Tag Archives: economics

They Will Get Burned

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In Europe, the corporate elite
Have started, their worries, to bleat
They’re now quite concerned
That they will get burned
If dollar sales start to retreat
 
For years, when the dollar was rising
Weak unit sales, it was disguising
But now the buck’s falling
Which they find appalling
As earnings forecasts, they’re downsizing
 

Markets are very interesting constructs.  Not only do they help find a clearing price for supply and demand of something, but they also tend to take on anthropomorphic characteristics in many eyes as some type of creature beyond anyone’s control, but with a tinge of malevolence.  Part of that latter feeling comes from markets’ ability to make every pundit seem like a fool.  After all, it was just 3 days ago when I was reliably informed by the punditry that equity values were set to collapse as the US economy entered a depression.  It seems we may have to wait a few more days for that situation to play out.  And, in fact, they have now changed their tune.  While ascribing the rebound to President Trump’s reversal on some issues, the overall doom and gloom story has moved to the background.  But if there is one thing I have continuously discussed since Trump’s election is that volatility was very likely to increase, and that has certainly been the case. 

Shifting our focus to the FX markets, though, I couldn’t help but chuckle at a Bloomberg article this morning titled, The Dollar’s Slide is Raising Red Flags for Corporate Earnings.  As I am based in the US, the fact that this was a front-page article had me somewhat confused.  A long career in speaking with corporate accounts on FX made it clear that a weak dollar was the best thing for earnings of US multinationals.  Generally, when the dollar was strong, CFOs would ascribe any earnings problems to that issue as a catch-all excuse, but when the dollar declined, outperformance by a company was the result of brilliant execution.

So, you can understand my initial confusion.  But upon reading the article, it turns out they were talking about European corporates, who for the first time in three years find that hedging their US dollar sales is critical.  Not only that, but they have also been quick to highlight that all new hedges will be at worse rates and therefore future earnings are already sure to be impacted.  Now, a quick look at the chart below does show that the euro has risen to its highest level in three years.  But it also shows that compared to the past 20 years, the euro is nowhere near high levels. In fact, it sits well below the median price (somewhere in the 40th percentile actually).  Perhaps European corporate Treasurers have simply forgotten their history.  Or more likely, just like US corporate Treasurers when the dollar is rising, they are seeking a scapegoat.

I cannot emphasize enough that the FX rate is not the driver, but the release valve for all the things that happen in the global economy.  Other actions take place, whether interest rate changes, policy or market, economic adjustments, policy or market, or exogenous events, and the FX rate is the place where equilibria are found.  In fact, arguably, that is the biggest flaw in the Trump administration’s idea that if they weaken the dollar, it will solve policy problems.  The dollar is the tail to the economy’s dog.

In the meantime, the reason one runs a hedge program with consistency is to mitigate the big moves in FX and their impacts on earnings.  But remember, even the best hedge programs lag large secular moves.

Ok, I’ll step down off my high horse and let’s look at how markets behaved overnight.  After yesterday’s second consecutive rally in the US, the picture elsewhere in the world is more mixed.  In Asia, the Nikkei (+0.5%) continued its rebound but the Hang Seng (-0.75%) and CSI 300 (-0.1%) saw no benefit overnight.  Elsewhere in the region winners and losers were pretty evenly split and nobody saw a movement of more than 0.8% in either direction.  In Europe, red is today’s color, but it’s a pale red with losses across the board of the 0.1% to 0.25% variety.  The only news overnight was German Ifo data, which showed a bit of a surprising uptick in the current business climate as well as expectations.  Perhaps the promise of more German fiscal largesse is outweighing concerns over tariffs.  As to US futures, they, too, are lower by about -0.15% at this hour (7:20).

In the bond market, yields are sliding around the world with Treasuries (-3bps) continuing to back away from their recent highs while European sovereigns see yields decline between -3bps and -4bps.  Even JGB yields slipped -1bp overnight.  My take is some of the fear has ebbed away from the market.

In the commodity markets, oil (+1.1%) remains in its recent trading range, with a still very large gap above the market in price terms.  The demand story seems fixed at weakening demand because of either slowing growth, or the electrification of everything or something like that, while the supply story is starting to see hints that oil companies are going to back off production with prices at current levels.  The latter feels like the larger short-term risk, although nothing has changed my longer-term view of lower prices here.  In the metals markets, gold (+0.7%) is rebounding after a difficult two days, arguably some real profit taking was seen.  Meanwhile silver (-0.5%) which actually outperformed gold for the past two sessions is giving some of those gains back and copper (+0.8%) is continuing its rebound after a dramatic decline from the all-time highs seen just one month ago.  Talk about a V-shaped recovery!

Source: tradingeconomics.com

Finally, the dollar is softer this morning, giving back about half of yesterday’s 1% gains.  In the G10, SEK and NOK (both +1.1%) are leading the way although the euro (+0.6%) is having a good day, as is the yen (+0.75%). The pound (+0.5%) is a bit of a laggard but after seeing this interview of Ed Miliband (UK Secretary of Energy and Climate Change), and his either inability to understand the implications of his policy, or his willingness to lie about it, I cannot believe the pound will continue to track the euro.  The UK’s energy policy appears designed to destroy the UK economy.  Consider that solar power is a key pillar of their future efforts to achieve net zero carbon emissions, and the UK is the nation that gets the least solar coverage in the world.  After all, it rains there half the time.  Meanwhile, the government is keen to end all other sources of energy.  No matter what you think of President Trump’s policies, they are not nationally suicidal like the UK’s.

Turning to the EMG bloc, gains are the norm, but not universal.  The CE4 are doing well but ZAR (-0.2%) and KRW (-0.6%) with the latter suffering from weaker than expected GDP growth in Q1 while the former, after a strong run since early in April, appears to merely be taking a breather.

We finally see some notable data this morning with Initial (exp 222K) and Continuing (1880K) Claims, Durable Goods (2.0%, 0.3% ex-Transport) and the Chicago Fed National Activity Index (0.11) all at 8:30, then at 10:00 we get Existing Home Sales (4.13M).  Yesterday saw New Home Sales pick up more than expected and the Beige Book indicate that economic activity was unchanged from the past, but uncertainty had risen.

Here’s what we know; the world is not ending but it is continuing to change from the structures created in the post WWII period.  This process is just beginning and anybody who claims to know where things are headed is lying.  I continue to believe in my bigger picture views, but day to day, there is no rhyme or reason, especially given the importance of headline bingo.

Good luck

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Tripping Off Tongues

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Recession is tripping off tongues
And pundits ain’t twiddling their thumbs
Political shades
Are driving tirades
And screams at the top of their lungs
 
But are we that likely to see
A minus in our ‘conomy?
We certainly could
And probably should
But life doesn’t always agree

 

The major discussion point over the weekend has been recession, and how likely we are to see one in the US in the coming months.  Of course, this matters to the punditry not because of any concern over the negative impacts a recession has on the population, but ‘more importantly’ because recessions tend to result in sharp declines in equity values.  And let’s face it, do you honestly believe that the editors of the New York Times or the Wall Street Journal are remotely interested in the condition of the majority of the population?  Me neither. 

However, if they can call out something that they believe can impede President Trump, or detract from his current high ratings, they will play that over and over and over.  Funnily enough, when I went to Google Trends, I looked up “recession” over the past 90 days with the result below:

That peak was on March 11 although there was no data of note that day compared to a reading of 9 today. Looking at the news of that day, even CNN had a hard time finding bad news with the four top stories being 1) the Continuing Resolution vote in the House being passed, 2) the Department of Education announcing a 50% RIF, 3) 25% tariffs on steel and aluminum being imposed and 4) Ukraine accepting terms for a 30-day ceasefire.  From an economic perspective, the tariffs clearly will have an impact, but it seems a leap that the average American can go from 25% tariffs on imported steel and aluminum to recession in one step.  And based on the positive responses that continue to be seen regarding President Trump’s efforts to reduce the size of government, I doubt the DOE cuts were seen as the beginning of the end of the economy.  

And yet, recession was the talk of the punditry this weekend.  To try to better understand why this is the case, I created the following table of several major economic indicators and their evolution since December, prior to President Trump’s inauguration.

Key indicatorsDecJanFeb
NFP323125151
Unemployment Rate4.10%4.00%4.10%
CPI2.90%3.00%2.80%
Core CPI3.20%3.30%3.10%
PCE2.60%2.50% 
Core PCE2.90%2.60% 
IP1.10%0.30%0.70%
Capacity Utilization77.60%77.70%78.10%
ISM Mfg49.250.950.3
ISM Services5452.853.5
Retail Sales0.70%-1.20%0.20%

Source: tradingeconomics.com

Once again, while I am certainly no PhD economist, this table doesn’t strike me as one demonstrating a clear trend in worsening data, certainly not on an across-the-board basis.  Rather, while you might say January was soft, the February data has largely rebounded.  My point is that despite ABC, NBC, Bloomberg, the BBC and CNN all publishing articles or interviews on the topic this weekend, I’m not yet convinced that is the obvious outcome.

