Tag Archives: #Fed

Cause Regret

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Again China’s leading the news
With stories ‘bout financing blues
So, terms on old debt
Which now cause regret
Have lengthened, more pain to defuse

Meanwhile, from the FOMC
Three speakers were clear as can be
Rate hikes are in store
This month, and then more
On this much, they all did agree

One of the key themes earlier this year that was supposed to have a big market impact was the China reopening story.  You may recall back in February when President Xi Jinping responded to the mass protests with blank papers held aloft, by deciding that permanently locking down a billion people was no longer an effective strategy, and a tacit declaration was made that there were no more Covid restrictions to be imposed or enforced.  Everybody assumed that the Chinese economy would vault out of the gates and that commodity demand would rocket higher while overall global economic activity increased.  Alas, that is not how things played out at all.  Instead, Chinese economic activity has disappointed at every turn with an initial blip higher and then a gradual slide back to less substantial activity.

 

Part of the problem has clearly been the efforts made by companies and countries around the world to reduce or eliminate China’s impact on supply chains.  But part of the problem, and arguably the larger part, was self-inflicted.  That was the massive debt buildup on the back of a two decades long leveraging of the Chinese property market.  You may recall China Evergrande, the first of the big property companies to come under pressure, but it has been an ongoing process for several years now.  The problem, in a nutshell, is that the model that had been used, buy huge swathes of land from city governments with leverage, promise to build housing (whose price had been rising nonstop for two decades) and then sell these flats to people on a highly leveraged basis, collapsed along with the covid lockdowns.  Suddenly, Chinese home buyers were out of work and could no longer afford the previously purchased homes.  As well, the construction companies could not complete the projects given all the workers were locked up in their own homes and unable to get to the construction sites.  However, debt remained a constant and was due regardless of the other issues.

 

The outcome was a significant slowdown in Chinese construction activity, an enormous number of unfinished (or even not yet started) apartment projects, and a lot of losses for both individuals and the property companies.  Now, as China emerged from its covid lockdowns, the government did try to relax some of its previous policy strictures but things in the property sector remain quite soft.  For China, where the property sector represented more than 25% of GDP, this is a problem.  As such, last night we saw the next steps by the Chinese government in this process with further easing on repayment terms by extending the maturity of a large amount of debt by one year, from 2024 to 2025.  It seems that the Chinese were paying attention to the Biden administration’s efforts regarding student loan payment delays and thought, we’ll do that too.  Of course, there is no Supreme Court in China to overturn this policy.  Do not be surprised if next summer, we hear about a further extension of these loans as can kicking is a government’s true superpower. 

 

A perfect encapsulation of this policy was the Chinese loan data released last night where new loans rose by CNY 3.05 trillion, far more than expected and aggregate financing also exploded higher, by CNY 4.2 trillion.  These are strong indications that the Chinese government is back offering substantial fiscal support to the economy in order to help get things moving again.  It should be no surprise that Chinese share prices rallied, nor that the renminbi has rallied a bit as well, pulling away from its recent multi-month lows.  It seems that the market has pushed things far enough to get a policy reaction rather than merely words.  At this point, the big question is, have we seen the end of the recent CNY weakening trend?  If the dollar continues its recent broad decline, then that is a quite probable scenario.  However, if the Fed continues to hew to its higher for longer mantra, and keeps pushing rates higher, be careful, of assumptions of a dollar collapse.

 

Speaking of the Fed, yesterday saw three Fed speakers, Barr, Daly and Mester, all explain that more tightening was still needed to push inflation back to their target. [emphasis added.]

Michael Barr: “we’ve made a lot of progress in monetary policy, the work that we need to do, over the last year.  I would say we’re close, but we still have a bit of work to do.”

Mary Daly: “We’re likely to need a couple more rate hikes over the course of this year to really bring inflation back into a path that along a sustainable 2% path.”

Loretta Mester: “in order to ensure that inflation is on a sustainable and timely path back to 2%, my view is that the funds rate will need to move up somewhat further from its current level and then hold there for a while as we accumulate more information on how the economy is evolving.”

 

It’s almost as if they are all reading from the same script!  At any rate, it seems very clear that regardless of tomorrow’s CPI print, they are going to hike by 25bps later this month.  The real question is, will the data continue to show the strength necessary to drive several more hikes after that?  As I have repeatedly explained, NFP is the most important number.  As long as Powell and the Fed can point to the employment situation and say there is no jobs recession, they will have cover to continue to tighten policy, maybe much higher.  6% or even higher is not out of the question.

 

And yet, despite the ongoing hawkishness from the Fed, the market is no longer concerned, at least that seems to be the case today.  Equity markets in the US managed to eke out gains yesterday and overnight saw Asia with bolder moves higher (Japan excepted as the strengthening yen is weighing on Japanese corporate profitability.). European bourses are higher, although the FTSE 100 is under pressure after mildly disappointing UK labor data this morning where the Unemployment Rate jumped to 4.0% for the first time since December 2021 when it was falling post covid.  US futures are a touch higher at this hour (8:00) but seem to be biding their time for tomorrow’s CPI data.

 

Bond markets, though, have rallied with 10-year Treasury yields lower today by a further 3bps and now back below the all-important 4.0% level, albeit just barely.  European sovereigns are also seeing some demand with yields sliding between 1bp and 2bps across the continent.  Even JGB yields edged a bit lower in a global bond buying spree.

 

Commodity prices are broadly higher with oil (+0.6%) continuing its rebound of the past week, while gold (+0.5%) is feeling a little love on the back of the dollar’s broad weakness today.  As to the base metals, they are ever so slightly firmer, retaining yesterday’s gains.

