Tag Archives: #Fed

Flags at Half-Mast

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Twas just seven days in the past
When fears of recession forecast
Were rapidly rising
And folks analyzing
The data had flags at half-mast
 
But in a remarkable twist
Turns out that recession was missed
Instead, all is great
With not long to wait
Til worries no longer exist!

 

Until this week, I had always understood the Covid-linked recession to be the shortest on record, lasting just a few months.  But apparently, that is no longer the case.  You may recall that after last Friday’s weaker than expected NFP data and the increase in the Unemployment Rate to 4.3%, the commentariat was certain that the Fed had maintained their monetary policy too tight for too long.  The result was that the US had entered a recession, or at least was on the cusp of one.  Certainly, this appeared to be the market narrative as equity markets sold off aggressively on Friday and then again on Monday.  While there was much discussion of the impact of the BOJ’s policy adjustments and that as an additional catalyst, the key is panic was rampant.

However, it appears it was nothing more than a bad dream.  As of this morning, the S&P 500 is essentially unchanged from where it was at last Friday’s close as can be seen in the chart below.  

A graph on a white background Description automatically generated

Source: tradingeconomics.com

All of the angst that had been felt because of that NFP print (which was still positive at 114K) and all of the clutching of pearls and gnashing of teeth that analysts suffered was unnecessary as the Fed sensibly made no policy changes and the equity market absorbed some volatility and is back to flat on the week.  

Does this imply everything is fine with the world?  Absolutely not.  There are still numerous concerns for both the economy and the financial markets, notably the bond market, but the world has not ended, and equity markets are reflecting that fact.  

All joking aside, the economy continues to show a mixed picture and arguably the biggest medium-term concern should be the willingness of investors to continue to finance the US deficit.  This is a fundamental that cannot be ignored forever and one that revealed itself again this week as both the 10-year and 30-year auctions had tails* of more than 3 basis points.  The implication of those outcomes is that demand for US Treasury debt at current levels could be waning, and that is a genuine problem.  

Consider that, already, interest payments by the Treasury on its debt exceed $1 trillion annually.  If buyers in the market demand higher interest rates and there are no expenditure reductions (which seems likely regardless of the election outcome), either yields will rise, or other buyers will need to be found.  Who might those other buyers be?  Well, obviously, the Fed is the number one suspect, although if they were to restart QE with inflation running above target, I suspect it would be very difficult to hide and the impact on inflation would likely be to push it higher, clearly not their goal.  Therefore, as I have written before, be ready for regulatory changes that require banks and insurance companies to hold larger portfolios of Treasury securities as part of their capital buffers.  This process would be far more opaque politically but would create the price insensitive bid that the Treasury needs.

To recap, the recession has not yet arrived, investors are climbing out of their foxholes and there are potential concerns regarding the bond market and natural demand for the ongoing increases in issuance.  While next week’s CPI data will be closely scrutinized, my sense is the equity narrative is going to be far more focused on production and consumption than on prices. 

In the meantime, let’s review last night’s session and see how things are behaving as we head into the weekend.  After yesterday’s impressive rally in the US, where all Monday’s fears were erased because the Initial Claims number seemed to indicate the job market wasn’t collapsing, Asian markets had a pretty good session as well.  The Nikkei (+0.6%) and Hang Seng (+1.2%) both followed the US higher as did virtually every other market in Asia except mainland Chinese shares (CSI 300 -0.35%) after Chinese inflation figures printed a touch higher than forecast.  It does seem to feel like the Chinese market is decoupling from the rest of the world.  Meanwhile, European bourses are all firmer this morning led by Spain’s IBEX (+0.9%) and the CAC (+0.5%) in Paris.  Clearly, fears over Monday’s meltdown have abated everywhere.  Lastly, at this hour (7:30), US futures are pointing slightly higher as well.  As I said above, Monday was just a bad dream.

In the bond markets, yields are declining almost everywhere with 10-year Treasuries falling 4bps and all European sovereigns seeing yields decline by between -3bps and -5bps.  Whatever fears existed during the auctions seem to have abated somewhat, at least for now.  But the bigger picture concerns over Treasury supply remain in place, if in the background today.

In the commodity markets, oil (+0.4%) continues to creep higher and has now retraced all its losses from the week.  However, the big picture here remains that oil is rangebound between $70/bbl and $90/bbl.  While the Middle East situation continues to cause some concerns, the absence of a widely anticipated strike by Iran on Israel has left traders on edge, but not actively hedging the prospects.  As to the metals markets, both gold and silver, which had very strong rebounds yesterday, are little changed on the morning, consolidating those gains.  Interestingly, copper (+1.6%) is showing a bit of life, perhaps on the view that the recession has not yet arrived, or more likely because traders who had shorted the red metal are closing positions ahead of the weekend.

Finally, the dollar is mixed this morning with a variety of gainers and laggards across both the G10 and EMG blocs.  In the former, AUD (-0.3%) is lagging as it adjusts after yesterday’s strong gains based on a more hawkish RBA view.  At the same time, JPY (+0.5%) is higher this morning although it has been trading either side of 147.00 for the past three sessions with no obvious directional bias.  Given the importance of monetary policy decisions to this currency pair, the fact that the BOJ walked back their hawkishness and the Fed speakers we have heard this week have continued the mantra of the time is not yet right for a cut, although September may be good, it shouldn’t be that surprising that it has found a new short-term equilibrium.

In the emerging markets, the chart below showing the relative moves of ZAR, MXN and BRL, the three key risk proxies, shows that all have strengthened from their worst levels on Monday, an indication that traders are returning to the carry trade.

A graph of stock market Description automatically generated

Source: tradingeconomics.com

It is also worth noting that CNY (+0.2%) continues to track the yen at a slower pace.  The idea that the PBOC is willing to let the renminbi trade in a more volatile manner as long as it does not strengthen aggressively vs. the yen remains intact.

There is no data on the docket today and once again there are no Fed speakers scheduled either.  To my eyes, the market is exhausted after the wild moves at the beginning of the week.  I expect that there is limited appetite for aggressive price action in any market today and absent either an Iranian attack on Israel or a true black swan event, my best guess is it will be a quiet session heading into the weekend. 

Good luck and good weekend

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*A tail in a bond auction simply describes how much higher the actual results were than the market’s anticipation of those results prior to the auction’s completion as priced in the when-issued market.  Typically, for 10-year bonds, that tail is close to zero, and even 30-year bonds average about 1bp.  A 3bp tail is considered quite wide and concerning as it indicates a lack of buying interest by investors of all stripes.

A New Boogeyman

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Confusion today is what reigns
As no pundit clearly explains
Why previous claims
Have gone up in flames
And how much more pain still remains
 
They still blame the Bank of Japan
With spoiling their well thought out plan
And too, yesterday
When bonds went astray
It gave them a new boogeyman

 

Yesterday started out so well for all those who were convinced that it was the BOJ’s surprising and extreme actions last week that led to an unwarranted selloff in stocks and other risk assets.  First off, the BOJ, via one of its members Ichida-san, basically apologized for their actions and said that they would not be making any other changes after all.  That led to a rally in equities and a sell-off in bonds as risk assets were suddenly back in favor.  Alas, by the end of the day, that was no longer the case.

But let’s look at what the BOJ actually did last week.  On the interest rate front, they raised their base rate to 0.25% and regarding their balance sheet, they indicated they had a plan to slow down its growth at a very gradual pace.  Remember, they did not say they were going to sell JGBs, they said that by 2026 they would be buying half as many JGBs as they do today.

Also, let’s remember that inflation in Japan is currently measured at 2.8%, so the base rate remains deeply negative in real terms.  I understand the signaling impact of what they did as any change in the status quo while there is a significantly leveraged market can have major impacts.  And that is what we saw during the past week.  It is also important to remember that given the length of time that the Japanese have maintained their ZIRP/NIRP monetary policy, the opportunity for very large institutions to build up very large positions was, to be succinct, very large.  The chart below shows for just how long Japanese interest rates have been near zero, more than twenty years.

Source: tradingeconomics.com

My point is that Japanese investors have been seeking alternative opportunities for an entire generation.  As well, the concept of the carry trade has been in place for that same amount of time.  It will take a long time for these ideas to be changed and the positions along with them.  Now, according to a Bloomberg article, JPMorgan’s analysts claimed that three-quarters of the carry trade has already been unwound.  And maybe they are right about that.  But I assure you that three-quarters of Japanese investors have not adjusted their positions in the fixed income market.  We have not come to the end of this road.