My good friend the Inflation Guy™, Mike Ashton, made an excellent point in a recent podcast of his that is very well worth remembering.   The breadth of the US economy is extraordinarily wide and covers areas from manufacturing to agriculture to finance to energy and technology along with the necessary housing markets as well as the entire population consuming both goods and services.  Added to the private sector, the government sector is also huge, although President Trump and Elon Musk are trying hard to shrink it.  But the point is that it is not merely possible, but likely, that while some areas of the economy may go through weak patches, that doesn’t mean the entire economy is going to sink into the abyss.

If we think back to the last two recessions, the most recent was Covid inspired, which resulted from the government literally shutting down the economy for a period of several months, while giving out money.  Net, things weakened, but even then, there were stronger parts and weaker parts.  Go back to the GFC and the housing bubble popped and dragged banks along with it.  That was the problem because banking weakness inhibits the free flow of money and that will impact everyone.

The question to be asked now, I would suggest is, are we likely to see another catalyst that will have such widespread impacts?  Higher tariffs are not going to do the trick.  Shrinking government, although I believe it is critical for a better long-term trajectory for the economy, will have a short-term impact, but it is not clear to me that it will negatively impact the economy writ large.  Certainly, the Washington DC area, but will it impact the Rocky Mountain area?  Or Texas and Florida?  

Now, a recession could well be on the way.  Running 7% budget deficits was capable of papering over many holes in the economy and pumping lots of liquidity into it as well.  If those deficits shrink, meaning spending shrinks, the pace of activity will slow.  But negative?  It seems a stretch to me, at least based on what we have seen so far.  One last thing here, is how might this potential weakening economic growth impact inflation? Now, we all ‘know’ that a recession causes inflation to decline, don’t we?  Hmmm. While that makes intuitive sense, and we hear it a lot, perhaps the Inflation Guy™ can help here as well.  Back in February he wrote a very good explanation about how that is not really the case at all, at least based on the macroeconomic data.  The truth is economic growth and inflation have very little correlation at all.

Of course, perhaps the most critical issue for the punditry is, will a recession drive stock prices lower?  Here the news is far less sanguine if you are a shareholder and believe there is going to be a recession.  As you can see from the below chart of the S&P 500, pretty much every recession for the last 100 years has resulted in a decline in stock market indices.

Source: macrotrends.net

This is a log chart so some of those dips don’t seem that large, but the average downturn during a recession is about 30%, although that number can vary widely.  To sum it up, while the data doesn’t scream recession to me, it cannot be ruled out.  As well, both President Trump and Secretary Bessent have indicated that weakness is likely going to be a result of their early actions, although the idea is to pave the way for a more stable economic performance ahead.  As I have written repeatedly, volatility is likely the only thing of which we can be certain as all these changes occur.  Hedge your exposures!

Ok, let’s look at the overnight activity.

The rumor is Trump may delay
His tariffs as he tries to weigh
How much he should charge
And how much, writ large,
These nations are going to pay

Equity futures in the US are higher this morning as the big story is that President Trump is considering narrowing the scope of nations who will have tariffs imposed on April 2nd.  Apparently, his administration has identified the “dirty fifteen” nations with the largest bilateral imbalances and they will be first addressed.  The telling comment in the WSJ article I read was when Trump said, “Once you give exemptions for one company, you have to do that for all. The word flexibility is an important word. Sometimes there’s flexibility, there’ll be flexibility.”  To my ear, the final plans are not in place, but my sense is he will impose then remove tariffs, rather than avoid them initially.  Interestingly, that story was written last night, yet Asian equity markets were not that ebullient.  Japan (-0.2%) saw no benefit although Chinese shares (HK +0.9%, CSI 300 +0.5%) fared better. Things elsewhere in the region were mixed with both gainers (India, Thailand) and laggards (Korea, Taiwan, Indonesia) with many bourses little changed overall.

In Europe, green is the predominant color this morning but movement is modest with Spain’s IBEX (+0.4%) the leader and lesser gains elsewhere.  While US futures are all higher by about 1% or more at this hour (6:45) apparently the Europeans aren’t as excited at the tariff delay process.

In the bond market, yields have backed up virtually across the board with Treasuries (+4bps) leading the way higher and most European sovereigns showing yields rising by 1bp or 2bps.  It’s interesting, while there has been much discussion regarding German yields having traded substantially higher in the wake of the effective end of the debt brake and anticipation of much further issuance, a look at the chart below tells me that after that gap higher on the news, concerns over German finances have not deteriorated at all.  And after all, the difference is about 25bps higher, hardly the end of the world.

Source: tradingeconomics.com

In the commodity markets, oil (+0.7%) is continuing its gradual rebound from the lows seen on, ironically, March 11th.  Arguably, what this tells us is that despite the weekend barrage of recession focused articles, the market doesn’t really see that outcome.  In the metals, strength is the word, again, with copper (+1.25%) making new all-time highs on the back of China’s stated goals of growing its strategic stockpile.  Not surprisingly, both gold (+0.2%) and silver (+0.6%) are also climbing this morning alongside copper as commodities remain in greater demand than a recession would indicate.

Finally, the dollar is a bit softer despite rising Treasury yields with both the euro (+0.3%) and pound (+0.4%) bouncing after last week’s modest declines.  And this is despite lackluster Flash PMI readings this morning out of Europe.  The biggest winner is NOK (+0.6%) which given the dollar’s broad weakness and oil’s rebound makes perfect sense.  Otherwise, while the dollar’s weakness is broad, it is no deeper than the aforementioned currencies.

Given the length of this note already (my apologies) and the dearth of data to be released, with only the Chicago Fed National Activity Index (exp +0.08), I will cover data tomorrow as we do end the week with GDP and PCE data.

Headline bingo remains the key concern for all market participants, but ultimately, my altered view of a softer dollar and higher commodities remains intact.

Good luck

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Starting to Fret

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In DC, they’re starting to fret
That Trump will make good on his threat
If government closes
The risk that it poses
Is markets become quite upset

 

There is yet another budget showdown in Washington as the Biden administration never passed the bills necessary to fund the government for the rest of this fiscal year ending on September 30th.  The previous continuing resolution (CR) expires at midnight on Saturday and if a new funding law is not enacted, then a government “shutdown” occurs.  Now, a government shutdown is not like a company that runs out of money shutting down.  Rather roles the President deems essential continue to operate, along with the military, but other roles see the people furloughed until new legislation is passed.  Everybody gets paid back wages when things go back to normal.

The situation is that the House of Representatives did pass a CR to fund the government at almost the exact same levels as last year and sent it to the Senate.  However, in the Senate, it needs to beat a filibuster, so needs 60 votes to pass and get to President Trump’s desk.  However, last night, Senate Minority Leader Shumer declared the Democrats would not support the bill, so would rather have the government shut down.  This is a big change from the previous 3 times that there were government shutdowns, because each of those was blamed on Republican intransigence.  

In the end, whatever the politics, the market impact has been negative for stocks while bonds held up, even rallied.  Of course, previous shutdowns all were amidst very different economic environments as inflation was quiescent and bull markets in both stocks and bonds were extant.  As such, arguably, the momentum behind the market was sufficient to offset any concern over the shutdown.  But this time markets are already under pressure going into the potential shutdown.  I fear that market dislocation, at least in the equity markets, could be far more severe if this one occurs.  Something to keep in mind.

The history shows the US
Has long done all things to excess
But now, as they try
With less, to get by
The pundits complain of regress

Reading the WSJ this morning, I couldn’t help but think of the George Costanza opposite day episode of Seinfeld when reading the Heard on the Street column decrying the fact that the Trump administration is seeking to rein in fiscal excess.  Of course, this is an issue that has been fodder for the punditry for a long time, how the US was living beyond its means and borrowing too much money.  But now, this article is concerned about the opposite.  The key concern is that if the US government doesn’t continue to run massive deficits, the economy will slow and corporate profits will fall dramatically, resulting in falling equity prices.

Arguably, this would always be the case if a change of this nature were to be made.  And remember, the punditry was all in on making these changes.  However, now, they point to Germany and the DAX, which has outperformed US markets over the past several weeks as the model.  (chart below from WSJ)

And what is Germany doing so well?  Why, they are talking about borrowing an extra €500 billion, eliminating their debt brake that ensures budget deficits remain below 0.35% of GDP, and funding a huge buildup in defense spending.  Germany, which has long been seen as the only source of fiscal rectitude is now being lionized for getting rid of that trait.  As I said, opposite day!