 

And finally, the dollar is softer across the board this morning as it seems to be following treasury yields lower and ignoring the Fed commentary.  The dollar’s weakness is evident in both the G10 and EMG blocs with JPY and NOK (both +0.6%) the leading gainers while only NZD (-0.4%) is under any pressure as traders prepare for the RBNZ meeting this evening and seem to be reducing their positions.  As to the emerging markets, KRW (+1.0%) was the leading gainer on the back of the Chinese fiscal policy story, although we saw strength throughout the APAC bloc.  Both EMEA and LATAM are a bit more mixed with much less significant movement, so seemingly following the bigger trend.

 

Today’s only data point has already been released, the NFIB Small Business Optimism Index, which printed at a higher than expected 91.0.  While this is a good sign, it is important to understand that the long history of this index shows an average near 100 and the current readings still mired near the lowest levels in its history, only surpassed by the massive recessions of 1980-1982 and the GFC in 2009.

 

There are no Fed speakers scheduled today, although we get a bunch more tomorrow after the CPI report is released.  For now, the market is looking askance at the dollar while Treasury yields sink.  My take is there is further upside in yields and therefore in the dollar.  However, that is not today’s trade. 

 

Good luck

Adf

Confusion Reigns

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

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

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

 

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

 

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

 

Australia

6

Brazil

10

Canada

10

China

27

Germany

19

India

14

Ireland

35

Japan

20

Korea

25

Mexico

18

South Africa

12

Spain

12

Sweden

13

UK

9

US

11

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Today

Dallas Fed

-20.0

Tuesday

Durable Goods

-0.9%

 

-ex transportation

0.0%

 

Case Shiller Home Prices

-2.60%

 

New Home Sales

675K

 

Consumer Confidence

103.8

Thursday

Initial Claims

264K

 

Continuing Claims

1772K

 

Q1 GDP

1.4%

Friday

Personal Income

0.3%

 

Personal Spending

0.2%

 

Core PCE Deflator

0.3% (4.7% Y/Y)

 

Chicago PMI

44.0

 

Michigan Sentiment

63.9

Source: Bloomberg

 

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

 

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

 

Good luck

Adf

Canada’s Burning

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

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

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Good luck

Adf

This Time They’ll Skip

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Twas clearly much more than a quip

When several Fed speakers did flip

The narrative’s tune

‘Bout rate hikes in June

Implying that this time they’ll skip

 

However, don’t think that they’re done

As they know that in the long run

Inflation’s not dead

And Jay Powell’s said

They’ll not stop til this battle’s won

 

We learned some important new things yesterday regarding the economy and the Fed’s current reaction function, namely that the Labor market continues to be pretty hot and, more importantly, that despite that fact, the Fed is almost certainly going to forego a rate hike this month.  Regarding the Labor market, yesterday’s JOLTs Job Openings data printed back above 10 million openings after a dip below that level in the previous two months indicated that there was less labor demand.  This is crucial because the Fed clearly watches this number closely as part of their employment situation dashboard, and more openings implies more wage pressure higher, the key thing Powell and friends are trying to ameliorate.  After the release, stocks, which had opened lower already, fell a further 0.5% as expectations for a 25bp rate hike in two weeks rose further.

 

But never fear, when it comes to supporting financial markets, the Fed is always there to help and yesterday was no different than normal.  While, as noted yesterday, non-voter and uber-hawk Loretta Mester was clear she saw no reason to pause, we subsequently heard from two other Fed speakers, Philadelphia’s Patrick Harker and Governor (and vice-chairman select) Phillip Jefferson, that now would be a good time to pause skip a meeting and look around at how the already 500 basis points of rates hikes are impacting the economy. 

 

“I am in the camp increasingly coming into this meeting thinking that we really should skip, not pause, but skip an increase.  A pause would mean the Fed is going to hold its policy interest rate steady for a while.  It is too soon to make that call,” explained Harker at the OMFIF* Economic and Monetary Policy Institute. [emphasis added]

 

Meanwhile, Philip Jefferson explained, “a decision to hold our policy rate constant at a coming meeting should not be interpreted to mean that we have reached the peak rate for this cycle.  Indeed, skipping a rate hike at a coming meeting would allow the Committee to see more data before making decisions about the extent of additional policy firming.” [emphasis added]

 

Rounding out the guidance was an article from the Fed Whisperer, the WSJ’s Nick Timiraos, highlighting these two speeches and clearing any doubt that a rate hike on June 14th is a dead issue.  So, summing things up, the Fed is going to hold fire in two weeks but fully well expects to tighten policy further starting in July unless something really significant occurs.  It should be no surprise that the Fed funds futures market has adjusted its pricing to a 30% probability of a hike in June (down from ~65% yesterday morning) and an additional 45% probability of one by July.  I am confident, that barring a remarkably strong NFP number on Friday, that we will see that June probability shrink even further, likely to around 20%.

 

How will this impact markets?  Well, yesterday saw the first equity weakness in a while, although US markets only fell about -0.6% on the day.  However, we are already seeing a rebound as Asian markets were broadly higher, albeit not dramatically so, and we are seeing real strength in Europe this morning with the DAX higher by more than 1.1% and leading the way.  The interesting thing about Europe is that early this morning we saw the PMI Manufacturing data releases and it was not a pretty picture.  Germany (43.2) was the laggard, but the Eurozone as a whole (44.8) was hardly something to write home about.  In fact, these PMI readings have been sub-50 since last July, a pretty strong indication of a recession.  Adding to the dysfunction was German April Retail Sales, falling -8.6% Y/Y, back to Covid levels, and before that, last seen in 1980!  Arguably, this ongoing weakness in economic data is going to stay Madame Lagarde’s hand when it comes to the ECB’s policy tightening.  The combination of lower headline CPI data and clearly weaker economic activity will make any more rate hikes, especially in the face of a Fed that is not hiking this month, much more difficult.

