Tag Archives: #Fed

With Conceit

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On Friday, two final Fed speakers
Explained they are both simply seekers
Of lower inflation
Hence, justification
That they’re simply policy tweakers
 
We now have nine days til they meet
When both bulls and bears will compete
To offer their vision
While casting derision
On each other’s views with conceit
 
It appears to be a slow day to start what has the potential for quite an interesting week.  While the Fed is in their quiet period, we have central bank meetings in Japan, the Eurozone, Norway and Canada as well as the first look at Q4 GDP and the all-important December PCE data.  As I said, while it is slow today, there is much to anticipate.

But first let’s finish up last week, where the equity rally continued unabated despite continued pushback from Fed speakers.  Notably, SF’s Mary Daly, who is usually a reliable dove, was very clear that it is too soon to consider cutting interest rates.  Her exact words, “We need to see more evidence that it is heading back down to 2% consistently and sustainably for me to feel confident enough to start adjusting the policy rate,” seem pretty clear that she is not ready for a cut yet.  Meanwhile, Chicago’s Austan Goolsbee was similarly confident that it is premature to consider cutting rates any time soon.  

Arguably, of more importance is the fact that the Fed funds futures market is now pricing in slightly less than a 50% probability of a rate cut in March and about 5 rate cuts this year, rather than the 6 to 7 cuts that were in the price ten days ago.  So, we heard a great deal of jawboning to remove just one rate cut from the market perception.  For the life of me, I cannot look at the recent CPI data as well as the situation in the Red Sea and the Panama Canal, where though caused by different situations, show similar outcomes in forcing a significant amount of shipping volumes to change their route to a longer, more costly one and see lower inflation in our future.  I understand that there was a disinflationary impulse, but to my eye that has ended.

Now, it is entirely possible that we see the rate of inflation decline on the back of a recession, but that is not the market narrative at this point.  Rather, the market appears to be priced for the perfection of a soft landing, where the Fed will be able to tweak rates lower while inflation continues to soften, and unemployment remains low.  Alas, I still see that as a pipe dream.  As I have written in the past, it seems far more likely that we see either one rate cut as the economy continues to perform and inflation remains stubborn or 10 or more amidst a sharp slowdown in economic activity and rising unemployment, but five doesn’t seem correct to me.

In the meantime, today is a waiting game for all the things yet to appear this week.  Looking at the overnight activity, we continue to see the dichotomy between China and Japan with the former seeing its equity markets continue to crater (CSI 300 -1.6%, Hang Seng -2.3%) while the latter has made yet another new 34 year high (Nikkei +1.6%).  Last night, the PBOC left their key Loan Prime Rates unchanged, as expected, but still a disappointment to a market that is desperate for some stimulus from the government there.  So far, all the activity has been directly in the financial markets where the Chinese have banned short-selling and “advised” domestic institutions to stop selling any equities, and yet the markets there continue to underperform.  Perhaps President Xi will decide that common prosperity requires fiscal stimulus of a significant nature, but that has not yet been the case.  Both the Hang Seng and mainland markets have fallen precipitously, but there is no obvious end game yet.  Meanwhile, European bourses are all in the green, on the order of 0.5% while US futures are higher by a similar amount at this hour (7:45).

Bond markets are having a better day around the world today with yields falling everywhere.  Treasury yields are the laggard, only down by 3bps, while European sovereigns have fallen 5bps and even JGB’s fell 1 bp overnight.  Perhaps it is the sterner talk by central bankers regarding rate cuts (ECB speakers have also pushed back hard on the idea that rate cuts are coming in March, with the June meeting the favorite now), which has investors becoming more comfortable that inflation will continue its recent declines.  As there has been exactly zero data released today, that is the most rational explanation I can find.

In the commodity markets, quiet is the word here as well with oil (+0.35%) edging higher, thus holding onto last week’s gains, while metals markets are mixed.  Gold is unchanged on the day; copper is modestly softer, and aluminum is modestly firmer.  As has been the case for the past several weeks, there is not much information to be gleaned from these markets right now.  I expect that over time, we will see commodity prices trade higher as the decade long lack of investment in the sector plays out, but in the short-term, there is little on which to see regarding price trends, absent a major uptick in the Middle East dynamics.  After all, even avoiding the Red Sea hasn’t had much impact.

Lastly, the dollar is mixed overall.  Against its G10 counterparts, JPY, GBP and NZD all have edged higher by about 0.2%, but we are seeing similar weakness in NOK and AUD.  In the EMG bloc, we actually see a few more laggards than leaders with ZAR (-0.8%), HUF (-0.5%), and KRW (-0.4%) all suffering a bit on the session while CLP (+0.5%) is the leading light in the other direction.  Ultimately, the big picture here remains the dollar is tied to the yield story and if the Fed really does maintain higher for longer, the dollar will find support.

As mentioned above, there is a lot of data to digest this week as follows:

TuesdayBOJ Rate Decision-0.1% (unchanged)
WednesdayFlash Manufacturing PMI48.0
 Flash Services PMI51.0
 Bank of Canada Rate Decision5.0% (Unchanged)
ThursdayNorgesbank Rate Decision4.5% (Unchanged)
 ECB Rate Decision4.0% (Unchanged)
 Durable Goods1.1%
 Q4 GDP2.0%
 Chicago Fed National Activity0.03
 Initial Claims200K
 Continuing Claims1828K
FridayPersonal Income0.3%
 Personal Spending0.4%
 PCE0.2% (2.6% Y/Y)
 Core PCE0.2% (3.0% Y/Y)

Source: tradingeconomics.com

So, the end of the week is when we get inundated, although the Eurozone Flash PMI data comes on Wednesday as well.  But without a major data miss, all eyes and ears will be on the central banks right up until we see Friday’s PCE data.  Regarding that, there is a growing expectation that the core number will be quite soft, with many pundits calling for an annual number below 3.0% on the core reading.  However, given what we have seen from inflation readings everywhere, including the slightly hotter than forecast CPI numbers, I would fade that view.

The one thing of which I am confident is that if the Core PCE print is soft, you can expect the futures markets to price 6 or 7 cuts into this year and more cuts everywhere with the concomitant rise in both stock and commodity prices, especially given the Fed’s inability to push back immediately.  However, my view is that the world of today is not the world of the past 15 years, and that higher inflation and higher interest rates are an integral part of the future.  As well, unless there is a financial crisis of some sort, where more banks are under pressure like last March, I remain in the very few rate-cuts camp and think the equity rally has an expiry date before the summer.  As to the dollar, I think it holds up well in that circumstance.  While I changed my view based on the Powell pivot at the December FOMC meeting, the data has not backed him up, at least not yet.

Good luck

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Ending QT

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The lady from Dallas explained
The balance sheet might be constrained
So, ending QT
Is likely to be
The way the Fed’s goals are attained
 
However, investors ain’t sure
That ending QT is the cure
So, worries abound
As traders have found
Most stocks have now lost their allure

Over the weekend, Dallas Fed President Lorie Logan, whose previous role was head of markets at the NY Fed and so knows a thing or two about the monetary plumbing, explained in a speech that QT, at its current pace, is likely going to be too restrictive going forward.  While she threw in the obligatory line about the idea the Fed may still need to raise the Fed funds rate if inflation remains too robust, I would contend that this is another sign the Fed is coming to the end of its tightening regime.  She explained that the swift decline in the Reverse Repo (RRP) facility indicated there may be a significant decline in liquidity in markets and that could have a detrimental impact on equity prices the economy’s future path and derail the widely assumed soft-landing scenario.