So, analysts found another cause for yesterday’s negative outcomes, the 10-year bond auction.  It turns out that investors are seeking more yield than the market had anticipated ahead of the auction.  This led to a 3 basis point tail, meaning that the auction cleared at a yield, 3.96%, 3 basis points higher than traders were pricing ahead of time (typical 10-year tails are well less than 1bp.)  There were less bids than anticipated, and generally this is not a good story for Secretary Yellen and the Treasury.  The story that circulated was that the reason stocks fell in the afternoon was the weak auction.  Alas, the timing of that does not make sense.  Equity markets had already given back their morning gains before the auction results were announced and were lower on the day at 1:00pm.  But narrative writers need a story, and that was a good one.

So, what really happened?  Who knows?  But FWIW this poet has seen enough market action during his career to recognize that while fundamentals matter in the long-run, daily changes are often completely random, or at least seemingly so.  Large orders can drive markets, especially when liquidity is lower because of holiday schedules and the time of year.  And lately, the combination of algorithmic trading and extreme retail speculation will also move markets in surprising directions.

I believe that we remain in a period of change.  Monetary policies around the world are adjusting to the realities of inflation remaining stickier than policymakers want to believe.  In addition, the political cycle continues to be difficult to forecast, notably in the US, with market perceptions of very different economic policies to be implemented depending on the next US president.  And finally, I believe the best way to describe the global economy is that it is in transition.  After a decade or more of easy money policies around the world, as those policies start to change, they impact different segments of the economy at different rates.  This means that some parts of an economy can be in recession while other parts can be doing fine.  And that gives rise to confusing data with no broad trend.  This may explain why manufacturing survey data is so weak while service survey data has held up well.  

My best guess is that we are going to continue to see confusion until policy makers are more aligned.  In fact, that is why there are so many calls for the Fed to start cutting rates soon, so they can catch up and unify monetary policies around the world.

Ok, let’s see how things looked overnight.  After yesterday’s reversal and lower closes in the US, that theme was extended largely around the world.  Japanese shares fell (-0.75%) as did shares everywhere else in Asia (Korea, India, Australia, etc.) except in China, where both mainland and Hong Kong shares were essentially flat.  The story is no better in Europe where shares are lower by between -0.7% (DAX ) and -1.1% (CAC, FTSE 100) as investors demonstrate they are concerned with the future.  As to the US, at this hour (7:15) futures are very slightly lower.

In the bond market, after yesterday’s poor auction, and ahead of today’s 30-year Treasury auction, yields have fallen from their highest points.  Treasury yields (-3bps) are pacing the European sovereign market (Bunds -3bps, OATs -3bps, Gilts -1bp, BTPs -2bps) as the fear factor on stocks seems to be encouraging some haven buying.  But the most interesting thing was that JGB yields fell -5bps overnight and are now back down to 0.84%.  The BOJ Summary of Opinions (effectively their Minutes) was released last night and clarified that they are not interested in a rapid tightening of policy.  Given GDP growth was negative last quarter, this can be no surprise.

In the commodity markets, oil is little changed this morning but has recouped most of its losses from the past week and sits back at $75/bbl.  This is still a range-bound situation, and we need something really big to change that.  Gold (+1.1%) is making a comeback and back over $2400/oz as the fear factor seems to be playing a role here today.  However, copper (-0.2%) continues to demonstrate short-term concerns over economic activity around the world.

Finally, the dollar is having a much less volatile session than we have seen recently.  AUD (+0.5%) is the biggest mover I can find after hawkish comments from the RBA, claiming they will not hesitate to raise interest rates again if inflation reappears.  However, the yen (+0.15%) seems like it has found at least a temporary home, perhaps gaining some support on what appears to be a risk off day.  Funnily, though, the major risk proxies in the EMG space, ZAR and MXN are virtually unchanged this morning.  I believe that like most markets today, more clues are sought before views are expressed.

Speaking of clues, this morning brings the other US data with Initial (exp 240K) and Continuing (1870K) Claims at 8:30.  Richmond Fed president Barkin speaks at 3:00 this afternoon, the same time we will hear from Banxico on their rate decision (no change expected).  But once again, there is not much new information expected, so markets are going to respond, in my view, to equity activity.  If US stocks can find support, look for other markets to follow along.  However, that does not feel like today’s message.  As to the dollar, against the majors, I think it has found a temporary range.

Good luck

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Ueda-san Blinked

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Let’s consider fear
It’s not only for traders
Ueda-san blinked

 

I’m old enough to remember the time when the BOJ turned hawkish, raised their base rate by the most in 15 years and promised to keep going. As well, Ueda-san explained they would slowly reduce their presence in the JGB market.  In fact, I’m willing to wager you remember that too.  After all, that was the message the market gleaned from the BOJ policy meeting that ended on July 31st, just seven days ago.  Since then, equity markets around the world have fallen dramatically, the yen rallied dramatically, bond yields declined dramatically, and risk was definitively reduced.

Narratives were being rewritten around the world and concerns over the strength of the US economy were raised.  Remember the lackluster employment report and all the discussion of the Sahm Rule having been triggered which implied the US was already in a recession?  The global fear was if the US fell into recession, it would drag the rest of the world with it, since for now, the US economy is the strongest one around.

Well, apparently, policymakers around the world decided that the recent market chaos was a bit too uncomfortable for their political masters.  It is a fair question to ask whether it was the BOJ’s more hawkish actions or the FOMC’s less dovish actions which drove recent market gyrations.  But last night, the BOJ is the one that blinked first.  Deputy Governor Shinichi Uchida, speaking to local business leaders in northern Japan said the following [emphasis added]:

“I believe that the bank needs to maintain monetary easing with the current policy interest rate for the time being, with developments in financial and capital markets at home and abroad being extremely volatile. In contrast to the process of policy interest rate hikes in Europe and the United States, Japan’s economy is not in a situation where the bank may fall behind the curve if it does not raise the policy interest rate at a certain pace. Therefore, the bank will not raise its policy interest rate when financial and capital markets are unstable.”

And presto!  Fear has receded dramatically with the removal of concerns of further tightening by the BOJ, at least anytime soon.  The biggest response was by the yen (-1.9%), with the dollar now having retraced about 50% of its decline vs. the yen since the BOJ meeting as per the chart below. (You can see where USDJPY was at the time of the BOJ announcement on the chart.). So, is everything better in the world?  Clearly not, but one of the drivers of recent volatility has been walked back.  As I wrote back on Monday, no politician is willing to tolerate short-term pain for long-term gain, and this is simply further proof of that statement.

Source: tradingeconomics.com

As to the rest of the market complex, most other asset classes are also unwinding some of the recent fear driven moves.  Looking at equities, yesterday’s rebound extended further throughout almost every market in Asia with Japan’s Nikkei (+1.1%) rebounding more than 3% from its early session lows and gains of more than 1% in virtually every market in the time zone.  The lone outlier here was China’s CSI 300 which was essentially flat on the day.  Throughout Europe, as well, we are seeing gains of 1% or more across the board led by the IBEX (+1.65%) and CAC (+1.6%).  As to US futures, at this hour (6:45) they too are showing gains of 1% or more.  

One of the key themes among certain analyst circles has been that the BOJ’s ongoing liquidity spigot, which was ostensibly turned off last week, was THE key driver of all markets globally.  In fact, the conspiratorial view was that global monetary policy was highly coordinated and that the reason the Fed was able to maintain its current policy stance effectively was because the BOJ would knowingly maintain its ultra easy policy. Ostensibly, this allowed the Fed to be seen as fighting inflation, the key political issue in the US, while Japan was able to maintain that inflation was still not stably at their target despite their core rate having printed above the 2% target for the past 28 consecutive months. I am not a fan of conspiracy theories as somebody always talks, but the results that we have seen over the past several years certainly indicate that was possible.

The question going forward is, will the BOJ restart their policy tightening this year?  Perhaps, the next coordinated steps will be the Fed’s first cut in September, and possibly November, followed by the BOJ getting back on the tightening path by December.  But for now, it appears that the past week was far too much market excitement for policymakers to handle.