 

As to bond yields, this morning they have stabilized after their recent sharp declines.  Right now, we are looking at slightly higher yields, on the order of 1bp to 2bps, which seems to be merely a trading reaction to the previous week’s decline of 18bps.  With the House having passed the debt ceiling bill last night (it now moves to the Senate), that market drama seems to have ended so I expect we will get back to talking about the economy and the Fed again, as well as, of course, inflation.

 

Oil prices (-0.4%) are continuing their downward slide as regardless of any supply questions, this market sees demand as cratering as we head into a recession.  It is, of course, this price action, that has the deflationistas back crowing again about the inevitable collapse of CPI and how the Fed will need to reverse course quickly.  I am not in that camp, but only time will tell.  Meanwhile, gold (+0.25%) and copper (+2.3%) are telling a different story, especially copper.  It is hard to make sense of a rising copper price, the metal most closely associated with economic activity, and a simultaneous decline in oil.  But hey, nobody ever said markets made sense.  This will resolve itself at some point, but clearly not today.

 

Finally, the dollar is a non-event today, with about half the G10 and EMG blocs rising and the other half sliding, none more than about 0.3%.  Movement like this is hard to define as anything more than position adjustments and trading activity with no real catalysts seen.

 

On the data front, we get a bunch of releases today as follows:

 

  • ADP Employment 170K
  • Nonfarm Productivity -2.4%   
  • Unit Labor Costs 0%    
  • Initial Claims 235K   
  • Continuing Claims 1800K
  • ISM Manufacturing 0
  • ISM Prices Paid 3

 

The ADP number is a day late due to the Memorial Day holiday on Monday, but I cannot help but look at the productivity and ULC data and consider how negative that is for the economy writ large.  As well, we hear again from Patrick Harker, the last scheduled speaker before the FOMC meeting on the 14th.  Of course, we heard his views yesterday so I doubt there will be anything new.

 

A skip is not a pause, and I believe that the Fed will not be deterred from their mission at this stage.  This means that the market will continue to price in tighter Fed policy and the dollar is likely to benefit accordingly.

 

Good luck

Adf

 

 

 

*OMFIF is the Official Monetary and Financial Institutions Forum, a think tank devoted to banking and central banking.  I, too, have never heard of this before.

Far From a Floor

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As energy prices decline

Inflation, at least the headline,

Continues to shrink

As central banks think

Their actions have been quite benign

 

The problem is that at its core

Inflation is far from a floor

So, Christine and Jay

Ain’t ready to say

They’re done and won’t hike anymore

 

European inflation readings continue to fall alongside the ongoing decline in energy prices.  Headline numbers in France, Italy and Germany, as well as Spain and most of the Eurozone, have fallen sharply in the past month and seem likely to continue to do so.  Core inflation readings, however, for those countries that measure such things, and for the Eurozone as a whole, are demonstrating the same stickiness that we have seen here in the US.  Ultimately, the problem is that an inflationary mindset has begun to take hold in many people’s view.  While there is a great deal of complaining about rising prices, people continue to pay them, and the hangover of fiscal stimulus that was seen everywhere and continues to be pumped into economies around the world has allowed companies to raise prices while maintaining sales. 

 

There continues to be a strong disagreement within the analyst community regarding the future of inflation as there are many who have watched the trajectory of energy price declines and anticipate a return to 0%-2% inflation by the end of the year.  At the same time, there is another camp, in which the Fxpoet falls, that expects inflation to remain sticky in the 4% range for the foreseeable future.  Arguably, until such time as the massive amount of liquidity that was injected into the economy in response to Covid (and the GFC) is removed, I fear prices will err on the side of rising faster than we had become used to for so long.

 

Taking this one step further, the central bank playbook on inflation, as written by Paul Volcker in the 1980’s, was to tighten monetary policy enough to cause a severe recession and break demand.  We all know that Chairman Powell has read that book and is following it as best he can these days.  And, he has most of his team on board with that view.  Just this morning, Cleveland Fed President, and known hawk, Loretta Mester explained to the FT, “I don’t really see a compelling reason to pause – meaning wait until you get more evidence to decide what to do.  I would see more of a compelling case for bringing rates up…and then holding for a while until you get less uncertain about where the economy is going.”  These are not the words of someone who is concerned that rising interest rates are going to derail the US economy.  It is sentiment like this that has the Fed funds futures market pricing in a 64% probability of a rate hike in two weeks’ time.  It is also sentiment like this that is supporting the dollar, which has traded to its highest level in more than two months and is crushing the large, vocal contingent of dollar short positions around.

 

But, heading back to the recession argument, the data that we continue to receive shows no clear signs in either direction, rather it shows lots of conflict.  Yesterday I mentioned the decline in GDI, a seeming harbinger of weaker growth.  Meanwhile, yesterday’s data releases perfectly encapsulated the issue, with Consumer Confidence printing at a higher than expected 102.3, while the Dallas Fed Manufacturing Index fell to a wretched -29.1, far worse than expected and a level only reached during recessions in the past.  And there’s more to this story as last night China’s PMI data was all released at worse than expected levels (Manufacturing 48.8, Non-manufacturing 54.5, Composite 52.9) with all 3 readings slowing compared to April and an indication that the Chinese reopening story seems well and truly dead. 

 

This poses a sticky problem for President Xi as the clearly slowing Chinese economy seems likely to require further stimulus, whether fiscal, monetary, or both, with the ‘smart money ‘betting on monetary easing.  However, the renminbi (-0.4%) fell again last night and has been sliding pretty steadily since January.  Now, firmly above 7.10, it is fast approaching levels that the PBOC has previously indicated are inappropriate.  The question is, what will they do?  Easing monetary policy opens the door to rising prices, a potentially severe problem in China, while standing pat will likely result in further economic decline, not exactly what Xi is seeking.  My money is on easier policy and if necessary, price controls, something at which the Chinese government excels.