For some context, the RRP facility peaked almost exactly one year ago, touching about $2.55 trillion as the Fed was paying more on excess reserves than was available in short-term paper and Treasury bills.  But as the government has flooded the market with T-bills of late, and there is no indication that pace is going to slow down, the yield on bills rose above the IOER rate the Fed was paying.  As such, money market funds have pushed funds from the RRP into purchasing bills and the RRP facility now has “just” $694 billion as of Friday.  A look at the chart below from the FRED database of the St Louis Fed shows the sharp downward trajectory of the facility’s balances.  But also notice that prior to March 2021, this facility basically was at $0 for its entire history.  My point is that this facility does not have a long history of supporting market activities or liquidity, rather it is a recent construct designed to help smooth out temporary fluctuations.  It’s just that the concept of temporary here seems akin to the Fed’s concept of transitory when it comes to inflation.

At any rate, the FOMC Minutes also mentioned the idea that QT would likely need to slow down, and the committee needed to discuss the proper timing of these things.  Logan’s comments were exactly in this vein as the Fed seem like they are working very hard to prepare market participants for the beginning of an easing cycle.  It’s kind of funny that throughout November and December, the Fed seemed a bit concerned that markets were overexuberant, but after a modest equity market sell-off to start the year, much of which can probably be put down to profit-taking on a tax advantaged* basis, they seem suddenly concerned that things are falling apart.

Logan’s comments were in the wake of Friday’s data which showed NFP stronger than expected, although another month of downward revisions for previous readings, and showed wages gaining a bit more than expected.  The initial move here was that further tightening was on the way, or certainly that easing was delayed, but then the ISM Services index was released at 10:00am and it was much worse than expected, 50.6, with the Employment sub-index printing at a horrible 43.7, its lowest level excluding the Covid months, and indicative that perhaps the job market is not quite so robust.  This helped unwind the tightening discussion and Friday’s markets ultimately closed little changed.

Which brings us to this morning, where the most noteworthy price action is in the commodity space with oil (-2.8%) sharply lower after Saudi Arabia cut its pricing indicating that demand is slow, and gold (-1.25%) falling sharply although a rationale there is far harder to find given the dollar is essentially unchanged on the day and it certainly doesn’t appear that peace is breaking out in either Israel/Gaza or in Ukraine.

While there has been a bit of data released from Europe, none of it was substantially different from expectations and it showed that the status quo remains there, overall, a weak Eurozone economy with prices still on the sticky side.  As well, there have been no speakers this morning which just leaves us all unsure of the next big thing.

Now, in fairness, we do have the next big data point coming on Thursday, CPI in the US, which I am assured by so many analysts is THE critical data point.  I was also confident that NFP was critical, so perhaps CPI will be less exciting than forecast.  In the meantime, a look at the rest of the overnight session shows that Japan was on holiday so there was no market activity, but Chinese shares have continued their weak ways, falling more than -1.3% across all the indices there.  It seems to me that despite some very real efforts to inculcate fear of China by certain politicians, President Xi has an awful lot of domestic issues to address.  European shares, though, are little changed with a few very modest gainers (DAX +0.15%) and a few very modest decliners (FTSE 100 -0.2%) and everything else in between.  US futures are softer this morning as the weekend story regarding Boeing’s 737 Max being grounded is weighing on the stock and the market as a whole.

In the bond market, Treasuries are unchanged on the day while European sovereigns are all seeing yields climb between 4bps and 5bps.  This move seems like a catch-up to Friday’s US price action, which if you remember saw a sharp decline in yields early and a rebound later on.  Ultimately, this space will continue to be driven by the central banks with the Fed funds futures market still pricing in a > 60% probability of a 25bp cut in March with Europe seen likely to follow shortly thereafter.

Having already touched on commodities, a look at the dollar shows that while the euro, pound and yen are all little changed, there is a bit more movement in the dollar’s favor amongst some less liquid currencies with AUD (-0.4%), NOK (-0.85% on weak oil prices) and KRW (-0.4%) leading the way.  I continue to see the FX markets as an afterthought to the broad economic picture right now but have not changed my view that if the Fed does lead the way in easing policy, the dollar is likely to slide.

On the data front, here is what this week brings:

TodayConsumer Credit$9B
TuesdayNFIB Small Biz Optimism91.0
 Trade Balance-$65.0B
ThursdayInitial Claims210K
 Continuing Claims1853K
 CPI0.2% (3.2% Y/Y)
 -ex food & energy0.2% (3.8% Y/Y)
FridayPPI0.1% (1.3% Y/Y)
 -ex food & energy0.2% (1.9% y/Y)

Source: tradingeconomics.com

As well, we do hear from several Fed speakers this week starting with Bostic today and then Williams and Kashkari as the week progresses.  At this stage, I expect that we are likely to see less volatility as my guess is most profit adjustments have been made and all eyes are turned to CPI on Thursday.  Until then, it is likely to be a dull week (famous last words!)

Good luck

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*This tax advantage is simply that taxes will not be due until April 2025, so perhaps tax deferred is a better description.

Clearly the Rage

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While AI is clearly the rage
Where Mag 7 try to engage
Consider the fact
That during this act
They’re fighting each other backstage

Just a little aside regarding the situation in equity markets, which in the US really means the Magnificent 7 these days.  One of the key features of their cumulative success was that these companies had no significant overlap regarding their business models.  Online shopping, iphones, EV’s, search, GPUs, streaming services and a social network clearly intersected to some extent, but the main focus of all these companies was spread out in different directions.  Yes, Amazon prime competes with Netflix, as does Apple TV, and yes, Amazon Web Services, Microsoft Azure and Google Cloud are all in the same business, but there is a huge amount in that particular segment that is still unfulfilled, so competition but not cutthroat.

But AI is a different kettle of fish.  All of them are actively investing in their own AI programs and working to integrate them into their current services and products.  And we are already seeing announcements of new GPU’s to directly compete with Nvidia and bring that supply chain in-house for the other users.  The point is, there is going to be a lot more investment, if not overinvestment, in this space with, arguably, quite a while before whatever AI does starts to really help the bottom line.  In other words, do not be surprised to see margins start to decline in these companies which is unlikely to help drive their share prices higher.  As well, with investment focused on this new area, we need to expect to see a reduction in share repurchases, removing one of the key bids to the market.

All I’m saying is that even in a soft or no landing scenario, it strikes me that the Magnificent 7 may be running out of room to continue their amazing run of share price gains.  And if they start to stumble, just the very nature of the equity indices, where their capital weightings are so large combined, > 30%, I suspect the indices themselves may find themselves under a lot of pressure, regardless of whether the Fed cuts rates or not.  And if the Fed cuts rates because the economy is slipping into recession, or has already gotten there, that cannot be good for margins either.  While timing is everything in life, this is something that needs to be on everyone’s radar, because it will change the risk narrative, and that matters for all markets.  Just sayin’.

While last week was mercif’ly free
Of Fedspeak, the FOMC
This week will explain
Again and again
Why higher for longer’s the key

As the market returns to full strength, at least from a staffing perspective, post the Thanksgiving holiday, things are opening fairly quietly.  A quick recap of the data since I last wrote shows that the mix of good and bad continues to leave prospects uncertain going forward.  This has allowed both the soft/no landing camp and the recession camp to point to specific things and claim they are on the right track.  So, Durable goods were pretty lousy in October and Michigan Sentiment also fell sharply, but Initial Claims fell as well, indicating that the labor market remains robust overall.  In other words, uncertainty continues to reign.  

One of the interesting things is that different markets appear to be pricing very different outcomes.  For instance, commodity markets, or at least energy markets, are clearly in the recession camp as oil prices remain under pressure, falling another 1.5% this morning as the market awaits the outcome of Thursday’s delayed OPEC+ meeting.  Talk is that there could be another 1 million bbl/day production cut to help support prices, but nothing is yet certain.  At the same time, both copper and aluminum remain under pressure, sliding a bit further last week and this morning while gold (+0.5%) is back firmly above $2000/oz, hardly a sign of a positive future.

However, as dour as the commodity markets feel, equity markets remain quite resilient overall.  Although this morning, we are seeing modest declines around the world, with European bourses lower by -0.2% or -0.3%, and US futures are currently (8:00) down by -0.15%, the month of November has been a big winner almost everywhere.  Gains, ranging from 5% – 11% are the order of the month as equity investors have gone all-in on the idea of a soft landing and that the major central banks are going to be slowly reducing interest rates to ensure economic growth continues.

