
	Case Shiller Home Prices	-2.60%
	New Home Sales	675K
	Consumer Confidence	103.8
Thursday	Initial Claims	264K
	Continuing Claims	1772K
	Q1 GDP	1.4%
Friday	Personal Income	0.3%
	Personal Spending	0.2%
	Core PCE Deflator	0.3% (4.7% Y/Y)
	Chicago PMI	44.0
	Michigan Sentiment	63.9

Source: Bloomberg

On the speaker front, the ECB has their summer confab in Sintra, Portugal this week with Powell, Lagarde, Ueda and Bailey all speaking on Wednesday and Thursday. It will certainly be interesting to hear them all together as they try to convince themselves they are in control.

I remain skeptical as to the potential for further gains in risk assets, but I have been skeptical for months and been wrong. As to the dollar, if yields are going to decline, I could see the dollar slide further, but if risk does get jettisoned, I expect the dollar to find a bid.

Good luck

Adf

The Battle’s Been Won

Posted on June 16, 2023 by fxpoet

‘Bout Jay and the FOMC
The market has come to agree
The battle’s been won
And hiking is done
So, buy stocks with verve and with glee

In Europe, though, Madame Lagarde
Is finding that things are still hard
Inflation’s not tamed
And she will be blamed
If prices, she cannot retard

Meanwhile on the world’s other side
Where growth has begun to backslide
The PBOC
More cash will set free
As Xi tries to hold back the tide

When looking at the market activity yesterday, it is easy to conclude that the market believes the Fed has instituted their last hike. This was evident in the equity market’s performance where all three major indices rallied more than 1% and it was evident in the FX market where the dollar was pummeled, falling by 1% or more against 7 of its G10 counterparts as well as about half the EMG bloc. In addition, Treasury yields fell sharply as the idea that the Fed is going to continue hiking, as implied by Chairman Powell in his comments on Wednesday, seems to have faded from memory.

But that’s not all! While key markets are beginning to discount any further Fed activity, the ECB not only raised their rate structure by 25bps as expected, but Madame Lagarde essentially promised another hike in July and this morning the ECB’s hawks are circling and hinting that a September rate hike is quite possible as well.

Now, we already know that the Fed’s dot plot is calling for 2 more rate hikes this year, but the Fed funds futures market is not in accord with that view. Rather, it is pricing a 70% probability of a July hike as the final move. But, will they hike again? Clearly, between now and the end of July we will all have seen a great deal more data, including both an NFP and CPI report, and that will have a major impact on the Fed. But after yesterday’s US data dump, which showed Retail Sales holding up far better than expected while both the Import and Export Price Indices showed price declines, there has been a significant increase in the chatter of the Fed pulling off a soft landing after all. And, if the landing is soft, do they need to hike more?

Although the manufacturing side of the economy remains lackluster, Services have been killing it. There is one other reason to believe the Fed will remain on hold as well, and that is the employment situation. While we have seen a much hotter than forecast NFP print basically each month for the past year, we are starting to see Initial Claims data tick higher. Yesterday’s 262K was both higher than expected and the highest print since October 2021 when claims were tumbling during the post-pandemic recovery. More ominously, the 4-week and 13-week moving averages (analyzed to seek a trend and remove the weekly choppiness) are both clearly trending higher. If that number continues to rise, the Fed’s confidence in the economic recovery continuing is likely to be impaired. In fact, I think this is the feature that is most likely to cause the Fed to stop hiking.

If we pivot to Asia for a moment, we see a completely different set of concerns in both China and Japan. Starting with China, after cutting their lending rates earlier this week, the PBOC is still struggling to figure out how to support what is a clearly softening economy. Although there has been much lip service paid to the fact that China will no longer prop up the property market and investment and is instead seeking to generate more domestic consumption, the fact that the youth unemployment rate is at a record 20.8% and that the only playbook the Chinese really understand is infrastructure spending and leveraged property speculation, they are falling back into that trap. Rumors abound that the government is going to put forth a CNY1 trillion (~$140B) spending package and that the PBOC is going to ease restrictions on property lending, removing the ban on second home purchases in small cities. Remember, property speculation was a critical part of China’s rapid growth as people there have little confidence in a social safety net and were using those second homes as an investment to secure their nest egg. Alas, with China’s population shrinking, that may no longer be an interesting investment for the middle class. So, while China’s problems are different, they are no less severe than those in the West.

