Tag Archives: #Fed

One, Two, Three

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On Monday, no one could agree
So, Powell unleashed; one, two, three
At least with respect
To how they dissect
The prospect for rate cuts they see
 
For Bostic, he sees only one
Before the committee is done
While Cook thinks that two
Are likely to do
And Goolsbee said three need be spun

 

During a session with very little new news, and ultimately, very little in the way of net market movement, it was quite interesting to hear from three different Fed speakers with somewhat different views of what the future holds.

In order of their views, as opposed to the timing of their comments, Atlanta Fed President Raphael Bostic reiterated his view from Friday in a different venue.  He explained that given the resilience of the economy, he sees little reason for any rate cuts in the near term and that his ‘dot’ was for just one cut this year, later in the year.  The thing about Bostic is he has proven to be flexible, arguably adhering to the Keynesian concept of, when the facts change, he changes his mind.  While it is not clear to me that the facts have actually changed, his perception of them certainly has.  At this point, it appears that he has become one of the more hawkish FOMC members and he is a current voter on the FOMC.

One step further toward the median we found Governor Lisa Cook, who explained that “the path of disinflation, as expected, has been bumpy and uneven, but a careful approach to further policy adjustments can ensure that inflation will return sustainably to 2% while striving to maintain the strong labor market.”  In other words, we have been surprised by the two consecutive hotter than expected CPI reports and so despite our fervent desire to cut rates as quickly as possible, if we were to do so, whatever credibility we still have would be thrown away.  At least, that is how I read her comments as she is a clear dove and desperate to cut.  To her credit, as a governor, she is making the effort to be a bit more restrained.

Lastly, we heard from Chicago Fed President, Austan Goolsbee, who during his interview (at Yahoo! Finance) quickly highlighted that his ‘dot’ was for three cuts this year.  He further explained that housing was the problem, at least with respect to their forecasts, and why they had expected inflation to decline more rapidly. Now, based on the housing data we continue to see, at least the price data, inflation is unlikely to decline much further at all.  Add in the fact that commodity prices, notably energy prices, have been rebounding for the past month and any hopes for another leg lower in either CPI or PCE are slipping away.  Also, Goolsbee is not a current voter, so many take his views a bit less seriously.

Now, let me ask, do you feel more enlightened?  Me neither.  If I were to assess the current situation, my read is that the majority of the FOMC really does want to cut rates as they believe they have done enough regarding inflation.  Frighteningly, there was an article in the FT this morning from Mohamed El-Erian, claiming that the time is ripe for allowing inflation to run hotter in order to support nominal growth.  We know that is every FinMin’s wet dream, but historically central bankers pushed back on that thesis.  However, El-Arian now claims that the central banks are on board as well.  If this is true, the only conclusion is that all fiat currencies are going to decline in value vs. stuff.  The relative pace of these declines will ebb and flow based on interest rate differentials and other circumstances, but it is not a net positive for the ordinary consumer.

Ok, let’s turn our attention to the overnight session and how markets are behaving.  The bulls have to be disappointed that the recent Fed speakers have not been more dovish, and we have seen that in another lackluster equity session in the US yesterday, with all three major indices lower by about -0.3%.  In Asia, while Japanese shares were essentially unchanged, we saw some strength in China and Hong Kong with the noteworthy story being President Xi’s invitation to keep several US CEOs currently visiting there, in country with the promise of a meeting with him.  The read is he is open to deeper business relationships.  As to the rest of the region, equity markets were mixed with some gainers and some laggards and no large movers.  As to Europe this morning, the color on the screen is green, with a few gains of 0.5% (Germany and Spain) and the rest much more subdued.  US futures are pointing higher at this hour (7:00), by about 0.5%, so the bulls are back.

In the bond market, yields have backed off a bit with Treasuries lower by 2bps and European sovereigns falling between 3bps (Germany) and 6bps (Italy) as the ECB speak continues to point to rate cuts clearly coming, with more hope for April making its way into the market, at least according to Italy’s Panetta.  In what cannot be a huge surprise, 10-year JGB yields remain unchanged as the idea of a tightening cycle there is slowly ebbing from traders’ minds.