 

One cannot be surprised that with news like this, risk is taking a breather today, despite the ongoing euphoria over NVDA and AI.  Yesterday’s mixed performance in the US led to substantial weakness overnight in Asia, with all main indices falling by at least -1.0%.  Meanwhile, Europe this morning is also largely in the red, albeit only to the tune of -0.5%, and at this hour (8:00) US futures are pointing lower by -0.3% across the board. 

 

At the same time, the combination of falling inflation rates in Europe and the fact that a debt ceiling deal appears to be coming together has yields continuing to slide with Treasuries (-4.4bps) actually underperforming European sovereign yields which are all lower by between 7bps and 8bps.  The other thing to note here is that the yield curve inversion in the US, currently back to -78bps, is showing no signs of righting itself soon.  It has been nearly one year since the curve inverted, and recession alarms have been ringing everywhere, although one has not yet been sighted.  I expect continued volatility in this market as the debt ceiling bill will allow for a significant uptick in issuance right away and the question is, who will buy all this debt? 

 

Oil prices (-2.8%) continue to point to slowing economic activity and that is confirmed by weakness in the base metals as well.  While the Fed sees no signs of a recession, it seems pretty clear that some markets disagree.  Do not be surprised to see another production cut by OPEC+ as the summer progresses.

 

Finally, the dollar is king again, rising against virtually all its G10 and EMG counterparts, with the G10, sans JPY, all falling between -0.4% and -0.6%.  This is a broadscale risk-off move and one which is likely to continue as long as we see the combination of tough talk from the Fed and slowing economic data.

 

Speaking of economic data, today brings Chicago PMI (exp 47.2), JOLTS Job Openings (9.4M) and the Fed’s Beige Book this afternoon.  It is pretty clear that manufacturing activity remains in the doldrums here but pay close attention to the JOLTS data as the Fed is watching it closely for clues as to labor market tightness.  A weak number there is likely to have a bigger market impact than anything else today.

 

Net, I see no reason to dispute the dollar’s strength at the current time.  Talk to me when the Fed changes its tune, and we can see a dollar reversal.  Until then, higher for longer is both the interest rate and USD mantra.

 

Good luck

Adf

 

Widened the Spread

Posted on by

Twixt ceilings for debt and the Fed

The market has widened the spread

Of rates here at home

Despite what Jerome

Last weekend ostensibly said

Thus, dollars remain to the fore

As traders want so many more

The megacaps rise

But in a surprise

There’s less and less talk of the war

The debt ceiling negotiations remain at the top of the market’s list of concerns as the ostensible X-date of June 1stapproaches.  Certainly, the positive aspect is that both sides are talking as opposed to merely grandstanding, but as is always the case in a political standoff with a non-political impact, it is clear no deal will be reached until the Nth hour.  The other thing to remember is that the June 1st date is not a hard deadline, it is the current estimate by Secretary Yellen and subject to change.  In the end, nothing has changed my view that a deal will be reached as both sides desperately want one, but also, no deal will be reached until both sides can explain to their supporters that they did everything possible to achieve their agendas.

However, this process is clearly having an impact on the markets, especially in the interest rate space as we have seen 10-year Treasury yields, which are higher today by 3.3bps, rise 36 basis points in the past two weeks.  In addition, the yield curve inversion, which at one point had fallen to as low as -41bps, is back to a -64bp difference.  Not only that, but the 4-week T-bill, the nearest expiry past the X-date, is now yielding 5.47%, far above Fed funds and the highest spot on the yield curve.  That is clearly a direct response to fears over a possible default.  My sense is this process will go on right through Memorial Day and US interest rates may well have further to rise between now and then.

But this begs the question, are US rates dragging up rates around the world?  I would argue the answer is yes.  Looking at European sovereigns, which have all seen yields rise by around 3bps-4bps today (Gilts are actually +8bps), they have all risen in concert with Treasury yields.  During the same time frame that Treasuries rose 36bps, Bunds are +28bps, OATS +25bps and Gilts +43bps.  Yet during that period, the dollar has gained more than 1% vs. both the euro and the pound (and all the other G10 currencies as well). 

Perhaps what we are seeing is a new safe haven asset being born, the US megacap tech stock.  The likes of Apple, Microsoft and Alphabet have seen steady strength, helping to drive the NASDAQ 100 Index up nearly 5% during this same two-week period.  In fact, a quick look at YTD performance in US equity markets shows that the Dow Jones Industrials are +0.4% YTD while the NASDAQ is up 21.5%.  In the past, there was a concept during bouts of USD strength that investors were buying dollars to buy Treasuries.  I think right now investors are buying dollars to buy Apple!  In fairness, one can see the premise as regardless of the debt ceiling outcome or timing, the belief that Apple (or Microsoft or Alphabet) shares will react to that news rather than their own positive stories generates no concerns.

Of course, those names are the exceptions to the rule as the bulk of the rest of the market has been under pressure recently on the back of all the catastrophic predictions if the debt ceiling isn’t raised and the US defaults on its debt.  This can be seen in the fact that the other major indices have seen almost no movement, just sideways trading, during the recent period in question.

Turning to the Fed, it appears that we are reaching an inflection point in the tightening process, or at least in the rate hiking cycle.  While prior to the last FOMC meeting, virtually every speaker was on the same message, we are starting to see some differences.  Most importantly, Powell, last weekend, hinted that there was some concern that the continued rate hikes were starting to impact financial stability (seriously, after 4 major bank failures it is now a concern?). But the implication is that while inflation remains job number one, there are other issues on the agenda.  That seems to be the dovishness that was attributed to Powell over the weekend.