Uncertainty is
“Extremely high” over both
Wages and prices

So, Ueda-san
Will keep liquidity flows
Like flooding rivers

As to Japan, I’m old enough to remember when there was a growing belief that once Kuroda-san stepped down as BOJ head, his replacement would have free rein to tighten policy. Boy, were we ever wrong about that. After last night, while there was no policy adjustment as expected, Ueda-san’s comments can only be construed as strongly dovish and the market got the message. JGB yields slid a few basis points and are back below 0.40% while the yen is the only currency that is underperforming the dollar. Meanwhile, the Nikkei (+0.65%) continues its recent strong performance as the second best major index after only the NASDAQ.

The one thing that we know is that things do not seem to be evolving as per much of the consensus from earlier this year. While there is still a long way to go before this cycle ends, and I still expect a more significant economic slowdown globally, the possibility that Chairman Powell pulls off a soft landing cannot be dismissed. And as I saw on Twitter yesterday, if he does so, he will be hailed as the greatest Fed chair ever, even more so than Paul Volcker. Alas, I fear things will not work out that way. Remember that monetary policy works with long and variable lags, and I would contend that the economy is likely just beginning to feel the true impacts of tighter policy. Now, this may only happen in the manufacturing sector, where the cost of capital is such a critical input, but history has shown if that sector stumbles, it drags the economy down with it. Remember that so much of the service economy exists to service manufacturing, so the two are quite intertwined.

Remember, too, there are potential exogenous shocks, both positive and negative, that can have a big impact. What if the Ukraine war ended? What if China invaded Taiwan? What if there was an escalation of fighting in the Middle East with a dramatic reduction in oil production? All I am pointing out is that myopically focusing on just the economic data is not sufficient for a risk manager. Sh*t happens and it can matter a lot.

Ok, as to today, we already know that risk is on. The data coming out this morning is Michigan Sentiment (exp 60.0) and of the three Fed speakers, two have already commented with Governor Waller not talking economics or policy, but rather bank regulation and Bullard was more theoretical than policy focused, so really there has been nothing new there either. In a little while, Richmond’s Barkin will discuss inflation, so that could be interesting. But for right now, the market has made up its mind. Everything is right as rain so add risk. That means the dollar is likely to remain under pressure with a test of its lows (EUR 1.11, DXY 102) coming soon to a screen near you.

Heading into a bank holiday weekend, I expect positions to be lightened but the recent dollar weakening trend to remain intact.

Good luck and good weekend

Adf

Firmly On Hold

Posted on June 15, 2023 by fxpoet

For now the Fed’s firmly on hold
While Powell made statements quite bold
It’s time to assess
How great is the mess
Created by stories we’ve told

This morning then, Christine is live
With certainty that twenty-five
Is how much she’ll hike
As she tries to spike
Inflation while growth she’ll still drive

To virtually nobody’s surprise, the Fed left policy rates on hold yesterday after what has been characterized by many as a hawkish pause. This seems a fair assessment given the effort by Chairman Powell to stress that inflation remains too high and has not been falling as rapidly as they would like to see. For instance, comments like the following during the press conference were quite clear:

“If you look at core PCE inflation over the last six months, you’re not seeing a lot of progress. It’s running at a level over 4.5%, far above our target and not really moving down. We want to see it moving down decisively, that’s all.”

“We’re two-and-a-quarter years into this, and forecasters, including Fed forecasters, have consistently thought inflation was about to turn down and typically forecasted that it would, and been wrong.”

“What we’d like to see is credible evidence that inflation is topping out and then getting it to come down.”