In the commodity markets, oil (+0.2%) is creeping higher again as Russia has indicated it is going to restrict production alongside the lost output from refinery damage caused by Ukraine.  As well, after the UN Security Council vote yesterday, it appears that concerns are rising that there is no chance of a ceasefire anytime soon.  Meanwhile, gold (+1.2%) is screaming higher this morning and once again approaching $2200 as what appears to be a combination of growing geopolitical jitters combines with the growing awareness by market participants that inflation is not going to be addressed has investors seeking alternatives to fiat currencies.  Base metals, though, are not seeing the same boost, although are a touch higher overall.

Finally, the dollar is under some pressure this morning with most G10 currencies firmer, although the Swiss franc (-0.2%) is suffering a bit.  In fact, the biggest winner is NZD (+0.45%) but there is precious little to explain this movement.  One currency that is not gaining is the yen, which is unchanged on the session while the dollar remains just below its multi-decade highs set back in October 2022.  In the EMG bloc, the story is more mixed with some gainers (CZK +0.2%, HUF +0.3%) and some laggards (ZAR -0.3%, TWD -0.2%), but as you can see, the movement has been muted.

On the data front, this morning brings Durable Goods (exp 1.1%, 0.4% ex-transport) and Case Shiller Home Prices (6.7%). We also see Consumer Confidence (107.0) at 10:00.  There are no Fed speakers scheduled, but do not be surprised if there is an interview or two from a news source as they continue to try to tweak their message.

To me, the big picture is that there has been a clear relaxation by the Fed, and other central banks, in their attitude toward inflation.  As such, I expect to see risk assets perform and bonds lag.  However, regarding FX, it is all about the timing of the changes that are announced, or guided, rather than the absolute destruction in their value over time.  For now, though, the Fed remains the tightest policy around and the dollar should benefit because of that.

Good luck

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Threw in the Towel

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There once was a banker named Powell
Who fought, prices, high with a growl
Then going got tough
So he said, “enough”
And basically, threw in the towel
 
His problem’s inflation’s alive
And truthfully, starting to thrive
The worry is he
Will soon say that three
Percent’s the rate for which he’ll strive

 

With several days to digest the latest FOMC meeting results, and more importantly, the Powell press conference, my take is the Chairman recognizes that to get to 2.0% is going to be extremely painful, too painful politically during this fraught election cycle.  And so, while he tried very hard to convince us all that the Fed was going to get to 2.0%, he stressed it will “take time”.  The subtext of that is, it’s not going to happen in the next several years, at least, and this poet’s view is it may not happen again for decades.  The key to recognizing this subtle shift is to understand that despite increased forecasts for both growth and inflation, the Fed remains hell-bent on cutting interest rates.  Even the neo-Keynesian views which the Fed follows would not prescribe rate cuts in the current economic situation.  But rate cuts are clearly on the table, at least for now.

This begs the question, why is he so determined to cut interest rates with the economy growing above trend?  At this stage, the explanation that makes the most sense to me is…too much debt that needs to be refinanced in the coming years.

Consider, current estimates for total debt around the world are on the order of $350 trillion.  That compares to global GDP of just under $100 trillion.  Many estimates indicate that the average maturity of that debt is about 5 years which means that something on the order of $70 trillion of debt needs to be refinanced each year.  Now, the US portion of that debt is estimated at about $100 trillion, of which ~$34.5 trillion is Treasury debt, and the rest is made up of corporate, mortgage, municipal and private debt.  Remember, too, that total US GDP is currently about $28 trillion as of the end of February (according to the FRED database from the St Louis Fed), so the ratio here is similar to the global ratio.  [Note, this does not include unfunded mandates like Social Security and Medicare, just loans and bonds outstanding.]