In truth, bond markets are of a similar mind as equities with 10-year yields lower by between 25bps and 40bps during November throughout the G10 (Japan excepted but even there lower by 10bps).  Clearly, all this can be traced back to the QRA released back on November 1st when Treasury Secretary Yellen let it be known that there would not be as much coupon issuance as had been anticipated, and that more of the Federal government’s borrowing would take place in the T-Bill market.  That was the starting gun for the bond market rally and the ensuing stock market rally. 

So, which of these two views is correct?  That, of course, is the $64 trillion question, and one with no clear answer yet.  As I have written numerous times, and as we saw last week, the data continues to be mixed, with both positive and negative signs.  While the Fed, and virtually every other G10 central bank continues to harp on the idea that they will not be cutting rates anytime soon, markets are pricing in rate cuts starting in early Q2 of 2024.

Ultimately, there will be a winner of this battle, but the game is still afoot.  FWIW, while I have long been concerned that the imbalances in the economy were going to lead to a more significant correction in equity prices, there is another side to the story that is worth exploring, and that is the concept of fiscal dominance.  

According to the St Louis Fed, a good definition of fiscal dominance is: “…the possibility that accumulating government debt and deficits can produce increases in inflation that dominate central bank intentions to keep inflation low.”  The corollary here is that the Fed is losing its power over one of its key mandates, stable prices, because the Federal government’s fiscal impulse is so great as to overwhelm the Fed’s actions.  

With 2024 a presidential election year, and with the TGA currently at $725 billion plus negotiations for more spending on Ukraine, Israel and the southern border, there will be no shortage of additional Federal moneys flowing into the economy.  Add to this the fact that the surge in T-Bill issuance will move savings from a “dead zone” in the standing RRP facility, which is still at $935 billion, to more active money, able to be used in the real economy, and it is easy to see how economic activity is going to be supported throughout 2024.  Whatever your views on the appropriateness of these policies, the reality on the ground is that the current administration will do everything in its power to be re-elected and that includes spending as much money as possible.  Remember, too, that there is no operable debt ceiling, so they can issue as much debt as they want to fund whatever they can get legislated.  

If the Fed has lost control of the narrative, and it does appear to be slipping through their fingers, then we will need to start to focus elsewhere to find market drivers. Of course, if the Fed is losing its grip, do not think for a moment they will go meekly into the sunset.  Instead, I could see several more rate hikes as they continue to try to fight for price stability amid an economy flush with cash.  In other words, this story is nowhere near finished.

At this point, let’s take a look at this week’s data, which will bring updated GDP and PCE readings amongst other things.

TodayNew Home Sales723K
 Dallas Fed Manufacturing-17
TuesdayCase Shiller Home Prices4.0%
 Consumer Confidence101.0
WednesdayQ3 GDP5.0%
 Goods Trade Balance-$85.7B
ThursdayInitial Claims220K
 Continuing Claims1872K
 Personal Income0.2%
 Personal Spending0.2%
 Core PCE0.2% (3.5% Y/Y)
 Chicago PMI45.4
FridayISM Manufacturing47.6

Source: Tradingeconomics.com

Despite Friday being the first of December, payrolls are not released until next week due to the holiday last week.  Plus, in addition to the data above, we hear from seven different Fed speakers over ten venues including Chairman Powell Friday morning.  That will be the last Fed speaker until the next FOMC meeting, so it will be keenly watched.  However, I would wager a great deal it will continue to harp on progress made but higher for longer to prevent any resurgence in inflation.

As to the dollar, right now, it is softening as market participants focus on the idea of Fed cuts and simultaneously reduce large, long USD positions.  For now, I feel like lower is the way forward, but if we start to see increased hawkishness again because there is no landing, merely continued growth, look for the dollar to return to its winning ways.

Good luck

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Markets No Longer Have Fear

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The CPI data made clear
That markets no longer have fear
But Jay and his team
Will still push the theme
That cuts in Fed funds just ain’t near

As such markets have been persuaded
It’s time for the Fed to be faded
The bulls are on top
And they just won’t stop
Til new record highs have been traded

By now, you are all well aware that yesterday’s CPI data came in a bit softer than the forecasts with the headline printing at 3.2% Y/Y while the core printed at 4.0% Y/Y.  Both of these were 0.1% lower which doesn’t seem to be that big a difference.  But the bulls are stampeding on the idea that if you look at the recent trend, the annualized rate for the past 6 months is lower still (3.0% and 3.1% respectively) and the implication is that inflation is dead and the Fed has achieved the impossible, reducing inflation without causing a recession.  And maybe they have, but boy, that is a lot to take away from a single data point that printed a smidge lower than expectations.

Two weeks ago, in the wake of the last FOMC meeting, I wrote (Bulls’ Fondest Dreams) that the Fed changed their tune and despite all the pushback we have received from Fed speakers in the interim, they definitely saw the end of the hiking path coming into view.  Yesterday’s data seemed to confirm this view, at least in the markets’ eyes.  As such, we saw a massive rally in both stocks and bonds, with 10-year yields falling 20 basis points at one point in the day before closing lower by about 17bps.  They are 2bps higher this morning on the bounce.  Interestingly, European sovereign yields also fell quite sharply despite the lack of local news as the price action once again proved that the 10yr Treasury yield is the only bond price that really matters in the world.

So, to me the question is now, is this view correct?  Has the Fed actually threaded the needle and successfully reduced inflationary pressures without causing a meaningful economic slowdown?  If so, Chairman Powell will rightly be hailed as a brilliant central banker, even if there was some luck involved.  How can we know, and more importantly, when will we be certain this is the case?

I think it is important to try to separate the markets and the economy as the two are really quite different.  The economy is where we all live.  From an individual perspective, I would contend it is a combination of one’s employment situation(and whether there is concern over losing one’s job or finding a new one), the true cost of living, meaning the ability to afford the mortgage/rent as well as put food on the table, and then to see if there is any additional money left to either save or spend on desires rather than necessities.  It seems abundantly clear that from this perspective, there is a large segment of the population that doesn’t feel great about things.  This was made clear in an FT survey that showed just 14% of those surveyed thought things had gotten better economically under the Biden Administration’s policies.

However, if this poet has learned nothing else in his time trading in, and observing, financial markets, it is that policymakers do not care one whit about those issues.  Despite periodic attempts to seem down-to-earth, the reality is they all exist within a policy bubble with no concerns about the rent or their next meal.  In this bubble exist only numbers like yesterday’s CPI or today’s Retail Sales (exp -0.3% headline, 0.0% ex autos).  GDP, to them, is not a measure of people’s confidence or belief in the state of the current world, it is a policy variable that they are trying to manage or manipulate so they can make positive pronouncements.

There is obviously quite a gulf between those two views of the world and the markets are the connection, trying to interpret the reality on the ground through the lens of the data.  Well, the policymakers must be thrilled today because the extraordinary bullishness that is now evident across all risk markets, in their minds, means that their jobs are secure.  When things are going well, reelection/reappointment are the expected outcomes.  However, that FT survey was clearly a warning shot across the bow of their Good Ship Lollipop that everything was going to be great going forward.

So, what’s it going to be?  As I wrote after the FOMC meeting, I believe the market is prepped to rally through the rest of the year.  After yesterday’s data, that seems even clearer.  But do not forget that one of the key rationales for the Fed’s change of heart was that the market was doing the Fed’s work for them, tightening policy by raising rates and watching risk assets drift lower, thus tightening financial conditions.  Let me tell you, financial conditions loosened a lot yesterday, and if this rally continues, you can be certain that Powell and friends will grow more concerned about a rebound in inflation.  The market has completely removed any probability of a December rate hike, or any further rate hikes by the Fed as of yesterday with the first cut now priced for May 2024.  At this stage, it seems probable that the October PCE data will be on the soft side so much will depend on the next NFP and CPI readings, both of which are released before the next FOMC meeting.