The lesson, if you haven’t learned it yet, is that the ascendance of Donald Trump to the presidency is going to continuously change many long-held beliefs in governments around the world, as well as in the punditry, who may find that things which seemed great in theory may have consequences previously unconsidered.  From a market perspective, this means volatility will continue to be the best estimate for the future.

Ok, let’s turn our attention to markets and see how things performed overnight.  After yesterday’s mixed session in the US, where the DJIA could not manage a gain despite cooler than expected CPI readings, overnight saw a mixed picture as well.  Japan was either side of unchanged while both Hong Kong (-0.6%) and China (-0.4%) slipped as did most other Asian markets with Malaysia (+1.7%) the true exception.  In Europe, though, screens are green as excess government spending is rewarded, although the gains are modest, 0.3% or so.  

On the topic of excess spending regarding Germany, I read yesterday that the plan to alter the constitution may have serious problems (meaning that spending may not materialize) because about 50 Bundestag members in the old parliament lost their seats in the election, so it is not clear they will be willing to vote to overturn the constitution during the current lame duck session and allow the debt brake to be set aside for defense purposes.  As I said when the story first arose, we are still a long way from Germany paying their own way defensively.  US futures, meanwhile, are slightly softer at this hour (7:15).

In the bond market, yesterday saw yields climb a few bps and this morning those trends remain with Treasury yields (+2bps) not climbing as much as European sovereigns (+3bps to 4bps) as there appears to still be a level of confidence that all the extra defense spending will happen.  One story that should have Europeans concerned is that the European Commission, in their effort to find funding for their newly found defensive aggressiveness, have spied the €10 trillion in savings that European citizens hold.  Frau von der Leyen, the European Commission President was quoted as saying, ”we’ll turn private savings into much needed investment.” 

Call me crazy but my economics classes taught me the identity that Savings º Investment, so I am not sure why those savings aren’t already being invested.  Perhaps European citizens are not investing where Frau von der Leyen wants and that is the problem.  At any rate, I suppose even if Germany fails to overcome its constitutional debt brake, the EU will get there anyway.

In the commodity markets, oil (-0.3%) is edging lower after a nice run for the past several days as it bounced off the bottom of its trading range.  Yesterday’s EIA data showed a large draw in gasoline, but I am given to understand that is a seasonal thing (H/T Alyosha).  Meanwhile, nothing has dissuaded investors that gold (+0.25%) is a good thing to hold as it rallied further after yesterday’s gains, although both silver (-0.3%) and copper (-0.4%) are a touch softer this morning.

Finally, the dollar is somewhat firmer this morning, albeit not dramatically so.  Of course, it has been under significant pressure during the past week+, so this trading response ought be no surprise.  SEK (-0.8%) is the laggard in the G10, but you must remember that it has been the leading gainer over the past month.  Meanwhile, AUD (-0.5%) and NZD (-0.45%) are also under a bit of pressure this morning, but the rest of this bloc has seen far less movement.  In the emerging markets, HUF (-0.6%) is the laggard with the rest of the bloc seeing declines on the order of -0.3% or less.  As I said, nothing dramatic here to see.

Yes, yesterday’s CPI data was a bit cooler than anticipated, but as my friend The Inflation Guy™, Mike Ashton, explained here, I wouldn’t get too excited that inflation is collapsing back to the Fed’s 2% target.  This morning brings the weekly Initial (exp 225K) and Continuing (1900K) Claims data as well as PPI (headline 0.3%, 3.3% Y/Y; core 0.3%, 3.5% Y/Y). However, given CPI is already out, I don’t think it will have much impact.  Rather, as we have observed lately, politics remains the key driver of all market reactions.  The unfolding government shutdown in the US and the German debt drama are the two most noteworthy issues right now, but Ukraine and the Middle East are still out there to offer surprises.

Once again, volatility is the only thing about which we can be sure.  That said, my confidence is growing that the dollar will decline over time.

Good luck

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In a Trice

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The calendar’s not e’en turned twice
Since Trump, with JD as his Vice
Have taken the reins
And beat up on Keynes
While weeding out waste in a trice
 
For markets, the problem, it seems
Is rallies are now merely dreams
So, equity buyers
Are putting out fires
While thinking up pump and dump schemes
 
For bondholders, it’s not so clear
If salvation truly is near
But one thing seems sure
The buck will endure
Much weakness throughout this whole year

 

We have not even reached 50 days of a Trump presidency as of this morning and nobody would fault you if you estimated we had three years of policies enacted to date.  The pace of changes has been blistering and clearly most politicians, let alone investors, have not been prepared for all that has occurred.

One of the things that I read regularly is that Trump is destroying the Rules Based Order (RBO) which was underpinned by the Pax Americana of the US essentially being the world’s policeman.  This is cast as a distinct negative under the premise that things were going great and now, he is upsetting the applecart for his own personal reasons.  Of course, market participants had grown quite accustomed to this framework, had built all sorts of models to profit from it and with the Fed’s help of monetization of debt, were able to gain significantly at the expense of those without market linked assets.  Hence, the K-shaped recovery.

But while that is a lovely narrative, is it really an accurate representation of the way of the world?  If the US was truly the world’s policeman, and we certainly spend enough on defense to earn that title, perhaps it was time for the US to be fired from that role anyway.  After all, there is currently raging military conflict in Ukraine, Lebanon, Syria, Congo, Sudan and the ongoing tensions in Gaza.  That’s a pretty long list of wars to claim that things were going great.

Secondly, the question of financing all this conflagration, as well as other economic goals, notably the alleged transition to net zero carbon energy production, appears to be reaching the end of the line.  While the US can still borrow as needed, (assuming the debt ceiling is raised), the reality is that the US gross national debt outstanding is greater than $36,000,000,000,000 relative to GDP that is a touch under $28,000,000,000,000.  On a global basis, total (not just government) debt is in excess of $300,000,000,000,000 while global GDP clocks in somewhere just north of $100,000,000,000,000.  Arguably, on a credit metric basis, the world is BB- or B+, a clear indication that all that debt is unlikely to be repaid.

If we consider things considering this information, perhaps the RBO had outlived its usefulness.  Arguably, the loudest complaints are coming from those who benefitted most greatly and are quite unhappy to see things change against them.  But as evidenced by the polls taken after President Trump’s speech last Tuesday evening, the bulk of the American public is still strongly supporting this agenda.  The idea that the president and his Treasury secretary are seeking to engineer a short-term recession early, blame it on fixing Biden’s mess, and having things revert to stronger growth in time for the 2026 mid-term elections is not crazy.  In fact, there have been several comments from both men that short-term pain would be necessary to achieve a stabler, long-term gain.

So, what does this mean for the markets?  You have no doubt already recognized that volatility is the main event in every market, and I don’t see that changing anytime soon.  But some of the themes that follow this agenda would be for US equities to suffer relative to other markets, as the last decade plus of American exceptionalism, led by massive deficit spending and borrowing, would reverse under this new thesis.  Add to this the sudden realization that other nations are going to be investing significantly more in their own defense, and money will be flowing out of the US into Europe, Japan and emerging markets around the world.

Bonds are a tougher call as a weaker economy would ordinarily mean lower yields, but the question of tariff impacts on prices, as well as reshoring, which, by definition, will raise prices, could mean we see the yield curve steepen with the Fed cutting rates more aggressively than currently priced, but 10-year and 30-year yields staying right where they are now.

I believe this will be a strong period for commodities as all that foreign capex will be a driver, as will the fact that, as I will discuss shortly, the dollar is likely to underperform significantly.  Gold will retain its haven characteristics as well as remain in demand for foreign central banks, while industrial metals should hold their own.  As to oil, my take is lower initially, as OPEC returns its production and slowing GDP weighs on demand, at least for a while, although eventually, I suspect it will rebound along with economic activity.

Finally, the dollar will remain under significant pressure across the board.  Clearly, Trump is seeking a weaker dollar to help the export industries, as well as discourage imports.  Add to this the potential for lower yields, lower short-term rates, and an exit of equity investors as US stocks underperform, and you have the making of at least another 15% decline in the greenback this year.

With this as backdrop, we need to touch on three key stories this morning.  First, Friday’s NFP report was pretty much in line with expectations at the headline level but seemed a bit weaker in some of the underlying bits, specifically in the Household Survey where a total of 588K jobs were lost and there was a large increase in the number of part-time workers doing so for economic reasons.  Basically, that means they wanted full-time work but couldn’t find a job.  Markets gyrated after the release, with yields initially sliding but then rebounding to close higher on the day.  Equities, too, closed higher on the day although that had the earmarks of a relief rally after a lousy week overall.  The thing about this report is that it did not include any of the government changes that have been in the press, so next month may offer more information regarding the impact of DOGE and their cuts.