Here’s the problem, we have all heard about the fact that the US debt service has climbed above $1 trillion per annum and given the underlying principle is growing, that debt service is growing as well.  In addition, on the private side, there is a huge proportion of corporate debt that has become a serious problem for banks and investors, notably the loans made for commercial real estate, but personal and credit card debt as well.  The Fed cannot look at this situation and conclude that higher rates, or even higher for longer, is going to help all the debtors.  And if the debtors default…that is going to be an economic disaster of epic proportions.Add it up and the only logical answer is Powell is going to gaslight everyone with the idea that the Fed is going to remain vigilant regarding inflation.  And they will right up until the time when the pain becomes too great, or too imminent and they cut.  I think that we are seeing the first signals from markets this is going to be the case from both gold and bitcoin.  But if I am correct, and the Fed cuts despite still elevated inflation readings, look for the dollar to decline sharply, at least initially until other central banks cut as well, look for bonds to fall sharply and look for hard assets to rally.  As to stocks, I expect that initially it will be seen as a positive and juice the rally, but that over time, stocks will begin to lag hard assets.  Quite frankly, this looks like it is a 2024 event, so perhaps if that first cut really comes in June, the summer is going to be far more interesting than anybody at the Fed would like to see.

Kanda told us all
“We are always prepared” to
Prevent yen weakness
 
Meanwhile in Beijing
The central bank responded
Nothing to see here

 

“The current weakening of the yen is not in line with fundamentals and is clearly driven by speculation. We will take appropriate action against excessive fluctuations, without ruling out any options.”  So said Masato Kanda, the current Mr Yen at the MOF.  It seems possible, if not likely, the yen’s decline in the wake of the BOJ move last week came as a bit of a surprise.  This morning, the yen (+0.1%) has edged away from its lows from last week, but USDJPY remains above the 151 level and very close to the level when the MOF/BOJ intervened in October 2022.  Adding to the pressure was Friday’s very surprising sharp decline in the CNY, which many in the market took to mean the PBOC was comfortable with a weaker yuan. 

Economically, a weaker yuan seems to make sense, but the PBOC’s concern is that it could lead to increased capital outflows, something which they are desperate to prevent.  As such, last night, the CNY fixing was nearly 1200 points stronger than expected, with the dollar rate below 7.10, and we saw significant dollar selling by the large Chinese banks.  Apparently, Friday’s movement was a bit too much.  I suspect that these two currencies will continue to track each other at this point with both currently at levels which, in the past, have been demarcation lines for intervention.   

Here’s a conspiratorial thought, perhaps the Fed’s dovishness is a response to the weakness in the yen and Powell’s best effort to help the BOJ avoid having to intervene again.  The thing about intervention is it, by definition, represents a failure of monetary policy, at least in the market’s eyes.  And in the end, all G10 central banks are in constant communication.

Ok, let’s survey the markets overnight.  All the currency activity seemed to put a damper on equity investors as Asia saw weakness across the board with Japan (Nikkei -1.2%) falling, although still above 40K, and both Hong Kong and mainland shares in the red.  In Europe this morning, red is also the predominant color, although the declines are more muted, ranging from -0.1% (DAX) to -0.4% (CAC).  Finally, US futures, at this hour (7:00) are also slipping lower, down 0.25% on average.

In the bond market, Treasury yields are backing up 3bps this morning, bouncing off the critical 4.20% technical level again.  As well, in Europe, sovereign yields are rising between 2bps and 3bps across the board.  There has been no data of note, but we have heard a bit more from ECB bankers with a surprising comment from Austria’s Holtzmann that he saw no reason for rate cuts at all.  That is an outlier view!  And despite what is happening in the FX markets, JGB yields remain unchanged yet again.

Turning to commodities, oil (+0.3%) is edging higher this morning as, after a strong rally early in the month and a small correction, it appears that $80/bbl is a new floor for the price.  In the metals markets, after last week’s pressure lower, this morning both precious (gold +0.3%) and base (copper +0.1%) metals are edging higher.  There has not been much in the way of news driving things in this session.

Finally, the dollar is a touch softer this morning, but that is after a strong week last week.  We’ve already touched on the Asian currencies, and it is true the entire bloc, which had been under pressure, is a bit stronger this morning.  But we are seeing strength across the board with G10 currencies higher on the order of 0.2% and most EMG currencies firmer by between 0.1% and 0.2%.  So, while the movement is broad, it is not very deep.  I maintain this is all about US yields and the fact that despite Powell’s newfound dovishness, the Fed remains the tightest of the bunch.