And there is one more thing that must be remembered when it comes to the bond market.  The US is still going to issue an enormous amount of debt going forward between refinancing ($8.3 trillion though 2024) the current debt and the new $2 trillion budget deficit that needs to be funded for next year.  Can bonds continue to rally in the face of that much supply?  Maybe they can, but it would seem to require a reengagement of foreign buyers rather than relying entirely on domestic savers.  Either that or the Fed will need to end QT and possibly even restart QE.  In the latter case, inflation would almost certainly become a major issue again.  The point is, while everyone is feeling great this morning, there are still numerous perils to be navigated in order to maintain economic growth with a low inflation regime.  I hope Jay and all the central bankers are up to the task, but a little skepticism seems in order.

Ok, the overnight session can be summed up in one word: BUY!  Equity markets everywhere rallied with strong gains in Asia (Hang Seng +3.9%) and Europe, after rallying yesterday, continuing higher by nearly 1% this morning.  US futures are also all green this morning, generally +0.5% at this hour (7:30).

Bond markets have mostly held onto yesterday’s impressive gains with some trading activity, but movements all within a basis point or two from yesterday’s close.  The exception was Asian government bond markets, where prices rallied sharply, and yields tumbled there as well, following the US lead.

Metals prices are ripping higher again this morning, with gold, silver, and copper all up nicely after strong gains yesterday.  The outlier here is oil, which is a touch lower (-0.4%) this morning after a very lackluster session yesterday.  Now, in fairness, it has been creeping higher for the past several sessions, but compared to other markets, oil is remarkably quiet right now.

Finally, the dollar got smoked yesterday, with the euro rallying 1.5% and similar moves across the other European currencies.  Meanwhile, AUD rallied more than 2% yesterday as the combination of rocketing metals prices and a broadly weaker dollar were just the ticket for the currency.  In the EMG bloc, ZAR (+3.0%) and MXN (+1.5%) were the big winners yesterday although, interestingly, most of the APAC currencies had much more muted runs, on the order of 0.5%-1.0% gains.  This morning, price activity is much more subdued as FX traders are trying to get their bearings again.  It was, however, a 3-sigma day, a rare occurrence.

On the data front, as well as Retail Sales, we also see PPI (exp 2.2% headline, 2.7% ex food & energy) and the Empire Manufacturing Survey (-2.8) along with EIA oil information where inventory builds are forecast.  There is only one Fed speaker, vice chairman of supervision Michael Barr, and I don’t expect he will be able to sway any views today.

For now, the die is cast, and the bulls are in the ascendancy.  We will need to see some very big changes in the data trajectory for the current momentum to stall, and quite frankly, I don’t see what that will be for now.  So, go with the flow here, higher stocks, lower yields and a softer dollar seem to be the trend for now.  There will be some trading back and forth, but you can’t fight City Hall.

Good luck

Adf

The Bond, or Not the Bond

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The bond, or not the bond, that is the question:
Whether ‘tis nobler for the Fed to consider
That long-term yields have offered outrageous fortune,
Or to take Arms against a Sea of inflation
And in opposing it: hike rates yet again

(with deepest apologies to William Shakespeare)

For some reason, the ongoing cacophony of Fedspeak regarding whether the rise in long-term yields is helping the Fed in their efforts, or whether it is merely incidental, brought this famous soliloquy to mind.  We have had no less than eight different Fed speakers from the time Dallas Fed president Logan first mentioned the idea several weeks ago through yesterday discuss the subject with the majority continuing to latch on to the benefits for the Fed, although some dismiss the issue.  Now, in any definition of financial conditions I have ever seen, long-term yields are part of the construction, so it is perfectly reasonable to take them into account.  Clearly, the Fed is aware of this as QE was created entirely to ease financial conditions and consisted of simply buying bonds to lower long-term yields.  However, now that the Fed is in QT mode, their ability to control the long end of the curve has vanished.  In fact, if anything it is simply pushing those yields higher by removing themselves, a price-insensitive buyer, from the mix.

The problem for Chairman Powell is that whatever the Fed’s reaction function is with respect to data, the market’s reaction function to any hint that the Fed has finished tightening policy is well understood by one and all; BUY STONKS!!  The reason I believe this is a concern for Powell and co. is that they fear a rally in equities will signal an all-clear on the inflation front.  And it is abundantly clear that there is nobody on the FOMC who is prepared to claim victory over inflation.  That is exclusively the stance of the CNBC bulls and the administration sycophants who are paid to make that case specifically.  Reality, however, continues to demonstrate that inflation remains a feature of our everyday lives and I suspect that the FOMC mostly understands that.  Remember, too, that the Fed is data dependent, or so they say, which implies that they are not in a position to anticipate the death of inflation, rather they will only accept that premise when they see the body.

Where does this leave us now?  I suspect that the ongoing dance between the Fed and the markets with respect to the future of inflation will continue to play out for at least another year.  In fact, nothing has changed my view that inflation will remain well above their 2.0% target for the foreseeable future, likely finding a new home in the 3.5% +/- range.  And as long as Powell is Fed Chair, I see no indication he is willing to reverse course.  While the Fed may not hike rates again, certainly the market does not believe that is going to be the case with just a 9.6% probability of a hike in December now priced, I find it extremely difficult to believe they will cut rates anytime soon absent clear signs that we are already in a recession.

Though soft-landing bulls have all scoffed
The fact that the data was soft
In China implies
It cannot surprise
If growth worldwide can’t stay aloft

So, is a recession coming soon to an economy near you?  That is the $64 trillion question and one where there are myriad views expressed daily.  The most recent inkling that economic activity is slowing more sharply than had previously been thought was the surprisingly weak Chinese trade data, where not only did their trade surplus decline substantially (to a still robust $56.5B) but exports fell in absolute terms, they did not merely rise more slowly than imports.  The implication is that global growth is slowing more rapidly than the narrative explains.  

We already know that Europe is in a world of trouble with Germany the current sick man of the continent, but we also have seen the latest Atlanta Fed GDPNow data showing that growth in the US is slowing as well with the latest reading at 1.2%.  The UK is struggling as are many Asian nations, notably South Korea and Taiwan, or at least their export industries which are the key economic drivers there.

Another clue is the recent sharp decline in the price of oil, which has fallen -5.0% this week and ~-10% in the past month.  Clearly, a part of this price decline is based on the growing belief (hope?) that the Israeli-Palestinian conflict will not spread into a wider Middle East conflagration that affects oil production.  But part of this is the fact that oil inventories are building as are gasoline and diesel inventories with the result that prices are falling sharply.  Given it wasn’t that long ago when there were shortages in these products, it appears that demand is falling sharply as well.  Remember, diesel fuel is what drives the world as essentially no industry or commerce could continue without its use.  The fact that less is being used is a clear signal of slowing activity.

Putting it all together shows that amidst what appears to be a slowing global growth impulse, markets are pricing out further central bank monetary policy tightening.  Equity markets have been looking at the second part of that equation, less tightening and potential easing, while ignoring the first part, slower growth leading to lower profits.  It is very easy, at least for me, to accept the idea that markets have not yet understood that slower economic activity will lead to lower profits and subsequently, lower equity prices.  Alas, I understand that sequence so remain quite cautious overall.

Ok, how has this translated overnight?  Well, after a modest rally in the US yesterday, equity markets in Asia were a bit softer, declining on the order of -0.35% while European bourses are edging slightly higher this morning, maybe +0.1%.  US futures at this hour (7:45) are basically unchanged as we all await Chairman Powell’s dulcet tones at 10:15 this morning.