The second story comes from north of the border where Mark Carney, former BOC and BOE head, was elected to lead the Labour Party in Canada and replace Justin Trudeau.  As is always the case, when there is new leadership, there is excitement and he said he will call for a general election in the next several weeks, ostensibly to take advantage of this new momentum.  It seems that President Trump’s derision of not only Trudeau, but Canada as well in many Canadian’s eyes, will play a large role with the two lead candidates, Carney and Poilievre, fighting to explain that they are each better placed to go toe-to-toe with Trump on critical issues.

Here’s the thing, though.  Despite much angst about the US-Canada relationship on the Canadian side of the border, the market viewpoint is nothing has really changed.  a look at the chart below shows that after a bout of weakness for the Loonie in the wake of the US election and leading up to Trump’s tariff announcements, USDCAD is basically unchanged since mid-December, with one day showing a spike and reversal in early February.  My point is that the market has not, at least not yet, determined that the Canadian PM matters very much.

Source: tradingecoomics.com

The last story to discuss is Chinese inflation data which was released Saturday evening in the US and showed deflation in February (-0.7% Y/Y) for CPI and continuing deflation in PPI (-2.2%).  In fact, as you can see from the below chart, PPI in China has been in deflation for several years now.  Recently there have been several articles explaining this offers President Xi a great opportunity for significant stimulus because no matter how much the government spends and how much debt they monetize, inflation won’t be a problem for a long time to come.  I would counter that given deflation has been the norm for several years, they have had this opportunity for quite a while and done nothing with it.  Why will this time be different?  Ultimately, the default result in China is when things are not looking like they will achieve the targeted growth of “about 5%”, you can be sure there will be more investment to build things up adding still more downward pressure on prices as production facilities increase.  

Source: tradingeconomics.com

The renminbi’s response to this news has been modest, at best, with a tiny decline overnight of -0.25%.  And a look at the chart there shows it is remarkably similar to the CAD, with steady weakness through December and then no real movement since then.  Given the dollar’s recent weakness overall, this seems unusual.  Although, we also know that China prefers a weaker currency to help support their export industries, so perhaps this in not unusual at all.

Source: tradingeconomics.com

Ok, this note is already overly long, so will end it here.  We do have important data later this week with both CPI and Retail Sales coming.  As well, the consensus from the Fedspeak is that they are pretty happy right here and not planning to do anything for a while.

The big picture is best summarized, I believe, by the idea that we are at the beginnings of a regime change in markets as discussed above.  Volatility continues to be the driving force, so hedging remains crucial for those with natural exposures.

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Dynamited

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Investors don’t seem that excited
‘Bout Germany’s now expedited
Designs to rearm
And that caused much harm
To Bunds, with their price dynamited

 

One of the biggest impacts of President Trump’s recent friction with Ukraine and its security is that European nations now realize that their previous ability to make butter, not guns, because the US had enough guns for everybody is no longer necessarily the case.  Mr Trump’s turn inward, which should be no surprise given his campaign rhetoric and America First goals, apparently was a surprise to most European leaders.  It seems they couldn’t believe the US would change course in this manner.  Regardless, the upshot is that Europe finds itself badly under armed and is now promising to change this.

The country best placed to start this process is Germany, where soon-to-be Chancellor, Friedrich Merz has promised a €500 billion spending spree on new defense items.  However, as the Germans don’t have this money laying around, they will need to borrow it.  The wrinkle in this plan is that enshrined in Germany’s constitution is a debt brake designed to prevent fiscal profligacy, kind of like this.  So, Merz has proposed waiving the debt brake for defense expenditures, but in order to do so, will need a two-thirds majority vote in the Bundestag (German parliament).  Now given AfD has been quite anti-war, it is not clear he will be able to obtain the requisite votes but for now, that is not the concern.

However, the German bund market clearly believes he will be successful as evidenced by the chart below. Overall, German 10-year yields rose 30bps yesterday, a dramatic move, and dragged most European sovereigns along for the ride as the new narrative is that all European nations will increase borrowing to spend on their defense.  It is worth noting, though, that the reason German yields have been so low is because the economy there has been exhibiting approximately 0% growth for more than a year as they continue to commit energy suicide seek to achieve their idealistic greenhouse gas emission goals.

Source: tradingeconomics.com

The trick, though, is that while Germany, with a debt/GDP ratio around 60%, has plenty of fiscal space to follow through, assuming they can alter their constitution, the rest of Europe is in a much more difficult spot with both France and Italy already under EU scrutiny for their budget deficits and debt/GDP ratios.  Recall, a key aspect of the Eurozone’s creation was the regulation designed to keep national budget deficits below 3% of GDP and drive the debt/GDP ratios to 60% or below.  Right now, Germany is the only nation that fits within those parameters. 

While I have no doubt that they will alter the rules as necessary elsewhere in Europe and certainly given the now perceived existential crisis for Europe, those limits are sure to be ignored, the story in Germany remains different because of the constitution.  Markets, though, clearly believe that a lot more debt is about to be issued by European nations, hence the dramatic decline in bond prices and jump in yields.  

But there are other knock-on effects here as well, notably that the euro is climbing dramatically against the dollar, up nearly 4% in the past week, and far ahead of the pound and most G10 currencies with only the SEK (+1.0% overnight, +6.1% in past week) outperforming the single currency.  For a while I have suggested that short-term rates were losing their sway over the FX markets and traders were looking at 10-year yields.  Certainly, the recent price action indicates that remains the case as Treasury yields (+2bps) have bounced off their lows but have risen far less than their G10 counterparts.  In fact, a look at the movement in 10-year government bond yields over the past month and year reveals just how significant these changes have been.

Source: Bloomberg.com

I feel safe in saying that for the next several weeks, perhaps months, this story of European defensive revival and the knock-on effects is going to be top of mind for both investors and pundits.  Only history will determine if these dramatic changes in policy stances will have been effective in reducing the chance of war or not and if they will have been beneficial or detrimental to economies around the world. As much of the current narrative is driven by politics rather than economics, punditry on the latter is going to be worse than usual.  Once again, I harken back to the need for a robust hedging plan for all those with exposures.  As recent price action across all markets demonstrates, volatility is back, and I believe here to stay for a while.

Ok, let’s run down the rest of the markets not yet discussed.  Yesterday’s US equity bounce was widely appreciated by many although this morning, futures markets are all pointing lower by between -0.75% and -1.25%, enough to wipe out yesterday’s gains.  As to Asia overnight, Japan (+0.8%) followed the US and both Hong Kong (+3.3%) and China (+1.4%) are continuing to get positive vibes from the Chinese twin meetings of policymakers.  More stimulus continues to be the driving belief there although China’s history has shown their stimulus efforts have tended to fall short of initial expectations.  As to Europe, this morning only the DAX (+0.5%) is continuing yesterday’s gains as concerns begin to grow that while Germany can afford to spend more money on defense, the rest of Europe is not in the same situation, so government procurement contracts may be less prevalent than initially hoped.  This is evident in the -0.4% to -1.0% declines seen across both the UK and most of the rest of the continent.

We’ve already discussed bonds, although I should mention that JGB yields have risen 10bps as well, up to new highs for the move and finally above 1.50%

In the commodity space, oil (+0.65%) which has had a very rough week, falling more than -5% in the past seven days, seems to be finding a bit of support.  Recall yesterday’s chart showing the bimodal distribution and that we are now in supply destruction territory.  Ultimately, that should support the price, but the timing is unclear.  In the metals markets, this morning sees red across the board, although not dramatically so, with both precious and base metals sagging on the order of -0.5%.

And lastly the dollar continues to decline, albeit not as swiftly as yesterday.  However, while it is considerably weaker vs. its G10 counterparts, versus the EMG bloc, the story is far less clear.  For instance, the only notable EMG currency gaining ground this morning is CLP (+1.2%) while virtually every other major emerging market currency is actually slipping a bit.  Look at this list; CNY -0.2%, MXN -0.25%, PLN -0.3%, ZAR -0.15%, INR -0.3% and HUF -0.5%.  I have a feeling we are going to see more behavior like this going forward, where G10 currencies are now trading on a different basis than EMG currencies.