On the data front, there is a lot of information to be released, but I suspect all eyes will be on Friday’s PCE data.  

TodayChicago Fed Nat’l Activity-0.9
 New Home Sales680K
TuesDurable Goods1.0%
 -ex Transport0.4%
 Case Shiller Home Prices6.8%
 Consumer Confidence106.7
ThursdayInitial Claims215K
 Continuing Claims1808K
 Q4 GDP3.2%
 Chicago PMI46.0
 Michigan Sentiment76.5
FridayPersonal Income0.4%
 Personal Spending0.4%
 PCE0.4% (2.4% Y/Y)
 Core PCE0.3% (2.8% Y/Y)
Source: tradingeconomics.com

In addition to that menu, Fed speakers will be about with five scheduled including Chairman Powell on Friday morning.  Remember, too, that Friday is a holiday, Good Friday, with market liquidity likely to be somewhat impaired as Europe will be skeleton staffed.  As well, it is month end, so my take is if Powell veers from the script, or perhaps reinforces the dovish theme, we could see an outsized move.  Just beware.

Recent activities by the BOJ and PBOC indicate that the market has found a sore spot for the central banks.  If the data this week doesn’t cooperate, meaning it remains stronger than forecast, it will be very interesting to hear what Chairman Powell has to say on Friday.  Cagily, he speaks after the PCE data, so he will be able to respond.  But especially if that data comes in hot, we are likely to see more volatile markets going forward.  However, today, it is hard to get too excited.

Good luck

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Jejune

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Come Wednesday through Friday this week
It’s payrolls and Powell to speak
Let’s take time today
To hear people say
What’s driving the year-to-date streak
 
The first key is so many think
That Powell and friends need to blink
And cut rates quite soon
Else markets will swoon
And ‘flation will not rise, but sink
 
The other idea that’s around
Is AI and Bitcoin are bound
To fly to the moon
An idea, jejune,
For OG’s, though elsewhere profound

 

Once again, lackluster was an apt description of the market activity yesterday, although given the plethora of information that is on the horizon, we cannot be surprised by this result.  As such, I thought it might be worthwhile to review the themes that seem to be driving markets these days, as well as how expectations are built into pricing.

Clearly, the biggest story remains the Fed and its potential timeline for the mooted rate cuts necessary to achieve the much-vaunted soft landing.  As of this morning, the probability of a May cut remains near 24% with June the odds-on favorite for the first action.  While there has been some back and forth with respect to the actual probabilities, there has been no major change in that view for several weeks.  My question continues to be, why are so many people of the opinion that the Fed must cut rates?  

So far, at least based on both the GDP and payroll data, the economy is chugging along quite well with the current monetary policy settings while inflation remains well above the Fed’s target.  Arguably, a great deal of that is due to the fiscal impulse that has been ongoing, but there is no sign that is going to end anytime soon.  In fact, it strikes me that easing monetary policy amid a period of fiscal excess may juice the inflation data substantially.  Literally every Fed speaker has made this exact point, that things are going well, inflation seems to be trending lower, but there is more certainty needed before a cut would be appropriate.

Adjacent stories here are related to the election in the US, with many assuming the Fed will cut rates to help support the Biden administration (I think this is extremely unlikely).  The other key story has to do with the other G7 central banks, and their ability/willingness to change policy prior to the Fed.  Considering that Japan, Canada, the UK and Europe are all basically in recession, or right on the cusp, there is a far greater need to ease monetary policy in those places.  However, they have a serious concern that if they cut before the Fed, the dollar will rally sharply and negatively impact both economic activity and market activity, as well as undermine their currencies.  In the end, everybody is waiting for Godot Powell, and it is not clear he is going to come through.

The second key story is the remarkable performance of both Bitcoin and the tech sector.  There have been many stories comparing the current move in the NASDAQ to various times in the late 1990’s and the runup to the Tech bubble then.  We all know that eventually, despite the internet having an amazingly profound impact on all our lives, the tech sector corrected more than 80% from its early 2000 peak and it took 15 years to regain those levels.  I don’t think anybody is willing to say that the current tech leaders are bad companies with problems, but the price one pays for a company’s shares is THE key to long-term investment performance.  AI can be transformative in many ways and that doesn’t mean these shares will not decline and decline sharply.