These were just some of the comments but give a flavor for what the mindset appears to be in the Eccles Building. Looking at the dot plot, the median expectation is for two more rate hikes in 2023 and there were zero expectations of a rate cut. The point is that higher for longer, which is what they have been preaching for upwards of a year, remains the mantra and given how robust the employment situation remains, they do not seem likely to change that view in the near term. A quick look at the Fed funds futures market shows a market probability of 71% for a rate hike in July where things peak, and then pricing for a cut in January. However, as I have maintained, I see inflation remaining quite sticky and the probability of a rate cut as far lower than that.

The market response was perfectly sensible in the bond market, where yields continue to climb, and the yield curve inversion increased to -91bps. 2-Year yields are now back to 4.73% as traders and investors price in a much higher probability that even if rates don’t rise much further, they are unlikely to fall back. In fact, 10-Year yields around the world have all risen further as the global tightening cycle seems set to continue. Recall, we saw Canada, Australia and now the Fed come out hawkishly and this morning the ECB is set to follow suit with a 25bp rate hike. At this stage, there are no G10 central banks that believe they have solved the inflation problem…and they are right.

A quick look at European sovereign yields ahead of the ECB announcement shows they have risen between 5bps and 10bps this morning as there is clearly an expectation that after the extremely hawkish commentary from Powell yesterday, Madame Lagarde will be forced to follow suit. In truth, that seems a reasonable expectation and when looking at the OIS market in Europe, expectations appear to be for another one or two hikes after today’s move. Given that inflation remains sticky there too, that doesn’t seem far-fetched.

On last thing regarding central bank hikes is the Bank of England next week, where a 25bp hike is fully priced, but more impressively, an additional 4 hikes are priced in by the end of the year. Inflation in the UK has clearly been even more problematic than in the Eurozone or the US, while the Old Lady has been lagging lately so this does make sense as well.

There are, though several places where tighter policy is not on the cards, namely China and Japan. Starting with Japan first, YCC remains the current policy framework and there is no indication they are going to change things anytime soon. 10-year yields there remain well below the YCC cap and there is much more discussion regarding the potential for a snap election in Japan than about monetary policy. The yen (-0.8%) is weakening further today as the more hawkish Fed combined with the continued dovishness of the BOJ weigh on the currency. We’ve seen this movie before when the dollar ran up above 150 in October, and while that is still a long way from today’s price, the trend since March has been very clear. Absent a major policy change from either the Fed or the BOJ, look for a weaker yen over time.

As to China, they did cut their Medium-Term Lending Facility rate by 10bps last night as widely expected although the currency did not really move as it was fully priced already. However, the Chinese government is clearly flailing about for ways to support the economy without increasing the leverage that already exists. The problem is that the PBOC toolkit, as well as the CCP toolkit, relies on centralized direction not market activity, and it appears that the limits of those policies are starting to be reached. There is little reason to believe the renminbi is going to rebound in the short-term as a weaker currency is the only outlet valve they have. Given measured inflation in China has been so low, I expect we can see a continued grind lower (dollar higher) in the second half of the year. Think 7.50 by Christmas.

With all that news, US equity markets had a mixed picture yesterday with the NASDAQ continuing its run higher with a small (0.4%) gain, but the rest of the market under more pressure. Chinese equities responded quite positively to the rate cut there with substantial gains, but the Nikkei was simply flat on the day. And now, European bourses are in the red by about -0.7% with US futures also pointing lower.

Oil prices (+0.75%) are edging higher but that is after a reversal yesterday brought them back below $70/bbl. There remains a great deal of controversy over just how badly demand is going to be hit given the lackluster Chinese economy and the huge split on views regarding the US and Europe with a recession call still quite popular although there are those who are now calling for a successful soft landing by the Fed. Precious metals are a little less precious this morning as are base metals which are indicative of dollar strength I believe. However, net, I would say the commodity space is more in the recession camp than not.

Finally, the dollar is stronger vs virtually all its EMG counterparts with HUF (-1.25%) the laggard as market participants take profits in anticipation of a rate cut from Hungary vs. the Fed’s tough talk. But the bulk of the bloc is weaker across all three regions. In the G10, while the yen is worst off, we are seeing weakness almost everywhere except NOK (+0.3%) which is clearly benefitting from oil’s modest rally. Given the Fed’s unambiguous hawkishness, I suspect the dollar will remain better bid than not for a while yet.