Turning to bond markets, yields around the world are rebounding with 10-year Treasury yields higher by 4bps this morning and European sovereign yields higher by between 6bps and 9bps.  UK Gilt yields are also 4bps higher and overnight in Asia, Australia, New Zealand and other countries saw yields rebound as well.  The only outlier here was Japan, with JGB yields unchanged.  The armchair analysis is that bonds as havens are not nearly as critical today as they seemed to be on Monday and Tuesday.  If the policy directive is the Fed cuts next, this process should be able to continue.

In the commodity markets, we are also seeing a reversal of the recent losses with oil (+1.75%) really bouncing sharply.  Arguably, part of this move is concern over the anticipated Iranian attacks on Israel and whether that will spill over into a wider Middle East conflagration impacting supply.  But part of this is likely just a trading response to the recent sharp declines seen.  In the metals markets, gold (+0.5%) and silver (+1.0%) are bouncing although gold has been the best performer in this space throughout the past gyrations.  Copper (-1.7%) though is still under pressure and indicating that economic activity is slowing.

Finally, the dollar is firmer this morning, at least based on the DXY, led by its strength vs. the yen and CHF (-1.3%).  However, looking at other currencies, we see AUD (+0.8%), NOK (+1.35%), SEK (+1.0%) and even CAD (+0.4%) all stronger.  As well, both MXN (+1.6%) and ZAR (+1.0%) are firmer as it appears that traders are feeling more confident their carry trade positions are going to work well again.  It should be noted that CNY (-0.4%) has reversed course, lagging the yen move, but then it lagged the yen strengthening move very dramatically.  Currencies remain the final outlet valve for economies as they adjust to changes in policy.  As such, with this new narrative of the BOJ backing off and the Fed getting set to cut, I expect that volatility in this space is likely to settle down for the time being.  We will need a new catalyst to get people trading, and it seems the next opportunity will be next week’s US CPI followed by the Jackson Hole Symposium at the end of the month.  Perhaps, although the beginning of August was far more volatile than expected, we are about to settle back into the doldrums.

There is no first-tier data released today but we do see the EIA oil inventories where further drawdowns are expected.  Yesterday’s API was fairly neutral, but right now, it seems that the story is the Middle East, not inventories.  Interestingly, there are no Fed speakers on the calendar either, although as we have seen consistently, it seems likely that we will hear from at least one before the day is through.

Today is a relief rally based on what appears to be a slight change in the narrative.  It seems the apocalypse of tighter Japanese monetary policy and still tight US monetary policy is to be avoided.  If that is the case, then look for markets to return toward their pre-BOJ levels, at least for now.  For the dollar writ large, I feel like we could see general underperformance although there are clearly still a few currencies that may weaken further, notably the yen.

Good luck

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The World is Ending

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The world is ending
At least, that’s the way it feels
Owning equities
 
The narrative writers are caught
‘Cause stories those writers had wrought
No longer apply
And folks now decry
The idea that dips should be bought
 


Remember the idea of the summer doldrums where everybody is on vacation, so markets move very little? Yeah, neither do I!  Here’s a different idea though, when risk is under pressure, all correlations go to 1.0.  Look at the following three charts (source: tradingeconomics.com) and explain to me how they behave independently:

There is rioting in the streets today, perhaps not in your neighborhood directly, but in many places around the world (the UK, Bangladesh, Kenya, others), as the global order that we have known for the past X years gets tested.  How big is X?  There will be many different answers to that question, but in this poet’s mind, what we are witnessing in its full glory today is the beginning of the unwinding of the market excesses that began when global interest rates headed to 0.00% in the wake of the GFC in 2009, so X=15 years.  

It is easy to wax philosophical on this subject, discussing the merits of moderating the business cycle and why interest rate policy is a net benefit, and you can be sure that before this week is over, we will get policy interventions.  But ultimately, markets need to clear to function effectively, and I would argue that the last time markets actually cleared was in 1974.  The next big opportunity to allow markets to clear was in October 1987 and the Maestro, although he had not yet earned that moniker, stepped in after that Black Monday and promised unlimited liquidity to prevent too much damage. 

Ever since then, central bankers around the world, led by the Federal Reserve, but do not forget actions like Mario Draghi’s “whatever it takes” moment, have decided that they need to manage the global economy, and market responses, and that markets were only effective if they were going higher.  (It’s ironic that TradFi people scoffed at the crypto maxim ‘number go up’, yet they believed exactly the same thing, only in a different wrapper.) As well, we all know that the concept of political will does not exist anymore, at least not in the West, as no elected politician will ever choose to fight for a policy that has short-term pain and long-term gain.  The result of this constant intervention and guidance from policymakers is that things get overdone, and bubbles inflate.  And it is much easier to inflate a bubble when you maintain policy rates at 0.00% (or negative rates in some cases).  

At this point, you will read many stories about which particular catalyst drove this market reaction, whether it was last week’s BOJ meeting where Ueda-san surprised the market and hiked rates as well as promised to reduce QQE, or whether it was the fact that Chairman Powell did not cut rates, or if it was the weak payroll report.  Others will point to the escalation in hostilities in Ukraine and the Middle East as flashpoints getting people to exit risk positions.  But in the end, the catalyst is not important.  As I wrote on Friday, and is so well explained in Mark Buchanan’s book, Ubiquity, the market was rife with ‘fingers of instability’ and an avalanche has begun.

To this poet’s eye, there needs to be more excess wrung from the market.  After all, given the underlying trade of virtually the entire bull market has been the JPY carry trade, where traders and investors borrowed JPY at 0.00%, converted it to another currency and either held that currency to earn the interest rate differential, or for the truly aggressive, used the currency to buy other risky assets (NVDA anyone?), and that trade has been building for years.  Deutsche Bank has estimated that it grew to $20 trillion in size.  I assure you it is not completely unwound!

However, as I mentioned above, I am confident that central bankers are already getting intense pressure from their respective governments to ‘do something’ to stop the rout.  But central bankers are already (save Japan) in cutting mode.  And the Fed just passed on cutting rates last week.  If they were to cut today, no matter what they said, it would remove any doubt that the only thing they care about is the stock market.  It would destroy whatever credibility they still retain.  But do not count out that response, at this stage, it’s probably 50:50 they cut this week if things continue.  After all, the Fed funds futures market is now pricing in a 95% probability of a 50bp cut in September and a total of 125bps of cuts by December!

I will be the first to say I have no idea where things are going to head from here because while market internals point to further unwinding of risky assets, policy responses have not yet been seen.  So, the best advice I can offer if you are not leveraged is do not panic.  If you are, you have probably been stopped out already anyway.  In the meantime, let’s take a look at the damage overnight.

Equity Markets in Asia:

  • Nikkei 225       -12.4%
  • Hang Seng       -1.5%
  • CSI 300            -1.2%
  • ASX 300           -3.7%   
  • KOSPI               -8.8%
  • TAIEX               -8.3%
  • Nifty 50           -2.7%

In other words, it was quite the rout, with tech shares getting hammered everywhere.  Perhaps the most surprising thing to me as that the CSI 300 didn’t fall further, although I suspect that there was significant intervention by the government to prevent that from happening.  (After all, you don’t need to be a western government to want the number to go up!)

Equity Markets in Europe:

  • DAX                 -2.6%   
  • CAC                 -2.4%
  • FTSE 100         -2.4%
  • IBEX                 -2.8%’
  • FTSE MIB         -3.0%

This tells me that these markets were not nearly as leveraged as Asian markets, likely because prospects throughout Europe have been relatively less interesting to many investors.  After all, if you are leveraging up via borrowing yen, you want to buy growth, not value, stocks, and there aren’t that many growth names in Europe.

Finally, US futures, at this hour (7:00) are lower by:

  • S&P 500          -3.0%
  • NASDQ            -4.5%
  • DJIA                 -2.1%

Bond markets are also seeing very significant movement, in the opposite direction as they are performing their safe haven role brilliantly today.  While the movements today are solid, with Treasury and European sovereign yields all lower by between 5bps and 7bps, to see the real story, you need to see the move since Friday’s opening (these are all 10-year yields).