Bond yields are also quiet this morning with Treasuries (+2bps) one of the larger movers as European sovereigns are almost all unchanged right now.  It seems that the market has found a new temporary home around the 4.60% level and the yield curve inversion continues to deepen, now at -36bps.  JGB yields, which have fallen from their recent YCC-tweak induced highs, have edged up overnight by 3bps, but are at 0.85%, still far from the 1.00% target or cap or concept, whatever they are calling it now.

We already know that oil is under pressure, having fallen sharply yesterday and another -1.2% this morning.  In fact, at $76.35/bbl, it is trading at its lowest level since mid-July.  Gold, too, has been suffering, down -0.3% this morning and drifting further away from the $2000/oz level as those Middle East fears seem to dissipate.  Copper and aluminum are also under pressure on the slowing growth story worldwide.  Foodstuffs, however, are generally bid lately, as we can all discern every time we go grocery shopping.

Finally, the dollar is back to its dominant ways again, rallying vs. almost all its counterparts in both the G10 and EMG blocs.  USDJPY is marching back toward 151 this morning, the euro is back below 1.07 and the pound back below 1.23.  Meanwhile, in the EMG space, ZAR (-1.1%) is the laggard although it has competition from CLP (-0.9%), KRW (-0.7%) and HUF (-0.7%) as virtually the entire bloc is under pressure.  In fact, CNY (-0.15%) is about the best performer as the PBOC continues to prevent any significant further declines.

Aside from Powell’s speech this morning, we hear from Williams, Barr and Jefferson, but there is absolutely no data to be released.  Given the dearth of new data on the calendar, this week is going to continue to be all about the Fedspeak.  In fact, Powell speaks again tomorrow and there are 5 more speakers as well by Friday, so rather than data, this week is about parsing language.  Of course, Powell will set the tone today, and I am confident he will continue to push back on the idea the Fed is done.  But we shall see.

In the end, it still seems to me that a higher dollar is the path of least resistance.  Manage accordingly.

Good luck

Adf

News Not to Like

Posted on by 
Before we all hear from Chair Jay
This morning we’ll see QRA
The question is will
The bond market kill
The vibe all things are okay

While no one expects a rate hike
Of late, there’s been news not to like
Both housing and wages
Have moved up in stages
Though as yet, there’s not been a spike

We are definitely in a period where there is a huge amount of new information to digest on a daily basis, whether it is data or policy actions by central banks and finance ministries.  During times like this, we have historically seen slightly less liquidity in markets as the big market-makers reduce their activity to prevent major blowups.  Of course, the result is that we have periods that are quite punctuated by sharp moves on the back of the latest soundbite.

So, with that in mind, let’s look at today’s stories.  Starting last night, we saw JGB yields rise to yet another new high for the move, touching 0.98%, before the BOJ executed an unscheduled bond-buying exercise to push back a bit.  Ultimately, the 10-year JGB closed back at 0.94%, but despite the brave words from Ueda-san yesterday, it is clear there will be no collapse in the JGB market.  They simply will not allow anything like that to happen.  At the same time, USDJPY retraced about 0.3% of its recent decline, but continues to hold above 151 for now.  We did hear from Kanda-san, the new Mr Yen, that they were watching carefully, but given the rise in JGB yields has been matched by the rise in Treasury yields, it is hard to get too bullish, yet, on the yen.  

This is the first big assumption that has not played out as anticipated.  Prior to the BOJ meeting, the working assumption was that when they adjusted YCC the yen would start to rally sharply.  My view has always been that the yen won’t rally sharply until the Fed changes their tune, and that is not yet in the cards.  If the BOJ intervenes, it is probably a good opportunity to sell at those firmer yen levels as until policies change, a weaker yen remains the most likely outcome.

Turning to the US, at 8:30 this morning the Treasury is due to announce the makeup of the $776 billion of debt they will be borrowing this quarter.  The key issue is how much will be short-dated T-bills and how much will be pushed out the curve.  The higher the percentage of long-dated issuance, the more pressure we will see on the bond market going forward.  The 10-year yield is already back to 4.90% this morning, rising another 3bps, and we are seeing pressure throughout Europe as well with yields there up between 1bp and 3bps except for Italian BTPs which have seen yields rise 9bps this morning.  That has taken the Bund-BTP spread back to 200bps, the place where the ECB starts to get concerned.

But back to the US, where a second key narrative assumption has been that housing prices would be falling, thus reducing pressure on the inflation metrics over time.  Alas, that assumption, too, has been called into question after yesterday’s Case Shiller home price data showed a rise in home prices across the country, back toward the peak seen in June 2022.  While the number of transactions continues to decline, given the reduction in both supply and demand it seems that it is still a sellers’ market.  If housing prices don’t decline, then it seems even more unlikely that rents will decline and that means that inflation is going to remain much stickier than the Fed would like to see.  This does not accord well with the thesis that a slowing economy is going to help bring down housing demand followed by slowing inflation.  

As well, there was another data point yesterday, the Employment Cost Index, which rose a more than expected 1.1% Q/Q, and looking at the chart of its recent movement, shows little inclination that it is heading lower.  This is a key data point for the Fed as rising wages is something of which they are greatly afraid given the belief in its impact on prices.  While the White House may have celebrated the UAW’s ability to extract significant gains from the big three automakers, I’m guessing the Fed was a bit more circumspect on the effects those wage gains will have on overall wages in the economy and inflation accordingly.  

Adding all this up tells me that the ongoing belief that inflation is going to be declining steadily going forward, thus allowing the Fed to reduce the Fed funds rate and achieve the highly sought soft-landing is in for a rude awakening.  Rather, I remain quite concerned that monetary policy is going to remain much tighter for much longer than the market bulls believe.  And that means that I remain quite concerned equity multiples will derate lower along with equity markets overall.

Turning to the overnight price action, after a late rebound in the US taking all three major indices higher on the day, though just by 0.3% or so, we saw a big boost in Tokyo, with the Nikkei jumping 2.4%, as it seems there is joy in the idea that the BOJ may allow yields to rise further.  Either that or they were happy to see the BOJ buy bonds, I can’t tell which!  Europe, though, is a touch softer this morning with very marginal declines and US futures markets are looking to reverse yesterday’s gains, all -0.35% or so, at this hour (8:00).

Oil prices are higher this morning, up 1.8% as concerns about escalation in the Middle East seem to be growing after some comments about a wider war and further attacks by both Iranian and Hamas leaders.  Gold is little changed today but did suffer in yesterday’s month end activity although copper is firmer this morning in something of a surprise given the continuing weak PMI data we have been seeing.

Finally, the dollar continues to flex its muscles as the DXY is back just below 107 with both the euro and pound lower this morning by about -0.25%, and virtually all EEMEA currencies under pressure as well.  Other than the yen’s modest rebound, the dollar is higher vs. just about everything.

On the data front, in addition to the QRA and the FOMC later this afternoon, we see ISM Manufacturing (exp 49.0), Construction Spending (0.5%) and JOLTS Job Openings (9.25M).  Overnight we saw weaker PMI data from Japan (48.7) and China (Caixin 49.5), although for some reason, European PMI data is not released until tomorrow.

At this point, it is very much a wait and see session but as far as I can tell, the big picture has not yet changed.  Inflation remains stickier than the Fed wants, and the market seems to believe which leads me to believe we are going to see yields remain higher for quite a while yet.  I would estimate we will see 5.5% 10-year yields before we see 4.5% yields and if that is the direction of travel, equity markets are going to have a tough time while the dollar maintains its bid.

Good luck

Adf

Aghast

Posted on by 
The BOJ did
Absolutely nothing new
Can we be surprised?

The last of the key central bank meetings finished last night with the BOJ not only leaving policy on hold, as expected, but not even hinting that changes were in the offing.  Much had been made earlier this month about a comment from Ueda-san that they may soon have enough information to consider policy changes.  This was understood to mean that YCC might be ending soon.  Oops!  If that is going to be the case, it was not evident last night.  Rather, the status quo seems the long-term view in Tokyo right now.  Not surprisingly, the yen suffered accordingly, selling off another -0.5% overnight and is now back at its weakest point (highest dollar) since October 2022 when the BOJ intervened actively.