On the data front, there is a lot coming today as follows: Retail Sales (exp -0.2%, +0.1% ex autos); Initial Claims (245K); Continuing Claims (1768K); Empire Manufacturing (-15.1); Philly Fed (-14.0); IP (0.1%); and Capacity Utilization (79.7%). At this point, the Retail Sales data is likely the most important as the discussion regarding a recession will hinge on whether or not economic activity is still improving. Remember, though, this data is nominal, not inflation adjusted. On a real basis, Retail Sales have been falling for 6 months straight, not a good sign. As to the Fed speaking slate, nobody is on the calendar today, but we will hear from three (Bullard, Waller and Barkin) tomorrow, with all likely to be focused on reiterating the hawkish message.

A hawkish Fed bodes well for the dollar going forward, so unless (until?) something in the US economy breaks, my money is on higher rates and a stronger dollar.

Good luck

Adf

Canada’s Burning

Posted on June 8, 2023 by fxpoet

In Europe, the data today
Showed growth’s in a negative way
Recession is here
Though not too severe
While pundits are filled with dismay

Meanwhile in the States there’s a haze
Of smoke for the last several days
That Canada’s burning
Is somewhat concerning
As forests there still are ablaze

Arguably, the story that is getting the most press is the ongoing wildfires in Canada which has led to significant smoke issues throughout the Midwest and East Coast of the US. In fact, at one point yesterday, the FAA closed LaGuardia Airport in New York because the smoke was so thick. The latest that I have seen indicates these fires are likely to continue to burn for a number of days yet as they are nowhere near under control in Canada. I guess we will need to get used to an orange sun rather than a yellow one for the time being. While there is no evidence yet of any true behavioral changes, be alert for government edicts to prevent people from traveling or going outside and a short-term reduction in economic activity, at least in June while this is ongoing. I fear that the willingness of government officials to declare states of emergency and take on dictatorial powers has grown since Covid, so it will be interesting to see how this plays out. A headline across the tape just now (7:00) shows that LaGuardia is shut down for inbound flights again due to reduced visibility. In the end, be careful as inhaling too much smoke will not be good for you.

But after that, which is truly wagging every tongue in NY, the other story of note is that the Eurozone has fallen into a technical recession, with the final revision of Q1 GDP falling to -0.1%, and Q4’s numbers being revised lower as well, to -0.1%, after much weaker than previously assumed data from both Germany and Ireland was incorporated into the statistics. You may recall the argument in the beginning of 2022 when the US suffered through two consecutive quarters of negative real GDP growth, but there was a great effort to claim that was not a recession. And officially it was not as in the US a recession is not official until the NBER declares it so in hindsight. But Europe does not have an NBER and there is no argument at this point that the Eurozone went through quite a weak patch recently.

Arguably, though, of more importance is whether this weakness will continue or whether we have just witnessed the much-anticipated recession. This matters a great deal because next week, the ECB meets and is widely expected to raise its interest rate scheme by a further 25bps with the market pricing in an additional hike there by summer. If the Eurozone is in recession, especially if it starts to deepen a bit more aggressively than the recent -0.1% quarterly data, will the ECB have the resolve to continue to fight inflation and keep raising rates? Granted, their mandate is purely inflation focused, unlike the Fed’s dual mandate of inflation and employment, so they would be well within their rights to do so. But…continuing to raise interest rates into a clear recession is a very difficult decision as it can easily be seen as a policy error. At this point, my take is they will indeed hike next week, but I am far more skeptical about future hikes especially as the Fed is pausing skipping this meeting and may well be done. The idea that the ECB will continue to tighten policy aggressively while the Fed is not seems pretty far-fetched based on its history.

Speaking of rate hikes, Canada is in the news there as well after the BOC surprised the market and unpaused (?) by hiking 25bps yesterday. Essentially, they have concluded that economic activity is too strong to allow inflation to return to their 2% goal, the same reasoning we heard from the RBA last week when they surprised markets and raised their base rate. While the FX market response was not quite as aggressive as in Australia (CAD rose 0.5% on the news and has basically tread water since then), the move has certainly forced rethinking the assumption that the Fed is actually going to skip this meeting. Arguably, much will depend on next Tuesday’s CPI data with current estimates there for 4.2% headline and 5.2% core. Any number that prints hot will get tongues wagging about the Fed continuing to raise rates with corresponding market impacts. For now though, we can merely guess.