Speaking of AI’s impact, my good friend the @inflation_guy, Mike Ashton, wrote a terrific piece about the potential impact on the economy overall, comparing it to the internet, the last significantly transformative technological revolution.  This is a must read!  Ultimately, while the impact of the internet was significant, it was not nearly as productivity enhancing as many had forecast at the initial stages of the mania.  Just keep that in mind with respect to AI as well.

As to Bitcoin, it is pushing to new all-time highs as flows into the spot ETF’s are quite substantial and driving the move.  However, it strikes me that the rationale for buying Bitcoin is very different than the rationale for buying NVIDIA.  Bitcoin believers are concerned over the integrity of the entire concept of money and its future.  They look at the dramatic increase in Treasury issuance and ask, is that debt really risk-free?  They are seeking to own alternative assets, outside the current monetary framework.  Meanwhile, buying the AI craze is as mainstream as you can get, counting on the equity values to rise substantially from here and protect your wealth, even if it is denominated in a currency that is subject to inflation and devaluation.  But for now, the two are linked at the proverbial hip.  

I would not look to short either process at this point, but having seen numerous bull markets in my time, the one thing I know is that trees don’t grow to the sky.  At some point, there will be a significant correction in both these asset classes, and we are sure to hear a great deal of screaming about how the Fed needs to come in and stop it.

In China, last night Premier Li
Revealed what their growth ought to be
Though clearly well-meant
To reach five percent
Is certainly no guarantee

 

One other key story overnight was Premier Li Qiang’s speech in which he declared the GDP growth target for China this year is “around 5%” with inflation to run at 3% and a budget deficit also at 3%.  While this all sounds great, there is reason for some skepticism.  Perhaps the biggest issue is that domestic demand for products is not growing and is unlikely to start doing so until the property crisis is behind them.  However, given President Xi’s unwillingness to face that music, the drawn-out process to address the situation will likely weigh on overall economic activity for a few more years yet.  

There is a potential knock-on effect of this, though, and something that I have not really considered in the past but need to investigate further.  We all know that there is a concerted effort by G10 nations to reshore and friendshore manufacturing capacity, and that has been a key driver of US economic activity.  Recall, that was the entire goal of the Inflation Reduction Act.  It has also been clear that there is currently a boom in factory construction in the US, something else supporting GDP data.  Now, if the US, and much of the G10, is adding to manufacturing capacity while China maintains its own manufacturing capacity, that is a LOT of capacity to build stuff.  It is not unreasonable to expect that the prices of manufactured goods will decline given what could well be significant excess supply.

In the US, regardless of who wins the presidential election, it is very easy to foresee another increase in import tariffs on Chinese goods (Trump has proposed a 60% tariff on all Chinese imports).  We have heard similar rumblings from Europe as well.  The point is that absent a substantial change in trade policy, goods inflation is likely to be well-contained.  Services inflation is a different issue, and given services represents a much larger proportion of the US economy, seems likely to keep price pressures pushing higher.  But rampant price rises are far less likely if we wind up with duplicate production sources for various goods.  Of course, tariffs will feed directly into inflation data, and the Fed cannot address that at all.

My point is that the economy is a highly interconnected and complex system and tracking all the potential outcomes is extremely difficult, if not impossible.  This is just one that I hadn’t considered in the past but may have some legs.  To be continued…

Ok, I have gone on too long so here’s the recap for overnight.  The Hang Seng sold off (-2.6%) but otherwise in Asia and Europe shares are little changed.  Yields are broadly lower (Treasuries -3bps, Europe -5bps on average) while oil prices have slipped a bit.  Gold (+0.5% and new all-time highs) is the commodity outlier.  Finally, the dollar remains little changed and is likely to stay that way until we see the next monetary policy adjustments.

ISM Services (exp 53.0) is the only data release today and only Michael Barr is speaking. I see no reason for things to move very far until tomorrow, when both ADP Employment is released, and Chairman Powell testifies.  Equity futures are pointing a bit lower this morning after a soft session yesterday.  That drift feels like it can continue as we await the rest of the week’s news.