Meanwhile, yesterday we heard from two regional Fed presidents.  James Bullard from St Louis, who said that he saw at least two more rate hikes (50bps total) as necessary to be certain they have slain the inflation dragon.  As per Bloomberg news, “I think we’re going to have to grind higher with the policy rate in order to put enough downward pressure on inflation and to return inflation to target in a timely manner,” Bullard said at an event in Florida on Monday.  “I’m thinking two more moves this year — exactly where those would be this year I don’t know — but I’ve often advocated sooner rather than later.”

However, we also heard from Minneapolis President Neel Kashkari with a different message, “I think right now it’s a close call, either way, versus raising another time in June or skipping.  What’s important to me is not signaling that we’re done.”  I guess the Eccles Building will be rocking in June when they next meet.

As it stands currently, at least according to the Fed funds futures market, the market is pricing in a 23% probability of a 25bp rate hike on June 14th.  Remember, though, between now and then we see a lot of critical data including this week’s Core PCE release, next week’s NFP data and finally the May CPI data, scheduled to be released the day before the FOMC announcement.  In the meantime, all eyes seem to be on the debt ceiling negotiations, and reasonably so, given the fallout could begin before the big data comes. 

Looking at today, the big movers overnight were the bond markets with equity markets mildly in the red in both Asia and Europe.  US futures are also edging lower, but barely -0.1% at this hour (7:45).  As to commodities, oil (+0.5%) is edging higher on word that the Saudis are going to push for another production cut, while gold (-0.5%) is sliding on the back of the strong dollar and the base metals are falling again, clearly anticipating a recession.

As to the dollar, it remains king of the hill, continuing to rally vs. virtually all its G10 counterparts with only the yen (+0.1%) managing to hold its own.  In the emerging market space, the story is similar with HUF (-1.0%) the laggard on expectations of a rate cut today and the bulk of the bloc lower.  The one outlier seems to be KRW (+0.4%) which saw substantial equity inflows as the driver.  I would be remiss if I didn’t mention that CNY has rallied substantially in my absence and is now well above 7.0500 as there is a growing belief the PBOC will continue to ease policy to support the Chinese economy.

On the data front today, we see preliminary PMI data (exp 50.0 Mfg, 52.5 Services) and New Home Sales (665K).  The European flash PMI data was slightly soft, but pretty close to expectations.  Meanwhile, only Dallas Fed President Lorie Logan is on the docket today, but don’t be surprised to hear from others on CNBC or BBG as they basically cannot shut up.

In the wake of the Silicon Valley Bank failure, I was convinced the Fed was going to be finished and accordingly, changed my views on the dollar.  I had been bullish until a clear pivot was seen and I thought that was the case.  However, it increasingly appears that no pivot is coming and that higher for longer is the future.  In that case, I have to revert to my original stance and look for continued dollar strength until we get that signal.

Good luck

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Every Reason

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

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

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

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

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

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

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

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

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

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

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

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

Good luck and stay safe
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Confidence Wilts

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As central banks worldwide prepare
To raise rates investors don’t dare
Buy bonds, bunds or gilts
While confidence wilts
Defining Jay Powell’s nightmare

The upshot is negative rates
Are no longer apt for long dates
But we’re still a ways
From NIRP’s end of days
While Christine and friends have debates

Whatever else you thought mattered to markets (e.g. Russia/Ukraine, oil prices, omicron) you were wrong.  Right now, there is a single issue that has every pundit’s tongue wagging; the speed at which the Fed tightens policy.  Don’t get me wrong, oil’s impressive ongoing rally feeds into that discussion, but is clearly not the driver.  So too, omicron’s impact as it spreads rapidly, but seems clearly to be far less dangerous to the vast majority of people who contract the disease.  As to Russia and the widespread concerns that it will invade the Ukraine shortly, that would certainly have a short-term market impact, with risk appetite likely reduced, but it won’t have the staying power of the Fed tightening discussion.

So, coming full circle, let’s get back to the Fed.  The last official news we had was that tapering of asset purchases was due to end in March with the Fed funds rate beginning to rise sometime after that.  Based on the dot plot, expectations at the Eccles Building were for three 0.25% rate increases this year (Jun, Sep and Dec).  Finally, regarding the balance sheet, expectations were that process would begin at a modest level before the end of 2022 and its impact would be minimal, you remember, as exciting as watching paint dry.  However, while the cat’s away (Fed quiet period) the mice will play (punditry usurp the narrative).

As of this morning, the best I can figure is that current market expectations are something along the following lines: QE will still end in March but the first of at least four 0.25% rate hikes will occur at the March FOMC meeting as well.  In fact, at this point, the futures market is pricing in a 12.5% probability that the Fed will raise rates by 0.50% in March!  In addition, regarding the balance sheet, you may recall that in 2017, the last time the Fed tried to reduce the size of the balance sheet, they started at $10 billion/month and slowly expanded that to $50 billion/month right up until the stock market tanked and they reversed course.  This time, the punditry has interpreted Powell’s comments that the runoff will be happening more quickly than in 2017 as a starting point of between $40 billion and $50 billion per month and rising quickly to $100 billion/month as they strive to reach their target size, whatever that may be.

