Tag Archives: #Fed

Much Hotter

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This weekend both wars got much hotter
Iran attacked ships on the water
Ukraine sent its drones
Across three time zones
And struck inside Vlad’s magna mater

Thus, oil has risen a bit
While gold and stocks both trade like sh*t
And soon, CPI
Will prove or deny
That views at the Fed are now split

By now, of course, you know that there has been more military activity in the Strait of Hormuz with the IRGC attacking commercial ships and the US retaliating with significant strikes of military sites along the Strait.  From what I can see, there are factions within the IRGC that do not want to end the conflict and whatever government exists within Iran has no control over them.  As such, it is no surprise that the price of oil (+3.5%) has risen, but even in this scenario, it is well off its overnight highs.

Source: tradingeconomics.com

At this point, I believe the trading community will need far greater proof that there is a shortage of oil before responding with significantly higher prices.  Of course, one way that could come about is if Ukraine continues its success with attacks on Russian oil infrastructure as there has been an uptick in that activity with several refineries having been hit in the past several days and Russia imposing an export ban on diesel.  Net, things in the oil space remain precarious, but for all the analysts who continue to promulgate the idea that the end is nigh, markets continue to disagree.  As always, I vote with markets here.

And, not surprisingly, other markets have responded in a similar fashion to their recent trends with higher oil prices leading to pressure on both stocks and bonds, as well as precious metals while the dollar finds some support.  The thing is, my take is the strength of these correlations has been waning somewhat.  Frankly, and remarkably, it appears as though an increase in military activity in the Strait of Hormuz has become somewhat normalized to traders and they are looking for other, fresher signals as to their next move.

What might those other signals be?  Well, much was made of SK Hynix’s IPO in the US on Friday, which many pundits are now calling the top as the stock fell sharply in Korea overnight, down -15.4% dragging the KOSPI down -9.0% and tech stocks, in general much lower.  Of course, the KOSPI had risen dramatically over the past year, as you can see below, and is still higher by more than 100%  in the past year despite the recent decline of more than 25% since its peak on June 22.

Source: finance.yahoo.com

The problem with calling the top in stocks is that the earnings data, which starts in earnest this week, has been pretty good so far.  If companies continue to earn real profits, investors will continue to purchase stocks.

So, where else can we turn for new information?  Tomorrow brings the latest CPI report (exp 3.8% headline, 2.9% core), and you know that will be heavily scrutinized as the punditry tries to determine the FOMC’s reaction function and if it has changed with the new Chairman.  At this point, I do believe the Fed’s reaction function has changed, and more importantly, I don’t think anybody knows what it will be like, the Fed included.  The previous Fed whisperer, Nick Timiraos at the WSJ put out an article overnight discussing the idea that Chairman Warsh needs to decide whether to undo the most recent rate cuts.  However, there is no evidence that Warsh speaks to Timiraos and based on everything Warsh has said, he is not likely to tip his hand.  Chairman Warsh does testify to Congress this week, but I expect he will deflect all questions about the future path of monetary policy, and let’s face it, with the likes of Maxine Waters on the House committee, they won’t understand anything he says anyway.

And really, those are the only things that I think matter for now, so let’s review the overnight activity in markets.  As mentioned above, stocks are generally under pressure, but not universally so.  For instance, in Asia, Tokyo (-1.9%), China (-1.8%) and the aforementioned South Korea all had rough sessions, but HK, Taiwan, India and Australia were all basically flat on the day.  The big surprise is Taiwan as given the semiconductor weakness; I would have thought that market would have been significantly impacted.  But I guess not.  Meanwhile, European investors appear to be completely focused on tomorrow’s France-Spain World Cup semifinal as equity indices there are virtually unchanged this morning.  As to US futures, at this hour (7:30) NASDAQ futures are weaker by -1.2%, but the other markets are little changed.

Bond yields are higher this morning, but not hugely so.  Treasury yields have edged up by 1bp, and European sovereign yields are higher by 2bps across the board with UK Gilts (+4bps) the real laggard there.  Overnight, JGB yields backed up 4bps as well, but that story has more to do with the GPIF than anything else.

Remember Friday?
Japan was bringing home yen
They were just kidding

Think back to Friday.  Japanese FinMin Katayama mentioned that the GPIF and other Japanese pension funds ought to consider investing more money in Japan and less abroad.  That got tongues wagging about a major policy change coming that would serve to support the yen, and the JGB market while undermining Treasuries as the idea was the GPIF would sell their US Treasuries and buy JGBs instead.  Well, it turns out that is not actually the case.  The GPIF reevaluates its policy annually but has expressed no urgency to change things now despite the FinMin’s comments, at least according to Reuters.  The upshot is that JGBs sold off as did the yen (-0.3%) as per the below chart.

Source: tradingeconomics.com

Perhaps more surprisingly, though, the dollar is mixed on the day, not higher across the board as might have been expected given the uptick in oil and military activity.  So, we have seen weakness in GBP (-0.1%), AUD (-0.2%) and INR (-0.5%) while EUR (+0.1%), NZD (+0.2%), NOK (+0.3%) and KRW (+0.4%) have all had decent sessions.  Net, the DXY is essentially unchanged this morning.

Finally, and quickly, both gold (-1.5%) and silver (-2.0%) are under pressure with the higher oil price although copper (+0.6%) continues to find support and remains well above $6.00/lb.

In addition to the CPI data, it is a pretty busy week as follows:

TuesdayNFIB Small Biz Optimism95.6
 CPI-0.1% (3.8% y/Y)
 -ex food & energy0.2% (2.9% Y/Y)
 Warsh Testimony 
WednesdayPPI-0.1% (6.2% Y/Y)
 -ex food & energy0.3% (5.2% Y/Y)
 Empire State Mfg8.9
 Warsh Testimony 
 Fed’s Beige Book 
ThursdayInitial Claims218K
 Continuing Claims1811K
 Retail Sales0.2%
 -ex Autos-0.1%
 Philly Fed13.5
FridayHousing Starts1.30M
 Building Permits1.40M
 IP0.2%
 Capacity Utilization76.2%
 Michigan Sentiment51.5

Source: tradingeconomics.com

We also hear from 9 other Fed speakers (it almost seems like they didn’t get the memo about reducing communication) but with Warsh on the stand both Tuesday and Wednesday, I don’t think the others will matter that much.  Of course, it will be interesting to hear the other speeches if CPI comes in softer than expected as it may put a crimp in the hawks’ views.

In the end, not that much has really changed I would argue.  The war is an exogenous variable, and the market has learned to largely ignore it.  The Fed is still too uncertain in its new construction for many views to have changed, but I think the one thing we can conclude is that the old models of their reaction function are no longer viable.  My take is the beauty of the task forces for Chairman Warsh is they won’t report for at least 3 months, and probably more like 6 months, so until they report, absent a massive spike in measured inflation, the Fed is not going to do anything.  The Fed funds futures market is now pricing a one-third probability of a hike at the end of this month and certainty of one and 50% probability of two by the end of the year.  I would fade those trades.

Good luck

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Young Turks? Or Warhorses?

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Stories about yen
Have multiplied like rabbits
Is it really news?

You know it has been a slow session when the yen’s movement, as seen in the chart below, was enough to draw 4 headline stories in Bloomberg.

Source: tradingeconomics.com

And here is a screenshot of the 4 headlines on Bloomberg.com

While it may look dramatic on the screen, that almost one yen move represents less than 0.6%, and as you can see, about half of it has already retraced.  The underlying premise is that FinMin Katayama, in a regular speech about general things, suggested that the GPIF (Japan’s national pension fund) ought to consider investing more assets in Japan and JGBs rather than internationally.  The idea is that if the GPIF changes its investment mix, so will many other Japanese institutional funds, and they do have a lot of money there, upwards of $2 trillion equivalent.  This is not to say that they are going to invest all their money back home, just that the mix could change somewhat.

Now, if they were to do this, it would certainly have an impact on both the FX and global bond markets, with the yen likely to strengthen along with JGB prices (hence JGB yields declining) and potentially Treasury yields rising as a key buyer of US debt would reduce its appetite.  