  • US                    -20bps
  • Germany         -10bps
  • UK                   -9bps
  • Japan               -20bps
  • Australia          -17bps

The US yield curve, at least the 2yr-10yr measurement, is virtually flat today and 30yr yields are now higher than both of those maturities.  Also, look at JGB yields, down to 0.77%, as Japanese investors take their toys and go home.  The thing about this move, and the reason I don’t believe the unwinding is over yet, is that once the Japanese investment community starts to move, it takes a long time for them to get to be where they want given the amount of the assets involved.  And despite all the clutching of pearls about the US ability to sell the amount of debt they need to fund themselves; it won’t be a problem for right now.  Many people around the world will be all too happy to buy Treasury bonds regardless of some political foibles in the US.

Commodity markets are under pressure this morning, but not seeing the same type of pain as equity markets. The story here is that commodities are not directly impacted by the current movements (if anything declining interest rates should help them) but when margin calls come, people sell whatever they can that is liquid.  So, gold (-1.6%) is being liquidated to cover margin calls, not because people don’t want it.  Oil (-1.6%) is likely feeling pressure because these equity moves presage potential economic weakness and a reduction in demand, and we are seeing the same response from the industrial metals.  My take is gold is the one thing, besides bonds, that people are going to be willing to hold, and will rebound first.

Finally, the dollar is under pressure, net, but we are seeing massive movements in both directions.

  • JPY       +2.5%
  • EUR     +0.4%
  • GBP     -0.3%   
  • AUD     -0.9%
  • MXN    -3.3%
  • NOK     -1.0%
  • ZAR      -2.0%
  • CNY     +0.8%  
  • CHF      +0.8%
  • KRW    -0.5%

See if you can determine which were the favorite currencies to hold long against short JPY (AUD, MXN, ZAR). Meanwhile, the renminbi is able to gain as it continues to weaken, net against the yen, its most important competitor.  Remember, currencies are the outlet valves for economies when other markets cannot move enough.  The thing to keep in mind, especially as a hedger, is that volatility is going to be very high for a while yet.  This will not all quiet down and go away in a week’s time. 

At this point, it’s fair to ask, does data matter anymore?  Probably not today, but it will be key for the central banks if for no other reason than to cloak their actions in some fundamental story.  Alas for the Fed, there is virtually nothing to be released this week.  All we see is:

TodayISM Services51.0
TuesdayTrade Balance-$72.4B
ThursdayInitial Claims250K
 Continuing Claims1880K

Source: tradingeconomics.com

As well, and perhaps remarkably, so far on the calendar we only have three Fed speakers, Goolsbee, Daly and Barkin.  However, it seems almost certain we will hear from others, especially if the rout continues.

Right now, fundamentals do not matter.  My sense is we will see a bounce of some sort after the first wave ends, perhaps as soon as tomorrow, but the narrative of the soft landing has been discarded.  Look for more political pressure on the Fed to act, and to act soon.  Also, do not be surprised if the rest of the week ultimately sees a slower, but steady, decline in risk assets as those who haven’t panicked react to the situation and reevaluate just how much they love their positions.  Consider, Warren Buffet sold some of his favorite positions last week and is loaded with cash to act.  But there is nobody who is more patient than he.  

Good luck

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German Malaise

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With central bank meetings ahead
Tonight BOJ, then the Fed
The discourse today’s
On German malaise
And why vs. the PIGS its widespread
 


As investors await the news from Ueda-san tonight and Chairman Powell tomorrow, the market discussion has revolved around the potential problems that Madame Lagarde is going to have going forward given the split in economic outcomes within the Eurozone.  As can be seen in the below graph, German GDP growth (grey bars) has been running at a negative rate for the past 4 quarters.  But you can also see that the situation in both Spain (red bars) and Italy (blue bars) has been the opposite, with both of those nations maintaining a steady pace of growth.

 

Source: tradingeconomics.com

So, while Germany is the largest single economy within the Eurozone, its current trajectory is very different than much of the rest of the bloc, ironically specifically the PIGS.  Should the ECB ignore German weakness and manage monetary policy toward the overall group?  Or should they ease more aggressively in order to support the Germans while risking a rebound in still sticky inflation?

Perhaps the first thing to answer is why Germany has been suffering for so long. This is an easy question to answer. Germany’s energy policy, Energiewende, has been an unmitigated disaster.  Their efforts to address climate change have led to the highest energy costs in Europe which, not surprisingly, has resulted in a massive reduction in manufacturing activity.  Areas where Germany had been supreme, like chemicals and autos, are hugely energy intensive industries, so as their cost of production rose, the companies moved their activities elsewhere.  Adding to the insanity was the policy to shutter their nuclear fleet, which had produced 10% of the nation’s electricity, during the post Ukraine invasion energy crisis.  And ultimately, this is the problem.  The cost of money is not Germany’s economic problem, it is their policies which have undermined their own growth ability.  While the ECB cannot ignore Germany outright, there is nothing they can do that will help the nation rebound in any meaningful way.  With that in mind, I would contend Lagarde needs to focus on the rest of the bloc to make sure policy suits them.  But that is a political discussion.

What are the likely impacts of this situation?  Eurozone growth, overall, surprised on the high side despite the lagging German data.  As well, inflation readings released thus far this month have shown that prices remain sticky on the continent.  With that in mind, the idea the ECB needs to cut aggressively seems to make little sense.  This is not to say they will maintain tighter policy, just that it doesn’t seem justified to ease.  But right now, the market zeitgeist is all about easing monetary policy (except in Japan) so I expect they will do just that going forward.  With this in mind, it strikes that the euro (+0.15%) is going to struggle to rally from current levels absent a dramatic shift in Fed policy to aggressive rate cuts.  As to European bourses, I suspect that they will reflect each nations’ own circumstances, so the DAX seems likely to lag going forward.

Will he, or won’t he?
Though inflation’s been falling
Hiking pressure’s real
 
A quick thought regarding tonight’s BOJ meeting and whether Ueda-san believes that further rate hikes are appropriate for the Japanese economy.  As with many things Japanese, the proper move is not necessarily the obvious one.  A dispassionate view of the recent data trends shows that inflation (2.8%) has been sliding slowly, GDP growth (-0.5%) has been falling more quickly and Unemployment (2.5%) remains at levels consistent with the economy’s situation given the shrinking population.   On the surface, this does not seem like a situation where hiking is desperately needed except for one thing, the yen remains broadly weak.  The chart below shows that since the advent of Abenomics in 2011, the yen has lost 50% of its value. 

 

Source: tradingeconomics.com

Now, initially, that was a key plank of the Abenomics platform, weakening the yen to end deflation.  Well, kudos to them, 13 years later they have achieved that result.  But where do they go from here?  There is a growing belief that the BOJ is going to hike by 15bps tonight and bring their base rate up to 0.25%.  I disagree with this theory given the very clear recent direction of travel in the inflation data in Japan as despite the yen’s weakness, it dispels any notion that a rate hike is needed to push things along.  One positive of the weak yen is that the balance of trade has returned to surplus in Japan.  

Source: tradingeconomics.com

For decades, Japan ran a large positive trade balance but since the GFC, that situation has been far less consistent.  However, the trade balance remains an important domestic signal as to the strength of the economy and its recent return to surplus is welcomed by the Kishida government.  It is not clear how raising interest rates will help that situation.  Net, with inflation sliding and the economy under pressure, hiking interest rates does not make any sense to me.

Ok, let’s take a look at how markets have behaved overnight.  Yesterday’s lackluster US equity market performance was followed by very modest strength in Japan (+0.15%), although weakness throughout the rest of Asia with the Hang Seng (-1.4%) the laggard, although mainland Chinese (-0.6%) and Australian (-0.5%) shares also suffered.  Meanwhile, in Europe this morning bourses on the continent are higher by about 0.4% across the board after the Eurozone GDP data seemed to encourage optimism.  The UK (FTSE 100 -0.2%), however, is under a bit of pressure amid ongoing discussions in the new Labour government about the need for austerity.  At this hour (7:20) US futures are edging higher by about 0.25%.

In the bond market, after yesterday’s sharp decline in yields around the world, it has been far less exciting with Treasury yields edging down another basis point and European sovereigns either unchanged or 1bp lower.  Perhaps the most interesting things is that JGB yields fell 2bps overnight and the 10yr yield is now back below 1.00%.  That doesn’t seem like a market preparing for a rate hike there.