And that is the background for today’s session. Yesterday saw a bit of a pullback in risk assets in the US with most of Asia following lower, although Chinese stocks held up. Eurozone bourses are all marginally higher this morning, as it seems the growth data was less concerning and hopes that the ECB would be forced to stop hikes sooner have been a driving force. As to US futures, they are all essentially unchanged this morning as everybody continues to wait for the Fed next week.

Bond markets, though, were a bit shaken by the BOC move with yields climbing in the US yesterday and a further 1bp rise this morning back to 3.80%. In addition, 2yr yields are back up to 4.55%, and with the Treasury now having no debt ceiling at all, I expect we will see significant issuance driving yields higher still. In Europe, the picture is more mixed with yields either side of unchanged as there is confusion on how to play this market. And one final thing is in Japan, where JGB yields have edged higher by 2bps overnight and are now at 0.434%, slowing approaching the YCC cap. That is a potential issue for the not-too-distant future so we will keep on top of it.

Oil prices continue their slow rebound, up 0.9% this morning and actually up 4.3% in the past week. Perhaps the Saudi production cuts are finally being priced, or perhaps the idea that Canada has indicated stronger growth is seen as a harbinger of a better economic situation and less demand destruction. As to metals prices, gold, which fell sharply yesterday, is rebounding slightly and the base metals are mixed. As long as we get conflicting economic signals (weakness in Europe, strength in North America) I think these metals will have a difficult time choosing a direction.

Finally, the dollar is generally softer this morning, which given the higher yields in the US is a bit surprising. But NOK (+0.7%) leads the way on oil strength, and we continue to see strength throughout the commodity bloc. Even the euro has rallied this morning, although that feels far more like position adjustments than fundamentally driven movement. As to the EMG bloc, ZAR (+0.7%) is once again at the head of the list, entirely on commodity movement but most of EMEA is stronger while Asian currencies were generally under a bit of pressure overnight. At this point, I continue to believe most markets are awaiting the FOMC meeting as the next potential catalyst and so expect limited directional trading until then.

On the data front, Initial (exp 235K) and Continuing (1802K) Claims are on tap this morning, neither of which seem likely to move the needle. Yesterday’s Trade data was modestly better than expected while Consumer Credit grew a bit more than expected. In the end, though, it is still all about the Fed. As such, I expect more back and forth but no secular movement until we hear from the FOMC.

Good luck

Adf

Every Reason

Posted on January 20, 2022 by fxpoet

While prices in Europe are leaping
According to Christine’s bookkeeping
She’s got “every reason”
To keep on appeasin’
The ECB doves who are sleeping

So, rather than look to the Fed
She’s focused on China instead
Where they just cut rates
As growth there stagnates
And Covid continues to spread

One has to wonder exactly what Christine Lagarde is looking at when she makes comments like she did this morning. Specifically, she said the following in a radio interview in France, [emphasis added] “We have every reason to not react as quickly and as abruptly as we could imagine the Fed might, but we have started to respond and we, of course, stand ready to respond with monetary policy if figures, data, facts, require it.” Remember, the ECB has a single mandate, achieving price stability which they define as 2% inflation over the medium term. With this in mind, let me recount this morning’s data, which clearly has Madame Lagarde nonplussed: German Dec PPI +5.0% M/M and +24.2% Y/Y, the highest figures ever in the history of German record keeping back to 1949. Eurozone Dec CPI +0.4% M/M and 5.0% Y/Y, also the highest since the creation of the Eurozone. I realize I am a simple FX salesman, but to my uneducated eye, those indications of inflation seem somewhat above 2.0%. Perhaps mathematics in France is different than here in the US, but I would challenge Madame Lagarde to explain a bit more carefully why, despite all evidence to the contrary, she thinks the ECB is acting in accordance with their mandate. I suspect there are about 83 million people in Germany who may be wondering the same thing.