But this is just a suggestion, and one that has been made numerous times in the past with no further action.  At the same time, yesterday’s US 30-year Treasury auction was extremely well-received with more than 77% indirect bidders.  That statistic is generally seen as foreign investors and central banks.  With the yield coming at 5.058%, it is not surprising that foreign bidders, especially the Japanese, would have significant interest.  After all, their currency continues under pressure, so if the GPIF holds Treasuries, in yen terms they look better almost every day.

The other spate of stories this morning was about the carry trade, and how Goldman Sachs has just explained to its clients that the carry trade, notably shorting yen to hold dollars, amongst other things, is an excellent risk reward trade right now.  I’m guessing Katayama-san didn’t really want to hear that.

My larger point, though, is that despite the yen (+0.4%) having moved a relatively modest amount, it certainly garnered a lot of attention.  In other words, there’s not much else to discuss.

Since Warsh and his minions last met
The question was who they would vet
To lead the task forces
Young Turks? Or warhorses?
Alas, tis the latter quintet

The other moment of excitement yesterday came from the Fed when they released the names of the leaders of each of Chairman Warsh’s five task forces.  The list is linked here.  It certainly did engender a lot of discussion with different analysts taking different views, and while I have some opinions, mine are no more useful than anybody else’s as they are not going to change things.  My observation, though, is that there is an awful lot of old school thinking represented by the list, which is somewhat disappointing for those of us who were looking for a new direction from the Fed.  As an example, Mervyn King, ex-BOE governor, and active participant in forward guidance, seems unlikely to offer many new views on communications.  But that is what we have.  Hopefully some new thinking will come about.

And that’s all there is regarding news, I think so let’s turn to market activity.  Under the theme, you can’t keep tech stocks down, yesterday’s US equity rally was followed by more strength (Tokyo +1.2%, HK +0.6%, Korea +2.5%, India +1.1% and Australia +0.5%) than weakness (China -2.0%, Taiwan -0.8%) in Asia.  The rest of the smaller regional exchanges were largely higher as well.  Arguably, the fact that whatever is happening in the Strait of Hormuz, oil prices have no strong bid, is part of that investment thesis.  As to Europe, other than Spain (+0.5%), the rest of the continent and the UK are all +/-0.1%.  And US futures at this hour (7:15) are showing softness in the NASDAQ (-0.5%) but otherwise not much movement.

Bond yields, though, are uniformly lower, backing off their recent test of 4.60% in 10-year Treasuries, as now that the auctions have passed, I think a lot of the short positioning into those auctions has been covered.  If oil continues to trade either side of $70/bbl, it is hard to make the case inflation will be running away.  So, Treasuries (-2bps) continue to back off while European sovereign yields have slipped by a similar amount.  The outlier was the JGB market (-13bps) which as you can see in the below chart has really changed vs. its following of Treasury yields, entirely on the GPIF story.

Source: tradingeconomics.com

In the commodity space, oil (+0.3%) continues to erase the gains seen Tuesday after the increase in military activity in the Strait.  Even though that seems to be ongoing, the markets just don’t care.

Source: tradingeconomics.com

As to the metals, yesterday’s gains are being moderated with both gold (-0.4%) and silver (-0.7%) slightly softer while copper is unchanged on the day.

Finally, the FX market, away from the yen, remains generally uninteresting.  Three weeks ago, much was made of the DXY’s break higher from a longer-term range as it traded through 100.50, almost reaching 102.00.  but as you can see in the chart below, for now, that excitement seems to be fading with a nice little downtrend developing since June 24th.

Source: tradingeconomics.com

In these dog days of summer, it is hard to get too excited.  Generically, while I remain in the camp that the Fed will not adjust rates this year, and so the market will need to reduce the current 33bps of rate hikes priced into the Fed funds futures curve as you can see below, I also think that ongoing inward investment into the US is going to underpin the dollar over the medium term.

There is no data to be released today, and yesterday’s numbers saw a marginally better Initial Claims number (215K vs 218K expected) and a slightly worse than forecast Existing Home Sales number.  As well, we heard from NY Fed president Williams who said his new main concern is that demand for AI infrastructure is going to drive inflation higher and he is wary of that.  Of course, that is exactly at odds with Chairman Warsh’s view that AI is going to reduce inflationary pressures.  Next week, Chairman Warsh will be testifying to Congress and there are four other Fed speakers, but my take is that over time, we will hear less and less from the rest of the Committee. (Or maybe that is just wishful thinking on my part!)

At any rate, it is shaping up to be a quiet one, so close up early and take a long weekend, you’ve earned it!

Good luck and good weekend

Adf

Rise Like the Sea

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So, let’s take a sec to discuss
Inflation, and why it’s a plus
At least for some folks.
In gentle broad strokes,
Though most of us see it and cuss

For those who hate Trump it’s a key
To help destroy his legacy
For Congress, they need
Inflation to plead
That taxes must rise like the sea

And what of the Fed and their role
To keep it in check, on the whole
Now, if they’re successful
T’would truly be stressful
For everyone on their payroll

If you were a government and wanted to design the perfect process by which to extract more money from your citizens allowing you to spend more money on the things you wanted, whatever their views, all while explaining that their lying eyes were deceiving them when they complained, it would be hard to come up with a better process than the official inflation figures.  Of course, today we get more of those figures with PCE and its variants set to be released at 8:30.  While I am here, these are the current market median estimates: PCE (0.5%, 4.1% Y/Y), Core PCE (0.3%, 3.4% Y/Y) although I see no forecast for the Dallas Fed Trimmed Mean reading, the one that Chair Warsh says he wants to focus on.  Too, it is key to remember that they are May numbers.  How many of you can remember what happened in May?

For instance, looking at the easiest one, oil (-1.0% today), as per the below chart, you can see that WTI ranged between 86.50 and 106.50 during May, mostly sliding, bur arguably averaging in the low 90’s.

Source: tradingeconomics.com

This morning, it is trading below $70/bbl, back to the price on March 2nd, the first market day of the Iran conflict.  The BLS indicated that upwards of 60% of the rise in CPI was driven by the rise in energy prices, which tells me that whatever today’s numbers are, they are ancient history and next month’s are going to be lower.  I don’t know about you, but I am quite happy that energy prices are falling back to pre-war levels as, a) it makes life more affordable, and b) cheap and abundant energy leads to significant economic output, something good for us all.

But here’s the thing, with energy prices declining, those who benefit from high inflation need a new story, and there is none better than semiconductors.  The top headline in the WSJ this morning is The Data-Center Boom Is Sparking a Third Wave of Inflation, right on time for the next big inflation scare.  The big winner, at least today, Micron Technology, which had blowout earnings last night and jump-started a serious Techquity™ rally overnight with Tokyo (+4.6%), China (+1.6%) and Korea (+5.4%) leading the way.  HK (-1.4%) lagged and the rest of Asia was mixed, but that gives you an idea.

But the point of the article was that we all need to be prepared and accept that higher inflation is coming because the massive resource demands to build AI are coming along before the productivity gains can moderate the price impact.  And I have no doubt that the resource demands are going to support prices.  I remain uncertain over how quickly AI’s impact will be deflationary, even disinflationary.

And here’s the thing, my lived experience, plus my frequent conversations with The Inflation Guy, Mike Ashton, have me in the camp that CPI is going to live in the mid to high threes for a while to come, regardless of the metrics the Fed uses to measure things.

But I have begun to discern that there is a large community that benefits from rising inflation because it helps them achieve their goals.  After all, we know that governments love inflation as it devalues the real value of their outstanding debt, so a steady depreciation is their best friend.  As well, Congress’s baseline budgeting ruse, which starts each year from the previous year’s expenditures, not from zero, is a huge beneficiary of inflation.  I understand that since about 1980, the BLS has adjusted the CPI calculation somewhere between 30 and 40 times and you can guess the direction of most of those adjustments.  Of course, companies that sell products are a big fan as well, as they tend to adjust prices to both include new costs, and increase margins.  And they have a natural scapegoat; CPI is out of their hands.

All I’m saying is that while there appears to be a strong effort to fight inflation, I’m not a believer.  (And here I should highlight that I use the term ‘inflation’ in the manner it has become understood, rising prices, and not in its classical form of an increase in the money supply, which is 100% the Fed’s doing.)