The arguments for this type of action are the economy is much stronger now than it was in 2017 and, more importantly, inflation is MUCH higher than it was in 2017, as well as the fact that the balance sheet is more than twice the size, so bigger steps are needed.  Now, don’t get me wrong, I am a strong proponent of the Fed disentangling itself as much as possible from the markets and economy, however, I can’t help but wonder if the Fed moves according to the evolving Street narrative, just how big an impact that will have on asset markets.  Consider that since the S&P 500 traded to its most recent high on January 4th, just 2 weeks ago, it has fallen 5.0%.  The NASDAQ 100 has fallen 10.5% from its pre-Thanksgiving high and 8.5% from its level on January 4th.  Ask yourself if you believe that Jay Powell will sit by and watch as a much deeper correction unfolds in equity markets.  I cannot help but feel that the narrative has run well ahead of reality, and that next week’s FOMC meeting is going to be significantly more dovish than currently considered.  We have seen quite substantial market movement in the past several weeks, and if there is one thing that we know for sure it is that central banks abhor sharp, quick movement in markets, whether higher (irrational exuberance anyone?) or lower (Powell pivot, “whatever it takes”.)

The argument for higher interest rates is clear with inflation around the world (ex Japan) soaring, but central bankers are unlikely, in my view, to tighten as rapidly as the market now seems to believe.  They simply cannot stand the pain and more importantly, fear the onset of a recession for which they will be blamed.  For now, though, this is the only story that matters, so we have another week of speculation until the FOMC reveals their latest moves.

Ok, so yesterday was a massive risk-off day, with equities getting clobbered while bonds sold off sharply on fears of central bank actions.  In fact, the only things that performed well were oil, which rose 2.7% (and another 1.5% this morning) and the dollar, which rallied against virtually all its G10 and EMG counterparts.  Overnight saw the Nikkei (-2.8%) follow in the footsteps of the US markets although the Hang Seng (+0.1%) and Shanghai (-0.3%) were far more sanguine.  Interestingly, European bourses are mostly green today (DAX +0.25%, CAC +0.55%, FTSE 100 +0.25%) despite further data showing inflation is showing no sign of abating either on the continent (German CPI 5.7%) or in the UK (CPI 5.4%, RPI 7.5%).  As to US futures, +0.2% describes them well at this hour.

Bond markets remain under severe pressure with yields higher everywhere except China and South Korea.  Treasuries (+1.4bps) continue their breakout and seem likely to trade to 2.0% sooner rather than later.  Bunds (+2.6bps and yielding +0.003%) have traded back to a positive yield for the first time since May 2019.  Of course, with inflation running at 5.7%, that seems small consolation.  OATs (+2.4bps) and the rest of the continental bonds are showing similar yield rises while Gilts (+5.2bps) are leading the way lower in price as investors respond to the higher than already high expectations for inflation this morning.  Remember, the BOE is tipped to raise the base rate as well next week, but the global impact will be far less than whatever the Fed does.

Oil prices continue to soar as the supply/demand situation continues to indicate insufficient supply for growing demand.  This morning, the IEA released an update showing they expect demand to grow by an additional 200K barrels/day in 2022 while OPEC+ members have been unable to meet their pumping quotas and are actually short by over 700K barrels/day.  I don’t believe it is a question of IF oil is going to trade back over $100/bbl, it is a question of HOW SOON.  Remember, with NatGas (-0.5% today) still incredibly expensive in Europe, utilities there are now substituting oil for gas as they try to generate electricity, adding more demand to the oil market.  And remember, none of this pricing includes the potential ramifications if Russia does invade the Ukraine and the pipelines that run through Ukraine get shut down.

Finally, the dollar is retracing some of yesterday’s substantial rally, falling against all its G10 brethren (NOK +0.45%, AUD +0.4%, CAD +0.3%) led by the commodity currencies, and falling against most of its EMG counterparts with RUB (+1.4%) and ZAR (+1.05%) leading the way.  The former is clearly benefitting from oil’s sharp rally, but also from rising interest rates there.  Meanwhile, a higher than expected CPI print in South Africa, (5.9%) has analysts calling for more rate hikes there this year and next with as much as 250bps expected now.

On the data front, yesterday saw a horrific Empire Manufacturing outcome (-0.7 vs. exp 25.0), clearly not a positive sign for the economic outlook.  This morning brings only Housing Starts (exp 1650K) and Building Permits (1703K), neither of which seem likely to move the needle.

With the Fed silent, the narrative continues to run amok (an interesting visual) but that is what is driving markets right now.  This is beginning to feel like an over reaction to the news we have seen, so I would be wary of expecting a continuation of yesterday’s risk-off sentiment.  While we will almost certainly see some more volatility before the FOMC announcements next week, it seems to me that we are likely to remain within recent trading ranges in the dollar rather than break out for now.

Good luck and stay safe
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Lest Things Implode

Posted on by

The central banks all through the West
Are trying to figure how best
To, policy, tighten
But not scare or frighten
Investors and so they are stressed

Meanwhile from Beijing data showed
That Chinese growth actually slowed
With prospects now dimmed
The central bank trimmed
Two interest rates, lest things implode

There is a new contest amongst the punditry to see who can call for the most shocking rate policy by the Fed this year.  With the FOMC in their quiet period, they cannot respond to comments by the likes of JPM Chair Jamie Dimon (the Fed could raise rates 7 times this year!) or hedge fund manager and noted short seller Bill Ackman (the Fed should raise rates by 50 basis points in March to shock the market), and so those comments get to filter through the market discussion and creep into the narrative.  A quick look at Fed funds futures shows that the market is now pricing in not only a 25bp rate hike, but a probability of slightly more at the March meeting.

Now, don’t get me wrong, I think the Fed is hugely behind the curve, as evidenced by the fact they are still purchasing assets despite raging inflation, and think an immediate end to asset purchases would be appropriate policy, as well as raising rates in 0.5% increments or more until they start to make a dent in the depth of negative real yields, but I also know that is not going to happen.  Time and again they have effectively explained to us all that while inflation is certainly not a good thing, the worst possible outcome would be a decline in the stock market.  Their deference to investors rather than to Main Street has become a glaring issue, and one that does not reflect well on their reputation.  And yet, Chairman Powell has never given us a reason to believe that he will simply focus on inflation, which is currently by far the biggest problem in the economy.