Certainly, traders do not believe her or her colleagues when they say, as Pablo Hernandez de Cos did “an increase in interest rates is not expected in 2022.” De Cos is the head of the Spanish central bank and a Governing Council member and clearly not a hawk. Yet, the OIS market in Europe is pricing in 0.20% of rate hikes by the end of 2022 (the ECB has been moving in 10 basis point increments), so two rate hikes. I also realize that there appear to be many econometric models around that are forecasting a return to much lower inflation within the next twelve months, certainly those are the models the central banks themselves are using. It seems that the real question is at what point will the central banks, specifically the Fed and ECB, recognize that their models may not be a very accurate representation of reality? And I fear the answer is, never!

Perhaps Madame Lagarde was channeling Yi Gang, the PBOC’s Governor, although the situation on the ground in China is clearly different than that in Europe. For instance, after cutting two important interest rates last Friday, the PBOC cut two different interest rates last night, the 1-year loan prime rate by 0.10% down to 3.70%, and the 5-year rate was cut by 5 basis points to 4.60%. China continues to struggle with their zero covid policy. They continue to fall behind the curve there as the omicron variant is so incredibly transmissible. But what is clear is that China is growing increasingly concerned over the pace of growth in the economy and so the PBOC has begun to act even more aggressively. While 5 and 10 basis point moves may not seem like a lot, given how infrequently the PBOC has been willing to cut interest rates, they are an important signal to market participants that support is at hand. This was made clear by the equity markets last night where the Hang Seng, home to so many property companies, exploded higher by 3.4% although Shanghai’s market was quite subdued, actually slipping 0.1%.

In the end, it is clear that global synchronicity is not an appropriate way to think about the current macroeconomic situation. Given the dramatically different ways that different nations approached the Covid pandemic, it should be no surprise that there are huge differences in rates of growth and inflation around the world. The hedging implications of this outcome are that it will require more specific analysis of each country in which there is an exposure to determine the best way to mitigate risks there.

With that in mind, let us take a look at markets this morning. Despite Shanghai’s lackluster performance, the rest of Asia was actually quite solid with the Nikkei (+1.1%) rounding out the top markets. Europe, on the other hand, has been less positive with the DAX (+0.1%) edging higher while both the CAC (-0.1%) and FTSE 100 (-0.1%) are slipping a bit. I guess more promises of ongoing policy ease were not enough to overcome the soaring inflation story on the continent. US futures are all pointing higher at this hour, with NASDAQ (+0.9%) leading the way although that index has fallen by 10% from its highs, so has more room to catch up.

Looking at the bond market, I can’t help but wonder if we have seen peak hawkishness earlier this week, at least for the Fed. After the long weekend, we saw the 10-year Treasury yield trade up to 1.88%, but since then it has slipped back with today’s price action seeing yields fall an additional 2.7 basis points and placing us 4bps off those highs. Now, this could simply be a short-term correction, but with the Fed announcement next week, it really does feel like the market has gotten way ahead of itself. At this point, the only way next week’s FOMC could be seen as hawkish would be if they actually raised rates, something to which I ascribe a zero probability. One other thing to recall is that recent surveys continue to show a large contingent of fund managers believe that inflation is transitory which implies that they are likely to take advantage of the current rise in yields and prevent things from running away.

On the commodity front, oil (-0.4%) has stopped running higher, although this pause seems much more like a consolidation than a change in views. NatGas (-1.5%) is also a bit softer today in both the US and Europe as seasonal or higher temperatures continue to reduce marginal demand. Turning to metals markets, gold (-0.2%) is slightly softer this morning, but overall, despite rising interest rates, has held up quite well lately and remains well above the $1800/oz level. Interestingly, silver (0.0% today +4.6% this week) seems to be having a much better time of things and technically looks to have broken out higher. Arguably, this information blends well with the thought that bond yields may have peaked, but we shall see.