One other thing.  My friend JJ who writes Market Vibes, posted a chart of 1yr breakevens as of yesterday and I reproduce it below.

This is not a signal that the market expects prices to rise, but rather is following the decline in oil prices pretty well.  Once again, I will ask, please explain given market signals, why everyone is so sure the Fed is going to hike.  I maintain my one cut by year end view which is at least 50bps below the current Fed funds futures market pricing.  Ask yourself how the FOMC ‘hawks’, and I use that term loosely, will be able to argue for higher rates if oil continues its trajectory and inflation readings decline.  Precautionary?  How about they will simply say, we want to screw Trump, at least they would be honest then.

Ok, on to other markets overnight.  European bourses are all higher this morning, but since none of them have any real tech exposure, they are not running away.  Rather, 0.3% to 0.7% encompasses the magnitude of movement we have seen.  As to US futures, at this hour (7:25), NASDAQ (+2.0%) is leading the way, but the whole group is higher.

In the bond market, yesterday saw yields decline about -8bps in the 10-year Treasury and -6bps in the 2-year.  this morning they are little changed, consolidating those price gains.  As to European sovereigns, yields there also slipped yesterday, but not as dramatically, about -4bps, and this morning they are largely unchanged.  Overnight, JGB yields fell -3bps as declining oil prices are feeding through to inflation expectations.

The precious metals complex continues to get hurt, with gold (-0.6%) and silver (-0.5%) still under pressure and at new lows for the year, but copper (+1.25%) seems to have found a short-term floor at $6.00/lb.

And finally, the dollar, which has been en fuego lately, rising for the past six consecutive sessions, as per the below chart, is consolidating for now.

Source: tradingeconomics.com

Nothing has changed the yen story, where the dollar creeps ever so slightly higher each day, now just below 162.00 but overall, today’s movement has been quite muted, about +0.15% in the dollar against most currencies, as the focus turns to inflation, at least for today.

On the data front, in addition to the PCE data we get a bunch more as follows:

Initial Claims225K
Continuing Claims1800K
GDP Q1 Final1.6%
Personal Income0.4%
Personal Spending0.6%
Durable Goods-4.5%
-ex Transport0.6%
Chicago Fed National Activity0.12

Source: tradingeconomics.com

Will anyone care about this data?  I doubt it, Core PCE is THE thing today, so we will watch and see how that comes out. But mark my words, if it is soft, the hawkish Fed narrative is going to come under real pressure as stocks rally and yields and the dollar slip.

Good luck

Adf

‘Pocalypse Dreams

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Though many have preached the buck’s dead
The greenback keeps moving ahead
And right now, it seems
Their ‘pocalypse dreams
Are still all confined to their head(s)

But narrative writers ignore
Whatever they said from before
Right now, it’s the buck
That’s causing bad luck
As rate hike bets all start to soar

In a fairly rare set of circumstances, the dollar has drawn the spotlight in markets for the past few sessions.  While it always matters to some extent, it is rarely seen as the cause of many other market movements, just a coincident one.  But right now, I read more about how the strong dollar is driving equity weakness and commodity weakness as more and more bets get placed on the Fed hiking rates aggressively to address inflation by the end of the year.

Using the DXY as proxy, the first chart is the one everybody wants you to focus on, showing the last year and how we have had a clear break above the trading range top of 100.50 and now people are creating targets for just how high it can go.

Source: tradingeconomics.com

And it certainly can go higher, as a quick step back to get some more perspective shows where the dollar has been during the past 5 years. It seems to me I could create a narrative that the dollar has been massively undervalued over the past 18 months, and this move is simply returning it closer to its longer-term fair value.  In fact, just eyeballing, it seems quite reasonable to think the 5yr average of the DXY is somewhere around 103-104 (subsequently confirmed with Grok), still a few percent higher than current levels.  Reversion to the mean anyone?

Source: tradingeconomics.com

All of this, though, begs the question, are rate hikes really on the near-term horizon?  I remain firmly in the camp that is not the case.  Fortunately, someone on my side is super smart, Bob Elliott, former hedge fund manager at Bridgewater.

On the rate hike front, the below CME probability table has barely changed from yesterday as the narrative is strong that rate hikes are coming.  

I cannot really understand why this is suddenly the belief set given the fact that the key driver of recent higher inflation data has been the price of oil, and that price continues to fall, down a further -2.0% this morning.  I understand that gasoline prices have not fallen quite as dramatically, but nothing about the chemistry has changed and I remain highly confident that those prices will be falling as well, catching down to oil.

Source: tradingeconomics.com

So, I remain confused as to why everybody seems to believe the Fed, which despite a new Chair remains the same institution that observed inflation run higher for years during Covid and calling it transitory, has become the reincarnation of the Bundesbank.  In fact, the only rationale I see is that other than Waller, Warsh and Bowman, who were all appointed by Trump, everybody else in that room has TDS and is terrified that things will work out such that by the time the election rolls around, the economy is ticking over nicely with inflation a historical issue.  And frankly, I think most of them do share that affliction.

But other than Powell, and Cook to some extent, none of them have really felt the force of the critiques that come with upsetting President Trump, and frankly he didn’t care about Cook per se, she was just a convenient target to get ousted so he could put his man in there.  And in fairness, Cook is a massive dove, and should agree with Trump on this policy, but I’m sure she doesn’t because…Trump.  I am confident none of them signed up for being in that spotlight.

Apparently, BOA is calling for 3 rate hikes this year in the final four meetings.  I think that’s nuts, but futures are pricing a 2/3 chance of a hike at the end of July, which I also think is nuts.

The recent hiccup in stocks, and the steadier downturn in commodities has been blamed on dollar strength which is being driven by expectations of rate hikes coming soon.  While I like the dollar in the long-term, that is because I believe investment flows into the US will drive it, not financial arbitrage flows.  As things evolve, I expect the market to understand the Fed will not be hiking rates and narratives will need to find a new bogeyman.

Ok, let’s tour markets quickly.  Yesterday’s equity market selloff in the US, following the tech selloff in Asia closed well off the lows and futures this morning are pointing slightly higher.  Asia was mixed overnight with Korea (+3.3%) rebounding sharply although there was weakness in Japan (-0.9%), Taiwan (-2.25%), Indonesia (-3.6%) and the Philippines (-2.2%).  But on the flip side, China (+0.5%), HK (+0.3%) and India (+1.0%) all followed Korea while other regional exchanges had much more limited movement.  It appears that people are trying to figure out what to do for now.

In Europe, Germany (-1.0%) is the laggard after Germany cancelled its plans for a new warship and Rheinmetall, the company set to win biggest there, got crushed.  But elsewhere +/-0.3% or less is the norm with little new information as traders await the next shoe to drop.

In the bond market, interest is low as 10-year Treasury yields continue to track around the 4.5% level and movement has been 1bp or so lower across all of Europe.  Nothing to see here for now.  Just wait until views start to change on rate hikes though!

Metals markets continue to get hammered with gold (-1.7%), silver (-2.9%) and copper (-1.6%) all still falling as the opening narrative about higher rates and a stronger dollar play out.  The thing is, I think the fundamentals remain positive for metals markets as there continues to be central bank demand for gold as well as industrial interest in silver and copper and long-term shortages of supply.  But right now, none of that matters.

Finally, looking beyond the DXY, it is no surprise the euro (-0.35%) and pound (-0.35%) are lower given the DXY’s continued rise, but the yen (-0.1% and at a new low (dollar high) for the move) continues to slide and there is weakness pretty much across the board in both the G10 and EMG blocs.  KRW (-1.0%) is today’s laggard while INR (+0.2%) is the lone currency holding its own.  This continues to be a dollar focused story so when the rates story changes, so will the dollar.

On the data front, we see New Home Sales (exp 640K) and then EIA Oil inventories with yet another large draw expected.  And that’s it for today.  As long as this rate hike narrative remains primary, look for weaker risk appetite and a strong dollar.  But I think it is a short-term phenomenon.