However, with the market having already priced in a 0.25% rate hike for March, it is entirely realistic they will raise rates at that meeting.  The key question, though, is will they be able to continue to tighten policy when equity markets start to respond more negatively?  For the past 35 years (since Black Monday in 1987) the answer has been a resounding NO.  Why does anybody think this time is different?

Interestingly, at the same time virtually every Western central bank is trying to figure out the best way to fight the rapidly rising inflation seen throughout the world, the Middle Kingdom has their own, unique, issues, namely disappointing economic growth and expanding omicron growth leading up to the Winter Olympics.  Of course, the last thing that President Xi can allow is any inkling that things in China are not running smoothly, and so after the release of weaker than expected IP, Fixed Asset, Retail Sales and GDP data for Q4, the PBOC cut both its Medium-Term Lending and 7-day Reverse Repo rates by 0.10% last night.  In addition to the weaker data came the news that yet another property developer, Logan Group, may have made guarantees that do not appear on their balance sheet to the tune of $812 million.  I have lost count of the number of property developers in China that are now under growing pressure ever since the initial stories about China Evergrande.  But that is the point, the entire property sector is under huge pressure of imploding and property development has been somewhere between 25%-30% of the Chinese GDP growth.  This does not bode well for Chinese GDP growth going forward, which does not bode well for global growth.  PS, one last thing to mention here is the Chinese birth rate fell to its lowest level since 1950!  Only 10.62 million babies were born in 2021, despite significant efforts by the government to encourage family growth.  As demographics is destiny, unless the Chinese change their immigration policies, the nation is going to find itself in some very difficult straits as the population there ages rapidly and the working population shrinks.  Just sayin’.

Ok, with that out of the way, a look around today’s holiday markets shows that risk is on!  Aside from the Hang Seng (-0.7%) overnight, which is where so many property firms are listed, every other major market is in the green.  The Nikkei (+0.75%) and Shanghai (+0.6%) were both solid performers as that PBOC rate cut was seen as encouraging.  In Europe, the DAX (+0.4%), CAC (+0.6%) and FTSE 100 (+0.6%) are all firmer as are the peripheral markets.  Even US futures (+0.1% across the board) are firmer although there is no trading here today due to the MLK holiday.

Bond markets, on the other hand, are under pressure everywhere as Treasury futures are down 13 ticks or about 3 basis points higher, while European sovereigns (Bunds +1.7bps, OATs +2.0bps, Gilts +2.8bps) are all seeing higher yields as well.  In fact, 10-year Bunds are approaching 0.0% for the first time since May 2019.  Asia was no different with only China (-0.8bps) seeing a yield decline and sharp rises in Australia (+6.7bps) and South Korea (+9.7bps).

In the commodity markets, WTI (0.0%) is flat although Brent (-0.3%) is edging down from its multi-year highs.  NatGas (-0.6%) is also edging lower and European gas prices are falling even more significantly as a combination of LNG cargoes and warmer weather eases some pressure on that market.  Gold (+0.2%) is firmer, despite what appears to be a risk-on day, although copper (-0.7%) is under a bit of pressure.  In other words, the noise is overwhelming the signal here.

As to the dollar this morning, mixed is the best description as there are gainers and losers in both G10 and EMG blocs.  Interestingly, despite oil’s lackluster trading, both NOK (+0.3%) and CAD (+0.2%) are the leading gainers in the G10 while JPY (-0.25%) is following its risk history, selling off as equities gain.  In the emerging markets, RUB (-0.55%) is the worst performer as there seems to be growing concern over the imposition of tighter sanctions in the event Russia does invade the Ukraine.  KRW (-0.45%) is next in line after North Korea launched yet two more ballistic missiles, raising tension on the peninsula.  On the plus side, THB (+0.4%) has been continuing its recent gains as the nation opens up more completely from Covid lockdowns.

It is a relatively light data week with Housing the main focus, and with the Fed in their quiet period, we won’t be getting help there either.

Tuesday Empire Manufacturing 25.0
Wednesday Housing Starts 1650K
Building Permits 1700K
Thursday Initial Claims 220K
Continuing Claims 1521K
Philly Fed 19.8
Existing Home Sales 6.41M
Friday Leading Indicators 0.8%

Source: Bloomberg

In truth, it is shaping up to be a quiet week.  Next week brings the central bank onslaught with the Fed, BOJ and BOC, but until then, we will need to take our cues from equities and geopolitical tensions to see if anything occurs that may inspire the jettisoning of risk assets in a hurry.  My gut tells me we will not be seeing anything of that nature, and so a range bound week for the dollar seems in store.

Good luck and stay safe
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Buying Will Stop

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It seems nearly every day now
Some Fed members make the same vow
First buying will stop
Next Fed funds will pop
Then asset run-off we’ll allow

Thus far markets have been subdued
Though some players now have construed
That buying the dip
Has lost all its zip
While selling all rallies is shrewd

Another day, another series of Fed speakers explaining that inflation is the primary focus, that when QE stops in March it may (read will) be appropriate to raise the Fed Funds rate by 0.25% and that the Fed has powerful tools to prevent inflation from getting out of hand.  While it is encouraging that they have finally figured out inflation is a problem, the fact that they still don’t understand it is a problem of their own making is somewhat disconcerting.  However, moving in the right direction is clearly a positive.