Good luck

Adf

Finally Dead

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It’s been, now, two weeks since the Fed
Said rate cuts were not straight ahead
Their confidence lacked
Support to abstract
Inflation was finally dead
 
Which brings us now to CPI
Where analysts identify
Used cars and soft gas
As just ‘nuff to pass
The test and wave ‘flation bye-bye

 

Finally, the CPI report will be released this morning so we will be able to collectively exhale!  The current consensus forecasts are for a 0.2% M/M rise in the headline, leading to a 2.9% Y/Y outcome and a 0.3% M/M rise in the ex-food & energy reading leading to a 3.7% Y/Y increase.  Those annual numbers would be down from 3.4% and 3.9% respectively.

A key part of the thesis for the ongoing decline is that Used Car prices will continue to fall as well as gasoline prices, which fell about 30 cents/gallon on the NYMEX exchange.  However, rent increases remain stubbornly high and any declines in foodstuffs seem to have ended.  There was a ‘brilliant’ article by a UC Berkeley economist, Ulrike Malmendier, that determined most people’s view of inflation was skewed by the prices of things they bought most frequently, rather than the ‘proper’ economists’ view of the totality of prices.  Who would have thunk it?  Honestly, it is hard to believe that some of these people have degrees at all.

At any rate, the market is highly fixated on the number and there is no doubt that many are looking for a soft outcome and, perhaps, sufficient proof for the Fed to gain enough confidence to cut rates in March.  As it stands, right now the Fed funds futures market is pricing a 15.5% probability of a March cut and a 57.5% probability of a May cut.  But the pining for this cut is palpable.  I will reiterate my view that based on the current trajectory of economic data, there is no reason for the Fed to cut at all absent a major downturn.  Clearly, given the government’s ongoing fiscal largesse, economic activity continues to move along.  While price rises have been slowing over time, I would contend there is no risk of a major deflationary event.  

The flip side of this argument is that the Federal government cannot afford to continue with interest rates this high.  Much has been made of the fact that interest payments on the Federal debt are now in excess of $1 trillion per annum, more than either defense spending or Medicare, and trending inexorably higher.  While they remain <5% of GDP, the fact that the government is running a budget deficit of >7% of GDP and slated to do so for the foreseeable future, there will come a time when this process will be unsustainable.  However, as Japan has proven over the past twenty years, things previously thought impossible are not necessarily so if the population tolerates them.  Right now, the major financial problem for the government is not the deficit, but inflation.  So that is where the attention is focused.  Eventually, something will have to give, but it is not clear that will occur within the next several political cycles, and ultimately, that’s the only time things like this will be addressed.  So, look for more of the same for now.

Turning back to markets, ahead of the CPI report, most markets around the world have remained quiet, with one notable exception, Japanese equities which have continued their impressive rally.  After a mixed and lackluster session yesterday in the US, the Nikkei rose nearly 3.0% overnight as the ongoing yen weakness and a growing suspicion that the BOJ is not going to act anytime soon continues to support things there. Chinese markets remain closed all week for the New Year holiday but the rest of the APAC markets had solid sessions.  European bourses, however, are under some pressure this morning with all of them lower by between -0.3% and -0.6%.  The data from the UK showed that the employment situation was better than expected, with lower Unemployment and firmer wage growth.  This will not encourage the BOE to consider cutting rates anytime soon.  As to US futures, at this hour (7:45) they are somewhat lower with the NASDAQ (-0.75%) leading the way down.

Meanwhile, in the bond market, yields have edged lower everywhere except the UK (+2bps and see employment data for explanation) as Treasuries (-2bps) show the way and most of Europe has followed directly in its footsteps with similar yield declines.  Interestingly, JGB yields were unchanged overnight despite the equity rally and yen weakness.

Oil prices (+0.75%) are bouncing this morning as any hopes of a ceasefire in the Middle East have faded for now but we are also seeing broad-based strength across the metals markets with gold (+0.4%), copper (+0.75%) and aluminum (+0.3%) all finding support this morning.  Perhaps this is on the back of dollar weakness in anticipation of a cool CPI print.