Also, not surprisingly, after the yen weakened further, we started to hear from the MOF trying to scare the market.  FinMin Shunichi Suzuki once again explained that he would not rule out any actions with respect to the currency market if volatility (read depreciation) increased too much.  But as of yet, there have been no BOJ sightings and I suspect they will not enter the market until 150.00 is breached once again.  Maybe next week.

With central bank meetings now past
The markets’ response has been fast
It seems there’s a pox
On both bonds and stocks
And owners of both are aghast

While further rate hikes may be rare
Investors feel some small despair
No rate cuts are planned
Throughout any land
And bond yields are now on a tear

Turning to the rest of the G10, what was made clear over the past two weeks is that policy rates are not anticipated to fall anytime soon.  While some central banks seemed to finish for sure (ECB, SNB, BOE) others seem like there may be another in the pipeline (Fed, Riksbank, Norgesbank, BOC, RBA), but in no case is there a discussion that inflation has reached a place of comfort for any central bank.  Rather, even those banks on hold seem comfortable that policy rates need to remain at current levels in order to continue to battle the scourge of inflation.  If anything, the hawks from most central banks continue to push for further tightening, although I suspect that will be a difficult hill to climb given the inherent dovishness of most central bank chiefs.

So, what are we to expect if this is the new home for interest rates rather than the ZIRP/NIRP to which we had become accustomed for the past 15 years?  The first thing to consider is that despite the higher rate structure, the financial position of the private sector, at least in the US, remains strong.  Corporates termed out debt and tend toward being cash rich, so for now, they are benefitting from high interest rates as they locked in low financing and are earning the carry.  Many households are in the same position, having refinanced home mortgages at extremely low rates so are not feeling the pain of the recent rise in mortgage rates.  Of course, this has reduced the amount of activity in the housing market and is a problem for first-time buyers, but that is not the majority, so net, the pain is not so great.

However, the US is unique in this situation as most of the rest of the world are beholden to short-term rates in their financing.  This is true in the commercial sector, where bank lending is a far more important part of the capital structure than public debt.  Those loans are floating, which is also true in the household sector where most mortgages elsewhere have 5-year fixed terms and so are already repricing higher and impacting homeowners.  In fact, if you want one reason as to why the US is likely to outperform the rest of the world, this would be a good place to start.  Despite much higher interest rates, the pain is not being felt across much of the US economy while it is being felt acutely throughout Europe and the UK.  

The upshot of this process is that inflation is likely to remain with us for quite a while going forward.  This means that central banks are going to have a great deal of difficulty reversing course absent a major crash in economic activity.  Given the US tends to lead the world’s capital markets, it also means that the combination of continuing gargantuan issuance by the Treasury to finance the never-ending budget deficits along with the stickiness of inflation implies that interest rates need to be higher.  We saw this price action yesterday with 10yr Treasury yields jumping to 4.5%, another new high for the move, and importantly, a larger move than the 2yr yield.  This is the ‘bear steepening’ that I have been writing about, with longer end yields rising faster than shorter yields.  Ultimately, this will be quite a negative for risk assets, especially paper ones, although hard assets ought to benefit.  The world that we knew has changed, so we all need to adjust accordingly.

Turning to the overnight session, yesterday’s US weakness was followed by Japan (-0.5%) but Chinese shares bucked the trend, rising strongly on hopes that the recent data shows the worst is past for the mainland.  That seems odd given the lack of additional stimulus forthcoming from the government, but that is the story.  European shares are mostly a bit lower this morning after flash PMI data was released showing growth in the Eurozone remains elusive.  Germany is still in dire straits with its Manufacturing PMI <40, but the whole of Europe is sub 50 for the past four months at least.  Finally, US futures are bouncing slightly this morning, but that seems like a trading reaction to two consecutive days of sharp losses rather than new optimism.

Other than YK Gilts, which traded at much higher levels back in August, European sovereigns are following Treasury yields to their highest level in more than a decade.  And despite the weak economic story, the fact remains that sticky inflation is the clear driver for now.  Consider that the ECB has essentially explained they have finished raising rates with their policy rate at 4.0% while CPI is running at 5.2% headline and 5.3% core.  Those numbers do not inspire confidence that the ECB has done its job.  I continue to look for higher long-term yields going forward.

Part of the reason for this is that oil (+0.9%) continues to find support.  While it had a couple of days of a modest pullback, we are back above $90/bbl and the news remains bullish the outcome.  The latest is the Russia is halting deliveries of diesel fuel, a particular sore spot as there are already tight supplies around the world, especially here in the US.  I see no reason for oil to decline structurally, and that is going to continue to pressure inflation higher.  Perhaps of more interest is the fact that the metals complex is rallying today, despite the rise in interest rates.  Gold (+0.3%), silver (+1.3%), copper (+0.8%) and aluminum (+1.1%) are all in the green.  Again, I would say that owning hard assets is going to be a better outcome than paper ones.

Finally, the dollar is mixed this morning, showing gains against the euro, pound and yen, but softer vs. the commodity bloc with AUD, NZD, CAD and NOK all firmer this morning.  As well, EMG currencies are having a better session, rising a bit vs. the greenback, but recall, the dollar has had quite a good run lately.  My take is there is a lot of profit-taking as we head into the weekend given the lack of fundamental stories that would undermine the buck.  Nothing has changed my view it has further to rise.

On the data front, the only releases are the flash PMIs here (exp 48.0 Manufacturing, 50.6 Services) and we get our first Fed speaker, Governor Lisa Cook, a confirmed dove.  We have already had a lot of activity this week so I suspect that heading into the weekend, it is going to be a quiet session as traders and investors start to plan for next week’s excitement.

Good luck and good weekend
Adf

Problems Galore

Posted on by 
The story continues to be
The China of President Xi
Has problems galore
With more still in store
So, traders, as such, want to flee

The issue for markets elsewhere
Is knock-on effects aren’t rare
Protecting the yuan
Means it is foregone
Bond sales will send yields on a tear

For yet another day, China is offering the biggest market stories.  In no particular order we have seen the following overnight; China Evergrande filed for Chapter 15 bankruptcy, a process by which foreign entities can access the US bankruptcy court system, regarding $19 billion of their offshore debt; the PBOC set their CFETS fixing more than 1000 pips lower than market expectations, the largest gap since the process began in 2018, in their effort to arrest the yuan’s consistent decline; and Chinese police visited the homes of the protesters who were complaining about Zhongzhi’s missed payments (I wrote about these Monday in Risks Were Inbred).  And this doesn’t include the fact that Country Garden, the largest property developer in China is losing money quite rapidly and may also be on the brink of bankruptcy.  It seems the Chinese property bubble is deflating.

Ultimately, there appear to be two main impacts of the gathering storm in China, market participants are increasingly leery of taking on risk in general, and the PBOC’s efforts to stem the decline of the yuan means they must sell their holdings of Treasuries to generate the dollars to deliver into the FX market thus adding downward pressure to the bond market.  Of course, one of the typical outcomes of a risk-off attitude is that bond markets rally as investors exit equities and run to bonds.  This stands at odds to the recent bond market behavior, although it is quite evident this morning.  In fact, after touching yields above 4.30% in the 10yr Treasury yesterday, this morning we have seen a half-point rally with yields declining about 5bps in the US.  In Europe, the yield declines have been even greater, mostly around -10bps, so this is a real reprieve for bond markets everywhere.

The key question here is whether we have seen the worst, or if other potential selling catalysts will appear.  Consider for a moment the fact that between China and Japan, they represent >26% of foreign owned US Treasury debt, and that both of these nations are dealing with rapidly weakening currencies.  Not only that, but both have demonstrated they are quite willing to intervene in FX markets to arrest those declines, and as mentioned above, that typically requires selling Treasuries.  It’s a self-reinforcing cycle as higher yields beget currency sales which beget Treasury sales to intervene, which results in higher yields starting the cycle all over.  