On the data front, this morning brings Initial (exp 235K) and Continuing (1880K) Claims as well as the Trade Balance (-$127.4B) and Nonfarm Productivity (1.2%) and Unit Labor Costs (3.0%) all at 8:30.  We also hear from two more Fed speakers, Waller and Bostic later in the day.  Yesterday’s ADP employment data was much weaker than expected, falling to 77K, while the ISM Services data held up well although the prices paid piece did rise.  In addition, there has been a change in tone from the Fed speakers as we are now hearing mention of the possibility of stagflation due to the Trump tariffs, although there was no indication as to which way they will lean if that is the economic path forward.

I continue to highlight volatility as the watchword for now and the near future at least.  As long as politics has become the key driver, and as long as President Trump is that driver, given his penchant to shake things up, the one thing of which I am sure is we have not seen the last dramatic change in perception.  With that in mind, my view is the dollar will remain under pressure for a while yet.

Good luck

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Eyes Like a Bat

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The new Mr Yen
Is watching for excess moves
With eyes like a bat

 

While every day of this Trump presidency is filled with remarkable activity at the US government level, financial markets are starting to tune out the noise.  Yes, each pronouncement may well be important to some part of the market structure, but the sheer volume of activity is overwhelming investment views.  The result is that while markets are still trading, there seem to be fewer specific drivers of activity.  Consider the fact that tariffs have been on everyone’s mind since Trump’s inauguration, but nobody, yet, has any idea how they will impact the global macro situation.  Are they inflationary?  Will sellers reduce margins?  Will there be a strong backlash by the US consumer?  None of this is known and so trading the commentary is virtually impossible.

With that in mind, it is worth turning our attention this morning to Japan, where the yen (-0.4%) has been steadily climbing in value, although not this morning, since the beginning of the year as you can see from the chart below.

Source: tradingeconomics.com

Amongst G10 currencies, the yen is the top performer thus far year-to-date, rising about 5%.  Arguably, the key driver here has been the ongoing narrative that the BOJ is going to continue to tighten monetary policy while the Fed, as discussed yesterday, is still assumed to be cutting rates later in the year.  

Let’s consider both sides of that equation.  Starting with the Fed, just yesterday Atlanta Fed president Bostic explained to a housing conference, “we need to stay where we are.  We need to be in a restrictive posture.”  Now, I cannot believe the folks at the conference were thrilled with that message as the housing market has been desperate for lower rates amid slowing sales and building activity.  But back to the FX perspective, what if the Fed is not going to cut this year?  It strikes me that will have an impact on the narrative, and by extension, on market pricing.

Meanwhile, Atsushi Mimura, the vice finance minister for international affairs (a position known colloquially to the market as Mr Yen) explained, when asked about the current market narrative regarding the BOJ’s recent comments and their impact on the yen, said, “there is no gap with my view.  Amid high uncertainty, we have to keep watching the impact of any speculative trading on, not only the exchange market, but also financial markets overall.”  

If I were to try to describe the current market narrative on the yen, it would be that further yen strength is likely based on the assumed future narrowing of interest rate differentials between the US and Japan.  That has been reinforced by Ueda-san’s comments that they expect to continue to ‘normalize’ policy rates, i.e. raise them, if the economy continues to perform well and if inflation remains stably at or above their 2% target.  With that in mind, a look at the below chart of Japanese core inflation shows that it has been above 2.0% since April 2022.  That seems pretty stable to me, but then I am just a poet.

Source: tradingecomnomics.com

Adding it all up, I feel far better about the Japanese continuing to slowly tighten monetary policy as they have a solid macro backdrop with inflation clearly too high and looking like it may be trending a bit higher.  However, the other side of the equation is far more suspect, as while the market is pricing in rate cuts this year, recent Fed commentary continues to maintain that the current level of rates is necessary to wring the last drops of inflation out of the economy.

There is a caveat to this, though, and that is the gathering concern that the US economy is getting set to fall off a cliff.  While that may be a bit hyperbolic, I do continue to read pundits who are making the case that the data is starting to slip and if the Fed is not going to be cutting rates, things could get worse.  In fairness to that viewpoint, the Citi Surprise Index is pointing lower and has been declining since the beginning of December, meaning that the data releases in the US have underperformed expectations for the past two months. (see below)

Source: cbonds.com

However, a look at the Atlanta Fed’s GDPNow estimate shows that Q1 is still on track for growth of 2.3%, not gangbusters, but still quite solid and a long way from recession.  I think we will need to see substantially weaker data than we have to date to get the Fed to change their wait-and-see mode, and remember, employment is a lagging indicator, so waiting for that to rise will take even longer.  For now, I think marginal further yen strength is the most likely outcome as we will need a big change in the US to alter current Fed policy.

Ok, let’s see how markets have behaved overnight.  Yesterday saw a reversal of recent US equity performance with the DJIA slipping while the NASDAQ rallied, although neither moved that far.  In Asia, the Nikkei (+0.3%) edged higher as did the CSI 300 (+0.2%) although the Hang Seng (-0.3%) gave back a small portion of yesterday’s outsized gains.  The rest of the region, though, was under more significant pressure with Korea, Taiwan, Indonesia and Thailand all seeing their main indices decline by more than -1.0%.  In Europe, red is the most common color on the screen with one exception, the UK (+0.35%) where there is talk of resurrecting free trade talks between the US and UK.  But otherwise, weakness is the theme amid mediocre secondary data and growing concern over US tariffs.  Finally, US futures are nicely higher this morning after Nvidia’s earnings were quite solid.

In the bond market, Treasury yields (+4bps) have backed up off their recent lows but remain in their recent downtrend.  Traders keep trying to ascertain the impacts of Trump’s policies and whether DOGE will be able to find substantial budget cuts or not with opinions on both sides of the debate widely espoused.  European sovereign yields have edged higher this morning, up 2bps pretty much across the board, arguably responding to the growing recognition that Europe will be issuing far more debt going forward to fund their own defensive needs.  And JGB yields (+4bps) rose after the commentary above.

In the commodity markets, oil (+1.1%) is bouncing after a multi-day decline although it remains below that $70/bbl level.  The latest news is that Trump is reversing his stance on Venezuela as the nation refuses to take back its criminal aliens.  Meanwhile, gold (-1.1%) is in the midst of its first serious correction in the past two months, down a bit more than 2% from its recent highs, and trading quite poorly.  There continue to be questions regarding tariffs and whether gold imports will be subject to them, as well as the ongoing arbitrage story between NY and London markets.  However, the underlying driver of the barbarous relic remains a growing concern over increased riskiness in markets and rising inflation amid the ongoing deglobalization we are observing.

Finally, the dollar is modestly firmer overall vs. its G10 counterparts, with the yen decline the biggest in the bloc.  However, we are seeing EMG currency weakness with most of the major currencies in this bloc lower by -0.3% to -0.5% on the session.  In this case, I think the growing understanding that the Fed is not cutting rates soon, as well as concerns over tariff implementation, is going to keep pressure on this entire group of currencies.

On the data front, we see the weekly Initial (exp 221K) and Continuing (1870K) Claims as well as Durable Goods (2.0%, 0.3% ex Transport) and finally the second look at Q4 GDP (2.3%) along with the Real Consumer Spending piece (4.2%).  Four Fed speakers are on the calendar, Barr, Bostic, Hammack and Harker, but again, as we heard from Mr Bostic above, they seem pretty comfortable watching and waiting for now.

While I continue to believe the yen will grind slowly higher, the rest of the currency world seems likely to have a much tougher time unless we see something like a Mar-a Lago Accord designed to weaken the dollar overall.  Absent that, it is hard to see organic weakness of any magnitude, although that doesn’t mean the dollar will rise.  We could simply chop around on headlines until the next important shift in policy is evident.

Good luck

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Scapegoated

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The people of Germany voted
With Friedrich Merz, at last, promoted
The nation, to lead
Though sure to misread
The sitch, with the Right still scapegoated

 

The result of the German Federal elections was very much as expected, the CDU/CSU won 28.5% of the votes and the largest share while AfD garnered 20.8%, the SPD just 16.4% (it’s worst showing in modern times) and the Greens gaining 11.6%.  A tail of other mostly very left-leaning parties made up the balance.  However, one cannot look at a map of the distribution of votes without noticing that the part of the country that was East Germany prior to the fall of the Berlin Wall, still sees things very differently than the rest of the nation.

Source: Reuters.com

Regardless of the distribution, however, the outcome will result in some sort of coalition government, almost certainly to be a combination of the CDU and SPD.  On the surface, it would seem this left-right coalition will be doomed to failure, and that could well be the case, but because the consensus amongst the ‘right-thinking’ people in politics is that AfD is the devil incarnate, or perhaps more accurately, Hitler incarnate, Herr Merz will not be able to rule with a sure majority of conservative voters.

As with virtually every election, the economy is a top priority of the voters, especially since GDP growth, as measured, has essentially been zero for the past three years as per the below chart, and is mooted to stay there on present policies.