So, after Brainerd, Waller, Barkin and Evans all basically said the same thing, here is what we know.  It seems a virtual certainty that the Fed Funds rate will be raised at the March meeting with a very high likelihood of at least two more hikes as the year progresses.  Mr Waller even suggested more than four total this year, although that is clearly a minority view, right now, on the FOMC.  The problem is that 25 basis point increments every 12 weeks is not going to make much of a dent in inflation running at 7.0%.  And, even if inflation falls back down to 4.0%, it will still take more than three years for the Fed to even reach a point where real yields are back to 0.0%.   Not only that, when Waller was asked about 0.50% increments, he dismissed the idea as being destabilizing for markets.  (Yet again we can read between the lines and recognize that preventing an equity market decline remains the Fed’s primary focus regardless of recent comments on inflation.)

But back to the real yield story.  It is important to understand that negative real yields are not a bug in their plans, they are the feature.  Negative real yields are the only way for the US (and every overly indebted nation) to reduce the value of their debt without a technical default.  The Fed knows this playbook from their actions in the wake of WWII, where they capped yields at 2.50% and inflation ran at 10.0%.  A few years later, the debt/GDP ratio had fallen from 125% to 35% and the country’s finances were back in order.  That process worked then because the US economy dominated the global economy and essentially everything was manufactured here.  Given the dramatic changes that have taken place in the ensuing 80 years, it is not clear that the citizenry in the US will be quite as patient this time, but that is almost certainly the Fed’s plan.

If we assume that real yields are set to remain negative for a long time into the future, what are the likely impacts going to be?  First and foremost, real assets like commodities and real estate should perform well and maintain their value if not appreciate.  Bonds, on the other hand, will have a tougher time, although there are many things which may help support them, not least of which would be a reversal of policy by central banks.  Equities are going to find themselves segregated into companies that have businesses and are profitable and those that have benefitted from the ongoing monetary largesse of the central banks and may find that funding their businesses will get more difficult.  In other words, credit is going to matter going forward in this environment.  Finally, the dollar’s behavior will be contingent on just how other nations approach the real yield question.  For those countries that follow sound money policies, and seek to end financial repression, their currencies should benefit.  However, all signs are pointing, at this time, to the fact the US will not be considering sound money policies as they are short-term politically unpalatable, and the dollar will underperform going forward.  I apologize for the dour message on a Friday, but the constant Fed blather becomes difficult to tune out after a while.

Ok, here’s what we have seen overnight.  Yesterday’s tech rout in the US took equity markets lower across the board and that was followed in Asia as well (Nikkei -1.3%, Hang Seng -0.2%, Shanghai -1.0%).  Europe, too, is in the red with fairly solid declines in the DAX (-0.6%) and CAC (-0.6%) although the FTSE 100 (-0.1%) is outperforming after November GDP data showed surprisingly strong growth in the UK across both manufacturing and services. Meanwhile, US futures are hovering either side of unchanged although NASDAQ futures have recently turned down a bit more aggressively.

An interesting feature of today’s price action is that not only are stocks being sold, but so are bonds, and everywhere.  Treasury yields are higher by 3.0bps, although that is simply unwinding yesterday’s rally where yields fell a similar amount.  European sovereigns are also selling off with yields higher across the board (Bunds +2.4bps, OATs +2.4bps, Gilts +2.8bps).  While the positive news from the UK seems a rationale for the Gilt market, German GDP actually fell in Q4 bringing their Y/Y number down to 2.7% and one would have thought that might support Bunds.

Where, you may ask, are investors hiding if they are selling both stocks and bonds?  Commodities are looking better this morning with oil (+0.7%) continuing its recent rally although NatGas (-2.6%) remains beholden to the winter weather.  A warmer day here in the Northeast is undermining the price.  Precious metals (Au +0.1%, Ag +0.2%) are both on the right side of unchanged and most industrial metals are doing well (Cu -0.7%, Zn +1.9%, Sn +2.3%).  Agricultural prices are also beholden to the weather so are seeing a mixed bag this morning.

Finally, the dollar is mixed this morning, with an equal set of gainers and losers in both the G10 and EMG blocs.  JPY (+0.3%) is the leader in the clubhouse as the very obvious risk-off sentiment is encouraging repatriation of funds while AUD (-0.3%) is the laggard, seemingly on the back of the hawkish Fed comments (or perhaps on the fact that Novak Djokovic will not be playing in the Australian Open after all!)  In the emerging markets RUB (-0.6%) is the worst performer on the back of fears of further sanctions as the Ukraine situation continues to escalate, while INR (-0.35%) has also suffered overnight, this more on the talk of Fed hawkishness.  However, after those two, decliners have moved very little, certainly not enough to make a case about anything in particular.  On the plus side, CLP (+0.5%) and ZAR (+0.4%) are the leaders.  The peso is following yesterday’s strength with more as traders anticipate more hawkishness from the central bank while the rand is trading on the back of some key technical levels having been breached and pointing to yet more strength short-term.

Data this morning brings Retail Sales (exp -0.1%, +0.1% ex autos) as well as IP (0.2%), Capacity Utilization (77.0%) and Michigan Sentiment (70.0).  Yesterday’s PPI data did nothing to dispel the idea that inflation is well entrenched in the US economy regardless of what Fed members say in testimony or commentary.

Using the dollar index (DXY) as a proxy, the dollar has fallen 1.5% since this time last week.  Heading into this year, dollar bullishness was rampant as expectations for much tighter Fed policy were seen as likely to push the dollar higher.  However, the early price action is beginning to dispel that notion.  I have a feeling that we are going to see investors sell dollar rallies at the same time they sell equity rallies.  This is a huge sentiment change from the previous “buy the dip” mentality that had been prevalent since Ben Bernanke first introduced QE all those years ago.  Caveat emptor is the new watchword, for both stocks and the dollar.

Good luck, good weekend and stay safe
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