Good luck

Adf

Future With Dread

Posted on by 
The story today is the Fed
And whether, when looking ahead
Inflation they see
Stays well above three
Or if it just might fall instead

Meanwhile, every comment I’ve read
Discussing the ‘deal’ have all said
Too much was conceded
The US retreated
And look to the future with dread

Starting with the MOU with Iran, and having read the text of the agreement, at least the one published by Bloomberg, Iran has sworn to never have a nuclear weapon and then will effectively be readmitted to polite society, with sanctions and restrictions eventually removed.  The several comments I have read on the deal highlight numerous potential loopholes and semantics regarding tolls and fees and are uniformly unhappy with the deal.  But I’ve also read that many on Iran’s side are unhappy with the deal.  Arguably, the best sign the deal is going to last is just that, neither side got everything they wanted, but both got some of the things they wanted.  Time will tell how this all plays out, but certainly the oil market remains positive that the direction of travel is toward a normalization of flows through the Strait of Hormuz.

However, while the political pundits are going to continue to focus on that issue, markets have turned their focus to the FOMC meeting and how things play out under new Chairman Kevin Warsh.  The previous Fed whisperer, Nick Timiraos at the WSJ, continues to push Governor Powell’s message as there is not yet a new Fed whisperer.  My take is Timiraos will not be the one simply because his loyalties will not lie with Warsh. 

The thing in which we can be most confident is there will be no rate change at today’s meeting although the market continues to price a rate hike in December as per the below CME table.

All the drama will come with the release of the SEP (Summary of Economic Projections) which is the quarterly document the Fed publishes showing the range of economic forecasts by the individual FOMC members regarding GDP, Unemployment and interest rates.  This document also includes the dot plot.  It is important to note that the SEP only started to be released in 2007, so this is not a long-standing tradition, but part of Ben Bernanke’s changes to the institution.

And this is a key feature of what makes Kevin Warsh different.  He has indicated that the Fed talks too much (I agree) and believes that some ambiguity in what is going on is a desired outcome.  This is a controversial stance as Wall Street has minted money on the back of forward guidance, recognizing the Fed has their back whenever they blow up because they built up huge leverage and were wrong.  

While I completely understand the idea that political discussions need to be in the open, I am far more suspect with respect to monetary policy discussions.  Prior to forward guidance, market participants were far more cautious in their positioning as the probability of getting the direction of a trade wrong was far greater.  But once the Fed says, ‘rates are going to stay low for a very long time’, traders can lever up positions massively relying on the fact that their funding costs are going to remain in check.  And it is the massive leverage where the risks to the market lie, not the level of rates per se.

So, the question today is how Chairman Warsh will handle his desire to reduce communications compared to the previous actions of publishing the data and numerous FOMC members speeches.  One thought is he may refuse to put his own forecasts into the document, a sign of what he wants going forward but I am confident he has other ways to move forward.

The other issue is the question of the tone of the statement, which had ostensibly been leaning dovish but seems now likely to be neutral.  My sense is whatever he does, it will be incremental, at least at the beginning, but I anticipate that he is going to make substantial changes to the way the FOMC operates during his tenure as that is why he was put in the role. 

So, with that as our backdrop, let’s see how markets have absorbed the text of the deal as we all await the FOMC this afternoon.  Yesterday’s mixed US performance, with only the DJIA managing a gain while tech stocks dragged down both the NASDAQ and the S&P, was followed by more positivity than not in Asia with gains in Japan (+0.7%), China (+1.0%), Korea (+1.6%) and India (+0.5%) while HK (-0.75%) slipped a bit.  It is always a bit of a surprise when HK and China move in opposite directions, and it seems today’s split arose from different interpretations from a policy conference regarding future PBOC activities as well as potential future government support for a clearly weakening consumer economy.  Other regional exchanges had a mix of gainers and laggards as well, as the overall session was directionless.

In Europe, the picture is also mixed although the movement has been more muted than those in Asia.  Both Germany and the UK are flat to slightly lower this morning with the former under pressure after BMW offered a terrible profit forecast while the latter, despite lower-than-expected inflation readings, is lagging on growth concerns.  However, France (+0.2%) and Spain (+0.5%) have both managed to rally a bit on some slightly positive earnings news.  As to US futures, at this hour (7:15), they are modestly higher across the board.

Bond yields are generally little changed this morning with only UK gilts (-5bps) and JGBs (-4bps) showing any movement at all.  Gilts responded positively to the inflation data while JGBs seemed to take solace in the trade data showing Japan was back to a deficit.  

In the commodity markets, oil (+0.7%) is having a very quiet session after several sharp declines in a row while metals markets are largely unchanged this morning.  It appears even traders here are awaiting the FOMC outcome.  One thing I have seen is a recent report from the World Gold Council showing 45% of central banks surveyed plan to buy the barbarous relic in the next 12 months.

And finally, the dollar is slightly stronger this morning, but like most other markets, not showing much movement at all.  The below chart of the DXY for the past month shows just how lackluster price action has been with a total range of just 1.5%.  The red line is the midpoint of that range showing there is just not a lot of pressure in either direction right now.

Source: tradingeconomics.com

Meanwhile, USDJPY has basically spent the past two weeks hovering just above 160.00 with nary a peep from the MOF or BOJ.  Again, the situation there is the policy changes necessary to strengthen the yen are likely to have very negative economic consequences initially, and that is not something any government is likely to do.

On the data front, ahead of the Fed we see Retail Sales (exp +0.5%, +0.5% ex-autos) and then the EIA oil inventories with more draws expected.  And that’s really all there is.  I anticipate a very quiet session ahead of the Fed and then all will depend on how the market interprets Warsh’s signals.

Good luck

Adf

Changing the Fate

Posted on by 
With things in the Gulf getting hotter
And risk assets heading to slaughter
The question on lips
Can stocks e’er eclipse
Their highs, or ‘stead sink ‘neath the water
 
But really, the question I’d ask
Is Chairman Warsh up to the task
Of changing the fate
Of the Fed funds rate
And if so, what will he unmask?

It is very difficult to focus on the Gulf situation as not only is it fluid, but there is also no direction of travel whatsoever.  So, this morning I want to have a different conversation.  Let me start by explaining this isn’t my idea, per se, although the analysis is solely mine.  Listening to the Macro Voices podcast Sunday morning while walking the dog, (he’s the one on the left)

Michael Every was on and expressed a very interesting thought, one that I had not considered, nor heard anywhere else.  What if the Fed, as Chairman Warsh seeks to adjust how it works, decides that they are going to put their fingers on the scale with respect to the interest rates paid by different industries, not merely by differently rated credits.  The idea is that in conjunction with the Treasury, Warsh and Bessent would decide which industries needed to have the most cost-effective funding for the nation to be able to maintain and develop the industries necessary for national defense reasons.

Now, I know this is anathema to almost all of us having been raised on the idea(l) of free markets and that markets are better at allocating, well everything, but in this case credit, than any cabal of central bankers.  And in a world where markets were truly free and where everyone competed on a level playing field, I am 100% in agreement with that view.  Alas, I’m not sure if you noticed, but that is not the world in which we live.

If Covid taught us nothing else, it was that 40 years of globalization and creating the most efficient processes for manufacturing resulted in significant fragility in those very processes.  It turns out that while economists in the US, Europe, Japan, the World Bank and IMF all explained that this was a great outcome (the US prints paper notes and gets lots of stuff for it), that only works when there is peace on earth.  During this period, China chose to play by a different set of rules, explaining they were just a poor country so didn’t need to play by the G10’s rules, and massively subsidized numerous industries while essentially ignoring all environmental issues.  That tilted the playing field pretty aggressively, and while President Trump has been adamant about that very issue for a decade, he was largely ridiculed, right up until Europe recently figured out that China was eating their lunch too, and now they are looking to impose tariffs on China’s excessive exports.  There is an excellent Substack that comes out Sunday mornings called The Brawl Street Journal,written by an analyst in Germany.  This week’s, linked here, explains that very issue extremely well.

So, I’ve set the table here, and the key to understand is the table is tilted horribly, with China getting the benefit of the doubt for almost everything.

Now, let’s consider what Mr Every’s idea would mean.  Below is a chart showing current 10-year yields for Treasuries and a series of corporate bonds delineated by their credit ratings.