With this in mind, we need to consider, what can break the cycle?  Well, if the Fed were to turn dovish and indicate they agreed with the futures markets that rate cuts are coming early next year, I suspect the dollar would fall against most currencies, especially these two, and the cycle would break.  Alternatively, China could step up and guarantee the debt of Countrywide and Evergrande thus removing the investor risk and reduce pressure dramatically.  Finally, I suppose the Fed could make a deal with the BOJ and PBOC and directly absorb their bond sales, so they never hit the market while restarting QE.  That, too, would likely end the cycle.  It is possible there are other ways to break the cycle, but I doubt we will see any of these occurring anytime soon and so the cycle will have to wear out naturally.  That will occur when either or both of the currencies decline far enough so the market believes the trade has ended and unwinds their short positions.  In other words, none of this has changed my view that 7.50 is on the cards for USDCNY as the year progresses, very possibly with 10yr yields getting to 4.5% or more.  And don’t be surprised if we see another move to 150.00 in USDJPY.

But, away from the China connection, things are very much in the summer doldrums.  Equity markets have been treading fearfully and continue to do so this morning.  However, while we have seen several days of declines, there has been no panic selling of note.  So, yesterday’s US weakness was followed by selling throughout Asia and this morning in Europe with most markets down about -1.0%.  US futures, too, are softer, down about -0.5% at this hour (8:00).

Oil prices (-0.85%) which stabilized yesterday, are back under a bit of pressure on the overall negative risk sentiment as they continue to trade either side of $80/bbl.  Metals prices, meanwhile, are mixed with precious metals finding a bit of support while base metals suffer today.  The most interesting story here I saw today was that CODELCO, the world’s largest copper miner in Chile, may be going bankrupt as previous projects didn’t pan out.  That strikes me as a very large potential problem, but one for the future.  

Finally, the dollar is mixed this morning.  It had been softer overall in the overnight session, but as risk is getting marked down, the dollar is gaining strength.  The biggest mover has been PHP (+1.1%) which rallied after the central bank indicated they were going to put a floor under the currency and adjust rates accordingly.  After that, the EMG bloc has not done very much, +/- 0.25% type activity.  However, just recently, G10 currencies started to slide with NOK (-0.8%) the laggard as oil slides, but the entire bloc now coming under pressure.  This is all about risk off.  

There is no US data today nor are there any Fed speakers.  As such, the dollar will take its cues from the equity markets, and the bond market to some extent.  Right now, equity weakness is driving the risk attitude and that means the dollar is likely to remain bid into the weekend.  Next week brings the Fed’s Jackson Hole meeting where everybody will be looking for any policy hints by Chairman Powell on Friday morning.  But for now, the dollar is on top of the mountain.

Good luck and good weekend

Adf

Finding a Cure

Posted on by 
Apparently President Xi
Is keen to continue to be
The story du jour
While finding a cure
For China and its ‘conomy

But elsewhere, the market’s fixation
Is central bank communication
Tomorrow, Chair Jay
Seems likely to say
They’ve not yet defeated inflation

The story in China continues to be one of weakening economic activity and a government that is increasingly desperate to address the situation while maintaining their iron grip on everything that occurs in the country.  Of course, the problem with this thesis is that economic activity works far better without government interference, but that is the bed they have made.  At any rate, the word out of the CCP’s Politburo is that more support is coming with expectations now for lower interest rates as well as still looser property investment policies.  While it seems they don’t want to make direct cash injections into the economy yet, that appears to be the next step.

However, the announcements last night were sufficient for a bullish slant on everything China along with positive knock-on effects for those nations that are heavily reliant on a strong China for their own economic progress.  The result is that we saw dramatic strength in Chinese equity markets with the Hang Seng (+4.1%) and CSI (+2.9%) both having their best days in months.  Even with these moves, though, the Hang Seng remains more than 37% below its 2021 highs while the CSI is about 34% off those levels.  The point is that while last night’s session was quite positive, belief in the Chinese economic story remains a bit suspect yet.

Elsewhere, however, the PBOC is doing its level best to prevent the renminbi from declining sharply as they set the fix nearly 1% stronger than expected based on analysts’ models, and ultimately, the currency closed 0.6% stronger on the session.  Now, it remains well above the 7.00 level, but it seems quite clear that Pan Gongsheng, the freshly appointed PBOC governor, is making a statement that the renminbi should not fall dramatically.  I suspect that if the Chinese economy continues to flounder, that attitude may change, but for now, that is the party line.  As such, it should be no surprise that the rest of the APAC currency bloc performed well last night, along with AUD (+0.3%) the best G10 performer.

But away from that story, the market’s attention is turning almost entirely to the trio of central bank meetings that are starting with announcements due tomorrow afternoon (Fed), Thursday morning (ECB), and Thursday night late (BOJ).  Let us begin with the Fed, where the meeting commences shortly, and they are set to discuss the current situation in the economy as well as how things have changed since their June meeting and what their forecasts for the future look like.  

One area that is worth discussing is the Fed’s Reverse Repurchase Program (RRP or reverse repo) which serves as a low-risk investment outlet for excess funds in the system.  Prior to the debt ceiling crisis, there was a great deal of concern that when the Treasury started to issue T-bills to refill the Treasury General Account, the government’s checking account, the liquidity to buy those bills might come out of the stock market and undermine the stock market rally.  But there was another potential source, the RRP program, which prior to the debt deal had more than $2.3 trillion parked, mostly cash held by Money market funds.  However, since the TGA bottomed at the end of May, and the Treasury has been issuing T-bills at a record rate, it turns out that the entire TGA balance has been filled by a reduction in RRP.  In other words, there has been no liquidity drain from the markets, writ large, hence the equity markets continued ability to rally.  That amount has been approximately $500 Billion.  (See chart below with data from Bloomberg and the poet’s calculations)

Of course, there is a cost to this, and that is that the Treasury has been paying a higher yield on T-bills than those money market funds could get in the RRP market, and that, my friends, is adding to the already gargantuan budget deficit.  Since the start of this process, 3mo T-bill yields have risen 50bps, right alongside the Fed funds rate.  In essence, the Treasury is paying to keep the stock market higher.  

There is another short-dated money issue and that is Interest on Reserves, the rate the Fed pays banks for excess reserves that are held at the Fed.  That is currently set at 5.15%, between the Fed’s 5.00% to 5.25% band for Fed funds.  One subtle tweak the Fed could make is to alter that relative level when they raise rates tomorrow in an attempt to adjust the amount that is held there.  After all, other uses for those funds could be satisfying loan demand assuming that existed.  Arguably, a lowering of that rate would imply the Fed is seeking fewer excess reserves in the system, somewhat of a tightening exercise.  

At this stage, the 25bp rate hike is baked in the cake and is assumed by virtually every analyst with just 5 of the 108 analysts surveyed by Bloomberg calling for no hike.  Futures markets are pricing a 97% probability as well, so the reality is that all the action will be in the press conference as well as any new tweaks to the statement.  In my view, there has not yet been enough evidence of a considered slowing in inflation for the Fed to change its tune, but by the September meeting, we will have seen a lot more data and depending on how that plays out, things could be different.  But not this month.

Heading into this morning’s session, that Chinese stock rally was not really widely followed elsewhere as the Nikkei was unchanged and most of Europe is higher by just basis points.  That minimal movement is true in US futures as well.

Bond yields are a touch firmer, about 2bps across Treasuries and virtually the entire European space with only Italy (+4bps) an outlier.  The only data of note was the German IFO report, which was on the soft side, but not dramatically so.  I suspect that the yield move is in anticipation of the coming central bank activities.

In the commodity space, after another rally yesterday, oil is essentially unchanged and consolidating its recent gains.  However, the base metals have rallied sharply on the back of the China news with copper higher by almost 2% and aluminum by 1%.  Meanwhile, gold continues to trade in a very narrow range just below $2000/oz.