Speaking of the dollar, it is broadly softer, albeit not dramatically so.  GBP (+0.4%) is the leading G10 currency although CHF (-0.4%) has fallen on the back of a much lower than expected CPI reading there, just 1.3% Y/Y, with market participants now looking for rate cuts sooner rather than later.  In the EMG bloc, things are mixed although there are more gainers than laggards with ZAR (+0.5%) the leader of the pack on those strong metals prices.

Looking at this week’s data beyond today shows the following:

ThursdayInitial Claims220K
 Continuing Claims1880K
 Retail Sales-0.1%
 -ex autos0.2%
 Empire State Manufacturing-15
 Philly Fed-8
 IP0.3%
 Capacity Utilization78.8%
 Business Inventories0.4%
FridayPPI0.1% (0.6% Y/Y)
 Ex Food & energy0.1% (1.6% Y/Y)
 Housing Starts1.46M
 Building Permits1.509M
 Michigan Sentiment80.0

Source: tradingeconomics.com

As well, today we already saw the NFIB Small Business Optimism Index show a little less optimism printing at 89.9, down 2 points from last month.  Of course, things would not be complete without a bit more Fedspeak, with 6 more on the calendar including Governor Waller, perhaps the 3rd most important voice there.

Overall, while I don’t think the rate of inflation has much further to fall, and in fact, I expect it to rise again as the spring and summer progress, today’s number feels like it could be soft.  Here’s the thing, the market is anticipating that soft number so it is not clear to me how much further they can drive risk assets higher on this news.  They need something new.  However, if it is hot, look for a sharp down day in risk assets and higher yields and a higher dollar.

Good luck

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Singing the Blues

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Here’s what’s underlying most views
Inflation is yesterday’s news
But what if it’s not
And starts to turn hot?
Those bulls will be singing the blues
 
So, care must be taken, I think
As in the bulls’ armor, a chink
Is wages keep rising
While homes are surprising
Be careful, the Kool-Aid, you drink

 

Market activity has generally been benign as investors and traders await the next big news.  Arguably, that is next Tuesday’s US CPI data given the dearth of new information otherwise due to be released this week.  The one thing we have in spades this week is central bank speakers, with three from the Fed yesterday and four more today, including the first comments I have seen from the newest Governor, Adriana Kugler.  As well we have been regaled by ECB, BOE and BOC speakers and they will continue all week as well.

Thus far, the message has been pretty consistent with the general theme that inflation has fallen nicely and is expected to continue to do so.  However, in a great sign of some humility, they are unwilling to accept that because price levels have fallen for the past 3 months that their job is done.  Obviously, the recent NFP and ISM data have shown no indication that the economy is even teetering on the brink of a slowdown, let alone desperate for rate cuts for support.  And for this, I applaud them.

But in this case, the central bank community seems to be in a small minority of economic observers who are not all-in on the idea that rate cuts are necessary right now.  Because, damn, virtually every other analyst seems to be on that train.  

There is a very good analyst group that calls themselves Doomberg, which mostly write about energy policy and its impacts on everything else, but in this morning’s article, I want to highlight a more general comment they made which I think is really important:

“How can you tell the difference between an analyst and an advocate? It is all in the handling of data that runs counter to assertion. To an analyst, being wrong is disappointing, but it is primarily an opportunity to learn—an expected element in a feedback loop of continuous improvement. When knowledge is your only objective, there is no such thing as a bad fact, only one which you do not yet understand. Not so for the advocate. The advocate has tied their hopes (and often their livelihoods) to a specific outcome and feels compelled, whether consciously or not, to rationalize away or attack inconvenient realities. It is advocacy when every perturbation in the weather is tagged as evidence of climate change, each squiggle of unfavorable price action is declared market manipulation, and no act or utterance from a favored politician is disqualifying.”

First, I cannot recommend their writings highly enough as they are consistently thoughtful, well-researched and important.  But second, I think this point is exactly in tune with the Goldilocks welcoming committee as they will ignore every piece of data that runs counter to their narrative and double down by saying the Fed is overtightening because inflation is collapsing, and deflation is going to be the economic problem soon.