Source: tradingeconomics.com

One of the key issues that is currently under discussion there is the constitutionally enshrined ‘debt-brake’ which prevents the German government from running deficits of greater than 0.35% of GDP in any fiscal year.  In order to change the constitution, there needs to be a 2/3’s approval in the Bundestag, but AfD holds a blocking minority and one of their policy platforms has been fiscal prudence.

Arguably, this begs a larger question, what exactly constitutes economic growth?  For instance, if government debt is rising more quickly than economic output, is that actually a growing economy?  And is that process sustainable going forward?  It is quite interesting to look at the government debt dynamics of different nations and ask that question, especially since Germany’s situation really stands out.  

Perhaps, after looking at this group of charts, it is worth reevaluating exactly how much actual growth has been occurring and how much economic activity has simply been government borrowing recycled into the economy across all these nations.  Of course, this process has not been restricted to G-7 nations, it is a global phenomenon, with China doing exactly the same thing as are virtually all nations.  In fact, Germany is unique amongst large nations for bucking the trend.

The reason this issue matters is there is a limit to how far a government can increase its leverage ratio.  At some point, investors will stop buying debt which will force the central bank to buy the debt.  Of course, they will do so by printing more money and devaluing the currency.  We know this because we have seen it happen before many times throughout history with Germany’s Weimar Republic in 1923, Argentina in the 1980’s and Zimbabwe in 2007-2008 as just the most recent examples.  In fact, the reason the Germans have the debt brake is that there is a national memory of that hyperinflation from a century ago.

Circling back to the growth question, what is it that constitutes economic growth?  If you remember your college macroeconomics classes, this is the equation that is used to calculate economic activity in an economy:

            Y = C + I + G + NX

Where:

Y = GDP

C = Consumption

I = Investment

G = Government spending

NX = Net Exports

This equation is taken as gospel in the economics and political worlds.  However, it is not often recalled that it was created in the 1930’s by John Maynard Keynes.  It is not a law of nature, but merely was Keynes’ way of expressing something that had not been effectively measured previously.  Nearly 100 years later, though, perhaps it is time to reevaluate the process.  Remember, economies grew prior to Keynes creating this equation when government activity was a much smaller proportion of the economy.  But as we can see by the dramatic rise in government debt, that is no longer the case.  Perhaps Germany is a peek behind the GDP curtain that shows absent constantly increasing government borrowing, economic growth is stagnant.  Neil Howe’s Fourth Turning could well be the conclusion of this period of government excess, where things will be extremely volatile during the change, but less government will be the norm on the other side, at least for a few generations!

Ok, sorry for the history and theoretical discussion, but that chart of German government debt vs. the rest of the world was really eye-opening.  Let’s turn to markets from the overnight session.

After Friday’s sharp downward movement in the US, the picture in Asia was far more mixed.  Japan (+0.25%) managed a small gain while Hong Kong (-0.6%) and China (-0.2%) both lagged.  Elsewhere in the region, New Zealand (-1.8%) stood out for its weakness, although Korea, India and Taiwan were all softer in the session as well.  Ironically, it seems that better than expected Retail Sales data in NZ hurt sentiment for further policy ease by the RBNZ and concerns over trade with China given US pronouncements is also hurting the situation there, at least for today.

In Europe, Germany’s DAX (+0.9%) is leading the way higher after IfO Expectation data was released a touch better than forecast at 85.4.  However, it is important to remember that while this was a positive outcome, the average reading prior to Covid was between 95 and 103.  As to the rest of Europe, there are more gainers than laggards but little of real note absent any other data.  US futures at this hour (7:00) are pointing higher by at least 0.5% across the board.

In the bond market, Friday saw a very sharp decline in yields, -10bps in Treasuries, after weak readings in the Flash PMI data, especially services at 49.7, Existing Home Sales and Michigan sentiment.  That helped bring global yields lower.  This morning, Treasuries have bounced just 1bp and we are seeing similar rises in most of Europe.  JGB yields are also unchanged and have continued to consolidate near recent highs.

In the commodity markets, after a sharp sell-off on Friday on the back of stories about increased supply from Kurdistan, oil (0.0%) is unchanged this morning.  Meanwhile gold (+0.5%) is rebounding from its regular Friday sell-off, almost as though there were efforts by some to depress the price at the end of every week.  It will be interesting to see what happens this Friday which is month end as well.  As to silver and copper, they are little changed and dull this morning.

Finally, the dollar is asleep this morning, with very limited movement vs. almost any of its counterparts.  USDJPY remains below 150, but the yen has actually fallen -0.3% on the session, while the biggest movers are in Eastern Europe (CZK +0.8%, HUF +0.4%, PLN +0.35%), perhaps on the back of the German election results offering hope for a more useful German government.  We shall see about that.  Otherwise, nobody is concerned over the dollar right now.

On the data front this week, it is a quiet one with PCE data the highlight on Friday.

TodayChicago Fed Natl Activity0.21
TuesdayCase Shiller Home Prices4.4%
 Consumer Confidence103.0
WednesdayNew Home Sales680K
ThursdayInitial Claims220K
 Continuing Claims1874K
 Q4 GDP (2nd look)2.3%
 Real Consumer Spending4.2%
 Durable Goods2.5%
 -ex Transport0.3%
FridayPersonal Income0.3%
 Personal Spending0.2%
 PCE0.3% (2.5% Y/Y)
 Core PCE0.3% (2.6% Y/Y)
 Chicago PMI41.5

Source: tradingeconomics.com

In addition to the data, we also hear from seven Fed speakers over 9 venues, but again, are they really going to change the cautious approach at this stage?  And does it even matter?  For now, financial markets are far more focused on President Trump and his cabinet’s activities than interest rate policy which seems set to remain in place for a while.

When it comes to the dollar, nothing has changed my perspective on relative interest rates in the front end, with US rates likely to be far stickier at current levels than others, but the back end has a potentially different outcome.  Recall that Bessent and Trump are focused on the 10-year yield and getting that lower and seem far less concerned over the Fed for now.  To achieve that they will need to demonstrate the ability to reduce spending and the deficit situation.  While a promising start has been seen with DOGE, we are still a long way from a balanced budget.  My take is the dollar, writ large, is going to take its cues from the 10-year yield for now, so bonds are the market to watch.  If we see yields head back toward 4.0%, the dollar will decline and any significant move higher in yields will likely see the dollar climb as well.

Good luck

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Japanese Tao

Posted on by

Japanese prices
Are rising ever higher
Probably nothing!
 
Meanwhile Ueda
Explained QE can still be
The Japanese Tao

 

Japanese inflation data was released last night, and the picture was not very pretty.  In fact, let me show you.  The first chart shows the monthly readings of annual inflation for the past 5 years.  Last night’s 4.0% reading was not the highest in that period, (that distinction belongs to Feb 2023 at 4.3%), but it is pretty clear that any sense of declining inflation is beginning to dissipate and has been doing so for the past year.  PS, remember, Japanese interest rates range from 0.5% in the overnight to 1.425% in the 10-year, so real rates remain highly negative regardless of your timeframe.

The second picture takes a longer-term perspective to help us better understand the long history of inflation in Japan.  While a decade ago, inflation showed an uptick of nearly the recent magnitude, that was driven specifically by the government raising the GST (goods and services tax) which was Japan’s answer to a VAT.  It was highly controversial at the time but was also understood to have a truly transitory impact as it was a one-off rise in prices.  However, beyond that period, the Japanese have been living with inflation somewhere between -2.2% in the wake of the GFC and 2.0% since the turn of the century.  In fact, going back to the 1990’s, inflation didn’t reach current levels, and one must head back to 1981 to see significant inflation in Japan.  This means there are two generations of people who have basically never seen prices rise in the current manner.

So, what do you think the central bank is considering?  Let me give you Ueda-san’s own words, [emphasis added] “In exceptional cases where long-term interest rates rise sharply in a way somewhat different from normal movements, we will flexibly increase purchases of government bonds to promote stable formation of interest rates in the market.”  You read that correctly inflation is rising sharply, JGB yields are rising in sync and the BOJ’s response is to BUY MORE BONDS!!!  You cannot make this stuff up.  I guess old habits die hard.

The market response to this was as you might expect.  JGB yields dipped 2bps, Japanese equities managed a modest rally (+0.3%) as they seem caught between lower rates and higher inflation, and the yen ( -0.5%) weakened.  In essence, it appears the combination of a strengthening yen and rising interest rates has the potential to wreck the Japanese government’s budget, and the BOJ went back to form and discussed more QE as a response.  This is simply more proof that there isn’t a central bank in the world that truly cares about inflation.  While stable inflation may be a mandate, it is the last of their concerns.