Data: streetstats.finance

Makes sense, less creditworthy names pay more.  That is how things have always been within a market system as the worse the credit rating, the higher the perceived risk of the investor and therefore the higher yield they demand.

But what if that were to change?  What if the Fed and Treasury decided that companies that manufactured products, be they semiconductors, automobiles, tractors, airplanes or flat panel screens, and mining companies that mined in the US (and Canada) and energy extraction companies that drilled in the US (and Canada) needed a lower cost of capital to be more competitive globally as those companies were the ones necessary for the US to maintain its global hegemon status.  But media companies, and retailers, non-bank financial institutions and home health services companies, for example, were not deemed as critical.  Perhaps the new “credit” curve might look like this instead (all hypothetical)

The point is, China has been subsidizing numerous manufacturing industries for decades with the goal of excess production designed to drive other nations’ competitors out of business and gain a strategic advantage in all those industries.  It is why President Trump’s tariffs were a problem for them, and the rest of the world, as the US had been the dumping ground for much excess Chinese production in the past, and now that stuff is going elsewhere.  

The world we once knew is no longer the world in which we live.  Mr Every’s term, economic statecraft, is much more applicable today than any time in the past 40 years, probably longer, since the end of WWII.  Statecraft implies nations will use all the power they have, economic, military and diplomatic, to achieve their desired goals.  For more than 70 years, the US did not play by those rules under the assumption that if they created a level playing field, and even tilted it in favor of weaker allies, peace would reign.  China doesn’t play by those rules, and that is how we have arrived where we are.  

This is all hypothetical, but remember, Chairman Warsh has talked about restructuring the Fed.  All the economists think he is talking about shrinking the balance sheet.  But what if he is talking about completely changing credit markets with Fed support?  I would argue that is not on many bingo cards.

So, briefly, let’s consider how markets would respond to this action by the ‘new’ Fed.  Here are my conclusions, I would love to hear yours.

  • Stocks – broadly lower, although clearly favored sectors would continue to perform well.  But overall leverage would shrink and that has been a huge part of this rally.
  • Bonds – a steeper Treasury yield curve seems certain as subsidies for those favored industries will weigh on the US budget.  Meanwhile, non-favored industries would find themselves with real difficulties in terms of financing.
  • Commodities – offsetting forces here as industrial metals would see increased demand, and getting supply on line takes years if not a decade, but energy may result in a glut sooner as drilling takes much less time to get going.  Precious metals would soar, I believe, on the basis of investors and central banks, seeking an asset with no counterpart.
  • FX – this is the toughest call as different nations will be impacted in very different manners.  Commodity producing nations (e.g., Chile, Norway, US) should see relative strength.  Consuming nations would likely suffer somewhat, although Japan and Korea, for instance, could essentially fall within the US umbrella as their key industries are the US focus.

Again, this is all hypothetical but is probably worth some thought.  In the meantime, a brief tour of markets overnight after Friday’s sharp declines in the US shows nobody is very happy this morning.  The tradingeconomics.com screenshot below shows futures as of 6:10am.

What sticks out to me is Italian equities are bucking the trend, although there has been no data and I cannot find a specific catalyst there.  Also, it is interesting that US futures are broadly higher this morning despite growing concerns that the situation in the Gulf is going to heat up again.  But Asia had a rough session and most of Europe is feeling a little pain as well.

In the bond market, after climbing on Friday, yields continue higher this morning across the board.  The below Bloomberg screenshot explains things well.  Recognize that Canadian and Mexican markets haven’t opened yet and Australian markets were closed last night for the King’s Birthday.  But net, there is growing concern over inflation on a worldwide basis it appears.  

Turning to the commodity markets, oil (+3.8%) is higher again, after falling on Friday as there were missile attacks by Iran on Israel in response for Israel’s ongoing attacks on Hezbollah in Lebanon. This situation remains fraught and frankly nobody has any idea when it will settle down into something a bit less volatile.  If we look at a chart of the past six months of oil price movement, I have drawn a line at $95/bbl, which to my eye offers a pretty good estimate of the average since things began.  There are still many doomsayers who believe $200/bbl oil is coming soon, but that has been their forecast since March.  Something to remember about commodity markets is that they do not forecast the future, they are the prices at which physical stuff clears, so it appears that so far, there is ample inventory available.

Source: tradingeconomics.com

Not surprisingly, given the recent relationship between gold and oil, the barbarous relic is lower this morning by -0.7% while silver, though unchanged on the day, suffered dramatically on Friday, falling $6/oz or about 8%.

Finally, the dollar is little changed this morning, but that is after a sharp rally on Friday in the wake of the much better than expected NFP data (+172K with revisions higher in the previous two months of +93K) which helped push yields higher as a rate hike this year has now been priced by the futures market as per the below CME table.

But more than just the futures market is thinking that way.  The below chart showing the 2-year Treasury vs. Fed Funds shows that not only have 2-year yields moved above Fed funds, but they are accelerating higher.  This is seen as another harbinger of a higher Fed funds rate.

Source: tradingeconomics.com

So, the DXY is back over 100.00, USDJPY breeched 160.00, and is right on that number as I type at 6:50am, and generally, the dollar is pushing the top of its recent ranges.  The one exception here is KRW (+1.6%) where the central bank and Finance Ministry both were actively jawboning the currency higher after it traded to yet another new low (dollar high).

As there is no data of note this morning, I will go through that tomorrow given how long things got today.  The world is changing rapidly and the most important thing, I think, is to recognize that old relationships may no longer be valid.  Nimbleness is critical, whether investing or hedging.

Good luck

Adf

Beware

Posted on by 
While news from Iran shows the war
Continues apace, like before
On Wall Street it seems
It’s over, with dreams
Of stock market rallies galore

Now, I realize stocks look ahead
And discount the future instead
But wars tend to last
They don’t end so fast
Beware in which markets you tread

As March and Q1 ended, it appears that there have been some changes in opinions in the investment community.  At least that is what I glean from the following Bloomberg screenshot of major global equity markets including yesterday’s US session and the overnight activity.

As far as I can tell, missiles are still flying in the Middle East, the US and Israel continue to attack specific targets with B-52’s dropping significant amounts of precision guided bombs, the Strait of Hormuz continues to have extremely restricted movement and the UAE, according to the WSJ, is now ready to join the war directly.  None of that seems like de-escalation of fighting, but then I am not a military strategist, so perhaps I don’t understand the concept of de-escalation well.

One take I saw this morning was that equity markets are pricing in the increased likelihood that the US will be leaving the conflict.  On the surface, I liked that idea, and that would certainly explain some of the US rally yesterday, but that doesn’t explain why Asia soared and Europe has rallied as well, given they would have to deal with the rest of the process.  This evening at 9:00 President Trump will be addressing the nation, so I presume we will have a better understanding of things after that.  

One other thing to remember is that the president uses his Truth Social posts to add to the fog of war and create strategic uncertainty for all parties involved.  I read this morning that the administration has been speaking (not directly) with some Iranians and creating a plan for the future, but it is not clear if those people have sufficient power to unite the country there yet.  All in all, while anything is possible, it strikes this poet that things in Iran have not ended, nor will they until the Strait of Hormuz is back to full operational capacity regardless of the President expressing the view that the US (and Israel) have done the hard part and Europe and Asia can deal with the Strait themselves.

But that is where we stand this morning, with risk back in vogue across the board as oil (-1.5% and back below $100/bbl) slipping while gold (+1.5%) continues its rebound.  Bonds (-3bps this morning and down by 20bps from their peak on Friday) continue to rally and have taken European sovereigns along for the ride with most of Europe seeing yields slide between -7bps and -9bps although German bunds, which have held up the best, are only lower by -4bps.  Happy Days are here again!

With all that good news, let’s consider what else is going on, away from Iran, that may impact markets.  At this point, we know the Fed is on hold this month, and likely through the autumn, at least, given the short-term inflation impacts of the oil situation.  

Source: cmegroup.com

As an aside, there have been a number of analysts who are calling for a significant rise in food inflation but be careful on that front.  As @inflation_guy, Mike Ashton points out, [emphasis added]

“…secondary knock-on effects that will be felt eventually in CPI. One that has gotten a lot of press recently is that less oil means less fertilizer and less fertilizer means less crop production and less crop production means higher prices for food. I actually think that’s probably overblown in terms of what the consumer will see, because most of the cost of consumer food items is in the packaging and delivery and not the raw goods, and so as raw food commodity prices go up it will likely be partially offset by transportation prices declining.” 