While I am often quite critical of the Fed and their comments, and still think they speak far too much, right now, I am very happy to see them maintain a reluctance to cut rates just because the market is pricing in those cuts.  Certainly, to my eye, looking at the totality of the data (as Chairman Powell likes to say) there is little indication that prices are collapsing.  In fact, the super-core data, which was all the rage last year, has turned higher.  I understand why Wall Street analysts are better described as Wall Street advocates, but for the independent analysts out there, and over the past several years those numbers have exploded higher, it is remarkable to me that more of them are not suspect on the idea that rates need to be cut and cut soon.  In fact, at this point, one month into the year, I continue to like my 2024 forecasts of perhaps one cut in the first half of the year, but a reversal as inflation reignites.

Yes, the futures market is now only pricing five cuts into 2024, but nothing has changed my view that the pricing is bimodal, either 0 or 10 cuts will be the outcome, with the former if the economy continues along its recent pace and the latter if the recession finally arrives.  Given that interest rates, led by Treasury yields, are the clear driver of global market movements, and given that inflation is going to play a critical role in their movement going forward, I have altered my view as to the most important piece of data.  Whereas I used to believe it was NFP, it is now entirely CPI/PCE.  As I wrote yesterday, if next week’s print is at 0.4% M/M, watch out for a significant repricing.

But now, let’s turn to today.  President Xi continues to have problems with his stock market and is seemingly getting a bit more desperate aggressive in his efforts to prevent a complete implosion.  Last night, the head of the CSRC (China’s SEC analog) was replaced as blame needs to be placed on others for Xi’s policy errors.  It ought not be surprising that Chinese shares, after a weak start, rebounded on the news and closed higher by about 1%.  However, the Hang Seng could not manage any gains and the Nikkei edged lower as well.  All in all, it was not a great session overnight.  In Europe this morning, the markets are lower by between -0.25% and -0.5% as once again we saw weak German data (IP -1.6%) continuing to point to a recession on the continent.  Finally, US futures are basically flat at this hour (7:30).

In the bond market, yields, which all slid a bit yesterday on what seemed to be a profit-taking move after that massive runup following the NFP and ISM data, are a bit higher this morning, with Treasury yields up by 3bps and most of Europe seeing similar movements, between 2bps and 4bps.  As I wrote above, this story remains all about inflation’s future, and as data comes in to add to the conversation, I suspect that will be the key mover going forward.

Oil prices (+1.0%) are continuing their modest recent rebound with WTI touching $74/bbl this morning and Brent above $79/bbl.  Comments by the Biden administration that they would continue to attack Iranian proxy groups seems to have traders worried about an escalation.  But a more concerning story is that Ukraine has been targeting Russian refineries in an effort to degrade Putin’s cash flow.  They have already hit several and reduced capacity by 4%-5%.  If that continues successfully, then oil prices are going to go much higher.  This doesn’t seem to be in the bigger narrative right now, so beware.  As to the metals markets, they are all slightly softer this morning, but movement has been tiny.

Finally, the dollar is under a modest amount of pressure this morning, which given the rising yields and softer commodities, seems out of character.  Granted, the movements are small, with most currencies just 0.1% – 0.2% firmer vs. the dollar.  And this could also be profit-taking given the dollar’s recent rally.  After all, the euro remains below 1.08 and USDJPY above 148.00 so this is hardly a collapse.

Turning to the data today, the Trade Balance (exp -$62.2B) is this morning’s release and then after oil inventories, at 3:00 we get Consumer Credit ($16.0B).  As mentioned above, we have many more Fed speakers as well, and I sense that will be of far more interest to market participants.  I don’t anticipate anybody straying from the current theme of inflation has been falling nicely but they are not yet convinced.  If someone strays, that could move markets, but again, I see little to drive things today, or this week.

Good luck

Adf

With Conceit

Posted on by

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

Adf

Ending QT

Posted on by

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

Adf

*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

Posted on by 
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

Adf

Markets No Longer Have Fear

Posted on by 
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