As to the dollar, it is mixed this morning with both gainers and losers in both the G10 and EMG spaces. The funny thing is, other than RUB (-0.6%) which is leading the way lower today on the back of threats of more substantial sanctions in the event Russia does invade the Ukraine, the rest of the story is much harder to pin down. For instance, from a news perspective Bank Indonesia met last night and left rates on hold, as expected, but indicated that it would begin normalizing monetary policy in March, returning its RRR to its pre-covid levels, but the rupiah only rose 0.2%. In fact, today’s leading gainer is ZAR (+0.75%), but given the dearth of either data or news, the best bet here seems to be a response to precious metals strength. One other thing to remember is that despite easing by the PBOC, the renminbi continues to edge higher. Frankly, I see no reason for it to weaken anytime soon, especially with my view the dollar will be suffering going forward.

On the data front, Initial Claims (exp 225K), Continuing Claims (1563K), Philly Fed (19.0) and Existing Home Sales (6.43M) are on the calendar. Remember, Empire Manufacturing was a huge bust earlier this week, so watch the Philly Fed number for any indication of weakness and slowing growth here at home. In fact, it is that scenario that will allow the Fed to remain on the dovish side, although I fear it will not slow down the inflation train.

If there are any inklings that the Fed is not going to be as hawkish as had seemed to be believed just a few days ago, I expect that the dollar will come under further pressure. In fact, in order to change that view we will need to see a very hawkish outcome from next Wednesday’s FOMC, something I do not anticipate. Payables hedgers, I fear the dollar may be near its peak, so don’t miss out.

Good luck and stay safe
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Walking the Walk

Posted on December 17, 2021 by fxpoet

Two central banks managed to shock
The market by walking the walk
The Old Lady jacked
By fifteen, in fact
Banxico then doubled the talk

So, now that it’s all said and done
C bankers, a new tale have spun
The virus no longer
Is such a fearmonger
Inflation’s now job number one

Talk, as we all know, is cheap, but from the two largest central banks, that’s mostly what we got. While Chairman Powell got a positive market response from his erstwhile hawkish comments initially, yesterday investors started to rethink the benefits of tighter monetary policy and decided equity markets might not be the best place to hold their assets. This is especially true of those invested in the mega-cap tech companies as those are the ones that most closely approximate an extremely long-duration bond. So, the NASDAQ’s -2.5% performance has been followed by weakness around the globe and NASDAQ futures pointing down -0.9% this morning. As many have said (present company included) the idea that the Fed will be aggressively tightening monetary policy in the face of a sharp sell-off in the stock market is pure fantasy. The only question is exactly how far stocks need to fall before they blink. My money is on somewhere between 10% and 20%.

Meanwhile, Madame Lagarde continues to pitch her view that inflation remains transitory and that while it is higher than the target right now, by next year, it will be back below target and the ECB’s concerns will focus on deflation again. So, while the PEPP will indeed be wound down, it will not disappear as it is always available for a reappearance should they deem it necessary. And in the meantime, they will increase the APP by €40 billion/month while still accepting Greek junk paper as part of the mix. Even though inflation is running at 4.9% (2.6% core) as confirmed this morning, they espouse no concern that it is a problem. Perhaps the most confusing part of this tale is that the EURUSD exchange rate rallied on the back of a more hawkish Fed / more dovish ECB combination. One has to believe that is a pure sell the news result and the euro will slowly return to recent lows and make new ones to boot.

One final word about the major central banks as the BOJ concluded its meeting last night and…left policy unchanged as universally expected. There is no indication they are going to do anything different for a long time to come.

However, when you step away from the Big 3 central banks, there was far more action in the mix, some of it quite surprising. First, the BOE did raise the base rate by 15 basis points to 0.25% and indicated that it will be rising all throughout next year, with expectations that by September it will be 1.00%. The MPC’s evaluation that omicron would not derail the economy and price pressures, especially from the labor market, were reaching dangerous levels led to the move and the surprise helped the pound rally as much as 0.7% at one point. Earlier yesterday, the Norges Bank raised rates 25bps, up to 0.50%, and essentially promised another 25bp rise by March. Then, in the afternoon, Banco de Mexico stepped in and raised their overnight rate by 0.50%, twice the expected hike and the largest move since they began this tightening cycle back in June. It seems they are concerned about “the magnitude and diversity” of price pressures and do not want to allow inflation expectations to get unanchored, as central bankers are wont to say.