In fact, I expect that most central banks are terrified of the current situation as they understand, intellectually, that the oil price shock will be temporary, but will feel significant pressure when inflation starts to rise to “do something about it”.  Australia already hiked rates, but that was assumed prior to the onset of the war.  The calculation they are all trying to make is will the negative impacts on growth outweigh the rising pressure on inflation and what will the timeline be like.  In the end, my take is very few will hike in response to this event, especially if the military activity ends before the end of April.  And that is why they get paid the big bucks, to get those decisions right.  Alas, their collective track record is not great.

And beyond that, I don’t see much news directly driving the narrative.  It is still the war, and all the individual takes there, and a much lesser role to the Fed and other central banks.  Economic data is decidedly not part of the current discussion in any meaningful way and given the impact the war is going to have on data for a while going forward, it will be very difficult to suss out underlying trends from headline numbers.  

I’ve already discussed most market segments, leaving just currencies untouched at this point.  Given the reversal in views, we cannot be surprised that the dollar, which has been a major beneficiary of the war, has reversed its recent price action as well.  In fact, using the euro as our proxy, we can see in the below chart that the reversal started at 7:00am yesterday morning and the single currency has rebounded by 1.25% since then.

Source: tradingeconomics.com

And while the euro (+0.5% today) has rallied this morning, it mostly lags other currencies with the pound (+0.7%), AUD (+0.8%), CHF (+1.0%) and SEK (+1.0%) all having very strong sessions.  As well, the yen (+0.2%) has backed away from the 160 level and even CAD (+0.2%) and NOK (+0.5%) are stronger despite the decline in oil prices.  It should be no surprise that the EMG bloc is also showing strength with CLP (+1.1%) leading the way followed by HUF (+1.0%) and ZAR (+0.9%). One disappointment is KRW (+0.2%) which has been one of the worst performers for the past month (-4.0%) and is barely rebounding.  Chile is intricately bound to the price of copper, which has rallied slightly (+1.0%) in the past week, but continues to lag the precious metals.  However, there is a story about the major copper company there, Codelco, which is supporting the currency this morning.  Net, the dollar is giving back some of its recent gains today and will likely continue to do so if risk appetite remains robust.

While data hasn’t had much impact, this morning we see ADP Employment (exp 40K) as well as Retail Sales (+0.5%, +0.3% ex autos) and then ISM Manufacturing (52.5) and Prices Paid (73.0).  Yesterday’s data was in line with expectations and did nothing to alter any perceptions about the economy or path of interest rates.

And that’s all we have.  US futures are rising this morning (+1.0% across the board at 8:00) and for now, risk is the way.  I guess we will have to hear what the President says this evening to consider changing views.

Good luck

Adf

All Will Reject

Posted on by 
Down Under the latest decision
To raise rates was made midst division
Inflation there’s rising
So, it’s not surprising
The two sides have had a collision

But elsewhere this week I’d expect
That central banks all will reject
A hike in their rate
As long as the Strait
Stays closed, though inflation’s unchecked

For a while now, I have been making the case that central bank activities, at least in the West, had a diminishing impact on market behavior, and that was before the war in Iran began.  My thesis had been based on the idea that fiscal policies had become so overwhelming that market participants realized that the odd 25 basis point rate move was not going to move the needle, at least not on a short-term horizon.  

Then, of course, at the beginning of the month, the Iran conflict began which garnered all the market’s attention, rightfully so.  But here we are, 17 days into the conflict and suddenly, investors seem far less concerned with the situation.  Naturally, the halting of ~20% of daily oil flows through the Strait remains a critical issue, but arguably, until something there changes, the market seems to have absorbed that in its price.  Consider the following screen shot of equity markets from 6:30 this morning.  it is very difficult to look at this and conclude there is any sense of panic.

Source: tradingeconomics.com

Sure, equity markets have slipped over the past month, but the magnitude of that decline has been pretty modest considering oil prices have jumped 50% during that period.   The lesson I take from this is that speculative positioning has been substantially reduced because, frankly, we have not seen nearly as much fear response as I would have anticipated heading into this situation.  If we look at the CNN Fear & Greed Index below, sure it says we are in extreme fear (below 25 on the chart), although this is nowhere near the lows seen during the past year as per the below chart from cnn.com

But if you go to the link above, it shows a series of charts covering different facets of the stock market, and frankly, none of them demonstrate to me that fear is that rampant, despite their labels.  After all, most of the charts show the current readings right in the middle of the range over the past year.

Which takes us back to, what is driving markets these days?  Two and a half weeks into the war, I presume that margin calls have been settled and those positions adjusted or reduced accordingly.  After all, margin clerks demand settlement immediately, not in two weeks’ time, so they are done.  Economic data has been underwhelming, although we are beginning to see the first inklings of war-related weakness with yesterday’s Empire State Manufacturing disappointment (-0.2 vs 7.1 last month and 3.2 expected), but even more so with this morning’s German and European ZEW Economic Sentiment Indices.

                                                                                                                Actual           Previous          Forecast

Source: tradingeconomics.com

This is the first March data we are seeing, and I suspect all of it is going to be lousy.  But again, that is already priced in, I believe, hence the relative lack of movement.

And so, I turn to the central bank community, with virtually the entire G7 having meetings this week.  While I don’t anticipate any rate movement other than last night’s RBA hike of 25bps, which was priced in before the conflict began, I expect that we are going to need to listen to what they all say as our best indication of current expectations of future behavior, and whether they will react to the oil price rise, or recognize higher rates will not open the Hormuz Strait.  At this point, especially since there has been insufficient inflation data to alter decisions, I expect a lot of talk about carefully monitoring the situation, but no promises to do anything.  And remember, knock-on effects of higher oil prices into other things take time to be felt, so given the completely reactive nature of all central banks, that is not going to be a reason to raise rates.  Ironically, central banks are back in the market discussion despite themselves!

Ok, let’s tour the markets and see how things have behaved overnight.  Yesterday saw a very solid US session, although as in the table above, this morning futures are very modestly lower.  In Asia, Tokyo (-0.1%) slipped a bit after Katayama-san, the FinMin, explained she was watching the yen closely and would consider “bold moves” (a euphemism for intervention) if deemed necessary.  Elsewhere in the region, though, only China (-0.7%) failed to follow the US with Korea (+1.6%), India (+0.75%), Taiwan (+1.5%) and Singapore (+1.2%) representative of the price action.  Other markets had lesser gains, but gains they were.

Meanwhile, European bourses are all in the green as well, albeit not as robustly as Asian exchanges showed.  Spain (+0.8%) is the leader, but 0.5% gains in France and the UK are also extant while Germany (+0.1%) is still trying to shake off that horrible ZEW number.

In the bond market, Treasury yields slipped again yesterday, down -3bps, and this morning, European sovereigns are showing similar activity, with yields sliding between -3bps and -5bps across the entire continent and the UK.  This is certainly odd behavior if the market believes that oil prices are going to remain higher for longer.  If I look at the combination of the early March data weakness and the fact that bond investors are not panicking in any sense, there is no indication that central banks are going to do anything for now, but I suspect that economic weakness will be the issue that arises going forward.  After all, inflation has not seemed to be their driver for a while now.

In the commodity space, yesterday saw oil prices slide about 4%, while this morning they are higher by 3.0%.  but a look at the chart tells me that for now, they have found a new equilibrium just below $100/bbl +/- a bit. 

Source: tradingeconomics.com

It is important to remember that despite the large jump in prices recently, on an inflation adjusted basis, the current level is still only half as high as the 2008 spike to $145/bbl.  In other words, I might contend that it is not the price of oil, so much, right now, but rather its availability that is going to be the key issue going forward.  Naturally, Europe has jumped in to explain that they believe high oil prices help them denounce the US removal of sanctions on Russian oil as they will not countenance such things despite the loss of their key suppliers.  I’m glad I don’t live in Europe.