In the commodity space, everybody still hates commodities with oil (-0.5%) continuing its recent slide.  In fact, it is down nearly 10% in the past month (which is good for us as we refill our gas tanks).  In the metals markets, copper continues to slide, down another -1.5% this morning as optimism over economic and manufacturing activity around the world remains absent, especially in China.  For instance, the Politburo there met yesterday and pledged to help the domestic economy, although they did not lay out specific actions they would take.  Recall last week’s Third Plenum was also a disappointment, so until the market perceives China is back and growing rapidly, or that the global growth impulse without them is picking up, it seems that industrial metals will remain under pressure.  Gold (+0.4%) however, remains reasonably well bid as continued Asian central bank buying along with retail interest in Asia props up the price.

Finally, the dollar is generally under modest pressure although the outlier is the yen (-0.6%) which does not appear to be expecting a BOJ hike tonight.  But elsewhere, the movements in both the G10 and EMG blocs have been pretty limited overall, on the order of 0.15% – 0.35%.  It is hard to find an interesting story about any particular currency as a driver today.

On the data front, this morning brings the Case-Shiller Home Price Index (exp +6.7%), JOLTs Job Openings (8.0M) and the Consumer Confidence Index (99.7).  I keep looking at that Case-Shiller index and wondering when the housing portion of the inflation readings is going to decline given its consistent strength.  But really, I suspect that all eyes will be on Microsoft’s earnings this afternoon along with the other hundred plus names that are reporting today.  With the Fed coming tomorrow, macro is not important right now.  So, more lackluster trading seems the most likely outcome today, although with the opportunity for some fireworks starting around midnight when the BOJ statement comes out.

Good luck

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A Bruising

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While many consider AI
The future, and can’t wait to buy
The stocks that convey
The future’s today
Perhaps that result’s not yet nigh
 
For instance, today’s biggest news
Is Windows is stuck with, screen, blues
What’s happened is that
A bug, not a gnat
Disrupted what most people use

Oops!  That seems to be the response so far by Microsoft and Crowdstrike as they try to troubleshoot and fix an apparent bug in the most recent release of their software.  The result of this bug is that computers all over the world that use Microsoft Windows as their operating system have, this morning, the dreaded ‘blue screen of death’, something with which far too many of us are familiar.  This problem has affected airports, airlines, banks and businesses of all stripes, essentially shutting down key processes and by extension the businesses themselves.  And consider, this is allegedly because of a single bug in a new rollout of security software.
 
We all know that bugs are an inherent part of the computing world, and most of us have lived through glitches in the past.  The difference this time, though, is that as more and more businesses move more and more of their computing operations into the cloud, the impact of any imperfection in the computer code grows exponentially.  This will not stop the migration of business operations to the cloud, of that I am certain.  But perhaps it will force some businesses to rethink what it means to be secure.
 
Additionally, given the hype surrounding AI, and the growing belief amongst a subset of businesses and investors, that companies which are not utilizing AI are going to wither and die due to its absence, perhaps this situation will cause some to rethink the pace of that utilization.  Remember, the essence of the AI hype is that the computers will be able to replace humans in many jobs, thus increasing efficiency and with it, profitability.  However, not only is the jury still out, but I would contend it has not yet started deliberations as; to date, I have not seen a single application where the results from AI are so superior to human actions, that the vast expenses to train and run AI applications make economic sense.  There is no killer app. 
 
Rather, the best analogy I have seen is that AI represents an advance similar to Microsoft Excel, where prior to the existence of spreadsheets, calculations by hand were incredibly time consuming and correspondingly expensive, but once Excel came along, analyzing data became a routine and much less expensive task.  The difference is Excel was cheap to buy and didn’t use much power to run.  AI is hugely expensive to train and then to run as well.  And bringing this full circle, removing operations from human oversight opens the door to situations like today, where things just don’t work.  Also, consider that Nvidia has sold ~$60 billion of chips in the past year, which means that companies like Microsoft, Alphabet, Apple and Meta have spent that much money on those chips as they build out their AI capabilities.  However, their revenues have not increased by nearly that much, certainly not from any AI initiatives.  Maybe the “killer” in killer app refers to what it is going to do to company profitability for those firms trying to lead this charge.
 
And, since this is a note about money and finance, let’s consider one other issue, the drive by many governments to eliminate cash.  Consider how things would be if cash was gone and all payments were electronic, but then a bug in the system resulted in banking and payments software shutting down.  Exactly how will firms conduct business?  I’m not talking about large-scale manufacturing operations, but rather about the grocery store or the McDonalds or pizza place where you want to get something to eat.  If there is no cash, what do you do?  Money is truly a remarkable invention and until the point when computer systems work 100% of the time, not 99.9%, the absence of a physical medium of exchange has the potential to be devastating to many people if the network goes down.  Just sayin’.
 
For many it was quite confusing
That stocks could absorb such a bruising
But data keeps hinting
That nobody’s minting
More profits, they just might be losing
 
Ok, let’s take a look at markets as we try to prepare for today’s activities.  It seems that as of 7:00am in NY, the bug has been fixed and things are starting to get back to normal.  But this is going to leave a mark.  Yesterday saw the first down day across the board in US markets in weeks with the DJIA (-1.3%) leading the way lower.  Most of Asia followed this move although Japanese declines (Nikkei -0.2%) were mitigated by the release of CPI data that showed no acceleration in prices in Japan.  The Hang Seng (-2.0%) reflected the tech sell-off and equities throughout the region were lower with one exception, mainland Chinese shares rose 0.5% after the end of the Third Plenum.  While many had hoped for some new economic stimulus, it seems that President Xi believes he is already on the right path and will not change.  As to European bourses, they are all lower this morning, following the trend started in the US yesterday while US futures are little changed right now.
 
Treasury yields, which traded higher during yesterday’s session despite the sharp sell-off in stocks, are unchanged this morning and European sovereigns, which closed before the full move was complete in the US have edged up the last 1bp to 2bps to maintain their relative spreads.  The ECB left rates on hold, as universally expected, but Madame Lagarde disappointed the doves by not promising a cut in September.  Despite weakening growth on the continent, inflation remains uncomfortably high it seems.  The same is not true in the US, though, where more Fed speakers gave the same message that things are going well, they are watching unemployment, and a rate cut is likely coming in the not too distant future.
 
In the commodity markets, oil edged lower yesterday after a nice rally Wednesday, and is continuing that this morning, down a further -0.5%.  But the pain trade is in metals with gold (-1.2%) and silver (-1.8%) leading the way lower on what appears to be some market technical issues rather than specific fundamental questions.  Both copper and aluminum are also softer this morning, but that is reflective of the continued concerns over economic growth.
 
Finally, the dollar is firmer again this morning, despite the modestly more hawkish discussion from the ECB and despite the ongoing belief that the Fed is preparing to cut rates at the September meeting.  Yesterday saw some impressive movement with BRL (-1.0%) and CLP (-2.0%) amid that broad-based dollar strength.  However, this morning, the worst performers are SEK (-0.6%) and NOK (-0.4%) with the rest of both the G10 and EMG blocs within 0.2% of Thursday’s closing levels.  The NOK is clearly following oil lower, and SEK is following NOK, as there has been no news or commentary from either nation that would offer a solid rationale for the move.  As I often explain, sometimes currency markets are simply perverse.
 
There is no US data due this morning, but we do hear from two more Fed speakers, Williams and Bostic. However, both have already spoken this week and there certainly hasn’t been any data that would likely have changed their views.  It seems all eyes will be on the equity markets this morning.  If they follow yesterday’s moves lower, I think we may see a more traditional risk-off outcome, but even if stocks rebound, it is hard to get too negative on the greenback.
 
Good luck and good weekend
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Ending Debates

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There once was a banker named Jay
Who lived deep inside the Beltway
His words, when he spoke
Would sometimes evoke
A dovish response on the day
 
On Monday, we all got to hear
His views, and to some he was clear
Quite soon he’ll cut rates
Thus, ending debates
‘Bout ‘flation the rest of the year

 

While the market awaits this morning’s Retail Sales data (exp 0.0%, 0.1% ex autos), the focus for most traders and investors has been on Chairman Powell’s speech and discussion yesterday at the Economic Club of Washington DC.  The following headlines came from his prepared remarks and were highlighted all over the tape:

*POWELL: LAST THREE INFLATION READINGS DO ADD TO CONFIDENCE 

*POWELL: LABOR MARKET ESSENTIALLY NO TIGHTER THAN PRE-PANDEMIC 

*POWELL: JOB MARKET DOESN’T HAVE SLACK, ESSENTIALLY EQUILIBRIUM 

Then, following up in a Q&A, the money lines were these, “Now that inflation has come down and the labor market has indeed cooled off, we’re going to be looking at both mandates.  They’re in much better balance.”  