Inflation is, however, not the last of our concerns, at least as we try to live day to day.  This is what has me concerned about Chairman Powell and his minions at the Fed, they continue to believe that the current interest rate structure is restrictive and despite the fact there is virtually no evidence prices are ever going to get back to their target of 2.0%, let alone true stability, still see cuts as the way forward.  Perhaps I am mistaken to believe that the Fed will see the light and maintain current policy levels or even tighten as inflation rebounds.  If that is the case, my entire dollar thesis is going to come under a lot of pressure!

Ok, away from the Japanese antics overnight, a brief word about China.  Last night, Premier Li Qiang explained that China will look to “vigorously” improve the services sector of the economy, specifically education, health care, culture and sports, as they once again try to adjust the balance of economic activity to a more domestic focus rather than their historical mercantilist process.  Earlier this week the PBOC reiterated their support for the property market, although for both these efforts, this is not the first time they have been discussed, and the evidence thus far is all their efforts have been fruitless.  But for one day, at least, these comments have been embraced as the Hang Seng (+4.0%) and CSI 300 (+1.3%) both rallied sharply on the news of more domestic support for the Chinese economy.  The Chinese are set to hold a key economic confab as they try to plan how to shake things up a bit, and these comments, as well as a seeming promise the PBOC is going to cut rates again, are all of a piece.  Maybe they will be successful this time, but I am not holding my breath.

Otherwise, the only other noteworthy economic news came from the Flash PMI’s across Europe which were soggy at best, certainly not indicative of significant growth coming soon.  With that in mind, let’s look at the rest of the markets’ overnight performance.  The rest of Asia’s equity markets were mixed with Taiwan’s the best performer and several modest declines elsewhere including India, Australia and New Zealand.  In Europe, though, despite those modest PMI outcomes, most markets are higher led by the CAC (+0.5%).  Perhaps, the view is the ongoing weakness will force the ECB to cut rates more quickly, and we have heard several ECB members indicate further cuts are coming.  However, counter to that, Isabel Schnabel, one of the more hawkish members, mentioned this morning that she believed they were already at neutral, and more cuts may not be necessary.  While that is not the consensus view yet, it is worth remembering.  As to the US futures market, at this hour (7:00), all three major indices are basically unchanged.

In the bond market, yields have fallen across the board with Treasuries, after sliding yesterday, down another 2bps this morning and back below 4.50% for the first time in a week.  In a Bloomberg interview yesterday, Secretary Bessent explained that although his goal is to reduce the issuance of T-bills and term out debt, given the situation which he inherited from the previous administration, that process will take longer than some had considered previously.  In other words, there won’t be a large increase in 10-year issuance any time soon. European sovereign yields are also much softer, down between -3bps and -5bps on those further rate cut hopes, or perhaps the lackluster PMI data.

In the commodity markets, oil (-0.8%) is backing off its recent rally highs, but remains quiet overall and well within its ever-tightening trading range.  It seems traders don’t know how to handicap the constant discussions from the Trump administration and whether Russian sanctions will end or not, as well as how quickly OPEC may ramp up production and what is happening to demand.  While none of these things are ever certain, right now they seem particularly fraught.  In the metals space, gold (-0.4%) is backing off from yesterday’s latest all-time highs, and taking both silver and copper with it, but the uptrend in all three of these metals remains quite strong.

Finally, the dollar is higher this morning gaining ground against all its G10 counterparts with the yen being the worst performer, but also against all its EMG counterparts with HUF (-1.0%) the true laggard although the entire CE4 are under pressure, arguably responding to the mayhem over how the Ukraine situation plays out.  After all, they are the closest in proximity and likely to be the most impacted.

On the data front, this morning brings Flash PMI data (exp manufacturing 51.5. Services 53.0), Existing Home Sales 4.12M) and Michigan Sentiment (67.8).  We also hear from two more Fed speakers, Jefferson and Daly, but again, caution and stasis are the story until further notice, and that notice is not coming from Mary Daly but rather from Jay Powell.

Perhaps the most interesting thing happening right now is that although tariffs remain a major economic force and are clearly on the table, they are not even the 4th most important topic in the market.  Back to my earlier comments, I sincerely hope that the BOJ’s overwhelming dovish stance is not a harbinger of things to come here in the States.  Right now, I don’t think so, but I am far less confident than I was earlier this week.

Good luck and good weekend

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Caution and Fear

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For Jay and the FOMC
There’s nothing that’s likely to be
Enough to adjust
The often discussed
Reduction in rates, all agree
 
But as we look off to next year
The sitch has become much less clear
The dot plot and SEP
Could very well prep
Investors for caution and fear

 

*Let me begin by explaining this will be the last poetry for 2024 as I take some time to reflect on the past year as well as my views for 2025.  Come January 2nd, I will offer those views, as I always do, in a long-form poem.  For all of you who have come along for the ride, thank you very much, I sense next year may be even more interesting than the one ending in a few weeks*.

Now, back to our regularly scheduled programming.  To my eye, the ongoing coordinated policy easing by central banks around the world (US, Europe, UK, Canada, China, Switzerland, etc.) feels at odds to the ongoing inflation data that seems to show a reluctance for price rises to slow back to the preferred pace of those same central banks.  Certainly, in the US, as evidenced by both the CPI data Wednesday, and even more so by yesterday’s PPI data, the null hypothesis that the rate of inflation is slowing toward 2% feels as though it is no longer valid.  One needn’t dig too far under the surface to see core and median inflation readings with 3% and 4% handles and given this is almost entirely in the services sector, the sector that encompasses more than two-thirds of the economy, it seems increasingly hard to make the case that inflation is going to decline much further.  This is not to imply we are heading for hyperinflation, just that the slow pace of price increases that existed since the GFC seems to have ended.

At least in the US, the economic growth story appears to be a bit more positive than elsewhere around most of the world, and so the opportunity exists for wages to keep up with prices.  Alas, elsewhere in the world, that is not necessarily the case.  Yesterday, Madame Lagarde and the ECB cut rates by a further 25bps, as universally expected, and the market is looking for another 25bp cut in January.  However, despite what is a clearly slowing growth impulse on the continent, even Lagarde felt it necessary to caution about the sticky services prices in Europe and how they must be careful in their policy decisions to prevent a reemergence of inflation.  Remember, too, the ECB’s sole mandate is price stability, so theoretically, even if Europe falls into recession, it is not the ECB’s task to rescue the economy there.

Perhaps the one place where policy ease is appropriate is China, where the pace of activity in the economy is very clearly slowing.  President Xi and his minions have not yet been able to arrest the decline in the property market there, which given such a large proportion of Chinese GDP growth over the past decade was contingent upon an ever-growing property sector and consistently rising prices, is a problem.  An interesting feature of their recent announcements is that they seem ready to have the central bank lend directly to the government (monetizing debt) to finance activity rather than have the central bank buy bonds from the Chinese banking community (otherwise known as QE).  In fact, arguably the biggest problem in China is that the banking system there is dangerously overleveraged and undercapitalized when taking a true account of bad loans outstanding.  It seems that Xi and friends have figured out it would simply be cheaper to print money and directly give it to the government rather than pass it through a creaking banking system that no longer works.  While this almost certainly is smart policy given the circumstances, it doesn’t speak well of the overall situation there.

(As an aside, can we really be surprised that the Chinese banking system, which is basically an arm of the government’s finance ministry which directed lending to favored companies/industries without any real analysis, is having problems?)

Under the guise, a picture is worth 1000 words, a quick look at the below chart from tradingeconomics.com which shows the trajectory of outstanding Yuan Loan Growth over the past 10 years is pretty descriptive.  Banks in China have lost their ability to help the government implement monetary policy so the government is going to simply do it themselves.  The “moderately loose” policy the Politburo announced seems likely to go beyond moderate as 2025 progresses, at least in this poet’s eyes.

In the end, there are many problems extant in the global economy.  As well, there has been an uptick in overall uncertainty with the election of Donald Trump as US president given his history of sudden, unpredictable pronouncements.  I would contend that the one constant in 2025 and beyond is that volatility is far more likely to increase than decrease across markets everywhere.

Ok, let’s take a quick tour of the overnight activity before my short-term hiatus.  Once again, US equity markets were under modest pressure yesterday as I continue to see more and more pundits calling for a short-term pullback before the next leg higher.  That weakness was followed by Asian markets selling off with China (-2.4%) and Hong Kong (-2.1%) both suffering from ongoing disappointment that the modest loosening wasn’t dramatic loosening!  Interestingly, despite the JPY (-0.55%) weakening further (its 5th consecutive down day) the Nikkei (-1.0%) couldn’t gain any traction, perhaps undercut by concerns over the tech story and rising US rates.  However, both Korea and India put in solid positive sessions.  Clearly Asia is not a monolithic market.  