As to the metals markets, Zzzzzzz is the only way to describe them.  While copper (-1.2%) has slipped, neither gold nor silver has moved overnight, and both remain essentially at their new homes of $5000/oz and $80/oz.

Finally, the dollar is also doing little this morning, essentially unchanged vs. most its major counterparts.  NOK (+0.6%) is enjoying oil’s rally while ZAR (-0.5%) is suffering from the lack of gold movement.  And otherwise, it is hard to get excited about anything with movement +/- 0.2% or less across both G10 and EMG currency blocs.

There is no primary data released this morning in the US.  The FOMC begins its two-day meeting and tomorrow at 2:00 we will learn that policy is unchanged, but all eyes will be on the dot plot and the SEP report to try to better understand the potential future path.  But for today, absent a major change in the Iran situation, I don’t imagine it is going to be very exciting anywhere.

Good luck

Adf

Keep Up the Fighting

Posted on by 
The Strait of Hormuz remains closed
And right now, both sides seem disposed
To keep up the fighting
While pundits keep writing
That Trump will soon find himself hosed

Meanwhile, this week central banks meet
And none are expected to treat
The oil price spike
With any rate hike
Though keep eyes on each balance sheet

Nothing seems to have changed dramatically in Iran with US bombing attacks continuing and Iranian missile and drone attacks continuing.  It remains a daunting challenge to discern reality on the ground there as every news source spins any information to their political viewpoint, and I, for one, have been unable to pull much signal from the noise.  This is truly the fog of war.

With that in mind, it does appear that different markets are taking very different cues from the situation, with some (oil and the dollar) continuing to hew to a strong risk-off viewpoint while others, equities and bonds, remain unconvinced that the world is about to end.

As such, perhaps we should take a few moments to consider the fact that this week, we are going to see interest rate decisions from every major Western central bank in the following order: RBA, BoC, FOMC, ECB, BOE, BOJ, SNB, starting tonight and concluding on Thursday.

Of all these banks, only the RBA is expected to move, raising its base rate by 25bps to 4.10%, although that was baked in prior to the events in Iran beginning.  I would contend this is not a response to the oil price.  In fact, one must assume that central bankers are aware of the history of responses to exogenous price shocks, like an oil spike, and that any attempt to offset the inflationary consequences in the past has led to major economic pain.  It is not hard to understand that a sharp rise in oil prices, and the concurrent rise in gasoline and diesel, acts as a “tax” on the economy which tends to reduce economic activity.  Hiking rates into that scenario would very likely result, and historically has resulted, in a recession in short order.

Remember, the reason central banks, in general, look to core inflation, is because they know they cannot impact the prices of food or energy via interest rate policy.  While the ultimate impact of this oil price spike will only be known many months from now, if the conflict ends in the next several weeks, it is likely that any structural price issues will be avoided.  Of course, we have no idea how long things will last right now, so as investors and hedgers, reduced exposure to financial markets is likely the best advice for almost everyone.

Which means, it’s time to look at the markets and see what they are telling us.  After Friday’s soft close in the US, Asia saw a mix of outcomes.  Tokyo (-0.1%) did little overall, and we saw some weakness in Australia (-0.4%), New Zealand (-0.3%) and the Philippines (-0.9%) with Indonesia (-1.6%) the regional laggard.  However, there were numerous markets who ignored the oil price and rallied including Hong Kong (+1.5%), Korea (+1.1%), India (+1.3%) and Singapore (+0.6%) with mainland China essentially unchanged in the session.  China released a raft of data showing that the economy there continues to have property troubles (House Prices -3.2%), but the rest of things were largely in line with their reduced GDP expectations excepting Unemployment, which rose to 5.3%.  

Europe, too, is seeing a mixed picture this morning with some gainers (Germany, UK) and some laggards (Spain, France, Italy) although none of the movement is very significant, < 0.3% in every case.  US futures at this hour (7:10) are all pointing nicely higher, in fact, by 0.5% to 0.8%.

My point is that despite fears of the death of the equity rally, as I type this morning, the S&P 500 is just 4.5% from its all-time high made at the end of January.  I am no technician, but the chart below shows both the long-term direction and the 52-week moving average, and the current price is well above both of these indicators.  This is not to say the market cannot decline from here, just that the broader trend remains higher.  It does not feel very apocalyptic to me at this point.

Source: tradingeconomics.com

Turning to the bond market, yields are lower across the board this morning with Treasuries (-3bps) backing off the highest levels seen last week, and currently at 4.25%.  While that rate is clearly above the lows, it hardly smacks of panic nor of a bond-buying strike.  Of course, historically, when uncertainty rises, Treasuries have been a primary safe haven, and that has not been the case this time either.  It appears to me that investors are caught between fears of rising inflation and fears of economic contraction so don’t know whether they want to hold their bonds or sell them.  As to European sovereigns, all are in fine fettle this morning with yields slipping between -2bps (Germany) and -6bps (UK).  Again, this does not smack of inflation fears today.

Which takes us to the key driver of almost everything, oil.  Right now, WTI is trading lower by -1.5% and is back below the $100/bbl level.  While, of course, the recent trend is higher, that is entirely on the back of the Iran situation.  If/when that is resolved, I expect the price to retreat sharply right away, although probably not to its prewar levels for another few months.  But if it traded back to $70/bbl, that would remove virtually all the inflation talk and investors would need to look elsewhere for cues.

Source: tradingeconomics.com

In the metals markets, gold (0.0%) is trading just above $5000/oz and silver (-1.6%) just below $80/oz, and neither has responded as would have been expected prior to the Iran conflict.  Recall, both peaked at the end of January, just before the Kevin Warsh as Fed chair announcement, and as you can see below, both have largely gone nowhere, albeit with a lot of daily volatility attached to that lack of movement.

Source: tradingeconomics.com

It makes no sense to me that after a 5000-year history as the ultimate monetary safe haven, gold has suddenly lost its allure in that capacity.  As such, I continue to believe that the lack of follow-through higher during this war is a result of leveraged investors needing to raise cash to cover margin calls and given the gains that were available in their gold positions, and the liquidity in the market, gold was the most convenient way to manage positions.  Remember, leverage has been a key part of the story of recent market moves, with margin debt at all-time highs, > $1.1 trillion, although it represents just 1.9% of outstanding market capitalization, less than the all-time high percentages seen ahead of the financial crisis.

Source: investing.com

Nothing has changed my take on the underlying demand for precious metals at this point.

Finally, the dollar is a bit softer this morning but has retained most of its gains from this move.  However, as a descriptor of today’s lack of fear, the dollar’s pull back is as clear a signal as any.  So, the euro (+0.5%) is rebounding away from the 1.1400 level seen Friday, while the yen (+0.4%) is backing away from the 160 level.    AUD (+1.0%) seems like it is preparing for this evenings’ RBA rate hike, but the dollar is lower across the board after a solid run ever since the Warsh announcement.  Looking at the DXY (-0.35%) below, you can see that today’s move is modest in the scheme of things, and we will need to see a lot more dollar selling before this trend changes.

Source: tradingeconomics.com

EMG currencies are having a very strong day, almost like the war is over.  CZK (+1.8%), HUF (+1.7%), PLN (+1.1%), ZAR (+1.0%), MXN (+0.9%) and KRW (+0.9%) are representative of today’s price action.  I’m wondering if I missed the news that the war ended!

On to the data this week, which in addition to all those central bank meetings includes a large array of generally secondary data, although PPI is part of the mix.

TodayEmpire State Manufacturing3.2
 IP0.1%
 Capacity Utilization76.2%
WednesdayPPI0.3% (2.9% Y/Y)
 -ex Food & Energy0.3% (3.7% Y/Y)
 Factory Orders0.2%
 FOMC Rate DecisionUnchanged
ThursdayInitial Claims215K
 Continuing Claims1855K
 Philly Fed9.0
 New Home Sales720K

Source: tradingeconomics.com

I imagine that folks will look at the PPI data to see if they can glean anything about inflation going forward, but it, too, is a February number, so will not have anything from the war.  It will also be interesting to see what Chairman Powell says in his press conference, but I can’t imagine much new information will flow there either.  After all, with the war, they are kind of stuck for now.