Not surprisingly, the market took this as confirmation that rate cuts are coming soon, although the futures market continues to price September as the likely first move.  While the meeting in 2 weeks has only a 9% probability priced in for a 25bp cut, looking at September’s pricing, 25bps are guaranteed and there are now some traders/investors looking for a 50bp cut, with that probability at 12.5%.  

Personally, I think there is a better chance of a July cut, especially if the PCE data next week are as soft as the CPI data were last week, than a 50bp cut in September.  My sense is that to get 50bps in September we would need to see the Unemployment Rate rise to 4.7% by that meeting with NFP pushing toward zero.  And while anything is possible, that seems highly unlikely in terms of the speed of the adjustment for those economic data series.  Other than the pandemic, even during deep recessions in the past, the rate didn’t rise that quickly.

As such, the market is now quite comfortable with the idea that the long-awaited initial rate cut will be here before the Autumnal equinox.  So, if that is the case, what does it mean?

One cannot be surprised that equity markets remain buoyant as we continue along the goldilocks trail of solid growth with slowing inflation.  Cutting rates into this environment will just add fuel to the equity fire.  There has been much made in financial discussions about the recent performance of small-cap stocks during the past several sessions.  It seems they have finally awoken from their deep slumber and have performed quite well, better even than the mega-cap tech names.  This has generated great excitement and we have seen several analysts raise their equity forecasts ever higher.  It seems that S&P 500 at 6000 is now a conservative view!

In the Treasury market, the yield curve has been slowly reverting to its more normal shape with 2-year yields falling more rapidly than 10-year yields.  This is the bull steepening that many had been anticipating, where yields overall decline, it’s just that the front end of the curve falls faster than the back.  History has shown that this type of movement typically foreshadows a recession, as the steepening accelerates when the Fed is slashing rates as the economy heads into a tailspin.  But maybe this time is different.  Ultimately, it can be no surprise that the yield curve is moving back to its normal shape of long-term yields higher than short-term yields.  After all, this inversion has been the longest in history.  I am just concerned that the speed of the onset of the coming recession may be much faster than most people assume.

As to commodity markets and the dollar, if the Fed is moving into a policy easing cycle, then commodity prices, especially precious metals and energy, ought to rally from here.  There may be a delay in industrial metals as a weak economy will weigh on demand there.  And the dollar will likely have a considerable down leg as well, although it will be tempered as central banks elsewhere around the world feel emboldened to be more aggressive with their own policy easing.

So, with that as a framework ahead of any potential future Fed actions, let’s look at what happened in the immediate wake of the Powell comments.  (As an aside, SF Fed President Daly also spoke yesterday and reiterated her concerns over the rise in the Unemployment Rate, indicating she was ready to cut.  Too, Chicago Fed president Goolsbee explained he was on the same page.)

Of course, given the Powell commentary, it is no surprise that US equity markets rallied yesterday with a new record high close from the DJIA although neither the NASDAQ nor S&P 500 could hold their record highs into the close.  Nonetheless, it was a strong day in the US markets.  In Asia, though, the picture was more mixed with the Nikkei (+0.2%) edging higher alongside a small move higher in USDJPY, and mainland Chinese shares (CSI 300 +0.6%) also gaining on hopes for some positivity from the Third Plenum.  But the Hang Seng (-1.6%) fell on fears of a Trump victory and the imposition of more tariffs on goods from there. The rest of the APAC space saw mixed reviews with some gainers (Taiwan, New Zealand, Korea) and some laggards (Australia, Malaysia, Singapore) although most of this movement was in small increments, 0.25%-0.35%.

European bourses, though, are having a tougher day as they are all lower on the session.  It seems that concerns over a Trump victory are manifesting themselves in concerns over European sales into the US or the imposition of tariffs here as well.  Adding to the misery, German ZEW data revealed a turn back down after several positive months, as concerns over the political situation in France and declining exports there weighed on the reading.  The upshot is that there is weakness everywhere, led by the CAC (-0.8%) in Paris and the IBEX (-0.8%) in Madrid.  (I think I wrote that exact sentence yesterday!). In the end, after a nice run as investors started to bet on ECB rate cuts, that story seems to be diminishing.  As to US futures, at this hour (7:30) they are modestly firmer, 0.2% or so.

In the bond market this morning, it appears that everyone around the world is excited about the possibility of Fed rate cuts as yields are lower across the board.  Treasury yields are down 6bps and European sovereign yields have fallen between 3bps and 5bps.  Even JGB yields slid 3bps overnight.  As has been the case for quite a while, the US yield story leads the global yield story.  If the Fed is going to start to cut, I expect that yields around the world are going to decline further, at least until inflation returns.

In the commodity markets, oil (-1.6%) is under pressure after weak oil demand data from China overnight undermined hopes that the Third Plenum would result in more government stimulus from the Xi government. This weakness is evident in industrial metals as well with both Cu (-0.65%) and Al (-1.0%) sliding further. However, precious metals are responding as one would expect to rate cuts, especially with inflation still around, as both gold and silver higher by 0.7% this morning, taking gold to new all-time highs.

Finally, the dollar continues to range trade overall with the DXY little changed on the day and hanging out just above 104, which happens to be its 60-year average!  While most currencies in both the G10 and EMG blocs are within +/-0.2% of yesterday’s closes, the one outlier is ZAR (+0.8%), which seems to be responding to some domestic plans to increase infrastructure investment in conjunction with private companies.

Other than the Retail Sales data mentioned above, there is nothing of note on the calendar today, although we will hear from new Fed governor Adriana Kugler.  At this point, I think it is becoming clear that the entire FOMC is on the same page; higher for longer is dead, long live the beginning of policy ease.  It is setting up to be a quiet session although I expect to see continues support for rate sensitive products like equities and precious metals.  The dollar, though, seems stuck as every central bank is ready to cut!

Good luck

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Just Simply Don’t Care

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On Tuesday, six Fed members spoke
And none of them, from the pack, broke
While May’s CPI
Caught everyone’s eye
No ideas of cuts did it stoke
 
But markets just simply don’t care
Instead, all is well, traders swear
Nvidia rose
And at Tuesday’s close
No other firm could quite compare

 

Another day, another new all-time high for the S&P 500 and the NASDAQ (boy, my call from two weeks ago didn’t age well!).  And so it goes, the Fed imagines it is maintaining tight financial conditions and is trying to rein in spending and price pressures, and equity investors simply buy more NVDA every day.  Yesterday, the chipmaker became the most valuable company in the world, or at least the one with the largest market capitalization, cresting Microsoft and Apple, although all three are now worth about $3.3 trillion each.  I raise the point because it is such a perfect description of market sentiment.  It seems that everyone has placed their hopes (and potentially future wealth) on the back of a single company.  I’m sure it will work out well 😱.

In fact, as the investing community narrows its focus to an ever-smaller number of companies, and news elsewhere appears to show cracks in the façade of a solid economy, I suspect that problems may be coming our way.  For instance, remember Battery Electric Vehicles, and how they were the future?  Not just Tesla, but all these companies like Lucid, Polestar, Nikola, VinFast and Fisker?  Well, every name on this list has either gone bankrupt or is on the edge with Fisker being the latest to file Chapter 11.  The point is that in an environment where liquidity is abundant, or overly so, investment decisions tend to be less well thought out.  While the Fed has certainly tightened policy dramatically and been resolute in its efforts to maintain that tighter policy while inflation still percolates, the federal government’s excessive largesse (the CBO just announced they now expect a budget deficit this fiscal year of $1.9 trillion, up from the $1.5 trillion estimate last quarter) is too much for the Fed to stop.

One other thing to note about Nvidia, and AI in general, is that in China, Ali Baba has reduced the charge for using its AI function and it appears that AI, rather than being a new revenue stream for companies may simply become increased overhead of doing business.  In that world, as margins of the Apples and Microsofts and Googles compress, perhaps there will be more discernment before the next order of Nvidia chips.  There are many imbalances in this market, and it appears most of them are a result of the mania for AI.  When this passes, and it will pass, be prepared for some repricing of risk.