Summing up central bank week, the adjustment has been significant from the last round of meetings with inflation clearly now the main focus for every one of them, perhaps except for Turkey, where they cut the one-week repo rate by 100 basis points to 14.0% and continue to watch the TRY (-7.0%) collapse. It is almost as if President Erdogan is trying to recreate the Weimar hyperinflation of the 1920’s without the war reparations.

Will they be able to maintain this inflation fighting stance if global equity markets decline? That, of course, is the big question, and one which history does not show favorably. At least not the current crop of central bankers. Barring the resurrection of Paul Volcker, I think we know the path this will take.

This poet is seeking his muse
To help him define next year’s views
Thus, til New Year’s passed
Do not be aghast
My note, you’ll not have, to peruse

Ok, for my final note of the year, let’s recap what has happened overnight. As mentioned above, risk is under pressure after a poor performance by equity markets in the US. So, the Nikkei (-1.8%), Hang Seng (-1.2%) and Shanghai (-1.2%) all fell pretty sharply overnight. This morning, Europe has also been generally weak, but not quite as badly off as Asia with the DAX (-0.65%) and CAC (-0.7%) both lower although the FTSE 100 (+0.3%) is bucking the trend after stronger than expected Retail Sales data (+1.4%). Meanwhile, Germany has been dealing with soaring inflation (PPI 19.2%, a new historic high) and weakening growth expectations as the IFO (92.6) fell to its lowest level since January and is trending sharply lower. US futures are also pointing lower at this hour.

Bond markets, meanwhile, are generally firmer although Treasury yields are unchanged at this time. Europe, though, has seen declining yields across the board led by French OATs (-2.6bps) and Bunds (-1.8bps) with the peripherals also doing well. Gilts are bucking this trend as well, with yields unchanged this morning.

In the commodity space, oil (-1.75%) is leading the energy sector lower along with NatGas (-1.9%), but metals markets are going the other way. Gold (+0.5%, and back above $1800/oz) and silver (+0.7%) feel more like inflation hedges this morning, and we are seeing strength in the industrial space with copper (+0.45%), aluminum (+2.1%) and tin (+1.8%) all rallying.

Lastly, looking at the dollar, on this broad risk-off day, it is generally stronger vs. its G10 counterparts with only the yen (+0.2%) showing its haven status. Otherwise, NZD (-0.5%) and AUD (-0.4%) are leading the way lower with the entire commodity bloc under pressure. As to the single currency, it is currently slightly softer (-0.1%) but I believe it has much further to run by year end.

In the EMG bloc, excluding TRY’s collapse, the biggest mover has actually been ZAR (+0.6%) after it reported that the hospitalization rate during the omicron outbreak has collapsed to just 1.7% of cases being admitted. This speaks to the variant’s less pernicious symptoms despite its rapid spread. Other than that, on the plus side KRW (+0.25%) benefitted from central bank comments that they would continue to support the economy but raise rates if necessary. On the downside, CLP (-0.4%) is opening poorly as traders brace for this weekend’s runoff presidential election between a hard left and hard right candidate with no middle ground to be found. However, beyond those moves, there has been much less activity.

There is no economic data today and only one Fed speaker, Governor Waller at 1:00pm. So, the FX market will once again be seeking its catalysts from other markets or the tape. At this point, if risk continues to be shed, I expect the dollar to continue to recoup its recent losses and eventually make new highs.

As I mention above, this will be the last daily note for 2021 but the FX Poet will return with his forecasts on January 3rd, 2022, and the daily will follow afterwards. To everyone who continues to read, thank you for your support and I hope everyone has a happy and healthy holiday season.

Good luck, good weekend and stay safe
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fxpoetry

Explaining the rhyme and rhythm of the FX markets each day

Tag Archives: #ECB

Just Kidding

A Suggestion

A Bad Dream

Havoc We’ll Wreak

Confusion Reigns

The Battle’s Been Won

Firmly On Hold

Canada’s Burning

Every Reason

Walking the Walk