Finally, the dollar is slightly firmer this morning overall as the China story did not bleed over into any other areas and traders seem to be adjusting positions ahead of the Fed meeting.  Surprisingly, NOK (-0.6%) is the worst performer despite oil’s recent gains, but elsewhere, in both the G10 and EMG, it is modest dollar strength around.

This morning we see Case Shiller Home Prices (exp -2.35%) and then the Consumer Confidence reading (112.0) although typically, these do not move markets.  With no Fed speakers, the ongoing earnings calendar is likely to be the key driver of markets, although it is not until later this week when we hear from some of the Megacap names that people are getting excited.  I suspect there will be little net movement today ahead of tomorrow’s FOMC announcements.

Good luck

Adf

Quite a Surprise

Posted on by 
While many are looking ahead
To Europe, Japan and the Fed
Today’s PMI’s
Were quite a surprise
As weakness was truly widespread

Meanwhile, from Beijing, what we heard
Was policies they now preferred
Included support
For housing to thwart
The story that weakness occurred

While most market participants are anxiously awaiting this week’s central bank meetings for the next steps in monetary policy by the big 3 (Fed, ECB & BOJ), we did see a bit of surprising news from two sources this morning which has led to some market reactions.  The first thing to note was that the Chinese remain very disappointed that they cannot will their economy to grow faster in isolation and so have announced yet another round of policies intended to foster economic growth.  

The key plank of this policy is to further relax property investment rules, the so-called three red lines from several years ago, in order to encourage people to start buying houses again.  The property slump in China was first recognized when China Evergrande, one of the largest property development companies in the country, started down its road to bankruptcy nearly 2 years ago.  Since then, it has been a slow-motion train wreck with many more firms needing to halt debt payments, restructure debt and even go out of business.  Naturally, this didn’t sit well with the Chinese government, especially since property was a key part of the social safety net.  (Chinese families bought property as a nest egg investment since price appreciation had been so strong for so long.  Price declines have scared new investment away at the same time that many families need to cash in on their investment, adding further downward pressure to the housing market.)

The other main plank of this policy change was a renewed effort to deal with local government debt.  Historically, local governments would issue debt to fund economic investment and would repay that debt by selling property to investors and home buyers.  But with the property market in such a slump, these local governments no longer have the cash flow available to stay current on the debt, let alone repay it.  As such, the Chinese government is going to step into the market and restructure the debt in some manner with simple restructuring on the table as well as debt-swaps, where I assume debt holders will wind up with equity ownership of some extremely illiquid assets.  Neither of these things points to economic strength in China so I would continue to look for further measures as well as more direct fiscal support as we go forward.  As well, although CNY is little changed today, do not be surprised to see it continue its weakening trend.

The other major news this morning came from the Flash PMI data across Europe, which was, in a word, putrid.  While the initial data overnight from Australia and Japan was a bit soft, the continent redefined weakness.  Manufacturing remains mired in a serious recession in Europe as evidenced by Germany’s 38.8 reading, far below expectations and the second lowest print in the series, exceeded only by the Covid lows in April 2020.  But the weakness was widespread with France (44.5) underperforming expectations and the Eurozone as a whole (42.7) even worse.  Services data, while better than Manufacturing is also softening, and the Composite readings show are sub 50 across the board.  UK data was also soft, just not quite as awful, but the general takeaway is growth is slowing in the Eurozone and the UK.

Later this morning we see the US numbers (exp 46.2 Mfg, 54.0 Sevices) as well as the Chicago Fed National Activity Index (exp -0.13), which will help flesh out the story of US economic activity as well.  But the big picture remains that economic activity around the world is suffering, of that we can be sure.

And yet, despite this weakening growth story, expectations for rate hikes by both the Fed and ECB remain a virtual lock although the BOJ seems likely to remain on hold for a while yet.  We will delve into the central banking story tomorrow though.  For today, markets continue to respond to the PMI data as well as the China story.

And how have they reacted you may ask?  Well, starting in Asia, Chinese shares did not seem to like the announcements coming from Beijing as both the Hang Seng (-2.1%) and CSI (-0.45%) suffered although the Nikkei (+1.25%) embraced the idea that the BOJ was going to continue to print as much money as possible.  It should be no surprise that European bourses are in the red after that data with a particular note for Spain (-0.8%) which is also dealing with an election outcome that seems destined to result in another hung parliament.  But don’t worry, US futures continue to point to modest gains at this hour (8:00) although that remains highly earnings dependent I believe.

In the bond market, yields are lower across the board with Treasuries (-3.3bps) that laggard as virtually all the European sovereigns have seen yields slide by 6bps or so.  Apparently, the European investment community is not willing to believe the ECB will continue to raise interest rates into a very obvious recession on the continent.  We shall see if they do so.  As to JGB’s, they saw yields rise 2.4bps, but are still not too close to the YCC cap.  I expect that we will see a little more volatility in the JGB market ahead of Friday’s BOJ announcement as speculators try to get ahead of any potential policy change.

In the commodity space, oil (+0.75%) continues its recent winning ways and is up more than 11% in the past month.  Given the economic news, this has to be a supply driven story.  I have written many times about the structural deficit in oil that we are likely to face given the ESG movement’s systematic underinvestment in oil production.  The problem is that even with a recession, oil demand continues to grow and even the IEA, a complete convert to ESG and net-zero ideas, admits that oil demand will grow to a new record this year in excess of 102 million bbl/day globally.  Rising demand and static or falling supply will drive prices higher, that much is clear.  The base metals are under a bit of pressure, though, this morning, responding as would be expected to the weaker economic story and gold (+0.3%) continues to find support, arguably today on the basis of lower yields around the world.

Finally, the dollar is mixed, although I would argue leaning slightly stronger today.  The worst performer is CZK (-0.8%) which is suffering from weakness in its largest export market, Germany, as well as continuing to respond to central bank comments from late last week about policy ease.  On the flip side, ZAR (+0.7%) as there is a growing influx of investment into rand bonds given the huge yield advantage.  In the G10, JPY (+0.45%) is today’s leader, although if the BOJ stands pat, I have to believe that further weakness is in the future.  Meanwhile, EUR (-0.3%) is the laggard on the back of that terrible PMI data.

There is a lot of data out there this week in addition to the 3 big central bank meetings.

Today	Chicago Fed National Activity	-0.13
Tuesday	Case Shiller Home Prices	-2.40%
	Consumer Confidence	112.0
	Richmond Fed	-10
Wednesday	New Home Sales	725K
	FOMC Decision	5.50% (current 5.25%)
Thursday	ECB Decision	3.75% (current 3.50%)
	Initial Claims	235K
	Continuing Claims	1750K
	GDP Q2 (2nd look)	1.8%
	Durable Goods	1.0%
	-ex Transport	0.1%
Friday	BOJ Decision	-0.1% (current -0.1%)
	Personal Income	0.5%
	Personal Spending	0.4%
	Core PCE Deflator	0.2% (4.2% Y/Y)
	Michigan Sentiment	72.6
Source: Bloomberg

Obviously, there is plenty of information to be gleaned this week, although there are no scheduled Fed speakers after the meeting and press conference on Wednesday.  I guess they are all going on vacation!  

My read on the current situation is that economic activity continues to slow, although perhaps not yet to a recessionary level.  As well, I fear that inflationary pressures will remain stickier than we would like and that for now, the Fed is not feeling any pressure to end their current higher for longer policy.  In fact, it will be next week’s NFP data that is the first really critical release, as a weak number there will start to give weight to the idea that the terminal rate has been reached.  However, if we see strength in job growth, pencil in at least one more hike past Wednesday.  As to the dollar, I am confident that if the US is ending their tightening cycle, the other major central banks will be ending theirs soon as well.  I see no dollar collapse, nor even significant weakness for quite a while yet.

Good luck
Adf