Ok, but back to the other stuff, namely the overwhelming amount of Fedspeak that keeps coming from all these FOMC members.  Yesterday, we actually had seven members speak, NY’s John Williams was not on the calendar ahead of time, and to a (wo)man, they explained that patience remains a virtue.  Happily, Bloomberg News put together the following list of key comments from the entire group:

Despite the modestly softer than expected CPI data last week, and even yesterday’s somewhat softer than expected Retail Sales data, it is hard to look at this grouping of comments and expect a rate cut is coming anytime soon.  Now, the one thing we can never forget is that markets can move incredibly quickly when it comes to readjusting its views on a subject.  In addition, history has shown that when the Fed figures out they are behind the curve and the economy is beginning to slow, they have the ability to cut rates very quickly as well.  But right now, I just don’t see the roadmap for a rate cut before the end of the year.  If this is the case, the one thing that seems most evident is that the dollar will maintain its overall bid.  Despite all the talk that the dollar is losing its reserve status, and that too much debt is going to destroy it, the reality remains there is no viable alternative as a means to store wealth and for governments to store reserves.  I don’t doubt the day will come when a substitute is found, but I do doubt I will be around to see it.

Ok, let’s see how the rest of the world celebrated the new leader in the market cap sweepstakes.  In Asia, the Nikkei (+0.25%) edged higher but the Hang Seng (+2.9%) had a fantastic run as the tech stocks resident there seemed to follow Nvidia.  Not surprisingly, Taiwan and Korea had good days, but elsewhere in the region, there was far more red than green as tech stocks are not the basis of those markets.  As to Europe, it is a mixed picture there but probably more red than green.  UK (+0.15%) stocks have edged higher after the UK inflation report showed that the headline number touched 2.0% for the first time in three years, but it doesn’t appear that will be enough to get the Tories re-elected next month.  However, we have seen most of the continent bleed lower after the European Commission warned a series of nations (including France and Italy) that they needed to address their budget deficits which are far above the 3% “limit” that was embedded in the entire Eurozone project.  Meanwhile, despite the fact that the US equity markets will be closed today for the Juneteenth holiday, futures are trading although they are little changed at this hour (7:45).

It is also a bank holiday here, so there will be no bond trading in the US, but in Europe, yields are a bit higher this morning, between 2bps and 4bps, bucking the trend from yesterday’s Treasury market and seeming to demonstrate a little concern over the ongoing political ructions on the continent.  However, there is one place where yields are having difficulty finding a base, Japan.  Despite all the talk that the BOJ was going to allow yields to rise more aggressively, or that there was no cap at 1.00%, JGBs fell 1bp overnight and have shown no inkling of moving higher in any substantial amount.  With this in mind, look for the yen to remain under pressure.

In the commodity markets, the early part of the month, which saw oil prices slide is just a memory now as once again, WTI (+0.1%) is holding onto its gains from yesterday and is now firmly above $81/bbl.  It appears that demand figures are starting to improve and inventory draws are being seen now.  Watch at the pump.  In the metals markets, after rallies yesterday, the precious set are holding the gains, up just 0.1% each, but copper has rebounded a further 1.5%, again an indication that economic activity seems better than feared.

Finally, the dollar is slightly softer this morning, slipping a touch against most of its G10 and EMG counterparts, but the noteworthy thing is that no currency has moved more than 0.25% in either direction.  In other words, nobody seems to care this morning here.

There is no data and no Fed speakers given the holiday so not only will things slow quickly by 11:00am, it seems a safe bet that movement will be di minimus.  Tomorrow brings a reawakening, but for today, enjoy the sunshine.

Good luck

Adf

Ne’er Have Nightmares

Posted on by

Said Harker, it’s likely one cut
Is all that we’ll need this year, but
Depending on data
My current schemata
Might wind up by changing somewhat
 
However, in truth no one cares
‘Bout Harker and views that he shares
As long as, stocks, tech
Don’t suddenly wreck
Investors will ne’er have nightmares

 

“If all of it happens to be as forecasted, I think one rate cut would be appropriate by year’s end.  Indeed, I see two cuts, or none, for this year as quite possible if the data break one way or another.  So, again, we will remain data dependent.”  These sage words from Philadelphia Fed president Patrick Harker are exactly in line with the message from Chairman Powell last week, as well as the dot plot release.  In other words, there was nothing new disclosed.  Now, today, we will hear from six more Fed speakers (Barkin, Collins, Kugler, Logan, Musalem, and Goolsbee) and I will wager that none of them will offer a substantially different take.  

At this point, market participants seem to feel quite confident they understand the Fed’s current reaction function and so will respond to data that they believe will drive different Fed actions than those defined by Harker above.  But if the trend of data remains stable, the Fed will not be the driving force in the market going forward.

In fact, there appears to be just one thing (or maybe two) that matters to every market, the share prices of Nvidia and Apple.  As long as they continue to rise, everything will be alright.  At least that’s what a growing share of investors and analysts have come to believe.  Alas, this poet has been in the market far too long to accept this gospel as truth.  I assure you there are other issues extant; they are simply hidden by the current Nvidia-led zeitgeist.

For example, Europe remains on tenterhooks for several reasons, only one of which is likely to be settled very quickly, the upcoming French election.  But remember, there is still a war in Ukraine and NATO and European nations have just upped the ante by allowing their weapons to be used to attack into Russia in addition to supplying F-14 fighter jets as part of the package.  In an almost unbelievable outcome so far, while Russian piped natural gas to Europe has fallen to essentially nil, Russia has become Europe’s largest supplier of LNG, surpassing cargoes from both the US and UAE.  I’m not sure I understand the idea behind sanctioning Russian oil and buying their gas, but then I am not a European politician, so perhaps there are nuances that escape me.  But the point is that Russia can cut that off as well, and once again disrupt the already weak Eurozone economy.

At the same time, Germany, still the largest economy in Europe, remains in economic purgatory as evidenced by today’s ZEW data (Sentiment 47.5, exp 50.0; Current Conditions -73.8, exp -65) as well as the fact that Germany’s largest union, IG Metall, is now demanding a 7% wage increase for this year, far above the inflation rate and exactly the sort of thing that, if agreed, will delay further rate cuts by the ECB.  Productivity growth throughout Europe remains lackluster and combining that with the structurally high cost of energy due to European energy policies like Germany’s Energiewend, is certain to keep the continent and its finances under pressure.  Right now, equity markets in Europe are following US markets higher, but they lack a champion like Nvidia or Apple, and are likely to be subject to a few hiccups going forward.

Or perhaps we can gaze eastward to China, where economic activity remains lackluster, at best as evidenced by the slowdown in Fixed Asset Investment and IP, as well as by the fact that the PBOC continues to try to create support for the still declining property sector without cutting rates further and inflating a bubble elsewhere.  The onshore renminbi continues to trade at the limit of the 2% band as the PBOC adjusts the currencies level weaker by, literally, one pip a day, and the offshore version is trading 0.25% through the band and has been there for the past month.  The economic pressure for the Chinese to weaken their currency is great, but obviously, the political goal is to maintain stability, hence the incremental movements.

My point is that Nvidia is not the only thing in the world and while its stock price performance has been extraordinary, I would contend it is not emblematic of the current global situation.  Rather, it is an extreme outlier.  Not only that, but when other things break, they will have deleterious impacts on many financial markets, probably including the NASDAQ.  Just sayin’!

However, despite my warnings that things will not always be so bright, so far in this session, they have been.  Overnight, Japanese stocks (+1.0%) followed the US higher as did Australia (+1.0%) and much of Asia other than Hong Kong (-0.1%) which slipped a bit.  Meanwhile, as all sides in the French election try to pivot toward the center to gather votes, European bourses are all in the green as well, somewhere between 0.25% and 0.5%.  As to US futures, at this hour (7:30), they are little changed.

Bond yields have continued to rebound from the lows seen Friday, with Treasury yields edging up another basis point this morning.  However, European sovereigns have seen demand with yields slipping a few bps, perhaps on the idea that growth remains lackluster as evidenced by the ZEW report, or perhaps on the idea that the French election may not be as terrible as first discussed.  Meanwhile, JGB yields edged up 1bp but remain below the 1.00% level despite Ueda-san explaining that a rate hike was on the table for July and that QT and rate hikes were different processes and independent decisions.