So, it continues to come down to market interpretations of commentary regarding the war.  As I said, this morning, investors don’t seem that worried things will get worse.  The Greed and Fear index is at 22, not great, but we have seen worse just recently.  Again, lighter positions are the way to go in my view.

Good luck

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Sanae Lightning

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It has been two weeks
Since she rolled the dice. Sunday
It came up hard eight!
 
Leaders round the world
Would sell their soul to obtain
The Sanae lightning

Source: asia.nikkei.com

Japanese PM Takaichi scored a resounding victory yesterday, capturing more than 76% of the seats with her coalition partners, and she now commands a super-majority, enabling her to control the dialog completely, pass any legislation and even change the constitution.  As I said, every other elected leader in the world pines for that type of power and approval, even Xi!  

The immediate market response was a 5.0% rally in the Nikkei as expectations for an aggressive fiscal policy expansion to the economy gets priced in.  Add to this more defense spending and the mooted tax cuts on food, and it is easy to understand the response.  

Interestingly, the yen, which had been under pressure from fears of unfunded spending, after declining at first, reversed course and strengthened nearly 1% from its worst levels early in the Tokyo session as per the below chart.  It certainly seems logical that yen weakness would be coming on this basis, but perhaps, what we are going to see is the Japanese use some of their FX reserves, which total about $1.3 trillion, to help fund the ¥5 trillion (~$32 billion) that the tax cuts will cost.  That would mean selling Treasuries to sell USD and buy JPY, helping to support the yen while allowing the BOJ to leave rates on hold.  In truth, it makes a lot of sense.  We shall have to see how things progress from here.

Source: tradingeconomics.com

Some pundits, when looking ahead
Are worried that Warsh at the Fed
With Bessent, will try,
To Treasury, tie
Their efforts, some assets to shed

The other big story this morning is a growing concern about a potential accord between the Fed and the Treasury once Kevin Warsh is confirmed and takes his seat as Fed chair.  Bloomberg has a big article on the subject, but it is around all over.  When combined with another article on China recommending its banks to reduce their Treasury holdings, it has helped create a narrative that the US is going to have major fiscal problems going forward which will result in massive money printing and much higher inflation.

Of course, the thing about this that I don’t understand is that Warsh is on record, repeatedly, for saying he wants the Fed’s balance sheet to shrink, and that its expansion has been one of the major economic issues in the US since QE2 back in 2012.  I also find it interesting that Warsh’s apparent desire to see the Fed’s balance sheet hold almost exclusively short-dated Treasuries, 3-years and under, is seen as a concern given that has been the Fed’s stated goal since they started shrinking the balance sheet back in April 2022.

Recall, Chairman Powell explained that in order to maintain the ample reserves framework they are currently using, the balance sheet needs to grow alongside the economy.  However, this is completely at odds with Warsh’s stated beliefs that the ample reserves framework is no longer effective and needs to be replaced eventually.  Of course, if I look at 10-year Treasury yields (+2bps today) over the past 5 years, as per the below chart, it is hard to get overly excited that things have changed much since the end of the Covid adjustments.  

Source: tradingeconomics.com

Perhaps Chinese selling will drive yields higher, or perhaps others will sell because they are concerned that the Fed and Treasury working together is inherently bad for the economy and will lead to higher inflation but so far, that is not the case.  As to inflation, while CPI and PCE remain higher than the Fed’s target, it does not appear to be galloping away at this stage.  In fact, there is much discussion on X that Truflation is now running at 0.68% and that the Fed will soon need to cut rates aggressively!  Of course, if inflation is running at 0.68%, can someone please explain the ‘affordability’ crisis that has gotten so much press?  PS, I don’t see Truflation as being an accurate representation of the world, but it sure is good for narrative writers sometimes!

And that is how we have started the week.  The Super Bowl was pretty dull overall, with defensive excellence, but nothing spectacular.  Someone made the point that this was the AI Super Bowl for advertising and the last two times we saw something dominate the advertising (dot.com in 2000 and crypto in 2022), within a year, both sectors had been decimated in the equity markets.  In the meantime, a quick tour of the overnight session shows the following:

Stocks – Asia was strong across the board with Japan (+3.9%) giving back some of the early gains but still rocketing to new highs.  The rest of the region was similarly strong, especially Korea (+4.1%) but gains of between 1.5% and 2.0% were the norm.  I guess everybody is positive on Takaichi-san!  Europe, however, has not been as robust although there are mostly gains there led by Spain (+0.6%) and Germany (+0.3%).  The laggard here is the UK (-0.1%) which is struggling as PM Starmer appears to be coming to the end of his disastrous term.  His appointment of Ambassador to the US looks to be the final straw as Peter Mandelson is widely mentioned in the Epstein files and now Starmer has lost his chief of staff because of that.  The UK will be better off, I believe, if Starmer is pushed out, although if they put in Ed Miliband, it could actually get worse given his personal insanity regarding energy.  But I would buy a Starmer removal.  As to US futures, at this hour (7:20), they are modestly lower, -0.15% or so.

Bonds – European sovereign yields are edging higher this morning, around 1bp across the board as there has been no data to change opinions and the bond markets, worldwide (Japan excepted) remain the dullest of places to play.  Japan (+6bps) did see a response to the Takaichi victory, which is what one would have expected.  We will have to watch this yield closely as if it truly does start to break out, there will be ramifications worldwide.  However, if we look at the chart below of 10-year and 30-year JGBs, they remain below the peak seen several weeks ago and, surprisingly, the overnight move was more pronounced in the 10-year than the 30-year.  Watch this space.

Source: tradingeconomics.com

Commodities – oil (+0.3%) has been chopping around either side of unchanged all evening as questions about Iran remain unanswered.  There was a story in the WSJ about the US holding back on any military action because Iran has so many medium range ballistic missiles and any reprisal could be devastating to the Middle East overall.  But if I have learned anything from observing President Trump and his negotiating style, it is impossible to know what the next move will be.  I would not rule out either a successful deal or a military strike at this point, with the former resulting in lower oil prices while the latter would see a sharp rally.  In the metals, gold (+0.9%) and silver (+2.7%) are both continuing their volatile rebound from last week’s sharp selloff, while copper is unchanged this morning.  As I have said, nothing has changed this supply demand balance in physical metals, although the paper, futures market, can still do many remarkable things that don’t necessarily make sense.

FX – the dollar is softer across the board this morning, slipping against both G10 (EUR +0.5%, GBP +0.3%, JPY +0.4%, CHF +0.7%) and EMG (MXN and BRL +0.25%, PLN +0.65%, ZAR +0.25%, CNY +0.15%) with little in the way of data as a driver anywhere.  While I have not specifically seen a reboot of the dollar is collapsing narrative, I presume the concerns over a potential Fed-Treasury accord are an underlying thesis today.

On the data front, we see both NFP and CPI this week as they come a few days late due to the short government shutdown.

TuesdayNFIB Small Biz Optimism99.9
 Retail Sales0.4%
 -ex autos0.3%
 Employment Cost Index0.8%
WednesdayNonfarm Payrolls70K
 Private Payrolls70K
 Manufacturing Payrolls-5K
 Unemployment Rate4.4%
 Average Hourly Earnings0.3% (3.6% Y/Y)
 Average Weekly Hours34.2
 Participation Rate62.3%
ThursdayInitial Claims218K
 Continuing Claims1850K
 Existing Home Sales4.15M
FridayCPI0.3% (2.5% Y/Y)
 Ex food & energy0.3% (2.5% Y/Y)

Source: tradingeconomics.com

In addition, we hear from seven more Fed speakers, with Governor Miran making three appearances as he seeks to make his case for cutting rates.

Nothing has changed my view that Warsh and Bessent are the two most important voices now, with the rest of the Fed relegated to biding their time until Warsh shows up.  As to the data, the Citi surprise index continues to show that data is better than most forecasts which speaks well of the economic situation.

Source: cbonds.com

I am not a proponent of the world ending, the Treasury market collapsing or the dollar dying despite a lot of doom porn that this is the near future.  I would contend the dollar remains rangebound for now, and we need a definitive policy adjustment to see that situation change.  Until then…choppy is the way.

Good luck

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