In Europe this morning, the screens are green, but it is a pale green, with gains on the order of 0.1% to 0.3% only as investors seem to have taken some heart by the ECB’s cut and modest dovish follow up.  Meanwhile, US futures are slightly firmer at this hour (8:00).

In the bond market, yields continue to climb in the US (Treasuries +2bps) and Europe (Bunds +4bps, OATs +3bps Gilts +2bps) as bond investors are far more circumspect of the ECB cutting rates while inflation lurks in the background.  Chinese yields continue to fall, with the 10-year there hitting a new low of 1.78% and talk now that by the end of 2025, Chinese yields may fall below those in Japan!  Now that would be something, and I suspect the FX markets would see a lot of volatility if that happens.

Oil prices (+0.5%) continue to hold the $70/bbl level with very little impetus after the rally early in the week.  Metals prices, though, are under modest pressure this morning, perhaps on the idea that Chinese demand is going to falter.  After all, if Chinese shares can’t hold up, why would traders believe they will be buying up copper, silver and gold?  All three are lower by about -0.2% this morning.

Finally, the dollar is mixed this morning, having rallied vs. some counterparts like JPY, BRL (-0.75%) and ZAR (-0.55%) while declining vs. the euro (+0.45%), NOK (+0.75%) and the CE4 currencies.  My take is the euro’s rebound, and that of the CE4, is more position related after a sell-off yesterday and given today is Friday, rather than anything fundamental.

There really is no data today and while we do see Retail Sales next Tuesday (exp 0.5%, 0.4% ex autos), I think it’s really all about the Fed next Wednesday.  The market is still pricing 97% probability of a cut, and I don’t see anything changing that.  Rather, the Fed’s dot plot will be the story for markets as the narrative starts to account for higher inflation and therefore, a higher long-term outcome for the neutral rate.

Again, none of this portends a weaker dollar as we head to the end of 2024.  For 2025, you will need to wait for January 2nd to see my views then.

Good luck, good weekend and have a wonderful holiday season

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Growth Stank

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Three score and a year have now passed
Since flags in the States flew half-mast
In honor of Jack
Who wouldn’t backtrack
On his goal of world peace at last

 

It has been sixty-one years since President John F Kennedy was assassinated in Dallas.  This was one of the most dramatic and impactful events in the history of the US with many still of the belief that it was an inside job.  One needn’t wear a tin-foil hat all the time to recognize that the government has done nothing but grow dramatically since then, with the defense complex the leader of the pack.  Perhaps in his second term, President Trump will release the case files in an effort to shine a light on the underbelly of the government.  This poet has no idea what occurred that day (although I did recently visit the 6th floor museum in Dallas, a quite interesting place) and I would guess that all these years later, there are very few, if any, people who may have been involved that are still alive.  Of course, the risk is that powerful organizations like the CIA and FBI could be forever tarred with this if they were involved, and that would have dramatic implications going forward, hence their desire to maintain secrecy.  I highlight this simply as another potential flashpoint in the upcoming Trump presidency.

The data from Europe revealed
That if there is growth, it’s concealed
The PMI’s sank
And German growth stank
Thus Christine, her razor, will wield

Let us now discuss the Eurozone.  Not only do they have an increasingly hot war on their border and not only are they being inundated by a major blizzard interrupting power and transportation throughout France, Germany and Scandinavia, but their economies appear to be slowing down far more rapidly than previously anticipated.  But that inflation was slowing as quickly!

This morning the Flash PMI data was released for Germany, France and the Eurozone as a whole, as well as the UK.  It did not make for happy reading if you are a politician or policymaker in any of these nations.

IndicatorCurrentPrevious
 Germany 
Manufacturing PMI43.243.0
Services PMI49.451.6
Composite PMI47.348.6
 France 
Manufacturing PMI43.244.5
Services PMI45.749.2
Composite PMI44.848.1
 Eurozone 
Manufacturing PMI45.246.0
Services PMI49.251.6
Composite PMI48.150.0
 UK 
Manufacturing PMI48.649.9
Services PMI50.052.0
Composite PMI49.951.6

Source: tradingeconomics.com

One needn’t look too hard to see that the economic situation in Europe is ebbing toward a recession or at least toward much slower growth (German GDP was also released at a slower than expected 0.1% Q/Q, -0.3% Y/Y).  While the ECB is very aware of this situation, the problem is that like most other central banks, their strong belief that inflation is going to reach their 2.0% goal has not yet been realized let alone shown an ability to stay at that level over time.  However, the ongoing comments from ECB members is that more rate cuts are coming with only the timing and size in question.  There is still a strong belief that interest rates in Europe (and the UK) are well above ‘neutral’.

Of course, it will not surprise you to see the chart of the EURUSD exchange rate given this information as the single currency collapses continues its sharp decline.

Source: tradingeconomics.com

Since the end of September, the single currency has declined ~7.0% in a quite steady fashion.  All the technical levels that had been in play have been broken with the next noteworthy level to consider being parity.  I have been clear for a while that I expected the dollar to continue to perform well and nothing has changed that view.  The combination of an increase in fear amid the escalation of tensions in Ukraine and Russia’s intimation that the US and NATO have entered the war already and the very divergent paths of the US and Eurozone economies can only lead to the conclusion that the euro is going to continue to decline for a while.  And remember, this price action has very little to do with potential Trump tariff or other policies as they remain highly uncertain.  The euro is simply a victim of its own leaders’ ineptitude on both the economic and diplomatic/military fronts.  Any Trump tariffs that are imposed on Europe will simply add to the pain.

Before we head to other asset classes, let’s take a quick look beyond the euro in the FX markets.  It should be no surprise that the dollar is broadly higher, although not universally so.  Versus the rest of the G10, even the yen has not been able to find enough haven demand to hold up as the greenback rallies against them all with the euro (-0.6%) and pound (-0.6%) sharing honors as the laggards.  However, in the EMG bloc, the picture is more mixed with CE4 currencies all sliding but ZAR (+0.4%) rallying amid the ongoing rebound in the price of gold (+1.2%) which is also benefitting from increased fear and risk disposition.  As to Asian currencies, most were somewhat weaker but other than KRW (-0.4%) the moves were unimpressive.

On the commodity front, oil (-0.6%) is slipping a bit heading into the weekend but it has had an excellent week, rallying more than 4%.  There are many cross tensions in this market as on one side we have fears that the Russia/Ukraine situation will impact supply, or that Iran will react to Israel’s ongoing campaign in Lebanon and do something about the Strait of Hormuz.  These are obviously bullish for crude.  But the flip side is that Trump has made very clear his desire to open up far more land for drilling and is seeking to increase supply substantially, a negative price signal.  

Turning to bond markets, there is demand everywhere as the combination of risk aversion and weaker Eurozone growth have brought the buyers out of the woodwork.  Treasury yields have slipped -4bps and in Europe, the entire continent is seeing yields decline between -7bps and. -8bps.  After the PMI data this morning, the Euribor futures market upped pricing for a December ECB rate cut from a 15% to a 50% probability.  Add to that comments from ECB members Stournaras and Guindos and it seems quite likely that rates in Europe are going to decline.

Finally, equity markets have shown very little consistency.  Yesterday’s strong US rally was followed by strength in Japan (+0.7%) but massive weakness in China (CSI 300 -3.1%, Hang Seng -1.9%) as concerns over those Trump tariffs continue to weigh on investors there.  However, it was only China that suffered as pretty much every other market in the region saw gains, with some (India +2.55, Taiwan +1.6%, New Zealand +2.1%) quite substantial.  European shares, however, are more mixed with most continental bourses showing modest declines although the UK (+0.8%) has managed to buck that trend despite the weak PMI data and weak Retail Sales data as investors seem to be prepping for a BOE rate cut next month.  As to US futures, at this hour (7:30) they are little changed.

Yesterday’s data showed Initial Claims sliding but Continuing Claims rising to their highest level, above 1.9M, in three years.  It appears that while layoffs aren’t increasing, finding a job once you are unemployed is much tougher.  Philly Fed was also softer than forecast and that seemed to help the Fed funds futures market push up the probability of a December cut to 59% this morning, up from 55% yesterday.  This morning, we see the Flash PMI data here (exp Mfg 48.5, Services 55.0) and then Michigan Sentiment (73.7).  There are no Fed speakers on the schedule so I expect that this morning’s trends may run for a little longer, but as it is Friday, I would not be surprised to see a little reversal amid week ending profit taking.  However, the dollar has further to go, mark my words.

Good luck and good weekend

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