In the commodity markets, oil is unchanged this morning but that is after a strong rally yesterday in NY with WTI closing above $80/bbl for the first time since the end of April, as suddenly, the story is oil demand is improving while supply will remain tight on the back of OPEC+ measures.  I’m not sure how that jives with the IEA’s recent comments that there would be a “massive”oil supply glut going forward, (which I find ridiculous), and perhaps market participants have turned to my view.  Metals, though, remain in the doghouse falling yet again across the board.  Something else I don’t understand is how the demand story for metals can be weak while the demand story for oil can be improving given both are critical to economic activity.  

Finally, the dollar continues to find support, despite its oft-expected demise, as it gains vs. virtually all of its counterparts both G10 and EMG.  The biggest laggards this morning are NZD (-0.6%) and NOK (-0.4%) in the G10 while we have seen weakness in the CE4 (HUF -0.5%, CZK -0.55%, PLN -0.5%) as well as most Asian currencies.  The outliers here are ZAR (+0.5%) which continues to benefit from the re-election of President Ramaphosa and his coalition with centrist parties, and MXN (+0.4%) which seems to be finding a floor after its extraordinary decline in the wake of the election there two weeks ago.

On the data front, this morning we see Retail Sales (exp 0.2%, 0.2% ex autos), IP (0.3%) and Capacity Utilization (78.6%) in addition to all those Fed speakers.  While Retail Sales can be impactful, it would need to be extraordinary, in my view, to alter the current Fed viewpoint of wait for lots more data.  

My take is it will be a quiet session today, and likely for the rest of the week, as the next important data point is not until PCE on June 28th.  Til then, trading ranges seem the most likely outcome, although if I had to choose a side, I would be looking for the dollar to continue to grind higher.

Good luck

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The Fed’s Tug-of-War

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Each month there’s a Payrolls report
That pundits and traders exhort
To rise or to fall
Subject to their call
And whether they’re long or they’re short
 
But this month, there seems to be more
At stake, for the Fed’s tug-of-war
If joblessness rises
Each pundit advises
That rate cuts, this summer, we’ll score

 

Here we are on the first Friday of the month and, as almost always, markets remain quiet ahead of the release of the monthly Payroll report.  For good order’s sake, here are the current median expectations:

Nonfarm Payrolls185K
Private Payrolls170K
Manufacturing Payrolls5K
Unemployment Rate3.9%
Average Hourly Earnings0.3% (3.9% Y/Y)
Average Weekly Hours34.3
Participation Rate62.7%
Source: tradingeconomics.com

Recall, on Wednesday, the ADP Employment number was a bit softer at 152K while the ISM Employment sub-indices showed conflicting data between Manufacturing (much stronger at 51.1) and Services (weaker at 47.1).  Ironically, the headline ISM data was the other way around, with Manufacturing weaker and Services stronger than expected.  One other data point of note was the JOLTS Job Openings which shrunk about 300K to 8.059M, still high relative to the number of unemployed people, but with the ratio falling to 1.24 jobs/unemployed person.  That ratio is down from nearly 2:1 shortly after the pandemic, but up from about 1:1 pre-pandemic.

As with so much of the other data that we have seen over the past months, there is no clear direction here. Economy bulls can make the case that job growth remains solid and that there is no indication that a recession is on the way.  While the no-landing thesis has lost adherents, there are still many soft-landing adherents to be found.  At the same time, the economic bears have plenty of data to claim that a recession is around the corner, if we are not already in one.  I saw an analysis by Mike Shedlock (@MishGEA), a well-respected economist, that claims the NFP data has overstated job growth by 3.4 million jobs as per the following Tweet:

Since the beginning of 2023, looking at BLS data, the initial NFP report has been revised down in twelve of the fourteen months where there has been a third revision, by a total of 496K.  I created a chart to show the consistency of those revisions to help you get a better idea of the issue.

Source: data BLS, graph @fx_poet

Something that has always been true with respect to economic data, and NFP is no different than any other piece of information, is that the revisions tell an important story.  When initial data gets revised lower on a consistent basis, it has been indicative of a slowing economy.  Remember that when the NBER declares a recession, it is always a backward-looking effort, it is never in real-time.  But revisions are a key part of that process.  As well, given the fudge factors built into the BLS model, notably the birth/death factor for new businesses, history has shown that particular piece of the puzzle is always a lagging indicator as during a recession, more companies fail than are created, and that needs to be addressed via the revisions.

In the end, the issue is no matter the actual data point this morning, it will almost certainly be revised substantially before the end of the summer and could well tell a very different tale.  But today’s task is to understand what tale it is going to tell right now.

To that end, the narrative, the best that I can tell, is that we are seeing a gradual reduction in economic activity, but nothing dramatic.  Recession is still a remote concern, perhaps for 2025 or 2026, but the slowdown in activity will open the door for the Fed to start to ease policy going forward.  While the futures market is virtually certain that there will be no Fed action next week, the probability of a July cut has risen to 22.5% from less than 16% a week ago.  Several big banks are calling for a July cut, including JPM and Goldman Sachs, and there is a group of analysts who maintain that the underlying data that has been released indicates we are already in recession, and that rate cuts are coming very soon.

Here’s the thing, this focus on the Fed cutting rates remains, IMHO, a bad indicator of future risk asset strength.  Rather, as I showed earlier this week, when the Fed is cutting rates, it is usually because the economy is already in a recession and earnings are declining rapidly.  So, while the first cut may be sweet, the second should be a serious warning of what is coming down the pike.  I have already made my bed regarding my view that the top is in, but a softish number this morning, especially if the Unemployment Rate were to rise to 4.0% or 4.1%, would certainly increase the July cut probabilities, and almost certainly be followed by an equity market rally.  However, I would call that the last leg of the move.  As to my opinion of what today’s number will be, my sense, looking through my lens of further economic weakness (although still sticky inflation) is that it will be on the soft side, but not dramatically so.  Maybe 130K-150K.

Ok, ahead of the data, a quick tour of the markets shows that stocks in Asia were mixed with Japan edging lower, China and Hong Kong seeing declines of about -0.5%, but South Korea (+1.2%) and India (+2.1%) having strong sessions.  The same cannot be said for Europe, where every major index is lower by between -0.5% (Spain) and -1.0% (France) as German IP (-0.1%) continues to lag and the French Trade Balance (-€7.6B) fell into a deeper deficit than forecast.  Not surprisingly, US futures are essentially unchanged ahead of the NFP.

In the bond market, yields are edging up from their recent lows with Treasuries up 1bp and European sovereign yields higher by between 3bps and 5bps despite yesterday’s rate cut from the ECB.  Or perhaps because of it as remarkably, the ECB raised its own inflation forecasts and then cut rates.  The political imperative to cut interest rates is clearly growing quite strongly.

In the commodity markets, while oil (+0.7%) continues to rebound from its recent lows as OPEC+ worked to clarify their statements about future production, the big move today is in metals where gold (-1.8%) is selling off sharply after the news that the PBOC did not buy any additional metal during the month of May.  As they have been one of the key supporters of the barbarous relic, their absence really was a surprise.  Most pundits believe they are simply taking a break for now given the sharp rise in the price of the metal, but that they will return.  However, the other metals have all sold off alongside gold, with silver (-3.0%) and copper (-2.25%) giving back a good portion of their gains from the past two sessions.

Finally, the dollar is basically unchanged ahead of the NFP data with none of the G10 currencies moving more than 0.1%.  In the EMG bloc, though, ZAR (+0.9%) is the outlier, as despite the weakness in the gold price, the political situation seems to be getting better with a coalition government looking to be formed shortly.

In addition to the payroll data, we see Consumer Credit (exp $11B) this afternoon, and confusingly, despite the Fed being in its quiet period, Governor Lisa Cook is on the calendar to speak at noon today.  I would guess this will not be a discussion on monetary policy, but you never know.

At this point, it’s all about the data.  A hot number should see yields rise, stocks fall and the dollar bounce.  A cool number the opposite as more and more people anticipate that first rate cut.  Buckle up!

Good luck and good weekend

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